Annual Report 2008

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

The Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 (the ”Securities Act“) and the Securities Exchange Act of 1934 (the ”Exchange Act“). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as ”expects,“ ”anticipates,“ ”targets,“ ”goals,“ ”projects,“ ”intends,“ ”plans,“ ”believes,“ ”seeks,“ ”estimates,“ ”continues,“ ”endeavors,“ ”may,“ variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified below, as well as on the inside back cover of this Annual Report to Shareholders and under ”Part I, Item 1A. Risk Factors,“ and elsewhere in our Annual Report on Form 10-K. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.

Overview

We sell Internet Protocol (IP)-based networking and other products and services related to the communications and information technology industry. Our products and services are designed to address a wide range of customers’ business needs, including improving productivity, reducing costs, and gaining a competitive advantage. Our corresponding technology focus is on delivering networking products and solutions that simplify and secure customers’ infrastructures and offer integrated services. Our products and services help customers build their own network infrastructures that support tools and applications that allow them to communicate with key stakeholders, including customers, prospects, business partners, suppliers, and employees. At a high level, we group our product offerings into the following categories: our core technologies, routing and switching; advanced technologies; and other products. In addition to our product offerings, we provide a broad range of service offerings, including technical support services and advanced services. Our customer base spans virtually all types of public and private agencies and businesses and primarily consists of large enterprise companies, service providers, commercial customers, and consumers.

In fiscal 2008, we achieved record financial results. Our results for fiscal 2008 reflected increases in net sales, net income, and net income per diluted share from fiscal 2007, as we have continued to achieve balance in year-over-year revenue growth from our products and services, customer markets, and geographic theaters. We believe this balance is attributable in part to the successful implementation of our strategy. Net income and net income per diluted share increased by 10% and 12%, respectively, in fiscal 2008 compared with fiscal 2007.

Strategy and Focus Areas

We believe the growth we experienced in fiscal 2008 was attributable to the continued deployment by customers of our end-to-end architecture and the convergence of data, voice, video, and mobility into IP networks. In addition, our approach of achieving balance across products and services, customer markets and geographic theaters contributed to our growth and strong financial position. Video applications, including IP television (IPTV), Cisco TelePresence systems, unified communications, physical security and other video products, have the potential to accelerate the growth of bandwidth demand and to increase loads on networks, which may require upgrades to existing networks. We delivered several new products during the year, and we are pleased with the breadth and depth of our innovation across all aspects of our business and the impact that we believe this innovation will have on our long-term prospects.

From a geographic perspective, we are focusing on expanding our presence in the Emerging Markets theater, and we are making additional investments in emerging countries, China and India in particular. From a customer markets perspective, we are continuing to invest in the enterprise, service provider, commercial, and consumer markets.

The investments we have made and our architectural approach are based on the belief that collaboration and networked Web 2.0 technologies that enable user collaboration, including unified communications and Cisco TelePresence systems, and the increased use of the network as the platform for all forms of communications and information technology will create new market opportunities for us. As part of the second major phase of the Internet, we believe the industry is evolving as both personal and business process collaboration enabled by networked Web 2.0 technologies help to increase innovation and productivity. We will endeavor to lead this market transition both through product development and adoption in the external customer marketplace and through our own internal adoption and use.

As we have exited fiscal 2008, we continue to see uncertain market conditions, primarily in the United States. While it is difficult to predict, we believe it is possible that these uncertain market conditions we see in the United States may spread to our other geographies. In addition, we have seen a slowdown in capital expenditures by a few of our service provider customers and believe there may be potential for a broader slowdown in the global service provider market in the next few quarters. Should these conditions persist or spread or such capital expenditures decline, our operating results could be adversely affected. However, we believe that our strategy and our ability to innovate and execute may enable us to improve our relative competitive position in difficult business conditions, and may continue to provide us with long-term growth opportunities. As we have done in the past, we will attempt to use the current market uncertainty as an opportunity to expand our share of our customers’ information technology spending and to continue moving into product adjacencies.

Revenue

Net sales increased by 13% in fiscal 2008 compared with fiscal 2007. Revenue increased compared with fiscal 2007 in each of our five geographic theaters and in each of our customer markets. During the second half of fiscal 2008, we experienced slower year-over-year growth in sales to the service provider market in the United States. Sales to the enterprise market in the United States were relatively flat in fiscal 2008 compared with fiscal 2007. Revenue for the Emerging Markets theater increased significantly during fiscal 2008 compared with fiscal 2007, due to higher shipments and recognition of previously deferred revenue. Revenue for the Asia Pacific theater increased in fiscal 2008 as our customers in this theater, particularly in China and India, continued to invest in communications and information technology. Revenue also increased in the European Markets and Japan theaters during fiscal 2008.

The increase in our revenue in fiscal 2008 also reflected balance across our products and services. The largest proportion of the increase in net product sales in fiscal 2008 was in sales of advanced technologies. Sales of our advanced technologies, which represented a larger proportion of our net product sales than routing, increased by 21% in fiscal 2008, due primarily to strength in sales of our unified communications and video systems products. The increase in our sales of advanced technologies reflects our balanced product portfolio and our efforts to constantly innovate and evolve into new markets and product adjacencies. In fiscal 2008, we also experienced strength in sales of our routing products, led by our high-end routers. The increase in switching revenue in fiscal 2008 was led by higher sales of our fixed-configuration switches.

We have focused on expanding our service model. In fiscal 2008, our net service revenue increased by approximately 18% compared with fiscal 2007. Our service and support strategy seeks to capitalize on increased globalization, and we believe this strategy, along with our architectural approach, has the potential to further differentiate us from competitors.

Operating Margin

In fiscal 2008, our gross margin percentage increased compared with fiscal 2007. The increase was driven by higher product gross margin, which was due to lower manufacturing costs and higher shipment volume, partially offset by higher sales discounts, rebates, and product pricing. Operating expenses in fiscal 2008 increased in both absolute dollars and as a percentage of revenue compared with fiscal 2007, primarily as a result of increased headcount-related expenses. The effects of unfavorable foreign currency exchange rates also increased operating expenses. Our headcount increased in fiscal 2008, reflecting investments in sales as well as research and development (R&D), investments in our service business, and the effect of acquisitions.

Other Financial Highlights

The following is a summary of our other financial highlights for fiscal 2008:

  • Our backlog at the end of fiscal 2008 was $4.8 billion, compared with $3.9 billion at the end of fiscal 2007.
  • Our deferred revenue at the end of fiscal 2008 was $8.9 billion, compared with $7.0 billion at the end of fiscal 2007.
  • We generated cash flows from operations of $12.1 billion. Our cash and cash equivalents, together with our investments, were $26.2 billion at the end of fiscal 2008, compared with $22.3 billion at the end of fiscal 2007.
  • We repurchased 372 million shares of our common stock for $10.4 billion during fiscal 2008.
  • Days sales outstanding in accounts receivable (DSO) at the end of fiscal 2008 was 34 days, compared with 38 days at the end of fiscal 2007.
  • Our inventory balance was $1.2 billion at the end of fiscal 2008, compared with $1.3 billion at the end of fiscal 2007. Annualized inventory turns were 11.8 in the fourth quarter of fiscal 2008, compared with 10.3 in the fourth quarter of fiscal 2007. Our purchase commitments with contract manufacturers and suppliers were $2.7 billion at the end of fiscal 2008, compared with $2.6 billion at the end of fiscal 2007.

Critical Accounting Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us 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 describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. The accounting policies described below are significantly affected by critical accounting estimates. Such accounting policies require significant judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements, and actual results could differ materially from the amounts reported based on these policies.

Revenue Recognition

Our products are generally integrated with software that is essential to the functionality of the equipment. Additionally, we provide unspecified software upgrades and enhancements related to the equipment through our maintenance contracts for most of our products. Accordingly, we account for revenue in accordance with Statement of Position No. 97-2, ”Software Revenue Recognition,“ and all related interpretations. For sales of products where software is incidental to the equipment, or in hosting arrangements, we apply the provisions of Staff Accounting Bulletin No. 104, ”Revenue Recognition,“ and all related interpretations. Revenue is recognized when all of the following criteria have been met:

  • When persuasive evidence of an arrangement exists. Contracts, Internet commerce agreements, and customer purchase orders are generally used to determine the existence of an arrangement.
  • Delivery has occurred. Shipping documents and customer acceptance, when applicable, are used to verify delivery.
  • The fee is fixed or determinable. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.
  • Collectibility is reasonably assured. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history.

