Cisco Systems, Inc. (NASDAQ:CSCO)
F4Q09 (Qtr End 7/25/09) Earnings Call Transcript
August 5, 2009 4:30 pm ET
Blair Christie – SVP, Corporate Communications
John Chambers – Chairman and CEO
Frank Calderoni – EVP and CFO
Rob Lloyd – EVP, Worldwide Operations
Ned Hooper – Chief Strategy Officer and SVP, Corporate Development & Consumer Group
Padmasree Warrior – Chief Technology Officer
Jeff Evenson – Sanford Bernstein
Paul Silverstein – Credit Suisse
Simona Jankowski – Goldman Sachs
Tal Leoni – Bank of America
Mark Sue – RBC Capital Markets
Richard Gardner – Citigroup
Nikos Theodosopoulos – UBS
Simon Leopold – Morgan Keegan
Brian Modoff – Deutsche Bank
Jeff Kvaal – Barclays Capital
John Marchetti – Cowen and Company
Ittai Kidron – Oppenheimer
Welcome to Cisco Systems fourth quarter and fiscal year 2009 financial results conference call. (Operator instructions) Now, I would like to introduce Ms. Blair Christie, Senior Vice President of Corporate Communications for Cisco Systems. Ma’am you may begin.
Good afternoon everyone and welcome to our 78th quarterly conference call. I am Blair Christie and I’m joined by John Chambers, our Chairman and CEO; Frank Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, Executive Vice President of Worldwide Operations, Ned Hooper, Chief Strategy Officer and Senior Vice President Consumer Business, and Padmasree Warrior, Chief Technology Officer.
In Q4 fiscal year 2009 press release is on US high-tech market wire and on the Cisco website at www.newsroom.cisco.com. I would like to remind you that we have a corresponding web cast with slides. In those slides you will find the financial information we cover during this conference call, as well as additional financial metrics and analysis that you might find helpful.
Additionally, downloadable Q4 financial statements will be available following the call, including revenue by product and geography. Income statements, full-GAAP to non-GAAP reconciliation information, balance sheets, and cash flow statements can be found on our website in the Investor Relations section. Just click on the financial section of the website to access the web cast and slides and these documents.
A replay of this call will be available via telephone from August 5th through August 12th at 866-357-4205 or 203-369-0122 for international callers. It is also available from August 5th through October 16th on Cisco’s Investor Relations website.
Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results. Our commentary today will be providing information on both our Q4 financial results and our full fiscal 2009 financial results. Financial results in the press release are unaudited.
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 annual report on Form 10-K and quarterly report on form 10-Q, 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 and I would like now turn it over to John for his commentary on the quarter. John?
Blair, thank you, very much. During the opening comments of the conference call, I will focus on what I view to be the key takeaways for Q4 fiscal year 2009. First, a very candid discussion about what we are seeing in the market on a global basis, relative to Q4, and its effect on our Q1 fiscal 2010 expectations.
Second, an update giving the current economic challenges, and how we are reducing the expenses, prioritizing our many opportunities for future growth, as well as our progress in realigning the resources, all of this with a focus on investing in new market adjacencies, emerging technologies, and emerging markets.
Third, on a very positive note, a detailed discussion on sequential order trends in Q4 and progress on several of our 30 plus market adjacencies that we are focused on, and finally, our revenue guidance for Q1 fiscal year 2010, with the appropriate caveats. Frank will follow these opening comments with additional details on Q4 and the majority of the fiscal year 2009 discussion.
The third section of the call will focus on business momentum from a strategy, customer segment, geographic, and product basis. Frank, will then follow with additional financial parameters around our guidance. I will then wrap it up with some comments in terms of Cisco’s momentum going into Q1 fiscal 2010, and finally, our Q&A session.
From a summary point of view, I think there were a number of key takeaways from the results in Q4 FY09 and I will attempt to summarize these at this time. First, on the areas we control or influence such as our key financials we are doing very well. Whether it is in the area of expense reduction, resource realignment, margins case generations, or acquisitions.
If you look at my key takeaways, first Q4 was a very solid quarter from the financial perspective. The following are some high level financial takeaways for the quarter. Revenue was $8.5 billion. Earnings per share, on a non-GAAP basis were $0.31. GAAP earnings per share were $0.19. Expense reductions, we exceeded the $1.5 billion expense reduction goals as Frank had outlined in prior calls. Non-GAAP gross margins were about 65%, and service revenues grew at 5% year-over-year.
We generated $2 billion in cash in Q4; resulting in total cash and investments of approximately $35 billion and we repurchased $800 million of stock during the quarter. DSOs were 34 days and non-GAAP inventory turns were 11.3. Book-to-bill was comfortably above 1. Non-GAAP operating expenses were approximately $3.3 billion in Q4 FY09, down 8.5% year-over-year in Q4.
And as a percentage of revenue, we are 39.2%, which was in line with our guidance that Frank and I provided at 39% to 40%, but perhaps the financial measurements that we are most pleased with overall is our ability to focus on preparing Cisco for the future, and still maintaining very strong profit, as a percentage of revenue, doing what is clearly the toughest economic challenge of our lifetime.
Non-GAAP net income was $8 billion for fiscal year ’09 and was 22% of revenue for the year. And for Q4 FY09 it was 1.8 billion, which translates into 21.5% of revenue. You have gone through the toughest economic period, we have seen in our lifetime and have maintained comfortably over 20% none GAAP net income as a percentage of revenue, it is a pretty good achievement.
Frank will cover both additional details on Q4 numbers and a summary of the fiscal year 2009 financials in his discussion. My second key takeaway, even more positive than the financial disciplinary results in the quarter, Q4 had both the first positive sequential product order growth, and was also the first quarter in the entire fiscal year that was anywhere close to having normal sequential order seasonality.
For me personally, this was the most important takeaway in the quarter. In other words, while it is too early to say that this is a definite trend, and therefore the much anticipated recovery, the sequential order numbers were very solid and more along the line of our normal seasonal quarterly results for the first time in the last four quarters.
Let me explain a little more detail, why this is important during periods of economic transitions, and during these periods of economic transitions, even more important to me than year-over-year numbers. During normal economic times, year-over-year numbers are very indicative of the health of the business.
However, during economic transition, upturns and downturns, sequential order comparisons to the same quarters are very useful and determined to help the business and possible directional changes. We know that our sequential order growth rates follow similar patterns during normal times.
This clarity has not been the case for the first three quarters of fiscal year ’09, where we saw very large swing averaging 10% to 15% below our normal sequential order patterns. However, we saw a dramatic difference trend in Q4, the order rate on a sequential basis in Q4, was in line with our normal patterns of up approximately 10%, Q3 to Q4.
Additionally, we believe that sequential order rates in Q1 could follow a normal order pattern as well, which is historically down in the mid-single digits, from an order perspective. I will explain how this translates into Q1 revenue guidance in a moment.
While it is too soon to call a recovery, just returned to normal pattern, is the first major positive order trend, we have seen in over the last several quarters. Trends also occurred across most of our theaters on a global basis. One final thought, while this is in very important trend, I would want to see the sequential trends continue for several more quarters, before we be comfortable with saying that we are returning to normal business momentum.
And as we returned to normal business momentum, I will then go back to focusing on year-over-year numbers at the primary measurement of business momentum in the health of our business.
A third key takeaway for the quarter, our new innovative organization structure determines councils, boards, and working groups, it is operating extremely effectively. Almost all of our 30 plus market adjacencies, which include products geographies solutions etcetera are progressing well. We would discuss progress in a couple of these market adjacencies, in future quarterly conference calls.
Fourth, we are very pleased with our progress and aggressively managing our expenses, and exceeding our stretch goal of reducing our annualized expense run rate by $1.5 billion that he committed in the Q1 conference call. We have also realigned approximately $1 billion of resource to new market adjacencies and opportunities.
During Q4, we also aligned our engineering and our sales organizations around an expanding focus on customer segments and solutions. Rob just did a real nice job in the sales side and partnered [ph] the entire year engineering team did amazing job there, and I'm very comfortable, we structured the way we want to be for the future.
Fifth, assuming there are no major surprises to our expectations on economic trends, we have completed our major expense reductions and limited restructuring. And we are now moving the entire focus of the company to growth, starting first with improvements in sequential order growth, followed by year-over-year growth.
