Cisco Systems' CEO Discusses F4Q 2013 Results - Earnings Call Transcript

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Cisco Systems, Inc. (CSCO) F4Q 2013 Earnings Conference Call August 14, 2013 4:30 PM ET

Executives

Melissa Selcher - Senior Director, Analyst and Investor Relations

John Chambers - Chairman and Chief Executive Officer

Frank Calderoni - Executive Vice President and Chief Financial Officer

Rob Lloyd - President, Development and Sales

Gary Moore - President and Chief Operating Officer

Analysts

Tal Liani - Bank of America Merrill Lynch

Simona Jankowski - Goldman Sachs

Ben Reitzes - Barclays Capital

Simon Leopold - Raymond James

Brian Modoff - Deutsche Bank

Amitabh Passi - UBS

Mark Sue - RBC Capital Markets

Rod Hall - JPMC

Jess Lubert - Wells Fargo Securities

Jayson Noland - Robert Baird

Operator

Welcome to Cisco Systems’ Fourth Quarter and Fiscal Year 2013 Financial Results Conference Call. At the request of Cisco Systems, today’s call is being recorded. If you have any objections, you may disconnect.

Now, I would like to introduce Melissa Selcher, Senior Director, Analyst and Investor Relations. Ma’am, you may begin.

Melissa Selcher

Thank you, Kim. Good afternoon, everyone, and welcome to our 94th quarterly conference call. This is Melissa Selcher and I am joined by John Chambers, our Chairman and Chief Executive Officer; Frank Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, President of Development and Sales; and Gary Moore, President and Chief Operating Officer. I would like to remind you that we have corresponding webcast with slides on our website in the Investor Relations section.

Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found on the Investor Relations website. Click on the Financial Reporting section of the website to access these documents. Throughout this call, we will be referencing both GAAP and non-GAAP financial results. The matters we will be discussing today include forward-looking statements and as such are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on the Form 10-Q and 10-K 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. Unauthorized recording of this conference call is not permitted. All comparisons throughout this call will be on a year-over-year basis unless otherwise stated.

I will now turn the call over to John for his commentary on the quarter.

John Chambers

Mel, thank you very much. As we closed fiscal year ‘13 we are pleased to announce another strong quarter and strong end to our fiscal year. Q4 was a record quarter on many fronts with record revenues of $12.4 billion and record non-GAAP operating income, record non-GAAP net income, and non-GAAP earnings per share of $0.52. In every case, we exceeded the midpoint of our guidance. We generated $4 billion in operating cash flow in the quarter, another record as well.

Delivering the record results we did this quarter and every quarter this year despite the challenging macroeconomic backdrop speaks to our increasing strategic position in the market and our ability to manage our overall business as a portfolio across technologies, customer segments, and geographic regions.

With this backdrop in mind, I want to highlight five key takeaways from Q4. First, our results, we continue to consistently deliver. Our performance in Q4 FY ‘13 was differentiated versus many of our peers. We drove both top line growth of 6% and bottom line growth in terms of non-GAAP EPS growth of 11% with stable gross margins for the year and strong operating margins. From the $4 billion cash from operations, we returned over $2.1 billion to our shareholders in buyback and dividend. Secondly, we are leading many of the technology transitions in the market which are increasing in pace. With the networks squarely at the center of cloud, mobility, BYOD, security and the internet and everything. We believe we’re uniquely positioned to help our customers meet their business goals and they are asking us to play this role. An example is our continued success and mobility where we are driving the transition to a unified access architecture and cloud and saw revenue growth of over 30% in our wireless business this quarter. Our data center business is a tech improved point. We successfully drove the transition to a converged architecture and you see this is in our data center results, a 2 billion plus business in five years growing revenue over 40% year-over-year in the most recent quarter and we’re not stopping.

At Cisco Live in June we previewed our application centric infrastructure strategic within SEMI (ph). We’re delivering the next wave of industry innovation from the cloud through the campus and driving our continued market leadership. Third, we delivered the strong performance and what continues to be a challenging and inconsistent global macroeconomic environment. While we saw continued momentum in year-over-year orders in the U.S. enterprise up 9% U.S. commercial up 12% and an upturn in U.S. public sector which grew at 4% and APJC our Asia-Pacific, Japan, China operations we saw the same weakness many of our peers experienced with orders down 3%. Along with economic challenges impacting several of our Top 5 emerging markets.

Last quarter I described a continued slow recovery and I haven't seen anything to suggest that this dynamic will change in the short term but this recovery is more mixed and inconsistent than the others I’ve seen.

Fourth, we’re committed to our long term financial model including driving profitable revenue growth of 5% to 7%. In this tight environment, we as leaders must continue to see rebalance our resources to indepth into opportunities, in my opinion we’re managing our opportunities and our business better than we have ever have and our customers and shareholders are seeing the benefits.

And fifth, we believe our vision and strategy are working. We’ve never lost when we are aligned with our customers, helping them to solve their most important business challenges. You saw that in our U.S. enterprise and commercial business, global search for other customers and even entire countries. When we partner with our customers on their business priorities the results speak for themselves. As an example I look at our success selling solutions that deliver business results not selling products in (inaudible) as U.S. enterprise business resulting in terms of pipeline more than 50% year-over-year increase in orders of over $1 million in that territory. At the country level I look at 27% year-over-year increase in orders with Israel in Q4. As we align across all political parties to focus on the countries priorities, job creation, inclusion, education, healthcare, future infrastructure and technology industry development. When we partner with a customer and in this case a country is real to drive their success our business benefits which Forbes refers to as profits through peace.

The latest industry data shows our relevance with customers is only growing as we move to become the number one IT Company, to provide additional details on our Q4, FY ’13 results I would like to turn the call over to Frank. After Frank I will then walk through some additional details in terms of what we’re seeing in the business, Frank will then detail our guidance and then we will wrap up with a quick summary and move in to my favorite part which is the Q&A. Frank, to you.

Frank Calderoni

Thanks John. I’m pleased with our strong performance in Q4 and throughout FY ’13. We delivered top-line growth for the full fiscal year of 6% and grew profits faster than revenue for each quarter and for the full year. We effectively managed our business with strong operational execution while maintaining stable growth margins and delivering profitable growth and return for our shareholders. Starting with the full fiscal year performance our total revenue was $48.6 billion, our non-GAAP net income was $10.9 billion and this was up 8%. Non-GAAP earnings per share on a fully diluted basis was $2.2 per share which grew 9% year-over-year.

As for our GAAP net income it was $10 billion or $1.86 per share on a fully diluted basis representing increases of 24% and 25% respectively. We generated strong operating cash flows of $12.9 billion increasing 12%. We returned $6.1 billion of cash to our shareholders through our dividends and share buybacks representing 52% of free cash flow, which is $11.7 billion. This is consistent with the capital allocation strategy that we introduced a year ago.

Moving on to Q4 results, we had solid execution which results consistent with our expectations. Total revenue was $12.4 billion growing 6% year-over-year and non-GAAP EPS was $0.52 per share growing 11%. Our Q4 marked the seventh consecutive quarter, where we grew profits faster than revenue as measured through earnings per share. In this quarter, we closed three more acquisitions, including SolveDirect, Ubiquisys, and JouleX and we announced two more acquisitions in security and software. Composite Software provides enterprise data virtualization software and services, and Sourcefire is a leading intelligent cyber security solutions company. These acquisitions are aligned with our portfolio approach of driving long-term returns in complementing our innovation engine.

In terms of our business momentum, we saw product and service revenue both grow at 6% with total product book-to-bill comfortably over 1. Total revenue from a geographic perspective grew 7% for the Americas, 12% for EMEA, and decreased 3% for APJC. We delivered strong and consistent non-GAAP operating margins of 28.2%. Within our operating margins, we have driven stability in our gross margins and maintained a concentrated focus and discipline on our operating expenses. In Q4, our total non-GAAP gross margin was 62.1% and this compared to 61.9% a year ago and 63% last quarter.