In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met. When a sale involves multiple elements, such as sales of products that include services, the entire fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element are met. The amount of product and service revenue recognized is affected by our judgment as to whether an arrangement includes multiple elements and, if so, whether vendor-specific objective evidence of fair value exists. Changes to the elements in an arrangement and our ability to establish vendor-specific objective evidence for those elements could affect the timing of the revenue recognition.

Revenue deferrals relate to the timing of revenue recognition for specific transactions based on financing arrangements, service, support, and other factors. Financing arrangements may include sales-type, direct-financing, and operating leases, loans, and guarantees of third-party financing. Our total deferred revenue for products was $2.7 billion and $2.2 billion as of July 26, 2008 and July 28, 2007, respectively. Technical support services revenue is deferred and recognized ratably over the period during which the services are to be performed, which is typically from one to three years. Advanced services revenue is recognized upon delivery or completion of performance. Our total deferred revenue for services was $6.1 billion and $4.8 billion as of July 26, 2008 and July 28, 2007, respectively.

We make sales to distributors and retail partners and recognize revenue based on a sell-through method using information provided by them. Our distributors and retail partners participate in various cooperative marketing and other programs, and we maintain estimated accruals and allowances for these programs. If actual credits received by our distributors and retail partners under these programs were to deviate significantly from our estimates, which are based on historical experience, our revenue could be adversely affected.

Allowance for Doubtful Accounts and Sales Returns

Our accounts receivable balance, net of allowance for doubtful accounts, was $3.8 billion and $4.0 billion as of July 26, 2008 and July 28, 2007, respectively. The allowance for doubtful accounts was $177 million, or 4.4% of the gross accounts receivable balance, as of July 26, 2008, and $166 million, or 4.0% of the gross accounts receivable balance, as of July 28, 2007. The allowance is based on our assessment of the collectibility of customer accounts. We regularly review the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay.

Our provision for doubtful accounts was $34 million, $6 million, and $24 million for fiscal 2008, 2007, and 2006, respectively. If a major customer’s creditworthiness deteriorates, or if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our revenue.

A reserve for future sales returns is established based on historical trends in product return rates. The reserve for future sales returns as of July 26, 2008 and July 28, 2007 was $103 million and $74 million, respectively, and was recorded as a reduction of our accounts receivable. If the actual future returns were to deviate from the historical data on which the reserve had been established, our revenue could be adversely affected.

Inventory Valuation and Liability for Purchase Commitments with Contract Manufacturers and Suppliers

Our inventory balance was $1.2 billion and $1.3 billion as of July 26, 2008 and July 28, 2007, respectively. Inventory is written down based on excess and obsolete inventories determined primarily by future demand forecasts. Inventory write-downs are measured as the difference between the cost of the inventory and market based upon assumptions about future demand and are charged to the provision for inventory, which is a component of our cost of sales. At the point of the loss recognition, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.

In addition, we record a liability for firm, noncancelable, and unconditional purchase commitments with contract manufacturers and suppliers for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. As of July 26, 2008, the liability for these purchase commitments was $184 million, compared with $168 million as of July 28, 2007, and was included in other current liabilities.

Our provision for inventory was $102 million, $214 million, and $162 million for fiscal 2008, 2007, and 2006, respectively. The provision for the liability related to purchase commitments with contract manufacturers and suppliers was $97 million, $34 million, and $61 million in fiscal 2008, 2007, and 2006, respectively. If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, we could be required to increase our inventory write-downs and our liability for purchase commitments with contract manufacturers and suppliers and gross margin could be adversely affected. Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain flexibility to help ensure competitive lead times with the risk of inventory obsolescence.

Warranty Costs

The liability for product warranties, included in other current liabilities, was $399 million as of July 26, 2008, compared with $340 million as of July 28, 2007. See Note 10 to the Consolidated Financial Statements. Our products are generally covered by a warranty for periods ranging from 90 days to five years, and for some products we provide a limited lifetime warranty. We accrue for warranty costs as part of our cost of sales based on associated material costs, technical support labor costs, and associated overhead. Material cost is estimated based primarily upon historical trends in the volume of product returns within the warranty period and the cost to repair or replace the equipment. Technical support labor cost is estimated based primarily upon historical trends in the rate of customer cases and the cost to support the customer cases within the warranty period. Overhead cost is applied based on estimated time to support warranty activities.

The provision for product warranties issued during fiscal 2008, 2007, and 2006 was $511 million, $510 million, and $444 million, respectively. If we experience an increase in warranty claims compared with our historical experience, or if the cost of servicing warranty claims is greater than expected, our gross margin could be adversely affected.

Share-Based Compensation Expense

Share-based compensation expense recognized under SFAS 123(R) was as follows (in millions):

Table of Share-Based Compensation Expense

The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the award, and actual and projected employee stock option exercise behaviors. The use of a lattice-binomial model requires extensive actual employee exercise behavior data and a number of complex assumptions including expected volatility, risk-free interest rate, expected dividends, kurtosis, and skewness.

The weighted-average assumptions, using the lattice-binomial model and the weighted-average estimated grant date fair values of employee stock options granted during the respective years are summarized as follows:

Table of Management’s Discussion and Analysis of Financial Condition and Results of Operations

The weighted-average assumptions were determined as follows:

  • We used the implied volatility for two-year traded options on our stock as the expected volatility assumption required in the lattice-binomial model consistent with SFAS 123(R) and Staff Accounting Bulletin No. 107 (”SAB 107“). The selection of the implied volatility approach was based upon the availability of actively traded options on our stock and also upon our assessment that implied volatility is more representative of future stock price trends than historical volatility.
  • The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our employee stock options.
  • The dividend yield assumption is based on the history and expectation of dividend payouts.
  • The estimated kurtosis and skewness are technical measures of the distribution of stock price returns, which affect expected employee exercise behaviors, and are based on our stock price return history as well as consideration of various academic analyses.

Because share-based compensation expense recognized in the Consolidated Statements of Operations is based on awards ultimately expected to vest, it has been reduced for forfeitures. If factors change and we employ different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may differ significantly from what we have recorded in the current year.

Investment Impairments

Our fixed income and publicly traded equity securities, collectively, are reflected in the Consolidated Balance Sheets at a fair value of $21.0 billion as of July 26, 2008, compared with $18.5 billion as of July 28, 2007. See Note 7 to the Consolidated Financial Statements. We recognize an impairment charge when the declines in the fair values of our fixed income or publicly traded equity securities below their cost basis are judged to be other-than-temporary. The ultimate value realized on these securities, to the extent unhedged, is subject to market price volatility until they are sold. We consider various factors in determining whether we should recognize an impairment charge, including the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the investee, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. Our ongoing consideration of these factors could result in additional impairment charges in the future, which could adversely affect our net income. There were no impairment charges on investments in fixed income or publicly held companies during fiscal 2008, 2007, or 2006.

We also have investments in privately held companies, some of which are in the startup or development stages. As of July 26, 2008, our investments in privately held companies were $706 million, compared with $643 million as of July 28, 2007, and were included in other assets. See Note 5 to the Consolidated Financial Statements. We monitor these investments for impairment and make appropriate reductions in carrying values if we determine that an impairment charge is required, based primarily on the financial condition and near-term prospects of these companies. These investments are inherently risky because the markets for the technologies or products these companies are developing are typically in the early stages and may never materialize. Our impairment charges on investments in privately held companies were not material during fiscal 2008, 2007, or 2006.

Goodwill Impairments

Our methodology for allocating the purchase price relating to purchase acquisitions is determined through established valuation techniques. Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to tangible and identifiable intangible assets acquired less liabilities assumed. We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances for each reporting unit. The goodwill recorded in the Consolidated Balance Sheets as of July 26, 2008 and July 28, 2007 was $12.4 billion and $12.1 billion, respectively. In response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill. There was no impairment of goodwill in fiscal 2008, 2007, or 2006.

Income Taxes

We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective tax rates differ from the statutory rate primarily due to the tax impact of state taxes, foreign operations, R&D tax credits, tax audit settlements, nondeductible compensation, and international realignments. Our effective tax rate was 21.5%, 22.5%, and 26.9% in fiscal 2008, 2007, and 2006, respectively.