When we saw the market change early in fiscal year ’09, we made a decision to accelerate our normal process to realign and restructure resources rather than go through a broad base layoff. Few quarters ago, we announced our plan to have limited restructuring as part of our portfolio realignment and that would have resolved reductions of 1,500 to 2,000 jobs during the second half of fiscal ‘09.
We shared with you that limited restructuring is in our ongoing part of our business process in something we have done for many years. Although this recent action was unusual as the number of job reductions, were higher than normal. We have completed the recent limited restructurings and expect the total number of jobs reduced will be slightly over the high-end of the range provided.
I want to thank our employees and our leadership team for their very effective execution of these changes, which were very challenging and at times painful for us all. In terms of those areas that we can control or influence, we continue to feel very comfortable with our long-term vision and differentiated strategy, as we move into new market adjacencies, and prioritize our existing opportunities.
Our new organization structure of counsels, boards, working groups, as discussed in the last few calls is operating very effectively. These structures, most important, allow speed, scale, flexibility, and rapid replications. We will continue to move into additional market adjacencies, and are currently at 30.
And our perhaps equally important many of our leading customers understand how this highly innovative management structure and new business models can launch this many new major products and markets adjacencies with both quality and volume. We execute for, with a compelling financial position, and an innovation engine both from products in a business model perspective that should allow us to expand our leadership in the marketplace.
Our internal started up, as well as our acquisition in small companies continue to feel out our architectural strategies. For example, our video strategy from the home to the service provider to the enterprise is being described by many of our customers I talk with as world class innovation and have equal importance world-class execution.
The pure digital acquisition with the Flip video formally becomes a part of Cisco during Q4. We really brought home to many of our customers how our architectural playoff across all customer segments. Our consumer flip momentum continues to be extremely positive, Ned nice job and Jonathan nice job Christie and the entire team, and we even have founded expanding into the enterprise marketplace, where we got our first million dollar commitment for flips from a single enterprise customer.
We continue to believe that video architecture is the most important Web 2.0 next-generation play and is one of the key competitive advantages versus our peers. For those areas that we can control and influence, we feel we are doing reasonably well. The key market transitions, we already did collaboration virtualization and video networking, which will drive productivity and growth in network loads for the next decade are evolving even faster than we thought one or two quarters ago.
While we intend to be very transparent with what we are seeing in the market and have established a good track record in terms of seeing trends early. Our views do not tend to change every month or quarter, and even when they do evolve to change dramatically as we lead the exception. It is with this consistency obtained focus on the long-term, while not getting distracted by short-term market activities that we believe and will be one of the keys to our future success.
No one knows for sure when the upturn will occur, but as we said in prior quarters, we are going to continue to be very aggressive to position ourselves for the inevitable upturn, while continuing to maintain high financial management in aligning resources to new opportunities.
Also, as we said in prior conference calls over many years, Cisco will always be affected by major economic challenges, capital spending patterns, new and existing competitors, and our ability to execute or not, on our strategy and other factors as discussed in our SEC filings.
For purpose of our long-range goals, as well as our quarterly guidance, we are also assuming that our vision of how the industry and the market we evolve will be accurate and that we will execute effectively on that vision. With all this in mind, we continue to provide our guidance with all the appropriate caveats, one quarter at a time.
And encourage each of our shareholders to not get to far ahead of themselves in building on the positive for this quarter. With this discussion in mind, our revenue guidance for Q1 FY 2010, including our using caveats, as discussed earlier and in our financial reports is for revenue to decrease in the 15% to 17% range year-over-year.
In summary, we believe that we are very well positioned in the industry from a vision, differentiated strategy, and execution perspective. We believe, we are entering the next phase of the Internet as growth and productivity was sooner on collaboration, enabled by network Web 2.0 technologies.
We would do our best to provide the product architectures and the experience to help our customers in the implementation of these collaborative capabilities from both a technology and a business perspective. We will also share with the customers, how we have done this internal internally.
In short, we are going to tend to exhibit a strategy over the next decade, is very similar to what we do in the early 90s. And as we said before, it powered our growth for decades. Now Frank let me turn it over to you for more additional details.
Thank you, John. I am pleased with how well we manage the business this quarter and what continues to be a difficult economic environment. During this quarter, we maintained our focus on reducing our annual expense run rate, while continuing to invest in our strategic growth areas.
Our solid results in Q4 FY09 once again showcased our ability to manage profitably across varying economic cycles, while delivering innovative products and services that provide real value to our customers. For today's call, I will comment on our fourth quarter financial results and then on our full-year 2009 results.
Starting with Q4 results. Total revenue for the fourth quarter was $8.5 billion, a decrease of approximately 18% year-over-year, within the range given last quarter of minus 17% to 20%. A tough comparison giving Q408 was the highest revenue generating quarter in Cisco's history.
Total service revenue was $1.8 billion, up approximately 5% year-over-year. Total product revenue was $6.7 billion down approximately 22% year-over-year. Switching revenue was $2.8 billion, a decrease of 20% year-over-year. Modular switching revenue was down 23% year-over-year, while fixed switching revenues declined 17% year-over-year.
Routing revenue was $1.5 billion, down 27% year-over-year, representing a decrease of 27%, 29%, and 24% year-over-year in high-end, mid-range, and low-end respectively. Advanced technologies revenue totaled $2 billion, representing a decrease of 19% year-over-year. This was primarily due to declines in video systems of approximately 30%, unified communications of approximately 5%, and security of approximately 19%.
Other product revenue totaled $387 million, a decrease of 32% year-over-year. We experienced a decline in total revenue across all geographies on a year-over-year basis. Quarterly revenue declined ranging from 5% in Japan to 38%, for our emerging market theater, with quarterly revenue in the U.S. and Canada theatre down 13%, down 20% in Asia-Pacific, and down 19% in our European markets.
Despite the challenging revenue environment, the strength of our business model enabled us to effectively manage our gross margin. Q4 FY09 total non-GAAP gross margin was 65.3%, up point two-tenths a point, quarter-over-quarter and up four-tenths percent year-over-year.
For product only, non-GAAP gross margin for the fourth quarter was 64.7% up one-tenth of a percentage point quarter-over-quarter. For the quarter-over-quarter comparison, favorable product mix, and cost savings offset by increased discounts and lower pricing. Our non-GAAP service margin for the fourth quarter was 67.5% that was up from 67% last quarter and 63.1% in Q4 fiscal year ‘08.
Service margin performance quarter-over-quarter was due to strong margin as a result of high revenues and technical support services. Service margin performance year-over-year was better than expected, due to strong margins in both technical support services and advanced services from cost improvement combined with higher-than-expected mix of our technical support versus our advanced services.
Total gross margin by theater, range from approximately 58.6% for emerging markets to approximately 72.9% in Japan. Gross margin improved on a quarter over quarter basis in US and Canada and Japan. However, Asia-Pacific emerging markets and European markets saw declines in gross margins on a quarter-over-quarter basis, due to increased discounts.
In emerging markets, we saw some additional decline in margins as a result of an increase in deferred revenue as it is related to our financing programs. Non-GAAP operating expenses were approximately $3.3 billion in Q4 that was up $200 million quarter-over-quarter, as expected, due to project related spending, seasonality of our variable compensation, and certain real estate charges, partially offset by benefits from our lower head count.
Non-GAAP operating expenses as a percentage of revenue were 39.2% in Q409, versus 35.3% in Q408, within the range that we provided last quarter. In the current environment we have focused on operational efficiency and expense management as mentioned in our prior calls.
To that end, Cisco employees have clearly responded by exceeding our stretch goals to remove $1.5 billion from our annual run rate of operating expenses. I would like to take a moment to really thank and congratulate our employees for their exceptional effort achieving this goal.
Interest and other income was $73 million for Q4, which was higher-than-expected, reflecting one-time realized gains of $41 million in some of our investment sales.
Our Q4 FY09 non-GAAP tax provision rate of 20%, lower than last quarter, due largely to favorable tax benefits arising from our state audit settlement.