Our non-GAAP product gross margin was 60.8%. This compared to 60.4% a year ago and also 62.1% last quarter. We saw good gross margin stability across most of our product areas. Our non-GAAP service gross margin was 67.1% and this also compared to 66.5% last quarter and 67.1% in Q4 of FY ‘12. Total gross margins by geography where Americas is at 61.8%, EMEA was at 64.4%, and APJC was at 59.5%.

Our non-GAAP operating expenses were $4.2 billion, or 33.9% as a percentage of revenue compared to 34.4% in Q4 fiscal year ‘12. We made headcount investments this past quarter of approximately 900. These additions were driven by our acquisitions and portfolio investments in sales as well as in services.

Now, moving on to the non-GAAP tax provision rate, that was 20.1%. Our non-GAAP net income was $2.8 billion, and this represents an increase of 13%. As a percentage of revenue, non-GAAP net income was 22.9%. As I mentioned earlier, our non-GAAP earnings per share on a fully diluted basis was $0.52 and this is versus $0.47 in the fourth quarter of fiscal year 2012, and it represents 11% increase.

From a GAAP net income perspective, it was $2.3 billion representing an increase of 18% as compared to $1.9 billion in the fourth quarter of fiscal year ‘12. Our GAAP earnings per share on a fully diluted basis was $0.42 versus $0.36 in the same quarter of fiscal ‘12 and this represents a 17% increase. As a reminder, we announced in June that our GAAP net income and GAAP earnings per share for Q4 FY ‘13 included an impact of the TiVo patent litigation settlement. We recorded a charge of $172 million, or $0.03 per share. The non-GAAP earnings this quarter exclude this charge. During the quarter we returned $2.1 billion to our shareholders including 1.2 billion through the share repurchase and 918 million to our quarterly dividend. Total cash and cash equivalents and investments were $50.6 billion including $10.2 billion which was available in the U.S. at the end of the quarter. Cash flow from operations was a strong $4 billion up 29% and this was an all-time record. Our product backlog at the end of fiscal 2013 was approximately $4.9 billion as compared to approximately 5 billion at the end of fiscal 2012.

In terms of our key balance sheet metric, DSO or day sales outstanding was 40 days reflecting a slightly reduced linearity profile of product and service billings this quarter. This impact was partially offset by strong collections on our receivables and finally our non-GAAP inventory returns was strong at 12.8.

Overall our priority of long term possible growth is proving to be effective. We’re driving focused and discipline in the right areas of the business which helps us to continue to be ahead and innovate IT solution for our customers. We remain highlight focused on shareholder value through rigorous expense management and strong cash return to our shareholders. We remain confident in our ability to continue to execute. John I will now turn it back over to you for more detail on the business moment.

John Chambers

Thank you Frank. I will now provide some additional detail on the performance in Q4 and trends we’re seeing in our business and in the market. I will first walk through our product portfolio in terms of year-over-year revenue growth followed by discussing geographic and customer segments in terms of year-over-year orders. First in core networking, we have driven innovation in execution of (inaudible) switching portfolio which has resulted in solid growth of our switching business this quarter of 5%. Our Nexus switching product line continues with it's strong double digit growth over 20% and in the campus our full converged wired and wireless Catalyst 3850 platform continues it's very strong performance with the current quarter order rate of over a 150 million after only two quarters in the market.

Despite how you program new technologies and potentially disrupt your competitors. Our performance in switching has been extremely solid and we’re innovating to continue to lead in the future and we saw another strong record quarter in our wireless business up 32%. We were particularly pleased with the performance of our cloud networking business based upon our acquisition of Meraki, this quarter which grew orders over 100% from the prior quarter within order run-rate now annualizing Q4 of over $250 million. This speaks to the power of industry leading technologies, in this acquired integrating to architecture accelerate about world leading channel organization.

