The Financial Director interview - I'm not worried about our share price

For many in the UK, Cisco Systems first burst onto the scene about two years ago as part of Nasdaq’s television ad campaign. Cisco, the company whose products “make the internet work”, was exactly the sort of stock that Nasdaq wanted to publicise in its attempt to show what could be achieved by companies listing on the American up-start tech-based share market.

Like the rest of the internet generation, Cisco’s shares topped out a year ago, at a time when the company was valued at almost $600bn. But this is no ordinary dotcom slump. True, the company is today worth about a quarter of what it was. The difference is, with some 40,000 employees worldwide, Cisco is a substantial, profitable business in its own right.

Revenues in the year to end-July 2000 rose 55% to more than $18bn, while net income was up by almost a third to $2.7bn. For 14 successive fiscal quarters, in fact, Cisco Systems beat US analysts’ earnings per share forecasts by one cent per share.

February’s Q2 announcement would have been the 15th quarter in a row, but Cisco missed its forecasts – by one cent per share. In effect, Cisco undershot real expectations by two cents – and saw the thick end of $40bn wiped from its market capitalisation in a single day as its shares fell 15%.

Chief executive officer John Chambers had warned analysts in January that Cisco couldn’t be regarded as “immune” from the expected slowdown in the US economy but, nonetheless, the extent to which the brakes were applied caught many investors on the hop: Q2 sales were up 55% year-on-year to $6.8bn, but were only 3.5% ahead of Q1. As a result, Salomon Smith Barney reduced its revenue growth expectations to just 15%.

As FD of Cisco’s UK activities, Mike Tierney is understandably a little reluctant to delve too deeply into territory that is the domain of group CFO Larry Carter in San Jose, California. After an excellent first quarter, Tierney says: “There was probably a lot of optimism. The speed – certainly within two or three months – at which things got that bit cooler probably took everybody by surprise.”

Cisco remains about as upbeat as it’s possible to be. “Our long-term outlook is still good and we still expect to grow 30-50% a year. We still have a lot of confidence in the market, we’re still investing in the future, and we are still developing products,” he says.

When companies that have grown as unrelentingly quickly as Cisco has – headcount was up 110% in 18 months – start to apply the brakes, however, that can create real cultural difficulties. Like novice investors caught in their first bear market, optimism can quickly turn to ill-thought-out, self-feeding panic. Tierney admits that this can be a problem: “You need a steady hand on the management helm to concentrate people on the job that they’re meant to be doing. People don’t want to talk about a slowdown: if they talk too much about it, it actually happens.”

In Cisco’s favour is that, in the good times, it was never profligate.

Enter the lifts in one of Cisco’s three glass-fronted offices in dreary Stockley Park, near Heathrow, and staff are confronted with posters emblazoned with the words “Frugality fact”. One, for example, trumpets about how Cisco saved $10m in its travel bill last year and challenges the reader: “Are you contributing to our success?”

“Cisco is a frugal company and it likes to do more with less,” Tierney says. “Larry Carter would have this tattooed on us from birth, if he could.

I can say there are no cutbacks. We’re not planning any major initiatives to curtail our activities. It’s just, let’s make sure we’re getting the most for each pound.”

When we ask Tierney to say what the biggest hassle is in his job, he talks about the difficulty in recruiting new staff. Then he takes us by surprise: “At the moment I’d like people to not focus on the share price of the company,” he says, seemingly flying in the face of what shareholder value creation is supposed to be about. “There is too much focus on the share price. Every permanent employee in the company gets share options – what level you’re in dictates what amount you get – but in the good times, that’s great. Last year it was over-inflated with the bubble. Now that we’re in a period of uncertainty the senior management and I have got to try to convince people to take their eye off the share price. Focus on what you’re meant to be doing. You wish people wouldn’t let it distract them.”

The problem is that Cisco may not be a normal dotcom, but it can hardly avoid all the wreckage of failed and failing internet companies. To use a 19th century analogy, Cisco has been benefiting from the railway boom by making steel rails, not by running railways – but if the steam is coming out of railways then there’s no market for the steel.

So what, in Tierney’s opinion, is the outlook for the internet economy, given that surfers appear to be staying away in droves – and even B2B projects are being hit?

The bursting of the dotcom boom has tarnished the reputation of e-business, he says. “Fortunately, there’s an awful lot of really good stuff happening at the basic business level using the internet.” He cites, for example, “huge numbers of productivity gains” that companies are making by using networks and web pages better. “I personally think there’s a huge way to go. There are huge savings to be made within industry still. If common sense is applied and people see the things that they can do on the internet, then it’s saving real money in everyday situations. You can save money by combining your data and voice networks. You can save a lot of money by taking intermediaries out of passing data from one system to another, or data from internal customers to external customers. It’s just passing information, but if it saves you setting up half a call-centre, it’s quite rewarding.”

Cisco’s technology – but more importantly, its management ethos – allows it to close the books remarkably quickly: it operates a so-called 24-hour close (only the uncharitable would describe it more accurately as 36 hours).

The company’s month-ends and quarter-ends are on Saturdays and, by noon on the following Monday, the system has churned out an income statement.

By close of play on the Monday, it’s got a balance sheet. All the schedules are completed by Wednesday, and the board discusses the figures on Thursday.

If it’s a quarter-end, then a statement is released to Nasdaq after hours on the following Tuesday. So within ten days of a period-end, Cisco is telling the world how well it did.

