Cisco Systems, Inc.
Q3 2010 Earnings Call Transcript
Published:
- Operator:
- Welcome to Cisco Systems Third Quarter and Fiscal Year 2010 Financial Results Conference Call. [Operator Instructions] Now I'd like to introduce Ms. Laura Graves, Director of Global Investor Relations, Corporate Communications for Cisco Systems. Ma'am, you may begin.
- Laura Graves:
- Thank you, operator. Good afternoon, everyone, and welcome to our 81st quarterly conference call. This is Laura Graves, and I'm joined by John Chambers, our Chairman and CEO; Frank Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, Executive Vice President of Worldwide Operations; Ned Hooper, Chief Strategy Officer and Senior Vice President of our Consumer Business; and Padmasree Warrior, our Chief Technology Officer. The Q3 fiscal year 2010 press releases is on the U.S. high-tech Marketwire and on the Cisco website at newsroom.cisco.com. I would like to remind you that we have a corresponding webcast with slides. In those slides you will find the financial information that we cover during this conference call, as well as additional financial metrics and analysis that you may find helpful. Downloadable Q3 financial statements will be available following the call, including revenue by product and geography, income statements, full GAAP to non-GAAP reconciliation information, balance sheet and cash flow statements can be found on our website in the Investor Relations section. Click on the Financial Reporting section of the website to access the webcast slides and these documents. A replay of this call will be available via telephone from May 12 through May 19 at (866)357-4205 or (203)369-0122 for international callers. A replay will also be available from May 12 through July 23 on Cisco's Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results. The financial results in this press release are unaudited. The matters we will be discussing today, include forward-looking statements, and as such are subject to the risks and uncertainties that we discussed in detail in our documents filed with the SEC, specifically the most recent annual report on Form 10-K, quarterly report on Form 10-Q, and any applicable amendments which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. And finally, unauthorized recording of this conference call is not permitted. So with that, I'd like to turn the call over to John for his commentary on the quarter.
- John Chambers:
- Laura, thank you very much. During the opening comments of the conference call, I will focus on what I view to be the key takeaways for Q3 fiscal year 2010
- Frank Calderoni:
- Thank you, John. I'm pleased with the outstanding financial results for Q3 FY '10, with the achievement of most metrics at or above the high end of our guidance, and which demonstrates our ability to execute within our business model. Total revenue for the third quarter was $10.4 billion, an increase of approximately 27% year-over-year, above the high end of our guidance provided last quarter of 23% to 26% year-over-year. We did have an extra week this quarter, which resulted in approximately a 4% to 5% increase in revenue year-over-year or 3% to 4% sequentially, Q2 to Q3. Total product revenue was $8.4 billion, up 31% year-over-year. Switching revenue was $3.7 billion, an increase of 40% year-over-year. Modular switching revenue was up approximately 45% year-over-year, while fixed switching revenue increased 30% year-over-year. Our switching revenue for the quarter represents a record in dollar term and the highest year-over-year switching revenue growth we've experienced in nearly a decade. Routing revenue was $1.7 billion, up 23% year-over-year, representing an increase of 37% year-over-year in high end, an increase of 1% in mid-range, and an increase of 7% in low end. The Advanced technologies revenue totaled $2.4 billion, representing an increase of 18% year-over-year. We saw increases in Unified Communications of 26%, wireless 27%, video systems of 9% and security was up 15% year-over-year. Other product revenue totaled $630 million, an increase of approximately 71% year-over-year. The year-over-year growth was led by strong sales of cable and optical products, the inclusion of sales of Flip Video products from our Q4 '09 acquisition of Pure Digital, as well as solid growth in our Emerging Technologies, which includes Unified Computing, TelePresence and Physical Security, among others. Total services revenue was a record $1.9 billion, up approximately 11% year-over-year. Services resumes double-digit growth and actually continue to grow at a fairly consistent rate throughout fiscal years 2009 and 2010. We experienced an increase in total revenue across all geographic segments on a year-over-year basis. Year-over-year revenue range from an increase of approximately 15% in Europe to approximately 41% in Asia-Pacific theater. Revenues in the U.S. and Canada theater was up approximately 29%. Japan was up approximately 25% and Emerging Markets was up approximately 30%. Q3 FY '10 total non-GAAP gross margin was 65.2%, down 0.4 percentage points quarter-over-quarter and up 1/10 of a point year-over-year. For product only, non-GAAP gross margin for the third quarter was 65.3%, down 0.3 percentage points quarter-over-quarter. The decrease was primarily due to higher discounts, partially offset by higher volume and cost savings. While we were pleased with our overall performance in gross margins this quarter, we do recognize the variability in product mix and other factors that will impact the gross margin. On a year-over-year basis, non-GAAP product gross margin was up 0.7 percentage points, primarily driven by higher volume, mix and cost savings, partially offset by higher discounts. Our non-GAAP service gross margin for the third quarter was 64.8%, down from 65.9% last quarter, and 67% in Q3 fiscal year '09. This service gross margin decrease quarter-over-quarter was primarily driven by mix and increased costs from the additional weeks, which resulted in greater headcount expense, partially offset by volume. The year-over-year decrease was driven by some similar factors. Services margin will typically experience some variability over time due to various factors such as the change in mix between technical support services and advanced services, as well as the timing of contract initiations and renewals. Total gross margin by theater ranged from approximately 62.9% for Asia-Pacific and Emerging Markets to approximately 71.1% in Japan. We saw a variability in our margins across theaters due to