Table of Contents

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

 
FORM 10-Q
 
(Mark one)
x 	 	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
 
For the quarterly period ended April 26, 2003
 
OR
 
¨	 	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
 
For the transition period from                          to                         
 
Commission file number 0-18225

 
CISCO SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
 
California	 	77-0059951	
(State or other jurisdiction of
incorporation or organization)	 	(I.R.S. Employer
Identification Number)	
 
170 West Tasman Drive
San Jose, California 95134
(Address of principal executive office and zip code)
 
(408) 526-4000
(Registrant’s telephone number, including area code)

 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.    YES   x     NO   ¨
 
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).      YES   ¨     NO   x
 
As of May 14, 2003, 7,018,744,853 shares of the Registrant’s common stock were outstanding. 

Table of Contents
 Cisco Systems, Inc.
 
FORM 10-Q for the Quarter Ended April 26, 2003
 
INDEX
 
 	  	 	  	Page

Part I.	  	Financial Information	  	 	
		
Item 1.	  	Financial Statements (Unaudited)	  	 	
		
 	  	a)       Consolidated Statements of Operations for the three and nine months ended April 26, 2003 and April 27, 2002	  	3	
		
 	  	b)       Consolidated Balance Sheets at April 26, 2003 and July 27, 2002	  	4	
		
 	  	c)       Consolidated Statements of Cash Flows for the nine months ended April 26, 2003 and April 27, 2002	  	5	
		
 	  	d)       Consolidated Statements of Shareholders’ Equity for the nine months ended April 26, 2003 and April 27, 2002	  	6	
		
 	  	e)       Notes to Consolidated Financial Statements	  	7	
		
Item 2.	  	Management’s Discussion and Analysis of Financial Condition and Results of Operations	  	30	
		
Item 3.	  	Quantitative and Qualitative Disclosures About Market Risk	  	68	
		
Item 4.	  	Controls and Procedures	  	69	
		
Part II.	  	Other Information	  	 	
		
Item 1.	  	Legal Proceedings	  	70	
		
Item 2.	  	Changes in Securities and Use of Proceeds	  	70	
		
Item 3.	  	Defaults Upon Senior Securities	  	70	
		
Item 4.	  	Submission of Matters to a Vote of Security Holders	  	70	
		
Item 5.	  	Other Information	  	71	
		
Item 6.	  	Exhibits and Reports on Form 8-K	  	71	
		
 	  	Signature	  	73	

2

Table of Contents
 
PART  I.    FINANCIAL INFORMATION
 
Item 1.    Financial Statements
 
 Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per-share amounts)
(Unaudited)
 
 	  	Three Months Ended
	 	  	Nine Months Ended
	 	
 	  	April 26, 2003
	 	  	April 27, 2002
	 	  	April 26, 2003
	 	  	April 27, 2002
	 	
NET SALES:	  	 	 	 	  	 	 	 	  	 	 	 	  	 	 	 	
Product	  	$	3,799	 	  	$	3,993	 	  	$	11,703	 	  	$	11,671	 	
Services	  	 	819	 	  	 	829	 	  	 	2,473	 	  	 	2,415	 	
 	  				  				  				  				
Total net sales	  	 	4,618	 	  	 	4,822	 	  	 	14,176	 	  	 	14,086	 	
 	  				  				  				  				
COST OF SALES:	  	 	 	 	  	 	 	 	  	 	 	 	  	 	 	 	
Product	  	 	1,086	 	  	 	1,515	 	  	 	3,467	 	  	 	4,608	 	
Services	  	 	263	 	  	 	239	 	  	 	765	 	  	 	748	 	
 	  				  				  				  				
Total cost of sales	  	 	1,349	 	  	 	1,754	 	  	 	4,232	 	  	 	5,356	 	
 	  				  				  				  				
GROSS MARGIN	  	 	3,269	 	  	 	3,068	 	  	 	9,944	 	  	 	8,730	 	
		
OPERATING EXPENSES:	  	 	 	 	  	 	 	 	  	 	 	 	  	 	 	 	
Research and development	  	 	725	 	  	 	838	 	  	 	2,375	 	  	 	2,617	 	
Sales and marketing	  	 	1,019	 	  	 	1,063	 	  	 	3,092	 	  	 	3,230	 	
General and administrative	  	 	184	 	  	 	164	 	  	 	512	 	  	 	463	 	
Amortization of purchased intangible assets	  	 	92	 	  	 	129	 	  	 	284	 	  	 	411	 	
In-process research and development	  	 	3	 	  	 	—  	 	  	 	3	 	  	 	37	 	
 	  				  				  				  				
Total operating expenses	  	 	2,023	 	  	 	2,194	 	  	 	6,266	 	  	 	6,758	 	
 	  				  				  				  				
OPERATING INCOME	  	 	1,246	 	  	 	874	 	  	 	3,678	 	  	 	1,972	 	
Interest income	  	 	161	 	  	 	220	 	  	 	514	 	  	 	687	 	
Other loss, net	  	 	(26	)	  	 	(70	)	  	 	(552	)	  	 	(1,046	)	
 	  				  				  				  				
INCOME BEFORE PROVISION FOR INCOME TAXES	  	 	1,381	 	  	 	1,024	 	  	 	3,640	 	  	 	1,613	 	
Provision for income taxes	  	 	394	 	  	 	295	 	  	 	1,044	 	  	 	492	 	
 	  				  				  				  				
NET INCOME	  	$	987	 	  	$	729	 	  	$	2,596	 	  	$	1,121	 	
 	  				  				  				  				
Net income per share—basic	  	$	0.14	 	  	$	0.10	 	  	$	0.36	 	  	$	0.15	 	
 	  				  				  				  				
Net income per share—diluted	  	$	0.14	 	  	$	0.10	 	  	$	0.36	 	  	$	0.15	 	
 	  				  				  				  				
Shares used in per-share calculation—basic	  	 	7,062	 	  	 	7,306	 	  	 	7,165	 	  	 	7,310	 	
 	  				  				  				  				
Shares used in per-share calculation—diluted	  	 	7,158	 	  	 	7,454	 	  	 	7,257	 	  	 	7,473	 	

See Notes to Consolidated Financial Statements	 	3	 	 	

Table of Contents
 Cisco Systems, Inc.
CONSOLIDATED BALANCE SHEETS
(In millions, except par value)
(Unaudited)
 
 	  	April 26, 2003
	  	July 27, 2002
	 	
ASSETS	  	 	 	  	 	 	 	
Current assets:	  	 	 	  	 	 	 	
Cash and cash equivalents	  	$	3,940	  	$	9,484	 	
Short-term investments	  	 	4,048	  	 	3,172	 	
Accounts receivable, net of allowance for doubtful accounts of $274 at April 26, 2003 and $335 at July 27, 2002	  	 	1,157	  	 	1,105	 	
Inventories	  	 	765	  	 	880	 	
Deferred tax assets	  	 	1,935	  	 	2,030	 	
Lease receivables, net	  	 	181	  	 	239	 	
Prepaid expenses and other current assets	  	 	595	  	 	523	 	
 	  			  				
Total current assets	  	 	12,621	  	 	17,433	 	
Investments	  	 	12,328	  	 	8,800	 	
Property and equipment, net	  	 	3,805	  	 	4,102	 	
Goodwill	  	 	3,813	  	 	3,565	 	
Purchased intangible assets, net	  	 	551	  	 	797	 	
Lease receivables, net	  	 	48	  	 	39	 	
Other assets	  	 	3,090	  	 	3,059	 	
 	  			  				
TOTAL ASSETS	  	$	36,256	  	$	37,795	 	
 	  			  				
LIABILITIES AND SHAREHOLDERS’ EQUITY	  	 	 	  	 	 	 	
Current liabilities:	  	 	 	  	 	 	 	
Accounts payable	  	$	480	  	$	470	 	
Income taxes payable	  	 	544	  	 	579	 	
Accrued compensation	  	 	1,293	  	 	1,365	 	
Deferred revenue	  	 	2,954	  	 	3,143	 	
Other accrued liabilities	  	 	2,220	  	 	2,496	 	
Restructuring liabilities	  	 	304	  	 	322	 	
 	  			  				
Total current liabilities	  	 	7,795	  	 	8,375	 	
Deferred revenue	  	 	805	  	 	749	 	
 	  			  				
Total liabilities	  	 	8,600	  	 	9,124	 	
 	  			  				
Commitments and contingencies (Note 6)	  	 	 	  	 	 	 	
Minority interest	  	 	11	  	 	15	 	
Shareholders’ equity:	  	 	 	  	 	 	 	
Preferred stock, no par value: 5 shares authorized; none issued and outstanding	  	 	—  	  	 	—  	 	
Common stock and additional paid-in capital, $0.001 par value: 20,000 shares authorized; 7,018 and 7,303 shares issued and outstanding at April 26, 2003 and July 27, 2002, respectively	  	 	20,592	  	 	20,950	 	
Retained earnings	  	 	6,767	  	 	7,733	 	
Accumulated other comprehensive income (loss)	  	 	286	  	 	(27	)	
 	  			  				
Total shareholders’ equity	  	 	27,645	  	 	28,656	 	
 	  			  				
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	  	$	36,256	  	$	37,795	 	

See Notes to Consolidated Financial Statements	 	4	 	 	

Table of Contents
 
 Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
 
 	  	Nine Months Ended
	 	
 	  	April 26,
2003
	 	  	April 27,
2002

Cash flows from operating activities:	  	 	 	 	  	 	 	 	
Net income	  	$	2,596	 	  	$	1,121	 	
Adjustments to reconcile net income to net cash
provided by operating activities:	  	 	 	 	  	 	 	 	
Depreciation and amortization	  	 	1,166	 	  	 	1,353	 	
Provision for doubtful accounts	  	 	94	 	  	 	91	 	
Provision for on-hand inventory	  	 	26	 	  	 	150	 	
Deferred income taxes	  	 	131	 	  	 	(373	)	
Tax benefits from employee stock option plans	  	 	19	 	  	 	51	 	
In-process research and development	  	 	3	 	  	 	25	 	
Net (gains) losses on investments and provision for losses	  	 	523	 	  	 	1,076	 	
Change in operating assets and liabilities:	  	 	 	 	  	 	 	 	
Accounts receivable	  	 	(142	)	  	 	385	 	
Inventories	  	 	89	 	  	 	665	 	
Prepaid expenses and other current assets	  	 	(79	)	  	 	(20	)	
Accounts payable	  	 	10	 	  	 	(208	)	
Income taxes payable	  	 	(319	)	  	 	51	 	
Accrued compensation	  	 	(72	)	  	 	208	 	
Deferred revenue	  	 	(133	)	  	 	619	 	
Other accrued liabilities	  	 	(203	)	  	 	(171	)	
Restructuring liabilities	  	 	(18	)	  	 	(45	)	
 	  				  				
Net cash provided by operating activities	  	 	3,691	 	  	 	4,978	 	
 	  				  				
Cash flows from investing activities:	  	 	 	 	  	 	 	 	
Purchases of short-term investments	  	 	(6,759	)	  	 	(4,166	)	
Proceeds from sales and maturities of short-term investments	  	 	7,346	 	  	 	4,702	 	
Purchases of investments	  	 	(13,024	)	  	 	(13,600	)	
Proceeds from sales and maturities of investments	  	 	7,975	 	  	 	10,658	 	
Purchases of restricted investments	  	 	—  	 	  	 	(291	)	
Proceeds from sales and maturities of restricted investments	  	 	—  	 	  	 	1,471	 	
Acquisition of property and equipment	  	 	(504	)	  	 	(2,243	)	
Acquisition of businesses, net of cash and cash equivalents	  	 	3	 	  	 	14	 	
Change in lease receivables, net	  	 	49	 	  	 	344	 	
Purchases of investments in privately held companies	  	 	(141	)	  	 	(52	)	
Lease deposits	  	 	—  	 	  	 	320	 	
Purchase of minority interest of Cisco Systems, K.K. (Japan)	  	 	(59	)	  	 	(91	)	
Other	  	 	126	 	  	 	98	 	
 	  				  				
Net cash used in investing activities	  	 	(4,988	)	  	 	(2,836	)	
 	  				  				
Cash flows from financing activities:	  	 	 	 	  	 	 	 	
Issuance of common stock	  	 	279	 	  	 	431	 	
Repurchase of common stock	  	 	(4,549	)	  	 	(952	)	
Other	  	 	23	 	  	 	(1	)	
 	  				  				
Net cash used in financing activities	  	 	(4,247	)	  	 	(522	)	
 	  				  				
Net (decrease) increase in cash and cash equivalents	  	 	(5,544	)	  	 	1,620	 	
Cash and cash equivalents, beginning of period	  	 	9,484	 	  	 	4,873	 	
 	  				  				
Cash and cash equivalents, end of period	  	$	3,940	 	  	$	6,493	 	

See Notes to Consolidated Financial Statements	 	5	 	 	

Table of Contents
 
 Cisco Systems, Inc.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In millions)
(Unaudited)
 
Nine Months
Ended April 27, 2002
	    	Shares of
Common Stock
	 	    	Common Stock
and
Additional
Paid-In Capital
	 	  	Retained
Earnings
	 	    	Accumulated
Other
Comprehensive
Income (Loss)
	 	  	Total
Shareholders’
Equity
	 	
BALANCE AT JULY 28, 2001	    	7,324	 	    	$	20,051	 	  	$	7,344	 	    	$	(275	)	  	$	27,120	 	
Net income	    	—  	 	    	 	—  	 	  	 	1,121	 	    	 	—  	 	  	 	1,121	 	
Change in unrealized gains and losses
on investments, net of tax	    	—  	 	    	 	—  	 	  	 	—  	 	    	 	382	 	  	 	382	 	
Other	    	—  	 	    	 	—  	 	  	 	—  	 	    	 	(3	)	  	 	(3	)	
 	    	 	 	    	 	 	 	  	 	 	 	    	 	 	 	  				
Comprehensive income	    	 	 	    	 	 	 	  	 	 	 	    	 	 	 	  	 	1,500	 	
 	    	 	 	    	 	 	 	  	 	 	 	    	 	 	 	  				
Issuance of common stock	    	50	 	    	 	431	 	  	 	—  	 	    	 	—  	 	  	 	431	 	
Repurchase of common stock	    	(61	)	    	 	(171	)	  	 	(781	)	    	 	—  	 	  	 	(952	)	
Tax benefits from employee stock
option plans	    	—  	 	    	 	51	 	  	 	—  	 	    	 	—  	 	  	 	51	 	
Purchase acquisitions	    	8	 	    	 	128	 	  	 	—  	 	    	 	—  	 	  	 	128	 	
Amortization of deferred stock-based
compensation	    	—  	 	    	 	141	 	  	 	—  	 	    	 	—  	 	  	 	141	 	
 	    			    				  				    				  				
BALANCE AT APRIL 27, 2002	    	7,321	 	    	$	20,631	 	  	$	7,684	 	    	$	104	 	  	$	28,419	 	
 	    			    				  				    				  				
Nine Months
Ended April 26, 2003
	    	Shares of
Common Stock
	 	    	Common Stock
and
Additional
Paid-In Capital
	 	  	Retained
Earnings
	 	    	Accumulated
Other
Comprehensive
Income (Loss)
	 	  	Total
Shareholders’
Equity
	 	
BALANCE AT JULY 27, 2002	    	7,303	 	    	$	20,950	 	  	$	7,733	 	    	$	(27	)	  	$	28,656	 	
Net income	    	—  	 	    	 	—  	 	  	 	2,596	 	    	 	—  	 	  	 	2,596	 	
Change in unrealized gains and losses
on investments, net of tax	    	—  	 	    	 	—  	 	  	 	—  	 	    	 	294	 	  	 	294	 	
Other	    	—  	 	    	 	—  	 	  	 	—  	 	    	 	19	 	  	 	19	 	
 	    	 	 	    	 	 	 	  	 	 	 	    	 	 	 	  				
Comprehensive income	    	 	 	    	 	 	 	  	 	 	 	    	 	 	 	  	 	2,909	 	
 	    	 	 	    	 	 	 	  	 	 	 	    	 	 	 	  				
Issuance of common stock	    	35	 	    	 	279	 	  	 	—  	 	    	 	—  	 	  	 	279	 	
Repurchase of common stock	    	(341	)	    	 	(987	)	  	 	(3,562	)	    	 	—  	 	  	 	(4,549	)	
Tax benefits from employee stock
option plans	    	—  	 	    	 	19	 	  	 	—  	 	    	 	—  	 	  	 	19	 	
Purchase acquisitions	    	21	 	    	 	227	 	  	 	—  	 	    	 	—  	 	  	 	227	 	
Amortization of deferred stock-based
compensation	    	—  	 	    	 	104	 	  	 	—  	 	    	 	—  	 	  	 	104	 	
 	    			    				  				    				  				
BALANCE AT APRIL 26, 2003	    	7,018	 	    	$	20,592	 	  	$	6,767	 	    	$	286	 	  	$	27,645	 	

See Notes to Consolidated Financial Statements	 	6	 	 	

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

1.     Description of Business
 
Cisco Systems, Inc. (the “Company” or “Cisco”) manufactures and sells networking and communications products and provides services associated with that equipment and its use. Its products are installed at corporations, public institutions, and telecommunication companies, and are also found in small and medium-sized commercial enterprises. Cisco provides a broad line of products for transporting data, voice, and video within buildings, across campuses, or around the world.
 
2.     Summary of Significant Accounting Policies
 
Fiscal Year
 
The Company’s fiscal year is the 52- or 53-week period ending on the last Saturday in July. Fiscal 2003 and 2002 are 52-week fiscal years.
 
Basis of Presentation
 
The accompanying financial data as of April 26, 2003 and for the three and nine months ended April 26, 2003 and April 27, 2002 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The July 27, 2002 Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K, as amended, for the fiscal year ended July 27, 2002.
 
In the opinion of management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to present a fair statement of financial position as of April 26, 2003, results of operations for the three and nine months ended April 26, 2003 and April 27, 2002, cash flows and shareholders’ equity for the nine months ended April 26, 2003 and April 27, 2002, as applicable, have been made. The results of operations for the three and nine months ended April 26, 2003 are not necessarily indicative of the operating results for the full fiscal year or any future periods.
 
Employee Stock Option Plans
 
Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure an Amendment of FASB Statement No. 123”, amends the disclosure requirements of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), to require more prominent
 
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Table of Contents
Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results.
 
The Company accounts for stock-based awards to employees and directors using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under the intrinsic value method, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in the Company’s Consolidated Statements of Operations.
 
The Company is required under SFAS 123, to disclose pro forma information regarding option grants made to its employees based on specified valuation techniques that produce estimated compensation charges. The pro forma information is as follows (in millions, except per-share amounts):
 
 	    	Three Months Ended
April 26,
2003
	 	    	Three Months Ended
April 27,
2002
	 	  	Nine Months Ended
April 26,
2003
	 	  	Nine Months Ended
April 27,
2002
	 	
Net income—as reported	    	$	987	 	    	$	729	 	  	$	2,596	 	  	$	1,121	 	
Compensation expense, net of tax	    	 	(291	)	    	 	(372	)	  	 	(972	)	  	 	(1,144	)	
 	    				    				  				  				
Net income (loss)—pro forma	    	$	696	 	    	$	357	 	  	$	1,624	 	  	$	(23	)	
 	    				    				  				  				
Basic net income per share—as reported	    	$	0.14	 	    	$	0.10	 	  	$	0.36	 	  	$	0.15	 	
 	    				    				  				  				
Diluted net income per share—as reported	    	$	0.14	 	    	$	0.10	 	  	$	0.36	 	  	$	0.15	 	
 	    				    				  				  				
Basic net income (loss) per share—pro forma	    	$	0.10	 	    	$	0.05	 	  	$	0.23	 	  	$	0.00	 	
 	    				    				  				  				
Diluted net income (loss) per share—pro forma	    	$	0.10	 	    	$	0.05	 	  	$	0.22	 	  	$	0.00	 	

For additional information regarding pro forma information, see Note 8 to the Consolidated Financial Statements. 
 
Computation of Net Income per Share
 
Basic net income per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of common shares and dilutive potential common shares outstanding during the period. Dilutive potential common shares consist of employee stock options and restricted common stock.
 
8

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

Recent Accounting Pronouncements
 
Consolidation of Variable Interest Entities
 
Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), was issued in January 2003. FIN 46 requires that if an entity is the primary beneficiary of a variable interest entity, the assets, liabilities and results of operations of the variable interest entity should be included in the Consolidated Financial Statements of the entity. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. The Company has not invested in any variable interest entities after January 31, 2003. For those arrangements entered into prior to January 31, 2003, the provisions of FIN 46 are required to be adopted at the beginning of the first interim or annual period beginning after June 15, 2003.
 
As discussed in Note 6 to the Consolidated Financial Statements, the Company has invested in Andiamo Systems, Inc. (“Andiamo”), a storage switch developer. This investment was made in April 2001 in the form of an $84 million debt instrument. In connection with this investment, Cisco obtained a call option that provided the Company the right to purchase Andiamo. The purchase price under the call option is based on a valuation of Andiamo using a negotiated formula, further described in Note 6 to the Consolidated Financial Statements. On August 19, 2002, the Company entered into a definitive agreement to acquire Andiamo, which represents the Company’s exercise of its rights under the call option. The Company also entered into a commitment to provide non-convertible debt funding to Andiamo of approximately $100 million through the close of the acquisition.
 
The Company has evaluated its debt investment in Andiamo and has determined that Andiamo is a variable interest entity under FIN 46. The Company has concluded that it is the primary beneficiary as defined by FIN 46 and, as a result, the Company is required to consolidate Andiamo beginning the first day of the first quarter of fiscal 2004. To date, the Company has expensed substantially its entire investment in Andiamo as research and development costs, as if such expenses constituted the development costs of the Company.
 
FIN 46 will require Cisco to account for Andiamo as if it had consolidated it since the Company’s initial investment in April 2001. If the Company consolidated Andiamo from the date of its initial investment, the Company would be required to account for the call option as a repurchase right. Under Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation” (“FIN 44”), and related interpretations, variable accounting is required for substantially all Andiamo employee stock and options because the ending purchase price is primarily derived from a revenue-based formula. Therefore, beginning in the first quarter of fiscal 2004, the Company will revalue the stock and options of Andiamo each quarter based on an independent valuation of Andiamo until the completion of the acquisition which is expected in the third quarter of fiscal 2004, but no later than July 31, 2004.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Consequently, on July 27, 2003, the first day of fiscal 2004, Cisco will record a non-cash cumulative charge based on the adoption of FIN 46, in the range of $200 million to $500 million (the variable compensation from April 2001 through July 2003). This will be reported as a separate line item in the Consolidated Statements of Operations, net of tax. The charge will be based on the value of the Andiamo employee stock and options and their expected vesting upon FIN 46 adoption pursuant to the independent evaluation, and does not necessarily reflect the value of Andiamo as a whole nor indicate the expected valuation of Andiamo upon acquisition. Subsequent to the adoption of FIN 46, changes to the value of Andiamo will result in adjustments to the non-cash stock compensation charge based upon the expected vesting of the employee stock and options and will be reflected as operating expenses. These adjustments will be recorded commencing in the first quarter of fiscal 2004 and continue until such time as the acquisition of Andiamo is completed, which is expected to close in the third quarter of fiscal 2004, but no later than July 31, 2004. These adjustments will be based on changes in the valuation of Andiamo using the negotiated formula. The value computed under the negotiated formula is largely based on revenues derived from specific storage switch products.
 
Excluding the non-cash stock compensation cumulative charge and any future non-cash variable stock compensation adjustments, the impact of consolidating Andiamo will not materially affect the Company’s operating results or financial condition. Other than the investment in Andiamo, the Company does not anticipate that the adoption of FIN 46 will have a material impact on its operating results or financial condition.
 
Accounting for Derivative Instruments and Hedging Activities
 
Statement of Financial Accounting Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”) was issued in April 2003 . SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS 149 is generally effective for derivative instruments, including derivative instruments embedded in certain contracts, entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company does not expect the adoption of SFAS 149 to have a material impact on its operating results or financial condition.
 
Reclassifications
 
Certain reclassifications have been made to prior period balances in order to conform to the current period presentation.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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3.     Business Combinations
 
The Company completed three acquisitions during the first nine months of fiscal 2003. During the first quarter of fiscal 2003, the Company completed the acquisition of AYR Networks, Inc. to augment the continued evolution of Cisco IOS Software, the network systems software for the Company’s routing and switching platforms. During the second quarter of fiscal 2003, the Company completed the acquisition of Psionic Software, Inc. to complement its continued development of network security software in the vulnerability assessment and management security services areas. During the third quarter of fiscal 2003, the Company completed the acquisition of Okena, Inc. to further enhance its security portfolio of network-integrated solutions and appliances for Virtual Private Networks (“VPN”), firewalling, intrusion protection and security management. A summary of the purchase acquisitions completed in the first nine months is summarized as follows (in millions):
 
Acquired Company
	    	Shares Issued
	    	Consideration Including Assumed Liabilities
	    	In-Process R&D Expense
	  	Goodwill
	  	Purchased Intangible Assets
	
AYR Networks, Inc.	    	9	    	$	97	    	$	—  	  	$	59	  	$	—  	
Psionic Software, Inc.	    	1	    	 	13	    	 	—  	  	 	8	  	 	5	
Okena, Inc.	    	9	    	 	160	    	 	3	  	 	96	  	 	45	
 	    		    			    			  			  			
Total	    	19	    	$	270	    	$	3	  	$	163	  	$	50	

The purchase prices of all acquisitions were also allocated to tangible assets and deferred stock-based compensation.
 
As of April 26, 2003 and July 27, 2002, the Company’s total remaining unamortized deferred stock-based compensation was $125 million and $182 million, respectively, and was reflected as a debit to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity for all acquisitions to date. Deferred stock-based compensation represents the intrinsic value of the unvested portion of the restricted shares exchanged or options assumed and is amortized as compensation cost over the remaining future vesting period of the restricted shares exchanged or stock options assumed of each acquired company. Additions to deferred stock-based compensation, net of canceled unvested options, in the first nine months of fiscal 2003 were $47 million. The amortization of deferred stock-based compensation, in the first nine months of fiscal 2003 was $104 million.
 
The Company’s methodology for allocating the purchase price to in-process research and development (“in-process R&D”) is determined through established valuation techniques in the high-technology communications equipment industry and expensed upon acquisition because technological feasibility has not been established and no future alternative uses exist. Total in-process R&D expense for the first nine months of fiscal 2003 and 2002 was $3 million and $37 million, respectively. The in-process R&D expense that was attributable to stock consideration for the first nine months of fiscal 2003 and 2002 was $3 million and $25 million, respectively.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table presents details of the purchased intangible assets acquired during the first nine months of fiscal 2003 (in millions, except number of years):
 
 	    	    Psionic Software, Inc.    
	    	    Okena, Inc.    
	
 	    	Estimated         Useful Life        
(in Years)
	  	Amount
	    	Estimated           Useful Life          
(in Years)
	    	        Amount        
	
Technology	    	3.0	  	$	5	    	4.5	    	$	38	
Other	    	—  	  	 	—  	    	2.5	    	 	7	
 	    	 	  			    	 	    			
 	    	 	  	$	5	    	 	    	$	45	

The Consolidated Financial Statements include the operating results of each business from the date of acquisition. Pro forma results of operations have not been presented because the effects of these acquisitions were not material on either an individual or aggregate basis to the Company’s results.
 
The Company acquired AuroraNetics, Inc. in the first quarter of fiscal 2002. During the first nine months of fiscal 2003, the Company issued approximately 2.7 million shares of common stock with a value of $39 million to the former shareholders of AuroraNetics, Inc., as a result of the achievement of certain agreed-upon milestones. Such amounts were allocated to goodwill and deferred stock-based compensation totaling $31 million and $8 million, respectively. The Company may also be required to issue up to an additional 2.7 million shares of common stock to such former shareholders under the terms of the definitive acquisition agreement, if certain other agreed-upon milestones are achieved.
 
The following tables present details of the Company’s total purchased intangible assets (in millions):
 
April 26, 2003
	  	Gross
	  	Accumulated Amortization
	 	  	Net
	
Technology	  	$	771	  	$	(420	)	  	$	351	
Technology licenses	  	 	523	  	 	(414	)	  	 	109	
Patents	  	 	115	  	 	(68	)	  	 	47	
Other	  	 	142	  	 	(98	)	  	 	44	
 	  			  				  			
Total	  	$	1,551	  	$	(1,000	)	  	$	551	

July 27, 2002
	  	Gross
	    	Accumulated Amortization
	 	  	Net
	
Technology	  	$	893	    	$	(429	)	  	$	464	
Technology licenses	  	 	523	    	 	(323	)	  	 	200	
Patents	  	 	128	    	 	(54	)	  	 	74	
Other	  	 	135	    	 	(76	)	  	 	59	
 	  			    				  			
Total	  	$	1,679	    	$	(882	)	  	$	797	

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The estimated future amortization expense of purchased intangible assets as of April 26, 2003 is as follows (in millions):
 
Fiscal Year:
	  	Amount
	
2003 (remaining three months)	  	$	78	
2004	  	 	237	
2005	  	 	171	
2006	  	 	54	
2007	  	 	9	
2008	  	 	2	
 	  			
Total	  	$	551	

The following table presents the changes in goodwill allocated to the Company’s reportable segments during the first nine months of fiscal 2003 (in millions):
 
 	  	Balance at July 27, 2002
	  	Acquired
	  	Balance at April 26, 2003
	
Americas	  	$	2,335	  	$	97	  	$	2,432	
EMEA	  	 	593	  	 	61	  	 	654	
Asia Pacific	  	 	140	  	 	21	  	 	161	
Japan	  	 	497	  	 	69	  	 	566	
 	  			  			  			
Total	  	$	3,565	  	$	248	  	$	3,813	

In the first nine months of fiscal 2003, the Company purchased a portion of the minority interest of Cisco Systems, K.K. (Japan). As a result, the Company increased its ownership from 92.4% to 94.8% of the voting rights of Cisco Systems, K.K. (Japan) and recorded goodwill of $54 million.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

4.    Restructuring Costs and Other Special Charges
 
On April 16, 2001, the Company announced a restructuring program, which included a worldwide workforce reduction, consolidation of excess facilities, and restructuring of certain business functions. The following table summarizes the activity related to the liability for restructuring costs and other special charges as of April 26, 2003 (in millions):
 
 	  	Workforce
Reduction
	 	    	Consolidation of
Excess Facilities
and
Other Charges (3)
	 	    	Impairment of
Goodwill
and Purchased
Intangible Assets
	 	  	Total
	 	
Initial charge in the third quarter of fiscal 2001	  	$	397	 	    	$	484	 	    	$	289	 	  	$	1,170	 	
Noncash charges	  	 	(71	)	    	 	(141	)	    	 	(289	)	  	 	(501	)	
Cash payments	  	 	(265	)	    	 	(18	)	    	 	—  	 	  	 	(283	)	
 	  				    				    				  				
Balance at July 28, 2001	  	 	61	 	    	 	325	 	    	 	—  	 	  	 	386	 	
		
Adjustments (1)	  	 	(35	)	    	 	128	 	    	 	—  	 	  	 	93	 	
Cash payments	  	 	(26	)	    	 	(131	)	    	 	—  	 	  	 	(157	)	
 	  				    				    				  				
Balance at July 27, 2002	  	 	—  	 	    	 	322	 	    	 	—  	 	  	 	322	 	
		
Adjustments (2)	  	 	—  	 	    	 	40	 	    	 	—  	 	  	 	40	 	
Cash payments	  	 	—  	 	    	 	(58	)	    	 	—  	 	  	 	(58	)	
 	  				    				    				  				
Balance at April 26, 2003	  	$	—  	 	    	$	304	 	    	$	—  	 	  	$	304	 	

Note 1: Due to changes in previous estimates, in fiscal 2002, the Company reclassified $35 million of restructuring liabilities related to the workforce reduction charges to consolidation of excess facilities and other charges. The initial estimated workforce reduction was approximately 6,000 regular employees. Approximately 5,400 regular employees have been terminated and the liability has been paid. In addition, during the third quarter of fiscal 2002, the Company increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $93 million due to changes in real estate market conditions. The increase in restructuring liabilities was recorded as research and development ($39 million), sales and marketing ($42 million), general and administrative ($8 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations.
 
