UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)


[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~APRIL 27,~~October 26, 2002


[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to ___________

Commission file number 0-18225

CISCO SYSTEMS, INC.

(Exact name of ~~registrant~~Registrant as specified in its charter)


California (State or other jurisdiction of incorporation or organization)		77-0059951 (I.R.S. Employer Identification Number)

170 West Tasman Drive
San Jose, California 95134
(Address of principal executive office and zip code)

(408) 526-4000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the ~~registrant~~Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the ~~registrant~~Registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.

YES [X] NO [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES [ ] NO [X]

~~NO [ ]~~

As of ~~May 24,~~November 18, 2002, ~~7,316,574,545~~7,225,133,163 shares of the ~~registrant’s~~Registrant’s common stock were outstanding.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements (Unaudited)
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
EXHIBIT 99.1
EXHIBIT 99.2

Cisco Systems, Inc.

FORM 10-Q for the Quarter Ended ~~April 27,~~October 26, 2002

INDEX


			Page

Part I.	Financial Information

Item 1.	Financial Statements (Unaudited)

	a)	Consolidated Statements of Operations for the three ~~and nine~~ months ended ~~April 27,~~October 26, 2002 and ~~April 28,~~October 27, 2001		3

	b)	Consolidated Balance Sheets at ~~April 27,~~October 26, 2002 and July ~~28, 2001~~27, 2002		4

	c)	Consolidated Statements of Cash Flows for the ~~nine~~three months ended ~~April 27,~~October 26, 2002 and ~~April 28,~~October 27, 2001		5

	d)	Consolidated Statements of Shareholders’ Equity for the ~~nine~~three months ended ~~April 27,~~October 26, 2002 and ~~April 28,~~October 27, 2001		6

	e)	Notes to Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		26

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		5255

Item 4.	Controls and Procedures		56

Part II.	Other Information

Item 1.	Legal Proceedings		5356

Item 2.	Changes in Securities and Use of Proceeds		57

Item 6.	Exhibits and Reports on Form 8-K		5357

	Signature		5458

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

NET SALES:
Product $ 3,993 $ 4,007 $ 11,671 $ 15,982
Service 829 721 2,415 2,013

Total net sales 4,822 4,728 14,086 17,995

COST OF SALES:
Product 1,515 4,131 4,608 8,563
Service 239 269 748 796

Total cost of sales 1,754 4,400 5,356 9,359

GROSS MARGIN 3,068 328 8,730 8,636

OPERATING EXPENSES:
Research and development 838 1,028 2,617 2,987
Sales and marketing 1,063 1,351 3,230 4,147
General and administrative 164 195 463 587
Restructuring costs and other special charges — 1,170 — 1,170
Amortization of goodwill — 181 — 494
Amortization of purchased intangible assets 129 95 411 263
In-process research and development — 109 37 855

Total operating expenses 2,194 4,129 6,758 10,503

OPERATING INCOME (LOSS) 874 (3,801 ) 1,972 (1,867 )
Interest and other income (losses), net 150 236 (359 ) 931

INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME TAXES 1,024 (3,565 ) 1,613 (936 )
Provision for (benefit from) income taxes 295 (872 ) 492 85

NET INCOME (LOSS) $ 729 $ (2,693 ) $ 1,121 $ (1,021 )

Net income (loss) per share—basic $ 0.10 $ (0.37 ) $ 0.15 $ (0.14 )

Net income (loss) per share—diluted $ 0.10 $ (0.37 ) $ 0.15 $ (0.14 )

Shares used in per-share calculation—basic 7,306 7,251 7,310 7,170

Shares used in per-share calculation—diluted 7,454 7,251 7,473 7,170


			Three Months Ended

			October 26,			October 27,
			2002			2001

NET SALES:
	Product		$	4,013		$	3,656
	Service			832			792

		Total net sales		4,845			4,448

COST OF SALES:
	Product			1,237			1,500
	Service			250			256

		Total cost of sales		1,487			1,756

	GROSS MARGIN			3,358			2,692
OPERATING EXPENSES:
	Research and development			824			917
	Sales and marketing			1,098			1,096
	General and administrative			154			151
	Amortization of purchased intangible assets			114			146
	In-process research and development			—			37

		Total operating expenses		2,190			2,347

OPERATING INCOME				1,168			345
Interest income				179			234
Other income (loss), net				(475	)		(922	)

INCOME (LOSS) BEFORE PROVISION FOR (BENEFIT FROM) INCOME TAXES				872			(343	)
Provision for (benefit from) income taxes				254			(75	)

	NET INCOME (LOSS)		$	618		$	(268	)

Net income (loss) per share— basic			$	0.09		$	(0.04	)

Net income (loss) per share— diluted			$	0.08		$	(0.04	)

Shares used in per-share calculation— basic				7,249			7,307

Shares used in per-share calculation— diluted				7,327			7,307

See Notes to Consolidated Financial Statements

Cisco Systems, Inc.
CONSOLIDATED BALANCE SHEETS
(In millions, except par value)
(Unaudited)


				April 27,		July 28,					October 26,		July 27,
				2002		2001					2002		2002

ASSETS	ASSETS								ASSETS
Current assets:	Current assets:								Current assets:
	Cash and cash equivalents			$	6,493	$	4,873		Cash and cash equivalents		$	6,986	$	9,484
	Short-term investments				2,478		2,034		Short-term investments			3,325		3,172
	Accounts receivable, net of allowance for doubtful accounts of $346 at April 27, 2002 and $288 at July 28, 2001				990		1,466		Accounts receivable, net of allowance for doubtful accounts of $346 at October 26, 2002 and $335 at July 27, 2002			1,109		1,105
	Inventories, net				869		1,684		Inventories, net			828		880
	Deferred tax assets				2,010		1,809		Deferred tax assets			2,106		2,030
	Lease receivables, net				272		405		Lease receivables, net			194		239
	Prepaid expenses and other current assets				498		564		Prepaid expenses and other current assets			548		523

			Total current assets		13,610		12,835			Total current assets		15,096		17,433

Investments	Investments				12,090		10,346		Investments			10,877		8,800
Restricted investments					—		1,264
Property and equipment, net	Property and equipment, net				4,002		2,591		Property and equipment, net			3,921		4,102
Goodwill	Goodwill				3,350		3,189		Goodwill			3,709		3,565
Purchased intangible assets, net	Purchased intangible assets, net				1,090		1,470		Purchased intangible assets, net			682		797
Lease receivables, net	Lease receivables, net				42		253		Lease receivables, net			41		39
Other assets	Other assets				2,942		3,290		Other assets			2,872		3,059

			TOTAL ASSETS	$	37,126	$	35,238			TOTAL ASSETS	$	37,198	$	37,795

LIABILITIES AND SHAREHOLDERS’ EQUITY	LIABILITIES AND SHAREHOLDERS’ EQUITY								LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:	Current liabilities:								Current liabilities:
	Accounts payable			$	436	$	644		Accounts payable		$	540	$	470
	Income taxes payable				292		241		Income taxes payable			508		579
	Accrued compensation				1,266		1,058		Accrued compensation			1,083		1,365
	Deferred revenue				3,122		2,470		Deferred revenue			2,980		3,143
	Other accrued liabilities				2,523		2,553		Other accrued liabilities			2,424		2,496
	Restructuring liabilities				341		386		Restructuring liabilities			336		322

			Total current liabilities		7,980		7,352			Total current liabilities		7,871		8,375

Deferred revenue	Deferred revenue				711		744		Deferred revenue			771		749

			Total liabilities		8,691		8,096			Total liabilities		8,642		9,124

Commitments and contingencies (Note 6)	Commitments and contingencies (Note 6)								Commitments and contingencies (Note 6)

Minority interest	Minority interest				16		22		Minority interest			10		15

Shareholders’ equity:	Shareholders’ equity:								Shareholders’ equity:
	Preferred stock, no par value: 5 shares authorized; none issued and outstanding				—		—		Preferred stock, no par value: 5 shares authorized; none issued and outstanding			—		—
	Common stock and additional paid-in capital, $0.001 par value:								Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized; 7,233 and 7,303 shares issued and outstanding at October 26, 2002 and July 27, 2002, respectively			20,875		20,950
		20,000 shares authorized; 7,321 and 7,324 shares issued and outstanding at April 27, 2002 and July 28, 2001, respectively			20,631		20,051		Retained earnings			7,527		7,733
	Retained earnings				7,684		7,344		Accumulated other comprehensive income (loss)			144		(27	)
	Accumulated other comprehensive income (loss)				104		(275	)
										Total shareholders’ equity		28,546		28,656
			Total shareholders’ equity		28,419		27,120
										TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	37,198	$	37,795
			TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	37,126	$	35,238

See Notes to Consolidated Financial Statements

Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)


					Nine Months Ended										Three Months Ended

					April 27,			April 28,							October 26,			October 27,
					2002			2001							2002			2001

Cash flows from operating activities:	Cash flows from operating activities:										Cash flows from operating activities:
	Net income (loss)				$	1,121		$	(1,021	)
	Adjustments to reconcile net income (loss) to net cash provided by operating activities:										Net income (loss)				$	618		$	(268	)
		Depreciation and amortization				1,353			1,615		Adjustments to reconcile net income (loss) to net cash provided by operating activities:
		Provision for doubtful accounts				91			123			Depreciation and amortization				410			459
		Provision for inventory				109			2,697			Provision for doubtful accounts				47			26
		Deferred income taxes				(373	)		(1,431	)		Provision for (benefit from) inventory				7			(29	)
		Tax benefits from employee stock option plans				51			705			Deferred income taxes				(27	)		(540	)
		In-process research and development				25			739			Tax benefits from employee stock option plans				3			43
		Net (gains) losses on investments and provision for losses				1,076			43			In-process research and development				—			25
		Restructuring costs and other special charges				—			501			Net (gains) losses on investments and provision for losses				474			971
		Change in operating assets and liabilities:										Change in operating assets and liabilities:
			Accounts receivable			385			197				Accounts receivable			(51	)		259
			Inventories			665			(1,730	)			Inventories			49			229
			Prepaid expenses and other current assets			(20	)		(66	)			Prepaid expenses and other current assets			(36	)		70
			Accounts payable			(208	)		(85	)			Accounts payable			70			(185	)
			Income taxes payable			51			786				Income taxes payable			(70	)		34
			Accrued compensation			208			(108	)			Accrued compensation			(282	)		122
			Deferred revenue			619			1,000				Deferred revenue			(141	)		321
			Other accrued liabilities			(130	)		74				Other accrued liabilities			(18	)		(83	)
			Restructuring liabilities			(45	)		668				Restructuring liabilities			14			(70	)

				Net cash provided by operating activities		4,978			4,707					Net cash provided by operating activities		1,067			1,384

Cash flows from investing activities:	Cash flows from investing activities:										Cash flows from investing activities:
	Purchases of short-term investments					(4,166	)		(2,870	)	Purchases of short-term investments					(1,671	)		(2,327	)
	Proceeds from sales and maturities of short-term investments					4,702			3,459		Proceeds from sales and maturities of short-term investments					1,941			1,724
	Purchases of investments					(13,600	)		(14,613	)	Purchases of investments					(4,981	)		(2,790	)
	Proceeds from sales and maturities of investments					10,658			12,732		Proceeds from sales and maturities of investments					2,251			2,040
	Purchases of restricted investments					(291	)		(758	)	Purchases of restricted investments					—			(19	)
	Proceeds from sales and maturities of restricted investments					1,471			941		Proceeds from sales and maturities of restricted investments					—			161
	Acquisition of property and equipment					(2,243	)		(1,814	)	Acquisition of property and equipment					(122	)		(292	)
	Acquisition of businesses, net of cash and cash equivalents					14			(13	)	Acquisition of businesses, net of cash and cash equivalents					2			14
	Change in lease receivables, net					344			224		Change in lease receivables, net					43			165
	Purchases of investments in privately held companies					(52	)		(960	)	Purchases of investments in privately held companies					(12	)		(19	)
	Lease deposits					320			(320	)	Lease deposits					—			(73	)
	Purchase of minority interest of Cisco Systems, K.K. (Japan)					(91	)		(365	)	Purchase of minority interest of Cisco Systems, K.K. (Japan)					(59	)		(37	)
	Other					98			(573	)	Other					91			(138	)

				Net cash used in investing activities		(2,836	)		(4,930	)				Net cash used in investing activities		(2,517	)		(1,591	)

Cash flows from financing activities:	Cash flows from financing activities:										Cash flows from financing activities:
	Issuance of common stock					431			1,106		Issuance of common stock					41			171
	Repurchase of common stock					(952	)		—		Repurchase of common stock					(1,077	)		(350	)
	Other					(1	)		(15	)	Other					(12	)		—

				Net cash (used in) provided by financing activities		(522	)		1,091					Net cash used in financing activities		(1,048	)		(179	)

Net increase in cash and cash equivalents						1,620			868
Net decrease in cash and cash equivalents											Net decrease in cash and cash equivalents					(2,498	)		(386	)
Cash and cash equivalents, beginning of period	Cash and cash equivalents, beginning of period					4,873			4,234		Cash and cash equivalents, beginning of period					9,484			4,873

Cash and cash equivalents, end of period	Cash and cash equivalents, end of period				$	6,493		$	5,102		Cash and cash equivalents, end of period				$	6,986		$	4,487

See Notes to Consolidated Financial Statements

Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In millions)
(Unaudited)


			Common Stock					Accumulated									Common Stock						Accumulated
			and					Other			Total						and						Other			Total
Nine Months	Shares of		Additional		Retained			Comprehensive			Shareholders'
Ended April 28, 2001	Common Stock		Paid-In Capital		Earnings			Income			Equity
Three Months														Shares of			Additional			Retained			Comprehensive			Shareholders'
Ended October 27, 2001														Common Stock			Paid-In Capital			Earnings			Income			Equity

BALANCE AT JULY 29, 2000		7,138	$	14,609	$	8,358		$	3,530		$	26,497
BALANCE AT JULY 28, 2001															7,324		$	20,051		$	7,344		$	(275	)	$	27,120
Net loss		—		—		(1,021	)		—			(1,021	)		—			—			(268	)		—			(268	)
Change in unrealized gains and losses on investments		—		—		—			(3,504	)		(3,504	)
Change in net unrealized gains and losses on investments															—			—			—			555			555
Other		—		—		—			(15	)		(15	)		—			—			—			(2	)		(2	)

Comprehensive loss		—		—		—			—			(4,540	)
Comprehensive income															—			—			—			—			285

Issuance of common stock		128		1,106		—			—			1,106			23			171			—			—			171
Repurchase of common stock															(27	)		(74	)		(276	)					(350	)
Tax benefits from employee stock option plans		—		659		—			—			659			—			43			—			—			43
Purchase acquisitions		45		2,161		—			—			2,161			8			128			—			—			128
Amortization of deferred stock-based compensation		—		210		—			—			210			—			53			—			—			53

BALANCE AT APRIL 28, 2001		7,311	$	18,745	$	7,337		$	11		$	26,093
BALANCE AT OCTOBER 27, 2001															7,328		$	20,372		$	6,800		$	278		$	27,450


				Common Stock						Accumulated									Common Stock						Accumulated
				and						Other			Total						and						Other			Total
Nine Months	Shares of			Additional			Retained			Comprehensive			Shareholders'
Ended April 27, 2002	Common Stock			Paid-In Capital			Earnings			Income (Loss)			Equity
Three Months																Shares of			Additional			Retained			Comprehensive			Shareholders'
Ended October 26, 2002																Common Stock			Paid-In Capital			Earnings			Income			Equity

BALANCE AT JULY 28, 2001		7,324		$	20,051		$	7,344		$	(275	)	$	27,120
BALANCE AT JULY 27, 2002																	7,303		$	20,950		$	7,733		$	(27	)	$	28,656
Net income		—			—			1,121			—			1,121			—			—			618			—			618
Change in unrealized gains and losses on investments		—			—			—			382			382
Change in net unrealized gains and losses on investments																	—			—			—			194			194
Other		—			—			—			(3	)		(3	)		—			—			—			(23	)		(23	)

Comprehensive income		—	��		—			—			—			1,500			—			—			—			—			789

Issuance of common stock		50			431			—			—			431			7			41			—			—			41
Repurchase of common stock		(61	)		(171	)		(781	)		—			(952	)		(88	)		(253	)		(824	)		—			(1,077	)
Tax benefits from employee stock option plans		—			51			—			—			51			—			3			—			—			3
Purchase acquisitions		8			128			—			—			128			11			90			—			—			90
Amortization of deferred stock-based compensation		—			141			—			—			141			—			44			—			—			44

BALANCE AT APRIL 27, 2002		7,321		$	20,631		$	7,684		$	104		$	28,419
BALANCE AT OCTOBER 26, 2002																	7,233		$	20,875		$	7,527		$	144		$	28,546

See Notes to Consolidated Financial Statements

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Description of Business

Cisco Systems, Inc. (the “Company” or “Cisco”) ~~is the worldwide leader in~~manufactures and sells networking ~~for the Internet. Cisco Internet Protocol (“IP”)-based networking solutions are the foundation of the Internet~~ and communications products and provides services associated with that equipment and its use. Its products are installed at corporations, public institutions, and telecommunication companies, and are also found in ~~a growing number of~~small and medium-sized commercial enterprises. Cisco provides a broad line of ~~solutions~~products for transporting data, voice, and video within buildings, across campuses, or around the world. ~~Cisco solutions allow networks, both public and private, to operate with flexibility, security, and performance.~~

2. Summary of Significant Accounting Policies

Fiscal Year

The Company’s fiscal year is the 52 or 53 weeks ending on the last Saturday in July. Fiscal ~~2002~~2003 and ~~2001~~2002 are 52-week fiscal years.

Basis of Presentation

The accompanying financial data as of ~~April 27,~~October 26, 2002 and for the three ~~and nine~~ months ended ~~April 27,~~October 26, 2002 and ~~April 28,~~October 27, 2001 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The July ~~28, 2001~~27, 2002 Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July ~~28, 2001.~~27, 2002.

In the opinion of management, all adjustments (which include normal recurring adjustments except as disclosed herein) necessary to present a fair statement of financial position as of ~~April 27,~~October 26, 2002, results of operations, ~~for the three and nine months ended April 27, 2002 and April 28, 2001, and~~ cash flows and shareholders’ equity for the ~~nine~~three months ended ~~April 27,~~October 26, 2002 and ~~April 28,~~October 27, 2001, have been made. The results of operations for the three ~~and nine~~ months ended ~~April 27,~~October 26, 2002 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

~~Certain reclassifications have been made to prior period balances in order to conform to the current period presentation.~~

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Employee Stock Options

The Company accounts for stock-based awards to employees and directors using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees”. Under the intrinsic value method, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in the Company’s Consolidated Statements of Operations.

The Company is required under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), to disclose pro forma information regarding option grants made to its employees based on specified valuation techniques that produce estimated compensation charges.

Computation of Net Income (Loss) per Share

Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of common shares and dilutive potential common shares outstanding during the period. Diluted net loss per share is computed using the weighted-average number of common shares and excludes dilutive potential common shares outstanding, as their effect is antidilutive. Dilutive potential common shares ~~primarily~~ consist of employee stock ~~options.~~options and restricted common stock.

~~Goodwill and Purchased Intangible~~Long-Lived Assets

In ~~July 2001,~~ the ~~Financial Accounting Standards Board (“FASB”) issued Statement~~first quarter of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 requires goodwill to be tested for impairment under certain circumstances, and written down when impaired, rather than being amortized as previous standards required. Furthermore, SFAS 142 requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite.

~~SFAS 142 is effective for~~ fiscal ~~years beginning after December 15, 2001; however,~~2003, the Company elected to early-adopt the standard effective the beginning of fiscal 2002. In accordance with SFAS 142, the Company ceased amortizing goodwill totaling $3.2 billion as of the beginning of fiscal 2002, including $55 million of acquired workforce intangible previously classified as purchased intangible assets, net of related deferred tax liabilities.

