Cisco's Earnings Conference Call: "Weakness" in Q4, Layoffs Coming
Cisco’s conference call with analysts is getting underway. Minutes ago it reported an 18 percent drop in profit, but its fiscal third-quarter profit of $1.8 billion, or 33 cents a share, was better than analysts had expected. Revenue was $10.9 billion, up from $10.4 billion.
“This quarter played out as we expected,” Chief Executive John Chambers said in a statement. “We have acknowledged our challenges. We know what we have to do.”
All eyes and ears will be on whatever further plans Chambers discloses as part of his plan to turn the networking giant around.
1:34 pm: So the call is getting underway.
The usual earnings boilerplate. Forward-looking statements blah-blah-blah.
And here’s John Chambers.
I’d like to crystalize where Cisco stands at this time. The network is the most valuable asset in IT. Cisco is a very strong company in a healthy market with a few problematic areas. And that we are taking comprehensive steps to address.
The first is streamlining our operating model. We are making it easy for our customers and partners to do business with us and speeding decision making.
$1 billion FY 12 costs coming out.
Divesting underperforming operations (Like the Flip Camera??!?! -.Ed)
We are focused on making changes to our operations that make consistent profitable growth. We are moving quickly and will continue to execute our action plan.
Q3 met expectations, Q4 will continue to show weakness while we do the hard work to make the changes behind the scenes.
We know what we have to do. We have a clear game plan. We have had to make big changes before and each time we have emerged stronger.
First on today’s call we will share perspective on the current environment.
Second we will share areas that are under pressure including what we think are market driven and not.
Missed third and fourth things. :(
Starting with the current environment. He’s listing off the five priorities again mentioned in the streamlining press release the other day.
1:39 pm: We have acknowledged our challenges and the need for speed. We are intensifying our focus
Areas of concern: We’ve had several areas come under pressure. Consumer, set top boxes, switching and public sector. We have taken action and are excuting well in our next generation of video and set top.
The switching market is in the midst of a significant transition. Price per port is coming down. This is good for our customers. It will enabler faster adoption going forward. In the short term it puts pressure on our revenue opportunities. Our gross margins have come under pressure because of a transition at the high end as customers adopt Nexus 7K.
In order to address this shift we have introduced a new set of products, our largest ever refresh in so short a time period.
We are transforming both our cost and organization structure. From a product capability and innovation perspective we are positioned well. We are highly leveraged to benefit as the market stabilizes.
Public sector: We are seeing pressures on public sector spending all over the world.
We are in almost every sector of government, and the vast majority of business is new every quarter. You may be starting to see these changes in earlier phases from our market peers.
Public sector has traditionaly repesented 20 percent of our business.
No excuses, we must adjust quickly. We are and we will.
What’s going well: Solid sales growth across key markets. In a number of cases actions to improve gross margins.
Collaboration: A $4 billion revenue and order perspective. Our year-over-year growth has exceeded 25 percent in ever quarter and in Q3 was 39 percent including the Tandberg acquistion. Annual run rate of $1.15 billion.
Data center virtualization and cloud, $1.5 billion run rate, growing 60+ percent.
UCS grew to 1,570 customers. That’s the univeral compute product aimed at data centers.
BRIC countries grew 18 percent, Russia 14 percent, others grew as well.
We gain mindshare among global service providers. Service provider video remains a key priortity. Our servce provider video strategy will remain network centric.
Services grew 14 year over year.
1:48 pm: We are taking very specific steps to address our challenges. We are identifying key areas of work, simplifying operating models, managing our portfolio where we elminate or cut low producing areas. What we have done to date, we have appointed a COO, reorged sales and services. We’ve moved away from board and council structure. Finally streamlined operations across the company.
We closed Flip and restructured home networking. I asked Gary to become COO and to have a laser focus on simplifying operations.
Now Gary Moore is speaking.
As we look in our portfolios aligning with our priorties. Aligning people and investments to move with speed and agility.
A comprehensive portfolio review starting with consumer business. We are looking both at current and long term market potential. We will keep you posted on these decisions.
We have re-organized the major functions of sales and services, and moved away from a broad council and board structure.
Our $5 billion R&D budget will be focused on accelerating leadership while employing world class product development processes. We will focus on speeding up the time to innovation. We have appointed two seasoned leaders for the eningeering team.
We are looking across the business for actions to improve costs. Using Q4 as our base, majority of the actions wil be taken by Q1 FY12.
“Focus on workforce deployment levels.” That sounds like some layoffs may be looming.
Reduce our line and redeploy.
WE DO ANTICIPATE A WORKFORCE REDUCTION. There, he said it.
There’s an early retirement program in place. The decision to include headcount reductions as a way of reducing expense is difficult. It is not something we take likely.
Chambers is speaking again.
1:55 pm: Now I’d like to move on to Q3 and highlights.
European markets were mixed, better in north than south.
Emerging countries doing well, especially the BRIC countries.
