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FEATURE

CEO John Chambers and CFO Dennis Powell Discuss Cisco's Q4 and Fiscal Year 2007 Performance

August 7, 2007

Cisco announced fourth quarter and 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 the strongest quarter we have seen from a balanced product, geographic and customer segment perspective in many years. And it was another record quarter from revenue, GAAP and non-GAAP net income and earnings per share perspective.

We achieved total record revenue of approximately $9.4B, an 18% year-over-year increase. If you took Cisco on a standalone basis, this was once again one of the fastest year-over-year revenue growth rates 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 was even stronger than revenue growth with product book to bill comfortably above 1. Product orders grew in the 19-20% range.

GAAP Net Income was $1.9B representing a 25% increase year-over-year. Non-GAAP net income was a record $2.3B, an increase year-over-year of approximately 21%. GAAP earnings per share (E.P.S.) were $0.31 and non-GAAP E.P.S. were a record $0.36 which were increases of 24% and 20% respectively year-over-year.

Cash generated from operations was $2.7B. We repurchased $1.5B of common stock. And we exited the quarter with $22.3B in cash, cash equivalents, and investments.

Why is Cisco experiencing such strong growth while many of your peers have been experiencing more challenges in the market place?

John Chambers: We believe that there are a number of factors that are unique to Cisco's ability to grow. First, is our unique balance across over two dozen product areas, four customer segments and across major developed and emerging countries. Second, is our vision that the network is becoming the platform for all forms of communications and IT. Third, is the convergence of all data, voice, video and mobility into IP networks which is clearly our core competency and we have industry leading IP expertise in all functions of Cisco.

Additionally, and different than almost all our counterparts, we approach this from both a business architecture and technology architecture perspective, across what we define as a combination of network-of-networks in each of our four customer segments. From a product perspective, we approach the market with an end-to-end architecture where the products are first loosely then tightly integrated together, rather than focusing on individual routers, switches, security, wireless, storage, Unified Communications or other stand-alone products. We also continue to be reasonably good at internal innovation, acquisitions and partnerships.

In addition, it is our view that to be effective on the above market transitions, you have to combine a vision of where the industry is going to go, identify what is your sustainable differentiated strategy given that vision, and a discipline to execute in a 12-18 month implementation against this 3 to 5+ year strategy, while not getting distracted in terms of short term focus on decisions that may make next quarter or year's results look good as opposed to preparing for the long run. Another factor is our global balance of our business combined with our tremendous cash generation engine and strong balance sheet.

Finally, and potentially the most important in what we believe will drive Cisco's growth for the next decade is what we are calling the second major phase of the Internet's effect on business and communications. We believe this phase two of the Internet will result in dramatic innovation and productivity increases enabled by collaboration and Web 2.0 technologies, such as Unified Communication and TelePresence.

Cisco has experienced healthy growth over the last year in the Emerging Markets. To what do you attribute this success?

John Chambers: Balance for fiscal year 2007 was very good across the four Emerging Market operations. Middle East and Africa operations led the way with order growth in the high 50s, followed by Russia and CIS with growth of approximately 40%, and Eastern Europe for the year had growth in the high 30s followed by Latin America with growth in the high 20s. Again, it is the balance across all four operations that is our greatest strength.

The business process and collaborative approach to our Emerging Markets resulted in order growth throughout the year of approximately 35% to 50% and very solid gross margins and profit contributions which can often be challenging for high tech companies in these markets. Order growth for the fiscal year was approximately 40%.

While this business by definition will be lumpy and based in part upon large orders, we have been pleased with the consistent performance. This model appears to have legs for the next decade.

We are seeing an increasing need for collaborative technologies across industries and geographic regions. How is TelePresence affecting this change in business operations?

John Chambers: In Q4, the number of TelePresence systems grew by over 400% from Q3. The customer excitement and understanding about both the process change and the collaboration that TelePresence enables has been dramatic. This is especially true at the CEO level where the CEOs not only grasp the effectiveness from a time and travel cost savings, but almost uniformly, they understand the value of the business transformation to their organizations. This is the first time in my career that I have seen this type of excitement and interest from CEOs for a technology.

We now have TelePresence orders from approximately 50 customers. These customers are realizing that the life-like experience unique to TelePresence is enabling business transformation that could drive top and bottom line growth. Using TelePresence to create new products and services, and enhancing competitive positioning by leveraging expertise and speeding execution and decision making have become the key purchase drivers, even over the reduced travel costs that we know can be dramatic and oftentimes pay for the system in less than one year.

