John Chambers - Chairman, CEO
Frank Calderoni - CFO, EVP
Cisco Systems, Inc. (CSCO) Annual Shareholders Meeting Call November 19, 2013 1:00 PM ET
Good morning ladies and gentlemen. It is now 10 a.m. and the 2013 Annual Meeting of the shareholders at the Cisco Systems will please come to order. I am John Chambers, Chairman of the Board and Chief Executive Officer of the company, and I will chair this meeting. On behalf of all of us at Cisco, I want to welcome you and thank you for your attendance. It was also fun walking through the group earlier in terms of what questions you may have and I will try to address some of these questions during the regular business discussion later in the meeting.
Before proceeding to the business portion of the meeting, I would like to introduce the other directors and executives of the company present here today. I am going to ask the directors and our Cisco executives to please stand as I call your name. Carol Bartz is participating from home. She is really sick and I talked to her this morning, she can barely talk, so Carol thank you for joining us via WebEx.
Thank you Carol. That’s her best voice I have heard there.
Michele Burns; Gregory Brown; Michael Capellas; Larry Carter; Brian Halla; Dr. John Hennessy; Dr. Christina Johnson; Rod McGeary; Arun Sarin; and Steve West.
I would also like to take this opportunity to thank two of our board members who because of the age restriction were not able to stay for a re-election, and is with a great deal of pleasure and sincerity I just want to thank Kovacevich for the years he spent here at Cisco and on the board and Larry Carter, special thanks to you, unbelievably good CFO and thank you for your many years of service. We are really proud of you.
I would also like to acknowledge the following Cisco executives here today. Gary Moore, our President and Chief Operating Officer; Rob Lloyd, our President, Development and Sales; Frank Calderoni, our Executive Vice President and Chief Financial Officer; Mark Chandler, our Senior Vice President, Legal Services, General Counsel and Secretary and Chief Compliant Officer; well that’s the longest title we’ve got. Prat Bhatt, our Senior Vice President, Corporate Controller and Chief Accounting Officer; Prat, where are you? Thank you. Pankaj Patel, our Executive Vice President and Chief Development Officer, Pankaj thank you. Chuck Robbins, our Senior Vice President of Worldwide Field Operations. Rebecca Jacoby, our Senior Vice President and Chief Information Officer. Kathleen Weslock, our Senior Vice President and Chief Human Resources Officer; and Randy Pond our Executive Vice President of Operations, Processes, and Systems
Also present to assist in the meeting are Chris Mueller, PricewaterhouseCoopers, the company's independent registered public accounting firm. Stand up for a second because I could impose on you, thank you. And Gordy Davidson, Fenwick & West, the Company’s outside corporate legal counsel. Gordy, thank you for being here.
I would now like to turn this over to Frank for the formal part of the meeting. Frank, to you.
Thank you, John. First, I will give the report on the notice of the meeting and the presence of a quorum and then make several announcements. The Board of Directors has fixed the close of business on September 20, 2013, as the record date for the determination of shareholders entitled to vote at this meeting. Notice of this meeting was duly given to all shareholders of record on or about September 30, 2013. IVS Associates has been appointed as the inspector of election for this meeting and Mr. Creig Dunlop, who is representing IVS Associates, has informed me that shareholders owning a majority of the outstanding shares of the common stock are present, in person or represented by proxy, and as a result, there is a quorum of shareholders for this meeting. Therefore, this meeting is now open to proceed with its business.
As you can see in the agenda and the rules of the meeting that we distributed, after I have completed the introductory matters, I will turn to the business portion of the meeting. After the formal business meeting, we will have a business review presented by John Chambers, followed by a question-and-answer session. If you have a question you would like to ask, please write your question on the cards that have been provided and pass your card to the aisle. We will have representatives collect your questions, and similar to what we do in our company and other meetings, during the Q&A session, we will focus on your most frequently asked questions in the time that we have allotted. To expedite the flow of business during the meeting, I will first propose each item of business for discussion in the order listed in the proxy statement and then you will vote on each of the items discussed. Please refer to the agenda and the rules of the meeting handout for more detailed information regarding the order of business and the rules of conduct for this meeting.
We will now proceed to the items of business set forth in the agenda. The first matter to be considered is the election of the Directors of the Company. The following individuals have been nominated by the Board of Directors upon the recommendation of the nomination and governance committee of the Board. To serve as Directors until the next annual meeting of shareholders and until the successors are elected and qualified; Carol Bartz, Marc Benioff, Gregory Brown, Michele Burns, Michael Capellas, John Chambers, Brian Halla, Dr. John Hennessy, Dr. Kristina Johnson, Rod McGeary, Arun Sarin, and Steve West. No other nominations were received by July 28, 2013, the deadline specified in the last year’s proxy statement for nominations. Therefore, the nominations are closed. The Board of Directors recommends that the shareholders vote for the election of each of the nominees. We will vote on the election of the directors momentarily.
The next matter to be considered is the approval of the amendment and the restatement of the Cisco Systems Inc. 2005 stock incentive plan including an additional of 135 million shares authorized for issuance under the plan and another amendment as described in the proxy statement. The 2005 stock incentive plan as amended and restated is designed to give Cisco the flexibility to responsibly address its future equity compensation needs. The Board of Directors recommends that the shareholders vote for this proposal. Again, we’re going to vote on this momentarily.
The next matter to be considered is the advisory resolution to approve the executive compensation. This is a non-binding resolution that the shareholders approve the compensation of Cisco’s named executive officers as disclosed pursuant to the SEC’s compensation disclosure rules including the compensation discussion and analysis section of the proxy statement, the compensation tables and the narrative discussion. The Board of Directors recommends that the shareholders vote for this proposal. And again, we’ll vote on this momentarily.
The next matter to be considered is the ratification of the appointment of PricewaterhouseCoopers as the Company’s independent registered public accounting firm for the fiscal year ending July 26, 2014. The Board of Directors recommends that the shareholders vote for this proposal. Ms. Chris Moller of PricewaterhouseCoopers has informed me that she does not wish to make a statement at this time. Ms. Moller will be available to respond to any appropriate questions during the Q&A section. And again we’ll vote on this momentarily.
I will now introduce a resolution proposed by a Cisco shareholder for consideration. Cisco’s response to the proposal can be found in our proxy statement. As our next item of business James [McRitchie] has given notice of a proposed resolution in accordance with our bylaws and the rules of the Securities and Exchange Commission. Is James [McRitchie] here? Would you please step forward? And according to the rules you have five minutes to present your proposal. Thank you.
I am James [Macritchie] rising in support of proxy proposal number five, proxy advisor competition. Of course everyone can read my proposal in your proxy materials. Unfortunately, most don’t. It’s like a California Voter Information Guide, getting thicker every year. Based on questions that funds have been asking, many of them haven’t read the materials either even though they have million and sometimes 10s of million invested in Cisco. Many funds rely on proxy advisors subscription services spend an average of about $200,000 worth of time on each proxy. For that price they have to take something of a cookie cutter approach. If they could spend $10,000 they could do a much better job. But they would have a hard time keeping subscribers. And most shareowners still wouldn’t get the analysis, or any analysis.
My proposal to hold the competition solves these problems. How could it work? The competition would be announced and opened for entries about six months after this meeting. Each contestant would pay an upfront non-refundable fee of $200,000 to Cisco, only those with considerable expertise would be expected to enter because they’re paying that upfront cost. Each contestant would pay on each entry would be announced in turn their names and website addresses displayed on a publically accessible Cisco website page. This voting would then appear in next year’s proxy is voting item and the item would be which of the following proxy advisors do you think deserves cash awards for the usefulness of information they have provide to shareholders, you may vote for as many advisors as you like, see each advisors website for their information for Cisco shareholders, prices of $20,000, $15,000, $10,000 and $5,000 will be awarded to advisors based on the number of shares voted to approve the usefulness of their advice.
Then the name and website of each competitor would be listed in chronological order of entry followed by checkboxes for approval, disapproval and abstention for each entity or entry. The advisor receiving the most approval votes would get first price, second get second and so on, basically it's fairly simple. Right now only a relatively small number of share owners get any analysis because most are subscribed to our service.
With the proxy advisor contest all share owners would get multiple analysis and contestants would be incentivized to spend much more time on their efforts. Competition will result in better service. Some of you may ask does the analysis provided by proxy advisors matter. Well, if gross operating margins are squeezed at Cisco as some of predicted it would matter a great deal, it all happens do you want for example a recent BA in art history providing the same cookie cutter analysis to our company and its share owners, wouldn’t it be better to have a competition among experts willing to bet their own money on firms specific analysis. Please vote and favor a proxy item number five, proxy competition. Thank you.
Thank you. The Board of Directors recommends that the shareholders vote against this proposal for the reasons that are set forth in the company’s proxy statement. We will now vote on each of the discussed items of business. If you have returned your proxy card voted by telephone or voted at the internet is not necessary for you to vote by ballet unless you wish to change your vote. If you have not already return your proxy card voted by telephone or voted at the internet and you wish to change your vote please raise your hand to receive a shareholder ballet. And we’ll make sure that one is delivering to you.
So, as soon as you completed we’ll just have someone come down and will collect those ballets and we'll pass them over to the inspector of election. So any change of votes or any other votes that you’d like to make.
Okay, any others before I close the polls? Okay. The polls are now closed for each item of business represented at this meeting. We’re going to take a few minutes now to tabulate the ballots.
Mr. Dunlop, would you now please provide me with the inspector of elections report? Thank you.
According to the preliminary report of the inspector of elections, each of the persons nominated as a director has been elected. Each nominee received the support of at least 85% of the shares voted, with approximately 97% average support. Each nominee also received the support of at least 57% of the company's outstanding shares.
The proposal to approve the amendment and restatement of the Cisco Systems Inc. 2005 Stock Incentive Plan has been approved, with the support of approximately 88% of the shares voted and approximately 59% of the outstanding shares voted for this proposal.
The advisory resolution regarding executive compensation has been approved with the support of approximately 94% of the shares voted, and approximately 63% of the outstanding shares voted for this proposal.
The proposal to ratify the appointment of PricewaterhouseCoopers as the company's independent, registered public accounting firm, has been approved with the support of approximately 98% of the shares voted, and approximately 80% of the outstanding shares voted for this proposal.
The shareholder proposal by James McRitchie was not approved, with approximately 99% of the shares voted, voting against this proposal. Approximately 1% of the outstanding shares voted for this proposal.
I will now turn the meeting back over to our Chairman, John Chambers. Thank you.
Frank, thank you once again. The matters for which this annual meeting of the shareholders was called to consider have been completed. Since we have received no notice of any other business to come before the meeting, the 2013 Annual Meeting of Shareholders is hereby adjourned.
I will now proceed with the business review presentation. If you have a question that you would like to ask, please write it down and submit it to the aisle and for those of you attending by webcast, please submit it electronically. We would try to get to as many of those as we can during the timeframe allotted and once again I want to thank you for joining us today.
This is the part I actually enjoy the most, sharing with our shareholders how we as an entire company, our board of directors come together, focus on maximizing shareholder return, and our commitment to you. We will be covering forward-looking statements as you would expect during this discussion and we may do some GAAP versus non-GAAP correlation in terms of looking through our website for focus.
As we went around the room these were the same questions you ask. I want to try to cover a little bit of what we are seeing on the macro environment, we are going to focus about how we maximize your shareholder return and how we are going to use our capital allocation especially the $15 billion that just got approved by the Board of Directors recently. I have heard strongly over here, some of you want dividends, over here people wanted to do more share buybacks.
We’re talking about where the strategy of the company is going. We will say given that the strategy feels pretty good, that’s probably what you’re hearing from customers and key analysts. Alright, what happened in Q1? And what are your challenges and opportunities as you go forward?
I think the thing that has changed the most in the last 12 to 18 months is the pace at which change is occurring; whether it's in technology, economic or new business models. We almost view it’s changing at an exponential rate and changes used to take place in three years, take place in one, and very candidly changes in a quarter that used to take place every two to three quarters now takes place in one quarter; almost a month equivalent to the quarter change that we saw before. There is a realization of our customers on a global basis that the pace of change for their business models and their own survival is changing. We saw all that, the Fortune500 as an example. Only 24% of the Fortune500, and just 25 years ago, even or on that list today.
And by many experts analysis, MIT and other, when you look going forward, out of the large companies that exist today, 87% of them will have a major revenue turn down in the next decade plus and out of that only 11% will actually recover.
As you look at what this really means it’s a survival rate that companies have to constantly reinvent themselves and don’t have to change very rapidly. For us this is what we do as a company. I think most people would argue we do this better than anyone else and why I would love to avoid the bumps that occur along the way every time we’ve hit one of these bumps we’ve emerged as a stronger company. And it usually gives us an opportunity with our customers to completely transform their business. The changes are occurring however to faster pace from a technology you see in the current server market and very quickly go to mobile cloud. You’re seeing a generation of applications that are more consumer right even in the business. And Big Data which already focuses on you almost think of it being crunch to the datacenter it’s going to be done more at the edge of the network where literally unstructured data such as data voice video and social will play a much larger role.
Intelligence connecting all the devices the road is going to be very large and we think will be the next way to the Internet. You combine that with how fast business models change. How a Walmart has to move to physical and a virtual environment to compete against Amazon? How service providers have to reinvent themselves in terms of their revenue stream moving from just decade ago where all the revenue was always from voice today they have to reinvent themselves in terms of the new services they provide. New challenges in terms of competition and the importance of security and privacy been [experiment] in many of our customers’ minds.
The nice thing we believe is the network is right in the center of this and we’ll speak to have the changing role of IT occurrence. Several of you’ve asked what has allowed Cisco our leadership, our Board, the Executives here, to stay ahead of our peers because our peers from 15 years ago none of them exists. From 10 to 15 years one exist in a meaningful way and from great companies like Alcatel, Lucent, Nortel, Siemens, Ericsson, who are many times our size just less than a decade ago we move past them all. And the challenges that you probably ask about three years ago are nowhere remember if you would -- how many of you attended the meeting three years ago just have curiosity. Remember when you expressed the concern about what Huawei would do or HP, or Avaya and many people were concerned about commoditization of our products those competitors we pulled away from most of them. So we do catch these transitions remarkably well.
And as catching technology and business transitions is the first thing we do well by listening direct to customers. So the second thing we do well it’s a customer driven company everything we do we can always tie it back to specific customer. But what you’re going to see this year is the year when architectures come together and that’s how you combine your products to solve customers’ goals as opposed to sell them router or a switch and why that’s important that allows us to take on a new generation of competitors that we’ll talk about later, the fight label type of competitors who bring together most and expensive hardware they can find to make things work together. And this is the strategy we have going forward.
Going back to the market transitions, every time we’ve made a move it’s when something moves to the internet that’s what we do, we moved in switching that’s when we moved into telephony and many people tease we went into telephony, I said Cisco you can't even spell it that might have been true, but we knew how to get 65% market share. And ability to stay focused as literally the world move from PCs into any device smartphones, the ability when video went into the Internet we moved in that category. And now you’re seeing literally the Internet of things be the next big wave that we think is going to occur in the market.
You can often say Cisco did you really catch transitions or did you just respond after they occurred, the answer is we do both. When we respond after they occur we usually do that through acquisition. But here is an article written in May of 2005 that said where are you going. And in very simple terms here is the exact quote.
Now the point that I am making -- next slide please, the point that I am making is we outlined almost a decade ago that data, voice and video would move to the Internet and that’s where we’re going to get our short term growth. That is that occurred networks will become much more application centric and we used the app word, application aware networks. As that occurred you suddenly would have a role in terms of how IT would evolve. And within that we had to play in the datacenter as our next logical move. And if you watch that’s exactly what we did. 2005 at the time of the article it was data voice video it’s where we became the number one video player, the number data player we already were there, the number one voice player.
In 2010 that’s when we made the moves that we started laying the groundwork for in 2005. We moved into the datacenter and you remember our competitors said you won’t even last your 15th meeting I think you won’t even last a year in this market and fast forward to the day we’re the number two player in areas like servers, in terms of rack blade servers drawing at 45% year-over-year. But what we did is we caught the concept with compute and storage coming together with the network and we did this through partners. And with partners like FlexPod from NetApp and from EMC what we’re doing together with the VCE products you suddenly see us breaking away from our peers.
Now this each one of these has been bigger than the parallel one. The next move we think will be all around applications. It will be within applications centric infrastructure I wasn’t smart enough to call it application centric 10 years ago. But the intelligence in the network that all of sudden will bring together the power of applications with distributive intelligence capabilities throughout and at the base to be able to scale to tens of billions of devices with security. And as simple as that sounds that's the next major move we're going to make. What you are seeing is business leadership grasping, where they are going to get growth where they differentiate themselves? And while company’s is very worth on this philosophy most CEOs that I talk with grasp their company, probably is going to end up being at last half technology and half their traditional business.
And some of in my opinion think even further long. They view themselves as financial intuition that specializes in finance that just happens to be a technology company. A retail company that specializes in technology just have to specialize in providing retail to the consumer and you know where I am headed. It is this capability that calls these companies to have to reinvent themselves to adjust to new models and that's where we can remake a difference for our customers. Our ability to move what IT call fast IT.
How do you move into new areas like mobility, security the capability to do collaboration at a speed that allows your customers to always future proof their environment? Here is the chart we have used for three years in a row, just a quick report card. Cloud we set as our objective, Synergy named as the number one could infrastructure provider. And many people again thought that we couldn't play at that level.
Mobility [indiscernible] four years ago we talked here and said have you brought it up? It's now where the number one player and many aspects of mobility and by the time you go small cell all the way edge of the network, no one has a portfolio like we do. Video we're going to continue to work on, we've done some things brilliantly, some things we need to do better. Emerging markets is where 50% of the GDP growth of the world is today and it's where the majority of opportunities will be. Although we’re always looking about how we bring jobs as you said back to America in terms of how that occurs.
And the ability to identify the opportunities and security is the number priority for every one of my customers, our customers is a group both at the CIO level but at the CEO level. And then the move after you watch what we do in security, you are going to see us move to that. So it's clearly an area that there is not a problem with growth opportunities if we execute right, but the [indiscernible] is smaller and we will distinguish ourselves not by just building the best individual product but how we accomplish our customers business outcomes.
Now this where a little bit of the Cisco magic comes in, every market we enter we set as a minimum goal of 40% market share, and do you have sustainable differentiation. And remember even great companies that you think about whether IBM or HP or Microsoft at the past never got out of more than two or three key product areas.
And the three areas over to your right starting with cloud, the good news is we're number one with 16% we clearly indent to expand our opportunities there, on server blades we moved into the number two position, our goal is to pass HP to become the number one. In security you are going to see us make a number that's internally an acquisition like Sourcefire as we move together.
But this is what architectures bring it together, because customers aren't going to buy boxes, they are going to buy how this all ties together into an architecture that allows them to accomplish their goals. Now that's the Cisco magic for the next five to 10 years. When you do this right you look at a customer and you say by this approach I do the things that do not add value to your business at Wal-Mart or to your business at GE or JPMorgan Chase.
We basically make the technology work well together in an open system environment and we allow you to focus on generating the applications for your end user result. Now because none of our peers are in more than one or two major product areas with a number one, two or three position, and remember what I showed you on the prior slide, we're number one in 13 areas, number two in five and number three in one.
And if this plays out the way that we believe it will, we have a huge competitive advantage which will also allow us to take on the white label players with total cost of ownership the ability to future proof customers environment more than any other player and to look people in the eye and say we do it literally because we provide the best product in every area that was designed to work together.
The next frontiers you just begin to read about we launch the Internet of things with the World Forum in Barcelona with Cisco who was the key lead on the launch. But we had players come together that you never might have thought of Cisco with Rockwell and how you focus on manufacturing, how you focus on healthcare and retail. And what that was all about is not just connecting devices which were in from the time Cisco was founded with the 1,000 devices connected to the Internet, about the time I joined Cisco less than a million, today over 10 billion on its way to 50 billion by the end of 2020, on its way to 500 billion. Why should you care? The answer is the power of the network squared is its capability.
So if you had two phones the power of your telephone group is four, you had 416, if you had 10,000, you have 110,000, think what it means with 50 billion? It will completely transform every industry starting with manufacturing retail insurance all the way through and the ability to connect the device with common scale security the ability to use the data in an effective way, most of the decision being made at the edge of the network, the ability to tie the together to center point and you can do your big data at the edge, if it's about a consumer going through a retail store or crunch the big data if you are doing something on a healthcare to allow a person to live longer.
All of that can run across Cisco, but what is also interesting is the devices are just an instrument. It’s the applications that you load it on. Of those 10 billion devices that exist now 77 billion downloads will occur this next year. Now that means a lot of network capacity, but that's not what we’re after, it's how do you tie those applications so uniquely to Cisco routing and switching, the ability to do it in a cloud, in a data center, at the Wide Area part of the network all the down the edge in a way that no one else can do, with the number one products in each category you begin to see the advantage we bring to our customers.
The ability to reinvent ourselves as well, and while if you would ask people two years ago what would be the relevance of the network, a lot of people said, network would just become dumb pipes, it's all about software. Wrong. People were understanding if you don’t put [indiscernible] throughout and application centric infrastructures throughout you're not going to be able to manage what’s going to occur to control it, if you get the right machine to the right machine with the information of the machine to the right person at the right point in time.
Now this is a survey of 13,000 IT professionals in over a dozen countries around the world. 78% of them basically said the network is going to become much-much more important and much-much more strategic for where we go.
This is a favorite chart I could talk about it for an hour, but it's what we do, this is how we're going to approach application centric infrastructure, how are you going to be able to take the capability to run those applications, because that's what customers want. And how you allow them to generate them faster than anybody else in the world can do and protect their investment, make them open and simple. How if you're interested in the technology terms how do you not separate the control plane and the data plane but how do you separate literally the applications, from the infrastructure with a common policy that allows you to this anywhere you want that network. Remember when I said in that one quote 2005, its irrelevant where you run the applications, we can make it completely transparent on that. But what we do uniquely and this is where some of you asked me SDN, Software Defined Networking, is an element that we're going to embrace and run better than anyone else but not as a separate network, we've already seen that movie, that was ATN to the desktop and for those of you who are my age, you understand that was supposed to win. But that was two networks on top of each other, and what's a problem with SDN a virtual network on top of a physical network, complexity. You have costs associated with managing both, when there's a problem, was it the API, was it the virtual network, was it the physical network, who's going to troubleshoot for you. It does not scale and what you want to do is embrace what you're trying to do with software, in terms of programmability and flexibility and then encompass that we're so much more as you bring together the power of virtual and physical network together, and you do this not by software alone you have to have huge A6 capability and that's software and hardware together. [Indiscernible] we develop our A6 we do probably 80% of the resources are software people putting functionality into silicon.
And before that A6 even comes out we're usually putting more software into silicon. And much of this merchant silicon you hear about in our industry probably 90% plus of the features are things that Cisco invented a decade ago. So our ability to combine the best worlds to solve our customers' problems is clearly where we're going to go, but our philosophy has been different than all of our peers, we didn’t just stay internal like many of the companies in the industry did, we said innovation is about doing it yourself including your internal startups which we're getting pretty good at doing. It's about partnering and we are unequaled in the industry in terms of how to partner and it's also about acquiring. Now these are the acquisitions we've just done in the last year. Padma, you've done an amazing job heading up the group.
Pankaj, the engineering team is on fire, couple of areas we can improve on, but it's the best innovation we've ever had in total. And look at the lineup that Robin Gehry at the application centric infrastructure launch in New York just a short time ago, had in terms of partners committed to where we're going to go, on stage with us. I mean this is who's who. Now you're about to compete with Cisco, this is the power you bring. And it wasn't just a company representative on stage; these were the very top executives, often the CEOs and key strategists. Why did they do this, because of that architecture chart that I showed you in front, according to the customers that [indiscernible] we did it? In front of a live TV audience do you believe this is going to be one of three top movers for the whole IT industry of this next decade and you had the who-who in companies say, yes. Top cloud player OVH literally out of Europe, number one in Europe and number three in the world, and you begin to get a Microsoft on stage with you and this is the most we've ever done with Microsoft ever, where [indiscernible] who's their key engineering lead talks about how this technology ties it together in a way that's never been done before, and if the two of us don't mess it up Cisco and Microsoft, this is going to change both out joint top lines and bottom lines.
No one innovates like Cisco, now that's not to say we don't have our share of mistakes, we do acquisitions, a third of them are going to fail, if we knew what third they were we would never have done it. Same thing if you are going to be in emerging markets, you are always going to have a couple of countries, units executed in or a couple countries that are going through political turmoil et cetera. But it is companies who take the risk to go ahead and keep a focus and never lose track of where they want to end up that will win in this environment.
On the last quarter, we hit our objectives on earnings per share, we were actually $0.02 over consensus, our gross margins, Gary, Frank and the entire engineering team were stronger than thought at 63%, but we missed our revenue number, first time I’ve ever done that at Cisco. And it speaks to pace of change. During the quarters the first month was dramatically different than the second month and the third month if there was a month you did not want to close your books on it was October this year with the federal shutdown going on in the confidence. And so, we took a hard look, what do we think, we need to do better and we would literally look in every aspect at Cisco and what we can better in each groups and we were at the Board during committee meetings today I and Christina we were talking in each of areas acquisitions example what could we do in each element even though we are the best in the industry at this but we need to get better.
Like this three overwriting areas that we saw in the slowdown emerging markets really surprised us. Just two quarters ago, it was going to 13% this quarter minus 12%. Now the things we can do there in terms of exactly focus and even though we see the emerging markets slowing GDP vise most of you probably would agree, you watch Japan’s GDP was cut in half and they just announced it because of exports terms emerging slowing.
We easily see these turn downs two to three quarter ahead of our peers so we were shocked for not BMK actually ahead of us and said they missed their quarter due to largely turn emerging market suddenly falling off a cliff. Now you can look at his as a negative or you do the reserve. Every transition we’ve been through we don’t hunk down, we realized probably took a shot, we realized what we need to change ourselves and then we look at it from an opportunity perspective. So, just like an 1998 with Asian financial crisis everybody pulled up, we doubled down, became the number one player in every country in Asia, we’ve done that in 2001 with service about it as many people wanted us to walk away. Our ability to see the downturn in 2007, 2008 and respond to it and come out of it even stronger and with the bumps we went through three years ago where we said here are the concerns we came out of these bumps with our gross margins, our market share and switching accepter beyond what anybody expected.
So, we take these challenges, we turn them into positives. We also look in terms of what was occurring with new product announcements. We lost our high end riding leadership over decade ago for several years. It took us a number of years to get it back, we never going to do that again. So, we announced new products to high end the CRSX and NCS which is almost like a nervous system; it can download the entire Netflix library in one second. And you are going to say John, you might sell to them.
Now remember with the CRSX, about seven years ago, we said it can do a billion phone calls, people said you only have to sell seven of them, we sold 10,000. We believe this will be a video world with huge interconnectivity of things and devices tying together. We also introduced a new high end switch and the [indiscernible] product, the Nexus 9000. Now each of these will be out in volume if we do our job right in Q4 of this fiscal year. In the interim you’re going to see it slow a little bit for our traditional audience switching as people make decisions to continue on with their current capabilities which most of them would do every time that will hesitate some of them and normally you wouldn’t even see this if business were normal. You would just us power through this and wouldn’t even mention it but I want to tell you it does have an impact both in last quarter and for the next several. It automatically self-cracks by Q4.
The other element is service provider; service provider is a third of our business, that is effected by our routing business obviously with those high end products. It's effected by emerging markets but there are also things we need to do better. At the low end of the edge came in we need the resources over their quicker. We need to think of service providers as a customer as opposed to a mobile player, a data center player, a collaboration player et cetera and how do we tie this together. You’ll see us make those change and take two of our best leaders and give them kind of like if you will sponsorship across the whole company to make this happen.
Does that make sense in terms of what happened to us? This was $600 million of surprise in terms orders, it was big. And when you’re down 600 million in one quarter by definition you start off of a lower base for the next quarter and that’s where we made the changes.
First one, largely macro, second one, we’re not going to lose leadership in the high end, you wouldn’t have seen it normally as the business were flowing normally, the third one in area that we can improve on. So, that’s where it ties into our overall strategy but the key takeaway is the fast are going to beat the slow. And if you’re only an 800 pound gorilla in the same products you were selling a decade ago, you’re going to be in trouble. You got to say how do you move on mobility, how do you movie on Cloud, how do you move on security, how do you move on Cloud relation, how do you move on software and we have the capability to do that in a way that no one else does. And we have the track record.
Every other major company you see in terms of our team there is one or two things well. We do 18 reasonably well and we know we’re going to improve on each one. And its ability to capture where these markets going and understand it. Now it’s nice to talk to you in terms of proof points and this is what I do like, we just had a CIO conference with 95 of probably 300 or 400 CIOs in the world give or take 10 of them.
In that session we went through the strategy the one we just went through with you but was in much more detail. We talked about where markets are going and how we would get there. We basically went through what was our plan for the future and we said how many of you believe in this strategy, it was unbelievable in the room, we then went through all six of the IT players. Now remember in this world where there is not much growth going on in profits or numbers, it's how are going to take share from others. We ask from Microsoft, Intel, HP, Oracle, SAP and Dell. Being our peers how many of you in the room will be much more committed to them a year from now than a year before. And in the room no one more than 10 CIOs raised their hand on any one company and some of them had as few as two to three votes.
Then I swallowed hard and asked what are you going to do with Cisco? And I would have been ecstatic if 60% of the room raised their hand, it was all 95%. You ask anybody here what happened. And I went to two of the critics in the room and I knew they have been tough on us and as I stood there and waited for them to say something, I said John if you all execute, we believe your vision and strategy, if you all execute you will become the number one IT player.
And by the way you are the only one positioned to do it, because elements like security you’ve got to think differently on security, how do you solve my problems on it. You think about what just occurred with the [indiscernible] launch in New York. To have that type of power on stage when you talk about how do you future proof the data in the environment.
Now sometimes people will be critical and that's fair but what we realize and if you talk to Rebecca our CIO, she no longer makes decisions about applications or the network or the data center of security separately. She looks at how she delivers services across the Company. And so when you think about [indiscernible] launch don't think about it in terms of servers like UCS or our cloud strategy or our common policy or our controllers or how we use A6 and software together. Think about how we bring this across the entire company in a way that no one else can to future proof the environment.