Note 2: During the first nine months of fiscal 2003, the Company increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $40 million, which was recorded during the first quarter of fiscal 2003, due to changes in real estate market conditions. The increase in restructuring liabilities was recorded as research and development ($16 million), sales and marketing ($16 million), general and administrative ($4 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations.
 
Note 3: Amounts related to the net lease expense due to the consolidation of excess facilities will be paid over the respective lease terms through fiscal 2010.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5.    Balance Sheet Details
 
The following tables provide details of selected balance sheet items (in millions):
 
 	  	April 26,
2003
	 	  	July 27 ,
2002
	 	
Inventories:	  	 	 	 	  	 	 	 	
Raw materials	  	$	51	 	  	$	38	 	
Work in process	  	 	259	 	  	 	297	 	
Finished goods	  	 	422	 	  	 	490	 	
Demonstration systems	  	 	33	 	  	 	55	 	
 	  				  				
Total	  	$	765	 	  	$	880	 	

Property and equipment, net:	  	 	 	 	  	 	 	 	
Land, buildings, and leasehold improvements	  	$	3,384	 	  	$	3,352	 	
Computer equipment and related software	  	 	1,112	 	  	 	1,021	 	
Production, engineering, and other equipment	  	 	2,267	 	  	 	2,061	 	
Operating lease assets	  	 	588	 	  	 	505	 	
Furniture and fixtures	  	 	348	 	  	 	366	 	
 	  				  				
 	  	 	7,699	 	  	 	7,305	 	
Less, accumulated depreciation and amortization	  	 	(3,894	)	  	 	(3,203	)	
 	  				  				
Total	  	$	3,805	 	  	$	4,102	 	
 	  				  				
Other assets:	  	 	 	 	  	 	 	 	
Deferred tax assets	  	$	1,440	 	  	$	1,663	 	
Investments in privately held companies	  	 	529	 	  	 	477	 	
Income tax receivable	  	 	727	 	  	 	392	 	
Structured loans, net	  	 	47	 	  	 	61	 	
Other	  	 	347	 	  	 	466	 	
 	  				  				
Total	  	$	3,090	 	  	$	3,059	 	

Deferred revenue:	  	 	 	 	  	 	 	 	
Services	  	$	2,351	 	  	$	2,207	 	
Product	  	 	1,408	 	  	 	1,685	 	
 	  				  				
Total	  	 	3,759	 	  	 	3,892	 	
Less, current portion	  	 	(2,954	)	  	 	(3,143	)	
 	  				  				
Non-current deferred revenue	  	$	805	 	  	$	749	 	

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

6.    Commitments and Contingencies
 
Leases
 
The Company leases office space in numerous U.S. locations, as well as locations elsewhere in the Americas International; Europe, the Middle East, and Africa (“EMEA”); Asia Pacific; and Japan. Future annual minimum lease payments under all noncancelable operating leases with an initial term in excess of one year as of April 26, 2003 were as follows (in millions):
 
Fiscal Year:
	  	Amount
	
2003 (remaining three months)	  	$	73	
2004	  	 	265	
2005	  	 	226	
2006	  	 	173	
2007	  	 	136	
Thereafter	  	 	745	
 	  			
Total	  	$	1,618	

Guarantees and Product Warranties
 
Financial Accounting Standards Board Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), requires that upon issuance of a guarantee, the guarantor must disclose and recognize a liability for the fair value of the obligation it assumes under that guarantee. The initial recognition and measurement requirement of FIN 45 is effective for guarantees issued or modified after December 31, 2002. As of April 26, 2003, the Company’s guarantees that were issued or modified after December 31, 2002 were not material.
 
The disclosure requirements of FIN 45 are effective for interim and annual periods ending after December 15, 2002, and are applicable to the Company’s product warranty liability and certain guarantees issued before December 31, 2002. The Company’s guarantees issued before December 31, 2002, which would have been disclosed in accordance with the disclosure requirements of FIN 45, were not material. As of April 26, 2003 and July 27, 2002, the Company’s product warranty liability was $246 million and $242 million, respectively. The following table summarizes the activity related to the product warranty liability during the nine month period ended April 26, 2003 (in millions):
 
 	  	Amount
	 	
Balance at July 27, 2002	  	$	242	 	
Accrual for warranties issued during the period	  	 	270	 	
Payments	  	 	(266	)	
 	  				
Balance at April 26, 2003	  	$	246	 	

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The Company accrues for product warranty costs based on historical trends in product failure rates and the expected material and labor costs to provide warranty services. The products sold are generally covered by a warranty for periods of 90 days, one year, five years and limited lifetime.
 
In the normal course of business, the Company indemnifies other parties, including customers, lessors and parties to other transactions with the Company, with respect to certain matters. The Company has agreed to hold the other party harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, the Company has entered into indemnification agreements with its officers and directors and the Company’s bylaws contain similar indemnification obligations to the Company’s agents.
 
It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material impact on the Company’s operating results or financial position.
 
Derivative Instruments
 
The Company conducts business on a global basis in several currencies. As such, it is exposed to adverse movements in foreign currency exchange rates. The Company enters into foreign exchange forward contracts to minimize the short-term impact of foreign currency fluctuations on certain foreign currency receivables, investments, and payables. The gains and losses on the foreign exchange forward contracts offset the transaction gains and losses on certain foreign currency receivables, investments, and payables recognized in earnings.
 
The Company does not enter into foreign exchange forward contracts for trading purposes. Gains and losses on the contracts are included in other loss, net, in the Company’s Consolidated Statements of Operations and offset foreign exchange gains or losses from the revaluation of intercompany balances or other current assets, investments, and liabilities denominated in currencies other than the functional currency of the reporting entity. The Company’s foreign exchange forward contracts related to current assets and liabilities generally range from one to three months in original maturity. Additionally, the Company has entered into foreign exchange forward contracts related to long-term customer financings with maturities of up to two years. The foreign exchange contracts related to investments generally have maturities of less than one year.
 
The Company periodically hedges foreign currency forecasted transactions related to certain operating expenses with currency options. These transactions are designated as cash flow hedges. The effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and subsequently reclassified into earnings
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. These currency option contracts generally have maturities of less than one year. The Company does not purchase currency options for trading purposes. Foreign exchange forward and option contracts as of April 26, 2003 are summarized as follows (in millions):
 
 	  	Notional
Amount
	  	Fair   Value  

Forward contracts:	  	 	 	  	 	 	 	
Purchased	  	$	874	  	$	(3	)	
Sold	  	$	493	  	$	(5	)	
Option contracts:	  	 	 	  	 	 	 	
Purchased	  	$	508	  	$	24	 	
Sold	  	$	113	  	$	 —	 	
 
The Company’s foreign exchange forward and option contracts expose the Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company minimizes such risk by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect any material losses as a result of default by counterparties.
 
Legal Proceedings
 
Beginning on April 20, 2001, a number of purported shareholder class action lawsuits were filed in the United States District Court for the Northern District of California against Cisco and certain of its officers and directors. The lawsuits have been consolidated, and the consolidated action is purportedly brought on behalf of those who purchased the Company’s publicly traded securities between August 10, 1999 and February 6, 2001. Plaintiffs allege that defendants have made false and misleading statements, purport to assert claims for violations of the federal securities laws, and seek unspecified compensatory damages and other relief. Cisco believes the claims are without merit and intends to defend the actions vigorously.
 
In addition, beginning on April 23, 2001, a number of purported shareholder derivative lawsuits were filed in the Superior Court of California, County of Santa Clara and in the Superior Court of California, County of San Mateo. There is a procedure in place for the coordination of such actions. Two purported derivative suits have also been filed in the United States District Court for the Northern District of California, and those federal court actions have been consolidated. The consolidated federal court derivative action was dismissed by the court, and plaintiffs have appealed from that decision. The complaints in the various derivative actions include claims for breach of fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment, and violations of the California Corporations Code; seek compensatory and other damages, disgorgement, and other relief; and are based on essentially the same allegations as the class actions.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In addition, the Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.
 
Investment in Andiamo Systems, Inc.
 
On August 19, 2002, Cisco entered into a definitive agreement to acquire privately held Andiamo. The acquisition of Andiamo is expected to close in the third quarter of fiscal 2004, but no later than July 31, 2004.
 
Under the terms of the agreement, common stock and options of Cisco will be exchanged for all outstanding shares and options of Andiamo not owned by Cisco at the closing of the acquisition. The amount of the purchase price for the remaining equity interests in Andiamo not then held by Cisco is not determinable at this time, but will be based primarily upon a formula-based valuation of Andiamo to be determined by applying a multiple to the actual, annualized revenue generated from sales by Cisco of products attributable to Andiamo during a three-month period shortly preceding the closing. Under its agreements with Andiamo, Cisco is the exclusive manufacturer and distributor of all Andiamo products. The multiple will be equal to Cisco’s average market capitalization during a specified period divided by Cisco’s annualized revenue for a three-month period prior to closing, subject to adjustment as follows: (i) if the multiple so calculated is less than 10, then the multiple to be used for purposes of determining the transaction price shall be the midpoint between 10 and the multiple so calculated; (ii) if the multiple so calculated is greater than 15, then the multiple to be used for purposes of determining the transaction price shall be the midpoint between 15 and the multiple so calculated. There is no minimum purchase price, and the maximum purchase price is limited to approximately $2.5 billion in shares of Cisco common stock valued at the time of closing. As discussed in Note 2 to the Consolidated Financial Statements, the adoption of FIN 46 will require the Company to account for Andiamo as if Cisco had consolidated Andiamo from the date of its initial investment.
 
The acquisition has received the required approvals from both companies and is subject to various closing conditions and approvals, including stockholder approval by Andiamo.
 
As of April 26, 2003, Cisco has made an $84 million investment in Andiamo in the form of convertible debt, which will be convertible into approximately 44% of the equity in Andiamo, subject to certain terms and conditions. Furthermore, Cisco is also committed to provide additional funding to Andiamo in the form of non-convertible debt through the closing of the acquisition of approximately $100 million, subject to periodic funding. As of April 26, 2003, the Company has funded $55 million of this additional non-convertible debt. Substantially all of Cisco’s investment in Andiamo has been expensed as research and development costs, as if such expenses constituted the development costs of the Company.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Purchase Commitments with Contract Manufacturers and Suppliers
 
The Company uses several contract manufacturers and suppliers to provide manufacturing services for its products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, the Company enters into agreements with certain contract manufacturers and suppliers that allow them to procure inventory based upon criteria as defined by the Company. As of April 26, 2003, the Company has purchase commitments for inventory of approximately $738 million, compared with $825 million as of July 27, 2002.
 
Other Commitments
 
In fiscal 2001, the Company entered into an agreement to invest approximately $1.0 billion in venture funds managed by SOFTBANK Corp. and its affiliates (“SOFTBANK”). These venture funds are required to be funded upon demand by SOFTBANK. As of April 26, 2003, the Company has funded $209 million of this investment commitment, compared with $100 million as of July 27, 2002.
 
The Company provides structured financing to certain qualified customers to be used for the purchase of equipment and other needs through its wholly owned subsidiary, Cisco Systems Capital Corporation. As of April 26, 2003, the outstanding loan commitments were approximately $105 million, subject to customers satisfying certain financial covenants, of which approximately $46 million was eligible for draw down. As of July 27, 2002, the outstanding loan commitments were approximately $948 million, of which approximately $209 million was eligible for draw down. These loan commitments may be funded over a two- to three-year period provided that these customers achieve specific business milestones and satisfy certain financial covenants.
 
The Company has entered into several agreements to purchase or develop real estate, subject to the satisfaction of certain conditions. As of April 26, 2003, the total amount of commitments, if certain conditions are met, was approximately $70 million, compared with $491 million as of July 27, 2002.
 
As of April 26, 2003, the Company has a commitment of approximately $130 million to purchase the remaining portion of the minority interest of Cisco Systems, K.K. (Japan), compared with $190 million as of July 27, 2002.
 
The Company also has certain other funding commitments of approximately $126 million as of April 26, 2003 related to its privately held investments, compared with $152 million as of July 27, 2002.
 
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

7.    Shareholders’ Equity
 
Stock Repurchase Program
 
In September 2001, the Board of Directors authorized a stock repurchase program to acquire outstanding common stock. Under the program, up to $3 billion of Cisco common stock could be reacquired over two years. In August 2002, the Board of Directors increased Cisco’s stock repurchase program by $5 billion available for repurchase through September 12, 2003. In March 2003, the Board of Directors increased Cisco’s stock repurchase program by an additional $5 billion with no termination date.
 
During the first nine months of fiscal 2003, the Company repurchased and retired 341 million shares of Cisco common stock for an aggregate purchase price of $4.5 billion. As of April 26, 2003, the Company has repurchased and retired 465 million shares of Cisco common stock for an aggregate purchase price of $6.4 billion since inception of the program and the remaining authorized amount for stock repurchases under this program was $6.6 billion. 
 
Comprehensive Income
 
The components of comprehensive income, net of tax, are as follows (in millions):
 
 	  	Three Months Ended
	 	  	Nine Months Ended
	 	
 	  	April 26,
2003
	 	  	April 27,
2002
	 	  	April 26,
2003
	  	April 27,
2002

Net income	  	$	987	 	  	$	729	 	  	$	2,596	  	$	1,121	 	
Other comprehensive income (loss):	  	 	 	 	  	 	 	 	  	 	 	  	 	 	 	
Change in unrealized gains and losses on investments, net of tax	  	 	(6	)	  	 	(199	)	  	 	294	  	 	382	 	
Other	  	 	(3	)	  	 	9	 	  	 	19	  	 	(3	)	
 	  				  				  			  				
Total	  	$	978	 	  	$	539	 	  	$	2,909	  	$	1,500	 	

The change in net unrealized gains and losses on investments of $294 million and $382 million, net of tax, during the first nine months of fiscal 2003 and 2002, respectively, was primarily due to the effects of the recognition of charges in the Consolidated Statements of Operations of $412 million and $858 million, pre-tax, respectively, attributable to the impairment of certain publicly traded equity securities during the first quarter periods. The impairment charges were related to the decline in the fair value of certain publicly traded equity investments below their cost basis that were judged to be other-than-temporary.
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.    Employee Stock Option Plans
 
Stock Option Program Description
 
The Company has two plans under which it grants options: the 1996 Stock Incentive Plan (the “1996 Plan”) and the 1997 Supplemental Stock Incentive Plan (the “Supplemental Plan”).
 
Stock option grants are designed to reward employees for their long-term contribution to the Company and provide incentives for them to remain with the Company. The number and frequency of stock option grants are based on competitive practices, operating results of the Company and government regulations. Since the inception of the 1996 Plan, the Company has granted options to all of its employees and the majority has been granted to employees below the vice president level. No options have been granted to directors or executive officers under the Supplemental  Plan.
 
Distribution and Dilutive Effect of Options
 
The following table illustrates the grant dilution and exercise dilution (in millions, except percentages):
 
 	    	Nine Months
Ended
April 26, 2003
	 	    	Fiscal Year
Ended
July 27, 2002

 	    			    			
Shares of common stock outstanding	    	7,018	 	    	7,303	 	
 	    			    			
Granted and assumed	    	176	 	    	282	 	
Canceled	    	(44	)	    	(82	)	
 	    			    			
Net options granted	    	132	 	    	200	 	
 	    			    			
Grant dilution (1)	    	1.9	%	    	2.7	%	
 	    			    			
Exercised	    	25	 	    	54	 	
Exercise dilution (2)	    	0.4	%	    	0.7	%	

Note 1: The percentage for grant dilution is computed based on options granted and assumed less options canceled as a percentage of shares of common stock outstanding.
 
Note 2: The percentage for exercise dilution is computed based on options exercised as a percentage of shares of common stock outstanding.
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table summarizes the options granted to the Named Executive Officers during the periods indicated. The Named Executive Officers represent the Company’s Chief Executive Officer and the four other most highly paid executive officers whose salary and bonus for the Company’s fiscal year ended July 27, 2002 were in excess of $100,000.
 
 	  	Nine Months
Ended
April 26, 2003
	 	  	Fiscal Year
Ended
July 27, 2002
	 	
Options granted to the Named Executive Officers	  	4 million	 	  	10 million	 	
 	  			  			
Options granted to the Named Executive Officers as a % of net options granted	  	3.0	%	  	5.0	%	
 	  			  			
Options granted to the Named Executive Officers as a % of outstanding shares	  	0.06	%	  	0.14	%	
 	  			  			
Cumulative options held by Named Executive Officers as % of total options outstanding	  	4.5	%	  	4.6	%	

Basic and diluted shares outstanding for the three and nine months ended April 26, 2003 were 7.2 billion shares and 7.3 billion shares, respectively. Diluted shares outstanding include the dilutive impact of in-the-money options, which is calculated based on the average share price for each fiscal period using the treasury stock method. Under the treasury stock method, the tax-effected proceeds that would be hypothetically received from the exercise of all in-the-money options are assumed to be used to repurchase shares. In the first nine months of fiscal 2003 , the dilutive impact of in-the-money employee stock options was approximately 87 million shares or 1.2% of the average basic shares outstanding based on Cisco’s average share price of $13.16.
 
The maximum number of shares issuable over the term of the 1996 Plan is limited to 2.5 billion shares. The share reserve was increased pursuant to the automatic share increases effected annually beginning in December 1996 and expired in December 2001. The share reserve had automatically increased on the first trading day of each December by an amount equal to 4.75% of the outstanding shares on the last trading day of the immediately preceding November.
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

General Option Information
 
A summary of option activity follows (in millions, except per-share amounts):
 
 	  	Options
Available
for Grant
	 	    	Options Outstanding
	
 	  			    	Number
Outstanding
	 	    	Weighted-Average
Exercise Price
per Share
	
BALANCE AT JULY 28, 2001	  	522	 	    	1,060	 	    	$	29.41	
Granted and assumed	  	(282	)	    	282	 	    	 	17.72	
Exercised	  	—  	 	    	(54	)	    	 	6.99	
Canceled	  	82	 	    	(82	)	    	 	36.94	
Additional shares reserved	  	342	 	    	—  	 	    	 	—  	
 	  			    			    	 	 	
BALANCE AT JULY 27, 2002	  	664	 	    	1,206	 	    	 	27.17	
Granted and assumed	  	(176	)	    	176	 	    	 	11.61	
Exercised	  	—  	 	    	(25	)	    	 	6.29	
Canceled	  	44	 	    	(44	)	    	 	32.60	
Additional shares reserved	  	3	 	    	—  	 	    	 	—  	
 	  			    			    	 	 	
BALANCE AT APRIL 26, 2003	  	535	 	    	1,313	 	    	$	25.30	

The following table summarizes significant ranges of outstanding and exercisable options as of April 26, 2003 (shares and aggregate intrinsic value in millions, except number of years and per-share amounts):
 
 	    	Options Outstanding
	    	Options Exercisable
	
Range of
Exercise Prices
	    	Number
Outstanding
	    	Weighted-
Average
Remaining
Contractual
Life
(in Years)
	    	Weighted-
Average
Exercise Price
per Share
	    	Aggregate
Intrinsic
Value
	    	Number
Exercisable
	    	Weighted-
Average
Exercise
Price
per Share
	    	Aggregate
Intrinsic
Value
	
$0.01 – 6.21	    	   154	    	2.66	    	$  4.74	    	$	1,478	    	148	    	$  4.79	    	$1,413	
  6.22 – 11.78	    	   145	    	6.05	    	    9.56	    	 	693	    	  70	    	    9.31	    	352	
11.79 – 13.04	    	   147	    	6.46	    	  12.67	    	 	245	    	  74	    	  12.34	    	148	
13.05 – 16.15	    	   201	    	7.42	    	  15.63	    	 	21	    	  57	    	  15.78	    	1	
16.16 – 20.53	    	   176	    	7.24	    	  19.25	    	 	—  	    	  59	    	  18.97	    	—  	
20.54 – 35.91	    	   146	    	5.15	    	  28.02	    	 	—  	    	126	    	  27.90	    	—  	
35.92 – 50.38	    	   137	    	6.46	    	  49.10	    	 	—  	    	  69	    	  48.82	    	—  	
50.39 – 54.53	    	   141	    	5.70	    	  54.37	    	 	—  	    	  89	    	  54.37	    	—  	
54.54 – 72.56	    	     66	    	6.11	    	  63.95	    	 	—  	    	  39	    	  64.15	    	—  	
 	    		    	 	    	 	    			    		    	 	    		
Total	    	1,313	    	5.98	    	$25.30	    	 	$2,437	    	731	    	$25.33	    	$1,914	

As of July 27, 2002, 634 million outstanding options were exercisable and the weighted average exercise price for exercisable options was $23.51. The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value based on Cisco’s closing stock price of $14.34 as of April 25, 2003, that would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of April 26, 2003 was 295 million options. 
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table presents the option exercises for the nine months ended April 26, 2003 and option values as of that date for the Named Executive Officers (in millions):
 
 	    	Number of
Shares
Acquired
on
Exercise
	  	Value
Realized
	    	Number of Securities Underlying Unexercised Options at April 26, 2003
	    	Intrinsic Value of
Unexercised In-the-Money
Options at April 26, 2003
	
 	    		  		    	  Exercisable  
	    	Unexercisable
	    	  Exercisable  
	    	Unexercisable
	
Named Executive Officers	    	—  	  	—  	    	$	41	    	$	18	    	$	165	    	$	8	
 
Pro forma Information
 
Pro forma information is as follows (in millions, except per-share amounts):
 
 	    	Three Months
Ended
April 26,
2003
	 	    	Three Months
Ended
April 27,
2002
	 	  	Nine Months
Ended
April 26,
2003
	 	  	Nine Months
Ended
April 27,
2002
	 	
Net income—as reported	    	$	987	 	    	$	729	 	  	$	2,596	 	  	$	1,121	 	
Compensation expense, net of tax	    	 	(291	)	    	 	(372	)	  	 	(972	)	  	 	(1,144	)	
 	    				    				  				  				
Net income (loss)—pro forma	    	$	696	 	    	$	357	 	  	$	1,624	 	  	$	(23	)	
 	    				    				  				  				
Basic net income per share—as reported	    	$	0.14	 	    	$	0.10	 	  	$	0.36	 	  	$	0.15	 	
 	    				    				  				  				
Diluted net income per share—as reported	    	$	0.14	 	    	$	0.10	 	  	$	0.36	 	  	$	0.15	 	
 	    				    				  				  				
Basic net income (loss) per share—pro forma	    	$	0.10	 	    	$	0.05	 	  	$	0.23	 	  	$	0.00	 	
 	    				    				  				  				
Diluted net income (loss) per share—pro forma	    	$	0.10	 	    	$	0.05	 	  	$	0.22	 	  	$	0.00	 	

The value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
 
 	    	Employee Stock Option Plans
	
 	    	Three Months
Ended
April 26,
2003
	    	Three Months
Ended
April 27,
2002
	    	Nine Months
Ended
April 26,
2003
	    	Nine Months
Ended
April 27,
2002
	
Expected dividend	    	  0.0%	    	  0.0%	    	  0.0%	    	  0.0%	
Risk-free interest rate	    	  3.2%	    	  4.8%	    	  3.2%	    	  4.7%	
Expected volatility	    	45.4%	    	47.4%	    	45.8%	    	47.4%	
Expected life (in years)	    	5.7  	    	5.6  	    	5.8  	    	  5.5  	
 
The Black-Scholes option pricing model was developed for use in estimating the value of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions including the expected stock price volatility. The Company uses projected data for expected volatility and expected life of its stock options based upon historical and other economic data trended into future years. Because the
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the estimate, in management’s opinion, the existing valuation models do not provide a reliable measure of the fair value of the Company’s employee stock options. Under the Black-Scholes option pricing model, the weighted-average estimated values of employee stock options granted during the three and nine months ended April 26, 2003 were $6.09 and $5.48, respectively, and the weighted-average estimated values of employee stock options granted during the three and nine months ended April 27, 2002 were $8.11 and $8.66 per share, respectively. The value of shares of common stock relating to the Employee Stock Purchase Plan included in compensation expense was not material. 
 
9.    Income Taxes
 
The Company paid net income taxes of $1.2 billion and $744 million for the first nine months of fiscal 2003 and 2002, respectively. The Company’s income taxes currently payable for federal and state purposes have been reduced by the tax benefits from employee stock option transactions. These benefits totaled $19 million and $51 million in the first nine months of fiscal 2003 and 2002, respectively, and were reflected as a credit to additional paid-in capital in the Consolidated Statements of Shareholders’ Equity.
 
10.    Segment Information and Major Customers
 
The Company’s operations involve the design, development, manufacturing, marketing, and technical support of networking and communications products and services. Cisco products include routers, switches, access, and other networking equipment. These products, primarily integrated by Cisco IOS Software, link geographically dispersed LANs and WANs.
 
The Company conducts business globally and is managed geographically. The Company’s management relies on an internal management system that provides sales and standard cost information by geographic theater. Sales are attributed to a theater based on the ordering location of the customer. The Company’s management makes financial decisions and allocates resources based on the information it receives from this internal management system. The Company does not allocate research and development, sales and marketing, or general and administrative expenses to its geographic theaters in this internal management system, as management does not use the information to measure the performance of the operating segments. Management does not believe that allocating these expenses is significant in evaluating a geographic theater’s performance. Based on established criteria, the Company has four reportable segments: the Americas; EMEA; Asia Pacific; and Japan.
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Summarized financial information by theater for the third quarter and first nine months of fiscal 2003 and 2002, as taken from the internal management system previously discussed, is as follows (in millions):
 	  	Three Months Ended
	 	  	Nine Months Ended
	 	
 	  	April 26, 2003
	 	  	April 27, 2002
	 	  	April 26, 2003
	 	  	April 27, 2002
	 	
Net sales:	  	 	 	 	  	 	 	 	  	 	 	 	  	 	 	 	
Americas	  	$	2,526	 	  	$	2,727	 	  	$	7,853	 	  	$	7,875	 	
EMEA	  	 	1,294	 	  	 	1,304	 	  	 	3,900	 	  	 	3,860	 	
Asia Pacific	  	 	459	 	  	 	432	 	  	 	1,437	 	  	 	1,351	 	
Japan	  	 	339	 	  	 	359	 	  	 	986	 	  	 	1,000	 	
 	  				  				  				  				
Total	  	$	4,618	 	  	$	4,822	 	  	$	14,176	 	  	$	14,086	 	
 	  				  				  				  				
Gross margin:	  	 	 	 	  	 	 	 	  	 	 	 	  	 	 	 	
Americas	  	$	2,005	 	  	$	2,105	 	  	$	6,263	 	  	$	5,900	 	
EMEA	  	 	1,053	 	  	 	1,051	 	  	 	3,177	 	  	 	3,043	 	
Asia Pacific	  	 	379	 	  	 	364	 	  	 	1,183	 	  	 	1,086	 	
Japan	  	 	283	 	  	 	286	 	  	 	818	 	  	 	790	 	
 	  				  				  				  				
Standard margin	  	 	3,720	 	  	 	3,806	 	  	 	11,441	 	  	 	10,819	 	
Production overhead	  	 	(138	)	  	 	(129	)	  	 	(414	)	  	 	(480	)	
Manufacturing variances and other related costs	  	 	(313	)	  	 	(609	)	  	 	(1,083	)	  	 	(1,609	)	
 	  				  				  				  				
Total	  	$	3,269	 	  	$	3,068	 	  	$	9,944	 	  	$	8,730	 	

The Company has reclassified net sales for each geographic theater for the nine months ended April 27, 2002 to reflect the breakdown of services revenue for EMEA, Asia Pacific and Japan theaters, all of which were previously included in the Americas theater in the first six months of fiscal 2002.
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following table presents net sales for groups of similar products and services (in millions):
 
 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Net sales:	  	 	 	  	 	 	  	 	 	  	 	 	
Routers	  	$	1,250	  	$	1,437	  	$	3,798	  	$	4,300	
Switches	  	 	1,882	  	 	1,898	  	 	5,775	  	 	5,511	
Access	  	 	192	  	 	252	  	 	687	  	 	751	
Other	  	 	475	  	 	406	  	 	1,443	  	 	1,109	
 	  			  			  			  			
Product	  	 	3,799	  	 	3,993	  	 	11,703	  	 	11,671	
Services	  	 	819	  	 	829	  	 	2,473	  	 	2,415	
 	  			  			  			  			
Total	  	$	4,618	  	$	4,822	  	$	14,176	  	$	14,086	

The majority of the Company’s assets as of April 26, 2003 and July 27, 2002 were attributable to its U.S. operations. In the third quarter and first nine months of fiscal 2003 and 2002, no single customer accounted for 10% or more of the Company’s net sales.
 
11.    Net Income per Share
 
The following table presents the calculation of basic and diluted net income per share (in millions, except per-share amounts):
 
 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Net income	  	$	987	  	$	729	  	$	2,596	  	$	1,121	
 	  			  			  			  			
Weighted-average shares—basic	  	 	7,062	  	 	7,306	  	 	7,165	  	 	7,310	
Effect of dilutive potential common shares	  	 	96	  	 	148	  	 	92	  	 	163	
 	  			  			  			  			
Weighted-average shares—diluted	  	 	7,158	  	 	7,454	  	 	7,257	  	 	7,473	
 	  			  			  			  			
Net income per share—basic	  	$	0.14	  	$	0.10	  	$	0.36	  	$	0.15	
 	  			  			  			  			
Net income per share—diluted	  	$	0.14	  	$	0.10	  	$	0.36	  	$	0.15	

Dilutive potential common shares consist of employee stock options and restricted common stock. Employee stock options to purchase approximately 857 million shares and 724 million shares in the third quarter of fiscal 2003 and 2002, respectively, and 898 million shares and 653 million shares in the first nine months of fiscal 2003 and fiscal 2002, respectively, were outstanding, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the average share price of the common shares and, therefore, the effect would have been antidilutive.
 
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Cisco Systems, Inc.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

12.    Pending Business Combinations
 
In March 2003, the Company announced a definitive agreement to acquire SignalWorks, Inc. for a total purchase price of approximately $13.5 million payable in common stock. This acquisition will be accounted for as a purchase and closed on May 7, 2003.
 
In March 2003, the Company also announced a definitive agreement to acquire the business of The Linksys Group, Inc. and to assume all outstanding stock options for a total purchase price of approximately $500 million payable in common stock. This acquisition will be accounted for as an asset purchase and is expected to close in the fourth quarter of fiscal 2003.
 
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Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
 
This Quarterly Report on Form 10-Q, including this 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 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,” variations of such words, and similar expressions are intended to identify such forward-looking statements. In addition, any statements which 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. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are referred to risks and uncertainties identified below, under “Risk Factors” and elsewhere herein. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.
 
Critical Accounting Policies
 
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions, and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements in the Annual Report on Form 10-K, as amended, for the fiscal year ended July 27, 2002 describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, inventory allowances, warranty costs, investment impairments, goodwill impairments, contingencies, restructuring costs and other special charges, and taxes. Actual results could differ materially from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the Consolidated Financial Statements.
 