~~Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally two to five years.~~

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

The following table presents the impact of SFAS 142 on net income (loss) and net income (loss) per share had the standard been in effect for the three and nine months ended April 28, 2001 (in millions, except per-share amounts):

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

Net income (loss)—as reported $ 729 $ (2,693 ) $ 1,121 $ (1,021 )
Adjustments:
Amortization of goodwill — 181 — 494
Amortization of acquired workforce intangible previously classified as purchased intangible assets — 4 — 9
Income tax effect — (25 ) — (70 )

Net adjustments — 160 — 433

Net income (loss)—adjusted $ 729 $ (2,533 ) $ 1,121 $ (588 )

Basic net income (loss) per share—as reported $ 0.10 $ (0.37 ) $ 0.15 $ (0.14 )
Basic net income (loss) per share—adjusted $ 0.10 $ (0.35 ) $ 0.15 $ (0.08 )
Diluted net income (loss) per share—as reported $ 0.10 $ (0.37 ) $ 0.15 $ (0.14 )
Diluted net income (loss) per share—adjusted $ 0.10 $ (0.35 ) $ 0.15 $ (0.08 )

The Company is required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. As of April 27, 2002, no impairment of goodwill has been recognized. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

~~Recent Accounting Pronouncement~~

~~In October 2001, the FASB issued~~adopted Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 establishes a single accounting model, based on the framework established in Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (“SFAS 121”), for long-lived assets to be disposed of by sale, and resolves implementation issues related to SFAS 121. The ~~Company is required to adopt~~adoption of SFAS 144 ~~no later than~~did not have a material impact on the ~~first quarter~~Company’s operating results or financial position.

Recent Accounting Pronouncement

In July 2002, the Financial Accounting Standards Board issued Statement of ~~fiscal 2003~~Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption of SFAS ~~144~~146 to have a material impact on its operating results or financial position.

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

3. Business Combinations

During the first quarter of fiscal ~~2002,~~2003, the Company completed the ~~acquisitions~~acquisition of ~~Allegro Systems,~~AYR Networks, Inc. ~~(“Allegro”)~~to augment the continued evolution of Cisco IOS® Software, the network systems software for the Company’s routing and AuroraNetics, Inc. (“AuroraNetics”). No acquisitions were completed during the second and third quarters of fiscal 2002. A summary of the purchase transactions completed in the first nine months of fiscal 2002switching platforms. The acquisition is ~~outlined~~summarized as follows (in millions):

Consideration Purchased
Including Assumed In-Process Intangible
Acquired Company Liabilities R&D Expense Goodwill Assets

Allegro $ 138 $ 28 $ 5 $ 105
AuroraNetics 51 9 16 14

Total $ 189 $ 37 $ 21 $ 119

Consideration Purchased
Including Assumed In-Process Intangible
Acquired Company Liabilities R&D Expense Goodwill Assets

AYR Networks, Inc. $97 $— $59 $—

In connection with the above purchase acquisitions, the Company may be required to pay certain additional amounts of up to $145 million, payable in common stock and to be accounted for under the purchase method, contingent upon Allegro and AuroraNetics achieving certain agreed upon milestones.

The amounts allocated to in-process research and development (“in-process R&D”) were determined through established valuation techniques in the high-technology communications equipment industry and were expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. Total in-process R&D expense for the first nine months of fiscal 2002 and 2001 was $37 million and $855 million, respectively. The in-process R&D expense that was attributable to stock consideration for the same periods was $25 million and $739 million, respectively.

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

~~The remaining~~ purchase price was ~~primarily~~also allocated to tangible assets and deferred stock-based compensation. ~~At April 27,~~As of October 26, 2002 and July ~~28, 2001,~~27, 2002, the total unamortized deferred stock-based compensation was ~~$175~~$162 million and ~~$293~~$182 million, respectively, and was reflected as a debit to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity. Deferred stock-based compensation is amortized as compensation cost over the remaining future vesting period of the stock options assumed of each acquired company. In the first quarter of fiscal 2002, the amortization of deferred stock-based compensation was $44 million and the additional deferred stock-based compensation net of canceled unvested options was $24 million.

The Company’s methodology for allocating the purchase price to in-process research and development (“in-process R&D”) is determined through established valuation techniques in the high-technology communications equipment industry and expensed upon acquisition because technological feasibility has not been established and no future alternative uses exist. Total in-process R&D expense for the first quarter of fiscal 2003 and 2002 was $0 million and $37 million, respectively. The in-process R&D expense that was attributable to stock consideration for the first quarter of fiscal 2002 was $25 million.

The Consolidated Financial Statements include the operating results of ~~each business~~AYR Networks, Inc. from the date of acquisition. Pro forma results of operations have not been presented because the ~~effects~~effect of ~~these acquisitions were~~the acquisition was not material ~~on either~~to the Company’s results.

During the first quarter of fiscal 2003, the Company issued approximately 2.7 million shares of common stock with a current value of $39 million to the former shareholders of AuroraNetics, Inc. as a result of the achievement of certain agreed-upon milestones. Such amounts were allocated to goodwill and deferred stock-based compensation totaling $31 million and $8 million, respectively. The Company is also required to issue up to an ~~individual or aggregate basis.~~additional 2.7 million shares of common stock to such former shareholders under the terms of the definitive acquisition agreement if certain other agreed-upon milestones are achieved.

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following tables present details of the Company’s total purchased intangible assets (in millions):


				Accumulated								Accumulated
April 27, 2002		Gross		Amortization			Net
October 26, 2002									October 26, 2002	Gross		Amortization			Net

Technology	Technology	$	1,096	$	(441	)	$	655	Technology	$	893	$	(497	)	$	396
Technology licenses	Technology licenses		523		(291	)		232	Technology licenses		523		(351	)		172
Patents	Patents		212		(75	)		137	Patents		128		(64	)		64
Other	Other		135		(69	)		66	Other		135		(85	)		50

	Total	$	1,966	$	(876	)	$	1,090	Total	$	1,679	$	(997	)	$	682

Accumulated
July 28, 2001 Gross Amortization Net

Technology $ 1,053 $ (240 ) $ 813
Technology licenses 523 (191 ) 332
Patents 232 (44 ) 188
Acquired workforce 91 (20 ) 71
Other 117 (51 ) 66

Total $ 2,016 $ (546 ) $ 1,470

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

~~The following table presents details of the amortization expense of purchased intangible assets as reported in the Consolidated Statements of Operations (in millions):~~

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

Reported as:
Cost of sales $ 5 $ 6 $ 17 $ 16
Operating expenses 129 95 411 263

Total $ 134 $ 101 $ 428 $ 279

Accumulated
July 27, 2002 Gross Amortization Net

Technology $ 893 $ (429 ) $ 464
Technology licenses 523 (323 ) 200
Patents 128 (54 ) 74
Other 135 (76 ) 59

Total $ 1,679 $ (882 ) $ 797

The estimated future amortization expense of purchased intangible assets as of ~~April 27,~~October 26, 2002 is as follows (in millions):


Fiscal Year:	Fiscal Year:	Amount		Fiscal Year:	Amount

2002 (remaining three months)		$	134
2003			416
2003 (remaining nine months)				2003 (remaining nine months)	$	244
2004	2004		291	2004		234
2005	2005		199	2005		154
2006	2006		49	2006		49
2007	2007		1	2007		1

	Total	$	1,090	Total	$	682

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table presents the changes in goodwill allocated to the Company’s reportable segments during the first ~~nine~~three months of fiscal ~~2002~~2003 (in millions):


		Balance at						Balance at			Balance at				Balance at
		July 28,						April 27,			July 27,				October 26,
		2001		Acquired		Adjustments		2002			2002		Acquired		2002

Americas	Americas	$	2,177	$	11	$	38	$	2,226	Americas	$	2,335	$	40	$	2,375
EMEA	EMEA		531		6		12		549	EMEA		593		28		621
Asia Pacific	Asia Pacific		110		2		4		116	Asia Pacific		140		11		151
Japan	Japan		371		87		1		459	Japan		497		65		562

	Total	$	3,189	$	106	$	55	$	3,350	Total	$	3,565	$	144	$	3,709

In the first ~~nine months~~quarter of fiscal ~~2002,~~2003, the Company purchased a portion of the minority interest of Cisco Systems, K.K. (Japan). As a result, the Company increased its ownership from 92.4% to ~~91.4%~~94.8% of the voting rights of Cisco Systems, K.K. (Japan) and recorded goodwill of ~~$85~~$54 million. ~~The adjustments during the first nine months of fiscal 2002 were due to the reclassification of~~

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

~~acquired workforce intangible and the related deferred tax liabilities to goodwill as a result of the adoption of SFAS 142.~~

4. Restructuring Costs and Other Special Charges ~~and Provision for Inventory~~

On April 16, 2001, ~~due to macroeconomic and capital spending issues affecting the networking industry,~~ the Company announced a restructuring program, ~~to prioritize its initiatives around a focus on profit contribution, high-growth areas of its business, reduction of expenses, and improved efficiency. This restructuring program~~which included a worldwide workforce reduction, consolidation of excess facilities, and restructuring of certain business functions.

As a result of the restructuring program and decline in forecasted revenue in the third quarter of fiscal 2001, the Company recorded restructuring costs and other special charges of $1.2 billion and an additional excess inventory charge of $2.2 billion. The following paragraphs provide detailed information relating to the status of the restructuring liabilities and additional excess inventory reserve as of April 27, 2002.

~~Worldwide Workforce Reduction, Consolidation of Excess Facilities, and Other Special Charges~~

The following table summarizes the activity related to the liability for restructuring ~~liabilities during the first nine months~~costs and other special charges as of ~~fiscal~~October 26, 2002 (in millions):

Balance at Cash Balance at
July 28, 2001 Adjustments(1) Payments April 27, 2002(2)

Workforce reduction $ 61 $ (35 ) $ (26 ) $ —
Consolidation of excess facilities and other charges 325 128 (112 ) 341

Total $ 386 $ 93 $ (138 ) $ 341

Consolidation of Impairment of
Excess Facilities Goodwill
Workforce and and Purchased
Reduction Other Charges (3) Intangible Assets Total

Initial charge in third quarter of fiscal 2001 $ 397 $ 484 $ 289 $ 1,170
Noncash charges (71 ) (141 ) (289 ) (501 )
Cash payments (265 ) (18 ) — (283 )

Balance at July 28, 2001 61 325 — 386
Adjustments (1) (35 ) 128 — 93
Cash payments (26 ) (131 ) — (157 )

Balance at July 27, 2002 — 322 — 322
Adjustments (2) — 40 — 40
Cash Payments — (26 ) — (26 )

Balance at October 26, 2002 $ — $ 336 $ — $ 336

1311

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

~~The following table summarizes the activity related to the restructuring liabilities from the third quarter of fiscal 2001 to April 27, 2002 (in millions):~~

Total Non-Cash Cash Balance at
Charge Adjustments(1) Charges Payments April 27, 2002(2)

Workforce reduction $ 397 $ (35 ) $ (71 ) $ (291 ) $ —
Consolidation of excess facilities and other charges 484 128 (141 ) (130 ) 341
Impairment of goodwill and purchased intangible assets 289 — (289 ) — —

Total $ 1,170 $ 93 $ (501 ) $ (421 ) $ 341

Note 1: Due to changes in previous estimates, in fiscal 2002, the Company reclassified $35 million of restructuring liabilities related to the workforce reduction charges to consolidation of excess facilities and other charges. The initial estimated workforce reduction was approximately 6,000 regular employees. ~~As of April 27, 2002, approximately~~Approximately 5,400 regular employees have been terminated and the liability has been paid. In addition, during the third quarter of fiscal 2002, the Company increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $93 million due to changes in real estate market conditions. The increase in ~~the~~ restructuring liabilities ~~related to the consolidation of excess facilities and other charges~~ was ~~allocated to~~recorded as research and development ($39 million), sales and marketing ($42 million), general and administrative ($8 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations.

Note 2: During the first quarter of fiscal 2003, the Company increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $40 million due to changes in real estate market conditions. The increase in restructuring liabilities was recorded as research and development ($16 million), sales and marketing ($16 million), general and administrative ($4 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations.

Note 2:3: Amounts related to the net lease expense due to the consolidation of excess facilities will be paid over the respective lease terms through fiscal 2010.

~~Provision for Inventory~~

~~The following is a summary of the change in the additional excess inventory reserve during the third quarter of fiscal 2002 (in millions):~~

Excess Inventory Excess Inventory
Reserve Benefit

Reserve balance as of January 26, 2002 $ 139 $ —
Usage:
Inventory scrapped (45 ) —
Inventory utilized (21 ) 21
Settlement of purchase commitments — 6

(66 ) $ 27

Remaining reserve balance as of April 27, 2002 $ 73

1412

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

~~The following is a summary of the additional excess inventory reserve from the third quarter of fiscal 2001 to April 27, 2002 (in millions):~~

Excess Inventory Excess Inventory
Reserve Benefit

Initial additional excess inventory charge $ 2,249 $ —
Usage:
Inventory scrapped (1,077 ) —
Sale of inventory (153 ) 23
Inventory utilized (444 ) 444
Settlement of purchase commitments (502 ) 232

(2,176 ) $ 699

Remaining reserve balance as of April 27, 2002 $ 73

5. Balance Sheet Details

The following tables provide details of selected balance sheet items (in millions):

      April 27,             July 28,
2002 2001

Inventories, net:

Raw materials $ 45 $ 662
Work in process 299 260
Finished goods 462 669
Demonstration systems 63 93

Total $ 869 $ 1,684

Other assets:

Deferred tax assets $ 1,400 $ 1,314
Investments in privately held companies, net 551 775
Income tax receivable 443 443
Lease deposits — 320
Structured loans, net 106 84
Other 442 354

Total $ 2,942 $ 3,290

October 26, July 27,
2002 2002

Inventories, net:

Raw materials $ 55 $ 38
Work in process 283 297
Finished goods 444 490
Demonstration systems 46 55

          Total $ 828 $ 880

Property and equipment, net:

Land, buildings, and leasehold improvements $ 3,300 $ 3,352
Computer equipment and related software 1,055 1,021
Production, engineering, and other equipment 2,125 2,061
Operating lease assets 520 505
Furniture and fixtures 361 366

7,361 7,305
Less, accumulated depreciation and amortization (3,440 ) (3,203 )

          Total $ 3,921 $ 4,102

Other assets:

Deferred tax assets $ 1,534 $ 1,663
Investments in privately held companies, net 484 477
Income tax receivable 392 392
Structured loans, net 45 61
Other 417 466

          Total $ 2,872 $ 3,059

Deferred Revenue:

Service $ 2,127 $ 2,207
Product 1,624 1,685

          Total 3,751 3,892
Less, current portion (2,980 ) (3,143 )

Non-current deferred revenue $ 771 $ 749

1513

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

~~5. Balance Sheet Details (continued)~~

April 27, July 28,
2002 2001

Deferred revenue:

Service $ 2,134 $ 2,027
Product 1,699 1,187

Total 3,833 3,214

Less, current portion (3,122 ) (2,470 )

Long-term deferred revenue $ 711 $ 744

6. Commitments and Contingencies

Leases

The Company leases office space in U.S. locations, as well as locations in the Americas; Europe, the Middle East, and Africa (“EMEA”); Asia Pacific; and Japan. Future annual minimum lease payments under all noncancelable operating leases with an initial term in excess of one year as of ~~April 27,~~October 26, 2002 ~~are~~were as follows (in millions):


Fiscal Year:	Fiscal Year:	Amount		Fiscal Year:	Amount

2002 (remaining three months)		$	68
2003			256
2003 (remaining nine months)				2003 (remaining nine months)	$	211
2004	2004		245	2004		260
2005	2005		212	2005		219
2006	2006		163	2006		168
2007				2007		133
Thereafter	Thereafter		775	Thereafter		714

	Total	$	1,719	Total	$	1,705

The Company had entered into several agreements to lease sites in San Jose, California where its headquarters is located and certain other facilities, both completed and under construction, which include additional manufacturing facilities, in the surrounding areas of San Jose, California; Boxborough, Massachusetts; Salem, New Hampshire; Richardson, Texas; and Research Triangle Park, North Carolina.

Under these agreements, the Company could, at its option, purchase the land or both land and buildings. The Company could purchase the buildings at approximately the amount expended by the lessors to construct the buildings. As part of the lease agreements, the Company had restricted its investment securities as collateral for specified obligations of the lessors under the leases.

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

In the third quarter of fiscal 2002, the Company elected to purchase all of the land and buildings as well as certain sites under construction under the above lease agreements. The total purchase price was approximately $1.9 billion of which $1.6 billion was purchased during the third quarter of fiscal 2002 and was primarily funded by the liquidation of restricted investment securities and lease deposits. The remaining property will be purchased in the fourth quarter of fiscal 2002 for cash of approximately $250 million. As a result, the Company will no longer have any leased sites under such agreements by the end of fiscal 2002.

Derivative Instruments

The Company conducts business on a global basis in several currencies. As such, it is exposed to adverse movements in foreign currency exchange rates. The Company enters into foreign exchange forward contracts to ~~reduce~~minimize the short-term impact of foreign currency fluctuations on certain foreign currency receivables, investments, and payables. The gains and losses on the foreign exchange forward contracts offset the transaction gains and losses on ~~the~~certain foreign currency receivables, investments, and payables recognized in earnings.

The Company does not enter into foreign exchange forward contracts for trading purposes. Gains and losses on the contracts are included in ~~interest and~~ other income ~~(losses)~~(loss), net, in the Company’s Consolidated Statements of Operations and offset foreign exchange gains or losses from the revaluation of intercompany balances or other current assets, investments, and liabilities denominated in currencies other than the functional currency of the reporting entity. The Company’s foreign exchange forward contracts related to current assets and liabilities generally range from one to three months in original maturity. Additionally, the Company ~~enters~~has entered into foreign exchange forward contracts related to long-term ~~financing commitments~~customer financings with maturities of up to ~~three~~two years. The foreign exchange contracts related to investments generally have maturities of less than one year.

The Company periodically hedges foreign currency forecasted transactions related to certain operating expenses with ~~purchased~~ currency options. These transactions are ~~treated~~designated as cash flow ~~hedges~~hedges. The effective portion of the derivative’s gain or loss is initially reported as a component of

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

accumulated other comprehensive income (loss) and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in ~~accordance with Statement of Financial Accounting Standards No. 133.~~earnings immediately. These ~~purchased~~ currency ~~options~~option contracts generally have maturities of less than one year. The Company does not purchase currency options for trading purposes.

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

Foreign exchange forward and option contracts as of ~~April 27,~~October 26, 2002 are summarized as follows (in millions):


		Notional		Fair				Notional		Fair
		Amount		Value				Amount		Value

Forward contracts:	Forward contracts:						Forward contracts:
	Purchased	$	649	$	(1	)	Purchased	$	605	$	—
	Sold	$	900	$	—		Sold	$	557	$	(1	)
Option contracts:	Option contracts:						Option contracts:
	Purchased	$	203	$	2		Purchased	$	564	$	11
							Sold	$	517	$	(1	)

The Company’s foreign exchange forward and option contracts expose the Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company minimizes such risk by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one ~~party~~counterparty resulting from this type of credit risk is monitored. Management does not expect any material losses as a result of default by ~~other parties.~~counterparties.

Legal Proceedings

The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

Beginning on April 20, 2001, a number of purported shareholder class action lawsuits were filed in the United States District Court for the Northern District of California against Cisco and certain of its officers and directors. The lawsuits ~~are essentially identical, purport to bring suit~~have been consolidated, and the consolidated action is purportedly brought on behalf of those who purchased the Company’s publicly traded securities between August 10, 1999 and ~~April 16, 2001, and have now been consolidated.~~February 6, 2001. Plaintiffs allege that defendants have made false and misleading statements, purport to assert claims for violations of the federal securities laws, and seek unspecified compensatory damages and other relief. Cisco believes the claims are without merit and intends to defend the actions vigorously.

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

for the Northern District of California, and those federal court actions have been consolidated. The complaints in the various derivative actions include claims for breach of fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment, and violations of the California Corporations ~~Code,~~Code; seek compensatory and other damages, disgorgement, and other ~~relief,~~relief; and are based on essentially the same allegations as the class actions.

~~Cisco~~Investment in Andiamo Systems, Inc.

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

~~Certain Investments in Privately Held Companies~~

On August 19, 2002, Cisco ~~has~~ entered into ~~investment agreements with four~~a definitive agreement to acquire privately held ~~development stage companies, pursuant to which Cisco has an option to acquire the remaining interests not owned by Cisco in each company for consideration consisting~~Andiamo Systems, Inc. (“Andiamo”). The acquisition of shares of Cisco’s common stock. In addition, each company has a put option enabling them to require Cisco to acquire the remaining interests not owned by Cisco in such company, subject to the fulfillment of various conditions, including the achievement of specified technology and other milestones.

