Cisco Systems Q4 Earnings Call Transcript

123jump.com Staff
18 Aug, 2009
New York City

The computer networking gear maker net sales declined 18% to $8.54 billion in the quarter. Net quarterly income slumped 46% to $1.1 billion. Earnings per share plummeted to 19 cents from 33 cents a year-ago quarter. Net sales for the fiscal year 2009 fell 9% to $36.1 billion.

Cisco Systems, Inc. ((CSCO))
Q4 2009 Earnings Call Transcript
August 5, 2009 4:30 p.m. ET

Executives

Blair Christie – Senior Vice President, Corporate Communications
John T. Chambers – Chairman and Chief Executive Officer
Frank A. Calderoni – Executive Vice President and Chief Financial Officer
Robert Lloyd – Executive Vice President, Worldwide Operations
Ned Hooper – Chief Strategy Officer and Senior Vice President, Corporate Development & Consumer Group
Padmasree Warrior – Chief Technology Officer

Analysts

Jeffrey Evenson – Sanford C. Bernstein & Co.
Paul Silverstein – Credit Suisse
Simona Jankowski – Goldman Sachs
Tal Leoni – Bank of America/Merrill Lynch
Mark Sue – RBC Capital Markets
Richard Gardner – Citigroup
Nikos Theodosopoulos – UBS
Simon Leopold – Morgan Keegan
Brian Modoff – Deutsche Bank
Jeff Kvaal – Barclays Capital
John Marchetti – Cowen and Company
Ittai Kidron – Oppenheimer & Co.

Presentation

Operator

Welcome to Cisco Systems fourth quarter and fiscal year 2009 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 and welcome to our 78th quarterly conference call. I am Blair Christie and I’m joined by John Chambers, our Chairman and CEO; Frank Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, Executive Vice President of Worldwide Operations, Ned Hooper, Chief Strategy Officer and Senior Vice President - Consumer Business, and Padmasree Warrior, Chief Technology Officer.

The Q4 fiscal year 2009 press release is on US High Tech Marketwire and on the Cisco website at www.newsroom.cisco.com. I would like to remind you that we have a corresponding webcast with slides. In those slides you will find the financial information we cover during this conference call, as well as additional financial metrics and analysis that you might find helpful.

Additionally, downloadable Q4 financial statements will be available following the call, including revenue by product and geography. Income statements, full-GAAP to non-GAAP reconciliation information, balance sheets, and cash flow statements can be found on our website in the Investor Relations section. Click on the financial section of the website to access the webcast and slides and these documents.

A replay of this call will be available via telephone from August 5th through August 12th at 866-357-4205 or 203-369-0122 for international callers. It is also available from August 5th through October 16th on Cisco’s Investor Relations website.

Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results. Our commentary today will be providing information on both our Q4 financial results and our full fiscal 2009 financial results. Financial results in the press release are unaudited.

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

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

John T. Chambers

Blair, thank you, very much. During the opening comments of the conference call, I will focus on what I view to be the key takeaways for Q4 fiscal year 2009. First, a very candid discussion about what we are seeing in the market on a global basis, relative to Q4, and its effect on our Q1 fiscal 2010 expectations.

Second, an update given the current economic challenges, and how we are reducing the expenses, prioritizing our many opportunities for future growth, as well as our progress in realigning the resources, all of this with a focus on investing in new market adjacencies, emerging technologies, and emerging markets.

Third, on a very positive note, a detailed discussion on sequential order trends in Q4 and progress on several of our 30 plus market adjacencies that we are focused on, and finally, our revenue guidance for Q1 fiscal year 2010, with the appropriate caveats. Frank will follow these opening comments with additional details on Q4 and the majority of the fiscal year 2009 discussion.

The third section of the call will focus on business momentum from a strategy, customer segment, geographic, and product basis. Frank, will then follow with additional financial parameters around our guidance. I will then wrap it up with some comments in terms of Cisco’s momentum going into Q1 fiscal year ’10, and finally, our Q&A session.

From a summary point of view, I think there were a number of key takeaways from the results in Q4 FY09 and I will attempt to summarize these at this time. First, on the areas we control or influence such as our key financials we are doing very well whether it is in the area of expense reduction, resource realignment, margins, case generations, or acquisitions.

If you look at my key takeaways, first Q4 was a very solid quarter from the financial perspective. The following are some high level financial takeaways for the quarter. Revenue was $8.5 billion. Earnings per share, on a non-GAAP basis were $0.31. GAAP earnings per share were $0.19. Expense reductions, we exceeded the $1.5 billion expense reduction goals as Frank had outlined in prior calls. Non-GAAP gross margins were about 65%, and service revenues grew at 5% year-over-year.

We generated $2 billion in cash in Q4; resulting in total cash and investments of approximately $35 billion and we repurchased $800 million of stock during the quarter. DSOs were 34 days and non-GAAP inventory turns were 11.3. Book-to-bill was comfortably above 1. Non-GAAP operating expenses were approximately $3.3 billion in Q4 FY09, down 8.5% year-over-year in Q4.

And as a percentage of revenue, we are 39.2%, which was in line with our guidance that Frank and I provided at 39% to 40%, but perhaps the financial measurements that we are most pleased with overall is our ability to focus on preparing Cisco for the future, and still maintaining very strong profits, as a percentage of revenue, during what is clearly the toughest economic challenge of our lifetime.

Non-GAAP net income was $8 billion for fiscal year ’09 and was 22% of revenue for the year. And for Q4 FY09 it was $1.8 billion, which translates into 21.5% of revenue. We have gone through the toughest economic time period we have seen in our lifetime and have maintained comfortably over 20% non-GAAP net income as a percentage of revenue; it is a pretty good achievement.

Frank will cover both additional details on Q4 numbers and a summary of the fiscal year 2009 financials in his discussion.

My second key takeaway, even more positive than the financial disciplinary results in the quarter, Q4 had both the first positive sequential product order growth, and was also the first quarter in the entire fiscal year that was anywhere close to having normal sequential order seasonality.

For me personally, this was the most important takeaway in the quarter. In other words, while it is too early to say that this is a definite trend, and therefore the much anticipated recovery, the sequential order numbers were very solid and more along the line of our normal seasonal quarterly results for the first time in the last four quarters.

