Cisco Systems, Inc., Q3 2008 Earnings Call, May-06-2008 - NasdaqGS:CSCO

NasdaqGS:CSCO

During the Cisco Systems, Inc. Q3 2008 Earnings Call, Frank Calderoni, the Chief Financial Officer, provided the following comments and insights:

1. Introduction:

   • Frank was introduced as the Chief Financial Officer of Cisco Systems.

2. Financial Highlights for Q3:

   • Total revenue for the third quarter was $9.8 billion, an increase of 10.4% year-over-year.
   • Routing revenue was strong at $2 billion, up 14% year-over-year, driven by high-end router portfolio growth of 26% year-over-year.
   • Switching revenue was $3.2 billion, an increase of 3% year-over-year, driven by growth in the 6500 switching portfolio.
   • Advanced Technologies revenue totaled $2.4 billion, representing an increase of 17% year-over-year, led by strong performance in Unified Communications and Video Systems.
   • Other product revenue totaled $569 million, an increase of 3% year-over-year.
   • Total service revenue was $1.6 billion, up approximately 15% year-over-year, with solid growth across all geographies, and particularly strong growth in advanced services at 35%.
   • Revenue growth by geography ranged from 5% year-over-year in the US and Canada to a high of 44% in emerging markets.
   • Q3 total non-GAAP gross margin was 65.4%, approximately flat quarter-over-quarter and up 0.9 points year-over-year.
   • Product-only non-GAAP gross margin for the third quarter was 65.9%, flat from the previous quarter.
   • Non-GAAP service margins for the third quarter were 62.7%, down from 63.5% in the previous quarter.
   • Total gross margin by geography ranged from 64% for emerging markets to 70% in Japan.
   • Non-GAAP operating expenses as a percentage of revenue were approximately 36% in Q3 fiscal year '08, up from 35.2% in Q3 '07, with foreign exchange impact adding approximately 0.9 points to the ratio.
   • Excluding foreign exchange, non-GAAP operating expenses for Q3 grew at 10% year-over-year, balanced with revenue growth.
   • Interest and other income was $168 million for Q3, lower than guidance of $200 million due to macroeconomic conditions and lower gains from the sale of fixed income and public equity investments.
   • Q3 FY'08 non-GAAP tax provision rate was 24%.
   • Non-GAAP net income for the third quarter of fiscal 2008 was $2.3 billion, compared to $2.1 billion in the third quarter of fiscal year 2007, representing a 9.4% increase year-over-year.
   • Non-GAAP earnings per share on a fully diluted basis for the third quarter was $0.38, up from $0.34 in the third quarter of fiscal year 2007 or a 12% increase year-over-year.
   • GAAP net income for the third quarter was $1.8 billion, as compared to $1.9 billion in the third quarter of fiscal year 2007.
   • GAAP earnings per share on a fully diluted basis for the third quarter were $0.29, down from $0.30 in the same quarter of fiscal year 2007.
   • A charge of $246 million or $0.04 per share was recorded during the quarter relating to the intent to purchase the remaining interest in Nuova Systems, which was excluded from non-GAAP net income.

3. Balance Sheet and Cash Flow:

   • Total cash, cash equivalents, and investments at the end of Q3 was $24.4 billion, up $1.7 billion from Q2.
   • During Q3, Cisco generated $3 billion in cash flow from operations and $336 million in proceeds from stock option exercises.
   • Cisco repurchased $2 billion of common stock, or 83 million shares, at an average price of $24.4 per share.
   • Accounts receivable ended the quarter at $4.2 billion, flat from Q2.
   • Days sales outstanding (DSO) was 39 days, the same as in Q2.
   • Total inventory at the end of Q3 was $1.3 billion, approximately the same level as in Q2.
   • Non-GAAP inventory turns improved from 10.5 last quarter to 10.7 this quarter.
   • Inventory purchase commitments at the end of Q3 were $2.7 billion, relatively flat from the end of Q2.
   • Deferred revenue was $8.6 billion in Q3, an increase of $607 million from Q2 and $2.3 billion from Q3 FY '07.
   • Deferred product revenue was $2.9 billion, up $201 million from the previous quarter.
   • Deferred service revenue was $5.7 billion, up $406 million from the previous quarter due to the addition of several large multi-year service contracts.
   • Headcount at the end of Q3 totaled 65,225, a net increase of approximately 1,100 from Q2 FY '08, primarily due to hires in engineering, sales, and services.

4. Conclusion:

   • Frank expressed pleasure with the company's performance for the third quarter of the fiscal year, enabled by the portfolio management approach to innovation, a broad and growing global footprint, and a team dedicated to outstanding execution.

   • He highlighted the company's ability to deliver solid financial results with excellent cash flow and a strong book-to-bill during a quarter of somewhat uncertain macroeconomic conditions, illustrating the power of the business model.

   • Frank stated that the company would continue to invest in its diversified technology portfolio while maintaining a focus on profitability to take advantage of market transitions and drive toward long-term growth targets of 12% to 17% over the next 3 to 5 years.

During the Cisco Systems, Inc. Q3 2008 Earnings Call, Rick Justice provided additional insights on the service provider business, particularly addressing the context around the order growth in North America, excluding Scientific Atlanta. Here’s a detailed summary of Rick Justice’s comments:

1. Service Provider Order Growth Context:
   • Rick Justice adds context to the service provider business, noting that after twelve quarters of over 20% booking growth in the U.S., the company is now facing some tough comparisons.
   • He explains that the natural ebb and flow of orders, along with the introduction of new EDGE technology, aligns with these tough comparisons, which impacts the order growth numbers.
   • Despite the current challenges, Rick Justice emphasizes that there is optimism for the longer term, given the strong relationships Cisco has established with service providers.

In summary, Rick Justice provides reassurance about the service provider business, highlighting the cyclical nature of the industry and the strong foundation Cisco has built with its service provider customers. He suggests that despite the current challenges, the outlook for the longer term remains positive.

Blair Christie, the Senior Vice President of Corporate Communications for Cisco Systems, made the following statements during the Q3 2008 Earnings Call:

1. Introduction:

   • Thanked the operator and greeted everyone, welcoming them to the 73rd quarterly conference call.
   • Introduced the executives present, including John Chambers (Chairman and CEO), Frank Calderoni (Chief Financial Officer), Rick Justice (Executive Vice President of Worldwide Operations and Business Development), Don Proctor (Senior Vice President of the Software Group), Ned Hooper (Senior Vice President of Corporate Development and Consumer and Small Business Group), and Jim McDonald (Chief Executive of the Service Providers Video Technology Group).

2. Press Release and Webcast Information:

   • Noted that the Q3 fiscal year 2008 press release is available on FuelNation Marketwire, a European Financial and Technology Wire, and the Cisco website.
   • Mentioned the availability of a webcast with slides, which contains financial information covered during the call and additional financial metrics and analysis.

3. Website Information:

   • Directed listeners to the Cisco website for downloadable Q3 financial statements, including revenue segments by product and geography, income statements for GAAP to non-GAAP reconciliation information, balance sheets, and cash flow statements.

4. Replay Availability:

   • Announced that a replay of the call would be available via telephone and on Cisco's investor relations website from May 6th through July 18th.

5. Forward-Looking Statements Disclaimer:

   • Reminded listeners that the call would include forward-looking statements subject to risks and uncertainties, referring to detailed documents filed with the SEC, specifically the most recent annual reports on Forms 10-K and 10-Q.

6. Unauthorized Recording Disclaimer:

   • Stated that unauthorized recording of the conference call is not permitted.

7. Transition to John Chambers:

   • Turned the call over to John Chambers for his commentary on the quarter.

8. Q&A Session Announcement:

   • Announced the opening of the call for Q&A, requesting that analysts ask only one question.

9. Conclusion and Next Conference Call Announcement:

   • Thanked participants for their questions and announced the date and time of the next quarterly conference call, which would reflect Cisco's fourth quarter fiscal year 2008 results.

   • Provided information on where to find downloadable Q3 financial statements.

   • Reminded listeners of Cisco's policy to not comment on financial guidance during the quarter unless through a public disclosure.

