View of Cisco’s Practices Disputed

Joseph Menn presented an inaccurate view of Cisco Systems’ vendor financing practices and accounting treatment of those transactions in his recent article, “Putting a Spotlight on Cisco’s Lending” (May 25).

Cisco has always followed conservative accounting policies, and the company stands by its lending and leasing practices. All of the transactions mentioned in the Los Angeles Times article were properly accounted for in a manner disclosed in all relevant financial filings and according to generally accepted accounting principles (GAAP).

In his story, and in an accompanying chart, Mr. Menn focuses on seven companies -- Digital Broadband Communications Inc., American Metrocomm Corp., Vectris Communications Inc., Rhythms Net Connection Inc., ICG Communications Inc., PSInet Inc. and WinStar Communications Inc. -- to whom Cisco provided financing, and he draws a vague correlation between that financing and Cisco’s increasing revenue.

To clarify:

* Digital Broadband, AMC and Vectris received structured loans. This means that Cisco did not book any revenue on these loans unless payments were received.

* Rhythms, ICG and PSInet received sales-type leases, in which revenue was booked up front and appropriate reserves were taken. At the time these companies received the leases, they had hundreds of millions of dollars of cash on their balance sheets and were considered creditworthy by the financial community. As their financial situation began to decline, however, Cisco increased the reserves taken. Cisco also made significant recoveries as part of bankruptcy proceedings.

* WinStar was a sales-type lease that eventually was fully reserved.

Mr. Menn asserted that “[t]he story of Cisco’s aggressive lending highlights the lengths to which one of the darlings of Wall Street would go to keep reporting revenue increases during the height of the tech boom.”

But in fact, Mr. Menn neglected to report that the amount of revenue Cisco recognized as a result of financing these companies was approximately 1% of Cisco’s total revenue. It is certainly true that Cisco extended credit to companies that ultimately experienced financial difficulty. But this was a future neither we nor others -- including vendors, equity holders and debt holders, who invested in the competitive environment created after passage of the Telecommunications Act of 1996 -- could possibly have predicted at the time the credit was extended.

It is also a matter of fact that, having understood there were risks involved with providing financing, Cisco adhered to very conservative accounting policies from the beginning of its lending and leasing activity. In making its financing decisions, Cisco looked at a number of factors pertaining to the customer’s financial situation, including the customer’s creditworthiness, probability of success and capability of repayment. And, importantly, Cisco always followed GAAP in recording any revenue that resulted from this financing.

In the case of structured financing, the company’s policy has always been to never recognize any revenue unless payments were received. With respect to sales-type leases, Cisco booked revenue upfront, including appropriate reserves, according to GAAP, and monitored the customer’s financial situation over time. If the customer’s financial picture began to decline, Cisco took appropriate reserves against the lease, continuing to increase these reserves, if necessary.

At the time this type of financing was most prevalent in the industry, few companies followed such conservative accounting practices as Cisco in their treatment of and accounting for such financing.

All of the underlying transactions cited by Mr. Menn are included in a shareholder lawsuit now before the court. This is an unwarranted suit that we are vigorously contesting, and we expect to prevail. It is unfortunate that Mr. Menn’s arguments so closely reflected those of the plaintiffs and was unable to present a more factual and balanced view of the matter.

Betsy Rafael

Vice President,

Corporate Controller

Cisco Systems

San Jose