Let me explain a little more detail, why this is important during periods of economic transitions, and during these periods of economic transitions, even more important to me than year-over-year numbers. During normal economic times, year-over-year numbers are very indicative of the health of the business.

However, during economic transition, upturns and downturns, sequential order comparisons to the same quarters are very useful in determining the health of the business and possible directional changes. We know that our sequential order growth rates follow similar patterns during normal times.

This clearly has not been the case for the first three quarters of fiscal year ’09, where we saw a very large swing averaging 10% to 15% below our normal sequential order patterns. However, we saw a dramatic different trend in Q4, the order rate on a sequential basis in Q4, was in line with our normal patterns of up approximately 10%, Q3 to Q4.

Additionally, we believe that sequential order rates in Q1 could follow a normal order pattern as well, which is historically down in the mid-single digits, from an order perspective. I will explain how this translates into Q1 revenue guidance in a moment.

While it is too soon to call a recovery, just returned to normal pattern, is the first major positive order trend, we have seen in over the last several quarters. Trends also occurred across most of our theaters on a global basis. One final thought, while this is a very important trend, I would want to see the sequential trends continue for several more quarters, before we will be comfortable with saying that we are returning to normal business momentum.

And as we return to normal business momentum, I will then go back to focusing on year-over-year numbers as the primary measurement of business momentum in the health of our business.

The third key takeaway for the quarter, our new innovative organization structure built around councils, boards, and working groups is operating extremely effectively. Almost all of our 30 plus market adjacencies, which include products, geographies, solutions, etc., are progressing well. We would discuss progress in a couple of these market adjacencies in future quarterly conference calls.

Fourth, we are very pleased with our progress and aggressively managing our expenses, and exceeding our stretch goal of reducing our annualized expense run rate by $1.5 billion that we committed in the Q1 conference call. We have also realigned approximately $1 billion of resource to new market adjacencies and opportunities.

During Q4, we also aligned our engineering and our sales organizations around an expanding focus on customer segments and solutions. Rob just a real nice job on the sales side and Padma and Ned, the entire engineering team did an amazing job there, and I''m very comfortable we structured the way we want to be for the future.

Fifth, assuming there are no major surprises to our expectations on economic trends, we have completed our major expense reductions and limited restructuring. And we are now moving the entire focus of the company to growth, starting first with improvements in sequential order growth, followed by year-over-year growth.

When we saw the market change early in fiscal year ’09, we made a decision to accelerate our normal process to realign and restructure resources rather than go through a broad base layoff. Few quarters ago, we announced our plan to have limited restructuring as part of our portfolio realignment and that would have resolved reductions of 1,500 to 2,000 jobs during the second half of fiscal ’09.

We shared with you that limited restructuring is an ongoing part of our business process and something we have done for many years. Although this recent action was unusual as the number of job reductions were higher than normal. We have completed the recent limited restructurings and expect the total number of jobs reduced will be slightly over the high end of the range provided.

I want to thank our employees and our leadership team for their very effective execution of these changes, which were very challenging and at times painful for us all. In terms of those areas that we can control or influence, we continue to feel very comfortable with our long-term vision and differentiated strategy, as we move into new market adjacencies, and prioritize our existing opportunities.

Our new organization structure of councils, boards, working groups, as discussed in the last few calls is operating very effectively. These structures, most important, allow speed, scale, flexibility, and rapid replications. We will continue to move into additional market adjacencies, and are currently at 30.

And perhaps equally important many of our leading customers understand how this highly innovative management structure and new business models can launch this many new major products and markets adjacencies with both quality and volume. We exit Q4 with a compelling financial position and an innovation engine both from products in a business model perspective that should allow us to expand our leadership in the marketplace.

Our internal start ups as well as our acquisition of small companies continue to fill out our architectural strategies. For example, our video strategy from the home to the service provider to the enterprise is being described by many of our customers I talk with as world class innovation and of equal importance, world-class execution.

The Pure Digital acquisition with the Flip Video formally becomes a part of Cisco family during Q4, really brought home to many of our customers our architectural playoff across all customer segments. Our consumer Flip momentum continues to be extremely positive. Ned, nice job and Jonathan, nice job, Christie and her entire team, and we even have founded expanding into the enterprise marketplace, where we got our first million dollar commitment for flips from a single enterprise customer.

We continue to believe that video architecture is the most important Web 2.0 next-generation play and is one of the key competitive advantages versus our peers. For those areas that we can control and influence, we feel we are doing reasonably well. The key market transitions, we already did collaboration, virtualization and video networking, which will drive productivity and growth in network loads for the next decade are evolving even faster than we thought one or two quarters ago.

While we intend to be very transparent with what we are seeing in the market and have established a good track record in terms of seeing trends early our views do not tend to change every month or quarter, and even when they do evolve to change dramatically as we lead the exception. It is with this consistency obtained focus on the long-term, while not getting distracted by short-term market activities that we believe and will be one of the keys to our future success.

No one knows for sure when the upturn will occur, but as we said in prior quarters, we are going to continue to be very aggressive to position ourselves for the inevitable upturn, while continuing to maintain high financial management in aligning resources to new opportunities.

Also, as we said in prior conference calls over many years, Cisco will always be affected by major economic challenges, capital spending patterns, new and existing competitors, and our ability to execute or not on our strategy and other factors as discussed in our SEC filings.

For purpose of our long-range goals, as well as our quarterly guidance, we are also assuming that our vision of how the industry and the market will evolve will be accurate and that we will execute effectively on that vision. With all this in mind, we continue to provide our guidance with all the appropriate caveats, one quarter at a time.

And encourage each of our shareholders to not get too far ahead of themselves in building on the positive for this quarter. With this discussion in mind, our revenue guidance for Q1 FY2010, including our using caveats as discussed earlier and in our financial reports, is for revenue to decrease in the 15% to 17% range year-over-year.

In summary, we believe that we are very well positioned in the industry from a vision, differentiated strategy, and execution perspective. We believe we are entering the next phase of the Internet as growth and productivity will center on collaboration, enabled by network Web 2.0 technologies.

We would do our best to provide the product architectures and the experience to help our customers in the implementation of these collaborative capabilities from both a technology and a business perspective. We will also share with the customers how we have done this internally.