Routing grew 7 percent
new product revenue grew 15 percent
data center 31 percent
security 2 percent
and video connected home decreased.
Frank (missed the last name) is giving the numbers and will give the guidance for Q4
Frank Calderoni, CFO, is speaking.
Next quarter we will report new geographic segments as announced in the reorganization earlier this week.
Calderoni is running through the Q3 numbers but the important stuff is the Q4 guidance.
Cisco reduced hiring to get expenses under control.
Balance sheet: Cash $43.4 billion. Up $3.1 from last quarter, including net borrowings of $1.5 billion, and operating cash flow of $3 billion. About $6 billion held in the U.S.
Chambers says the Japan team did an “amazing job” after the earthquake.
Calderoni is speaking again.
Headcount: 73,408, 40 percent were from acquisitions.
Wonder what that number will be next quarter?
Here’s the guidance for Q4:
We will take $1 billion out of annual expenses. In connection with these actions we expect future restructuring charges. The extent relating to these activities is not currently known.
We expect further restructuring charges of $40 million, bringing the total to $190 million.
In Q3 we started a voluntary early retirement program. We expect changes of $500 to $1.1 billion from that. The extent will depend on number of employees who elect to participate.
2:08 pm: Q4 we expect revenue flat to up 2 percent year on year.
Non GAAP operating margin 24-25 percent.
Non-GAAP EPS to be 37-39 cents.
We expect non-GAAP total gross margin at about 62 percent though it may vary.
We are moving quickly and will continue to implement our action plan. We will continue to show some weakness while we work through this.
Chambers is speaking again. He’s talking about Fiscal 2012 which starts in July.
Our portfolio positions is for growth next year. We will communicate what we expect at our analysts meeting in September.
We are completely committed as a leadership team to make the required fundamental operating changes to our model.
I have always believed that our strategy and direction starts and stops with our customes. We are well positioned in their minds for leadership. No one has Cisco’s breadth of innovation or the reach of our innovation model nor the talent of our employees.
Time for Q&A with analysts.
Barclays asks: Spend a little time talking about switching, which was down 9 percent. If you could help us understand what has shifted in the switching landscape and how long it will take to get back.
Chambers: That is a problematic area we have to address. I am very pleased with the new products. We are extremly competitive at the low end, and in the emiddle, and if you look where we are we need a little work on the high end.
Chambers: You will see us moving faster. Our products cycles will be 3 years instead of 5. If you want some additional data, our orders for the swtiching category. The fixed orders were up 8 percent, modular down 10 percent. We have seen some balancing.
We’re coming down with Moore’s Law but faster than Moore’s Law. We have some share challenges, but overall our port position is very solid. Our gross margin is at the high end.
Bank of America question: The revenue growth is healthy sequentially in the guidance. Why do we see revenues growing, but gross margins going down?
Chambers: During Q4 is traditionally our strongest quarter. Our sales force is incented there. It’s a quarter we grow well. But it comes at the back end of the quarter. We had a very good booking quarter in UCS. We did not get a lot of those shipped. Q4 will be very solid in the data center. Cloud activity is taking off. But you are clearly going to see in that quarter. We will provide in September an update on long term guidance; 12-17 percent is off the table.
A question RBC Capital: Asking about whether or not Cisco may end up in a perpetual state of restructuring.
Chambers: Really look hard at our margin components, and see where we need to make a difference. If they are not strategic, we will trim back and we will really cut back.
Each time we’ve done this in the past, we’ve done it crisply and we emerge stronger. Our employees know we’re going to make this change. We want to do it surgically, not with a blunt instrument. I’m not only energized, our whole group is moving fast. Something about working until 9:30 and eating lousy pizza.
Chambers: In 2001 we went through this extremely well.
Question from Goldman Sachs: Asking about the video priority. We agree its part of the future. The thesis has been that there’s a big infrastructure investment. There are a number of offerings including Skype that seem to be significantly lower cost. She’s basically asking about competitive threats to Cisco’s strategy on video.
Chambers: First, we bet on video five years ago. We said video would be the next voice. Second, video will not be standalone streaming through dumb pipes. Medianet enables you to build upon it. To push it to communities of interest, and you can search it.
To your point, you are seeing a number of peers focusing on video. But this is a big growth market and you are going to see a lot of competition.
A lot of our emerging technologies might sell $1 but they might load the networks with 3 to 5 dollars. I love anything that loads networks.
Chambers is especially talkative today.
Question from Oppenheimer: About switching. What you haven’t talked about is strategy around switching. Why should we assume the margin profile of that business will change? Are you more willing to lose share to maintain margin?
Chambers: A tough question.
Chambers: In terms of switching, if you’ve standalone switches and you’re just in the background you’re going to have a hard time over the next five years.
As you tie together switches to data centers and to device type you have an architecture that no one else has.
Port share: We are holding our own with lots of competitors coming at us. Whether it’s on price we’re going to go at them.
We’re starting to win some of our financial accounts back.
I would think about it as port share in one category, but in another market share, but also margin comparison, but also what you want your revenue to be.
