Company Description:
Cisco Systems, Inc., incorporated in December 1984, designs, manufactures and sells Internet protocol (IP)-based networking and other products related to the communications and information technology industry, and provides services associated with these products and their use. The Company provides a line of products for transporting data, voice and video within buildings, across campuses and around the world. Its products, which include primarily routers, switches and products that the Company refers to as its advanced technologies, are installed at enterprises, public institutions, telecommunications companies, commercial businesses and personal residences. The Company conducts its business globally and is managed geographically in five segments: the
Click here for a full description of the company’s operations (provided by Reuters).
Annual Report Highlights (latest report is for the period ending
Table of Contents:
- Products and Services
- Customers and Markets
- Sales Overview
- Acquisitions, Investments, and Alliances
- Competition
- Research and Development
- Manufacturing
- Patents, Intellectual Property, and Licensing
- Employees
- Management’s Discussion and Analysis
- Detailed Discussion of Fiscal 2007 and 2006
- Stock Repurchase Program
Products and Services
Cisco sells Internet Protocol (IP)-based networking and other products and services related to the communications and information technology industry. Company’s products and services are designed to address a wide range of customers’ business needs, including improving productivity, reducing costs, and gaining a competitive advantage. Cisco’s corresponding technology focus is on delivering networking products and solutions that simplify and secure customers’ infrastructures and offer integrated services. Company’s products and services help customers build their own network infrastructures that support tools and applications that allow them to communicate with key stakeholders, including customers, prospects, business partners, suppliers, and employees. Company’s product offerings fall into several categories: core technologies, routing and switching; advanced technologies; and other products. In addition to the product offerings, company provides a broad range of service offerings, including technical support services and advanced services. Cisco’s customer base spans virtually all types of public and private agencies and businesses, comprising large enterprise companies, service providers, commercial customers, and consumers.
Company’s offerings fall into several categories:
- Routing - Routing technology is the foundation of a computer network. Routers interconnect computer networks, moving information such as data, voice, and video from one network to another across metropolitan-area networks (MANs) and wide-area networks (WANs). Cisco offers a broad range of routers, from core network infrastructure for service providers and large businesses to access routers for the service-rich branch office to home network deployments for telecommuters and consumers.
- Switching - Switching is another integral networking technology that is used in buildings, campuses, and data centers to build local-area networks (LANs), across cities to build MANs, and across great distances to build WANs. Cisco’s switching systems offer many forms of connectivity to end users, workstations, and servers, and function as aggregators on LANs, MANs, and WANs.
- Application Networking Services - Cisco Application Networking Services is a comprehensive portfolio of application networking solutions to enable the successful and highly secure delivery of applications within data centers and across the WAN to remote and branch office users. Using technology to accelerate, maximize availability of, and secure both application traffic and computing resources, these solutions are designed to provide a powerful framework to help ensure the successful deployment and delivery of business applications across the entire organization.
- Home Networking - Home networking products connect different devices in the household, through wired or wireless connections, allowing users to share Internet access, printers, music, movies, and games throughout the home. Company’s products include voice and data modems, routers, network cards, media adapters, Internet video cameras, network storage, USB adapters, and other products that enable customers to share an Internet connection or move digital content around their homes or small-office environments. These products are available from Linksys and Scientific-Atlanta and sold through select retailers, value-added resellers, online retailers, and e-commerce and service providers worldwide.
- Hosted Small-Business Systems - This solution combines products and services designed to provide small businesses with voice and data networking, along with business applications and Internet access, through a single high-speed connection from a service provider. Hosted small-business systems include integrated voice and data products on the customer’s premises coupled with security, quality of service, provisions for voice over Internet Protocol (VoIP), and monitoring and management services, all hosted and delivered by the telecommunications provider.
- Security - Cisco security solutions include a wide range of information security products and services designed to protect critical information systems from unauthorized use, defend against attack, and minimize the effect of Internet-borne worms, spam, viruses, and other malware. As part of this strategy, company offers numerous network security technologies embedded within its routers and switches, in standalone security appliances and as host-based software agents with central management and analysis.