There are several factors – some of which are unique to Cisco – that enable it to achieve this sort of performance. First and foremost was the management’s determination to get better information, faster, to give the company competitive advantage. CFO Larry Carter used to hold a revenue meeting after the period end, Tierney explains. Then he decided to move it to before the period end. “The reaction was, ‘Well, Larry, we don’t know what the revenue is going to be so we’ll have to wait for the period end.’ He said, ‘You figure it out.’ So they did.” New systems allowed them to capture revenue data up to the previous day. Then they worked with the manufacturing arm so they could quantify, say, on a Wednesday, where they would finish on a Saturday by looking at shipment and manufacturing schedules. “Necessity is the mother of invention: they actually went and did the thing just because they moved the meeting – simple, really.”

It helps that 90% of Cisco’s orders are received electronically and filtered through an Amsterdam office that acts as a European shared services centre for revenue purposes. It also helps that Cisco sells indirectly through a few hundred partners, rather than directly to thousands of end-customers.

“We don’t have to negotiate 10,000 contracts and interact with 10,000 purchasing systems,” Tierney says.

As orders are received electronically they can usually then be scheduled for manufacture electronically – especially the more modular units rather than the bespoke, configured systems – and most of the manufacturing is automatically outsourced to third parties. Cisco itself does very little manufacturing.

“When an order is received in Amsterdam it can, say, for a lower-end router, be received electronically, go into the master scheduler in our database in San Jose, it can then go onto the production line at the outsourced company in Scotland and be shipped to the customer – and never physically go near Cisco.” This makes Cisco about as near as you can get to a virtual corporation. “We’ll suddenly discover it’s just an empty building,” Tierney jokes.

All of this means that Cisco can close its books pretty quickly but – more importantly – it has an executive information system that operates like corporate telemetry. Key data is available on Cisco’s intranet the next day and is accessible by managers throughout the company on a drill-down-not-up basis. Oh, and the sales people forecast on a weekly basis.

“Every Monday, everybody rolls out the forecast,” he says. “There’s no point in me coming on after the period end saying to the general manager, I know how you did in week number three. He wants to know during that week how he’s doing. And this system allows us to tell him on a Thursday, ‘You forecast $5m for the week and we’re only at $500,000 – so we’d better get onto the troops to get them to start pulling the finger out.'”

Another key component of the system is “linearity”. To avoid the “hockey stick” curve, by which sales forecasts are achieved in the dying hours of the relevant period, the system plots the period-to-date curves against a straight line: if sales for a 13-week period are forecast to be $130m, then by week four you’d better be on $40m. Part of the sales teams’ remuneration is based on minimal divergence from linearity. By rewarding in a way that discourages tail-end bunching of orders, Cisco gets benefits from being able to manufacture and ship in time to book the order as a sale, rather than having it fall over into the next period. “Having the bookings come in nice and evenly throughout the quarter means you’re not giving away discount to try and pull business in,” Tierney adds. It also means that customers don’t try to squeeze extended credit in return for early bookings so there’s no knock-on effect on DSO. And, of course, manufacturing costs are reduced by utilising the plants more efficiently throughout the period.

Not having to worry about compiling and consolidating loads of numbers at the end of every period means that Tierney and his counterparts around the world are able to spend more time creating value rather than measuring it. He has relatively little financial accounting to worry about. Instead, a large part of his time is spent working with sales on preparation of bids. “We have a lot of internal control over the discount levels and so on that people can sell at, and there are a lot of rules in terms of the cleanliness of the sale in terms of conditional sales, and so forth.

My job is to help the sales guy meet those rules and to be part of the solution. I’ve got to work with the sales guys to put together the bids to make sure that they are right in the first place.”

Cisco’s UK headcount is about 2,700 at present, though the company is looking at taking up more than a million square feet of office space in Reading. That would allow for a UK staff of more than 20,000. Even Tierney is amazed at the growth: “Sooner or later the law of large numbers comes into effect.” Just don’t ask what the share price will be like then.

CURRICULUM VITAE

Name: Mike Tierney

Age: 44

Qualification: ACMA

 

Career:

1996: FD Cisco UK

1994-96: Marketing finance manager, Amdahl UK

1991-94: Financial controller, Germany, Austria & Switzerland, Amdahl

1988-91: FP&A controller, Amdahl, Munich

1986-88: Finance manager, Schlumberger ATE UK

1984-86: Financial controller, Emulex Europe

1981-84: Financial controller, TT Systems Ireland

1980-81: KPMG, Limerick

Key metrics: Quarter-on-quarter growth, year-on-year growth. Percentage of base target – and base target is this 30-50% growth range. We look at bookings per head, or sometimes the bookings per account manager. Expense to bookings ratio. We look at linearity, and that covers a number of KPIs: a lot of companies, including Cisco, aren’t immune from what we call the hockey stick.

Biggest challenge: The thing that really excites me is being involved in a customer sale that really benefits the company. It’s a great feeling – the sales guys look at you as a part of the team.

Biggest hassle: Trying to hire people is difficult. I’ve not got a big team. We support quite a few sales people with two full time people and some contract people. Also, at the moment I’d like people to not focus on the share price.

You can be FD at any company except Cisco. Which?: A yacht charter company – I love sailing. Or EMC. I’ve competed against it and found it a very good competitor. A good competitor helps us to keep on our toes.