In short, we are going to attempt to exhibit a strategy over the next decade, is very similar to what we did in the early 90s. And as we said before, it powered our growth for decades. Now Frank, let me turn it over to you for more additional details.

Frank A. Calderoni

Thank you, John. I am pleased with how well we managed the business this quarter in what continues to be a difficult economic environment. During this quarter, we maintained our focus on reducing our annual expense run rate, while continuing to invest in our strategic growth areas.

Our solid results in Q4 FY09 once again showcased our ability to manage profitably across varying economic cycles, while delivering innovative products and services that provide real value to our customers. For today''s call, I will comment on our fourth quarter financial results and then on our full-year 2009 results.

Starting with Q4 results. Total revenue for the fourth quarter was $8.5 billion, a decrease of approximately 18% year-over-year, within the range given last quarter of minus 17% to 20%. A tough comparison giving Q408 was the highest revenue generating quarter in Cisco''s history.

Total service revenue was $1.8 billion, up approximately 5% year-over-year. Total product revenue was $6.7 billion, down approximately 22% year-over-year. Switching revenue was $2.8 billion, a decrease of 20% year-over-year. Modular switching revenue was down 23% year-over-year, while fixed switching revenues declined 17% year-over-year.

Routing revenue was $1.5 billion, down 27% year-over-year, representing a decrease of 27%, 29%, and 24% year-over-year in high-end, mid-range, and low-end respectively. Advanced technologies revenue totaled $2 billion, representing a decrease of 19% year-over-year. This was primarily due to declines in video systems of approximately 30%, unified communications of approximately 5%, and security of approximately 19%. Other product revenue totaled $387 million, a decrease of 32% year-over-year.

We experienced a decline in total revenue across all geographies on a year-over-year basis. Quarterly revenue declined ranging from 5% in Japan to 38% for our emerging markets theater, with quarterly revenue in the U.S. and Canada theatre down 13%, down 20% in Asia-Pacific, and down 19% in our European markets.

Despite the challenging revenue environment, the strength of our business model enabled us to effectively manage our gross margin. Q4 FY09 total non-GAAP gross margin was 65.3%, 0.2% quarter-over-quarter and up 0.4% year-over-year.

For product only, non-GAAP gross margin for the fourth quarter was 64.7%, up 0.1% quarter-over-quarter. For the quarter-over-quarter comparison, favorable product mix and cost savings offset by increased discounts and lower pricing. Our non-GAAP service margin for the fourth quarter was 67.5%. That was up from 67% last quarter and 63.1% in Q4 fiscal year ‘08.

Service margin performance quarter-over-quarter was due to strong margin as a result of high revenues and technical support services. Service margin performance year-over-year was better than expected, due to strong margins in both technical support services and advanced services from cost improvement combined with higher-than-expected mix of our technical support versus our advanced services.

Total gross margin by theater, range from approximately 58.6% for emerging markets to approximately 72.9% in Japan. Gross margins improved on a quarter-over-quarter basis in US and Canada and Japan. However, Asia-Pacific, emerging markets and European markets saw declines in gross margins on a quarter-over-quarter basis, due to increased discounts.

In emerging markets, we saw some additional decline in margins as a result of an increase in deferred revenue as it related to our financing programs. Non-GAAP operating expenses were approximately $3.3 billion in Q4, that was up $200 million quarter-over-quarter as expected due to project related spending, seasonality of our variable compensation and certain real estate charges partially offset by benefits from our lower headcount.

Non-GAAP operating expenses as a percentage of revenue were 39.2% in Q409, versus 35.3% in Q408, within the range that we provided last quarter. In the current environment we have focused on operational efficiency and expense management as mentioned in our prior calls.

To that end, Cisco employees have clearly responded by exceeding our stretch goals to remove $1.5 billion from our annual run rate of operating expenses. I would like to take a moment to really thank and congratulate our employees for their exceptional effort in achieving this goal.

Interest and other income was $73 million for Q4, which was higher than expected, reflecting one-time realized gains of $41 million from some of our investment sales. Our Q4 FY09 non-GAAP tax provision rate was 20%, lower than last quarter, due largely to favorable tax benefits arising from our state audit settlements. As we communicated earlier in Q4, we did take a one-time GAAP tax charge related to a change in the tax treatment of share-based compensation as a result of a court case between Xilinx and the Internal Revenue Service. The impact to Q4 was $174 million to the GAAP income statement and $550 million to our balance sheet.

Non-GAAP net income for the fourth quarter was $1.8 billion, representing a decline of 23% year over year. As a percentage of revenue, non-GAAP net income was 21.5%. Non-GAAP earnings per share on a fully diluted basis for the fourth quarter were $0.31 versus $0.40 in the fourth quarter of fiscal year 2008, a 23% decline year over year.

GAAP net income for the fourth quarter was $1.1 billion, as compared to $2 billion in the fourth quarter of fiscal year 2008. GAAP earnings per share on a fully diluted basis for the fourth quarter were $0.19 versus $0.33 in the same quarter of fiscal year 2008.

For Q4 ''09, there was a $0.12 difference between our GAAP and non-GAAP earnings per share. Approximately $0.07 is related to our expected GAAP to non-GAAP differences, such as stock compensation, amortization of purchased intangibles, IT R&D, and intangible asset impairment; $0.03 related to the tax matter discussed previously; and $0.02 related to a voluntary early retirement program we extended to eligible U.S. and Canada employees this quarter. The additional items this quarter were unusual occurrences outside the ordinary cost of business. Therefore, they were excluded from our non-GAAP earnings.

Now switching to our full-year performance. Total revenue for fiscal year 2009 was $36.1 billion, a decrease of approximately 9% over fiscal year ''08 revenue of $39.5 billion. Routing revenue ended the year at $6.3 billion, down 21% year over year; switching revenue was $12 billion, a decrease of 11% from last year; and advanced technologies revenue was down 4% year over year to $9.2 billion. Total service revenue was approximately $7 billion, a growth of 8% in fiscal year 2009.

Total non-GAAP gross margin for fiscal year 2009 was 65%, down 0.1% year over year. For product only, non-GAAP gross margin was down 0.7% year over year due to discounts, pricing, lower volume and mix, partially offset by cost savings. The total service gross margins were up 3.4% year over year.