- Storage Area Networking – Company provides storage area networking products that deliver multilayer, scalable, and highly secure connectivity between servers and storage systems, including products such as storage arrays and tape drives.
- Unified Communications – Cisco Unified Communications integrate voice, video, data, and mobile applications on fixed and mobile networks, delivering a media-rich collaboration experience to the workspace. Specific products include IP phones, client software, servers, and network appliances supporting call control, contact centers, messaging, conferencing, voice mobility, and collaboration including presence and preference information. These products include the Web-based collaborative product offerings from the acquisition of WebEx Communications, Inc.
- Video Systems – Company’s video systems consist primarily of digital set-top boxes and digital media technology products. Digital set-top boxes provide video entertainment services to consumers. They enable subscribers to access a variety of interactive digital television services developed either by Cisco or third parties. Company’s equipment includes Standard-Definition (SD) basic digital set-tops, DOCSIS (Data Over Cable System Interface Specification) Set-top Gateway (DSG) digital set-tops, High-Definition (HD) digital set-tops, Digital Video Recorder (DVR) set-tops, HD-DVR set-tops, Multi-Room DVR set-tops, Media Center DVR set-tops, and Digital-only set-tops. These products are sold primarily through Scientific-Atlanta.
- Wireless Technology – Company offers a broad variety of in-building and outdoor wireless networking products. These products include access points, wireless LAN controllers, wireless integrated switches and routers, wireless management software, wireless LAN clients and client software, bridges, antennas, and accessories.
- Other Products – Cisco’s other products are comprised primarily of cable access, service provider VoIP services, and optical networking products. Company provides optical networking products for both the enterprise and service provider markets. Scientific-Atlanta markets and sells analog and digital optoelectronics which may reside in a network operator’s head-end, in other facilities such as distribution hubs, and in optical nodes. Other products also include such emerging technologies as digital media products, physical security products, and TelePresence.
- Service - In addition to the product offerings, company provides a broad range of service offerings, including technical support services and advanced services. Technical support services help ensure that company’s products operate efficiently, remain available, and benefit from the most up-to-date system software. Advanced services are services that are part of a comprehensive program that is designed to provide responsive, preventive, and consultative support of company’s technologies for specific networking needs.
Customers and Markets
Company’s customers’ IT collaboration networking needs are influenced by numerous factors, including the size of the organization, number and types of technology systems, geographic location, and the business applications deployed throughout the network. Company’s customer base is not concentrated in any particular industry, geography, or market segment. In each of the past three fiscal years, no single customer has accounted for 10 percent or more of Cisco’s net sales. Company’s customers are primarily in the following markets:
- Large
- Service Providers – Service providers offer data, voice, and video communication services to businesses, governments, utilities, and consumers. They include regional, national, and international telecommunications carriers as well as Internet, cable, and wireless service providers. Service providers use a variety of company’s routing, switching, optical, storage, security, video systems, and network management products in their own networks. Additionally, many service providers offer managed network services incorporating company’s enterprise and commercial products for unified communications and call centers, virtual private networks (VPNs), security, and managed firewalls for their business customers.
- Commercial – Commercial customers are defined as those having 20 to 1,000 employees, and company furthers divide commercial customers into two distinct sub-segments: small and medium-sized businesses (SMBs) with 20 to 250 employees and mid-market businesses with 250 to 1,000 employees. Company’s SMB customers require their communications networks to help them solve their business challenges and they often desire those networks to be completely hosted and managed by their channel partner or service provider. Mid-market customers are served by a combination of company’s sales department and channel partners and typically require the latest advanced technology that is available to company’s large enterprise partners, but without the complexity.
- Consumer – Consumer customers, primarily individuals and businesses operating in small offices or home offices, have infrastructure and networking needs on a smaller scale.
Sales Overview
As of the end of fiscal 2007, company’s worldwide sales and marketing department consisted of 21,465 individuals (35% of all employees), including managers, sales representatives, and technical support personnel. Company has field sales offices in more than 80 countries and sells its products and services both directly and through a variety of channels with support from company’s sales force. A substantial portion of company’s products and services is sold through company’s channel partners and the remainder is sold through direct sales. Company’s channel partners include systems integrators, service providers, other resellers, distributors, and retail partners.