higher discounting offset by cost savings and volume. Gross margin increases on a year-over-year basis in Emerging Markets, Japan, Asia-Pacific and Europe and decreased quarter-over-quarter. U.S. and Canada declined year-over-year and was flat quarter-over-quarter. Non-GAAP operating expenses were approximately $3.8 billion in Q3, up approximately 9% quarter-over-quarter, driven by the extra week and increased investments in product innovation and strategic growth opportunities. Non-GAAP operating expenses were up 20% year-over-year. The expenses associated with the extra week in the quarter contributed approximately four percentage points of the year-over-year increase. Non-GAAP interest and other income was $72 million for Q3. This amount reflects investment gains realized in our portfolio and a gain from the early termination of a lease agreement with a customer, partially offset by higher interest expense from our recent bond offering. GAAP interest and other income was $58 million for the third quarter of fiscal year '10. Our Q3 FY '10 non-GAAP tax provision rate was 19.1%. Our non-GAAP tax provision reflects a decrease in our forecasted effective tax rate for the fiscal year from 22% to 21% due to a relative increase in foreign income taxed at other than U.S. rate. During Q3 FY '10, the U.S. Court of Appeals for the Ninth Circuit affirmed a 2005 U.S. Tax Court ruling involving Xilinx. The case impacted the tax treatment of share-based compensation. While Cisco was not a party to the case, the tax accounting change caused by the decision resulted in a tax benefit to Cisco of $158 million, which was excluded from our non-GAAP earnings and our non-GAAP tax rates. This represents a reversal of the charge recorded in Q3 FY '09. Non-GAAP net income for the third quarter was $2.5 billion, representing an increase of 41% year-over-year. As a percentage of revenue, non-GAAP net income was 23.9%. Non-GAAP earnings per share on a fully diluted basis for the third quarter was $0.42 versus $0.30 in the third quarter of fiscal year 2009, a 40% increase year-over-year. GAAP net income for the third quarter was $2.2 billion as compared to $1.3 billion in the third quarter of fiscal year 2009. GAAP earnings per share on a fully diluted basis for the third quarter was $0.37 versus $0.23 in the same quarter fiscal year 2009. We closed the TANDBERG acquisition at the end of the third quarter. And there was negligible impact on our income statement, while our balance sheet does fully reflect the impact of the close of the acquisition and the related purchase accounting. GAAP results include a $14 million loss for Q3 related to our hedging of foreign currency consideration for our acquisition of TANDBERG. While these hedges have resulted in GAAP losses of $10 million year-to-date, they allowed us to effectively lock in a purchase price at currency levels more favorable than those prevailing, when the deal was first announced. Now moving on to the balance sheet. Our balance sheet continues to be very strong, providing us with significant financial flexibility. The total of cash, cash equivalents and investments for the quarter was $39.1 billion, down approximately $530 million from last quarter. The TANDBERG acquisition resulted in a net use of approximately $2.6 billion of cash. During the quarter, we generated $3 billion cash from operations. Moving on to accounts receivables. Our receivables balance was $4.1 billion at the end of Q3, down from $4.2 billion at the end of Q2, fiscal year '10. At the end of Q3, days sales outstanding or DSO was 39 days, remaining unchanged from the Q2 level that we had last quarter, and as compared to 27 days in Q3 fiscal year '09. DSO reflects a shipment profile fairly consistent with last quarter, while also including the addition of TANDBERG to our balance sheet late in the quarter. As the technology industry moves to a recovering supply-demand environment, shifts in lead times and inventory levels will occur. We have improved our lead times throughout the quarter on most products, and expect these lead times to continue to improve throughout the next quarter. I would like to acknowledge and thank our partners and our customers for their continued support as we have worked through this together. Total inventory at the end of Q3 was $1.3 billion, up approximately 3% quarter-over-quarter. Non-GAAP inventory turns were 11.1 this quarter, down 6/10 of a point from last quarter, and up 4/10 over Q3 of last year. As part of the management of our supply chain, we enter into purchase inventory purchase commitments as a normal course of business. These agreements allow our contract manufacturers and suppliers to procure inventory on our behalf based on our expectations of customer demand over multiple quarters. Typically, these agreements are firm and non-cancelable. Cisco's inventory purchase commitments at the end of Q3 were $4.3 billion, an increase of approximately 30% from the end of Q2. These inventory levels and purchase commitments reflect our increased confidence, allow us supply chain flexibility and support anticipated higher business volumes and longer-term product demand projections in our business. During the quarter, we repurchased $2.2 billion of common stock under the stock repurchase program or 87 million shares at an average price of $25.76 per share. The remaining authorized repurchase amount under the stock program was approximately $9.3 billion at the end of the quarter. Deferred revenue was $10.3 billion at the end of Q3, up approximately 7% quarter-over-quarter, and an increase of approximately 17% compared with Q3 fiscal year '09. Deferred product revenue was $3.5 billion, and deferred service revenue was approximately $6.8 billion, increases of approximately 28% and 13% year-over-year, respectively. At the end of Q3, our headcount totaled 68,574, an increase of approximately 2,700 from last quarter, or a net increase of 1,000 aside from the acquisition of TANDBERG. In closing, from a financial perspective, this was an outstanding quarter for Cisco. Based upon the robustness of our Product and Services portfolio we have seen in our business, we've seen our business return to a financial position that we believe is, in many cases, stronger than where we were prior to the economic downturn. This strong financial position provides Cisco a solid foundation for continued innovation and strategic investments, which we believe will allow us to capitalize on the significant growth opportunities that are ahead of us. I'll now turn it back to you, John.