   • Directed listeners to contact the investor relations department for any follow-up questions.

   • Concluded the call.

John Chambers made numerous comments during the earnings call, covering a wide range of topics. Below is a detailed summary of his statements:

Opening Comments:

• Business Momentum and Strategy:

  • Comfortable with long-term growth projections of 12% to 17%.
  • Reasonably comfortable with top-line growth and pleased with bottom-line and earnings per share growth.
  • Innovation engine is performing well from product, architectural, and leadership perspectives.
  • Better positioned with enterprise and service provider customers in terms of customer satisfaction, technology, and business architecture.

• Key Financial Highlights:

  • Total revenue of approximately $9.8 billion, a 10.4% year-over-year increase.
  • Order growth within expectations.
  • Product book-to-bill greater than 1.
  • Non-GAAP net income of $2.3 billion, an increase of approximately 9% year-over-year.
  • GAAP net income of $1.8 billion, representing a decrease of 5% year-over-year.
  • Non-GAAP earnings per share of $0.38, an increase of 12% year-over-year.
  • Cash generated from operations of $3 billion.
  • Repurchased $2 billion of common stock.
  • Ended the quarter with $24.4 billion in cash, cash equivalents, and investments.

• Four Key Takeaways:

  • Continued balance in the business model across products, customer segments, and geographies.
  • Market transitions as a core competency.
  • Phase II of the internet, driven by collaboration enabled by networked Web 2.0 technologies.
  • Innovation leadership across all aspects of the business.

Geographic and Customer Segment Discussion:

• Geographic Momentum:

  • Asia Pacific: Very solid with year-over-year growth in the high-teens.
  • Japan: Strong growth in the mid-20s, first time in 15 quarters above 20% year-over-year.
  • Europe: Mid-teens order growth year-over-year.
  • US: Mid-single-digit order growth year-over-year.
  • Emerging Markets: Revenue growth over 40% year-over-year, but order growth approximately 10%.

• Customer Segments:

  • Global commercial orders: 18% growth year-over-year.
  • Enterprise: 9% growth year-over-year.
  • Service provider: 6% growth year-over-year.
  • Consumer (Linksys): 13% growth year-over-year.

Product Highlights:

• Revenue Growth:
  • CRS-1: Grew approximately 150% year-over-year.
  • Unified communications (including WebEx): Grew approximately 45% year-over-year.
  • Fixed Switching: Grew at 11% year-over-year.
  • WebEx: Grew approximately 20% year-over-year.
  • Security (including IronPort): Grew in the low double-digits year-over-year.
  • High-end routers: Grew approximately 25% year-over-year.
  • Application networking: Grew approximately 30% year-over-year.
  • TelePresence orders: Grew over 1000% year-over-year.

Innovation Leadership:

• Product Innovation:

  • ASR 1000: Leading-edge product for service providers at the edge.
  • Nexus 7000: First in the new generation of unified fabric data center switches.
  • Nexus 5000: Industry's first open standards-based access-layer switch to support I/O consolidation.
  • Applications Extension Platform on ISR: Programmable feature for ISR router.
  • Business-to-Business TelePresence: New capabilities and strategic relationships with global service providers.
  • WebEx: New version for Mac users and integration with Unified Communication suite.

• New Business Model Innovation:

  • Services delivery model in Bangalore.
  • Cross-functional business and social networking communities.
  • Productivity benefits enabled by new business models.

Guidance and Outlook:

• Q4 Fiscal 2008:
  • Revenue growth guidance: Approximately 9% to 10% year-over-year.
  • Despite economic challenges, Cisco will continue to be aggressive in investments.

Summary:

• Vision, Strategy, and Execution:
  • Momentum continues to be strong, especially in product leadership, innovation, and top leadership.
  • Balance is reasonably good across geographies, products, services, and customer segments.
  • Optimistic about global economies outside the US.
  • Continued focus on controlling and influencing factors.
  • Long-term growth opportunities remain in the 12% to 17% range.

Chambers also provided detailed answers to specific questions during the Q&A session, covering topics such as the pipeline, service provider confidence, commercial business, and the duration of spending cuts in the US.