- Systems integrators and service providers typically sell directly to end users and often provide system installation, technical support, professional services, and other support services in addition to network equipment sales.
- Distributors hold inventory and typically sell to systems integrators, service providers, and other resellers. In addition, Linksys home networking products are generally sold through distributors and retail partners.
Backlog
Cisco’s backlog at
Acquisitions, Investments, and Alliances
The markets in which company competes require a wide variety of technologies, products, and capabilities. Through acquisitions, investments, and alliances Cisco is able to deliver a broader range of products and services to customers in target markets.
Company employs the following strategies to address the need for new or enhanced networking products and services:
- it develops new technologies and products internally;
- it enters into joint-development efforts with other companies;
- it resells other companies’ products; and
- it acquires all or parts of other companies.
Acquisitions
Cisco has acquired many companies, and company expects to make future acquisitions. Mergers and acquisitions of high-technology companies are inherently risky, especially if the acquired company has yet to ship a product. Prior acquisitions have resulted in a wide range of outcomes, from successful introduction of new products and technologies to an inability to do so.
Investments in Privately Held Companies
Company makes investments in privately held companies that develop technology or provide services that are complementary to its products or provide strategic value.
Strategic Alliances
Cisco pursues strategic alliances with other companies in areas where collaboration can produce industry advancement and acceleration of new markets. The objectives and goals for a strategic alliance can include one or more of the following: technology exchange, product development, joint sales and marketing, or new-market creation. Companies with whom company has strategic alliances in some areas may be competitors in other areas.
Competition
Company competes in the networking and communications equipment markets, providing products and services for transporting data, voice, and video traffic across intranets, extranets, and the Internet. These markets are characterized by rapid change, converging technologies, and a migration to networking solutions that offer superior advantages. As company continues to expand globally, it may see new competition in different geographic regions. In particular, company has experienced price-focused competition from competitors in
Barriers to entry are relatively low, and new ventures to create products that do or could compete with company’s products are regularly formed. In addition, some of company’s competitors may have greater resources, including technical and engineering resources, than it does. As company expands into new markets, it will face competition not only from its existing competitors but also from other competitors, including existing companies with strong technological, marketing, and sales positions in those markets. Company also sometimes faces competition from resellers and distributors of its products.
The principal competitive factors in the markets in which Cisco presently competes and may compete in the future include:
· The ability to provide a broad range of networking products and services
· Product performance
· Price
· The ability to introduce new products, including products with price-performance advantages
· The ability to reduce production costs
· The ability to provide value-added features such as security, reliability, and investment protection
· Conformance to standards
· Market presence
· The ability to provide financing
Cisco regularly seeks to introduce new products and features in areas including routers, switches, advanced technologies, and other product technologies. Company’s research and development expenditures were $4.5 billion, $4.1 billion, and $3.3 billion in fiscal 2007, 2006, and 2005, respectively. All of its expenditures for research and development costs have been expensed as incurred.
Cisco’s success depends in part upon its ability, on a cost-effective and timely basis, to continue to enhance its existing products and to develop and introduce new products that improve performance and reduce total cost of ownership. To achieve these objectives, company’s management and engineering personnel works with customers to identify and respond to customer needs, as well as with other innovators of internetworking products, including universities, laboratories, and corporations. Company also expects to continue to make acquisitions and investments where appropriate to provide itself with access to new technologies. Company intends to continue developing products that meet key industry standards and to support important protocol standards as they emerge.
Manufacturing
Cisco primarily employs an outsourced manufacturing strategy that relies on contract manufacturers for manufacturing services, although it continues to operate the Scientific-Atlanta manufacturing facilities acquired in the Scientific-Atlanta acquisition, including its principal facility in
Company presently uses a variety of independent third-party companies to provide services related to printed circuit board assembly, in-circuit test, and product repair as well as product assembly. Proprietary software on electronically programmable memory chips is used to configure products to customer needs and to maintain quality control and security. The manufacturing process enables Cisco to configure the hardware and software in unique combinations to meet a wide variety of individual customer requirements.
