Financial Analysis of Cisco Systems

P/E (Price Earnings ratio)12 Profitability12 Financial strength13 Management Effectiveness14 accounting policies/ issues14 Inventory14 Revenue Recognition15 Impairment of Assets15 Allowance for doubtful Accounts16 Depreciation17 Bibliography17 Introduction Company Overview Cisco Systems was incorporated in California in December 1984. The company’s core competency lies in producing networking components and other products in the communications and information technology industries. With 61,535 employees worldwide as of Q3 FY 2007 and offices in 75 countries, Cisco is one of the largest companies in the IT/Networking industry.

Cisco was founded by a group of computer scientists from Stanford University.

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On February 16, 1990, six years after its inception, the company went public at a split-adjusted price of about 6 cents per share. Financial Summary Today, trading at approximately $32/share, the company has seen an increase in stock price of over 500 times its initial public offering. Total revenues have grown to over $34 Billion (an increase of over 6 billion from 2006) and has enjoyed steady growth since recovering from the dot com collapse.

Figure 1: Cisco’s first ten years Figure 2: Cisco’s last ten years Product Lines Cisco primarily produces Internet Protocol (IP)-based networking products for the communications and information technology industries, addressing a wide range of customer needs. Cisco also provides a line of products for transporting data, voice, and video within buildings, across campuses, and around the world.

The Company’s offerings fall into 8 major categories: Routing Routers interconnect networks, moving information such as data, voice, and video from one network to another.

The Company offers a wide range of routers from core network infrastructure for service providers and large businesses to home network deployments for telecommuters and consumers. Switching Switching is another integral networking technology that is used in buildings and campuses to build local-area networks, across cities to build metropolitan-area networks, and across great distances to build wide-area networks. The company’s switching systems offer many forms of connectivity to end users, workstations, and servers, and function as aggregators on LANs, MANs, and WANs. Enterprise IP Communications

Enable the transmission of voice services over open standards-based Internet Protocol-based networks.

Security A range of network security products and services that offer mission critical protection of information systems from unauthorized use, defense against attack, and minimized damage dut to internet born worms and viruses. Home Networking Home networking products connect different devices in the household, allowing users to share Internet access, printers, music, movies, and games throughout the home through both wired and wireless connections. Optical Networking Storage Area Netwroking

Products that deliver standard-based connectivity between servers and storage systems, this may include products such as arrays and tape drives. Wieless Technology A variety of both in-building and outdoor wireless LAN, as well as wireless bridging products. Social Responsibility Cisco adheres to a business strategy with a strong focus on corporate citizenship. It has built social relationships/partnerships with local organizations around its campuses to ensure business sustainability.

Highlighted by a commitment to environmentally conscious operations and products, Cisco strengthens its reputation while empowering its employees.

Insert here the purpose of this document. For many documents, this may be taken from the RUP. Corporate Governance The Board of Directors is selected through the voting for nominees elected by shareholders. John P.

Morgridge was succeeded as the Chairman of the Board by the current CEO John Chambers due to an age policy that was adopted in 2005 restricting Morgridge’s re-election. Morgridge has since been named Chairman Emeritus. 20 percent of the Board of Directors of Cisco also serve on other Boards. Larry R. Carter serves for Qlogic Corporation and Charles H.

Giancarlo serves for Netflix Inc. The base salary of the board ranges from 350k-460k per year, but with bonuses and options the compensation can reach up to $4 million. Reporting Strategy Cisco‘s pre-2006 reporting strategy was to divide its geographic sections up in four segments: The Americas, Europe, the Middle East, and Africa (“EMEA”); Asia Pacific; and Japan. Since 2006 Cisco as adopted a new strategy dividing markets as follows: United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan. Cisco reported record revenue of $9. 43 billion in 2006.

Orders are up 20 percent in the European Markets and up 13 percent in the U. S. The company also reports solid growth in mid 30’s y/y its Emerging Markets and high teens y/y in Asia Pacific Organization Structure As products have become more diverse and customer segments increasingly blurred, Cisco’s organizational structure was modified in August of 2001. It did so in order to better focus its resources on changing customer needs as well as emphasize its strengths in the market place. The organizational structure now consists of centralized engineering and marketing rganizations. This way the company has the ability to prevent product and resource overlaps and more effectively allocate its resources to areas yielding optimum profitability.