Effective at the beginning of the first quarter of 2008, we adopted Financial Interpretation No. 48, ”Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109“ (”FIN 48“), which is a change in accounting for income taxes. FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, ”Accounting for Income Taxes“ (”SFAS 109“). The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. As a result of the implementation of FIN 48, we reduced the liability for net unrecognized tax benefits by $451 million and accounted for the reduction as a cumulative effect of a change in accounting principle that resulted in an increase to retained earnings of $202 million and an increase to additional paid-in capital of $249 million. See Note 13 to the Consolidated Financial Statements for additional information.

Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest.

Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding effect to the provision for income taxes in the period in which such determination is made.

Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation of our deferred tax assets and liabilities; by expiration of or lapses in the R&D tax credit laws; by transfer pricing adjustments including the post-acquisition integration of purchased intangible assets from certain acquisitions into our intercompany R&D cost sharing arrangement; by tax effects of nondeductible compensation; by tax costs related to intercompany realignments; or by changes in tax laws, regulations, or accounting principles, including accounting for uncertain tax positions or interpretations thereof. Significant judgment is required to determine the recognition and measurement attribute prescribed in FIN 48. In addition, FIN 48 applies to all income tax positions, including the potential recovery of previously paid taxes, which if settled unfavorably could adversely affect our provision for income taxes or additional paid-in capital. Further, as a result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries is subject to reduced tax rates and in some cases is wholly exempt from tax. Our failure to meet these commitments could adversely affect our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and 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. There can be no assurance that the outcomes from these continuous examinations will not have an adverse impact on our operating results and financial condition.

Loss Contingencies

We are subject to the possibility of various losses arising in the ordinary course of business. We consider the likelihood of 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 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 and whether new accruals are required.

Third parties, including customers, have in the past and may in the future assert claims or initiate litigation related to exclusive patent, copyright, trademark, and other intellectual property rights to technologies and related standards that are relevant to us. These assertions have increased over time as a result of our growth and the general increase in the pace of patent claims assertions, particularly in the United States. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop 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.

Financial Data for Fiscal 2008, 2007, and 2006

Net Sales

The following table presents the breakdown of net sales between product and service revenue (in millions, except percentages):

Table of Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Data for Fiscal 2008, 2007, and 2006 Net Sales The following table presents the breakdown of net sales between product and service revenue (in millions, except percentages).

During the first quarter of fiscal 2008, we enhanced our methodology for attributing certain revenue transactions, including revenue deferrals, and the associated cost of sales for each, to the respective geographic theater. As a result, we have reclassified fiscal 2007 and 2006 net sales by theater, net product sales by theater, and gross margin by theater to conform to the current year’s presentation.

Net sales, which include product and service revenue, for each theater are summarized in the following table (in millions, except percentages):

Table of Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Data for Fiscal 2008, 2007, and 2006 Net sales, which include product and service revenue, for each theater are summarized in the following table (in millions, except percentages).

Net Product Sales

The following table presents the breakdown of net product sales by theater (in millions, except percentages):

Table of Management’s Discussion and Analysis of Financial Condition and Results Operations Financial Data for Fiscal 2008, 2007 and 2006 Net product sales The following table presents the breakdown of net product sales by theater (in millions, except percentages)

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

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations The following table presents net sales for groups of similar products (in millions, except percentages).

Gross Margin

The following table presents the gross margin for products and services (in millions, except percentages):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Gross Margin The following table presents the gross margin for products and services (in millions, except percentages).

The following table presents the gross margin for each theater (in millions, except percentages):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations The following table presents the gross margin for each theater (in millions, except for percentages).

(1) The unallocated corporate items primarily include the effects of amortization of acquisition-related intangible assets and employee share-based compensation expense. We do not allocate these items to the gross margin for each theater because management does not include the information in measuring the performance of the operating segments.

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):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Research and Development, Sales and Marketing, and General and Administrative Expenses

Interest and Other Income (Loss), Net

The following table presents the breakdown of interest and other income (loss), net (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Interest and Other Income (Loss), Net

Discussion of Fiscal 2008 and 2007

The following discussion of fiscal 2008 compared with fiscal 2007 should be read in conjunction with the section of this report entitled ”Financial Data for Fiscal 2008, 2007, and 2006.“

Net Sales

Net sales increased by 13% in fiscal 2008 compared with fiscal 2007. Revenue increased in each of our five geographic theaters and in each of our customer markets in fiscal 2008 compared with fiscal 2007, as we benefited from increased information technology-related capital spending in our markets. Our sales also benefited from our entry into new markets and the development of adjacent product offerings.

Net sales by theater in a particular period may be significantly impacted by several factors related to revenue recognition, including the complexity of transactions such as multiple element arrangements; the mix of financings provided to our channel partners and customers; and final acceptance of the product, system, or solution, among other factors. In addition, certain customers tend to make large and sporadic purchases and the net sales related to these transactions may also be affected by the timing of revenue recognition.

Net Product Sales by Theater

United States and Canada

Net product sales in the United States and Canada theater increased during fiscal 2008 compared with fiscal 2007; however, during the second half of fiscal 2008, we experienced slower growth in net product sales in this theater due to unfavorable economic and market conditions and the associated impact on information technology spending. In particular, during the second half of fiscal 2008, we experienced slower year-over-year growth in sales in the service provider market in the United States due to lower spending by a few large customers, after having experienced higher year-over-year growth during the first six months of fiscal 2008. In the enterprise market, our product sales were relatively flat in fiscal 2008 compared with fiscal 2007 despite increased sales to the U.S. federal government. In the commercial market, we experienced an increase in net product sales in fiscal 2008 compared with fiscal 2007, due in part to the contribution of sales from WebEx Communications, Inc. (”WebEx“), which we acquired during the fourth quarter of fiscal 2007.

European Markets

The increase in net product sales in the European Markets theater in fiscal 2008 compared with fiscal 2007 was attributable to growth across our customer markets, with particular strength in the commercial market. In fiscal 2008, we experienced strong revenue growth in Germany and the United Kingdom, although we experienced slower year-over-year growth in sales in the European Markets overall compared with fiscal 2007.

Emerging Markets

In fiscal 2008, net product sales in the Emerging Markets theater increased compared with fiscal 2007 due to increased shipments and recognition of previously deferred revenue. We experienced continued network deployments across our customer markets in this theater, with particular strength in Brazil and Russia. Certain of our customers in the Emerging Markets theater tend to make large and sporadic purchases, and the net sales related to these transactions may also be affected by the timing of revenue recognition. Further, some customers may continue to require greater levels of financing arrangements, service, and support in future periods, which may also impact the timing of recognition of the revenue for this theater. As a result of these and other factors, the growth rate in net product sales for this theater in fiscal 2008 is not likely to continue consistently throughout future periods. Net product sales may fluctuate from period to period and such changes may or may not be indicative of a trend in future net product sales for this theater.

Asia Pacific

The increase in net product sales in the Asia Pacific theater in fiscal 2008 compared with fiscal 2007 was primarily attributable to the balanced growth in the enterprise, service provider, and commercial markets. In particular, China and India experienced strong growth in fiscal 2008.

Japan

Net product sales in the Japan theater increased in fiscal 2008 compared with fiscal 2007 primarily due to service providers building out next-generation networks.

Net Product Sales by Groups of Similar Products

Routers

The increase in net product sales related to routers in fiscal 2008 compared with fiscal 2007 was primarily due to higher sales of our high-end routers, with strength in our Cisco CRS-1 Carrier Routing System and Cisco 7600 Series Routers. Sales of our high-end routers, which represent a larger proportion of our total router sales than sales of our midrange and low-end routers, increased by approximately $925 million in fiscal 2008 compared with fiscal 2007. Our high-end router sales are primarily to service providers, which tend to make large and sporadic purchases. We believe that the increase in high-end router sales is attributable to service providers scaling their network capacity to accommodate actual and projected increases in data, voice, video traffic and implementation of next-generation networks to provide customized solutions. In fiscal 2008, our sales of our integrated services routers, which we include in the category of midrange and low-end routers, also increased and contributed to growth in sales of our advanced technologies products, such as our security, unified communications, and wireless offerings.

Switches

The increase in net product sales related to switches in fiscal 2008 was primarily due to higher sales of local-area network (LAN) fixed-configuration switches, which increased in fiscal 2008 by approximately $815 million compared with fiscal 2007, with the increase driven primarily by higher sales of the Cisco Catalyst 2960, 3560, and 3750 Series Switches. The increase in sales of LAN fixed-configuration switches was a result of the continued adoption by our customers of new technologies throughout their networks from the data center to the wiring closet, including Gigabit Ethernet, 10 Gigabit Ethernet, and Power over Ethernet. Additionally, growth in advanced technologies, such as unified communications and wireless LANs, created demand for LAN fixed-configuration infrastructure as additional endpoints are added to the network. Net product sales related to our modular switches were relatively flat in fiscal 2008 compared with fiscal 2007.

