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CISCO฀SYSTEMS,฀INC.฀2004฀ANNUAL฀REPORT
BUILDING฀TOMORROW’S฀NETWORKS

Table of contents

  • Page 1
    CISCO฀SYSTEMS,฀INC.฀2004฀ANNUAL฀REPORT BUILDING฀TOMORROW'S฀NETWORKS

  • Page 2
    ...proud฀to฀feature฀its฀employees฀in฀this฀year's฀annual฀report: On฀the฀front฀cover฀(left฀to฀right):฀Lyn฀Gardiner,฀Sr.฀Manager,฀Worldwide฀Sales฀Productivity;฀Carey฀Wan,฀Software฀Engineer;฀Marie฀King,฀Corporate฀Operations฀Specialist On฀the...

  • Page 3
    ...Cash฀Flows฀ Consolidated฀Statements฀of฀Shareholders'฀Equity฀ Notes฀to฀Consolidated฀Financial฀Statements฀ Report฀of฀Independent฀Registered฀฀ Public฀Accounting฀Firm฀ Supplementary฀Financial฀Data฀and฀ Stock฀Market฀Information Shareholder฀Information...

  • Page 4
    ...:฀that฀computers฀should฀be฀able฀to฀talk฀to฀each฀other.฀Cisco฀has฀ spent฀the฀past฀20฀years฀building฀on฀that฀idea,฀connecting฀billions฀of฀bytes฀ of฀data-and฀millions฀of฀people. 2฀฀CISCO฀SYSTEMS,฀INC. 2004฀ANNUAL฀REPORT฀฀3

  • Page 5
    ... homes,฀schools,฀airports,฀hotels-even฀into฀orbit.฀Access฀means฀making฀ everyone฀more฀productive,฀equipping฀us฀with฀the฀tools฀and฀information฀ we฀need฀to฀take฀our฀organizations฀to฀the฀next฀level. 4฀฀CISCO฀SYSTEMS,฀INC. 2004฀ANNUAL...

  • Page 6
    ...฀a฀telephone฀call฀with฀a฀click฀of฀your฀mouse.฀Integrating means฀organizations฀save฀money฀by฀gathering฀all฀their฀systems฀on฀one network,฀maximizing฀their฀investments฀in฀the฀network.฀ 6฀฀CISCO฀SYSTEMS,฀INC. 2004฀ANNUAL฀REPORT฀฀7

  • Page 7
    BUILDING฀IT฀BIGGER฀AND฀FASTER MAKING฀IT฀SMARTER฀AND฀SAFER With฀voice฀and฀video฀joining฀traditional฀data,฀the฀demand฀for฀services฀and฀information฀ delivered฀over฀the฀Internet฀is฀increasing.฀Cisco฀is฀leading฀the฀way฀in฀delivering฀...

  • Page 8
    ...฀per฀year.฀Innovating฀means฀ constantly฀improving฀the฀way฀we฀build฀and฀deliver฀our฀solutions.฀Innovating฀means฀setting฀ goals฀that฀are฀seemingly฀beyond฀our฀grasp-and฀then฀reaching฀them. 10฀฀CISCO฀SYSTEMS,฀INC. 2004฀ANNUAL฀REPORT...

  • Page 9
    ...fiscal฀2001.฀Our฀revenue฀growth฀is฀a฀result฀of฀ a฀gradual฀global฀economic฀recovery,฀coupled฀ with฀increased฀information฀technology-related฀ capital฀spending JOHN฀T.฀CHAMBERS PRESIDENT฀AND฀CHIEF฀EXECUTIVE฀OFFICER 12฀฀CISCO฀SYSTEMS,฀INC.

  • Page 10
    ....฀ We฀routinely฀evaluate฀the฀most฀effective฀use฀ of฀our฀cash.฀Our฀Board฀of฀Directors฀considers฀ During฀fiscal฀2004,฀revenues฀from฀Cisco's฀ core฀technologies฀of฀routing฀and฀switching฀ increased฀year-over-year฀by฀11฀percent฀and฀15...

  • Page 11
    ...฀of฀Cisco's฀ success฀over฀the฀last฀20฀years฀and฀is฀integral฀to฀our฀ growth฀over฀the฀next฀20.฀Our฀ability฀to฀innovate฀฀ internally฀and,฀at฀the฀same฀time,฀form฀strategic฀฀ alliances฀and฀successfully฀integrate฀acquisitions฀will...

  • Page 12
    ...to฀our฀customers.฀We฀helped฀build฀the฀฀ foundation฀of฀the฀Internet฀by฀building฀the฀routers฀฀ and฀switches฀that฀fueled฀it,฀and฀we฀believe฀that฀the฀ best฀is฀yet฀to฀come฀in฀terms฀of฀increases฀in฀productivity฀ ฀ and฀standard...