The engineering side has eleven technology groups with people heading multiple groups and reporting to one person who then reports to the CEO. The marketing side has one head who reports to the CEO as well. Operating Environment From incorporation in 1984 until around 2004, Cisco monopolized the industry of commercial routers and networking products.

However, competition from rising giants like Juniper Networks Inc. (JNPR), Nortel Networks Corp (NT) and to some extent also Alcatel-Lucent (ALU) has given Cisco growing competition. Cisco is now in a position where competition drives its operating practices and inspires constant improvements in areas such as customer service and sales/marketing in order to maintain its market leadership.

Though Cisco has lost market share to rising competitors, overall outlook remains good with new product lines set for production.

Cisco campuses operate in many countries. While it primarily operates in the United States, it also has campuses in the Americas, EMEA, Asia Pacific, Japan, United Kingdom, France, Belgium, the Netherlands, Singapore, Hong Kong, Australia, Japan, and India. Cisco owns and leases manufacturing facilities, which are primarily test and assembly operations, exclusively in the United States. As of July 29, 2006, Cisco employed 49,926 employees, including approximately 19,600 employees in locations outside the United States.

Even though Cisco employees are not unionized the relationship between Cisco and its employees is considered to be a good one.

Competition for technical personnel in the industry in is intense. Cisco believes that its future success depends in large part on its continued ability to hire, assimilate, and retain qualified personnel. Risks Cisco faces risk in various departments, as does any manufacturing company, such as fluctuations in demand for its products, competition and price points. Out-dated technology, lawsuits and unpredictable events that may change the market are also risks that Cisco faces regularly.

Legal In April 2001, a series of shareholder class action lawsuits were filed against Cisco claiming that Cisco made false and misleading statements leading to the acquisition of their shares. Additionally, shareholder derivative lawsuits were filed claiming breach of fiduciary duty, waste of corporate assets, mismanagement and unjust enrichment.

On August 18th 2006, Cisco, in effort to cease ongoing litigation, stated that liability insurers would pay $91. 75 million to the plaintiffs to settle all claims against its officers and directors.

Cisco and all of its individual defendants continue to deny all allegations in the lawsuit. In early 2007, Cisco filed a lawsuit against Apple for trademark infringement concerning the newly released iphone.

Cisco claimed that it had been using the trademark since 2000 when it acquired Infogear, a small company out of Redwood City, CA that manufactured consumer devices. Infogear had been using the iphone trademark since 1996. Apple and Cisco came to an agreement in February 2007 and agreed to use the iphone trademark on their own products. General management outlook

In 2006, Cisco focused its attention to five key areas: the commercial market segment, sales coverage, technology growth and expansion, strengthening support and expanding its presence in emerging markets. In the future, Cisco expects to focus on next-generation service provider network build-outs, strengthening product offerings in the consumer market, and providing more comprehensive solutions to customers as they employ internet solutions. Cisco’s three long-term financial priorities include seeking profitable growth opportunities, to achieve profitability targets and improve productivity and continually increasing shareholder value.

In 2006, Cisco increased net sales, net income, and net income per share compared to the prior year. In February 2006, Cisco completed the acquisition of Scientific-Atlanta, Inc. (“Scientific-Atlanta”), a provider of set-top boxes, end-to-end video distribution networks, and video integration systems. Sales of advanced technologies increased by 34% over 2005 in part due to the acquisition of Scientific-Atlanta (which increased sales of advanced technologies by 19%) and also to its strength in unified communications, wireless technology, storage area networking and security markets.

While Cisco enjoyed increases in all major market segments, the largest increases were seen in the United States and emerging markets.

In spite of the Cisco’s overall success, gross margin percentage decreased compared to fiscal 2005. This was primarily due to the acquisition of Scientific-Atlanta. Other contributing factors included the sales of certain switching and routing products and the effect of stock-based compensation expense under SFAS 123(R). Operating expenses increased primarily because increased sales and engineering headcount-related expenses as well as the effect of Cisco’s adoption of SFAS 123(R). Additional notes 1.