As we have shared before, we fully intend to transform both our organizational structure and the processes by which we deliver our products and services through collaboration and Web 2.0 across every function within Cisco. Just to give you some initial data, we now have 110 TelePresence systems deployed around the world. In the first half of this year, we conducted over 17,000 TelePresence meetings.

Another key concept to understand is that the effectiveness of TelePresence, in my opinion, will follow Metcalfe's Law. Metcalfe Law's states that "the value of a telecommunications network is proportional to the square of the number of users of the system." That is absolutely what I believe we are experiencing with TelePresence. Two, four, ten user sites are nice, but when we begin to hit 50 to 100, there will be tremendous efficiencies and value to our company as it relates to changing our organizational structure and business processes.

Why is Dennis Powell retiring as CFO?

John Chambers: Cisco is the strongest we've been in many years with solid growth, a healthy balance sheet, and a world-class management team in place. I believe in making smooth leadership transitions when we're at the top of our game, and now-as we enter a new cycle for the business-is the time evolve our financial leadership team.

Dennis has been a true leader and a great financial partner, and he helped lead the company through the most challenging economic times our industry ever experienced, adjusting to increased government compliance requirements with classic Cisco integrity. Dennis has developed an extremely strong financial team with multiple, very qualified candidates to succeed him.

Who will be Cisco's new CFO?

John Chambers: After careful consideration, the board and I have selected Frank Calderoni, from multiple very qualified candidates, to succeed Dennis. Frank brings tremendous experience into this role both from his three years at Cisco and his prior experience as a CFO in our industry at QLogic and SanDisk, as well as his tenure at IBM. Frank will continue the day-to-day leadership of Customer Solutions Finance while he continues to work closely with Dennis and I and the senior leadership team to effectively take on his new position at the end of January.


Q4 FY 2007 GAAP Reconciliation

RECONCILIATION OF GAAP TO NON-GAAP NET INCOME
(In millions, except per-share amounts)
Three Months Ended Twelve Months Ended
July 28, 2007
July 29, 2006
July 28, 2007
July 29, 2006
GAAP net income$ 1,930 $ 1,544 $ 7,333 $ 5,580
Employee share-based compensation expense222 211 931 1,050
Impact to cost of sales from purchase accounting adjustments to inventory- 4 - 26
Payroll tax on stock option exercises10 2 36 15
Compensation expense related to acquisitions and investments29 21 93 123
In-process research and development74 1 81 91
Amortization of purchased intangible assets157 215 563 453
Total adjustments to GAAP income before provision for income taxes492 454 1,704 1,758
Income tax effect (1)(154) (126) (603) (452)
Effect of retroactive tax legislation (2)- -(60) -
Total adjustments to GAAP provision for income taxes(154)(126) (663) (452)
Non-GAAP net income$ 2,268 $ 1,872 $ 8,374 $ 6,886
Diluted net income per share:
GAAP$ 0.31 $ 0.25 $ 1.17 $ 0.89
Non-GAAP$ 0.36 $ 0.30 $ 1.34 $ 1.10
Shares used in diluted net income per share calculation:
GAAP6,275 6,187 6,265 6,272
Non-GAAP6,263 6,181 6,249 6,259

(1) The income tax effect for the adjustments relating to GAAP income before provision for income taxes was 35.4% for fiscal 2007 and has been determined using the applicable tax rates in jurisdictions to which these adjustments relate.

(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 fiscal 2007 included a benefit of $60 million related to fiscal 2006 R&D expenses, while non-GAAP net income for fiscal 2007 excluded this benefit.

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 Twelve Months Ended
July 28, 2007
July 29, 2006
July 28, 2007
July 29, 2006
Shares used in diluted net income per share calculation-GAAP6,275 6,187 6,265 6,272
Effect of SFAS 123(R) (12) (6) (16) (13)
Shares used in diluted net income per share calculation-Non-GAAP 6,263 6,181 6,249 6,259


# # #

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 (such as the development of our markets, the future of networking, Cisco's strategy and positioning, and our ability to foresee market transitions) 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 and evolution 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 and other customer markets; 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; 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 related 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 twelve months ended July 28, 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, and shares used in non-GAAP net income per share calculation.

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 and shares used in non-GAAP net income per share calculation, 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, tax effects of post-acquisition integration of purchased intangible assets from significant acquisitions, and significant effects of retroactive tax legislation (such as Cisco's U.S. federal research and development (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, refer to the Form 8-K regarding this executive question and answer furnished today with the Securities and Exchange Commission.

Copyright © 2007 Cisco Systems, Inc. All rights reserved. Cisco, the Cisco logo, Cisco Systems, Catalyst, Linksys and WebEx 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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