Non-GAAP operating expenses were $13.7 billion in FY09. That was down from $14.1 billion in FY08. The year-over-year decline was due primarily to savings from discretionary savings, favorable foreign exchange, as well as lower headcount.

Non-GAAP net income for fiscal year 2009 was $8 billion, down approximately 17% from fiscal year 2008 non-GAAP net income of $9.6 billion. Non-GAAP earnings per share on a fully diluted basis for fiscal year 2009 were $1.35. That was down from $1.56 in fiscal year 2008, representing a 13% decrease year over year.

GAAP net income for fiscal year 2009 was $6.1 billion, or $1.05 per share on a fully diluted basis, compared to $8.1 billion, or $1.31 per share on a fully diluted basis in fiscal 2008, representing 24% and 20% decreases year over year, respectively.

Product backlog at the end of fiscal year 2009 was $3.9 billion, as compared to $4.8 billion at the end of fiscal 2008. Our backlog as a percentage of our Q4 product revenue was approximately 59% and up three percentage points from Q4 ''08. This level of backlog combined with our products and service deferred revenue positions really position us well as we enter fiscal year 2010.

Now moving on to the balance sheet. Our balance sheet continues to be strong, providing us with significant financial flexibility. Despite continued economic pressures, we have continued to strengthen key financial metrics. The total of cash, cash equivalents and investments for the quarter was $35 billion. It was up $1.4 billion from last quarter. Of this total balance, $5.9 billion was held within the United States at the end of Q4.

During the quarter, cash flow from operations was approximately $2 billion. Moving on to accounts receivable, our accounts receivable balance was $3.2 billion at the end of Q4. At the end of Q4, our days sales outstanding or our DSO was 34 days, driven by the timing of service billings to the latter part of the quarter, offset by very strong collections. This compares to 27 days in Q3 ’09 and 34 days in Q4 ’08.

Total inventory at the end of Q4 was $1.1 billion. That was up slightly quarter-over-quarter. Non-GAAP inventory turns were 11.3 this quarter, up 0.6% compared to last quarter and down 0.3% compared to Q4 of last year.

Our inventory management as measured by turns remains world-class. Inventory purchase commitments at the end of Q4 were $2.2 billion, a 2% reduction from the end of Q3. For the quarter, we repurchased 800 million of common stock or 42 million shares at an average price of $19.02 per share, and we ended this quarter with approximately 4.8 billion remaining in the current stock repurchase authorizations.

Deferred revenue was $9.4 billion at the end of Q4 ’09, an increase of approximately 6% year-over-year. Deferred product revenue of $2.9 billion and deferred service revenue of $6.5 billion, both increases of approximately 6% year-over-year.

At the end of Q4, our headcount totaled 65,545; a net decrease of 1,013 from last quarter. The reduction in headcount was the result of our continued pause in external hiring and our limited restructuring. As we communicated in our Q3 ’09 earnings call, we did expect to reduce approximately 1,500 to 2,000 jobs during Q3 and Q4 timeframe, as part of our portfolio realignment.

Having completed these higher than normal limited restructurings, we expect the number of jobs reduced to be slightly above the high end of the range.

In summary, from a financial perspective we are very pleased with our Q4 and fiscal 2009 results, which illustrate the resiliency of our business model, as well as the strength of our business. While we remain focused in FY10 on operational excellence and efficiency, we will continue to make investments in key growth areas across our market adjacencies that we believe will position us and the company overall for long-term success.

I will now turn the call back over to John.

John T. Chambers

Frank, thank you very much, well done. Now moving on to a strategy review, discussion of customer segment, geographic, and product review. Q4 continued to see the balance between innovation and operational effectiveness in almost every aspect of our business.

The innovation and execution has never been broader and more successful, ranging from product announcements, technology architectures, acquisitions, and a rapidly evolving business architecture leadership in our customer''s mind. Cisco has had a continued explosion of collaboration enabled by network, Web 2.0 Technologies in everything we do.

Always listen carefully to our customers and in many ways feedback from our leading edge customers about this activity in Q4 was pivotal. Truly a tipping point in terms of both their understanding and in many cases their commitment to next generation intelligent networks becoming their platform for productivity, standard of living, and global competitiveness.

The 30-plus new market adjacencies all tie to the common theme of the network becoming the platform for transformation in business models, government services, and the connected consumer.

I would like to articulate and provide additional clarification to our approach to what some of the financial community calls a portfolio growth opportunity and market adjacencies. I would also like to cover several of these market adjacencies with additional color in terms of our progress, goals, and objectives. We will continue to do this in most of our conference calls moving forward and highlight in each of them several market adjacencies. Our goal is for you to view this as not just a portfolio play with growth opportunities, but also pieces of both a technology and business architectural play that has the potential to power a substantial part of our growth as well as our traditional core markets.

We had a similar approach years ago on a smaller scale where we identified market transitions that extended the role of the network. In other words, they were extensions of our core products. These have become known today as advanced and emerging technologies.

Today, Cisco is focused on how we can use our technology and solutions to solve the challenges of business, society, government, and our communities. As we do this, we are becoming closer to our customers, helping them solve their top issues, and increasing our position as a strategic business partner, in addition to creating new opportunities where we can extend the role of the network. We call these opportunities market adjacencies. And while today many of them may be considered small and fast moving, tomorrow many of them could be billion dollar businesses for Cisco. This is not just a portfolio play, but rather, tightly related parts of the portfolio that architecturally come together to increase the potential success of many of our new adjacencies as well as our traditional markets.

In some cases these market adjacencies allow Cisco to lead in key market transitions, like video and virtualization, or in other cases to open up new markets for us, like Smart Grid and Smart+Connected Communities, while others represent new global business models and go to market plans, like emerging markets in China, India, and Mexico. And still others refer to how we are transforming Cisco and our own business processes. We see interdependencies across these market adjacencies and although each are in different phases of execution, they all build on the increased role of the network. The common thread is the network. It is the platform for growth and innovation.

In summary, today we are investing in 30-plus new market opportunities that are adjacent to our core business, and in each of these cases the technology architectures drive innovation in our core products, which we believe translates into growth. Assuming we are successful in many of these opportunities, you will see us expand well beyond 30 that we have today.