The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than our historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have an adverse impact on our revenue.
 
A reserve for sales returns is established based on historical trends in product return rates. 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 purchases are based upon future demand forecasts. 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 allowances and our gross margins could be adversely affected.
 
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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

We accrue for warranty costs based on historical trends in product failure rates and the expected material and labor costs to provide warranty services. If we were to experience an increase in warranty claims compared with our historical experience, or costs of servicing warranty claims were greater than the expectations on which the accrual had been based, our gross margins could be adversely affected.
 
We have experienced significant volatility in the market prices of our publicly traded equity investments. These investments are recorded on the Consolidated Balance Sheets as of April 26, 2003 at a fair value of $554 million, compared with $567 million as of July 27, 2002. We recognize an impairment charge in the Consolidated Statements of Operations when the decline in the fair value of our publicly traded equity investments below their cost basis is judged to be other-than-temporary. We consider various factors in determining whether we should recognize an impairment charge including, but not limited to, 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 issuer, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. The ultimate value realized on these equity investments is subject to market price volatility until they are sold. We also have investments in privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. As of April 26, 2003, the investments in privately held companies were $529 million, compared with $477 million as of July 27, 2002.
 
We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances for each reporting unit, which are the operating segments as described in Note 10 to the Consolidated Financial Statements. In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing, or otherwise exiting businesses, which could result in an impairment of goodwill.
 
We are subject to the possibility of various loss contingencies arising in the ordinary course of business. We consider the likelihood of 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.
 
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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Net Sales
 
We manage our business based on four geographic theaters: the Americas; EMEA; Asia Pacific; and Japan. Net sales, which include product and service revenue, for each theater are summarized in the following table (in millions):
 
 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Net sales:	  	 	 	  	 	 	  	 	 	  	 	 	
Americas	  	$	2,526	  	$	2,727	  	$	7,853	  	$	7,875	
EMEA	  	 	1,294	  	 	1,304	  	 	3,900	  	 	3,860	
Asia Pacific	  	 	459	  	 	432	  	 	1,437	  	 	1,351	
Japan	  	 	339	  	 	359	  	 	986	  	 	1,000	
 	  			  			  			  			
Total	  	$	4,618	  	$	4,822	  	$	14,176	  	$	14,086	

Net sales in the third quarter of fiscal 2003 decreased by $204 million or 4.2% from $4.8 billion in the third quarter of fiscal 2002 to $4.6 billion primarily related to the decrease in net product sales. The decrease in net product sales was due to the challenging global economic environment, geopolitical issues and continued constraints on information technology-related capital spending, in particular service provider customers. Net sales in the first nine months of fiscal 2003 increased by $90 million or 0.6% from the first nine months of fiscal 2002. The following table is a breakdown of net sales between product and service revenue (in millions):
 
 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Net sales:	  	 	 	  	 	 	  	 	 	  	 	 	
Product	  	$	3,799	  	$	3,993	  	$	11,703	  	$	11,671	
Services	  	 	819	  	 	829	  	 	2,473	  	 	2,415	
 	  			  			  			  			
Total	  	$	4,618	  	$	4,822	  	$	14,176	  	$	14,086	

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

Net Product Sales
 
Net product sales in the third quarter of fiscal 2003 decreased by $194 million or 4.9% from $4.0 billion in the third quarter of fiscal 2002 to $3.8 billion. Net product sales in the first nine months of fiscal 2003 were $11.7 billion, compared with $11.7 billion in the first nine months of fiscal 2002. The following table is a breakdown of net product sales by theater (in millions):
 
 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Net product sales:	  	 	 	  	 	 	  	 	 	  	 	 	
Americas	  	$	1,919	  	$	2,113	  	$	6,032	  	$	6,104	
EMEA	  	 	1,153	  	 	1,159	  	 	3,467	  	 	3,426	
Asia Pacific	  	 	416	  	 	393	  	 	1,305	  	 	1,220	
Japan	  	 	311	  	 	328	  	 	899	  	 	921	
 	  			  			  			  			
Total	  	$	3,799	  	$	3,993	  	$	11,703	  	$	11,671	

Net product sales in the Americas theater consist of net product sales in the United States and Americas International, which includes Canada, Mexico and Latin America. Net product sales in the Americas theater in the third quarter of fiscal 2003 decreased by $194 million or 9.2%, compared with the third quarter of fiscal 2002. Net product sales in the United States were $1.7 billion in the third quarter of fiscal 2003, compared with $1.9 billion in the third quarter of fiscal 2002, a decrease of $207 million or 10.8%. Continued slowdown in the United States economy and the uncertainty regarding the war in Iraq may have adversely affected business confidence and information technology-related capital spending during the third quarter of fiscal 2003. Net product sales in the Americas International were $213 million for the third quarter of fiscal 2003 , compared with $200 million in the third quarter of fiscal 2002, an increase of $13 million or 6.5%. Net product sales in the EMEA theater in the third quarter of fiscal 2003 decreased by $6 million or 0.5% , compared with the third quarter of fiscal 2002. Net product sales in the Asia Pacific theater in the third quarter of fiscal 2003 increased by $23 million or 5.9%, compared with the third quarter of fiscal 2002. Net product sales in Japan in the third quarter of fiscal 2003 decreased by $17 million or 5.2%, compared with the third quarter of fiscal 2002. The changes in net product sales in the Americas International, EMEA, Asia Pacific, and Japan theaters were not significant.
 
Net product sales in the Americas theater for the first nine months of fiscal 2003 decreased by $72 million or 1.2%, compared with the first nine months of fiscal 2002. Net product sales in the United States were $5.4 billion in the first nine months of fiscal 2003, compared with $5.4 billion in the first nine months of fiscal 2002, an increase of $8 million or 0.1%. Net product sales in the United States experienced modest growth due to sales to the United States federal government during the first quarter of fiscal 2003. Despite this modest growth, the slowdown in the economy, over-capacity, and constraints on information technology-related capital spending have continued to affect both enterprise and service provider customers, especially service provider customers. Net product sales in the Americas International were $586 million in the first nine months of fiscal 2003, compared with $666 million in the first nine months of fiscal 2002, a decrease of $80 million or 12.0%. Net product sales in the EMEA theater in the first nine months of fiscal 2003 increased by $41 million or 1.2%, compared with
 
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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
the first nine months of fiscal 2002, as incumbent service providers began deploying products during the first quarter of fiscal 2003. Net product sales in the Asia Pacific theater in the first nine months of fiscal 2003 increased by $85 million or 7.0%, compared with the first nine months of fiscal 2002, due to infrastructure builds, broadband acceleration and investments by Asian telecom carriers. The change in net product sales for the Japan theater was not significant.
 
The following table presents net sales for groups of similar products (in millions):
 
 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Net product sales:	  	 	 	  	 	 	  	 	 	  	 	 	
Routers	  	$	1,250	  	$	1,437	  	$	3,798	  	$	4,300	
Switches	  	 	1,882	  	 	1,898	  	 	5,775	  	 	5,511	
Access	  	 	192	  	 	252	  	 	687	  	 	751	
Other	  	 	475	  	 	406	  	 	1,443	  	 	1,109	
 	  			  			  			  			
Total	  	$	3,799	  	$	3,993	  	$	11,703	  	$	11,671	

Net product sales related to routers, which represented 32.9% of our total product sales in the third quarter of fiscal 2003, decreased by $187 million or 13.0%, compared with the third quarter of fiscal 2002. The decrease in the third quarter of fiscal 2003, compared with the third quarter of fiscal 2002, was due to decreases in sales of mid-range and high-end routers. Net product sales related to routers in the first nine months of fiscal 2003 decreased by $502 million or 11.7%, compared with the first nine months of fiscal 2002. The decrease in the first nine months of fiscal 2003, compared with the first nine months of fiscal 2002, was primarily due to decreases in sales of mid-range and low-end routers.
 
Net product sales related to switches, which represented 49.5% of our total product sales in the third quarter of fiscal 2003 were $1.9 billion, compared with $1.9 billion in the third quarter of fiscal 2002. The sales in the third quarter of fiscal 2003, compared with the third quarter of fiscal 2002, reflect a decrease in sales of modular switches offset by increases in sales of fixed and WAN switches. Net product sales related to switches in the first nine months of fiscal 2003 increased by $264 million or 4.8%, compared with the first nine months of fiscal 2002. The increase in the first nine months of fiscal 2003, compared with the first nine months of fiscal 2002, was primarily due to increases in sales of fixed and WAN switches partially offset by a decrease in sales of modular switches.
 
Net product sales related to access products, which represented 5.1% of our total product sales in the third quarter of fiscal 2003, decreased by $60 million or 23.8%, compared with the third quarter of fiscal 2002. Net product sales related to access products in the first nine months of fiscal 2003 decreased by $64 million or 8.5%, compared with the first nine months of fiscal 2002. The decrease in the third quarter and first nine months of fiscal 2003, compared with the same periods in fiscal 2002 was primarily due to decreases in sales of Digital Subscriber Line and dial access products partially offset by an increase in sales of wireless LAN products.
 
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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Net product sales related to other products, which represented 12.5% of our total product sales in the third quarter of fiscal 2003, increased by $69 million or 17.0%, compared with the third quarter of fiscal 2002. The increase in the third quarter of fiscal 2003, compared with the third quarter of fiscal 2002, was due to increases in sales of IP telephony and content networking. Net product sales related to other products in the first nine months of fiscal 2003 increased by $334 million or 30.1%, compared with the first nine months of fiscal 2002. The increase in the first nine months of fiscal 2003, compared with the first nine months of fiscal 2002, was primarily due to increases in sales of IP telephony, content networking, security and network management products.
 
Net product sales may be adversely affected in the future by changes in the geopolitical environment and global economic conditions, sales cycles and implementation cycles of our products, changes in the mix of our customers between service provider and enterprise, 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. Service provider customers typically have longer implementation cycles, require a broader range of service including design services and often have acceptance provisions, which can lead to a delay in revenue recognition. In order to improve customer satisfaction, we continue to attempt to reduce our manufacturing lead times, which may result in corresponding reductions in order backlog. A decline in backlog levels could result in more variability and less predictability in our quarter-to-quarter net sales 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, price and product competition in the communications and networking industries, introduction and market acceptance of new technologies and products, as well as the adoption of new networking standards. In addition, the outbreak of Severe Acute Respiratory Syndrome could have an adverse impact on our net product sales, in particular in Asia.
 
Two-tier distribution channels are given business terms which allow them to return a portion of inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. In addition, increasing two-tier distribution channels 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 to two-tier distributors based on a sell-through method utilizing information provided by our distributors and we also maintain accruals and allowances for all cooperative marketing and other programs.
 
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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Net Service Revenue
 
Net service revenue in the third quarter of fiscal 2003 decreased by $10 million or 1.2% from the third quarter of fiscal 2002. Net service revenue in the first nine months of fiscal 2003 increased by $58 million or 2.4% from the first nine months of fiscal 2002. The increase in net service revenue for the first nine months of fiscal 2003, compared with the same period in fiscal 2002 was primarily due to increased technical support service contract initiations and renewals associated with product sales. In addition, revenue from advanced services, which provides consultative support of our technologies for specific networking needs, also increased. Net service revenue is generally deferred and, in most cases, recognized ratably over the service period obligations, which are typically one to three years. Net service revenue will typically experience some variability over time due to various factors such as the timing of technical support service contract initiations and renewals. 
 
Gross Margin
 
The following table shows a breakdown of our gross margin (in millions):
 
 	  	Three Months Ended
	 	  	Nine Months Ended
	 	
 	  	April 26, 2003
	 	  	April 27,
2002
	 	  	April 26, 2003
	 	  	April 27, 2002
	 	
Gross margin:	  	 	 	 	  	 	 	 	  	 	 	 	  	 	 	 	
Americas	  	$	2,005	 	  	$	2,105	 	  	$	6,263	 	  	$	5,900	 	
EMEA	  	 	1,053	 	  	 	1,051	 	  	 	3,177	 	  	 	3,043	 	
Asia Pacific	  	 	379	 	  	 	364	 	  	 	1,183	 	  	 	1,086	 	
Japan	  	 	283	 	  	 	286	 	  	 	818	 	  	 	790	 	
 	  				  				  				  				
Standard margin	  	 	3,720	 	  	 	3,806	 	  	 	11,441	 	  	 	10,819	 	
Production overhead	  	 	(138	)	  	 	(129	)	  	 	(414	)	  	 	(480	)	
Manufacturing variances and other related costs	  	 	(313	)	  	 	(609	)	  	 	(1,083	)	  	 	(1,609	)	
 	  				  				  				  				
Total	  	$	3,269	 	  	$	3,068	 	  	$	9,944	 	  	$	8,730	 	

The following table shows the total standard margin, which includes product and services, for each theater (in percentages):
 
 	  	Three Months Ended
	 	  	Nine Months Ended
	 	
 	  	April 26, 2003
	 	  	April 27, 2002
	 	  	April 26, 2003
	 	  	April 27, 2002
	 	
Standard margin:	  	 	 	  	 	 	  	 	 	  	 	 	
Americas	  	79.4	%	  	77.2	%	  	79.8	%	  	74.9	%	
EMEA	  	81.4	%	  	80.6	%	  	81.5	%	  	78.8	%	
Asia Pacific	  	82.6	%	  	84.3	%	  	82.3	%	  	80.4	%	
Japan	  	83.5	%	  	79.7	%	  	83.0	%	  	79.0	%	
Total	  	80.6	%	  	78.9	%	  	80.7	%	  	76.8	%	
 
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Our standard margin varies due to a number of reasons, including, but not limited to, shifts in product mix, sales discounts, sales channels, changes in component costs and impact of value engineering. Production overhead is primarily related to labor, depreciation on equipment, and facilities charges associated with manufacturing activities. Manufacturing variances and other related costs are primarily related to warranty, freight, provision for inventory and other nonstandard costs.
 
Gross margin for product and services in the third quarter and first nine months of fiscal 2003 and 2002 was as follows (in millions, except percentages):
 
 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Gross Margin:	  	 	 	  	 	 	  	 	 	  	 	 	
Product	  	$	2,713	  	$	2,478	  	$	8,236	  	$	7,063	
Services	  	 	556	  	 	590	  	 	1,708	  	 	1,667	
 	  			  			  			  			
Total	  	$	3,269	  	$	3,068	  	$	9,944	  	$	8,730	

 	  	Three Months Ended
	  	Nine Months Ended
	
 	  	April 26, 2003
	  	April 27, 2002
	  	April 26, 2003
	  	April 27, 2002
	
Gross Margin:	  	 	 	  	 	 	  	 	 	  	 	 	
Product	  	 	71.4%	  	 	62.1%	  	 	70.4%	  	 	60.5%	
Services	  	 	67.9%	  	 	71.2%	  	 	69.1%	  	 	69.0%	
Total	  	 	70.8%	  	 	63.6%	  	 	70.1%	  	 	62.0%	
 
Product Gross Margin
 
Product gross margin increased from 62.1% in the third quarter of fiscal 2002 to 71.4% in the third quarter of fiscal 2003. Product gross margin increased from 60.5% in the first nine months of fiscal 2002 to 70.4% in the first nine months of fiscal 2003. The increase in product gross margin for the third quarter and first nine months of fiscal 2003, compared with the same periods in fiscal 2002, was due to lower component costs and value engineering, partially offset by the impact of product pricing reductions and changes in the mix of products sold which resulted in an increase in standard margin of approximately 3% and 5% for the respective periods. Value engineering is the process by which the production costs are reduced through component redesign, board configuration, test processes and transformation processes.
 
In addition, manufacturing costs related to warranty, freight, provision for inventory and other nonstandard costs decreased by $296 million and $526 million for the third quarter and first nine months of fiscal 2003, respectively, compared with the same periods in fiscal 2002. During the third quarter and first nine months of fiscal 2003, compared with the same periods a year ago, the lower provision for inventory was partially offset by an excess inventory benefit in the third quarter and first nine months of fiscal 2002.
 
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Product gross margin may be adversely affected in the future by changes in the mix of products sold or channels of distribution, increases in material or labor costs, excess inventory and obsolescence charges, changes in shipment volume, loss of cost savings due to changes in component pricing, charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand and price competition. If warranty costs associated with our products are greater than we have experienced, product gross margin may also be adversely affected. Product gross margin may also be affected by geographic mix, as well as the mix of configurations within each product group.
 
Service Gross Margin
 
Service gross margin decreased from $590 million or 71.2% in the third quarter of fiscal 2002 to $556 million or 67.9% in the third quarter of fiscal 2003, a decrease of $34 million or 3.3%. Service gross margin was $1.7 billion or 69.0% in the first nine months of fiscal 2002, compared with $1.7 billion or 69.1% in the first nine months of fiscal 2003, an increase of $4.1 million or 0.1%. Service gross margin will typically experience some variability over time due to various factors such as the changes in mix between technical support services and advanced services, as well as the timing of technical support service contract  initiations and renewals.
 
Research and Development, Sales and Marketing, and General and Administrative Expenses
 
Research and development (“R&D”), sales and marketing, and general and administrative (“G&A”) expenses are summarized in the following table (in millions, except percentages):
 
 	  	Three Months Ended
	 	  	Nine Months Ended
	 	
 	  	April 26, 2003
	 	  	April 27,
2002
	 	  	April 26, 2003
	 	  	April 27, 2002
	 	
Research and development	  	$	725	 	  	$	838	 	  	$	2,375	 	  	$	2,617	 	
Percentage of net sales	  	 	15.7	%	  	 	17.4	%	  	 	16.8	%	  	 	18.6	%	
Sales and marketing	  	 	1,019	 	  	 	1,063	 	  	 	3,092	 	  	 	3,230	 	
Percentage of net sales	  	 	22.1	%	  	 	22.0	%	  	 	21.8	%	  	 	22.9	%	
General and administrative	  	 	184	 	  	 	164	 	  	 	512	 	  	 	463	 	
Percentage of net sales	  	 	4.0	%	  	 	3.4	%	  	 	3.6	%	  	 	3.3	%	
 	  				  				  				  				
Total	  	$	1,928	 	  	$	2,065	 	  	$	5,979	 	  	$	6,310	 	
 	  				  				  				  				
Percentage of net sales	  	 	41.7	%	  	 	42.8	%	  	 	42.2	%	  	 	44.8	%	
 
R&D expenses in the third quarter of fiscal 2003 decreased by $113 million or 13.5% from the third quarter of fiscal 2002. R&D expenses in the first nine months of fiscal 2003 decreased by $242 million or 9.2% from the first nine months of fiscal 2002. The decrease in R&D expenses for the third quarter and the first nine months of fiscal 2003, compared with the same periods in fiscal 2002 was due to lower expenditures on prototypes, lower depreciation on lab equipment, and reduced discretionary spending . We have continued to invest in R&D efforts in a wide
 
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variety of areas such as data, voice, and video over IP; advanced access and aggregation technologies such as cable, wireless, mobility and other broadband technologies; advanced enterprise switching; optical technology; storage area networking; content networking; security; network management; and advanced core and edge routing technologies; among others. We have also continued to purchase or license technology in order to bring a broad range of products to 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 in the third quarter of fiscal 2003 decreased by $44 million or 4.1% from the third quarter of fiscal 2002. Sales and marketing expenses in the first nine months of fiscal 2003 decreased by $138 million or 4.3% from the first nine months of fiscal 2002. Sales expenses decreased for the third quarter and the first nine months of fiscal 2003, compared with the same periods in fiscal 2002, due to the decrease in advertising investments, reduced discretionary spending and the decrease in the size of our sales force. However, our marketing expenses have increased for the third quarter and the first nine months of fiscal 2003, compared with the same periods in fiscal 2003, as we have continued to invest in both our new growth market opportunities and our branding strategy, including investments in a new marketing campaign.
 
G&A expenses in the third quarter of fiscal 2003 increased by $20 million or 12.2% from the third quarter of fiscal 2002. G&A expenses in the first nine months of fiscal 2003 increased by $49 million or 10.6% from the first nine months of fiscal 2002. The increase in G&A expenses for the third quarter and the first nine months of fiscal 2003, compared with the same periods in fiscal 2002 was primarily related to real estate allocations and other items.
 
During the first nine months of fiscal 2003, we increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $40 million, which was recorded during the first quarter of fiscal 2003, due to changes in real estate market conditions. The increase in restructuring liabilities was recorded as R&D ($16 million), sales and marketing ($16 million), G&A ($4 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations. In addition, during the first nine months of fiscal 2002, we increased the restructuring liabilities related to the consolidation of excess facilities and other charges by $93 million, which was recorded in the third quarter of fiscal 2002, due to changes in real estate market conditions. The increase in restructuring liabilities was recorded as research and development ($39 million), sales and marketing ($42 million), general and administrative ($8 million) expenses and cost of sales ($4 million) in the Consolidated Statements of Operations. There can be no assurance that future changes in real estate market conditions will not result in additional real estate liabilities. 
 
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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Amortization of Purchased Intangible Assets
 
Amortization of purchased intangible assets included in operating expenses was $92 million in the third quarter of fiscal 2003, compared with $129 million in the third quarter of fiscal 2002. Amortization of purchased intangible assets included in operating expenses was $284 million in the first nine months of fiscal 2003, compared with $411 million in the first nine months of fiscal 2002. The decrease in the amortization of purchased intangible assets for the third quarter and the first nine months of fiscal 2003, compared with the same periods in fiscal 2002 was primarily related to the accelerated amortization for certain technology and patent intangibles in the prior year period due to a reduction in their estimated useful lives, which have now been fully amortized. For additional information regarding purchased intangible assets, see Note 3 to the Consolidated Financial Statements.
 
In-Process Research and Development
 
Our methodology for allocating the purchase price to in-process research and development (“in-process R&D”) is determined through established valuation techniques in the high-technology communications equipment industry and expensed upon acquisition because technological feasibility has not been established and no future alternative uses exist (See Note 3 to the Consolidated Financial Statements). The fair value of the existing purchased technology and patents, as well as the technology under development, is determined using the income approach, which discounts expected future cash flows to present value. The discount rates used in the present value calculations are typically derived from a weighted-average cost of capital analysis and venture capital surveys, adjusted upward to reflect additional risks inherent in the development life cycle. We consider the pricing model for products related to these acquisitions to be standard within the high-technology communications equipment industry. However, we do not expect to achieve a material amount of expense reductions as a result of integrating the acquired in-process technology. Therefore, the valuation assumptions do not include significant anticipated cost savings.
 
For acquisitions completed to date, the development of these technologies remains a significant risk due to the remaining efforts to achieve technical viability, rapidly changing customer markets, uncertain standards for new products, and significant competitive threats from several companies. The nature of the efforts to develop these technologies into commercially viable products consists principally of planning, designing, experimenting, and testing activities necessary to determine that the technologies can meet market expectations, including functionality and technical requirements. Failure to bring these products to market in a timely manner could result in a loss of market share or a lost opportunity to capitalize on emerging markets, and could have a material adverse impact on our business and operating results.
 
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The following table summarizes the key assumptions underlying the valuation for our purchase acquisition completed in the first nine months of fiscal 2003, for which in-process R&D was recorded (in millions, except percentages):
 
Acquired Company
	    	Estimated Cost to
Complete Technology at
Time of Acquisition
	    	Risk-Adjusted
Discount Rate for
In-Process R&D
	 	
Okena, Inc.	    	$	3	    	22.0 	%	
 
The key assumptions primarily consist of an expected completion date for the in-process projects, estimated costs to complete the projects, revenue and expense projections assuming the products have entered the market, and discount rates based on the risks associated with the development life cycle of the in-process technology acquired. Failure to achieve the expected levels of revenue and net income from these products will negatively impact the return on investment expected at the time that the acquisitions were completed and may result in impairment charges. Actual results from the acquired companies to date did not have a material adverse impact on our business and operating results except for certain purchase acquisitions where the purchased intangible assets were impaired and written down as previously reflected in the Consolidated Statements of Operations.
 
Interest Income
 
Interest income was $161 million in the third quarter of fiscal 2003, compared with $220 million in the third quarter of fiscal 2002. Interest income was $514 million in the first nine months of fiscal 2003, compared with $687 million in the first nine months of fiscal 2002. The decrease in interest income for the third quarter and the first nine months of fiscal 2003, compared with the same periods in fiscal 2002, was primarily due to lower average interest rates.
 
Other Loss, Net
 
Other loss, net, primarily consists of net realized gains (losses) and impairment charges on investments, as well as provision for losses on investments in privately held companies. Other loss, net, was $26 million in the third quarter of fiscal 2003, compared with $70 million in the third quarter of fiscal 2002. Other loss, net, was $552 million in the first nine months of fiscal 2003, compared with $1.0 billion in the first nine months of fiscal 2002. The other loss, net, in the first nine months of fiscal 2003 and 2002 included a charge of $412 million and $858 million, pre-tax, respectively, related to the impairment of certain publicly traded equity securities during the first quarter periods. The impairment charges were due to the decline in the fair value of certain publicly traded equity investments below their cost basis that were judged to be other-than-temporary.
 
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Provision for Income Taxes
 
The effective tax rate was 28.5% in the third quarter of fiscal 2003 and 28.7% for the first nine months of fiscal 2003. The effective tax rate was 28.8% in the third quarter of fiscal 2002 and 30.5% for the first nine months of fiscal 2002. The effective tax rate differs from the statutory rate primarily due to the impact of nondeductible in-process R&D, acquisition-related costs, research and experimentation tax credits, state taxes, and the tax impact of non-U.S. operations.
 
Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws or interpretations thereof. 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. 
 
Recent Accounting Pronouncements
 
Consolidation of Variable Interest Entities
 
FIN 46 was issued in January 2003 and requires that if an entity is the primary beneficiary of a variable interest entity, the assets, liabilities and results of operations of the variable interest entity should be included in the Consolidated Financial Statements of the entity. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. We have not invested in any variable interest entities after January 31, 2003. For those arrangements entered into prior to January 31, 2003, the provisions of FIN 46 are required to be adopted at the beginning of the first interim or annual period beginning after June 15, 2003.
 
As discussed in Note 6 to the Consolidated Financial Statements, we have invested in Andiamo, a storage switch developer. This investment was made in April 2001 in the form of an $84 million debt instrument. In connection with this investment, we obtained a call option that provided us the right to purchase Andiamo. The purchase price under the call option is based on a valuation of Andiamo using a negotiated formula, further described in Note 6 to the Consolidated Financial Statements. On August 19, 2002, we entered into a definitive agreement to acquire Andiamo, which represents the exercise of our rights under the call option. We also entered into a commitment to provide non-convertible debt funding to Andiamo of approximately $100 million through the close of the acquisition.
 
We have evaluated our debt investment in Andiamo and have determined that Andiamo is a variable interest entity under FIN 46. We have concluded that we are the primary beneficiary as defined by FIN 46 and, as a result, we are required to consolidate Andiamo beginning the first day of the first quarter of fiscal 2004. To date, we have expensed substantially our entire investment in Andiamo as research and development costs, as if such expenses constituted our development costs.
 
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FIN 46 will require us to account for Andiamo as if we had consolidated it since our initial investment in April 2001. If we consolidated Andiamo from the date of our initial investment, we would be required to account for the call option as a repurchase right. Under FIN 44 and related interpretations, variable accounting is required for substantially all Andiamo employee stock and options because the ending purchase price is primarily derived from a revenue-based formula. Therefore, beginning in the first quarter of fiscal 2004, we will revalue the stock and options of Andiamo each quarter based on an independent valuation of Andiamo until the completion of the acquisition which is expected in the third quarter of fiscal 2004, but no later than July 31, 2004.
 
Consequently, on July 27, 2003, the first day of fiscal 2004, we will record a non-cash cumulative charge based on the adoption of FIN 46, in the range of $200 million to $500 million (the variable compensation from April 2001 through July 2003). This will be reported as a separate line item in the Consolidated Statements of Operations, net of tax. The charge will be based on the value of the Andiamo employee stock and options and their expected vesting upon FIN 46 adoption pursuant to the independent evaluation, and does not necessarily reflect the value of Andiamo as a whole nor indicate the expected valuation of Andiamo upon acquisition. Subsequent to the adoption of FIN 46, changes to the value of Andiamo will result in adjustments to the non-cash stock compensation charge based upon the expected vesting of the employee stock and options and will be reflected as operating expenses. These adjustments will be recorded commencing in the first quarter of fiscal 2004 and continue until such time as the acquisition of Andiamo is completed, which is expected to close in the third quarter of fiscal 2004, but no later than July 31, 2004. These adjustments will be based on changes in the valuation of Andiamo using the negotiated formula. The value computed under the negotiated formula is largely based on revenues derived from specific storage switch products.
 
The estimated range of the non-cash stock compensation cumulative charge, the future non-cash variable stock compensation adjustments, and the final purchase price of Andiamo are subject to uncertainty. The valuation of Andiamo is subject to change based on the ability of Andiamo to meet its revenue projections, the market for its products, its ability to develop relevant technology, as well as other factors. The valuation will be performed by an independent third-party using a consistent methodology.
 
Excluding the non-cash stock compensation cumulative charge and any future non-cash variable stock compensation adjustments, the impact of consolidating Andiamo will not materially affect our operating results or financial condition. Other than the investment in Andiamo, we do not anticipate that the adoption of FIN 46 will have a material impact on our operating results or financial condition.
 
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Accounting for Derivative Instruments and Hedging Activities
 
SFAS 149 was issued in April 2003 and amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS 149 is generally effective for derivative instruments, including derivative instruments embedded in certain contracts, entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. We do not expect the adoption of SFAS 149 to have a material impact on our operating results or financial condition.
 
Liquidity and Capital Resources 
 
The following sections discuss the effects of the changes in our balance sheets, cash flows, and commitments on our liquidity and capital resources.
 
Balance Sheet and Cash Flows
 
Cash and Cash Equivalents and Total Investments     Cash and cash equivalents and total investments were $20.3 billion as of April 26, 2003, a decrease of $1.14 billion or 5.3% from $21.5 billion at July 27, 2002. The decrease was primarily a result of cash used for the repurchase of common stock of $4.5 billion and capital expenditures of $504 million. This was partially offset by cash provided by operating activities of $3.7 billion.
 
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, shipment linearity, accounts receivable collections, inventory management, and the timing of tax and other payments. For additional discussion, see the “Risk Factors” section below.
 
Accounts Receivable, net     Accounts receivable was $1.2 billion and $1.1 billion as of April 26, 2003 and July 27, 2002, respectively. Days sales outstanding (“DSO”) in receivables as of April 26, 2003 and July 27, 2002 were 23 days and 21 days, respectively. Our accounts receivable and DSO were primarily impacted by shipment linearity and collections performance. Our targeted range for DSO performance continues to be 40 to 50 days.
 
Inventories     Inventories were $765 million as of April 26, 2003, a decrease of $115 million or 13.1% from $880 million at July 27, 2002. Inventories consist of raw materials, work in process, finished goods, and demonstration systems. Approximately 36.3% of our finished goods inventory was located at distributor sites. Inventory turns were 7.0 in the third quarter of fiscal 2003 and 7.1 in the fourth quarter of fiscal 2002. Inventory levels and the associated inventory turns reflect our ongoing inventory management efforts. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology and customer requirements. 
 