I think this will be one of the most important move Cisco has ever made with all the appropriate caveats; we'll give you regular updates on how that occurs. In the net of things it's about connecting all these devices, where are you going to go and how do you make it done and we are the leader in doing the forearm and we did our smart plus connected community six years ago, we did our smart grid with [indiscernible] electricity four years ago.
We formed an eco-system of partners that's unequal in the industry because they trust us and they know most IP. So if we execute and I do think it's a matter of execution and I don't minimize the complexity for the Board here, but if we execute right I think we have a good chance to become the number one IT player. If we do that we also should be the best to giving back, because when you talk to government leaders around the world, if there are specialty emerging markets you are going to be successful there, you better also learn how to get back.
We have won almost every award that there is, and we didn't do it as to say how good we're, we did it purely because it was the right thing to do. We track every employee in the company that is in the environment that is life threatening for them, their spouse and their children, and we the team talked to many of them.
I am not saying another companies should do this but this is just who we're. We put our customers up in pedestal which is where they belong, we're number one in almost all customer satisfaction areas, but that's not acceptable. We have to rethink how we achieve their desires whether they are delighted with this each time that they -- as oppose to you are better to rest of your peers. This is the opportunity in front of Cisco, this is where we're trying to go, I don't minimize the challenges or that we could miss. But we have done things again and again by outlining goals, seeing it before anyone else does in the world and then responding to it.
Does that makes sense to your strategy? I just asked the shareholders, I will ask the Board later today. How many of you think that makes sense strategy wise? So measures on do we execute. Now let me go to question if there are any other question written down please pass them to middle and put it back. And if somebody could come and collect the question here. What's the first question we have? And anything is a fair game.
John your first question is what impact are you seeing from a global and macro-perspective? Did the federal shutdown have any impact on your most recent quarterly results?
I believe that we are in a period of much slower economic growth than we should be in for a whole bunch of different reasons. Most of the CEOs in America and half of them out of the business counsel believe that the growth GDP next year will be below 2%, half of them above 2. But if they believe that they're going to be more hesitant. Very few CEOs that I know view the U.S. as turning down; it's just heavy slow moving. In terms of the federal government piece it was 50 billion out of -- 50 million out of the quarter, in fact it was relatively small, my team, our team, really Rob's team and Chuck's team did an amazing job managing through that, state and local business actually grew at 13% and our federal was down minus 3. And remember at state and local that 3.5 years ago let us in the slowdown, it was the first early warning signal of a downturn that we saw.
In terms of the global GDP for emerging countries, they are going to hit pretty hard you see that in the data and the analysts keep estimating a number and then they keep dropping it down a little bit. Our numbers would indicate it might get tougher before it gets better and emerging, but we see most of these trends changing in the next several quarters including our own product trend on the direction. If you want to watch our numbers and say what do you really look at Cisco or what do you look at John in terms of the numbers in health in the U.S. watch Brian Marlier's enterprise numbers in the U.S. and Alison Gleeson's small to medium business numbers. Both of them grew this last quarter at 8% to 9%, that's solid, it's not great. When you see him getting into low double digits, that usually means the economy is slowly picking up and if we execute right when you see him get in the low teens that means usually it’s picking up at a faster face. So actually that's the one number I watch more than any others around the area, next question please.
John we have a question from our webcast audience. What is your dividend and share buyback philosophy, will you continue to increase your dividend, does last week's stock buyback announcement change that approach in any way.
I can't say yes, yes, and yes I'll get in trouble with the board, if you watch what they did this last week it clearly was an indication of $15 billion being committed to use for capital for repurchase. That says we believe in this stock and we believe in the execution, we believe in the leadership team to make it happen and we believe we're going to win. And if you really believe that many of you of the shareholders you ought to be buying your stock back, we're going to that at a faster face for a couple of quarters than we traditionally have done with 50% of the capital we returned to you to the shareholders. Commitment was that Frank and I made a short time ago. In terms of the dividend, you're not going to see us, when we hit a little bump, overreact. If your dividend increase [indiscernible] you do it at a regular playing time in terms of the overall market. To the question here, I don't know if that was your question it got submitted on the dividend, we're agnostic whether we pay a certain amount of this money in dividend or in share repurchase. Share repurchase has the advantage if you really believe the PE ratio is low and you think you're going to do better, huge leverage for you to buy it back, yet many of us [indiscernible] an income basis of the dividend. So we all listen to our shareholders and we will do what you would like to do on that. So yes, we are going to be aggressive using my words and Frank's words in the market during a period of the next couple of quarters, that within that we're agnostic what combination to dividends and share buyback we do in terms of the direction. We're focused on your shareholder return, we know both of them have an impact, if you have a strong opinion share it with your investor relations person here at Cisco, does that make sense.
John, what is your acquisition strategy and your approach to emerging markets for the next year in light of the challenging economic outlook?
You could have been sitting in our acquisition committee meeting that Michael led today, and John was there and Christine and I marked Binny off. On this we've decided that given the uncertainty of the market we want to keep a certain amount of our powder dry in terms of opportunities. You will see us focus on a little more of strategic acquisitions, the smaller ones will be more the one that fill into the pieces. Having said that if you do believe we're an inflexion point which we clearly believe we are these is usually when it’s the time to move carefully but selectively. So we will continue to be active in the acquisition market, and Padma, I couldn’t be more pleased with what you and Pankaj are doing in that area in terms of the strategy on it. We think it's a very important innovation and remember if we weren't in acquisitions, we'd have no switching products, no video products, no major security products and I could go on and on, acquisitions are how we often kickstart into new market or expand out the architecture. Next question.
John, given the shifting competitive dynamics, how will Cisco counter the commoditization threat of white box hardware, Amazon web services, public cloud and SDN?
Okay, so, I know sometimes my team gets nervous when we very directly call out future transitions that we must deal with, but if the answer is if you don't see these challenges coming at you two-three-four years out and respond to them at that level then by the time they hit you it’s too late, and so if you watch and let’s choose while label boxes, if the answer is you only have best in class single products that weren't designed to work together at low operating cost, white label wins, but if they're designed to work together that dramatically lowers the cost of your expenses to operate them, that future proofs your environment, allows you to bring applications out faster with scale and with security and actually at the same time reduces your cost in terms of cap ex and op ex, that's a winning play, in our opinion very strongly.
And that's why if you watch Frank I've never, he is a very kind and serious person. But when he talks about gross margins he actually smells [indiscernible] and our ability to maintain gross margins is how you tie these architectures together in a way that no one else can and when you do that and with Gary reading our challenge and push on gross margins across the company and value added on to it you suddenly get in an environment that you can protect that and we gave pretty strong indication for this short term that our gross margin range was not going to move and with all the appropriate caveats that go with it that's three years of legal training, but if you really watch where we've headed it is these architectural plays that will allow us to take on an Amazon web services and when our group does that as a competitor we do very well but make no mistake about it we want to go sell them these new architectures too, because they can purchase an awful lot, but that’s where we had to bet, not now, you had to make your investments one-two-three years ago, we've been on the architecture for a decade and much like you saw out of that 2005 where we have lots of things we need to do better we get the transitions right at Cisco, and when we get knocked down which we do periodically we come back in a way that no one else does and that's I believe we would do with the current challenge although this one is small compared to the others. Products are in great shape, margins are in great shape, customers love us, need to do a little bit better in service of order, with lasting position we found ourselves in. Next question?
John, what are you doing in the short-term to grow revenue?
I was going to refer that to Rob or Chuck here, but I don’t have a mic on them. We went through this. The team just Rob Lloyd and Gary Moore, I just took a number of our senior members off to a two day work, this last weekend. We’re actually present at the board, and they talked about -- our topics were growth, growth and then growth and focusing on what we need to do in the short-term, where are the leverage points, who would take the lead on that that would put the badge on the table and say I will own this piece, what are we going to do the same if it was working. So we don’t make the mistake of having some things working well and change it and break it. But for areas we needed to do better, what are we going to do better; very specific, specific goals in each category that each of those people who take the lead would be measured on. So focused on short-term opportunities, we believe you got to put more up in the air. Because Chuck tracks his pipeline and individual sales reps has a certain percentage of the pipeline fill out. And I think Chuck your average region might have 47% to 55% of their pipeline spilled out at each quarter. We could think, given the slowness of decision cycles and the hesitation you’re seeing, we need to put more into that pipeline. So we need to put more balls up in the air too. Next question?
John, what are you doing to drive the stock price?
Every one of us is focused on the stock price; every board member, every one of us across the board, each one of us have different responsibilities or combined capabilities. There servo was you’re going to lead the gross margin focus. There servo was you’re going to focus about services getting back up to 9% to 11% growth. Their servo was to re-focus about what we are going to do in search of order, and that is Pankaj; and take a dominant lead the way. It is the ability to say how do we get predictability? How do we share with you? We ask every shareholder, that we talk with the large shareholders after our quarter, were we’re honest and transparent with them?. Without exception they said, you’ve identified the areas, you’re very candid with us. And out of the 44 analyst who have buy or sell recommendations on this mainly I will buy, only two have downgraded us. A nice way of saying they really believe in the company if we are actually right, and that I think is the ball in our court. Maybe a last question if you want?
It is always dangerous to say that because if we don’t get a good question to end on, you got a problem.
What will Cisco look like three to five years from now?
That one is going to end on. If we do our job right, we will transform ourselves from selling best in class boxes, and we are the best, and you see that in our market share; to combining those architecturally in a way that the best of the capability in the industry future proofs their investment, and moves more and more into software and recurring revenue and catches those market transitions and mobility and cloud, that we talked about earlier, and becomes the number one player in security.
But that's the technical piece how, what we would like if we do our job right, and I think it’s within our grasp moves, see if we can execute to get there as the number one IT player. And that’s not based on volume. It’s based on value you bring to your customers. And if you bring that type of value to the customers, as more of them become “a retail company” that just also is a technology company, or a bank that is a technology company just happens to specialize in finance, then we have the opportunity to become their number one partner and candidly we should have the profits and the return for our shareholders to go with that.
I want to thank you for joining us today. It’s really been a pleasure as always. All of us are hurt when the stock doesn’t go up. But we are all behind moving it up and if you watch our track record over the last 16 quarters it has been revenue growth every quarter. We will return to that, and hopefully in a relatively short time period. So, Frank, thank you, Mark, thank you for being here. And Board of Directors and myself will stay around after this for any questions you may have. Thank you.
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