In the fourth quarter of fiscal 2007, company fully implemented the lean manufacturing model, which it began transitioning to in the third quarter of fiscal 2006.
Company has not entered into any significant long-term contracts with any manufacturing service provider. Company generally has the option to renew arrangements on an as-needed basis, primarily annually.
Patents, Intellectual Property, and Licensing
Cisco seeks to establish and maintain its proprietary rights in its technology and products through the use of patents, copyrights, trademarks, and trade secret laws. Company also seeks to maintain its trade secrets and confidential information by nondisclosure policies and through the use of appropriate confidentiality agreements. Company has obtained a substantial number of patents and trademarks in the
Although company believes the protection afforded by its patents, copyrights, trademarks, and trade secrets has value, the rapidly changing technology in the networking industry and uncertainties in the legal process make its future success dependent primarily on the innovative skills, technological expertise, and management abilities of its employees rather than on the protection afforded by patent, copyright, trademark, and trade secret laws.
The industry in which Cisco competes is characterized by rapidly changing technology, a large number of patents, and frequent claims and related litigation regarding patent and other intellectual property rights. There can be no assurance that the company’s patents and other proprietary rights will not be challenged, invalidated, or circumvented; that others will not assert intellectual property rights to technologies that are relevant to the company; or that company’s rights will give it a competitive advantage.
Employees
As of
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Revenue
Net sales increased by 23% in fiscal 2007 compared with fiscal 2006. Revenue increased in our four largest geographic theaters in fiscal 2007 compared with fiscal 2006, primarily in the service provider, commercial, and enterprise markets. The largest proportion of the increase in net product sales was related to higher sales of advanced technologies. Sales of our advanced technologies, which represented a larger proportion of our net product sales than routing, increased by approximately 44% over fiscal 2006 due to the additional contribution of Scientific-Atlanta, and also due to strength in sales of our unified communications, security, wireless, and storage products.
In fiscal 2007, we also experienced strength in routing, led primarily by our high-end routers, and in switching, led by our fixed-configuration and modular switches.
We also have been focused on expanding our service model. In fiscal 2007, our net service revenue increased by approximately 20% compared with fiscal 2006. Our service and support strategy seeks to capitalize on increased globalization, and we believe this strategy, along with our architectural approach, has the potential to further differentiate us from competitors.
Operating Margin
In fiscal 2007, our gross margin increased in absolute dollars compared with fiscal 2006. However, our gross margin percentage decreased compared with fiscal 2006 primarily due to increased net sales from Scientific-Atlanta, whose business model has a lower gross margin percentage than other Cisco products.
Operating expenses in fiscal 2007 increased in absolute dollars compared with fiscal 2006, primarily due to increased investments in headcount, but decreased as a percentage of revenue.
Other Financial Highlights
- During fiscal 2007, we generated cash flows from operations of $10.1 billion.
- We repurchased 297 million shares of our common stock during fiscal 2007 for $7.8 billion.
- We used $3.3 billion for acquisitions, net of cash, cash equivalents, and investments acquired.
- Our purchase commitments with contract manufacturers and suppliers were $2.6 billion at the end of fiscal 2007, compared with $2.0 billion at the end of fiscal 2006.
We believe our growth was attributable to the continued deployment by customers of our end-to-end architecture and the convergence of data, voice, video and mobility into IP networks, together with our differentiated strategy and execution.
The investments we have made and our architectural approach are based on the belief that collaboration and “Web 2.0,” the technologies that enable user collaboration, including such technologies as unified communications and TelePresence, and the increased use of the network as the platform for all forms of communications and information technology will create new market opportunities for us.
Detailed Discussion of Fiscal 2007 and 2006
Net Sales
The increase in net product sales primarily occurred across Cisco’s four largest geographic theaters as it experienced increased information technology-related capital spending by its customers in its service provider, enterprise, and commercial markets. The increase in service revenue was primarily due to increased technical support service contract initiations and renewals associated with higher product sales that have resulted in a larger installed base of equipment being serviced.
