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FEATURE

Chairman and CEO John Chambers and CFO Frank Calderoni Discuss Cisco First Quarter Fiscal Year 2010 Performance

November 4, 2009

Cisco announced first quarter fiscal year 2010 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 key financial highlights of the quarter?

John Chambers: First, from a financial perspective, the quarter was very strong versus our expectations, given the challenges that were occurring in the global economy. Almost all of our financial measurements were above or at the high end of our expectations.

Revenues of $9 billion year-over-year, decreasing by approximately 13 percent, were dramatically better than our expectations of down 15-17 percent.

Cash generated from operations in the first quarter was approximately $1.5 billion, and we repurchased $1.8 billion of stock during the quarter under our repurchase program.

Product book to bill was above 1.

Services continued to outpace other parts of our business with year-over-year revenue growth of approximately 7 percent.

Although there is always room for improvement, we are very pleased with the first quarter financial results.

Are there other characteristics that support a strong first quarter fiscal year 2010?

John Chambers: Yes. First, another key reason that we characterize the first quarter as strong is that almost all of the financial sequential measurements from the fourth quarter of fiscal year 2009 to the first quarter of fiscal year 2010 were at the high end or above the same period as the first quarters from the last five normal economic years, that is from fiscal year 2004 through fiscal year 2008.

In other words, the sequential growth for financial measurements from the fourth quarter to the first quarter was very strong versus prior normal economic times. This includes sequential product bookings, sequential product revenue, and product book to bill. It also included non-GAAP product gross margins, operating income, net income and earnings per share. Again, each of these is in terms of sequential growth from the fourth quarter of fiscal year 2009 to the first quarter of fiscal year 2010.

Secondly, we saw similar revenue trends from the fourth quarter of fiscal year 2009 to the first quarter of fiscal year 2010 at 6 percent sequential growth. Similarly we also saw positive indicators in our year-over-year revenue trends. The growth rates improved from minus 18 percent in the fourth quarter to down approximately 13 percent year-over-year in the first quarter.

But of even more interest was that, from a sequential product orders perspective, the first quarter was very much in line with what we have seen in prior first quarters over a normal five-year period, that is fiscal year 2004 to fiscal year 2008, which was down sequentially in the mid-to-low single digits.

Third is that we are starting to see solid indications of economic recovery in most geographies around the world. The improving economic outlook, combined with what appears to be a very solid execution due to our organizational structure and business models, enabled Cisco to move into 30-plus market adjacencies, while reducing operating expenses by 10 percent year-over-year and also reducing headcount.

In our opinion, the first quarter of fiscal year 2010 results, especially in the U.S., again followed our normal sequential order pattern indicating the initial phase of the recovery is well underway based upon our order momentum. While the continued strength of the recovery and eventual job creation may still be in question, we clearly are basing our decisions and investments upon an optimistic evolution of the economy. If we get surprised, we will adjust.

How would you characterize the customer segments and geographies?

John Chambers: As a general statement, our position in terms of both a technology partner and a business partner to our customers in service provider, enterprise and government is continuing to expand in a very positive way.

On a global basis, our total product orders year-over-year were down in the high single digits, which was a major improvement from fiscal year 2009 fourth quarter's year-over-year total product orders, which were down in the low 20s.

First, in terms of the U.S., it was a strong turn-around from the fourth quarter of fiscal year 2009's negative order growth of approximately 20 percent year-over-year to the first quarter of fiscal year 2010's flat year-over-year growth.

Enterprise led the way with over a 30-point sequential quarter swing, with negative fourth quarter growth in the 20s to approximately 10 percent year-over-year positive order growth in the first quarter.

U.S. Public Sector continued to be solid, with growth in the high single digits year-over-year, while Service Provider was still down year-over-year in the high single digits. However, for Service Provider, this was a significant improvement from being down over 30 percent year-over-year in the fourth quarter of fiscal year 2009. Commercial showed improvement, down in the mid single digits in the first quarter, versus down in the mid 20s in the fourth quarter of fiscal year 2009 year-over-year.

While the U.S. clearly led the way in the first quarter in terms of geographies and customer segments, there was also very solid improvement in Japan, Asia Pacific and even in parts of Europe, while Emerging Markets, which excludes China and India, continued to be challenging.

Second, Japan continued to show solid improvements, with positive order growth rates year-over-year in the mid single digits with good balance across Enterprise, Public Sector and Service Provider. Public Sector was up the most, with year-over-year order growth above 40 percent, while Commercial continued to be challenged, decreasing in the mid teens year-over-year.

Asia Pacific overall was down in the low single digits, with the Public Sector up over 30 percent year-over-year while the other segments were down between the mid single digits and the mid teens.

The Emerging Markets, not including some emerging countries in Asia, continued to experience challenges with overall year-over-year orders decreasing in the high 20s. The challenges spread equally across all customer segments.

Europe, speaking very candidly, was a pleasant surprise with orders year-over-year down in the low teens. Public Sector was down in the low single digits and the other major segments were down in the mid to upper teens year-over-year.

What market adjacencies are you focusing on?

John Chambers: The three market adjacencies I'd like to cover are Virtualization, Video and Collaboration.

