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Cisco Systems, Inc. 2005 Annual Report
A New Way

Table of contents

  • Page 1
    A New Way Cisco Systems, Inc. 2005 Annual Report

  • Page 2
    ...'03 '04 '05 Fiscal Year '01 '02 '03 '04 '05 Consolidated Statements of Operations Data (in millions, except per-share amounts) Years Ended July 30, 2005 July 31, 2004 July 26, 2003 Net sales Income before provision for income taxes and cumulative effect of accounting change Net income Net...

  • Page 3
    ... Letter to Shareholders Reports of management Report of Independent Registered Public Accounting Firm Selected Financial Data management's Discussion and Analysis of Financial Condition and Results of operations Quantitative and Qualitative Disclosures About market Risk Consolidated Statements...

  • Page 4
    ... at a neighborhood center. Teachers review lesson plans with their colleagues at distant schools using an electronic whiteboard. A parent monitors reading lists and receives a student progress report at home. And a kindergartner tours the grand Canyon or the great Pyramid on a wireless laptop in the...

  • Page 5
    ... readings directly to her physician. virtually everywhere, Cisco networking helps enable better care-and healthier lives. CT scans and minivans Collaborating in real time, auto designers in Japan, assembly technicians in the United States, and component makers worldwide trade data over a Cisco...

  • Page 6
    ... clientele using Cisco solutions designed especially for growing businesses. Wine lovers can survey the ripening vineyards through a video link, read about the latest vintage, and order bottles right from the winery's Website. And every employee-from the cellar master to the office manager-can tap...

  • Page 7
    ... Protocol (IP)-based contact center, where her account profile immediately appears in front of the call agent. Instead of "What's your account number?" the customer hears "Let me suggest some options that should suit your needs." Similar personalized services are also available in wireless-equipped...

  • Page 8
    ...customers. Speedier services and deeper defenses. and government loans Citizens now go online instead of getting in line when they need to renew a driver's license, apply for a student loan, or pay a parking fee. Cisco self-defending networks help ensure that the government's Web-accessible offices...

  • Page 9
    to our shareholders: John T . Chambers President and Chief Executive officer 12 Cisco Systems, Inc.

  • Page 10
    .... We achieved an outstanding financial performance with record profits and cash generation, year-over-year growth in our core routing and switching products, and very strong growth in our six advanced technologies. Our enterprise, service provider, and commercial customer market segments all...

  • Page 11
    ...services router is designed to allow customers to customize solutions by adding security, voice, and wireless capabilities to a single routing platform. In our core switching families, we made five key product announcements in fiscal 2005, and Cisco's switching products continue to maintain a number...

  • Page 12
    ... right thing to do, but is also just plain "good business." We employ and advocate responsible business practices and programs, which builds a lasting trust with our key stakeholders-customers, partners, employees, and shareholders. In the fall of 2005, Cisco will release its first Corporate Social...

  • Page 13
    ... by Cisco's Board of Directors, has established and maintains a strong ethical climate so that our affairs are conducted to the highest standards of personal and corporate conduct. Management also has established an effective system of internal control over financial reporting. Cisco's policies...

  • Page 14
    ... audit of Cisco Systems, Inc.'s 2005 consolidated financial statements and of its internal control over financial reporting as of July 30, 2005 and audits of its 2004 and 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United...

  • Page 15
    Selected Financial Data Five Years Ended July 30, 2005 (in millions, except per-share amounts) The following selected financial data should be read in conjunction with the Consolidated Financial Statements and related notes which appear on pages 40 to 70 of this Annual Report: July 30, 2005 July ...

  • Page 16
    ... 2005, days sales outstanding (DSO) were 31 days and annualized inventory turns were 6.6. During the fiscal year, we repurchased $10.2 billion or 540 million shares of our common stock at an average price of $18.95. At the end of fiscal 2005, our cumulative purchases since the inception of the share...

  • Page 17
    ... assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as...

  • Page 18
    ... Financial Statements. Our products 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, technical support labor...

  • Page 19
    ...to reserves that are considered appropriate, as well as the related net interest. Our effective tax rates differ from the statutory rate primarily due to acquisition-related costs, research and experimentation tax credits, state taxes, and the tax impact of foreign operations. The effective tax rate...

  • Page 20
    ...'s 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): Years Ended July 30, 2005 July 31, 2004 variance in Dollars variance in Percent July 31, 2004 July...

  • Page 21
    ... 2005, 2004, and 2003." Net Sales The increase in net product sales can be attributed to the continued gradual recovery in the global economic environment coupled with increased information technology-related capital spending in our enterprise, service provider, commercial, and consumer markets...

  • Page 22
    ...are designed to align our focus on long-term growth, capture emerging market opportunities, and serve our customers better. Net Product Sales by Groups of Similar Products Routers The increase in net product sales related to routers in fiscal 2005 was primarily due to sales of high-end routers. Our...