Net income and net income per share prior to fiscal 2006 did not include stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123 because Cisco did not adopt the recognition provisions of SFAS 123. 1. 2Stock-based compensation expense prior to fiscal 2006 is calculated based on the pro forma application of SFAS 123 as previously disclosed in the notes to the Consolidated Financial Statements. 1. 3Net income and net income per share prior to fiscal 2006 represent pro forma information based on SFAS 123 as previously disclosed in the notes to the Consolidated Financial Statements.

Financial performance/ position analysis Figure 3: Key ratios for Cisco along with industry averages for year 2005 and 2006 Quantitative analysis on financial performance P/E (Price Earnings ratio) From 2005 to 2006 there was a 25% decrease in the price earnings ratio.

Even in 2007, Cisco is below the industry, which is 29. 92. The closer the P/E is to 1, the more stable the shares are, since this would reflect that the price per share is closer to the earning per share. This would make sense since Cisco is the industry standard. Profitability

Gross Margin, shows how well the company is buying goods, then turning around and selling them for profit.

Cisco’s margin has gone down slightly from 2005 to 2006 (2. 13%), but is still well above the industry average and doesn’t raise any immediate red flags (50. 06). By Cisco having a higher margin than the industry, this means it has more cash to spend on business operations as compared to its peers. As indicated by the operating margin, Cisco controls its costs and expenses better that its peers.

The net profit margin takes into account all the activities of the company. It should follow the operating margin.

Net profit margin is down by approximately 17. 8% . As indicated in the MD ;A, in spite of the Cisco’s overall success, gross margin percentage decreased compared to fiscal 2005.

This was primarily due to the acquisition of Scientific-Atlanta, whose business model has a lower gross margin percentage than the Cisco margin. Other contributing factors included the sales of certain switching and routing products and the effect of stock-based compensation expense under SFAS 123(R). Operating expenses increased primarily because increased sales and engineering headcount-related expenses as well as the effect of Cisco’s adoption of SFAS 123(R).

Financial strength As reflected in the ratio analysis, Cisco is above its peers. Cisco seems to be more liquid than the industry. This is favorable since this ratio measures a company’s capacity to pay its immediate debt.

The decrease in liquidity from 2005 to 2006 is primarily due to an increase in current liabilities. There was a decrease in the quick ratio and current ratio of 2. 92% and 1. 96% respectively. Total Debt/Equity From 2005 to 2006, the debt to equity ration went up from . 46 to .

81, indicating that for every $1 invested, there is now $. 1 in liabilities. The industry indicates XXXXX.. double check One of the reasons why the ratio increase was due to the Board of Directors authorizingan aggregate repurchase of up to $40 billion of common stock. The purchase price for the shares of common stock repurchased was reflected as a reduction to shareholders’ equity.

In addition, Cisco took on debt of $6. 5 billion, contributing to the increase in debt/equity ratio. Furthermore, in 2005, Cisco omitted long term debt in its balance sheets do to “uncertainty of amount and timing of future payments”.

We believe that these reasons are not properly justified, and that further investigation on why these figures were omitted should be conducted. Management Effectiveness As compared to the industry, Cisco is above regarding return on assets and equity. Although there was a decrease in .

35 in the return on assets, it is significantly above the industry (6. 29). This indicates that Cisco is able to reinvest its earnings more efficiently that its competitors. Normally, companies that have higher return on equity values are more attractive to investors. A higher return on equity reflects how much is earned for every $1 invested. ccounting policies/ issues Inventory a.

) Policy : Inventories are stated at the lower of cost or Market. Cost is computed using standard cost, which approximates actual cost on a first in, first-out (FIFO) basis. Analysis: The adoption of lower of cost or Market sounds reasonable since the cost of computer and networking equipments (company’s main focus area) fluctuates drastically and possibilities are even before the equipment is sold in the market the fair market value would be changed. b. )  Policy: The Company provides inventory write downs based on excess and obsolete inventories determined primarily by future demand forecasts.

