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Cisco CEO John Chambers and CFO Dennis Powell Discuss Q3 Fiscal Year 2005 Results

May 10, 2005

Cisco has announced its Q3 Fiscal Year 2005 financial results. John Chambers, president and CEO, and Dennis Powell, CFO and senior vice president, had the following to say regarding the company's results and business outlook.

Were you pleased with the company's performance?

John Chambers: I was pleased with our very solid results in what is typically a seasonally challenging quarter. I am very comfortable with our $6.2 billion in revenue-an approximate 2 percent sequential quarter-over-quarter and 10 percent year-over-year increase-and even more pleased with our order growth in Q3.

I believe that this quarter's results demonstrate that we have the right strategy in place to deliver profitable growth. As we said at our Analyst meeting in December, we believe that the markets in which we participate, according to the view of a number of industry resources, will support growth over the coming years in the 10 to 15 percent annual growth range. Cisco is clearly delivering on its long-term financial priorities with revenue up 13 percent and pro forma operating profit up 18 percent year-to-date.

Why do you believe that you have been able to sustain positive momentum over the last two years in ways that many of your industry peers and competitors have not?

John Chambers: I believe that we have been able to sustain this momentum due to what I believe is one of Cisco's greatest strengths-our balance across all major geographies, four major market segments, and our very broad range of what are rapidly becoming very tightly integrated core and advanced technology products.

Let me give you some balance across the last eight quarters to put this quarter in proper perspective. Over the last eight quarters, each of our geographic regions has led in terms of sequential order growth at least one quarter and no region has been the leader for more than two quarters which is obviously, very good balance even adjusted for economic challenges that affected some theaters. From a product perspective, over the last eight quarters advanced technologies have been the number one sequential growth leader four times, switching has led twice, and routing three times, including one tie. This spread was relatively smooth over the eight quarters in terms of leaders. From a market segment perspective, service provider has been growth leader in four of those quarters, commercial has led three times, and enterprises twice-again with one tie. All data comparisons are in product bookings and sequential quarter product booking growth.

In my opinion our tightly integrated strategy, from both a technology and business architecture perspective, enabled by the Intelligent Information Network allows us to come together with this unique balance.

Are you seeing momentum in your advanced technology markets?

John Chambers: We continue to be very comfortable with our strategy in the advanced technology markets both as individual segments and, over time, as tightly coupled architectural alignment with each of our advanced technologies, as well as our core routing and switching.

Our enterprise IP Telephony continued on a very strong pace with year-over-year order growth above 35 percent. This quarter the IPT group blew past the $1B annualized run rate to become the second $1B advanced technology for Cisco.

Storage Area Networking saw an approximate year-over-year order growth rate exceeding 70 percent. Our top two peers in this marketplace had year over year growth rates that were relatively flat or even down slightly in the most recently reported quarter.

The Networked Home achieved year-over-year order growth in the high twenties. There are many competitors in this market, but two of our primary competitors in this area had year-over-year revenue growth in the low 20s. Wireless, in terms of orders, grew the high teens year-over-year. This would compare to the growth of approximately 10 percent year-over-year that our largest US wireless peer achieved in their most recent quarter. After several large wins, our Optical business orders grew year-over-year in the high 20s. This would compare to our largest primarily focused optical player who achieved year over year growth of over 30 percent.

Finally, we continue to gain both architectural and mindshare advantage in our security strategy and products. We have never had as much activity and interest as we do at this point in time. Recently we announced a number of new security products in February and additional products just last week following quarter end and are in a normal product transition time period. We saw order growth in security up in the low teens year-over-year. Our peers in this industry varied from negative year-over-year revenue growth to the high 20s in their most recently reported quarter.

Cisco's service provider market segment orders grew sequentially over 20 percent this quarter and year-over-year over 25 percent. What has boosted this segment this quarter? Is this sustainable?

John Chambers: Our customers are experiencing how the network can provide tremendous value to their businesses. Our strategy uniquely differentiates Cisco from the rest of the industry by providing an integrated technology and business architecture perspective. We are seeing the majority of our leading edge customers strongly encourage an integrated approach. We are seeing service providers, realize the true power of IP networking in delivering comprehensive products and services to their end users, with Cisco as a key business partner every step of the way.

