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FEATURE

CEO John Chambers and CFO Dennis Powell Discuss Cisco's Q2 Fiscal Year 2007 Performance

February 6, 2007

Cisco announced second quarter fiscal year 2007 financial results. John Chambers, chairman and CEO, and Dennis Powell, CFO, had the following to say regarding the company's results and business outlook.

How would you characterize this quarter?

John Chambers: This quarter was once again another very strong and record quarter from a revenue, GAAP and non-GAAP net income and earnings per share perspective.

We achieved record revenue of approximately $8.4B, a 27% year-over-year increase and a Cisco standalone increase of approximately 18%, which was above our standalone guidance of 14-15%. Once again, this is the fastest standalone year-over-year revenue growth rate we have seen in several years. We are obviously pleased with both the growth on the top and bottom lines, as well as the market share gains.

Order growth continued to be very solid with product book to bill of greater than 1. Product bookings growth, not including Scientific Atlanta, grew in the mid teens.

Non-GAAP net income was $2.1B, an increase year-over-year of approximately 28%, and GAAP net income was $1.9B, an increase year-over-year of approximately 40%. Non-GAAP earnings per share were a record $.33 and GAAP EPS were a record $.31 which were increases of 27% and 41% respectively year-over-year. Cash generated from operations was $2.7B. We repurchased $3.3B of common stock. And we exited the quarter with $20.7B in cash, cash equivalents, and investments.

What were some of the highlights from the quarter?

John Chambers: The key takeaway on Q2 is that the momentum remained strong. The product balance was very strong across all areas, and our customer segments were solid with commercial leading the way.

Routing revenue grew year-over-year by 18%, switching revenue grew year-over-year by 13%, and advanced technologies' revenue grew year-over-year by approximately 23%, not including Scientific Atlanta. Scientific Atlanta's revenue grew approximately 21% year-over-year for the comparable period, aligned to conform to Cisco's fiscal quarters. The advanced technology revenues are now becoming larger in terms of their total contribution to our top line than routing. This speaks to Cisco's constant evolution moving into new markets and product adjacencies. Substantially all the advanced technologies grew year-over-year in double digits, led by storage, unified communications, wireless, and security.

From a Cisco standalone customer segment perspective we saw continued strength in the commercial market, with product order growth continuing of approximately 20% year-over-year. The commercial customer segment also achieved the best balance across all five of our theaters with order growth in each theater being in double digits.

From a U.S. perspective, the service provider market segment continued to lead the way with order growth in the low 20s. Scientific Atlanta was above the high end of our expectations with year-over-year order growth comfortably above 20%. Video continues to drive network demand and is potentially "the killer application."

The global enterprise business, which includes the public sector, was solid with order growth of approximately 12%.

From a geographic perspective, momentum was strong from an orders perspective and balance was good across our large theaters.

As anticipated we saw very strong order growth from the Emerging Markets theater approaching 40% year-over-year, with the Middle East and Africa leading the way with year-over-year order growth approaching 80%.

The improvement we saw in Q4 and in Q1 in our European operations continued in Q2 with very solid year-over-year order growth in the low teens. Balance across the Canadian operations was very good with order growth of approximately 30% year-over-year.

The Asia Pacific theater continued its solid momentum with growth in the low teens from an order perspective. After several good quarters in a row China grew orders only in low single digits. And Japan continued to show slight year-over-year improvements with order growth in the low single digits.

You recently relocated senior executives to India. How does this relate to the growth in the services arena, and what does Cisco hope to achieve?

John Chambers: In December of 2006, Wim Elfrink, our Chief Globalization Officer moved to Bangalore and took approximately 10 executives with him to develop our new service and support model. We believe this should have a very positive benefit throughout the region.

Our Customer Advocacy services revenue now represents approximately 15% of our total revenue. In Q2 our Cisco stand-alone revenues for services grew year-over-year approximately 20%. Our customer satisfaction numbers remained very high in Q2. To the best of our knowledge, no other large high tech company is achieving these types of both balance and growth results from such a broad product portfolio as well as a strong services portfolio.

With the expanding services model, we fully intend to dramatically differentiate Cisco both in customer satisfaction, as well as services revenue and profit growth.

