robbins geller rudman & dowd llp christopher p....
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ROBBINS GELLER RUDMAN & DOWD LLP
CHRISTOPHER P. SEEFER (201197) Post Montgomery Center One Montgomery Street, Suite 1800 San Francisco, CA 94104 Telephone: 415/288-4545 415/288-4534 (fax) [email protected]
– and – SAMUEL H. RUDMAN 58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631/367-7100 631/367-1173 (fax) [email protected]
Lead Counsel for Plaintiffs
[Additional counsel appear on signature page.]
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
OAKLAND DIVISION
In re CISCO SYSTEMS INC. SECURITIES LITIGATION
) ) ) ) ) ) ) ) )
Lead Case No. C 11-1568-SBA
CLASS ACTION
This Document Relates To:
ALL ACTIONS.
CONSOLIDATED AMENDED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS
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1 TABLE OF CONTENTS
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I. INTRODUCTION 1
II. JURISDICTION AND VENUE 11
III. PARTIES 11
IV. SOURCES OF ALLEGATIONS 13
V. SUBSTANTIVE ALLEGATIONS 16
A. Before the Class Period, Analysts and Investors Were Concerned About the Company’s Organizational Structure and that Cisco’s Growth and Diversification Strategy Would Cause the Company to Lose Focus on the Core Switching and Technology Businesses and Enter Less Profitable Businesses in Which the Company Was Inexperienced 16
B. February 3, 2010: Defendants Falsely Represent that Cisco’s Game Plan for Emerging from the Financial Crisis was “Hitting on All Cylinders” that the Company Was Able to “Catch Market Transitions and Move into New Market Adjacencies . . . While Still Maintaining Revenue Growth and Market Share Gains in . . . Traditional Areas” and that the Company’s “New Organization Structure Was Operating Very Effectively” – Chambers Sells $97.2 Million of Cisco Stock Days Later 22
C. May 12, 2010: Chambers and Calderoni Reiterate that the Game Plan Is “Hitting on All Cylinders,” Cisco Is “Gaining Market Share” and the Company’s Expansion into Market Adjacencies Is “Exceeding . . . Expectations” – Less Than a Week Later, Chambers Sells Another $31 Million of Cisco Stock 70
D. August 11, 2010: Defendants Falsely Represent that Cisco’s 4Q10 and FY10 Results Positively Proved the Effectiveness of the Organization Structure and the Growth and Diversification Strategy, that the Company’s Success in New Markets Was Stronger than Anticipated and the Key Take Away Was that the Company’s Strategy and Vision Were Absolutely Working – Chambers Sells $5 Million of Stock a Week Later 77
E. November 10, 2010: Cisco’s Stock Price Declines 16.2% after Defendants Reveal Problems in the Public Sector, Set-Top Box and Consumer Businesses but Falsely Assure Investors the Problems Are Temporary Air Pockets and Continue to Make Misleading Statements 87
F. February 9, 2011: Cisco’s Stock Price Declines 14.2% After Defendants Reveal Additional Problems in the Public Sector, Set-Top Box and Consumer Businesses, Unexpected Declines in Switching Revenues, Disappointing Router Revenues and Declines in Product Gross Margins 98
G. April and May 2011: Defendants Admit Cisco’s Move into Several New Markets Was Not Successful by Revealing that the Company Would Exit Consumer Businesses and Also Admit that the Company’s Organizational
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Structure Was Not Operating Very Effectively and Needed to Be Overhauled and Simplified 99
H. May 11, 2011: Cisco’s Stock Price Declines 4.8% after the Company Reports Additional Problems with the Switching and Consumer Businesses and Plans to Reduce Expenses by $1 Billion; Chambers Reiterates that Cisco Will Streamline the Organization and Overhaul Its Business Model Dramatically 104
I. July 18, 2011: Cisco Announces that 11,500 Employees Will Be Laid Off as Part of Its Continued Implementation of a Comprehensive Action Plan to Simplify the Organization, Refine Operations and Reduce Expenses 108
J. August 10, 2011: Defendants Report that the Switching Business Is Still Under Pressure Due to Increased Competition and Cisco’s Rapid Introduction of New Products and that Cisco Was Still Simplifying the Organization to Accelerate the Speed of Decision Making 110
K. September 13, 2011: Defendants Admit that Cisco’s Organization Structure Was `Fat” During the Class Period and that It `Slowed Decision Making Down” and Caused the Company to `Get Away from the Basics” 112
VI. SUMMARY OF CHAMBERS’ INSIDER SELLING 113
VII. LOSS CAUSATION 115
VIII. CLASS ACTION ALLEGATIONS 117
IX. PRAYER FOR RELIEF 123
X. JURY DEMAND 123
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1 I. INTRODUCTION
1. This is a federal securities fraud class action on behalf of all persons who purchased
or otherwise acquired the common stock of Cisco Systems, Inc. (“Cisco” or the “Company”) between
February 3, 2010 and May 11, 2011 (the “Class Period”). The defendants are Cisco, John T. Chambers
(“Chambers”), Cisco’s Chairman and Chief Executive Officer (“CEO”), and Frank Calderoni (“Calderoni”),
the Company’s Executive Vice President (“EVP”) and Chief Financial Officer (“CFO”).
2. Cisco designs, manufactures and sells internet protocol (“IP”) based networking and
other products related to the communications and information technology (“IT”) industry and provides
services related to their use worldwide. From 2000 to 2008, Cisco pursued a growth by acquisition
strategy; the Company’s net revenues more than doubled from $18.9 billion in 2000 to $39.5 billion
in 2008, and earnings tripled from $2.7 billion to $8.1 billion. 1 A majority of Cisco’s revenues were
generated from sales of switches and routers, markets the Company dominated, selling more than
70% of all products. To continue its growth, Cisco diversified its product offerings and increased
the number of markets from 2 in 2007 to 26 in 2009 and more than 30 during the Class Period.
3. In 2007, Chambers overhauled Cisco’s management structure to support the
Company’s growth and diversification by acquisition strategy, stating that large companies begin to
slow down “because they didn’t move out of their primary markets” fast enough. The new organization
structure included: (a) an operating committee comprised of 15 top executives and Chambers; (b) 12
councils, each comprised of an average of 14 people; (c) 47 boards, each comprised of an average of
14 people; and (d) working groups that were small temporary teams working on individual projects.
4. Analysts expressed concerns about the new management structure and diversification
into new markets. The new organization structure was criticized by many as adding bureaucracy,
stripping away accountability and slowing decision making. Analysts were also concerned that
Cisco was inexperienced in many of the new markets (particularly the consumer market and service
1 Cisco’s fiscal year ends on July 31. August through October is Cisco’s first fiscal quarter; November through January is the second fiscal quarter; February through April is the third fiscal quarter; and May through July is the fourth fiscal quarter.
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provider market), that these new markets were not as profitable as the switching and router markets
and that the diversification strategy could cause Cisco to lose focus on the core switching and router
businesses in which there were an increasing number of competitors. They noted that Cisco’s
expansion into the data center blade server market made the Company a competitor with large-
channel partners like Hewlett-Packard (“HP”), IBM and Dell that generated billions of dollars of
revenue for Cisco. They also noted that HP responded by expanding into the switching market with
its 2009 acquisition of 3Com, which could erode Cisco’s dominant position in that market.
5. As detailed below, during the Class Period defendants misled investors by repeatedly
telling them that Cisco was successfully diversifying into new businesses while increasing revenues
and market share in its traditional switching and router businesses and that the new organizational
structure was operating successfully. For example, on February 3, 2010, Chambers and Calderoni
assured investors that Cisco was able to “catch market transitions and move into new market
adjacencies . . . while still maintaining revenue growth and market share gains in . . . traditional areas”
and emphasized that the Company’s “new organization structure of councils, boards and working
groups . . . [was] operating very effectively.” Defendants made similar statements when Cisco
reported its results in May 2010, August 2010 and November 2010.
6. Information provided by former Cisco employees and other sources, admissions by
defendants and the Company later in the Class Period (and after the Class Period), Chambers’
suspicious sale of most of his Cisco stock, the substantial declines in the price of Cisco’s stock
following the disclosure of previously concealed problems, the reactions of analysts and others to
those disclosures and other facts establish that defendants’ statements during the Class Period were
materially false and misleading and strongly suggest that defendants knew it. The truth was that
there were several undisclosed problems with the Company’s core switching and routing businesses,
several of the consumer businesses, the cable set-top box business and the public sector business that
contradicted defendants’ false positive statements.
7. Defendants knew several factors were causing revenues, gross margins and market
share to decline in the core switching and router businesses, which comprised a majority of Cisco’s
revenues. Existing competitors and new entrants to the market, including new entrant and former
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channel partner HP and existing competitors Juniper Networks, Inc. (“Juniper”) and Huawei
Technologies Co., Ltd. (“Huawei”), offered lower prices and technically superior network equipment.
In addition, customers were increasingly buying network equipment from multiple vendors rather
than Cisco alone after a Gartner, Inc. (“Gartner”) report in May 2009 recommended that companies
invest in multivendor networks because successful integration of a second vendor could be achieved
with little operational risk and could reduce capital expenditures by at least 30%.
8. Defendants also knew, as they revealed in February 2011, that Cisco introduced 85
new products in 2009 and 2010, including five new Nexus switches, that would cause revenues and
gross margins to decline because the new products had lower prices and lower gross margins and
cannibalized sales of the higher-priced and higher-margin products they replaced. Indeed, beginning
in February 2011, Chambers and Calderoni admitted the number of new products was unprecedented
because Cisco “never had more than one or two new switching products in 18 months, much less all
five lines at the same time within a year.” They also admitted that Cisco had to sell two to three times
the number of Nexus switches to generate the same amount of revenue from sales of the Catalyst
switches they replaced because fewer Nexus switches were needed to perform the functions of the
Catalyst switches and because Nexus switches had lower prices. And they admitted that new
products always had dramatically lower gross margins – including Nexus switch gross margins that
were 1,800 basis points lower than the Catalyst switches they replaced – and that it took three to four
years for margins to recover.
9. Defendants knew Cisco’s expansion into the consumer market included many failures
and ultimately resulted in the closing of some businesses (Flip, Eos) and substantial cutbacks in
others (cable set-top boxes). One former employee stated that revenues in the consumer business
were substantially less than internal forecasts in 2010 because: (a) Cisco halted the development of
new Linksys routers – including products that were currently in development; (b) Cisco reduced the
number of existing Linksys products already available for sale by 50%; and (c) sales of the
Company’s new “Valet” router were less than forecast. Indeed, the former employee stated that
Linksys’ share of the consumer home networking market declined from 52% in 2009 to 24% in
February 2011 after these decisions were made. The same former employee reported that the
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revenue targets for the consumer segment were reduced in spring 2010 because they were not
attainable. Sales of the Flip video camcorder, a product Cisco obtained with its $533 million
acquisition of Pure Digital Technologies, Inc. (`Pure Digital”) in 2009, were also less than forecast;
and in April 2011, Cisco announced it was shutting down the business.
10. Defendants also knew there were problems in the service provider business. Orders
for cable set-top boxes, a business Cisco entered when it acquired Scientific Atlanta, Inc. (`Scientific
Atlanta”) in 2006 for $7.1 billion, were artificially inflated in the last three quarters of FY10 and
masked declining demand because, as five former Cisco employees stated, Cisco provided customers
with huge price discounts so the Company could pull in orders from future quarters. The set-top box
business generated $2 billion in annual revenue, and Cisco reported that service provider orders
increased more than 20% in each of the last three quarters in FY10. Cisco then revealed in
November 2010 that total service provider orders increased by just 8% in 1Q11 and that orders for
traditional set-top boxes declined 35%, including a 40% decline in the North American cable
business, which accounted for a majority of the business. Chambers claimed that the 35% decline
was due to reductions in consumer spending and a transition from traditional set-top boxes to IP-
based set top boxes. Chambers admitted that `we saw the transition coming” but said nothing about
the huge price discounts. Skeptical analysts questioned the timing of the disclosure and Chambers’
stated reasons for the decline.