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Commitments
 
Leases     We lease office space in numerous U.S. locations, as well as locations elsewhere in the Americas International; EMEA; Asia Pacific; and Japan. Future annual minimum lease payments under all noncancelable operating leases with an initial term in excess of one year as of April 26, 2003 were as follows (in millions):
 
Fiscal Year:
	  	Amount
	
2003 (remaining three months)	  	$	73	
2004	  	 	265	
2005	  	 	226	
2006	  	 	173	
2007	  	 	136	
Thereafter	  	 	745	
 	  			
Total	  	$	1,618	

Investment in Andiamo Systems, Inc.     On August 19, 2002, we entered into a definitive agreement to acquire privately held Andiamo. The acquisition of Andiamo is expected to close in the third quarter of fiscal 2004, but no later than July 31, 2004.
 
Under the terms of the agreement, our common stock and options will be exchanged for all outstanding shares and options of Andiamo not owned by us at the closing of the acquisition. The amount of the purchase price for the remaining equity interests in Andiamo not then held by us is not determinable at this time, but will be based primarily upon a formula-based valuation of Andiamo to be determined by applying a multiple to the actual, annualized revenue generated from sales by us of products attributable to Andiamo during a three-month period shortly preceding the closing. Under our agreements with Andiamo, we are the exclusive manufacturer and distributor of all Andiamo products. The multiple will be equal to our average market capitalization during a specified period divided by our annualized revenue for a three-month period prior to closing, subject to adjustment as follows: (i) if the multiple so calculated is less than 10, then the multiple to be used for purposes of determining the transaction price shall be the midpoint between 10 and the multiple so calculated; (ii) if the multiple so calculated is greater than 15, then the multiple to be used for purposes of determining the transaction price shall be the midpoint between 15 and the multiple so calculated. There is no minimum purchase price, and the maximum purchase price is limited to approximately $2.5 billion in shares of our common stock valued at the time of closing. As discussed in Note 2 to the Consolidated Financial Statements, the adoption of FIN 46 will require us to account for Andiamo as if we had consolidated it from the date of our initial investment.
 
The acquisition has received the required approvals from both companies and is subject to various closing conditions and approvals, including stockholder approval by Andiamo.
 
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As of April 26, 2003, we have made an $84 million investment in Andiamo in the form of convertible debt, which will be convertible into approximately 44% of the equity in Andiamo, subject to certain terms and conditions. Furthermore, we are also committed to provide additional funding to Andiamo in the form of non-convertible debt through the closing of the acquisition of approximately $100 million, subject to periodic funding. As of April 26, 2003, we have funded $55 million of this additional non-convertible debt. Substantially all of our investment in Andiamo has been expensed as research and development costs, as if such expenses constituted our development costs.
 
Purchase Commitments with Contract Manufacturers and Suppliers     We use several contract manufacturers and suppliers to provide manufacturing services for our products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, we enter into agreements with certain contract manufacturers and suppliers that allow them to procure inventory based upon criteria as defined by us. As of April 26, 2003, we have purchase commitments for inventory of approximately $738 million, compared with $825 million as of July 27, 2002.
 
Other Commitments     In fiscal 2001, we entered into an agreement to invest approximately $1.0 billion in venture funds managed by SOFTBANK Corp. and its affiliates (“SOFTBANK”). These venture funds are required to be funded upon demand by SOFTBANK. As of April 26, 2003, we have funded $209 million of this investment commitment, compared with $100 million as of July 27, 2002.
 
We provide structured financing to certain qualified customers to be used for the purchase of equipment and other needs through our wholly owned subsidiary, Cisco Systems Capital Corporation. As of April 26, 2003, the outstanding loan commitments were approximately $105 million, subject to customers satisfying certain financial covenants, of which approximately $46 million was eligible for draw down. As of July 27, 2002, the outstanding loan commitments were approximately $948 million, of which approximately $209 million was eligible for draw down. These loan commitments may be funded over a two- to three-year period, provided that these customers achieve specific business milestones and satisfy certain financial covenants.
 
We have entered into several agreements to purchase or develop real estate, subject to the satisfaction of certain conditions. As of April 26, 2003, the total amount of commitments, if certain conditions are met, was approximately $70 million, compared with $491 million as of July 27, 2002.
 
As of April 26, 2003, we have a commitment of approximately $130 million to purchase the remaining portion of the minority interest of Cisco Systems, K.K. (Japan), compared with $190 million as of July 27, 2002.
 
We also have certain other funding commitments of approximately $126 million as of April 26, 2003 related to our privately held investments, compared with $152 million as of July 27, 2002.
 
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Stock Repurchase Program
 
In September 2001, the Board of Directors authorized a stock repurchase program to acquire outstanding common stock. Under the program, up to $3 billion of Cisco common stock could be reacquired over two years. In August 2002, the Board of Directors increased Cisco’s stock repurchase program by $5 billion available for repurchase through September 12, 2003. In March 2003, the Board of Directors increased Cisco’s stock repurchase program by an additional $5 billion with no termination date.
 
During the first nine months of fiscal 2003, the Company repurchased and retired 341 million shares of Cisco common stock for an aggregate purchase price of $4.5 billion. As of April 26, 2003, the Company has repurchased and retired 465 million shares of Cisco common stock for an aggregate purchase price of $6.4 billion since inception of the program and the remaining authorized amount for stock repurchases under this program was $6.6 billion. 
 
Liquidity and Capital Resource Requirements
 
Based on past performance and current expectations, we believe that our cash and cash equivalents, short-term investments, and cash generated from operations will satisfy our working capital needs, capital expenditures, investment requirements, stock repurchases, commitments (see Note 6 to the Consolidated Financial Statements), future customer financings, and other liquidity requirements associated with our existing operations through at least the next 12 months. In addition, there are no transactions, arrangements, and other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of our requirements for capital resources.
 
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RISK FACTORS
 
Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report.
 
OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS WHICH MAY ADVERSELY AFFECT OUR STOCK PRICE
 
Our operating results have been in the past, and will continue to be, subject to quarterly and annual fluctuations as a result of a number of factors. These factors include:
 
 	•	 	Fluctuations in demand for our products and services, such as has occurred in the last three years, especially with respect to Internet businesses and telecommunications service providers;	
 
 	•	 	Changes in sales and implementation cycles for our products and the reduced visibility into our customers’ spending plans and associated revenue;	
 
 	•	 	Our ability to maintain appropriate inventory levels and purchase commitments;	
 
 	•	 	Price and product competition in the communications and networking industries which can change rapidly due to technological innovation;	
 
 	•	 	The overall trend toward industry consolidation both among our competitors and our customers;	
 
 	•	 	The introduction and market acceptance of new technologies and products and our success in new markets, as well as the adoption of new networking standards;	
 
 	•	 	Variations in sales channels, product costs, or mix of products sold;	
 
 	•	 	The timing and size of orders from customers;	
 
 	•	 	Manufacturing lead times;	
 
 	•	 	Fluctuations in our gross margins, and the factors that contribute to this as described below;	
 
 	•	 	Our ability to achieve targeted cost reductions;	
 
 	•	 	The ability of our customers, channel partners and suppliers to obtain financing or to fund capital expenditures;	
 
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RISK FACTORS
 
 	•	 	The timing and amount of employer payroll tax to be paid on employees’ gains on stock options exercised;	
 
 	•	 	Actual events, circumstances, outcomes, and amounts differing from judgments, assumptions, and estimates used in determining the values of certain assets (including the amounts of related valuation allowances), liabilities and other items reflected in our financial statements;	
 
 	•	 	How well we execute on our strategy and operating plans; and	
 
 	•	 	Changes in accounting rules, such as recording expenses for employee stock option grants.	
 
As a consequence, operating results for a particular future period are difficult to predict, and therefore, prior results are not necessarily indicative of results to be expected in future periods. Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition which could adversely affect our stock price.
 
OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED BY THE UNCERTAIN GEOPOLITICAL ENVIRONMENT AND UNFAVORABLE ECONOMIC AND MARKET CONDITIONS
 
Adverse economic conditions worldwide have contributed to slowdowns in the communications and networking industries and may continue to impact our business, resulting in:
 
 	•	 	Reduced demand for our products as a result of continued constraints on information technology-related capital spending by our customers, particularly service providers;	
 
 	•	 	Increased price competition for our products, not only from our competitors but also as a consequence of customers disposing of unutilized products;	
 
 	•	 	Increased risk of excess and obsolete inventories;	
 
 	•	 	Excess facilities and manufacturing capacity; and	
 
 	•	 	Higher overhead costs as a percentage of revenues.	
 
Recent turmoil in the geopolitical environment in many parts of the world, including terrorist activities and military actions, particularly the war in Iraq, may continue to put pressure on global economic conditions. If the economic and market conditions in the United States and globally do not improve, or if they deteriorate further, we may continue to experience material
 
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RISK FACTORS
 
adverse impacts on our business, operating results, and financial condition as a consequence of the above factors or otherwise. We do not expect the trend of lower capital spending among service providers to reverse itself in the near term.
 
OUR REVENUES FOR A PARTICULAR PERIOD ARE DIFFICULT TO PREDICT AND A SHORTFALL IN REVENUES MAY HARM OUR OPERATING RESULTS
 
As a result of a variety of factors discussed in this report, our revenues for a particular quarter are difficult to predict. Our net sales may grow at a slower rate than in past periods and, in particular periods, may decline. Our ability to meet financial expectations could also be adversely affected if the nonlinear sales pattern seen in some of our past quarters recurs in future periods. We have experienced periods of time during which shipments exceeded net bookings, leading to nonlinearity in shipping patterns. This can increase costs, as irregular shipment patterns result in periods of underutilized capacity and periods when overtime expenses may be incurred, as well as leading to additional costs arising out of inventory management.
 
In addition, to improve customer satisfaction, we continue to attempt to reduce our manufacturing lead times, which may result in corresponding reductions in order backlog. A decline in backlog levels could result in more variability and less predictability in our quarter-to-quarter net sales and operating results. Long manufacturing lead times have caused our customers in the past to place the same order multiple times within our various sales channels and cancel the duplicative orders when the product is received, or place orders with other vendors with shorter manufacturing lead times. Such multiple ordering (along with other factors) may cause difficulty in predicting our sales, and as a result could impair our ability to manage parts inventory effectively.
 
We plan our operating expense levels based primarily on forecasted revenue levels. These expenses and the impact of long-term commitments are relatively fixed in the short-term. A shortfall in revenue could lead to operating results being below expectations as we may not be able to quickly reduce these fixed expenses in response to short-term business changes.
 
Any of the above factors could have a material adverse impact on our operations and financial results.

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RISK FACTORS
 
WE EXPECT GROSS MARGIN VARIABILITY OVER TIME
 
Although we have experienced increasing product gross margins, our recent level of product gross margins may not be sustainable and may be adversely affected in the future by a number of factors, including but not limited to:
 
 	•	 	Changes in customer, geographic or product mix, including mix of configurations within each product group;	
 
 	•	 	Increases in material or labor costs;	
 
 	•	 	Excess inventory;	
 
 	•	 	Obsolescence charges;	
 
 	•	 	Changes in shipment volume;	
 
 	•	 	Loss of cost savings due to changes in component pricing or charges incurred due to inventory holding periods if parts ordering does not correctly anticipate product demand;	
 
 	•	 	Increased price competition;	
 
 	•	 	Changes in distribution channels;	
 
 	•	 	Increased warranty costs;	
 
 	•	 	How well we execute on our strategy and operating plans; and	
 
 	•	 	Introduction of new products or entering new markets, and different pricing and cost structures of new markets .	
 
Changes in service gross margin may result from various factors such as changes in the mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals.
 
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RISK FACTORS
 
DISRUPTION OF OR CHANGES IN THE MIX OF OUR PRODUCT AND SERVICES DISTRIBUTION MODEL OR CUSTOMER BASE COULD HARM OUR SALES AND MARGINS
 
If we fail to manage distribution of our products and services properly, or if our distributors’ financial condition or operations weaken, our revenues and gross margins could be adversely affected. Furthermore, a change in the mix of our customers between service provider and enterprise, or a change in the mix of direct and indirect sales, could adversely affect our revenues and gross margins.
 
We use a variety of channels to bring our products and services to our end user customers, including system integrators, two-tier distributors and direct sales. System integrators integrate our products and services into an overall network solution that they typically resell to an end user. Two-tier distributors stock inventory and sell to resellers who may themselves be system integrators. Direct sales occur to both enterprise accounts and service providers. A substantial portion of our products and services is distributed through our channel partners and the remainder is distributed through direct sales. If sales through indirect channels increase, this may lead to greater difficulty in forecasting the mix of our products, and to a certain degree, the timing of orders from our customers.
 
Historically, we have seen fluctuations in our gross margins based on changes in the balance of our distribution channels. Although variability to date has not been significant, because each distribution channel has a unique profile, there can be no assurance that changes in the balance of our distribution model in future periods would not have an adverse effect on our gross margins and profitability.
 
For example:
 
 	•	 	As we respond to demand from certain categories of customers to sell directly to them, we could risk alienating channel partners adversely affecting our distribution model.	
 
 	•	 	Because direct sales may compete with the sales made by channel partners, these channel partners may elect to use other suppliers that do not directly sell their own products.	
 
 	•	 	Some of our system integrators may demand that we absorb a greater share of the risks that their customers may ask them to bear, which may affect our gross margin.	
 
 	•	 	Some of our channel partners may have insufficient financial resources and may not be able to withstand changes in business conditions, including the current economic downturn. Revenues from indirect sales could suffer if our distributors’ financial condition or operations weaken.	
 
 	•	 	Service provider customers may demand rigorous acceptance testing or prime contracting. As we develop more “solution” oriented products, enterprise customers may demand similar terms and conditions. Such terms and conditions can lower gross margin and defer revenue recognition.	

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RISK FACTORS
 
OUR INVENTORY MANAGEMENT RELATING TO OUR SALES TO DISTRIBUTORS IS COMPLEX, AND EXCESS FINISHED GOODS MAY HARM OUR GROSS MARGINS
 
We must manage our inventory relating to sales to our distributors effectively. With respect to finished goods, inventory held by our two-tier distributors could affect our results of operations. Distributors may increase orders during periods of product shortages, cancel orders if their inventory is too high, or delay orders in anticipation of new products. Distributors also may adjust their orders in response to the supply of our products and the products of our competitors that are available to the distributor and in response to seasonal fluctuations in end-user demand. If we have excess inventory, we may have to reduce our prices and write down inventory, which in turn could result in lower gross margins. Our two-tier distribution channels, in contrast to our one-tier distributors, are given business terms which allow them to return a portion of inventory and participate in various cooperative marketing programs. We recognize revenue to two-tier distributors based on a sell-through method utilizing information provided by our distributors and we also maintain accruals and allowances for all cooperative marketing and other programs.
 
SALES TO THE SERVICE PROVIDER MARKET ARE ESPECIALLY VOLATILE AND CONTINUED DECLINES OR DELAYS IN SALES ORDERS FROM THIS INDUSTRY MAY HARM OUR OPERATING RESULTS AND FINANCIAL CONDITION
 
Sales to the service provider market have been characterized by large and often sporadic purchases with longer sales cycles. Although we continue to invest in development of new products aimed at this market segment, we have experienced significant decreases in sales to service providers as market conditions have changed. Sales activity in this industry depends upon the stage of completion of expanding network infrastructures, the availability of funding, and the extent that service providers are affected by regulatory, economic, and business conditions in the country of operations. Continued declines or delays in orders from this industry could have a material adverse effect on our business, operating results, and financial condition. The slowdown in the general economy, over-capacity, changes in the service provider market, and the constraints on capital availability have had a material adverse effect on many of our service provider customers, with a number of such customers going out of business or substantially reducing their expansion plans. These conditions have had a material adverse effect on our business and operating results, and we expect that these conditions may continue for the foreseeable future. Finally, service provider customers typically have longer implementation cycles, require a broader range of service including design services, demand that vendors take on a larger share of risks, often require acceptance provisions which can lead to a delay in revenue recognition and expect financing from vendors. All these factors can add further risk to business conducted with service providers. 
 
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RISK FACTORS
 
A SHORTAGE OF ADEQUATE COMPONENT SUPPLY OR MANUFACTURING CAPACITY COULD INCREASE OUR COSTS OR CAUSE A DELAY IN OUR ABILITY TO FULFILL ORDERS AND OUR FAILURE TO ESTIMATE CUSTOMER DEMAND PROPERLY MAY RESULT IN EXCESS OR OBSOLETE COMPONENT SUPPLY THAT COULD ADVERSELY AFFECT OUR GROSS MARGINS
 
Our growth and ability to meet customer demands depend in part on our ability to obtain timely deliveries of parts from our suppliers. We have experienced component shortages in the past that have adversely affected our operations. We may in the future experience a shortage of certain component parts as a result of strong demand in the industry for those parts or problems experienced by suppliers. If shortages or delays persist, the price of these components may increase, or the components may not be available at all. We may not be able to secure enough components at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed. Accordingly, our revenues and gross margins could suffer until other sources can be developed. There can be no assurance that we will not encounter these problems in the future. Although in many cases we use standard parts and components for our products, certain components are presently available only from a single source or limited sources. We may not be able to diversify sources in a timely manner, which could harm our ability to deliver products to customers and seriously impact present and future sales.
 
We believe that we may be faced with the following challenges going forward:
 
•	 	New markets in which we participate may grow quickly, and thus consume significant component capacity;	
 
•	 	As we continue to acquire companies and new technologies, we are dependent, at least initially, on unfamiliar supply chains or relatively small supply partners; and	
 
•	 	We face competition for certain components, which are supply constrained, from existing competitors and companies in other markets.	
 
Manufacturing capacity and component supply constraints could be significant issues for us. We use several contract manufacturers and suppliers to provide manufacturing services for our products. During the normal course of business, in order to reduce manufacturing lead times and ensure adequate component supply, we enter into agreements with certain contract manufacturers and suppliers that allow them to procure inventory based upon criteria as defined by us. If we fail to anticipate customer demand properly, an oversupply of parts could result in excess or obsolete components that could adversely affect our gross margins. For additional information regarding our purchase commitments, see Note 8, “Commitments and Contingencies”, on pages 38 to 40 of our 2002 Annual Report to Shareholders. A reduction or interruption in supply, a significant increase in the price of one or more components, a failure to adequately authorize procurement of inventory by our contract manufacturers, or a decrease in demand of products could materially adversely affect our business, operating results and financial condition and could materially damage customer relationships. Furthermore, as a result of binding price or purchase commitments with suppliers, we may be obligated to purchase components at prices that are higher than those available in the current market. In the event that we become committed to purchase components at prices in excess of the current market price when the components are actually utilized, our gross margins could decrease.
 
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RISK FACTORS
 
The fact that we do not own the bulk of our manufacturing facilities could have an adverse impact on the supply of our products and on operating results. Financial problems of contract manufacturers on whom we rely, or reservation of manufacturing capacity by other companies, inside or outside of our industry, could either limit supply or increase costs.
 
THE MARKETS IN WHICH WE COMPETE ARE INTENSELY COMPETITIVE WHICH COULD ADVERSELY AFFECT OUR REVENUE GROWTH
 
We compete in the networking and communications equipment markets, providing products and services for transporting data, voice, and video traffic across intranets, extranets, and the Internet. These markets are characterized by rapid change, converging technologies, and a migration to networking solutions that offer superior advantages. These market factors represent both an opportunity and a competitive threat to us. We compete with numerous vendors in each product category. The overall number of competitors providing niche product solutions may increase due to the market’s potential for attractive, long-term growth.
 
Our competitors include 3Com, Alcatel, Avaya, Avici, Check Point Software, Ciena, Dell, Ericsson, Enterasys, Extreme Networks, Foundry Networks, Fujitsu, Huawei, Juniper, Lucent, NetScreen, Nokia, Nortel Networks, Redback Networks, Riverstone, Siemens AG, and Sycamore Networks, among others. Some of these companies compete across many of our product lines, while others are primarily focused in a specific product area. Barriers to entry are relatively low, and new ventures to create products that do or could compete with our products are regularly formed. In addition, several of our current and potential competitors may have greater resources, including technical and engineering resources, than we do. In addition, as we expand into new markets, we will face competition not only from our existing competitors but from other companies as well, including existing companies with strong technological, marketing and sales positions in these markets.
 
The principal competitive factors in the markets in which we presently compete and may compete in the future include:
 
 	•	 	The ability to provide a broad range of networking products and services;	
 
 	•	 	Product performance;	
 
 	•	 	Price;	
 
 	•	 	The ability to provide new products;	
 
 	•	 	The ability to provide value-added features such as security, reliability, and investment protection;	
 
 	•	 	Conformance to standards;	

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 	•	 	Market presence; and	
 
 	•	 	The ability to provide financing.	
 
We also face competition from customers to whom we license or supply technology and suppliers from whom we transfer technology. The inherent nature of networking requires interoperability. As such, we must cooperate and at the same time compete with many companies. Our inability to effectively manage these complicated relationships with customers and suppliers could have a material adverse effect on our business, operating results, and financial condition and accordingly affect our chances of success.
 
WE DEPEND UPON THE DEVELOPMENT OF NEW PRODUCTS AND ENHANCEMENTS TO EXISTING PRODUCTS AND IF WE FAIL TO PREDICT AND RESPOND TO EMERGING TECHNOLOGICAL TRENDS AND CUSTOMERS’ CHANGING NEEDS, OUR OPERATING RESULTS AND MARKET SHARE MAY SUFFER
 
The markets for our products are characterized by rapidly changing technology, evolving industry standards, new product introductions, and evolving methods of building and operating networks. Our operating results depend on our ability to develop and introduce new products into existing and emerging markets and to reduce the production costs of existing products. We believe the Internet and other data, voice and video networks are evolving into a “network of networks” which will require common technology platforms and broad end-to-end solutions for particular applications rather than products aimed at particular market segments. In that environment, customers will be more concerned with overall solutions rather than with whether the solution is built around a particular technology, such as routing or switching. The process of developing new technology is complex and uncertain, and if we fail to accurately predict customers’ changing needs and emerging technological trends, our business could be harmed. We must commit significant resources to develop new products before knowing whether our investments will result in products the market will accept. In particular, if the “network of networks” model does not emerge as we believe it will, many of our investments may prove to be without value. Furthermore, we may not execute successfully on that vision because of errors in product planning or timing, technical hurdles which we fail to overcome in a timely fashion, or because of a lack of appropriate resources. This could result in competitors providing those solutions before we do, and loss of market share, revenues and earnings. The success of new products is dependent on several factors, including proper new product definition, component costs, timely completion and introduction of these products, differentiation of new products from those of our competitors, and market acceptance of these products. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, and achieve market acceptance of our products, or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.
 
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RISK FACTORS
 
OUR BUSINESS SUBSTANTIALLY DEPENDS UPON THE CONTINUED GROWTH OF THE INTERNET AND INTERNET-BASED SYSTEMS; CHANGES IN INDUSTRY STRUCTURE AND MARKET CONDITIONS COULD LEAD TO DISCONTINUANCES OF CERTAIN OF OUR PRODUCTS OR BUSINESSES
 
A substantial portion of our business and revenue depends on growth of the Internet and on the deployment of our products by customers that depend on the continued growth of the Internet. As a result of the current economic slowdown and reduction in capital spending, which have particularly affected telecommunications service providers, spending on Internet infrastructure has declined, which has had a material adverse effect on our business. To the extent that the economic slowdown and reduction in capital spending continue to adversely affect spending on Internet infrastructure, we could continue to experience material adverse effects on our business, operating results, and financial condition.
 
Because of the rapid introduction of new products, and changing customer requirements related to matters such as cost-effectiveness and security, we believe that there could be certain performance problems with Internet communications in the future, which could receive a high degree of publicity and visibility. As we are a large supplier of networking products, our business, operating results, and financial condition may be materially adversely affected, regardless of whether or not these problems are due to the performance of our own products. Such an event could also result in a material adverse effect on the market price of our common stock independent of direct effects on our business.
 
In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses. Any decision to limit investment in or to dispose of or otherwise, exit businesses may result in the recording of special charges, such as inventory and technology related write-off, workforce reduction costs, charges relating to consolidation of excess facilities, or claims from third parties who were resellers or users of discontinued products. Our estimates with respect to the useful life or ultimate recoverability of our carrying basis of assets, including purchased intangible assets, could change as a result of such assessments and decisions. Further, our estimates relating to the liabilities for excess facilities are affected by changes in real estate market conditions. Additionally, we are required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.
 
WE HAVE MADE AND EXPECT TO CONTINUE TO MAKE ACQUISITIONS WHICH COULD DISRUPT OUR OPERATIONS AND HARM OUR OPERATING RESULTS
 
Our growth is dependent upon market growth, our ability to enhance our existing products, and our ability to introduce new products on a timely basis. We intend to continue to address the need to develop new products and enhance existing products through acquisitions of other companies, product lines, technologies and personnel. Acquisitions involve numerous risks, including the following:
 
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 	•	 	Difficulties in integrating the operations, technologies, products and personnel of the acquired companies;	
 
 	•	 	Diversion of management’s attention from normal daily operations of the business;	
 
 	•	 	Potential difficulties in completing projects associated with in-process research and development;	
 
 	•	 	Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;	
 
 	•	 	Initial dependence on unfamiliar supply chains or relatively small supply partners;	
 
 	•	 	Insufficient revenues to offset increased expenses associated with acquisitions; and	
 
 	•	 	The potential loss of key employees of the acquired companies.	
 
Acquisitions may also cause us to:
 
 	•	 	Issue common stock that would dilute our current shareholders’ percentage ownership;	
 
 	•	 	Assume liabilities;	
 
 	•	 	Record goodwill and non-amortizable intangible assets that will be subject to impairment testing on a regular basis and potential periodic impairment charges;	
 
 	•	 	Incur amortization expenses related to certain intangible assets;	
 
 	•	 	Incur large and immediate write-offs, and restructuring and other related expenses; or	
 
 	•	 	Become subject to litigation.	
 
Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions we make could harm our business and operating results in a material way. Prior acquisitions have resulted in a wide range of outcomes, from successful introduction of new products and technologies to an inability to do so. Even when an acquired
 
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company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that preacquisition due diligence will have identified all possible issues that might arise with respect to such products.
 
From time to time, we have made acquisitions that result in in-process research and development expenses being charged in an individual quarter. These charges may occur in any particular quarter resulting in variability in our quarterly earnings.
 
See also the discussion of risks related to new product development, which also applies to acquisitions, above under the risk factor entitled, “We depend upon the development of new products and enhancements to existing products and if we fail to predict and respond to emerging technological trends and customers’ changing needs, our operating results and market share may suffer.”
 
ENTRANCE INTO NEW OR DEVELOPING MARKETS EXPOSES US TO ADDITIONAL COMPETITION AND WILL LIKELY INCREASE DEMANDS ON OUR SERVICE AND SUPPORT OPERATIONS
 
As we focus on new market opportunities, such as storage, wireless, security, transporting data, voice, and video traffic across the same network, we will increasingly compete with large telecommunications equipment suppliers as well as startup companies. Several of our current and potential competitors may have greater resources, including technical and engineering resources, than we do. Additionally, as customers in these markets complete infrastructure deployments, they may require greater levels of service, support, and financing than we have provided in the past. Demand for these types of service or financing contracts may increase in the future. There can be no assurance that we can provide products, service, support, and financing to effectively compete for these market opportunities. Further, provision of greater levels of services by us may result in a delay in the timing of revenue recognition. In addition, if we successfully move into other markets, such as the consumer market, we will be subject to additional risks associated with that market, including the effects of general market conditions and reduced consumer confidence.
 
PRODUCT QUALITY PROBLEMS COULD LEAD TO REDUCED REVENUES AND GROSS MARGINS
 
We produce highly complex products that incorporate leading-edge technology, including both hardware and software. Software typically contains “bugs” which can unexpectedly interfere with expected operations. There can be no assurance that our pre-shipment testing programs will be adequate to detect all defects—either in individual products or which could affect numerous shipments—which might interfere with customer satisfaction, reduce sales opportunities, or affect gross margins if the cost of remedying the problems exceeded reserves established for that purpose. In the past, we have had to recall certain components. While the cost of such recalls was not material, there can be no assurance that such a recall, depending on the product involved, would not have a material impact. An inability to cure a product defect could result in the failure
 
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of a product line, temporary or permanent withdrawal from a product or market segment, damage to our reputation, inventory costs, product reengineering expenses, and a material impact on revenues and margins.
 
INDUSTRY CONSOLIDATION MAY LEAD TO INCREASED COMPETITION AND MAY HARM OUR OPERATING RESULTS
 
There has been a trend toward industry consolidation in our markets for several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in operating results and could have a material adverse effect on our business, operating results, and financial condition. Furthermore, particularly in the service provider market, rapid consolidation will lead to fewer customers, with the effect that loss of a major customer could have a material impact on results not anticipated in a customer marketplace comprised of more numerous participants.
 
DUE TO THE GLOBAL NATURE OF OUR OPERATIONS, POLITICAL OR ECONOMIC CHANGES, OR OTHER FACTORS, IN A SPECIFIC COUNTRY OR REGION COULD HARM OUR COSTS, EXPENSES AND FINANCIAL CONDITION
 
We conduct significant sales and customer support operations in countries outside of the United States and also depend on non-U.S. operations of our contract manufacturers and our distribution partners. For fiscal 2002 and the first nine months of fiscal 2003, we derived 46% and 49.3% of our revenues, respectively, from sales outside the United States. Accordingly, our future results could be materially adversely affected by a variety of uncontrollable and changing factors including, among others, foreign currency exchange rates; political or social unrest or economic instability in a specific country or region; trade protection measures and other regulatory requirements which may affect our ability to import or export our products from various countries; political considerations that affect service provider and government spending patterns; difficulties in staffing and managing international operations; and adverse tax consequences, including imposition of withholding or other taxes on payments by subsidiaries. In addition, the outbreak of Severe Acute Respiratory Syndrome (SARS) could have an adverse impact on our operations in Asia. If there is a significant spread of SARS beyond Asia, other aspects of our operations could be negatively impacted. Any or all of these factors could have a material adverse impact on our costs, expenses and financial condition.
 
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RISK FACTORS
 
WE ARE EXPOSED TO FLUCTUATIONS IN CURRENCY EXCHANGE RATES WHICH COULD NEGATIVELY IMPACT OUR FINANCIAL RESULTS AND CASH FLOWS
 
Because a significant portion of our business is conducted outside the United States, we face exposure to adverse movements in non-U.S. currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results and cash flows. Historically, our primary exposures have related to non-dollar-denominated sales in Japan, Canada, and Australia, and certain non-dollar-denominated operating expenses in Europe, Latin America, and Asia, where we sell primarily in U.S. dollars. Additionally, we have exposures to emerging market currencies, which can have extreme currency volatility. An increase in the value of the dollar could increase the real cost to our customers of our products in those markets outside the United States where we sell in dollars, and a weakened dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we must purchase components in foreign currencies.
 
Currently, we hedge only those currency exposures associated with certain assets and liabilities denominated in nonfunctional currencies and periodically will hedge anticipated foreign currency cash flows. The hedging activities undertaken by us are intended to offset the impact of currency fluctuations on certain nonfunctional currency assets and liabilities. Our attempts to hedge against these risks may not be successful resulting in an adverse impact on our net income.
 
WE ARE EXPOSED TO THE CREDIT RISK OF SOME OF OUR CUSTOMERS AND TO CREDIT EXPOSURES IN WEAKENED MARKETS WHICH COULD RESULT IN MATERIAL LOSSES
 
Most of our sales are on an “open credit” basis, with typical payment terms of 30 days in the United States, and, because of local customs or conditions, longer in some markets outside the United States. We monitor individual customer payment capability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts. Beyond our open credit arrangements, we have also experienced demands for customer financing and facilitation of leasing arrangements. We expect demand for customer financing to continue. We believe customer financing is a competitive factor in obtaining business, particularly in supplying customers involved in significant infrastructure projects. Our loan financing arrangements may include not only financing the acquisition of our products and services but also providing additional funds for other costs associated with network installation and integration of our products and services and for working capital purposes. We do not recognize revenue on such loan financing arrangements until cash payments are received.
 
