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Cisco Systems, Inc. (CSCO)

F2Q10 (Qtr End 12/31/09) Earnings Call

February 3, 2010 4:30 pm ET

Executives

Blair Christie – Senior Vice President, Corporate Communications

John T. Chambers - Chairman of the Board, Chief Executive Officer

Laura Graves - Investor Relations

Frank A. Calderoni - Chief Financial Officer, Executive Vice President

Ned Hooper - Chief Strategy Officer and Senior Vice President of Consumer Business

Rob Lloyd - Executive Vice President of Worldwide Operations

Padmasree Warrior - Chief Technology Officer

Analysts

Mark Sue – RBC Capital Markets

Tal Liani – Bank of America/Merrill Lynch

Jeff Evenson – Sanford Bernstein

Simona Jankowski – Goldman Sachs

Ittai Kidron – Oppenheimer

Brian Modoff – Deutsche Bank

Nikos Theodosopoulos – UBS

Sanjay Badwani (ph) - Stifel Nicolaus

Paul Silverstein – Credit Suisse

Richard Gardner – Citigroup

Simon Leopold – Morgan Keegan

John Marchetti – Cowen and Company

Paul Mansky - Canaccord Adams Analysts

Presentation

Operator

Welcome to Cisco Systems’ second quarter and fiscal year 2010 financial results conference call. At the request of Cisco Systems today’s conference is being recorded. If you have any objections you may disconnect.

Now, I would like to introduce Ms. Blair Christie, Senior Vice President of Corporate Communications for Cisco Systems. Ma’am, you may begin.

Blair Christie

Great. Thank you Bridget. Good afternoon everyone. Welcome to our 80th quarterly conference call. I am joined by John Chambers, our Chairman and CEO, Frank Calderoni, Executive Vice President and Chief Financial Officer, Rob Lloyd, Executive Vice President of World Wide Operations, Ned Hooper, Chief Strategy Officer and Senior Vice President of Consumer Business, and Padmasree Warrior, Chief Technology Officer, as well as Laura Graves, our Director of Global Investor Relations.

The 2Q fiscal year 2010 press release is on US High Tech Market wire and on the Cisco website at www/newsroom.cisco.com. I would like to remind you that we have a corresponding web cast with slides. In those slides you will find the financial information we cover during this conference call, as well as additional financial metrics and analysis that you might find helpful.

Additionally, downloading Q2 financial statements will be available following the call, including revenue by product and geography. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statements can also be found on our website in the investor relations section. Click on the financials of the section of the website to access the slides and these documents.

A replay of this call will be available via telephone from February 3 through February 10 at 866-357-4205 or 203-369-0122 for international callers. And is also available from February 3 through April 23 on Cicso’s investor relations website.

Throughout this conference call, we will be referring both GAAP and non-GAAP financial results. The financial results in the press release are unaudited. The matters we will be discussing today include forward looking statements and as such are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent annual report on Form 10K, quarterly report on Form 10Q, and any applicable amendments which identify important risk factors that could cause actual results to differ materially from those contained in the forward looking statement.

Unauthorized recording of this conference call is not permitted. I’d now like to turn it over to John for his commentary on the quarter. John?

John T Chambers

Thank you, Blair, and welcome back, by the way. During the opening comments of the conference call, I will focus on what I view to be the key take-aways for Q2, fiscal year 2010. First, from a very candid discussion about what we are seeing in the market on a global basis relative to Q2 and its effect on our Q3 fiscal 2010 expectation.

Second, an update on our rapidly improving financial measurements and some interesting geographic and sequentially quarter metrics. Third, a high level summary of some of our investments and results in new market adjacencies in Q2. And then finally our revenue guidance for Q3 fiscal year 2010 with the appropriate caveats.

Following these opening comments, Frank will provide additional details on Q2. In the third section we will focus on business pro minimum from a strategy, customer segment, geographic and product basis. Frank will then follow with additional financial parameters around our guidance. I will then wrap it up with some comments in terms of Cisco’s momentum going into the Q3 fiscal year ’10. And finally our Q&A section.