To put the Q3 momentum in the service provider segment in perspective, we saw very solid sequential and year-over-year growth in the service provider segment in four of our five theaters during Q3. The U.S. led the way with growth sequentially above 20 percent and year-over-year above 40 percent. It was the first quarter in 15 quarters for the US service provider segment of our business to be above $500 million in orders.

One of Cisco's greatest strengths is our balance across all major geographies, four major market segments including service provider, and our very broad range of what are rapidly becoming very tightly integrated core and advanced technology products.

MORE INFORMATION

News Release
Cisco Systems Reports Third Quarter Fiscal Year 2005 Earnings

Webcast
Q3 FY05 Financial Results

Related Link
Customer Highlights and Technology Innovations Fact Sheet:
Third Quarter, FY 2005

Q&A: Dennis Powell on Cisco's Q2 Fiscal Year 2006 Performance
Can you give us an update on the results of your long-term financial priorities?

Dennis Powell: I am pleased with our focus and execution on our three key long-term financial priorities. As we continue to focus on profitable growth, we have been able to achieve a 10 percent increase in revenue year-over year, and the twelfth consecutive quarter of Cisco's pro forma net income exceeding $1 billion and our pro forma profits exceeding 20 percent of revenue. On a fiscal year-to-date basis, while our revenue increased 13 percent, our pro forma operating profit increased 18 percent, reflecting our continued focus on productivity. Finally, I am pleased that our Return on Invested Capital remains above 50 percent. We will continue to make strategic investments in certain customer segments, technologies, and theaters, while maintaining a healthy and conservative balance sheet.

When will Cisco begin expensing stock options and how will your report the expense?

Dennis Powell: Cisco will implement this change beginning in the first quarter of our fiscal year 2006. We will continue to present our results in both GAAP and Pro Forma, however the effect will only be included in the GAAP presentation.

What do you expect the amount of the stock option expense to be going forward?

Dennis Powell: While the impact on a go-forward basis is affected by a number of complex variables including our stock price, and making predictions of future values is difficult, we expect the impact on a go-forward basis to be somewhat less than the current value in our 10Q and 10K filings. We will provide more detail on the estimated expense in our upcoming Q4 FY05 conference call.

Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
April 30, 2005
May 1, 2004
April 30, 2005
May 1, 2004
NET SALES:
Product $ 5,189 $ 4,730 $ 15,328 $ 13,543
Service 998 890 2,892 2,576
Total net sales 6,187 5,620 18,220 16,119
COST OF SALES:
Product 1,697 1,452 5,012 4,193
Service 355 301 1,005 855
Total cost of sales 2,052 1,753 6,017 5,048
GROSS MARGIN 4,135 3,867 12,203 11,071
OPERATING EXPENSES:
Research and development 790 801 2,362 2,295
Sales and marketing 1,180 1,131 3,414 3,295
General and administrative 237 215 684 605
Payroll tax on stock option exercises 3 3 7 12
Stock-based compensation related to acquisitions and investments 47 101 126 188
Amortization of purchased intangible assets 54 60 171 182
In-process research and development 6 2 20 3
Total operating expenses 2,317 2,313 6,784 6,580
OPERATING INCOME 1,818 1,554 5,419 4,491
Interest Income 142 127 399 388
Other income, net 8 40 65 177
Interest and other income, net 150 167 464 565
INCOME BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 1,968 1,721 5,883 5,056
Provision for income taxes 563 510 1,682 1,468
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 1,405 1,211 4,201 3,588
Cumulative effect of accounting change, net of tax - - - (567)
NET INCOME $ 1,405 $ 1,211 $ 4,201 $ 3,021
Income per share before cumulative effect of accounting change:
Basic $ 0.22 $ 0.18 $ 0.64 $ 0.52
Diluted $ 0.21 $ 0.17 $ 0.63 $ 0.51
Net income per share:
Basic $ 0.22 $ 0.18 $ 0.64 $ 0.44
Diluted $ 0.21 $ 0.17 $ 0.63 $ 0.43
Shares used in per-share calculation:
Basic 6,435 6,816 6,529 6,872
Diluted 6,541 7,074 6,656 7,095


