Welcome to Cisco Systems’ Fourth Quarter and Fiscal Year 2012 Financial Results Conference Call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect.
Now I’d like to introduce Melissa Selcher, Senior Director, Analyst and Investor Relations. Ma'am, you may begin.
Thank you. Good afternoon, everyone, and welcome to our 90th quarterly conference call. This is Melissa Selcher, Senior Director, Analyst and Investor Relations, and I'm joined by John Chambers, our Chairman and Chief Executive Officer; Frank A. Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, Executive Vice President of Worldwide Operations; and Gary Moore, Executive Vice President and Chief Operating Officer.
The Q4 fiscal year 2012 press release is on the U.S. High Tech Marketwire and on the Cisco website along with the corresponding webcast with slides.
Additionally, downloadable Q4 and full fiscal year 2012 financial statements will be available following the call in the Investor Relations section of our website, including revenue and gross margin by geographic segments, as well as revenue by product categories. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets 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 and these documents.
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 discuss in detail in our forms filed with the SEC, specifically the most recent annual report on Form 10-K and quarterly report on 10-Q, and any applicable amendments which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. Unauthorized recording of this conference call is not permitted.
I'll now turn it over to John for his commentary on the quarter.
John T. Chambers
Mel, thank you very much. As we closed fiscal year ‘12, I am pleased to discuss our strong performance, continued execution of our plan to deliver profitable growth, and commitment to our shareholders. For the full fiscal year, we delivered non-GAAP earnings per share growth of 14% year-over-year, and revenue growth of 7%, a record year in terms of earnings per share and revenue. For Q4, we delivered our non-GAAP earnings per share growth of 18% and revenue growth of 4%, also a record quarter in terms of revenue.
Our strategy delivering intelligent networks and technology architecture is built on integrated products, services and software platforms to fuel our customers’ business is proving the right long term strategy for our success, and you’re seeing it in our results.
The success of our service provider business, where we’ve moved from an individual product provider in today’s market where many of our customers use Cisco as their best strategic partner, and being their top business and technology objectives. It is a clear example of our strategy playing out to our advantage.
Our role as the official network infrastructure supporter for the London Olympics and Paralympics is another example of our ability to strategically partner. In this case with the British government, the London Organizing Committee of the games, NBC and NBT. And to do this, we drove incredible outcomes and experiences.
From a technology perspective, which obviously excites, especially our engineering team, but me as well, the 1,800 Wi-Fi hotspots in the 34 venues and over 80,000 data connections that we provided had a capacity four times larger than the network infrastructure of any previous games and help connect 10 million spectators, 76,000 volunteers; 22,000 athletes and coaches enable and experience in ways before never thought possible.
All of this was done reliably and in a highly secure manner in front of a worldwide TV audience of over 4.2 billion. NBC used Cisco’s software capability and infrastructure to support all the web content, live streaming the equivalent of 7.5 months of 24X7 broadcast across six channels, letting viewers pause live TV while switching between TV, tablets and smartphones. It was a complex challenge, but it’s exactly the type of challenge that Cisco is uniquely positioned to handle. And we executed remarkably well, not just again on the technology objective, but on the business objectives of our partners. Congratulations to the Cisco team and our partners for a job done very well.
There is no question our industry and our world is evolving at a lighting pace. The network is squarely at the center of the major market transitions; cloud, mobile, visual, virtual and social, and our innovation engine continues to fuel our growth, our customers’ success and our industry leadership.
Our disciplined focus on our operating model and our company’s ongoing evolution enable us to continue to deliver record customer and partner satisfaction levels, and drive leverage in our financial model.
As we move into FY ‘13, our focus on profitable growth continues and we remain committed to driving shareholder value. To provide some important update, along with our FY ‘12 and Q4 results, I’d like to turn the call over to Frank.
I will then walk through what we’re seeing in the business and where we’re focusing going forward. Frank would detail our guidance and then we’ll wrap up with my favorite part the Q&A. Frank on to you.
Frank A. Calderoni
Thanks, John, and good afternoon to everyone. For the full 2012 fiscal year, we grew profits safer than revenue as we had committed to do with our operating model of discipline decision-making, down portfolio management, strong operational execution and a focus on driving profitable growth. Through these efforts, we have improved our operating margin leverage increasing our value proposition to shareholders. In my section, all results will be on a year-over-year basis updated.
Starting with the fiscal year performance, for the full year 2012 fiscal year, total revenue was $46.1 billion, an increase of 7%. non-GAAP net income was $10.0 billion, up 11%. non-GAAP earnings per share on a fully diluted basis were $1.85, which grew 14%.
GAAP net income was $8 billion or $1.49 per share on a fully diluted basis, representing increases of 24% and 27% respectively. We generated strong free cash flow, meaning cash flow from operations activity, less capital expenditures during FY ‘12 of $10.4 billion, increasing 16%.
Given the stabilization, we’ve seen in our business and our confidence going forward, along with the ongoing commitment to returning cash to our shareholders, I am pleased to announce that we are increasing our quarterly dividend for Q1, FY ‘13 by 75% to $0.14 per share, which represents a 3.2% yield on today’s share price.
Going forward we intend to our capital allocation strategy to return a minimum of 50% of our free cash flow annually to dividend and share repurchases while providing sufficient financial flexibility to effectively invest in the business and strategic opportunities.
To provide some additional detail on revenue and profitability for certain product areas for the full fiscal year. Starting with switching; switching revenue was up 3% in particular we are pleased to see stability in our switching gross margins, as an example of what we are achieving with our newer product as they ramp, we’ve seen the gross margin levels with our Nexus 7000 improved approximately 10 points over the past eight quarters.
Routing revenue grew 2%, the transition to our new platforms is going very well with the market shift from wireline to wireless providing us with a true competitive advantage. Collaboration revenue was up 3% FY '12 was the year of transition from a go-to-market perspective with increasing SaaS and software-based offering, which now represents approximately 50% of our overall collaboration business.
Wireless had a very strong year with revenue up 19% with continued wireless LAN upgrades and deployments driving strong growth. Security revenue was up 12% reflecting the growing requirements of security and cloud, as well as BYOD deployment.
In our data center business had strong growth with revenues up 87%, we continue to execute on our data center strategy by staying on top of innovation as well as delivering a convert stock architectural approach for our customers to meet their networking as well as their computing requirement.
Now moving on to our Q4 results, we had a solid quarter, total revenue in Q4 was $11.7 billion, up 4%; total product revenue was $9.2 billion, up approximately 3%, and services revenue was $2.5 billion, up approximately 12%.
Total revenue from a geographic perspective grew 7% for Americas, 9% for APJC and decreased 5% for EMEA. The decrease in EMEA was driven by a decrease in product revenue consistent with the macroeconomic related weakness that we’ve seen in product orders over the past two quarters driven largely by weakness in Southern and Central Europe.
Total product book-to-bill for Q4 was comfortably above one and in line with normal Q4 seasonality. Q4 FY ‘12 total non-GAAP gross margin was 61.9%, down 1.2 percentage points quarter-over-quarter and down 0.8% on a year-on-year basis.
Non-GAAP product gross margin for the fourth quarter was 60.4%, a decrease of 1.6 percentage points quarter-over-quarter. The quarter-over-quarter decrease was primarily driven by pricing, product mix, driven by strength in our data center business and to a lesser degree higher overall manufacturing costs due to higher warranty expense.
Our non-GAAP service margin for the fourth quarter was 67.1%, that was flat quarter-over-quarter and down 1.5 percentage points year-over-year. Total non-GAAP gross margin by geographic region was 62.7% for Americas, 61.6% for EMEA, and 69.6% for APJC. On a quarter-over-quarter basis, Americas was flat, while EMEA decreased 2.3 percentage points and APJC decreased 3.7 percentage points.
As a reminder, the APJC revenue benefited in Q3 from the completion of several large multiyear projects that we discussed from last quarter’s call, which did have favorable margin impact in Q3. The margin decrease was also driven by a mix related to strengthen our data center as well as SP Video and higher manufacturing costs.
Non-GAAP operating expenses were 34.4% of revenue, approximately $4 billion in Q4 FY ‘12 and that was approximately flat as compared to the previous quarter. We recognize pretax charges of $202 million to our GAAP operating expenses primarily related to the intended sale of real estate consistent with our ongoing efforts to optimize our real estate portfolio and our restructuring activities.
Our non-GAAP operating income was $3.2 billion, 27.5% of revenue for Q4 and grew 14% consistent with our strategic financial goal of growing profits faster than revenue. We will continue to target non-GAAP operating margin consistent with our focus on balancing investments between gross margin as well as operating expense.
