Summary of Cisco Systems (CSCO) May 9, 2012 Earnings Conference Call Transcript (Q3/2012)

Overview of operations

In Q3, Cisco had record revenues, non-GAAP earnings per share, non-GAAP operating income and non-GAAP net income. Cisco remains first or second in every product market in which it participates. It gained market share with its service provider customers, which is 1/3 of its total business, and has maintained or gained market share in the majority of its product categories.

Cisco sees continued strong performance in its core networking portfolio. Its switching margins are stable and equivalent to the level of several years ago. Cisco is seeing a transition to 10-gig E drivers, driving higher ASP's and more server business. NGN routing revenues were flat. High end routing revenues were up significantly, while optical routing revenues were down.

The company's service provider business has grown due to its architectural approach, while the revenue growth of competitors Juniper, Huawei and Alcatel either declined or grew only modestly.

Cisco maintains a strong position in enterprise and commercial accounts. The fear a year ago that competitors were gaining share has not happened, and in many cases, Cisco is gaining significant market share from those competitors. In response to a question concerning competition by Huawei in the enterprise market, Chambers responded that Huawei may have spread itself too thin and its numbers are not that impressive given the amount of government support it receives. Further, Huawei customers are returning to Cisco after seeing price increases after a few years with Huawei. Finally, privacy is not Huawei's strength, and it is a very important consideration for customers.

One of the biggest market transitions going on in the industry is the explosion of mobility and device proliferation. In Q3, Cisco introduced strong new products in security and wireless. One example is the AP 3600, which is a flagship wireless product and which is off to a very good start.

Cisco saw strong cloud architecture growth, particularly in emerging countries. Its strategic partnership with EMC and VMware is going extremely well. Over 70% of the leading cloud providers are using Cisco's CloudVerse, which integrates a unified data center with a cloud intelligent network. In cloud and BYOD, there is strong demand for advanced service offerings.

Over the next 5 to 6 years, Cisco will be trying to move away from a business that is so correlated to the macro environment. Cisco is moving more to a certain percentage of business beyond servers, such as software and WebEx that will be chargeable by the month, and it is looking at new business models that will get a more predictable stream of revenue base. Part of the movement will be to areas like entertainment and video from the home, which is fairly macro-resistant in terms of customer spending. The NDS acquisition will be valuable in helping Cisco's video strategy.

Evaluation of markets

Because Cisco is so pervasive in products and markets, and because 80 percent of its business is new every 120 days, it sees a change in economic climate 2 to 4 quarters before its peers.

Cisco sees cautious IT spending, especially in the enterprise accounts. The company is not seeing a significant downturn. Instead, it is seeing longer cycles and smaller deals. The customers in the enterprise market are in very good financial shape. They are just keeping their powder dry.

There are several areas of continuing concern: Europe and the global economy, the public sector, India, and conservative IT spending. Europe and conservative IT in enterprise spending has gotten worse over the last quarter. Service providers and the financial services industry group have been slow.

However, customers have indicated they will likely increase spending in the second half of the year, but at the same time, they want to see what happens with Europe and government policy.

Cisco sees the best prospects for growth in APJC, unless there is a surprise in China. When CEO Chambers went to China over a month ago, he did not see warning signs of major issues with the economy.

Financials

Cisco's Q3 revenue increased 7 percent year-over-year. Total product revenue increased 5 percent year-over-year. Services revenue increased 13 percent year-over-year. Top revenue gains were the UCS business, which grew 57% year-over-year and data center revenue, which grew by 67 percent. Giving conservative guidance, Cisco sees revenue growth in Q4 to be 2 to 5 percent year-over-year.

Year-over-year total revenue grew 3% for the Americas, 5% for Europe/Middle East/Africa (EMEA) and 24% for Asian Pacific/Japan/China (APJC). The growth in the APJC region was led by service providers, due to the completion of several large multiyear projects in the region.

Total non-GAAP gross margin was 63.1 percent, which increased .7 percent from the prior quarter, but decreased .8 percent year-over-year. For products only, non-GAAP gross margin for Q3 was 62.0 percent, which increased 1.1 percent from the last quarter, but declined 1.1 percent year-over-year. The quarterly margin increase was mostly attributable to costs savings and product mix, although this was partially offset by pricing, discounts and rebates. Non-GAAP services margin for Q3 was 67.1%, which decreased 0.9% from last quarter, but increased 0.1% year-over-year. For Q4, Cisco anticipates non-GAAP gross margin will be 61% to 62%.

In Q3, total product orders grew 4 percent year-over-year. Products orders in the Americas grew 5 percent, were flat in EMEA (though emerging markets in Europe and Russia showed considerable growth), and grew by 7 percent in APJC. There is still weakness in India. Japan had considerable growth (39 percent), while orders declined by 8 percent in China due to the timing of several large deals. Total product book-to-bill for Q3 was approximately 1.

In Q3, total service provider orders grew by 5 percent. The Americas grew by 5 percent (growth in the United States was 9 percent), APJC grew by 8 percent and AMEA grew by 1 percent.

Wireless orders grew 19% year-over-year, SP Wi-Fi orders grew 127% year-over-year, and orders for the ASR 5000, Cisco's mobile packet core, grew over 100% year-over-year.

Customer market growth was as follows: service providers grew 5%, enterprise declined 1%, commercial grew 8%, public sector grew 3% year-over-year.

Cisco's strategic goal is to grow profits faster than revenue. It accomplished that goal, in that non-GAAP operating income grew 12% year-over-year, versus the 7 percent revenue growth. Non-GAAP operating income was 28.6% of revenue in Q3. For Q4, Cisco projects non-GAAP earnings per share will be $0.44 to $0.46 per share.

Cisco added 1,353 employees quarter-over-quarter. The hiring was primarily in services and strategic engineering hiring.

In Q3, Cisco bought back stock in the amount of $550 million, at an average price of $20.28/share. It also paid $432 million in dividends, which was $.08/share. It intends to strongly support the dividend, and assess opportunities to increase it. However, its flexibility is limited unless it can repatriate its cash, which would require change in corporate income tax policies.

The full transcript of the conference call can be found on Seeking Alpha at the following link:
http://seekingalpha.com/article/575911-cisco-systems-ceo-discusses-q3-2012-results-earnings-call-transcript