Cisco 2012 Annual Report Download - page 54

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The provision for product warranties issued during fiscal 2012, 2011, and 2010 was $661 million, $456 million,
and $469 million, respectively. The increase in the provision in fiscal 2012, as compared with fiscal 2011, was
primarily due to increased shipment volume of products with higher warranty costs and longer warranty lives,
and also due to increased warranty charges related to specific products. If we experience an increase in warranty
claims compared with our historical experience, or if the cost of servicing warranty claims is greater than
expected, our profitability could be adversely affected.
Share-Based Compensation Expense
Share-based compensation expense is presented as follows (in millions):
Years Ended July 28, 2012 July 30, 2011 July 31, 2010
Share-based compensation expense ........... $1,401 $1,620 $1,517
Prior to the initial declaration of a quarterly cash dividend on March 17, 2011, the fair value of restricted stock
and restricted stock units was measured based on an expected dividend yield of 0% as we did not historically pay
cash dividends on our common stock. For awards granted on or subsequent to March 17, 2011, we used an
annualized dividend yield based on the per share dividends declared by our Board of Directors as of the grant
date. See Note 14 to the Consolidated Financial Statements.
The determination of the fair value of employee stock options and employee stock purchase rights on the date of
grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of
highly complex and subjective variables. For employee stock options and employee stock purchase rights, these
variables include, but are not limited to, the expected stock price volatility over the term of the awards, the risk-
free interest rate, and expected dividends as of the grant date. For employee stock options, we have historically
used the implied volatility for two-year traded options on our stock as the expected volatility assumption required
in the lattice-binomial model. For employee stock purchase rights, we used the implied volatility for traded
options (with lives corresponding to the expected life of the employee stock purchase rights) on our stock. The
selection of the implied volatility approach was based upon the availability of actively traded options on our
stock and our assessment that implied volatility is more representative of future stock price trends than historical
volatility. The valuation of employee stock options is also impacted by kurtosis and skewness, which are
technical measures of the distribution of stock price returns and the actual and projected employee stock option
exercise behaviors.
Because share-based compensation expense is based on awards ultimately expected to vest, it has been reduced
for forfeitures. If factors change and we employ different assumptions in the application of our option-pricing
model in future periods or if we experience different forfeiture rates, the compensation expense that is derived
may differ significantly from what we have recorded in the current year.
Fair Value Measurements
Our fixed income and publicly traded equity securities, collectively, are reflected in the Consolidated Balance
Sheets at a fair value of $38.9 billion as of July 28, 2012, compared with $36.9 billion as of July 30, 2011. Our
fixed income investment portfolio, as of July 28, 2012, consisted primarily of high quality investment-grade
securities. See Note 8 to the Consolidated Financial Statements.
As described more fully in Note 9 to the Consolidated Financial Statements, a valuation hierarchy is based on the
level of independent, objective evidence available regarding the value of the investments. It encompasses three
classes of investments: Level 1 consists of securities for which there are quoted prices in active markets for
identical securities; Level 2 consists of securities for which observable inputs other than Level 1 inputs are used,
such as quoted prices for similar securities in active markets or quoted prices for identical securities in less active
markets and model-derived valuations for which the variables are derived from, or corroborated by, observable
market data; and Level 3 consists of securities for which there are unobservable inputs to the valuation
methodology that are significant to the measurement of the fair value.
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