- John Chambers:
- Frank, thank you. Well done. Now moving on to the discussion of strategy, customer segments, geography, product review, et cetera. Q3 continued the trend of balance between innovation and operational effectiveness in almost every aspect of our business. In recent past conference calls, we have gone into certain important discussions of our strategy, and we will continue this trend in most of our future calls. However, given the very strong results of this quarter, we think the strategy speaks for itself, and we'll focus in this conference call on the normal customer segments, geographies and product results. Now moving on to customer segments and geographies, where the discussion on a global basis will be measured by orders both year-over-year and, at times, sequentially. When you look at both product orders and geographies, what a difference a year makes. Q3 product orders were up approximately 34% year-over-year. Just one quarter ago, product orders grew at 11% pace. Two quarters ago, they were down in high single digits. And three quarters ago, and comparing year-over-year numbers, they were down in low 20s year-over-year. Now onto the discussion, first as it relates to customer segments. Our Service Provider business on a global basis in terms of product orders in Q3 was up approximately 30% year-over-year. Commercial was up 40%. Enterprise was up 26%. And consumer was up 50% -- in fact, over 50%, sorry about that. In terms of geography, which is the primary way we run the business, results across all four of our largest theaters were remarkably consistent in terms of enterprise, public sector, service provider, commercial and consumer, with every customer segment in each of our four largest theaters growing approximately 20% or better year-over-year. Again, the total U.S. grew year-over-year approximately 34%; Europe, approximately 40%; emerging markets in the high 40s; Asia-Pacific, approximately 34%. The balance across these customer segments was remarkably very solid in each of these theaters as well. Japan continues to see some challenging economic times. And our growth in Japan was up 2% year-over-year. In the U.S., to provide additional detail, the enterprise grew 27%, public sector 44%, service providers grew 30%, commercial grew 34% and consumer grew 64%, all on a year-over-year basis. Given the interest that many of you have on specific countries around the world and specifically as it relates to Europe, the following is a summary of some of our top countries' year-over-year growth. The U.K. grew 28%. Germany grew 12%. France grew 27%. The Netherlands grew 23%. Italy was down 1%. And Switzerland grew 28%. And the rest of the world
- Frank Calderoni:
- Thank you, John. Let me remind you again that our comments include forward-looking statements. You should review our recent SEC filings that identify important risk factors, and understand that actual results could materially differ from those contained in the forward-looking statements. The guidance we are providing is on a non-GAAP basis with a reconciliation to GAAP. For Q4 FY '10, we anticipate total revenue to be up approximately 25% to 28% year-over-year. Because the sequential increase between Q3 and Q4 needs to be adjusted for a few one-time items, we want to also provide a quarterly guidance for each year. Our analysis of historical quarter-over-quarter growth between fiscal Q3 and fiscal Q4 results in a typical sequential increase of approximately 5% to 6%. On a sequential Q3 to Q4 basis, the impact of the extra week in Q3 is 3% to 4% of total revenue. This should be reduced from a normal sequential increase as we return to a 13-week quarter in Q4. Additionally, please note that throughout 2009, TANDBERG recorded revenue in the range of approximately $200 million to $300 million per quarter depending upon seasonality. Based upon projected revenue after adjustments for purchase accounting and for normal TANDBERG seasonality, we believe TANDBERG will contribute 2% to the sequential growth in Q4, or approximately $200 million which is also included in our revenue guidance for Q4. If you assume a normal sequential increase of 5% to 6%, reduced by the 3% to 4% for the extra week, then adding 2% for TANDBERG, we arrived at approximately a 3% to 5% increase on a sequential basis for Q4 FY '10. On a year-over-year basis, this equates to 25% to 28% guidance for Q4 FY '10. At this point, let me remind you in light of regulation FD, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. Let me now give you some additional details on the Q4 financial guidance. As we have said in the past, forecasting gross margin has always been challenging due to various factors such as volume, product mix, variable component cost, customer and channel mix and competitive pricing pressure. That being said, we believe total gross margin in Q4 will be approximately 64% to 65%, reflecting the revenue guidance I just shared with you. With recent acquisitions and our entry into some lower-margin markets, gross margin could be negatively impacted by product mix. There will be times when we will be at the high end of this range, but we'd encourage you to be conservative in your short- and long-term modeling. We believe Q4 operating expenses will be approximately 36 1/2% to 37% of revenue. We expect interest and other income to be approximately $10 million in the fourth quarter. Our tax provision rates for Q4 is expected to be approximately 21%. We are modeling share count to be down approximately 10 million shares quarter-over-quarter in weighted average shares outstanding for EPS purposes. In this estimate of share count, we are not taking into consideration any further change in stock price that could occur in the fourth quarter fiscal year '10. While we expect to continue our share repurchase program, it is difficult to predict the exact weighted average shares outstanding. As a point of reference, a $1 movement in our average stock price would change the calculated shares outstanding for purposes of determining earnings per share by approximately $17 million. While we are extremely pleased with our TANDBERG acquisition and our customer buy-in through our collaboration strategy, going forward in the near term, we expect the impact of TANDBERG to be slightly dilutive to our non-GAAP EPS by slightly less than $0.01 per share on a quarterly basis. Regarding cash flow from operations, we would expect to generate $2 billion to $2.5 billion during the fourth quarter. For our Q4 FY '09 GAAP earnings, we anticipate that GAAP EPS will be $0.06 (sic) [$0.07] to $0.09 per share lower than our non-GAAP EPS, primarily due to stock compensation expense and acquisition-related charges. Please see the slides that accompany this webcast for more detail. Other than those items noted above, there are no other significant differences between GAAP and our non-GAAP guidance. This guidance assumes no additional acquisitions, asset impairments, restructuring and tax or other events which may or may not be significant. I will now turn the call back to you, John.