Our headcount at the end of Q4 totaled 66,639. That was up approximately 14,100 quarter-over-quarter. The additions are strategic including approximately 500 new university graduates, who were hired in Q4 mostly in engineering to approximately 300 additional hires in R&D and growth areas such as data center and approximately 330 in services to fulfill customer contracts.
From a geographic perspective, over half of the headcount added this past quarter were in emerging markets and other growth markets. We routinely review our business to determine where we need to align investments based on growth opportunities. Additionally, we continue to evaluate our organizational structure as part of our plan to drive simplicity, speed of decisions, as well as agility across Cisco. If we decide to exit or reduce investments in a business, we will have to make associated decisions that could impact our workforce.
Our Q4 FY ‘12 non-GAAP tax provision rate was 21.7%. Non-GAAP net income for the fourth quarter was $2.5 billion, which represented an increase of 15%. As a percentage of revenue, non-GAAP net income was 21.6%. Non-GAAP earnings per share on a fully diluted basis for the fourth quarter was $0.47 versus $0.40 in the fourth quarter of fiscal year 2011, which was an increase of 18%.
GAAP net income for the fourth quarter was $1.9 billion as compared to $1.2 billion in the fourth quarter of fiscal year 2011, an increase of 56% year-over-year. GAAP net earnings per share on a fully diluted basis for the fourth quarter was $0.36 versus $0.22 per share in the same quarter of fiscal 2011, which was an increase of 64%.
The total of cash, cash equivalents and investments at quarter end was $48.7 billion, up $304 million from last quarter. Of this total balance, approximately $6.2 billion was available in the U.S. at the end of the quarter. Our cash flow from operations in the fourth quarter was approximately $3.1 billion.
During Q4, we did repurchase $1.8 billion of common stock under the share repurchase program of 108 million shares at an average price of $16.62 per share. A dividend payment of $425 million representing $0.08 per share was also declared and paid during the quarter. Product backlog at the end of fiscal 2012 was approximately $5 billion as compared to approximately $4.5 billion at the end of fiscal 2011.
Now, let me turn the call over to John for additional color on the quarter. John?
John T. Chambers
Frank, thank you very much. I'll now provide a more detailed discussion of the market and our five foundational priority areas in terms of revenues followed by then by discussion on geographic and customer segments and that discussion will be in terms of orders or what we internally refer to as bookings. The following foundational priority results are shared in terms of the year-over-year revenue growth for Q4 unless otherwise stated.
First, our core business, we continue to feel very good about our performance in our core markets, routing, switching, wireless and security. We continue to perform well in routing growing revenues 4% year-over-year while many of our peers are experiencing negative growth and sometimes negative growth in double digits. As you would expect, current industry analysts show our market share gains in both SP Core and Edge routing to be up dramatically year-over-year. We saw strong performance in mobility with ASR 5K up 67% and in the edge with ASR non-K up 97%.
We continue to do a good job of maintaining our access routing market share of approximately 85% with slight fluctuations up and down each quarter. Optical was down 20%. CapEx budgets will continue to be challenged in the current environment, especially European Series Routers and government in the developed world. With the strength of our portfolio, alignment of our priorities with our customer’s priority and our architectural approach we believe we can continue to grow our shares spend in our key customer accounts with service providers being perhaps the best example from a customer segment perspective.
Now, moving on switching, overall switching revenues flat this quarter at $3.6 billion, with fixed switching up 3% and modular switching down 7%. Within the fixed switching, our Nexus 2 and Nexus 5K switching had another good quarter and was up more than 24% year-over-year due in part to strong data center build outs.
From a modular switching perspective, our Nexus 7000 (inaudible) strong growth, up approximately 13% in Q4. Our corresponding Cat6K decline reflects the product transitions to the Nexus 2, 3, 5 and 7K as planned. A number of factors have driven the strong demand including the gig Ethernet 10G transition with the 10G port shipments growing 54%, and solid momentum in the top 10 MSDCs were full-year FY ’12 growth was 38% year-over-year.
The most recent quarterly industry LANE switching market share estimates are in line with our goals of 70% revenue and 50% (inaudible) in terms of market share, reflecting our continued competitive stands in this market. Our wireless business is very strong, growing 22% in Q4, with mobility driving one of the biggest market transitions in the industry.
With new products such as our flagship AP 3600 being well received with sequential order growth that is quarter-to-quarter – order growth of over 100%. In addition to the growth in enterprise and commercial segments, a number of large service provider Wi-Fi Deployments are now in full swing, driven by the ability to retain and attract customers with a bundled Wi-Fi offering.
Security grew 8% with growth of 15% in network security and 10% decline in content security. Network security growth was fueled by our high-end parallel offerings and product transitions to the data center systems and solutions in a day-to-day service engine, what we call [eyes] internally. I believe we have the right leaders and the right strategy to lead in security market and expect to continue to invest and execute here.
Transitions like the move to could-based delivery models and transitions to bring you in device, play to our strength and we plan to continue to capitalize on these opportunities especially in the security space.
Now moving on to the data center. Data center performance was extremely strong with overall data center revenue coming at 90% in Q4, up more than 42% from Q3 with year-over-year UCS order growth that is booking growing 58%, driven by the Romney Transition, seasonality trends and Cisco’s compelling unified data center value proposition. The innovation we’re driving and our traction in the data center is truly incredible, as measured on with every scale, revenue growth, market share and customer mind share. Our ability to move first in this market transition to unified compute, storage and networking and deliver on long-term ongoing innovation around unified fabric, unified compute and unified management has helped solidify our position as a leader in the next generation data centers.
Our approach to the data center has always been based upon open architecture and ecosystem of partners, proven solutions such as Vblock with VMware and EMC, FlexPod, with NetApp, the Exxon with Citrix and Private Cloud with Microsoft, have seen significant traction in the market and we expect we’ll remain a key driver of our strategy going forward.
Momentum with VCE continues to be very strong. we saw continued traction in enterprise data centers and cloud service providers, both with new customers and existing customers going to our footprint. With strong demand growth in the second quarter, VCE continues to achieve our expectation that again, is our partnership with VMware and EMC with order growth in the most recent quarter of approximately 58% year-over-year.
An area that many of you’ve asked us to discuss is our view and the focus on software defined data centers and specifically the effect on our strategy as it relates to networking. Our major discussion is around evolving networks to be more programmable, more virtual and more flexible. Make no mistake about it, our goal is to lead this evolution along with our partners and I would point to three advantages that we have in this marketplace.
First, customers understand that optimizing for the hardware and software combination to drive consistent experience, policy, quality of service, security and mobility, is the only way in our opinion to meet their total cost of ownership, reliability and scalability requirements. They want their networking vendor to deliver an evolutionary and also a comprehensive approach.
Second, we have a complete framework. Across the group folios it addresses all the elements of network virtualization. We’ve recently announced an initial set of techniques under the Cisco open network environment umbrella called Cisco ONE. The customer and partner reception has been very positive and we have a quite a bit more of our sleeve as you’d expect in this area.
Third, our global market presence gives us a unique clearance in the customer requirements, which helps us ensure our innovation engine is ahead of the market. Cisco pioneered network virtualization in 2009, when we introduced the Nexus 1000V, the first virtualized switch. Today, while our startups in this space can generally count their production customers on at most two hands, Cisco has more than 6,000 Nexus 1000V production customers using the distributed virtual networks to deliver highly secure, multi-tenant data center environment.
We have been driving the future of the data center for a number of years now, together with our strategic partners whether it is EMC, VMware, Microsoft, IBM, NetApp, Citrix, Intel and many others, our open approach is driving innovation and unique customer value. To be clear, we will continue to utilize our unmatched expertise in this evolution of the network and build band partner. As we've always done to drive network leadership for generations to come and the while we view this positive business driver for us going forward, it is also important to realize this evolution will play out over many years in the future.
Now, let me move on to collaboration. Collaboration declined 8% to $992 million in the most recent quarter. The decline is driven primarily by decrease in teleprinter sales due largely to challenges in the public sector, which were down year-over-year almost 30% in the European markets, which were down in terms of telepresence in the mid-30s as well.
We did see the launch of our new TX9000 immersive system gained solid acceptance in the first quarter. We believe that the move to post-PC World will be a driver of our business going forward, and placed our advantage. It also enables our evolution to a new business models and greater mix of software and software-as-a-service.
Let me just give you a couple of quick points on this. Our Jabber software application that enables instant messaging conferencing, voice and telepresence video to multiple devices across most major operating systems has gained significant traction increasing 55% in license volume, Cisco WebEx increased again in this quarter solidly on a global basis.
In our new enterprise, licensing agreements are off to a strong start with key U.S. enterprise customers. We believe strongly that an open architecture that enables communication at any device to any other is one of the top productivity drivers for this decade.
Now, let me move on to video. After three quarters in a row of comfortable double-digit growth, SP Video declined by 2% in Q4. Lower CMPS shipments were partially offset by growth in IP set top boxes where we continue to gain market share and cable modem.
