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FEATURE

Chairman and CEO John Chambers and CFO Frank Calderoni Discuss Cisco Q2 Fiscal Year 2009 Performance

February 4, 2009

Cisco announced second quarter fiscal year 2009 financial results. John Chambers, chairman and CEO, and Frank Calderoni, CFO, had the following to say regarding the company's results and business outlook.

What are some of the financial highlights of the quarter?

John Chambers: The second quarter fiscal year 2009 was a solid quarter for Cisco from a revenue and earnings perspective given the many challenges that we are all seeing occur in the global marketplace.

While our year-over-year comparisons show that we are not immune to the challenging economic environment, I am very pleased with our continued strong profitability and ongoing cash generation, which provides us the flexibility to be agile and differentiate ourselves during this difficult period.

Revenue was $9.1 billion, a 7.5% year-over-year decrease.

Cash generated from operations was $3.2 billion, bringing our total cash plus investments to approximately $29.5 billion.

GAAP earnings per share were $0.26, a 21% decrease year-over-year. Non-GAAP earnings per share were $0.32, down 16% year-over-year.

The second quarter year-over-year product revenue was down approximately 11%.

In spite of a difficult economy, we continue to drive technological innovation and product leadership from our Core, Advanced and Emerging Technologies.

The following is a summary of each of these areas for the second quarter in terms of year-over-year product revenue growth: Core product revenue declined 15% year-over-year, with switching down 11%, and routing down 23%. Services revenue increased 10% year-over-year. Total Advanced Technologies revenue grew 1%.

The Emerging Technologies Group orders in total grew approximately 48% year-over-year. The number of customers that have ordered TelePresence systems is now 312 in total and grew by 65 new accounts in the second quarter.

While growth in most of our countries around the world was challenging, we did see year-over-year order growth from the mid teens to the high 20s in the following countries: Mexico, Germany and Australia. However, we did find that the majority of our large countries such as the U.S., U.K., India, Russia and Italy had negative order growth year-over-year in the second quarter.

With all of this economic uncertainty, is Cisco evaluating a layoff, and how is the company preparing the employee base for challenging times?

John Chambers: While we have always done what is necessary as an organization to ensure the long term success of our company, we have come to the decision at this point in time that the realignment and restructuring of resources to new opportunities is the most effective way, rather than a large across-the-board layoff, to position us for the future. If business continues to change dramatically, we would obviously do what is necessary to bring our expense structure in line with revenues. If that is the case, layoffs could be necessary as they have been one time in the past.

Also in the spirit of complete openness, we are constantly realigning and restructuring resources as a part of our normal business process. As an example, in fiscal year 2008 and the first quarter in 2009, we realigned and restructured approximately 1,000 jobs of a global workforce of 67,000 employees. With the speed that we are moving on so many fronts, we will continue this normal process, which in the near-term could result in the reduction of 1,500 to 2,000 jobs. This is something we will continue to do both in good and challenging times, but thought it was important to provide this level of detail, especially to our employee family during these uncertain times.

Many of you have asked us if we need to do a broad company layoff in order to manage our expenses. My own view is that if you have to do a layoff, and we try everything possible to avoid them, it needs to be of critical mass to justify the loss of business momentum, impact on employees and disruption in key projects.

Being very transparent, our definition of a company-wide layoff, if we had to do one, probably would be to lay off at least 10% of our workforce. In very direct terms, we are not going to consider a layoff at this point in time. And while there are no guarantees, we think the odds are reasonable that if we execute effectively as outlined during our earnings call, that we may be able to avoid large downsizing events.

I am counting on the help of each of the Cisco family members to help us effectively realign our resources into our growth opportunities in order to potentially avoid the requirement of a broad layoff.

What is Cisco doing internally from both a products and business model perspective that should allow the company to continue to be a leader in the marketplace?

John Chambers: We have an innovation engine that results in product leadership across the broadest range of products that we have had in our history architected from the home to the data center, across our enterprise, commercial, consumer and service provider market segments. We believe this product pipeline across almost all of our existing and new priorities is the strongest we have had.