- John Chambers:
- Thank you, Frank. The following is a summary of my views of Cisco's momentum and opportunities entering Q4 of fiscal year 2010. As we discussed in some detail during the call, it has really been a pleasure watching the steady evolution of business momentum improving for Cisco over the last year. Our early optimism about the economic downturn over a year ago in the January and February and March period of 2009 turned out to be very accurate. We have continued to see the momentum improved each quarter, and the results of this quarter were truly outstanding although helped by an extra week as discussed earlier. Our long-term comfort level with our goal of 12% to 17% year-over-year growth with all the appropriate caveats appears to be even more likely. And our current guidance for Q4 year-over-year growth in the 25% to 28% is, obviously, well above our long-term goal of 12% to 17%. Our balance of innovation as illustrated from almost a complete product refresh cycle across every major product family as well as our technology architecture really come into life, and most of our customers understanding is achieving the desired results. While it's too early in the business architecture innovation with our leading-edge customers, we are also achieving and often over achieving the desired results in both customer business partnerships, as well as our revenue growth and market share objectives. Our new, innovative, dynamic network organization structure consisting of councils, boards and working groups, are clearly getting the results as indicated in proof points from Q2 and Q3. And we are starting to see our customers are having interactive discussions with us regarding how they can move their organization model to this new dynamic structure. The key enabler of this organizational structure and supporting business models is the intelligent network, delivering both the communications and IT capabilities of a company. At the forefront of these market transitions is video, data center virtualization and collaboration. In terms of the new emerging technologies that are enabling the desired government and business results for the future. So in summary, while there are always challenges in front of us from the economy, job creation, competition, supply chain, regulatory environment and many other factors, that could be a surprise to us versus our expectations and guidance, we are, in my opinion, the best positioned we've ever been to achieve our long-term goals and aspirations. We will continue to attempt to be as transparent in terms of our views of the economic challenges, especially in Europe as well as other challenges that we discussed on this and prior calls. And as we said many times before, it would not be a dramatic surprise to see our results differ in a given quarter, either below or above our guidance. Balance this quarter as evidenced from a country, theater, product family, customer segments and market adjacencies perspective was probably the best we've seen in recent history, and definitely the best given our rapidly expanding role into 30-plus market adjacencies. As you would expect, given our productivity increases and the success in our innovation on both a product and a business perspective, we are going to expand our sales, engineering and other resources, especially in these new market adjacencies. As we continue to aggressively invest, we will also continue to maintain our focus on the financial models. Once again, with our use of caveats as discussed earlier on our financial reports, our Q4 guidance is for year-over-year revenue to increase into 25% to 28% range. I want to thank the entire Cisco family for working together as a team to ensure that our company is in a solid position to not only weather the challenging economic environment, but even more importantly, to be ready to continue to accelerate our investments assuming the current trends hold. I know it has not been easy, and we are all working hard to maintain our culture of innovation, trust, stretch mentality and giving back, all during a tough period of time for ourselves, our family and our friends. While we expect a continued recovery throughout the entire year and we clearly gave a very aggressive forecast for Q4, it is important that expectations do not get ahead of market realities, especially until we see job creation. It would not be a big surprise to us to see economic growth and markets bounce up and down over the next 12 months. And we strongly urge our investors not to dramatically change their models beyond Q4 guidance just given. We will continue to share with you what we are seeing in the market and our own expectations for our business as transparently as we can. As always, I want to thank our shareholders, customers, employees and partners, for their support and continued confidence in our ability to execute during rapid industry consolidation, market transition and challenging economic times. Laura, let me now turn it over to you for the Q&A session.
- Laura Graves:
- Thanks very much. And before we do that, John, just real quickly, I want to confirm that our GAAP EPS will be between $0.07 to $0.09 per share lower than non-GAAP EPS. I think, Frank, you were talking a little fast and you said $0.06 to $0.09. It's actually $0.07 to $0.09. So with that, Operator, can we go ahead and open the call for questions, please?
- Operator:
- [Operator Instructions] Thank you. Our first question comes from Jeff Kvaal with Barclays.
- Jeffrey Kvaal:
- My first question is about the sequential growth rates. I was wondering if you could help us understand a little bit how much of the declining lead times is contributing to you that are helpful in your outlook for the July quarter.
- John Chambers:
- Well, the declining lead times mean that people won't be ordering as far out ahead as they normally do. And we, clearly, were also giving a little bit of indication that when you compare order growth rates for Q4 this coming quarter to order growth rates of a year ago, order growth of a year ago was very, very strong. I think we said in double digits in the call, and book-to-bill was comfortably above one. So in terms of the sequential growth, I think you're now seeing it come back into normal lines. I don't think it makes a big difference in terms of sequential growth, Q3 to Q4, in terms of numbers. Do you, Frank?
- Frank Calderoni:
- No, I don't. Again, we've seen improvement in lead times coming into this quarter, Q3, and we're seeing that we'll continue to see lead times to improve as we go through our Q4 as well. And what we expect to do by the end of Q4 is seeing our lead times actually recover to normal for most of our products.
- Operator:
- Our next question comes from Jeff Evenson with Sanford Bernstein.
- Jeffrey Evenson:
- I'm wondering, Frank, when you went through the detailed math of how to compute sequential growth, how you got to the conclusion that the extra week added 3% to 4% onto your overall growth? Or is that should be put in as a correction factor?
- Frank Calderoni:
- So Jeff, one of the things and we mentioned this last quarter as well going into Q3, it's always difficult to actually determine exactly how much the extra week is worth. We also went back five or six years ago when we had it as well. But what we've done throughout the quarter and after the quarter closed is we performed significant amount of analysis both on our order side as well as on our revenue side. And based on looking at some of the trends we saw throughout the quarter, we feel fairly comfortable with the estimates that I provided, whether you look at it from a year-to-year or a quarter-to-quarter. It ranges from like $300 million to $400 million. So on average, it's about $350 million in the quarter for the extra week. And looking at it again several different ways, we feel comfortable that was what the extra week is worth. So whenever you're doing any compares, it's important to kind of remove that to get to a normal sequential trend from a Q3 to Q4 perspective, and that's what we tried to do in providing that guidance.
- Operator:
- Our next question comes from Tal Liani with Bank of America Merrill Lynch.
- Tal Liani:
- I have a question about the revenues. So my question is about the Advanced Technologies, when you look at this quarter and last quarter sequentially, Advanced Technologies are slowing down from 12% to 5% to 2%, and then you see growth. The stronger growth is coming from "the legacy part" the switchers and routers, where you have product refresh. So the question is first, how much of the growth you're seeing is coming because you're refreshing your product? And second is what is happening on the Advanced Technologies side? Why don't we see a stronger growth?
- John Chambers:
- So just to kind of repeat the numbers, I think in fairness, a number of you challenge us saying, "How are you doing on your core Routing and Switching technology a year ago?" and saying, "Are you getting too much growth from Advanced Technologies?" And in this quarter where we clearly reinvented ourselves and core Routing and Switching grew 23% and 40%, respectively. Now the question is Advanced Technology is not growing as fast, a fair question. Advanced Technologies grew at 18%. Our core one group of Advanced Technologies, if I remember right, grew at about 22%. And the Advanced Technologies last quarter were, I think, plus or minus 1%. So I'm actually pretty comfortable with where we are though some of them, such as the areas of Unified Communications, and we used the example of phones to give you some real, real positive updates, we're good. You saw Wireless picking up momentum again with the next generation of Wireless within it, and I would say 18% was pretty solid in that. I think a few key takeaway, and I was teasing Frank earlier, whenever we have a question, if it's about traditional products, say 20% to 40% growth or additional customer segments, say 20% to 40%, and if it's about new product introductions, say 200% to 500% either sequentially or year-over-year, and I was actually very comfortable with the mix. You will see big order swing that, but I think 18% up from 1% a quarter ago is pretty good numbers on that, and the momentum's going in the right way. Rob, I don't want to make any comments, but when you re-think about our sales force, they're across so many product areas now in such a broad based. I think when you see an 18% number in that category, that isn't bad.