Advanced Technologies

The increase in net product sales related to advanced technologies in fiscal 2008 compared with fiscal 2007 was primarily due to the following:

  • Sales of unified communications increased by approximately $825 million, due to the contribution of sales from WebEx, which we acquired during the fourth quarter of fiscal 2007, and due to sales of IP phones and associated messaging, conferencing and contact center software as our customers continued to transition from an analog-based to an IP-based infrastructure.
  • Sales of video systems, which include solutions and systems designed to enable video-specific delivery systems for service providers, increased by approximately $355 million. The increase was attributable to several factors, including an increase in the demand for high-definition (HD) and IP set-top boxes, network upgrades, and international growth. Our sales of video systems grew at a slower year-over-year rate in fiscal 2008 compared with the year-over-year rate in fiscal 2007, as our sales of video systems products in fiscal 2007 benefited from the U.S. Federal Communications Commission (FCC) requirements effective July 1, 2007, which required separable security for set-top boxes sold in the United States.
  • Sales of security products increased by approximately $180 million, primarily due to revenue from IronPort Systems, Inc., which we acquired during the fourth quarter of fiscal 2007; revenue from module and line card sales related to our routers and LAN switches as customers continued to emphasize network security; and revenue from sales of our next-generation adaptive security appliance products, which integrate multiple technologies, including virtual private network (VPN), firewall, and intrusion prevention services, on one platform.
  • Sales of application networking services increased by approximately $125 million. The increase was primarily due to higher demand from customers for wide-area network (WAN) optimization solutions.
  • Sales of wireless LAN, home networking, and storage area networking products increased by approximately $75 million, $55 million, and $50 million, respectively.

Other Product Revenue

The increase in other product revenue in fiscal 2008 compared with fiscal 2007 was primarily due to an increase in sales of cable products, Cisco TelePresence systems, and other emerging technology products.

Net Service Revenue

The increase in net service revenue in fiscal 2008 compared with fiscal 2007 was primarily due to increased technical support service contract initiations and renewals associated with higher product sales, which have resulted in a larger installed base of equipment being serviced, and increased revenue from advanced services, which relates to consulting support services for specific networking needs. The increase in advanced services revenue in fiscal 2008, compared with fiscal 2007, was attributable primarily to our revenue growth in the Emerging Markets theater, advanced technologies products, and our service provider market.

Gross Margin

Gross margin percentage increased during fiscal 2008 compared with fiscal 2007 primarily due to the factors described under ”Product Gross Margin“ below, partially offset by the slight decrease in service gross margin percentage described below. The gross margin for each theater is derived from information from our internal management system. The gross margin percentage for a particular theater may fluctuate and period-to-period changes in such percentages may or may not be indicative of a trend for that theater.

Product Gross Margin

The increase in product gross margin percentage during fiscal 2008 compared with fiscal 2007 was due to the following factors:

  • Lower overall manufacturing costs related to lower component costs and value engineering, partially offset by other manufacturing-related costs, increased product gross margin percentage by 2.1%. Value engineering is the process by which production costs are reduced through component redesign, board configuration, test processes, and transformation processes.
  • Higher shipment volume, net of certain variable costs, increased product gross margin percentage by 0.5%.
  • Sales discounts, rebates, and product pricing decreased product gross margin percentage by 1.7%.
  • Changes in the mix of products sold decreased product gross margin percentage by 0.1%.
  • Net effects of amortization of purchased intangible assets and share-based compensation expense decreased product gross margin percentage by 0.1%.

Service Gross Margin

Our service gross margin percentage decreased slightly in fiscal 2008 compared with fiscal 2007 due primarily to advanced services constituting a higher proportion of total service revenue in fiscal 2008. Our service gross margin from technical support services is higher than the service gross margin from our advanced services, and our revenue from advanced services may continue to increase to a higher proportion of total service revenue due to our continued focus on providing comprehensive support to our customers’ networking devices, applications, and infrastructures. Additionally, we have continued to invest in building out our technical support and advanced services capabilities in the Emerging Markets theater.

Factors That May Impact Net Sales and Gross Margin

Net product sales may continue to be affected by factors including the challenges that are currently affecting economic conditions in the United States; changes in the geopolitical environment and global economic conditions; competition, including price-focused competitors from Asia, especially from China; new product introductions; sales cycles and product implementation cycles; changes in the mix of our customers between service provider and enterprise markets; changes in the mix of direct sales and indirect sales; variations in sales channels; and final acceptance criteria of the product, system, or solution as specified by the customer. Sales to the service provider market have been characterized by large and sporadic purchases, especially relating to our router sales and sales of certain advanced technologies. In addition, service provider customers typically have longer implementation cycles, require a broader range of services, including network design services, and often have acceptance provisions that can lead to a delay in revenue recognition. Certain of our customers in the Emerging Markets theater also tend to make large and sporadic purchases and the net sales related to these transactions may similarly be affected by the timing of revenue recognition. As we focus on new market opportunities, customers may require greater levels of financing arrangements, service, and support, especially in the Emerging Markets theater, which may result in a delay in the timing of revenue recognition. To improve customer satisfaction, we continue to focus on managing our manufacturing lead-time performance, 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 and operating results.

Net product sales may also be adversely affected by fluctuations in demand for our products, especially with respect to Internet businesses and telecommunications service providers, whether or not driven by any slowdown in capital expenditures in the service provider market, price and product competition in the communications and information technology industry, introduction and market acceptance of new technologies and products, adoption of new networking standards, and financial difficulties experienced by our customers. We may, from time to time, experience manufacturing issues that create a delay in our suppliers’ ability to provide specific components, resulting in delayed shipments. To the extent that manufacturing issues and any related component shortages result in delayed shipments in the future, and particularly in periods when we and our suppliers are operating at higher levels of capacity, it is possible that revenue for a quarter could be adversely affected if such matters are not remediated within the same quarter. For additional factors that may impact net product sales, see ”Part I, Item 1A. Risk Factors“ in our Annual Report on Form 10-K. Our distributors and retail partners participate in various cooperative marketing and other programs. In addition, increasing sales to our distributors and retail partners generally 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 for sales to our distributors and retail partners based on a sell-through method using information provided by them, and we maintain estimated accruals and allowances for all cooperative marketing and other programs.

Product gross margin may be adversely affected in the future by changes in the mix of products sold, including further periods of increased growth of some of our lower-margin products; introduction of new products, including products with price-performance advantages; our ability to reduce production costs; entry into new markets, including markets with different pricing structures and cost structures, as a result of internal development or through acquisitions; changes in distribution channels; price competition, including competitors from Asia, especially from China; changes in geographic mix of our product sales; the timing of revenue recognition and revenue deferrals; sales discounts; increases in material or labor costs; excess inventory and obsolescence charges; warranty costs; changes in shipment volume; loss of cost savings due to changes in component pricing; effects of value engineering; inventory holding charges; and the extent to which we successfully execute on our strategy and operating plans. Service gross margin may be impacted by various factors such as the change in mix between technical support services and advanced services, the timing of technical support service contract initiations and renewals, and the timing of our strategic investments in headcount and resources to support this business.

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

R&D Expenses

R&D expenses increased in fiscal 2008 compared with fiscal 2007 primarily due to higher headcount-related expenses and compensation expense related to our purchase of the minority interest in Nuova Systems, Inc. (”Nuova Systems“). See Note 3 to the Consolidated Financial Statements. The higher headcount-related expenses reflect our continued investment in R&D efforts for routers, switches, advanced technologies, and other product technologies. We have also continued to purchase or license technology in order to bring a broad range of products to 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

Sales and marketing expenses in fiscal 2008 increased compared with fiscal 2007 primarily due to an increase in sales expenses of approximately $935 million. Sales expenses increased primarily due to an increase in headcount-related expenses including the addition of sales expenses related to WebEx, which we acquired in the fourth quarter of fiscal 2007. Foreign currency fluctuations, net of hedging, increased total sales and marketing expenses by approximately $250 million during fiscal 2008 compared with fiscal 2007.

G&A Expenses

G&A expenses for fiscal 2008 increased, compared with fiscal 2007, primarily due to increased headcount-related expenses and increased information technology-related spending.