As we began to think about this market move into the cloud, we see more software content and potentially more profitable growth opportunities. The NDF deal that we just closed will enable us to achieve these goals at a faster pace than we would have been able to do on our own. [Almost] without exception and I learn Rob can think of one, our customers understand that NDS bring Cisco at a much faster pace into the higher end of their business models.
A combination of data center, cloud, software combined with our capabilities and knowledge of video positions us very well for the future. The timing could not have been better in terms of what’s going on in the market and I would like to take full credit for that, however this just happened to be how the market and our peers in the events of all together. Bottom line, so far, so very good.
When you think about what NDF does for us, their software and the services model should accelerate the delivery of Videoscape, a key component of our SP video strategy. With NDS, we have the opportunity to transform the way the next generation video is delivered to consumers worldwide. We believe our customers clearly appreciate the value of NDS to the Cisco portfolio and we look forward to delivering highly differentiated opportunities together.
NDS also has a strong recurring revenue stream as its primary source of revenue and is expected to help accelerate our evolutions of this business to more of a recurring revenue base both in the video, but in the other segments of our business as well.
Well, Frank will provide more details on the transition. I would be thrilled and I want to thank and welcome personally the NDF team on behalf of all the Cisco leadership team to the Cisco family.
Finally, our architectural approach in focused on delivering solutions has cemented our role as a strategic business partner with our customers worldwide. While we often discuss the innovation in our products, the innovation we are driving in our services solution and integrated architecture is as equally as impressive and fundamental.
Services which are a key ingredient to our move into solutions, and integrated architecture was up 12% this quarter, with particular strength in advanced services growing to 24%. Cisco's smart services and offering that navigates us the intelligence from Cisco's 50 plus million devices and customer connections to protect and optimize network investment, grew FY ‘12 orders by over 240%. And as a good example of an innovative offering fueling our services growth and attractive business model for Cisco and for our partners.
We are very pleased with our progress to date across almost the entire company. There are areas for continued focus and improvement and execution. And this is where I am asking you Gary to take the lead for us, you have done a tremendous job this last year and we just want to keep it going.
In summary, I am pleased with the innovation and differentiation we are driving across the business. I will now move on to provide some color on the geographic and customer segments, the following geographic and customer segment growth rates are in terms of year-over-year product orders for Q4 unless specified otherwise. In Q4, Cisco's total product orders grew approximately 2% year-over-year. I want to remind you that both the comparable Q4 of FY ‘11 and also the quarter we are now entering Q1 FY ‘12 where very strong year-over-year order quarters averaging comfortably into double-digits and therefore we will make the toughest year-over-year comps in terms of orders we will face for the next fiscal year and that this Q4 we just reporting and in Q1 for next year.
Looking at the numbers from a geographic perspective, specifically the Americas products grew orders by 4%. We saw the U.S. slightly stronger with Canada and Latin America both down. We first signal slowing of the market almost 15 months ago, the initial indicators of the slowdown occurred first in the U.S. state and local government followed by large, large global enterprise accounts, then general enterprise accounts in the U.S. then U.S. Federal and then into the commercial marketplace.
In Q4, with the exception of Federal government, we saw positive growth and/or uptrend especially in the second half of the quarter. Now I want to say, it is way too early to call this a trend, but if this were to continue through Q1, this would be a solid indicator of potential future market improvement in the U.S.
Just to give you some additional data and I’m going to give you by Q3 and Q4 order trends in the U.S. The following is a summary of the U.S. performance in those areas. U.S. state and local government grew 7% in Q3 and 17% in Q4, I’d remind you 15 months that was the first one that really slowed dramatically.
GET and our largest 29 enterprise accounts declined in double-digits in Q3 and increased in double-digits in Q4. Those are our global enterprise accounts again in the theater. While U.S. enterprise grew 1% in Q3, it grew 4% in Q4. U.S. commercial for Q3 was 6% and for Q4 it was 7%. As expected our U.S. Federal business declined in both quarters with minus 8% decline in Q3 and minus 11% decline in Q4.
In Europe, Middle-East and Africa and in Russia region product orders were down 6%. The primary weakness was across all sections of Europe with most of customers not foreseen improvement in the near future. The UK was down 13%, Germany was down 4%, France was down 12%, Italy was down 24%, Europe not including emerging markets and EMEA and Russia represent approximately 19% of our company’s business. Public sector in Europe was down 13%, social (inaudible) was down 15%, enterprise on the other hand was up 2% and commercial was flat.
On the positive side, our emerging markets in EMEA grew 12% with Russia up 12%. Emerging markets represents about 23% of EMEA to total business. Asia-Pacific, Japan and China are, their theater, of the three regions, it grew the fastest at 12%. We expected this growth in APJC and they delivered, and I want to congratulate (inaudible) and that and also how they’re going into the new role.
There was also a nice rebound following Q3 growth of 7% up to 12% in Q4. China had a strong quarter up 17%, Japan which has been very solid all year was up 12%, Australia up over 13% and India flat. We continue to see India challenged largely self-inflicted by their own internal issues, but getting back to flat growth after multiple quarters of double-digit negative growth was encouraging. As many of you may be aware, we recently promoted (inaudible) run the APCJC region from sales operations to head up our global services business reporting to Gary Moore.
We are deliberately moving away, moving many of our high potential leaders at all levels within the company to new functions in the business as opposed to just promoting within a functional silo to provide the expediencies and the prospective that our customers and shareholders expect future leaders at Cisco.
Now, moving on to a customer market view, enterprise global grew at 6% in Q4 versus Q3 minus 1%. While we were glad to see some (inaudible) at the enterprise, we remain conservative and cautious in our expectations given the uncertainty remaining in the macroenvironment.
Commercial on a global basis grew 4%, but the U.S. as I said earlier continue to be very solid, which is 7% growth year-over-year. Service provider declined 1%, again I’d like to just share with you the data that in Q4 FY ‘11, we saw 19% growth, so some really some tough comps this quarter. In Q1 of this year, we saw growth of 16% and Q2 of fiscal year 12 growth of 12%. We will currently have some challenging comps in these three quarters and FY ‘13 and Q4 of last year.
Despite the decline in orders this quarter, we believe we’ve gained more than our share available market, and we believe this will be seen in share increases in the SP market. For the year, our service provider business grew 8%. Public sector in total global was up 1% for the year – 1% for Q4 and was up 3% for the year.
We have always been able to control and [roughly] adjust both opportunities and possible challenges in the marketplace, this is a core strength. We will always have strategic partners with whom we believe partnering complete our commitment to open standards and to any to any positions as incredibly well to navigate through the changing industry dynamics. We've done this successfully for decades, and we feel very comfortable with our ability to control our own destiny.
And thinking about our guidance for Q1 FY '13, which Frank will give you in a moment here are the top things on my mind. First, from a challenges perspective, we are modeling Europe to continue to be very challenging over the several quarters. Second challenge global public spending will also continue to be challenge especially in the U.S. Federal Government and European government. And third, many of our customers continue to anticipate a challenging next 12 months on a global basis, and therefore these CEO will remain conservative both in their IT expenditures but also when they’re hiring.
However we’re also seeing a number of potential drivers for growth and balance to these challenges. First, our solid position in commercial accounts, and the strength of our channels, which Rob, we never should underestimate, how key that is for us. Second, Cloud and our ability to expand both our products and architectural wins in the data center, which grew this last quarter comfortably about 50%. Third, Cisco’s expanding value with both traditional and new service providers and new partners in this area, especially in the growth areas such as cloud, video, mobility, open architecture, and hosted UC at a time when many of our competitors in the service provider marketing are really struggling.
Fourth, emerging countries, which represents about 20% of our business, and yet approximately 50% of the world’s global GDP, while we are pleased with our progress in many of our top emerging countries, we believe we can do even better. Starting with the alignment of more resources to the emerging country opportunities, which Frank, he talked about earlier in terms of our headcount changes with 700 to the 1,400 going to emerging countries.
Fifth, while we are very strong in the enterprise marketplace. we think we can do even better with the appropriate caveats in our technology and business architecture approach to their leading accounts, in many ways taking our enterprise strength to the next level by replicating key parts of our success is in the service provider market.
Finally, we believe our continued profitable growth in leadership and services positioned us very well with the foundational base for future growth and profitability. We all understand the uncertainties in the macroenvironment, so as you would expect, we will focus on what we can control and influence with particular emphasis on gaining share of wallet and profitable market share leadership, managing tight expense control and enhancing shareholder value.
Frank, let me move on to you for Q4 guidance.
Frank A. Calderoni
Thanks, John. I would like to remind you again that our comments include forward-looking statements and you should review our recent SEC filings that do 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 the current pipeline and our view of business trends based upon the information that we have available today and of course the actual results could be above or below our guidance.