- Operator:
- Mark Sue with RBC Capital Markets.
- Mark Sue:
- If we net out the TANDBERG and we look at it just from a year-over-year point of view, it seems to imply some deceleration closer to 23% to 25%. Is there something brewing in Europe which is giving you some pause in your conservatism for July? And it seems you mentioned seasonality more on this call implying a return to steady state, does that mean in the October quarter, we kind of dip back to more seasonality and down sequentially which is often seasonally the case?
- John Chambers:
- A series of questions, Mark, so let me take a crack at the overall concept. Our long-term growth projections are 12% to 17%. Q4 last year was the first solid quarter we had in terms of sequential numbers. It was up comfortably, book-to-bill comfortably above one. Bookings were growing, I don't remember the numbers, almost 10 points faster than revenues sequentially within that, and so it's beginning to get more of a normal Q4 to compare to. So it isn't all the way back to a normal run rate, but it was a lot different than Q3 which has very easy year-over-year comps when things were flat and only the enterprise customers had started to turn up. So actually, if we're in the 20s in the market versus a reasonable Q4 of a year to go sequentially, much less in the mid20s taking out that 2% for TANDBERG, that's pretty good numbers. So I'm very comfortable with that position. I don't think it indicates a deceleration at all. I think the numbers were very easy comps just like many of our peers will see through the next couple quarters. We turn probably a couple quarters earlier than our peers did. We signaled that to the market, and we're very pleased with growth now in the mid-20s off of a Q4 that was clearly a tipping point on the upside, not a continued real easy year-over-year comparison.
- Laura Graves:
- And for what he's asking you on seasonality, then, going into Q1, we're going to wait and talk about that next quarter.
- John Chambers:
- We could talk about it, but I'd watch how the momentum plays out a little bit. To answer your indirect question, normal seasonality should apply but the real issue is what are the growth rates long-term? What are the directions? We just don't want our shareholders getting ahead and people question us just two quarters ago, could we grow 12%, and now all of a sudden, we're coming in to the mid-20s, and people say, "Is there a deceleration occurring?" Of course not. There's not a deceleration occurring. The momentum feels good on a global basis, the year-over-year numbers versus an upturn. Remember, the next three to four quarters are all now starting to compare against reasonably good sequential growth from years before. So that's how I'd answer it, Mark, and I know you're setting me up because there are a lot of questions from some of your peers that may not grasp that.
- Mark Sue:
- And you're not worried about Europe, John?
- John Chambers:
- I think, if you're watching our projections, Mark, it grew 30% this quarter, and if you look at the countries, the balance was really good. In the U.K. at 28%, France at 27%, Germany, if I remember, at 12%, the Netherlands, was in the 20s, et cetera. Southern Europe start [ph] off, and so you'd expect that out a bit late, Spain perhaps, et cetera, but it looks reasonably good. If there was a segment of our business that we would probably model at a little bit slower growth rate than the other four large theaters, it would probably be Europe. But their forecast is comfortably in double digits for next quarter with all the appropriate caveats, and whether that's in the 20% range or the 10% range, time will tell. Europe's about 22% of our business, if I'm remembering right, to kind of giving you the data points off out. To answer the indirect question, have we seen that issue spread globally other than business awareness, no we've not. The momentum feels pretty good on a global basis. I had to agree with our optimistic comments of some of our peers of the last week that technology spending is clearly on fire and going in the right direction. And again, repeating the common theme that it doesn't get much better than this Q3. And if we had told you a year ago that Q4, we'd talking about year-over-year growth rates in the mid-20s, most of you who would have said we were missing the direction, and yet that is what's occurred.
- Operator:
- Our next question comes from Ittai Kidron with Oppenheimer.
- Ittai Kidron:
- I had just a clarification, Frank and a question for you, John. Clarification, Frank you haven't mentioned the year-over-year growth rates in home networking, if you could provide that? And John, I wanted to tie in Tal's question with margins. If you look at the change in mix, if I remember correctly switching and routers are your higher margin products whereas Advanced Technology is just typically below the average. And so with this change in mix more in favor to theoretically your higher margin products, just given the growth rates year, we're still seeing a quite decline here in gross margins. And so, if you can provide a little bit color as to where are you seeing the compression in the gross margin in your businesses, a little bit more granular, that'll be appreciated. Is it really coming from your core switching routing business?
- Frank Calderoni:
- So breaking the question in a detail point, our home networking group. Now remember, the reason we still report this as a separate area so you can compare apples to apples. If we talk about Consumer, the Consumer business was up over, I think 55% year-over-year. So our total Consumer business, including that, is up 55%. The Home Networking as we used to define it as a stand-alone category was down about 8%. And then it came in at about $210 million in terms of revenue for the quarter. So you can see what the current base is and the current balance. In terms of the margins, I think this is just normal pressure. To answer your question, I think it's just normal mix that goes slightly up and down. We encourage people when the margins were in the 65% to 66% range, which they still are, not to get overly optimistic about that. We think 64% to 65% is right, and there might be times where we dip below the 64%. But we think, day in and day out, the margins are in the product range that we expect, and we want people to encourage you to model in that 64% to 65% range. There's nothing unusual going on from competition. There's no more major price competition that we have traditionally seen, and I think it's more of a mix issue that tweaks up and down. But to be able to break it by individual products would be mathematically almost impossible to balance up and down. There's so many different moving balls on it. But to answer your overall question, there's nothing unusual going on other than just normal mix that might tweak up or down. So again, reminding everyone, when it's above 65%, don't get overly excited, when it's below 64%, don't get overly pessimistic. 64% to 65% is where I encourage you to model, and we don't see anything at this time and as we do unbelievably good in some of the low-margin products better when we're forecasting that would change that in the short run.