Effect of Foreign Currency

Foreign currency fluctuations, net of hedging, increased total R&D, sales and marketing, and G&A expenses by $332 million, or approximately 2.5%, in fiscal 2008 compared with fiscal 2007.

Headcount

Our headcount increased by 4,594 employees in fiscal 2008, reflecting the effects of our investments in sales and R&D described above as well as increased investments in our service business and acquisitions. We expect our headcount to increase as we continue to invest in our business. If we do not achieve the benefits anticipated from these investments, our operating results may be adversely affected.

Share-Based Compensation Expense

Employee share-based compensation expense under SFAS 123(R) was as follows (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Share-Based Compensation Expense Employee share-based compensation expense under SFAS 123(R) was as follows (in millions):

(1) Share-based compensation expense related to acquisitions and investments of $87 million and $34 million for fiscal 2008 and 2007, respectively, is disclosed in Note 3 to the Consolidated Financial Statements and is not included in the above table.

Share-based compensation expense included compensation expense for share-based payment awards granted prior to, but not yet vested, as of July 30, 2005 based on the grant date fair value using the Black-Scholes model, and compensation expense for share-based payment awards granted subsequent to July 30, 2005 based on the grant date fair value using the lattice-binomial model. In conjunction with the adoption of SFAS 123(R), we changed our method of attributing the value of share-based compensation to expense from the accelerated multiple-option approach to the straight-line single-option method. Compensation expense for all share-based payment awards granted on or prior to July 30, 2005 is recognized using the accelerated multiple-option approach, whereas compensation expense for all share-based payment awards granted subsequent to July 30, 2005 is recognized using the straight-line single-option method. Employee share-based compensation expense for fiscal 2008 increased compared with fiscal 2007 primarily due to the higher average per share option values during fiscal 2008 compared with fiscal 2007.

Amortization of Purchased Intangible Assets and In-Process Research and Development

The following table presents the amortization of purchased intangible assets and in-process R&D (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Amortization of Purchased Intangible Assets and In-Process Research and Development The following table presents the amortization of purchased intangible assets and in-process R&D (in millions).

The increase in the amortization of purchased intangible assets included in operating expenses for fiscal 2008 compared with fiscal 2007 was primarily due to the additional amortization of purchased intangible assets related to acquisitions completed near the end of fiscal 2007. For additional information regarding purchased intangibles, see Note 4 to the Consolidated Financial Statements.

Our methodology for allocating the purchase price, relating to purchase acquisitions, to in-process R&D is determined through established valuation techniques. See Note 3 to the Consolidated Financial Statements for additional information regarding the acquisitions completed in fiscal 2008 and the in-process R&D amounts recorded for these acquisitions. In-process R&D was expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed.

Interest Income, Net

The components of interest income, net, are as follows (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Interest Income, Net The components of interest income, net, are as follows (in millions):

The increase in interest income in fiscal 2008 was primarily due to higher average total cash and cash equivalents and fixed income security balances in fiscal 2008 compared with fiscal 2007, partially offset by lower interest rates. The decrease in interest expense in fiscal 2008 compared with fiscal 2007 was due to lower interest rates. Interest expense includes the effect of $6.0 billion of interest rate swaps that we had entered into in connection with the issuance of our fixed-rate notes due in 2011 and 2016, prior to the termination of these interest rate swaps in the third quarter of fiscal 2008, and also includes, for the period following such termination, the amortization of the hedge accounting adjustment of the carrying amount of the fixed-rate debt.

Other Income (Loss), Net

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

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Other Income (Loss), Net The components of other income (loss), net, are as follows (in millions):

Our net gains on investments recognized in other income (loss), net, decreased in fiscal 2008 compared with fiscal 2007 primarily as a result of market conditions. See Note 7 to the Consolidated Financial Statements for the unrealized gains and losses on investments. The other expenses for fiscal 2008 consisted primarily of foreign exchange activities and contributions to charitable organizations.

Provision for Income Taxes

The provision for income taxes resulted in an effective tax rate of 21.5% for fiscal 2008, compared with an effective tax rate of 22.5% for fiscal 2007. The 1.0% decrease in the effective tax rate for fiscal 2008, compared with fiscal 2007, was primarily attributable to a net tax settlement of $162 million and the tax impact of foreign operations partially offset by the expiration of the U.S. federal R&D tax credit and by the tax costs related to the intercompany realignment of certain of our foreign entities.

On July 29, 2007, we adopted FIN 48, which was a change in accounting for income taxes. FIN 48 required a comprehensive model for the financial statement recognition, measurement, classification, and disclosure of uncertain tax positions. See Note 13 to the Consolidated Financial Statements for additional information on our provision for income taxes, including the effects of the adoption of FIN 48 on our Consolidated Financial Statements.

For a full reconciliation of our effective tax rate to the U.S. federal statutory rate of 35% and further explanation of our provision for income taxes, see Note 13 to the Consolidated Financial Statements.

Discussion of Fiscal 2007 and 2006

The following discussion of fiscal 2007 compared with fiscal 2006 should be read in conjunction with the section of this report entitled ”Financial Data for Fiscal 2008, 2007, and 2006.“

Net Sales

The increase in net product sales primarily occurred across our four largest geographic theaters as we experienced increased information technology-related capital spending by our customers in our service provider, enterprise, and commercial markets. The increase in service revenue was primarily due to increased technical support service contract initiations and renewals associated with higher product sales, which have resulted in a larger installed base of equipment being serviced. The United States and Canada and Emerging Markets theaters contributed approximately 70% of the total increase to net sales. The largest proportion of the increase in net product sales was related to higher sales of advanced technologies, which contributed approximately 44% of the total increase, and higher sales of switches, which contributed approximately 30% of the total increase.

On February 24, 2006, we completed the acquisition of Scientific-Atlanta, Inc. (”Scientific-Atlanta“), a provider of set-top boxes, end-to-end video distribution networks, and video integration systems. Scientific-Atlanta’s net sales reflect the contribution of Scientific-Atlanta for the full fiscal 2007, compared with net sales for fiscal 2006 which only included net sales subsequent to the February 2006 acquisition date, as summarized in the following table (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Discussion of Fiscal 2007 and 2006 The following table shows net sales.

Net Product Sales by Theater

United States and Canada

The increase in net product sales in the United States and Canada theater during fiscal 2007 compared with fiscal 2006 was due to an increase in net product sales in the service provider market, growth in the commercial and enterprise markets, and the additional contribution of Scientific-Atlanta. In the service provider market, we experienced balanced growth across our wireline, wireless, and cable operations. In the commercial market, we experienced growth across all of the U.S. regional operations. During fiscal 2007, the growth rate for the enterprise market fluctuated throughout the year and was slower overall than the service provider and commercial markets, but experienced strong growth during the fourth quarter of fiscal 2007 with good balance across all geographic areas. Sales to the U.S. federal government also increased compared with fiscal 2006.

European Markets

The increase in net product sales in the European Markets theater during fiscal 2007 compared with fiscal 2006 was due to balanced growth in net product sales across all of our customer markets and most of our geographic areas, led by the enterprise and commercial markets. During fiscal 2007, net product sales in the United Kingdom, Germany, and France increased from fiscal 2006.

Emerging Markets

The increase in net product sales in the Emerging Markets theater represented the largest percentage increase of any theater in fiscal 2007 compared with fiscal 2006. The increase was primarily as a result of continued network deployment by service providers and growth in the enterprise and commercial markets as customers continue to adopt our architectural platform, led by strength in the Middle East and Africa, Russia and the Commonwealth of Independent States (CIS), and Eastern Europe.

Asia Pacific

The increase in net product sales in the Asia Pacific theater during fiscal 2007 was attributable to growth in the enterprise, commercial, and service provider markets, with China, India, and Australia experiencing strong growth during fiscal 2007.

Japan

Net product sales in the Japan theater, which represented approximately 4% of net product sales, increased slightly in fiscal 2007 compared with fiscal 2006.

Net Product Sales by Groups of Similar Products

Routers

The increase in net product sales related to routers in fiscal 2007 compared with fiscal 2006 was primarily due to higher sales of our high-end routers, with strength in our Cisco CRS-1 Carrier Routing System, Cisco 7600 Series, and Cisco 12000 Series products. Sales of our high-end routers increased by approximately $855 million in fiscal 2007 compared with fiscal 2006. During fiscal 2007, our sales of our integrated services routers also increased and contributed to growth in sales of our advanced technologies products, such as security, unified communications, and wireless.

