Cisco Systems' CEO Discusses Q1 2012 Results - Earnings Call Transcript

 |  About: Cisco Systems, Inc. (CSCO)
by: SA Transcripts


Welcome to Cisco System's First Quarter and Fiscal Year 2012 Financial Results Conference Call. At the request of Cisco Systems, today's conference is being recorded. If you have any objections, you may disconnect. Now, I would like to introduce Melissa Selcher, Director of Corporate Communications and Investor Relations. Ma'am, you may begin.

Melissa Selcher

Thank you. Good afternoon, everyone, and welcome to our 87th quarterly conference call. This is Melissa and I'm joined by John Chambers, our Chairman and Chief Executive Officer; Frank Calderoni, Executive Vice President and Chief Financial Officer; and Gary Moore, Executive Vice President and Chief Operating Officer.

The Q1 fiscal year 2012 press release is on U.S. high tech market wire and on the Cisco website at I'd like to remind you that we have corresponding webcast with slides. In those slides, you will find financial information that we cover during this conference call, as well as additional financial metrics and analysis that you may find helpful.

Additionally, downloadable Q1 financial statements will be available following the call in the Investor Relations section of our website, including revenue by geographic segments, as well as product category. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet and cash flow statements can also be found on our website in the Investor Relations section. Click on the Financial Reporting section of the website to access the webcast slides in these documents.

A replay of this call will be available via telephone from November 9 through November 20, at (866)493-8039 or (203)369-1749 for international callers. A webcast replay is available from November 9 through January 20, on Cisco's Investor Relations website at

Throughout this conference call, we'll be referencing both GAAP and non-GAAP financial results. The financial results in the press release are unaudited. The matters we'll be discussing today include forward-looking statements, and as such, are subject to the risks and uncertainties that we discussed in detail in our documents filed with the SEC. Specifically, the most recent annual report on Form 10-K, and in 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.

As we start the fiscal year, I wanted to identify some reporting changes that are reflected in our commentary. We have included the details of the changes in the slides, and we will provide reclassified historical financial information as applicable, on our website following this call.

As we discussed in our last earnings call, we transitioned our region reporting from 4 geographic regions to 3. As a reminder, the 3 regions are the Americas, EMEA and Asia-Pacific, Japan and China or APJC. Our geographies continue to be the primary way we run the business. We've also updated our product revenue reporting to better align with our 5 foundational priorities. Expect that this enhanced reporting will be helpful to investors. This change provides revenue reporting for a number of components of our prior new products category.

Effective this quarter, we are providing total revenue and year-over-year growth disclosures, switching, next-generation or NGN routing; collaboration; security; wireless; service provider video; data center and other products. There are also certain reclassifications which are outlined in the slides that accompany this call. I'll now turn it over to John for his commentary on the quarter.

John T. Chambers

Well, thank you very much. Since last quarter's conference call, we continue to make major progress on our comprehensive action plan to position ourselves for the next stage of growth and profitability. In this conference call, we will reduce the amount of detail covered in the formal part of the call, focusing more on the highlights and our interpretation of the results, while providing a lot of the detail we've traditionally covered in the script, through the accompanying slides. This will allow more time for questions, we welcome your feedback on this approach.

First, in my part of the call, I will do a high-level financial review, then cover in reasonable detail, our progress and results as it relates to executing on our 3-year plan, that we believe will drive the future of Cisco and our intelligent networks; second, we will give you an update on our Q1 progress with regards to our 5 foundational priorities; third, we will cover the order momentum in each of our 3 geographic regions; fourth, we will cover order momentum in our 4 customer segments: enterprise, public sector, commercial and service provider; and finally, I will provide a quick summary, and then Q2 FY '12 revenue guidance.

In the second part of the conference call, Frank will go into more detail from a financial perspective, as well as expand on our Q2 FY '12 guidance. I will then make some summary comments regarding the perspective on Q2, and our momentum going into the remainder of fiscal year '12.

First, we made very solid progress in Q1, both in terms of our results and execution in the first quarter of our 3-year plan. Our performance in Q1 FY '12 exceeded the guidance we provided last quarter, for both revenue and earnings per share. We had record quarterly revenue in Q1 and our revenue grew year-over-year was 5% compared to our guidance of 1% to 4%. Non-GAAP earnings per share were $0.43, again above our expectations. Non-GAAP gross margins were 62.4%, higher than our original expectations, while the non-GAAP product gross margins were 61.3%. Make no mistake about it, our entire company continues to be focused on gross margin improvements.

While revenue and earnings in Q1 were very solid, we were especially pleased with our product order growth year-over-year, of approximately 13%. Overall, product book-to-bill was approximately 1, which is a solid, given the historical Q1 results. We are a very strong company, with a very strong balance sheet, solid customer relationships and leadership in many healthy markets. However, we will continue to address a few areas for improvement. With the power of the entire company focused on these improvements.

In Q1, we are beginning to see how the restructuring and organizational changes benefited not only our shareholders, but also our customers. We are, in our opinion, in the sweet spot of what our customers are focused on, whether it is in cost reductions, productivity, business transformation or revenue growth. This ties 1:1 to our 5 foundational priorities, and our customers clearly understand this.

When I reflect over the last 20 years I've spent at Cisco, I continue to be impressed with the expanding franchise value, that is Cisco. Our ability to change with industry trends, customer needs and get in front of major technology shift, is quite remarkable. When I look back at the last 2, 3 quarters, the steadfast commitment of our people to adapt to a rapid change, and continue to execute against market demands, reflect the intangible value of Cisco and our relationship with our customers. The ability of a $40 billion revenue company to turn quickly and move forward, and not emerge weaker but much stronger.

Our customers not only expect this. It was interesting when you talk to them, they almost assume that is a given, that we would adjust to these market trends. Of particular importance to me, is the feedback that I'm receiving from the meetings I've had with enterprise CEOs and CIOs and service provider CEOs and Chief Technical Officers. They are strongly supportive of the changes we've made. In short, we've organized our business around how they want to buy their key technology, how the business transitions they're focused on, and as I said above, their goals whether they;re expense reduction or revenue growth is a 1:1 correlation.

Our customers' feedback is that they understand the importance of the transitions we've made and strongly, strongly support our strategy and the new organization structure. In many cases, given our footprint with customers, this change was not optional. They needed us to be more aligned with their needs, because we are such an important technology partner to them. This is to me, an indicator of long-term value creation.

The results in terms of customer momentum and orders were extremely well balanced, across our 5 foundational priorities, our geographic regions, our 4 customer segments. We believe this is a strong indication of our progress and potential success, regarding our vision, strategy and 3-year plan covered at our September Financial Analyst Conference.

Second, I would like to provide an update on our 5 foundational priorities, which we believe will be the key to -- in both our terms of our growth of the Internet, and also, our differentiation and total cost of ownership proposition versus our peers in the industry. These 5 foundational priorities are the key drivers, are the future of the network and the core Internet. They are in our opinion, not only the most important, but also the most difficult elements in intelligent networking, and at the same time, the hardest to provide an integrated leadership approach.

Our customers know Cisco is uniquely able to deliver in these areas to support their business success, and protect as much as possible, their investment, flexibility and future innovation capabilities from both a technology and a new business model perspective. The first foundational priority is leadership in the core, that is routing, switching and services. Q1 updates will be right in terms of orders and revenues from a year-over-year perspective. Total switching orders grew 10%, and were flat from a revenue perspective. We continue to focus aggressively on gross margins, and as such, we saw some improvements in gross margin in switching, while there is still need for a continuous improvement.

An example of this would be our Nexus product line, where the Nexus 7000 gross margins increased 2 points from Q4 to Q1, and the Nexus 2000, 3000, 4000 and 5000 in total, increased by almost 5 points from Q4 to Q1. As a note of interest, our switching gross margins in Q1, have returned to almost identical level they were in Q1 of last fiscal year, which is well above our overall product gross margins. Gary, it's a nice job done by engineering, supply chain, sales, everybody going together, just tremendous interest, and we're just getting started. We are seeing stability in our switching portfolio from an order, market share and gross margin perspective. Total next generation routing grew 7% in terms of orders, and minus 3% in terms of revenues. High end routing grew 11% in orders and 4% in revenues, mid-low end routing grew 4% in orders and was down 16% in revenues.

Service orders grew at 16% and revenue at 12% year-over-year. Through continued focus on solution net selling, and early-stage architectural engagements, we had growth both from new business opportunities and in existing customers. Additionally, we are continuing to see strong adoption of our smart services portfolio, a software-driven services offering across all our geographies and all customer segments.

The second priority is collaboration, which represents an enormous productivity opportunity in a wide variety of our customers and in all industries. It's probably the one the CEOs understand the best in terms of the potential for their companies. Collaboration orders grew by 16% and revenues by 12%. And currently, is at a yearly run rate of $4.3 billion. TelePresence orders grew at 15% and revenues by 9%. Unified Communications orders grew at 16% and revenues by 13% year-over-year.

Third, the data center. The data center is evolving from bare metal, to virtualization, to the cloud. Results in this area have been particularly outstanding, given that we are taking on the big competitors in the data center. As we focus on this market transition with the convergence of server, processing capabilities, networking and storage into the cloud, the UCS in the data center grew year-over-year at 122% in terms of orders and 116% in terms of revenues, and is now at a $1 billion annualized revenue run rate.

Even though the Nexus 2000 and 5000 are included in our switching product summary, not the data center, they are obviously tied very tightly to the UCS. Again, you saw the Nexus 2000 through the 5000 combination orders growth of approximately 120%, and revenue growth of approximately 80%. These 2 product lines together, now have an annualized run rate of approximately $1 billion.

We are focusing on all aspects of Cisco in gross margins. With our aggressive focus, you saw the UCS and Nexus 2000 through 5000 combined margin increase in Q1 by 3 points from Q4. We added 15,700 -- I'm sorry, I highlighted one extra 0, 1,572 new UCS customers in Q1, bringing the total to 8,983.

Now moving on to video. Our video strategy is in excellent shape, and analysts find us gaining market share in both the service provider video, emerging video technology and TelePresence categories. We have by far and away, the strongest end-to-end architecture for video going from the cloud to the end device, enabled by our Medianet architecture and the Videoscape platform. This makes video a much more practical, easier to use and easier to consume. Along with cloud and mobility, video is one of the most significant transitions our service provider customers are experiencing, and not only has our commitment to this business not changed, our quarterly results confirm the opportunity for Cisco in this space.

In terms of set-top boxes, we are very much committed to this marketplace, but it's really the architecture that we're committed to, as this moves into the cloud with our Videoscape capability. Our service providers customers asked us to partner with them as they move from traditional set-top boxes, to IP set-top boxes, to the cloud, which again, is enabled by our Videoscape solutions. Receptivity so far has been very, very good in terms of our strategy, we have demonstrated our capability to bring video to large volumes of any combination of devices, whether they are Cisco, our peers or even our competitors.

The following video data illustrates the pervasive video growth that is occurring in their market. Service provider video grew orders 26% year-over-year, to a yearly run rate of approximately $4 billion, while revenues grew about 13%. As mentioned earlier, and not including our video numbers, TelePresence grew orders at 15%, and they are currently at an annualized run rate of $1.4 billion. Emerging video technologies grew at 41%, granted from a small base.

Now moving on to fifth, to our architecture for business transformation. Our technology architectures are gaining momentum in our enterprise, public sector, commercial and service provider customers. These customers recognize the value of an integrated network architecture, and the many important factors of an architectural approach, including increased reliability, security, products actually designed to work together, easily addressing new business demands and ability to adopt new technologies faster, such as cloud, video and mobility.

We are also rapidly improving our ability to translate for our customers how technology architectures, enable them to achieve their most important and most challenging business goals. When you share your strategy in terms of the top 5 foundation of priorities, customer segments and geographic regions, combined with the organization changes in our structures, especially for engineering, our customers clearly understand what we're doing and understand the advantages for them.

In summary, our strategy is working, we are capitalizing on the major generation shifts happening in IT. These include the consumerization of IT, movement to the cloud, everything mobile, business social network and pervasive video. We're in the right spot at the right time. These generation shifts, lead to a convergence of both our products and of our customer segments, where no longer will enterprise and service provider and commercial and public sector be separate, where the products be separate from routing and switching in the data center and the end devices, you will see them all come together in an architecture-shared approach.

Many of these were decisions driven by market transitions and architectures, and many of these were made over the last decade in terms of the decisions. We are now proving beneficial to our customers, employees and our shareholders. No other technology company has a major presence in all of these segments on a global basis, and as a result, Cisco is the forefront of the technologies that enable this convergence. This is what embodies the Cisco franchise, and with the power that goes along with it.

Third is a discussion of our 3 geographic regions. As a base for your consideration, the American region -- the Americas overall, represent approximately 58% of our business. EMEA represents approximately 26% of our business, and that's Europe, Middle East, Africa and Russia, and Asia Pacific, Japan and China represents 16% of our business. Balance was unusually good across all 3 regions. The Americas grew orders by 12% year-over-year; EMEA grew product orders by 13%; and Asia-Pacific, Japan and China grew by 13% year-over-year.

As a reminder for those of you who have may not followed this as much over the last couple of years, in Q1, 1 year ago, our product book-to-bill was well below 1, with product revenue growing dramatically faster than product orders. To be specific, we experienced 11% difference between product orders, as compared to product revenue growth in Q1 of last year. While the momentum we are seeing is now solid and we feel very comfortable with our position as we exit Q1, we feel it is important to remind you of our order comparison year-over-year, as well as state that we will continue to be cautious, given our broader economic environment and encourage you to be doing the same.

The next point to me was very interesting in terms of countries within the geographic regions. This is a little bit more detail. If you balance and take our top 10 countries in terms of the size of operations, in terms of the business they did with Cisco this quarter, each of these countries grew a minimum of 7% to a maximum of 43%.

Of specific interest regarding the top 10 countries, the U.S. grew at 9%, and Japan, in spite of the economic challenges, our liaisons [ph] team there did an amazing job, Edzard, amazing job as well, and grew an amazing 43%. From the emerging countries, China grew 27%, Russia grew 11%, Brazil grew 28%; Mexico grew 29% in terms of orders, with only India, of the top 5 emerging countries, and India was not in our top 10 global countries in terms of volume, as many of you have been reading, India has some unique challenges and was down 24% year-over-year.

Fourth, customer segments. As we discussed earlier, Cisco's total product orders grew approximately 13% year-over-year. Balance was also unusually good across each of these customer segments on a global basis. Enterprise grew by 11%; commercial grew by 12%; service provider grew by 16% and a very pleasant surprise, public sector grew by 10% year-over-year.

As we discussed on the last quarter's conference call in terms of health of the U.S. economy, we continue to see very strong growth from our 4 U.S. geographic enterprise operations, which achieved approximately 15% year-over-year orders. All 4 of those were relatively well balanced.

And once again, our 4 U.S. commercial operations had equally as well-balanced growth, which grew over 20% in the U.S. U.S. service provider grew approximately 6%; the U.S. public sector grew 5%, and I know there'll be a lot of questions on this, so let me try to give you a flavor for it year-over-year.

Although the breakdown in orders from the U.S. public sector vary dramatically, both from a positive and negative perspective, I'm going to give you a feel for the ones that were positive first. Federal defense, state government and higher education business grew positively, while federal civilian, local government and K-12 grew negatively year-over-year.

Fifth, this is our first quarter in executing our 3-year plan outlined in the September Financial Analyst Conference. We were pleased with hitting or exceeding all our expectations in most cases, in terms of order rates, book-to-bill, gross margins and the very good balance across our 5 foundational priorities, geographic regions and customer segments. Cash generated from operations during this quarter was a very solid $2.3 billion, Frank, nice job, and returned $1.9 billion to our shareholders through buyback and a dividend.

When asked what is the key takeaway from the quarter, for me, it is simply that our strategy and vision, outlined in our 3-year plan is taking hold, and off to a very good start. Our customers understand and appreciate our strategy. They understand and appreciate our organization changes, and our technology and business architecture is built upon the integrated products, services and software platform. Our ability to help them solve the most important business issues through these intelligent networks is our strategic differentiator.

There will always be challenges. At the present time, we are watching very closely the developments in Europe, and the global economy, public sector spending, India business and the follow-up from the flooding in Thailand. In our opinion, we are in much better position versus our competitors based upon this architectural leadership, product leadership, emerging market leadership, and the strength of our customer and partner relations, combined with our current business momentum in the networking industry. Once again, we are firmly committed to driving shareholder and customer value.

Now moving on to Q2 FY '12 revenue guidance. Before I get to the numbers, let me remind you again, that our comments include forward-looking statements, and actual results could materially differ. Also, Cisco will always be affected by major economic changes, capital spending patterns, new and existing competitors, potential issues affecting our suppliers, our ability to execute not only on our strategy, but also on other risk factors discussed in our SEC filings.

The guidance is based upon current pipeline and our view of the business trends based upon the information we have available today, and could be above or below our guidance. Also, we see the uncertainties in the global markets over the last several quarters, and even today, it is too early to determine the effect on capital spending in calendar year 2012. Therefore, we would expect you to be conservative on our expectations for Q3 and Q4, and even expectations in Q2. Again, with all the appropriate caveats discussed during the conference call.

With that in mind, Q2 FY '12, we expect revenue growth to be in the range of 7% to 8% on a year-over-year basis. I now will turn it over to Frank, for the more details from a financial perspective, as well as to expand on our Q2 FY '12 guidance. Frank, to you.

Frank A. Calderoni

Thank you, John. We had solid results for Q1 FY '12, which underscores our commitment to our 3-year financial strategy that we outlined at the Financial Analyst Conference in September. Total revenue for the first quarter was $11.3 billion, an increase of approximately 5% year-over-year, above our expectations of 1% to 4% growth.

Total services revenue was $2.3 billion, up approximately 12% year-over-year. Total product revenue was $9 billion, up approximately 3% year-over-year. Switching revenue was $3.7 billion, that was flat year-over-year. Next-generation networking or NGN routing was $2.1 billion, down 3% year-over-year. We experienced an increase in total revenue across all geographic regions on a year-over-year basis. Our year-over-year revenue increase was 4% for Americas, 2% for EMEA and 11% for APJC. Total product book-to-bill in Q1 was approximately 1. Our Q1 FY '12, total non-GAAP gross margin was 62.4%, that's down 0.3 percentage points quarter-over-quarter, and down 1.9 percentage points year-over-year and better than our expectations.

For product only, non-GAAP gross margin for the first quarter was 61.3%, a slight increase of 1/10 of a percentage point quarter-over-quarter. This quarter's performance was driven by cost savings, which includes positive impacts from our value engineering efforts in key product areas such as switching, and higher volume, partially offset by discounts and rebates.

On a year-over-year basis, non-GAAP product gross margin was down 2.7 percentage points. Our non-GAAP service margin for the first quarter was 66.8%, that's down from 68.6% last quarter and up from 65.7% in Q1 FY '11.

Total gross margins by geographic region was 63.1% for the Americas, 61.7% for EMEA and 60.8% for APJC. Non-GAAP operating expenses were approximately $4.1 billion in Q1 FY '12, down approximately $120 million when compared to Q4 FY '11. We continue to execute well on our planned $1 billion reduction from our annualized FY '12 expense run rate using Q4 FY '11 as our base. We are pleased by our progress to date, and we are on track to achieve the full targeted savings we committed by the end of the third quarter of FY '12.

Non-GAAP operating expenses as a percentage of revenue, was 36.2% in the quarter versus 37.5% in Q4 FY '11. During the first quarter, we recognized pretax restructuring charges to our GAAP financial statements, of approximately $200 million, bringing the total restructuring charges related to our July 2011 announcement to approximately $925 million through the end of Q1.

At the end of the first quarter, our headcount totaled 63,465. That was down approximately 8,400, driven by the completion of the sale of Juares Mexico manufacturing facility in Q1, as well as by our restructuring actions. Non-GAAP operating margin for the first quarter was 26.1%. Our Q1 FY '12 non-GAAP tax provision rate was 22%. Non-GAAP net income for the first quarter was $2.3 billion, representing a decrease of 4% year-over-year. As a percentage of revenue, non-GAAP net income was 20.6%. Our non-GAAP earnings per share on a fully diluted basis for the first quarter, was $0.43 per share versus $0.42 per share in the first quarter fiscal year 2011, a 2% increase year-over-year.

GAAP net income for the first quarter was $1.8 billion as compared to $1.9 billion in the first quarter of fiscal year 2011. GAAP earnings per share on a fully diluted basis for the first quarter, were $0.33 per share versus $0.34 in the same quarter of fiscal year 2011.

Now moving on to the balance sheet. Starting with our total of cash, cash equivalents and investments, at the end of the quarter was $44.4 billion, that's down $197 million from last quarter. Of this total balance, $3.8 billion was held within the U.S. at the end of Q1 FY '12. Our cash flow from operations this quarter was approximately $2.3 billion.

Moving on to accounts receivables. Our account receivable balance was $4.3 billion at the end of Q1. At the end of Q1 as well, our days sales outstanding or our DSO was 35 days compared to 38 days at the end of both Q4 of FY '11 and Q1 of FY '11. Our total inventory at the end of Q1 was $1.6 billion, as compared to $1.5 billion in Q4. Non-GAAP inventory turns were 10.9 this quarter, down 0.5 compared to last quarter and, up 0.1 from Q4 -- I'm sorry, Q1 of fiscal 2011.

Inventory purchase commitments at the end of the quarter Q1, were $4.2 billion, that's down 3%, or approximately $135 million quarter-over-quarter. For the quarter, we repurchased $1.5 billion of common stock under the stock repurchase program for 100 million shares, at an average price of $15.37 per share. The remaining approved amount of stock repurchase under this program was approximately $8.7 billion, as of quarter end. A dividend payment of $322 million representing $0.06 per share, was declared and paid during the quarter.

Total deferred revenue was $12.4 billion at the end of Q1, an increase of approximately 15% compared with Q1 FY '11. Deferred product revenue was $4.1 billion, an increase of approximately 14% year-over-year, and deferred services revenue was approximately $8.3 billion, an increase of approximately 16% year-over-year.

Let me now provide a few comments regarding our outlook for the second quarter. 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 is based on our current pipeline, and our view of the business trends based upon the information that we have available today, and some of the actual results could differ, either above or below our guidance.

We previously communicated that we will recognize total pretax restructuring charges through our GAAP financial results, in an amount not to exceed $1.3 billion for fiscal year 2012, as related to our July 2011 announcement. As I mentioned earlier, our total restructuring charges were approximately $925 million through the end of Q1. In Q2 FY '12, we expect additional pretax charges to our GAAP financial results of up to $100 million.

In light of the uncertainty in the macro environment, we encourage you to continue to model conservatively, and it's important that expectations do not get ahead of where the market is today. The guidance we are providing is on a non-GAAP basis, with reconciliation to GAAP. As John said earlier, the Q2 FY '12, we expect revenue growth to be in the range of 7% to 8% on a year-over-year basis. As we have said in the past, forecasting gross margin have always been challenging due to various factors, such as volume, product mix, cost savings and competitive pricing pressures.

For the second quarter, we anticipate non-GAAP gross margin to be approximately in the range of 61.5% to 62%. We are continuing to actively monitor and evaluate the flooding situation in Thailand. We have business continuity plans in place, in order to minimize any potential impact, as we expect this situation to continue for the next several quarters.

In our guidance for the second quarter, we have factored in the minimal impact that we have estimated at this time. Our non-GAAP operating margin in Q2, is expected to be in the range of 26% to 27%. Our non-GAAP tax provision rate is expected to be approximately 22% in the second quarter. Our Q2 FY '12 non-GAAP earnings per share, is expected to range from $0.42 to $0.44 per share, and we anticipate our GAAP earnings in Q2 will be $0.08 to $0.11 per share, lower than our non-GAAP EPS. This range includes our typical differences, as well as an impact of $0.01 to $0.02 of this delta, related to our anticipated restructuring charges.

Other than those quantified items above, there are no other significant differences between GAAP and our non-GAAP guidance. This guidance assumes no additional acquisitions, asset impairments, restructurings and tax or other events, which may or may not be significant. As a reminder, Cisco will not comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure.

We are committed to our 3-year financial strategies, and we are very pleased with the progress we are making, especially with the backdrop of the broader macroeconomic environment. However, in terms of forward-looking guidance, we will continue to take it one quarter at a time, and we advise you to do the same. As we build the company that can be both innovative and disciplined, we will remain focused on achieving profitable growth, where EPS can grow faster than revenue. We believe our strategy and financial model supports this goal, and we are very confident in our ability to successfully execute on our strategy moving forward. Now let me turn this back over to John. John?

John T. Chambers

Thank you, Frank and nice job. Moving forward, we would like to provide some perspective on Q2 and our momentum going into the rest of fiscal year '12. We believe our vision strategy and financial strength, broad architectural portfolio, as well as our culture that accepts change, position us well for growth. We have always used these market transitions to make bold and decisive decisions, and then to execute in a way that further extends our leadership versus our peers.

To have your order growth accelerate in Q4, and then again in Q1, with the global economic challenges we've all seen, while simultaneously making all the internal organizations of each function in Cisco and priority changes, points to pretty solid execution. Rob, I wanted to congratulate you, Rob Lloyd, especially on the sales and the momentum, and Gary, just an excellent job on the operational changes and the improvements.

Gary B. Moore

Thanks, John.

John T. Chambers

Very welcome, nice job. In every major market transition, we have historically emerged even stronger, with more market share and intense targeted focus. In our opinion, we are well on our way to doing this once again. You will continue to see us move very aggressively, to pull away from our competitors, as they adjust to these market challenges. Having already made these changes, both in cost, as well as organization changes lining how our customers buy, this is also, in our opinion, a major competitive advantage.

Our challenges last year caused us to make some needed changes. But as you would expect from Cisco, we will not stop here. We will be aggressively continuing to change and transform and stimulate our Cisco entrepreneurial spirit, through the combination of innovation and operational excellence. At the same time, we will maintain our laser focus on creating value for our shareholders, customers, partners and employees. You will continue to see us very focused, agile, aggressive and a lean Cisco moving forward.

Our goal over the past 2, 3 quarters was to simplify our operation model and focus on our organization. Our customers had validated that we have done just that. They understand the values that Cisco's franchise delivers to them.

This is a key point, and perhaps, the second key takeaway from the call in terms of the transition going on. Information technology is clearly moving to business technology. We are seeing that across all industries and geographies. At the heart of this transition, our intelligent networks, which drive new businesses, revenues and consumption models, enable new customer and employee experiences and drive efficiencies. Cisco's leadership and networking, video, collaboration and the cloud, all put together in an integrated architectural approach, uniquely position Cisco as our customer's strategic business partner.

I want to thank our employees, our Cisco family for the speed and willingness to change that has positioned us to move with our customers and drive value for our shareholders. I know it has not been easy, but you have executed and adapted to these changes and opportunities extremely well, and that more than anything, embodies the Cisco franchise. Our ability to emerge quickly, stronger and more driven, as we have in the past, and as our Q1 results certainly reflect our improvement at this time.

Make no mistake about it, all of these efforts are putting in place our focus on driving shareholder value, while continuing to stay focused on the success of our customers, employees and partners. I want to thank our shareholders, employees, customers and partners, as we transition to reinvigorated Cisco, the aggressive, the focused, the simplified Cisco you have come to expect over the years.

Mel, let me turn it over to you.

Melissa Selcher

Thank you, John. We will now open the floor to Q&A. We still request that sell-side analysts, please ask only one question. Operator, please open the floor to questions.

Question-and-Answer Session


Your first question comes from Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos - UBS Investment Bank, Research Division

My question, John, if you can talk a little bit about the order linearity month-by-month in the quarter, compare it to what you were expecting in the normal seasonal pattern there? And then, any of the macro uncertainty in Europe kind of disrupts, even temporarily during the quarter?

John T. Chambers

It's a key question. I thought that might be one of the couple, because I think it's a very indicative of a key takeaway. Our quarter linearity, month-by-month, was almost identical to what we would see every month in prior Q1s. And without getting too specific, if you kind of think of it, the first month, 22% to 24%; the second month 28% to 30% of your business; the third month, let's say 46% to 48%, we're right in the middle of that across-the-board. So linearity was extremely good, and it occurred almost every week, Frank. As we watched the numbers, Rob's linearity, his accuracy was really good. Gary, the same thing with the services numbers.

Frank A. Calderoni

And Nikos, you can also see that if you look at our DSO at 35 days, I think that was a good reflection of the improvement on DSO, because of the balance throughout the quarter.


And your next question comes from Simona Jankowski with Goldman Sachs.

Simona Jankowski - Goldman Sachs Group Inc., Research Division

I just have some questions on your gross margins. Just wanted to find out, John, what drove the upside, relative to your expectations? And I also found your comment very interesting that you're switching margins are now back to the levels of a year ago. Yet obviously, the overall margin is about 2 points lower, so I was just curious, how much of that is just due to the mix shift to UCS? And is there any other component of that 2 points of margin compression that you still expect to reverse?

John T. Chambers

Sure. So it was, I think, a major accomplishment in terms of our switching margins being back to where they were a year ago. And candidly, our order momentum and revenues back to double-digit in terms of the orders this quarter for switching. The progress, we still have room for improvement especially on the high end of our 7000. But as we said on the other segments of the Nexus and with the Cat 2 and Cat 3 switching products, very, very good. And we'll continue to stay focused on those. We saw progress in the UCS segment combined with the Nexus 2000 to 5000 of about 2 to 3 points, although the UCS clearly is at a dramatically-lower gross margins than our core traditional business. The elements that you're talking about, it'd be easy to say it's mix, but we need to do a better job, Gary, I think in the routing margins, I think Penn College is on board on that. And the routing margins, in part because of the orders in China, which will be spread over Q1 and Q2, very aggressive as you can imagine with our key competitor there. I think we need to continuously focus on that. And that's what we're really talking about with operational excellence, and not just making a transaction stop. It's continuing along that line, and making this part of our DNA Gary in consistency, in terms of the direction. The other issue is everyone in the company is now focused on gross margins. Our sales people get paid for the first time, you can probably say, we should've done it earlier, on total profit contribution of their regions. And so you see Chuck, and you see Chris, and you see Edzard focusing on their gross margins, as well as their bookings revenues, and really focus on the discounts. We see very good involvement in terms of -- we're getting much faster on being easier to do business with. But in our contract negotiations, you see the same thing. So it's a combination, Simona. I'd say, good job in a couple areas, several areas, we have to do better, then we've got to build on our basic DNA, because there's always been mix changes.

Frank A. Calderoni

John, just really emphasizing the emphasis that we put on gross margin. Especially, with a focus on cost. As I mentioned, seeing the improvements in the first quarter, I know it's still early as far as FY '12, but seeing the improvements on the value engineering. And then also Simona, I think a much more stable markets across-the-board as it relates to the pricing environment, was helpful as well.


The next question comes from Tal Liani with Bank of America Merrill Lynch.

Tal Liani - BofA Merrill Lynch, Research Division

My question is really about the macro. You grew revenues sequentially in the quarter that is supposed to be down. Normally, so normal seasonality. And I look also at the sequential trends in the individual sector, segments. You had one slide that you showed it for a second, but it looks like things are slightly better almost in every important place. And the question is, whether you can speak about a better environment in certain areas, not only on a year-over-year basis, because the year-over-year may be a function of weak environment last year, rather than improvement over the last few months. So I'm wondering if you can relate to strong areas where -- areas where you were surprised with some recovery, if we can call it in orders, on a sequential basis, whether it's product areas or geographic areas.

John T. Chambers

So let me kind of start in sequence. Obviously, the best execution of any of our countries on a global basis was Japan, and that environment provides on the growth of 43%. Edzard's involvement there on the theater basis, eventually a home run. So I think that was a surprise, even though we had some good business in the pipeline, that looks good. And actually, we think Japan, well not at these levels, but at a very good level, will grow for us this year, healthily. And I think that speaks to customer relationships and the Cisco franchise I alluded to. The other surprise for me was clearly, government. While the U.S. government turned positive in total, it was very mixed. To your point, Tal, in areas like state and local government, they were the first ones to see the downturn, and when we saw this first in part, because most of our orders are new in the quarter, we usually see these transitions 2 to 4 quarters ahead of our peers, unfortunately, as we did this time. So you had a lower base in state government to balance it on. The defense [indiscernible] in Intel was solid within it. Higher education, especially private, higher education was very good. You begin to get to areas that were surprising in government on a lower side. The education spending, the civil part was a little bit tougher. To the geographic areas, and Frank, you'll probably kick me underneath the table. But I think, given especially what we said on the day, I'm going to take a little bit of risk, with all the appropriate caveats we all understand to be in place. Europe was stronger than we would have anticipated. Remember, Europe isn't just Europe. It's Middle East, it's Eastern Europe, it's Africa and Russia. But if you look at it growing at 13%, we have factored in next quarter, probably for it to be in the mid-single digits. Obviously, there are some areas such as emerging markets we'd expect to do better, but Europe, we think is going to be a challenge for us for this next quarter, as it probably will be for others. The Americas is really solid. In fact, if you go through it, I mean Canada was on a tear at 30% growth, if I remember right, or 28% growth, somebody might want to check on that. Actually, 27% growth -- 34% growth, I mean we were at that 34% growth, it was very strong. Latin America, Jaime just a great job. And by the way, Nick in Canada, amazing, congratulations on that, we need it again this quarter. Jaime in Latin America, the growth was extremely good again. And the U.S. enterprise growth at 15% and commercial growth well above 20%, Ryan and Alison, just a very good job. And our federal group, Bruce and Pat. I mean it is a tough market, and we're moving into new areas in that marketplace. And so we had to grow at about 5%. So areas that we're going to watch, Europe and India obviously, are 2 geographies we are watching. India. it is partially currency and macro, but it's a large part the government gears are grinding into a halt, and I think you've seen a lot of business leaders and other people say they've got to freeze that. That's not a problem of money, but they've got to unfreeze this and get it going again. So that will come back, although it might take another quarter or 2, before they get running well. Rest of Asia is good. China, we're on fire again. We have great relationships in terms of key businesses there. Owen's done a great job and the growth again in the high 20s within China. In terms of key areas in the Europe, will surprise you. We did pretty well in many of the geographies in Europe. France was at 13%, the Netherlands at 16%. U.K. and Germany at 7% and 8%, if I remember right. Southern Europe is weak as we had thought. So Tal, that's kind of how I'd break it down. Wildcards, again, Americas, double-digit growth in terms of orders this next quarter, I'd say with a reasonable profitability and all the appropriate caveats, Europe mid-single digits. Asia-Pacific, a little bit well, because of how well will Japan do again, and what would India do. That's probably the one that could swing in the medium amount, from high single digits to low double digits. Tal, was that too much discussion in my end or about what you expected?

Tal Liani - BofA Merrill Lynch, Research Division



Next question comes from Ittai Kidron with Oppenheimer.

Ittai Kidron - Oppenheimer & Co. Inc., Research Division

I had a couple of questions. John, can you talk about your revenue guidance range? As you were speaking, I had to go back all the way to 2008 and I couldn't find a quarter where you gave a range of just $100 million on the revenue. So has anything changed in your ability to predict your business? Or should we take that to mean that your guidance is one of your more-conservative estimate, such that you feel very comfortable about giving such a narrow range? And the second question, Frank, relating to the gross margin and following on Simona's question earlier, I understand that China headwind this quarter in mix, but is there a timeframe where that headwind gets stripped out? Should we think about the second half of your fiscal year having a little bit more tailwind to it rather than a headwind?

John T. Chambers

So I'll take the first one and Ittai, since you give such nice compliment, you get to be the one that gets 2 questions. So we'll try to hold it to one for the others. In terms of the range, I think your observation is right, in terms of we have more data than we traditionally do going into the second quarter. If you watch, we closed Q4 with very solid momentum in terms of order growth at 11%, and you all know that the inventory buildup in Q4 got us back to the inventory we wanted, going into a normal Q1. Q1 book-to-bill, we were at the very high end of the range of what you previously see in Q1. So our weeks of backlog are in pretty good shape on that, even from Frank's perspective. And the third element is, that our field, we really spent a lot of time on getting the execution down with tools like and others. And what Rob has done with each of his 3 regional leads, and each of the 3 regional leads have gone into really in-depth weekly, monthly, quarterly anticipation of their numbers. And so we know our pipeline down to a much more detailed level, and literally, every week, Rob and I bet a bottle of wine, on how accurate will the forecast be for the week. And we're usually above his team, and how it would be for the month in the quarter, and he's been right on his number. So we're assuming the forecast accuracy will continue, which gives you a good feeling inside about being accurate. We've got a good backlog going into it. We factored in some of the challenges, including the Thai flooding a little bit and India a little bit softer and Europe a little bit softer. And so that's why you see our range a little bit tighter. Frank, from your side on the gross margin question?

Frank A. Calderoni

Ittai, as far as you asked about China and gross margin. So when we talked about going into Q1, we had certain transactions in China that were affecting the margins for Q1. Those transactions actually end up splitting between shipping in the Q1, as well as Q2, so there's a little bit more of a balance, rather than as much of the full amount impacting us in the first quarter. That was factored into what we announced as far as Q1 and also factored into the guidance I gave for Q2. As far as going forward, I mean, we always are going to be looking at being competitive in China, and making sure that we see that as one of our areas of growth and we'll continue to watch go through that. The transactions that we've been talking about are more on the routing side, as John alluded to in the earlier question from the standpoint of even putting much more focus as we look at our routing portfolio, and dealing with some of the more balance of the business around the world, knowing that in China and other parts of the world, we have a different margin profile, from routing standpoint. But how we balance that and get some are efforts underway, to help improve the cost structure, similarly to what we've experienced over this past year on the switching site.

John T. Chambers

And also Frank, as we saw on switching, again off of that, as with the ASR 9000 and the 5000, as you begin to get more volume, it begins to get improvements in margins as well. So Colette]s leading our effort here, and I think we've got Gary pretty consistent focus on it, although still lots of rooms for improvement. Would you make any comments there?

Ittai Kidron - Oppenheimer & Co. Inc., Research Division

And the facts are, I mean, value engineering has helped somewhat here but remember, the payback is really longer term. So we have a lot of things that we continue to do there from an investment point of view. But I think you guys covered it actually pretty detailed.


The next question comes from Rod Hall with JPMorgan.

Rod B. Hall - JP Morgan Chase & Co, Research Division

I just wanted to clarify one thing you said and then I've got a question on the deferred revenues. So my deferred revenue question is just -- whether you can give us any color on what's driving that increase in deferred revenues. Is it just China or are there other products that are driving that? And I wondered, you made a comment about the Thailand's, impacting you're adjusting for that. Can you guys give us any idea what exactly is exposed in Thailand? Or just any more color you can give us on what the exposure looks like there?

John T. Chambers

Sure. I think as all of our peers were evaluating this, and it's a moving target on that, our exposure is in the disk drives for our set-top boxes and in some of the optical work. We've sized that for this quarter, built it into our forecast and for others. Unfortunately, Rod, I think it's going to be more than a one quarter phenomenon for that. As you look at Japan, you have to go down through each tier, the effect on that and the balance within it. And so as you would expect from the minute the flooding started, we've had our crisis center in action just like we did for the Japan earthquake, 24 hours a day, 7 days a week. Frank, in terms of the issue on deferred revenue?

Frank A. Calderoni

Revenue. So Rod, the deferred revenue, as you know was up on a year-to-year basis, 16% in total. Product was up 14% and services was up 16%. On the services, a majority of that was related to multiyear transactions that we have. We normally see multi-year transactions at the end of our Q4 and the end of our Q2. Good news is, we had quite a few, Gary, in the first quarter, which is unusual that we've seen very strong. So that added to the deferred on the services side. And on the product side, a combination of -- we continue to see a good progress from certain transactions that become as a service. And as a service transactions are more annuity product transactions, that get amortized over a period of time so that was up in the quarter. And then the other thing is, as we look at larger transactions, larger transactions sometimes have acceptance criteria, and with the acceptance criteria, of course, that ends up having to be deferred. So we had a larger amount of those large transactions in the quarter, which drove the overall growth. I think that's a good indicator of having a good quarter from a revenue standpoint and then, also seeing a large amount of deferred, just bodes well for the future.


Our next question comes from Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets, LLC, Research Division

If we take your improved product order growth and your linearity, is there something we should extrapolate going forward? Or underneath the data, is there a little bit of catch-up from previously weak protocols, implying some temporary impact? Just wondering how you feel about the dynamic. It does sound perhaps, you're now at a revenue base, which you can build upon.

John T. Chambers

Yes. The answer to the very last part of revenue base in which we can build upon. When you look for book-to-bill of 1, and normally, our experience has been revenues grow about 1% less than our booking growth does, because last year's Q1, product revenue grew at 21% and product orders grew at 10%. You had that 10 to 11-point delta talked about before, which calls the skew of a 3% product revenue growth for this quarter and a 13% product order growth. So it is almost mathematically right on the number. And you're right as you move into Q2 and Q3 and Q4, you've got much more of a normal correlation on it. And you've got your backlog and inventory where you want it to be, as you go into these in terms of momentum and predictability, Mark.


Our next question comes from Ehud Gelblum with Morgan Stanley.

Ehud Gelblum - Morgan Stanley, Research Division

So a couple of things. First of all, the turnaround in Japan is amazing. I must admit, I probably did focus more in Europe and the U.S. than in Japan lately, so I may have missed if there was a big turnaround from a country perspective, aside from your business. But if you can talk a little bit about what maybe has happened in Japan, when it started turning around, and it is something we should be tracking going forward, we use to break it out now, you stop breaking it out, I guess a year, 2 years ago, when it stopped being something good to talk about, and then it was continually bad. So I just want to understand a little bit more about that, what's going on there? And then on the gross margin side, we were supposed to see, obviously, lower gross margin from those routing deals in China. You've talked a little bit about it, but can you quantify, it sounds like they're spread some this quarter and some next quarter, can you quantify a little bit as to how much those China routing deals did impact gross margin this quarter? Was it the 30 basis points we saw or was it maybe like 60, 70 and you need some offsetting measures in cost reductions and improvements that may have gone the other way to bring us back to the smaller gross margin delta that we're all looking for, and just flow to the next quarter will be awesome.

John T. Chambers

Okay. So on Japan, we're not making any comment about the economic environment over there, nor a signal that in our opinion, is getting better or worse. I think Japan is just an example where our leadership team has executed extremely well, and we've got our very tight relationships with our customers, especially, the service provider in large enterprise customers very, very tight. Edzard Overbeek went to manage Japan, he came from Europe, he learned the language, he invested in the country, he built a great leadership team, Arizon [ph] came up from the team, and he's got a very strong team as well. They handled the terrible crisis of the Japanese earthquake, both in how we treated our employees and customers extremely well. Customers remember how you treat them through that. And then they built their relationship with service providers not selling them routers and switches, but saying, "How do we achieve your business goals in Japan and outside of Japan, with players like NTT, et cetera on that?" And it really speaks to moving where your customers are buying, and moving what you're selling, not routers and switches, if you will, but moving how you combine video consumerization of IT, social networking, collaboration, data center virtualization and how that accomplishes their goals in service providers to hit their key revenue generation spots. Revenue generation, as you know, from our service provider today, they're almost identical around the world. First is its mobility, the second area that they're really focused on is video, first, entertainment video and boy, that's why we did not leave that set-top box. I think for anybody that thought we'd leave the set-top boxes, they just didn't understand service providers. They are looking at how you do this from the cloud, how you charge from it differently. So when you're able to help them make this transition from a traditional set-top box to a IP set-top box with the BNI acquisition we did just last couple of weeks, and then moving straight to Videoscape, we have an architecture there, that makes a huge difference for them. Then you go into the service providers, and you say, "We've got the cloud capability that allows you to move into new revenue streams into your small to medium to enterprise business and your consumer, and we've got the best price performing products with the UCS and the Nexus." And then you talk about how you do collaboration, business transformation, and you'd really drive it through. If you were to use an example of taking that even a step further, obviously, Japan is on a roll on this, with the announcement that we made with Rob Lloyd and Edzard this week and KT in Korea. That was not a joint venture opportunity. That was an opportunity on how we go to market in smart services across the 14-country area. We are joined at the hip with them on every aspect of their business increase. We are looking how they provide cloud technologies to the smart cities and smart connected communities, how we work together on this innovation segment to bring video into education and healthcare, how you do collaboration to really drive productivity of businesses, et cetera. And these type of relationships, in my opinion, have not existed with service providers before. So you're seeing what you saw develop over the last couple of years, and Gary, you've seen it in Shell and GE and Walmart and Home Depot and Best Buy and many others, you're seeing a very tight relationship, where our top priority is almost matched 1:1 versus what the customers do. So that's what you saw in Japan. We're not perfect to this yet and obviously, many of the service providers and enterprise accounts aren't as far along, as some have mentioned, but the trend is, we are connected on almost every product area, architecturally, in a way that we achieve their business goals. Frank, a comment on the other area?

Frank A. Calderoni

Ehud, on the China transactions, as I alluded to earlier, so we factored them into the guidance for the full amount of the transaction, the 2 transactions in Q1. We did have some of them ship in Q1. More of it is going to be shipped in Q2. If I look at the balance, there's more in Q2 than in Q1, there was an impact, a negative impact to the margin in Q1 for that, which did ship. And to answer your question, we did make up for that delta with some of the other cost improvements that I mentioned earlier, as far as some of the value engineering and more specifically, as it relates to some of the switching-margin improvement that we saw in the quarter. In the second quarter again, factoring in how much is expected right now to ship in the second quarter, as far as the negative impact on margin, and then also, balancing some of the other cost benefits that we started to see in Q1 and some of that continuing to Q2.


Our next question comes from Brian Modoff with Deutsche Bank.

Brian T. Modoff - Deutsche Bank AG, Research Division

Question. What are your thoughts on enterprise and carrier IT spending environment in the first half and the second half of calendar year '12? I know it's a little early, but what are your top-tier customers telling you in terms of budget, product, used case priorities?

John T. Chambers

Yes. It's one that I ask in every single meeting. With many of our large companies, their budgets going to be up a little bit more than I anticipate. I was thinking it's going to be flat to down. With the average enterprise customer, when I do the polling, it's going to be probably flat to slightly down. Commercial, their business is good and they see their payback, they're going to spend within it. Service providers will probably spend a ratio, maybe of 2x to 3x what they are going to spend in terms of their actual own revenue growth type of opportunities. And I think most CEOs are going to do exactly what we're going to do here, like Gary and I and Frank will do, which is we'll start with a conservative budget, and then we'll see how the year develops in terms of the balance. So therefore, if we're going to grow to the indirect part of your question, Brian, this is where you've got to move in to really meeting their business needs. For those that really talk about cost control, we're able to go in and say, "Here's what you can do on cost of ownership, and a data center built by Cisco with UCS and the Nexus to partner with EMC and our VCE correlation there. You can really take cost of ownership as they do these consolidations, down by as much as 50%, 60%, 70%. You can combine networks and architectures for those customers that are in the productivity. We can talk about how collaboration really enables productivity and completely change the business models. For video, you can talk about where you're going in terms of that approach, and maybe a good example of that to kind of bring it to life for you, would be what we did this last week with -- for Virginia. A really, an area where state government and higher education came together, so the governor of Virginia with the 4 presidents of the 4 top universities in Virginia, came together were saying, how do they share teaching capabilities, how do they get another 100,000 degrees out over the next certain number of years, how do they place their state in a better competitive advantage? We did it over TelePresence. We did the announcements in 4 or 5 different locations. But the press really got what we accomplished on it. As we did that, the savings to Virginia, in terms of education costs would have more effective use of their teachers, with the creativity of collaboration among 4 university presence, which I think, is a good model for the rest of the country, with the governor saying, "I'm going to fund this." And as you can imagine, there was not a single discussion about routing and switching. It was all how does video change education, how do you use Medianet to be able to make the video really usable, how do you bring it not just to each classroom or each dormitory, but how do you bring it to the home, how you make the state more competitive. When you play at that level, you're going to get people spending money with you, even in very, very tight times. That's what we're trying to accomplish. So a nice way of saying, we're trying to get a larger share of spend, and moving to areas such as the data center consolidations or such as collaboration of video, where we haven't been as heavy before.


Our next question comes from Simon Leopold with Morgan Keegan.

Simon M. Leopold - Morgan Keegan & Company, Inc., Research Division

I was hoping we could drill down a little bit on routers and service provider. I think this quarter, this is probably the biggest router sales we've seen since 2001. And given what your closest competitors have reported, it sounds like that market's weak for them, not for you. And everything we've been hearing about service provider, whether it's the markets in North America or Europe, they don't sound all that impressive, yet you put up a great number. So I'm trying to figure out a little bit about how much of this is lumpiness? How much is regional exposure? Couldn't you help us understand both the October quarter, as well as your thoughts of what's happening over let's say the next 1 or 2 quarters in routing?

John T. Chambers

Sure. I think starting with your basic assumption that service providers will spend money if you can help them do any of the 4 goals that I mentioned. And the fifth goal was to cut their operating costs. We're in a sweet spot to be able to do all 5 of those with service providers. So the conversation in most of the service providers, it doesn't matter if it's NTT or KT or Telstra or AT&T or Verizon or Deutsche Telekom, it isn't about an RFP on the router capability, it is about how do you help them achieve their goals, in terms of new revenues, in terms of better productivity, in terms of entertainment, in terms of achieving the mobility. How do you help them charge for the over-the-top type of capabilities? How do you help them cut their support costs down? We're in those discussions across-the-board with most all of the players. And there are only 2 real players that can bring entertainment video in a major way to us, and we got very lucky that Motorola got purchased by Google. So all of a sudden, you have major service providers saying, "Cisco, we see you now even more important in terms of the partnership and the direction on it." The third element is candidly, we're just beating our competition. We are more aggressive on the competition, we are going to be tough on our competitors, whether they are Juniper or HP and Huawei and Avaya, and it's something that I think, we were a little bit to general on in the past. We are seeing some pretty aggressive measures, including companies offering networks for free to our customers, and we're handling that pretty well as Gary and Frank alluded to, in terms of the commonality of the market. Now service provider, we've never had 2 back-to-back orders like we've had in the high teens, in a very, very long time. So it does tend to be, using your words, a little bit, lumpy. But the relationships are solid and that's exactly what we announced with KT, and that's exactly what you saw in Japan and what we're doing a better and better job in the U.S. And then we got lucky in some of the combinations. I think you're going to see a consolidation in this market. The customers clearly understand that. They clearly understand the value we bring to them, and we are aligned one-for-one with the service providers. We don't compete against them. They need smart, consistent networks. That's something IBM and HP does not provide. They actually compete with them. So right spot, right time. Our bet on service providers in all ways, including set-tops are working out for us. We're getting better at translating technology to business applications, still have a ways to go on that. And Gary, the advance services on this, plays a huge role. In terms of that, you might want to spend a moment on the advance services, how key they are, both in service providers and the enterprise, and achieving our goals.

Gary B. Moore

Yes, I think, first off, Surya and his team are running routing. He's got an intensity to win, too , and he knows how to build great products, and he's got a fabulous team. And they partner extremely well with the services team. And I think some of our people, really are starting to see the value of services listing to their customers about how do we -- it's not about the technology, it's about how do I get that business result? And the services that we've built, not just the ones around smart services, where there's a lot of automation, but the services we built, to include the work that we've done to enable our partners in and a lot of our accounts, it's really getting close to the customer and helping them implement the technology to solve their business problems. And doing that broader set of consulting. So we do that better in service provider than anywhere else, because our service provider customers push us to that. So we've built a heck of a team under Sameer Padhye in the services organization, and they execute extremely well.

John T. Chambers

Also, the growth numbers, as you alluded to, in the service provider environment are very strong, both with the CRES in terms of the high end. As we talked about it, growth was literally, I think in revenues were over 30%, but we saw very good progress and we're starting to get our portfolio place going after long palette situations on the mobile edge with the ASR 5000 and on a fixed edge with the ASR 9000. They grew respectively in terms of bookings at 17% and 75% level. Our challenge in enterprise routing at the low end, where low-end routing is actually folding into many other different ways of accomplishing the same goal. I think this is one of the challenges we have. We have a good team on it, Gary and we're talking about how we put more functionality in. That when you look for the growth, the actual growth and service provider is dramatically higher than the number we used, it's being pulled down by enterprise access routing, and that's more not of a product-to-product comparison, more of an architecture decision, that I think we need to focus on a little bit more.


Our next question comes from Shaw Wu with Sterne Agee.

Shaw Wu - Sterne Agee & Leach Inc., Research Division

First, great quarter, guys. I just wanted to just a little bit deeper dive in terms of your switching business. You talked about how some of the refreshes there helped out, in terms of the Cat 2000, 3000 and the Nexus. What about the Cat 6500, where you have a new strategy there with line cards as supposed to full systems. Any color there could help.

John T. Chambers

Sure. If you look, the Cat 6500, as we said before, has literally, great gross margins. And it has been probably, the best utility product we've had, maybe ever at Cisco in terms of its staying power. And with the new line cards, what we did with our customers very effectively is, we said, "You can take what you have and just upgrade to additional functionality and capacity." So we gave our customers that capability and flexibility where they didn't have to move to the next generation of switches if they didn't want to, or they can move them to different places in the networks in terms of direction. In terms of what we're seeing with that, it is very solid, I'm looking at the numbers right now in terms of gross margins, good improvements in each category that the Cats 2000 and 3000 were already there. I still -- we still have a way to go with the 7000 in terms of margins, although I mentioned, it was a good improvement capability. And the Cat 6000, I think it speaks to an architectural advantage. That probably took some wind out of some of our competitors' sales. The other issue that you all know, as we made it really hard on a good but a new startup that we intend to beat, in low latency, and we've got very competitive product leadership back and taking those accounts back. So you're seeing us very focused, even on companies that might only be generating $20 million a quarter, we're going to have product leadership in switching across-the-board. We are going to lead in the switching market. We're going to be tough there.


Our next question comes from Jeff Kvaal with Barclays Capital.

Jeffrey T. Kvaal - Barclays Capital, Research Division

I was wondering, gentlemen, if you wouldn't mind telling us -- talking a little bit through the pricing dynamic. I think a lot of us have gotten some indication that pricing is tough in these markets. You have a bit of extra gross margin to play with. And are there areas where you feel like you are able to be a little bit more aggressive than you've been in the past? I think particularly, we have some emphasis on the campus or the Catalyst which is we market. Where a lot of the conversations seems to be tougher perhaps, on the higher end stuff.

John T. Chambers

Okay. So in several categories, first, as you already know, I don't believe in giving anything away, and we don't lead with price. We lead with the value, we lead with architectures, we lead with the capabilities. So the first way we address the pricing pressure is if you're able to help a customer dramatically reduce their cost, focus on collaboration, which is the biggest productivity tool in the CEOs of large financial institutions, as an example know that, you're finding financial institutions just standardized on us. And when you look at us in terms of our collaboration capability, guess what, it's all switching through and routing for in a big way. You begin to put video on top of that, and every one of our major routers and switches now is capable of Medianet, and as customers think about how does video play out, they see where that occurs. Then we move straight past talking about selling switches or routers in this "competitive situation," we talk about how we can help achieve your productivity goals or how we can help in terms of achieve your education goals, or your new revenue generation goals. And if you can save a point off of productivity, or if you can take their savings by several hundred million dollars down, they're not going to argue about a couple of extra points. That's also a way we've learned to do a very good job, depending on our competitors that just good enough is not just good enough, it just doesn't hunt. And the ability to forward this in, in terms of where the architecture is going, and we're going after HP, very aggressive on that, and we've learned how to compete with that, I think and in a very effective way. We have to take on Huawei in China. We can't let them make their profits in China and then, do a breakeven around the rest of the world. And we are very competitive in China, and Owen Chang is doing an amazing job there in terms of taking on some competitors on their home turf, but also partnering with other players. And don't be surprised if you see us partner with more Chinese players, in a win-win type of fashion. You are seeing some aggressive acts maybe in some acts of desperation by some people to try to get orders. We have seen complete offers for a network to be given away. So you are seeing some aggressiveness in that. Huawei will always compete on price, they're going to be tough on us the long run. They're probably the one that will be our toughest competitor 4 to 5 years out, if we make our transition right. And I think if we do our job right, just see us pull away from the single-product-type vendors, as this becomes more of an architectural play and work and you saw my business type of play. Nice way of saying, I think we're handling this much better than before. And I think we're also getting volumes in these new switching products, which hopefully, get some gross margin improvement too.


The next question comes from John Slack with Citigroup.

John Slack - Citigroup Inc, Research Division

My question is regarding the guide is, it's now off of a solid quarter. It's actually flat to down slightly sequentially. Usually, you see acceleration as you move throughout the fiscal year. I mean, how should we think about kind of, is it conservatism as we look into Q2? And then how should we think a little further out about how -- kind of the sequential progression of the year goes?

John T. Chambers

Well if you think, and then you about our guiding, when we just said at the financial conference our long-term goal of 5% to 7%, to be forecasted in 7% to 8% year-over-year growth, with the economic challenges we see with Europe, with public sectors spending down India, that's pretty aggressive, giving guidance. And I think if you would look in terms of sequence-wise, if we continue to get the numbers, then we're talking about year-over-year, it does play out very much in terms of the quarter-by-quarter scenario you talked about. I'd be careful about going that out too far in Q3 and Q4 in terms of the direction. But if you watch the numbers, 7% to 8% in Q2, we continue to do well as we look out in the future, then I think you will see the normal sequential numbers for those single digit type of growth numbers. And I'm not forecasting what we're going to do the second half of the year, I'm clearly talking about trend. Nice way of saying, John, I think that this forecast is pretty aggressive and we are looking at book-to-bill kind of in the 1 range if we do it right.

Frank A. Calderoni

John, I just, as I said before in the prepared comments, we're taking this one quarter at a time. We're pleased with the performance in Q1, of course, good guidance for Q2. But with the backdrop of the macro environment, especially for the back half of the year, it's challenging at this point to kind of get too aggressive as far as expectations from that standpoint.


Our next question comes from Jayson Noland with Robert Baird.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

I wanted to follow up on the competitive question and ask about Huawei, John, specifically. They launched the formal channel program in the U.S. enterprise recently, and we would expect this to be an uphill battle for them, but we've been surprised how many resellers said that they would at least consider Huawei, or take a meeting with them. What kind of progress do you expect Huawei to show here in enterprise over the next year or 2?

John T. Chambers

We're going to make it hard on them in the U.S. and we're going to be very tough. We do have as you know, the #1 relationship with our channels. We're usually the most profitable or very high profits in each of our channel partners. We are a channel-driven company "period" in terms of our direction. And we've learned to, with our partners, be able to articulate the advantages in terms of the importance of intellectual property, the importance of integrity in terms of how we do deals and the partnership that we've had for many years. When you see the growth numbers in the enterprise and the commercial, like you saw this last quarter and the quarter before, it means we're doing extremely well here. But repeating the same thing. They're going to be a tough competitor. We're just going to try to make it as tough as we can on them, and we plan to beat them. But they'll be around 4 or 5 years from now.


Next question comes from Brian Marshall with ISI Group.

Brian Marshall

I had a question on security. If you look at it last year, I think we've done about 9% from a fiscal perspective. Can you talk a little bit about what kind of progress or success you had with the new SecureX architecture? And specifically, do you think this is going to be geared more towards maintaining or protecting? I should say, the margins in the switching and routing side? Or is this going to be looking at a little bit more stand-alone security product lines going forward?

John T. Chambers

Sure. Brian, if we do our job right, it will help protect our traditional margins, but in a different way than you said, and I would never think of it as standalone. If it's standalone, we don't bring our competitive advantages. What I've asked the team to do is to put security into every ASICS, every product, every software capability, to bring that together in a way that no one else can. Because we have the nodes across the network, the background of the Internet, the capability to do this and the trust by many groups, and we get to see what is occurring. Security to me should be the best architectural play that we can differentiate ourselves on. SecureX is a good step, but it's got a long way to go. The security numbers this quarter weren't bad. They were up a little bit and you probably saw it in one of your slides in terms of the improvement. But I think we have a long ways to go here. Chris Young, our new addition to leading this, is world-class in security and we were very fortunate to get him, and our partner was kind enough to let us get him in terms of that, and I think you will see he will put his mark on this organization very quickly, and at a different level of intensity. So very important, not standalone. When you provide the best security and you can provide the best video strategy with a video capabilities already built into your product such as Medianet, and you can provide the best wireless strategy, and you can tie that to the cloud and the best architectures in the virtual data center, and you combine that with being able to bring these to any devices in your customer's networks, and then you say, "Here's how this architecture solves the business problem. And by the way, you're betting your future on this, it better be secure."We have huge advantages, we'll begin to do that. But we've got to get much more of an integrated product. Our products are still architecturally headed the right way, but still a 2-piece meal in terms of its delivery today. And I'm counting on Chris in a big way to take that next step.


The next question comes from Brian White with Ticonderoga.

Brian J. White - Ticonderoga Securities LLC, Research Division

John, could you talk a little bit about, maybe what you're seeing in the financial vertical? And how that differs, if you take a look at the U.S., Europe and also over in Asia?

John T. Chambers

Got you. So this will be the last question, Mel has informed me. I get to be the CEO sometimes, but not on time. The financial vertical is one that you're very much aware of, is under tremendous regulatory pressure and candidly, profit pressure. In terms of the balance around the world, it is one that does move up and down pretty dramatically. What we saw this last quarter in our large financials, especially here in the U.S. was actually a very good quarter. We think this next quarter is going to be a little bit tougher on it, because of the capital spend issues that you're probably very much aware of, Brian. In terms of what we're trying to do, and I won't refer to the name of the company, but a very, very large financial institution in the U.S., we're aligning at the hip in terms of how we do collaboration together and how we change their relationship with both their financial advisors to their customers, the relationships in the branch, how they get the productivity on collaboration, et cetera. And so what you're going to see us, is try to talk about share wallet spend, and align with their business goals in terms of how they create new revenues, how they make up for lost profits, because of regulatory issues, et cetera, within it. The financial institutions over in Asia are obviously stronger in terms of the purchasing capability. And in Europe, it's tight as you would expect. But you begin to get into the Middle East, and you begin to get into Russia and Africa, it's a good vertical for us. And often, very much a leading edge indicator. We're probably doing a better job of getting closer to our financial institutions over the last year, Gary, I would say than the years 2 or 3 before that. They're starting to drive our direction more, but they're going through some tough times. And so I think you will see it would be sporadic by quarter and sporadic by geographic region. With that, Mel is telling me that we're done. I want to thank you for taking the time today. We've tried to be even more transparent and candid on what we're seeing. We'll try to tell you both the good, the bad and the ugly as we go through this, and we also want to be very upfront. The market transitions we went through over the last 2 to 3 quarters, I don't think any other company in the industry could've gone through and accelerated orders through that. So I think in terms of what we can control or influence, we're in very good shape. We don't take anything for granted, we've got to deliver full value for our shareholders everyday. We are all over productivity and gross margins, and value engineering and how we drive that. And at the same time, we really are getting very good and a little bit lucky, in terms of the market is evolving, as we started to build our architectures 10 years ago, as we started to combine products when nobody else thought you could combine products, and how, if you combine products, our customers sure doesn't want to have the #7 player, the #3 player, the #9 player, the #2 player, trying to integrate those products together from the cost of ownership perspective and from a services perspective and then, bet a large part of their future on it. So we're doing well on the architectural sales and business momentum. That's what we talked about in terms of IT moving to business technology. And at the heart of that, is intelligent networks. So thank you for the comments about the quarter. We're going to try to do better every quarter if we can. And with that, Mel, let me turn it over to you.

Melissa Selcher

Okay, thanks, John, and Frank and Gary. Cisco's next quarterly conference call which, will reflect our second quarter fiscal 2012 results, will be on Wednesday, February 8, 2012 at 1:30 Pacific time, 4:30 Eastern time. Additionally, downloadable Q1 FY '12 financial statements will be available following the call, including revenue by geography and product categories. 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. Click on the Financial Reporting section of the website to access the webcast slides and these documents. Again, I would like to remind you that in light of regulation FD, Cisco plans to retain its long-standing policy to not comment on its financial guidance during the quarter, unless it's done through an explicit public disclosure. Please call the Investor Relations department with any follow-up questions for this call. Thank you for your participation and continued support. This concludes our call.


Thank you for participating in today's conference call. If you would like to listen to the call in its entirety, you may call (866)493-8039. For participants dialing from outside the U.S., please dial (203)369-1749. This concludes today's conference. You may disconnect at this time.

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 All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!