By Greg Markus (TMF Boring)

Cisco Systems, Inc.
(Nasdaq: CSCO)
170 W. Tasman Dr.
San Jose, CA 95134
(408) 526-4000

PRINCEVILLE, HI (Aug. 5, 1997) /FOOLWIRE/ -- Cisco Systems today reported results for its fiscal fourth quarter and fiscal year ending July 26, 1997.

Q4 RESULTS. Net sales for the fourth quarter were $1,765.1 million, compared with $1,292.1 million for the same period last year, an increase of 37%. Pro forma net income, which excludes the write-off of purchased in-process R&D and the realized gain on the sale of an investment, was $383.2 million or $0.55 per share, compared with pro forma net income of $286.2 million or $0.42 per share for the fourth quarter of 1996, increases of 34% and 31%, respectively.

FY 1997 RESULTS. Net sales for fiscal 1997 were $6,440.2 million, compared with $4,096.0 million for fiscal 1996, an increase of 57%. Pro forma net income, which excludes the write-offs of in-process R&D from the Netsys, Telebit, Ardent, Global Internet Software, and Skystone acquisitions and the gain from the sale of a minority stock investment, was $1,413.9 million or $2.05 per share, versus pro forma net income of $923.0 million or $1.38 per share during fiscal 1996, increases of 53% and 49%, respectively.

INCOME STATEMENT DETAILS. Approximately 47% of bookings came from outside the U.S. Revenues from training, service and support for the fourth quarter was $125 million, versus $115 million reported for Q3. Gross margin declined slightly to 65.1%, from 65.3% in Q3, due to changes in product mix. In general, pricing for components remained stable and continues to follow normal learning curves. Total operating expenses for the quarter, excluding the $291 million one-time writeoff for in process R&D, decreased slightly to 32.4% of sales, as compared to Q3's 32.6%. R&D increased sequentially to 11.4% of sales from 11.1%, while the company's combined sales, marketing, and general and administrative expenses decreased to 21.0% from 21.5% for Q3. The tax provision for the quarter remained constant at 37%. Pro forma net income for the quarter was 21.7% of sales, the same as last quarter.

ONE-TIME ITEMS. During July 1997, Cisco completed the acquisitions of Ardent Communications Corp., Global Internet Software Group, and Skystone Systems Corp. for a combined purchase price of $305.2 million and took a one-time charge of $290.6 million, or $0.35 per share on an after-tax basis, as a write-off of in-process R&D. The company also realized a pretax gain of $18.0 million from the sale of a portion of one minority stock investment which, on an after-tax basis, contributed $0.02 per share to net income for the quarter.

BALANCE SHEET DETAILS. Cash, short-term, long-term and restricted investments increased by approximately $165 million to $2.9 billion. Cisco is currently generating on average an excess of $125 million dollars in positive cash flow per month. During the quarter, the company repurchased 5 million shares of stock for approximately $323 million and used approximately $60 million cash for two acquisitions. Accounts receivable increased sequentially by $31 million to $1.2 billion. Days of sales outstanding (DSO) decreased to 60 days from 63 days at the end of Q3. The quality of accounts receivable remains good, and depending on the linearity of orders and product shipment during the current quarter, management expects a modest improvement in DSO. Inventory was approximately $255 million, an increase of $21 million from Q3 to meet customer ordering requirements and shifts in product mix. Quarterly inventory turns were 10.1 versus 10.4 last quarter, reflecting good execution by Cisco's manufacturing organization. At year end, the total headcount was 10,728, an increase of 277 over Q3.

WILDCARD TOPIC. This quarter's conference-call "wildcard" topic was Cisco's Service Provider business segment. Approximately one-third of the company's engineering resources are focused on this area, and the sales organization is now aligned toward this market, as well. For purposes of discussion, the market may be categorized into three areas: Internet backbone, multiservice backbone -- also referred to as voice/data/video integration, and network-to-user -- also known as the "last mile."

INTERNET BACKBONE. Cisco continues to make good progress in expanding its high-end leadership and complementing its internal development with acquisitions, such as Skystone for high-speed OC-12 and OC-48 SONET technologies. Cisco's Gigabit Switch Router (GSR) will be announced as the Cisco 12000 in September. That platform is currently operating in the Internet, with first revenue shipments occurring in Q1 and volume shipments occurring in Q2 and Q3. The Cisco 12000 family will be further complemented by new chassis and interfaces, including OC-48, in Q2 and beyond. Cisco is also pleased with recent customer performance benchmarks for the Cisco 7500; results versus competitive products indicate the 7500's continued leadership. Tag switching has been endorsed in the standards committee as MPLS: multi-protocol label switching, and Cisco believes MPLS is on its way to becoming a standard. Cisco experienced a record quarter in terms of bookings and revenues for high-end routers. As forecasted in prior conference calls, Cisco's LAN switching bookings and revenues are now greater than those for high-end routing. WAN switching orders were up sequentially, but not as much as management would have liked. Cisco sees NORTHERN TELECOM (NYSE: NT) as being probably its strongest competitor in WAN, with Cascade [now part of ASCEND (Nasdaq: ASND)] second.