  • Page 23
    ... or labor costs; excess inventory and obsolescence charges; warranty costs; changes in shipment volume; loss of cost savings due to changes in component pricing; impact of value engineering; inventory holding charges; and how well we execute on our strategic and operating plans. 26 Cisco Systems...

  • Page 24
    ...2005. We intend to continue to add both engineering and sales resources as we focus on developing the next wave of advanced technologies, growing the commercial market segment, capitalizing on our emerging market opportunities, and increasing our market share gains. If we do not achieve the benefits...

  • Page 25
    ...net, are as follows (in millions): Years Ended July 30, 2005 July 31, 2004 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...

  • Page 26
    ... rate primarily due to acquisition-related costs, research and experimentation tax credits, state taxes, and the tax impact of foreign operations. During the fourth quarter of fiscal 2005, the Internal Revenue Service completed its examination of our federal income tax returns for the fiscal years...

  • Page 27
    ... two years. A summary of the accounting of the initial consolidation under FIN 46(R) and the subsequent purchase of Andiamo, after stock price-related adjustments, is as follows (in millions): Amount Cumulative effect of accounting change, net of tax benefit of $5 variable stock-based compensation...

  • Page 28
    ... Financial Condition and Results of Operations Net Product Sales by Groups of Similar Products Routers The increase in net product sales related to routers was attributable to sales of high-end routers, which increased by $556 million primarily as a result of higher spending by service providers...

  • Page 29
    ...we announced plans to increase the size of our sales force. 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 30
    ... not limited to, the volatility of our stock price and employee stock option exercise behaviors. We will recognize compensation cost for stock-based awards issued after July 30, 2005 on a straight-line basis over the requisite service period for the entire award. Liquidity and Capital Resources The...

  • Page 31
    ... inventory and deferred cost of sales are related to unrecognized revenue on shipments to distributors and retail partners and shipments to enterprise and service provider customers. Manufacturing finished goods consist primarily of build-to-order and build-to-stock products, including home...

  • Page 32
    ... operating leases with an initial term in excess of one year. Purchase Commitments with Contract Manufacturers and Suppliers We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of...

  • Page 33
    ...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 plans are recorded as an increase to common...

  • Page 34
    ... the Consolidated Balance Sheets at fair value with unrealized gains or losses, to the extent unhedged, reported as a separate component of accumulated other comprehensive income, net of tax. Fixed Income Securities At any time, a sharp rise in interest rates could have a material adverse effect on...

  • Page 35
    ... exchange contracts mitigate the variability in operating expenses associated with currency movements. Primarily because of our limited currency exposure to date, the effect of foreign currency fluctuations has not been material to our Consolidated Financial Statements. In fiscal 2005, the effect of...

  • Page 36
    .... In order to manage our exposure to changes in the value of certain equity securities, we may, from time to time, enter into equity derivative contracts. As of July 30, 2005, we had entered into forward sale and option agreements on certain publicly traded equity securities designated as fair value...

  • Page 37
    ...-share amounts) Years Ended July 30, 2005 July 31, 2004 July 26, 2003 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 marketing general and administrative Amortization of purchased...

  • Page 38
    ... Short-term investments Accounts receivable, net of allowance for doubtful accounts of $162 at July 30, 2005 and $179 at July 31, 2004 Inventories Deferred tax assets Prepaid expenses and other current assets Total current assets Investments Property and equipment, net goodwill Purchased intangible...

  • Page 39
    ... activities: Cumulative effect of accounting change, net of tax Depreciation and amortization Stock-based compensation related to acquisitions and investments Provision for doubtful accounts Provision for inventory Deferred income taxes Tax benefits from employee stock option plans In-process...

  • Page 40
    ... 9 to the Consolidated Financial Statements. The purchase price of shares of common stock repurchased was reflected 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 plans are recorded as...

  • Page 41
    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 42
    ... that stock inventory and typically sell to systems integrators, service providers, and other resellers. In addition, certain products are sold through retail partners. The Company refers to these sales through distributors and retail partners as its two-tier system of sales to the end customer...

  • Page 43
    ... into one share of common stock of Cisco Systems, K.K. (Japan) at any time at the option of the holder. Use of Estimates The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make...

  • Page 44
    ... Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." The Company's assessment of the estimated compensation charges is affected by the Company's stock price as well as assumptions regarding a number of complex and subjective variables and the related tax...

  • Page 45
    ... Communications, Inc. to add server fabric switches, a new class of server networking equipment that is designed to help improve resource utilization and reduce equipment and management costs, to its switching product portfolio consisting of network and storage switches. 48 Cisco Systems, Inc.

  • Page 46
    ...$1,591 $112 $ $ 1,067 Under the terms of the definitive agreements, the purchase consideration for the acquisitions in fiscal 2005 consisted of cash and shares of Cisco common stock and stock options assumed. The purchase consideration for the Company's acquisitions is also allocated to tangible...

  • Page 47
    ... Consolidated Financial Statements include the operating results of each business from the date of acquisition. Pro forma results of operations have not been presented because the effects of these acquisitions, individually or in the aggregate, were not material to the Company's results. Purchased...