- Operator:
- Our next question comes from Rod Hall with JPMorgan.
- Rod Hall:
- John, I wonder if you could talk a little bit about government exposure in Europe? If you can give us any idea how much revenues is coming in from the government sector, that would be helpful over there. And also in Europe, if you could talk about, and I think this is probably due short of time frame, but you could talk about the last couple of weeks, is that debt crisis really has only come to the forefront then, whether you've had discussions with business managers or others that might suggest that there's more caution over there? So that's why -- those are two questions for you. And then for Frank, Frank, could you quantify for us what the balance sheet impacts of the TANDBERG inclusion in the quarter were particularly on inventory? But it'd be nice to know what the working capital impacts were just so we can go back out what the underlying movements and working capital look like.
- Laura Graves:
- Rod, I think to keep things moving, I'm going to ask John to address the European question, and then we'll take the others with you off line.
- John Chambers:
- The European markets were up 30% as we said before. Breaking by category, I'll just give them to you. The Enterprise was 19%, Public Sector was 26% growth year-over-year, the Service Provider was 32%, commercial was 54% and Consumer was 24%. So when we tease [ph], the answer is 20% to 40% in those categories. It is pretty accurate. It was remarkable balance across every theater in terms of the customer segments, the key products, the country growth, et cetera. In terms of nervousness, I think it had everybody's attention in Europe but we have not seen, Rod [ph], I think anything unusual from our teams, and actually they're forecasting a reasonably good Q4 from a European side with the appropriate caveats. If there's one theater we're watching, we watched that very carefully. But I haven't seen anything that makes us abnormally concerned at this time. In fact, when we hold our top -- I think it was 1,800 partners the other day in a meeting, we said how many of you anticipate the second half of the year being a better year-over-year growth in the first half, it was all but maybe 1% or 2% raised their hand. So optimism is pretty good around the world. I think there will always be a couple of challenges as to be [ph] now see in Europe. I think we're cautiously optimistic that we'll work through that. If we get surprised, we'll adjust but at the present time, we're not seeing anything that makes us abnormally nervous.
- Rod Hall:
- And on government exposure?
- John Chambers:
- Government exposure is 26% Public Sector spend year-over-year growth. It's in that range. It's not abnormally big or abnormally small. It's right in the middle of the other groups. Our enterprise is very small strong, and our other groups -- let me if can do the math here real quickly. I think you're close to it being about 15% to 17% of our business in Europe.
- Operator:
- Our next question comes from Simona Jankowski with Goldman Sachs.
- Simona Jankowski:
- I just wanted to clarify first if the incremental 2,000 to 3,000 in headcount additions was on top of the 1,000 you just added this quarter or including that? And then the question I wanted to ask you is in terms of the recent debate that has kind of re-emerged on net neutrality, can you just give us a sense, John, for any change in tone of your discussions with the major service provider customers in North America?
- John Chambers:
- Sure. So the increase in headcount from acquisitions was about 1,700 people. The net incremental increase in new hires or truly incremental was 1,000. So 1,000 of the 2,000 to 3,000, and we're clearly the trend here to accelerate that hiring position is basically in sales and especially in new markets adjacencies. In terms of the change on the net neutrality issue, I think you are seeing a concern from many groups about are we going to be one of the first countries to regulate the internet and to begin to determine what services, et cetera come on over it. So I think this will be a pretty active discussion point going back and forth between organizations, regulatory groups and business community, and I think there'll probably be a pretty healthy give and take. I think the objectives people are trying to achieve aren't necessarily bad at all. But I think all of us have concern with regulating the Internet and the dangers that go along with that. And a difficulty for us to say as a country in the U.S. probably an open standards in not regulating the Internet and open this, while we would do it when we're strongly encouraging other countries not to do so. So I think the discussion is just beginning. I hope we'll find a way to go back and forth between all the interested parties to achieve the benefits and not the negatives that can go with this.
- Operator:
- Our next question comes from Ehud Gelblum with Morgan Stanley.
- Ehud Gelblum:
- First, the clarification, Frank, you mentioned that several times in your narrative about higher discounts in various areas. Was those higher than normal? Was that why you mentioned them? Or because there are always discounts I'm wondering as in certain areas and maybe just more detail of the higher discounts and how it impacted you? My comment is that when you mentioned 4% to 5% on the 14th week on a year-over-year basis in 3% or 4%, I'm guessing you mean that's the actual 14th week. My guess is that in most quarters, you're back-end loaded so that in the final week, whether that be the 14th week, the 15th week, 12th week or 7-week quarter, you would have a disproportionately high amount of revenue in that week. So I would imagine that you're actually hurting yourself a little bit by saying it's 4% to 5% if that's actually the way you're calculating because by the variation of it being the last week, it is higher than otherwise normally would have been. So I'm wondering if it actually maybe didn't -- the 14th week by itself maybe isn't that high and that's just a comment, just to throw it out there. And then finally the numbers, it was terrific that you gave those numbers specifically on the products with the Nexus 7000, ASR 9000, the growth rates and the run rates, they're terrific. But given that they are somewhat sort of next-generation types of devices on your Catalyst 6500 and your 7600 router, do you have any sense as to what the combination of let's say, your Nexus 7000 and CAT6K and your combination of ASR 9000 and 7600 how are those doing as a group category?
- Laura Graves:
- [indiscernible] discounts and then the week please?
- Robert Lloyd:
- When we look at margins as we as we talked in the prior quarters, the factors that drive margin variability has to do with the volume, the mix, the cost and then also the price which is discounting rebate. So what I highlighted from a products perspective is really just looking at some of the major drivers, not to identify that it was a significant amount, but just the main drivers in the quarter were discounts and rebates who with benefit offsetting that was driven by the higher volume and cost savings. So nothing significantly unusual. It's just some of the drivers of that comes into play from the product side. On the services side, primarily related to the mix between our advisory services and our technical services and also the extra week does have an impact with higher cost there. So those are just some of the factors that we constantly look at as John said before, that's impacting our margins. So nothing out of the ordinary.
