Cisco 2006 Annual Report Download - page 27

30 Cisco Systems, Inc.
Amortization of Purchased Intangible Assets
Amortization of purchased intangible assets included in operating expenses was $393 million in scal 2006, compared with $227 million
in scal 2005. The increase was related primarily to additional amortization from the Scientic-Atlanta acquisition and an impairment charge
of $69 million from a write down of purchased intangible assets related to certain technology and customer relationships due to a reduction
in expected future cash ows. For additional information regarding our purchased intangible assets, see Note 3 to the Consolidated
Financial Statements.
In-Process Research and Development
Our methodology for allocating the purchase price, relating to purchase acquisitions, to in-process R&D is determined through established
valuation techniques in the high-technology communications industry. In-process R&D expense in scal 2006 was $91 million, compared with
$26 million in scal 2005. See Note 3 to the Consolidated Financial Statements for additional information regarding the acquisitions completed
in fiscal 2006 and fiscal 2005 and the in-process R&D recorded for each acquisition. In-process R&D was expensed upon acquisition
because technological feasibility had not been established and no future alternative uses existed. The acquisition of Scientic-Atlanta
accounted for $88 million of the in-process R&D during scal 2006, which related primarily to projects associated with Scientic-Atlanta’s
advanced models of digital set-top boxes, network software enhancements and upgrades, and data products and transmission products.
The fair value of the existing purchased technology and patents, as well as the technology under development, is determined using the
income approach, which discounts expected future cash ows to present value. The discount rates used in the present value calculations
are typically derived from a weighted-average cost of capital analysis and venture capital surveys, adjusted upward to reect additional
risks inherent in the development lifecycle. We consider the pricing model for products related to these acquisitions to be standard within
the high-technology communications industry. However, we do not expect to achieve a material amount of expense reductions as a result
of integrating the acquired in-process technology. Therefore, the valuation assumptions do not include signicant anticipated cost savings.
For purchase acquisitions completed to date, the development of these technologies remains a signicant risk due to the remaining
efforts to achieve technological feasibility, rapidly changing customer markets, uncertain standards for new products, and significant
competitive threats. The nature of the efforts to develop these technologies into commercially viable products consists primarily of
planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations,
including functionality and technical requirements. Failure to bring these products to market in a timely manner could result in a loss of
market share or a lost opportunity to capitalize on emerging markets and could have a material adverse impact on our business and
operating results.
The following table summarizes the key assumptions underlying the valuation for our purchase acquisitions completed in scal 2006
for which in-process R&D was recorded (in millions, except percentages):
In-Process
R&D Expense
Estimated Cost to
Complete Technology
at Time of Acquisition
Risk-Adjusted
Discount Rate for
In-Process R&D
KiSS Technology A/S $ 2 $ 1 22.0%
Scientific-Atlanta, Inc. 88 93 17.0%
Other 1 1 22.0%
Total $ 91 $ 95
The key assumptions primarily consist of an expected completion date for the in-process projects; estimated costs to complete the projects;
revenue and expense projections, assuming the products have entered the market; and discount rates based on the risks associated with
the development lifecycle 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 completed and may result
in impairment charges. Actual results from the purchase acquisitions to date did not have a material adverse impact on our business and
operating results.
Management’s Discussion and Analysis of Financial Condition and Results of Operations