  • Page 48
    ... table presents details of the amortization expense of purchased intangible assets as reported in the Consolidated Statements of Operations (in millions): Years Ended July 30, 2005 July 31, 2004 July 26, 2003 Reported as: Cost of sales operating expenses Total $ - 227 $ 13 242 $ 15 394...

  • Page 49
    ... Transactions Involving Stock Compensation," and related interpretations, variable accounting was required for substantially all Andiamo employee stock and options because the ending purchase price was primarily derived from a revenue-based formula. Effective January 24, 2004, the last day of the...

  • Page 50
    ... purchase of Andiamo, after stock price-related adjustments, is as follows (in millions): Amount Cumulative effect of accounting change, net of tax benefit of $5 variable stock-based compensation Deferred stock-based compensation Net assets Total $ 567 58 90 7 $ 722 In fiscal 2005, the Company...

  • Page 51
    ... inventory and deferred cost of sales manufacturing finished goods Total finished goods Service-related spares Demonstration systems Total Property and equipment, net: Land, buildings, and leasehold improvements Computer equipment and related software Production, engineering, and other equipment...

  • Page 52
    ...502 $ 3,527 975 $ 4,502 6. Lease Receivables, Net Lease receivables represent sales-type and direct-financing leases resulting from the sale of the Company's and complementary third-party products and services. These lease arrangements typically have terms from two to three years and are generally...

  • Page 53
    ... Fair value July 30, 2005 Fixed income securities: U.S. government notes and bonds Corporate notes, bonds, and asset-backed securities Municipal notes and bonds Total fixed income securities Publicly traded equity securities Total Reported as: Short-term investments Investments Total $ 3,453...

  • Page 54
    ... in interest rates. The gross unrealized losses related to publicly traded equity securities were due to changes in market prices. The Company's management has determined that the gross unrealized losses on its investment securities at July 30, 2005 are temporary in nature. The Company reviews its...

  • Page 55
    ...provide manufacturing services for its products. During the normal course of business, in order to manage manufacturing lead times and help assure adequate component supply, the Company enters into agreements with contract manufacturers and suppliers that either allow them to procure inventory based...

  • Page 56
    ...of July 31, 2004, the outstanding loan commitments were $61 million, of which $22 million was eligible for draw-down. As of July 30, 2005, the Company had a commitment of approximately $25 million to purchase the remaining minority interest of Cisco Systems, K.K. (Japan), compared with approximately...

  • Page 57
    ... 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 five years...

  • Page 58
    ... of all of plaintiffs' claims, reimbursement of a portion of plaintiffs' attorneys' fees and agreement to maintain certain Company policies and consider others. On February 16, 2005, a purported shareholder derivative lawsuit was filed in the Superior Court of California, County of Santa Clara...

  • Page 59
    ...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 terminates on January 3, 2010. In fiscal 2005...

  • Page 60
    ... maximum number of shares issuable over the term of the 1996 Plan is limited to 2.5 billion shares. Options granted under the 1996 Plan have an exercise price equal to the fair market value of the underlying stock on the grant date and expire no later than nine years from the grant date. The options...

  • Page 61
    ... 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 27, 2002 granted and assumed Exercised Canceled Additional shares reserved...

  • Page 62
    ...to Consolidated Financial Statements The following table presents the option exercises for the year ended July 30, 2005, and option values as of that date for the Named Executive Officers (in millions): NUmBER oF SECURITIES UNDERL YINg UNExERCISED oPTIoNS AT JUL Y 30, 2005 Number of Shares Acquired...

  • Page 63
    Notes to Consolidated Financial Statements 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...

  • Page 64
    ... Consolidated Financial Statements The items accounting for the difference between income taxes computed at the federal statutory rate and the provision for income taxes consisted of the following: Years Ended July 30, 2005 July 31, 2004 July 26, 2003 Federal statutory rate Effect of: State taxes...

  • Page 65
    Notes to Consolidated Financial Statements The components of the deferred tax assets (liabilities) are as follows (in millions): July 30, 2005 July 31, 2004 ASSETS Allowance for doubtful accounts and returns Sales-type and direct-financing leases Inventory allowances and capitalization Investment ...

  • Page 66
    ... 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 67
    ... 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 30, 2005, the Company announced definitive agreements to acquire privately...

  • Page 68
    ... 1,086 $ 0.16 $ 0.15 $19,688 $19,834 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: 2005 Fiscal High Low High 2004 Low First quarter Second quarter Third...

  • Page 69
    ... stock 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...

  • Page 70
    ...range Worldwide Offices Corporate Headquarters San Jose, California, USA European Headquarters Amsterdam, Netherlands Americas Headquarters San Jose, California, USA Asia Pacific Headquarters Singapore of service offerings, including technical support and advanced services. Cisco sells its products...

  • Page 71
    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# 9564130508 • SKU# 1028-AR-05 Printed on recycled paper.