Our innovative organization structure of councils and boards brings together leaders from across the functions, all of our corporate functions, to define, plan, execute, and monitor our progress in these market adjacencies. This disciplined approach allows our teams to scale and work across the opportunities with both speed, flexibility, and then to be able to replicate these models quickly. You can expect these market adjacencies to become a growing part of our business over time, just as the advanced technologies did looking back several years ago. While some of these may be able to be discussed in ways similar to our early advanced technologies, others may not easily be discussed as standalone segments. We will consistently share our position in these markets, so you can monitor our progress.

These business processes are evolving rapidly in each of the market adjacencies, supported by the new organizational structure, and as such should be considered work in process. We will do our best to give you periodic updates on each of these areas, so that you can monitor our progress by both categories and potentially our progress on architectural plays.

Today, I''d like to cover quickly three market adjacencies examples. Those three are, first,
Smart+Connected Communities; second, Small Business; third, Smart Grid. As a reminder, if we hit or exceed 50% of the focus market adjacencies, we will declare success, and that if we execute expectations on too many of these market adjacencies, it means we probably did not take enough risk.

Smart+Connected Communities - we continue to make progress with our initiative to help cities use the network to deliver better city management, enhanced quality of life for citizens, drive economic development, and cultivate environmental sustainability. Last quarter, we mentioned we had reached an agreement with Incheon, Korea Mayor Ahn, and Gale International, a major global city developer. We''re proud to announce we will join them this week in opening the city, Songdo in Incheon, where we are Gale''s technology partner across the board. We expect our partnership with Gale to lead us into several other opportunities around the world as we expand this partnership to go after new projects in China, like Meixi Lake Project, in Changsha, the capital of Hunan province.

Additionally this quarter we announced the launch of several Smart+Connected Community products, such as the Mediator. This product converges 60-plus building systems in--onto the IP network, ranging from air conditioning to lighting, security, and access control. Similar to how voice services transformed as they came onto the IP network, we are now transforming real estate by bringing building systems onto the network, driving down operational costs, generating additional revenue, and decreasing a building''s carbon footprint. Based on these developments with the appropriate caveats, we are seeing an even larger opportunity for Cisco with Smart+Connected Communities from several hundred million dollars, as I mentioned last quarter, to multi-billion-dollar opportunities in the next five to ten years.

Second, Small Business. We continue to make strong progress in our adjacent small business markets, potentially one of the fastest growing growth opportunities for Cisco. Our current market share in most industry analysts'' opinion is in the low-double-digits, and therefore, provides Cisco with an opportunity for growth even if IT spending remains constrained. While small businesses are quick to pull back at the start of a downturn, they traditionally start buying sooner and more broadly as the general economy recovers.

We are beginning to see signs of recovery in that small businesses are projected to spend over $7 billion on networking technology in 2010. Over the past year, we have created dedicated teams across all functions to meet the needs of small business customers and the channel partners to serve them. We now offer purpose-built, small -- Cisco small business products for customers who want simple but reliable network solutions. As an example, in Q4 we introduced the new Cisco ESW 500 switches that are highly competitive based on price, features, and support.

As a snapshot of what is possible in the future, we could combine our small business products with our investment in cloud services to provide “as-a-service” offerings delivered through Cisco partners.

Third, Smart Grid. In the area of Smart Grid, we have a well defined vision and strategy and we are now focused on execution to the extent that our thought leadership developed an eco system of partners to drive open standards and deliver an end-to-end solution for our customers. Cisco will lead in defining the end-to-end architecture that will enable our vision of securely managing energy on electrical grids all the way from generation to the consumption in homes and buildings. These efforts are highlighted by our collaboration with partners Landis+Gyr, IBM, and GE; utility partners, such as Florida Power & Light and Duke Energy; and standard bodies, such as the National Institute of Standards and Technology; the Federal Regulation and Oversight of Energy; and the North American Electric Reliability Corporation.

Cisco''s Smart Grid approach is complemented by our recent announcement of Smart+Connected Communities and Smart Connected buildings. Our vision and differentiated strategy for each of these market adjacencies is only about a year old. Our ability to move resources quickly to capture market transition is a direct result of the collaborative processes embedded in our councils, boards, and working groups, and enabled by the way we use network enabled Web 2.0 technologies. As a result, we''re making decisions faster and moving with speed, scale, flexibility, and replication, common focus points that you''ll hear from us again and again.

At this time, we will cover our customers segments, geographies, products for Q4 in more detail. The customer segments and geographies will be discussed in terms of orders unless indicated otherwise. The product review will be primarily in revenue growth.

First, on customer segments. For the discussion we will measure by both orders year over year and sequentially on a global basis. As a general statement, our position in terms of both technology partner and a business partner through our customers in service provider, enterprise, and government is to continue to expand in a very positive way.

Also, as we''ve already discussed, the numbers in terms of year-over-year growth in these markets are challenging. However, from a sequential order point of view, that is Q3 compared to Q4, we saw double-digit growth in terms of orders in enterprise, commercial, and government. Service provider growth continues to be challenging on a global basis with sequential order growth in the low single digits.

At this time, I would like to cover year-over-year growth rates in our customer segments as we''ve done in prior quarters. Starting with the positives, the public sector was the least impacted by the global economic challenges of all our customer segment markets, but was still down globally 3%. The U.S. public sector, which includes both federal and local, was up 4%. The U.S. federal business was very strong with growth in the mid-teens, Japan was up 28%, Asia Pacific was down 23% in public sector, and Europe was down by 7%. Emerging market public sector was down approximately 19% year over year.

In other global customer segments, our enterprise business continued to be tough and was down approximately 30% on a global basis, when compared to a very strong ending to last year''s Q4 FY08. Service provider spending continued to be tight and down in the upper 20s year over year. The commercial market was also down in the mid-20s, while the consumer was up in the low-single-digits.

Geographies - as a reminder, this is how I primarily manage our business based upon five geographic theaters. This quarter we will give both sequential and year over year order growth.

On a global basis, most of our markets began to stabilize and show sequential Q3 to Q4 improvements. The U.S., Asia Pacific, Japan, and emerging market theaters, all grew orders sequentially from Q3 to Q4 in double digits. The one exception, Europe, continued to be challenged growing sequentially in mid-single-digits.