Switches

The increase in net product sales related to switches in fiscal 2007 was primarily due to higher sales of LAN fixed-configuration switches, which increased during fiscal 2007 by approximately $1.1 billion compared with fiscal 2006. Sales of LAN modular switches also increased during fiscal 2007 compared with fiscal 2006. The increase in sales of LAN switches was a result of the continued adoption by our customers of new technologies, including Gigabit Ethernet, 10 Gigabit Ethernet, and Power over Ethernet. This has resulted in higher sales of fixed-configuration switches, including the Cisco Catalyst 3750, 2960, and 3560 Series, and our high-end modular switches, the Cisco Catalyst 6500 Series.

Advanced Technologies

The increase in net product sales related to advanced technologies in fiscal 2007 compared with fiscal 2006 was primarily due to the following:

  • Video systems sales increased by approximately $1.2 billion during fiscal 2007. The increases were attributable to several factors, including Scientific-Atlanta product sales being included in fiscal 2006 only subsequent to its acquisition in February 2006 compared with a full year in fiscal 2007; an increase in the demand for HD set-top boxes; network upgrades; international expansion; and the FCC requirements effective July 1, 2007, which required separable security for set-top boxes sold in the United States.
  • Unified communications sales increased by approximately $390 million during fiscal 2007, primarily due to sales of IP phones and associated software as our customers continued to transition from an analog-based to an IP-based infrastructure, and also the addition of sales from the acquisition of WebEx.
  • Home networking product sales increased by approximately $240 million during fiscal 2007. Scientific-Atlanta products composed the majority of the increase in home networking product sales during fiscal 2007.
  • Sales of security products increased by approximately $240 million during fiscal 2007, primarily due to module and line card sales related to our routers and LAN modular switches as customers continued to emphasize network security, and also due to sales of our next-generation adaptive security appliance product, which integrates multiple technologies including VPN, firewall, and intrusion prevention services on one platform.
  • Sales of wireless LAN products increased by approximately $190 million during fiscal 2007 primarily due to new customers, continued deployments with existing customers, and their adoption of our unified architecture platform.
  • Other sales of advanced technologies relating to sales of storage area networking products increased by approximately $110 million during fiscal 2007 and application networking services increased by approximately $85 million during fiscal 2007.

Other Product Revenue

The increase in other product revenue during fiscal 2007 compared with fiscal 2006 was primarily due to an increase in sales of optical networking products, sales of IP-based communications solutions to service providers, and the additional contribution from Scientific-Atlanta. Other product revenue also includes sales of emerging technology products.

Net Service Revenue

The increase in net service revenue during fiscal 2007 compared with fiscal 2006 was primarily due to increased technical support service contract initiations and renewals associated with higher product sales, which have resulted in a larger installed base of equipment being serviced, and increased revenue from advanced services. The increase in advanced services revenue during fiscal 2007 compared with fiscal 2006 was attributable primarily to our revenue growth in the service provider market, the Emerging Markets theater, and advanced technologies products.

Gross Margin

Gross margin increased in absolute dollars but gross margin percentage decreased during fiscal 2007 compared with fiscal 2006 primarily due to higher net product sales from Scientific-Atlanta and also due to the factors described under ”Product Gross Margin“ below. The decrease in service gross margin also contributed to the lower gross margin percentage.

Product Gross Margin

The decrease in product gross margin percentage during fiscal 2007 compared with fiscal 2006 was due to the following factors:

  • Changes in the mix of products sold decreased product gross margin percentage by 1.9%, with 1.7% of this decrease related to the mix impact of higher net product sales from Scientific-Atlanta.
  • Sales discounts, rebates, and product pricing decreased product gross margin percentage by 1.7%.
  • Lower overall manufacturing costs related to lower component costs, value engineering and other manufacturing-related costs increased product gross margin percentage by 0.9%.
  • Higher shipment volume, net of certain variable costs, increased product gross margin percentage by 0.9%.
  • Net effects of amortization of purchased intangible assets and share-based compensation expense decreased gross margin percentage by 0.1%.

Service Gross Margin

Our service gross margin percentage for fiscal 2007 decreased from fiscal 2006, primarily due to strategic investments in headcount as well as advanced services representing a higher proportion of total service revenue. Additionally, we have continued to invest in building out our technical support and advanced services capabilities in the Emerging Markets theater.

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

R&D expenses increased for fiscal 2007 compared with fiscal 2006 primarily due to higher headcount-related expenses reflecting our continued investment in R&D efforts for routers, switches, advanced technologies, and other product technologies. Scientific-Atlanta contributed an additional $153 million of R&D expenses for fiscal 2007 compared with fiscal 2006. R&D expenses included employee share-based compensation expense which decreased by $57 million compared with fiscal 2006.

Sales and marketing expenses for fiscal 2007 increased compared with fiscal 2006 primarily due to an increase in sales expenses of $998 million. Sales expenses increased primarily due to an increase in headcount-related expenses. Scientific-Atlanta contributed an additional $86 million of sales and marketing expenses for fiscal 2007 compared with fiscal 2006. Sales and marketing expenses for fiscal 2007 included employee share-based compensation expense which decreased by $35 million compared with fiscal 2006.

G&A expenses for fiscal 2007 increased compared with fiscal 2006 primarily due to increased headcount-related expenses and approximately $65 million of real estate-related charges. Also, Scientific-Atlanta contributed an additional $54 million of G&A expenses for fiscal 2007 compared with fiscal 2006.

Headcount

Our headcount increased by 11,609 employees during fiscal 2007, reflecting the investment in R&D and sales described above and also reflecting increases in investments in our service business; headcount related to our Juarez, Mexico manufacturing facility; and acquisitions. Approximately 3,300 of the new employees were attributable to acquisitions we completed in fiscal 2007.

Share-Based Compensation Expense

In fiscal 2007, employee share-based compensation expense was $931 million, and share-based compensation expense related to acquisitions and investments was $34 million. In fiscal 2006, employee share-based compensation expense was $1 billion and share-based compensation expense related to acquisitions and investments was $87 million.

Amortization of Purchased Intangible Assets and In-Process Research and Development

Amortization of purchased intangible assets included in operating expenses was $407 million in fiscal 2007, compared with $393 million in fiscal 2006. The increase in the amortization of purchased intangible assets included in operating expenses in fiscal 2007 compared with fiscal 2006 was primarily due to the additional amortization of purchased intangible assets related to our acquisitions of Scientific-Atlanta and WebEx, partially offset by an impairment charge of $69 million in fiscal 2006. For additional information regarding purchased intangibles, see Note 4 to the Consolidated Financial Statements.

We recorded in-process R&D of $81 million in fiscal 2007 in connection with the purchase acquisitions completed. The total estimated cost to complete the technology at the time of these acquisitions was $22 million and the risk-adjusted discount rates for the in-process R&D recorded in connection with the acquisitions completed in fiscal 2007 ranged from 16% to 29%. We recorded in-process R&D of $91 million in fiscal 2006 in connection with the purchase acquisitions completed. The total estimated cost to complete the technology at the time of these acquisitions was $95 million and the risk-adjusted discount rates for the in-process R&D recorded in connection with the acquisitions completed in fiscal 2006 ranged from 17% to 22%.

Interest Income, Net

The components of interest income, net, are as follows (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Interest Income, Net The components of interest Income, net, are as follows (in millions) for the periods ending July 28, 2007 and July 29, 2006:

The increase in interest income during fiscal 2007 compared with fiscal 2006 was primarily due to higher average interest rates on our portfolio of cash and cash equivalents and fixed income securities, and higher average balances. The increase in interest expense was due to fiscal 2007 having a full year of interest expense on the $6.5 billion in senior unsecured notes compared with fiscal 2006, which only included interest expense subsequent to the issuance date in February 2006. Interest expense included the effect of $6.0 billion of interest rate swaps which effectively convert fixed-rate interest expense to floating-rate interest expense based on the London Interbank Offered Rate (”LIBOR“).

Other Income (Loss), Net

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

Table in Management's Discussion and Analysis of Financial Condition and Results of Operations Other Income (Loss), Net The components of other income (loss), net, are as follows (in millions) for the periods ending July 28, 2007 and July 29, 2006:

The other expenses for fiscal 2007 and 2006 consisted primarily of contributions of publicly traded equity securities and products to charitable organizations.