11. By August 2010, defendants also knew there were problems with the public sector
business. Cisco’s public sector business was important to analysts and investors because it generated
22% of Cisco’s revenues and because governments in the United States and abroad faced serious
budget cuts due to substantial declines in tax revenues following the financial crisis. In addition,
one-third of public sector revenues were from sales of switches, which were generating lower
revenues and gross margins because of competition and the Company’s rapid introduction of lower-
priced and lower-margin products. On August 11, 2010, defendants assured investors that the `public
sector in the US is very solid for us, both in the federal and the state and local,” that `Public Sector
Europe actually held up pretty well” and that management felt `very confident, very strong about the
forecast and a pipeline of opportunities.”
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12. But the following quarter, during the November 10, 2010 conference call, Chambers
reported orders in the public sector segment declined 25% year-over-year, 48% quarter-over-quarter
and that the public sector business would continue to be challenging for at least several quarters.
Skeptical analysts were surprised given the previous reassurances; the conference call was
contentious; and some analysts believed defendants knew about the problems earlier. UBS analyst
Nikos Theodosopoulos (“Theodosopoulos”) said the new negative outlook related to the decline in
public sector and set-top box orders was a “pretty significant reset when the rest of the industry isn’t
seeing it,” and Chambers admitted the “challenge [was] fair.” The same day, Bloomberg News host
Betty Liu (“Liu”) questioned Chambers’ contention that the decline in public sector orders was a
surprise because “[w]e’ve been talking all year long about a budget tightening among state
governments.” J.P. Morgan analyst Rod Hall believed defendants did know about the problems
earlier, reporting, “[w]e believe that Cisco had expected a weak start to FQ1[’11] due to aggressive
selling in FQ4’10. In our opinion, this masked developing weakness in government spending.”
13. Defendants knew about the undisclosed problems in all of Cisco’s businesses from
their receipt of internal reports, their participation in meetings and their close relationship with
Cisco’s customers. Chambers, Calderoni and other Cisco executives repeatedly stated that they and
other Cisco employees routinely met with customers; former Cisco employees described reports that
reflected the concealed problems and were discussed in various meetings; and Edward Zabitsky of
ACI Research wrote that Cisco had the most sophisticated customer feedback loop he had ever seen
in any business. But defendants caused Cisco’s stock price to be artificially inflated by concealing
the negative information and falsely assuring investors that Cisco was successfully expanding into
new markets while increasing revenues and market share in the core switching and router markets.
14. As a result, class members purchased Cisco securities at artificially inflated prices and
were damaged when the stock price subsequently declined after defendants began to reveal the
previously concealed adverse information. Chambers, however, unloaded 5.5 million shares of his
Cisco stock – 83% of the stock he owned – for $134 million, which was 12 times the $11.4 million he
received from selling 500,000 Cisco shares before the Class Period. In February and March 2010, he
exercised options that did not expire for months and sold the stock for $97.2 million, which some
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found suspicious even though they did not know about the undisclosed problems that contradicted
Chambers’ false positive statements. Chambers sold another 1.27 million shares for $31.3 million on
May 17-18, 2010, just days after Cisco’s May 12, 2010 earnings release and conference call, during
which he assured investors that Cisco had “emerged from this downturn gaining market share,” that the
Company’s “innovation and operation engine [was] hitting on all cylinders” and “applie[d] to products,
organization structure, business models and movements into 30-plus market adjacencies” and that the
“new innovative, dynamic network organization structure of councils, boards and working groups
[was] operating very effectively.” On August 18, 2010, Chambers sold another 243,178 shares for
$5.4 million, just one week after telling investors that Cisco’s 4Q10 and FY10 results were “extremely
positive proof in terms of the effectiveness of organization structure, business models, innovation
and execution capabilities, while focusing on over 30 major new market adjacencies at the same
time.” While Chambers was selling his stock at artificially inflated prices, Cisco spent $6 billion to
repurchase 249 million shares of its stock, which contributed to the artificial inflation.
15. In November 2010, defendants began to reveal some, but not all, of the problems that
contradicted their false positive statements and concealed Cisco’s true condition. On November 11,
2010, Cisco’s stock price declined 16.2% after the Company disclosed less-than-expected results in
the cable set-top box business, the public sector business and the consumer business. On February
10, 2011, Cisco’s stock price declined another 14.2% after it disclosed additional problems in the set-
top box, public sector and consumer businesses, an unexpected decline in switching sales, less-than-
expected router sales and unexpected declines in gross margins and earnings. On May 12, 2011,
Cisco’s stock price declined 4.8% after the Company disclosed additional problems in the switching,
consumer and public sector businesses and a plan to reduce expenses by $1 billion through a
reduction in force.
16. Investors and analysts were surprised and angry at the revelation of problems that
contradicted defendants’ earlier positive statements. As detailed below, the conference calls in
November 2010 and February 2011 were contentious, and analysts openly questioned defendants’
previous representations, when they knew about the previously concealed adverse information, why
Cisco was repurchasing its stock and why Chambers sold his stock.
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17. After the unexpected adverse disclosures in November 2010, analysts challenged
Chambers about the problems in the public sector business given his reassurances in August 2010.
One analyst asked why Cisco repurchased 110 million shares during 1Q11 when defendants said
during the August 11, 2010 conference call that the Company expected to repurchase 40 million
shares and whether it “indicate[d] anything about when you came to the conclusion that things were
going to be weaker than you maybe thought three months ago.” Michael Shedlock criticized the
insider selling by Chambers and other insiders, writing that the insiders “bailed hand over fist” as
Cisco repurchased billions of shares and failed to pay dividends despite having more than $40 billion
in cash. Indeed, he wrote that it allowed management to “pretend it [was] increasing shareholder
value while corporate insiders [got] to dump massive numbers of shares” and was “nothing more than
shareholder rape.”
18. After the unexpected negative disclosures in February 2011, analysts again
challenged Chambers given his reassurances in November 2010 that the problems disclosed then
were temporary “air pockets” that Cisco would “power through.” The financial press reported that
“Chambers was trying to contain the damage,” that the Q&A session did not start for 50 minutes
because Chambers “wouldn’t shut up” and that his “endless droning worried analysts” because “if you
keep talking about how everything is fine, it usually means everything’s not fine.”
19. In April and May 2011, defendants acknowledged additional problems, and the
financial press noted the contradiction between the disclosures and defendants’ positive statements
during the Class Period. On April 6, 2011, Cisco disclosed a memorandum from Chambers to all
Cisco employees in which he admitted various problems with the Company’s complicated
organizational structure and execution. The same day, it was reported in The Wall Street Journal
that Chambers “confessed the once highflying technology company has lost its focus, lacks discipline
and needs to overhaul its operations” and that Cisco’s problems included “ill-judged acquisitions, a
byzantine management structure and lost market share” that “should have seasick Cisco investors
asking whether their ship needs a new captain.” The next day, Chambers stated that investors should
expect an accelerated exit from some businesses and changes in operational strategy. On April 12,
2011, Cisco announced it was closing the Flip business and reorganizing other consumer businesses.
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On May 5, 2011, the Company announced significant changes to streamline operations and simplify
its organizational structure.
20. Despite low expectations following the unexpected negative news reported during the
1Q11 and 2Q11 conference calls and the revelation of additional problems in April and May 2011,
Cisco revealed more unexpected negative news on May 11, 2011 when it reported 3Q11 results.
Cisco reported substantial declines in switching revenues, consumer product orders, public sector
orders, a plan to reduce expenses by $1 billion and the official abandonment of the Company’s 12%
to 17% annual revenue growth target.
21. The financial press reported that investors heard a different tone from the usually
exuberant Chambers during the May 11, 2011 conference call, one that was more grounded in the
Company’s new reality of losing market share in its core routing and switching business to rivals like
HP and Juniper. MarketWatch reported that Chambers’ admission that Cisco was having some “share
challenges” was his “first official acknowledgement of that new reality,” as was his statement that Cisco
was no longer expecting annual revenue growth of 12% to 17%. Deutsche Bank analyst Brian
Modoff reported that he was “struck by the highly cautious tone” of the call, which focused on the
switching business and the revenue and margin declines caused by competition and cannibalization.
22. Others were more critical and called for Chambers’ ouster. On May 13, 2011, Henry
Blodget (“Blodget”) stated that Chambers had failed and should be fired.
For more than a decade, John Chambers has failed. Chambers’ shareholder-value-creation strategy has failed. His growth strategy has failed. His management structure has failed. And the result is that Cisco’s stock has been dead in the water for more than a decade, even when measured from the bottom of the NASDAQ bust. Ten years is a long time – plenty of time to evaluate a CEO’s performance. And based on Chambers’ performance, as Cisco begins its latest re-organization and rebuilding, it’s time for Cisco’s board to seriously consider giving John Chambers his walking papers.
23. After the Class Period, defendants continued to acknowledge numerous problems
with the business that contradicted their positive statements during the Class Period, analysts
reported that the Company needed to take dramatic steps to turn things around and others criticized
Chambers for damaging shareholders. In June and July 2011, consumer advocate and Cisco
shareholder Ralph Nader (“Nader”) demanded that Cisco disgorge some of the $43 billion in cash to
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shareholders and wrote that a shareholder revolt would focus on “the details of mismanagement; and
executive self-enrichment that fostered this climate of leaving the shareholders behind.”
24. Later in July, during the Company’s annual Cisco Live! convention, Chambers
admitted Cisco was too complex and had lost focus as it expanded into new markets and that he was
overhauling the Company. On July 18, 2011, the Company announced it was slashing its workforce
by 16% by selling its 5,000 employee set-top box manufacturing plant and laying off an additional
6,500 employees. Analysts applauded the move as necessary but also noted more needed to be done,
particularly as it related to the core switching and router technologies, where Cisco’s revenues,
market share and gross margins had declined.
25. When Cisco announced 4Q11 and FY11 results on August 10, 2011, Chambers and
Calderoni revealed additional information contradicting their statements during the Class Period that
Cisco was successfully diversifying into 30+ market adjacencies while maintaining revenue and
market share growth in routing and switching and that the Company’s organization structure was
operating very effectively. They reported that there were declines in switching and router sales and
product gross margins and that the switching business was still under pressure with declines in
average selling prices and gross margins caused by increased competition and the “rapid introduction
by Cisco of new products almost across the board,” including “the largest switching portfolio refresh in
our history.” They told investors Cisco was reorganizing and simplifying its organization structure
and exiting or cutting back on underperforming operations and that the changes made and to be
made were dramatic and would continue for several years.
26. During the Company’s Annual Financial Analyst conference on September 13, 2011,
Chambers and Calderoni unveiled a three-year plan that projected annual revenue growth of just 5%
to 7% from FY12 to FY14 and even lower growth rates for switching revenues. They acknowledged
that the Company’s results had been impacted by competition from HP, Huawei and other companies
and that Cisco was “fat” with “an extra 4 or 5 inches around the waistline” during the Class Period,
which “slowed decision-making down” and caused Cisco to “[get] away from the basics.”
27. The Company’s new Chief Operating Officer (“COO”), Gary Moore, also stated that
Cisco had “gained a few inches around the waist,” had “become fairly complex relative to allowing
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people to actually work with one another – get decisions made quickly; respond to customers” and was
“losing in the marketplace because of that complexity.” He stated that Cisco had exited ten businesses,
reduced its investment in six others and reduced the time it took to approve some deals by 70%.
28. In October 2011, Nader announced plans to ask Cisco shareholders to pledge a penny
per share to pay the costs of assigning a watchdog to monitor the Company’s behavior if it did not
increase dividends; and 24/7 Wall Street named Chambers the most overpaid American CEO based
on his $18.9 million of compensation and the more than 30% decline in the Company’s stock price.
29. The following chart (which is also attached in foldout form) illustrates the primary
events during the Class Period and their impact on Cisco’s stock price.
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II. JURISDICTION AND VENUE
30. The claims asserted herein arise under §§10(b) and 20(a) of the Securities Exchange
Act of 1934 (“Exchange Act”) [15 U.S.C. §§78j(b) and 78t(a)] and Rule 10b-5 promulgated thereunder
by the U.S. Securities and Exchange Commission (“SEC”) [17 C.F.R. §240.10b-5].
31. This Court has jurisdiction over the subject matter of this action pursuant to 28 U.S.C.
§1331 and §27 of the Exchange Act.
32. Venue is proper in this District pursuant to §27 of the Exchange Act and 28 U.S.C.
§1391(b). Many of the acts charged herein, including the preparation and dissemination of
materially false and misleading information, occurred in substantial part in this District.
33. In connection with the acts alleged in this complaint, defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to,
the mails, interstate telephone communications and the facilities of the national securities markets.
III. PARTIES
34. New England Teamsters & Trucking Industry Pension Fund (“New England Fund”) and
The Council of the Borough of South Tyneside Acting in Its Capacity as the Administering
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Authority of the Tyne and Wear Pension Fund (“Tyne and Wear Fund”) were appointed lead plaintiffs
on October 17, 2011. Dkt. No. 57. The New England Fund is a multi-employer pension fund
overseeing approximately $3 billion of assets, and has approximately 75,000 participants and 23,000
active members. The Tyne and Wear Fund is an English municipal, multi-employer, pension fund
overseeing more than $7.5 billion in assets, and has approximately 112,000 participants. The New
England Fund and Tyne and Wear Fund each purchased Cisco securities at artificially inflated prices
during the Class Period as a result of defendants’ misconduct and suffered damages when the
artificial inflation was removed from the stock price.
35. Defendant Cisco designs, manufactures and sells IP-based networking and other
products related to the communications and IT industry and provides services related to their use
worldwide. Defendant Cisco maintains its corporate headquarters in San Jose, California.
36. Defendant John T. Chambers is, and was at all relevant times, Chairman of the Board
and Chief Executive Officer of Cisco. According to Cisco’s Amended and Restated Bylaws,
Chambers, as CEO, was the general manager and chief executive officer of Cisco; was responsible
for the general supervision of the affairs of the Company; was required to sign or countersign all
certificates, contracts and other instruments as authorized by the Board of Directors (the “Board”); was
required to make reports to the Board and shareholders; and had the authority to perform other duties
incident to his position. Chambers prepared and approved Cisco’s press releases, was quoted in the
press releases and was the primary spokesperson during the Company’s earnings conference calls.
37. Chambers’ total compensation was $18.9 million in FY10 and $12.9 million in FY11
according to Cisco’s proxy statement. Chambers was named the most overpaid CEO in 2011 by 24/7
Wall Street based on the $18.9 million in overall compensation Chambers received in FY10 and the
31.4% decline in the Company’s stock price in 2011. In addition, during the Class Period, Chambers
sold 5,515,451 shares of Cisco stock for proceeds of $133,996,830 while in possession of material,
adverse, undisclosed information.
38. Defendant Frank Calderoni is, and was at all relevant times, Executive Vice President
and Chief Financial Officer at Cisco. Like Chambers, Calderoni prepared and approved Cisco’s press
releases, was quoted in the press releases and made statements during the Company’s earnings
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conference calls. Calderoni’s total compensation was $10.2 million in FY10 and $7.9 million in
FY11 according to Cisco’s proxy statement.
39. Chambers and Calderoni are collectively referred to as the Individual Defendants.
They knowingly or with deliberate recklessness made materially false and misleading statements
during the Class Period that concealed Cisco’s true condition and caused the Company’s stock to trade
at artificially inflated prices. They are liable for the billions of dollars in damages incurred by
plaintiffs and the class when the stock price declined after Cisco revealed its true condition by
publicly disclosing the previously concealed material adverse information.
IV. SOURCES OF ALLEGATIONS
40. Some of the allegations included herein are based on information provided by several
former Cisco employees referred to as confidential witnesses (“CW”). The information provided by
the former employees is reliable and credible because: (a) the witnesses worked at Cisco during the
Class Period or before the Class Period but described problems that continued during the Class
Period; (b) each of the witnesses stated he or she had personal knowledge of the information
provided; (c) the witnesses’ job titles and responsibilities support their claims of personal knowledge
of the information provided; (d) many of the witnesses’ accounts corroborate one another; and (e) the
witnesses’ accounts are corroborated by other information alleged herein.
41. CW1 was a marketing program manager in Cisco’s Consumer Product division from
August 2006 until February 2011, when CW1 left the Company. CW1 was a marketing liaison
between several groups (engineering, product developers and marketing) within the Linksys (a
consumer router product) division and was involved in several product releases per month. During
the Class Period, CW1 reported to the Director of Marketing, Scott Kabat, who reported to the Vice
President of Marketing for Consumer Products, Simon Fleming, who reported to Jonathan Kaplan,
the former CEO of Pure Digital, who was made the head of the consumer division when Cisco
acquired Pure Digital in March 2009. Kaplan reported to the Chief Strategy Officer, Ned Hooper,
who reported to Chambers. As detailed below, CW1 said there were problems in the consumer
segment including the discontinuation of Linksys router development and the number of Linksys
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products available for sale that caused Cisco’s share of the home router market to decline from 52%
in 2009 to 24% in February 2011 and a reduction to the forecast in the Spring of 2010.
42. CW2 was a business development manager in Cisco’s service provider segment for
five and one-half years until CW2 was laid off in July 2009. CW2’s job responsibilities included
evaluating competitive challenges facing Cisco and how Cisco could respond to those challenges.
CW2 prepared reports every two months that identified the future direction of the market, actions by
Cisco’s competitors and proposals for Cisco to counter its competitors. CW2 stated that the reports
were received by high-level executives in the service provider segment. CW2 presented the reports
at Service Provider Committee meetings attended by Tony Bates (who resigned in October 2010),
who reported directly to Chambers. According to CW2, Tony Bates would brief the members of
Cisco’s executive committee – Chambers, Calderoni, Randy Pond, Rick Justice and Robert Lloyd. As
detailed below, CW2 stated that Cisco was losing switching and router sales to competitors in 2009
that offered better products and lower prices. CW2 also said that the set-top box business was
declining when CW2 left Cisco and that the committee-based organizational structure slowed
decision-making at the Company.
43. CW3 was a contract employee and senior financial analyst in Cisco’s cable set-top box
group from 2007 until July 2011 when CW3 resigned. CW3’s job responsibilities included booking
set-top box orders, providing information needed to determine the amount of revenue to be
recognized on multiple element orders, budgeting expenses to be incurred by the cable set-top box
division, and reviewing and reconciling the financials and forecasts of Scientific Atlanta. As
detailed below, CW3 said that Cisco provided “huge discounts” to cable set-top box customers in 2010
– including a “big push” at the end of FY10 – that pulled in orders from future quarters and gave the
appearance of an optimistic and robust outlook for the division but also reduced margins on those
orders and caused future orders to decline. CW3 also stated that the discounted prices were often
reduced further between the order date and the shipment date, that the set-top box order forecast for
FY11 was $1.2 billion which was substantially less than the $2 billion of annual revenues generated
by the set-top box business in previous years, and that revenues were substantially less because of
order cancellations and price erosion.
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44. CW4 worked at Cisco from February 2007 until May 2011 when CW4 resigned.
CW4 was a manager of worldwide channels finance from May 2010 until CW4 resigned. CW4
provided support to various sales leadership teams throughout the Company. Prior to May 2010,
CW4 worked in different sales finance roles and supported Financial Controllers within various
operating segments by preparing weekly forecasts, managing expenses, and performing various
financial planning and analysis functions. As detailed below, CW4 stated that Cisco provided steep
price discounts on products and that the price would decline further between the order date and the
shipment date. CW4 also said that Cisco had an excessively complex and unwieldy organizational
and management structure that resulted in duplication of work, a lack of clarity on who was
responsible for different matters and greatly slowed down decision making. CW4 also described the
Company’s forecasting process.
45. CW5 was a services portfolio analyst who worked at Cisco from January 2010 to
January 2011 when CW5 was laid off. CW5’s primary job responsibilities were to analyze and
determine growth trends in Cisco’s services portfolio by obtaining data (including contracts with
customers) from personnel in the Company’s finance, operations, marketing and sales groups. CW5
prepared monthly, quarterly and annual reports summarizing the data and believed the reports were
provided to senior executives, including Chambers, Calderoni and the Chief Marketing Officer. As
detailed below, CW5 reviewed data that showed Scientific Atlanta was consistently operating at a
loss and also stated that there were problems with Cisco’s organizational structure, including multiple
layers of management, high turnover, vaguely understood responsibilities and numerous committees
responsible for different functions.
46. CW6 joined Scientific Atlanta as a financial analyst in February 2007 and remained at
Cisco until October 2010 when CW6 resigned. CW6 worked in Atlanta and was responsible for the
financial analysis of Scientific Atlanta’s cable modem business, which generated about $240 million
in annual revenue. CW6 stated that cable customers were reducing capital expenditures by
purchasing products from lower-cost Asian competitors beginning in late 2008 and that, by summer
2010, cable operators were also losing subscribers. CW6 said that throughout 2010, the Scientific
Atlanta division of Cisco provided significant price discounts to cable customers so they would
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increase and accelerate their orders, that the price discounts became more elaborate as the year
progressed and that the price discounts negatively impacted gross margins.
47. CW7 was a contract employee at Cisco’s Commercial Finance Solutions Group in
Lawrenceville, Georgia from October 2007 until October 2010 when CW7 resigned. CW7 was
responsible for reviewing proposed sales transactions of cable products that deviated from defined
pricing and discounting terms and conditions. CW7 worked with sales personnel to write up deals
and was responsible for ensuring all details were included in materials submitted to high-ranking
management personnel at Scientific Atlanta/Cisco, including Vice President of Finance John
Morton, for review and either approval or rejection. As detailed below, CW7 stated that orders from
cable companies were extremely robust through the end of 2008, as cable companies were switching
from analog to digital networks, but that cable set-top box orders declined significantly in 2009 and
2010. CW7 also stated that beginning in 2009, lower-cost Chinese competitors like Huawei became
more prevalent and that Cisco provided significant price discounts to cable operators.
V. SUBSTANTIVE ALLEGATIONS
A. Before the Class Period, Analysts and Investors Were Concerned About the Company’s Organizational Structure and that Cisco’s Growth and Diversification Strategy Would Cause the Company to Lose Focus on the Core Switching and Technology Businesses and Enter Less Profitable Businesses in Which the Company Was Inexperienced
48. Description of the business . Cisco was incorporated in California in December 1984,
and its headquarters are in San Jose, California. Cisco designs, manufactures and sells IP-based
networking and other products related to the communications and IT industry and provides services
associated with these products and their use. It provides a broad line of products for transporting
data, voice and video within buildings, across campuses and around the world. Its products are
designed to transform how people connect, communicate and collaborate and are installed at
enterprise businesses, public institutions, telecommunications companies, commercial businesses
and personal residences.
49. Switches and routers generate a majority of revenues . The Company’s core routing
and switching technologies generated a majority of the Company’s revenues and are commonly
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referred to as the plumbing or pipes of the internet because they direct data over the internet.
