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FEATURE

Chairman and CEO John Chambers and CFO Frank Calderoni Discuss Cisco Q3 Fiscal Year 2009 Performance

May 6, 2009

Cisco announced third 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: We exit the third quarter with a compelling financial position and an innovation engine from both a products and business model perspective that should allow us to expand our leadership in the marketplace.

The following is a quick snapshot of our third quarter financial highlights:

Revenue was $8.2 billion, a 17% year-over-year decrease.

Cisco generated $2 billion in cash in the third quarter, resulting in total cash and investments of $33.6 billion. We repurchased $1.2 billion of stock during the quarter.

Product book to bill was approximately 1.

In terms of our overall customer segment business, the public sector was the least impacted across all customer segments markets, but orders were still down 12% overall. For the U.S. public sector, which includes both Federal and State/Local, orders were down in the mid-single digits. Japan and Asia Pacific public sector were both positive at 12% and 20%, order growth respectively.

In other customer segments, Enterprise and Service Provider orders were down year-over-year by 27% and 33%, respectively, on a global basis. Consumer orders were down 19% year-over-year. The commercial market orders were down 31%.

Moving on to orders by Geography, the following are in terms of orders year-over-year. Japan orders were down year-over-year in the third quarter by approximately 20%. For the U.S., orders in the third quarter were down by approximately 22% year-over-year. Asia Pacific orders were down 27% year-over-year. European Markets in total were down approximately 28% year-over-year in the third quarter. And Emerging Markets was down by 31% year-over-year.

How is the company managing through the downturn, positioning for the upturn?

John Chambers: No one knows for sure when the upturn will occur, but we are going to be very aggressive this calendar year to position ourselves for the inevitable up-turn, while continuing to maintain tight financial management in aligning resources to new opportunities.

Our Playbook and Gameplan for handling economic challenges is working extremely well. There is also a large advantage to having the leadership team that has been through these types of challenges over four times in the last two decades.

During each of the past economic slowdowns, Cisco has always navigated very effectively through difficult times to expand our share of our customers spend, while moving aggressively into market adjacencies. As a result, we were better positioned coming out of the transition versus our peers. For example, this strategy served us well during the last downturn when our strategic investments resulted in our Advanced Technologies segments and our new organizational structure of councils, boards and working groups.

We believe that we are very well positioned in the industry from a vision, differentiated strategy, and execution perspective. We believe we are entering the next phase of the Internet as growth and productivity will center on collaboration enabled by networked Web 2.0 technologies. We are going to attempt to execute a strategy over the next decade that is similar to what we did in the early 90s and as we've said before, it powered our growth for the next decade.

Even with the challenging times in the global economy, what are you proud of as you look back on the quarter?

John Chambers: This quarter may have been the most innovative and operationally effective quarter in our history. The innovation and execution has never been broader and more successful ranging from product announcements, technology architecture and business architecture leadership in our customers' minds. Cisco has had an explosion of collaboration enabled by networked Web 2.0 technologies in everything we do.

I always listen carefully to our customers. And in many ways, our customers' feedback of this activity in the third quarter was pivotal, truly a tipping point, in terms of both their understanding and in many cases, their commitment, to next generation intelligent networks becoming their platform for productivity, standard of living, and global competitiveness.

How have organizational changes helped the company operate more effectively?

John Chambers: Our new organizational structure of councils, boards and working groups is operating very effectively. These structures allow speed, scale, flexibility and rapid replication. An example of this speed, scale and replication is that we have added three more market adjacencies, Virtual Healthcare, Safety and Security and Smart Communities, bringing the total of these cross-functional priorities/adjacent markets to 29.

Some examples of what the new organizational structure has helped enable the company to do are:

  • Virtualization, first in the data center and then going all the way to our homes, is becoming a reality as illustrated by our announcement of the Unified Computing System in March. We are seeing a significant market transition in the data center as networking, computing, storage and software technologies begin to converge and then compete with each other in new ways.
  • What is most exciting about this market transition is the rise of new business models enabled by technology architectures, such as cloud computing, and the opportunity to finally address customers' greatest needs in terms of reducing costs and complexity, while increasing their business agility. Many of our customers believe the future data center can best be enabled by the network, and we think this uniquely positions Cisco to lead through this next market transition.