First--Virtualization: In terms of our data center portfolio offering, we are seeing solid momentum driven by our Nexus 5000 and 7000 family-both growing in the triple digits year-over-year from an orders and revenues basis in the first quarter. Over the last quarter, we added over 250 customers for a total of over 1,000 customers for the Nexus 7000. The Unified Computing System is also experiencing positive market reception with a very good initial ramp and order pipeline.

On Tuesday, November 3rd, we announced the Virtual Computing Environment coalition formed jointly by Cisco and EMC with VMware, which represents a major breakthrough in the way that IT is delivered and consumed by our customers. The key industry transition happening is the movement from the current data centers to next-generation data centers and the journey to private clouds. It is really about bringing "IT as a service" to life.

With these industry trends in mind, this announcement represents an unprecedented level of collaboration in development, services and partner enablement to deliver the industry's first completely integrated IT offering that combines best-of-breed networking, compute, storage, security and management technologies with end-to-end vendor accountability. This move clearly signifies our focus on capturing the market transition around virtualization and private cloud infrastructures.

.

Next--Video: I believe that Video is the killer application that will drive the next generation of productivity and innovation. To give you some additional color on our progress in this area, TelePresence revenues once again grew in excess of 100 percent year-over-year in the first quarter, a proof point that our customers truly understand the productivity and value that video delivers both internally and with their own customers and partners.

In the first quarter of fiscal 2010, we conducted 77,000 Cisco internal meetings and had a record quarter in terms of units sold, selling 570 systems and adding 85 new customers. We just recently celebrated our three-year anniversary since launching TelePresence, and since that time we have conducted more than a half a million hours of internal meetings or 427,000 meetings. These are staggering figures and our customers are also experiencing high usage patterns. Today, we have approximately 500 customers and almost 3,200 systems sold.

You have also recently seen us make strategic announcements around Tandberg in Norway, Digital Video Networks in China, and Pure Digital earlier this year in the U.S. We believe we are well-positioned to take advantage of this major market transition as the network plays a key role in transforming how we communicate and collaborate.

Video is very much an art as well as a science and medianet is our architectural solution to enable access to any content, on any device, on any network. Medianet can adjust real time, change aspect ratio, bit rate and file format to optimize traffic and the user's experience. This is something that plays to Cisco's core strengths, and we feel we are very well positioned with our Service Provider and Enterprise customers to take advantage of this unique market transition.

Third -- Collaboration: We believe that collaboration is driving the next wave of business growth, innovation and productivity. The future of work is changing and organizations are looking for new ways to address their challenges. There are four key trends that are critical to customers that are driving collaboration -- consumerization of IT, global value chain, worker mobility and information overload. Cisco is delivering on these experiences to transform the way we collaborate with real-time voice and video interactions, as we enter new markets in this area.

As much as it is about video, our intention to acquire Tandberg is also about the integration of video into the broader $30 billion-plus market for collaboration. By acquiring Tandberg and extending our video endpoint product line, we hope to grow business interest in video as part of how enterprises communicate internally and between businesses.

Similarly, our interest in Starent is based on the exploding use of mobile devices by consumers and businesses in innovative ways for entertainment, social networking, collaboration and business productivity. Through our intent to acquire Starent Networks, we are focused on offering rich, quality multimedia experiences to mobile subscribers. Cisco and Starent bring complementary technologies and capabilities designed to accelerate this transition to the rapidly growing Mobile Internet, where the network is the platform to enable Service Providers to launch, deliver and monetize the next generation of mobile multimedia applications and services.

Frank Calderoni on Cisco's First Quarter Financial Position

What is your view of the first quarter overall from a financial perspective?

Frank Calderoni: I am pleased with our strong results for the first quarter of fiscal year 2010 which demonstrate our ability to execute on our innovation and operational excellence priorities within our business model.

As demonstrated this quarter, we are also using our strong financial position to invest in and accelerate growth opportunities for Cisco while continuing our internal focus on productivity.

What are some of the key financial specifics for the first quarter?

Frank Calderoni: Total revenue for the first quarter was $9 billion, a decrease of approximately 13 percent year-over-year.

Total service revenue was $1.8 billion, up approximately 7% year-over-year.

Total product revenue was $7.2 billion, down approximately 17% year-over-year.

Switching revenue was $2.9 billion, a decrease of 21 percent year-over-year. Modular switching revenue was down 19 percent year-over-year, while fixed switching revenue declined 22 percent year-over-year.

Routing revenue was $1.6 billion, down 17 percent year-over-year, representing a decrease of 15 percent, 19 percent and 20 percent year-over-year in High End, Mid Range and low end, respectively.

Advanced Technologies revenue totaled $2.3 billion, representing a decrease of 15 percent year-over-year. We saw declines in Unified Communications of approximately 10 percent, Video Systems of approximately 29 percent and Security of approximately 9 percent.

Other product revenue totaled $481 million, an increase of 9 percent year-over-year. Growth year-over-year was driven primarily by the inclusion of our acquisition late last fiscal year of Pure Digital, along with strong growth in TelePresence. We remain very pleased with the growth of TelePresence year-over-year.