Routers have been described as the heart and brains of IP networks that analyze and forward IP
packets from source to destination and as traffic cops that steer packets of information to their
intended destinations across vast and complex networks. In its 2010 Form 10-K, Cisco reports
routing technology is “fundamental to the Internet, and this technology interconnects public and
private IP networks for mobile, data, voice, and video applications” and that its routing products are
“designed to enhance the intelligence, security, reliability, scalability, and level of performance in the
transmission of information and media-rich applications.”
50. Switches perform the function of determining and regulating the flow of data traffic.
Cisco reports that switching technology is “another integral networking technology used in campuses,
branch offices, and data centers” that “are used within buildings in local-area networks (LANs), across
cities in metropolitan-area networks (MANs), and across great distances in wide-area networks
(WANs).” The Company’s switching products, according to Cisco, “offer many forms of connectivity
to end users, workstations, IP phones, access points, and servers, and also function as aggregators on
LANs, MANs, and WANs.” Cisco’s switching systems “employ several widely used technologies,
including Ethernet, Power over Ethernet, Fibre Channel over Ethernet, Packet over Synchronous
Optical Network, and Multiprotocol Label Switching.”
51. Advanced technologies are Cisco’s product groups that are focused on markets
adjacent to switching and routing and have exceeded or have the potential to exceed $1 billion of
annual revenues. These market adjacencies include unified communications, video, security,
wireless, home networks, ANS and storage.
52. In its quarterly earnings releases and conference calls, Cisco emphasized year-over-
year growth in net revenues, gross margin and earnings. The Company reported net revenues and
gross margin in each geographic segment – U.S. & Canada, European Markets, Emerging Markets
and Asia Pacific Markets. It also reported revenues by product type (switches, routers and new
products) and from services, and reported the product gross margin and service gross margin.
Switches and routers were Cisco’s core technology products and made up more than 60% of product
revenues and more than 50% of the Company’s total revenues from 2008 through 2010.
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(in millions) 2008 2009 2010 2011 Switching $13,538 $12,119 $13,568 $13,418 Routing $7,940 $6,311 $6,574 $7,100 New Technology $9,448 $9,903 $9,639 $13,025 Other $2,175 $1,608 $2,639 $983 Total Product Revenues $33,101 $29,131 $32,420 $34,256 Services $6,441 $6,986 $7,620 $8,692 Total Revenues $39,540 $36,117 $40,040 $43,218
53. During the conference calls – but not in reports filed with the U.S. Securities and
Exchange Commission – Cisco also reported revenues and orders by customer segment – enterprise
(companies with more than 1,000 employees), commercial (companies with less than 1,000
employees), consumer, service provider and public sector. During the November 10, 2010
conference call, Chambers stated that 23% of Cisco’s business was generated by the enterprise
segment, 20% by the commercial segment, 22% by the public sector segment and 33% by the
service provider segment. Analysts in turn reported these important metrics.
54. Concerns about growth and diversification by acquisition strategy . From 2000 to
2008, Cisco pursued a growth by acquisition strategy; the Company’s net revenues more than
doubled from $18.9 billion in 2009 to $39.5 billion in 2008; and earnings tripled from $2.7 billion to
$8.1 billion.
(in billions) 2000 2001 2002 2003 2004 2005 2006 2007 2008 Net Revenues $18.9 $22.3 $18.9 $18.9 $22.0 $24.8 $28.5 $34.9 $39.5 Net Income $2.7 ($1.0) $1.9 $3.6 $4.4 $5.7 $5.6 $7.3 $8.1 EPS $0.36 ($0.14) $0.25 $0.50 $0.62 $0.87 $0.89 $1.17 $1.31
55. In 2003, Cisco diversified into the consumer business by acquiring Linksys, a
manufacturer of home networking products, for $480 million in stock (29 million shares). In 2006,
Cisco expanded the home networking business by acquiring Scientific Atlanta for $7.1 billion in
cash. Scientific Atlanta manufactured and sold set-top boxes, end-to-end video distribution
networks and video system integration. Scientific Atlanta’s primary manufacturing facility was in
Juarez, Mexico. In 2009, Cisco acquired Pure Digital for $533 million (27 million shares). Pure
Digital manufactured and sold the “Flip” digital video recorder. In March 2009, Cisco also entered the
enterprise data center blade server market with its Unified Computing System, which made it a
direct competitor with important channel partners like HP, Dell and IBM.
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56. Analysts expressed concerns about Cisco’s growth and diversification by acquisition
strategy. They noted that the Company’s expansion into market adjacencies was key to Cisco’s ability
to grow 12% to 17% because Cisco was already the dominant seller of switches and routers, but
were concerned that Cisco was inexperienced in the new businesses and that it might cause
management to lose focus on the core routing and switching products when those businesses
included an increasing number of competitors.
57. They were also concerned about the expansion into the enterprise data center blade
server market because it threatened the switching and router revenues that channel partners HP, Dell
and IBM previously generated and because those partners became direct competitors in the
switching and routing businesses – HP through its acquisition of 3Com in November 2009 and IBM
and Dell through their OEM deals with Juniper and Brocade. Brigantine Advisors reported that HP
and IBM generated approximately $2 billion in switching revenues for Cisco; and on February 18,
2010, Cisco announced that it had informed HP it would not renew the System Integrator contract
expiring in April, which meant HP would no longer be a certified channel partner or global service
alliance partner.
58. Concerns about new organizational structure . In 2007, Chambers overhauled
Cisco’s management structure to support the Company’s growth and diversification by acquisition
strategy. Cisco increased the number of markets from 2 in 2007 to 26 in 2009 and more than 30
during the Class Period. Chambers said that large companies began to slow down “because they
didn’t move out of their primary markets” fast enough. The new organization structure included:
(a) an operating committee comprised of 15 top executives and Chambers; (b) 12 councils, each
comprised of an average of 14 people; (c) 47 boards, each comprised of an average of 14 people; and
(d) working groups that were small temporary teams working on individual projects.
59. The new organization structure was criticized by many as adding bureaucracy and
stripping away accountability. The Wall Street Journal reported in August 2009 that Cisco had
experienced difficulty executing with its new structure and that it slowed responses to rivals’ moves,
including the failure to match until April 2008 HP’s late-2007 decision to promote a warranty for
switches that provided free upgrades and support, which caused Cisco’s market share to fall.
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Decisions made collaboratively through the new structure increased to 70% in 2009 compared to just
10% in 2007. It also reported that 20% of Cisco’s senior leaders had left the Company since the
changes were made in 2007. Analyst Henry Blodget wondered if Chambers had “gone insane.”
60. Financial results begin to recover after financial crisis . After reporting increasing
revenues and earnings from 2000 to 2008, Cisco’s net sales and earnings declined in FY09 due to the
financial crisis and started to rebound in 4Q09 and 1Q10 but were still substantially less than sales in
4Q08 and 1Q09.
(in billions) 1Q08 2Q08 3Q08 4Q08 FY08 1Q09 2Q09 3Q09 4Q09 FY09 1Q10 Net Revenues $9.5 $9.8 $9.8 $10.4 $39.5 $10.3 $9.1 $8.2 $8.5 $36.1 $9.0 Net Income $2.2 $2.1 $1.8 $2.0 $8.1 $2.2 $1.5 $1.3 $1.1 $6.1 $1.8 EPS $0.36 $0.34 $0.30 $0.33 $1.31 $0.37 $0.26 $0.23 $0.19 $1.05 $0.30 # Shares 6,087 6,010 5,942 5,986 5,986 5,881 5,848 5,805 5,828 5,828 5,767
61. Much of the growth in net income and EPS was attributable to declining tax expenses
and the Company’s repurchase of millions of shares (which reduced the denominator – number of
outstanding shares – used to compute EPS). Cisco’s tax expense fell from 38.6% of pretax income in
2000 to 20.3% of pretax income in FY09 to 17.5% of pretax income in FY10 and 17.1% in FY11.
The Company accumulated $35 billion of cash and investments by the end of FY09 (and $44.5
billion by the end of FY11), most of which could not be repatriated to the U.S. without paying taxes
that were avoided previously. On June 28, 2011 Bloomberg reported that Cisco and Chambers
“gamed the tax system to park $32 billion in profits in low-tax countries” and reduce its income taxes
by $7 billion since 2005 by booking roughly half its worldwide profits at a foreign subsidiary where
the effective tax rate was 5%. Chambers repeatedly stated that the government should permit
repatriation of the cash without requiring Cisco to pay taxes because it would not cost the taxpayer
anything and would create jobs.
62. Reported EPS also increased because of the share repurchases. In 2002, Cisco had
7.44 billion shares outstanding. By the end of 2007, outstanding shares declined to 6.06 billion and
continued to decline to 5.73 billion by the end of 2010. Stock repurchases continued during the
Class Period, including 249 million shares repurchased for $6 billion from 2Q10 to 4Q10 as
Chambers sold 5.5 million of his Cisco shares for $134 million.
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63. Stock price lags NASDAQ . Although Cisco reported increasing revenues and profits
from its growth and diversification by acquisition strategy, parking profits in low-tax countries and
share repurchases, the Company’s stock price lagged the NASDAQ from September 2007 to January
2010. After Chambers was appointed CEO on January 31, 1995, Cisco’s stock price soared more
than 4,000%, from $1.875 in February 1995 to $77.31 in March 2000, compared to a 500% increase
in the NASDAQ (755 to 4,572). The stock then declined to $15.81 by March 2001, $12.18 in
September 2001 and $10.48 in September 2002. By September 2007, the Company’s stock price
increased 216% to $33.13, compared to a 130% increase in the NASDAQ (from 1172 to 2701). But
from September 2007 to January 2010, Cisco’s stock price declined 32% to $22.47. By comparison,
the NASDAQ declined 21% from September 2007 to January 2010.
64. On January 8, 2010, Electronics International reported that Cisco’s stock price had
been flat for about three months despite an increase in the NASDAQ and several positive
announcements, including a MarketWatch report that IT spending had started to recover based on
reports by Deutsche Bank and Wedbush Morgan and announcements by Cisco that it had plans for a
residential telepresence solution and that it was acquiring Rohati, a security technology company.
Electronics International also reported that analysts had recently started to ask more searching
questions of Chambers about his refusal to abandon the long-term 12% to 17% growth target for
Cisco and that other observers and investors were apprehensive about the number of different
markets into which Cisco was moving and wondered if the Company was biting off more than it
could chew.
65. Thus, entering the Class Period, defendants knew that Cisco’s stock price – which had
historically outperformed the NASDAQ – lagged the NASDAQ from September 2007 to January
2010 despite the growth and diversification by acquisition strategy; the new organizational structure;
the tax maneuvers and share repurchases that increased net income; the quarter-over-quarter growth
in net revenues in 4Q09 and 1Q10; and the quarter-over-quarter growth in net income in 1Q10.
They also knew investors were concerned about the new organization structure and expansion into
new markets. As a result, defendants knew that Cisco needed to report positive results in its core
switching and router businesses and in its newer consumer-based businesses to improve revenue and
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earnings growth and increase the Company’s stock price. That would show investors that Cisco was
successfully emerging from the financial crisis, expanding into new markets while maintaining
revenue growth and market share gains in routers and switches, and that the Company’s new
organizational structure was operating effectively.
B. February 3, 2010: Defendants Falsely Represent that Cisco’s Game Plan for Emerging from the Financial Crisis was “Hitting on All Cylinders” that the Company Was Able to “Catch Market Transitions and Move into New Market Adjacencies . . . While Still Maintaining Revenue Growth and Market Share Gains in . . . Traditional Areas” and that the Company’s “New Organization Structure Was Operating Very Effectively” – Chambers Sells $97.2 Million of Cisco Stock Days Later
66. On February 3, 2010, Cisco issued a press release and held a conference call to report
2Q10 results. Chambers and Calderoni told investors that 2Q10 results exceeded the Company’s
previous guidance, revenue growth would be higher in 3Q10 and Cisco was hitting on all cylinders.
In the press release, defendants made the following misleading statements:
“Our outstanding Q2 results exceeded our expectations and we believe they provide a clear indication that we are entering the second phase of the economic recovery. During the quarter we saw dramatic across the board acceleration and sequential improvement in our business in almost all areas ,” said John Chambers, chairman and chief executive officer, Cisco.
“We are confident that our aggressive strategy of investing in the business during the downturn and our focus on innovation, operational excellence, and productivity are driving our momentum and growth in the market. We believe that we are extremely well-positioned – by geography, in our customer segments, and in our key product categories – as economies around the world continue to improve and our customers increase their technology investments.”
* * *
“From a financial standpoint, Q2 was an outstanding quarter. Our performance with an eight percent year-over-year increase in Q2 revenue represents our third sequential quarter of positive growth and was well above the strong guidance we outlined during our first quarter conference call,” said Frank Calderoni, chief financial officer, Cisco. “We delivered strong gross margins and added $2.5 billion in cash from operations during our second quarter, bringing our total of cash and investments to $39.6 billion. We believe that these results demonstrate the strong foundation from which we can continue to focus on growing and capturing market transitions in our industry. ”
67. During the conference call, Chambers assured investors that Cisco was able to “catch
market transitions and move into new market adjacencies . . . while still maintaining revenue growth
and market share gains in our traditional areas,” that the Company’s “new organization structure of
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councils, boards and working groups . . . [was] operating very effectively” and that Cisco was
returning to its “prior financial operating model” of 12% to 17% annual revenue growth:
Given our views of the economy expressed over the last four quarters, with the expanding role of intelligent networks in all forms of communications and IT, combined with our ability to catch market transitions and move into new market adjacencies, we are proud of our ability to return to our prior financial operating model so quickly after the global economic slowdown. Our new organization structure of councils, boards and working groups as discussed in the last few calls is operating very effectively and has been an important part of managing through the recent downturn and then positioning us for the acceleration of results achieved during the last two quarters. These structures allow speed, scale, flexibility and rapid replication. We will continue to move into additional market adjacencies which are currently at about 30. And of perhaps equal importance, many of our leading customers now are beginning to understand how this highly innovative management structure combined with new business models can launch this many product families and movement into new market adjacencies while still maintaining revenue growth and market share gains in our traditional areas.
68. Chambers also told investors that “innovations in our traditional routing and
switching product families have a very high probability of gaining market share .”
69. Chambers assured investors that almost all of the Company’s customers believed that
Cisco was improving “from both a technology and a business partner perspective” and product orders
increased in each customer segment:
The feedback from customers in all major geographies and customer segments is rapidly improving in terms of their view of their own country, economic growth and their own business opportunities. While almost all of these customers indicated Cisco’s improving status in the organizations from both a technology and a business partner perspective, this is especially true in our service provider, enterprise and government accounts .
* * *
Our service provider business on a global basis in terms of product orders in Q2 was up 11% year-over-year . Our commercial was up 10%. Enterprise was up approximately 7%, and consumer, including our Pure Digital acquisition, was up over 80% . To again put this in perspective versus just one quarter ago in Q1 where our enterprise, including public sector, was down slightly year-over-year, consumer was up approximately 20%, and service provider and commercial were down in the low double digits. This is obviously an inflection point in the market in all customer segments .
70. Chambers stated that service provider orders increased in the “low 20s from a year-
over-year perspective” and that it was “one of the most robust positive turnarounds I have seen in
my career .” He stated that revenues from sales of the Flip increased from $50 million in 1Q10 to
$130 million in 2Q10 and that the “Nexus 5000 and 7000 showed extremely strong year-over-year
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improvements as their customer acceptance dramatically increased with revenue growth of
approximately 450% for the Nexus 5000 year-over-year and 140% for the 7000 .”
71. Chambers concluded his remarks by stating that “ our execution is on target in terms
of results measured from our customer partnership perspective, market share and share of our
customers’ total communications and IT expenditures as the network becomes the platform for
delivering these capabilities .” “In summary, for those areas that we control and influence, we
believe our vision, strategy and execution are in great shape and producing results . And for those
areas that we cannot influence or control, at the present time we’re also seeing positive
improvements, solid improvement.”
72. Analysts interpreted Chambers’ remarks as being very positive and asked why.
During the question-and-answer portion of the conference call, the very first question came from
RBC Capital Markets analyst Mark Sue, who asked Chambers why he was so confident and
aggressive on the sustainability of Cisco’s newfound strength. Chambers responded that the reason
for the confidence was the “type of balance across every single market segment, across all of our
major theaters, across all of our key product areas , and you see the products begin to tie together,
that combined with having talked to government leaders.” He emphasized that what Cisco could
control or influence was “really going very well ” and that the Company was “hitting on all cylinders .”
73. Deutche Bank analyst Brian Modoff asked when the strong growth in Nexus switches
would become significant and whether they would generate $1 billion in revenue during the year.
Chambers responded that “the business doubled from last quarter ” and that the Nexus switches would
generate $1 billion of revenue in calendar year 2010: “In terms of the basis for Nexus, in terms of
the $1 billion run rate, I feel very comfortable we will be on that in this calendar year. In fact, we
are rapidly closing on that already .”
74. Morgan Keegan analyst Simon Leopold stated that many of the analysts were worried
about the competitive dynamics and specifically the reactions of Cisco’s data center initiatives by
IBM and HP. He asked Chambers to quantify the exposure to these past partners and help the
analysts understand how it would trend over the next number of quarters. Chambers responded that
the impact “was not major at all” and that Cisco was “doing extremely well.”
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75. Responding to a question about gross margins from Credit Suisse analyst Paul
Silverstein, Chambers stated that “ we are seeing some very good but very tough price competition
from some of our competitors out of China ”; that new product margins “at first . . . are not quite
what we would like, but then they buil[d] up over time ”; and that analysts should “hold us
accountable as a leadership team to say in the 64%, 65% range .”
76. Following defendants’ misleading positive statements, Cisco’s stock price increased
0.4% from $23.07 on February 3, 2010 to $23.16 on February 4, 2010, compared to a 3.1% decline
in the S&P 500 and a 2.9% decline in the S&P Technology index. 2 It increased another 2.3% on
February 5, 2010 to $23.70, compared to a 0.3% increase in the S&P 500 and a 1.1% increase in the
S&P Technology index.
77. Analysts and the financial press reported that Cisco’s stock price increased after
Chambers’ bullish comments during the conference call and Cisco’s reporting of results and guidance
that beat Wall Street estimates. But some analysts also noted that they still had concerns about the
Company’s ability to grow at 12% to 17% given that most of the growth was in switching sales and
not from strategic moves into new markets. Other concerns included less-than-expected growth in
router sales, the 3.5% quarter-over-quarter growth forecast for 3Q10 and competition from HP, IBM
and Dell arising from Cisco’s entry into the blade server market in 2009.
78. On February 8, 2010, Morningstar Equity Research reported that Cisco’s core
franchise in routers and switches could be at risk in the extreme long term from new technologies
and the trend toward more open systems but that there were no material threats on the horizon. It
also reported that the more immediate threat was Cisco’s voracious appetite for growth, which put it
in conflict with channel partners and could result in lower revenues from those partners and drive a
larger portion of Cisco’s revenues to less profitable, more competitive businesses.
2 In its 2010 Annual Report, Cisco compared the performance of its stock price to the S&P 500 and the S&P Information Technology index.
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Reasons Why Defendants’ Knew or Were Deliberately Reckless in Not Knowing Their Statements Were Materially False and Misleading
79. Contrary to defendants’ positive representations, information provided from various
sources establishes that Chambers and Calderoni knew or were deliberately reckless in not knowing
that their statements were materially false and misleading because there were important undisclosed
problems with several of the Company’s businesses.
Defendants Knew Switches and Router Sales, Market Share and Gross Margins Were Declining
80. Information provided by former Cisco employees, admissions by Chambers and the
Company later in the Class Period and other information establish that defendants knew revenues
and gross margins on sales of switches and routers would decline due to increased competition,
Cisco’s introduction of new products (including Nexus switches) with lower prices and lower gross
margins, and customers shifting to multivendor networks from single vendor networks. As a result,
they also knew Cisco’s overall share of the switching and router markets were declining. These
problems in the Company’s core business contradicted defendants’ statements that Cisco was able to
“catch market transitions and move into new market adjacencies . . . while still maintaining revenue
growth and market share gains in . . . traditional areas” and that the Company’s “new organization
structure of councils, boards and working groups . . . [was] operating very effectively.” They also
contradicted defendants’ representations that the impact of competition from HP was not major at all
and that Cisco would report 64% to 65% gross margins despite price competition from Chinese
competitors and lower margins on new products. Further, Chambers’ statements that sales of Nexus
switches would reach $1 billion in calendar year 2010 were misleading because he failed to disclose
that the sales of these lower-margin products would cause revenues from Cisco’s other switching
products and product gross margins to decline.
81. Decline in sales, gross margins and market share . Contrary to Chambers’
representations, Cisco did not maintain revenue growth and market share gains in its traditional
switching and router businesses. As shown in the following chart, after switching revenues returned
to pre-crisis levels in 3Q10, they declined each of the next four quarters along with Cisco’s product
gross margins:
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Date of Earnings Release 11/04/09 02/03/10 05/12/10 08/11/10 11/10/10 02/09/11 05/11/11 08/10/11
Quarter 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 Switching Revenues $2,872 $3,396 $3,658 $3,642 $3,551 $3,151 $3,299 $3,436
QoQ 1.74% 18.25% 7.71% (0.44%) (2.5%) (11.26%) 4.70% 4.1% YoY (20.11%) 12.49% 41.34% 29.01% 23.64% (7.21%) (9.81%) (5.6%) Router Revenues $1,574 $1,606 $1,713 $1,681 $1,804 $1,672 $1,860 $1,733
QoQ 6.42% 2.03% 6.66% (1.87%) 7.32% (7.32%) 11.24% (16.8%) YoY (16.45%) 5.45% 23.68% 13.66% 14.61% 4.11% 8.58% (2%) Non-GAAP Product Gross Margin 66.3% 65.6% 65.3% 63.6% 64.0% 61.1% 63.1% 61.2% GAAP Product Gross Margin 65.4% 64.7% 64.3% 62.4% 62.6% 58.9% 60.4% 59.9%
82. Data compiled by the Dell’Oro Group, IDC Company (“IDC”) and Oppenheimer & Co.
Inc. (“Oppenheimer”) also establishes that Cisco’s share of the switching and router markets declined
from 1Q10 to 2Q11. On July 13, 2011, it was reported that data compiled by the IDC showed that
Cisco’s share of the L2/L3 switching market declined from 74.3% in 1Q10 to 68.5% in 1Q11 and that
Cisco’s share of the router market declined from 60.6% to 54.2%. Data compiled by IDC and
Oppenheimer that was published by Oppenheimer on August 24, 2011 shows that Cisco’s share of
the three Ethernet switching markets declined from 1Q10 to 2Q11. 3 As shown in the following
chart, Cisco’s share of the 1GbE market – by far the largest of the three markets – declined from 71.7%
in 1Q10 to 65.5% in 2Q11. During the same time period, the Company’s share of the 10GbE market
declined from 79.4% to 72.4%, and the Company’s share of the 100Mbps market declined from
78.4% to 66.3%.
