Networking leader Cisco Systems (Nasdaq: CSCO) reported fiscal first-quarter results Monday night, featuring sales growth of 66% to $6.5 billion, up from $3.9 billion a year ago. Pro forma net earnings, which leave out pretty much everything including payroll tax on stock option exercises, beat estimates by a penny. This surprised no one, since Cisco always beats estimates by a penny.

The San Jose, California technology bellwether now has trailing sales of $21.5 billion, up from $4.1 billion at the end of fiscal year 1996, an amazing 51% compound annual growth rate over the last four years. By 2004, CEO John Chambers expects the company to more than double its revenue to $50 billion. If the company can manage this feat, sales will grow at a 23% compound annual growth clip over the next four years.

Everyone is obsessed with Cisco's growth rate since it has driven the company's stock price over the last decade. That doesn't mean Cisco's broad product line, lean working capital management, and culture of speed aren't important. Attention to areas such as these, in fact, have kept Cisco's top line expanding rapidly, since sales growth flows from underlying business assets.

I saw nothing I didn't like in Cisco's first quarter. Receivables increased, but days sales outstanding are at 40 days, below the company's goal of 50 days. This isn't great from a time value of money standpoint, but Cisco is increasingly a global company and is selling more to service providers that expect longer payment terms than its traditional business customers. Cisco remains very efficient in the area of collections, so I don't see rising receivables as a business problem, even though it will affect cash flows.

Inventory turns dropped from 7.8 last quarter to 6.0, but the company deliberately built up component inventories in an effort to cut lead times. Management expects to correct the situation in the next three to four months, but investors shouldn't expect to see improvement in Q2. Again, speed of inventory is important, but so is keeping customers happy. Investors have to look at the business reasons behind changing financials, and then track developments quarter to quarter. At this point, Cisco is on top of its game.

The breadth and depth of growth across business lines and in different geographies was impressive. While Cisco's core business has always been routers, its ability to move into product areas such as hubs, LAN and WAN equipment, and now optics is really the key to its success. This ability to execute in new areas has given it an end-to-end product portfolio, which means it can provide a range of products and services to business customers and service providers alike.

Here's how Cisco's three main business lines grew sequentially in Q1 vs. Q4: 

   Unit       Q1    Q4
Enterprise   >20%   15%
Commercial   >20%   40%
Carriers    8%-9%   20%
While we see dips in sequential sales to commercial providers (small and medium businesses) and service providers (telephone companies), these kinds of fluctuations aren't unusual in the commercial segment, a fragmented market. While Chambers does have concerns regarding near-term spending among U.S. telecom carriers, these companies will have to upgrade pricey circuit-based systems with packet-switched networks, or continue building out new optical networks. As for a shakeout among telecom start-ups, there will be enough survivors to drive growth significantly higher over the next five years.

On the conference call, Chambers said that Cisco now has 12 product families generating more than $1 billion in annualized sales, and each of the three business units has at least three of these $1 billion product families in their lineup. This is an impressive arsenal.

What does all this mean? There isn't a company in a better position than Cisco to provide consumers, business customers, and service providers with end-to-end networking needs over the coming three to five years. The market is expected to grow 30% to 50% annually in economically strong countries, and Cisco expects to at least match the industry growth rate.

I imagine the Rule Maker will hold onto its Cisco shares for a long time. Keep in mind, however, that our cost basis (the price we paid for our shares) is a lot lower than the price Cisco's trading at now. We paid an average of $24.72 per share, which works out to 41x free cash flow, compared to the 93x it's trading at now.

The luster has come off the shares a bit perhaps as investors realize Cisco will have to perform heroically to keep pace with expectations. Consider that Chambers hopes to hit sales of $50 billion by 2004, which represents a 23% compound annual growth rate. Yet, as I wrote in last night's column, Cisco will have to grow its free cash flow at a 29% compound annual growth rate to double in value over the same period, and this assumes it will continue growing fast enough so investors will pay 50x free cash flow. Growing unrestricted profits at a rate faster than sales, when sales are growing as fast as they are, is an enormous challenge. Factor these issues into the process when thinking about Cisco as an investment.