February 3, 2004

Cisco has announced its Q2, Fiscal Year 2004 financial results. John Chambers, president and CEO, and Dennis Powell, CFO and senior vice president, had this to say regarding the company's results and business outlook.

Were you pleased with the company's performance?

More Information Release: Cisco Systems Reports Second Quarter Fiscal Year 2004 Earnings Fact Sheet: Customer Highlights and Technology Innovations: Second Quarter, FY 2004 Q&A: Dennis Powell On Cisco's Q2 Financial Position Can you give us an update on your three long-term financial priorities? Dennis Powell: I was pleased with our focus and execution on our three long-term key financial priorities. First, we continued to generate profitable growth, as evidenced by our increase in revenue and our profit after tax margin of 24.4 percent on a pro forma basis. Second, in Q2 we improved Cisco's productivity, as measured in terms of pro forma operating expense as a percentage of revenue, from 39.2 percent in the prior quarter to 37.9 percent in Q2. Our long term objective is to achieve 35 percent of operating expense as a percentage of revenue. Finally, we maintained our healthy and conservative balance sheet, including strong liquidity, and inventory turns in line with our goals. Days sales outstanding (DSOs) were higher than we would have liked at 34 days; however, this was not surprising given the non linear shipments in the quarter. I continue to be pleased with the high quality of accounts receivables. Cisco experienced some manufacturing issues that impacted shipping in the quarter. How did this influence the quarter? Dennis Powell: Early in Q2, we experienced a few technical manufacturing process issues that created a delay in our suppliers' ability to provide specific components-resulting in delayed shipments. We also experienced memory supply issues related to a die transition. Manufacturing, by its nature, involves uncertainties and, like all manufacturers, we will try to plan ahead to manage these types of issues. Fortunately, these issues occurred early in Q2, so we had time to take corrective action and recover by the end of the quarter. However, these issues did cause shipments to be more "back-end loaded" than normal, thus primarily attributing to an increase in both days sales outstanding (DSOs) and accounts receivables. While these manufacturing issues have largely been resolved, we continue to work proactively with our supply chain to address any items that remain or which may come up going forward. Why did you report two GAAP earnings per share numbers? Dennis Powell: We are reporting the two GAAP earnings per share numbers as they appear on the financial statements. As anticipated in our Q1 conference call, we recorded a one-time, non-cash charge of $567 million for the cumulative effect of an accounting change related to the adoption FIN 46, which addresses the "Consolidation of Variable Interest Entities." Our GAAP earnings per share on a fully diluted basis before the cumulative effect of the accounting change were $0.18, up from the prior quarter of $0.15, and up from $0.14 per share for the same quarter in fiscal year 2003. Our GAAP net income after the cumulative effect of the accounting change was $724 million, or $0.10 earnings per share.

John Chambers: In terms of issues we could control or influence, with the exception of some manufacturing challenges which we addressed this quarter, we were pleased with our results in what was a very solid quarter. In what has been a challenging environment for a number of companies over the last three years, we reported our seventh consecutive quarter of having pro forma net income exceed $1 billion and our profits exceed 20 percent of revenue. I was also pleased to see quarter-over-quarter revenue growth of 6 percent and year-over-year growth of 15 percent. I think the major takeaway from our Q2 results is very similar to what we said about Q1 - it is nice to see the second sequential revenue growth quarter for the first time in a very long time.

Additionally, we saw strong profitability, enjoyed a solid balance sheet with approximately $19.8 billion in cash, cash equivalents and total investments, continued to invest in advanced technologies, had strong operating performance and saw good geographic balance. By leveraging our business process changes and using networked IT as the enabler of our business strategies our productivity increased to $632,000 per employee - a 6 percent sequential increase and an 18 percent year-over-year increase. While there is always room for improvement, I feel we continue to position the company for the economic upturn.

Cisco is starting to see top-line growth, but is it sustainable?

John Chambers: We are more optimistic going into Q3 than we were going into the previous quarter about factors we can control or influence. However, in terms of seasonality, Q3 tends to be a very challenging quarter. That said, we remain focused on three broad potential growth opportunities - first, our core technologies, routing and switching; second, service providers; and third, Advanced Technologies.

Our balanced approach to these opportunities seems to be working well. Advanced Technologies showed across-the-board improvements and market share gains. In Q2, the six technologies, which include storage, security, home networking, optical, wireless and IP telephony grew to become 15 percent of our total revenue and 18 percent of our product revenue in Q2.

In high-end routing, both bookings and sequential revenue on the Cisco 12000 Series increased in the low double digits and the Cisco 10000 router continues to build momentum with additional wireless and wireline service provider wins in Q2. Bookings on the Cisco 10000 increased almost 100 percent sequentially.

What were some of the highlights in your Advance Technology markets this quarter?

John Chambers: Our advanced technologies showed across-the-board improvements and market share gains this quarter. After a slow start, our storage networking business picked up dramatically. In Q2, we achieved sequential revenue increase of over 120 percent and our customer base increased sequentially by approximately 80 percent in number of total customers. In security, revenues were up sequentially in the high single digits. This market has now become our first of the advanced technologies to achieve approximately the $1 billion yearly run rate goal. In home networking, Linksys' U.S. retail share grew 10 percent and revenues increased 39 percent sequentially. Wireless saw revenue growth in the upper single digits and a year-over-year increase of approximately 50 percent, optical revenue was up 10 percent sequentially and, finally while enterprise IP telephony market sequential revenues were down 10 percent, orders were up over 20 percent.

You just returned from the World Economic Forum (WEF). Based on your interactions with the global leaders at the summit and your customers, do you feel the global economy is rebounding?