In the case of three of the companies, the purchase prices for the remaining interests are generally based on the achievement of certain technology or other milestones by the companies. Subsequent to April 27, 2002, Cisco announced definitive agreements to acquire the remaining interests of two of these companies (Hammerhead Networks, Inc. and Navarro Networks, Inc.) for a total purchase price of approximately $258 million payable in common stock. These two acquisitions will be accounted for as purchases and areAndiamo is expected to close in the ~~fourth~~third quarter of fiscal ~~2002. Cisco anticipates that it will acquire~~2004, but no later than July 31, 2004.

Under the ~~remaining interest in the third company within the next three months for approximately $150 million.~~

~~In the case~~terms of the ~~fourth company,~~agreement, common stock of Cisco will be exchanged for all outstanding shares and options of Andiamo not owned by Cisco at the closing of the acquisition. The amount of the purchase price for the remaining ~~interest would~~equity interests in Andiamo not then held by Cisco is not determinable at this time, but will be based primarily upon a valuation of Andiamo to be determined by applying a multiple to the actual, annualized revenue generated from sales by Cisco of products attributable to Andiamo during a three-month period shortly preceding the ~~company’s products~~closing. Under its agreements with Andiamo, Cisco is the exclusive manufacturer and distributor of all Andiamo products. The multiple will be equal to Cisco’s average market capitalization during a specified period divided by Cisco’s annualized revenue for a three-month period ~~on an annualized basis. The acquisition,~~prior to closing, subject to adjustment as follows: (i) if ~~it occurs,~~the multiple so calculated is ~~expected~~less than 10, then the multiple to ~~close~~be used for purposes of determining the transaction price shall be the midpoint between 10 and the multiple so calculated; (ii) if the multiple so calculated is greater than 15, then the multiple to be used for purposes of determining the transaction price shall be the midpoint between 15 and the multiple so calculated. There is no ~~later than July 2004. The~~minimum purchase price, and the maximum purchase price is ~~not determinable at this time, and will range from $0~~limited to ~~a maximum purchase price of~~approximately $2.5 billion in shares of Cisco ~~shares~~common stock valued at the time of closing.

The ~~company’s put option~~acquisition has received the required approvals from both companies and is ~~exercisable only if the company has satisfactorily completed the development of a specified product~~subject to various closing conditions and approvals, including stockholder approval by ~~a specified date and commercial sales of that product have commenced.~~ Andiamo.

As of ~~April 27,~~October 26, 2002, Cisco has ~~funded $53 million of its~~made an $84 million investment ~~commitment to this company. Upon full funding~~in Andiamo in the form of ~~its commitment,~~convertible debt, which ~~is subject to termination if certain milestones are not achieved, Cisco will hold a promissory note that~~ is convertible into approximately 44% of the equity in Andiamo, subject to certain terms and conditions. This investment in Andiamo has been expensed as research and development costs, as if such expenses constituted the development costs of the ~~company. If either Cisco’s option or the company’s put option is exercised,~~Company. Furthermore, Cisco is also committed to provide additional funding to Andiamo in the ~~company~~form of non-convertible debt through the closing of the acquisition of approximately $100 million. ~~Since making its initial investment in the third quarter~~The Company had not funded any of ~~fiscal 2001, Cisco has expensed $52 million~~this additional amount as ~~research and development costs, which is equal to 100%~~ of ~~the net losses reported by the privately held company, as if such losses constituted development costs of Cisco.~~October 26, 2002.

1916

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Purchase Commitments with Contract Manufacturers and Suppliers

The Company uses several contract manufacturers and ~~supply partners~~suppliers to ~~manufacture~~provide manufacturing services for its products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, the Company enters into agreements with certain contract manufacturers and ~~supply partners~~suppliers that allow them to procure inventory based upon criteria as defined by the Company. As of ~~April 27,~~October 26, 2002, the Company ~~may be committed to~~has purchase commitments for inventory of approximately ~~$800~~$840 million, compared with $825 million as of ~~inventory.~~July 27, 2002.

Other Commitments

In fiscal 2001, the Company entered into an agreement to invest ~~$1.05~~approximately $1.0 billion in ~~the~~venture funds managed by SOFTBANK ~~Asia Infrastructure Fund, which is~~Corp. and its affiliates (“SOFTBANK”). These venture funds are required to be funded upon demand by ~~the general partner of the fund.~~SOFTBANK. As of ~~April 27,~~October 26, 2002, the Company has funded $100 million of this investment commitment.

The Company provides structured financing to certain qualified customers to be used for the purchase of equipment and other needs through its wholly-owned subsidiary, Cisco Systems Capital Corporation. ~~At April 27,~~As of October 26, 2002, the outstanding loan commitments were approximately ~~$1.3 billion,~~$376 million, subject to the customer achieving certain financial covenants, of which approximately ~~$400~~$190 million ~~is currently~~was eligible for draw down. These loan commitments may be funded over a two- to three-year period provided that these customers achieve specific business milestones and financial covenants.

The Company has entered into several agreements to purchase or construct real estate, subject to the satisfaction of certain conditions. As of ~~April 27,~~October 26, 2002, the total amount of commitments, if certain conditions are met, was approximately ~~$564~~$410 million.

~~At April 27,~~As of October 26, 2002, the Company has a commitment of approximately ~~$215~~$130 million to purchase the remaining portion of the minority interest of Cisco Systems, K.K. (Japan).

The Company also has certain other funding commitments of approximately $150 million ~~at April 27,~~as of October 26, 2002 related to its privately held investments.

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

7. Shareholders’ Equity

Stock Repurchase Program

In September 2001, the Board of Directors authorized a stock repurchase program to acquire outstanding common ~~stock in the open market or negotiated transactions.~~stock. Under the program, up to $3 billion of Cisco common stock could be reacquired over two years. In August 2002, the Board of Directors increased Cisco’s stock repurchase program by $5 billion to a total of $8 billion of Cisco common stock available for repurchase through September 12, 2003.

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

During the first ~~nine months~~quarter of fiscal ~~2002,~~2003, the Company repurchased and retired ~~approximately 61~~88 million shares of Cisco common stock for an aggregate purchase price of ~~approximately $952 million.~~$1.1 billion. As of October 26, 2002, the Company has repurchased and retired 212 million shares of Cisco common stock for an aggregate purchase price of $2.9 billion and the remaining authorized amount for stock repurchases under this program was $5.1 billion.

Comprehensive Income (Loss)

The components of comprehensive income (loss), net of tax, are as follows (in millions):


			Three Months Ended						Nine Months Ended								Three Months Ended

			April 27,			April 28,			April 27,			April 28,					October 26,			October 27,
			2002			2001			2002			2001					2002			2001

Net income (loss)	Net income (loss)		$	729		$	(2,693	)	$	1,121		$	(1,021	)	Net income (loss)		$	618		$	(268	)
Other comprehensive income (loss):
Other comprehensive income:															Other comprehensive income:
	Change in unrealized gains and losses on investments, net of tax			(199	)		(1,241	)		382			(3,504	)	Change in net unrealized gains and losses on investments, net of tax			194			555
	Other			9			(13	)		(3	)		(15	)	Other			(23	)		(2	)

		Total	$	539		$	(3,947	)	$	1,500		$	(4,540	)		Total	$	789		$	285

The change in ~~the~~net unrealized gains and losses on investments of $194 million and $555 million, after-tax, during the first ~~nine months~~quarter of fiscal 2003 and 2002, respectively, was primarily ~~related~~due to the effects of the recognition of a charge of $412 million and $858 million, pre-tax, ~~in the first quarter of fiscal 2002~~ attributable to the impairment of certain publicly traded ~~securities in its investment portfolio.~~equity securities. The impairment ~~charge was due~~charges were related to the ~~declines~~decline in the fair value of ~~the Company’s~~certain publicly traded equity investments below ~~the~~their cost basis that were judged to be other-than-temporary.

218. Employee Stock Option Plans

Stock Option Program Description

The Company has two plans under which it grants options: the 1996 Stock Incentive Plan (the “1996 Plan”) and the 1997 Supplemental Stock Incentive Plan (the “Supplemental Plan”).

Stock option grants are designed to reward employees for their long-term contribution to the Company and provide incentives for them to remain with the Company. The number and frequency of stock option grants is based on competitive practices, operating results of the Company and government regulations. Since the inception of the 1996 Plan, the Company has granted options to all of its employees and a majority has been granted to employees below the vice president level.

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.Distribution and Dilutive Effect of Options

The following table illustrates the grant dilution and exercise dilution (in millions, except percentages):

Three Months Fiscal Year
Ended Ended
October 26, 2002 July 27, 2002

Shares of common stock outstanding 7,233 7,303

Granted and assumed 83 282
Canceled (13 ) (82 )

Net options granted 70 200

Grant dilution (1) 1.0 % 2.7 %

Exercised 7 54
Exercise dilution (2) 0.1 % 0.7 %

Note 1: The percentage for grant dilution is computed based on options granted and assumed less options canceled as a percentage of total outstanding shares of common stock.

Note 2: The percentage for exercise dilution is computed based on options exercised as a percentage of total outstanding shares of common stock.

The following table summarizes the options granted to the Named Executive Officers. The Named Executive Officers represent the Company’s Chief Executive Officer and the four other most highly paid executive officers whose salary and bonus for the Company’s fiscal year ended July 27, 2002 were in excess of $100,000.

Three Months Fiscal Year
Ended Ended
October 26, 2002 July 27, 2002

Options granted to the Named Executive Officers 1 million 10 million

Options granted to the Named Executive Officers as a % of net options granted 1.4% 5.0%

Options granted to the Named Executive Officers as a % of outstanding shares 0.01% 0.1%

Cumulative options held by Named Executive Officers as % of total options outstanding 4.4% 4.6%

Basic and diluted shares outstanding for the quarter ended October 26, 2002 were 7.2 billion shares and 7.3 billion shares, respectively. Diluted shares outstanding include the dilutive impact of in-the-money options, which is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the tax-effected proceeds that would be hypothetically received from the exercise of all in-the-money options are assumed to be used to repurchase shares. In the first quarter of fiscal 2003, the dilutive impact of

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

in-the-money employee stock options was approximately 73 million shares or approximately 1% of the average basic shares outstanding based on Cisco’s average share price of $12.26.

The maximum number of shares issuable over the term of the 1996 Plan is limited to 2.5 billion shares. The share reserve was increased pursuant to the automatic share increases effected annually beginning in December 1996 and expired in December 2001. The share reserve has automatically increased on the first trading day of each December by an amount equal to 4.75% of the outstanding shares on the last trading day of the immediately preceding November.

General Option Information

A summary of option activity follows (in millions, except per-share amounts):

Options Outstanding

Options Weighted-Average
Available Number Exercise Price
for Grant Outstanding per Share

BALANCE AT JULY 28, 2001 522 1,060 $ 29.41
Granted and assumed (282 ) 282 17.72
Exercised — (54 ) 6.99
Canceled 82 (82 ) 36.94
Additional shares reserved 342 — —

BALANCE AT JULY 27, 2002 664 1,206 27.17
Granted and assumed (83 ) 83 10.07
Exercised — (7 ) 5.94
Canceled 13 (13 ) 35.35
Additional shares reserved 1 — —

BALANCE AT OCTOBER 26, 2002 595 1,269 $ 26.08

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table summarizes significant ranges of outstanding and exercisable options as of October 26, 2002 (shares and aggregate intrinsic value in millions, except number of years and per-share amounts):

Options Outstanding Options Exercisable

Weighted-
Average Weighted- Weighted-
Remaining Average Average
Contractual Exercise Aggregate Exercise Aggregate
Range of Number Life Price Intrinsic Number Price Intrinsic
Exercise Prices Outstanding (in Years) per Share Value Exercisable per Share Value

$ 0.01 - - 5.60 132 3.19 $ 4.42 $ 973 128 $ 4.54 $ 925
5.61 - - 9.78 149 6.07 8.41 502 77 7.24 347
9.79 - 15.92 152 5.51 12.82 11 116 12.48 7
15.93 - 16.24 149 7.94 16.08 — 23 16.05 —
16.25 - 20.61 181 7.73 19.24 — 31 18.44 —
20.62 - - 36.71 149 5.64 27.62 — 113 28.02 —
36.71 - 51.89 142 6.95 49.08 — 57 48.73 —
51.90 - 55.42 146 6.19 54.37 — 80 54.37 —
55.43 - 72.56 69 6.60 63.98 — 35 64.24 —

Total 1,269 6.25 $ 26.08 $ 1,486 660 $ 24.35 $ 1,279

As of July 27, 2002, 634 million outstanding options were exercisable and the weighted average exercise price for exercisable options was $23.51. The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value based on Cisco’s closing stock price of $11.78 as of October 25, 2002, that would have been received by the option holders had all option holders exercised their options as of that date. The following table presents the option exercises for the three months ended October 26, 2002 and option values as of that date for the Named Executive Officers (in millions):

Number of Securities Intrinsic Values of
Number of Underlying Unexercised Unexercised, In-the-Money
Shares Options at October 26, 2002 Options at October 26, 2002
Acquired

on Value
Exercise Realized Exercisable Unexercisable Exercisable Unexercisable

Named Executive Officers — — 37 19 $ 106 $ 2

The Company follows Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), in accounting for its employee stock options. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in the Company’s Consolidated Statements of Operations.

The Company is required under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), to disclose pro forma information

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

regarding option grants made to its employees based on specified valuation techniques that produce estimated compensation charges.

Pro forma information under SFAS 123 is as follows (in millions, except per-share amounts):

Three Months Fiscal Year
Ended Ended
October 26, July 27,
2002 2002

Net income — as reported $ 618 $ 1,893
Compensation expense, net of tax $ (368 ) $ (1,520 )

Net income — pro forma $ 250 $ 373

Basic net income per share — as reported $ 0.09 $ 0.26

Diluted net income per share — as reported $ 0.08 $ 0.25

Basic net income per share — pro forma $ 0.03 $ 0.05

Diluted net income per share — pro forma $ 0.03 $ 0.05

The value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions. The value of shares of common stock relating to the Employee Stock Purchase Plan included in the compensation expense was not material.

Employee Stock Option Plans

October 26, July 27,
2002 2002

Expected dividend 0.0 % 0.0 %
Risk-free interest rate 3.1 % 4.7 %
Expected volatility 45.9 % 47.5 %
Expected life (in years) 6.0 5.5

The Black-Scholes option pricing model was developed for use in estimating the value of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions including the expected stock price volatility. The Company uses projected data for expected volatility and expected life of its stock options based upon historical and other economic data trended into future years. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the estimate, in management’s opinion, the existing valuation models do not provide a reliable measure of the fair value of the Company’s options. Under the Black-Scholes option pricing model, the weighted-average estimated values of employee stock options granted during the first quarter of fiscal 2003 and fiscal year ended July 27, 2002 were $4.85 and $8.60 per share, respectively.

Cisco Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9. Income Taxes

The Company paid net income taxes of ~~$744~~$350 million and $390 million for the first ~~nine months~~quarter of fiscal 2003 and 2002, ~~and received net income tax refunds of $22 million for the first nine months of fiscal 2001.~~respectively. The Company’s income taxes currently payable for federal and state purposes have been reduced by the tax benefits from employee stock option transactions. These benefits totaled ~~$51~~$3 million and ~~$705~~$43 million in the first ~~nine months~~quarter of fiscal ~~2002~~2003 and ~~2001,~~2002, respectively, and were reflected as a credit to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity. Benefits increasing gross deferred tax assets totaled $833 million in the first nine months of fiscal 2001, and were credited directly to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity. In the first nine months of fiscal 2001, the Company’s valuation allowance against gross deferred tax assets attributable to employee stock option transactions increased by $879 million and was reflected as a debit to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity.

9.10. Segment Information and Major Customers

The Company’s operations involve the design, development, manufacturing, marketing, and technical support of networking and communications products and services. ~~The Company offers end-to-end networking solutions for its customers.~~ Cisco products include routers, ~~LAN~~switches, access, and ~~ATM switches, dial-up access servers, and network-management software.~~other networking equipment. These products, integrated by ~~the~~ Cisco IOS® Software, link geographically dispersed LANs and WANs into ~~complete end-to-end~~ networks.

The Company conducts business globally and is managed geographically. The Company’s management relies on an internal management system that provides sales and standard cost information by geographic theater. Sales are attributed to a theater based on the ordering location of the customer. The Company’s management makes financial decisions and allocates resources based on the information it receives from this internal management system. The Company does not allocate research and development, sales and marketing, or general and administrative expenses to its geographic theaters in this internal management system, as management does not use the information to measure the performance of the operating segments. Management does not believe that allocating these expenses is significant in evaluating a geographic theater’s performance. Based on established criteria, the Company has four reportable segments: the Americas; ~~Europe, the Middle East, and Africa (“EMEA”);~~EMEA; Asia Pacific; and Japan.

2223

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Summarized financial information by theater for the ~~third~~first quarter ~~and first nine months~~ of fiscal ~~2002~~2003 and ~~2001,~~2002, as taken from the internal management system previously discussed, is as follows (in millions):


			Three Months Ended						Nine Months Ended								Three Months Ended

			April 27,			April 28,			April 27,			April 28,					October 26,			October 27,
			2002			2001			2002			2001					2002			2001

Net sales:	Net sales:														Net sales:
	Americas		$	2,727		$	2,635		$	8,304		$	10,177		Americas		$	2,784		$	2,796
	EMEA			1,304			1,303			3,571			4,886		EMEA			1,313			1,055
	Asia Pacific			432			453			1,259			1,735		Asia Pacific			435			392
	Japan			359			337			952			1,197		Japan			313			205

		Total	$	4,822		$	4,728		$	14,086		$	17,995			Total	$	4,845		$	4,448

Gross margin:	Gross margin:														Gross margin:
	Americas		$	2,105		$	1,886		$	6,200		$	7,257		Americas		$	2,231		$	2,019
	EMEA			1,051			973			2,833			3,656		EMEA			1,071			814
	Asia Pacific			364			290			1,022			1,180		Asia Pacific			359			305
	Japan			286			256			764			932		Japan			261			153

		Standard margin		3,806			3,405			10,819			13,025			Standard margin		3,922			3,291
	Production overhead			(129	)		(150	)		(480	)		(451	)	Production overhead			(133	)		(191	)
	Manufacturing variances and other related costs			(609	)		(2,927	)		(1,609	)		(3,938	)	Manufacturing variances and other related costs			(431	)		(408	)

		Total	$	3,068		$	328		$	8,730		$	8,636			Total	$	3,358		$	2,692

The following table presents net sales for groups of similar products and services (in millions):															The following table presents net sales for groups of similar products and services (in millions):
																	Three Months Ended

																	October 26,			October 27,
																	2002			2001

Net sales:															Net sales:
															Routers		$	1,316		$	1,361
															Switches			1,996			1,731
															Access			249			256
															Other			452			308

Product															Product			4,013			3,656
Service															Service			832			792

																Total	$	4,845		$	4,448

~~Substantially all~~The majority of the Company’s assets ~~at April 27,~~as of October 26, 2002 and July ~~28, 2001~~27, 2002 were attributable to its U.S. operations. In the ~~third~~first quarter ~~and first nine months~~ of fiscal ~~2002~~2003 and ~~2001,~~2002, no single customer accounted for 10% or more of the Company’s net sales.

2324

Cisco Systems, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

~~The following table presents net sales for groups of similar products and services (in millions):~~

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

Routers $ 1,437 $ 1,361 $ 4,300 $ 5,827
Switches 1,898 2,069 5,511 7,471
Access 252 365 751 1,500
Other 406 212 1,109 1,184

Product 3,993 4,007 11,671 15,982
Service 829 721 2,415 2,013

Total $ 4,822 $ 4,728 $ 14,086 $ 17,995

~~10.~~11. Net Income (Loss) per Share

The following table presents the calculation of basic and diluted net income (loss) per share (in millions, except per-share amounts):

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

Net income (loss) $ 729 $ (2,693 ) $ 1,121 $ (1,021 )

Weighted-average shares— basic 7,306 7,251 7,310 7,170
Effect of dilutive securities:
Employee stock options 148 — 163 —

Weighted-average shares— diluted 7,454 7,251 7,473 7,170

Net income (loss) per share— basic $ 0.10 $ (0.37 ) $ 0.15 $ (0.14 )

Net income (loss) per share— diluted $ 0.10 $ (0.37 ) $ 0.15 $ (0.14 )

Three Months Ended

October 26, October 27,
2002 2001

Net income (loss) $ 618 $ (268 )

Weighted-average shares — basic 7,249 7,307
Effect of dilutive potential common shares 78 —

Weighted-average shares — diluted 7,327 7,307

Net income (loss) per share — basic $ 0.09 $ (0.04 )

Net income (loss) per share — diluted $ 0.08 $ (0.04 )

Dilutive potential common shares consist of employee stock options and restricted common stock. The weighted-average dilutive potential common shares, ~~that~~which were antidilutive for the ~~three and nine months ended April 28, 2001~~first quarter of fiscal 2002, amounted to ~~235~~159 million ~~and 382~~shares. Employee stock options to purchase approximately 967 million shares ~~respectively.~~

in the first quarter of fiscal 2003 and 675 million shares in the first quarter of fiscal 2002 were outstanding, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the average share price of the common shares and, therefore, the effect would have been antidilutive.