Not only is our architecture across any combination of networks enabling the next generation of productivity, entertainment and business models, but we believe we also have the strongest position in terms of customer relationships with enterprise, government, service provider and channel partners in helping to enable our customers' goals. For example, last week in trips across emerging markets, key customer events, and the World Economic Forum - where I met with over 100 customers individually, the consistent feedback was that Cisco is dramatically expanding our value to these customers across all of the above mentioned market segments on a global basis from both a technology and business partnership perspective. Many of these customers also stated their increasing preference for an end-to-end player with product leadership strengths as well as financial strengths, and the staying power that Cisco represents.

Just as we led in the first phase of the Internet, i.e., Web 1.0, from both internal utilization and the expertise we offered our customers to enable this capability, we believe we are uniquely positioned to provide very similar leadership in the second phase of the Internet, through collaboration enabled by networked Web 2.0 technologies. Once again we are leading in terms of our own utilization and partnering with our customers to drive their goals of changing business models enabled by the network.

What progress has the company made in addressing the financial and global economic challenges?

John Chambers: Last quarter we outlined our approach to economic slowdowns, and at this time we would like to give you an update on our progress. When we see these market transitions occurring, we go to our Playbook for Economic Downturns, where there are four basic guidelines that we follow.

First, is to be realistic about the cause of your challenges.
Is it primarily the macro environment or your strategy? We believe our long-term strategy is working very well and we will stay focused on its continued implementation.

Second, determine the length and depth of the downturn and respond appropriately.
As we were one of the first to discuss last quarter, we felt this downturn was occurring quicker and with more severity than many of our peers. The length of the downturn is still in question, and being very candid, no one, including us, really knows how long it will last. The majority of our customers are guessing 2010, while a smaller group sees the upturn toward the end of 2009. Given the coordinated activities of global central banks and the extremely large stimulus packages that are being implemented in almost all major countries; I tend to be a little more optimistic than most of my customers. Time will tell if that optimism is appropriate.

Third, prepare for the upturn.
We believe this is the time to differentiate ourselves from our peers and be aggressive in ways that will position Cisco for future, profitable growth and stronger market leadership. This is the area that I believe we can uniquely position Cisco with our process driven vision, strategy, and execution combined with our organizational structure around Councils and Boards that will allow us to move with speed, scale, flexibility and with a replicable process as the upturn inevitably returns.

Fourth, expand customer relationships.
We are attempting to move very rapidly across the majority of our service provider, enterprise and government accounts to dramatically expand both the technology relationship as well as the business relationship as it relates to the customers' future growth and their own flexibility in managing through the downturn while preparing for the upturn.

There is increasing interest and understanding of the value Cisco can bring to these customers in both managing through a downturn as well as preparing for the upturn, and catching the next wave of both business models and productivity.

It is very important to understand our focus on resource prioritization and realignment as we aggressively move into market adjacencies during this downturn, as compared to prior economic downturns. In short, this time it is different. In 2001 for example, we were at the end of a decade-long run of product cycles, productivity, and business model changes enabled by the first phase of the Internet. And, unfortunately, our six advanced technology investments were at least three to five years away from being significant in terms of financial results.

In 2009, we are almost in the exact opposite scenario. Our new product pipeline is extremely strong and most of the market adjacencies that we're entering have the potential to be material in the next two to three years.

We have also begun implementing our game plan for dealing with these challenges. This game plan for the current downturn is called our six point plan which we first outlined last quarter.

Frank Calderoni on Cisco's Q2 Fiscal Year 2009 Financial Position

What are some of the financial highlights for the second quarter 2009?

Frank Calderoni: Total revenue for the first quarter was $9.1 billion, a decrease of 7.5% year-over-year.

Total service revenue was $1.7 billion, up approximately 10% year-over-year with solid growth across our geographic theaters. Services revenue and our recurring product revenue stream primarily from our WebEx and Ironport business represented approximately 20% of our total revenue mix this quarter.