MULTISERVICE BACKBONE. In this area, Cisco shipped its STRATM technology, which results in major cost reductions and dramatic increases in capacity for the BPX and IGX switches. STRATM is in trial at approximately 15 customer sites, and the company is seeing very good acceptance for this technology for scaling the backbone. Cisco complemented its 3800 voice/video/data access solution with the acquisition of Ardent Technologies. The market for voice/video/data integration is expected to grow from $500 million in 1996 to $2.5 billion in the year 2000. Cisco will continue to move aggressively in this space and anticipates that in the next 12 to 18 months, approximately one-third of its acquisitions will be in this market category.

NETWORK-TO-USER. In this market, the shift from the consumer-oriented Internet to the business-oriented Internet is playing to Cisco's strength. Cisco's offering in this area include dial access, xDSL and, in the future, cable. In dial access, Cisco launched its AccessPath system for Point of Presence solutions with a single, integrated architecture incorporating elements of routing, switching, and dial access. Cisco continues to make key wins in the RBOC [Regional Bell Operating Companies], inter-exchange carriers, and PTTs -- two of which that have been publicly announced are GTE (NYSE: GTE) and NOKIA (NYSE: NOK.A). Cisco is currently shipping 56k technology for the AS5200. In the ADSL space, Cisco recently announced its intention to acquire Digaz technologies, which are complementary to Cisco's Telesend acquisition. Cisco has also extended its relationship with Alcatel to offer complete networking solutions telcos and other ISPs [Internet Service Providers] worldwide. Last month, Cisco launched its "Cisco Powered Network" program for service providers, with a very positive initial response.

AREAS OF STRENGTH. Acceptance of a single end-to-end vendor continues to go well, not only among enterprise customers but also in government and among service providers and even system integrators. Cisco's continues to gain market share in LAN switching; both ATM and LAN switching grew in excess of 100% year-over-year for Cisco in fiscal 1997. In Q4, Cisco announced three acquisitions in the service provider area and one in the small- to medium-business space. The company has also made a good start in developing key strategic alliances, including ones with MICROSOFT (Nasdaq: MSFT), GTE, HEWLETT-PACKARD (NYSE: HWP), Alcatel, and INTEL (Nasdaq: INTC). Cisco won a top award for Cisco Connection Online, its interactive commerce Web site. Cisco Connection resulted in double-digit expense savings in fiscal 1997, and the company is currently booking 32% of its business through Cisco Connection, with a run rate of over $2 billion, the largest of any company.

AREAS OF CONCERN. Given Cisco's "normal paranoia," the company always looks closely at areas of concern. Service provider spending is increasing but continues to be sporadic. Certain countries with slower economic growth, such as Japan, France, and probably Germany, continue to pose challenges. With only a few exceptions, peers and key competitors are cautious about the next one to two quarters, in light of seasonal issues -- especially in Europe -- and economic issues in specific countries. Strategic partnering is challenging to implement properly, even more difficult than making acquisitions.

GUIDANCE. Management has not seen any fundamental changes in terms of the technology or business drivers in the industry. Industry analysts continue to project industrywide growth of 30% to 50% over the next several years, and Cisco continues to endorse those projections, cautioning that there will be fluctuations from time to time above or below that rate. The U.S. tends to be strong for the industry as a whole, especially in enterprise accounts. Consolidation in the industry continues to accelerate, and as a result, many experts project a few larger players leading the industry. This plays to Cisco's advantage. However, this consolidation and technology architecture discussions can stretch out the sell cycle. In general, management feels better about the overall market going forward than they did six months ago, in part because redeployment in the company's sales force has had time to settle in and in part because of increased activity industrywide relative to a couple of quarters ago.

ADDITIONAL GUIDANCE. Management was pleased with the linearity in bookings and order flow throughout the quarter, which reflects a trend seen in Q3. Cisco is achieving its goal of one- to three-week lead times in most of its volume areas. Based on customer requests, Cisco is now aiming for one- to two-week lead times for most of its products. Shorter lead-times reduce visibility in terms of whether a given quarter will close at, above, or below expectations, however. Cisco expects gross margins to continue to decline in the future. The company's goal is to grow revenues at or above the industry's growth rate, although given Cisco's size and market-share leadership, growth in excess of the industry average is very challenging. Cisco's focus continues to be on balancing market share with EPS growth, which will require a careful mix of revenues, product mix, gross margins, and expenses, as well as investments in new market opportunities. In Q1, Cisco expects to invest more heavily than average in R&D and sales coverage, and those investments will not have meaningful revenue impact until fiscal Q3 and beyond. The share count for Q1 will depend upon any acquisition activity and how the price of the stock affects company stock options; keeping that in mind, management estimates a range of perhaps 10 million to 12 million in net incremental shares for Q1. Lastly, for fiscal 1998, Cisco will be lowering its tax provision from 37% to 35%, due to the implementation of various tax strategies and a slight reduction in the company's effective California tax rate.

NEXT REPORT. The next conference call will be Tuesday, Nov. 4, 1997 at 4:45pm Eastern time.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.

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