Cisco has just ended another strong, record quarter. To what do you attribute the strong results?

John Chambers: These record results for Q2 continue to be due to the momentum being created by the successful implementation of our strategy. We laid the cornerstones of this strategy three, five, and seven years ago.

Many of the market transitions we anticipated are converging today, as more and more communications and IT capabilities are moving into the network. Our architectural approach based on intelligence in the network and tightly coupled products is increasing the total available market to Cisco and is gaining share of total customer spend.

We believe that the network is becoming the platform for all forms of communications and IT. The expanding role of the network builds on the end-to-end and architecture-based differentiation that we have been investing in for many years.

More Information
Q&A: Dennis Powell on Cisco's Q2 Fiscal Year 2007 Financial Position

How would you characterize the financial position of Q2 fiscal year 2007?

Dennis Powell: We are very pleased with the financial results for both Cisco stand-alone and Scientific Atlanta, which exceeded our expectations this quarter for combined revenue, operating income and earnings per share.

Total revenue for the second quarter was $8.4B, an increase of 27% year-over-year. Cisco Q2 stand-alone revenue was $7.8B, or 18% growth year-over-year. Scientific Atlanta Q2 revenue was $639M, or 21% growth year-over-year for the comparable period, aligned to conform to Cisco's fiscal quarters.

EPS increased 27% from Q2 last year on a non-GAAP basis and 41% on a GAAP basis.

Cisco is now benefiting from the R&D tax credit, both in current quarter earnings and in the company's long term tax rate. What should investors know about the company's tax strategy?

Dennis Powell: Due to the legislative re-instatement of the U.S. Federal Research Tax Credit this quarter, GAAP net income for the second quarter and the first six months of fiscal 2007 included a $120 million tax benefit relating to the reinstatement of the U.S. federal R&D tax credit, including $60 million related to fiscal 2006 R&D expenses and $30 million related to the first quarter of fiscal 2007 R&D expenses. Non-GAAP net income for the second quarter and the first six months of fiscal 2007 excluded the $60 million tax benefit related to fiscal 2006 R&D expenses.


Q2 FY 2007 GAAP Reconciliation

RECONCILIATION OF GAAP TO NON-GAAP NET INCOME
(In millions, except per-share amounts)
Three Months Ended Six Months Ended
January 27, 2007 January 28, 2006 January 27, 2007 January 28, 2006
GAAP net income$ 1,921 $ 1,375 $ 3,529 $ 2,636
Employee share-based compensation expense
247 261 472 578
Payroll tax on stock option exercises
11 3 17 5
Compensation expense related to acquisitions and investments
27 30 48 70
In-process research and development
2 - 6 2
Amortization of purchased intangible assets
132 56 273 115
Total adjustments to GAAP income before provision for income taxes419 350 816 770
Income tax effect (1)
(189) (93) (290) (205)
Effect of retroactive tax legislation (2)
(60) - (60) -
Total adjustments to GAAP provision for income taxes (3)
(249) (93) (350) (205)
Non-GAAP net income$ 2,091 $ 1,632 $ 3,995 $ 3,201
Diluted net income per share:
GAAP$ 0.31 $ 0.22 $ 0.56 $ 0.42
Non-GAAP$ 0.33 $ 0.26 $ 0.64 $ 0.51
Shares used in diluted net income per share calculation:
GAAP6,291 6,248 6,255 6,301
Non-GAAP6,281 6,233 6,243 6,286

(1) The income tax effect for the adjustments relating to GAAP income before provision for income taxes was 35.5% for the first six months of fiscal 2007. The income tax effect has been determined using the applicable tax rates in jurisdictions to which these adjustments relate and includes share-based compensation tax benefits resulting from the reinstatement of the U.S. federal R&D tax credit in the second quarter of fiscal 2007 (see note 2 below).

(2) In the second quarter of fiscal 2007, the Tax Relief and Health Care Act of 2006 reinstated the U.S. federal R&D tax credit, retroactive to January 1, 2006. GAAP net income for the second quarter and the first six months of fiscal 2007 included a $120 million tax benefit relating to the reinstatement of the U.S. federal R&D tax credit, including $60 million related to fiscal 2006 R&D expenses and $30 million related to the first quarter of fiscal 2007 R&D expenses. Non-GAAP net income for the second quarter and the first six months of fiscal 2007 excluded the $60 million tax benefit related to fiscal 2006 R&D expenses.