3 The data reflected in the charts are based on calendar quarters, so the dollar amounts for Cisco do not match the amounts reported by the Company because Cisco’s fiscal year ended on July 31.
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Cisco Ethernet Switching (L2 & L3) ($ in Millions) Revenue: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps $440 $495 $490 $450 $405 $360 $270 $272 1GbE $1,610 $1,950 $2,225 $2,150 $2,190 $2,210 $1,800 $1,897 10GbE $540 $640 $885 $905 $1,000 $985 $960 $1,048 Total Revenue $2,590 $3,085 $3,600 $3,505 $3,595 $3,555 $3,030 $3,217
Revenue Market Share Snapshot 100Mbps 75.2% 77.3% 78.4% 75.6% 75.0% 71.3% 67.2% 66.3% 1GbE 66.9% 68.7% 71.7% 68.9% 69.1% 69.2% 66.3% 65.5% 10GbE 72.5% 72.3% 79.4% 76.4% 78.4% 73.5% 73.6% 72.4% Source: IDC, Company data, Oppenheimer & Co. Inc.
83. The data also shows that Cisco’s share of the 100Mbps and 10GbE markets, as
measured by ports, declined from 1Q10 to 2Q11; that the Company’s share of the 1GbE market
remained flat; and that the average selling price for ports in each of the three markets declined
substantially.
Cisco Ethernet Switching (L2 & L3) (in thousands) Ports: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps 12,075 11,415 14,005 12,910 12,250 11,655 11,100 11,193 1GbE 12,050 13,000 16,645 17,490 19,385 19,600 18,030 20,018 10GbE 335 395 630 795 845 900 990 1,190 Total Ports 24,460 24,810 31,280 31,195 32,480 32,155 30,120 32,401
Port Market Share Snapshot 100Mbps 52.4% 49.5% 56.4% 53.1% 52.1% 48.5% 49.3% 47.4% 1GbE 37.4% 37.1% 42.8% 41.5% 43.5% 42.8% 41.5% 42.2% 10GbE 57.3% 51.3% 63.3% 63.6% 62.1% 57.3% 59.5% 59.4% Source: IDC, Company data, Oppenheimer & Co. Inc.
Cisco Ethernet Switching (L2 & L3) Port ASP 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps $36 $43 $35 $35 $33 $31 $24 $24 1GbE 134 150 134 123 113 113 100 95 10GbE 1,612 1,620 1,405 1,138 1,183 1,094 970 881 Overall Port ASP $106 $124 $115 $112 $111 $111 $101 $99
84. By contrast, the data shows that HP, Juniper and Brocade’s share of the market
increased from 1Q10 to 2Q11 and that their average selling prices per port were often less than the
price of Cisco’s ports despite the substantial decline in Cisco’s port prices. As shown in the following
tables, HP’s share of all three switching markets – measured by revenues and ports – increased
substantially from 1Q10 to 2Q11, and the average selling prices of its ports were a fraction of Cisco’s
average selling prices.
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HP Ethernet Switching (L2 & L3) ($ in Millions) Revenue: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps $21 $23 $24 $49 $51 $52 $47 $45 1GbE $185 $206 $220 $381 $375 $350 $355 $368 10GbE $44 $66 $46 $90 $92 $125 $127 $152 Total Revenue $250 $295 $290 $520 $518 $527 $529 $565
Revenue Market Share Snapshot 100Mbps 3.6% 3.6% 3.8% 8.2% 9.5% 10.3% 11.7% 11.0% 1GbE 7.7% 7.3% 7.1% 12.2% 11.8% 11.0% 13.1% 12.7% 10GbE 6.0% 7.5% 4.1% 7.6% 7.2% 9.3% 9.7% 10.5% Source: IDC, Company data, Oppenheimer & Co. Inc. *HP and 3Com are consolidated starting in 2Q10.
HP Ethernet Switching (L2 & L3) (in thousands) Ports: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps 2,250 2,505 2,515 4,900 5,240 5,460 4,910 4,995 1GbE 3,225 3,535 3,720 8,015 8,160 8,140 8,483 8,827 10GbE 105 200 155 240 255 340 323 382 Total Ports 5,580 6,240 6,390 13,155 13,655 13,940 13,716 14,204
Port Market Share Snapshot 100Mbps 9.8% 10.9% 10.1% 20.2% 22.3% 22.7% 21.8% 21.2% 1GbE 10.0% 10.1% 9.6% 19.0% 18.3% 17.8% 19.5% 18.6% 10GbE 17.9% 26.0% 15.6% 19.2% 18.8% 21.7% 19.4% 19.1% Source: IDC, Company data, Oppenheimer & Co. Inc. *HP and 3Com are consolidated starting in 2Q10.
HP Ethernet Switching (L2 & L3) Port ASP 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps $9 $9 $10 $10 $10 $10 $10 $9 1GbE 57 58 59 48 46 43 42 42 10GbE 423 330 297 375 361 368 393 398 Overall Port ASP $45 $47 $45 $40 $38 $38 $39 $40 Source: IDC, Company data, Oppenheimer & Co. Inc. *HP and 3Com are consolidated starting in 2Q10.
85. As shown in the following tables, Juniper’s share of the 1GbE and 10GbE switching
markets also increased from 1Q10 to 2Q11, as measured by revenues and ports, and the average
selling prices of its ports were less than Cisco’s average selling prices.
Juniper Ethernet Switching (L2 & L3) ($ in Millions) Revenue: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 1GbE $38 $55 $56 $65 $72 $82 $63 $71 10GbE $11 $17 $19 $23 $25 $35 $28 $35 Total Revenue $49 $72 $74 $88 $97 $117 $91 $106
Revenue Market Share Snapshot 1GbE 1.6% 1.9% 1.8% 2.1% 2.3% 2.6% 2.3% 2.5% 10GbE 1.5% 1.9% 1.7% 1.9% 2.0% 2.6% 2.1% 2.4% Source: IDC, Company data, Oppenheimer & Co. Inc.
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Juniper Ethernet Switching (L2 & L3) (in thousands) Ports: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 1GbE 550 700 615 850 865 1,070 910 1,165 10GbE 6 10 12 18 26 46 40 61 Total Ports 556 710 627 868 891 1,116 950 1,226
Port Market Share Snapshot 1GbE 1.7% 2.0% 1.6% 2.0% 1.9% 2.3% 2.1% 2.5% 10GbE 1.1% 1.3% 1.2% 1.4% 1.9% 2.9% 2.4% 3.0% Source: IDC, Company data, Oppenheimer & Co. Inc.
Juniper Ethernet Switching (L2 & L3) Port ASP 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 1GbE $69 $79 $90 $76 $83 $77 $69 $61 10GbE 1,790 1,680 1,575 1,280 950 770 695 565 Overall Port ASP $88 $101 $118 $101 $109 $105 $96 $86
86. As shown in the following tables, Brocade’s share of the switching markets also
increased from 1Q10 to 2Q11, and the average selling prices of its ports were less than the average
selling prices of Cisco’s ports for many of the quarters.
Brocade Ethernet Switching (L2 & L3) ($ in Millions) Revenue: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps $3 $3 $2 $2 $3 $3 $4 $4 1GbE $60 $55 $50 $60 $55 $50 $45 $52 10GbE $25 $30 $25 $30 $35 $40 $38 $36 Total Revenue $88 $88 $77 $93 $92 $94 $86 $92
Revenue Market Share Snapshot 100Mbps 0.5% 0.5% 0.4% 0.4% 0.5% 0.6% 0.9% 0.9% 1GbE 2.5% 1.9% 1.6% 1.9% 1.7% 1.6% 1.7% 1.8% 10GbE 3.4% 3.4% 2.2% 2.5% 2.7% 3.0% 2.9% 2.5% Source: IDC, Company data, Oppenheimer & Co. Inc.
Brocade Ethernet Switching (L2 & L3) (in thousands) Ports: 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps 100 115 95 90 105 130 120 130 1GbE 415 430 450 550 565 560 424 430 10GbE 13 17 22 22 30 40 51 46 Total Ports 528 562 567 662 700 730 595 606
Port Market Share Snapshot 100Mbps 0.4% 0.5% 0.4% 0.4% 0.4% 0.5% 0.5% 0.6% 1GbE 1.3% 1.2% 1.2% 1.3% 1.3% 1.2% 1.0% 0.9% 10GbE 2.1% 2.2% 2.2% 1.8% 2.2% 2.5% 3.1% 2.3% Source: IDC, Company data, Oppenheimer & Co. Inc.
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1 Brocade Ethernet Switching (L2 & L3)
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Port ASP 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 100Mbps $30 $28 $24 $24 $25 $24 $29 $29 1GbE 145 128 111 110 97 89 106 121 10GbE 1,850 1,715 1,200 1,270 1,135 1,010 875 787 Overall Port ASP $167 $157 $136 $140 $132 $128 $145 $152
87. Data compiled by Infonetics Research and Jefferies & Company, Inc. (“Jefferies”) that
was published by Jefferies on June 3, 2011 shows that Cisco’s share of the three router markets – core
routers, edge routers and enterprise routers – declined from 1Q10 to 1Q11. Cisco’s share of the core
router market – which Jefferies estimated comprised $1.6 billion or 3% to 4% of Cisco’s calendar 2010
revenues – declined from 56% in 1Q10 to 51% in 2Q10, increased during the next two quarters but
failed to regain the lost share from 1Q10 to 2Q10, and then declined again in 1Q11 to 54%.
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88. Cisco’s share of the edge router market – which Jefferies estimated comprised $2.75
billion or 7% of Cisco’s calendar 2010 revenues – declined from 43% in 1Q10 to 33.9% in 1Q11.
89. Jefferies reported that Cisco’s share of the edge router market declined as it struggled
to keep pace with competitors on a number of fronts. Cisco did not introduce its ASR 9000 router to
the marketplace until 1Q09, several years later than competing next-generation platforms like
Juniper’s MX960 edge-routing platform, which was introduced in 4Q06, and Alcatel-Lucent’s 7750
edge-routing platform, which was introduced several years earlier. As shown in the following chart,
Juniper, Alcatel-Lucent and Huawei increased their shares of the edge-routing market from 1Q10 to
1Q11 as Cisco’s share of the market declined.
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90. The enterprise router market includes four key segments: high-end routers, mid-range
routers, branch-office routers and low-end routers. Jefferies reported that Cisco’s share of the
enterprise router market - which Jefferies estimated comprised $1.6 billion or 6% of Cisco’s calendar
2010 revenues – remained flat from 1Q10 to 1Q11 with market share declines in the high-end and
low-end segments.
CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 33 -
91. The decline in switching and router sales and the gross margins on those sales
reported by Cisco in 2Q11 and 3Q11 was unexpected by investors and the market, as reflected by the
stock price declines following their disclosure. The following facts strongly suggest defendants
knew revenues, gross margins and market share would decline in the Company’s core switching and
router products.
92. Decline in sales of Linksys routers . As alleged below in ¶¶129-138, defendants
knew that router revenues and gross margins would decline as a result of the consumer segment
halting the development of new Linksys routers and reducing the amount of existing Linksys routers
available for sale.
93. Cannibalization reduces sales and margins . Defendants knew that Cisco’s
unprecedented introduction of 85 new products, with lower prices and lower gross margins, was
causing a decline in switching and router revenues and product gross margins. Included in those 85
products was the Nexus 7000 modular data center switch, which Chambers revealed during the May
11, 2011 conference had a gross margin that was 1,800 basis points lower than the Catalyst 6500
switch it was replacing.
94. Reasons defendants knew revenues and gross margins were lower on Cisco’s new
products . The Nexus 7000 switch had lower margins because it lacked certain features of the
Catalyst 6500 switch, which resulted in a lower sales price. In addition, the Nexus 7000 cost more to
produce for several reasons. First, it was built using older ASICs and therefore required more of
them (30-40 pieces per circuit board) to get the performance needed. That, in turn, led to more
power consumption, which required additional cooling and increased costs further. Second, the
Nexus 7000 was designed to be the data center switch of the future, so it was designed for highly
dense 10GbE environments, while the Catalyst 6500 switch was designed for the 1GbE market. As
a result, the Nexus 7000 switch design required a higher investment in the chassis, power and other
features that raised the architectural costs and thus the initial cost of the solution. Third, the Catalyst
6500 switch had been available for more than ten years and had benefited from value engineering
efforts, economies of scale in manufacturing and warranty cost reductions due to quality
improvements and customer familiarity.
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95. Cisco had over 35,000 customers for the Catalyst 6500 switch, which was Cisco’s
highest-gross-margin switch platform, so defendants knew the transition from the Catalyst 6500 to
the Nexus 7000 switch would cause revenues and gross margins to decline. According to
Oppenheimer analyst Ittai Kidron (“Kidron”), component shortages in 2H09 negatively impacted order
fulfillment for the Nexus 7000 switch and pushed the orders out to FY10. Shipments increased
substantially in 1Q10 and remained at that level throughout FY10 as supply constraints slowly
eased. Shipments of the Nexus then increased in 1Q11 and 2Q11 compared to steep declines in sales
of Catalyst 6500 switches. Kidron reported that Nexus 7000 sales topped $330 million in 4Q11,
while Catalyst sales were $685 million, and that the gap was expected to continue narrowing.
96. Defendants also knew that transitions in wiring closet modular switches would cause
revenues to decline. The gradual centralization in the data center of switching intelligence and
features was making room for a simpler aggregation switch to get the job done in most wiring
closets. As a result, customers were buying more of Cisco’s Catalyst 4500 switch as a modular
wiring closet solution instead of the Catalyst 6500 switch. That caused revenue cannibalization
because the Catalyst 4500 switch was 30% cheaper than the Catalyst 6500 switch. According to
Oppenheimer analyst Kidron, by 2Q11, the disparity was even greater – the average selling price of
the Catalyst 6500’s 1GbE port was $229, compared to an average selling price of $116 for the
Catalyst 4500’s 1GbE port.
97. Defendants knew that average selling prices on modular 1GbE ports were declining.
According to Oppenheimer analyst Kidron, they declined steeply from $250 in 4Q09 to $153 in
1Q11 and $146 in 2Q11 due to the transition to the Catalyst 4500 switch and the transition from
1GbE ports to 10GbE ports. As shown in the tables in ¶¶83-86, average selling prices of all port
switches sold by Cisco and others were declining throughout the Class Period.
98. Defendants knew that a transition from Cisco’s higher-end Catalyst 3000 fixed
switches to the lower-end Catalyst 2000 fixed switches was also cannibalizing revenues. According
to Oppenheimer analyst Kidron, the average selling prices declined from approximately $110 in
1Q10 to $86 by 1Q11. In March 2010, Cisco refreshed the Catalyst 2000 and 3000 switching
platforms but narrowed the feature gap between the two platforms. For many customers, the
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refreshed Catalyst 2960-S packed enough performance and features compared to the higher-priced
and higher-margin Catalyst 3560-X/3750-X switches. In fact, Kidron reported in May 2011 that
Cisco was using the refreshed Catalyst 2960-S as a key competitive tool against HP in international
markets, which had caused a substantial drop in average selling prices from just over $40 per port in
1Q10 to just over $30 per port in 1Q11.
99. Defendants admit they knew revenues and gross margins would decline . During the
February 3, 2010 conference call, Chambers stated that sales of Cisco’s new Nexus switch doubled
from 1Q10 to 2Q10 and that he was very comfortable that sales would reach $1 billion by the end of
the calendar year. But Chambers said nothing about how the new Nexus switches would negatively
impact Cisco’s switching revenues and product gross margins, even though he admitted later in the
Class Period that he knew the new Nexus switches would cause them to decline.
100. Indeed, during the February 9, 2011 conference call, defendants admitted that the
decline in switching revenues and product gross margins was caused by the newer Nexus switches.
Chambers stated that Cisco was “in the middle of a major product transition, with dramatically higher
price performance.” He and Calderoni both claimed that the transition was faster than expected, but
other comments indicate the negative impact from the sale of newer Nexus switches was not a
surprise. First, both Chambers and Calderoni acknowledged that they had managed such product
transitions many times in the past.
101. Second, in response to a question from Bank of America/Merrill Lynch analyst Tal
Liani (“Liani”), Chambers admitted that Cisco would need to sell two to three times the number of
Nexus 7000 switches than the Catalyst 6000 switches they were replacing to generate the same
amount of revenue and that the Nexus 7000 switch had lower gross margins. He also stated that the
new 4000 line of switches generated lower revenues than the 6000 switch it was replacing.
102. Third, Chambers admitted that he knew many new products would be introduced at
the same time, which Cisco had not done in the past. Responding to a question from RBC Capital
Markets analyst Mark Sue, Chambers claimed he was surprised at the ramp-up of the switching
product line but then admitted Cisco had never before introduced new products in such a short time
period but had introduced core routers, edge routers, access routers, high-end switches and fixed and
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CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 36 -
modular component parts “all at once.” He also admitted that when new products come out, “they
always start at lower gross margins.”
103. Fourth, Chambers changed his story when another analyst asked him to explain why
he was surprised. Apparently recognizing the contradiction between Chambers’ claim of surprise and
his subsequent comments that Cisco had never before introduced so many products in such a short
time, Oppenheimer analyst Kidron asked Chambers, “specifically on the switching side, what is it
about this transition that you didn’t anticipate that is happening?” This time Chambers had a different
answer. Rather than claim surprise by the ramp-up of the switching product line, he stated that the
introduction of ten major switching products at the same time and the time it took to improve price
performance and gross margins were two things that challenged Cisco. He described this process as
a “Texas two-step,” acknowledged that Cisco needed to better manage these product transitions with a
faster “Texas two-step” and revealed that the Company was forming a working group to focus on
expanding gross margins.
104. Fifth, the unexpected decline in switching and router revenues and the product gross
margin reported by Cisco on February 9, 2011 contradicted statements made by Chambers during the
previous conference call on November 10, 2010, when Cisco announced disappointing results in the
set-top box business, public sector business and consumer business. Many analysts questioned
whether those disappointing results were indicative of problems in the switching and router markets.
As the The Wall Street Journal reported on November 12, 2010, Chambers “took pains to refute
suggestions that Cisco [was] losing ground to rivals in the switching and routing hardware that are
key pillars to its business.” Chambers assured investors that market-share momentum positioned
Cisco for growth and flexibility well into the future, that Cisco continued to execute well in its core
markets, that sales of new switches and routers were very strong, that Cisco was very well positioned
and that the challenges in the cable set-top box business, public sector business and consumer
business were just air pockets that Cisco would power through. Skeptical analysts issued reports
after the November conference call in which they questioned those reassurances and wondered if
there were problems in Cisco’s core switching and routing businesses. Thus, analysts were surprised
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when Cisco reported substantial declines in switching and routing revenues and in product gross
margins on February 9, 2011.
105. Sixth, after defendants reported the declines in switching and router revenues on
February 9, 2011 and acknowledged new products were cannibalizing sales of higher-priced and
higher-margin products, analysts issued reports in which they noted that the cannibalization by
Cisco’s new products appeared to reflect a strategy of trading revenues for gross margins. The
financial press reported that the conference call was contentious and that Chambers was trying to
contain the damage. Morgan Stanley analyst Ehud Gelblum (“Gelblum”) reported that the startling
decline in switching revenues resulted from the cannibalization by Cisco’s own higher-performance
low end switches and that Cisco appeared to be trading revenue for margins. Oppenheimer’s analyst
Kidron issued a report titled “Painful Product Transitions,” in which he wrote that the gross margin
pressure was “a reflection of multiple concurrent switching product transitions as well as Cisco
needing to aggressively protect its installed base” and that Oppenheimer was “disappointed with GM
and the slow pace by which it could recover.”
106. Seventh, Chambers and Calderoni admitted in subsequent interviews and
presentations that they knew the product transitions would cause revenues and gross margins to
decline. During an interview with Bloomberg’s Betty Liu on February 10, 2011, Chambers admitted
that it took Cisco a couple of years to get gross margins on new products to levels they wanted.
During the Goldman Sachs Technology & Internet conference on February 15, 2011, Calderoni said
that the transition from older, higher-margin switches to newer, lower-margin switches contributed
to the decline in switching revenues and product gross margins. He admitted Cisco knew that such
transitions caused revenues and gross margins to decline based on past experience and that the
impact would be greater than in the past because the Company completely revamped the switching
portfolio in a short period of time.
[W]hat was going on within switching, which is something that we’ve been through in the last couple of quarters, is a product transition. We have done this and seen this in the past as far as transition of products within switching from, let’s say, older generation to newer generation . The key for our success over a longer period of time is to ensure that we stay ahead from a competitive standpoint. So from a technology perspective, with the new 2K and 3K that we introduced over the past year, and if you look at it from the Nexus product, on the 2K, the 5K and the 7K,
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we’ve had a complete revamp of the switching portfolio in a short period of time. We’ve been through technology transitions in the past, but this is probably a timeframe where we’ve had more of it kind of compressed in a certain timeframe rather than staggered over a couple of years .
When you go through those transitions, and we’ve seen this in the past, a couple of things happen. First of all, you tend to sell more of a lower price entry with some of the newer products. Secondly, from a margin perspective, the value engineering or the engineering that you build into your cost of these new products usually comes in over a period of time, so your cost is going to continue to improve over a number of quarters . Then in turn, you’re also going to sell richer configurations as you add additional features to your base offering.
So while we were going through this transition over the last year across the entire product line, we’ve seen kind of a shift from higher-price, higher-margin to lower-margin initially.
107. Calderoni also acknowledged that Chambers’ comments on February 9, 2011 – that
Cisco would need to sell two to three times more newer products to generate the same amount of
revenue from sales of the older products – indicated that cannibalization could cut Cisco’s internet
business in half.
108. During the Bank of America Merrill Lynch TelePresence Session on February 23,
2011, Chambers admitted that Cisco “brought out a whole new line of products in each [switching]
product area” that were “double the price performance” and that new products were “always
dramatic in those lower gross margins. ” He also admitted that Cisco “never had more than one or
two new switching products in 18 months, much less all five lines at the same time within a year .”
He explained that new switches with double the price performance meant that Cisco would “ have to
sell twice as many switches as you did just a year ago with the same revenue .” Later in the session,
Chambers reiterated that lower revenues and margins following product transitions “always happens”
and that it took more than three years for margins to recover.
109. During a Wells Fargo Securities Tech Transformation Summit on April 7, 2011,
Chambers provided more detail on the number of new products introduced by Cisco and revealed
that the negative impact on revenues and margins from new products was even worse than he
described at the Bank of America Merrill Lynch TelePresence Session on February 23, 2011.
Chambers stated that 85 products came out in the last six months of 2010 and that five different
Nexus switching product lines were introduced at one time . He said, “[i]t usually takes us three to
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four years before [new products] come back up to the level of [gross] margins that the
predecessors were at” and that Cisco needed to sell three times the amount of new products – not
two times, as stated previously – to generate the same revenues of sales of older products .