The guidance we are providing is on a non-GAAP basis with the reconciliation to GAAP. I will first provide guidance excluding the recently closed acquisition of NDS and then conclude with the guidance that does include NDS. So looking forward, we are placing our guidance on neither a significant improvement nor a deterioration in global macroeconomic conditions in the near future.
We expect Q1 revenue growth to be in the range of 2% to 4% on a year-over-year basis. As we have said in the past, forecasting gross margin has always been challenging due to various factors such as volume, mix, cost savings as well as competitive pricing pressure. So for the first quarter of FY ’13, we anticipate non-GAAP gross margins to be in the range of 61% to 62%.
Our non-GAAP operating margin in Q1 is expected to be in the range of 26.5% to 27.5%, which is up approximately 0.4 to 1.4 points over Q1 FY ’12. Our non-GAAP tax provision rate is expected to be approximately 22% in the first quarter.
Our Q1 FY ’13 non-GAAP earnings per share is expected to be in the range of $0.45 to $0.47 per share, which is up approximately 5% to 9% year-over-year consistent with our goal of delivering profitable growth.
As we announced earlier this month, we have closed our acquisition of NDS, as with any acquisitions there will be adjustments to NDS’ historical financial reporting as we can form NDS to Cisco’s accounting policies.
The primary changes impacting the NDS income statements are write-down of deferred revenue as part of the purchase accounting adjustments, conformance to Cisco revenue recognition policies resulting in increased deferrals of revenue impacting the timing of the revenue recognition, as well as the classification adjustments that will increase NDS’ cost of goods sold and reduce operating expense.
The classification adjustment is related to a portion of NDS’ technology and development costs, which relate to the customization and integration of NDS’ software or specific customers. As the costs are customer specific, our policies require their classification at cost of goods sold. This will have no impact on the overall profitability, but will impact the NDS standalone gross margin percentage and will be approximately neutral to Cisco’s gross margin percentage over FY ’13.
In addition to these financial adjustments, there will be integration cost for the first one to two year. We expect the full-year FY ’13 impact of the acquisition to be approximately $1 billion to $1.1 billion in revenue and accretive to non-GAAP earnings per share of approximately $0.03 and in the second half of the year, this fiscal year, now we expect that benefit to increase over time.
In Q1 FY ’13, there will be minimal operating income contribution because of the accounting items referenced above and the integration costs. All NDS revenue will be classified as product and included within the service provider video category in our financial reporting.
In Q1, we are anticipating the NDS revenue to be approximately $200 million. We expect Q1 revenue growth including NDS, which is from a total company perspective to be in the range of 4% to 6% on a year-over-year basis.
For the first quarter of FY ’13, we anticipate non-GAAP gross margin including NDF again total company, to be in the range of 61% to 62%. Our non-GAAP operating margin in Q1 including NDS is expected to be in the range of 26.0% to 27.0%.
Our non-GAAP tax provision rate including NDS is expected to be approximately 22% in the first quarter and our Q1 FY ’13 non-GAAP earnings per share including NDS again total company, is expected to be in the range of $0.45 to $0.47 earnings per share, which is up approximately 5% to 9% year-over-year.
We anticipate our GAAP earnings in Q1 will be $0.09 to $0.13 per share lower than the non-GAAP EPS. This range includes our typical adjustments as well as any impact of up to $0.02 as a result of our anticipated restructuring charges.
Other than those quantified items noted 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. And as a reminder, Cisco will not comment on its financial guidance during the quarter, unless it is done through a specific public disclosure.
Related to our July 2011 announcements on restructuring, we have incurred total pre-tax charges of approximately $1 billion to our GAAP financial results to-date. We expect the total restructuring charges to be approximately $1.1 billion, which we will include to the first quarter of fiscal 2013.
This past year, operations excellence was one of our key focus items across the business and we executed as we said we would. This enabled us to continue to move forward on profitable growth in capital return. Our plan is to continue our focus on operational excellence and efficiencies, which we know is important to driving value for our shareholders.
Now I want to thank you again and turn the call back over to John.
John T. Chambers
Frank thank you and well done. As I reflect on FY ‘12, I am very pleased with our execution as a company. We delivered on our commitments to you, our shareholders, to our partners, and to our customers. We changed where we needed to, build around our core products, our channel and services strength, while prioritizing our resources to our five foundational areas. Each of us has a Cisco employee takes pride in our earnings per share growth twice as fast as revenue in FY ‘12.
Our operational discipline and ongoing company evolution is paying off, and the dividend and capital allocation roadmap we outlined today reflect our confidence in our business and our commitment to driving long-term shareholder value. Our products, solutions and innovations are at the heart of major market transitions. We are not just catching, we’re very often driving and leading these transitions. However what is most important to me personally is how we have architecturally tied hardware and software products together to deliver solutions to our customers that achieve their top priorities. And therefore enhance our value to the customers and our ability to achieve premiums in the market and to continue to be among the very best in the industry.
As billions more people and devices come on to the network in coming years, we will be fueling unprecedented innovation, creativity, transformation and opportunity. 15 years ago, we said everything will be connected and ways that were hard to imagine at that time. Today we see the Internet of everything as another driver for our growth and opportunities in coming years.
We always face good competitors and new technology transitions, but our track record of success is among the best in the industry. While our focus will always be on our customers and the major transitions, we are also a company that love to compete.
Our market share position across all of our largest market is the best that I can remember in recent history. And we strongly believe that we are making major gains in share of wallet across many of our top customers. As we look to next quarter, our projections with all the appropriate caveats for revenue growth in 46% is well above that of many of our industry peers. Growing as we have through challenging times reinforces our conviction to capitalize on our expanding growth opportunities when the global economy recovers.
As we look forward to FY ‘13, I want to thank our shareholders, employees, customers and partners for their ongoing commitment, together we will continue to do amazing things and we are committed to managing the company to deliver the value you expect in Cisco.
As a last note, let there be no mistake, we are listening to you, our shareholders the entire company is committed to driving long-term shareholder value creation. Now Mel, I’m going to open up the questions, I want to apologize it’s a little bit long, but trying to do the fiscal year NDS some other transitions and the quarter was a little challenging. Mel?
Okay. Thanks John and thanks Frank. Operator, now let's listen to the questions. We still request that qualified analysts please ask only one question. Operator please open the floor.
Thank you. Our first question comes from Rod Hall with JPMC.
Rod B. Hall – JPMorgan Chase & Co.
Yeah, thanks guys for taking my question. I just wanted to clarify on the capital allocation commentary. You guys had originally linked the dividend increase back to the international cash repatriation, and so I wonder John and Frank, may be one or both of you could comment on what the – if there’s any change in your thinking on the probability of getting any cash back or if you’ve just decided to move on with the dividend even though there’s really no decision made? And then I also wish you guys could clarify a little bit on the macro commentary you made John, because the guidance doesn’t seem, and it’s a little bit weak, it's not terribly weak, but you did say that one of the guys you're talking to are thinking the next 12 months is going to be pretty tough. And I just wonder if you could tell us whether you're seeing them cutting budgets already, or if they’re waiting to take any further actions until you see more evidence in the economy? Thanks.
John T. Chambers
Rod, I'm going to do something that Melissa is going to kick me for. When I answer your two questions, but then I'm going ask all of your colleagues please hold it to one. I'm going to take the easy part of capital allocation and give you the details, Frank as always. And I want to congratulate you Frank, you've been working on this for three quarters, you’ve worked with our finance committee, Board of Directors, we’re waiting for the right time to do this. So I want to just thank you very much. The easy part of the conversation is, no, this is not dependent in any way on repatriation nor are we signaling that. There are a number of leverage that we can pull in this area and putting the leverage together, we believe we’re in good shape to be able to do it with the U.S. case that we will be getting over the next several years. Frank taking the...
Frank A. Calderoni
John, definitely. So as I mentioned on the call, given the stabilization that we’ve seen in our business, and really on the conference that we’re going forward, and as John just mentioned really just the outreach with listening to shareholders over the past year, and what’s important to all of you and trying to balance both the buyback as well as the dividend, and provide a framework on what we want to do going forward over a multiple years and our commitment to that. And that is really what we outlined today to have a minimum and I trust minimum of 50% of our free cash flow that we will allocate through the combination of the dividend as well as the buyback. When we announced the dividend, we did say we would support the dividend over a longer period of time. And this is just a further verification of that, we’ll continue to support that over time and continue as it’s appropriate to support the buyback as you saw, we had $1.8 billion of buyback in this past quarter. But again it’s the provided framework, we feel comfortable based on the analysis that we’ve done kind of looking out in the near-term as far as managing the U.S. cash, be able to make this commitment and we’ll continue of course to be very strong advocate for Tax Suite form in the future as we work through this.