The allowance is measured as the difference between the cost of the inventory and market based upon assumptions about future demand and charged to the provision for inventory, which is a component of cost of sales. Analysis: Considering the highly volatile networking industry and ever evolving technological breakthroughs  its difficult to project future demands. Hence, it seems reasonable for Cisco to write mark downs based on future demands where a plummeting demand would indicate a possible better alternate solution. Conclusion

The policies represent conservative financial reporting behavior, as characteristic parameters like market demands which are used to calculate write downs may not be a true identifier of market forecast. Specially considering that in technological sector the initial curve of the technological acceptance is high. Once the technology becomes wide popular it can generate high revenues.

However, this conservative strategy though on one hand decreases the total financial assets of the company but gains a higher confidence from the investors and eventually a higher reliability on the future projections and hence helping the company in long run.

Revenue Recognition Cisco’s products are generally integrated with software that is essential to the functionality of the equipment. It also provides unspecified software upgrades and enhancements to the equipment through its maintenance contracts for its products. Therefore, the company accounts for revenue in accordance with Statement of Position, “Software Revenue Recognition”. This concept is accepted by GAAP for products that are integrated with software.

For products where software is incidental to the equipment, or in hosting arrangements, the company applies the provisions of Staff Accounting Bulletin “Revenue Recognition”.

The company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collect ability is reasonably assured. This policy seems very reasonable because of the integrated products that are offered by Cisco. The company offers many enhancements and upgrades to its products so it would make sense to use the policy of Software Revenue Recognition. The policy that Cisco uses reflects conservative financial reporting. It recognizes revenue when delivery has occurred, which means that if the package were lost, or damaged, they would not report revenue.

This means that earnings per share would not be as high as if they used another method. The company is able to keep better track of its sales with this procedure. The position that Cisco has taken on its policy of Revenue Recognition improves earnings quality. It has taken a more conservative approach to its financial reporting by adopting these specific revenue recognition policies. Impairment of Assets “Impairment of long-lived assets and certain identifiable intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.

Determination of recoverability of long-lived assets is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition.

Measurement of an impairment loss for long-lived assets and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. Impairment of an asset is the loss of a significant portion of the utility of an asset through casualty, obsolescence and lack of demand for the asset’s services. A loss should be recognized when an asset suffers a permanent impairment. Determining the amount of the loss depends on company policies.

Cisco seems to have a conservative view on determining the loss amount. By reporting the amount of loss at fair value less costs to sell, this is lowering the amount of cash received for the asset and therefore increasing the potential loss.

However, the final result on whether the impairment of the asset produced a loss or gain will depend on the book value of the asset at the time of the sale. It is probable that Cisco has a high rate of asset impairment since the technology industry is evolving at greater rates every year, therefore equipment is becoming obsolete quicker as time goes by. Allowance for doubtful Accounts The allowance for doubtful accounts is a contra-asset account containing the estimated ucollectible accounts receivable. Because the matching principle requires recording of the bad debt expense in the same accounting perid in which the related sales are made.

Cisco resolves the problem and satisfies the matching principle by using the estimates of the expected amount of bad debts, basing on the company’s assessment of the collectibility of customer accounts. Cisco’s accounts receivable balance, net of allowance for doubtful accounts, was $3. 3 billion and $2. 2 billionas of July 29. 2006 and July 30. 2005, respectively.

The allowance for doubtful accounts was $175 million, or 5. 0? of the gross accounts receivable balabce, as of July 29, 2006 and ? 162 million, or 6. 8? of the gross accounts receivable balance, as of July 30 2005.

The allowance is based on our assessment of the collectibility of customer accounts. Cisco regularly review the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. Cisco’s provision for doubtful accounts was ? 24 million for fiscal 2006, while no provision for doubtful accounts in fiscal 2005 and our provision for doubtful accounts was ? 19 million in fiscal 2004.

The policy reflect conservative financial reporting behavior.

Because as a contra-asset, the balance in Allowance for Doubtful Accounts is always subtracted from the balance of the asset Account Receivable. Thus the entry decreases the net book value of Account Receivable and total asset. As a giant company in computer communication industry, Cisco surely have a great number of their sales revenue been paid by account receivable. Allowance for doubtful account is necessarily made to report the assets as accurate as possible.

Depreciation Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets.