Arik Hesseldahl

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Cisco’s Chambers: We Grow, Our Competitors Shrink. Got It?

Cisco just reported earnings for the fourth quarter that were better than most people expected, given the lousy state of the world economy, especially in Europe. The company beat the earnings consensus by a penny and the expectation of sales by $100 million.

Cisco also raised its divided to 14 cents a share, nearly double the 8 cents it had been before. Investors are responding by kicking Cisco shares upwards in after-hours trading.

Now the conference call is under way. I’ll be listening for indicators about what CEO John Chambers sees going on in all the geographic regions around the world. I’ll also be hoping that some of the analysts ask him about his plan, if any, to respond to the threat of software-defined networking, which is a small thing now but could be hugely important in a few years, and could threaten Cisco’s business.

1:40 pm: Joining the call in progress. CFO Frank Calderoni is speaking.

Calderoni is now running through the quarter’s results. Americas grew 7 percent. Europe was weaker, driven primarily by weaknesses in the southern part of the continent.

Asia was up, too.

Calderoni: Asian revenue benefited from the completion of several long-term projects that helped improve margins there.

Calderoni is now talking about benefits from the sale of some real estate as part of the restructuring.

Calderoni: Headcount was 66,639, which is up about 1,400, including 500 university graduates, 300 more in R&D working on data centers and 300 in services. Half of the headcount was in emerging markets.

EPS was 47 cents non-GAAP versus 40 cents a year ago.

Cash: $48.7 billion, up $304 million from last quarter. Of that, $6.2 billion was available in the U.S. Cisco bought back 108 million at an average price of about $16.16 a share.

Now John Chambers is taking over.

1:47 pm: Paraphrasing Chambers: We continue to feel good about core business. We’re growing while peers are seeing negative growth and in some cases negative growth in the double digits.

Chambers: Switching revenue was flat at $3.6 billion. Within fixed switching, we had a record quarter up 24 percent due in part to data center build outs.

Chambers: Our wireless business is strong and grew 22 percent.

Chambers: More crazy growth in data center revenue, up 90 percent.

Chambers: We saw continued traction with enterprise data centers with several customers growing their footprint.

Chambers: Now he’s talking about software-defined networks.

Chambers: Optimizing for the software and hardware combination is the only way to meet a customer’s requirements.

1:54 pm: Paraphrasing Chambers: Our global customers presence gives us a unique glance into customer requirements. Cisco pioneered virtualized networking in 2009. Cisco has more than Nexus 1000v router customers. (The V stands for virtual, natch.)

Chambers: We will continue to build, buy and partner. Also, this evolution will play out over several years.

Chambers: We believe that the move to a post PC world will play to our advantage, specifically in the collaboration business.

Chambers: Almost without exception, our customers understand that our acquisition of NDS brings us higher into their business. NDS should accelerate Videoscape, and change the way video is delivered to customers worldwide.

1:59 pm: Chambers is now talking about geographic regions. He says to expect some tough comparisons because this quarter and the last one were relatively strong in certain regions.

In Q4 we saw positive growth and/or uptrends in the U.S. May be early to say, but it could indicate a recovery in the U.S. U.S. state and local governments were up, and they’re usually the first to slow down.

Chambers: U.S. federal government spending was down. Europe product orders down 6 percent. Most customers are not expecting an improvement. Europe accounts for 19 percent of revenue.

Asia grew the fastest at 12 percent.

Missed the rate of growth in the Americas which was 4 percent.

India is challenged, but is heading back to flat growth after several quarters with shrinking sales.

Chambers: He’s now talking about enterprise market. Remaining positive, but cautiously so.

Chambers: We are modeling Europe to stay challenging, as will government spending in the U.S. and Europe. CEOs will be conservative in their IT spending.

Now Calderoni is about to give guidance.

Calderoni: It’s on a non-GAAP basis. Q1 growth of 2 percent to 4 percent year on year, with gross margin at 61 percent to 62 percent.

Q1 EPS 45 cents to 47 cents per share, which is up 5 percent to 9 percent year on year.

2:11 pm: Calderoni: Talking about NDS acquisition and how it will affect next quarter now that the deal is closed.

Calderoni: He’s expecting non-GAAP EPS benefit of 2 cents to 3 cents. Also expects some integration charges of about $1 billion. NDS will bring in revenue of about $200 million. FY13 we expect non-GAAP margin including NDS to be 61 percent to 62 percent, which is essentially the same as without NDS.

Calderoni: Expects 2 cents to 3 cents in restructuring charges.

Chambers is speaking again. “We changed where we needed to.”

Here’s the Q&A.

First from JPMC: You linked dividend increase to interational cash repatriation (a favorite political saw of Chambers’.) He’s also asking about the outlook in the macroeconomy.

Chambers: Capital allocation answer: He’s congratulating Calderoni for the dividend. There are a number of levers we can pull. We can pay the dividend from cash in the U.S.