~~Cisco Systems, Inc.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(Unaudited)~~

~~11. Subsequent Events~~

12. Pending Business ~~Combinations~~Combination

~~The~~In October 2002, the Company announced a definitive ~~agreements~~agreement to acquire ~~the remaining interests of Hammerhead Networks, Inc. and Navarro Networks,~~Psionic Software, Inc. for a total purchase price of approximately ~~$258~~$12 million payable in common stock. ~~These acquisitions~~This acquisition will be accounted for as ~~purchases~~a purchase and ~~are~~is expected to close in the ~~fourth~~second quarter of fiscal ~~2002.~~2003.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

~~Certain~~Forward-Looking Statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements ~~contained~~regarding future events and our future results that are based on current expectations, estimates, forecasts, and projections about the industries in ~~this Quarterly Report on Form 10-Q, including, without limitation, statements containing~~which we operate and the ~~words “believes,~~beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” ~~“expects,” “projections,”~~variations of such words, and ~~words of~~ similar ~~import, constitute “forward-looking statements.” You should not place undue reliance on these~~expressions are intended to identify such forward-looking statements. ~~Our actual results could differ materially from those anticipated in~~Readers are cautioned that these forward-looking statements ~~for many reasons, including the~~are only predictions and are subject to risks, ~~faced by us described~~uncertainties, and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are referred to risks and uncertainties identified below, ~~under the heading “Risk Factors” and elsewhere in this Quarterly Report,~~ and in ~~other~~the documents ~~we file~~filed by us with the Securities and Exchange ~~Commission.~~Commission, specifically the most recent reports on Forms 10-K, 10-Q, and 8-K, each as it may be amended from time to time. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended July ~~28, 2001~~27, 2002 describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, inventory allowances, warranty costs, investment impairments, goodwill impairments, contingencies, restructuring costs and other special charges, and taxes. Actual results could differ materially from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements.

The allowance for doubtful accounts is based on our assessment of the ~~collectibility~~collectibilty of specific customer accounts and the aging of the accounts receivable. If there iswere a deterioration of a major customer’s ~~credit worthiness~~creditworthiness, or actual defaults ~~are~~were higher than our historical experience, our estimates of the recoverability of amounts due to us could be ~~adversely affected.~~overstated, which could have an adverse impact on our revenue.

A reserve for sales returns is established based on historical trends in product ~~returns.~~return rates. If the actual future returns ~~do not reflect~~were to deviate from the historical data on which the reserve had been established, our revenue could be adversely affected.

Inventory purchases and commitments are based upon future demand forecasts. If there iswere to be a sudden and significant decrease in demand for our products, or if there iswere a higher ~~risk~~incidence of inventory obsolescence because of rapidly changing technology and customer

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

requirements, we ~~may~~could be required to increase our inventory allowances and our gross ~~margin~~margins could be adversely affected.

We accrue for warranty costs based on historical trends in product return rates and the expected material and labor ~~usage~~ costs to provide warranty services. If we were to experience an increase in warranty claims ~~that are higher than~~compared with our historical experience, or costs of servicing warranty claims were greater than the expectations on which the accrual had been based, our gross ~~margin~~margins could be adversely affected.

We have experienced significant volatility in the market prices of our publicly traded equity investments. These investments are recorded on the ~~balance sheet~~Consolidated Balance Sheets as of October 26, 2002 at a fair value ~~and we~~of $458 million. We recognize an impairment charge in the Consolidated Statements of Operations when the decline in the fair value of our publicly traded equity investments below ~~the~~their cost basis is judged to be other-than-temporary. We consider various factors in determining whether we should recognize

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

an impairment charge including, but not limited to, the length of time and extent to which the ~~market~~fair value has been less than our cost basis, the financial condition and near-term prospects of the issuer, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. The ultimate value realized on these equity investments is subject to market price volatility until they are sold. We also have investments in privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. As of October 26, 2002, the investments in privately held companies, net were $484 million.

We ~~will~~ perform goodwill impairment tests on an annual basis and between annual tests in certain ~~circumstances.~~circumstances for each reporting unit, which are the operating segments as described in Note 10 to the Consolidated Financial Statements. In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing, ~~of,~~ or otherwise exiting businesses, which could result in an impairment of goodwill.

We are subject to the possibility of various loss contingencies arising in the ordinary course of business. We consider the likelihood of ~~the~~ loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred ~~or an asset has been impaired~~ and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted.

~~Net Sales and Gross Margin~~

~~The net sales and gross margin for the third quarter and first nine months of fiscal 2002 and 2001 were as follows (in millions, except percentages):~~

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

Net Sales:
Product $ 3,993 $ 4,007 $ 11,671 $ 15,982
Service 829 721 2,415 2,013

Total $ 4,822 $ 4,728 $ 14,086 $ 17,995

Gross Margin:
Product 62.1 % (3.1 )% 60.5 % 46.4 %
Service 71.2 % 62.7 % 69.0 % 60.5 %

Total 63.6 % 6.9 % 62.0 % 48.0 %

Net product revenue in the third quarter of fiscal 2002 decreased by 0.3% from the third quarter of fiscal 2001. Net product revenue in the first nine months of fiscal 2002 decreased by 27.0% from the first nine months of fiscal 2001. The decrease in net product revenue for the third quarter and first nine months of fiscal 2002 compared to the same periods last year was primarily a result of decreased unit sales of router, switch, and access products due to the unfavorable economic conditions and capital spending environment compared to the periods a year ago. Net product revenue was $4.0 billion in the second quarter of fiscal 2002.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

~~The increase in~~Net Sales

We manage our business based on four geographic theaters: the Americas; EMEA; Asia Pacific; and Japan. Net sales, which include product ~~gross margin~~and service revenue, for the third quarter and first nine months of fiscal 2002 compared to the same period last year was primarily related to the cost savings from lower component costs, value engineering, mix of products sold and an additional excess inventory charge recordedeach theater are summarized in the ~~prior year partially offset by lower shipment volumes. Due to~~following table (in millions, except percentages):

Three Months Ended

Amount Percentage of Net Sales

October 26, October 27, October 26, October 27,
2002 2001 2002 2001

Net sales:
Americas $ 2,784 $ 2,796 57.5 % 62.9 %
EMEA 1,313 1,055 27.1 % 23.7 %
Asia Pacific 435 392 9.0 % 8.8 %
Japan 313 205 6.4 % 4.6 %

Total $ 4,845 $ 4,448 100.0 % 100.0 %

Net sales in the first quarter of fiscal 2003 increased by $397 million or 8.9% from $4.4 billion in the first quarter of fiscal 2002 to $4.8 billion. The following table is a breakdown of net sales between product and service revenue (in millions):

Three Months Ended

October 26, October 27,
2002 2001

Net Sales:
Product $ 4,013 $ 3,656
Service 832 792

Total $ 4,845 $ 4,448

Product Revenue

From a ~~sudden and significant decrease in demand for our products~~geographic perspective, net product sales in the ~~third quarter of fiscal 2001, inventory levels exceeded our estimated requirements based on demand forecasts~~Americas theater, which include the United States, Canada, Mexico, and ~~an additional excess inventory charge of $2.2~~Latin America, increased by $173 million or 8.6% from $2.0 billion ~~was recorded in accordance with our accounting policy.~~

~~This additional excess inventory charge was subsequently reduced~~ in the ~~fourth quarter of fiscal 2001 by a $187 million benefit primarily related to lower settlement charges for purchase commitments. In the~~ first ~~second, and third~~ quarter of fiscal 2002 ~~this additional excess inventory charge was further reduced by a $290 million, $195 million, and $27 million benefit, respectively, primarily related~~ to inventory used to manufacture products sold and the settlement of purchase commitments for less than the estimated amount, which was credited to the provision for inventory. As of April 27, 2002, the remaining additional excess inventory reserve balance was $73 million. For additional information regarding the additional excess inventory reserve, see Note 4 to the Consolidated Financial Statements. Excluding the excess inventory benefit, product gross margin was 61.4%$2.2 billion in the ~~third~~first quarter of fiscal 2003. Net product sales in EMEA increased by $113 million or 10.7% from $1.1 billion in the first quarter of fiscal 2002 ~~compared with 55.5%~~to $1.2 billion in the ~~second~~first quarter of fiscal ~~2002. The increase~~2003. Net product sales in ~~product gross margin excluding the excess inventory benefit~~Asia Pacific decreased by $2 million or 1.0% from $392 million in the ~~third~~first quarter of fiscal 2002 ~~compared~~ to $390 million in the ~~second~~first quarter of fiscal 2003. Net product sales in Japan increased by $73 million or 35.6% from $205 million in the first quarter of fiscal 2002 ~~was primarily~~to $284 million in the first quarter of fiscal 2003.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Net product sales in the Americas and EMEA theaters increased as compared with the first quarter of fiscal 2002 due to higher revenue from the enterprise market in proportion to the service provider market. Service provider customers typically have longer implementation cycles, require a broader range of service, including design services, often have acceptance provisions, which can lead to a delay in revenue recognition. The slowdown in the general economy, over-capacity, and constraints on information technology-related capital spending have continued to impact our customers, in particular service provider customers. The changes in net product sales for the other theaters were not material.

The following table presents net sales for groups of similar products (in millions):

Three Months Ended

October 26, October 27,
2002 2001

Net product sales:
Routers $ 1,316 $ 1,361
Switches 1,996 1,731
Access 249 256
Other 452 308

Total $ 4,013 $ 3,656

Net product sales related to ~~cost savings~~routers, which represented 32.8% of our total product sales in the first quarter of fiscal 2003, decreased by $45 million or 3.3% from ~~lower component costs, value engineering, lower production overhead~~$1.4 billion in the first quarter of fiscal 2002 to $1.3 billion primarily due to decreases in our low, mid-range and ~~lower provision for inventory resulting~~edge routers, offset to some extent by an increase in high end routers. Net product sales related to switches, which represented 49.7% of our total product sales in the first quarter of fiscal 2003, increased by $265 million or 15.3% from ~~lower inventory balances.~~$1.7 billion in the first quarter of fiscal 2002 to $2.0 billion primarily due to increases in our sales of our fixed and modular switches. Changes in access and other net product sales were not material.

Service Revenue

Net service revenue in the ~~third~~first quarter of fiscal 2003 increased by $40 million or 5.1% from $792 million in the first quarter of fiscal 2002 ~~increased by 15.0% from the third quarter of fiscal 2001. Net service revenue in the first nine months of fiscal 2002 increased by 20.0% from the first nine months of fiscal 2001.~~to $832 million. The increase in net service revenue ~~for the third quarter and first nine months of fiscal 2002 compared to the same periods last year~~ was primarily due to ~~the increase in~~increased technical support service contract initiations and renewals associated with product sales. In addition, revenue ~~related to a higher installed base~~from advanced services, which provides consultative support of our technologies for specific networking ~~equipment. Service~~needs also increased. Net service revenue is generally deferred and, in most cases, recognized ratably over the service period obligations, which are typically one to three years. Net service revenue in the third quarter of fiscal 2002 increased by 4.4% to $829 million compared to net service revenue of $794 million in the second quarter of fiscal 2002. The increase in service gross margin for the third quarter and first nine months of fiscal 2002 compared to the same periods last year was primarily due to higher service revenue and cost efficiencies in our technical assistance centers. Service gross margin was 68.1% in the second quarter of fiscal 2002.

2829

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

We manage our business based on four geographic theaters: the Americas; Europe, the Middle East, and Africa (“EMEA”); Asia Pacific; and Japan. Financial information by theater for the third quarter and first nine months of fiscal 2002 and 2001 is summarized in the following table (in millions):Gross Margin

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

Net sales:
Americas $ 2,727 $ 2,635 $ 8,304 $ 10,177
EMEA 1,304 1,303 3,571 4,886
Asia Pacific 432 453 1,259 1,735
Japan 359 337 952 1,197

Total $ 4,822 $ 4,728 $ 14,086 $ 17,995

Gross margin:
Americas $ 2,105 $ 1,886 $ 6,200 $ 7,257
EMEA 1,051 973 2,833 3,656
Asia Pacific 364 290 1,022 1,180
Japan 286 256 764 932

Standard margin 3,806 3,405 10,819 13,025
Production overhead (129 ) (150 ) (480 ) (451 )
Manufacturing variances and other related costs (609 ) (2,927 ) (1,609 ) (3,938 )

Total $ 3,068 $ 328 $ 8,730 $ 8,636

The following table shows the standard margin for each ~~theater:~~theater and the total gross margin (in millions, except percentages):

Three Months Ended Nine Months Ended

April 27, April 28, April 27, April 28,
2002 2001 2002 2001

Standard margin:
Americas 77.2 % 71.6 % 74.7 % 71.3 %
EMEA 80.6 % 74.7 % 79.3 % 74.8 %
Asia Pacific 84.3 % 64.0 % 81.2 % 68.0 %
Japan 79.7 % 76.0 % 80.3 % 77.9 %

Total 78.9 % 72.0 % 76.8 % 72.4 %

Three Months Ended

Amount Standard Margin

October 26, October 27, October 26, October 27,
2002 2001 2002 2001

Gross margin:
Americas $ 2,231 $ 2,019 80.1 % 72.2 %
EMEA 1,071 814 81.6 % 77.2 %
Asia Pacific 359 305 82.5 % 77.8 %
Japan 261 153 83.4 % 74.6 %

Standard margin 3,922 3,291 80.9 % 74.0 %
Production overhead (133 ) (191 )
Manufacturing variances and other related costs (431 ) (408 )

Total $ 3,358 $ 2,692

Standard margin varies due to a number of reasons including, but not limited to, shifts in product mix, sales discounts, and sales channels. Production overhead is primarily related to labor, depreciation on equipment, and facilities charges associated with manufacturing activities. Manufacturing variances and other related costs are primarily related to provision for inventory, freight and other nonstandard costs.

29Gross margin for product and service in the first quarter of fiscal 2003 and 2002 was as follows (in millions, except percentages):

Three Months Ended

Amount Percentage

October 26, October 27, October 26, October 27,
2002 2001 2002 2001

Gross margin:
Product $ 2,776 $ 2,156 69.2 % 59.0 %
Service 582 536 70.0 % 67.7 %

Total $ 3,358 $ 2,692 69.3 % 60.5 %

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Product Gross Margin

Product gross margin was 69.2% in the first quarter of fiscal 2003, compared with 59.0% in the first quarter of fiscal 2002, respectively. The increase in product gross margin was primarily due to lower component costs, changes in the mix of products sold and improved inventory management.

Product gross margin may be adversely affected in the future by increases in material or labor costs, excess inventory and obsolescence charges, changes in shipment volume, loss of cost savings due to changes in component pricing, charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand, price competition, and changes in channels of distribution or in the mix of products sold. If ~~product or related~~ warranty costs associated with our products are greater than we have experienced, product gross margin may also be adversely affected. Product gross margin may also be ~~impacted~~affected by geographic mix, as well as the mix of configurations within each product group. ~~We continue to utilize third-party or indirect-distribution channels, which generally results in a lower product gross margin. These~~

Two-tier distribution channels are ~~generally~~ given privileges to return a portion of inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. In addition, increasing ~~third-party and indirect-distribution~~two-tier distribution channels generally ~~result~~results in greater difficulty in forecasting the mix of our products and, to a certain degree, the timing of orders from our customers. We recognize revenue to two-tier distributors based on a sell-through method utilizing information provided by our distributors and we also maintain accruals and allowances for all cooperative marketing and other programs.

Service Gross Margin

Service gross margin increased from 67.7% in the first quarter of fiscal 2002 to 70.0% in the first quarter of fiscal 2003. The increase in service gross margin was primarily due to the increase in service revenue combined with continued efficiencies in the delivery of our services. Service gross margin will typically experience some variability over time due to various factors such as the changes in mix between technical support services and ~~professional~~advanced services, as well as the timing of technical support service contract initiations and renewals.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Research and Development, Sales and Marketing, and General and Administrative Expenses

Research and development (“R&D”), sales and marketing, and general and administrative (“G&A”) expenses are summarized in the following table (in millions, except percentages):


															Three Months Ended

		Three Months Ended						Nine Months Ended						Amount					Percentage of Net Sales

		April 27,			April 28,			April 27,			April 28,			October 26,			October 27,		October 26,			October 27,
		2002			2001			2002			2001			2002			2001		2002			2001

Research and development	Research and development	$	838		$	1,028		$	2,617		$	2,987			$	824	$	917		17.0	%		20.6	%
	Percentage of net sales		17.4	%		21.7	%		18.6	%		16.6	%

Sales and marketing	Sales and marketing	$	1,063		$	1,351		$	3,230		$	4,147			$	1,098	$	1,096		22.7	%		24.6	%
	Percentage of net sales		22.0	%		28.6	%		22.9	%		23.0	%

General and administrative	General and administrative	$	164		$	195		$	463		$	587			$	154	$	151		3.2	%		3.4	%
	Percentage of net sales		3.4	%		4.1	%		3.3	%		3.3	%

In the third quarter of fiscal 2001, we announced a restructuring program to prioritize our initiatives around a focus on profit contribution, high-growth areas of our business, reduction of expenses, and improved efficiency. This restructuring program included a worldwide workforce reduction, consolidation of excess facilities, and restructuring of certain business functions. For additional information regarding the restructuring program, see Note 4 to the Consolidated Financial Statements. During the third quarter of fiscal 2002, we increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $93 million due to changes in real estate market conditions. The increase in the restructuring liabilities related to the consolidation of excess facilities and other charges was allocated to R&D ($39 million), sales and marketing ($42 million), G&A ($8 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

R&D, sales and marketing, and G&A expenses decreased in absolute dollars from the prior year primarily due to the impact of the restructuring program and cost control measures to contain hiring and reduce discretionary spending. As a result, total R&D, sales and marketing, and G&A expenses have been reduced on a quarterly basis by approximately $600 million compared to the high point in the second quarter of fiscal 2001.

R&D expenses in the ~~third~~first quarter of fiscal 2003 were $824 million, compared with $917 million in the first quarter of fiscal 2002, ~~decreased by 18.5% from the third quarter~~a decrease of fiscal 2001. R&D expenses in the first nine months of fiscal 2002 decreased by 12.4% from the first nine months of fiscal 2001. R&D expenses in the third quarter of fiscal 2002 decreased by 2.8% compared with R&D expenses of $862$93 million ~~in the second quarter of fiscal 2002.~~or 10.1%. A significant portion of the decrease in R&D expenses ~~for the third quarter and first nine months of fiscal 2002 compared to the same periods last year~~ was due to lower expenditures on prototypes, lower depreciation on lab equipment, and reduced discretionary spending. We have continued to invest in R&D efforts in a wide variety of areas such as data, voice, and video over IP; advanced access and aggregation technologies such as cable, wireless, and other broadband technologies; advanced enterprise switching; optical transport; storage networking; content networking; security; network management; and advanced core and edge routing technologies; among others. We have also continued to purchase or license technology in order to bring a broad range of products to ~~the~~ market in a timely fashion. If we believe that we are unable to enter a particular market in a timely manner with internally developed products, we may license technology from other businesses or acquire businesses as an alternative to internal R&D. All of our R&D costs have been expensed as incurred.