We’re also pleased with the initial uptick of 802.11ac modules for the AP 3600 leading the adoption of gigabit lap out the new industry standard for wireless LANs. In NGN routing total revenue for NGN routing was flat, the story across the industry this quarter was one of the edge, we saw our ASR 9000 revenues reach a record high with growth of 69% well outpacing our peers and the high end core we experienced weakness from our peers. In the quarter we introduced the CRS-X system with over 400 GPS capacity to address a surging demand for video, mobility and collaboration. We are very comfortable with our product leadership and plans for the future in this market.

In mobility we expanded our customer penetration with our newest ASR 5500 series with several key wins, this product tends to be large order driven and my word is i.e. lumpy even though I know you don’t like it now and so following strong growth for several quarters we saw a slight decline this quarter. We’re bringing advance software and management tools to carriers that will enable them to lower operating cost and drive efficiencies around their overall network spend. We believe our internal innovation coupled with the recent acquisitions of BroadHop, Cariden, Intucell and Ubiquisys position us to be the clear number one in this mobile market over the long run.

Cisco ONE continues to gain strong customer momentum by delivering in our view the most comprehensive framework for network programmability and SDN. We have more than doubled the number of beta customers to over 120 are utilizing Cisco ONE to program, orchestrate, and manage their networks. We also are continuing to invest in open source communities like OpenDaylight and OpenStack as a means we help accelerate our customers’ adoption to SDN and cloud. Technology from Sourcefire, our most recent announced acquisition is based on industry leading open source platform for security.

Moving on to the data center cloud, where we grew revenue 43% year-over-year growing across all regions. We are pleased to have moved into the number two position worldwide in the x86 blade market with approximately 20% market share something our peers would have considered impossible a few years ago. We saw this strong performance despite a very challenging compared to Q4 FY ‘12, where a year ago we blew out the numbers with 90% year-over-year growth.

Our partner ecosystem, including VCE and NetApp as well as hundreds of application partners continues to accelerate the adoption of our unified data center architecture as the leading data center platform. VCE specifically had a very strong quarter with order growth over 50% and strong demand from new and existing customers. We are seeing similar momentum with our FlexPod solution with NetApp, where FY ‘13 orders also grew over 50% compared to FY ‘12.

Moving on to video, total SP video revenues grew 23% driven largely by our NDS acquisition. We continue to see good performance with our video software and solution business that includes NDS driven by new innovative solutions like cloud, DVR, and compelling user interfaces.

Moving on to collaboration, we continue to improve our collaboration execution. Revenue was flat normalized for the underlying server revenue. Momentum as measured by collaborative orders reached a record high this quarter growing normalized 5%. That’s the first quarter in five quarters that we have grown positively from now. Revenue growth lagged as the profile of this business shifts to recurring revenue. We saw this trend in our conferencing performance, which was flat and UC when normalized was down 2%. TelePresence was up 3% driven by strength in endpoints.

Moving on to security, where revenue of $346 million was flat year-over-year. Network security is flat and content security was slightly down. A continued shift in the security business to term-based software licensing, i.e., recurring revenue is having a short-term impact on year-over-year revenue growth. Last month, we announced our intent to acquire Sourcefire for $2.7 billion, and we expect this acquisition to close in the second half of the calendar year. With this move, we made a major step forward to be our customer’s leading security partner and our aspirational goal to become the number one security company.

Finally, services, services revenues grew 6% representing 22% of total revenue. As we said before, we are committed to our long-term growth rate to 9% to 11% in services. Together with our partners, we are winning large multi-year service deals as our customers ask us to partner with them to meet their business goals. In summary, we believe our innovation to build by partner combined with our architectural approach is working extremely well. We continue to focus on market transition and customer priorities to drive our innovation and focus.