As you would expect from a year-over-year perspective, the geographic order rate numbers were challenging. U.S. was down approximately 20%; emerging markets down approximately 30%; Asia Pacific down in the low 20s; European market was down in the high 20s; and Japan was down in the low single digits.

The following is a quick summary of year-over-year numbers, and as you would expect, the geographic order rates by customer segments were, as I said earlier, challenging. First, for the U.S., within the U.S., U.S. enterprise was down mid-20s year over year; service provider down mid-30s; commercial was down in the mid-20s.

In Asia Pacific, enterprise was down year over year 30% approximately; service provider was down in the mid-teens; commercial was down in the teens. In emerging markets, enterprise was down approximately 40%; service provider was down in the mid-20s; and commercial was down in the mid-30s.

In European markets, enterprise was down in the mid-30s; service provider was down approximately 30%; and commercial was down approximately 30%.

Now, moving on to products. Product numbers for Q4 will be in terms of revenue year over year, but will be similar to what we saw in customer segments and geographies. Routing was down 27% year over year; switching was down approximately 20%; and total advanced technologies were down approximately 19% in terms of revenue year over year. In terms of advanced technologies, video was down 30% year over year; unified communication was down 5%; wireless was down 19%; security down 19%; and network home was down 26%.

Application networking systems was down 27% and storage was down 8%. Other products, including WebEx, were up 14%; TelePresence revenues were up 97%.

In terms of total revenue mix, Q4, routing was approximately 17%; switching was 33%; ATs were 24%; services, 21%; and others, about 5%. In terms of Q3 to Q4 sequential order growth rates, we saw a similar balance as we did in our overall business and geographies from an orders perspective, with seven of our top 10 largest products growing sequentially in double-digits.

Another point of possible interest is the very positive start we are seeing to our new products in the routing and switching areas, such as the Nexus 5000 and the Nexus 7000, both growing in terms of sequential order rate Q3 to Q4 approximately 100%.

The ASR 1000 is off to a great start with over 1,000 customers of which approximately 220 are service providers. It is growing year over year in terms of orders at above 80%. And finally, the ASR 9000, while it is too early to say for sure, is off to a very solid start, both in terms of opportunities and customer acceptance. The customer acceptance of these new products, combined with the continued success of our high-end routers and switches, such as the CRS-1 in terms of orders - the CRS-1 grew in excess of 25% in the quarter year over year, including more multi-chassis sales this year than in all prior years combined. I believe these trends signal a good chance of future market share gains, both in routing and switching categories.

Now, on to vision, strategy, and execution. In summary, although we would all like to avoid the downturn, our vision of how the industry is going to evolve appears to be playing out very much as we expected. We believe our differentiated strategy is also achieving the benefits to both Cisco and our customers that we thought was possible. And finally, our execution is on target in terms of results, as measured by customer partnerships perspective, market share, and share of our customers’ total communications and IT expenditures as the network becomes the platform for delivering these capabilities.

Now, I''ll turn it over to Frank for some additional details on both financial guidance and other financial highlights. Frank.

Frank A. Calderoni

Thank you, John. Let me remind you again that our comments include forward-looking statements. You should review our recent SEC filings that identify important risk factors and understand that actual results could materially differ from those contained in the forward-looking statements.

The guidance we are providing is on a non-GAAP basis with a reconciliation to GAAP. It continues to be difficult to provide a forecast given the variability and the uncertainties going on in the market. These events increase the potential that our actual results could vary materially from our expectations. Therefore, we anticipate total revenue for the first quarter to be down approximately 15% to 17% year over year. From a sequential perspective, we expect to see approximately 1% to 3% growth.

At this point, let me remind you that in light of Regulation FD, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure.

Now, let me give you some additional details on our Q1 financial guidance. As we have said in the past, forecasting gross margin has always been challenging due to various factors such as volume, product mix, variable comp costs, customer and channel mix, as well as competitive pricing pressures. That being said, we believe that total gross margin in Q1 will be approximately 64%, reflecting the revenue guidance I just shared with you.

With recent acquisitions and our entry into some lower margin markets, gross margin could be negatively impacted by our product mix. We believe Q1 operating expenses will be approximately 38% to 39% of revenue. This Q1 guidance reflects the savings from lower headcount and discretionary spending reductions, reflective of the expense management initiatives that we completed in fiscal year ''09, partially offset by some seasonality of our Q1 expenses.

We expect interest and other income to be approximately $25 million in the first quarter. Our tax provision rate for Q1 is expected to be approximately 22%. While we expect to continue our share repurchase program, it is difficult to predict the exact weighted average shares outstanding.

We are modeling share count to be up approximately 50 million shares quarter over quarter in weighted average shares outstanding for EPS purposes. In this estimate of share count we are not taking into consideration any further change in stock price that could occur in the first quarter of FY10. As a point of reference, a $1 movement in our average stock price would change the calculated shares outstanding for purposes of determining earnings per share by approximately 14 million.

Regarding cash flow from operations, we would expect to generate $1.2 billion to $1.5 billion during the first quarter. For our Q1 F10 GAAP earnings, we anticipate that GAAP EPS will be $0.05 to $0.07 per share lower than our non-GAAP EPS, primarily due to acquisition-related charges and stock compensation expenses. Please see the slides that accompany this webcast for more detail.

Other than those items noted above, there are no other significant differences between our GAAP and our non-GAAP guidance. This guidance assumes no additional acquisitions, asset impairments, restructurings, and tax or other events, which may or may not be significant.

I will now turn the call back to John.

John T. Chambers

Frank, thank you very much. The following is a summary of my view of Cisco''s momentum and opportunities entering Q1 of fiscal year 2010. In areas that Cisco can control or influence our leadership from a product perspective, innovation, architecture, and operational execution not only continues to be solid, as we''ve said before, but also our customers are beginning to grasp the productivity implications and the importance of both the technology and architectural plays.

As we said before, even if the market slowdown continues, we don''t see this changing our long term growth opportunities. If we execute the way that we have in prior slowdowns, and assuming the global economy recovers to a GDP growth rate similar to those in the middle of the decade, as we continue into Q1 FY10 we plan to aggressively invest in new and adjacent markets for the longer run.

On a global and U.S. basis, we continue to see the same challenges and uncertainties from an economic, political, and capital spending perspective that many of you continue to witness. However, on a global basis, we are starting to see potential positive trends in Asia Pacific, U.S., emerging markets, and Japan. We continue to see Europe, especially the U.K., to still be a very challenging business environment.