(3) The effective tax rate used in GAAP net income was 21.8% for the first six months of fiscal 2007, which includes a $60 million or 1.3% tax benefit from the reinstatement of the U.S. federal R&D credit related to fiscal 2006 R&D expenses. The effective tax rate used in non-GAAP net income was 25.0% for the first six months of fiscal 2007, which excludes the $60 million tax benefit from the reinstatement of the U.S. federal R&D credit related to fiscal 2006 R&D expenses.

Additional reconciliations between GAAP and non-GAAP financial measures are provided in the tables that follow on page 10.

RECONCILIATION OF SHARES USED IN THE GAAP AND NON-GAAP DILUTED NET INCOME PER SHARE CALCULATION
(In millions)
Three Months Ended Six Months Ended
January 27, 2007 January 28, 2006 January 27, 2007 January 28, 2006
Shares used in diluted net income per share calculation - GAAP6,291 6,248 6,255 6,301
Effect of SFAS 123(R) (10) (15) (12) (15)
Shares used in diluted net income per share calculation - Non-GAAP 6,281 6,233 6,243 6,286


# # #

This executive question and answer may be deemed to contain forward-looking statements, which are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among other things, statements regarding future events (including the development of our markets, the future of networking, our service and support model, our tax strategy and our positioning) 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 and customer 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 including the businesses and technologies of Scientific-Atlanta, Inc.; 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, including risks relating to our transition to a new manufacturing model; product defects and returns; litigation involving patents, intellectual property, antitrust, shareholder and other matters; natural catastrophic events; a pandemic or epidemic; achievement of the benefits anticipated from our investments in sales and engineering activities; 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 and Form 10-Q. The financial information contained in this executive question and answer 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 27, 2007 are not necessarily indicative of Cisco's operating results for any future periods. Any projections in this executive question and answer 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 executive question and answer.

This executive question and answer includes non-GAAP net income, non-GAAP net income per share data, shares used in non-GAAP net income per share calculation and effective tax rate used in arriving at non-GAAP net income.

These non-GAAP measures are not in accordance with, or an alternative for measures prepared in accordance with, generally accepted accounting principles and may be different from non-GAAP measures used by other companies. In addition, these non-GAAP measures are not based on any comprehensive set of accounting rules or principles. Cisco believes that non-GAAP measures have limitations in that they do not reflect all of the amounts associated with Cisco's results of operations as determined in accordance with GAAP and that these measures should only be used to evaluate Cisco's results of operations in conjunction with the corresponding GAAP measures.

Cisco believes that the presentation of non-GAAP net income, non-GAAP net income per share data, shares used in non-GAAP net income per share calculation and effective tax rate used in arriving at non-GAAP net income, when shown in conjunction with the corresponding GAAP measures, provides useful information to investors and management regarding financial and business trends relating to its financial condition and results of operations.

For its internal budgeting process, Cisco's management uses financial statements that do not include employee share-based compensation expense, impact to cost of sales from purchase accounting adjustments to inventory, payroll tax on stock option exercises, compensation expense related to acquisitions and investments, in-process research and development, amortization of purchased intangible assets, significant gains and losses on publicly traded equity securities, the income tax effects of the foregoing, and significant effects of retroactive tax legislation, such as Cisco's U.S. federal R&D tax credit relating to fiscal year 2006 R&D expenses. Cisco's management also uses the foregoing non-GAAP measures, in addition to the corresponding GAAP measures, in reviewing the financial results of Cisco.

For additional information on the items excluded by Cisco from one or more of its non-GAAP financial measures we refer you to the Form 8-K regarding Cisco's press release regarding its second quarter and first six months of fiscal 2007 earnings furnished today with the Securities and Exchange Commission.

© 2007 Cisco Systems, Inc. All rights reserved. Cisco, the Cisco logo, and Cisco Systems are registered trademarks or trademarks of Cisco Systems, Inc. and/or its affiliates in the United States 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. This document is Cisco Public Information.

 
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