  • Page 13
    ...฀of฀integrity.฀It฀is฀ critical฀for฀investors฀and฀other฀users฀of฀the฀consolidated฀ financial฀statements฀to฀have฀confidence฀that฀the฀financial฀ information฀that฀we฀provide฀is฀timely,฀complete,฀relevant,฀ and฀accurate.฀Management฀is...

  • Page 14
    ... 2001, amounted to 348 million shares. Note 2: Net income for fiscal 2004 included a noncash charge for the cumulative effect of accounting change relating to a stock compensation charge of $567 million, net of tax. See Note 3 to the Consolidated Financial Statements. Note 3: Net loss for fiscal...

  • Page 15
    ... and investments totaled $19.3 billion, days sales outstanding (DSO) were 28 days, and annualized inventory turns were 6.4. During the fiscal year, we repurchased $9.1 billion or 408 million shares of our common stock at an average price of $22.30. Our technology vision is based on an architectural...

  • Page 16
    ... of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on these policies. Revenue Recognition Our networking and communications products are integrated with software that is essential to the functionality of the equipment. We provide...

  • Page 17
    ...8 to the Consolidated Financial Statements. Our products sold are generally covered by a warranty for periods ranging from 90 days to five years, and for some products we provide a limited lifetime warranty. We accrue for warranty costs as part of our cost of sales based on associated material costs...

  • Page 18
    ... in the valuation of our deferred tax assets or liabilities, or by changes in tax laws or interpretations thereof. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of...

  • Page 19
    ...DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table is a breakdown of net sales between product and service revenue (in millions, except percentages): Variance in Dollars Variance in Percent Variance in Dollars Variance in Percent Years Ended July 31, 2004...

  • Page 20
    ... 73.9% 68.6% 69.6% 70.3% 70.6% 72.4% 70.1% 63.2% 63.8% 63.5% 65.0% 63.5% The following table shows the gross margin for products and services (in millions, except percentages): AMOUNT Years Ended July 31, 2004 July 26, 2003 July 27, 2002 July 31, 2004 PERCENTAGE July 26, 2003 July 27, 2002 Gross...

  • Page 21
    ... the Cisco Catalyst 3750 platform, introduced in the fourth quarter of fiscal 2003, and the Cisco Catalyst 3550 platform. The decline in sales of WAN switches was due to the continued technology migration away from Asynchronous Transfer Mode (ATM) to Internet Protocol (IP). 24 CISCO SYSTEMS, INC...

  • Page 22
    ...were related to our acquisition of the Linksys business in the fourth quarter of fiscal 2003. An increase of $252 million in sales of security products was primarily due to module and line card sales related to our routers and switches as customers continued to emphasize network security in light of...

  • Page 23
    ... sales expenses in connection with such new hires. G&A expenses increased primarily due to higher amortization of deferred stock-based compensation of $52 million attributable to our acquisitions, expenses related to investments in internal information technology systems and related program...

  • Page 24
    ...and discount rates based on the risks associated with the development life cycle of the in-process technology acquired. Failure to achieve the expected levels of revenue and net income from these products will negatively impact the return on investment expected at the time that the acquisitions were...

  • Page 25
    ...stock and options. See Note 3 to the Consolidated Financial Statements. The amount of deferred stock-based compensation was fixed at the date of acquisition and will be amortized over the remaining vesting period of the Andiamo employee stock and options of approximately two years. 28 CISCO SYSTEMS...

  • Page 26
    ... technology-related capital spending, particularly with respect to our service provider customers. The increase in service revenue was primarily due to increased technical support service contract initiations and renewals associated with product sales. Net Product Sales by Theater Net product sales...

  • Page 27
    ... restructuring of certain business functions. For additional information regarding the restructuring program, see Note 4 to the Consolidated Financial Statements. During fiscal 2003, we increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $45...

  • Page 28
    ... follows (in millions): Years Ended July 26, 2003 July 27, 2002 Net gains on investments in fixed income and publicly traded equity securities Impairment charges on publicly traded equity securities Net gains on investments in privately held companies Impairment charges on investments in privately...

  • Page 29
    ... stock option exercises and employee stock purchases. We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, shipment linearity, accounts receivable collections, inventory management...

  • Page 30
    ... of build-to-order and build-to-stock products, including home networking products. Service-related spares consist of reusable equipment related to our technical support and warranty activities. All inventories are accounted for at the lower of cost or market. Annualized inventory turns were...

  • Page 31
    ... structured financing to certain qualified customers for the purchase of equipment and other needs through our wholly owned subsidiary, Cisco Systems Capital Corporation. These loan commitments may be funded over a two- to three-year period, provided that these customers achieve specific business...

