November 5, 2001

Cisco has announced the financial results for its Q1, fiscal year 2002 quarter. Larry Carter, Cisco senior vice president and chief financial officer, discusses the results and Cisco's market position.

Q: How do you view the quarter? Were you pleased with the results?
A: Q1, fiscal year 2002 was a solid quarter. While there will always be areas we need to improve, given the very challenging economic environment and capital spending environment, Q1 was a solid quarter. We were especially pleased with the sequential revenue growth, the profitable market share gains, and the continued improvement in our financial performance. We were also pleased with our continued improvements in many financial areas. These improvements included gross margin, operating expenses, and balance sheet items such as day sales outstanding (DSO), inventory management, and cash generation.

Q: How is visibility moving forward? Why are you limiting guidance to Q2 FY02 only?
A: Because of very limited visibility and differing economic projections, we have limited ability to provide short-term guidance beyond Q2. However, our optimism in the longer-term, as the economies and capital spending around the world recover, remains strong. In terms of more specific industry guidance for Q2 from a revenue perspective, and obviously with the appropriate caveats given the uncertainties in the market and the challenges our peers face in the industry, we remain cautiously optimistic about the quarter and are modeling towards a flat to low sequential digit revenue increase.

Q: You've often said that Cisco is breaking away from its competitors. Do you feel performance this quarter validates this your strategy?
A: We continue to outperform our competitors in the market place. In broad terms, Cisco gained profitable market share while our top eight competitors saw revenues decline on average in the high-teens during the quarter. As we said in setting this strategy a little over a year ago, we felt there would be a rapid consolidation in the market that would evolve into fewer strong players and, that if we continued to maintain our momentum from a financial, market share, customer satisfaction, and ability to focus on both good and challenging market transitions, we had the chance to breakaway in this industry. Our results versus our industry peers this quarter are a major indication that this strategy is evolving as we anticipated. Having said that, we still have a long way to go.

Q: What is Cisco's competitive advantage in this consolidating market?
A: We believe that Cisco is the only company with the product depth, breadth of customers and geographic balance to provide consistent, end-to-end architecture in today's economic environment. We also believe that Cisco's culture of innovation, strategic risk taking and focus on market transitions is a competitive advantage. In addition, Cisco continued to make improvements in its financial strength, including increasing its cash and investments from Q4, FY01 to Q1 FY02 by approximately $550 million to $19.1 billion, with zero long-term debt. Cisco generated approximately $1.4 billion in operating cash flow during Q1. Cisco's ability to survive and compete long term is an important differentiator in the current environment. Maintaining a strong financial position gives us the flexibility to make investments in new technologies and operations that will provide for long-term success.

Q: Is Cisco gaining market share against its competitors?
A: In broad terms, we gained meaningful market share in the quarter. The eight key competitors we follow in North America, saw their revenues decrease on average in the high teens in their most recent quarterly results, while we showed 3% sequential revenue growth.

Q: Does Cisco plan additional reductions in headcount?
A: Having implemented a very difficult decision in the first half of the year, reducing headcount by approximately 20 percent since March 2001, including regular and temporary employees, and Cisco is now focused on the future. Given the projected improvement in the industry in the next 6-12 months, expenses associated with severance packages, the disruption to the business and confidence in the employee base, we do not believe that it makes sense to make dramatic changes in headcount at this time. If the market were to change in a major way versus what we are modeling, we would obviously have to adjust our expense model as well. Cisco's total reported headcount ended Q1 at 37,546, representing a net decrease of 553 over the previous quarter.

Q: How has Cisco done in terms of expense management?
A: Cisco made good progress during the quarter on our expense controls. We exceeded our $1 billion expense reduction target and achieved an annualized run rate of $2 billion, and we expect operating expenses for the second quarter to be flat to down.

Q: How have the events of September 11 affected your business?
A: As we indicated in some discussions earlier in the quarter, the events of September 11 caused only a moderate disruption in orders and linearity returned shortly after the attack, although at a slightly reduced rate. The attack occurred approximately half way through Cisco's Q1 and impacted about half of our quarter's results. There was some lost business and some replacement business orders, which we estimate at less than $100 million. While it is extremely difficult to predict, we believe the effect in Q1 and Q2 was, and will be, a reduction of about 5 percent off what would have been our best estimate of the run-rate for the time following September 11. We viewed the impact in Q1 to be primarily in the U.S. and, for Q2, will probably be more balanced throughout our entire global operations.

Q: How did Cisco do in the enterprise market?
A: In the enterprise space, we have never been closer to our customers, enjoying true customer loyalty and partnership. We continue to see momentum in our voice, video, and broadening acceptance of Cisco AVVID, our Architecture for Voice, Video and Integrated Data. We also introduced 12 new IP-based voice and video products and have reached the half-million unit milestone for our IP phones. The CatalystR 6000 Family enjoyed a strong quarter, and we introduced the industry's first 10-gigabit Ethernet modules in the Catalyst 6500 Series. Security is becoming increasingly important in this space, and Cisco became the number-one market share leader in firewall equipment worldwide.

Q: Has the U.S. service provider market leveled off?
A: This was a challenging quarter for service providers, especially in the U.S. and Europe. This is a market in transition, and we're continuing to see reduced capital spending and increased consolidation. The pattern is similar to what we've seen in the enterprise space, in terms of fewer select vendors in the network, which plays to Cisco's advantage. We are gaining market share in high-end routing, the IP core, the IP edge, and voice over IP markets. We saw solid growth in the cable space, and we shipped our 200,000th upstream port>double the number of all other vendors combined.

Q: How is Cisco doing in the commercial market?
A: In the commercial space Cisco, along with its partners, continues to enable a world where mobile business professionals can access the Internet and their corporate networks any time, anywhere. There continues to be opportunities in our commercial customer market segment as there has been a less significant drop in IT spending in this space. We continued to gain market share in our billion-dollar Catalyst 3500 and 2900 switching products, and we've also seen gains in Layer 2 and 3 fixed switching, Layer 2 managed switching, and Layer 3 gigabit switching.