We are clearly improving our markets there. Ah, Chambers just mentioned David Yen, just hired from Juniper.
Question from UBS: A question about operating expenses. Looking at the guidance, looks like it will be $4.1 billion and the annual savings of about $250 million per quarter. Should I look at annual opex at about $15.5 billion? Second, when you mentioned there would be a billion dollar charge from the severance, is all the opex you talked about to come just from the severance?
Chambers: Let’s assume $16.8 billion. We clearly have an expense run rate that’s too high given revenues. You have to bring expense growth down.
Calderoni: The restructuring would be in GAAP and not in the non-GAAP results. As we get more refined, we’ll identify it. Of the restructuring charges that I mentioned, those are part of the consumer announcement we already made, about $180 million. The other thing that would be part of the $1 billion would be early retirement but the program is open and it has 7 weeks left for employees to decide.
Calderoni: We’ll have a clearer view of it later.
UBS: What percentage of the opex will be from early retirement?
Chambers: We have our own internal modeling. Once you start talking about it you can do the math and figure out headcount reductions. Early retirement treats people with class. We will then look at the delta between employees and contractors. That will roll out and be announced to our employees first.
Management meetings will happen next week. We’re going to do it surgically. We’ve got to allow the teams to execute on the five stages. And then how you drive it through. This is heavy lifting. We’re not going to just do a haircut. You have to create a structure and then drive it through each layer. It will be shared later within this 120-day cycle.
Question from Credit Suisse: Back to margins. Regarding the long term structure. Is the pricing pressure coming just from Hewlett-Packard or Huawei and others? Another question on maintaining share at a lower price at cost of margin. How do you negotiate that?
Chambers. It’s very difficult. The question on lower price and lowering margin I don’t buy. Our gross margins on our prior generation, and current generation of switches are within a couple points. We’ve done a pretty good job on port share given how hard the competition is coming at us.
If you don’t get the market early you often don’t get it three years later. We’re going to get hit by HP and Huawei on price. That’s a given. There will be others who do it in a vertical stack like IBM. You have other players who come at us with silicon and software. We’re going to maintain our lead on switching. We know the barriers to entry are low, but they’ve been low for 20 years.
Question from Morgan Stanley: The gross margin was strong this quarter. Why was it strong?
Flip as it is now? Was it in the numbers and is it in the numbers for Q4?
Chambers: Occassionaly I speak a little bit fast. (You’re telling Me! -Ed.)
Chambers: On Flip. It was in the results for part of this quarter, but it’s out for next quarter. That’s about 1 percent of our business that is gone.
Calderoni: Margin improvement was 1.5 points. Half was related to non-recurring items. Exiting Flip contributed, and removal of some inventory impacts we had seen contributed to margins as well. Going into Q4 you don’t have the non-recurring.
Question from Deutsche Bank: About margins on switches.
Chambers: Gross margins on the 7000 series switches are about 18 points below those of the 6000.
Desutshe Bank asks more on switching. Revenue is down 9 percent and how did port shipments do and can you break it down on campus and data centers.
Chambers: Unsure on this one.
Chambers: Down 5 percent fixed, and orders up 8 percent year over year. Port shipment. We ran that analysis when we ran share of market. It’s a nice way of saying I don’t have the data to answer.
Deutsche Bank asks about councils. You went from 5 to 3. Do you think a direct line structure might be a better structure.
Chambers: We went from 9 councils to 3 and from 42 boards to 15. It connects our strategy with operations.
Gary Moore: At the high level, coming at it a different way. We moved to functional leadership driving the three councils we have left.
2:54 pm: The executives who run the councils “own the number,” Moore says. We have to be aligned and competitive.
The third council that we left in place. It is the emerging countries council.
We are doing business in countries where we don’t have infrastructure. I felt it was important to leave that council in place. Elimination of six councils and 31 boards is not the headline. It’s the way we have changed the way we’re operating. We’re going to drive our earnings faster than our revenue.
Chambers: We’ve simplified our organization, and we did with engineering and sales. It allows us to align cost structure and determine ownership on what asset to divest.
Question from Ticoderoga will be the last one. A question about a product that had some buzz at Interop.
Chambers: Our partners EMC and VMware called a market transition. We are making very good progress. Our pipeline looks very good. If I were to talk federal government alone, we moved quickly to collaboration, and we’re seeing decline. It’s an architectural play. If you’re a pinpoint player, you’re going to get commoditized. Our peers are now starting to come at it the same way.
Chambers’ closing remarks: I’d like to talk about the positives.
I’m going to focus on the areas that are problematic for us. Switching and public sector: We have to move faster and bring down expensive. We’re going to approach this simply. We’re going to simplify the focus of our operating model, and focus on the cost structure. And we’re going to divest underperforming assets. Our board, our leadership team, and our employees are totally unified in this. If I were a competitor, this is a tough company to bet against. There are areas where we must do different. The buck stops here, I get it.
3:01 pm: That ends the call.