  • Page 32
    ... Board Opinion No. 6, "Status of Accounting Research Bulletins," we are required to allocate the purchase price of the repurchased shares as a reduction to retained earnings and common stock and additional paid-in capital. Issuance of common stock and the tax benefit related to employee stock option...

  • Page 33
    ...sale and consequently are recorded in the Consolidated Balance Sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of tax. Fixed Income Securities At any time, a sharp...150 BPS U.S. government notes and bonds Corporate ...

  • Page 34
    ... than 18 months. We do not enter into foreign exchange forward and option contracts for trading purposes. We do not expect gains or losses on these derivative instruments to have a material impact on our financial results. See Note 8 to the Consolidated Financial Statements. 2004 ANNUAL REPORT 37

  • Page 35
    CONSOLIDATED STATEMENTS OF OPERATIONS (in millions, except per-share amounts) Years Ended July 31, 2004 July 26, 2003 July 27, 2002 NET SALES: Product Service Total net sales COST OF SALES: Product Service Total cost of sales GROSS MARGIN OPERATING EXPENSES: Research and development Sales and ...

  • Page 36
    ...: Accounts payable Income taxes payable Accrued compensation Deferred revenue Other accrued liabilities Total current liabilities Deferred revenue Total liabilities Commitments and contingencies (Note 8) Minority interest Shareholders' equity: Preferred stock, no par value: 5 shares authorized...

  • Page 37
    ... employee stock option plans In-process research and development Net (gains) losses and impairment charges on investments Change in operating assets and liabilities: Accounts receivable Inventories Prepaid expenses and other current assets Accounts payable Income taxes payable Accrued compensation...

  • Page 38
    ... 31, 2004, the Company's Board of Directors has authorized the repurchase of up to $25 billion of common stock under this program. For additional information regarding stock repurchases, see Note 9 to the Consolidated Financial Statements. The purchase price of shares of common stock repurchased was...

  • Page 39
    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS Cisco Systems, Inc. (the "Company" or "Cisco") manufactures and sells networking and communications products and provides services associated with that equipment and its use. The Company's products are installed at corporations,...

  • Page 40
    ... recognized when revenue recognition criteria for each element are met. Fair value for each element is established based on the sales price charged when the same element is sold separately. The Company uses distributors that stock inventory and typically sell to system integrators, service providers...

  • Page 41
    ... shares outstanding during the period. Diluted net loss per share is computed using the weighted-average number of common shares and excludes dilutive potential common shares outstanding, as their effect is antidilutive. Dilutive potential common shares primarily consist of employee stock options...

  • Page 42
    ... Company's employees and directors and common stock issued pursuant to the Employee Stock Purchase Plan is based on specified valuation techniques that produce estimated compensation charges. The following table reflects the pro forma information (in millions, except per-share amounts): Years Ended...

  • Page 43
    ... solutions that help customers defend against Distributed Denial of Service (DDoS) attacks and other security threats. In addition, during the third quarter of fiscal 2004, the Company completed the acquisition of Twingo Systems, Inc. to add desktop security features for Secure Sockets Layer (SSL...

  • Page 44
    ...of these acquisitions were not material to the Company's results. Purchased Intangible Assets The following table presents details of the purchased intangible assets acquired during fiscal 2004 and 2003 (in millions, except number of years): TECHNOLOGY Estimated Useful Life (in Years) TRADE NAMES...

  • Page 45
    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following tables present details of the Company's total purchased intangible assets (in millions): July 31, 2004 Gross Accumulated Amortization Net Technology Technology licenses Customer relationships Trade names Other Total July 26, 2003 $ 627 252 ...

  • Page 46
    ..., the Company obtained a call option that provided the Company the right to purchase Andiamo. The purchase price under the call option was based on a valuation of Andiamo using a negotiated formula. On August 19, 2002, the Company entered into a definitive agreement to acquire Andiamo, which...

  • Page 47
    ...based compensation was fixed at the date of acquisition and will be amortized over the remaining vesting period of Andiamo employee stock and options of approximately two years. A summary of the accounting of the consolidation under FIN 46(R) and the subsequent purchase of Andiamo, after stock price...

  • Page 48
    ... general and administrative ($8 million), and cost of sales ($4 million) in the Consolidated Statements of Operations. Note 2: During fiscal 2003, the Company increased the restructuring liabilities related to the consolidation of excess facilities and other charges by a total of $45 million, which...

  • Page 49
    ... 26, 2003 Inventories: Raw materials Work in process Finished goods Demonstration systems Total Property and equipment, net: Land, buildings, and leasehold improvements Computer equipment and related software Production, engineering, and other equipment Operating lease assets Furniture and fixtures...

  • Page 50
    ... basis that were judged to be other-than-temporary. The specific identification method is used to determine the cost basis of fixed income securities disposed of. The weighted-average method is used to determine the cost basis of publicly traded equity securities disposed of. 2004 ANNUAL REPORT 53

  • Page 51
    ... a loss is temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, and the Company's intent and ability to hold the investment for a period of time sufficient to allow for any anticipated...