Because of the current slowdown in the global economy, our exposure to the credit risks relating to our financing activities described above has increased. Although we have programs in place that are designed to monitor and mitigate the associated risk, including monitoring of particular risks in certain geographic areas, there can be no assurance that such programs will be effective in reducing our credit risks. There have been significant bankruptcies among customers both on
 
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open credit and with loan or lease financing arrangements, particularly among Internet businesses and service providers, causing us to incur economic or financial losses. There can be no assurance that additional losses will not be incurred. Although these losses have not been material to date, future losses, if incurred, could harm our business and have a material adverse effect on our operating results and financial condition.
 
A portion of our sales is derived through our resellers in two-tier distribution channels. These resellers/customers are generally given business terms which allow them to return a portion of inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. We maintain estimated accruals and allowances for such exposures. However, such resellers tend to have more limited financial resources than other resellers and end-user customers and therefore, represent potential sources of increased credit risk because they may be more likely to lack the reserve resources to meet payment obligations.
 
OUR BUSINESS DEPENDS UPON OUR PROPRIETARY RIGHTS, WHICH MIGHT PROVE DIFFICULT TO ENFORCE, AND THERE IS A RISK OUR PRODUCTS COULD BE HELD TO INFRINGE RIGHTS OF THIRD PARTIES
 
We generally rely on patents, copyrights, trademarks, and trade secret laws to establish and maintain proprietary rights in our technology and products. While we have been issued a number of patents and other patent applications are currently pending, there can be no assurance that any of these patents will not be challenged, invalidated, or circumvented, or that any rights granted under these patents will in fact provide competitive advantages to us. Furthermore, many key aspects of networking technology are governed by industry-wide standards which are usable by all market entrants, often with little or no royalty owed in connection with the use of the standards. In addition, there can be no assurance that patents will be issued from pending applications, or that claims allowed on any future patents will be sufficiently broad to protect our technology. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as do the laws of the United States. The outcome of any actions taken in these foreign countries may be different than if such actions were determined under the laws of the United States. While we are not dependent on any individual patents or group of patents for particular segments of the business for which we compete, if we are unable to protect our proprietary rights to the totality of the features (including aspects of products protected other than by patent rights), in a market we may find ourselves at a competitive disadvantage to others who do not have to incur the substantial expense, time and effort required to create the innovative products which have enabled us to be successful.
 
From time to time, third parties have asserted 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. Because of the existence of a large number of patents in the networking field, the secrecy of some pending patents and the rapid rate of issuance of new patents, it is not economically practical nor even possible to determine in advance whether a product or any of its components infringe or will infringe the patent rights of others. Third parties, including customers, have asserted claims and/or initiated litigation, and
 
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may in the future assert claims or initiate litigation, against us or our manufacturers, suppliers, or customers, alleging infringement of their proprietary rights with respect to our existing or future products or components of those products. Regardless of the merit of these claims, they can be time-consuming, result in costly litigation and diversion of technical and management personnel, or require us to develop a non-infringing technology or enter into license agreements; where claims are made by customers, resistance even to unmeritorious claims could damage customer relationships. There can be no assurance that licenses will be available on acceptable terms and conditions, if at all, in all such circumstances, or that our indemnification by their suppliers will be adequate to cover their costs if a claim were brought directly against us or our customers. If any infringement or other intellectual property claim made against us by any third party is successful, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable terms and conditions, our business, operating results and financial condition could be materially and adversely affected.
 
Many of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse effect on our business, operating results, and financial condition. Moreover, the inclusion in our products of software or other intellectual property licensed from third parties on a non-exclusive basis could limit our ability to protect our proprietary rights in our products.
 
OUR OPERATING RESULTS AND FUTURE PROSPECTS COULD BE MATERIALLY HARMED BY UNCERTAINTIES OF REGULATION OF THE INTERNET
 
Currently, few laws or regulations apply directly to access or commerce on the Internet. We could be materially adversely affected by regulation of the Internet and Internet commerce in any country where we operate. Such regulations could include matters such as voice over the Internet or using Internet Protocol, encryption technology, and access charges for Internet service providers. The adoption of regulation of the Internet and Internet commerce could decrease demand for our products, and at the same time increase the cost of selling our products, which could have a material adverse effect on our business, operating results, and financial condition.
 
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OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO RETAIN AND RECRUIT KEY PERSONNEL AND ANY FAILURE TO DO SO WOULD HARM OUR ABILITY TO MEET KEY OBJECTIVES
 
Our success has always depended in large part on our ability to attract and retain highly skilled technical, managerial, sales, and marketing personnel. In spite of the economic slowdown, competition for these personnel is intense, especially in the Silicon Valley area of Northern California. Volatility or lack of positive performance in our stock price may also adversely affect our ability to retain key employees, all of whom have been granted stock options. The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future, or delays in hiring required personnel, particularly engineering and sales personnel, could make it difficult to meet key objectives, such as timely and effective product introductions. In addition, companies in the networking industry whose employees accept positions with competitors frequently claim that competitors have engaged in improper hiring practices. We have received these claims in the past and may receive additional claims to this effect in the future.
 
ADVERSE RESOLUTION OF LITIGATION MAY HARM OUR OPERATING RESULTS OR FINANCIAL CONDITION
 
We are a party to lawsuits in the normal course of our business. Litigation can be expensive, lengthy, and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results, or financial condition. For additional information regarding certain of the lawsuits in which we are involved, see Item 1, “Legal Proceedings,” contained in Part II of this report. 
 
CHANGES IN EFFECTIVE TAX RATES OR ADVERSE OUTCOMES RESULTING FROM EXAMINATION OF OUR INCOME TAX RETURNS COULD ADVERSELY AFFECT OUR RESULTS
 
Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates, changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws or interpretations thereof. 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 effect on our operating results and financial condition.
 
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RISK FACTORS
 
OUR BUSINESS AND OPERATIONS ARE ESPECIALLY SUBJECT TO THE RISKS OF EARTHQUAKES, FLOODS, AND OTHER NATURAL CATASTROPHIC EVENTS
 
Our corporate headquarters, including certain of our research and development operations and our manufacturing facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. Additionally, certain of our facilities, which include one of our manufacturing facilities, are located near rivers that have experienced flooding in the past. A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition.
 
MANMADE PROBLEMS SUCH AS COMPUTER VIRUSES OR TERRORISM MAY DISRUPT OUR OPERATIONS AND HARM OUR OPERATING RESULTS
 
Despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results, and financial condition. In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results, and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.
 
WE ARE EXPOSED TO FLUCTUATIONS IN THE MARKET VALUES OF OUR PORTFOLIO INVESTMENTS AND IN INTEREST RATES; IMPAIRMENT OF OUR INVESTMENTS COULD HARM OUR EARNINGS
 
We maintain an investment portfolio of various holdings, types, and maturities. These securities are generally classified as available for sale and, consequently, are recorded on the Consolidated Balance Sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Part of this portfolio includes equity investments in several publicly traded companies, the values of which are subject to market price volatility. The current economic downturn and other factors have adversely affected the public equities market, and general economic conditions may continue to worsen. As a result, we may recognize in earnings the decline in fair value of our publicly traded equity investments below the cost basis when the decline is judged to be other-than-temporary. For information regarding the sensitivity of and risks associated with the market value of portfolio investments and interest rates, refer to the section titled “Quantitative and Qualitative Disclosures About Market Risk” included in this report and in our Annual Report on Form 10-K, as amended, for the fiscal year ended July 27, 2002. Furthermore, our equity investments in both publicly traded companies and private companies are subject to risk of loss of investment capital. These investments are inherently risky as the market for the technologies or products they have under development are
 
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typically in the early stages and may never materialize. We could lose our entire investment in these companies.
 
IF WE DO NOT SUCCESSFULLY MANAGE OUR STRATEGIC ALLIANCES WE MAY EXPERIENCE INCREASED COMPETITION OR DELAYS IN PRODUCT DEVELOPMENT
 
We have several strategic alliances with large and complex organizations and other companies with whom we work to offer complementary products and services. These arrangements are generally limited to specific projects, the goal of which is generally to facilitate product compatibility and adoption of industry standards. If successful, these relationships may be mutually beneficial and result in industry growth. However, these alliances carry an element of risk because, in most cases, we must compete in some business areas with a company with which we have a strategic alliance and, at the same time, cooperate with that company in other business areas. Also, if these companies fail to perform or if these relationships fail to materialize as expected, we could suffer delays in product development or other operational difficulties.
 
CHANGES IN TELECOMMUNICATIONS REGULATION AND TARIFFS COULD HARM OUR PROSPECTS AND FUTURE SALES
 
Changes in telecommunications requirements in the United States or other countries could affect the sales of our products. In particular, we believe it is possible that there may be changes in U.S. telecommunications regulations in the future that could slow the expansion of the service providers’ network infrastructures and materially adversely affect our business, operating results, and financial condition. Future changes in tariffs by regulatory agencies or application of tariff requirements to currently untariffed services could affect the sales of our products for certain classes of customers. Additionally, in the United States, our products must comply with various Federal Communications Commission requirements and regulations. In countries outside of the United States, our products must meet various requirements of local telecommunications authorities. Changes in tariffs or failure by us to obtain timely approval of products could have a material adverse effect on our business, operating results, and financial condition.
 
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OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE
 
Our common stock has experienced substantial price volatility, particularly as a result of variations between our actual financial results and the published expectations of analysts, and as a result of announcements by our competitors and us. Furthermore, speculation in the press or investment community about our strategic position, financial condition, results of operations, business or significant transactions can cause changes in our stock price. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies, in particular, and that have often been unrelated to the operating performance of these companies. These factors, as well as general economic and political conditions, may materially adversely affect the market price of our common stock in the future. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom have been granted stock options.

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 Item 3.    Quantitative and Qualitative Disclosures About Market Risk
 
We maintain an investment portfolio of various holdings, types, and maturities. These securities are generally classified as available for sale and, consequently, are recorded on the Consolidated Balance Sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Part of this portfolio includes equity investments in several publicly traded companies, the values of which are subject to market price volatility. During the first nine months of fiscal 2003 and 2002, we recognized a charge of $412 million and $858 million, pre-tax, respectively, attributable to the impairment of certain publicly traded equity securities (see Note 7 to the Consolidated Financial Statements). The impairment charges were related to the decline in the fair value of certain publicly traded equity investments below their cost basis that were judged to be other-than-temporary.
 
At any time, a sharp rise in interest rates could have a material adverse impact on the fair value of our investment portfolio. Conversely, declines in interest rates could have a material impact on interest earnings for our investment portfolio. We do not currently hedge these interest rate exposures.
 
We have also invested in several privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose our entire initial investment in these companies.
 
Readers are referred to pages 23 to 24 of the fiscal 2002 Annual Report to Shareholders for a more detailed discussion of quantitative and qualitative disclosures about market risk. The following analysis presents the hypothetical changes in fair value of public equity investments that are sensitive to changes in the stock market (in millions):
 
 	  	Valuation of Securities
Given X% Decrease
in Each Stock’s Price
	    	Fair Value as of
April 26, 2003
	  	Valuation of Securities
Given X% Increase
in Each Stock’s Price
	
 	  	(75%)
	  	(50%)
	  	(25%)
	    		  	25%
	  	50%
	  	75%
	
Corporate equities	  	$	139	  	$	277	  	$	416	    	$	554	  	$	693	  	$	831	  	$	970	
 
Our equity portfolio consists of securities with characteristics that most closely match the S&P Index or companies traded on the Nasdaq National Market. These equity securities are held for purposes other than trading. The modeling technique used measures the hypothetical change in fair values arising from selected hypothetical changes in each stock’s price. Stock price fluctuations of plus or minus 25%, 50%, and 75% were selected based on the probability of their occurrence and are representative of the historical movements in the Nasdaq Composite Index.
 
Our evaluation of equity investments in private and public companies is based on the fundamentals of the business, including among other factors, the nature of their technologies, and potential for financial return to us.
 
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 Item 4.    Controls and Procedures
 
 	a.	 	Evaluation of disclosure controls and procedures . Based on their evaluation as of a date within 90 days of the filing date of this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.	
 
 	b.	 	Changes in internal controls . There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.	
 
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 PART II.    OTHER INFORMATION
 
 Item 1.    Legal Proceedings
 
Beginning on April 20, 2001, a number of purported shareholder class action lawsuits were filed in the United States District Court for the Northern District of California against us and certain of our officers and directors. The lawsuits have been consolidated, and the consolidated action is purportedly brought on behalf of those who purchased our publicly traded securities between August 10, 1999 and February 6, 2001. Plaintiffs allege that defendants have made false and misleading statements, purport to assert claims for violations of the federal securities laws, and seek unspecified compensatory damages and other relief. We believe the claims are without merit and intend to defend the actions vigorously.
 
In addition, beginning on April 23, 2001, a number of purported shareholder derivative lawsuits were filed in the Superior Court of California, County of Santa Clara and in the Superior Court of California, County of San Mateo. There is a procedure in place for the coordination of such actions. Two purported derivative suits have also been filed in the United States District Court for the Northern District of California, and those federal court actions have been consolidated. The consolidated federal court derivative action was dismissed by the court, and plaintiffs have appealed from that decision. The complaints in the various derivative actions include claims for breach of fiduciary duty, waste of corporate assets, mismanagement, unjust enrichment, and violations of the California Corporations Code; seek compensatory and other damages, disgorgement, and other relief; and are based on essentially the same allegations as the class actions.
 
In addition, we are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
 
 Item 2.    Changes in Securities and Use of Proceeds
 
On April 9, 2003, we issued an aggregate of 9,144,291 shares of our common stock in connection with the acquisition of Okena, Inc. The offer and sale of the securities were effected without registration in reliance on the exemption afforded by Section 3(a)(10) of the Securities Act of 1933, as amended. The issuance was approved, after a hearing upon the fairness of the terms and conditions of the transaction, by the California Department of Corporations under authority to grant such approval as expressly authorized by the laws of the State of California.
 
 Item 3.    Defaults Upon Senior Securities
 
None 
 
 Item 4.    Submission of Matters to a Vote of Security Holders
 
None 
 
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 Item 5.    Other Information
 
On May 7, 2003, we completed our acquisition of privately-held SignalWorks, Inc. of Mountain View, California.
 
On May 14, 2003, we announced that Dennis Powell has been appointed our Chief Financial Officer, effective May 13, 2003. Dennis Powell was previously Senior Vice President of Corporate Finance and succeeds Larry Carter who retired after serving over eight years as our Chief Financial Officer. Larry Carter will remain on our Board of Directors and continue as a Senior Vice President advising us on special topics. In addition, Mark Chandler, Vice President, Legal Services and General Counsel, has been appointed our Secretary, effective May 13, 2003. Dennis Powell and Mark Chandler have also been named executive officers of the Company within the meaning of Rule 3b-7 under the Securities Exchange Act of 1934, as amended.
 
 Item 6.    Exhibits and Reports on Form 8-K
 
(a)	 	Exhibits	
 
The following documents are filed as Exhibits to this report:

10.2	  	Cisco Systems, Inc. Amended and Restated 1996 Stock Incentive Plan
(including related agreements)	
		
99.1	  	Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	
		
99.2	  	Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	
 
(b)	 	Reports on Form 8-K	
 
We filed or furnished five reports on Form 8-K during the quarter ended April 26, 2003. Information regarding each item reported on is as follows:
 
Date Filed or Furnished
	  	Item No.
	  	Description
	
January 28, 2003	  	Item 5	  	On January 24, 2003, we announced the signing of a definitive agreement to acquire Okena, Inc.	
		
February 4, 2003	  	Item 9	  	On February 4, 2003, we announced our second quarter results for the period ended January 25, 2003.	
		
March 20, 2003	  	Item 5	  	On March 19, 2003, we announced the signing of a definitive agreement to acquire SignalWorks, Inc. and on March 20, 2003, we announced the signing of a definitive agreement to acquire the business of The Linksys Group, Inc.	
 
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April 11, 2003	  	Item 9	  	On April 11, 2003, we announced that on April 10, 2003, the Compensation and Management Development Committee of the Board of Directors approved the granting of merit-based stock options to eligible employees to purchase an aggregate of approximately 75 million shares of our common stock at an exercise price of $13.04 per share.	
		
April 17, 2003	  	Item 5	  	On April 11, 2003, we announced the completion of our acquisition of Okena, Inc.	
 
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 SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 	 	 	 	Cisco Systems, Inc.	
		
Date: May 14, 2003	 	 	 	By	 	         /s/    Dennis D. Powell    	
		
 	 	 	 	Dennis D. Powell, Senior Vice President
and Chief Financial Officer	
 
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CHIEF EXECUTIVE OFFICER CERTIFICATION

I, John T. Chambers, President and Chief Executive Officer of Cisco Systems, Inc., certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Cisco Systems, Inc.;
 
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
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6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 14, 2003

/s/    John T. Chambers    
 
John T. Chambers
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
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CHIEF FINANCIAL OFFICER CERTIFICATION
 
I, Dennis D. Powell, Senior Vice President and Chief Financial Officer of Cisco Systems, Inc., certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Cisco Systems, Inc.;
 
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
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6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 14, 2003

/s/    Dennis D. Powell    

Dennis D. Powell
 
Senior Vice President and Chief Financial Officer
 
(Principal Financial Officer)
 
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EXHIBIT INDEX
 
EXHIBIT NO.
	  	 	
10.2	  	Cisco Systems, Inc. Amended and Restated 1996 Stock Incentive Plan (including related agreements)	
99.1	  	Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	
99.2	  	Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	
 
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Exhibit 10.2
 
CISCO SYSTEMS, INC.
1996 STOCK INCENTIVE PLAN
 
As Amended and Restated Effective March 18, 2003
 
ARTICLE ONE
 
GENERAL PROVISIONS
 
 	I.	 	PURPOSE OF THE PLAN	
 
This 1996 Stock Incentive Plan is intended to promote the interests of Cisco Systems, Inc., a California corporation, by providing eligible persons with the opportunity to acquire a proprietary interest, or otherwise increase their proprietary interest, in the Corporation as an incentive for them to remain in the service of the Corporation.
 
Capitalized terms shall have the meanings assigned to such terms in the attached Appendix.
 
All share numbers in this March 18, 2003 restatement reflect all splits of the Common Stock effected through March 22, 2000, including (i) the three (3)-for-two (2) split of Common Stock effected on December 16, 1997, (ii) the three (3)-for-two (2) split of Common Stock effected on September 15, 1998, (iii) the two (2)-for-one (1) split of Common Stock effected on June 21, 1999, and (iv) the two (2)-for-one (1) split of Common Stock effected on March 22, 2000.
 
 	II.	 	STRUCTURE OF THE PLAN	
 
A.    The Plan shall be divided into three separate equity programs:
 
(i)    the Discretionary Option Grant Program under which eligible persons may, at the discretion of the Plan Administrator, be granted options to purchase shares of Common Stock,
 
(ii)    the Automatic Option Grant Program under which eligible non-employee Board members shall automatically receive option grants at periodic intervals to purchase shares of Common Stock, and
 
(iii)    the Stock Issuance Program under which eligible persons may, at the discretion of the Plan Administrator, be issued shares of Common Stock directly, either through the immediate purchase of such shares or as a bonus for services rendered the Corporation (or any Parent or Subsidiary) or the attainment of designated performance goals.

 
B.    The provisions of Articles One and Five shall apply to all equity programs under the Plan and shall govern the interests of all persons under the Plan.
 
 	III.	 	ADMINISTRATION OF THE PLAN	
 
A.    The Primary Committee shall have sole and exclusive authority to administer the Discretionary Option Grant Program with respect to Section 16 Insiders.
 
B.    Administration of the Discretionary Option Grant Program with respect to all other persons eligible to participate in that program may, at the Board’s discretion, be vested in the Primary Committee or a Secondary Committee, or the Board may retain the power to administer that program with respect to all such persons. The members of the Secondary Committee may be Board members who are Employees eligible to receive discretionary option grants under the Plan or any other stock option, stock appreciation, stock bonus or other stock plan of the Corporation (or any Parent or Subsidiary). Administration of the Stock Issuance Program shall be vested in the Primary Committee, except to the extent the Board delegates administrative authority under the Stock Issuance Program to a Secondary Committee or retains such authority for itself.
 
C.    Members of the Primary Committee or any Secondary Committee shall serve for such period of time as the Board may determine and may be removed by the Board at any time. The Board may also at any time terminate the functions of any Secondary Committee and reassume all powers and authority previously delegated to such committee.
 
D.    Each Plan Administrator shall, within the scope of its administrative functions under the Plan, have full power and authority (subject to the provisions of the Plan) to establish such rules and regulations as it may deem appropriate for proper administration of the Discretionary Option Grant and Stock Issuance Programs and to make such determinations under, and issue such interpretations of, the provisions of such programs and any outstanding options or stock issuances thereunder as it may deem necessary or advisable. Decisions of the Plan Administrator within the scope of its administrative functions under the Plan shall be final and binding on all parties who have an interest in the Discretionary Option Grant or Stock Issuance Program under its jurisdiction or any option or stock issuance thereunder.
 
E.    Service on the Primary Committee or the Secondary Committee shall constitute service as a Board member, and members of each such committee shall accordingly be entitled to full indemnification and reimbursement as Board members for their service on such committee. No member of the Primary Committee or the Secondary Committee shall be liable for any act or omission made in good faith with respect to the Plan or any option grants under the Plan.
 
F.    Administration of the Automatic Option Grant Program shall be self-executing in accordance with the terms of that program, and no Plan Administrator shall exercise any discretionary functions with respect to any option grants made under that program.
 
2.

 
 	IV.	 	ELIGIBILITY	
 
A.    The persons eligible to participate in the Discretionary Option Grant Program are as follows:
 
(i)    Employees,
 
(ii)    non-employee members of the Board or the board of directors of any Parent or Subsidiary, and
 
(iii)    consultants and other independent advisors who provide services to the Corporation (or any Parent or Subsidiary).
 
B.    The persons eligible to participate in the Stock Issuance Program shall be limited to those individuals who render services to the Corporation (or any Parent or Subsidiary) in the capacity of independent, non-employee consultants and who are not otherwise Section 16 Insiders at the time of issuance.
 
C.    Each Plan Administrator shall, within the scope of its administrative jurisdiction under the Plan, have full authority to determine (i) with respect to the Discretionary Option Grant Program, which eligible persons are to receive option grants, the time or times when such option grants are to be made, the number of shares to be covered by each such grant, the status of the granted option as either an Incentive Option or a Non-Statutory Option, the time or times when each option is to become exercisable, the vesting schedule (if any) applicable to the option shares and the maximum term for which the option is to remain outstanding and (ii) with respect to stock issuances under the Stock Issuance Program, which eligible persons are to receive stock issuances, the time or times when such issuances are to be made, the number of shares to be issued to each Participant, the vesting schedule (if any) applicable to the issued shares and the consideration for such shares.
 
D.    The individuals who shall be eligible to participate in the Automatic Option Grant Program shall be limited to (i) those individuals serving as non-employee Board members on the Plan Effective Date, (ii) those individuals who first become non-employee Board members on or after the Plan Effective Date, whether through appointment by the Board or election by the Corporation’s shareholders, and (iii) those individuals who continue to serve as non-employee Board members at one or more Annual Shareholders Meetings held after the Plan Effective Date. A non-employee Board member who has previously been in the employ of the Corporation (or any Parent or Subsidiary) shall not be eligible to receive an option grant under the Automatic Option Grant Program at the time he or she first becomes a non-employee Board member, but shall be eligible to receive periodic option grants under the Automatic Option Grant Program while he or she continues to serve as a non-employee Board member. 
 
3.

 
 	V.	 	STOCK SUBJECT TO THE PLAN	
 
A.    The stock issuable under the Plan shall be shares of authorized but unissued or reacquired Common Stock, including shares repurchased by the Corporation on the open market. The maximum number of shares of Common Stock reserved for issuance over the term of the Plan shall not exceed 2,504,006,600 shares, subject to the automatic share increases described in Paragraph V.B. below. Such share reserve consists of the number of shares of Common Stock transferred from the Predecessor Plan, as of the Plan Effective Date (619,524,900), plus the number of shares added to the reserve pursuant to the automatic share increases effected in December 1996, December 1997, December 1998, December 1999, December 2000 and December 2001 (1,884,481,700 shares in the aggregate).
 
B.    The number of shares of Common Stock available for issuance under the Plan shall automatically increase on the first trading day of fiscal December each calendar year, beginning with fiscal December in calendar year 1996 and continuing through fiscal December in calendar year 2001, by a number of shares equal to four and three-quarters percent (4.75%) of the total number of shares of Common Stock outstanding on the last trading day in the immediately preceding fiscal November, but in no event shall any such annual increase exceed 480,000,000 shares.
 
C.    No one person participating in the Plan may receive stock options, separately exercisable stock appreciation rights or direct stock issuances for more than 18,000,000 shares of Common Stock in the aggregate per calendar year.
 
D.    Shares of Common Stock subject to outstanding options (including options incorporated into this Plan from the Predecessor Plan) shall be available for subsequent issuance under the Plan to the extent those options expire or terminate for any reason prior to exercise in full. Unvested shares issued under the Plan and subsequently cancelled or repurchased by the Corporation, at the original issue price paid per share, pursuant to the Corporation’s repurchase rights under the Plan shall be added back to the number of shares of Common Stock reserved for issuance under the Plan and shall accordingly be available for reissuance through one or more subsequent option grants under the Plan. However, should the exercise price of an option under the Plan be paid with shares of Common Stock or should shares of Common Stock otherwise issuable under the Plan be withheld by the Corporation in satisfaction of the withholding taxes incurred in connection with the exercise of an option or the vesting of a stock issuance under the Plan, then the number of shares of Common Stock available for issuance under the Plan shall be reduced by the gross number of shares for which the option is exercised or which vest under the stock issuance, and not by the net number of shares of Common Stock issued to the holder of such option or stock issuance. Shares of Common Stock underlying one or more stock appreciation rights exercised under Section IV of Article Two of the Plan shall not be available for subsequent issuance under the Plan.
 
E.    If any change is made to the Common Stock by reason of any stock split, stock dividend, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation’s receipt of consideration, appropriate adjustments shall be made to (i) the maximum number and/or class of
 
4.

securities issuable under the Plan, (ii) the maximum number and/or class of securities for which any one person may be granted stock options, separately exercisable stock appreciation rights and direct stock issuances in the aggregate under the Plan per calendar year, (iii) the maximum number and/or class of securities issuable under the Stock Issuance Program, (iv) the number and/or class of securities for which grants are subsequently to be made under the Automatic Option Grant Program to new and continuing non-employee Board members, unless the Plan Administrator determines otherwise, (v) the number and/or class of securities and the exercise price per share in effect under each outstanding option under the Plan and (vi) the number and/or class of securities and price per share in effect under each outstanding option incorporated into this Plan from the Predecessor Plan. Such adjustments to the outstanding options are to be effected in a manner which shall preclude the enlargement or dilution of rights and benefits under such options. The adjustments determined by the Plan Administrator shall be final, binding and conclusive.

5.

 
ARTICLE TWO
 
DISCRETIONARY OPTION GRANT PROGRAM
 
 	I.	 	OPTION TERMS	
 
Each option shall be evidenced by one or more documents in the form approved by the Plan Administrator; provided , however, that each such document shall comply with the terms specified below. Each document evidencing an Incentive Option shall, in addition, be subject to the provisions of the Plan applicable to such options.
 
A.     Exercise Price .
 
1.    The exercise price per share shall be fixed by the Plan Administrator but shall not be less than one hundred percent (100%) of the Fair Market Value per share of Common Stock on the option grant date.
 
2.    The exercise price shall become immediately due upon exercise of the option and shall, subject to the provisions of Section I of Article Four and the documents evidencing the option, be payable in one or more of the forms specified below:
 
(i)    cash or check made payable to the Corporation,
 
(ii)    shares of Common Stock held for the requisite period necessary to avoid a charge to the Corporation’s earnings for financial reporting purposes and valued at Fair Market Value on the Exercise Date, or
 
(iii)    to the extent the option is exercised for vested shares, through a special sale and remittance procedure pursuant to which the Optionee shall concurrently provide irrevocable instructions to (a) a brokerage firm (reasonably acceptable to the Corporation for purposes of administering such procedure in compliance with the Corporation’s pre-notification policy for sales of Common Stock) to effect the immediate sale of the purchased shares and remit to the Corporation, out of the sale proceeds available on the settlement date, sufficient funds to cover the aggregate exercise price payable for the purchased shares plus all applicable Federal, state and local income and employment taxes required to be withheld by the Corporation by reason of such exercise and (b) the Corporation to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale.
 
Except to the extent such sale and remittance procedure is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date.
 
6.

 
B.     Exercise and Term of Options .     Each option shall be exercisable at such time or times, during such period and for such number of shares as shall be determined by the Plan Administrator and set forth in the documents evidencing the option. However, no option shall have a term in excess of nine (9) years measured from the option grant date.
 
C.     Effect of Termination of Service .
 
1.    The following provisions shall govern the exercise of any options held by the Optionee at the time of cessation of Service or death:
 
(i)    Any option outstanding at the time of the Optionee’s cessation of Service for any reason shall remain exercisable for such period of time thereafter as shall be determined by the Plan Administrator and set forth in the documents evidencing the option, but no such option shall be exercisable after the expiration of the option term.
 
(ii)    Any option exercisable in whole or in part by the Optionee at the time of death may be subsequently exercised by the personal representative of the Optionee’s estate or by the person or persons to whom the option is transferred pursuant to the Optionee’s will or in accordance with the laws of descent and distribution.
 
(iii)    Should the Optionee’s Service be terminated for Misconduct, then all outstanding options held by the Optionee shall terminate immediately and cease to be outstanding.
 
(iv)    During the applicable post-Service exercise period, the option may not be exercised in the aggregate for more than the number of vested shares for which the option is exercisable on the date of the Optionee’s cessation of Service. Upon the expiration of the applicable exercise period or (if earlier) upon the expiration of the option term, the option shall terminate and cease to be outstanding for any vested shares for which the option has not been exercised. However, the option shall, immediately upon the Optionee’s cessation of Service, terminate and cease to be outstanding to the extent the option is not otherwise at that time exercisable for vested shares.
 
D.    The Plan Administrator shall have complete discretion, exercisable either at the time an option is granted or at any time while the option remains outstanding, to:
 
(i)    extend the period of time for which the option is to remain exercisable following the Optionee’s cessation of Service from the limited exercise period otherwise in effect for that option to such greater period of time as the Plan Administrator shall deem appropriate, but in no event beyond the expiration of the option term, and/or
 
7.

 
(ii)    permit the option to be exercised, during the applicable post-Service exercise period, not only with respect to the number of vested shares of Common Stock for which such option is exercisable at the time of the Optionee’s cessation of Service but also with respect to one or more additional installments in which the Optionee would have vested had the Optionee continued in Service.
 
E.     Shareholder Rights .     The holder of an option shall have no shareholder rights with respect to the shares subject to the option until such person shall have exercised the option, paid the exercise price and become a holder of record of the purchased shares.
 
F.     Repurchase Rights .     The Plan Administrator shall have the discretion to grant options which are exercisable for unvested shares of Common Stock. Should the Optionee cease Service while holding such unvested shares, the Corporation shall have the right to repurchase, at the exercise price paid per share, any or all of those unvested shares. The terms upon which such repurchase right shall be exercisable (including the period and procedure for exercise and the appropriate vesting schedule for the purchased shares) shall be established by the Plan Administrator and set forth in the document evidencing such repurchase right.
 