- John Chambers:
- In terms of the mix on the products, we gave an unusual amount of detail which we won't repeat in future calls once we have made the [indiscernible] because the startups are tremendously powerful here in terms of how quick acceptance occurs. This is about as good as you do with the next-generation product in a single category. But to do it across every product category, from 7000 Nexus to the 5000 to 2000, from the ASR to the 9000 to the 5000 to the 1000, to be able to do it with UCS, et cetera, it was across the board, very rapid increases. So best way to rub at the number that you ask is that if you have Switching grow at 40% and it's about 35% of our total business and you have Routing growing at 23%, and it's about 16%, 17% of our total business, you can count it back into the numbers. But overall, the numbers were very solid, no matter how you get a market share gain, enormous transitions, good mix, et cetera. It doesn't get any better on product transitions than what's going on now is the answer I would come away with on that share this aggression there in the extra week.
- Robert Lloyd:
- The extra does not necessarily mean that was the 14th week? I just want to clarify that.
- John Chambers:
- It was not the last week of any quarter. The last week of many quarter is very high in bookings and revenues. As you would expect, it wasn't the first week either. So I would model it in the middle. We had a lot of give and take. This an art on the number, and you can do the math. You can come up with the number of 300, 400, 500 to 600. We believe the numbers that Frank shared to be most likely on that. Each of you can make your twist but it is a -- I would've consider it a week in the middle. And it's a tough number to anticipate because when I asked around the room how many people were here and we did this five years ago, other than myself, no one in the room had been through it before. So it's our best estimate. If you're a little bit more optimistic, you can adjust appropriately. If you're a little bit more pessimistic on what it adds, you can adjust the others. It's probably right in the middle, if I we're guessing.
- Operator:
- Our next question comes from Nikos Theodosopoulos with UBS.
- Nikos Theodosopoulos:
- My question is on the lead times. Can you talk about which products are currently the ones that you still want to bring the lead times down in the fourth quarter? And at the end of the fourth quarter, once that's accomplished, would you expect your purchase commitment to start declining or do you think there would still be reasons for it to grow?
- John Chambers:
- We're probably not going to go by individual product areas. It varies because one time, it can be as simple as some ICM materials, the next time it's power switch, the next time it's an 861. I think in terms of starting to discuss individual lead time product areas, we'd probably just start down something, I don't want to start during the conference call, but I wanted to try to answer your question. We made progress in almost all areas last quarter and then again this quarter on lead times. There will always be two or three product areas that either we misforecast or there's a problem with one supplier. As long as it's two to three we're fine on that. But we do need to bring them down a little bit tighter in terms of total by another one to two weeks, and there are a couple of product areas that are currently running at the high end of that in terms of the categories. But break it down individually on it, I think would be probably something I don't want to start down the path on. So let me give you one more question, Nikos, in terms of asking so that I can answer one for you.
- Nikos Theodosopoulos:
- May be we could just stick on this topic. I mean assuming you accomplished the lead time reduction, so what do you think happens to purchase commitments? Because they've been going up quite rapidly? Should we see them start to grow with revenues or start declining post the July quarter? I'm just try to understand...
- John Chambers:
- What you're going to see is we think supply will be tight for the entire year, and we will assume that it will be tight. What I've asked Frank to do and Randy and Angel to do is to make whatever commitments we need to, to meet our customer delivery dates. So I'd expect us to continue to make commitments in terms of being sure we get the components in and stretching out over a period of time. So I'm really asking us to model not just for the next quarter but looking out two, three, four, five quarters and take the issues of supply constraints out of our dynamics on it. And it's a relatively inexpensive insurance policy to be doing that, and I think the way that we're handling is right. So I'd look for us to continue to make commitments throughout the year, and I think that's required, candidly that we think the supply agenda will be tight throughout the entire calendar year calendar year and maybe well into next year.
- Operator:
- Our next question comes from Brian White with Ticonderoga.
- Brian White:
- John, you talked a little bit about the order trends by enterprise and service provider. But could you talk a little bit about some of your discussions when you travel around the world, you talk to enterprise customers, you talk to service providers customers, what are the trends there and what are the important topics on their mind right now?
- John Chambers:
- Almost without exception, quite a difference a year makes, a year ago, I think we were one of the two optimists in Davos a year and a half ago, and I couldn't find the other one. And when you're talking to business leaders, the majority of them were very concerned. I'd say now, almost without exception, most people are beginning to slowly turn cautiously optimistic. They are very hesitant about adding headcount especially in the U.S. However, almost all of them have squeezed their expense levels down, have tightened things, probably cutting into muscle at times. And so they're looking as they want to grow new revenues, move into new markets about driving productivity and technology. It's a nice way of saying that I think you're going to see the optimism in the technology industry continue throughout the next year. And that most of our customers we talk to our now getting very much involved with how they drive productivity, how they move into new markets, et cetera, as opposed to focus on cutting expenses. And I guess the best example was in our partner community, that 1800, I took that survey up in front of everybody else, represents every country in the world imaginable, every size account, et cetera, and they were 98% or 99% very optimistic about the second half of the calendar year in terms of the question asked. When I was in India just a short time ago, uniform across the board, they feel very good about growth in the 8% to 10%. It was just a short time ago people were worried about China not growing as well and all of a sudden, we were worried about them growing too fast. But barring a surprise, the Chinese leadership are very good. They'll manage through that as well. So I think what you see is optimism building on a global basis. It won't be as big a bounce back as you normally feel for this deep of an economic downturn which would normally be probably 7% to 9% growth in GDP. In fact, most people are a lot more optimistic than this year ago, and I have very few pessimist customers at this times, almost regardless of countries. I think everybody's a little bit gun-shy, not want to stick their neck out or careful when they see a concern that it might have a domino effect. But right now, it's a dramatic change in terms of what we're seeing from almost every customer in the world.
