Analysis of Changes in Profitability and Growth: Cisco Systems, Inc. 1 By any stretch of the imagination, Cisco System s (CSCO) has been a strong growth company. A darling of the Internet boom of the late 1990s, it was one of the few technology companies tied to the Internet and telecommunications that prospered during that era. Its products - networking and communications equipment such as router and sw itching devices - built the infrastructure of the Internet. While most Internet and telecommunications firms str uggled and failed, their supplier, Cisco, capitalized on the new technology. At one poi nt in 2000, its market capitalization was over half a trillion dollars, the largest market capitaliza tion of any firm ever. Its stock price increased from $10 in 1995 to $80 in 2000, supported by sales growth from $2.0 billion in 1995 to $18.9 billion 2000. In early 2000, Ciscos P/E stood at 130 so investors saw plenty of room for more earnings growth. However, with the subsequent collapse of the technology bubble and the demise of telecommunications firm such as WorldCom, Qwes t, and AT&T, the anticipated growth failed to materialize. Indeed, in 2001 Cisco wrote down inventory by an astonish ing $2.3 billion (under the lower-of-cost-or-market rule), to reflect the dr op in demand for its products and the emergence of second-hand telecom equipment market. Exhibit 1 presents Ciscos income statements fo r the fiscal years 2000-2002 and balance sheets for 1999-2002. The exhibit also includes the cash flow from operations a nd cash investing sections of the cash flow statements. The 2000 sales of $18 .9 billion were up from $12.2 billion in 1999 and $8.5 billion in 1998, a tremendous gr owth record. But subsequent sales growth was not as impressive, as you can see, and led to declini ng earnings. Indeed, Cisc o posted a loss for 2001. Lower earnings on increasing shareholders equity clea rly implies that residual income is declining. By the end of 2002, Ciscos shares traded at $15, well down from the 2000 high of $80. Other information, most of the from the 10-K f ootnotes, that was useful in reformulating the financial statements is presented below. Note th at the cash flow statements from Exhibit 1 are particularly useful for identifying core income becau se some of the items in the reconciliation of net income to cash flow from operati ng activities involve unusual items. Questions: 1. What adjustments are necessary to reformulate the income statements and balance sheets to properly separate financ ing from operations? 2. What adjustments are necessary to separate core operations from othe r sources of income? What items are identified as core in the Balance Sheet? 3. Calculate Core RNOA and decompose the ratio for Cisco for 2002 and 2001. |