I will now move on to provide some color on our geographic and customer segments. The following geographic and customer segment growth rates are in terms of year-over-year product orders for Q4 unless specifically stated otherwise. In Q4, Cisco’s total product orders grew 4% year-over-year. Looking at the numbers from a geographic perspective, the Americas region grew 5%. As I discussed upfront, we continue to see solid minimum in the U.S. with U.S. enterprise up 9% and commercial up 12%. U.S. public sector growth of 4% was driven by state, local, and education strength in their buying season which was up 9% and federal business was – growth was up 3%. U.S. service provider was down slightly. We saw challenges in the Asia-Pacific, Japan, and China region down 30% due largely to macroeconomic challenges. We saw challenges in Japan due to reduced large SP CapEx and economic challenges. We also continue to work through the challenges in China and so only 6% decline in our business there. China is less than 5% of Cisco’s total revenue from an overall perspective. India recorded a highlight in Asia-Pacific at 19%. One of the most positive trends we saw in Q4 was the continued improvement in our Europe, Middle-East, Africa and Russian Region which was up 6% and Europe itself was up 6%. Economic conditions in Europe still vary significantly by region with the North and UK showing very positive progress, we remain cautious however given the instability of the southern region.

Our emerging markets business was up 8%, however we saw mixed results in our top five emerging countries, with India and Mexico up in double digits, Brazil and Russia approximately flat and China down 6%. The changes in macroeconomic conditions in the emerging markets both positive and negative are driving more inconsistent growth than in the past. Now on moving on to customer segment view again and from an orders perspective.

Enterprise declined two percent the decline was driven largely by EMEA Enterprise which declined 10% year-over-year. Commercial grew 5%, service provider were 6%, global public sector grew 6%. This once again has been a very positive trend with global public sector and if you would have just looked back over the last year Q1 of this last year global public sector was down 6%, Q2 was flat, Q3 up 1% and Q4 up 6%.

Our results demonstrate the mixed nature of the market. In technology areas we’re seeing switching and data center strength offset by routing and set-top box weakness. In customer segments we see public sector moment offset by softness this quarter in enterprise. In geographies we see improvement in the EMEA and Europe if you will offset by weakness in APJC.

Despite these trends we continue to grow. Our total product order growth continues to slowly increases over the last four quarters excluding acquisitions and divestures so they are apples to apples. Speaking to the power of our portfolio and our execution. While the trends of ICT spending and global GDP growth according to industry experts continue to be revised down for calendar year ’13.

Industry estimates have the growth of our total available market and we’re looking through calendar year 2017 in the 5% to 7% range once again echoing our view to this is the area that we ought to grow in over the longer time period. In summary I believe the macro effects will purely continue mixed environment but I feel very good about how we’re positioned and about what we can control. I will now turn it over to Frank to provide Q1, fiscal year ’14 guidance.

Melissa Selcher

Before Frank continues I want to clarify one number the Asia-Pacific, Japan, China region was down 3% in terms or orders year-over-year not 30%.

Frank Calderoni

Thanks John. Let me now provide a few comments on our outlook for the first quarter, let me remind you again that our comments include forward-looking statements and you should review our recent SEC filings that identify some important risk factors and understand that actual results can materially differ from those contained in the forward-looking statements and that actual results could also be above or below the guidance. This guidance we’re providing is on a non-GAAP basis with reconciliation to GAAP.

For Q1 FY '14, we’re managing the business to account for a slow and consistent recovery. With that in mind, we expect revenue growth to be in the range of 3% to 5% on a year-over-year basis. For the first quarter we anticipate non-GAAP gross margin to be in the range of 61% to 62%. Our non-GAAP operating margin in Q1 is expected to be in the range of 27.5% to 28.5% and our non-GAAP tax provision rate is expected to be approximately 21% in the first quarter.

Our Q1 FY ’14 non-GAAP earnings per share is expected to range from $0.50 to $0.51. We remain committed to our long term financial model of driving profitable growth, our growing revenue of 5% to 7%, and non-GAAP EPS 7% to 9%. As you would expect, we continued to make portfolio trade-offs to ensure we are investing in future growth through innovation such as cloud, data center, mobility, services, software, and security as well as driving operational efficiencies.