Sales and marketing expenses were $1.1 billion in the ~~third~~first quarter of fiscal 2003 and 2002, ~~decreased by 21.3% from the third quarter of fiscal 2001. Sales and marketing expenses in the first nine months of fiscal 2002 decreased by 22.1% from the first nine months of fiscal 2001.~~respectively. Sales and marketing expenses were ~~$1.1 billion~~primarily related to personnel expenses in ~~the second quarter of fiscal 2002. The decrease in~~our sales and marketing expenses for the third quarter and first nine months of fiscal 2002 compared to the same periods last year was principally due to the decrease in the size of our sales force and marketing organization, reducedorganizations, marketing and advertising investments, and ~~reduced investments in~~ general ~~corporate branding. However, we have continued our efforts to invest in certain key areas, such as expansion of our end-to-end networking strategy~~promotional and ~~service provider coverage, in order to be positioned to take advantage of future market opportunities.~~marketing program expenses.

G&A expenses in the ~~third~~first quarter of fiscal ~~2002 decreased by 15.9% from the third quarter of fiscal 2001. G&A expenses~~2003 were $154 million, compared with $151 million in the first nine months of fiscal 2002 decreased by 21.1% from the first nine months of fiscal 2001. G&A expenses in the third quarter of fiscal 2002 increased by 10.8% compared with G&A expenses of $148 million in the second quarter of fiscal 2002. ~~The decrease in~~ G&A expenses ~~for the third quarter and first nine months of fiscal 2002 compared to the same periods last year was~~were primarily related to ~~the reductions in~~our investments in infrastructure and personnel expenses in support and administrative ~~functions,~~functions.

During the first quarter of fiscal 2003, we increased the restructuring liabilities related to the consolidation of excess facilities and ~~discretionary spending.~~other charges by $40 million due to changes in real estate market conditions. The increase in restructuring liabilities was recorded as R&D ($16 million), sales and marketing ($16 million), G&A ($4 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations.

3132

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

~~Amortization of Goodwill~~

We elected to early-adopt Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) effective the beginning of fiscal 2002. In accordance with SFAS 142, we ceased amortizing goodwill. We are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. As of April 27, 2002, no impairment of goodwill has been recognized. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings. For additional information regarding SFAS 142, see Note 2 to the Consolidated Financial Statements.

Amortization of Purchased Intangible Assets

Amortization of purchased intangible assets included in operating expenses was ~~$129 million in the third quarter of fiscal 2002, compared to $95 million in the third quarter of fiscal 2001. Amortization of purchased intangible assets included in operating expenses was $411~~$114 million in the first ~~nine months~~quarter of fiscal ~~2002,~~2003, compared ~~to $263~~with $146 million in the first ~~nine months of fiscal 2001. Amortization of purchased intangible assets in the second~~ quarter of fiscal ~~2002 was $136 million.~~2002. The ~~increase~~decrease in the amortization of purchased intangible assets ~~for the third quarter and first nine months of fiscal 2002 compared to the same periods last year~~ was primarily related to the ~~additional amortization from recent acquisitions and~~ accelerated amortization for certain technology and patent intangibles in the prior year period due to a reduction in their estimated useful ~~lives.~~lives which have now been fully amortized. For additional information regarding purchased intangible assets, see Note 3 to the Consolidated Financial Statements.

In-Process Research and Development

The ~~amount expensed~~methodology for allocating the purchase price to in-process research and development (“in-process R&D”) ~~arose from purchase acquisitions (see~~is determined through established valuation techniques in the high-technology communications equipment industry and expensed upon acquisition because technological feasibility has not been established and no future alternative uses exists. (See Note 3 to the Consolidated Financial Statements). The fair ~~values~~value of the existing purchased technology and patents, as well as the technology ~~currently~~ under development, ~~were~~is determined using the income approach, which discounts expected future cash flows to present value. The discount rates used in the present value calculations ~~were~~are typically derived from a weighted-average cost of capital analysis and venture capital surveys, adjusted upward to reflect additional risks inherent in the development life cycle. We consider the pricing model for products related to these acquisitions to be standard within the high-technology communications equipment industry. However, we do not expect to achieve a material amount of expense reductions ~~or synergies~~ as a result of integrating the acquired in-process technology. Therefore, the valuation assumptions do not include significant anticipated cost savings.

~~The~~For acquisitions completed to date, the development of these technologies remains a significant risk due to the remaining efforts to achieve technical viability, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats from ~~numerous~~several companies. The nature of the efforts to develop these technologies into commercially viable products consists principally of planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations, including functionality and technical requirements. Failure to bring these products to market in a timely manner could result in a loss of market share

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

or a lost opportunity to capitalize on emerging markets, and could have a material adverse impact on our business and operating results.

The ~~following table summarizes the~~ key assumptions underlying the valuations for our purchase acquisitions ~~completed in the first nine months of fiscal 2002 (in millions, except percentages):~~

Estimated Cost to Risk-Adjusted
Complete Technology at Discount Rate for
Acquired Company Time of Acquisition In-Process R&D

Allegro Systems, Inc. $ 5 52.5 %
AuroraNetics, Inc. $ 2 35.0 %

~~The assumptions~~ primarily consist of an expected completion date for the in-process projects, estimated costs to complete the projects, ~~and~~ revenue and expense projections assuming the products have entered the ~~market.~~market, and discount rates based on the risks associated with the development life cycle of the in-process technology acquired. Failure to achieve the expected levels of revenue and net income from these products will negatively impact the return on investment expected at the time that the acquisitions were completed and may result in impairment charges. Actual results from the acquired companies to date did not have a material adverse impact on our business and operating results except for certain purchase acquisitions where the purchased intangible assets were impaired and written-down as reflected in the Consolidated Statements of Operations in the prior fiscal year (see Note 4 to the Consolidated Financial Statements).

~~Interest and Other Income (Losses), Net~~

Interest and other income (losses), net, were $150 million in the third quarter of fiscal 2002, compared with $236 million in the third quarter of fiscal 2001. Interest and other income (losses), net, were ($359) million in the first nine months of fiscal 2002, compared with $931 million in the first nine months of fiscal 2001. The decrease in interest and other income (losses), net, for the third quarter of fiscal 2002 compared to the same period last year was primarily due to lower net gains on investments and the impact of lower average interest rates. Interest and other income (losses), net, for the first nine months of fiscal 2002 included a charge of $858 million in the first quarter of fiscal 2002 related to the impairment on certain publicly traded securities in our investment portfolio. This impairment charge was due to the declines in the fair value of our publicly traded equity investments below the cost basis that were judged to be other-than-temporary.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

certain purchase acquisitions where the purchased intangible assets were impaired and written down as reflected in the Consolidated Statements of Operations.

Interest Income

Interest income was $179 million in the first quarter of fiscal 2003, compared with $234 million in the first quarter of fiscal 2002. The decrease in interest income was primarily due to lower average interest rates.

Other Income (Loss), Net

Other income (loss) primarily consists of net realized gains (losses) and impairment charges on investments, as well as provision for losses on investments in privately held companies. Other income (loss) was ($475) million in the first quarter of fiscal 2003, compared with ($922) million in the first quarter of fiscal 2002. The net loss in the first quarter of fiscal 2003 and 2002 included a charge of $412 million and $858 million, pre-tax, related to the impairment of certain publicly traded equity securities. The impairment charges were due to the decline in the fair value of certain publicly traded equity investments below their cost basis that were judged to be other-than-temporary.

Provision for Income Taxes

The effective tax rate was ~~28.8% for~~29.1% in the ~~third~~first quarter of fiscal ~~2002~~2003 and ~~30.5%~~21.9% for the first ~~nine months~~quarter of fiscal 2002. The effective tax rate differs from the statutory rate primarily due to the impact of nondeductible in-process R&D, acquisition-related costs, research and experimentation tax credits, state taxes, and the tax impact of ~~foreign~~non-U.S. operations.

Our future effective tax rates could be adversely affected ifby earnings ~~are~~being lower than anticipated in countries where we have lower statutory rates, changes in the valuation of our deferred tax assets or ~~by unfavorable~~liabilities, or changes in tax laws or interpretations thereof. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and ~~regulations.~~other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

Liquidity and Capital Resources

The following sections discuss the effects of the changes in our balance sheets, cash flows, and commitments on our liquidity and capital resources.

Balance Sheet and Cash Flows

Cash and Cash Equivalents and Total InvestmentsCash and cash equivalents and total investments were $21.2 billion as of October 26, 2002, a decrease of $268 million or 1.2% from $21.5 billion at July 27, 2002. The decrease was primarily a result of cash used for the

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

~~Liquidity~~repurchase of common stock of $1.1 billion and ~~Capital Resources~~

~~Cash and cash equivalents and total investments, including restricted investments, were $21.1 billion at April 27, 2002, an increase~~capital expenditures of ~~$2.5 billion from July 28, 2001. The increase~~$122 million. This was ~~primarily a result of~~partially offset by cash provided by operating activities of $5.0 billion and cash provided by the issuance of common stock of $431 million. This increase was partially offset by cash used in capital expenditures of $2.2 billion, cash used for the repurchase of common stock of $952 million, and a net decrease of $405 million in the fair value of investments.

In the third quarter of fiscal 2002, we elected to purchase all of the land and buildings as well as certain sites under construction under lease agreements. The total purchase price was approximately $1.9 billion of which $1.6 billion was purchased during the third quarter of fiscal 2002 and was primarily funded by the liquidation of restricted investment securities and lease deposits. The remaining property will be purchased in the fourth quarter of fiscal 2002 for cash of approximately $250 million. As a result, we will no longer have any leased sites under such agreements by the end of fiscal 2002.$1.1 billion.

We expect ~~our~~that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, shipment linearity, ~~and~~ accounts receivable collections, inventory management, and the timing of tax and other payments. For additional discussion, see ~~also~~ the Risk Factors ~~section below.~~section.

Accounts Receivable, NetAccounts receivable ~~decreased 32.5% from~~was $1.1 billion as of October 26, 2002 and July ~~28, 2001 to April~~ 27, ~~2002.~~2002, respectively. Days sales outstanding (“DSO”) in receivables ~~decreased to 19 days at April~~as of October 26, 2002 and July 27, 2002 ~~from 31 days at July 28, 2001. The decrease in~~were 21 days. Our accounts receivable and ~~days sales outstanding were~~DSO was primarily ~~due to~~impacted by shipment linearity and collections performance. Our targeted range for DSO performance continues to be 40 to 50 days.

Inventories, ~~decreased 48.4%~~NetInventories were $828 million as of October 26, 2002, a decrease of $52 million or 5.9% from $880 million at July ~~28, 2001 to April~~ 27, 2002. Inventories consist of raw materials, work in process, finished goods, and demonstration systems. Approximately 35.2% of our finished goods inventory was located at distributor sites. Inventory turns ~~excluding~~were 7.0 turns in the ~~additional excess inventory benefit previously discussed, were 7.5 times for the third~~first quarter of fiscal ~~2002~~2003 and ~~7.0 times for~~7.1 turns in the ~~second~~fourth quarter of fiscal 2002. ~~The inventory~~Inventory levels and the associated inventory turns ~~reflected~~reflect our ongoing ~~effort to reduce our manufacturing~~ inventory ~~balance.~~management efforts. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times ~~versus~~against the risk of inventory obsolescence because of rapidly changing technology and customer requirements.

~~We have~~Commitments

Investment in Andiamo Systems, Inc. On August 19, 2002, we entered into ~~investment agreements with four~~a definitive agreement to acquire privately held ~~development stage companies, pursuant~~Andiamo Systems, Inc. (“Andiamo”). The acquisition of Andiamo is expected to ~~which we have an option to acquire~~close in the ~~remaining interests~~third quarter of fiscal 2004 but no later than July 31, 2004.

Under the terms of the agreement, our common stock will be exchanged for all outstanding shares and options of Andiamo not owned by us ~~in each company for consideration consisting of shares of Cisco common stock. In addition, each company has a put option enabling them to require us to acquire~~at the ~~remaining interests not owned by us in such company, subject to the fulfillment of various conditions, including the achievement of specified technology and other milestones.~~

~~In the case of three~~closing of the ~~companies,~~acquisition. The amount of the purchase ~~prices~~price for the remaining equity interests in Andiamo not then held by us is not determinable at this time, but will be based primarily upon a valuation of Andiamo to be determined by applying a multiple to the actual, annualized revenue generated from sales by our products attributable to Andiamo during a three-month period shortly preceding the closing. Under its agreements with Andiamo, we are ~~generally based on~~ the ~~achievement~~exclusive manufacturer and distributor of ~~certain technology or other milestones~~all Andiamo products. The multiple will be equal to our average market capitalization during a specified period divided by our annualized revenue for a three-month period prior to closing, subject to adjustment as follows: (i) if the ~~companies. Subsequent~~multiple so calculated is less than 10, then the multiple to ~~April 27, 2002, we announced definitive agreements~~be used for purposes of determining the transaction price shall be the midpoint between 10 and the multiple so calculated; (ii) if the multiple so calculated is greater than 15, then the multiple to ~~acquire~~be used for purposes of determining the ~~remaining interests of two of these companies (Hammerhead Networks, Inc.~~transaction price shall be the midpoint between 15 and ~~Navarro Networks, Inc.)~~

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

~~for a total~~the multiple so calculated. There is no minimum purchase price, ~~of approximately $258 million payable in common stock. These two acquisitions will be accounted for as purchases~~ and ~~are expected to close in~~ the ~~fourth quarter of fiscal 2002. We anticipate that we will acquire the remaining interest in the third company within the next three months for approximately $150 million.~~

In the case of the fourth company, the purchase price for the remaining interest would be based upon a valuation to be determined by applying a multiple to the actual revenue generated from sales of the company’s products during a specified three-month period, on an annualized basis. The acquisition, if it occurs, is expected to close no later than July 2004. Themaximum purchase price is ~~not determinable at this time, and will range from $0~~limited to ~~a maximum purchase price of~~approximately $2.5 billion in shares of Cisco ~~shares~~common stock valued at the time of closing.

As of ~~April 27,~~October 26, 2002, we have ~~funded $53 million of our~~made an $84 million investment ~~commitment to this company. Upon full funding~~in Andiamo in the form of ~~our commitment,~~convertible debt, which ~~is subject to termination if certain milestones are not achieved, we will hold a promissory note that~~ is convertible into approximately 44% of the equity ~~of the company. If either~~in Andiamo, subject to certain terms and conditions. This investment in Andiamo has been expensed as research and development costs, as if such expenses constituted our ~~option or the company’s put option is exercised,~~development costs. Furthermore, we are also committed to provide additional funding to Andiamo in the ~~company~~form of non-convertible debt through the closing of the acquisition of approximately $100 million. ~~Since making our initial investment in the third quarter~~We had not funded any of ~~fiscal 2001, we have expensed $52 million~~this additional amount as ~~research~~of October 26, 2002.

Purchase Commitments with Contract Manufacturers and ~~development costs, which is equal to 100% of the net losses reported by the privately held company as if such losses constituted our development costs.~~

SuppliersWe use several contract manufacturers and ~~supply partners~~suppliers to ~~manufacture~~provide manufacturing services for our products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, we enter into agreements with certain contract manufacturers and ~~supply partners~~suppliers that allow them to procure inventory based upon criteria as defined by us. As of ~~April~~October 26, 2002, the Company has purchase commitments for inventory of approximately $840 million, compared with $825 million as of July 27, ~~2002, we may be committed to purchase approximately $800 million of inventory.~~2002.

Other CommitmentsIn fiscal 2001, we entered into an agreement to invest ~~$1.05~~approximately $1.0 billion in ~~the~~venture funds managed by SOFTBANK ~~Asia Infrastructure Fund, which is~~Corp. and its affiliates (“SOFTBANK”). These venture funds are required to be funded upon demand by ~~the general partner of the fund.~~SOFTBANK. As of ~~April 27,~~October 26, 2002, we have funded $100 million of this investment commitment.

We provide structured financing to certain qualified customers to be used for the purchase of equipment and other needs through our wholly-owned subsidiary, Cisco Systems Capital Corporation. ~~At April 27,~~As of October 26, 2002, the outstanding loan commitments were approximately ~~$1.3 billion,~~$376 million, subject to the customers achieving certain financial covenants, of which approximately ~~$400~~$190 million ~~is currently~~was eligible for draw down. These loan commitments may be funded over a two- to three-year period, provided that these customers achieve specific business milestones and financial covenants.

We have entered into several agreements to purchase or construct real estate, subject to the satisfaction of certain conditions. As of ~~April 27,~~October 26, 2002, the total amount of commitments, if certain conditions are met, was approximately ~~$564~~$410 million.

~~Item 2. Management’s Discussion and Analysis~~As of ~~Financial Condition and Results of Operations~~

~~At April 27,~~October 26, 2002, we have a commitment of approximately ~~$215~~$130 million to purchase the remaining portion of the minority interest of Cisco Systems, K.K. (Japan).

We also have certain other funding commitments of approximately $150 million ~~at April 27,~~as of October 26, 2002 related to our privately held investments.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Stock Repurchase Program

In September 2001, the Board of Directors authorized a stock repurchase program to acquire outstanding common ~~stock in the open market or negotiated transactions.~~stock. Under the program, up to $3 billion of ~~Cisco~~our common stock could be reacquired over two years. In August 2002, the Board of Directors increased our stock repurchase program by $5 billion to a total of $8 billion of our common stock available for repurchase through September 12, 2003.

During the first ~~nine months~~quarter of fiscal ~~2002,~~2003, we repurchased and retired ~~approximately 61~~88 million shares of ~~Cisco~~ common stock for an aggregate purchase price of approximately ~~$952 million.~~$1.1 billion. As of October 26, 2002, we have repurchased and retired 212 million shares of common stock for an aggregate purchase price of $2.9 billion and the remaining authorized amount for stock repurchases under this program was $5.1 billion.

WeBased on past performance and current expectations, we believe that our ~~current~~ cash and cash equivalents, short-term investments, and cash generated from operations will satisfy our ~~expected~~ working capital needs, capital expenditures, investment requirements, stock repurchases, commitments (see Note 6 to the Consolidated Financial Statements), future customer financings, and other liquidity requirements associated with our existing operations through at least the next 12 months. In addition, there are no transactions, arrangements, and other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of orour requirements for capital resources.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

Set forth below and elsewhere in this ~~Quarterly~~ Report and in ~~the~~ other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in ~~this Quarterly~~the Report.

~~YOU SHOULD EXPECT THAT~~ OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS

~~The results of operations for any quarter or fiscal year are not necessarily indicative of results to be expected in future periods.~~ Our operating results have been in the past, and will continue to be, subject to quarterly and annual fluctuations as a result of a number of factors. These factors include:

•      ~~Overall information technology spending;~~Fluctuations in demand for our products and services, such as has occurred in the last two years, especially with respect to Internet businesses and telecommunications service providers;

•      Changes in ~~general global economic conditions and specific market conditions in the communications and networking industries;~~
• ~~Fluctuations in demand for our products and services;~~
• The effects of terrorist activity and armed conflict, such as disruptions in general global economic activity, changes in logistics and security arrangements, and reduced customer demand for our products and services;
• ~~The long~~ sales and implementation ~~cycle~~cycles for our products and the reduced visibility into our customers’ spending plans and associated revenue;

•      ~~Inventory~~Our ability to maintain appropriate inventory levels and purchase ~~commitments exceeding our estimated requirements based upon future demand forecasts;~~
• ~~Existing network capacity, sharing of existing network capacity, and network capacity utilization rates of our customers;~~commitments;

•      Price and product competition in the communications and networking ~~industry;~~industries which can change rapidly due to technological innovation;

•      The overall trend toward industry ~~consolidation;~~consolidation both among our competitors and our customers;

•      The introduction and market acceptance of new technologies and products, as well as the adoption of new networking standards;

•      Variations in sales channels, product costs, or mix of products sold;

•      The timing and size of orders ~~timing of shipments, and the ability to satisfy all contractual obligations in customer contracts;~~from customers;

•      Manufacturing lead times;

•      ~~The impact of acquired businesses and technologies;~~
• ~~The geographical mix of~~Fluctuations in our ~~revenue and the associated impact on~~ gross ~~margin;~~margins;

•      Our ability to achieve targeted cost reductions;
• ~~Adverse changes in the public and private equity and debt markets;~~

•      The ability of our customers and suppliers to obtain financing or to fund capital expenditures;

•      The ~~trend toward sales of integrated network solutions;~~
• ~~The~~ timing and amount of employer payroll tax to be paid on employees’ gains on stock options exercised;
• Actual events, circumstances, outcomes, and amounts differing from judgments,

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

Actual events, circumstances, outcomes and amounts differing from judgments, assumptions and estimates used in determining the amounts of certain assets (including the amounts of related valuation allowances), liabilities and other items reflected in our financial statements.

		assumptions, and estimates used in determining the values of certain assets (including the amounts of related valuation allowances), liabilities and other items reflected in our financial statements; and

•		Changes in accounting rules, such as recording expenses for employee stock option grants.

As a consequence, operating results for a particular future period are difficult to predict, ~~especially~~and therefore, prior results are not necessarily indicative of results to be expected in ~~recent~~future periods. Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition.

In response to changes in industry and market conditions, we may strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses. Any decision to limit investment in or to dispose of or otherwise exit businesses may result in the recording of special charges, such as inventory and technology related write-offs and workforce reduction costs. Estimates with respect to the useful life or ultimate recoverability of our carrying basis of assets, including purchased intangible assets, could change as a result of such assessments and decisions. Additionally, we are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.

~~WE ARE EXPOSED TO GENERAL GLOBAL~~OUR BUSINESS MAY BE ADVERSELY AFFECTED BY UNFAVORABLE ECONOMIC AND MARKET CONDITIONS

~~Our business is subject to the effects of general~~Adverse economic conditions ~~in the United States and globally, and, in particular, market conditions~~worldwide have contributed to slowdowns in the communications and networking industries ~~which have reduced overall demand for networking products. In recent quarters,~~and may continue to impact our ~~operating results have been adversely affected~~business, resulting in:

• Reduced demand for our products as a result of a decrease in capital spending by our customers, particularly service providers;
• Increased price competition for our products, partially as a consequence of customers disposing of unutilized products;
• Increased risk of excess and obsolete inventories;
• Excess facilities and manufacturing capacity; and
• Higher overhead costs as a percentage of revenues.

Recent political turmoil in many parts of ~~unfavorable~~the world, including terrorist and military actions, may continue to put pressure on global economic ~~conditions and reduced capital spending in the United States, Europe, and Asia.~~conditions. If the economic and market conditions in the United States and globally do not improve, or if ~~we experience a worsening in the global economic slowdown,~~they deteriorate further, we may continue to experience material adverse impacts on our business, operating results, and financial ~~condition.~~condition as a consequence of the above factors or otherwise. We do not expect the trend of lower capital spending among service providers to reverse itself in the near term.

~~OPERATING~~OUR DIFFICULTY IN PREDICTING REVENUES MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS AND FINANCIAL RESULTS ~~FOR A PARTICULAR QUARTER ARE DIFFICULT TO PREDICT~~

As a result of a variety of factors discussed ~~herein, operating results~~in this Report, our revenues for a particular quarter are ~~extremely~~ difficult to predict. ~~Given the continued uncertainty surrounding many variables that may impact the industry in which we compete, our visibility into future periods is limited.~~ Our net sales may grow at a slower rate than experienced in past periods and, in particular periods, may decline. Our ability to meet financial expectations could also be adversely affected if the nonlinear sales pattern seen in certain of our past quarters recurs in

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

future periods. We ~~generally~~ have ~~had at least one quarter~~experienced periods of ~~the fiscal year~~time where shipments exceeded net bookings, leading to nonlinearity in shipping patterns. This can increase costs, as irregular shipment patterns result in periods of underutilized capacity and periods when ~~backlog has been reduced.~~ overtime expenses may be incurred, as well as leading to additional costs arising out of inventory management.

In addition, ~~in response~~ to improve customer ~~demand,~~satisfaction, we continue to attempt to reduce our ~~product~~ manufacturing lead times, which may result in corresponding reductions in order backlog. A decline in backlog levels could result in more variability and less predictability in our quarter-to-quarter net sales

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

and operating results going forward. OnIn the ~~other hand, for certain products, lead times are longer than our goal. If we cannot reduce~~past, long manufacturing lead times ~~for such products,~~caused our customers ~~may~~to place the same ~~orders~~order multiple times within our various sales channels and cancel the duplicative orders when the product is received from one of the channels from where it was ordered, or ~~not~~ place ~~further~~ orders ifwith other vendors with shorter manufacturing lead ~~times are available from~~times. Such multiple ordering (along with other ~~vendors.~~factors) may cause difficulty in predicting our sales, and as a result could impair our ability to manage parts inventory effectively.

We plan our operating expense levels primarily based on forecasted revenue levels. These expenses and the impact of long-term commitments are relatively fixed in the short-term. A shortfall in revenue could lead to operating results being below expectations as we may not be able to quickly reduce these fixed expenses in response to short-term business changes.

Any of the above factors could have a material adverse impact on our operations and financial results. For example, from time to time, we have made acquisitions that result in in-process research and development expenses being charged in an individual quarter. These charges may occur in any particular quarter resulting in variability in our quarterly earnings. Additionally, the operating results for a quarter could be materially adversely affected if a number of large orders are either not received or are delayed, for example, due to cancellations, delays, or deferrals by customers.

WE EXPECT GROSS MARGIN VARIABILITY OVER TIME

~~Product~~Although we have experienced increasing product gross ~~margin~~margins, product gross margins may be adversely affected in the future by ~~increases~~a number of factors, including but not limited to:

• Changes in customer, geographic or product mix, including mix of configurations within each product group;
• Increases in material or labor costs;
• Excess inventory;
• Obsolescence charges;
• Changes in shipment volume;
• Loss of cost savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand;

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

• Increased price competition;
• Changes in distribution channels;
• Increased warranty costs; and
• Introduction of new products and costs of entering new markets.

Changes in ~~material or labor costs, excess inventory, obsolescence charges,~~service gross margin may result from various factors such as the changes in ~~shipment volume, loss~~mix between technical support services and advanced services, as well as the timing of ~~cost savings, price competition,~~technical support service contract initiations and ~~changes in channels~~renewals.

DISRUPTION OF OR CHANGES IN THE MIX OF OUR PRODUCT DISTRIBUTION MODEL OR CUSTOMER BASE COULD AFFECT SALES AND MARGINS

If we fail to manage distribution of ~~distribution~~our products and services properly, or if our distributors’ financial condition or operations weaken, our revenues and gross margins could be adversely affected. Furthermore, a change in the mix of ~~products sold. If product~~our customers between service provider and enterprise, or ~~related warranty costs associated with~~a change in mix of direct sales and indirect sales, can adversely affect revenues and gross margins.

We use a variety of channels to bring our products to our customers, including system integrators, two-tier distributors who in turn sell to resellers, and direct sales to both enterprise accounts and service providers. Since each distribution channel has a distinct profile, the failure to implement the most advantageous balance in the delivery model for our products and services could adversely affect our gross margin and, therefore, profitability.

For example:

• As we respond to demand from certain categories of customers to sell directly to them, we could risk alienating channel partners and adversely affecting our distribution model.
• Because direct sales may compete with the sales made by channel partners, these channel partners may elect to use other suppliers that do not directly sell their own products.
• Some of our system integrators may demand that we absorb a greater share of the risks that their customers may ask them to bear, affecting our gross margin.
• Some of our channel partners may have insufficient financial resources and may not be able to withstand changes in business conditions, including the recent economic downturn. Revenues from indirect sales could suffer if our distributor’s financial condition or operations weaken.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

Service provider customers may demand rigorous acceptance testing or prime contracting. As we develop more “solution” oriented products, enterprise customers may demand similar terms and conditions. Such terms and conditions can lower gross margin and defer revenue recognition.

We must manage inventory effectively, particularly with respect to sales to distributors. Distributors may increase orders during periods of product shortages, cancel orders if their inventory is too high, or delay orders in anticipation of new products. Distributors also may adjust their orders in response to the supply of our products and the products of our competitors that are ~~greater than~~available to the distributor and to seasonal fluctuations in end-user demand. If we have ~~experienced, product~~excess inventory, we may have to reduce our prices and write down inventory, which in turn could result in lower gross margin may also be adversely affected. Product gross margin may also be impacted by geographic mix, as well as the mix of configurations within each product group. We continue to utilize third-party or indirect-distribution channels, which generally results in a lower product gross margin. Thesemargins. Our two-tier distribution channels, in contrast to our one-tier distributors, are ~~generally~~ given privileges to return a portion of inventory and participate in various cooperative marketing programs. In addition, ~~increasing third-party and indirect-distribution~~if sales through indirect channels ~~generally results in~~increase, this may lead to greater difficulty in forecasting the mix of our products, and to a certain degree, the timing of orders from our customers. We recognize revenue to two-tier distributors based on a sell-through method utilizing information provided by our distributors and we also maintain accruals and allowances for all cooperative marketing and other programs. Service gross margin will typically experience some variability over time due to various factors such as the changes in mix between support and professional services, as well as the timing of support contract renewals.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

~~WE ARE DEPENDENT UPON ADEQUATE COMPONENT SUPPLY AND MANUFACTURING CAPACITY~~

Our growth and ability to meet customer demands also depend in part on our ability to obtain timely deliveries of parts from our suppliers. We have experienced component shortages in the past that have adversely affected our operations. Although we work closely with our suppliers to avoid these types of shortages, there can be no assurance that we will not encounter these problems in the future. Although we generally use standard parts and components for our products, certain components are presently available only from a single source or limited sources.

~~While our suppliers have performed effectively and have been relatively flexible to date, we believe that we may be faced with the following challenges going forward:~~

• ~~New markets that we participate in may grow quickly and thus, consume significant component capacity~~
• ~~As we continue to acquire companies and new technologies, we are dependent, at least initially, on unfamiliar supply chains or relatively small supply partners~~
• ~~We face competition for certain components, which are supply constrained, from existing competitors and companies in other markets~~

Manufacturing capacity and component supply constraints could be significant issues for us. We use several supply partners to manufacture our products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, we enter into agreements with certain supply partners that allow these partners to procure inventory based upon criteria as defined by us. For additional information regarding our purchase commitments, see Note 6 to the Consolidated Financial Statements. A reduction or interruption in supply, a significant increase in the price of one or more components, or a decrease in demand of products could materially adversely affect our business, operating results and financial condition and could materially damage customer relationships.

~~WE COMPETE IN THE HIGHLY COMPETITIVE TELECOMMUNICATIONS EQUIPMENT MARKET~~

We compete in the Internet infrastructure market, providing solutions for transporting data, voice, and video traffic across intranets, extranets, and the Internet. The market is characterized by rapid change, converging technologies, and a conversion to networking solutions that offer superior advantages. These market factors represent both an opportunity and a competitive threat to us. We compete with numerous vendors in each product category. The overall number of competitors providing niche product solutions may increase due to the market’s long-term attractive growth. On the other hand, we expect the number of vendors supplying end-to-end networking solutions will decrease, due to consolidations in and accompanying economic pressure upon the industry.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

Our competitors include 3Com, Alcatel, Avaya, Check Point Software, Ciena, Ericsson, Enterasys, Extreme Networks, Foundry Networks, Fujitsu, Juniper, Lucent, Marconi, Nortel Networks, Redback Networks, Siemens AG, and Sycamore Networks, among others. Some of our competitors compete across many of our product lines, while others do not offer as wide a breadth of solutions. Several of our current and potential competitors may have greater resources, including technical and engineering resources, than we do.

~~The principal competitive factors in the markets in which we presently compete and may compete in the future are:~~

• ~~The ability to provide end-to-end networking solutions and support~~
• ~~Performance~~
• ~~Price~~
• ~~The ability to provide new technologies and products~~
• ~~The ability to provide value-added features such as security, reliability, and investment protection~~
• ~~Conformance to standards~~
• ~~Market presence~~
• ~~The ability to provide financing~~

We also face competition from customers to whom we license technology and suppliers from whom we transfer technology. The inherent nature of networking requires interoperability. As such, we must cooperate and at the same time compete with these companies. Our inability to effectively manage these complicated relationships with customers and suppliers, or the uncontrollable and unpredictable acts of others, could have a material adverse effect on our business, operating results, and financial condition.

~~WE HAVE INVESTED IN AND WILL CONTINUE TO INVEST IN NEW AND EXISTING MARKET OPPORTUNITIES~~

We have made investments in personnel, inventory, manufacturing capacity, and product development through internal efforts and acquisitions, as a result of growth in existing opportunities and new or emerging opportunities in our target markets over the past years. We will continue to invest in these markets either through additional investments or through re-alignment of existing resources. If we are unable to meet expected revenue levels in a particular quarter, it could have a material, negative impact on our operating results for that period as we may not be able to react quickly enough to scale back expenses.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

~~WE DEPEND UPON THE DEVELOPMENT OF NEW PRODUCTS AND ENHANCEMENTS TO EXISTING PRODUCTS AND ARE SUBJECT TO RAPID CHANGES IN TECHNOLOGY AND THE MARKET~~

Our operating results may depend on our ability to develop and introduce new products into existing and emerging markets and to reduce the costs to produce existing products. The success of new products is dependent on several factors, including proper new product definition, product cost, timely completion and introduction of new products, differentiation of new products from those of our competitors, and market acceptance of these products. The markets for our products are characterized by rapidly changing technology, evolving industry standards, new product introductions, and evolving methods of building and operating networks. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, and achieve market acceptance of our products, or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.

~~OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND INTERNET-BASED SYSTEMS~~

A substantial portion of our business and revenue depends on the continued growth of the Internet and on the deployment of our products by customers that depend on the continued growth of the Internet. As a result of the economic slowdown and the reduction in capital spending, spending on Internet infrastructure has declined, which has had a material adverse effect on our business. To the extent that the economic slowdown and reduction in capital spending continue to adversely affect spending on Internet infrastructure, we could continue to experience material adverse effects on our business, operating results, and financial condition.

We believe that there will be certain performance problems with Internet communications in the future, which could receive a high degree of publicity and visibility. As we are a large supplier of networking products, we may be materially adversely affected, regardless of whether or not these problems are due to the performance of our products. Such an event could also result in a material adverse effect on the market price of our common stock and could materially adversely affect our business, operating results, and financial condition.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

~~WE EXPECT TO MAKE FUTURE ACQUISITIONS WHERE ADVISABLE AND ACQUISITIONS INVOLVE NUMEROUS RISKS~~

The networking business is highly competitive, and as such, our growth is dependent upon market growth, our ability to enhance our existing products, and our ability to introduce new products on a timely basis. One of the ways we have addressed and will continue to address the need to develop new products is through acquisitions of other companies and technologies. Acquisitions involve numerous risks, including the following:

• ~~Difficulties in integrating the operations, technologies, products and personnel of the acquired companies~~
• ~~The risk of diverting management’s attention from normal daily operations of the business~~
• ~~Potential difficulties in completing projects associated with in-process research and development~~
• ~~Risks of entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions~~
• ~~Initial dependence on unfamiliar supply chains or relatively small supply partners~~
• ~~Insufficient revenues to offset increased expenses associated with acquisitions~~
• ~~The potential loss of key employees of the acquired companies~~

~~THE ENTRANCE INTO NEW OR DEVELOPING MARKETS EXPOSES OUR BUSINESS AND OPERATIONS TO RISKS~~

As we focus on new market opportunities, such as transporting data, voice, and video traffic across the same network, we will increasingly compete with large telecommunications equipment suppliers and startup companies. Several of our current and potential competitors may have greater resources, including technical and engineering resources, than we do. Additionally, as customers in these markets complete infrastructure deployments, they may require greater levels of service, support, and financing than we have experienced in the past. We expect that demand for these types of service contracts may increase in the future. There can be no assurance that we can provide products, service, support, and financing to effectively compete for these market opportunities. Further, provision of greater levels of services by us may result in less favorable timing of revenue recognition than we have historically experienced.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

SALES TO THE SERVICE PROVIDER MARKET ARE ~~SUBJECT TO VARIATION~~ESPECIALLY VOLATILE

Sales to the service provider market have been characterized by large and often sporadic ~~purchases.~~purchases with longer sales cycles. We have experienced significant decreases in sales to ~~the~~ service ~~provider market.~~providers as market conditions have changed. Sales activity in this industry depends upon the stage of completion of expanding network infrastructures, the availability of funding, and the extent that service providers are affected by regulatory, economic, and business conditions in the country of operations. Continued declines or delays in sales orders from this industry could have a material adverse effect on our business, operating results, and financial ~~condition.~~condition, particularly as we continue to invest in development of new products aimed at this market segment. The slowdown in the general economy, over-capacity, changes in the service provider market, and the constraints on capital availability have had a material adverse effect on many of our service provider customers, with a number of such customers going out of business or substantially reducing their expansion plans. These conditions have had a material adverse effect on our business and operating results, and we expect that these conditions may continue for the foreseeable future. Finally, service provider customers typically have longer implementation cycles, require a broader range of service, including design services, demand that vendors take on a larger share of risks, often have acceptance provisions which can lead to a delay in revenue recognition and expect financing from vendors. All these factors can add further risk to business conducted with service providers.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

WE ARE DEPENDENT UPON ADEQUATE COMPONENT SUPPLY AND MANUFACTURING CAPACITY

Our growth and ability to meet customer demands also depend in part on our ability to obtain timely deliveries of parts from our suppliers. We have experienced component shortages in the past that have adversely affected our operations. We may in the future experience a short supply of certain component parts as a result of strong demand in the industry for those parts or problems experienced by suppliers. If shortages or delays persist, the price of these components may increase, or the components may not be available at all. We may not be able to secure enough components at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed. Accordingly, our revenues and gross margins could suffer until other sources can be developed. There can be no assurance that we will not encounter these problems in the future. Although in many cases we use standard parts and components for our products, certain components are presently available only from a single source or limited sources. We may not be able to diversify sources in a timely manner, which could harm our ability to deliver products to customers and seriously impact present and future sales.

We believe that we may be faced with the following challenges going forward:

• New markets that we participate in may grow quickly and thus, consume significant component capacity;
• As we continue to acquire companies and new technologies, we are dependent, at least initially, on unfamiliar supply chains or relatively small supply partners; and
• We face competition for certain components, which are supply constrained, from existing competitors and companies in other markets.

Manufacturing capacity and component supply constraints could be significant issues for us. We use several contract manufacturers and suppliers to provide manufacturing services for our products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, we enter into agreements with certain contract manufacturers and suppliers that allow them to procure inventory based upon criteria as defined by us. If we fail to anticipate customer demand properly, an oversupply of parts could result in excess or obsolete components that could adversely affect our gross margins. For additional information regarding our purchase commitments, see Note 8, “Commitments and Contingencies”, on pages 38 to 40 of our 2002 Annual Report to Shareholders. A reduction or interruption in supply, a significant increase in the price of one or more components, a failure to adequately authorize procurement of inventory by our contract manufacturers, or a decrease in demand of products could materially adversely affect our business, operating results and financial condition and could materially damage customer relationships. Furthermore, as a result of binding price or purchase commitments with suppliers, we may be obligated to purchase components at prices

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

that are higher than those available in the current market. In the event that we become committed to purchase components at prices in excess of the current market price when the components are actually utilized, our gross margins could decrease.

The fact that we do not own the bulk of our manufacturing facilities could have an adverse impact on the future products supply and on operating results. Financial problems of contract manufacturers on whom we rely, or reservation of capacity by other companies, inside or outside of our industry, could either limit supply or increase costs.

WE HAVE MANY SUBSTANTIAL COMPETITORS

We compete in the networking and communications equipment markets, providing products and services for transporting data, voice, and video traffic across intranets, extranets, and the Internet. The market is characterized by rapid change, converging technologies, and a migration to networking solutions that offer superior advantages. These market factors represent both an opportunity and a competitive threat to us. We compete with numerous vendors in each product category. The overall number of competitors providing niche product solutions may increase due to the market’s long-term attractive growth.

Our competitors include 3Com, Alcatel, Avaya, Avici, Check Point Software, Ciena, Dell, Ericsson, Enterasys, Extreme Networks, Foundry Networks, Fujitsu, Huawei, Juniper, Lucent, Marconi, NetScreen, Nokia, Nortel Networks, Redback Networks, Riverstone, Siemens AG, and Sycamore Networks, among others. Some of these companies compete across many of our product lines, while others are primarily focused in a specific product area. Barriers to entry are relatively low, and new ventures to create products that do or could compete with our products are regularly formed. In addition, several of our current and potential competitors may have greater resources, including technical and engineering resources, than we do.

The principal competitive factors in the markets in which we presently compete and may compete in the future include:

• The ability to provide a broad range of networking products and services;

• Product performance;

• Price;

• The ability to provide new products;

• The ability to provide value-added features such as security, reliability, and investment protection;

• Conformance to standards;

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

• Market presence; and

• The ability to provide financing.