As we communicated earlier in Q4, we did take out one-time GAAP tax charge, related to a change in the tax treatment of share based compensations as a result of a court case between dialing and the internal revenue service. The impact of Q4 was $174 million to the GAAP income statement and $550 million to our balance sheet.
Non-GAAP net income for the fourth quarter was $1.8 billion, representing a decline of 23% year-over-year. As a percentage of revenue, non-GAAP net income was 21.5%. Non-GAAP earnings per share on a fully diluted basis for the fourth quarter were $0.31, versus $0.40 in the fourth quarter of fiscal year 2008, a 23% decline year-over-year.
GAAP net income for the fourth quarter was $1.1 billion, as compared to $2 billion in the fourth quarter of fiscal year 2008. GAAP earnings per share on a fully diluted basis for the fourth quarter were $0.19 versus $0.33 in the same quarter of fiscal year 2008. For Q409, there was a 12% difference between our GAAP and non-GAAP earnings per share.
Approximately, $0.07 is related to our expected GAAP to non-GAAP differences, such as stock compensation, amortization of purchased intangibles, IT R&D, and intangible asset impairment. $0.03 related to the tax matter discussed previously, and $0.02 related to a voluntary early retirement program, we extended to eligible U.S. and Canada employees this quarter.
The additional items this quarter, where unusual occurrences outside the ordinary cost of business, therefore they were excluded from our non-GAAP earnings. Now, switching to our full-year performance. Total revenue for fiscal year 2009 was $36.1 billion, a decrease of approximately 9% over fiscal year ‘08 revenue of $39.5 billion.
Routing revenue ended the year at $6.3 billion, down 21% year-over-year, Switching revenue was $12 billion, a decrease of 11% from last year, and Advanced Technologies revenue was down 4% year-over-year to $9.2 billion. Total service revenue was approximately $7 billion, growth of 8% in fiscal year 2009.
Total non-GAAP gross margin for fiscal year 2009 was 65%, down one-tenth of a point year-over-year. For product only, non-GAAP gross margin was down seven-tenth of a point year-over-year, due to discounts, pricing, lower volume, and mix, partially offset by cost savings.
The total service gross margins were up 3.4 percent points, year-over-year. Non-GAAP operating expenses were $13.7 billion in FY09 that was down from 14.1 billion in FY08. The year-over-year decline was due primarily to savings from discretionary savings, favorable foreign exchange, as well as lower headcount.
Non-GAAP net income for fiscal year 2009 was $8 billion, down approximately 17% from fiscal year 2008 non-GAAP net income of $9.6 billion. Non-GAAP earnings per share on a fully diluted basis for fiscal year 2009 were $1.35 that was down from $1.56 in fiscal year 2008, representing a 13% decrease year-over-year.
GAAP net income for fiscal year 2009 was $6.1 billion of $1.05 per share on a fully diluted basis, compared to $8.1 billion or $1.31 per share on a fully diluted basis in fiscal 2008, representing 24%, and 20% decreases year-over-year respectively. Product backlog at the end of fiscal year 2009 was $3.9 billion as compared to $4.8 billion at the end of fiscal 2008.
Our backlog as a percentage of our Q4 product revenue was approximately 59%, and up three percentage points from Q408. This level of backlog combined with our product and service deferral revenue positions, really position us well as we enter fiscal year 2010.
Now moving on to the balance sheet, our balance sheet continues to be strong, providing us with significant financial flexibility by continued economic pressure, we have continued to strengthen key financial metrics. Total of cash, cash equivalents and investments for the quarter was $35 billion, was up $1.4 billion from last quarter. Of this total balance, $5.9 billion was held within the United States at the end of Q4.
During the quarter, cash flow from operations was approximately $2 billion. Moving on to accounts receivable, our accounts receivable balance was $3.2 billion at the end of Q4. At the end of Q4, our days sales outstanding or our DSO was 34 days, driven by the timing of service billings to the latter part of the quarter, offset by very strong collections. This compares to 27 days in Q309 and 34 days in Q408.
Total inventory at the end of Q4 was $1.1 billion that was up slightly quarter-over-quarter, non-GAAP inventory turns were 11.3 this quarter up six-tenth of a point compared to last quarter and down three-tenth of a point compared to Q4 of last year.
Our inventory management as measured by turns remains world-class. Inventory purchase commitments at the end of Q4 were $2.2 billion, a 2% reduction from the end of Q3. For the quarter, we repurchased 800 million of common stock or 42 million shares at an average price of $19.02 per share, and we ended this quarter with approximately 4.8 billion remaining in the current stock repurchase authorizations.
Deferred revenue was $9.4 billion at the end of Q409, an increase of approximately 6% year-over-year. Deferred product revenue of $2.9 billion and deferred service revenue of $6.5 billion, both increases approximately 6% year-over-year. At the end of Q4, our headcount totaled 65,545; a net decrease of 1,013 from last quarter.
The reduction in headcount was the result of our continued pause in external hiring and our limited restructuring. As we communicated in our Q309 earnings call, we did expect to reduce approximately 1,500 to 2,000 jobs during Q3 and Q4 timeframe, part of our portfolio realignment.
Having completed these higher than nominal limited restructuring, we expect the number of jobs reduced to be slightly above the high-end of the range.
In summary, from a financial perspective we are very pleased with the Q4 and fiscal 2009 results, which illustrates through resiliency of our business model, as well as the strength of our business. While we remain focused in FY10 on operational excellence and efficiency, we will continue to make investments in key growth areas across our market adjacencies that we believe will position us and the Company overall for long-term success.
I will now turn the call back over to John.
Frank, thank you very much, well done. Now moving on to our strategy review, discussion of customer segment, geographic, and product review. Q4 continued to see the balance between innovation and operational effectiveness in almost every aspect of our business.
The innovation and execution has never been broader and more successful, ranging from product announcements, technology architectures, acquisitions, and a rapidly evolving business architecture readership in our customer's mind. Cisco has had a continued explosion of collaborative enabled – collaboration enabled by network, Web 2.0 Technologies in everything we do.
Always listen carefully to our customers and in many ways feedback from our leading hedge customers about this activity in Q4 was pivotal. Truly a tipping point in terms of both their understanding and in many cases their commitment to next generation intelligent networks becoming their platform for productivity and delivering global competitiveness.
For 30 plus new market adjacencies, all tied to the common theme as a network becoming the platform, were transformation in business models, government services, and the connected consumers.
I would like to articulate and provide additional clarification to our approach to what some of the financial committee calls a portfolio growth opportunity in market adjacencies.
I would also like to cover several of these market adjacencies with additional color in terms of our progress goals and objectives. We will continue to do this in most of our conference calls moving forward and highlight in each of them, several market adjacencies.
Our goal is for you to view this as not just a portfolio play of growth opportunities, but also pieces of both a technology and business architecture play that has the potential to power a substantial part of our growth, as well as our traditional core markets. We had a similar approach years ago on a smaller scale, where identified market transition that extended the role of the network in other words, they where extensions of our own products.
These have been commonly known today as advanced and emerging technologies. Today, Cisco is focused on how we can use the technology and solution to solve the challenges of business, decide a Government, and our communities. As we do this, we are becoming closer to our customers, helping them solve their top issues, and increasing our position as a strategic business partner.
In addition to creating new opportunities, where we can extend the role of the network. We call these opportunities market adjacencies. And while today many of them may be considered small and fast moving, tomorrow, many of them could be billion-dollar businesses for Cisco.
This is not just a portfolio play, but rather tightly related parts of the portfolio that could actually come together to increase the potential success of many of our new adjacencies, as well as our traditional markets. In some cases these market adjacencies allow Cisco to lead in key market transitions like, video and virtualization.
Or in other cases, they will open up new markets for us, like grid and smart connected communities. While others represent new global business models and go to market plans, like emerging markets in China, India, and Mexico, and still others refer to how we are transforming Cisco and our own business process.
We see in our dependencies across these market adjacencies and although each are in different faces of education, they all build on the increased role of the network. The comments read is the network, it is the platform for growth, and innovation.
In summary today, we are investing 30 plus new market opportunities that are adjacent to our core business and in each of these cases the technology architecture is driving innovation in our core products, which we believe translates into growth. Assuming we're successful in many of these opportunities, you will see us expand well beyond 30 that we have today.
Our innovative organization structure of councils and boards brings together leaders from across the functions, all of our corporate functions to define, plan, execute, and monitor our progress in these market adjacencies.
This disciplined approach allows our teams to scale and work across the opportunities with both speed flexibility and then to be able to replicate these models quickly. You can expect these market adjacencies to become a growing part of our business over time. Just as the advanced technologies did looking back several years ago.
While some of these may be able to be discussed in base ways similar to early advanced technologies, now this may not easily be discussed as stand-alone segments. We will consistently share our position in these markets, so you can monitor our progress. These business processes are evolving rapidly in each of the market adjacencies, supported by the new organization structure and as such should be considered work in process.
We will do our best to give you periodic updates in each of these areas, so that you can monitor our progress on both categories and potentially our progress on architectural place. Today, I would like to cover quickly, three market adjacencies examples. Those three are; first, smart connected communities; second, small business, third smart grids.
As a reminder, if we hit or exceed 50% of the focus market adjacencies, we will declare success and that if we execute expectations on to many of these market adjacencies means, we probably did not take enough risk. Smart connected communities, we continue to make progress with our initiative to help cities use the network to deliver better city management, enhanced quality of life for citizens, drive economic developments, and cultivate environmental sustainability.
Last quarter, we mentioned we had reached an agreement with Incheon, Korea Mayor Ahn and Gale International, a major global city developer. We are proud to announce we would join them this week in opening the City Songdo in Incheon, where we are Gale's technology partner across the board.
We expect our partnership with Gale to lead us into several other opportunities around the world, as we expand this partnership to go after new projects in China like Meixi Lake Project in Changsha, the capital of Hunan province.
Additionally, this quarter we announced the launch of several Smart+Connected Communities product, such as the Mediator. This product converges 60-plus building systems onto the IP network, ranging from air conditioning to lighting, security, and access control.
Similar to how voice services transformed as they came onto the IP network, we are now transforming real estate by bringing building systems onto the network, driving down operational costs, generating additional revenue, and decreasing a building's carbon footprint.
Based on these development that is with the appropriate caveats we are seeing an even larger opportunity for Cisco with Smart+Connected Communities from several hundred million dollars, as I mentioned last quarter to multi-billion-dollar opportunities in the next 5 to 10 years.
Second, Small Business, we continue to make strong progress in our adjacent small business market, potentially one of the fastest-growing growth opportunities for Cisco. Our current market share, in most industry analysts' opinion, is in the low double digits, and therefore provides Cisco with an opportunity for growth even if IT spending remains constrained.
While small businesses are quick to pull back at the start of a downturn, they traditionally start buying sooner and more broadly as the general economy recovers. We're beginning to see signs of recovery and as Small Businesses are projected to spend over $7 billion on networking technology in 2010.
Over the past year, we have created dedicated teams across all functions to meet the needs of small business customers, and the channel partners to serve them. We now offer purpose billed, small – Cisco Small Business products for customers who want simple, but reliable networks solutions.
As an example, in Q4, we introduced a new Cisco ESW 500 switches that are highly competitive based on price, features, and support. As a snapshot of what is possible in the future, we could combine our Small Business products with our investment in cloud services to provide as-a-service offerings delivered through Cisco partners.
Third, Smart Grid. In areas of Smart Grid, we have a well-defined vision and strategy, and we are now focused on execution, to extend our thought leadership, developed an ecosystem of partners to drive open standards, and deliver an end-to-end solution for our customers.
Cisco will lead in defining the end-to-end architecture that will enable our vision of securely managing energy on electrical grids all the way from the generation to consumption in homes and buildings.
These efforts are highlighted by our collaboration with partners Landis+Gyr, IBM and GE, utility partners such as Florida Power & Light and Duke Energy, and standard bodies such as National Institute of Standards and Technology, Federal Regulation and Oversight of Energy, and North American Electric Reliability Corporation.
Cisco's Smart Grid approach is complemented by our recently announced of Smart+Connected Communities and Smart Connected Building.
Our vision in differentiated strategy for each of these market adjacencies is only about a year old. Our ability to move resources quickly to capture market transition is a direct result of the collaborative processes embedded in our councils, boards, and working groups and enabled by the way we use network enabled Web 2.0. Technologies.
As a result, we are making decisions faster and moving with speed, skill, flexibility, and replication, common focus points that you will hear from us again and again. At this time, we will cover our customer segments, geographies products for Q4 in more detail.
The customer segment and geographies will be discussed in terms of orders, unless indicated otherwise. The product review will be primarily in revenue growth. First on customer segments, were the discussion will be measured by both orders year-over-year and sequentially on a global basis.
As a general statement, our position in terms of both technology partner and a business partner to our customers in service provider, enterprise and government is to continue and to expand in a very positive way. Also we have – as we have already discussed the number in terms of year-over-year growth in these markets are challenging.
However, from a sequential order point of view that is Q3 compared to Q4, we saw double-digit growth in terms of orders in the Enterprise, Commercial and Government. Service Provider growth continues to be challenging on a global basis with sequential order growth in the low single digits.
At this time I would like to cover year-over-year growth rates as we have done in prior quarters, starting with the positive to public sector with the lease impacted by the global economic challenges, all of our customer segments – of all our customer segments, but was still down globally 3%.
The U.S. public sector, which includes both federal state and local, was up 4%, the US Federal business was very strong with growth in the mid teens, Japan was up 28%, Asia Pacific was down 23% in public sector, and Europe was down by 7%. Emerging markets public sector was down approximately 19% year-over-year.
And other global customer segments, our enterprise business continues to be tough and was down approximately 30%. On a global basis when compared to a very strong ending to last year's Q4 FY08. Service provider spending continues to be tight and down in the upper 20s year-over-year.
Commercial market was also down in the mid-20s, while the consumer was up in the low single digits. Geography, as a reminder this is how our primary manage our business based upon five geographic theaters. This quarter, we will give both sequential and year-over-year quarter growth. On a global basis most of our markets began to stabilize and shows sequential Q3 to Q4 improvements.
The U.S. Asia-Pacific, Japan, and Emerging Markets Theater's all grew orders sequentially from Q3 to Q4 in double digits. The one exception Europe continues to be challenged growing sequentially in mid-single digits. As you would expect from a year-over-year perspective, the geographic order rate numbers were challenging.
U.S. was down approximately 20%, emerging markets down approximately 30%, Asia Pacific down in the low 20s, European markets was down in the high 20s, and Japan was down in the low single digits.
The following is a quick summary of year-over-year numbers and as you would expect the geographic order rates by customer were, as I said earlier, challenging. First for the U.S., within the U.S., U.S. enterprise was down mid-20s year-over-year, service provider down mid-30s, commercial was down in the mid-20s.
In Asia-Pacific enterprise was down year-over-year 30%, approximately service provider was down in the mid-teens, commercial was down in mid-teens. In emerging markets, enterprise was down approximately 40%, service provider was down in the mid-20s and commercial was down in the mid-30s.
In European markets enterprise was down in the mid-30s, service provider was down approximately 30, and commercial was down approximately 30. Now moving on to products. Product numbers for Q4, in terms of revenue year-over-year, but will be similar to what we saw in customer segment and geographies.
Routing was down 27% year-over-year, Switching was down approximately 20%, and total advanced technologies were down approximately 19% in terms of revenue year-over-year. In terms of Advanced Technologies video was down 30% year-over-year, Unified Communication was down 5%, Wireless was down 19%, Security down 19%, and Network Home was down 26%.
Application networking systems was down 27%, and storage was down 8%. Other products, including WebEx ran were up 14%, TelePresence revenues where up to 97%. In terms of total revenue mix Q4, Routing was approximately 17%, Switching was 33%, AT's were 24%, Services 21, and others about 5%.
In terms of Q3 due to Q4, sequential order growth rate, we saw similar balance, as we did in our overall business and geographies from an orders perspective with seven of four top ten largest products growing sequentially in double digits. Another point of possible interest is the very positive start, we are saying seeing to a our new products in the Routing and Switching areas such as the Nexus 5000 and the Nexus 7000, both growing in terms of sequential order growth Q3 to Q4 approximately 100%.
ASR-1000 is off to a great start with over 1000 customers of which approximately 220 our service providers. It is growing year-over-year in terms of orders at above 80%. And finally, while it is truly safe for sure is off to a very solid start, both in terms of opportunities and customer acceptance.
The customer acceptance of these new products combined with the continued success of our high-end routers and switches such as CRS-1 in terms of orders, the CRS-1 grew in excess of 25% in the quarter year-over-year, including more multi-chassis sales this year than in all prior years combined.
I believe these trends signal a good chance of future market share gains both in routing and switching categories. Now on to vision strategy and execution. In summary, although we had all liked to avoid the downturn. Our vision of how the industry is going to evolve appears to be playing out very much as we expected.
We believe our differentiated strategy is also achieving the benefits to both Cisco and our customers that we thought was possible. And finally, our education is on target in terms of results, as measured by a customer partnerships perspective, market share, and share of our customer’s total communications and IT expenditures.
As the network becomes the platform for delivering these capabilities. Now, I will turn it over to Frank for some additional details on both financial guidance and other financial highlights. Frank.
Thank you, John. Let me remind you again that our comments include forward-looking statements. You should review our recent SEC filings that identify important risk factors and understand that actual results could materially differ from those contained in the forward-looking statements.
The guidance we are providing is on a non-GAAP basis, with reconciliation to GAAP. It continues to be difficult to provide a forecast given the variability and the uncertainties going on in the market.
These events increase the potential that our actual results could vary materially from our expectations. Therefore, we anticipate total revenue for the first quarter to be down approximately 15% to 17% year-over-year. From a sequential perspective, we expect to see approximately 1% to 3% growth.
At this point, let me remind you that in light of Regulation FD, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure.
Now let me give you some additional details on our Q1 financial guidance. As we have said in the past forecasting gross margin has always been challenging, due to various factors such as volume, product mix, variable comp costs, customer, and channel mix, as well as competitive pricing pressures.
That being said, we believe total gross margin in Q1, to be approximately 64%, reflecting the revenue guidance I just shared with you. With recent acquisitions, our entry into lower margin markets gross margin could be negatively impacted by our product mix. We believe Q1 operating expenses will be approximately 38% to 39% of revenue.
This Q1 guidance reflects the savings from lower headcount and discretionary spending reduction, selective of the expense management initiative that we completed in fiscal year ‘09, partially offset by some seasonality of our Q1 expenses. We expect interest and other income to be approximately $25 million in the first quarter.
Our tax provision rate for Q1 is expected to be approximately 22%. While we expect to continue our share repurchase program, it is difficult to predict the exact weighted average shares outstanding. We are modeling share count to be up approximately 50 million shares quarter-over-quarter in weighted average shares outstanding for EPS purposes.
In this estimate of share count, we are not taking into consideration any further change in stock price that could occur in the first quarter of FY10. As a point of reference, a $1 movement in our average stock price would change the calculated shares outstanding for purposes of determining earnings per share by approximately $14 million.
Regarding cash flow from operations, we would expect to generate $1.2 billion to $1.5 billion during the first quarter. For our Q1 FY10 GAAP earnings, we anticipate that GAAP EPS will be $0.05 to $0.07 per share lower than our non-GAAP EPS, primarily due to acquisition related charges and stock compensation expense. Please see the slides that accompany this webcast for more details.
Other than those items noted above, there are no other significant differences between our GAAP and our non-GAAP guidance. This guidance assumes no additional acquisitions, asset impairments, restructuring, and tax or other events, which may or may not be significant. I will now turn the call back to John.
Frank, thank you, very much. The following is a summary of my view of Cisco's momentum and opportunities entering Q1 of fiscal year 2010.
In areas that Cisco can control or influence are leadership from a product perspective, innovation, architecture, and operational execution, not only continues to be solid as we said before, but also our customers are beginning to grasp the productivity implications and the importance of both the technology and architectural play.
As we said before, even if the market slowdown continues, we don’t see this changing our long-term growth opportunities. If we execute the way that we have in prior slow downs and assuming the global economy recovers to GDP growth rates similar to those in the middle of the decade, as we continue into Q1 FY10, we plan to aggressively invest in new and adjacent markets for the longer run.
On a global and U.S. basis, we continue to see the same challenges and uncertainties from an economic, political, and capital spending perspective that many of you continue to witness. However, on a global basis, we are starting to see potential positive trends in Asia Pacific, U.S., emerging markets, and Japan.
We continue to see Europe, especially the U.K. to still be in a very challenging business environment. Again, we want to thank the Cisco family for working together as a team to ensure that our Company in solid position to not only weather the challenging economic environment, but even more importantly to be ready to accelerate as the market turns.
I know it is has not been easy and we are working hard to maintain our culture of innovation products, a strategical mentality in getting back, all during tough periods of time for our sales, our family and our friends. As we continue to aggressively invest, we will also continue to maintain our focus on our financial models.
Once again with our usual caveats as discussed earlier and in our financial reports, our Q1 fiscal year 2010 guidance is for year-over-year revenue to decrease in the 15% to 17% range.
We believe our long-term growth opportunities remain in the 12% to 17% range again assuming our usual caveats in noble global GDP growth. We will focus on what we can retro and influence in an attempt to position Cisco, to gain momentum in the market transition whether they are industry consolidation, product transitions, market adjacency opportunities, or economic.
In summary, for those areas that we can control and influence, we believe our vision, strategy and education are in great shape in producing results. We were very pleased with our results and saw a number of positive expense in this quarter and the economy and in a business, especially comparing the sequential order results from Q3 to Q4.
If we continue to see these positive trends, for the next one to two quarters, we believe there is a good chance we will look back and see that the tipping point occurred in Q4. As we look back on fiscal-year ’09, we are pleased to have successfully demonstrated our ability to make difficult decisions and to tightly manage our business during one of their most economically challenging periods in our history.
We enthusiastically kick off fiscal year 2010, a year that promises new market transitions and (inaudible) including the celebration of Cisco's 25th anniversary as a business. This year we intend to celebrate a quarter century of being a company that stands for innovation, operational excellence, and integrity.
Cisco continues to be nimble, flexible, and customer driven, which has always been quoting our culture. I would like to thank all of our employees for their contributions to our success, as we celebrate the past and build towards our 25th anniversary together.
As always I want to also thank our shareholders, customers, Cisco family, and partners for their support and continued confidence in our ability to execute during rapid industry consolidation, market transitions, and challenging economic times.
Now Blair would like to give it back to you.
Great, thank you, John. What we would like to do now is open the floor to questions, we still do request that self analysts please ask only one question, so we can get to as many as possible. So (inaudible) if you can please go ahead and open up the call, we would like to –.
(Operator instructions) At this time, our first question is from Jeff Evenson of Sanford Bernstein, your line is open.
Jeff Evenson – Sanford Bernstein
I was wondering if you can give some comments on both the underlying business trends, your guidance for sequential growth, and the margin you guided to. Just, in a very quick calculations, even if I assume all your new revenue it comes from the acquisitions and from the new areas of entering, and that those products have 20% gross margins, pretty hard to get down to 64%, given what you just put up?
So, a bunch of questions, I will combine them into one answer. First if you look at what Frank and I outlined, we patterned revenue for Q1, very similar to what we have seen during normal time periods, which is flat-to-up perhaps a $100 million. That is a pretty aggressive in board states or within it.
In terms of our margins, we think overall as you get a mix of consumer products and software products coming together, as we said in last quarter conference call, 63% to 64%, is what we would normally model, we are staying with the high-end of that for this quarter in terms of the balance.
In terms of mix Jeff, I wish I could tell you, we are (inaudible) on the book, we will tell you now that we will get the total numbers right the majority of time, our mixes are all over the place in terms of the balance. So, maybe and I call back for a one-on-one session, Frank could into more details on it, but I think the combination does roundup and we have been doing the numbers pretty carefully together to what we outlined.
Jeff Evenson – Sanford Bernstein
Next question please.
Next question is from Paul Silverstein of Credit Suisse, your line is open, you may ask your question.
Paul Silverstein – Credit Suisse
John to related questions one, can you give a little more color on the order trends in third quarter or do you saw it from the beginning of the quarter to the end both on a global and a regional basis, you know related to that – you know you talked about in normal period, but we are in, what everybody knows has been extraordinarily non-normal period and if in fact we come on a (inaudible) recognized it is still early days, but I am not sure I understand the normal seasonal commentary in that context?
You know, Paul, it is new data point and Blair warned me ahead of time, I have got to be careful in how I walk through it, but our quarters are remarkably predictable in each of the quarters during normal times, in terms of what occurs in the Q4, and Q1, and Q2, and Q3.
This year very candidly Q1, Q2, and Q3 were below the normal sequential growth about 10% to 15%. Q4 was the exact opposite, it was right on par, approximately 10% growth Q3 to Q4 when I take everything into consideration that I measured.
In terms of the balance in linearity, it was very solid and much in line with what we expected and we ran – if I remember Frank and Rob, we ran above forecast at least for every week of every quarter, which as you see what happens when a sales force is on a trend.
So, within that Paul, you know last quarter I was kind of awarded that we signaled a potential leveling off, although no one knows for sure, this quarter we are clearly saying knowing our potential stepping point added to the upside, although we had wanted to see for a couple more quarters that we could see in front of us.
The balance was good on a geographic basis, in terms of the sequential trends and the one exception is Europe, which I think, we have got a great team in, but Europe seems to be running a couple of quarters behind the rest of the world, they were a couple of quarters late in seeing the economic slow down, and they will probably be a couple of quarters late in coming out of it. So, Paul I hope that helps clarify a little bit more, and I thank you for the questions.
Paul Silverstein – Credit Suisse
Just now we have to restrict to one question right now, we will get to you on the call back, okay. Next question please.
Thank you, next questions will be from Simona Jankowski of Goldman Sachs, your line is open, you may ask your question.
Simona Jankowski – Goldman Sachs
Hi thank you, I also wanted to dig into the gross margin trends, first on the quarter were there was some pricing pressure, but it seemed that that was more than offset by the mix. Can you just comment if that pricing pressure was down turn driven, in other words customer driven, versus competitive, you know from some of the new more aggressive competitors you have in all the various markets and related to that, if you can just give your best estimate, if it is your long-term gross margin trajectory taking into account some of the new businesses you are getting into?
Simona, (inaudible) at our pricing pressures, they were very much normal towards given tough economic times. Cisco’s sales on architecture, solutions, value-added capability, integration, investment, protection, and most of our competitors have met this with very aggressive pricing.
That is basically true in emerging markets in Asia. In terms of the trends, we didn’t see anything abnormal. We actually, as we said saw gross margins stay very, very solid, probably the area that is under the most pressure is service providers that tends to be up more of a price sensitive market is basically in Asia and I think you saw that in terms of our gross margins in Asia, but overall this business is normal. Again Rob’s team was very good about selling architectures and value-added plays.
To your indirect part of your question Simona, price is more of an advantage in terms of our competitors coming at us, during the very tough economic times in these normal times. So, I am very pleased with what we did on both market share, our win rates, our positioning overall, and we will continue to come down more as well in terms of price performance, but our ability to maintain our margins, I think is world class and very comfortable overall. So, as you begin to expand at overall, it is more of a mix issue. I don’t see abnormal pressure, you do see the pressure in different areas as we move forward.
Thank you, Simona. Next question please.
Next question is from Tal Leoni, Bank of America, your line is open you may ask your question.
Tal Leoni – Bank of America
Hi, I had a question on the quality of orders or maybe the profile of orders for next quarter, can you speak about orders that came from end customers versus orders that came from channel? Have you seen any change in the channel inventory level? Second, related to this is, when you look at this quarter orders or, sorry revenues advanced technologies went down sequentially, while the legacy parts went up sequentially, do you see to reversing the next quarter based on the orders you are seeing? Thanks.
Tal number of questions, in terms of the key trends, we take channel inventory into consideration as we give our guidance and as we talk about, sequentially the numbers, you did see orders start to replenish in the channel, we reflect that out in terms of our guidance and direction, but it does indicate increased channel confidence and we saw that consistently throughout the quarter to answer your question very directly. The other parts Frank, any comments.
There is nothing John I would add as far the channel inventory. I mean the channel inventory remained about consistent, where they are taking control of the inventory management well, and we have some good (inaudible).
And Rob wouldn’t say this directly, but I will, I think the channel programs have been world-class, we have been making it pretty tough on our peers in terms of competing very aggressively on the channels, we have great channel loyalty and our programs have been very effective. We have seen some of our peers, I have to adjust their strategy based upon that down.
Thank you. We will go to the next question please.
Our next question is from Mark Sue of RBC Capital Markets, your line is open.
Mark Sue – RBC Capital Markets
Are we starting to see the very early signs of an acceleration in month to month orders replacing their return to normal order seasonality? Can you extrapolate this trajectory in orders, which means it is a very near-term quarter where revenue will no longer be down year-over-year, and recognizing the improved magnitude of visibility, perhaps you can comment of the length of your visibility?
So, the trends are absolutely in a positive scenario, if you play out the numbers as we have outlined, and if the markets, if we look back two quarters from now and the next quarters goes, we all hope that they will, we will view this is a tipping point and more return to normal growth.
Time will tell that that growth range is during normal times. I personally believe, it will be in the 12% to 17% as we look out one, to two to three years into normal economic type of activity. Now, remember it does vary based on seasonality. So, we are forecasting a very solid Q1, based upon normal growth time periods and we forecast revenue flat or up one or two percentage points. Frank and I are forecasting about one to three in terms of the direction. So, it goes back to one of your colleagues, I think it was Mark’s comments about our seasonality was very much in line, during the quarter and we would hope that that continues through Q1. Q1 is traditionally our weakest quarter as you come off a very, very strong Q4 into getting the machines started, getting the cycles going again, etc.
Thanks, Mark. Next question please.
Our next question is from Hasan Imam of Thomas Weisel Partners. Your line is open. You may ask your question.
Hasan, are you there? Let’s go to our next question then. Operator, are you there?
Yes. One moment. Our next question will be from Richard Gardner of Citigroup. Your line is open.
Richard Gardner – Citigroup
Okay. Thank you very much. You mentioned earlier John that pricing pressure was pretty much business as usual perhaps outside of Asia Pac service provider. Can you talk specifically about the layer2/ layer 3 switching business and what you're seeing from HP ProCurve in terms of price competition on product sales service and warrantees and what you are doing to combat that? Thank you.
So I am going to explain to your question, Rich. I will do the reverse, I'll answer two questions at once, and Blair will probably shoot me afterwards. If you look at where we are versus our competition on both switching and routing, I am very comfortable with where we are. First, you start from a structural point of view, we've reorganized engineering and evolved it, I think pretty smoothly into one group owning the service provider and the routing products, another group owning the vast majority of our switching products.
Within the area, net owning the consumer as well as the chief strategy officer role, Kathy, the central organization, Martin the new emerging technologies. And candidly, that's playing out very well. As we did that first in the service provider routing segment, we began to see our positions in the industry and our product architecture is tied very tightly together and as I alluded to earlier, with the key products both the CRS success, but also how our ASR 1000 products and the 9000 are playing out. It’s always possible I get surprised, but I think we are going to get an increasing share of our wallet spends of our customers in the routing area over the – as you look into Q1, Q2 and Q3.
In switching, I think we are doing well, especially in the data center. And Rob, I'm going ask you to comment may be about data center overall a little bit here in a second. But if you watch it where we are in terms of the Nexus 7000 tying very tightly to the Nexus 500 tying very tightly to the Nexus 2000, tying that to our strategy in terms of the server integrated communications solutions, etc. We saw both very good business results and candidly I feel very, very good about where we are on these individual products. In terms of specific comments about key competitors, I think we are doing extremely well in our channel programs and candidly it's something that we enjoy a good competitor in. But if you watch what we are doing on the channels, we are not only holding our own.
I think in most of the surveys that have come out when they talk about where we are in terms of gaining share in the data center and in the architectural play and server technologies etc. they are saying the odds on us being successful are very high. And they have been pretty candid; they think that’s much higher than our peers’ ability to come into our traditional market. We have a lot of respect for large peers’. They are very, very good in the marketplace, but we are more than holding our own both on the competitive landscape as well as the channels. Rob will expand you into the data center, a little bit your thoughts?