Total product revenue was $7.3 billion, down approximately 11% year-over-year.

Switching revenue was $3.0 billion, a decrease of 11% year-over-year while routing revenue was $1.5 billion, down 23% year-over-year.

Advanced Technologies revenue totaled $2.4 billion, representing an increase of 1% year-over-year, with good performance in Video Systems with growth of approximately 18% year-over-year.

We also saw growth in Security of approximately 2% and Application Networking Services of approximately 1%. Unified Communications declined by approximately 5% year-over-year and home networking declined by 11% year-over-year.

Other product revenue totaled $418 million, a decrease of 22% year-over-year, related in part to our optical and cable businesses this quarter.

Total year-over-year revenue growth by geography ranged from up 1% year-over-year in both Japan and European Markets to down approximately 12% in Asia Pacific. Revenue in the Emerging Markets theater decreased by 11% and in the United States and Canada revenue decreased by approximately 9% year-over-year.

Interest and other income was $95 million for the second quarter which reflects lower net interest income as a function of lower market interest rates. Our diversified, high quality cash and investments portfolio continued to perform well within the challenging financial markets with relatively minor asset impairments.

GAAP net income for the second quarter was $1.5 billion, as compared to $2.1 billion in the second quarter of fiscal year 2008.

Non-GAAP net income for the second quarter of fiscal 2009 was $1.9 billion, representing a decline of 22% year-over-year. As a percentage of revenue, net income was 21%, a strong performance in this market.

GAAP earnings per share on a fully diluted basis for the second quarter were $0.26 versus $0.33 in the same quarter of fiscal year 2008.

Non-GAAP earnings per share on a fully diluted basis for the second quarter were $0.32, versus $0.38 in the second quarter of fiscal year 2008, a 16% decline year-over-year.

For the quarter, we repurchased $600 million of common stock, or 37 million shares of our stock at an average price of $16.40 per share. We ended the quarter with approximately $6.8 billion remaining in the current stock repurchase authorization.

How is Cisco's financial strength positioning the company to manage through the current economic environment as well as prepare for the upturn?

Frank Calderoni: We believe our vision, strategy and execution model will enable us to move into market adjacencies with tremendous speed, scale and flexibility. With $29.5 billion in cash, cash equivalents, and investments, a solid balance sheet, our Cisco Capital financing arm, and our robust portfolio of innovation-all of which provide a key competitive advantage-we believe we continue to be well positioned to compete effectively during the market downturn, and thereafter take advantage of the market upturn when it occurs.

Our conservative investment portfolio is invested in securities with an average credit rating of AA or better. Approximately 90% of our cash and fixed income portfolio is invested in cash or the highest rated short term (A-1+) or long term (AAA) securities. An ongoing focus on dynamic risk mitigation has significantly strengthened the cash and fixed income portfolio for Cisco since the onset of the financial crisis. This has resulted in an immaterial mark to market impact on our portfolio's valuation in absolute terms or when compared to last quarter.

Continued diligent focus on our accounts receivables, supply chain and ongoing review of excess and obsolete inventory, have delivered positive results again this quarter. As stated earlier, key metrics such as inventory turns, the level of purchase commitments, and days sales outstanding (DSO) remain strong and contribute to Cisco's consistent performance.

What else has the company done to manage the business to its financial model, and how has that helped position the company to take advantage of market transitions?

Frank Calderoni: We have long stated that our financial management and position are a competitive advantage for Cisco, and that belief has been even further strengthened even in light of the current economic condition. In one quarter's time, Cisco has realigned under $500 million into our growth areas and still managed to reduce our expense run rate.

Our financing arm (Cisco Capital) continues to provide financing to our customers and channel partners, which enables incremental sales of Cisco's products, services and networking solutions. In the first half of fiscal year 2009, Cisco Capital originated or facilitated approximately $2.1 billion in lease and longer-term loan arrangements.

