CISCO TO REASSURE INVESTORS OF ROSY FUTURE

December 8, 2000

COMMERCIAL NEWS

San Diego, CALIF. — As one of its more challenging years comes to a close, Wylie Wong reports that networking giant Cisco Systems will try to reassure investors that it can sustain its streak of strong financial results.

Cisco executives are expected to paint a rosy picture for the coming year despite a muddling stock price, growing competition from rival companies, and a potential slowdown next year in network equipment purchases by telecommunications carriers and Internet service providers.

The company will lay out its business strategy for the next year at its annual financial analyst meeting, a two-day affair that begins Monday in San Jose, Calif. Executives are expected to reiterate that Cisco plays in enough high-growth markets to stave off the financial woes that have afflicted rival Lucent Technologies, among others.

“All those negative issues are out there, but Cisco seems best positioned to weather through them,” said SG Cowen analyst Michael Jung. “They’re the most diversified company and can weather downturns. They have the largest breadth of products, a well-diversified geographical presence, and their markets are split between corporate and service providers.”

Investors have questioned the health of the networking industry lately as some Wall Street analysts have predicted a slowdown in telecommunications and network equipment sales next year. Emerging service providers, such as Covad Communications, PSINet and NorthPoint Communications, have struggled, which could slow or stop the pace of equipment purchases, for example.

Wall Street is increasingly watchful of the effect of these flailing businesses. While Cisco rival Nortel Networks beat earnings last quarter, for example, it missed some sales projections by analysts as sales of its flagship optical network equipment grew less than expected.

For Cisco, its falling stock price raises questions about whether the company will have to retreat from its long-running strategy of buying companies to enter new, high-growth marketing niches, such as optical networking equipment. Despite seeing its stock price fall from about $70 in mid-July to its current $48.50, the company has said repeatedly that it will continue its shopping spree.

In addition, emerging companies such as Juniper Networks have been nipping at the company’s heels, stealing market share from areas Cisco has historically dominated. In its two years selling equipment, Juniper has captured 30 percent market share for high-speed networking devices that manage heavy Net traffic for carriers, while Cisco’s market share has eroded to 68 percent, according to a recent report by the Dell’Oro Group.

Most analysts, however, remain upbeat on Cisco’s future. Morgan Stanley Dean Witter, for example, maintains a “strong buy” rating for Cisco’s stock, with a 12-month price target of $75.

“Given the company’s historically consistent earnings results, Cisco could be a safe haven for tech investors in what has been a very volatile market,” Morgan Stanley analyst Christopher Stix said in a recent report.

Analysts said Cisco is equally strong in sales of equipment to both service providers and corporations, protecting it from potential cutbacks in service provider spending in the next year. Cisco, which garners the majority of its revenue from corporate sales, expects companies to increase spending for networking equipment in the coming year.

Nine of Cisco’s 12 product families have an annual run rate of $1 billion or more, said A.G. Edwards analyst Peter Andrew. So if sales become weak in one area, other market segments can pick up the slack.

For example, Cisco last quarter said sales of high-speed Net access equipment were weaker than expected because emerging service providers were spending less, Jung said. “They did see that as weak, but despite that, they had a good quarter.”

In contrast, Lucent’s and Nortel’s revenues are tied mostly to service provider sales. In recent times, both have suffered from slower-than-expected sales of optical equipment.

Analysts expect Cisco to capture a good chunk of new, emerging markets, such as home networking, wireless equipment sales to service providers, and new networking hardware that will allow businesses to combine voice and data over a single network.

“We continue to believe that the market is moving more and more toward Cisco,” Andrew said.

Nevertheless, some analysts question whether the company can continue its strong revenue growth rates each year. Cisco in November upped its sales forecasts for its current second quarter and the 2001 fiscal year. Sequential growth will hit single or low double digits, while revenue for the fiscal year is expected to grow between 50 percent and 60 percent.

Jung estimates Cisco’s yearly revenue will grow 58 percent next year, after the company’s yearly revenue grew 32 percent in 1998, 43 percent in 1999 and 55 percent in 2000.

With overall revenue a bigger number each year, Jung expects sales growth to decline to the 25 percent to 30 percent range in 2002 and 2003. “No one is expecting a 65 percent growth increase every year. That’s against the law of large numbers,” he said.

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