Cisco 2007 Annual Report Download - page 26

2007 Annual Report 29
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Factors That May Impact Net Product Sales Net product sales may continue to be affected by changes in the geopolitical environment
and global economic conditions; competition, including price-focused competitors from Asia, especially China; new product introductions;
sales cycles and product implementation cycles; changes in the mix of our customers between service provider and enterprise markets;
changes in the mix of direct sales and indirect sales; variations in sales channels; and final acceptance criteria of the product, system, or
solution as specified by the customer. In addition, sales to the service provider market have been characterized by larger and more uneven
purchases, especially relating to our router sales and sales of certain advanced technologies. In addition, service provider customers
typically have longer implementation cycles, require a broader range of services, including network design services, and often have
acceptance provisions that can lead to a delay in revenue recognition. To improve customer satisfaction, we continue to focus on managing
our manufacturing lead-time performance, which may result in corresponding reductions in order backlog. A decline in backlog levels
could result in more variability and less predictability in our quarter-to-quarter net sales and operating results.
Net product sales may also be adversely affected by fluctuations in demand for our products, especially with respect to Internet
businesses and telecommunications service providers, price and product competition in the communications and information technology
industry, introduction and market acceptance of new technologies and products, adoption of new networking standards, and financial
difficulties experienced by our customers. We may, from time to time, experience manufacturing issues that create a delay in our suppliers’
ability to provide specific components, resulting in delayed shipments. To the extent that manufacturing issues and any related component
shortages, including those caused by any possible disruption related to our implementation of the lean manufacturing model, result in
delayed shipments in the future, and particularly in periods when we and our suppliers are operating at higher levels of capacity, it is
possible that revenue for a quarter could be adversely affected if such matters are not remediated within the same quarter. For additional
factors that may impact net product sales, see Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K.
Our distributors and retail partners participate in various cooperative marketing and other programs. In addition, increasing sales to
our distributors and retail partners generally results in greater difficulty in forecasting the mix of our products and, to a certain degree, the
timing of orders from our customers. We recognize revenue for sales to our distributors and retail partners based on a sell-through method
using information provided by them, and we maintain estimated accruals and allowances for all cooperative marketing and other programs.
Net Service Revenue
The increase in net service revenue during fiscal 2007 compared with fiscal 2006 was primarily due to increased technical support service
contract initiations and renewals associated with higher product sales, which have resulted in a larger installed base of equipment being
serviced, and increased revenue from advanced services, which relates to consulting support services for specific networking needs. The
increase in advanced services revenue during fiscal 2007 compared with fiscal 2006 was attributable primarily to our revenue growth in
the service provider market, the Emerging Markets theater, and advanced technologies products.
Gross Margin
Gross margin increased in absolute dollars but gross margin percentage decreased during fiscal 2007 compared with fiscal 2006 primarily
due to higher net product sales from Scientific-Atlanta and also due to the factors described under “Product Gross Margin” below. The
decrease in service gross margin also contributed to the lower gross margin percentage. The gross margin for each theater is derived from
information from our internal management system. The gross margin percentage for a particular theater may fluctuate and period-to-period
changes in such margin percentages may not be indicative of a trend for that theater.
Product Gross Margin
The decrease in product gross margin percentage during fiscal 2007 compared with fiscal 2006 was due to the following factors:
• Changes in the mix of products sold decreased product gross margin percentage by 1.9%, with 1.7% of this decrease related to the mix
impact of higher net product sales from Scientific-Atlanta.
• Sales discounts, rebates, and product pricing decreased product gross margin percentage by 1.7%.
• Lower overall manufacturing costs related to lower component costs, value engineering and other manufacturing-related costs
increased product gross margin percentage by 0.9%. Value engineering is the process by which production costs are reduced through
component redesign, board configuration, test processes, and transformation processes.
• Higher shipment volume, net of certain variable costs, increased product gross margin percentage by 0.9%.
• Net effects of amortization of purchased intangible assets and share-based compensation expense decreased gross margin
percentage by 0.1%.