John Chambers: Today's economy in the opinion of most of our customers has moved from a "show me economy" to more of a "how strong and how long will it last economy." From a customer CEO perspective, opinions continue to show increasing optimism toward the economy, but still a little, perhaps surprising caution toward capital spending and hiring. To put this in perspective, last quarter we said about half of the CEOs that I talked with in the U.S. would be described as having some "wind at their backs" for the first time in a long time, and the other half still had a "show-me, wait and see" attitude. Now most of the CEOs both in the U.S. and around the world are slowly increasing their optimism on the global economic recovery.

Expectations were high for Cisco coming into this quarter in the service provider space. How would you characterize the company's results in this sector?

John Chambers: Following a very solid Q1, our service provider business maintained momentum with a Q2 year-over-year increase in the high teens. However, the geographic balance was not as good as Q1 when all five theaters did seasonally well. In Q2, EMEA, Americas International and Asia Pacific showed good sequential order growth. Both the US and Japan were down sequentially.

During this quarter, where did Cisco see geographic strengths?

John Chambers: In the U.S., the trends were very similar to last year's Q2. As we said in the last conference call, we saw the normal seasonal slowdown in Federal Government Q2 orders and, as we noted in last quarter's call, this decrease was balanced by the normal seasonal increase in European Q2 orders. However, the U.S. enterprise segment, not including the Federal business, showed sequential product order growth in the mid-single digits and year-over-year order product growth in the high single digits.

Asia Pacific increased to 12 percent of our total bookings and we saw a solid balance across all of our Asia Pacific operations. In Europe, Middle East and Africa, Q2 from a seasonality point of view, is a good quarter for Cisco, and orders from Europe were a little better than we expected. We experienced solid growth across most of the major European geographies with solid double digit sequential order growth in the UK, France, Italy, Netherlands, Russia, Spain, and Switzerland. Germany saw slight sequential order growth.

In Americas International, we saw solid order growth for the second quarter in a row across the major geographies. Finally, in Japan we saw normal seasonality trends, this quarter after a strong Q1 which included large orders in the service provider segment. Japan represents 7 percent of our total business, as it did in Q2 of last year.

Where are you in achieving your productivity goal of $700,000 per employee? If you meet this goal, will you look at resuming hiring?

John Chambers: In Q2, employee productivity this quarter again increased, with a 6 percent sequential quarterly increase to $632,000 revenue per employee. As we have stated, we clearly understand that future earnings growth will likely be driven primarily by top-line revenue growth and associated productivity increases. As such, we continue to hold headcount relatively flat until we hit our $700,000 per employee productivity goal. Once we reach this goal, we will revisit the issue of hiring. However, consistent with our stretch goal mentality, and I have also communicated a productivity stretch goal of $1 million per employee. In short, as business opportunities grow, the company will grow to meet market needs.

For the three month period ended October 25, 2003, pro forma net income and pro forma net income per share excluded the following items: payroll tax on stock option exercises of $2 million, amortization of deferred stock-based compensation of $51 million, amortization of purchased intangible assets of $62 million and income tax effect of ($18) million.

Certain reclassifications have been made to prior year balances in order to conform to the current period's presentation.

This Q&A may be deemed to contain forward-looking statements, which are subject to the safe harbor provisions of the Private Litigation Reform Act of 1995. These forward-looking statements include, among other things, statements regarding future events and the future financial performance of Cisco that involve risks and uncertainties. Readers are cautioned that these forward-looking statements are only predictions and may differ materially from actual future events or results. Readers are urged to read the documents filed by Cisco with the SEC, specifically the most recent reports on Form 10-K, 10-Q and 8-K, each as it may be amended from time to time, which identify risk factors that could cause actual results to differ materially from the forward-looking statements. Among the important factors or risks that could cause actual results or events to differ materially from those in the forward-looking statements in this release are: business and economic conditions and growth trends in the networking industry and in various geographic regions; global economic conditions and uncertainties in the geopolitical environment; overall information technology spending; the growth of the Internet and levels of capital spending on Internet-based systems; variations in customer demand for products and services, including sales to the service provider market; the timing of orders and manufacturing lead times; changes in customer order patterns or customer mix; insufficient, excess or obsolete inventory; variability of component costs; increased price competition; variations in sales channels, product costs or mix of products sold; the ability to successfully acquire businesses and technologies and to successfully integrate and operate these acquired businesses and technologies; increased competition in the networking industry; dependence on the introduction and market acceptance of new product offerings and standards; rapid technological and market change; manufacturing and sourcing risks; product defects and returns; litigation involving patents, intellectual property, antitrust, stockholder and other matters; the ability to recruit and retain key personnel; financial risk management; currency fluctuations and other international factors; and potential volatility in operating results. The financial information contained in this release should be read in conjunction with the consolidated financial statements and notes thereto included in Cisco's most recent reports on Form 10-K and Form 10-Q, each as it may be amended from time to time. Cisco's results of operations for the three and six months ended January 24, 2004 are not necessarily indicative of Cisco's operating results for any future periods. Any projections in this release are based on limited information currently available to Cisco, which is subject to change. Although any such projections and the factors influencing them will likely change, Cisco will not necessarily update the information, since Cisco will only provide guidance at certain points during the year. Such information speaks only as of the date of this Q&A.

Cisco provides pro forma net income and pro forma net income per share data as additional information for its operating results. These measures are not in accordance with, or an alternative for, generally accepted accounting principles and may be different from pro forma measures used by other companies. Cisco believes that this presentation of pro forma net income and pro forma net income per share provides useful information to management and investors regarding certain additional financial and business trends relating to its financial condition and results of operations. In addition, Cisco's management uses these measures for reviewing the financial results of Cisco and for budget planning purposes.

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