  • The second phase of the Internet revolution is becoming viral. We all understand that phase one was about orders being entered on-line, customer support provided over the Internet, etc., which Cisco led in internal utilization first and then expanded across multiple industries over the next decade. While theoretical in some customers' minds, the numbers are now irrefutable and our leading-edge customers are for the first time, clearly understanding the impact.
  • New Business models for travel. Using myself as the example, but asking you to think about how this concept expands to each Cisco employee and then our customers and how we will work in the future. In the first 90 days of this calendar year I made 262 customer visits. And while I still went around the world twice physically, 200 of these visits were virtual through TelePresence. Many of these meetings were first time meetings, and it has become common to present to an entire senior management team of a Fortune global 100 or to heads of state, using this technology. We now average 4,700 TelePresence sessions weekly and have permanently cut our travel budget from $750 million run rate per year to $350 million run rate per year.
  • Video Architecture. Over the last several years, we expanded our leadership first in the networked home with Linksys. Then moved into home video entertainment with Scientific Atlanta, followed by our announcement this year at the Consumer Electronic Show in areas such as Media Hub, unifying music from any device to any device. And we are now dramatically expanding our networked video strategy to the consumer throughout the home with our recently announced acquisition of Pure Digital and the Flip. Make no mistake about it; we will have an end-to-end architecture in the home for video just like we are developing an end-to-end video architecture for enterprise business.
  • Smart Grid and the entire green initiative is an area that many of you may not have realized Cisco's thought, execution and partnership leadership, not to mention future business potential. We have moved to bring important solutions to marketing in terms of category and architectural thought leadership in the world in less than six months. This was highlighted by GE, Florida Power Light and Cisco's recent Energy Smart Miami announcement several weeks ago.
  • Smart, connected communities. Through a combination of public/private partnerships on a global basis, we have developed and set the pace for what cities of the future will become in terms of how they will use networked architectures for enabling everything from smart grids, green initiatives, safety and security, transportation, intelligent buildings, e-government, healthcare and education. For example, in the last month, we have announced a connected architecture with the top leaders in South Korea including Mayor Ahn in Incheon, and Gale International, the key developer of the new Incheon economic city outside of Seoul. We are driving similar strategies with other companies and countries throughout the world.
  • Sports and Entertainment. An area that might surprise you, but will play-out over the long run in terms of video entertainment for the home and our service provider strategy, is our focus on changing the fan experience. First, it will occur in sports stadiums and then it will go all the way to the home. In one meeting this quarter, we had over 42 professional sports teams with key representatives in the meeting, many at the commissioner level from major league baseball, basketball, football and hockey.

Frank Calderoni on Cisco's Q3 Fiscal Year 2009 Financial Position

What is a key take away from the quarter?

Frank Calderoni: I remain confident that our financial strength enables us to execute in both good and challenging environments. We believe our portfolio diversification, focus on innovation, operational excellence and speed of execution enables us to effectively navigate market transitions.

Cisco posted a very solid quarter in the third quarter fiscal year 2009. These results showcase our ability to manage profitability across varying economic cycles, while delivering products and services that provide real value to customers.

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

Frank Calderoni: Total revenue for the third quarter was $8.2 billion, a decrease of approximately 17% year-over-year.

Total service revenue was $1.7 billion, up approximately 9% year-over-year with solid growth across our geographic theaters.

Revenue from our recurring revenue streams represented approximately 23% of our total revenue mix this quarter versus 20% last quarter.

Total product revenue was $6.4 billion, down approximately 22% year-over-year. There is no doubt this has been a difficult macro environment.

Switching revenue was $2.6 billion, a decrease of 20% year-over-year. Modular switching revenue was down 22% year-over-year, while Fixed switching declined 17% year-over-year.Routing revenue was $1.4 billion, down 32% year-over-year, representing a decrease of 36%, 25% and 23% year-over-year in High End, Mid Range, and low end, respectively.

Advanced Technologies revenue totaled $2.1 billion, representing a decrease of 12% year-over-year. Within Advanced Technologies, Video Systems declined approximately 5% year-over-year, Unified Communications decreased approximately 7% year-over-year, and Security declined 14% year-over-year.

Other product revenue totaled $370 million, a decrease of 36% year-over-year.

Total revenue decreased across all geographies on a year-over-year basis. Quarterly revenue ranged from minus 14% in both European Markets and Japan to minus 22% for both Asia Pacific and the Emerging Markets theater. The U.S. and Canada theater was down 15%.

Interest and other income was $80 million for the third quarter, which reflects lower net interest income as a function of lower market interest rates and incremental interest expense associated with our $4 billion debt issuance earlier this quarter. Our diversified, high quality cash and investments portfolio continued to perform given the challenging financial markets.

GAAP net income for the third quarter was $1.3 billion, as compared to $1.8 billion in the third quarter of fiscal year 2008.

Non-GAAP net income for the third quarter of fiscal 2009 was $1.8 billion, representing a decline of 24% year-over-year. As a percentage of revenue, Non-GAAP net income was 21.5%, a solid performance in this market.

GAAP earnings per share on a fully diluted basis for the third quarter were $0.23 versus $0.29 in the same quarter of fiscal year 2008.

Non-GAAP earnings per share on a fully diluted basis for the third quarter were $0.30, versus $0.38 in the third quarter of fiscal year 2008, a 21% decline year-over-year.

