Mindmeld, here is the full text from the Cisco 10-Q
Consolidation of Variable Interest Entities
Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), was issued in January 2003. FIN 46 requires that if an entity is the primary beneficiary of a variable interest entity, the assets, liabilities and results of operations of the variable interest entity should be included in the Consolidated Financial Statements of the entity. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. The Company has not invested in any variable interest entities after January 31, 2003. For those arrangements entered into prior to January 31, 2003, the provisions of FIN 46 are required to be adopted at the beginning of the first interim or annual period beginning after June 15, 2003.
As discussed in Note 6 to the Consolidated Financial Statements, the Company has invested in Andiamo Systems, Inc. (“Andiamo”), a storage switch developer. This investment was made in April 2001 in the form of an $84 million debt instrument. In connection with this investment, Cisco obtained a call option that provided the Company the right to purchase Andiamo. The purchase price under the call option is based on a valuation of Andiamo using a negotiated formula, further described in Note 6 to the Consolidated Financial Statements. On August 19, 2002, the Company entered into a definitive agreement to acquire Andiamo, which represents the Company’s exercise of its rights under the call option. The Company also entered into a commitment to provide non-convertible debt funding to Andiamo of approximately $100 million through the close of the acquisition.
The Company has evaluated its debt investment in Andiamo and has determined that Andiamo is a variable interest entity under FIN 46. The Company has concluded that it is the primary beneficiary as defined by FIN 46 and, as a result, the Company is required to consolidate Andiamo beginning the first day of the first quarter of fiscal 2004. To date, the Company has expensed substantially its entire investment in Andiamo as research and development costs, as if such expenses constituted the development costs of the Company.
FIN 46 will require Cisco to account for Andiamo as if it had consolidated it since the Company’s initial investment in April 2001. If the Company consolidated Andiamo from the date of its initial investment, the Company would be required to account for the call option as a repurchase right. Under Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation” (“FIN 44”), and related interpretations, variable accounting is required for substantially all Andiamo employee stock and options because the ending purchase price is primarily derived from a revenue-based formula. Therefore, beginning in the first quarter of fiscal 2004, the Company will revalue the stock and options of Andiamo each quarter based on an independent valuation of Andiamo until the completion of the acquisition which is expected in the third quarter of fiscal 2004, but no later than July 31, 2004.
Consequently, on July 27, 2003, the first day of fiscal 2004, Cisco will record a non-cash cumulative charge based on the adoption of FIN 46, in the range of $200 million to $500 million (the variable compensation from April 2001 through July 2003). This will be reported as a separate line item in the Consolidated Statements of Operations, net of tax. The charge will be based on the value of the Andiamo employee stock and options and their expected vesting upon FIN 46 adoption pursuant to the independent evaluation, and does not necessarily reflect the value of Andiamo as a whole nor indicate the expected valuation of Andiamo upon acquisition. Subsequent to the adoption of FIN 46, changes to the value of Andiamo will result in adjustments to the non-cash stock compensation charge based upon the expected vesting of the employee stock and options and will be reflected as operating expenses. These adjustments will be recorded commencing in the first quarter of fiscal 2004 and continue until such time as the acquisition of Andiamo is completed, which is expected to close in the third quarter of fiscal 2004, but no later than July 31, 2004. These adjustments will be based on changes in the valuation of Andiamo using the negotiated formula. The value computed under the negotiated formula is largely based on revenues derived from specific storage switch products.
Excluding the non-cash stock compensation cumulative charge and any future non-cash variable stock compensation adjustments, the impact of consolidating Andiamo will not materially affect the Company’s operating results or financial condition. Other than the investment in Andiamo, the Company does not anticipate that the adoption of FIN 46 will have a material impact on its operating results or financial condition.
* The text to Note 6 is as follows
Investment in Andiamo Systems, Inc.
On August 19, 2002, Cisco entered into a definitive agreement to acquire privately held Andiamo. The acquisition of Andiamo is expected to close in the third quarter of fiscal 2004, but no later than July 31, 2004.
Under the terms of the agreement, common stock and options of Cisco will be exchanged for all outstanding shares and options of Andiamo not owned by Cisco at the closing of the acquisition. The amount of the purchase price for the remaining equity interests in Andiamo not then held by Cisco is not determinable at this time, but will be based primarily upon a formula-based valuation of Andiamo to be determined by applying a multiple to the actual, annualized revenue generated from sales by Cisco of products attributable to Andiamo during a three-month period shortly preceding the closing. Under its agreements with Andiamo, Cisco is the exclusive manufacturer and distributor of all Andiamo products. The multiple will be equal to Cisco’s average market capitalization during a specified period divided by Cisco’s annualized revenue for a three-month period prior to closing, subject to adjustment as follows: (i) if the multiple so calculated is less than 10, then the multiple to be used for purposes of determining the transaction price shall be the midpoint between 10 and the multiple so calculated; (ii) if the multiple so calculated is greater than 15, then the multiple to be used for purposes of determining the transaction price shall be the midpoint between 15 and the multiple so calculated. There is no minimum purchase price, and the maximum purchase price is limited to approximately $2.5 billion in shares of Cisco common stock valued at the time of closing. As discussed in Note 2 to the Consolidated Financial Statements, the adoption of FIN 46 will require the Company to account for Andiamo as if Cisco had consolidated Andiamo from the date of its initial investment.
The acquisition has received the required approvals from both companies and is subject to various closing conditions and approvals, including stockholder approval by Andiamo.
As of April 26, 2003, Cisco has made an $84 million investment in Andiamo in the form of convertible debt, which will be convertible into approximately 44% of the equity in Andiamo, subject to certain terms and conditions. Furthermore, Cisco is also committed to provide additional funding to Andiamo in the form of non-convertible debt through the closing of the acquisition of approximately $100 million, subject to periodic funding. As of April 26, 2003, the Company has funded $55 million of this additional non-convertible debt. Substantially all of Cisco’s investment in Andiamo has been expensed as research and development costs, as if such expenses constituted the development costs of the Company.
John |