Calderoni: Trying to balance the buyback and dividend. We want to have a minimum of free cash flow going to buybacks and dividends.

Calderoni: We feel comfortable that we can make this committment to be very strong advocates for tax reform.

Chambers: Now talking about the macro. Q4 last year in orders was the strongest we’ve seen in five quarters.

2:22 pm: Europe will be as tough as you’re hearing. I think it was up 14 percent for four quarters, and then up 6 percent, and then flat, and then down. So you can see the curve there.

2:24 pm: A question about business with the service providers.

Chambers: This is a business where we’re taking a good share of wallet. He’s pointing out that AT&T is boosting its capital spend.

Chambers: Balancing that is very tough compares. European service provides, the big ones, are not going to be spending very much in the second half of the year. We’ll get our share of spend there. We’re modeling that a little tougher.

Question from Deutsche Bank about SDN. How will Cisco compete with Nicira and VMWare?

Chambers: When you really think about SDN, I want to be candid. We think the future is going to be hardware and software combined. Secondly, we saw virtualization coming. We went into it early in 2009, which is exactly when we entered the data center. We see Nicira, Openflow type activity being a few years out. We are looking at partnerships we can work on.

And by SDN, naturally I mean software-defined networking.

Chambers: Als, it won’t threaten our partnership with VMWare. We need them and frankly they need us.

2:34 pm: Question from Morgan Stanley about cash management and paying of dividends and buybacks. Also about product order growth. Are we in a world where it accelerates for a year and then slows down?

Calderoni: We deliberately word it as meaning 50 percent. Some of the cash is distributed into the U.S. from overseas, and that’s cash that has already been taxed by the U.S.

2:37 pm: Chambers says he wants to get the company moving to a more predictable revenue growth rate. The question was about the possibility of alternating years where sales grow like crazy, slow down and then grow like crazy again, making comparisons difficult.

Question from B of A: How much of cash flow is generated in the U.S.? Everyone is trying to figure out how to think about Calderoni’s promise to use 50 percent of cash flow toward buybacks and dividends.

Calderoni: If you look at it from the buyback and dividend perspective, it comes from U.S. cash. That is what we would use for dividend and buyback. We will continue to forecast what we generate in the U.S. and work from that flow. Again with the mention of cash already taxed. (Man, I’m getting tired of all this accounting talk.)

Chambers: We’re not stepping off the cash repatriation issue, regardless of who wins the presidential election. Chambers says cash from operations were $10.8 billion.

2:43 pm: RBC Capital question. You’ve moved from a growth phase to a stabilization phase. What happens next? Do you exit some business and then acquire higher growth companies?

Chambers: There are a lot more opportunities we can go after within our five foundational principles. Things like smart grid and video are high-growth opportunities.

It’s so nice how John Chambers likes to publicly praise his executive team on the earnings call. He keeps complimenting Calderoni and COO Gary Moore. Also Robert Lloyd, EVP of Worldwide Operations.

Question from Morningstar: Looking at security, it looks like it has grown six quarters in row. What’s working in that business? And how can you take share more quickly?

Chambers: We think security is a big opportunity that can reach across products. Also, there have been some changes in leadership there.

Another question, missed the name of the firm: Asking about backlog.

Chambers: Our backlog is up $500 million. In terms of comparision, when you have 12 percent growth, you compare when you have 2-3 percent growth. The second issue is that we’re taking share. Our peers are at negative or flat growth. We are gaining share, if the economies turn. Europe is going to get worse before it gets better, and that means we’re going to focus on taking share from competitors.

Question from Raymond James: Asking about the data center business. Could you elaborate with context? In terms of data centers, could you tell us total revenue derived from data centers including other products like routers and switching? I think its about 15 percent. If we could understand your reliance on partnership that would be good.

Chambers: It’s almost impossible for us to get to that answer for the first part of the question. Run rate for UCS is $1.6 billion. Our value to our customers has probably never been more relevant in the data center. Our partnerships with EMC and VMWare are important, but we’ll continue to control our own destiny.

Rob Lloyd is also talking about something called Cisco One, a program under which the company plans to give some programming access to operating systems on the networking gear as part of addressing the perceived threat from software-defined networking players.

2:58 pm: Question from Topeka Capital: Are there any other pieces of the puzzle in the data center? Storage? Also about use cases.

Chambers says all the growth in servers is in blade servers.

Rob Lloyd: No. 1 use case for UCS is private cloud installations. Second is for cloud providers, looking at provisioning and management. Another is call control.

This is turning out to be the last question.

Chambers: It’s not about standalone products, it’s about solving the problems for the customers. He’s talking about some of the things Cisco did in the U.K. for the Olympic games. He covered some of this in his opening remarks.

Chambers: Bottom line, we did what we said we would do. Our strategy and vision appear to be working well. We wouldn’t be boosting the dividend and the buyback commitments if we didn’t feel confident.

And that’s the end of the call. Next call will be Nov. 13. See you then!


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