G.     Limited Transferability of Options .     During the lifetime of the Optionee, Incentive Options shall be exercisable only by the Optionee and shall not be assignable or transferable other than by will or by the laws of inheritance following the Optionee’s death. However, a Non-Statutory Option may be assigned in whole or in part during the Optionee’s lifetime to one or more members of the Optionee’s immediate family or to a trust established exclusively for one or more such family members or to one or more individuals, to the extent such assignment is in connection with the Optionee’s estate plan or pursuant to a domestic relations order. The assigned portion may only be exercised by the person or persons who acquire a proprietary interest in the option pursuant to the assignment. The terms applicable to the assigned portion shall be the same as those in effect for the option immediately prior to such assignment and shall be set forth in such documents issued to the assignee as the Plan Administrator may deem appropriate.
 
 	II.	 	INCENTIVE OPTIONS	
 
The terms specified below shall be applicable to all Incentive Options. Except as modified by the provisions of this Section II, all the provisions of Articles One, Two and Four shall be applicable to Incentive Options. Options designated as Non-Statutory Options when issued under the Plan shall not be subject to the terms of this Section II.
 
A.     Eligibility .     Incentive Options may only be granted to Employees.
 
8.

 
B.     Dollar Limitation .     The aggregate Fair Market Value of the shares of Common Stock (determined as of the respective date or dates of grant) for which one or more options granted to any Employee under the Plan (or any other option plan of the Corporation or any Parent or Subsidiary) may for the first time become exercisable as Incentive Options during any one calendar year shall not exceed the sum of One Hundred Thousand Dollars ($100,000). To the extent the Employee holds two (2) or more such options which become exercisable for the first time in the same calendar year, the foregoing limitation on the exercisability of such options as Incentive Options shall be applied on the basis of the order in which such options are granted.
 
C.     10% Shareholder .     If any Employee to whom an Incentive Option is granted is a 10% Shareholder, then the exercise price per share shall not be less than one hundred ten percent (110%) of the Fair Market Value per share of Common Stock on the option grant date, and the option term shall not exceed five (5) years measured from the option grant date.
 
 	III.	 	CORPORATE TRANSACTION/CHANGE IN CONTROL	
 
A.    In the event of any Corporate Transaction, each outstanding option shall automatically accelerate so that each such option shall, immediately prior to the effective date of the Corporate Transaction, become exercisable for all of the shares of Common Stock at the time subject to such option and may be exercised for any or all of those shares as fully-vested shares of Common Stock. However, an outstanding option shall not so accelerate if and to the extent: (i) such option is, in connection with the Corporate Transaction, either to be assumed by the successor corporation (or parent thereof) or to be replaced with a comparable option to purchase shares of the capital stock of the successor corporation (or parent thereof), (ii) such option is to be replaced with a cash incentive program of the successor corporation which preserves the spread existing on the unvested option shares at the time of the Corporate Transaction and provides for subsequent payout in accordance with the same vesting schedule applicable to those option shares or (iii) the acceleration of such option is subject to other limitations imposed by the Plan Administrator at the time of the option grant. The determination of option comparability under clause (i) above shall be made by the Plan Administrator, and its determination shall be final, binding and conclusive.
 
B.    All outstanding repurchase rights shall also terminate automatically, and the shares of Common Stock subject to those terminated rights shall immediately vest in full, in the event of any Corporate Transaction, except to the extent: (i) those repurchase rights are to be assigned to the successor corporation (or parent thereof) in connection with such Corporate Transaction or (ii) such accelerated vesting is precluded by other limitations imposed by the Plan Administrator at the time the repurchase right is issued.
 
C.    Immediately following the consummation of the Corporate Transaction, all outstanding options shall terminate and cease to be outstanding, except to the extent assumed by the successor corporation (or parent thereof).
 
9.

 
D.    Each option which is assumed in connection with a Corporate Transaction shall be appropriately adjusted, immediately after such Corporate Transaction, to apply to the number and class of securities which would have been issuable to the Optionee in consummation of such Corporate Transaction had the option been exercised immediately prior to such Corporate Transaction. Appropriate adjustments to reflect such Corporate Transaction shall also be made to (i) the exercise price payable per share under each outstanding option, provided the aggregate exercise price payable for such securities shall remain the same, (ii) the maximum number and/or class of securities available for issuance over the remaining term of the Plan, (iii) the maximum number and/or class of securities for which any one person may be granted stock options, separately exercisable stock appreciation rights and direct stock issuances under the Plan per calendar year and (iv) the maximum number and/or class of securities available for issuance under the Stock Issuance Program.
 
E.    The Plan Administrator shall have full power and authority to grant options under the Discretionary Option Grant Program which will automatically accelerate in the event the Optionee’s Service subsequently terminates by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of any Corporate Transaction in which those options are assumed or replaced and do not otherwise accelerate. Any options so accelerated shall remain exercisable for fully-vested shares until the expiration or sooner termination of the option term. In addition, the Plan Administrator may provide that one or more of the Corporation’s outstanding repurchase rights with respect to shares held by the Optionee at the time of such Involuntary Termination shall immediately terminate, and the shares subject to those terminated repurchase rights shall accordingly vest in full.
 
F.    The Plan Administrator shall have full power and authority to grant options under the Discretionary Option Grant Program which will automatically accelerate in the event the Optionee’s Service subsequently terminates by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of any Change in Control. Each option so accelerated shall remain exercisable for fully-vested shares until the expiration or sooner termination of the option term. In addition, the Plan Administrator may provide that one or more of the Corporation’s outstanding repurchase rights with respect to shares held by the Optionee at the time of such Involuntary Termination shall immediately terminate, and the shares subject to those terminated repurchase rights shall accordingly vest in full.
 
G.    The portion of any Incentive Option accelerated in connection with a Corporate Transaction or Change in Control shall remain exercisable as an Incentive Option only to the extent the applicable One Hundred Thousand Dollar limitation is not exceeded. To the extent such dollar limitation is exceeded, the accelerated portion of such option shall be exercisable as a Non-Statutory Option under the Federal tax laws.
 
10.

 
H.    The outstanding options shall in no way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets.
 
 	IV.	 	STOCK APPRECIATION RIGHTS	
 
A.    The Plan Administrator shall have full power and authority, exercisable in its sole discretion, to grant to selected Optionees or other individuals eligible to receive option grants under the Discretionary Option Grant Program stock appreciation rights.
 
B.    Three types of stock appreciation rights shall be authorized for issuance under the Plan: (i) tandem stock appreciation rights (“Tandem Rights”), (ii) stand-alone stock appreciation rights (“Stand-alone Rights”) and (iii) limited stock appreciation rights (“Limited Rights”).
 
C.    The following terms and conditions shall govern the grant and exercise of Tandem Rights under this Article Two.
 
1.    One or more Optionees may be granted a Tandem Right, exercisable upon such terms and conditions as the Plan Administrator may establish, to elect between the exercise of the underlying Article Two stock option for shares of Common Stock or the surrender of that option in exchange for a distribution from the Corporation in an amount equal to the excess of (i) the Fair Market Value (on the option surrender date) of the number of shares in which the Optionee is at the time vested under the surrendered option (or surrendered portion thereof) over (ii) the aggregate exercise price payable for such vested shares.
 
2.    No such option surrender shall be effective unless it is approved by the Plan Administrator, either at the time of the actual option surrender or at any earlier time. If the surrender is so approved, then the distribution to which the Optionee shall accordingly become entitled under this Section V may be made in shares of Common Stock valued at Fair Market Value on the option surrender date, in cash, or partly in shares and partly in cash, as the Plan Administrator shall in its sole discretion deem appropriate.
 
3.    If the surrender of an option is not approved by the Plan Administrator, then the Optionee shall retain whatever rights the Optionee had under the surrendered option (or surrendered portion thereof) on the option surrender date and may exercise such rights at any time prior to the later of (i) five (5) business days after the receipt of the rejection notice or (ii) the last day on which the option is otherwise exercisable in accordance with the terms of the instrument evidencing such option, but in no event may such rights be exercised more than nine (9) years after the date of the option grant.
 
D.    The following terms and conditions shall govern the grant and exercise of Stand-alone Rights under this Article Two:
 
11.

 
1.    One or more individuals eligible to participate in the Discretionary Option Grant Program may be granted a Stand-alone Right not tied to any underlying option under this Discretionary Option Grant Program. The Stand-alone Right shall cover a specified number of underlying shares of Common Stock and shall be exercisable upon such terms and conditions as the Plan Administrator may establish. Upon exercise of the Stand-alone Right, the holder shall be entitled to receive a distribution from the Corporation in an amount equal to the excess of (i) the aggregate Fair Market Value (on the exercise date) of the shares of Common Stock underlying the exercised right over (ii) the aggregate base price in effect for those shares.
 
2.    The number of shares of Common Stock underlying each Stand-alone Right and the base price in effect for those shares shall be determined by the Plan Administrator in its sole discretion at the time the Stand-alone Right is granted. In no event, however, may the base price per share be less than the Fair Market Value per underlying share of Common Stock on the grant date.
 
3.    The distribution with respect to an exercised Stand-alone Right may be made in shares of Common Stock valued at Fair Market Value on the exercise date, in cash, or partly in shares and partly in cash, as the Plan Administrator shall in its sole discretion deem appropriate.
 
E.    The following terms and conditions shall govern the grant and exercise of Limited Rights under this Article Two:
 
1.    One or more Section 16 Insiders may, in the Plan Administrator’s sole discretion, be granted Limited Rights with respect to their outstanding options under this Article Two.
 
2.    Upon the occurrence of a Hostile Take-Over, the Section 16 Insider shall have the unconditional right (exercisable for a thirty (30)-day period following such Hostile Take-Over) to surrender each option with such a Limited Right to the Corporation, to the extent the option is at the time exercisable for fully vested shares of Common Stock. The Section 16 Insider shall in return be entitled to a cash distribution from the Corporation in an amount equal to the excess of (i) the Take-Over Price of the vested shares of Common Stock at the time subject to each surrendered option (or surrendered portion of such option) over (ii) the aggregate exercise price payable for such vested shares. Such cash distribution shall be made within five (5) days following the option surrender date.
 
3.    The Plan Administrator shall pre-approve, at the time such Limited Right is granted, the subsequent exercise of that right in accordance with the terms of the grant and the provisions of this Section IV. No additional approval of the Plan Administrator or the Board shall be required at the time of the actual option surrender and cash distribution. Any unsurrendered portion of the option shall continue to remain outstanding and become exercisable in accordance with the terms of the instrument evidencing such grant.
 
F.    The shares of Common Stock underlying any stock appreciation rights exercised under this Section IV shall not be available for subsequent issuance under the Plan.

12.

 
ARTICLE THREE
 
AUTOMATIC OPTION GRANT PROGRAM
 
The following terms and provisions reflect the amendment to the Automatic Option Grant Program authorized by the Board on July 8, 1999 and approved by the shareholders at the 1999 Annual Shareholder Meeting on November 10, 1999.
 
 	I.	 	OPTION TERMS	
 
A.     Grant Dates .     Option grants under this Article Three shall be made on the dates specified below:
 
1.    Each individual who is first elected or appointed as a non-employee Board member on or after November 10, 1999 shall automatically be granted, on the date of such initial election or appointment, a Non-Statutory Option to purchase 30,000 shares of Common Stock, 1 provided that individual has not previously been in the employ of the Corporation or any Parent or Subsidiary.
 
2.    On the date of each Annual Shareholders Meeting, beginning with the 1999 Annual Shareholders Meeting, each individual who is re-elected to serve as an Eligible Director shall automatically be granted a Non-Statutory Option to purchase 15,000 shares of Common Stock 2 , provided such individual has served as a non-employee Board member for at least six (6) months. There shall be no limit on the number of such 15,000-share option grants any one Eligible Director may receive over his or her period of Board service, and non-employee Board members who have previously been in the employ of the Corporation (or any Parent or Subsidiary) shall be eligible to receive one or more such annual option grants over their period of continued Board service.
 
B.     Exercise Price .
 
1.    The exercise price per share shall be equal to one hundred percent (100%) of the Fair Market Value per share of Common Stock on the option grant date.

1	 	Prior to the July 8, 1999 restatement, the number of shares of Common Stock for which an initial option grant was to be made to each newly elected or appointed non-employee Board member was set at 20,000 shares (before taking into account any splits of the Common Stock effected after that date).	
 
2	 	Prior to the July 8, 1999 restatement, the number of shares of Common Stock for which a continuing non-employee Board member was to be granted an option at each annual shareholders meeting at which he or she was re-elected to the Board was set at 10,000 shares (before taking into account any splits of the Common Stock effected after that date).	
 
13.

 
2.    The exercise price shall be payable in one or more of the alternative forms authorized under the Discretionary Option Grant Program. Except to the extent the sale and remittance procedure specified thereunder is utilized, payment of the exercise price for the purchased shares must be made on the Exercise Date.
 
C.     Option Term .     Each option shall have a maximum term equal to the lesser of (i) nine (9) years measured from the option grant date or (ii) twelve (12) months following termination of Board service.
 
D.     Exercise and Vesting of Options .     Each option shall be immediately exercisable for any or all of the option shares. However, any shares purchased under the option shall be subject to repurchase by the Corporation, at the exercise price paid per share, upon the Optionee’s cessation of Board service prior to vesting in those shares. Each initial 30,000-share grant shall vest, and the Corporation’s repurchase right with respect to those shares shall lapse, in four (4) successive equal annual installments over the Optionee’s period of Board service, with the first such installment to vest upon the completion of one (1) year of Board service measured from the automatic grant date. Each annual 15,000-share grant shall vest, and the Corporation’s repurchase right with respect to those shares shall lapse, in two (2) successive equal annual installments over the optionee’s period of Board service measured from the automatic grant date.
 
E.     Termination of Board Service .     The following provisions shall govern the exercise of any options held by the Optionee upon his or her cessation of Board service:
 
(i)    The Optionee (or, in the event of Optionee’s death, the personal representative of the Optionee’s estate or the person or persons to whom the option is transferred pursuant to the Optionee’s will or the laws of inheritance) shall have a twelve (12)-month period following the date of such cessation of Board service in which to exercise each such option.
 
(ii)    During the twelve (12)-month exercise period, the option may not be exercised in the aggregate for more than the number of vested shares of Common Stock for which the option is exercisable at the time of the Optionee’s cessation of Board service.
 
(iii)    Should the Optionee cease to serve as a Board member by reason of death or Permanent Disability, then all shares at the time subject to the option shall immediately vest so that such option may, during the twelve (12)-month exercise period following such cessation of Board service, be exercised for all or any portion of those shares as fully-vested shares of Common Stock.
 
(iv)    In no event shall the option remain exercisable after the expiration of the option term. Upon the expiration of the twelve (12)-month exercise period or (if earlier) upon the expiration of the option term, the option shall terminate and cease to be outstanding for any vested shares for which the option has not been exercised. However, the option shall, immediately upon the
 
14.

 	Optionee’s cessation of Board service for any reason other than death or Permanent Disability, terminate and cease to be outstanding to the extent the option is not otherwise at that time exercisable for vested shares.	
 
 	II.	 	CORPORATE TRANSACTION/CHANGE IN CONTROL/HOSTILE TAKE-OVER	
 
A.    In the event of any Corporate Transaction, the shares of Common Stock at the time subject to each outstanding option but not otherwise vested shall automatically vest in full so that each such option shall, immediately prior to the effective date of the Corporate Transaction, become exercisable for all of the shares of Common Stock at the time subject to such option and may be exercised for any or all of those shares as fully-vested shares of Common Stock. Immediately following the consummation of the Corporate Transaction, each automatic option grant shall terminate and cease to be outstanding, except to the extent assumed by the successor corporation (or parent thereof).
 
B.    In connection with any Change in Control, the shares of Common Stock at the time subject to each outstanding option but not otherwise vested shall automatically vest in full so that each such option shall, immediately prior to the effective date of the Change in Control, become exercisable for all of the shares of Common Stock at the time subject to such option and may be exercised for any or all of those shares as fully-vested shares of Common Stock. Each such option shall remain exercisable for such fully-vested option shares until the expiration or sooner termination of the option term or the surrender of the option in connection with a Hostile Take-Over.
 
C.    Upon the occurrence of a Hostile Take-Over, the Optionee shall have a thirty (30)-day period in which to surrender to the Corporation each of his or her outstanding automatic option grants. The Optionee shall in return be entitled to a cash distribution from the Corporation in an amount equal to the excess of (i) the Take-Over Price of the shares of Common Stock at the time subject to each surrendered option (whether or not the Optionee is otherwise at the time vested in those shares) over (ii) the aggregate exercise price payable for such shares. Such cash distribution shall be paid within five (5) days following the surrender of the option to the Corporation. At the 1999 Annual Meeting on November 10, 1999, shareholder approval of a proposal amending the 1996 Stock Incentive Plan created an automatic pre-approval of each option grant with such a cash surrender right made under the Automatic Option Grant Program on or after this date and the subsequent exercise of that right in accordance with the provisions of this Section II.C, and no additional approval of the Board or any Plan Administrator shall accordingly be required at the time of the actual option surrender and cash distribution.
 
D.    Each option which is assumed in connection with a Corporate Transaction shall be appropriately adjusted, immediately after such Corporate Transaction, to apply to the number and class of securities which would have been issuable to the Optionee in consummation
 
15.

of such Corporate Transaction had the option been exercised immediately prior to such Corporate Transaction. Appropriate adjustments shall also be made to the exercise price payable per share under each outstanding option, provided the aggregate exercise price payable for such securities shall remain the same.
 
E.    The grant of options under the Automatic Option Grant Program shall in no way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets.
 
 	III.	 	REMAINING TERMS	
 
The remaining terms of each option granted under the Automatic Option Grant Program shall be the same as the terms in effect for option grants made under the Discretionary Option Grant Program.
 
16.

 
ARTICLE FOUR
 
STOCK ISSUANCE PROGRAM
 
Shares of Common Stock reserved for issuance under the Plan may be issued under the Stock Issuance Program through direct and immediate issuances without any intervening option grants. Only person who render services to the Corporation (or any Parent or Subsidiary) in the capacity of an independent, non-employee consultant and who are not otherwise Section 16 Insiders at the time of issuance may receive a stock issuance under the Program. Each such stock issuance shall be evidenced by a Stock Issuance Agreement which complies with the terms specified below. Shares of Common Stock may also be issued under the Stock Issuance Program pursuant to share right awards which entitle the recipients to receive those shares upon the attainment of designated performance goals. In no event may more than One Million (1,000,000) shares of Common Stock reserved for issuance under the Plan be issued pursuant to the provisions of the Stock Issuance Program.
 
A.     Purchase Price .
 
1.    The purchase price per share of Common Stock subject to direct issuance shall be fixed by the Plan Administrator, but shall not be less than one hundred percent (100%) of the Fair Market Value per share of Common Stock on the issuance date.
 
2.    Shares of Common Stock may be issued under the Stock Issuance Program for any of the following items of consideration which the Plan Administrator may deem appropriate in each individual instance:
 
(i)    cash or check made payable to the Corporation, or
 
(ii)    past services rendered to the Corporation (or any Parent or Subsidiary).
 
B.     Vesting/Issuance Provisions .
 
1.    Shares of Common Stock issued under the Stock Issuance Program may, in the discretion of the Plan Administrator, be fully and immediately vested upon issuance or may vest in one or more installments over the Participant’s period of Service or upon attainment of specified performance objectives. Alternatively, the Plan Administrator may issue share right awards under the Stock Issuance Program which shall entitle the recipient to receive a specified number of shares of Common Stock upon the attainment of one or more performance goals established by the Plan Administrator or the completion of a specified period of Service designated by the Plan Administrator. Upon the attainment of such performance goals or the completion of such Service requirement, fully-vested shares of Common Stock shall be issued in satisfaction of those share right awards.
 
17.

 
2.    Any new, substituted or additional securities or other property (including money paid other than as a regular cash dividend) which the Participant may have the right to receive with respect to his or her unvested shares of Common Stock by reason of any stock dividend, stock split, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation’s receipt of consideration shall be issued subject to (i) the same vesting requirements applicable to the Participant’s unvested shares of Common Stock and (ii) such escrow arrangements as the Plan Administrator shall deem appropriate.
 
3.    The Participant shall have full stockholder rights with respect to any shares of Common Stock issued to the Participant under the Stock Issuance Program, whether or not the Participant’s interest in those shares is vested. Accordingly, the Participant shall have the right to vote such shares and to receive any regular cash dividends paid on such shares.
 
4.    Should the Participant cease to remain in Service while holding one or more unvested shares of Common Stock issued under the Stock Issuance Program or should the performance objectives not be attained with respect to one or more such unvested shares of Common Stock, then those shares shall be immediately surrendered to the Corporation for cancellation, and the Participant shall have no further stockholder rights with respect to those shares. To the extent the surrendered shares were previously issued to the Participant for cash consideration, the Corporation shall repay that consideration to the Participant at the time the shares are surrendered.
 
5.    The Plan Administrator may in its discretion waive the surrender and cancellation of one or more unvested shares of Common Stock (or other assets attributable thereto) which would otherwise occur upon the cessation of the Participant’s Service or the non-attainment of the performance objectives applicable to those shares. Such waiver shall result in the immediate vesting of the Participant’s interest in the shares of Common Stock as to which the waiver applies. Such waiver may be effected at any time, whether before or after the Participant’s cessation of Service or the attainment or non-attainment of the applicable performance objectives.
 
6.    Outstanding share right awards under the Stock Issuance Program shall automatically terminate, and no shares of Common Stock shall actually be issued in satisfaction of those awards, if the performance goals or Service requirement established for such awards are not attained. The Plan Administrator, however, shall have the discretionary authority to issue shares of Common Stock under one or more outstanding share right awards as to which the designated performance goals or Service requirement have not been attained.
 
18.

 
 	II.	 	CORPORATE TRANSACTION/CHANGE IN CONTROL	
 
A.    All of the Corporation’s outstanding repurchase rights under the Stock Issuance Program shall terminate automatically, and all the shares of Common Stock subject to those terminated rights shall immediately vest in full, in the event of any Corporate Transaction, except to the extent those repurchase rights are to be assigned to the successor corporation (or parent thereof) in connection with such Corporate Transaction.
 
B.    The Plan Administrator shall have the discretionary authority, exercisable either at the time the unvested shares are issued or any time while the Corporation’s repurchase rights remain outstanding under the Stock Issuance Program, to provide that those rights shall automatically terminate in whole or in part, and the shares of Common Stock subject to those terminated rights shall immediately vest, in the event the Participant’s Service should subsequently terminate by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of any Corporate Transaction in which those repurchase rights are assigned to the successor corporation (or parent thereof).
 
C.    The Plan Administrator shall have the discretionary authority, exercisable either at the time the unvested shares are issued or any time while the Corporation’s repurchase rights remain outstanding under the Stock Issuance Program, to provide that those rights shall automatically terminate in whole or in part, and the shares of Common Stock subject to those terminated rights shall immediately vest, in the event the Participant’s Service should subsequently terminate by reason of an Involuntary Termination within a designated period (not to exceed eighteen (18) months) following the effective date of any Change in Control.
 
 	III.	 	SHARE ESCROW/LEGENDS	
 
Unvested shares may, in the Plan Administrator’s discretion, be held in escrow by the Corporation until the Participant’s interest in such shares vests or may be issued directly to the Participant with restrictive legends on the certificates evidencing those unvested shares.
 
19.

 
ARTICLE FIVE
 
MISCELLANEOUS
 
 	I.	 	FINANCING	
 
The Plan Administrator may permit any Optionee (other than a Section 16 Insider) to pay the option exercise price under the Discretionary Option Grant Program by delivering a full-recourse, interest bearing promissory note payable in one or more installments. The terms of any such promissory note (including the interest rate and the terms of repayment) shall be established by the Plan Administrator in its sole discretion. In no event may the maximum credit available to the Optionee exceed the sum of (i) the aggregate option exercise price payable for the purchased shares plus (ii) any Federal, state and local income and employment tax liability incurred by the Optionee in connection with the option exercise or share purchase.
 
 	II.	 	TAX WITHHOLDING	
 
A.    The Corporation’s obligation to deliver shares of Common Stock upon the exercise of options under the Plan shall be subject to the satisfaction of all applicable Federal, state and local income and employment tax withholding requirements.
 
B.    The Plan Administrator may, in its discretion, provide any or all holders of Non-Statutory Options under the Discretionary Option Grant Program or unvested shares of Common Stock under the Stock Issuance Program with the right to use shares of Common Stock in satisfaction of all or part of the Withholding Taxes to which such holders may become subject in connection with the exercise of their options or the vesting of their shares. Such right may be provided to any such holder in either or both of the following formats:
 
Stock Withholding :    The election to have the Corporation withhold, from the shares of Common Stock otherwise issuable upon the exercise of such Non-Statutory Option or the vesting of such shares, a portion of those shares with an aggregate Fair Market Value equal to the percentage of the Withholding Taxes (not to exceed one hundred percent (100%)) designated by the holder.
 
Stock Delivery :    The election to deliver to the Corporation, at the time the Non-Statutory Option is exercised or the issued shares vest, one or more shares of Common Stock previously acquired by such holder (other than in connection with the option exercise or stock vesting which triggers the Withholding Taxes) with an aggregate Fair Market Value equal to the percentage of the Withholding Taxes (not to exceed one hundred percent (100%)) designated by the holder.
 
20.

 
 	III.	 	EFFECTIVE DATE AND TERM OF THE PLAN	
 
A.    The Plan and each of the equity incentive programs thereunder shall become effective immediately upon the approval of the Corporation’s shareholders at the 1996 Annual Meeting. Options may be granted under the Plan at any time on or after the date of such shareholder approval. If such shareholder approval is not obtained, then this Plan shall not become effective, and no options shall be granted and no shares shall be issued under the Plan.
 
B.    The Plan shall serve as the successor to the Predecessor Plan, and no further option grants shall be made under the Predecessor Plan after this Plan is approved by the shareholders at the 1996 Annual Meeting. All options outstanding under the Predecessor Plan at the time of such shareholder approval shall be incorporated into the Plan at that time and shall be treated as outstanding options under the Plan. However, each outstanding option so incorporated shall continue to be governed solely by the terms of the documents evidencing such option, and no provision of the Plan shall be deemed to affect or otherwise modify the rights or obligations of the holders of such incorporated options with respect to their acquisition of shares of Common Stock.
 
C.    One or more provisions of the Plan, including (without limitation) the option/vesting acceleration provisions of Article Two relating to Corporate Transactions and Changes in Control, may, in the Plan Administrator’s discretion, be extended to one or more options incorporated from the Predecessor Plan which do not otherwise contain such provisions.
 
D.    The Plan shall terminate upon the earliest of (i) December 31, 2006, (ii) the date on which all shares available for issuance under the Plan shall have been issued as fully-vested shares or (iii) the termination of all outstanding options in connection with a Corporate Transaction. Upon such plan termination, all outstanding option grants shall thereafter continue to have force and effect in accordance with the provisions of the documents evidencing such grants.
 
 	IV.	 	AMENDMENT OF THE PLAN	
 
A.    The Board shall have complete power and authority to amend or modify the Plan in any or all respects but may delegate such authority in whole or in part to the Primary Committee, as the Board deems appropriate. However, no such amendment or modification shall adversely affect the rights and obligations with respect to stock options at the time outstanding under the Plan unless the Optionee consents to such amendment or modification. In addition, certain amendments may require shareholder approval in accordance with applicable laws and regulations.
 
B.    The Plan was amended by the Board on July 29, 1998 and approved by the Shareholders at the 1998 Annual Shareholders Meeting, in order to extend the automatic share increase provisions of the Plan for an additional three (3)-year through fiscal December in calendar year 2001. The Automatic Option Grant Program in effect under the Plan was amended by the Board on July 8, 1999 and approved by the shareholders at the 1999 Annual Shareholder Meeting, in order to increase the number of shares of Common Stock for which newly elected or
 
21.

appointed non-employee Board members and continuing non-employee Board members may be granted stock options under such program. The Plan was amended on January 9, 2001 to allow the Board to delegate, in whole or in part, its authority to amend the Plan to the Primary Committee as it deems appropriate. The Plan was amended on March 18, 2003 to implement the Stock Issuance Program pursuant to which up to One Million (1,000,000) shares of Common Stock reserved for issuance under the Plan may be issued pursuant to direct stock issuances under the Stock Issuance Program.
 
C.    Options to purchase shares of Common Stock may be granted under the Discretionary Option Grant Program that are in excess of the number of shares then available for issuance under the Plan, provided any excess shares actually issued under that program shall be held in escrow until there is obtained shareholder approval of an amendment sufficiently increasing the number of shares of Common Stock available for issuance under the Plan. If such shareholder approval is not obtained within twelve (12) months after the date the first such excess issuances are made, then (i) any unexercised options granted on the basis of such excess shares shall terminate and cease to be outstanding and (ii) the Corporation shall promptly refund to the Optionees the exercise or purchase price paid for any excess shares issued under the Plan and held in escrow, together with interest (at the applicable Short Term Federal Rate) for the period the shares were held in escrow, and such shares shall thereupon be automatically cancelled and cease to be outstanding.
 
 	V.	 	USE OF PROCEEDS	
 
Any cash proceeds received by the Corporation from the sale of shares of Common Stock under the Plan shall be used for general corporate purposes.
 
 	VI.	 	REGULATORY APPROVALS	
 
A.    The implementation of the Plan, the granting of any stock option under the Plan and the issuance of any shares of Common Stock under the Plan shall be subject to the Corporation’s procurement of all approvals and permits required by regulatory authorities having jurisdiction over the Plan, the stock options granted under it and the shares of Common Stock issued pursuant to it.
 
B.    No shares of Common Stock or other assets shall be issued or delivered under the Plan unless and until there shall have been compliance with all applicable requirements of Federal and state securities laws, including the filing and effectiveness of the Form S-8 registration statement for the shares of Common Stock issuable under the Plan, and all applicable listing requirements of any stock exchange (or the Nasdaq National Market, if applicable) on which Common Stock is then listed for trading.
 
22.

 
 	VII.	 	NO EMPLOYMENT/SERVICE RIGHTS	
 
Nothing in the Plan shall confer upon the Optionee any right to continue in Service for any period of specific duration or interfere with or otherwise restrict in any way the rights of the Corporation (or any Parent or Subsidiary employing or retaining such person) or of the Optionee, which rights are hereby expressly reserved by each, to terminate such person’s Service at any time for any reason, with or without cause.
 
23.

 
APPENDIX
 
The following definitions shall be in effect under the Plan:
 
A.     Automatic Option Grant Program shall mean the automatic option grant program in effect under Article Three of the Plan.
 
B.     Board shall mean the Corporation’s Board of Directors.
 
C.     Change in Control shall mean a change in ownership or control of the Corporation effected through either of the following transactions:
 
(i)    the acquisition, directly or indirectly by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation), of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than thirty-five percent (35%) of the total combined voting power of the Corporation’s outstanding securities pursuant to a tender or exchange offer made directly to the Corporation’s shareholders which the Board does not recommend such shareholders to accept, or
 
(ii)    a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination.
 
D.     Code shall mean the Internal Revenue Code of 1986, as amended.
 
E.     Common Stock shall mean the Corporation’s common stock.
 
F.     Corporate Transaction shall mean either of the following shareholder-approved transactions to which the Corporation is a party:
 
(i)    a merger or consolidation in which securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation’s outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction, or
 
(ii)    the sale, transfer or other disposition of all or substantially all of the Corporation’s assets in complete liquidation or dissolution of the Corporation.
 