How is the management team utilizing the company's strong financial position to sustain its investment in innovation and drive operational excellence in the business?

Frank Calderoni: Our business model provides us with the flexibility to continue to aggressively invest in new technologies and market adjacencies. Through strong portfolio management, in one quarter we realigned resources to our top five strategic priorities, launched the first unified computing architecture to the marketplace and increased investment in key customer segments such as public sector.

We remain committed to driving operational excellence and productivity improvement throughout the business. Our cost and expense management activities this past quarter enabled us to manage our business costs while still investing in areas where we believe we can accelerate development and Cisco's market leadership. During the quarter we took a number of actions, including reducing travel by approximately 50% compared to the second quarter, centralizing procurement activities to optimize our buying power, and aligning select core business processes for greater efficiency. As a result, we are well on track toward exceeding our target of removing over $1 billion from our annualized expense run rate by the end of this fiscal year and in line with our internal stretch target of $1.5 billion.

From a working capital perspective, we believe we implemented the right actions and strategies to effectively manage our cash flow and protect our strong balance sheet. With continued focus on our accounts receivables and supply chain, including our ongoing review and optimization of inventory levels, we have delivered positive results again this quarter. In the third quarter, we also closed a $4 billion debt offering, a portion of which was used to refinance $500 million of unsecured debt.

What has been significant to the company's success? How has the company's solid financial status ultimately helped customers?

Frank Calderoni: The key to our success has been our focus on customer needs and our ability to collaborate closely with them to develop creative and differentiated solutions, such as providing extended warranties across some aspects of our portfolio. Our financing arm (Cisco Capital) continues to provide solutions to customers and channel partners that enable incremental sales and opportunity. We continue to see positive payment behavior from our customers and believe there has been no material impact to the quality of our portfolio.



RECONCILIATION OF GAAP TO NON-GAAP NET INCOME

(In millions, except per-share amounts)

Three Months Ended Nine Months Ended
April 25, 2009
April 26, 2008
April 25, 2009
April 26, 2008
GAAP net income $ 1,348 $ 1,773 $ 5,053 $ 6,038

Employee share-based compensation expense

277 268 835 767

Payroll tax on stock option exercises (1)

1 1 20

Compensation expense related to acquisitions and investments

120 286 323 359

In-process research and development

3 3

Amortization of acquisition-related intangible assets

164 174 520 529

Total adjustments to GAAP income before provision for income taxes

561 729 1,682 1,678

Income tax effect

(156) (193) (512) (526)

Effect of retroactive tax legislation (2)

(106)

Total adjustments to GAAP provision for income taxes

(156) (193) (618 ) (526)
Non-GAAP net income $ 1,753 $ 2,309 $ 6,117 $ 7,190
Diluted net income per share:
GAAP $ 0.23 $ 0.29 $ 0.86 $ 0.97
Non-GAAP $ 0.30 $ 0.38 $ 1.04 $ 1.16
Shares used in diluted net income per share calculation:
GAAP 5,818 6,069 5,871 6,202
Non-GAAP 5,840 6,052 5,888 6,192

(1) Effective in the third quarter of fiscal 2009, Cisco no longer excludes payroll tax on stock option exercises for purposes of its non-GAAP financial measures.

(2) 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 nine months of fiscal 2009 included a $106 million tax benefit related to fiscal 2008 R&D expenses. Non-GAAP net income for the first nine 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 Nine Months Ended
April 25, 2009
April 26, 2008
April 25, 2009
April 26, 2008
Shares used in diluted net income per share calculation - GAAP 5,818 6,069 5,871 6,202
Effect of SFAS 123(R) 22 (17) 17 (10)
Shares used in diluted net income per share calculation - Non-GAAP 5,840 6,052 5,888 6,192



# # #

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 alignment and optimization of resources, our movement into market adjacencies, our investment in innovation, the future of the data center, the expansion of our leadership in the marketplace, and our positioning for the eventual economic recovery) 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, including the data center; 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; a pandemic or epidemic; 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 nine months ended April 25, 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. In addition, Cisco believes that the presentation of non-GAAP inventory turns provides useful information to investors and management regarding financial and business trends relating to inventory management based on the operating activities of the period presented.

For its internal budgeting process, Cisco's management uses financial statements that do not include employee share-based compensation expense, compensation expense related to acquisitions and investments, in-process research and development, amortization of acquisition-related intangible assets, the income tax effects of the foregoing, 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. In prior periods, Cisco has excluded other items that it no longer excludes for purposes of its non-GAAP financial measures; for example, effective in the third quarter of fiscal 2009, Cisco no longer excludes payroll tax on stock option exercises. From time to time in the future, there may be other items that Cisco may exclude for purposes of its internal budgeting process and in reviewing its financial results.

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, and Cisco Unified Computing System 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. This document is Cisco Public Information.

 
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