To update the numbers previously disclosed, as of the end of the second quarter of fiscal year 2009, we have a combined balance sheet and contingent liability position of approximately $4.4 billion. Of this $4.4 billion, we have a net reserve and deferred revenue position of $2.5 billion. This represents an overall reserve and revenue deferral position of over 50% of the financing portfolio position.

We have continued to see positive payment behavior from our customers and will continue to monitor that closely and believe there has been no material impact to the quality of our portfolio. Broadly speaking we believe our portfolio has on average, an approximate investment grade profile and we remain comfortable with the credit profile and the way we are deploying our capital.

Robust portfolio management and continued technology innovation are also key contributors in our ability to move quickly and take advantage of market transitions. As we continue our expansion into new markets we have the ability to quickly realign resources to accelerate our company priorities-first by freeing up resources and then by strategically applying them to the highest yielding business opportunities.




RECONCILIATION OF GAAP TO NON-GAAP NET INCOME

(In millions, except per-share amounts)

  Three Months Ended Six Months Ended
  January 24, 2009 January 26, 2008 January 24, 2009 (1) January 26, 2008
GAAP net income $ 1,504 $ 2,060 $ 3,705 $ 4,265

Employee share-based compensation expense

276 273 558 499

Payroll tax on stock option exercises

8 1 19

Compensation expense related to acquisitions and investments

59 34 203 73

In-process research and development

3 3

Amortization of acquisition-related intangible assets

190 177 356 355

Total adjustments to GAAP income before provision for income taxes

525 492 1,121 949

Income tax effect

(162) (173) (356) (333)

Effect of retroactive tax legislation (1)

(106)

Total adjustments to GAAP provision for income taxes

(162) (173) (462) (333)
Non-GAAP net income $ 1,867 $ 2,379 $ 4,364 $ 4,881
Diluted net income per share:
GAAP $ 0.26 $ 0.33 $ 0.63 $ 0.68
Non-GAAP $ 0.32 $ 0.38 $ 0.74 $ 0.78
Shares used in diluted net income per share calculation:
GAAP 5,864 6,202 5,901 6,273
Non-GAAP 5,885 6,197 5,919 6,267

(1) In the first quarter of fiscal 2009, the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 reinstated the U.S. federal R&D tax credit, retroactive to January 1, 2008. GAAP net income for the first six months of fiscal 2009 included a $106 million tax benefit related to fiscal 2008 R&D expenses. Non-GAAP net income for the first six months of fiscal 2009 excluded the $106 million tax benefit related to fiscal 2008 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 24, 2009 January 26, 2008 January 24, 2009 January 26, 2008
Shares used in diluted net income per share calculation - GAAP 5,864 6,202 5,901 6,273
Effect of SFAS 123(R) 21 (5) 18 (6)
Shares used in diluted net income per share calculation - Non-GAAP 5,885 6,197 5,919 6,267



# # #

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 our long-term vision and strategy, the acceleration of our resource alignment, our intent to gradually decrease operating expenses, our movement into market adjacencies and prioritization of our existing opportunities, and the positioning of our business to take advantage of new opportunities and for ongoing, long-term market leadership 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, our customer markets and 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 return on our investments in certain market adjacencies and geographical locations during the current economic downturn; 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 our product and service markets; 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, and governmental investigations; natural catastrophic events; our ability to achieve 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, and to manage expenses during the current economic downturn; risks related to the global nature of our operations, including our operations in emerging markets; 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, as each may be amended from time to time. Cisco's results of operations for the three and six months ended January 24, 2009 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 acquisition-related 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 intangible assets from significant acquisitions, and significant effects of retroactive tax legislation. 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 Cisco's earnings release furnished today to the Securities and Exchange Commission.

Copyright ©2009 Cisco Systems, Inc. All rights reserved. Cisco, the Cisco logo, Cisco Systems, Cisco TelePresence, Cisco WebEx, Ironport, WebEx and WebEx Connect 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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