Hi, John, in addition to our traditional very strong market position with the catalyst products 6-K and 4-K, our security and applications, our new portfolio is doing very well. We had a record quarter with the Nexus 7000, which is our core data center switch. And interestingly enough, market acceptance is high in all market segments, commercial, enterprise and service provider. You already mentioned that 5-K and 2-K combination of unified fabric and fabric extension approaching 1,000 customers with that technology. The 1-K received its first orders this quarter, which is our virtual machine soft switch, and that's off to a good start. And that’s off to a good start and then we are beginning to see obviously in the later half of this quarter, our first orders for Unified Computing. Over the next several quarters, we will be increasing the availability of that technologies across more markets. We will be introducing in addition to our current blade model, a series of new rack models. And I think our real opportunity there is the architecture is resonating with customers, with our partners, with system integrators, and with service providers. And I think the next couple of quarters is all about execution. So time will tell, but we are seeing very good market acceptance on our datacenter portfolio.
And Rich, if we don't have good, big competitors in each of the markets we are moving into from the home to the switching to the data centers to the smart grid, we're probably in the wrong market. So the good news is, we don’t like for competition.
Thanks, Rich. Next question please.
Our next question is from Nikos Theodosopoulos of UBS. Your line is open. You may ask your question.
Nikos Theodosopoulos – UBS
Yes. Thank you. Can I ask about the cash, just if you could repeat the US portion and what level of US cash do you feel comfortable? And John, I thought I heard you say at a recent conference – maybe I heard it wrong – that at that time you had $33 billion in cash and that Cisco would be aggressive and don’t expect us to end the year with $33 billion in cash. I meant – I took that to mean that the cash balance would come down either due to acquisitions or buybacks and the cash balance continues to grow. So can you revisit what you said and what you meant there or may be I just heard it wrong? Thank you.
Nikos, you heard the concept right. And remember, the year is the calendar year in terms of the direction. And it wasn't so much the year as we would be disappointed as we came out of this economic downturn. And as you look back a couple of years from now, I would be surprised to see our cash at that level. In terms of the utilization of the cash, $6 billion if I remember right is in the US, Frank, and about $29 billion outside the US. Ned, maybe some comments a little bit as your role of Chief Strategy Officer and, my key investment officer, your thoughts a little bit about where you see us going with some of the cash from an investments or acquisition or a partnering type role?
Sure, John. So the first thing I would say is, clearly we continue to be aggressive throughout the downturn in expanding ourselves in the markets and you did a good job of highlighting three of the market adjacencies pushing into today. We’ve been able to use our cash both to create partnerships and to emerging technology investments as well as acquisitions like Tidal Software, which (inaudible) that you talked about. So we are not going to stay in cash (inaudible) across the whole scale of investments see a big set of opportunities and across the priorities that we’ve outlined with the focus on virtualization and data center.
And just, Nikos, being very candid because we've known each other for a long time, we needed to get organization structures right both in engineering and the field. We needed to get a structure that can support your 30 plus market adjacencies and began to outline a vision of where we wanted to go in a differentiated strategy in each one of those. And then you begin to add your investments into that play. To do it in reverse order would get you into a lot of trouble. So the nice way of saying that I would look at it as having our decks pretty cleared, the aircraft carrier pointed into the right direction into the wind and over the next period of six, 12, 18 months, I think you will see us be aggressive. I would say we’ve been very aggressive in how fast we’ve moved on our priorities and architectural plays. And, Ned, any last thought?
Yes, the only thing I would just say, John, is the valuation is very, very important. As the market has moved up ahead of some of the performance of companies, we expect to be able to do deals at the right price and we are going to continue to be disciplined in that regard as well.
Thank you, Nikos.
Thank you, Nikos. Next question please.
Our next question is Simon Leopold of Morgan Keegan. Your line is open. You may ask your question.
Simon Leopold – Morgan Keegan
Thank you very much. I was hoping we could drill down on the data center opportunities that we’ve talked about in the past and revisit that, particularly in light of some of the more recent data on the may be the biggest spenders like Google and Microsoft that basically sound like they are going to spend less money on their data center initiatives over the next year or even Microsoft talking about fiscal 2011 being flat. Can you help me step back and look at may be a bigger picture. Thanks?
Sure. If you look at the overall play in the data center, I think the play is an absolute number play, but it’s also what does the next-generation data center look like. In our opinion, its clearly going to be rapid blaring of the network, the processor capability, the storage capability, the software that goes with that and that virtualization is we like to call it works all the end into their home. That is right in our sweet spot in terms of what we do as a company. In terms of our market share outside of the network and the data center, it is really small. And we are clearly taking on some very big traditional players there. But if you begin to think about our ability the grow the UCS system or the ability to grow an architectural play in the data center, suddenly we are playing for a 100 million, 200 million, 300 million type of opportunities. Now, without mentioning companies by specific names, but at least in one of these scenarios that you talked about I would be surprised if don’t expand our market share outside of our traditional areas dramatically as we move forward. So all of a sudden, we are a player in the data center in terms of permission to participate. The customers have been remarkably receptive to us playing here. We are in very good shape in terms of our initial pilots and program. Now, we got to deliver on those and if we do using the surveys as well as I have, most of the enterprise customers are giving us an opening that if we make our initial project successful and both in the excess plays and the UCS plays, we are going to get a chance to play much more aggressively even if the market were to say at a given static level. $85 billion is a lot of money, of which we are getting a very small slice of the pie today. It's a nice way of time and if we execute the growth areas [ph] for us are really, really exciting. And repeating the common themes, you are seeing in our products in this area growth rates of 100% quarter-over-quarter granted off of a small base.
Thank you, Simon. Next question please.
Thank you. Our next question will be from Brian Modoff of Deutsche Bank. Your line is open. You may ask your question.
Brian Modoff – Deutsche Bank
Yes, John. You mentioned earlier, you are seeing your first order for Unified Computing. We’ve been hearing that you are starting to see some traction in the Fortune 50 with perhaps trails moving into orders. Can you talk a little bit about that and when do you expect this to be significant for Cisco as a business?
Yes. I want to be careful and I obviously know exactly what our forecast is by quarter. But when you are starting off of a base of, let's just for mathematical purposes say $10 million, trying to predict when it hits $100 million curve by quarter and beyond. I think it will be significant absolutely this year, probably the second half of the years when you will begin to see the volumes really come into play on it if we are successful in our initial implementation. I guess it's very fair, Brian, for us in each of the quarters to take it beyond a concept type of approach to a little bit more meat. I can tell you that the initial systems that have gone into production are going very well and again repeating the common theme, the customers are giving us absolute permission to come in here. It is a cool architecture and with a lot of investment protection on it. Rob, anything you want to add?
John, actually to our pleasure, some of our initial orders are coming from medium sized enterprise accounts and I think the question was, will we see the breakthroughs in some of the Fortune 50? Obviously, they are going to take a little bit longer to evaluate an architecture and we do expect we are going to see some really interesting wins especially when the use case is virtualization, and especially when we are looking at enterprise applications that will be delivered inside the construct of a private cloud. That seems to be where we are finding the sweet spot. We are also finding tremendous traction with our service providers that are looking at delivering hosting and enterprise cloud based services. So I think we are going to see some good progress and the initial acceptance is happening very much with our channel partners and in some of our medium sized enterprise accounts.
And as you know, Mario, Prem and Luca and Sony [ph] are heading this up for us, and Mario doesn't get excited very easy. But he is about as optimistic as I’ve seen him over 14 years in the business or 15 years in the business in terms of the start we are off to here Brian. But it's too early to call for sure, but I couldn’t be more pleased with the start.
Okay. We will take the next question please.
Next question is from Jeff Kvaal of Barclays Capital. Your line is open. You may ask your question.
Jeff Kvaal – Barclays Capital
Yes. Hi, thanks very much John. I am wondering if you could go into your deferred revenue performance a little bit more. What are some of the things that are driving the sequential increase, and how we should think about that in terms of your own visibility? Thank you.
I would love to, but I think Frank would probably do a better job than me on this. Frank, if you don't mind handling that, I'll back you up with my details.
Okay. Thank you, John.