- Operator:
- Our next question comes from Paul Silverstein with Credit Suisse.
- Paul Silverstein:
- John, I know you'd kind of touched on it. But if you could give us some more insight on linearity? And just a clarification, from what you said that trust components do not impact EPS during the quarter?
- John Chambers:
- Components did not have an impact on UCS now. Did we make some of the shipments we could've made in the quarter because of long lead times, absolutely. We didn't make some of the shipments. And in two tier and small business, the products are either on the shelf or not. Was it a major impact in the quarter? No. Did it have some impact in the quarter in terms of either getting orders that could've shipped in this quarter if we'd been on earlier lead times into the quarter? It had some impact from that perspective.
- Paul Silverstein:
- Linearity?
- John Chambers:
- Linearity. Again, it's hard when you take that 5% out, I mean the extra week out. If you move the week out of the middle of the quarter, linearity was relatively versus what we'd expect. It was clearly loaded more in the second month of the quarter since that's where we put the extra week versus normal times. But people are back on hitting forecast very accurate, congratulations to you and your team, and they were pretty accurate the whole quarter. So I feel much better about having a good feel for our businesses and the momentum. And again, it was remarkably well balanced with almost all geographies except maybe Japan and Italy, Spain, Portugal, all geography is doing pretty well.
- Brian Modoff:
- But John, just to be clear, putting aside the extra week, if we looked at your last four weeks of the quarter just from a sequential standpoint, is it what you would have expected in terms of ongoing strength?
- Frank Calderoni:
- I would tell say it was.
- John Chambers:
- It isn't four weeks, it's five weeks. The last month of the quarter is always five weeks in terms of the direction on it.
- Paul Silverstein:
- But there was no attenuation as you went through the quarter?
- John Chambers:
- There was no acceleration i terms of value into the quarter, no.
- Paul Silverstein:
- The opposite question, John, which was there was no incremental weakness?
- John Chambers:
- No, the forecasts held for the quarter, again, -- Frank...
- Frank Calderoni:
- There was nothing unusual from that perspective in the quarter. It was a good quarter from the standpoint of the continuation of business throughout and then also how we performed. We actually, for me, lead time perspective, we actually improved throughout the quarter as I mentioned earlier. So we did see improvement as the quarter went on, and we expect that to continue as we move into Q4.
- Operator:
- Last question comes from Jason Ader with William Blair.
- Jason Ader:
- The historical seasonality has been up 5% to 6% in your Q4, I think I got that right. Now you're guiding 3% to 5% for this fourth quarter. So does this imply that there was catch-up spending in Q3 which makes the comparison a bit tougher and therefore you're guiding a little bit lower than the historical seasonality?
- John Chambers:
- I think you're reading too much into that. We are very, very comfortable with Q4. And this is why I really -- we made the statements beginning three quarters ago. We strongly encourage you to go back to year-over-year numbers because the quarterly numbers can vary by big deals, they can vary by shipments, et cetera. And this is why we said beginning two conference calls ago, we would be switching back to year-over-year being the numbers we strongly encourage you to focus in on. You can tell just by the questions on what did the extra week bring you or not bring you in this, the effect of the TANDBERG, in or not. And so I would strongly encourage our shareholders to look at year-over-year growth numbers as being the proper indicator to really watch the run rates on. And as lead times come back tighter, customers won't be ordering as far out. So you will see an actual contraction in terms of the bookings that go with that. And repeating the same thing, Q4 of last year was the tipping point on the upside. And you had a very good booking sequential quarter that we're comparing it against in terms of the numbers for next time period.
- Jason Ader:
- So one way to look at it then maybe if you guided 3% to 5% and you're able to show some exceeding of those expectations, it could be up sort of normal historical seasonality if you're able to exceed that 3% to 5%?
- John Chambers:
- I think we're reading in too much for an extra point. The number I really think we ought to focus on and I'm going to be focusing on myself this is how I run the business is what's the year-over-year number? The year-over-year number is amazingly strong. It is almost what is. It's 10 points higher than what we project our long-term growth to be, also not an easy comparable from a year ago. Our easy comparables were Q3, Q2, Q1. Now we're getting the comparables that had good sequential growth and good numbers, and yet we're forecasting growth even taking out TANDBERG in a very high level. So my own point of view, I would not add in a lot of plus or minus a point or two sequential growth being a major signal. It is absolutely the reverse of that. Watch our year-over-year numbers, that's where the real trends are. And I don't think there's anybody in this group that wouldn't be extremely excited if we -- over the next three to five years or at the high end of the 12% to 17% range and yet we're talking almost 10 points above the midpoint there. So that's what I'd encourage you to focus on. If I'm missing something here, come back at us over time through Laura or myself, and we want to listen. But the key signal is the market is extremely strong. We see very good trends, we're doing well in almost every product area, every geography, every customer segment. The innovation engine is on fire, we're transitioning from product line to product line. It is a smoother pace when you're only doing one of these, and yet we're doing a dozen of them at the same time and yet almost all of them are hitting and still getting reasonably good balance even in areas like we addressed with advance technologies which is a fair question, did you take your eye off the ball a little bit on that? Maybe. But it was 18% growth. That is unbelievably solid. So our views haven't changed. We do not have a problem with growth opportunities. It's about execution, our long-term vision and strategy is playing out exactly as we expected. Our game plan for economic downturns is right on the money. And hitting on all cylinders, and we're gaining market share in every product area. I don't think it gets much better than that. So again, I want to thank everybody for joining us today. I appreciate the healthy give and take and look forward to some of the follow-up conversations. Laura?
- Laura Graves:
- Thank you John. I'd like to remind everyone that Cisco's next quarterly conference call which will reflect our fourth quarter fiscal 2010 results will be held on Wednesday, August 11, 2010 at 1
- Operator:
- Thank you for your participating on today's conference call. If you would like to listen to the call in its entirety, you may call (866)357-4205. For participants dialing from outside the U.S., please dial (203)369-0122. This concludes today's call. You may now disconnect at this time.
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