A-1.

 
G.     Corporation shall mean Cisco Systems, Inc., a California corporation, and its successors.
 
H.     Discretionary Option Grant Program shall mean the discretionary option grant program in effect under Article Two of the Plan.
 
I.     Eligible Director shall mean a non-employee Board member eligible to participate in the Automatic Option Grant Program in accordance with the eligibility provisions of Article One.
 
J.     Employee shall mean an individual who is in the employ of the Corporation (or any Parent or Subsidiary), subject to the control and direction of the employer entity as to both the work to be performed and the manner and method of performance.
 
K.     Exercise Date shall mean the date on which the Corporation shall have received written notice of the option exercise.
 
L.     Fair Market Value per share of Common Stock on any relevant date shall be determined in accordance with the following provisions:
 
(i)    If the Common Stock is at the time traded on the Nasdaq National Market, then the Fair Market Value shall be deemed equal to the closing selling price per share of Common Stock on the date in question, as such price is reported on the Nasdaq National Market. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.
 
(ii)    If the Common Stock is at the time listed on any Stock Exchange, then the Fair Market Value shall be deemed equal to the closing selling price per share of Common Stock on the date in question on the Stock Exchange determined by the Plan Administrator to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.
 
M.     Hostile Take-Over shall mean the acquisition, directly or indirectly, by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation) of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than thirty-five percent (35%) of the total combined voting power of the Corporation’s outstanding securities pursuant to a tender or exchange offer made directly to the Corporation’s shareholders which the Board does not recommend such shareholders to accept.
 
A-2.

 
N.     Incentive Option shall mean an option which satisfies the requirements of Code Section 422.
 
O.     Involuntary Termination shall mean the termination of the Service of any individual which occurs by reason of:
 
(i)    such individual’s involuntary dismissal or discharge by the Corporation for reasons other than Misconduct, or
 
(ii)    such individual’s voluntary resignation following (A) a change in his or her position with the Corporation which materially reduces his or her level of responsibility, (B) a reduction in his or her level of compensation (including base salary, fringe benefits and target bonuses under any corporate-performance based bonus or incentive programs) by more than fifteen percent (15%) or (C) a relocation of such individual’s place of employment by more than fifty (50) miles, provided and only if such change, reduction or relocation is effected without the individual’s consent.
 
P.     Misconduct shall mean the commission of any act of fraud, embezzlement or dishonesty by the Optionee, any unauthorized use or disclosure by such person of confidential information or trade secrets of the Corporation (or any Parent or Subsidiary), or any other intentional misconduct by such person adversely affecting the business or affairs of the Corporation (or any Parent or Subsidiary) in a material manner. The foregoing definition shall not be deemed to be inclusive of all the acts or omissions which the Corporation (or any Parent or Subsidiary) may consider as grounds for the dismissal or discharge of any Optionee or other person in the Service of the Corporation (or any Parent or Subsidiary).
 
Q.     1934 Act shall mean the Securities Exchange Act of 1934, as amended.
 
R.     Non-Statutory Option shall mean an option not intended to satisfy the requirements of Code Section 422.
 
S.     Optionee shall mean any person to whom an option is granted under the Discretionary Option Grant or Automatic Option Grant Program.
 
T.     Parent shall mean any corporation (other than the Corporation) in an unbroken chain of corporations ending with the Corporation, provided each corporation in the unbroken chain (other than the Corporation) owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.
 
U.     Participant shall mean any person who is issued shares of Common Stock under the Stock Issuance Program.
 
A-3.

 
V.     Permanent Disability or Permanently Disabled shall mean the inability of the Optionee to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of twelve (12) months or more. However, solely for purposes of the Automatic Option Grant Program, Permanent Disability or Permanently Disabled shall mean the inability of the non-employee Board member to perform his or her usual duties as a Board member by reason of any medically determinable physical or mental impairment expected to result in death or to be of continuous duration of twelve (12) months or more.
 
W.     Plan shall mean the Corporation’s 1996 Stock Incentive Plan, as set forth in this document.
 
X.     Plan Administrator shall mean the particular entity, whether the Primary Committee, the Board or the Secondary Committee, which is authorized to administer the Discretionary Option Grant Program with respect to one or more classes of eligible persons, to the extent such entity is carrying out its administrative functions under those programs with respect to the persons under its jurisdiction.
 
Y.     Predecessor Plan shall mean the Corporation’s pre-existing 1987 Stock Option Plan in effect immediately prior to the Plan Effective Date hereunder.
 
Z.     Primary Committee shall mean the committee of two (2) or more non-employee Board members appointed by the Board to administer the Discretionary Option Grant Program with respect to Section 16 Insiders.
 
AA.     Secondary Committee shall mean a committee of two (2) or more Board members appointed by the Board to administer the Discretionary Option Grant Program with respect to eligible persons other than Section 16 Insiders.
 
BB.     Section 16 Insider shall mean an officer or director of the Corporation subject to the short-swing profit liabilities of Section 16 of the 1934 Act.
 
CC.     Service shall mean the performance of services for the Corporation (or any Parent or Subsidiary) by a person in the capacity of an Employee, a non-employee member of the board of directors or a consultant or independent advisor, except to the extent otherwise specifically provided in the documents evidencing the option grant or stock issuance.
 
DD.     Stock Exchange shall mean either the American Stock Exchange or the New York Stock Exchange.
 
EE.     Stock Issuance Agreement shall mean the agreement entered into by the Corporation and the Participant at the time of issuance of shares to such person under the Stock Issuance Program.
 
FF.     Stock Issuance Program shall mean the stock issuance program in effect under Article Four of the Plan.
 
A-4.

 
GG.     Subsidiary shall mean any corporation (other than the Corporation) in an unbroken chain of corporations beginning with the Corporation, provided each corporation (other than the last corporation) in the unbroken chain owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.
 
HH.     Take-Over Price shall mean the greater of (i) the Fair Market Value per share of Common Stock on the date the option is surrendered to the Corporation in connection with a Hostile Take-Over or (ii) the highest reported price per share of Common Stock paid by the tender offeror in effecting such Hostile Take-Over. However, if the surrendered option is an Incentive Option, the Take-Over Price shall not exceed the clause (i) price per share.
 
II.     10% Shareholder shall mean the owner of stock (as determined under Code Section 424(d)) possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Corporation (or any Parent or Subsidiary).
 
JJ.     Withholding Taxes shall mean the Federal, state and local income and employment withholding taxes to which the holder of Non-Statutory Options or unvested shares of Common Stock may become subject in connection with the exercise of those options or the vesting of those shares.
 
A-5.

 
CISCO SYSTEMS, INC.
 
NOTICE OF GRANT OF STOCK OPTION
 
Notice is hereby given of the following option grant (the “Option”) made to purchase shares of Cisco Systems, Inc. (the “Company”) common stock (the “Common Stock”):
 
Optionee:                                                                                                                            	  	 	
 
Grant Date:                                                                                                                        	  	 	
 
Type of Option:                                                       Incentive Stock Option	
                                                                                     Non-Statutory Stock Option	
Grant Number:                                                                                                                   	  	 	
 
Number of Option Shares:                                                                                    shares	  	 	
 
Exercise Price: $                                                                                                    per share	  	 	
 
Vesting Commencement Date:                                                                                             	  	 	
 
Expiration Date:                                                                                                                     	  	 	
 
Exercise Schedule
 
The Option shall become exercisable with respect to (i) twenty percent (20%) of the Option Shares upon Optionee’s completion of one (1) year of Service measured from the Vesting Commencement Date and (ii) the balance of the Option Shares in a series of forty-eight (48) successive equal monthly installments upon Optionee’s completion of each additional month of Service over the forty-eight (48)-month period measured from the first anniversary of the Vesting Commencement Date. In no event shall the Option become exercisable for any additional Option Shares after Optionee’s cessation of Service.
 
Should Optionee request a reduction to his or her work commitment to less than thirty (30) hours per week, then the Plan Administrator shall have the right, exercisable in connection with the approval of that reduction, to extend the period over which the Option shall thereafter vest and become exercisable for the Option Shares during the remainder of the option term. The decision whether or not to approve Optionee’s request for such reduced work commitment shall be at the sole discretion of the Plan Administrator. In no event shall any extension of the Exercise Schedule for the Option Shares result in the extension of the Expiration Date of the Option.
 
Optionee understands and agrees that the Option is offered subject to and in accordance with the terms of the Cisco Systems, Inc. 1996 Stock Incentive Plan (the “Plan”). Optionee further agrees to be bound by the terms of the Plan and the terms of the Option as set forth in the Stock Option Agreement attached hereto.
 
No Employment or Service Contract .    Nothing in this Notice or in the attached Stock Option Agreement or in the Plan shall confer upon Optionee any right to continue in Service for any period of specific duration or interfere with or otherwise restrict in any way the rights of the Corporation (or any Parent or Subsidiary employing or retaining Optionee) or of Optionee, which rights are hereby expressly reserved by each, to terminate Optionee’s Service at any time for any reason, with or without cause.
 
Definitions .    All capitalized terms in this Notice shall have the meaning assigned to them in this Notice or in the attached Stock Option Agreement.

 
STOCK OPTION AGREEMENT
 
Recitals
 
A.    The Board has adopted the Plan for the purpose of retaining the services of selected Employees, non-employee members of the Board or of the board of directors of any Parent or Subsidiary and consultants and other independent advisors who provide services to the Corporation (or any Parent or Subsidiary).
 
B.    Optionee is to render valuable services to the Corporation (or a Parent or Subsidiary), and this Agreement is executed pursuant to, and is intended to carry out the purposes of, the Plan in connection with the Corporation’s grant of an option to Optionee.
 
C.    All capitalized terms in this Agreement shall have the meaning assigned to them in the attached Appendix.
 
NOW, THEREFORE , it is hereby agreed as follows:
 
1.     Grant of Option .    The Corporation hereby grants to Optionee, as of the Grant Date, an option to purchase up to the number of Option Shares specified in the Grant Notice. The Option Shares shall be purchasable from time to time during the option term specified in Paragraph 2 at the Exercise Price.
 
2.     Option Term .    This option shall have a maximum term of nine (9) years measured from the Grant Date and shall accordingly expire at the close of business on the Expiration Date, unless sooner terminated in accordance with Paragraph 5 or 6.
 
3.     Limited Transferability .    This option may, in connection with the Optionee’s estate plan, be assigned in whole or in part during Optionee’s lifetime to one or more members of the Optionee’s immediate family or to a trust established for the exclusive benefit of one or more such family members. The assigned portion shall be exercisable only by the person or persons who acquire a proprietary interest in the option pursuant to such assignment. The terms applicable to the assigned portion shall be the same as those in effect for this option immediately prior to such assignment and shall be set forth in such documents issued to the assignee as the Corporation may deem appropriate. Should the Optionee die while holding this option, then this option shall be transferred in accordance with Optionee’s will or the laws of descent and distribution.
 
4.     Dates of Exercise .    This option shall become exercisable for the Option Shares in one or more installments as specified in the Grant Notice. As the option becomes exercisable for such installments, those installments shall accumulate and the option shall remain exercisable for the accumulated installments until the Expiration Date or sooner termination of the option term under Paragraph 5 or 6. As an administrative matter, the exercisable portion of this option may only be exercised until the close of the Nasdaq National Market on the last trading day before the Expiration Date or earlier date of termination of the option term under

 
Paragraph 5. Any later attempt to exercise this option will not be honored. For example, if Optionee ceases to remain in Service as provided in Paragraph 5(i) and the date three (3) months from the date of cessation is Monday, July 7, Optionee must exercise the exercisable portion of this option by 4 p.m. Eastern Daylight Time on Thursday, July 3. This is because Friday, July 4 is a United States holiday on which the Nasdaq National Market is closed for trading.
 
5.     Cessation of Service .    The option term specified in Paragraph 2 shall terminate (and this option shall cease to be outstanding) prior to the Expiration Date should any of the following provisions become applicable:
 
(i)    Should Optionee cease to remain in Service for any reason (other than death, Permanent Disability or Misconduct) while this option is outstanding, then Optionee shall have a period of three (3) months (commencing with the date of such cessation of Service) during which to exercise this option, but in no event shall this option be exercisable at any time after the Expiration Date.
 
(ii)    If Optionee dies while this option is outstanding, then the personal representative of Optionee’s estate or the person or persons to whom the option is transferred pursuant to Optionee’s will or in accordance with the laws of descent and distribution shall have the right to exercise this option. Such right shall lapse, and this option shall cease to be outstanding, upon the earlier of (A) the expiration of the twelve (12)- month period measured from the date of Optionee’s death or (B) the Expiration Date.
 
(iii)    Should Optionee cease Service by reason of Permanent Disability while this option is outstanding, then Optionee shall have a period of twelve (12) months (commencing with the date of such cessation of Service) during which to exercise this option. In no event shall this option be exercisable at any time after the Expiration Date.
 
(iv)    For purposes of this Agreement, Optionee’s period of Service shall not include any period of notice of termination of employment, whether expressed or implied. Optionee’s date of cessation of Service shall mean the date upon which Optionee ceases active performance of services for the Corporation following the provision of such notification of termination or resignation from Service and shall be determined solely by this Agreement and without reference to any other agreement, written or oral, including Optionee’s contract of employment.
 
(v)    During the limited period of post-Service exercisability, this option may not be exercised in the aggregate for more than the number of vested Option Shares for which the option is exercisable at the time of Optionee’s cessation of Service. Upon the expiration of such limited exercise period or (if earlier) upon the Expiration Date, this option shall terminate and cease to be outstanding for any vested Option Shares for which the option has not
 
2

been exercised. However, this option shall, immediately upon Optionee’s cessation of Service for any reason, terminate and cease to be outstanding with respect to any Option Shares in which Optionee is not otherwise at that time vested or for which this option is not otherwise at that time exercisable.
 
(vi)    Should Optionee’s Service be terminated for Misconduct or should Optionee otherwise engage in Misconduct while this option is outstanding, then this option shall terminate immediately and cease to remain outstanding.
 
6.     Special Acceleration of Option
 
(a)    This option, to the extent outstanding at the time of a Corporate Transaction but not otherwise fully exercisable, shall automatically accelerate so that this option shall, immediately prior to the effective date of the Corporate Transaction, become exercisable for all of the Option Shares at the time subject to this option and may be exercised for any or all of those Option Shares as fully-vested shares of Common Stock. No such acceleration of this option, however, shall occur if and to the extent: (i) this option is, in connection with the Corporate Transaction, either to be assumed by the successor corporation (or parent thereof) or to be replaced with a comparable option to purchase shares of the capital stock of the successor corporation (or parent thereof) or (ii) this option is to be replaced with a cash incentive program of the successor corporation which preserves the spread existing on the unvested Option Shares at the time of the Corporate Transaction (the excess of the Fair Market Value of those Option Shares over the aggregate Exercise Price payable for such shares) and provides for subsequent pay-out in accordance with the same option exercise/vesting schedule set forth in the Grant Notice. The determination of option comparability under clause (i) shall be made by the Plan Administrator, and such determination shall be final, binding and conclusive.
 
(b)    Immediately following the Corporate Transaction, this option shall terminate and cease to be outstanding, except to the extent assumed by the successor corporation (or parent thereof) in connection with the Corporate Transaction.
 
(c)    If this option is assumed in connection with a Corporate Transaction, then this option shall be appropriately adjusted, immediately after such Corporate Transaction, to apply to the number and class of securities which would have been issuable to Optionee in consummation of such Corporate Transaction had the option been exercised immediately prior to such Corporate Transaction, and appropriate adjustments shall also be made to the Exercise Price, provided the aggregate Exercise Price shall remain the same.
 
(d)    This Agreement shall not in any way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets.
 
7.     Adjustment in Option Shares .    Should any change be made to the Common Stock by reason of any stock split, stock dividend, recapitalization, combination of
 
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shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation’s receipt of consideration, appropriate adjustments shall be made to (i) the total number and/or class of securities subject to this option and (ii) the Exercise Price in order to reflect such change and thereby preclude a dilution or enlargement of benefits hereunder.
 
8.     Shareholder Rights .    The holder of this option shall not have any shareholder rights with respect to the Option Shares until such person shall have exercised the option, paid the Exercise Price and become a holder of record of the purchased shares.
 
9.     Manner of Exercising Option .
 
(a)    In order to exercise this option with respect to all or any part of the Option Shares for which this option is at the time exercisable, Optionee (or any other person or persons exercising the option) must take the following actions:
 
(i)    Pay the aggregate Exercise Price for the purchased shares in one or more of the following forms:
 
(A)    cash or check made payable to the Corporation;
 
(B)    to the extent the option is exercised for vested Option Shares, through a special sale and remittance procedure pursuant to which Optionee (or any other person or persons exercising the option) shall concurrently provide irrevocable written instructions (I) to a Corporation-designated brokerage firm to effect the immediate sale of the purchased shares and remit to the Corporation, out of the sale proceeds available on the settlement date, sufficient funds to cover the aggregate Exercise Price payable for the purchased shares plus all applicable taxes required to be withheld by the Corporation by reason of such exercise and (II) to the Corporation to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale transaction;
 
(C)    a promissory note payable to the Corporation, but only to the extent authorized by the Plan Administrator in accordance with Paragraph 13; and
 
(D)    shares of Common Stock held by Optionee (or any other person or persons exercising the option) for the requisite period necessary to avoid a charge to the Corporation’s earnings for financial reporting purposes and valued at Fair Market Value on the exercise date.
 
(ii)    Furnish to the Corporation appropriate documentation that the person or persons exercising the option (if other than Optionee) have the right to exercise this option.
 
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(iii)    Make appropriate arrangements with the Corporation (or Parent or Subsidiary employing or retaining Optionee) for the satisfaction of all tax withholding requirements applicable to the option exercise.
 
(b)    As soon as practical after the Exercise Date, the Corporation shall issue to or on behalf of Optionee (or any other person or persons exercising this option) a certificate for the purchased Option Shares, with the appropriate legends affixed thereto.
 
(c)    In no event may this option be exercised for any fractional shares.
 
(d)    Notwithstanding any other provisions of the Plan, this Agreement or any other agreement to the contrary, if at the time this option is exercised, Optionee is indebted to the Corporation (or any Parent or Subsidiary) for any reason, the following actions shall be taken, as deemed appropriate by the Plan Administrator:
 
(i)    any shares of Common Stock to be issued upon such exercise shall automatically be pledged against Optionee’s outstanding indebtedness; and
 
(ii)    if this option is exercised in accordance with subparagraph 9(a)(i)(B) above, the after tax proceeds of the sale of Optionee’s stock shall automatically be applied to the outstanding balance of Optionee’s indebtedness.
 
10.     Compliance with Laws and Regulations.
 
(a)    The exercise of this option and the issuance of the Option Shares upon such exercise shall be subject to compliance by the Corporation and Optionee with all applicable requirements of law relating thereto and with all applicable regulations of any stock exchange (or the Nasdaq National Market, if applicable) on which the Common Stock may be listed for trading at the time of such exercise and issuance.
 
(b)    The inability of the Corporation to obtain approval from any regulatory body having authority deemed by the Corporation to be necessary to the lawful issuance and sale of any Common Stock pursuant to this option shall relieve the Corporation of any liability with respect to the non-issuance or sale of the Common Stock as to which such approval shall not have been obtained. The Corporation, however, shall use its best efforts to obtain all such approvals.
 
11.     Successors and Assigns .    Except to the extent otherwise provided in Paragraphs 3 and 6, the provisions of this Agreement shall inure to the benefit of, and be binding upon, the Corporation and its successors and assigns and Optionee, Optionee’s assigns and the legal representatives, heirs and legatees of Optionee’s estate.
 
12.     Notices .    Any notice required to be given or delivered to the Corporation under the terms of this Agreement shall be in writing and addressed to the Corporation at its
 
5

 
principal corporate offices. Any notice required to be given or delivered to Optionee shall be in writing and addressed to Optionee at the address indicated below Optionee’s signature line on the Grant Notice. All notices shall be deemed effective upon personal delivery or upon deposit in the U.S. mail, postage prepaid and properly addressed to the party to be notified.
 
13.     Financing .    The Plan Administrator may, in its absolute discretion and without any obligation to do so, permit Optionee to pay the Exercise Price for the purchased Option Shares by delivering a full-recourse promissory note payable to the Corporation. The terms of any such promissory note (including the interest rate, the requirements for collateral and the terms of repayment) shall be established by the Plan Administrator in its sole discretion.
 
14.     Construction .    This Agreement and the option evidenced hereby are made and granted pursuant to the Plan and are in all respects limited by and subject to the terms of the Plan. All decisions of the Plan Administrator with respect to any question or issue arising under the Plan or this Agreement shall be conclusive and binding on all persons having an interest in this option.
 
15.     Governing Law .    The interpretation, performance and enforcement of this Agreement shall be governed by the laws of the State of California without resort to that State’s conflict-of-laws rules.
 
16.     Excess Shares .    If the Option Shares covered by this Agreement exceed, as of the Grant Date, the number of shares of Common Stock which may without shareholder approval be issued under the Plan, then this option shall be void with respect to those excess shares, unless shareholder approval of an amendment sufficiently increasing the number of shares of Common Stock issuable under the Plan is obtained in accordance with the provisions of the Plan.
 
17.     Additional Terms Applicable to an Incentive Option .    In the event this option is designated an Incentive Option in the Grant Notice, the following terms and conditions shall also apply to the grant:
 
(a)    This option shall cease to qualify for favorable tax treatment as an Incentive Option if (and to the extent) this option is exercised for one or more Option Shares: (A) more than three (3) months after the date Optionee ceases to be an Employee for any reason other than death or Permanent Disability or (B) more than twelve (12) months after the date Optionee ceases to be an Employee by reason of Permanent Disability.
 
(b)    No installment under this option shall qualify for favorable tax treatment as an Incentive Option if (and to the extent) the aggregate Fair Market Value (determined at the Grant Date) of the Common Stock for which such installment first becomes exercisable hereunder would, when added to the aggregate value (determined as of the respective date or dates of grant) of the Common Stock or other securities for which this option or any other Incentive Options granted to Optionee prior to the Grant Date (whether under the Plan or any other option plan of the Corporation or any Parent or Subsidiary) first become exercisable during the same calendar year, exceed One Hundred Thousand Dollars ($100,000) in the aggregate.
 
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Should such One Hundred Thousand Dollar ($100,000) limitation be exceeded in any calendar year, this option shall nevertheless become exercisable for the excess shares in such calendar year as a Non-Statutory Option.
 
(c)    Should the exercisability of this option be accelerated upon a Corporate Transaction, then this option shall qualify for favorable tax treatment as an Incentive Option only to the extent the aggregate Fair Market Value (determined at the Grant Date) of the Common Stock for which this option first becomes exercisable in the calendar year in which the Corporate Transaction occurs does not, when added to the aggregate value (determined as of the respective date or dates of grant) of the Common Stock or other securities for which this option or one or more other Incentive Options granted to Optionee prior to the Grant Date (whether under the Plan or any other option plan of the Corporation or any Parent or Subsidiary) first become exercisable during the same calendar year, exceed One Hundred Thousand Dollars ($100,000) in the aggregate. Should the applicable One Hundred Thousand Dollar ($100,000) limitation be exceeded in the calendar year of such Corporate Transaction, the option may nevertheless be exercised for the excess shares in such calendar year as a Non-Statutory Option.
 
(d)    Should Optionee hold, in addition to this option, one or more other options to purchase Common Stock which become exercisable for the first time in the same calendar year as this option, then the foregoing limitations on the exercisability of such options as Incentive Options shall be applied on the basis of the order in which such options are granted.
 
18.     Leave of Absence .    The following provisions shall apply upon the Optionee’s commencement of an authorized leave of absence:
 
(a)    The exercise schedule in effect under the Grant Notice shall be frozen as of the first day of the authorized leave, and this option shall not become exercisable for any additional installments of the Option Shares during the period Optionee remains on such leave.
 
(b)    If the option is designated as an Incentive Option in the Grant Notice, then the following additional provision shall apply:
 
If the leave of absence continues for more than ninety (90) days, then this option shall automatically convert to a Non-Statutory Option under the Federal tax laws at the end of the three (3)-month period measured from the ninety-first (91st) day of such leave, unless the Optionee’s reemployment rights are guaranteed by statute or by written agreement. Following any such conversion of the option, all subsequent exercises of such option, whether effected before or after Optionee’s return to active Employee status, shall result in an immediate taxable event, and the Corporation shall be required to collect from Optionee all withholding taxes applicable to such exercise.
 
(c)    In no event shall this option become exercisable for any additional Option Shares or otherwise remain outstanding if Optionee does not resume Employee status prior to the Expiration Date of the option term.
 
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19.      Further Instruments .    The parties agree to execute such further instruments and to take such further action as may be reasonably necessary to carry out the purposes and intent of this Agreement.
 
20.      Authorization to Release Necessary Personal Information .
 
(a)    Optionee hereby authorizes and directs Optionee’s employer to collect, use and transfer in electronic or other form, any personal information (the “Data”) regarding Optionee’s employment, the nature and amount of Optionee’s compensation and the fact and conditions of Optionee’s participation in the Plan (including, but not limited to, Optionee’s name, home address, telephone number, date of birth, social security number (or any other social or national identification number), salary, nationality, job title, number of shares of Common Stock held and the details of all options or any other entitlement to shares of Common Stock awarded, cancelled, exercised, vested, unvested or outstanding) for the purpose of implementing, administering and managing Optionee’s participation in the Plan. Optionee understands that the Data may be transferred to the Corporation or any of its Subsidiaries, or to any third parties assisting in the implementation, administration and management of the Plan, including any requisite transfer to a broker or other third party assisting with the exercise of Options under the Plan or with whom shares of Common Stock acquired upon exercise of this option or cash from the sale of such shares may be deposited. Optionee acknowledges that recipients of the Data may be located in different countries, and those countries may have data privacy laws and protections different from those in the country of Optionee’s residence. Furthermore, Optionee acknowledges and understands that the transfer of the Data to the Corporation or any of its Subsidiaries, or to any third parties is necessary for Optionee’s participation in the Plan.
 
(b)    Optionee may at any time withdraw the consents herein, by contacting Optionee’s local human resources representative in writing. Optionee further acknowledges that withdrawal of consent may affect Optionee’s ability to exercise or realize benefits from the option, and Optionee’s ability to participate in the Plan.
 
21.      No Entitlement or Claims for Compensation .
 
(a)    The grant of options under the Plan is made at the discretion of the Plan Administrator, and the Plan may be suspended or terminated by the Corporation at any time. The grant of an option in one year or at one time does not in any way entitle Optionee to an option grant in the future. The Plan is wholly discretionary in nature and is not to be considered part of Optionee’s normal or expected compensation subject to severance, resignation, redundancy or similar compensation. The value of the option is an extraordinary item of compensation which is outside the scope of Optionee’s employment contract (if any).
 
(b)    Optionee shall have no rights to compensation or damages as a result of Optionee’s Cessation of Service for any reason whatsoever, whether or not in breach of contract, insofar as those rights arise or may arise from Optionee’s ceasing to have rights under or be entitled to exercise this option as a result of such cessation or from the loss or diminution in
 
8

 
value of such rights. If Optionee did acquire any such rights, Optionee is deemed to have waived them irrevocably by accepting the option.

9

 
Appendix
 
The following definitions shall be in effect under the Agreement:
 
A.     Agreement shall mean this Stock Option Agreement.
 
B.     Board shall mean the Corporation’s Board of Directors.
 
C.     Code shall mean the Internal Revenue Code of 1986, as amended.
 
D.     Common Stock shall mean the Corporation’s common stock.
 
E.     Corporate Transaction shall mean either of the following shareholder-approved transactions to which the Corporation is a party:
 
(i)    a merger or consolidation in which securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation’s outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction, or
 
(ii)    the sale, transfer or other disposition of all or substantially all of the Corporation’s assets in complete liquidation or dissolution of the Corporation.
 
F.     Corporation shall mean Cisco Systems, Inc., a California corporation.
 
G.     Employee shall mean an individual who is in the employ of the Corporation (or any Parent or Subsidiary), subject to the control and direction of the employer entity as to both the work to be performed and the manner and method of performance.
 
H.     Exercise Date shall mean the date on which the option shall have been exercised in accordance with Paragraph 9 of the Agreement.
 
I.     Exercise Price shall mean the exercise price per share as specified in the Grant Notice.
 
J.     Expiration Date shall mean the date on which the option expires as specified in the Grant Notice.
 
K.     Fair Market Value per share of Common Stock on any relevant date shall be determined in accordance with the following provisions:
 
(i)    If the Common Stock is at the time traded on the Nasdaq National Market, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question, as the price is reported by the National Association of Securities Dealers on the Nasdaq National Market or any
 
A-1

successor system. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.
 
(ii)    If the Common Stock is at the time listed on any Stock Exchange, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question on the Stock Exchange determined by the Plan Administrator to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.
 
L.     Grant Date shall mean the date of grant of the option as specified in the Grant Notice.
 
M.     Grant Notice shall mean the Notice of Grant of Stock Option accompanying the Agreement, pursuant to which Optionee has been informed of the basic terms of the option evidenced hereby.
 
N.     Incentive Option shall mean an option which satisfies the requirements of Code Section 422.
 
O.     Misconduct shall mean the commission of any act of fraud, embezzlement or dishonesty by Optionee, any unauthorized use or disclosure by Optionee of confidential information or trade secrets of the Corporation (or any Parent or Subsidiary), or any other intentional misconduct by Optionee adversely affecting the business or affairs of the Corporation (or any Parent or Subsidiary) in a material manner. The foregoing definition shall not be deemed to be inclusive of all the acts or omissions which the Corporation (or any Parent or Subsidiary) may consider as grounds for the dismissal or discharge of Optionee or any other individual in the Service of the Corporation (or any Parent or Subsidiary).
 
P.     Non-Statutory Option shall mean an option not intended to satisfy the requirements of Code Section 422.
 
Q.     Option Shares shall mean the number of shares of Common Stock subject to the option as specified in the Grant Notice.
 
R.     Optionee shall mean the person to whom the option is granted as specified in the Grant Notice.
 
S.     Parent shall mean any corporation (other than the Corporation) in an unbroken chain of corporations ending with the Corporation, provided each corporation in the unbroken chain (other than the Corporation) owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.
 
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T.     Permanent Disability shall mean the inability of Optionee to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which is expected to result in death or has lasted or can be expected to last for a continuous period of twelve (12) months or more.
 
U.     Plan shall mean the Corporation’s 1996 Stock Incentive Plan.
 
V.     Plan Administrator shall mean either the Board or a committee of the Board acting in its administrative capacity under the Plan.
 
W.     Service shall mean the Optionee’s performance of services for the Corporation (or any Parent or Subsidiary) in the capacity of an Employee, a non-employee member of the board of directors or a consultant or independent advisor.
 