The
Net Product Sales by Theater
- European Markets – The increase in net product sales in the European Markets theater during fiscal 2007 compared with fiscal 2006 was due to balanced growth in net product sales across all of company’s customer markets and most of company’s geographic areas, led by the enterprise and commercial markets.
- Emerging Markets – The increase in net product sales in the Emerging Markets theater represented the largest percentage increase of any theater in fiscal 2007 compared with fiscal 2006. The increase was primarily as a result of continued network deployment by service providers and growth in the enterprise and commercial markets as customers continue to adopt company’s architectural platform, led by strength in the
Net Product Sales by Groups of Similar Products
- Routers – The increase in net product sales related to routers in fiscal 2007 compared with fiscal 2006 was primarily due to higher sales of company’s high-end routers. Sales of Cisco’s high-end routers, which represent a larger proportion of its total router sales compared with midrange and low-end routers, increased by approximately $855 million in fiscal 2007 compared with fiscal 2006. Company’s high-end router sales are primarily to service providers, which tend to make larger and more uneven purchases. Company believes that the increase in high-end router sales is attributable to service providers continuing to scale network capacity to accommodate actual and projected increases in data, voice and video traffic. During fiscal 2007, company’s sales of its integrated services routers (ISRs), which are included in the midrange and low-end routers, also increased and contributed to growth in sales of company’s advanced technologies products, such as security, unified communications, and wireless.
- Switches – The increase in net product sales related to switches in fiscal 2007 was primarily due to higher sales of local-area network (LAN) fixed-configuration switches, which increased during fiscal 2007 by approximately $1.1 billion compared with fiscal 2006. Additionally, growth in advanced technologies such as unified communications and wireless LANs creates demand for LAN fixed-configuration and modular switching infrastructure as additional endpoints are added to the network.
- Advanced Technologies – The increase in net product sales related to advanced technologies in fiscal 2007 compared with fiscal 2006 was primarily due to the following:
- Video systems, which include solutions and systems designed to enable video-specific delivery systems for service providers, increased by approximately $1.2 billion during fiscal 2007. The increases were attributable to several factors, including Scientific-Atlanta product sales being included in fiscal 2006 only subsequent to its acquisition in February 2006 compared with a full year in fiscal 2007; an increase in the demand for high-definition (HD) set-top boxes; network upgrades; international expansion.
- Unified communications sales increased by approximately $390 million during fiscal 2007, primarily due to sales of IP phones and associated software as Cisco’s customers continued to transition from an analog-based to an IP-based infrastructure, and also the addition of sales from the acquisition of WebEx Communications, Inc.
- Home networking product sales increased by approximately $240 million during fiscal 2007. Scientific-Atlanta products composed the majority of the increase in home networking product sales during fiscal 2007.
- Sales of security products increased by approximately $240 million during fiscal 2007, primarily due to module and line card sales related to company’s routers and LAN modular switches as customers continued to emphasize network security, and also due to sales of Cisco’s next-generation adaptive security appliance product, which integrates multiple technologies including virtual private network (VPN), firewall, and intrusion prevention services on one platform.
- Sales of wireless LAN products increased by approximately $190 million during fiscal 2007 primarily due to new customers, continued deployments with existing customers, and their adoption of Cisco’s unified architecture platform.
- Other sales of advanced technologies relating to sales of storage area networking products increased by approximately $110 million during fiscal 2007 and application networking services increased by approximately $85 million during fiscal 2007.
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 company’s revenue growth in the service provider market, the Emerging Markets theater, and advanced technologies products.
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%.
Service Gross Margin
Cisco’s service gross margin percentage for fiscal 2007 decreased from fiscal 2006, primarily due to strategic investments in headcount as well as advanced services representing a higher proportion of service revenue. Additionally, company has continued to invest in building out its technical support and advanced services capabilities in the Emerging Markets theater.