Sequentially, our total revenue was up 6 percent quarter-over-quarter.

GAAP net income for the first quarter was $1.8 billion, as compared to $2.2 billion in the first quarter of fiscal year 2009.

Non-GAAP net income for the first quarter was $2.1 billion, representing a decline of 15 percent year-over-year.

GAAP earnings per share on a fully diluted basis for the first quarter were $0.30 versus $0.37 in the same quarter of fiscal year 2009.

Non-GAAP earnings per share on a fully diluted basis for the first quarter were $0.36, versus $0.42 in the first quarter of fiscal year 2009, a 14 percent decline year-over-year.

For the quarter, we repurchased $1.8 billion of common stock under the stock repurchase program, or 76 million shares at an average price of $22.99 per share. Per our press release, our board approved an increase to the repurchase program of $10 billion. The remaining approved amount for stock repurchase under this program including the additional authorization is approximately $13.1 billion.

Can you discuss any accounting changes that impacted revenue and earnings?

Frank Calderoni: In the first quarter we adopted two new accounting standards which impact revenue recognition for Cisco - Emerging Issues Task Force (EITF) 08-1 and 09-3.

We are pleased that these standards which provide guidance on the accounting for multiple element arrangements were approved by the Financial Accounting Standards Board in the first quarter.

The impact of the new standards in the first quarter was an increase to revenue of approximately $50 million and a half-penny benefit to earnings per share.

We do not expect the new standards to have a material impact on our financial results in the second quarter. We do anticipate the new guidance will result in improved operational alignment of the accounting with new product offerings, including products from acquisitions, and related go-to-market strategies, particularly in our product and solution areas of collaboration, TelePresence and security.



RECONCILIATION OF GAAP TO NON-GAAP NET INCOME

(In millions, except per-share amounts)

  Three Months Ended
  October 24, 2009 October 25, 2008
GAAP net income $ 1,787 $ 2,201

Share-based compensation expense (1)

321 304

Payroll tax on stock option exercises (2)

--- 1

In-process research and development (3)

--- 3

Amortization of acquisition-related intangible assets

149 166

Other acquisition-related costs (4)

4 122

Total adjustments to GAAP income before provision for income taxes

474 596

Income tax effect

(145) (194)

Effect of retroactive tax legislation (5)

--- (106)

Total adjustments to GAAP provision for income taxes

(145) (300)
Non-GAAP net income $ 2,116 $ 2,497
Diluted net income per share:
GAAP $ 0.30 $ 0.37
Non-GAAP $ 0.36 $ 0.42
Shares used in diluted net income per share calculation:
GAAP 5,871 5,972
Non-GAAP 5,880 5,979

(1) Share-based compensation expense for the first quarter of fiscal 2010 and fiscal 2009 includes $28 million and $22 million, respectively, of share-based compensation related to acquisitions.

(2) 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.

(3) Effective beginning in fiscal 2010, Cisco no longer excludes in-process research and development for purposes of its non-GAAP financial measures as it is no longer expensed as a result of new accounting guidance.

(4) Other acquisition-related costs for the first quarter of fiscal 2010 includes a $42 million mark-to-market impact related to transactions to hedge a portion of the foreign currency consideration of an announced, pending business combination.

(5) 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 quarter 2009 included a $106 million tax benefit related to fiscal 2008 R&D expenses. Non-GAAP net income for the first quarter of fiscal 2009 excluded the $106 million tax benefit related to fiscal 2008 R&D expenses.

Certain reclassifications have been made to prior period amounts to conform to the current period's presentation.

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
  October 24, 2009 October 25, 2008
Shares used in diluted net income per share calculation - GAAP 5,871 5,972
Effect of share-based compensation expense 9 7
Shares used in diluted net income per share calculation - Non-GAAP 5,880 5,979



# # #

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 improving economic outlook and related opportunity, market transitions across collaboration, virtualization and video driving productivity and growth in network loads for the next decade, and the emergence of a new model of productivity based on collaboration and related business opportunity) 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, including relating to transactions to hedge foreign currency consideration for acquisitions; changes in provision for income taxes, including changes in tax laws and regulations or adverse outcomes resulting from examinations of our income tax returns; potential volatility in operating results; and other factors listed in Cisco's most recent report on Form 10-K. 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 report on Form 10-K filed on September 11, 2009, as it may be amended from time to time. Cisco's results of operations for the three months ended October 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, when applicable, share-based compensation expense, amortization of acquisition-related intangible assets, other acquisition-related costs, enhanced early retirement benefits, the income tax effects of the foregoing, significant effects of retroactive tax legislation, and significant transfer pricing adjustments related to share-based compensation. 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 and effective beginning in fiscal 2010, Cisco no longer excludes in-process research and development as it is no longer expensed as a result of new accounting guidance. 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 the news release furnished today to the Securities and Exchange Commission.

Copyright ©2009 Cisco Systems, Inc. All rights reserved. Cisco, the Cisco logo, Cisco Systems, Cisco IronPort, Cisco StadiumVision, Cisco TelePresence, Cisco Unified Computing System, and IronPort 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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