We also face competition from customers to whom we license or supply technology and suppliers from whom we transfer technology. The inherent nature of networking requires interoperability. As such, we must cooperate and at the same time compete with many companies. Our inability to effectively manage these complicated relationships with customers and suppliers, or the uncontrollable and unpredictable acts of others, could have a material adverse effect on our business, operating results, and financial condition and accordingly affect our chances of success.

WE DEPEND UPON THE DEVELOPMENT OF NEW PRODUCTS AND ENHANCEMENTS TO EXISTING PRODUCTS AND ARE SUBJECT TO RAPID CHANGES IN TECHNOLOGY AND THE MARKET

The markets for our products are characterized by rapidly changing technology, evolving industry standards, new product introductions, and evolving methods of building and operating networks. Our operating results depend on our ability to develop and introduce new products into existing and emerging markets and to reduce the costs to produce existing products. We believe the Internet and other data, voice and video networks are evolving into a “network of networks” which will require common technology platforms and broad end-to-end solutions for particular applications rather than products aimed at particular market segments. In that environment, customers will be more concerned with overall solutions rather than with whether the solution is built around a particular technology, such as routing or switching. The process of developing new technology is complex and uncertain, and if we fail to accurately predict customers’ changing needs and emerging technological trends, our business could be harmed. We must commit significant resources to develop new products before knowing whether our investments will result in products the market will accept. In particular, if the “network of networks” does not emerge as we believe it will, many of our investments may prove to be without value. Furthermore, we may not execute successfully on that vision because of errors in product planning or timing, technical hurdles which we fail to overcome in timely fashion, or because of lack of appropriate resources. This could result in competitors providing those solutions before we do, and loss of market share, revenues and earnings. The success of new products is dependent on several factors, including proper new product definition, component costs, timely completion and introduction of these products, differentiation of new products from those of our competitors, and market acceptance of these products. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, and achieve market acceptance of our products, or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND INTERNET-BASED SYSTEMS; CHANGES IN INDUSTRY STRUCTURE COULD LEAD TO PRODUCT DISCONTINUANCES

A substantial portion of our business and revenue depends on growth of the Internet and on the deployment of our products by customers that depend on the continued growth of the Internet. As a result of the economic slowdown and the reduction in capital spending, which have particularly affected telecommunications service providers, spending on Internet infrastructure has declined, which has had a material adverse effect on our business. To the extent that the economic slowdown and reduction in capital spending continue to adversely affect spending on Internet infrastructure, we could continue to experience material adverse effects on our business, operating results, and financial condition.

Because of the rapid introduction of new products, and changing customer requirements related to matters such as cost-effectiveness and security, we believe that there could be certain performance problems with Internet communications in the future, which could receive a high degree of publicity and visibility. As we are a large supplier of networking products, we may be materially adversely affected, regardless of whether or not these problems are due to the performance of our own products. Such an event could also result in a material adverse effect on the market price of our common stock independent of direct effects on our business, and could materially adversely affect our business, operating results, and financial condition.

In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing of, or otherwise, exiting businesses. Any decision to limit investment in or to dispose of or otherwise, exit businesses may result in the recording of special charges, such as inventory and technology related write-offs and workforce reduction costs, or claims from third parties who were resellers or users of discontinued products. Estimates with respect to the useful life or ultimate recoverability of our carrying basis of assets, including purchased intangible assets, could change as a result of such assessments and decisions. Additionally, we are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.

WE EXPECT TO MAKE FUTURE ACQUISITIONS; ACQUISITIONS INVOLVE NUMEROUS RISKS

Our growth is dependent upon, market growth, our ability to enhance our existing products, and our ability to introduce new products on a timely basis. We have and will continue to address the need to develop new products through acquisitions of other companies and technologies, including the personnel such acquisitions may bring to us. Acquisitions involve numerous risks, including the following:

Difficulties in integrating the operations, technologies, products and personnel of the acquired companies;

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

• Diversion of management’s attention from normal daily operations of the business;
• Potential difficulties in completing projects associated with in-process research and development;
• Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;
• Initial dependence on unfamiliar supply chains or relatively small supply partners;
• Insufficient revenues to offset increased expenses associated with acquisitions; and
• The potential loss of key employees of the acquired companies.

Acquisitions may also cause us to:

• Issue common stock that would dilute our current shareholders’ percentage ownership;
• Assume liabilities;
• Record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges;
• Incur amortization expenses related to certain intangible assets;
• Incur large and immediate write-offs; or
• Become subject to litigation.

Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions we make could harm our business and operating results in a material way. Prior acquisitions have resulted in a wide range of outcomes, from successful introduction of new products and technologies to an inability to do so. Even when an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that all preacquisition due diligence will have identified all possible issues that might arise with respect to such products.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

From time to time, we have made acquisitions that result in in-process research and development expenses being charged in an individual quarter. These charges may occur in any particular quarter resulting in variability in our quarterly earnings.

See also the discussion of risks related to new product development, which also applies to acquisitions, above under the risk factor entitled,“We depend upon the development of new products and enhancements to existing products and are subject to rapid changes in technology and the market”.

THE ENTRANCE INTO NEW OR DEVELOPING MARKETS EXPOSES OUR BUSINESS AND OPERATIONS TO RISKS

As we focus on new market opportunities, such as transporting data, voice, and video traffic across the same network, we will increasingly compete with large telecommunications equipment suppliers as well as startup companies. Several of our current and potential competitors may have greater resources, including technical and engineering resources, than we do. Additionally, as customers in these markets complete infrastructure deployments, they may require greater levels of service, support, and financing than we have provided in the past. We expect that demand for these types of service or financing contracts may increase in the future. There can be no assurance that we can provide products, service, support, and financing to effectively compete for these market opportunities. Further, provision of greater levels of services by us may result in a delay in the timing of revenue recognition.

PRODUCT QUALITY PROBLEMS COULD LEAD TO REDUCED REVENUES AND GROSS MARGINS

We produce highly complex products that incorporate leading-edge technology, including both hardware and software. Software typically contains “bugs” which can unexpectedly interfere with expected operations. There can be no assurance that our pre-shipment testing programs will be adequate to detect all defects - either in individual products or which could affect numerous shipments - which might interfere with customer satisfaction, reduce sales opportunities, or affect gross margins if the cost of remedying the problems exceeded reserves established for that purpose. In the past, we have had to recall certain components. While the cost of such recalls was not material, there can be no assurance that such a recall, depending on the product involved, would not have a material impact. An inability to cure a product defect could result in the failure of a product line, and withdrawal, at least temporarily from a product or market segment, damage to our reputation, inventory costs, product reengineering expenses, and a material impact on revenues and margins.

THE INDUSTRY IN WHICH WE COMPETE ISAND THE INDUSTRIES IN WHICH OUR CUSTOMERS COMPETE, ARE SUBJECT TO CONSOLIDATION

There has been a trend toward industry consolidation in our markets for several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

their market positions in an evolving industry. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in operating results ~~as we compete to be a single or primary vendor solution~~ and could have a material adverse effect on our business, operating results, and financial condition. Furthermore, particularly in the service provider market, rapid consolidation will lead to fewer customers, with the effect that loss of a major customer could have a material impact on results not anticipated in a customer marketplace comprised of more numerous participants.

OUR BUSINESS IS SUBJECT TO RISKS FROM ~~INTERNATIONAL~~GLOBAL OPERATIONS

We conduct ~~business globally.~~significant sales and customer support operations in countries outside of the United States and also depend on non-U.S. operations of our contract manufacturers and our distribution partners. For fiscal 2002, we derived 46% of our revenues from sales outside the United States. Accordingly, our future results could be materially adversely affected by a variety of uncontrollable and changing factors including, among others, foreign currency exchange rates; ~~regulatory,~~ political or social unrest or economic ~~conditions~~instability in a specific country or region; trade protection measures and other regulatory ~~requirements;~~requirements which may affect our ability to import or export our products from various countries; service provider and government spending ~~patterns;~~patterns affected by political considerations; difficulties in staffing and ~~natural disasters.~~managing international operations; and adverse tax consequences, including imposition of withholding or other taxes on payments by subsidiaries. Any or all of these factors could have a material adverse impact on our future ~~international~~ business.

WE ARE EXPOSED TO FLUCTUATIONS IN ~~THE~~CURRENCY EXCHANGE RATES ~~OF FOREIGN CURRENCY~~

AsBecause a ~~global concern,~~significant portion of our business is conducted outside the United States, we face exposure to adverse movements in ~~foreign~~non-U.S. currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results and cash flows. Historically, our primary exposures have related to ~~nondollar-denominated~~non-dollar-denominated sales in Japan, Canada, and Australia, and ~~nondollar-denominated~~certain non-dollar-denominated operating expenses in Europe, Latin America, and Asia, where we sell primarily in U.S. dollars. Additionally, we have exposures to emerging market currencies, which can have

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

extreme currency volatility. ~~We will continue~~An increase in the value of the dollar could increase the real cost to ~~monitor~~ our ~~exposures~~customers of our products in those markets outside the United States where we sell in dollars, and ~~may hedge against these or any other emerging market currencies as necessary.~~a weakened dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we must purchase components in foreign currencies.

~~At the present time,~~Currently, we hedge only those currency exposures associated with certain assets and liabilities denominated in nonfunctional currencies and periodically will hedge anticipated foreign currency cash flows. The hedging activities undertaken by us isare intended to offset the impact of currency fluctuations on certain nonfunctional currency assets and liabilities.

~~The formal adoption of the euro on January 1, 2002 as the common currency for members of the European Union did~~ Our attempts to hedge against these risks may not ~~have a material~~be successful resulting in an adverse ~~effect~~impact on our ~~internal systems, operating results, or financial condition.~~net income.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

WE ARE EXPOSED TO THE CREDIT RISK OF SOME OF OUR CUSTOMERS AND TO CREDIT EXPOSURES IN WEAKENED MARKETS

~~A portion~~Most of our sales ~~is derived through~~are on an “open credit” basis, with payment terms of 30 days typically in the United States, and, because of local customs or conditions, longer in some markets outside the United States. We monitor individual customer payment capability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts. Beyond our resellers in two-tier distribution channels. These resellers/customers are generally given privileges to return inventory, receive credits for changes in selling prices, and participate in cooperative marketing programs. We maintain estimated accruals and allowances for such exposures. However, such resellers tend toopen credit arrangements, we have ~~access to more limited financial resources than other resellers and end-user customers and therefore represent potential sources of increased credit risk. We have~~also experienced ~~increased~~ demands for customer financing ~~including loan financing~~ and facilitation of leasing ~~solutions.~~arrangements. We expect ~~demands~~demand for customer financing ~~may~~to continue. We believe customer financing is a competitive factor in obtaining business, particularly in supplying customers involved in significant infrastructure projects. Our loan financing arrangements may include not only financing the acquisition of our products but also providing additional funds for ~~soft~~other costs associated with network installation and integration of our products and for working capital purposes. ~~Due to~~We do not recognize revenue on such loan financing arrangements until cash payments are received.

Because of the current slowdown in the global economy, our exposure to the credit risks relating to ~~these resellers/customers~~our financing activities described above have increased. Although we have programs in place to monitor and mitigate the associated risk, including monitoring of particular risks in certain geographic areas, there can be no assurance that such programs will be effective in reducing our credit risks. ~~We also continue~~There have been significant bankruptcies among customers both on open credit and with loan or lease financing arrangements, particularly among Internet businesses and service providers, causing us to ~~monitor credit exposures from weakened~~incur economic or financial losses. There can be no assurance that, should economic conditions ~~in certain geographic regions,~~not improve, additional losses would not be incurred, and ~~the impact~~ that such ~~conditions may have on the worldwide economy. We have experienced~~ losses ~~due to customers failing to meet their obligations.~~would not be material. Although these losses have not been ~~significant,~~material to date, future losses, if incurred, could harm our business and have a material adverse effect on our operating results and financial condition.

A portion of our sales is derived through our resellers in two-tier distribution channels. These resellers/customers are generally given privileges to return a portion of inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. We maintain estimated accruals and allowances for such exposures. However, such resellers tend to have more limited financial resources than other resellers and end-user customers and therefore, represent potential sources of increased credit risk because they may be more likely to lack the reserve resources to meet payment obligations.

OUR BUSINESS DEPENDS UPON OUR PROPRIETARY RIGHTS, WHICH MIGHT PROVE DIFFICULT TO ENFORCE, AND THERE IS A RISK OUR PRODUCTS COULD BE HELD TO INFRINGE RIGHTS OF ~~INFRINGEMENT~~THIRD PARTIES

~~Our success is dependent upon our proprietary technology.~~ We generally rely ~~upon~~on patents, copyrights, trademarks, and trade secret laws to establish and maintain ~~our~~ proprietary rights in our technology and products. ~~We have a program to file applications for and obtain patents in the United States and in selected foreign countries where a potential market for our products exists. We~~While we have been issued a number of ~~patents;~~patents and other patent applications are currently pending, there can be no assurance, that any of these patents will not be challenged, invalidated, or circumvented, or that any rights granted

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

~~pending. There can be no assurance that any of~~under these patents will ~~not be challenged, invalidated, or circumvented, or that any rights granted thereunder will~~in fact provide competitive advantages to us. In addition, there can be no assurance that patents will be issued from pending applications, or that claims allowed on any future patents will be sufficiently broad to protect our technology. ~~Furthermore,~~In addition, the laws of some foreign countries may not ~~permit the protection of~~protect our proprietary rights to the same extent, as do the laws of the United States. ~~Although~~If we ~~believe~~are unable to protect our proprietary rights in a market we may find ourselves at a competitive disadvantage to others who do not have to incur the ~~protection afforded by our patents, patent applications, copyrights,~~substantial expense, time and ~~trademarks has value, the rapidly changing technology in the networking industry makes our future success dependent primarily on~~effort required to create the innovative ~~skills, technological expertise, and management abilities of our employees rather than on patent, copyright, and trademark protection.~~products which have enabled us to be successful.

~~The industry in which we compete is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights.~~ From time to time, third parties have asserted exclusive patent, copyright, trademark and other intellectual property rights to technologies and related standards that are ~~important~~relevant to us. These ~~claims~~assertions have increased ~~recently~~over time as a result of our ~~acquisitions~~growth and the general increase in the pace of ~~businesses~~patent claims assertions, particularly in the United States. Because of the existence of a large number of patents in the networking field, the secrecy of some pending patents and ~~technologies. Such~~the rapid rate of issuance of new patents, it is not economically practical nor even possible to determine in advance whether a product or any of its components infringe or will infringe the patent rights of others. Third parties, including customers, have ~~pursued~~asserted claims and/or initiated litigation, and may in the future assert claims or initiate litigation, against us or our manufacturers, suppliers, or customers, alleging infringement of their proprietary rights with respect to our existing or future products or components of those products. Regardless of the merit of these claims, they ~~could~~can be time-consuming, result in costly litigation and diversion of technical and management personnel, or require us to develop a ~~noninfringing~~non-infringing technology or enter into ~~royalty~~license agreements; where claims are made by customers, resistance even to unmeritorious claims could damage customer relationships. There can be no assurance that licenses will be available on acceptable terms and conditions, if at all, in all such circumstances, or ~~license agreements.~~that our indemnification by their suppliers will be adequate to cover their costs if a claim were brought directly against us or our customers. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop ~~noninfringing~~non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results and financial condition could be materially and adversely affected.

Many of our products are designed to include software or other intellectual property licensed from third parties. ~~While it~~It may be necessary in the future to seek or renew licenses relating to various aspects of our products, we believe that based upon past experience and standard industry practice, such licenses generally could be obtained on commercially reasonable terms. Because of the existence of a large number of patents in the networking field and the rapid rate of issuance of new patents, it is not economically practical to determine in advance whether a product or any of our components infringe patent rights of others. From time to time, we receive notices from or are sued by third parties regarding patent infringement claims. If infringement claims are found to have merit, we believe that, based upon industry practice, any necessary license or rights under such patents may be obtained on terms that would not have a material adverse effect on our financial condition. Nevertheless, therethese products. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse effect on our business, operating results, and financial condition. Moreover, the inclusion in our products of software or other intellectual property licensed from third parties on a non-exclusive basis could limit our ability to protect our proprietary rights in our products.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

WE FACE RISKS FROM THE UNCERTAINTIES OF REGULATION OF THE INTERNET

~~There are currently~~Currently, few laws or regulations ~~that~~ apply directly to access or commerce on the Internet. We could be materially adversely affected by regulation of the Internet and Internet commerce in any country where we operate. Such regulations could include matters such as voice over the Internet or using Internet Protocol, encryption technology, and access charges for Internet service providers. Our business could be materially adversely affected by the changes in the regulations surrounding the telecommunications industry. The adoption of regulation of the Internet and Internet commerce could decrease demand for our products, and at the same time increase the cost of selling our products, which could have a material adverse effect on our business, operating results, and financial condition.

OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO RETAIN AND RECRUIT KEY PERSONNEL

Our success has always depended in large part on our ability to attract and retain highly skilled technical, managerial, sales, and marketing personnel. In spite of the economic slowdown, competition for these personnel is intense, especially in the Silicon Valley area of Northern California. Volatility or lack of positive performance in our stock price may also adversely affect our ability to retain key employees, all of whom have been granted stock options. The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future, or delays in hiring required personnel, particularly ~~engineers~~engineering and sales personnel, could make it difficult to meet key objectives, such as timely and effective product introductions. In addition, companies in the networking industry whose employees accept positions with competitors frequently claim that competitors have engaged in improper hiring practices. We have received these claims in the past and may receive additional claims to this effect in the future.

WE FACE CERTAIN LITIGATION RISKS

We are a party to lawsuits in the normal course of our business. Litigation can be expensive, lengthy, and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results, ~~of operations,~~ or financial condition. For additional information regarding certain of the lawsuits in which we are involved, see ~~Note 6 to~~Item 1, “Legal Proceedings”, contained in Part II of this Report.

CHANGES IN EFFECTIVE TAX RATES COULD AFFECT OUR RESULTS

Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates, changes in the ~~Consolidated Financial Statements.~~valuation of our deferred tax assets and liabilities, or by changes in tax laws or interpretations thereof.

4852

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

OUR BUSINESS IS ESPECIALLY SUBJECT TO THE RISKS OF EARTHQUAKES, FLOODS, AND OTHER NATURAL CATASTROPHIC EVENTS, AND TO INTERRUPTION BY MANMADE PROBLEMS SUCH AS COMPUTER VIRUSES OR TERRORISM

Our corporate headquarters, including certain of our research and development operations and our manufacturing facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. Additionally, certain of our facilities, which include one of our manufacturing facilities, are located near rivers that have experienced flooding in the past. A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results, and financial condition. In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results, and financial condition. The ~~recent~~ terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce throughout the world and intensified the uncertainty of the U.S. ~~economy~~ and other economies. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

~~THE ENERGY CRISIS IN CALIFORNIA COULD DISRUPT OUR BUSINESS AND THE BUSINESSES OF OUR SUPPLIERS AND SUPPLY PARTNERS AND COULD INCREASE OUR EXPENSES~~

The western United States (and California in particular) has experienced repeated episodes of diminished electrical power supply, and we anticipate that this situation could reoccur in the future. As a result of these episodes, certain of our operations or facilities have been and could in the future be subject to “rolling blackouts” or other unscheduled interruptions of electrical power. The prospect of such unscheduled interruptions may continue for the foreseeable future, and we are unable to predict their occurrence or duration. Certain of our suppliers and supply partners are also located in this area and their operations may also be materially and adversely affected by such interruptions. These suppliers and manufacturers may be unable to manufacture sufficient quantities of our products to meet our demands, or they may increase the costs of such products, which in turn could have a material adverse effect on our business or results of operations.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

WE ARE EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF OUR PORTFOLIO INVESTMENTS AND IN INTEREST RATES

We maintain an investment portfolio of various holdings, types, and maturities. These securities are generally classified as available for sale and, consequently, are recorded on the ~~balance sheet~~Consolidated Balance Sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Part of this portfolio includes equity investments in several publicly traded companies, the values of which are subject to market price volatility. Recent events have adversely affected the public equities market and general economic conditions may continue to worsen. As a result, we may recognize in earnings ~~declines~~the decline in fair value of our publicly traded equity investments below the cost basis ~~that are~~when the decline is judged to be other-than-temporary. For information regarding the sensitivity of and risks associated with the market value of portfolio investments and interest rates, ~~see the~~refer to section titled “Quantitative and Qualitative Disclosures About Market Risk” ~~contained~~included in ~~this Quarterly Report.~~our Annual Report on Form 10-K for the fiscal year ended July 27, 2002. Furthermore, our equity investments in both publicly traded companies and private companies are subject to risk of loss of investment capital. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose our entire investment in these companies.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

RISK FACTORS

WE ARE SUBJECT TO RISKS ASSOCIATED WITH STRATEGIC ALLIANCES

We have ~~a number of~~several strategic alliances with large and complex organizations and ~~our ecosystem partners.~~other companies with whom we work to offer complementary products and services. These arrangements are generally limited to specific projects, the goal of which is generally to facilitate product compatibility and adoption of industry standards. If successful, these relationships may be mutually beneficial and result in industry growth. However, these alliances carry an element of risk because, in most cases, we must compete in some business areas with a company with which we have a strategic alliance and, at the same time, cooperate with that company in other business areas. Also, if these companies fail to perform or if these relationships fail to materialize as expected, we could suffer delays in product development or other operational difficulties.