So Jeff, as I mentioned in the script that we went through, if you look at our deferred revenue on a year-on-year basis, it was up 6% on the product side and 6% on the services side. As you know, what really contributes to the deferred revenue is when we have more complex transactions that have to be deferred from a revenue standpoint. We tend to see this a lot from a service perspective as far as anything that we look at solution transaction and that we also look at on the product side as far as any complex deal that has some revenue recognition item. I think it also shows that, as you look through the quarter, we continue to see some good opportunity that we expect to see over longer period of time, which I think is where the deferred revenue comes in. And as I also mentioned, if you look at our backlog that we ended the year at, plus if you take on the growth in our deferred revenue for the quarter, which again is a little bit of an improvement in the trend that we saw versus Q3, I think that really boards well for as far as what we have in the backlog moving into the new fiscal year.
In simple terms, Jeff, I love deferred revenue. It's a lot easier to predict your flow than some of the other areas are. Next question please.
Frank, (inaudible) we have time for two more.
Next question is from John Marchetti of Cowen and Company. Your line is open.
John Marchetti – Cowen and Company
Thanks. Just wanted to ask John, in the past, you’ve talked a little bit about the fact that during the economic upheaval times, your goal is to take share from some of your competitors. That really hasn’t occurred over the last few quarters and I am curious with your move into sort of these 30 new adjacencies if your thinking has shifted to more gaining overall wallet share as oppose to may be making sure you remain number one and two in every single one of these markets.
John, very fair question. First, I intend to be number one or number two in the vast majority markets we go into. Our vision, differentiated strategy and execution in each of these areas require that. If we are not able to do that, we will – as we did with optical, out of the six advanced technologies, it's still an important area to us. But we’ll pull it off the mainstream group and focus on the other five. To our position on share, I feel very comfortable with where we are in terms of our product, plans, and strategy in routing. And, as I mentioned earlier, as we did the organizational evolution several years ago, with Pankaj and Tony heading up the group, we are now seeing the products roll out which give us an architectural play as opposed to being developed multiple organizations within our team. And with all the appropriate caveats, we are not only gaining wallet share within the customers, I feel good about where we are on the wallet [ph] strategy overall.
Switching, we are doing well in a couple of the categories. A couple of areas I want to see us do better in. But you now look and you look within Tony Bates heading up all of our enterprise strategy. Vast majority of our switching products would use to be across four or five groups, largely underneath Tony and John McCool, the exception being obviously what Mario is doing in terms of the data center. I think you will see us execute equally as effectively there. But I think, in switching, you'll see market share by product categories first before you will see it in terms of the total type of approach the market. In terms of new market adjacencies, when we enter them, I want to be one or two. And they’ve got the play together. Everything we do in these market adjacencies if they are done right will build a technology architecture where the interdependencies between them become pretty exciting. Now I realize no one else in the industry believes that or is building their strategy that way. I think that's a mistake, personally. And I'm very comfortable with where we are, John. But stay tuned, continue to push me each quarter, see if we get the results or not and hopefully when we talk about Q1, we'll have some numbers that point towards your fair challenge.
Great. I think we have time for one more question.
Thank you. Our next question is from Ittai Kidron with Oppenheimer. Your line is open.
Ittai Kidron – Oppenheimer
Thank you. Last one second time in a row.
Ittai, we always say the best for you.
Ittai Kidron – Oppenheimer
I appreciate that. Wanted to focus a little bit more on your gross margin guidance for the next quarter, get a little bit more color, product versus service. Where do you expect the big movement downward? And also you mentioned, if I'm not mistaken, that emerging markets are part – significant contributor to that decline, but it seems like the order patterns are very bad in that region and have been so for sometime, doesn’t seem like there is a bottom to the year-over-year decline in order pattern. So is there some sort of a strong bounce back you expect in the emerging markets next quarter that the order patterns are just not telling us? If you can reconcile the gross margin with that, that will be appreciated.
Sure. I am going to talk a little bit in general terms. And then, Blair, I got ask you a question at the end. So if you look at where we are going in emerging markets, I am actually comfortable that if you see the trends continue just like they did this last quarter, you saw Q3 being the area where it leveled off and Q4 sequentially being the first time it turned up. The emerging markets did the same thing that the US did, as did Asia Pacific etc. in terms of sequential order growth in the double digits, so we had actually saw the same trends. Now, to the second part of the question, you are seeing in emerging markets and let’s say an oil producing type environment etc the budgets both of government and their core businesses got squeezed much tougher than many of the developed countries worlds did. And so their ability to respond back becomes more challenging on it. But now I am pretty comfortable with where we are in emerging.
The markets that I am actually concerned about that are probably going to lag by a couple of quarters the rest of the world are in Europe and again that’s not an execution on our teams part. I've got a great team over there, and Rob has a great team. I just think there were couple of quarters later going into this and you are seeing some pretty severe challenges in UK, Spain, and Italy. You have countries like Germany that I think are managing through in it pretty well. But in total, Western Europe and Eastern Europe I think are challenged. In terms of the margin analysis, it’s a mix issue as much as anything and to me, trending down or not I would again think 63, 64, and we clearly gave a margin indication for this next quarter at the higher end of that. Now we will have different mix issues which contribute to that, but I think these are pretty solid margins given the new markets we are entering into, the volume we are entering into etc. Frank?
John, let me just add two things. One on the product side, on the gross margin, as I mentioned, we now have some recent organizations acquisitions that we brought into the business, which will have a negative impact on the mix as well as some of the new products, especially in some of the adjacent markets that we talked about as they are early in their life cycle as well as the margin structure on those are lower, that plays into the mix on the product side. And then the other thing quickly I wanted to say on the service side is, we have been mentioning out for a couple of quarters, we are investing heavily in advanced services primarily in support of data center. We started brining on additional headcount in the Q3, Q4 timeframe that are going to be impacting the cost in Q1 that will bring the margins down on the service side primarily because of the additional cost, but its also going to change the mix between our technical service and our advanced services which do tend to have low margin. So those are the dynamics that we are taking into consideration in the guidance that we provided for Q1.
Ittai Kidron – Oppenheimer
The one question I didn’t get, Blair and thank you very much is where we are going with cloud some of these new architectures and how our strategy in cloud really pulls in many of the other strategies in many areas. Padma, maybe if you give us a snapshot on that since you are leading the strategy for me on cloud and the implementation and little bit how it might add to some of the other things we are doing.
Sure. Thank you, John. Cloud as we believe is perhaps one of the most network centric architectural shift that we are going to see in the IT industry in a long time. And the reason we believe that to be the case is virtualization is going to be the foundation to drive that. And so UCS becomes a core element from an architectural perspective in how we can enable large enterprises to build their own private cloud as well as service providers to provide the capability of virtual private clouds to enterprises and small businesses. Our cloud strategy is to link from an infrastructure perspective what we are doing in the data center all the way to the application delivery through SaaS. With SaaS offerings that we currently have with WebEx conferencing, security as a service with IronPort and some of the other capabilities. The key differentiation that we are focused on with respect to the network enablement is in providing security, which is a key concern of most enterprises in the today architecture with cloud as well as enabling higher levels of service agreements and providing the interoperability between different cloud architecture.
So an area kind of stay tuned on. And Blair, let me give it back to you. You ran us exactly on time, and you didn't have to nudge me except once or twice, to keep the pace going.
No keeping this quarter. Great. Thanks, John and everyone. Cisco’s next quarterly conference call which will reflect our first quarter fiscal 2010 results will be on Wednesday, November 4, 2009 at 1:30 p.m. Pacific / 4:30 p.m. Eastern. And additionally, as I said before, downloadable Q4 and FY2009 financial statements will be available following this call including revenue segments by product and geography, income statements, full GAAP to non-GAAP reconciliation information, balance sheets and cash flow statements can be found on our website in the Investor Relations section. Just click on the Financial Section of the website.
Again, I would like to remind you that in light of Regulation Fair Disclosure, Cisco plans to retain its long standing policy to not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. Please feel free to call the Investor Relations Department with any follow-up questions from this call. Thank you for your participation and continued support and this concludes our call.
Thank you for participating on today’s conference call. If you would like to listen to the call in its entirety, you may call 866-357-4205. For participants dialing from outside the U.S., please dial 203-369-0122.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!