Provision for Income Taxes

The provision for income taxes resulted in an effective tax rate of 22.5% for fiscal 2007, compared with an effective tax rate of 26.9% for fiscal 2006. The 4.4% decrease in the effective tax rate for fiscal 2007, compared with fiscal 2006, was primarily attributable to the tax impact of foreign operations and the reinstatement of the U.S. federal R&D tax credit partially offset by a favorable foreign tax audit settlement that occurred in fiscal 2006.

For a full reconciliation of our effective tax rate to the U.S. federal statutory rate of 35% and further explanation of our provision for income taxes, see Note 13 to the Consolidated Financial Statements.

Recent Accounting Pronouncements and Developments

SFAS 157

In September 2006, the FASB issued SFAS No. 157, ”Fair Value Measurements“ (”SFAS 157“). SFAS 157 defines fair value, establishes a framework for measuring fair value, and enhances fair value measurement disclosure. In February 2008, the FASB issued FASB Staff Position (”FSP“) 157-1, ”Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13“ (”FSP 157-1“) and FSP 157-2, ”Effective Date of FASB Statement No. 157“ (”FSP 157-2“). FSP 157-1 amends SFAS 157 to remove certain leasing transactions from its scope. FSP 157-2 delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2010. The measurement and disclosure requirements related to financial assets and financial liabilities are effective for us in the first quarter of fiscal 2009. The adoption of SFAS 157 for financial assets and financial liabilities is not expected to have a material impact on our results of operations or financial position. We are currently assessing the impact that SFAS 157 will have on our results of operations and financial position when it is applied to nonfinancial assets and nonfinancial liabilities beginning in the first quarter of fiscal 2010.

SFAS 159

In February 2007, the FASB issued SFAS No. 159, ”The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115“ (”SFAS 159“). SFAS 159 is expected to expand the use of fair value accounting but does not affect existing standards that require certain assets or liabilities to be carried at fair value. The objective of SFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS 159, a company may choose, at specified election dates, to measure eligible items at fair value and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for us in the first quarter of fiscal 2009, and it is not expected to have a material impact on our results of operations or financial position.

SFAS 141(R) and SFAS 160

In December 2007, the FASB issued SFAS No. 141 (revised 2007), ”Business Combinations“ (”SFAS 141(R)“) and SFAS No. 160, ”Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51“ (”SFAS 160“). SFAS 141(R) will significantly change current practices regarding business combinations. Among the more significant changes, SFAS 141(R) expands the definition of a business and a business combination; requires the acquirer to recognize the assets acquired, liabilities assumed and noncontrolling interests (including goodwill), measured at fair value at the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination; requires assets acquired and liabilities assumed from contractual and noncontractual contingencies to be recognized at their acquisition-date fair values with subsequent changes recognized in earnings; and requires in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset. SFAS 160 will change the accounting and reporting for minority interests, reporting them as equity separate from the parent entity’s equity, as well as requiring expanded disclosures. SFAS 141(R) and SFAS 160 are effective for financial statements issued for fiscal years beginning after December 15, 2008. We are currently assessing the impact that SFAS 141(R) and SFAS 160 will have on our results of operations and financial position.

SFAS 161

In March 2008, the FASB issued SFAS No. 161, ”Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133“ (”SFAS 161“), which requires additional disclosures about the objectives of using derivative instruments; the method by which the derivative instruments and related hedged items are accounted for under FASB Statement No.133 and its related interpretations; and the effect of derivative instruments and related hedged items on financial position, financial performance, and cash flows. SFAS 161 also requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. We are currently assessing the impact that the adoption of SFAS 161 will have on our financial statement disclosures.

IFRS

On August 27, 2008, the U.S. Securities and Exchange Commission (SEC) announced that they will issue for comment a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (IASB). Under the proposed roadmap, we could be required in fiscal 2014 to prepare financial statements in accordance with IFRS, and the SEC will make a determination in 2011 regarding the mandatory adoption of IFRS. We are currently assessing the impact that this potential change would have on our consolidated financial statements, and we will continue to monitor the development of the potential implementation of IFRS.

Liquidity and Capital Resources

The following sections discuss the effects of changes in our balance sheet and cash flows, contractual obligations, other commitments, and the stock repurchase program on our liquidity and capital resources.

Balance Sheet and Cash Flows

Cash and Cash Equivalents and Investments

The following table summarizes our cash and cash equivalents and investments (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Balance Sheet and Cash Flows Cash and Cash Equivalents and Investments The following table summarizes our cash and cash equivalents and investments (in millions): dates ending in July 26, 2008 and July 28, 2007.

The increase in cash and cash equivalents and investments was primarily a result of cash provided by operating activities of $12.1 billion, issuance of common stock of $3.1 billion related to employee stock option exercises and employee stock purchases, proceeds from the termination of interest rate swaps of $432 million, and excess tax benefits from share-based compensation of $413 million, partially offset by repurchase of common stock of $10.4 billion, capital expenditures of $1.3 billion, and acquisitions of businesses of $398 million.

Our total cash and cash equivalents and investments held outside of the United States in various foreign subsidiaries was $24.4 billion as of July 26, 2008, and the remaining $1.8 billion was held in the United States. If cash and cash equivalents and investments held outside the United States are distributed to the United States in the form of dividends or otherwise, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. For internal management purposes, we target specific ranges of net realizable cash, representing cash and cash equivalents and investments, net of (i) long-term debt and the present value of operating lease commitments, and (ii) U.S. income taxes that we estimate would be payable upon the distribution to the United States of cash and cash equivalents and investments held outside the United States. We believe that our strong cash and cash equivalents and investments position allows us to use our cash resources for strategic investments to gain access to new technologies, acquisitions, customer financing activities, working capital, and the repurchase of shares.

In August 2007 we entered into a credit agreement with certain institutional lenders that provides for a $3.0 billion unsecured revolving credit facility that is scheduled to expire on August 17, 2012. Advances under the credit agreement accrue interest at rates that are equal to, based on certain conditions, either (i) the higher of the Federal Funds rate plus 0.50% or Bank of America’s ”prime rate“ as announced from time to time, or (ii) LIBOR plus a margin that is based on our senior debt credit ratings as published by Standard & Poor’s Ratings Services and Moody’s Investors Service, Inc. The credit agreement requires that we maintain an interest coverage ratio as defined in the agreement. As of July 26, 2008, we were in compliance with the required interest coverage ratio and had not borrowed any funds under the credit facility. We may, upon the agreement of either the then existing lenders or of additional lenders not currently parties to the agreement, increase the commitments under the credit facility up to a total of $5.0 billion and/or extend the expiration date of the credit facility up to August 15, 2014.

We expect 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, the rate at which products are shipped during the period (which we refer to as shipment linearity), accounts receivable collections, inventory and supply chain management, excess tax benefits from share-based compensation, and the timing and amount of tax and other payments. For additional discussion, see ”Part I, Item 1A. Risk Factors“ in our Annual Report on Form 10-K.

Accounts Receivable, Net

The following table summarizes our accounts receivable, net (in millions) and DSO:

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Accounts Receivable, Net The following table summarizes our accounts receivable, net (in millions) and DSO: dates ending in July 26, 2008 and July 28, 2007.

Our DSO as of July 26, 2008 was positively affected by improved shipment linearity through the end of fiscal 2008 compared with the end of fiscal 2007.

Inventories and Purchase Commitments with Contract Manufacturers and Suppliers

The following table summarizes our inventories and purchase commitments with contract manufacturers and suppliers (in millions, except annualized inventory turns):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Inventories and Purchase Commitments with Contract Manufacturers and Suppliers The following table summarizes our inventories and purchase commitments with contract manufacturers and suppliers (in millions, except annualized inventory turns): dates ending in July 26, 2008 and July 28, 2007.

Our finished goods consist of distributor inventory and deferred cost of sales and manufactured finished goods. Distributor inventory and deferred cost of sales are related to unrecognized revenue on shipments to distributors and retail partners and shipments to customers. Manufactured finished goods consist primarily of build-to-order and build-to-stock products. Service-related spares consist of reusable equipment related to our technical support and warranty activities. All inventories are accounted for at the lower of cost or market. Inventory is written down based on excess and obsolete inventories determined primarily by future demand forecasts. Inventory write-downs are measured as the difference between the cost of the inventory and market, based upon assumptions about future demand, and are charged to the provision for inventory, which is a component of our cost of sales.

We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with contract manufacturers and suppliers that either allow them to procure inventory based upon criteria as defined by us or that establish the parameters defining our requirements. In certain instances, these agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. Consequently, only a portion of our reported purchase commitments arising from these agreements are firm, noncancelable, and unconditional commitments. In addition, we record a liability, included in other current liabilities, for firm, noncancelable, and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. The purchase commitments for inventory are expected to be fulfilled primarily within one year.