X.     Stock Exchange shall mean the American Stock Exchange or the New York Stock Exchange.
 
Y.     Subsidiary shall mean any corporation (other than the Corporation) in an unbroken chain of corporations beginning with the Corporation, provided each corporation (other than the last corporation) in the unbroken chain owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

A-3

 
INITIAL GRANT
 
CISCO SYSTEMS, INC.
NOTICE OF GRANT OF NON-EMPLOYEE DIRECTOR
AUTOMATIC STOCK OPTION
 
Notice is hereby given of the following option grant (the “Option”) to purchase shares of the Common Stock of Cisco Systems, Inc. (the “Corporation”):
 
Optionee :                                                                                                                            	  	 	
 
Grant Date :                                                                                                                         	  	 	
 
Exercise Price : $                                                                                                    per share	  	 	
 
Number of Option Shares :                                                                                    shares	  	 	
 
Expiration Date :                                                                                                                     	  	 	
 
Type of Option :    Non-Statutory Stock Option 	
 
Date Exercisable :    Immediately Exercisable 	
 
Vesting Schedule :    The Option Shares shall initially be unvested and subject to repurchase by the Corporation at the Exercise Price paid per share. Optionee shall acquire a vested interest in, and the Corporation’s repurchase right shall accordingly lapse with respect to, the Option Shares in a series of four (4) successive equal annual installments upon the Optionee’s completion of each year of service as a member of the Corporation’s Board of Directors (the “Board”) over the four (4)-year period measured from the Grant Date. In no event shall any additional Option Shares vest after Optionee’s cessation of Board service.	
 
Optionee understands and agrees that the Option is granted subject to and in accordance with the terms of the automatic option grant program under the Cisco Systems, Inc. 1996 Stock Incentive Plan (the “Plan”). Optionee further agrees to be bound by the terms of the Plan and the terms of the Option as set forth in the Automatic Stock Option Agreement attached hereto as Exhibit A .
 
Optionee hereby acknowledges receipt of a copy of the official prospectus for the Plan in the form attached hereto as Exhibit B . A copy of the Plan is available upon request made to the Corporate Secretary at the Corporation’s principal offices.

 
REPURCHASE RIGHT .    OPTIONEE HEREBY AGREES THAT ALL UNVESTED OPTION SHARES ACQUIRED UPON THE EXERCISE OF THE OPTION SHALL NOT BE TRANSFERABLE AND SHALL BE SUBJECT TO REPURCHASE BY THE CORPORATION, AT THE EXERCISE PRICE PAID PER SHARE, UPON OPTIONEE’S TERMINATION OF SERVICE AS A MEMBER OF THE CORPORATION’S BOARD OF DIRECTORS PRIOR TO VESTING IN THOSE SHARES. THE TERMS AND CONDITIONS OF SUCH REPURCHASE RIGHT SHALL BE SPECIFIED IN A STOCK PURCHASE AGREEMENT, IN FORM AND SUBSTANCE SATISFACTORY TO THE CORPORATION, EXECUTED BY OPTIONEE AT THE TIME OF THE OPTION EXERCISE.
 
No Impairment of Rights .    Nothing in this Notice or in the attached Automatic Stock Option Agreement or the Plan shall interfere with or otherwise restrict in any way the rights of the Corporation or the Corporation’s shareholders to remove Optionee from the Board at any time in accordance with the provisions of applicable law.
 
Definitions .    All capitalized terms in this Notice shall have the meaning assigned to them in this Notice or in the attached Automatic Stock Option Agreement.
 
DATED:                                    ,             
 
CISCO SYSTEMS, INC.	
	
By:                                                                                                   	
	
Title:                                                                                               	

 
                                                                                                         	
OPTIONEE	
	
Address:                                                                                         	

 
ATTACHMENTS
Exhibit A—Automatic Stock Option Agreement
Exhibit B—Plan Summary and Prospectus
 
2

EXHIBIT A
 
AUTOMATIC STOCK OPTION AGREEMENT

EXHIBIT B
 
PLAN SUMMARY AND PROSPECTUS

ANNUAL GRANT
 
CISCO SYSTEMS, INC.
NOTICE OF GRANT OF NON-EMPLOYEE DIRECTOR
AUTOMATIC STOCK OPTION
 
Notice is hereby given of the following option grant (the “Option”) to purchase shares of the Common Stock of Cisco Systems, Inc. (the “Corporation”):
 
Optionee:	  	                                                                                                                                                                           	
		
Grant Date:	  	                                                                                                                                                                        	
		
Exercise Price:	  	$                                  per share	
		
Number of Option Shares:	  	                                     shares	
		
Expiration Date:	  	                                                                                                                                                                        	
		
Type of Option:	  	Non-Statutory Stock Option	
		
Date Exercisable:	  	Immediately Exercisable	
		
Vesting Schedule : The Option Shares shall initially be unvested and subject to repurchase by the Corporation at the Exercise Price paid per share. Optionee shall acquire a vested interest in, and the Corporation’s repurchase right shall accordingly lapse with respect to, the Option Shares in a series of two (2) successive equal annual installments upon Optionee’s completion of each year of service as a member of the Corporation’s Board of Directors (the “Board”) over the two (2)-year period measured from the Grant Date. In no event shall any additional Option Shares vest after Optionee’s cessation of Board service.	
 
Optionee understands and agrees that the Option is granted subject to and in accordance with the terms of the automatic option grant program under the Cisco Systems, Inc. 1996 Stock Incentive Plan (the “Plan”). Optionee further agrees to be bound by the terms of the Plan and the terms of the Option as set forth in the Automatic Stock Option Agreement attached hereto as Exhibit A .
 
Optionee hereby acknowledges receipt of a copy of the official prospectus for the Plan in the form attached hereto as Exhibit B . A copy of the Plan is available upon request made to the Corporate Secretary at the Corporation’s principal offices.
 
REPURCHASE RIGHT .    OPTIONEE HEREBY AGREES THAT ALL UNVESTED OPTION SHARES ACQUIRED UPON THE EXERCISE OF THE OPTION SHALL NOT BE TRANSFERABLE AND SHALL BE SUBJECT TO REPURCHASE BY THE CORPORATION, AT THE EXERCISE PRICE PAID PER SHARE, UPON OPTIONEE’S TERMINATION OF SERVICE AS A MEMBER OF THE

CORPORATION’S BOARD OF DIRECTORS PRIOR TO VESTING IN THOSE SHARES. THE TERMS AND CONDITIONS OF SUCH REPURCHASE RIGHT SHALL BE SPECIFIED IN A STOCK PURCHASE AGREEMENT, IN FORM AND SUBSTANCE SATISFACTORY TO THE CORPORATION, EXECUTED BY OPTIONEE AT THE TIME OF THE OPTION EXERCISE.
 
No Impairment of Rights .    Nothing in this Notice or in the attached Automatic Stock Option Agreement or the Plan shall interfere with or otherwise restrict in any way the rights of the Corporation or the Corporation’s shareholders to remove Optionee from the Board at any time in accordance with the provisions of applicable law.
 
Definitions .    All capitalized terms in this Notice shall have the meaning assigned to them in this Notice or in the attached Automatic Stock Option Agreement.
 
DATED:                                          ,             
 
CISCO SYSTEMS, INC .	
	
By:                                                                                                   	
	
Title:                                                                                               	

 
                                                                                                         	
OPTIONEE	
	
Address:                                                                                         	

 
ATTACHMENTS
Exhibit A - Automatic Stock Option Agreement
Exhibit B - Plan Summary and Prospectus

2

EXHIBIT A
 
AUTOMATIC STOCK OPTION AGREEMENT

EXHIBIT B
 
PLAN SUMMARY AND PROSPECTUS

CISCO SYSTEMS, INC.
AUTOMATIC STOCK OPTION AGREEMENT
 
RECITALS
 
A.    The Corporation has implemented an automatic option grant program under the Corporation’s 1996 Stock Incentive Plan pursuant to which eligible non-employee members of the Board will automatically receive special option grants at designated intervals over their period of Board service in order to provide such individuals with a meaningful incentive to continue to serve as a member of the Board.
 
B.    Optionee is an eligible non-employee Board member, and this Agreement is executed pursuant to, and is intended to carry out the purposes of, the Plan in connection with the automatic grant of a stock option to purchase shares of the Corporation’s Common Stock under the Plan.
 
C.    The granted option is intended to be a non-statutory option which does not meet the requirements of Section 422 of the Internal Revenue Code.
 
D.    All capitalized terms in this Agreement, to the extent not otherwise defined in the Agreement, shall have the meaning assigned to them in the attached Appendix.
 
NOW, THEREFORE , it is hereby agreed as follows:
 
1.      Grant of Option .    The Corporation hereby grants to Optionee, as of the Grant Date, a Non-Statutory Option to purchase up to the number of Option Shares specified in the Grant Notice. The Option Shares shall be purchasable from time to time during the option term specified in Paragraph 2 at the Exercise Price.
 
2.      Option Term .    This option shall have a maximum term of nine (9) years measured from the Grant Date and shall accordingly expire at the close of business on the Expiration Date, unless sooner terminated in accordance with Paragraph 5, 6 or 7.
 
3.      Limited Transferability .    This option may, in connection with the Optionee’s estate plan, be assigned in whole or in part during Optionee’s lifetime to one or more members of the Optionee’s immediate family or to a trust established for the exclusive benefit of one or more such family members. The assigned portion shall be exercisable only by the person or persons who acquire a proprietary interest in the option pursuant to such assignment. The terms applicable to the assigned portion shall be the same as those in effect for this option immediately prior to such assignment and shall be set forth in such documents issued to the assignee as the Corporation may deem appropriate. Should the Optionee die while holding this option, then this option shall be transferred in accordance with Optionee’s will or the laws of descent and distribution.

 
4.     Exercisability/Vesting .
 
(a)    This option shall be immediately exercisable for any or all of the Option Shares, whether or not the Option Shares are vested in accordance with the Vesting Schedule set forth in the Grant Notice, and shall remain so exercisable until the Expiration Date or the sooner termination of the option term under Paragraph 5, 6 or 7.
 
(b)    Optionee shall, in accordance with the Vesting Schedule set forth in the Grant Notice, vest in the Option Shares in a series of installments over his or her period of Board service. Vesting in the Option Shares may be accelerated pursuant to the provisions of Paragraph 5, 6 or 7. In no event, however, shall any additional Option Shares vest following Optionee’s cessation of service as a Board member.
 
5.      Cessation of Board Service .    Should Optionee’s service as a Board member cease while this option remains outstanding, then the option term specified in Paragraph 2 shall terminate (and this option shall cease to be outstanding) prior to the Expiration Date in accordance with the following provisions:
 
(i)    Should Optionee cease to serve as a Board member for any reason (other than death or Permanent Disability) while this option is outstanding, then the period for exercising this option shall be reduced to a twelve (12)-month period commencing with the date of such cessation of Board service, but in no event shall this option be exercisable at any time after the Expiration Date. During such limited period of exercisability, this option may not be exercised in the aggregate for more than the number of Option Shares (if any) in which Optionee is vested on the date of his or her cessation of Board service. Upon the earlier of (i) the expiration of such twelve (12)-month period or (ii) the specified Expiration Date, the option shall terminate and cease to be exercisable with respect to any vested Option Shares for which the option has not been exercised.
 
(ii)    Should Optionee die during the twelve (12)-month period following his or her cessation of Board service and hold this option at the time of his or her death, then the personal representative of Optionee’s estate or the person or persons to whom the option is transferred pursuant to Optionee’s will or in accordance with the laws of descent and distribution shall have the right to exercise this option for any or all of the Option Shares in which Optionee is vested at the time of Optionee’s cessation of Board service (less any Option Shares purchased by Optionee after such cessation of Board service but prior to death). Such right of exercise shall terminate, and this option shall accordingly cease to be exercisable for such vested Option Shares, upon the earlier of (i) the expiration of the twelve (12)-month period measured from the date of Optionee’s cessation of Board service or (ii) the specified Expiration Date of the option term. Should this option be transferred during Optionee’s lifetime in accordance with the provisions of Paragraph 3, then the transferee(s) shall have the same limited time period in which to exercise this option for any or all of those vested Option Shares.
 
2

 
        (iii)     Should Optionee cease service as a Board member by reason of death or Permanent Disability, then all Option Shares at the time subject to this option but not otherwise vested shall immediately vest in full so that Optionee (or the personal representative of Optionee’s estate or the person or persons to whom the option is transferred upon Optionee’s death or to whom the option is transferred during Optionee’s lifetime in accordance with the provisions of Paragraph 3) shall have the right to exercise this option for any or all of the Option Shares as fully-vested shares of Common Stock at any time prior to the earlier of (i) the expiration of the twelve (12)-month period measured from the date of Optionee’s cessation of Board service or (ii) the specified Expiration Date.
 
        (iv)     Upon Optionee’s cessation of Board service for any reason other than death or Permanent Disability, this option shall immediately terminate and cease to be outstanding with respect to any and all Option Shares in which Optionee is not otherwise at that time vested in accordance with the normal Vesting Schedule set forth in the Grant Notice or the special vesting acceleration provisions of Paragraph 6 or 7 below.
 
6.     Corporate Transaction.
 
        (a)     In the event of a Corporate Transaction, all Option Shares at the time subject to this option but not otherwise vested shall automatically vest so that this option shall, immediately prior to the specified effective date for the Corporate Transaction, become fully exercisable for all of the Option Shares at the time subject to this option and may be exercised for all or any portion of such shares as fully-vested shares of Common Stock. Immediately following the consummation of the Corporate Transaction, this option shall terminate and cease to be outstanding, except to the extent assumed by the successor corporation or its parent company.
 
        (b)     If this option is assumed in connection with a Corporate Transaction, then this option shall be appropriately adjusted, immediately after such Corporate Transaction, to apply to the number and class of securities which would have been issuable to Optionee in consummation of such Corporate Transaction had the option been exercised immediately prior to such Corporate Transaction, and appropriate adjustments shall also be made to the Exercise Price, provided the aggregate Exercise Price shall remain the same.
 
7.     Change in Control/Hostile Take-Over.
 
        (a)     All Option Shares subject to this option at the time of a Change in Control but not otherwise vested shall automatically vest so that this option shall, immediately prior to the effective date of such Change in Control, become fully exercisable for all of the Option Shares at the time subject to this option and may be exercised for all or any portion of such shares as fully-vested shares of Common Stock. This option shall remain exercisable for such fully-vested Option Shares until the earliest to occur of (i) the specified Expiration Date, (ii) the sooner termination of this option in accordance with Paragraph 5 or 6 or (iii) the surrender of this option under Paragraph 7(b).
 
3

 
        (b)    Optionee shall have an unconditional right (exercisable during the thirty (30)-day period immediately following the consummation of a Hostile Take-Over) to surrender this option to the Corporation in exchange for a cash distribution from the Corporation in an amount equal to the excess of (i) the Take-Over Price of the Option Shares at the time subject to the surrendered option (whether or not those Option Shares are otherwise at the time vested) over (ii) the aggregate Exercise Price payable for such shares. This Paragraph 7(b) limited stock appreciation right shall in all events terminate upon the expiration or sooner termination of the option term and may not be assigned or transferred by Optionee.
 
        (c)    To exercise the Paragraph 7(b) limited stock appreciation right, Optionee must, during the applicable thirty (30)-day exercise period, provide the Corporation with written notice of the option surrender in which there is specified the number of Option Shares as to which the option is being surrendered. Such notice must be accompanied by the return of Optionee’s copy of this Agreement, together with any written amendments to such Agreement. The cash distribution shall be paid to Optionee within five (5) business days following such delivery date. Such option surrender and cash distribution has been pre-approved by the Corporation’s shareholders in connection with their approval of the Plan, and no additional approval of the Plan Administrator or the Board shall be required at the time of the actual option surrender and cash distribution. Upon receipt of such cash distribution, this option shall be cancelled with respect to the shares subject to the surrendered option (or the surrendered portion), and Optionee shall cease to have any further right to acquire those Option Shares under this Agreement. The option shall, however, remain outstanding for the balance of the Option Shares (if any) in accordance with the terms and provisions of this Agreement, and the Corporation shall accordingly issue a new stock option agreement (substantially in the same form as this Agreement) for those remaining Option Shares.
 
8.      Adjustment in Option Shares .    Should any change be made to the Common Stock by reason of any stock split, stock dividend, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation’s receipt of consideration, appropriate adjustments shall be made to (i) the number and/or class of securities subject to this option and (ii) the Exercise Price in order to reflect such change and thereby preclude a dilution or enlargement of benefits hereunder; provided, however, that the aggregate Exercise Price shall remain the same.
 
9.      Shareholder Rights .    The holder of this option shall not have any shareholder rights with respect to the Option Shares until such person shall have exercised the option, paid the Exercise Price and become a holder of record of the purchased shares.
 
10.     Manner of Exercising Option.
 
        (a)    In order to exercise this option for all or any part of the Option Shares for which the option is at the time exercisable, Optionee or, in the case of exercise after Optionee’s death, Optionee’s executor, administrator, heir or legatee, as the case may be, must take the following actions:
 
4

 
        (i)    To the extent the option is exercised for vested Option Shares, the Secretary of the Corporation shall be provided with written notice of the option exercise (the “Exercise Notice”) in substantially the form of Exhibit I attached hereto, in which there is specified the number of vested Option Shares to be purchased under the exercised option. To the extent that the option is exercised for one or more unvested Option Shares, Optionee (or other person exercising the option) shall deliver to the Secretary of the Corporation a Purchase Agreement for those unvested Option Shares.
 
        (ii)    The Exercise Price for the purchased shares shall be paid in one or more of the following alternative forms:
 
        –     cash or check made payable to the Corporation’s order; or
 
        –     shares of Common Stock held by Optionee (or any other person or persons exercising the option) for the requisite period necessary to avoid a charge to the Corporation’s earnings for financial reporting purposes and valued at Fair Market Value on the Exercise Date; or
 
        –     to the extent the option is exercised for vested Option Shares, through a special sale and remittance procedure pursuant to which Optionee shall provide irrevocable written instructions (A) to a Corporation-designated brokerage firm to effect the immediate sale of the vested shares purchased under the option and remit to the Corporation, out of the sale proceeds available on the settlement date, sufficient funds to cover the aggregate Exercise Price payable for those shares plus the applicable Federal, state and local income taxes required to be withheld by the Corporation by reason of such exercise and (B) to the Corporation to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale.
 
        (iii)    Appropriate documentation evidencing the right to exercise this option shall be furnished the Corporation if the person or persons exercising the option is other than Optionee.
 
        (iv)    Appropriate arrangement must be made with the Corporation for the satisfaction of all Federal, state and local income tax withholding requirements applicable to the option exercise.
 
        (b)    Except to the extent the sale and remittance procedure specified above is utilized in connection with the exercise of the option for vested Option Shares, payment of the Exercise Price for the purchased shares must accompany the Exercise Notice or Purchase Agreement delivered to the Corporation in connection with the option exercise.
 
5

 
        (c)     As soon as practical after the Exercise Date, the Corporation shall issue to or on behalf of Optionee (or any other person or persons exercising this option) a certificate or certificates representing the purchased Option Shares. To the extent any such Option Shares are unvested, the certificates for those Option Shares shall be endorsed with an appropriate legend evidencing the Corporation’s repurchase rights and may be held in escrow with the Corporation until such shares vest.
 
        (d)     In no event may this option be exercised for fractional shares.
 
11.     No Impairment of Rights .     This Agreement shall not in any way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise make changes in its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets. In addition, nothing in this Agreement shall in any way be construed or interpreted so as to affect adversely or otherwise impair the right of the Corporation or the shareholders to remove Optionee from the Board at any time in accordance with the provisions of applicable law.
 
12.     Compliance with Laws and Regulations .
 
        (a)    The exercise of this option and the issuance of the Option Shares upon such exercise shall be subject to compliance by the Corporation and Optionee with all applicable requirements of law relating thereto and with all applicable regulations of any stock exchange (or the Nasdaq National Market, if applicable) on which the Common Stock may be listed for trading at the time of such exercise and issuance.
 
        (b)     The inability of the Corporation to obtain approval from any regulatory body having authority deemed by the Corporation to be necessary to the lawful issuance and sale of any Common Stock pursuant to this option shall relieve the Corporation of any liability with respect to the non-issuance or sale of the Common Stock as to which such approval shall not have been obtained. However, the Corporation shall use its best efforts to obtain all such applicable approvals.
 
13.     Successors and Assigns .    Except to the extent otherwise provided in Paragraph 3 or 6, the provisions of this Agreement shall inure to the benefit of, and be binding upon, the Corporation and its successors and assigns and Optionee, Optionee’s assigns and the legal representatives, heirs and legatees of Optionee’s estate.
 
14.     Construction/Governing Law .    This Agreement and the option evidenced hereby are made and granted pursuant to the automatic option grant program in effect under the Plan and are in all respects limited by and subject to the express terms and provisions of that program. The interpretation, performance, and enforcement of this Agreement shall be governed by the laws of the State of California without resort to that State’s conflict-of-laws rules.
 
6

 
15.     Notices .     Any notice required to be given or delivered to the Corporation under the terms of this Agreement shall be in writing and addressed to the Corporation at its principal corporate offices. Any notice required to be given or delivered to Optionee shall be in writing and addressed to Optionee at the address indicated below Optionee’s signature line on the Grant Notice. All notices shall be deemed effective upon personal delivery or upon deposit in the U.S. mail, postage prepaid and properly addressed to the party to be notified.
 
7

 
EXHIBIT I
 
NOTICE OF EXERCISE
 
I hereby notify Cisco Systems, Inc. (the “Corporation”) that I elect to purchase              shares of the Corporation’s Common Stock (the “Purchased Shares”) at the option exercise price of $              per share (the “Exercise Price”) pursuant to that certain option (the “Option”) granted to me pursuant to the automatic option grant program under the Corporation’s 1996 Stock Incentive Plan on                              ,                  .
 
Concurrently with the delivery of this Exercise Notice to the Secretary of the Corporation, I shall hereby pay to the Corporation the Exercise Price for the Purchased Shares in accordance with the provisions of my agreement with the Corporation evidencing the Option and shall deliver whatever additional documents may be required by such agreement as a condition for exercise. Alternatively, I may utilize the special broker/dealer sale and remittance procedure specified in my agreement to effect payment of the Exercise Price for any Purchased Shares in which I am vested at the time of exercise.
 
_________________________, ________
Date
 	 	                                                                                                                                                  	
 	 	Optionee	

 	 	Address:                                                                                                                                    	

Print name in exact manner
it is to appear on the
stock certificate:	 	                                                                                                                                                  	
 	 	 	
Address to which certificate
is to be sent, if different
from address above:	 	                                                                                                                                                  	

 	 	 	
Social Security Number:	 	                                                                                                                                                  	

 
APPENDIX
 
The following definitions shall be in effect under the Agreement:
 
A.     Agreement shall mean this Automatic Stock Option Agreement.
 
B.     Board shall mean the Corporation’s Board of Directors.
 
C.     Change in Control shall mean a change in ownership or control of the Corporation effected through either of the following transactions:
 
(i)     the acquisition, directly or indirectly, by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation) of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than thirty-five percent (35%) of the total combined voting power of the Corporation’s outstanding securities pursuant to a tender or exchange offer made directly to the Corporation’s shareholders which the Board does not recommend such shareholders to accept, or
 
(ii)     a change in the composition of the Board over a period of thirty-six (36) consecutive months or less such that a majority of the Board members ceases, by reason of one or more contested elections for Board membership, to be comprised of individuals who either (A) have been Board members continuously since the beginning of such period or (B) have been elected or nominated for election as Board members during such period by at least a majority of the Board members described in clause (A) who were still in office at the time the Board approved such election or nomination.
 
D.     Code shall mean the Internal Revenue Code of 1986, as amended.
 
E.     Common Stock shall mean the Corporation’s common stock.
 
F.     Corporate Transaction shall mean either of the following shareholder-approved transactions to which the Corporation is a party:
 
(i)     a merger or consolidation in which securities possessing more than fifty percent (50%) of the total combined voting power of the Corporation’s outstanding securities are transferred to a person or persons different from the persons holding those securities immediately prior to such transaction, or
 
(ii)     the sale, transfer or other disposition of all or substantially all of the Corporation’s assets in complete liquidation or dissolution of the Corporation.
 
A-1

 
G.     Corporation shall mean Cisco Systems, Inc., a California corporation.
 
H.     Exercise Date shall mean the date on which the option shall have been exercised in accordance with Paragraph 10 of the Agreement.
 
I.     Exercise Price shall mean the exercise price payable per share as specified in the Grant Notice.
 
J.     Expiration Date shall mean the date on which the option term expires as specified in the Grant Notice.
 
K.     Fair Market Value per share of Common Stock on any relevant date shall be determined in accordance with the following provisions:
 
(i)     If the Common Stock is at the time traded on the Nasdaq National Market, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question, as the price is reported on the Nasdaq National Market. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.
 
(ii)     If the Common Stock is at the time listed on any Stock Exchange, then the Fair Market Value shall be the closing selling price per share of Common Stock on the date in question on the Stock Exchange determined by the Plan Administrator to be the primary market for the Common Stock, as such price is officially quoted in the composite tape of transactions on such exchange. If there is no closing selling price for the Common Stock on the date in question, then the Fair Market Value shall be the closing selling price on the last preceding date for which such quotation exists.
 
L.     Grant Date shall mean the date of grant of the option as specified in the Grant Notice.
 
M.     Grant Notice shall mean the Notice of Grant of Automatic Stock Option accompanying this Agreement, pursuant to which Optionee has been informed of the basic terms of the option evidenced hereby.
 
N.     Hostile Take-Over shall mean the acquisition, directly or indirectly, by any person or related group of persons (other than the Corporation or a person that directly or indirectly controls, is controlled by, or is under common control with, the Corporation) of beneficial ownership (within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing more than thirty five percent (35%) of the total combined voting power of the Corporation’s outstanding securities pursuant to a tender or exchange offer made directly to the Corporation’s shareholders which the Board does not recommend such shareholders to accept.
 
O.     1934 Act shall mean the Securities Exchange Act of 1934, as amended.
 
A-2

 
P.      Non-Statutory Option shall mean an option not intended to satisfy the requirements of Code Section 422.
 
Q.      Option Shares shall mean the number of shares of Common Stock subject to the option.
 
R.      Optionee shall mean the person to whom the option is granted as specified in the Grant Notice.
 
S.      Permanent Disability shall mean the inability of Optionee to perform his or her usual duties as a Board member by reason of any medically determinable physical or mental impairment which is expected to result in death or has lasted or can be expected to last for a continuous period of twelve (12) months or more.
 
T.      Plan shall mean the Corporation’s 1996 Stock Incentive Plan.
 
U.      Purchase Agreement shall mean the stock purchase agreement (in form and substance satisfactory to the Corporation) which must be executed at the time the option is exercised for unvested Option Shares and which will accordingly (i) grant the Corporation the right to repurchase, at the Exercise Price, any and all of those Option Shares in which Optionee is not otherwise vested at the time of his or her cessation of service as a Board member and (ii) preclude the sale, transfer or other disposition of any of the Option Shares purchased under such agreement while those Option Shares remain subject to the repurchase right.
 
V.      Stock Exchange shall mean the American Stock Exchange or the New York Stock Exchange.
 
W.      Take-Over Price shall mean the greater of (i) the Fair Market Value per share of Common Stock on the date the option is surrendered to the Corporation in connection with a Hostile Take-Over or (ii) the highest reported price per share of Common Stock paid by the tender offeror in effecting the Hostile Take-Over.
 
X.      Vesting Schedule shall mean the vesting schedule specified in the Grant Notice, pursuant to which Optionee will vest in the Option Shares in one or more installments over his or her period of Board service, subject to acceleration in accordance with the provisions of the Agreement.
 
A-3

 
CISCO SYSTEMS, INC.  
STOCK ISSUANCE AGREEMENT
 
RECITALS
 
This stock issuance agreement (this “Stock Issuance Agreement”) is made and entered into as of                              by and between Cisco Systems, Inc., a California corporation having a principal place of business at 170 West Tasman Drive, San Jose, California (the “Corporation”) and                              , an individual having a principal place of business at                          (“Consultant”).
 
A.     Capitalized terms not defined in this Stock Issuance Agreement shall have the meanings assigned to such terms in the Corporation’s 1996 Stock Incentive Plan (the “Plan”).
 
B.     The Board has adopted the Plan for the purpose of retaining the services of selected employees, non-employee members of the Board or of the board of directors of any Parent or Subsidiary and consultants and other independent advisors who provide services to the Corporation (or any Parent or Subsidiary).
 
C.     Consultant is to render valuable services to the Corporation pursuant to the consulting agreement by and between the Corporation and Consultant executed on                          (the “Consulting Agreement”), and this Stock Issuance Agreement is executed pursuant to Article              of, and is intended to carry out the purposes of, the Plan in connection with the Corporation’s grant of a share right award to Consultant.
 
NOW, THEREFORE , it is hereby agreed as follows:
 
1.     GRANT OF SHARE RIGHT AWARD . In full satisfaction of its obligation under Section          of the Consulting Agreement, the Corporation hereby grants to Consultant a share right award which entitles Consultant to receive          shares of Common Stock as soon as practicable following each Issuance Date, in each case subject to Consultant having provided continuous service to the Corporation pursuant to the Consulting Agreement through each such date. In no event will Consultant be issued any shares of Common Stock following Consultant’s termination of service pursuant to the Consulting Agreement. For purposes of this Stock Issuance Agreement, “Issuance Date” shall mean                              .
 
2.     NON-TRANSFERABILITY . This share right award shall be neither transferable or assignable by Consultant.
 
3.     ADJUSTMENT IN SHARE RIGHT AWARD SHARES . If any change is made to the Common Stock by reason of any stock split, stock dividend, recapitalization, combination of shares, exchange of shares or other change affecting the outstanding Common Stock as a class without the Corporation’s or its successor’s receipt of consideration, appropriate adjustments shall be made to the number and/or class of securities in effect under the share right award made hereunder. Such adjustments are to be effected in a manner which shall preclude the enlargement or dilution of rights and benefits under such share right award.

 
4.     STOCKHOLDER RIGHTS . Consultant shall have full stockholder rights with respect to any shares of Common Stock issued to Consultant hereunder. Accordingly, Consultant have the right to vote such shares and to receive any regular cash dividends paid on such shares.
 
5.     CONSTRUCTION . This Stock Issuance Agreement and the share right award evidenced hereby are made and granted pursuant to the Plan and are in all respects limited by and subject to the terms of the Plan. All decisions of the Plan Administrator with respect to any question or issue arising under the Plan or this Stock Issuance Agreement shall be conclusive and binding on all persons having an interest in this share right award.
 
IN WITNESS WHEREOF , the parties have entered into this Stock Issuance Agreement as of the date first written above.
 
Corporation:	 	CISCO SYSTEMS, INC.	
 	 	 	
 	 	By:	  	                                                                                            	
 	 	 	  	 	
Consultant:	 	 	  	                                                                                            	
 
2

Exhibit 99.1
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
 
I, John T. Chambers, President and Chief Executive Officer of Cisco Systems, Inc. (the “Company”), do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:
 
•	 	the Quarterly Report on Form 10-Q of the Company for the quarter ended April 26, 2003, as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and	
 
•	 	the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.	
 
Date: May 14, 2003

/s/    John T. Chambers
 
John T. Chambers
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
*    A signed original of this written statement required by Section 906 has been provided to Cisco Systems, Inc. and will be retained by Cisco Systems, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

Exhibit 99.2
 
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
 
I, Dennis D. Powell, Senior Vice President and Chief Financial Officer of Cisco Systems, Inc. (the “Company”), do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:
 
•	 	the Quarterly Report on Form 10-Q of the Company for the quarter ended April 26, 2003, as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and	
 
•	 	the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.	
 
Date: May 14, 2003

/s/ Dennis D. Powell
 
Dennis D. Powell
 
Senior Vice President and Chief Financial Officer
 
(Principal Financial Officer) 
 
*     A signed original of this written statement required by Section 906 has been provided to Cisco Systems, Inc. and will be retained by Cisco Systems, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.