Headcount
Company’s headcount increased by 11,609 employees during fiscal 2007, reflecting the investment in R&D, sales, and also reflecting increases in investments in its service business; its Juarez, Mexico manufacturing facility; and acquisitions. Approximately 3,300 of the new employees were attributable to acquisitions Cisco completed in fiscal 2007. Company’s headcount is expected to increase, as it continues to invest in engineering and sales headcount.
Stock Repurchase Program
As of
Financial Highlights:
Revenue Growth (1-yr): 22.6%
Revenue Growth (9-yr average): 18.7%
Net Income Growth (9-yr average): 18.9%
Earnings-Per-Share Growth (1-yr): 31.5%
Earnings-Per-Share (9-yr average): 44.6%
Free Cash Flow Growth (1-yr): 24.2%
Free Cash Flow Growth (9-yr average): 17.4%
Net Profit Margin (current): 21.0%
Net Profit Margin (10-yr average): 15.8%
Return On Equity (current): 26.5%
Return On Equity (10-yr average): 18.2%
Current Ratio (current): 2.36
Financial analysis:
- Debt ratio of 0.41 is certainly manageable, but it did double from ten years ago meaning that the past growth has been fueled in large part by increased borrowing. While not necessarily bad, this does make you wonder if the company will need to take on additional debt to grow in the future. Of course, the more debt the company has, the more it has to payout in interest payments, and the less is left for shareholders.
- Cisco’s ROA has picked up again during the past four years after several years of recovering after the stock market had burst in 2000. Currently, it’s at 14% and averages a respectable ROA of 11.5% for the past ten years.
- ROE is even more impressive, currently at 26.5% and averages at 18.2% for the past ten years.
- Profit margin is at a very healthy 21%, well above the 10-yr average of 15.8%. It has been improving consistently after the dip into the negative territory in 2001.
- Free Cash Flow has shown rather rapid growth during the latest fiscal period (24.2%), but this growth hasn’t been as consistent as one would have liked it to be: growth varies between single- and double-digit rates while occasionally showing negative growth. Having said that, 10-yr average growth has been a very nice 17.4%.
- Revenue and net income growth rates follow the same trend as the free cash flow and show the same lack of consistency. But, consistent or not, for the past ten years revenue growth has averaged 18.7% and net income grew at an average rate of 18.9%.
- Cisco has been consistently improving its inventory turnover rates, which tells me that they’re improving their operations by having as little of inventory on-hand as possible. They’ve recently completed the last phase of implementing the lean manufacturing model, so I would expect their efficiency numbers to further improve.
Discounted Cash Flow (DCF) Analysis:
I used discounted cash flow analysis to arrive at the intrinsic value of the company. I estimated that free cash flow would grow at an average rate of 14% per year for the next 10 years and at 3% (trailing GDP growth) perpetually after that.
I used a discount rate of 11% because I believe it’s slightly riskier than the average wide moat company due to unpredictability of demand for its products.
Using the assumptions listed above, my intrinsic value of the stock came out to $41.32. My intrinsic value of Cisco is about 10% more than what Morningstar has listed as a “fair value” for this company. It is most likely due to the fact that I have a stronger believe that this company will make good use of its extensive cash reserves and continue to grow its free cash flow at a relatively steady pace.
Pros:
- Cisco will benefit handsomely from the increased bandwidth demand due to growth of multimedia usage throughout public and private networks.
- Company has a large installed base of customers who are unlikely to switch.
- It has a very strong balance sheet and has enough cash to continue on the acquisition spree over the next several years.
- It has a fairly diversified product lineup, which makes for a more balanced growth.
- Cisco consistently repurchases its common stock. Last year it repurchased $7.8 billion worth of common stock.
Cons:
- Its margins may decrease further as it moves into markets with the increased price pressures.
- Much of the company's revenue depends upon large customers whose spending is uneven and varies with their budgets from year to year. This makes it difficult to forecast future revenue and earnings for the company.
- Cisco doesn’t do very well during bear markets, and we might have one on our hands in the near future.
Final Decision:
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