Cisco Systems, Inc.
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
April 30, 2005 May 1, 2004 April 30, 2005 May 1, 2004
NET SALES:
Product $ 5,189 $ 4,730 $ 15,328 $ 13,543
Service 998 890 2,892 2,576
Total net sales 6,187 5,620 18,220 16,119
COST OF SALES:
Product 1,697 1,452 5,012 4,193
Service 355 301 1,005 855
Total cost of sales 2,052 1,753 6,017 5,048
GROSS MARGIN 4,135 3,867 12,203 11,071
OPERATING EXPENSES:
Research and development 790 801 2,362 2,295
Sales and marketing 1,180 1,131 3,414 3,295
General and administrative 237 215 684 605
Total operating expenses (a) (b) (c) (d) 2,207 2,147 6,460 6,195
OPERATING INCOME (a) (b) (c) (d) 1,928 1,720 5,743 4,876
Interest income 142 127 399 388
Other income, net (e) 8 40 12 92
Interest and other income, net (e) 150 167 411 480
INCOME BEFORE PROVISION FOR INCOME TAXES (a) (b) (c) (d) (e) 2,078 1,887 6,154 5,356
Provision for income taxes (f) 582 528 1,723 1,499
NET INCOME $ 1,496 $ 1,359 $ 4,431 $ 3,857
Net income per share:
Basic $ 0.23 $ 0.20 $ 0.68 $0.56
Diluted $ 0.23 $ 0.19 $ 0.67 $ 0.54
Shares used in per-share calculation:
Basic 6,435 6,816 6,529 6,872
Diluted 6,541 7,074 6,656 7,095
A reconciliation between net income on a GAAP basis and pro forma net income is as follows:
GAAP net income $ 1,405 $ 1,211 $ 4,201 $ 3,021
(a) In-process research and development 6 2 20 3
(b) Payroll tax on stock option exercises 3 3 7 12
(c) Stock-based compensation related to acquisitions and investments 47 101 126 188
(d) Amortization of purchased intangible assets 54 60 171 182
(e) Gain on publicly traded equity securities - - (53) (85)
(f) Income tax effect (19) (18) (41) (31)
(g) Cumulative effect of accounting change, net of tax - - - 567
Pro forma net income $ 1,496 $ 1,359 $ 4,431 $ 3,857

For the three-month period ended January 29, 2005, pro forma net income and pro forma net income per share excluded the following items: in-process research and development of $2 million; payroll tax on stock option exercises of $3 million; stock-based compensation related to acquisitions and investments of $39 million; amortization of purchased intangible assets of $57 million and income tax effect of ($19) million.

Cisco Systems, Inc.
CONSOLIDATED BALANCE SHEETS
(In millions)
(Unaudited)
$ 35,594
April 30, 2005 July 31, 2004
ASSETS
Current assets:
Cash and cash equivalents $ 2,641 $ 3,722
Short-term investments 2,397 4,947
Accounts receivable, net of allowance for doubtful accounts of $175 at April 30, 2005 and $179 July 31, 2004 2,241 1,825
Inventories 1,280 1,207
Deferred tax assets 1,537 1,827
Prepaid expenses and other current assets 867 815
Total current assets 10,963 14,343
Investments 11,111 10,598
Property and equipment, net 3,298 3,290
Goodwill 5,063 4,198
Purchased intangible assets, net 459 325
Other assets 3,076 2,840
TOTAL ASSETS $ 33,970

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 706 $ 657
Income taxes payable 1,418 963
Accrued compensation 1,258 1,466
Deferred revenue 3,800 3,527
Other accrued liabilities 2,005 2,090
Total current liabilities 9,187 8,703
Deferred revenue 1,016 975
Total liabilities 10,203 9,678
Minority interest 11 90
Shareholders' equity 23,756 25,826
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 33,970 $ 35,594

Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Nine Months Ended
April 30, 2005 May 1, 2004
Cash flows from operating activities:
Net income $ 4,201 $ 3,021
Adjustments to reconcile net income to net cash provided by operating activities:
Cumulative effect of accounting change, net of tax - 567
Depreciation and amortization 751 945
Stock-based compensation related to acquisitions and investments 126 188
Provision for doubtful accounts 3 19
Provision for inventory 161 124
Deferred income taxes 216 305
Tax benefits from employee stock option plans 196 454
In-process research and development 20 3
Net (gains) losses and impairment charges on investments (83) (149)
Change in operating assets and liabilities:
Accounts receivable (407) (203)
Inventories (229) (371)
Prepaid expenses and other current assets 24 (13)
Lease receivables, net (123) (71)
Accounts payable 41 1
Income taxes payable 277 144
Accrued compensation (213) (41)
Deferred revenue 315 543
Other accrued liabilities (144) (498)
Net cash provided by operating activities 5,132 4,968
Cash flows from investing activities:
Purchases of short-term investments (3,775) (10,008)
Proceeds from sales and maturities of short-term investments 7,926 10,911
Purchases of investments (11,313) (16,054)
Proceeds from sales and maturities of investments 9,221 16,820
Acquisition of property and equipment (470) (487)
Acquisition of businesses, net of cash and cash equivalents (611) (104)
Change in investments in privately held companies (160) 20
Purchase of minority interest of Cisco Systems, K.K. (Japan) (9) (71)
Other 92 146
Net cash provided by investing activities 901 1,173
Cash flows from financing activities:
Issuance of common stock 592 930
Repurchase of common stock (7,743) (7,082)
Other 37 35
Net cash used in financing activities (7,114) (6,117)
Net (decrease) increase in cash and cash equivalents (1,081) 24
Cash and cash equivalents, beginning of period 3,722 3,925
Cash and cash equivalents, end of period $ 2,641 $ 3,949

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

Cisco Systems, Inc.
ADDITIONAL FINANCIAL INFORMATION
(In millions)
(Unaudited)
April 30, 2005 July 31, 2004
CASH AND CASH EQUIVALENTS AND TOTAL INVESTMENTS
Cash and cash equivalents $ 2,641 $ 3,722
Fixed income securities 12,591 14,411
Publicly traded equity securities 917 1,134
Total $ 16,149 $ 19,267
INVENTORIES
Raw materials $ 86 $ 58
Work in process 427 416
Finished goods:
Distributor inventory and deferred cost of sales
 371 316
Manufacturing finished goods
 185 206
Total finished goods 556 522
Service-related spares 180 177
Demonstration systems 31 34
Total $ 1,280 $ 1,207
PROPERTY AND EQUIPMENT, NET
Land, buildings, and leasehold improvements $ 3,490 $ 3,429
Computer equipment and related software 1,241 1,120
Production, engineering, and other equipment 2,981 2,643
Operating lease assets 111 94
Furniture and fixtures 354 356
8,177 7,642
Less, accumulated depreciation and amortization (4,879) (4,352)
Total $ 3,298 $ 3,290
LEASE RECEIVABLES, NET (a)
Current $ 244 $ 215
Noncurrent 317 231
Total 561 446
OTHER ASSETS
Deferred tax assets $ 1,139 $ 1,130
Investments in privately held companies 436 354
Income tax receivable 857 690
Lease receivables, net 317 231
Other 327 435
Total $ 3,076 $ 2,840
DEFERRED REVENUE
Service $ 3,322 $ 3,047
Product 1,494 1,455
Total 4,816 4,502
Reported as:
Current $ 3,800 $ 3,527
Noncurrent 1,016 975
Total 4,816 4,502

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

(a) The current portion of lease receivables, net, is recorded in prepaid expenses and other current assets and the noncurrent portion is recorded in other assets in the Consolidated Balance Sheets.

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 due to a variety of factors, including: 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; variations in sales channels, product costs or mix of products sold; our 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, shareholder and other matters; our ability to recruit and retain key personnel; our ability to manage financial risk; currency fluctuations and other international factors; potential volatility in operating results and other factors listed in Cisco's most recent reports on Form 10-K, 10-Q and 8-K. The financial information contained in this Q&A 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 nine months ended April 30, 2005 are not necessarily indicative of Cisco's operating results for any future periods. Any projections in this Q&A are based on limited information currently available to Cisco, which is subject to change. Although 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 to help investors better understand 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. Cisco believes when GAAP net income and GAAP net income per share are viewed in conjunction with pro forma net income and pro forma net income per share, investors are provided with a more meaningful understanding of Cisco's ongoing operating performance. In addition, Cisco's management uses these measures for reviewing the financial results of Cisco.

Copyright © 2005 Cisco Systems, Inc. All rights reserved. Cisco, Cisco Systems, the Cisco Systems logo and Linksys are registered trademarks or trademarks of Cisco Systems, Inc. and/or its affiliates in the U.S. and certain other countries. All other trademarks mentioned in this document are the property of their respective owners. The use of the word partner does not imply a partnership relationship between Cisco and any other company.