Again, we want to thank the Cisco family for working together as a team to ensure that our company is in solid position to not only weather the challenging economic environment, but even more importantly, to be ready to accelerate as the market turns. I know it has not been easy and we are working hard to maintain our culture of innovation, trust, a stretch goal mentality and giving back, all during tough periods of times for ourselves, our families, and our friends.

As we continue to aggressively invest, we will also continue to maintain our focus on our financial models. Once again, with our usual caveats, as discussed earlier and in our financial reports, our Q1 fiscal year 2010 guidance is for year-over-year revenue to decrease in the 15% to 17% range.

We believe our long term growth opportunities remain in the 12% to 17% range, again, assuming our usual caveats and normal global GDP growth. We will focus on what we can control and influence and attempt to position Cisco to gain momentum in market transitions, whether they are industry consolidation, product transitions, market adjacency opportunities, or economic.

In summary, for those areas that we can control and influence, we believe our vision, strategy, and execution are in great shape and producing results. We were very pleased with our results and saw a number of positive signs in this quarter in the economy and in our business, especially comparing the sequential order results from Q3 to Q4. If we continue to see these positive trends for the next one to two quarters, we believe there is a good chance we will look back and see that the tipping point occurred in Q4.

As we look back on fiscal year ''09, we are pleased to have successfully demonstrated our ability to make difficult decisions and to tightly manage our business during one of the most economically challenging periods in our history. We enthusiastically kick off fiscal year 2010, a year that promises new market transitions and milestones, including the celebration of Cisco''s 25th anniversary as a business. This year we intend to celebrate a quarter century of being a company that stands for innovation, operational excellence, and integrity. Cisco continues to be nimble, flexible, and customer driven, which has always been core to our culture.

I want to thank all of our employees for their contributions to our success as we celebrate the past and build towards our 25th anniversary together. As always, I want to also thank our shareholders, customers, Cisco family, and partners, for their support and continued confidence in our ability to execute during rapid industry consolidation, market transitions, and challenging economic times.

Now, Blair, I''d like to give it back to you.

Blair Christie

Great. Thank you, John. What we''d like to do now is open the floor to questions. We still do request that sell side analysts please ask only one question, so we can get through as many as possible. So, Bridget, if you could please go ahead and open up the call, we''d like to begin.

Question-and-Answer Session

Operator

Thank you. At this time, our first question is from Jeff Evenson of Sanford Bernstein, your line is open.

Jeffrey Evenson – Sanford C. Bernstein & Co.

I was wondering if you could give some comments on both the underlying business trends, your guidance for sequential growth, and the margin you guided to. Just, in a very quick calculation, even if I assume all your new revenue comes from the acquisitions and from the new areas of entering, and that those products have 20% gross margins, pretty hard to get down to 64%, given what you just put up?

John T. Chambers

So, a bunch of questions, I will combine them into one answer. First if you look at what Frank and I outlined, we patterned revenue for Q1, very similar to what we have seen during normal time periods, which is flat-to-up perhaps a $100 million. That is pretty aggressive in (inaudible) or within it.

In terms of our margins, we think overall as you get a mix of consumer products and software products coming together, as we said in last quarter conference call, 63% to 64%, is what we would normally model, we are staying with the high-end of that for this quarter in terms of the balance.

In terms of mix Jeff, I wish I could tell you, we are accurate in the mix, we will tell you now that we will get the total numbers right the majority of time; our mixes are all over the place in terms of the balance. So, maybe, I’ll call back for a one-on-one session, Frank could into more details on it, but I think the combination does roundup and we put the numbers pretty carefully together to what we outlined.

Jeffrey Evenson – Sanford C. Bernstein & Co.

Thanks.

John T. Chambers

Thanks, Jeff.

Blair Christie

Okay. Next question please.

Operator

Next question is from Paul Silverstein, Credit Suisse, your line is open. You may ask your question.

Paul Silverstein – Credit Suisse

John, two related questions. One, can you give a little more color on the order trends intra-quarter, what you saw from the beginning of the quarter to the end both on a global and a regional basis, and related to that – you talked about in normal period, but we are in, what everybody knows has been extraordinarily non-normal period and if in fact we are coming out, I recognize it is still early days, but I am not sure I understand the normal seasonal commentary in that context?

John T. Chambers

You know, Paul, it is new data point and Blair warned me ahead of time, I have got to be careful in how I walk through it, but our quarters are remarkably predictable in each of the quarters during normal times, in terms of what occurs in a Q4, a Q1, a Q2, a Q3.

This year very candidly Q1, Q2, and Q3 were below the normal sequential growth by about 10% to 15%. Q4 was the exact opposite; it was right on par, approximately 10% growth Q3 to Q4 when I take everything into consideration that I mentioned.

In terms of the balance in the linearity, it was very solid and much in line with what we expected and we ran – if I remember Frank and Rob, we ran above forecast almost every week of every quarter, which as you see what happens when a sales force is on a trend.

So, within that Paul, you know last quarter I was kind of worried that we signaled a potential leveling off, although no one knows for sure, this quarter we are clearly seeing knowing our potential tipping point headed to the upside, although we had wanted to see for a couple more quarters that we could see in front of us.

The balance was good on a geographic basis, in terms of the sequential trends and the one exception is Europe, which I think, we have got a great team in, but Europe seems to be running a couple of quarters behind the rest of the world, they were a couple of quarters late in seeing the economic slowdown, and they will probably be a couple of quarters late in coming out of it. So, Paul I hope that helps clarify a little bit more, and I thank you for the questions.

Paul Silverstein – Credit Suisse

Sure, John.

Blair Christie

Paul, we are going to have to restrict to one question right now, we will get to you on the call back, okay. Next question please.

Operator

Thank you. Next questions will be from Simona Jankowski of Goldman Sachs, your line is open. You may ask your question.

Simona Jankowski – Goldman Sachs

Hi, thank you. I also wanted to dig into the gross margin trends, first on the quarter there was some pricing pressure, but it seemed that that was more than offset by the mix. Can you just comment if that pricing pressure was down turn driven, in other words customer driven, versus competitive, you know from some of the new more aggressive competitors you have in all the various markets and related to that, if you can just give us your best estimate, if it is your long-term gross margin trajectory taking into account some of the new businesses you are getting into?