And taking the second part of your question, I’m going to break it into a couple of parts, first when you look at comparisons and these are both for orders and for revenues and revenues you see slide slightly behind the orders by maybe half quarter or a quarter, Q4 last year in orders was our strongest quarter that we’ve seen Rob, and during the last five quarters, and comfortably in double digits and so was Q1. So when you compare comps if you’re really comparing sequential comps, that number would obviously be a little bit different in terms of what you are looking at, I’ll encourage you to think about the market that way. So in year-over-year numbers these are actually pretty good aggressive numbers in terms of the marketplace especially when almost all of our large peers are forecasting flat to down revenues and many of our competitors are forecasting down dramatically in negative or actually double digit negative growth. So we don’t want to get ahead of ourselves.
Secondly, Europe, it will be as fast as you are hearing. Europe for us in the last four quarters, if I remember this right and keep me honest Rob, I think it was 13% four quarters ago, then up 7%, then flat and minus 6% this quarter. We can all draw the curve that’s probably going to get tougher before it gets better and that might last for a (inaudible). We’ve got an amazing team in Costa Rica, team over there. So we will get whatever it is to get, but that’s going to be tough.
Through the positive, normally I wouldn’t be real excited or point our interest, but when enterprise was going down from mid to go back up from 1% to 4% in the U.S. was clearly there and while federal government remain tough for several quarters with government spending going up a little bit, again in the 6% level driven by state and local government, now you all know seasonality, seasonality for state and local government was in our last quarter, so it is heavier in terms of total percentage of business in state and local during Q4, where Q1 is much heavier on federal. Federal business is going to be negative and be tough for several quarters as we look out into the future.
But if you watch the trends, we wanted to just sharing with you, we saw in the last 45 days of the quarter, we also have a good book-to-bill, which you saw in terms of our comments going in and I would want to watch it at least another quarter, but I get real excited on it. Latin America was a little bit soft as we said earlier. But overall, we think we’re getting our share of the market and our strategy seems to be winning well. So, [Matt], you got two answers Rod and two questions, and I will keep my answers tighter at Mill. Next question please.
Thanks. I think your next question comes from Jess Lubert with Wells Fargo Securities?
Thank you. Your next question comes from Jess Lubert with Wells Fargo Securities.
John T. Chambers
Jess Lubert – Wells Fargo Securities, LLC
Hi John, thanks for taking my question and congratulations on delivering a solid quarter in a tough environment. I was hoping you could expand upon what you’re hearing from your service provider customers with respect to their second half spending plans, to what degree do you still expect to see second half improvement and to what degree if there’s been a changing your expectations from carrier business, particularly from some of your North American carriers?
John T. Chambers
So, what we’re seeing in the service provider business, this one we believe we’re taking very good share of wallet spend and we got to win that everyday. And as you’d expect, our new – question was going to be what about the second half of this fiscal year in terms of cap spending? I think AT&T today said that their capital spending in second half of the year would be up over the first half of the year, that’s what we were expecting from them.
If mixed across the U.S., I don’t believe there is a flesh going to occur in terms of dramatic differences, second half of the year versus the first half. Asia-Pacific, we’re modeling pretty solid, and I think, [it’s already] done there, and what we see in Japan and in China and now started in India finally Rob. We are in good shape on, and we’ve done very well in Australia and in Korea already. That looks solid, we’ll get our share spin there. Balancing that, however, is very tough comps, because service provider had very tough comps in Q4 and Q1, and two of this last year. so that kind of, I think balances a little bit of what you’re seeing momentum wise, European service providers especially the large, what we call the large five or six are going to not be spending much in the second half of the year when compared to people what they might have thought six months ago.
Most of them are going to be very conservative in our opinion over the next two quarters. And we’ll get our share spin there and share of wallet and again, with that [one interest] there, I think would do well versus what’s available, we’re modeling that a little bit tougher. So overall, in service providers, we’re positioned extremely well, balanced dramatically different across the three theaters, and we think we will gain share of wallet as we go forward versus almost all of our peers, especially in the Routing segment, where we were real pleased about how much share we’ve taken. Thank you, Jess.
Okay, thanks, Jess. Next question?
And your next question comes from Brian Modoff with Deutsche Bank.
John T. Chambers
Brian Modoff – Deutsche Bank Securities
Hi, John. A question here, obviously you’ve addressed a little bit on SDN, but how do you see Cisco competing with VMware and Nicera in network virtualization? Do you see a need of beep up there? Do you see that have any effect on DCE, or maybe relationships that you have? Can you talk a little bit about that please?
John T. Chambers
Well, when you really think about SDN, I want to be very candid. We think the future is going to be hardware and software combined. we think when you have knowledge of the network, and are able to know what’s going on in the network, you can program to it. You can get dramatically better flexibility, et cetera. Its nice way of saying, we think it’s going to be A6 hardware and software combined.
Secondly, if you watch why we’ve done in this area, we saw virtualization coming early. So it wasn’t like its knock up on us. We went into the virtualization with the Nexus 1000V in 2009, which is exactly who entered the data center market with the UCS and our movement there. So we saw both of these trends coming.
Our view on this SDN OpenFlow in the same type of activity, as you are really looking multiple years out in terms of its impacts one way or the other. And our ability to handle transitions with our partners when it times compete and times partners has been unprecedented in the industry.
So as we look forward, we’re completely saying committed with VCE and our ability to work together. We are looking at the innovation that we can do in our market, and we will have partnerships like what occurs of Microsoft and IBM and Citrix in this area as well. So good growth this last quarter, but if you look at it, we think we will encompasses and really an architectural play pretty aggressively. Rob, would you add anything to that?
Just John that we obviously expect to leverage the strength of our install base, which is pervasive across the data center, multiple ecosystem players, we’re going to support multiple hypervisors, multiple applications and operating systems. So we’ve got that working underway in every area. And we can’t forget some of the innovation we got going both inside and outside the company.
John T. Chambers
Just want to add, with VMware and EMC, it’s been a very strong partnership. We’ve both benefited greatly from it. They candidly need us and we like very much being a partner with them. So, I think you’ll see us worked this out in terms of our direction. But we are going to be an open player, and we’ve shown in the marketplace when we compete, we can be really very tough. Thanks, Brian.
Thanks, Brian. Next question?
Thank you. Your next question comes from Simona Jankowski with Goldman Sachs.
Simona Jankowski – Goldman Sachs Group Inc.
Hi, thank you very much. Just wanted to ask a question about product gross margin, I think you said it was 60.4%, which is the lowest it’s been in quite sometime and I think one of the drivers you said it was pricing. So if you can just give us a few more examples of what areas you’re seeing pricing be a factor in particular? And then also on a go forward basis, can you comment on how you see product growth margins, especially now that they include NDS?
Frank A. Calderoni
Okay, Simona. If you look at where we are going, the pricing on a global basis has not changed, I don’t think materially in the last one to two quarters. Those people who come and ask about price and unbelievably aggressive pricing at our bids. We are now learning how to compete very effectively against and our comfort level in competing not with our traditional players in the marketplace, some of whom – some people had concerns 12 to 18 months ago. But taking on Huawei and others, we are getting very good on doing.
So, on a global basis we do not have normal pricing in any area. Anytime you win large deals in emerging markets such as China and India, especially, in service providers, those have tighter gross margins and clearly you saw us win some of those these quarters. So I would not say that it’s an unusual pricing environment, you just see time certain pressures based upon size, bids and also geographic issues, mix is probably something that I watch more and it was a positive mix when you have 90% growth with UCS and the Nexus. And well, the two together are clearly better than our server margins, it brings us down a little bit in terms of the direction. Frank, what would you add to that?
Frank A. Calderoni
Yeah, John. So we gave guidance for the quarter, for Q4, 61% to 62% came in at the high-end of that 61.9% overall at our product margin. As you said from a pricing standpoint, the pricing has been so stable now going on about two years, if you look at it from a quarter-on-quarter standpoint in the range of what we had expected. Yes, we did have a mix impact as you mentioned primarily from data center strength, which was positive. We also had a manufacturing cost was higher in this quarter driven by warranty costs. If you would kind of just normalize that Warranty Plus and Warranty Plus do kind of come up and down from quarter to quarter and you look at the margins going back, fairly consistent I would say from that perspective. And Simona, it’s been – also a good thing as far as going forward, similar to what we’ve done this past year, tremendous amount of focus on gross margins.
We have now incentives across the board from a leadership standpoint in the sales regions as well as in our business groups that are focused on profitability, which has been driving a lot of the emphasis on project like value engineering, which we saw great improvement on this past year and which we now going to see some further leverage as we move into FY ’13 and we’ve been investing more in FY ’13 to see that continue as we move in to FY ’14.