Inventory and supply chain management remain areas of focus as we balance the need to maintain supply chain flexibility to help ensure competitive lead times with the risk of inventory obsolescence because of rapidly changing technology and customer requirements. We believe the amount of our inventory and purchase commitments is appropriate for our revenue levels.

Financing Receivables 

The following table summarizes our financing receivables (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Financing Receivables The following table summarizes our financing receivables (in millions): dates ending in July 26, 2008 and July 28, 2007.

The increase in lease receivables was due to higher volume of sales-type and direct financing leases, which typically have terms from two to three years. The revenue related to financed service contracts, which primarily relates to technical support services, is deferred and included in deferred service revenue. The revenue is recognized ratably over the period during which the related services are to be performed, which is typically from one to three years. Financed service contracts increased due primarily to the financing of several large multiyear service agreements during fiscal 2008. A portion of the revenue related to loan receivables is also deferred and included in deferred product revenue based on revenue recognition criteria.

Long-Term Debt

The following table summarizes our long-term debt (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Long-Term Debt  The following table summarizes our long-term debt (in millions): dates ending in July 26, 2008 and July 28, 2007.

In February 2006, we issued $500 million of senior floating interest rate notes based on LIBOR due 2009 (the ”2009 Notes“), $3.0 billion of 5.25% senior notes due 2011 (the ”2011 Notes“), and $3.0 billion of 5.50% senior notes due 2016 (the ”2016 Notes“), for an aggregate principal amount of $6.5 billion. The proceeds from the debt issuance were used to fund the acquisition of Scientific-Atlanta and for general corporate purposes. The 2011 Notes and the 2016 Notes are redeemable by us at any time, subject to a make-whole premium. In fiscal 2008, we terminated $6.0 billion of interest rate swaps that we had entered into in connection with the issuance of our fixed-rate notes due in 2011 and 2016 and received proceeds of $432 million, net of accrued interest, which was recorded as a hedge accounting adjustment to the carrying amount of the fixed-rate debt and is amortized as a reduction to interest expense over the remaining terms of the fixed-rate notes. See Note 8 to the Consolidated Financial Statements. We were in compliance with all debt covenants as of July 26, 2008.

Deferred Revenue

The following table presents the breakdown of deferred revenue (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Deferred Revenue The following table presents the breakdown of deferred revenue (in millions): dates ending in July 26, 2008 and July 28, 2007.

The increase in deferred service revenue reflects an increase in the volume of technical support contract initiations and renewals, including several large multiyear service agreements, partially offset by the ongoing amortization of deferred service revenue. The increase in deferred product revenue was primarily related to shipments not having met revenue recognition criteria, other revenue deferrals, and the timing of cash receipts related to unrecognized revenue from two-tier distributors.

Contractual Obligations

Our cash flows from operations are dependent on a number of factors, including fluctuations in our operating results, shipment linearity, accounts receivable collections, inventory management, excess tax benefits from share-based compensation, and the timing and amount of tax and other payments. As a result, the impact of contractual obligations on our liquidity and capital resources in future periods should be analyzed in conjunction with such factors. In addition, we plan for and measure our liquidity and capital resources through an annual budgeting process.

The following table summarizes our contractual obligations at July 26, 2008 (in millions):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Contractual Obligations The following table summarizes our contractual obligations at July 26, 2008 (in millions).

Operating Leases

We lease office space in several U.S. locations. Outside the United States, larger leased sites include sites in Australia, Belgium, Canada, China, France, Germany, India, Israel, Italy, Japan, and the United Kingdom. Operating lease amounts include future minimum lease payments under all our noncancelable operating leases with an initial term in excess of one year.

Purchase Commitments with Contract Manufacturers and Suppliers

We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. We record a liability for firm, noncancelable, and unconditional purchase commitments for quantities in excess of our future demand forecasts consistent with the valuation of our excess and obsolete inventory. As of July 26, 2008, the liability for these purchase commitments was $184 million and is recorded in other current liabilities and is not included in the preceding table.

Purchase Obligations

Purchase obligations represent an estimate of all open purchase orders and contractual obligations in the ordinary course of business, other than commitments with contract manufacturers and suppliers, for which we have not received the goods or services. Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to the delivery of goods or performance of services.

Long-Term Debt

The amount of long-term debt in the preceding table represents the principal amount of the respective debt instruments including the current portion of long-term debt. See Note 8 to the Consolidated Financial Statements.

Other Long-Term Liabilities

Other long-term liabilities include noncurrent income taxes payable, accrued liabilities for deferred compensation and defined benefit plans, noncurrent deferred tax liabilities, and certain other long-term liabilities. Noncurrent income taxes payable of $749 million and noncurrent deferred tax liabilities of $80 million have been included only in the total column in the preceding table due to uncertainty regarding the timing of future payments. Noncurrent income taxes payable includes uncertain tax positions (see Note 13 to the Consolidated Financial Statements) partially offset by payments and certain other items.

Compensation Expense Related to Acquisitions and Investments

In connection with our purchase acquisitions, asset purchases, and acquisitions of variable interest entities, we have agreed to pay certain additional amounts contingent upon the achievement of agreed-upon technology, development, product, or other milestones, or continued employment with us of certain employees of acquired entities. See Note 3 to the Consolidated Financial Statements.

Other Commitments

We also have certain funding commitments primarily related to our investments in privately held companies and venture funds, some of which are based on the achievement of certain agreed-upon milestones, and some of which are required to be funded on demand. The funding commitments were approximately $359 million as of July 26, 2008, compared with approximately $140 million as of July 28, 2007.

Off-Balance Sheet Arrangements

We consider our investments in unconsolidated variable interest entities to be off-balance sheet arrangements. In the ordinary course of business, we have investments in privately held companies and provide financing to certain customers through our wholly owned subsidiaries, which may be considered to be variable interest entities. We have evaluated our investments in these privately held companies and customer financings and have determined that there were no significant unconsolidated variable interest entities as of July 26, 2008.

Certain events can require a reassessment of our investments in privately held companies or customer financings to determine if they are variable interest entities and if we would be regarded as the primary beneficiary. As a result of such events, we may be required to make additional disclosures or consolidate these entities. Because we may not control these entities, we may not have the ability to influence these events.

We provide financing guarantees, which are generally for various third-party financing arrangements to channel partners and other customers. We could be called upon to make payment under these guarantees in the event of nonpayment to the third party. As of July 26, 2008, the total maximum potential future payments related to these guarantees was approximately $830 million, of which approximately $610 million was recorded as deferred revenue on the consolidated balance sheet in accordance with revenue recognition policies and FASB Interpretation No. 45 (”FIN 45“).

Stock Repurchase Program

In September 2001, our Board of Directors authorized a stock repurchase program. As of July 26, 2008, our Board of Directors had authorized an aggregate repurchase of up to $62 billion of common stock under this program and the remaining authorized repurchase amount was $8.4 billion with no termination date. The stock repurchase activity under the stock repurchase program in fiscal 2007 and 2008 is summarized as follows (in millions, except per-share amounts):

Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations Stock Repurchase Program The stock repurchase activity under the stock repurchase program in fiscal 2007 and 2008 is summarized as follows (in millions, except per-share amounts):

(1) Includes stock repurchases that were pending settlement as of period end.

The purchase price for the shares of our common stock repurchased is reflected as a reduction to shareholders’ equity. In accordance with Accounting Principles Board Opinion No. 6, ”Status of Accounting Research Bulletins,“ we are required to allocate the purchase price of the repurchased shares as (i) a reduction to retained earnings until retained earnings are zero and then as an increase to accumulated deficit and (ii) a reduction of common stock and additional paid-in capital. Issuance of common stock and the tax benefit related to employee stock incentive plans are recorded as an increase to common stock and additional paid-in capital. As a result of future repurchases, we may report an accumulated deficit as a component in shareholders’ equity.

Liquidity and Capital Resource Requirements

Based on past performance and current expectations, we believe our cash and cash equivalents, investments, and cash generated from operations, and our ability to access capital markets, including committed credit lines, will satisfy our working capital needs, capital expenditures, investment requirements, stock repurchases, contractual obligations, commitments, future customer financings, and other liquidity requirements associated with our operations through at least the next 12 months. There are no other transactions, arrangements, or other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity, the availability, and our requirements for capital resources.