From a summary point of view, I think there were a number of key take-aways from the results in Q2 fiscal year ’10 and I will attempt to cover these at this time.

First from a financial perspective, the second quarter was very strong. Well exceeding even our own optimistic expectations. The financial results were in my opinion outstanding. Revenues of $9.8 billion increasing 8%, year over year were dramatically above the high end of our expectations of an increase of 1%-4%.

Q2 revenues showed a 9% sequential increase over Q1 revenues. The highest fiscal Q1 to Q2 sequential increase I’ve seen in the last decade.

Non-GAAP earnings per share of $0.40, a $0.25 year over year increase was again, well above our expectations.

Expense management was very solid with non-GAAP operating expenses as a percentage of revenue at 35.3% versus Q1 37%. Non-GAAP product gross margins were very solid at 65.6%. Case generated from operations in Q2 was approximately $2.5 billion. And we repurchased $1.5 billion of stocks during the quarter under our repurchase program.

Non-GAAP operating income as a percentage of revenue was a very strong 30.3% versus Q2 29.3%. Non-GAAP net income of $2.3 billion was up 25% year over year.

To put the sequential dramatic improvements of non-GAAP net income as an example in Q2 into comparable terms, Q1’s net income was a decrease over year over year of minus 15%.

Product book to build was approximately one. Services continued its strong growth with year over year revenue of approximately 6%. In an area that we have not discussed since the start of the downturn for obvious reasons, productivity has increased dramatically during the last two quarters. The data behind this is going back to last Q1, revenue per employee increased to $558,000. Which was up 8% over Q4 of fiscal year ’09. Q2 revenue for employee was $606,000, which was approximately a 9% increase over the prior quarter.

Parts of the increase was due to just raw revenue growth. But we believe in equal amount was due to our new organization structures and use of our own collaborative products. We were very pleased with this when you consider that out of the 30 plus market adjacent fees we’re moving into. Many of them do not have any measurable material revenue contribution at this time. Even though we’ve allocated a large amount of head count to these new market adjacent fees. In other words, we believe our real productivity was well above the hard numbers.

The market over the last year has evolved pretty much as we expected and indicated in our conference call. Q3 last fiscal year was the bottom. Q4 is our option, FYI. Now as we said at the time, was a tipping point, the beginning of the upturn from a capital spending perspective. Q1 fiscal year ’10 saw an acceleration in the first phase of the recovery. And in our option Q2 marked the second phase of the recovery, with additional across the board acceleration, in other words balance across the board, in all our geographies and market segments.

We saw very strong balance growth from a year over year perspective in almost all of these major geographies and market segment categories.

To give you additional detail on our geographic and market acceleration moving from Q1’s first phase to Q2’s second phase of the recovery. In Q1 from a theater perspective, only one theater, interestingly enough Japan, had meaningful product order growth. While in Q2, all five of the theaters saw flat to double digit product order growth.

In Q1, again from an order’s perspective, only two of our top 15 countries around the world saw year over year positive growth. In Q2, eight of 15 countries saw year over year positive growth.

From a Q2 market segment perspective, enterprise, social (inaudible) and commercial also ordered growth in the mid single digits to low double digit range. While in the prior quarter, Q1 all of these market segments were negative from a year over year perspective.

While most markets around the world are continuing to improve we were especially pleased with our product ordered growth in the US. Up approximately 17% year over year. Asia Pacific and Japan both grew in double digits year over year. Europe was up in low single digits and emerging markets were flat.

In our opinion based upon our business momentum and prior economic recoveries, this would indicate that the recovery from a capital spending perspective is very strong and moving into the second phase of a reasonably balanced across the board growth.

In our opinion Q2 FY10 results were remarkably well balanced from a product, geographic and market segment perspective. Which should indicate a solid economic recovery. While the continued strength of the recovery and the eventual job creation may still be in question, we clearly are basing our decisions and investments have fallen an optimism evolution of the economy.

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