In the past two years, we have managed the business with discipline and focus. In order to execute on the portfolio investment and operational efficiency opportunities that we see in FY ‘14, we are rebalancing our resources with a workforce reduction, which will impact approximately 4,000 employees or 5% of our global workforce. We expect to continue to deliver non-GAAP operating margins as a percentage of revenue in the high 20% consistent with our long-term financial model. We expect to take this action starting in Q1 FY ‘14 and currently estimate recognizing pre-tax charges to our GAAP financial results of up to $550 million. We expect that approximately $250 million to $300 million of these charges will be recognized during the first quarter of FY ‘14 with the remaining amount recognized during the rest of the fiscal year.

We anticipate our GAAP earnings in Q1 to be $0.16 to $0.20 per share lower than our non-GAAP EPS. Please see the slides that accompany this webcast for more detail. Other than those quantified items noted previously, there are no other significant differences between our GAAP as well as our non-GAAP guidance. This guidance assumes no additional acquisitions, asset impairments, restructurings, and tax or other events which may or may not be significant. And as a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. John, turn it back to you?

John Chambers

Frank, thank you very much. The most difficult decisions we make as leaders are those that impact our employees. However, we will always take the necessary actions to efficiently manage our business for the long run. Consistent with what we have said over the past two years, we are positioning Cisco to accelerate and lead with greater speed, flexibility, and agility. As we closed a very successful fiscal year ‘13, I am very pleased with how we are operating as a company and the value we are delivering to our customers, our partners, our employees, and our shareholders.

We have delivered on and remain committed to our long-term profitable revenue growth of 5% to 7% and capital returns of the minimum of 50% of free cash flow annually and believe Cisco is better positioned in the market today than ever before. As I look at the area as a very-sought momentum going to Q1, I feel extremely confident. I know it is a long list, but I ask you to bear with me as I think these areas of strength are proof of our increasing relevance and strong execution over the next number of years. Specifically, I am very pleased with the following: U.S. enterprise and commercial momentum, beta center and cloud leadership, mobility and wireless strategy, switching growth and leadership, European momentum and execution, SP strategy and architecture, global public sector improvements.

We have seen two things that have changed over the course of this year. First, the economic recovery is slower and more inconsistent with global GDP continuing to sit down for calendar year 2013 and global challenges in Southern Europe, several of the large emerging markets and Asia-Pacific. Second, the pace of change has continued to increase. This is an environment that we are very effective at and very much want to lead. We are going to focus on aligning our resources to our top opportunities, speeding the decision cycles and time to implementation, balance sheet expenses to revenues, and driving efficiencies in the business while investing in growth. We never convinced ourselves. The market will evolve a certain way because it’s convenient to our current business rather we align closely with our customers to transform to meet the long-term market needs.

We prioritize and invest for where we believe the market is going. Every technology company should move with this agility, many don’t, and those companies that don’t get left behind. Investments we made many years ago are paying off today. Nothing is more evident than what we discussed earlier in terms of our movement in the datacenter. It's started over seven years ago. We've recognized the impact of datacenter and cloud would have on networking and opportunity to bring innovation in terms of product architecture and go to market. We move from being unknown in the market to the number one cloud infrastructure provider today as reported by Synergy Research. We're driving the same strategy across our business using innovation, acquisitions, spin in and partnering to drive our agenda making strategic bets and investments to position us well for the future.

My confidence in our ability to be the number one IT Company is increasing. This leadership is evident and our customer and partner satisfaction scores that are the highest in the industry and our customers want us to do more. Now more than ever our customers and our partners want Cisco's help navigating these challenging landscape successfully. They recognize the benefit of a partner who is not only the leader in their product categories but can bring technology and solutions together in an architecture to lower operating costs, reduce time to market and future proof their investments.

I'd love any player to take us on in this strategic approach. This is a strategy we invented and have delivered on successfully for over two decades and we’re moving aggressively to play on in even broader scale. While we’re planning conservatively given the broader macro environment we remain very much a company on the offensive and very comfortable with maintaining our position as the disrupter in the industry. Both today and in the future, we'll measure our success by the value we deliver to our customers, partners, employees and shareholders.

Mel, let me turn it over to you for questions.

Melissa Selcher

Thanks John. We'll now open the floor to Q&A. We still request that sell side analysts please ask only one question. Operators please open the floor to questions.

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