  • Page 52
    ... The Company provides structured financing to certain qualified customers for the purchase of equipment and other needs through its wholly owned subsidiary, Cisco Systems Capital Corporation. These loan commitments may be funded over a two- to three-year period, provided that these customers achieve...

  • Page 53
    ... TO CONSOLIDATED FINANCIAL STATEMENTS The Company accrues for warranty costs as part of its cost of sales based on associated material product costs, technical support labor costs, and associated overhead. The products sold are generally covered by a warranty for periods ranging from 90 days to...

  • Page 54
    ..., 2004, the Company's Board of Directors has authorized the repurchase of up to $25 billion of common stock under this program. During fiscal 2004, the Company repurchased and retired 408 million shares of Cisco common stock at an average price of $22.30 per share for an aggregate purchase price of...

  • Page 55
    ... "Purchase Plan"), under which 321.4 million shares of the Company's common stock have been reserved for issuance. Eligible employees may purchase a limited number of shares of the Company's common stock at a discount of up to 15% of the market value at certain plan-defined dates. The Purchase Plan...

  • Page 56
    ... has, in connection with the acquisitions of various companies, assumed the stock option plans of the acquired companies or issued replacement options. OPTIONS OUTSTANDING Options Available for Grant WeightedAverage Exercise Price per Share Number Outstanding BALANCE AT JULY 28, 2001 Granted...

  • Page 57
    ... Company's employees and directors and common stock relating to the Employee Stock Purchase Plan is based on specified valuation techniques that produce estimated compensation charges. The following table reflects the pro forma information (in millions, except per-share amounts): Years Ended July...

  • Page 58
    .... Employee 401(k) Plans The Company sponsors the Cisco Systems, Inc. 401(k) Plan (the "Plan") to provide retirement benefits for its employees. As allowed under Section 401(k) of the Internal Revenue Code, the Plan provides tax-deferred salary contributions for eligible employees. The Company also...

  • Page 59
    ... the following: Years Ended July 31, 2004 July 26, 2003 July 27, 2002 Federal statutory rate Effect of: State taxes, net of federal tax benefit Export sales benefit Foreign income at other than U.S. rates Nondeductible in-process R&D Nondeductible deferred stock-based compensation Tax credits Other...

  • Page 60
    ...benefits associated with dispositions of employee stock options. The Company receives an income tax benefit calculated as the difference between the fair market value of the stock issued at the time of exercise and the option price, tax effected. These benefits were credited directly to shareholders...

  • Page 61
    ... TO CONSOLIDATED FINANCIAL STATEMENTS 12. SEGMENT INFORMATION AND MAJOR CUSTOMERS The Company's operations involve the design, development, manufacturing, marketing, and technical support of networking and communications products and services. Cisco products include routers, switches, Advanced...

  • Page 62
    ... per share because the exercise price of the stock options was greater than the average share price of the common shares, and, therefore, the effect would have been antidilutive. 14. PENDING BUSINESS COMBINATIONS As of July 31, 2004, the Company announced a definitive agreement to acquire the...

  • Page 63
    REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF CISCO SYSTEMS, INC.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and of shareholders' equity and of cash flows present fairly...

  • Page 64
    ...,834 $19,688 $20,652 $20,316 $21,197 $21,188 STOCK MARKET INFORMATION Cisco common stock is traded on the Nasdaq National Market under the symbol CSCO. The following table lists the high and low sales prices for each period indicated: 2004 Fiscal High Low High 2003 Low First quarter Second...

  • Page 65
    ... trades on the Nasdaq National Market under the ticker symbol CSCO. Investor Relations For further information about Cisco, additional copies of this report, Form 10-K, or other financial information without charge, contact: Investor Relations Cisco Systems, Inc. 170 West Tasman Drive San Jose, CA...

  • Page 66
    ... WORLDWIDE฀OFFICES Corporate฀Headquarters San฀Jose,฀California,฀USA European฀Headquarters Amsterdam,฀Netherlands Americas฀Headquarters San฀Jose,฀California,฀USA Asia฀Pacific฀Headquarters Singapore Cisco฀has฀offices฀in฀the฀following฀countries.฀Addresses...

  • Page 67
    Corporate฀Headquarters฀•฀Cisco฀Systems,฀Inc.฀•฀170฀West฀Tasman฀Drive฀•฀San฀Jose,฀CA฀95134-1706฀•฀USA Tel:฀(408)฀526-4000฀•฀(800)฀553-NETS฀(6387)฀•฀www.cisco.com฀ Lit#฀9562890407฀•฀SKU#฀1028-AR-04 ฀฀฀฀฀฀Printed฀on...