So many initiatives continue on the margin. And then I would say, as far as the guidance that we gave today for Q1, consistent guidance, 61% to 62% overall, which I would say, if you look at it from even a product standpoint, fairly consistent from a quarter-on-quarter standpoint, when you take into consideration the items that I mentioned.
John T. Chambers
Gary, you’ve been driving for us more discipline and really focus on profitability and value added engineering and even how we measure each of leaders in terms of profitability, maybe you can just spend a little bit of time on trends here and how that’s going to help us in the margin picture over the next year?
Yeah, John. So as Frank pointed out, when we started the transformation work last October, we invested more money in value engineering, which goes beyond just value engineering, it’s value design. So bringing together the engineering teams with the procurement teams as well as the overall supply chain team has really driven value and Frank and I set targets for them. They hit the targets, which we thought we set pretty aggressive targets. And that’s just one area where we think we have leverage to continue to drive the efficiency and effectiveness to drive profitability higher and certainly higher than revenue as we go forward.
John T. Chambers
Frank, I want to particularly thank [Ian Collard] and Kelly in how well they worked on your team, maybe you’re interfacing to engineering and manufacturing and making me well here. So it’s amounted to the indirect part of your question, we don't see anything unusual occurring in pricing, or margins, and while it’s always a possibility that's been wrong. We’ve actually been getting more accurate about forecasting that and mix rather than to be worse.
Great, thanks, Simona. Next question?
Thank you. Your next question comes from Ehud Gelblum with Morgan Stanley.
Ehud Gelblum – Morgan Stanley
Hey, guys, thanks. I’m just trying to speak my clarifications to make sure I understood them correctly, and then my real question. On the clarification, Frank, you gave lesser numbers, there were some $10 billion free cash flow last year assuming that’s roughly run rate, 50% payout of that as $5 billion and your new dividend rate will give you roughly about $3 billion a year in dividends. So that would leave about $2 billion for buybacks, you just did $1.8 billion in buybacks this last quarter. So the math that I just went through, almost I did it wrong, I just want to understand if I did do it wrong.
Frank A. Calderoni
We’re going to count there is a question…
Ehud Gelblum – Morgan Stanley
Let me ask my other question. My other question – I can throw that out there, and you can answer it any other time, because it would imply that, buybacks are going down. My other question really is when you look at your product order growth, it has now gone for the last couple of years where we have easier comps and your product order growth accelerates, and then you hit the tough comps, and your product order growth starts to decelerate for the last couple of quarters, I have it going down a few quarters in a row.
Are we in a world right now where product order growth accelerates for year that has easy comps and tough comps and decelerates and hit the easy comps and accelerates and that's kind of the pattern as we just kind of anniversary back and forth, or do you envision away, I know you’ve structured the company in a way that we can actually have a multi-year order growth reacceleration, because something breaks out of them hold, or something else takes hold?
John T. Chambers
Okay. So on the question, we deliberately word it as a minimum of 50% of CapEx going into that. you’re going to see us be aggressive, bit of opportunistic and predictability, we wanted to get the dividend to allow all that the shareholders clearly understood we’re committed to and if we do our job right at the right times we’re committed to raising. We also have been aggressive in share buybacks, and you continue to see us we’re appropriate to do that. So I was kind of thinking about the question, my sense of humor is getting better here or at least I think it is, Frank, would you add anything to that?
Frank A. Calderoni
I know that’s true, and then I wanted to stress that, because it’s the framework of the multiple years, and it’s also to set a minimum, so that you can expect us to at least get to the minimum. The other thing I just want to add the question was answered before, as far as when you look at U.S. cash and the question that came up on the tax rate. One thing to add that we factored in especially when you look at it in the near-term let’s say over the next year or year and a half. One of the other factors that does give us a little bit more flexibility from U.S. cash position as we periodically make some distributions of our cash to U.S. from somewhere our foreign subsidiary earnings, these are some earnings that have been previously taxed by the U.S. so we have a little bit of flexibility there, and that’s also have been factored in as I look at – or I take into consideration the commitment that we’re making on the 50%. So again, that does add, we had little bit of benefit from that just in this past quarter. if you kind of look at the overall balance sheet and will continue to see some of that in the near-term and will factor that in as far as distributing the cash to the dividend as well as the buybacks.
John T. Chambers
The answer to your question about overall product order growth and how you’re going to see waves like this, lowered not, I hope not, we went through the toughest recession in our lifetime and we went through an European Union issue that has shaken the world’s confidence and yeah, we navigated through those I think pretty well. And if you look at profit growth, which I think all of you have encouraged us to focus on as much or more than the revenue growth, we grew profits last year twice as fast as revenues and that’s non-GAAP profits. GAAP profits actually grew in the 21% and 27% range respectively. So, no, I would not expect this and it’s a lot easier to manage through normal times, but these are two or probably the three toughest economic times that I’ve seen in my lifetime and I think to be growing at the rates we did and gaining market share like we did, I’d have to give the Cisco team pretty good marks.
In terms of are we going to move over time to a more predictable revenue stream, the answer is yes, we do that too fast, you see short-term growth rates dropped. So we got to evolve into that. And so when you see models like NDS in terms of what we do with NDS and keeping their revenue stream and actually using it as the model for the future as opposed to the path that’s been able melt to not have a base behind this. So, we can build this revenue stream as good.
And if you watch what we’ve done with some of our products at multicore EDGE as an example, we’re leaning how to price both on the product itself and then price for software additions and be able to add and bring up gross margins over time. So, you’re beginning to see as we think this through, Gary and team and Rob and team have a lot of work going on to this. And so making that revenue stream a little bit more predictable is the key, making that transition from primarily acquisition to a regular revenue stream over the period of years, we have to do that delicately as you would expect.
So, I had answered your question, I hope not on order growth fluctuations, none of us want to go through the last three years or four years again. And in terms of, do we see our ability to transition through this and became a little bit more predictable, I think we’ve got to, we just have to be careful in the transition. Ehud, I hope that answers the question okay?
Ehud Gelblum – Morgan Stanley
Yeah, and I guess Frank does agree that your sense of humor has been better.
Frank A. Calderoni
I like your sense of humor.
All right, thanks Ehud. Next question please?
Thank you. Your next question comes from Tal Liani with Bank of America/Merrill Lynch.
John T. Chambers
Tal Liani – Bank of America/Merrill Lynch
Hi, I also have clarification on the question. So let me just stick with one clarification part. The how much of your cash flow is generated in the U.S. I am trying to reconcile between dividends and buybacks. I assume that buybacks are done also globally when you buy ADRs and convert them, but dividends have to be paid in U.S. dollars, in domestic cash flow generation. So when I do the math of how much cash flow you generate and then deduct the dividends, I'm not left with much for U.S. cash flow to do the buybacks unless most of your buybacks are done overseas. So I'm trying to understand the dynamics of the global use of cash flow from a buyback perspective and from a dividend perspective. Thanks.
Frank A. Calderoni
So, first of all, if you look at from a buyback and from a dividend perspective, both have to be funded as U.S. cash. As you know, we mentioned we had a U.S. cash balance in the end of the fourth quarter about little over $6 billion and that would be what we'd use for both the dividend as well as the buyback and any other U.S. need that we have, we have to fund out of that. We will continue as far as forecasting what we will generate in U.S. from an operations perspective and work in that flow.
The other aspect as I mentioned just a few minutes ago is probably taking into consideration some previously taxed cash that we have which is outside the United States that we have the potential right now based on our analysis to bring back and use as part of this in the near term. And I have clearly I wouldn’t go out there and make a commitment to a plan or a framework with the 50% commitment if we didn’t have the ability to kind of work through that. But the dividend right now with the increase that we have today would be about $2.8 billion on an annual basis and then the buyback of course does change from quarter-to-quarter, and we’ll have to work that in based on opportunistic as well as just kind of where we can fund that and work that through. But we’ve done extensive planning looking at this based on expected business results, and be able to work this through, and then we'll continue to always look at, as I said before, ways of being a strong aggregate for U.S. tax reform as we go into the next several years, which of course would give us even more flexibility.
So we are not stepping off that, we think regards of who wins, this is something our country needs to do and we’ll see what we can do as a industry and a business group in the period between the election and the next president becoming in the role. And we all know that there’s one President that’s already committed to supporting this, should he get elected in terms of the changes that need to be made?
In terms of the overall process, it’s more data point, cash from operations was $10.5 billion this year, a year ago it was $10 billion, that’s additional $1.5 that you should begin to think about our models. Lots of levers that Frank can pull, which ones he pulls in which sequence and which ones don’t get pulled, that’s really your call, Frank; I’m very pleased with what you’re doing and making this commitment. Thanks, Tal.
Great. Thanks, Tal. Next question, please?
Your next question comes from Mark Sue with RBC Capital Markets.
Mark Sue – RBC Capital Markets
Thank you. Gentlemen, if I look at Cisco from a S curve point of view, we went from a growth phase to now a stabilization phase, which results in faster profit growth and higher cash generation, which you’re commendably returning to shareholders. What happens next on the curve, and how do you fund future innovation so that the trajectory of the curve points higher, and can you do that without growing expenses or do you take the approach of exiting certain businesses, and then acquiring higher margin software companies?
Frank A. Calderoni
I’m going to take the easier part, which is really talking about growth opportunities. Then Gary, I’m going to ask for you to fill in, in terms of how much we’re freeing up resources to be able to move them both in terms of productivity duplication resources, layers, et cetera, which is what we did in this last change, and move into where the growth is like emerging markets.
In terms of the opportunities, Mark, I don’t think we’ll surprise you in a big way, but there are lot more opportunities, we can go after than we can bring down, so we’re going to stay within our five foundational frameworks with mobility and security, any across those, but even within those, when you think about the Internet of things, you begin to think about smart grids, you begin to think about how we do connected industries, how we really put this capability to work and drive video in a big way, each of those are major growth opportunities. And so what we will try do is share with you where we think the growth opportunities will come in normal times, and I think all of us would agree this is not no more anywhere near close to it. GDP growth in the U.S at 1.5% to 2% is anemic, growth in Europe and a full blown recession where every major country in Europe is showing negative year-over-year comps in mid to high single digits that is anemic. What we’ve seen in challenges in Asia, even though we’ve managed through them pretty well have been challenging.
So I think you’re talking about an economic question, I think you’re talking about our ability to move into new markets, and our ability for current core markets to grow, so I think it’s a combination of that. Now however, one thing that we’ve got much more discipline about and Gary, I really want to compliment you, and the whole team, but Rob, you and Frank as well as we’re starting to say, where do we have resources that we are choosing it effectively, how do we realigned that resources with productivity implications, how do we move into emerging markets effectively, how do we not have duplication of efforts across the board, so Gary, your thoughts.
Gary B. Moore
Yeah, so Mark, we wouldn’t make the commitments that we’ve made, if we didn’t feel very confident that we still have operating leverage to bring to bear here. I think we’re much more confident than we were a year ago about our disciplined focus approach, I think as the business is being well managed, you wouldn’t see the results we achieved in Q4 or for that matter FY ‘12, if we want it. But we still have a number of transformational things going on that drive revenue, reduce expense and make us more efficient.
So without going into detail in every one of those, we’re very confident that we still have almost 1,000 full time equivalents working on these programs to look at things. And what you don’t see is, during the last several quarters, internally we’ve also realigned 1,000 people, every quarter to the priority.
So if you think about what sales is doing, if you think about what engineering is doing, services and the rest of the business, we’re putting our best people where the greatest opportunity is, and we’re putting our resources where we have significant opportunity.
John T. Chambers
Rob, could you expand a little bit just to get market feeling, for example what you’ve done in sales, and how began to share the common resources, take players out, move resources to where the emerging markets are, et cetera?
Sure, John. We’re now a full year into creating these three regions with the vast majority of our go-to-market sales resources all under one of those three leaders. You can see right now that as the opportunities in emerging markets exists, we’re shifting investments and resources into emerging markets, and out of some of our slower markets in Europe, you can that we can prioritize architectures and investments across the board.
So the idea of creating that very simplified operating model with the vast majority of our resources is allowing those regional teams to actually move much more quickly, and we can see that in some of the results.
John T. Chambers
Yeah, what’s been exciting Rob, as you’ve done this, and when I look to your regional leaders in the eye, and your key VPs and Senior VPs and say how much effect this is going to have on the business, they’ve been in unanimous agreement, almost none, it will actually accelerate business overtime in terms of the direction.
So just giving you a feel Mark, we clearly understand the question you’re asking both directly and indirectly. We think we’re going to be even more disciplined and focused and we also think that, I always believe and hope this is not the market we’re in for the next ten years with the current slowness.
Great. Thanks. Next question, please?
And your next question comes from Grady Burkett with Morningstar.
Grady Burkett – Morningstar, Inc.
Yeah, thanks a lot for taking my questions. Looking at security, it looks like we’ve seen six quarters of sequential growth in this business. And it seems like the business is kind of turned the corner. Can you talk about what’s working in our business and what kind of things you can do to maybe start taking share and drive growth little faster?
John T. Chambers
Okay. If you watch what has happened in security, I think it’s a combination of issues. It’s been one that we’ve always felt architecturally could go across all of our products and time together in a unique way that no one else in the industry can replicate and our customers (inaudible) how to do that.
Second, we made some changes in the leadership there and I just want to congratulate Chris Young and the team that they are bringing together. We’ve got leadership teams we really believe in. Third, the way Gary structured engineering, we’re now moving much more effectively and crisply across the groups to say when we say, we’re going to go after securities, this is what we expect each one and each group to be able to do. I like their plans and directions and Gary may surprise you, but (inaudible) Chris let me to meet the other end. I think this is one that we can do a lot better growth on but it can be the best example of how we tie it all together.
So I like the movement, as you saw we got our growth primarily in network security, farewells et cetera on that. We got to expand that and get an architectural plays to move forward. Thanks Grady.
Thanks Grady. Next question please.
And our next question comes from Sanjiv Wadhwani with Stifel Nicolaus.
Sanjiv Wadhwani – Stifel Nicolaus & Company, Inc.
Thanks. John, I wanted to take another crack at the order growth situation. I understand that year-over-year comps are tough, but just going through the other metrics you’ve given which is your backlog is up I think 11% year-on-year, your book to bill is comfortably above one. But your order growth is still about 2%. So just trying to see if there is anything we can go through to help us explain sort of the disconnect over there?
John T. Chambers
Well, as you will see in our Q report, our backlog is up about $500 million versus last year. We clearly went out of this year with a good backlog, which is what you want in all Q4’s, because our orders come in very back-end loaded. In Q1, as you know, the order rate was – it’s always off dramatically versus Q4 even doing double-digit growth years.
In terms of the comps, the comps are tough when you have 12% or 13% growth in a quarter, and you compare with the next year to that, the comps in quarters where you only have 2% or 3% growth i.e. Q3 and Q4 this next year are lot different. So just with normal execution you’ll begin to see things balance throughout the year in terms of the comps.
The second issue is, we’re taking share at the present time, and our peers are all almost all at negative or flat growth. So for us to be at 4% to 6% or something, we are pretty pleased out in the industry given the economic challenges involved. I just don’t want to see ahead of this, we are gaining share at the present time, if the economies turn, I’d expect that to do better as they return, but I don’t want to mislead you, Europe is going to get worse before it gets better, and federal government spending is not going to improve in the short-term here in the U.S. So we are focused on share wallet where we want to be one and two years out, and I hope we’ll be apologizing to you a couple quarters out about being conservative. But I think these are pretty candid and aggressive numbers at the present time, especially based on what we’re seeing from our peers.
John T. Chambers
So I didn’t mind you taking a crack at me second time on Sanjiv, more than fair.
Thanks, Sanjiv. Next question, please.
Our next question comes from Paul Silverstein with Credit Suisse.
Paul Silverstein – Credit Suisse
Yeah. Hi, John. If I could return you all to the margins, two questions. One, Frank, can you quantify price impacts, historically it’s been running about 250 to 300 basis points of degradation a year. I heard the comment that there was nothing extraordinary about pricing, but if you could speak to that. Then a question, related question on operating margin; 34% is the best you have done in terms of OpEx as a percentage of revenue, going back to the telecom bubble days, you got to get back to fiscal 2000, you are at 34.5% now, I heard your comments about further improvement. Can you talk to that 34% benchmark?
Frank A. Calderoni
Paul, as John mentioned before, I mean, again if you look at the pricing aspect of, I mean, you can see it in the filings that we provide, the amount of impact on the pricing has been fairly stable from a quarter-on-quarter standpoint and that really hasn’t changed much as we look back over as I said eight quarters. I am not sure what more I can share on that from that perspective. But if you look at, pricing from the standpoint in the last quarter, it’s in the range of about half a point as far as how it impacts from quarter-to-quarter and again that’s fairly stable as you look at it over a number of quarters and that’s what we would anticipate.
The other items in gross margins I mentioned, you always have a mixed dynamics, it usually get benefits from a cost perspective; this quarter, we had more of a warranty impact that kind of took us on the negative side.
Now as far as the operating margin, yes, 34% is at a low level from what we had before. That is not – we’re not saying we want to obtain it, we will continue to work through, I mean we are also looking at a period of time where we are going to be investing in the portfolio to make sure that we have strategic investments that we need to make, a lot of that’s going to be done through just continuing to be much more efficient in aligning our portfolio as we work through it. And as Gary mentioned before, we continue to drive areas of productivity and efficiency continuing on some of the things that we’ve put in place over the last year to 18 months.