WE FACE RISKS ASSOCIATED WITH CHANGES IN TELECOMMUNICATIONS REGULATION AND TARIFFS

Changes in ~~domestic and international~~ telecommunications requirements in the United States or other countries could affect the sales of our products. In particular, we believe it is possible that there may be changes in ~~domestic~~U.S. telecommunications ~~regulation~~regulations in the future that could slow the expansion of the service providers’ network infrastructures and materially adversely affect our business, operating results, and financial condition. Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could affect the sales of our products for certain classes of customers. Additionally, in the United States, our products must comply with various Federal Communications Commission requirements and regulations. In countries outside of the United States, our products must meet various requirements of local telecommunications authorities. Changes in tariffs or failure by us to obtain timely approval of products could have a material adverse effect on our business, operating results, and financial condition.

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

~~RISK FACTORS~~

OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE

Our common stock has experienced substantial price volatility, particularly as a result of variations between our actual ~~and anticipated~~ financial results, and the published expectations of analysts, and as a result of announcements by our competitors and us. Furthermore, speculation in the press or investment community about our strategic position, financial condition, results of operations, business or significant transactions can cause changes in stock price. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies, in particular, and that have often been unrelated to the operating performance of these companies. These factors, as well as general economic and political conditions, may materially adversely affect the market price of our common stock in the future. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom have been granted stock options.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

At any time, a sharp rise in interest rates could have a material adverse impact on the fair value of our investment portfolio. Conversely, declines in interest rates could have a material impact on interest earnings for our investment portfolio. We do not currently hedge these interest rate exposures.

We have also invested in ~~numerous~~several privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose our entire initial investment in these companies. At any time, a sharp rise in interest rates could have a material adverse impact on the fair value of our investment portfolio. Conversely, declines in interest rates could have a material impact on interest earnings for our investment portfolio. We do not currently hedge these interest rate exposures.

Readers are referred to pages 2123 to 2224 of the fiscal ~~2001~~2002 Annual Report to Shareholders for a more detailed discussion of quantitative and qualitative disclosures about market risk.

The following analysis presents the hypothetical changes in fair ~~values~~value of public equity investments that are sensitive to changes in the stock market (in millions):

Valuation of Securities Valuation of Securities
Given X% Decrease Fair Value Given X% Increase
in Each Stock's Price as of in Each Stock's Price

Apr. 27,
(75%) (50%) (25%) 2002 25% 50% 75%

Corporate equities $ 255 $ 510 $ 765 $ 1,020 $ 1,275 $ 1,530 $ 1,785

Valuation of Securities Valuation of Securities
Given X% Decrease Fair Value Given X% Increase
in Each Stock's Price as of in Each Stock's Price

October 26,
(75%) (50%) (25%) 2002 25% 50% 75%

Corporate equities $ 115 $ 229 $ 344 $ 458 $ 573 $ 687 $ 802

Our equity portfolio consists of securities with characteristics that most closely match the S&P Index or companies traded on the Nasdaq National Market. These equity securities are held for purposes other than trading. The modeling technique used measures the hypothetical change in fair values arising from selected hypothetical changes in each stock’s price. Stock price fluctuations of plus or minus 25%, 50%, and 75% were selected based on the probability of their occurrence. Our equity portfolio consists of securities with characteristics that most closely match the S&P Index or companies traded on the NASDAQ National Market. The NASDAQ Composite Index has shown a 25%occurrence and ~~50% movement in each~~are representative of the ~~last three years and a 75% movement~~historical movements in ~~at least one of~~ the ~~last three years.~~Nasdaq Composite Index.

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Item 4. Controls and Procedures

a. Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Report, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
b. Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In addition, beginning on April 23, 2001, a number of purported shareholder derivative lawsuits were filed in the Superior Court of California, County of Santa Clara ~~in addition to one filed~~and in the Superior Court of California, County of San Mateo. ~~Those state court actions have been coordinated.~~There is a procedure in place for the coordination of such actions. Two purported derivative suits have also been filed in the United States District Court for the Northern District of California, and those federal court actions have been consolidated. The complaints in the various derivative actions include claims for breach of fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment, and violations of the California Corporations ~~Code,~~Code; seek compensatory and other damages, disgorgement, and other ~~relief,~~relief; and are based on essentially the same allegations as the class actions.

Item 2. Changes in Securities and Use of Proceeds

During the quarter ended October 26, 2002, the Company issued an aggregate of 2,716,241 shares and 9,094,039 shares of its common stock in connection with the acquisitions of AuroraNetics, Inc. and AYR Networks, Inc, respectively. The offer and sale of the securities were effected without registration in reliance on the exemption afforded by section 3(a)(10) of the Securities Act of 1933, as amended. The issuances were approved, after a hearing upon the fairness of the terms and conditions of the transaction, by the California Department of Corporations under authority to grant such approval as expressly authorized by the laws of the State of California.

Item 6. Exhibits and Reports on Form 8-K

(a)    Exhibits

   ~~None~~The following documents are filed as Exhibits to this Report:
99.1  Certification of Principal Executive Officer
99.2  Certification of Principal Financial Officer

(b)    Reports on Form 8-K

   The Company filed ~~one report~~five reports on Form 8-K during the quarter ended ~~April 27,~~October 26, 2002. Information regarding ~~the~~each item reported on is as follows:


Date		Item Reported On

~~February~~October 23, 2002		On October 22, 2002, the Company announced that it had entered into a definitive agreement to acquire Psionic Software, Inc.

October 11, 2002		On October 10, 2002, the Company completed the acquisition of AYR Networks, Inc.

September 18, 2002		On September 18, 2002, the Company announced that it had submitted to the SEC the Statements under Oath of Principal Executive Officer and Principal Financial Officer in accordance with the SEC’s order dated June 27, 2002.

August 20, 2002		On August 19, 2002, the Company announced that it had entered into a definitive agreement to acquire Andiamo Systems, Inc.

August 5, 2002		~~The~~On July 25, 2002, the Company announced that ~~John L. Hennessy was appointed~~it had entered into a definitive agreement to ~~the Board of Directors effective as of January 28, 2002.~~acquire AYR Networks, Inc.

5357

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the ~~registrant~~Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		Cisco Systems, Inc.

Date: ~~May 28,~~November 20, 2002	By	~~/s/~~ /s/ Larry R. Carter

	Larry R. Carter, Senior Vice President, Finance and Administration, Chief Financial Officer and Secretary

5458

CHIEF EXECUTIVE OFFICER CERTIFICATION

I, John T. Chambers, President and Chief Executive Officer of Cisco Systems, Inc., certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Cisco Systems, Inc. (the “Registrant”);

2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report;

3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Quarterly Report;

4. The Registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared;

b) evaluated the effectiveness of the Registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the “Evaluation Date”); and

c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The Registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant’s auditors and the audit committee of Registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant’s ability to record, process, summarize and report financial data and have identified for the Registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal controls; and

6. The Registrant’s other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 20, 2002


/s/ John T. Chambers John T. Chambers President and Chief Executive Officer (Principal Executive Officer)

CHIEF FINANCIAL OFFICER CERTIFICATION

I, Larry R. Carter, Senior Vice President, Finance and Administration, Chief Financial Officer and Secretary of Cisco Systems, Inc., certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Cisco Systems, Inc. (the “Registrant”);

c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal controls; and

Date: November 20, 2002


/s/ Larry R. Carter Larry R. Carter Senior Vice President, Finance and Administration, Chief Financial Officer and Secretary (Principal Financial Officer)

EXHIBIT INDEX

EXHIBIT
NO.
99.1 Certification of Principal Executive Officer
99.2 Certification of Principal Financial Officer


		Consideration						Purchased
		Including Assumed		In-Process				Intangible
Acquired Company		Liabilities		R&D Expense		Goodwill		Assets

Allegro		$	138	$	28	$	5	$	105
AuroraNetics			51		9		16		14

	Total	$	189	$	37	$	21	$	119


				Accumulated
July 28, 2001		Gross		Amortization			Net

Technology		$	1,053	$	(240	)	$	813
Technology licenses			523		(191	)		332
Patents			232		(44	)		188
Acquired workforce			91		(20	)		71
Other			117		(51	)		66

	Total	$	2,016	$	(546	)	$	1,470


				Accumulated
July 27, 2002		Gross		Amortization			Net

Technology		$	893	$	(429	)	$	464
Technology licenses			523		(323	)		200
Patents			128		(54	)		74
Other			135		(76	)		59

	Total	$	1,679	$	(882	)	$	797


		Balance at					Cash			Balance at
		July 28, 2001		Adjustments(1)			Payments			April 27, 2002(2)

Workforce reduction		$	61	$	(35	)	$	(26	)	$	—
Consolidation of excess facilities and other charges			325		128			(112	)		341

	Total	$	386	$	93		$	(138	)	$	341


				Consolidation of			Impairment of
				Excess Facilities			Goodwill
	Workforce			and			and Purchased
	Reduction			Other Charges (3)			Intangible Assets			Total

Initial charge in third quarter of fiscal 2001	$	397		$	484		$	289		$	1,170
Noncash charges		(71	)		(141	)		(289	)		(501	)
Cash payments		(265	)		(18	)		—			(283	)

Balance at July 28, 2001		61			325			—			386
Adjustments (1)		(35	)		128			—			93
Cash payments		(26	)		(131	)		—			(157	)

Balance at July 27, 2002		—			322			—			322
Adjustments (2)		—			40			—			40
Cash Payments		—			(26	)		—			(26	)

Balance at October 26, 2002	$	—		$	336		$	—		$	336


		Total					Non-Cash			Cash			Balance at
		Charge		Adjustments(1)			Charges			Payments			April 27, 2002(2)

Workforce reduction		$	397	$	(35	)	$	(71	)	$	(291	)	$	—
Consolidation of excess facilities and other charges			484		128			(141	)		(130	)		341
Impairment of goodwill and purchased intangible assets			289		—			(289	)		—			—

	Total	$	1,170	$	93		$	(501	)	$	(421	)	$	341


		Excess Inventory			Excess Inventory
		Reserve			Benefit

Reserve balance as of January 26, 2002		$	139		$	—
Usage:
	Inventory scrapped		(45	)		—
	Inventory utilized		(21	)		21
	Settlement of purchase commitments		—			6

			(66	)	$	27


Remaining reserve balance as of April 27, 2002		$	73


	Three Months			Fiscal Year
	Ended			Ended
	October 26, 2002			July 27, 2002

Shares of common stock outstanding		7,233			7,303

Granted and assumed		83			282
Canceled		(13	)		(82	)

Net options granted		70			200

Grant dilution (1)		1.0	%		2.7	%

Exercised		7			54
Exercise dilution (2)		0.1	%		0.7	%


				Options Outstanding

	Options						Weighted-Average
	Available			Number			Exercise Price
	for Grant			Outstanding			per Share

BALANCE AT JULY 28, 2001		522			1,060		$	29.41
Granted and assumed		(282	)		282			17.72
Exercised		—			(54	)		6.99
Canceled		82			(82	)		36.94
Additional shares reserved		342			—			—

BALANCE AT JULY 27, 2002		664			1,206			27.17
Granted and assumed		(83	)		83			10.07
Exercised		—			(7	)		5.94
Canceled		13			(13	)		35.35
Additional shares reserved		1			—			—

BALANCE AT OCTOBER 26, 2002		595			1,269		$	26.08


		Options Outstanding								Options Exercisable

				Weighted-
				Average		Weighted-						Weighted-
				Remaining		Average						Average
				Contractual		Exercise		Aggregate				Exercise		Aggregate
Range of		Number		Life		Price		Intrinsic		Number		Price		Intrinsic
Exercise Prices		Outstanding		(in Years)		per Share		Value		Exercisable		per Share		Value

$ 0.01 - - 5.60			132		3.19	$	4.42	$	973		128	$	4.54	$	925
5.61 - - 9.78			149		6.07		8.41		502		77		7.24		347
9.79 - 15.92			152		5.51		12.82		11		116		12.48		7
15.93 - 16.24			149		7.94		16.08		—		23		16.05		—
16.25 - 20.61			181		7.73		19.24		—		31		18.44		—
20.62 - - 36.71			149		5.64		27.62		—		113		28.02		—
36.71 - 51.89			142		6.95		49.08		—		57		48.73		—
51.90 - 55.42			146		6.19		54.37		—		80		54.37		—
55.43 - 72.56			69		6.60		63.98		—		35		64.24		—

	Total		1,269		6.25	$	26.08	$	1,486		660	$	24.35	$	1,279


	Employee Stock Option Plans

	October 26,			July 27,
	2002			2002

Expected dividend		0.0	%		0.0	%
Risk-free interest rate		3.1	%		4.7	%
Expected volatility		45.9	%		47.5	%
Expected life (in years)		6.0			5.5


		Three Months Ended

		Amount				Percentage

		October 26,		October 27,		October 26,			October 27,
		2002		2001		2002			2001

Gross margin:
	Product	$	2,776	$	2,156		69.2	%		59.0	%
	Service		582		536		70.0	%		67.7	%

	Total	$	3,358	$	2,692		69.3	%		60.5	%


	Estimated Cost to		Risk-Adjusted
	Complete Technology at		Discount Rate for
Acquired Company	Time of Acquisition		In-Process R&D

Allegro Systems, Inc.	$	5		52.5	%
AuroraNetics, Inc.	$	2		35.0	%

•		~~Overall information technology spending;~~Fluctuations in demand for our products and services, such as has occurred in the last two years, especially with respect to Internet businesses and telecommunications service providers;

•		Changes in ~~general global economic conditions and specific market conditions in the communications and networking industries;~~

•		~~Fluctuations in demand for our products and services;~~

•		The effects of terrorist activity and armed conflict, such as disruptions in general global economic activity, changes in logistics and security arrangements, and reduced customer demand for our products and services;

•		~~The long~~ sales and implementation ~~cycle~~cycles for our products and the reduced visibility into our customers’ spending plans and associated revenue;

•		~~Inventory~~Our ability to maintain appropriate inventory levels and purchase ~~commitments exceeding our estimated requirements based upon future demand forecasts;~~

•		~~Existing network capacity, sharing of existing network capacity, and network capacity utilization rates of our customers;~~commitments;

•		Price and product competition in the communications and networking ~~industry;~~industries which can change rapidly due to technological innovation;

•		The overall trend toward industry ~~consolidation;~~consolidation both among our competitors and our customers;

•		The introduction and market acceptance of new technologies and products, as well as the adoption of new networking standards;

•		Variations in sales channels, product costs, or mix of products sold;

•		The timing and size of orders ~~timing of shipments, and the ability to satisfy all contractual obligations in customer contracts;~~from customers;

•		Manufacturing lead times;

•		~~The impact of acquired businesses and technologies;~~

•		~~The geographical mix of~~Fluctuations in our ~~revenue and the associated impact on~~ gross ~~margin;~~margins;

•		Our ability to achieve targeted cost reductions;

•		~~Adverse changes in the public and private equity and debt markets;~~

•		The ability of our customers and suppliers to obtain financing or to fund capital expenditures;

•		The ~~trend toward sales of integrated network solutions;~~

•		~~The~~ timing and amount of employer payroll tax to be paid on employees’ gains on stock options exercised;

•		Actual events, circumstances, outcomes, and amounts differing from judgments,

•		Reduced demand for our products as a result of a decrease in capital spending by our customers, particularly service providers;

•		Increased price competition for our products, partially as a consequence of customers disposing of unutilized products;

•		Increased risk of excess and obsolete inventories;

•		Excess facilities and manufacturing capacity; and

•		Higher overhead costs as a percentage of revenues.

•		Changes in customer, geographic or product mix, including mix of configurations within each product group;

•		Increases in material or labor costs;

•		Excess inventory;

•		Obsolescence charges;

•		Changes in shipment volume;

•		Loss of cost savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand;

•		Increased price competition;

•		Changes in distribution channels;

•		Increased warranty costs; and

•		Introduction of new products and costs of entering new markets.

•		As we respond to demand from certain categories of customers to sell directly to them, we could risk alienating channel partners and adversely affecting our distribution model.

•		Because direct sales may compete with the sales made by channel partners, these channel partners may elect to use other suppliers that do not directly sell their own products.

•		Some of our system integrators may demand that we absorb a greater share of the risks that their customers may ask them to bear, affecting our gross margin.

•		Some of our channel partners may have insufficient financial resources and may not be able to withstand changes in business conditions, including the recent economic downturn. Revenues from indirect sales could suffer if our distributor’s financial condition or operations weaken.

•		~~New markets that we participate in may grow quickly and thus, consume significant component capacity~~

•		~~As we continue to acquire companies and new technologies, we are dependent, at least initially, on unfamiliar supply chains or relatively small supply partners~~

•		~~We face competition for certain components, which are supply constrained, from existing competitors and companies in other markets~~

•		~~The ability to provide end-to-end networking solutions and support~~

•		~~Performance~~

•		~~Price~~

•		~~The ability to provide new technologies and products~~

•		~~The ability to provide value-added features such as security, reliability, and investment protection~~

•		~~Conformance to standards~~

•		~~Market presence~~

•		~~The ability to provide financing~~

•		~~Difficulties in integrating the operations, technologies, products and personnel of the acquired companies~~

•		~~The risk of diverting management’s attention from normal daily operations of the business~~

•		~~Potential difficulties in completing projects associated with in-process research and development~~

•		~~Risks of entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions~~

•		~~Initial dependence on unfamiliar supply chains or relatively small supply partners~~

•		~~Insufficient revenues to offset increased expenses associated with acquisitions~~

•		~~The potential loss of key employees of the acquired companies~~

•		New markets that we participate in may grow quickly and thus, consume significant component capacity;

•		As we continue to acquire companies and new technologies, we are dependent, at least initially, on unfamiliar supply chains or relatively small supply partners; and

•		We face competition for certain components, which are supply constrained, from existing competitors and companies in other markets.

•		Diversion of management’s attention from normal daily operations of the business;

•		Potential difficulties in completing projects associated with in-process research and development;

•		Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;

•		Initial dependence on unfamiliar supply chains or relatively small supply partners;

•		Insufficient revenues to offset increased expenses associated with acquisitions; and

•		The potential loss of key employees of the acquired companies.

•		Issue common stock that would dilute our current shareholders’ percentage ownership;

•		Assume liabilities;

•		Record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges;

•		Incur amortization expenses related to certain intangible assets;

•		Incur large and immediate write-offs; or

•		Become subject to litigation.


	Valuation of Securities								Valuation of Securities
	Given X% Decrease						Fair Value		Given X% Increase
	in Each Stock's Price						as of		in Each Stock's Price
							Apr. 27,
	(75%)		(50%)		(25%)		2002		25%		50%		75%

Corporate equities	$	255	$	510	$	765	$	1,020	$	1,275	$	1,530	$	1,785

	a.		Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Report, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

	b.		Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

(a)		Exhibits

		~~None~~The following documents are filed as Exhibits to this Report:

		99.1 Certification of Principal Executive Officer

		99.2 Certification of Principal Financial Officer

(b)		Reports on Form 8-K

		The Company filed ~~one report~~five reports on Form 8-K during the quarter ended ~~April 27,~~October 26, 2002. Information regarding ~~the~~each item reported on is as follows:


EXHIBIT NO.

99.1		Certification of Principal Executive Officer
99.2		Certification of Principal Financial Officer