Frank A. Calderoni

Simona, when you look at our pricing pressures, they were very much normal for us given tough economic times. Cisco’s sales on architecture, solutions, value-added capability, integration, investment, protection, and most of our competitors have met this with very aggressive pricing. That is basically true in emerging markets and in Asia.

In terms of the trends, we didn’t see anything abnormal. We actually, as we said saw gross margins stay very, very solid, probably the area that is under the most pressure is service providers that tends to be up more of a price sensitive market especially in Asia and I think you saw that in terms of our gross margins in Asia, but overall this business is normal. Again Rob’s team is very good about selling architectures and value-added plays.

To your indirect part of your question Simona, price is more of an advantage in terms of our competitors coming at us during the very tough economic times than these normal times. So, I am very pleased with what we did on both market share, our win rates, our positioning overall, and we will continue to come down more as well in terms of price performance, but our ability to maintain our margins, I think is world class and very comfortable overall. So, as you begin to expand it overall, it is more of a mix issue. I don’t see abnormal pressure; you do see the pressure in different areas as we move forward.

Blair Christie

Thank you, Simona. Next question please.

Operator

Next question is from Tal Leoni, Bank of America, your line is open. You may ask your question.

Tal Leoni – Bank of America/Merrill Lynch

Hi, I had a question on the quality of orders or maybe the profile of orders for next quarter. Can you speak about orders that came from end customers versus orders that came from channel? Have you seen any change in the channel inventory level? Second, related to this is, when you look at this quarter orders or, sorry revenues advanced technologies went down sequentially, while the legacy parts went up sequentially, do you see it reversing the next quarter based on the orders you are seeing? Thanks.

John T. Chambers

Now a number of questions, in terms of the key trends, we take channel inventory into consideration as we give our guidance and as we talk about, sequentially the numbers. You did see orders start to replenish in the channel, we reflect that out in terms of our guidance and direction, but it does indicate increased channel confidence and we saw that consistently throughout the quarter to answer your question very directly. The other parts, Frank, any comments.

Frank A. Calderoni

There is nothing John I would add as far the channel inventory. I mean the channel inventory remained about consistent, where they are taking control of the inventory management well, and we have some good (inaudible).

John T. Chambers

And Rob wouldn’t say this directly, but I will, I think the channel programs have been world-class, we have been making it pretty tough on our peers in terms of competing very aggressively on the channels. We have great channel loyalty and our programs have been very effective. We have seen some of our peers have to adjust their strategy based upon that down.

Blair Christie

Thank you. We will go to the next question please.

Operator

Our next question is from Mark Sue of RBC Capital Markets, your line is open.

John T. Chambers

Hi Mark.

Mark Sue – RBC Capital Markets

Hi John. Are we starting to see the very early signs of an acceleration in month-to-month orders replacing their return to normal order seasonality? Can you extrapolate this trajectory in orders, which means it is a very near-term quarter where revenue will no longer be down year-over-year, and recognizing the improved magnitude of visibility, perhaps you can comment on the length of your visibility?

John T. Chambers

So, the trends are absolutely in a positive scenario, if you play out the numbers as we have outlined, and if the markets, if we look back two quarters from now and the next two quarters goes, we all hope that they will, we will view this is a tipping point and more return to normal growth.

Time will tell what that growth range is during normal times. I personally believe it will be in the 12% to 17% as we look out one, to two to three years into normal economic type of activity. Now, remember it does vary based on seasonality. So, we are forecasting a very solid Q1, based upon normal growth time periods and we forecast revenue flat or up one or two percentage points. Frank and I are forecasting about one to three in terms of the direction. So, it goes back to one of your colleagues, I think it was Mark’s comments about our seasonality was very much in line, during the quarter and we would hope that that continues through Q1. But Q1 is traditionally our weakest quarter as you come off a very, very strong Q4 into getting the machines started, getting the cycles going again, etc.

Blair Christie

Thanks Mark. Next question please.

Operator

Our next question is from Hasan Imam of Thomas Weisel Partners. Your line is open. You may ask your question.

Blair Christie

Hasan, are you there? Let’s go to our next question then. Operator? Bridget, are you there?

Operator

Yes, one moment. Our next question will be from Richard Gardner of Citigroup. Your line is open.

Richard Gardner – Citigroup

Okay. Thank you very much. You mentioned earlier John that pricing pressure was pretty much business as usual perhaps outside of Asia Pac service provider. Can you talk specifically about the layer 2/layer 3 switching business and what you''re seeing from HP ProCurve in terms of price competition on product sales, service and warrantees and what you are doing to combat that? Thank you.

John T. Chambers

So I am going to explain to your question, Rich. I will do the reverse, I''ll answer two questions at once, and Blair will probably shoot me afterwards. If you look at where we are versus our competition on both switching and routing, I am very comfortable with where we are. First, you start from a structural point of view; we''ve reorganized engineering and evolved it I think pretty smoothly into one group owning the service provider and the routing products, another group owning the vast majority of our switching products.

Within the area, Ned owning the consumer as well as the chief strategy officer role, Kathy, the central organization, Martin the new emerging technologies. And candidly, that''s playing out very well. As we did that first in the service provider routing segment, we began to see our positions in the industry and our product architecture is tied very tightly together and as I alluded to earlier, with the key products, with both the CRS success, but also how our ASR 1000 products and the 9000 are playing out. It’s always possible I get surprised, but I think we are going to get an increasing share of our wallet spends of our customers in the routing area over the – as you look into Q1, Q2 and Q3.

In switching, I think we are doing well, especially in the data center. And Rob, I''m going ask you to comment may be about data center overall a little bit here in a second. But if you watch it where we are in terms of the Nexus 7000 tying very tightly to the Nexus 5000 tying very tightly to the Nexus 2000, tying that to our strategy in terms of the server integrated communications solutions, etc. We saw both very good business results and candidly I feel very, very good about where we are on these individual products.

In terms of specific comments about key competitors, I think we are doing extremely well in our channel programs and candidly it''s something that we enjoy a good competitor in. But if you watch what we are doing on the channels, we are not only holding our own.

I think in most of the surveys that have come out when they talk about where we ar