So the overall, if I stand back and look at the overall commitment to what we’d talked about last summer at the end of the last fall I should say we kind of looked at a three model revenue growth in that 5% to 7% range, profits growing at 7% to 9%, so better than balanced growing profits faster. And with that you’re going have to see some leverage that’s Gary talked about. But we’ll have to continue to see how that plays out, but that is the objective that we laid out and one that we use as a management team to make sure as we make the decision we follow through on it.
John T. Chambers
Thank you, Paul.
Great, thanks. Next question.
Thank you. Our next question comes from Simon Leopold with Raymond James.
John T. Chambers
Simon Leopald – Raymond James
Hi, thanks a lot. I know they will get my question in. I wanted to follow-up on some of your commentary around data centers and thank you for the clarifications on software to fine networking, because I think that has caused tons of confusion for folks. But maybe if you could elaborate a little bit to help us with some context and there is really two parts to the one question and legitimately two parts with one question.
John T. Chambers
Simon Leopald – Raymond James
In terms of data centers, if we could get an understanding of your total revenue to derived from data center, so not just the data center segment, but if we’re to get an understanding of the overall revenue coming from the data center markets including other switch and products going in routing. I’m believing it’s between 10% and 15% of revenue, I want to make sure that that’s correct. And then just drilling down on the partners, I think there is some concern about the co-optation environment that you addressed. But if we could get an understanding of your diversification or dependency on partners beyond the VCE partnership, but how much is coming through partners indirect in that data center vertical in particular? Thank you.
Frank A. Calderoni
Okay, Simon, for the first part it’s almost impossible for us to get that answered. It’s not that we shouldn’t go through and look at it may be at future times think about how we’d answered. If you look at our run rate in what we consider data center and cloud that's primarily the UCS categories except or the run rate is well over $1.6 billion type of run rate in terms of that segment. We are up to over – I think 22% market share in North America, number two in terms of that segment and rapidly closing and the global market just little bit behind the number two player in terms of direction.
Our value to our customers has probably never been more relevant to the data center and where we’re going to go. And we – Rob made on a heavy comment, we work across not just in EMC, VMware partnership, which is very good and very strong and very successful but we are an open standard in terms of where we go here. And we fully will control our destiny not to be dependent on anyone in terms of our long-term strategy although strategic partnerships must be a part of achieving that strategy. Your thoughts, Rob?
Well, I think John as well you mentioned the Cisco 1 developers’ approach where we're going to give programmatic access to our operating systems. I think it's going to have big impact on the value the customers can subscribe through our data center portfolio, and it's something that we plan on leveraging going forward. So I think it's an ecosystem play John in summary, great relationships across multiple environments, and that's exact what our customers expect.
John T. Chambers
I've seen this multiple times before also when we look at markets and there’s often lot of excitement three to five years before it really is impactful some people might think. And each time that has occurred Cisco is not only responded will, we usually lead the transition. We're very comfortable doing it again, and as I said earlier, this didn’t speak up on a sweet note, it’s coming for well and you’ll see us address it through strategic partnerships, partnerships where we compete and partner at times you see us address it to internal start-up, see us address it to spin-in an acquisition, and it’s a firm and the play out. The nice thing is and this is the advantage of not being the big incumbent and this is largely new Greenfield trust to be going into in the direction, and if you think about Cloud and you think about virtualization, it is more network centric than any things been done. you got to know the network in this, and while there’s always a chance we’ll be wrong, I think we’ll be three to five years from now and saying, it was about the network and the structure.
Next question, please.
Thanks. Our next question comes from Brian White with Topeka Capital.
John T. Chambers
Brian J. White – Topeka Capital Markets
Yeah. Hi, John. The cloud market, 50% growth phenomenal and as we look forward, I’m wondering if there’s any other pieces to the puzzle we need to add here specifically, storage big data and what type of use cases, are you seeing in the most success in the storage market, is it in the Cloud market, is it more with enterprise customers and more with carriers?
John T. Chambers
Okay. Mel’s give me the signal that that’s the one we’re going to kind of end on in terms of our last question. so we delivered to you all being done by 3’o clock as we said we would on it. In terms of the cloud, the numbers and thank you for the complement of 50%, it was actually even better 90% revenue and 58% on the orders. And it does speak to a market where we’re just starting to get penetration and while we have very good share versus the market, the server growth and our blade servers as well, all other growth is going as opposed to back and that’s where our strength clearly is.
In terms of the use case board, we’re getting a lot of use and Rob, I’m going to ask about how service providers are going to do that, and some of the things we do with hosted unified communication to you in a second. I’ll take the enterprise piece. The enterprise piece, when you look and we’ve done our own surveys and we’ve looked at some outside surveys, we’re getting the vast majority of the true production clouds in the enterprise space, bid office Cisco and our partners and our win rate there is extremely, extremely good. Service provider sits even better, because very often they consider to close the incumbents in the data center actually competitors and Rob a little bit about both what we’re doing from a positioning perspective and a little bit, how they’re using more than just in their service provider space.
So I think across our portfolio, John the number one used case is private cloud. We’re seeing obviously the move towards converged infrastructure playing very well for our strengths with UCS and the partners we have. The trend is our enterprise customers are looking for more benefits from automation and actually taking the benefits of virtualization even further.
Second most popular used case is for cloud providers where they’re looking at provisioning and management as the number one area of focus. One of our used cases is extremely strong, it’s our own call control, call manager operating as a hosted collaboration solution where we have dozens of service providers delivering call control as an enterprise class application from those centralized data centers.
The third used case is massively scalable data centers which we’re winning in and you’ve mentioned that before about our position there and the strength we’ve seen and some of the innovations we’re bringing in those areas. And then obviously there are multiple used cases that exist across the board. But those are the three that we’re focused on, we’re winning in enterprise cost apps, we are seeing Microsoft and SharePoint and other applications, we’re seeing SAP and Oracle in our virtualized environments. And actually I think our strength is that we are bringing this infrastructure to enterprise class applications and matching service providers trying to drive services for business apps.
John T. Chambers
Yeah, it’s interesting. I’m going to talk about the sales meeting Rob a little bit more, but we had two really good competitors medium size that recently have said the same thing from their sales leadership to their field. And that is, that at Cisco sales technology and you compete against Cisco in technology you got a chance. The minute this goes to the business decision makers, then they begin to look at a business impact, cost of ownership where they’re trying to achieve their business goals, they’re now telling these teams when I’m with the major wireless player and when I was a major switch player in the data center. There are just saying you need to go away, you’re not going to beat Cisco there and it does speak to how our strategies come and melt together. It isn’t about standalone products, it’s about how do you solve customer problems, not just in theory, but having the services behind it Gary, which your team is doing amazing on having the capability to think about how you solve their problems with the British government. I mean, we did everything from job creation to education to help in the needs London in terms of the implication to point of the Olympics, to be an example how you do innovation within a country and tie together the innovation centers, that’s a different conversation than any company in the world has with the government leader.
And it’s our ability to really pull that together and to teach ourselves was Rob, which I know is very key, they’ve not – go just learn products, they’ve got to learn product technology architectures and then they can learn how does this solve their business architecture, but brand would be the first one that [gets] up to our enterprise environment to say that he is staring to see our ability to sell that, be more and more across the plan or at least in the business levels, Gary, our ability to pull together services and I guess that’s the right one to wrap up on Mel.
Bottom line for the quarter and for the year, we did what we said we would do, very pleased with the results. We appreciate your confidence and trust in us and continue to appreciate us on the challenges, our strategy and vision appear to be working well, we wouldn’t have done the dividend commitment and the cash commitment, if we didn’t see stabilization in our business and have good confidence going forward, and most of the major market transitions were all over, and a couple of them where we got good people we can do even better, and I think you all brought it up in a couple of your questions, and that’s what you saw reflecting our guidance probably more aggressive than most – any of our peers and the industry will see if that’s the right scenario or not and thank you for your confidence. Mel, let me turn back over to you.
Thanks, John. Cisco’s next quarterly call which will reflect our first quarter FY ‘13 will be on Tuesday November 13, 2012 at 1:30 pm pacific time 4:30 eastern time. We will hold our annual shareholders meeting on 30 November, 15. Downloadable Q4 and FY ‘12 financial statements will be available following the call, including revenue and gross margin by geography and revenue by product categories. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet 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 the 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 is done through an explicit public disclosure. Please call the Investor Relations department with any follow-up questions from this call. Thank you for your participation and continued support. This concludes our call.
Thank you for participating on today’s conference call. If you would like to listen to the call in its entirety, you may call 866-493-8039. For participants dialing from outside the U.S., please dial 203-369-1749. 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 www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!