110. When Cisco reported 3Q11 results on May 11, 2011, Chambers stated that Cisco was
“in the midst of a significant transition” that “placed pressure on our revenue opportunities across
the market” and that “gross margins have come under pressure due to the transition of our own
products.” Indeed, he stated that the gross margin on the Nexus 7000 switch was lower than the
gross margin on the Catalyst 6000 switch “by almost in the high teens.” Later in the conference call,
he said they were 1,800 basis points lower. When Cisco reported 4Q11 and FY11 results on August
10, 2011, Chambers stated that the switching business was still under pressure, with declines in
average selling prices and gross margins caused by increasing competition and the “rapid
introduction by Cisco ofnew products almost across the board,” including “the largest switching
portfolio refresh in our history.” During Cisco’s September 13, 2011 Annual Financial Analyst
conference, Calderoni stated that growth of switching revenues in FY11 was “flat” primarily because
of the switching product transition, “especially earlier in the year.”
111. Competition reduces sales and margins . Defendants also knew that increased
competition was causing declines in revenues, gross margins and market share. CW2, a former
Cisco business development manager who left the Company in July 2009, said Cisco was finding
itself in an increasingly untenable position even before the Class Period because many customers
preferred Avaya, Juniper and Alcatel-Lucent for high end switches and routers and Hewlett-Packard
and Huawei for low-end switches and routers. CW2 stated that Juniper’s routers, particularly the
J-series of routers, offered far superior performance to Cisco’s routers. CW2 stated that Cisco’s
strategy was not to compete against the router alone but to point out to customers that Cisco offered
an “end-to-end” solution for their network by providing a whole array of technology that supported the
entire network.
112. According to CW2, Cisco also told customers it would only repair problems with
parts of a network that were purchased from Cisco but would not repair other elements of the
network that the customer purchased from competitors. Additionally, CW2 said the global recession
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CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 40 -
caused spending by IT divisions to decline and caused customers to seek lower-cost products and
that Cisco would also routinely cut its prices significantly to win the business and prevent loss of
market share. The decline in Cisco’s switching port prices corroborates CW2.
113. CW2 also said that Huawei was cutting prices and doing crazy deals to increase its
share of the U.S. market, which the market share figures corroborate. CW2 described how Huawei
basically gave away the hardware to obtain a $200 million deal with Cox Communications where it
planned to make money on services related to the implementation of the equipment. On January 12,
2010, Dow Jones reported that Huawei’s share of the global mobile network equipment market
increased from 11% in 2Q08 to 20% in 2Q09 and that its $21.1 billion in revenues outside North
America exceeded Cisco’s $16.7 billion. It also reported that Huawei had the ability to rapidly
increase market share because it had established genuine credibility in the network equipment
market and because no more than 2% of Huawei’s 2009 sales were in North America. Huawei’s share
of the router market almost doubled, from $120.5 million or 4.5% in 1Q10 to $276.5 million or 8.4%
in 2Q11.
114. Defendants knew about the increasing threat of competition from Huawei because
Cisco sued Huawei in 2003, accusing it of copying Cisco’s software and violating patents.
Defendants also knew Huawei was a formidable competitor because it was a Chinese company that
reported substantial increases in revenues and was reportedly receiving assistance from the Chinese
government, including credit lines from the Chinese Development Bank, which reduced Huawei’s
cost of capital and provided financing to customers at rates lower than Huawei’s competitors.
Huawei’s reported revenues increased from $12.8 billion in 2007 to $18.3 billion in 2008, $21.8
billion in 2009 and $27.1 billion in 2010. Further, Huawei disclosed in its 2010 Annual Report that
revenues from sales outside China increased from $13.2 billion in 2009 to $17.8 billion in 2010. It
also disclosed in the 2010 Annual Report that Huawei received unconditional grants from the
Chinese government related to its research and development contributions to China and additional
grants that were conditioned upon the completion of certain research and development projects.
115. CW2 prepared reports every other month that identified the future direction of the
market, actions by Cisco’s competitors and proposals for Cisco to counter its competitors. CW2 said
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CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 41 -
that the reports included projected sales and margins of Cisco’s competitors and showed that, in the
months leading up to CW2’s departure in July 2009, competitors were taking market share away from
Cisco by lowering prices. CW2 said that this was especially the case with HP’s Pro-Curve switches
and that the competitive risk posed by HP was explicitly set forth in the reports CW2 prepared.
CW2 said that Cisco responded by lowering prices.
116. Corroborating CW2’s account, the financial press reported that Cisco’s competitors
offered technically advantaged individual components of a network at lower prices, which resulted
in enterprises purchasing components from different vendors rather than the entire network from
Cisco. For example, in a November 12, 2010 article in The Wall Street Journal, it was reported that
Carl Tidwell, the chief information officer for the American Type Culture Collection, said that he
purchased switching equipment from Extreme Networks because Cisco’s was pricier. In a February
23, 2011 article in The Wall Street Journal, it was reported that Renkim Corporation CEO Kevin
Gaffer (“Gaffer”) purchased his company’s switches from HP in December 2010 after HP launched a
discount program for Cisco customers. Gaffer stated that he paid $361 for a switch that would have
cost $4,987 at Cisco.
117. Defendants also knew that Cisco’s aggressive growth and diversification strategy put
it in conflict with the Company’s channel partners, from which it derived substantial revenue. In
March 2009, Cisco entered the enterprise data center blade server market with its Unified Computing
System, which caused a deterioration in its relationship with partners like HP, Dell and IBM by
turning them into competitors. This adversely impacted Cisco in two ways. First, it threatened the
switching revenues these channel partners generated for Cisco, which were substantial. Indeed,
Brigantine Advisors reported that HP and IBM generated approximately $2 billion in switching
revenues for Cisco. Second, HP expanded into the switching market in November 2009 with its
acquisition of 3Com. The Street’s James Rogers reported in May 2011 that relations between HP and
Cisco “soured rapidly” after Cisco unveiled its UCS server technology and, like a “spurned Silicon
Valley lover, hooked up with switch maker 3Com . . . to get back at Cisco.” On February 18, 2010,
Cisco announced it had informed HP that it would not renew the System Integrator contract expiring
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in April, which meant HP would no longer be a certified channel partner or global service alliance
partner.
118. As shown in the tables in ¶84, HP’s share of the 100Mbps switching market increased
from 3.6% in 4Q09 to 11.7% in 1Q11; its share of the 1GbE switching market increased from 7.1%
in 1Q10 to 13.1% in 1Q11; its share of the 10GbE switching market increased from 4.1% in 1Q10 to
10.5% in 2Q11; and the average selling prices of its switching ports were substantially less than the
average selling prices of Cisco’s ports. In March 2011, HP’s former CEO, Leo Apotheker, stated that
because of its very optimal price-performance ratio, HP had gained substantial market share quarter
after quarter after quarter and that it `beat the crap” out of the competition. In May 2011, Wedbush
Morgan analyst Kaushik Roy stated it was `very obvious that HP is gaining market share in the
switch business” due to aggressive prices and the HP brand and support. He explained that HP was
able to sell switches at gross margins well below Cisco’s 65% gross margins because HP’s overall
corporate gross margin was 24%.
119. Another competitive advantage for HP was that, unlike Cisco, HP released its
networking products with open-source code, which permitted the customer to develop customized
applications at a lower cost. HP noted that Cisco’s single-vendor approach locked in customers while
driving up cost and complexity with different architectures required at each point in the network.
120. Customers switching to multivendor networks . Defendants also knew that many
customers were no longer purchasing all of their network equipment from Cisco but instead were
operating `multivendor” networks because they were less complex to run, were cheaper and avoided
sole reliance on Cisco. In May 2009, Gartner – one of the world’s leading IT research and advisory
companies – reported that its clients were increasingly expressing interest in adding a second vendor
to their enterprise network infrastructures to achieve competitive leverage and avoid vendor lock-in
but were concerned it would multiply the complexity of their network operations. Gartner
recommended that companies should invest in multivendor networks because successful integration
of a second vendor could be achieved with little operational risk and could reduce capital
expenditures by at least 30%.
CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 43 -
121. In November 2010, Gartner issued another report after interviewing a diverse group
of organizations that were using a dual-vendor strategy and concluded that most organizations
should consider a dual-vendor or multivendor solution as a viable approach to building their
networks because significant cost savings could be achieved with no increase in network complexity.
122. Although Cisco contended the Gartner reports were “myth-based” because they focused
too much on acquisition costs and not enough on long-term total cost of ownership, in a May 13,
2011 article, Information Week reported that it had surveyed IT professionals and that Cisco was the
one living the myth. It stated that acquisition costs were not the most important consideration by IT
professionals and reported that IT professionals gave Cisco low marks for service innovation,
operation cost and acquisition cost. HP and Brocade topped Cisco on operation and acquisition cost.
123. Defendants admit competition caused declines in revenues, gross margins and
market share . Later in the Class Period, defendants admitted that competition caused declines in
revenues, gross margins and market share. During the February 9, 2011 conference call, Cisco
unexpectedly announced substantial declines in switching and router revenues and product gross
margins. Responding to a question from Bank of America/Merrill Lynch analyst Tal Liani about the
disappointing switching and router results, Chambers said “[t]here is always pricing pressure in every
segment from a number of competitors.” RBC Capital Markets analyst Mark Sue noted that Cisco’s
“pricing actions and extended payment terms [were] a direct response to increased competition,” which
defendants did not dispute.
124. Analysts noted the admissions. In a February 10, 2011 report, Morgan Stanley
analyst Ehud Gelblum wrote that Cisco appeared to be trading revenue for margins as “the core
switching business comes under attack from competitors.” Canaccord Genuity analyst Paul Mansky
reported that there were persisting concerns over competition, and Wedbush Morgan analyst Rohit
Chopra reported the declining sales were due to increased competition.
125. In an April 5, 2011 memorandum to all Cisco employees, Chambers wrote that he
spent “significant time” with customers and had “extremely candid conversations” about why they
purchased or did not purchase Cisco products. He wrote that “in switching we understand that our
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customers are buying across broader segments and specific needs in this market” and that “our
competitors in this area are fierce.”
126. During a Wells Fargo Securities Tech Transformation Summit on April 7, 2011,
Chambers admitted that switching was a “challenge” and was “going to be a tough market.” He
acknowledged that “competitors come at us purely on price” because they were willing to sell switches
at prices that generated 40% gross margins. He also acknowledged that competitors like IBM,
Oracle and HP “will come at us with a vertical stack,” that another group of competitors “will come at
us with merchant silicon” and that yet another group of competitors “will come at it with a software
architecture.” And Chambers admitted that Cisco had been in this position before and “took a little bit
of drop in terms of our market share” and “a little bit of drop in terms of our margins.”
127. During Cisco’s May 11, 2011 conference call, Chambers stated that “a whole bunch of
competitors [were] coming at us” and that “several of those competitors who are coming at us are
making great inroads.” He stated that “we are going to get hit by HP and Huawei on price,” that “we are
going to get hit by some traditional players who do their own ASICs, their own software and
hardware,” that “other players [] will do this in a vertical stack” and that other players were coming at
Cisco with silicon or software.
128. Vendor financing . Defendants’ use of Cisco’s vendor financing program to increase
sales strengthens the inference that they knew competition and cannibalization were causing declines
in revenues, gross margins and market share. During the Company’s February 3, 2010 conference
call, Calderoni admitted that Cisco provided vendor-backed financing through the Cisco Capital
organization. During the February 9, 2011 conference call, he revealed that the amount of financing
receivables and guarantees was $6.8 billion and that the Company provided financing to customers
to enable incremental sales. After that revelation, it was reported in the financial press that Cisco
competed with HP by providing customers with discounts, zero-interest leasing and pay-later
schemes. Stanimira Koleva, the head of Cisco’s Asia-Pacific Partner organization, told the Straits
Times , a Singapore publication, that the Company co-invested with partners to help them achieve a
fast ramp-up of their practices. The investment programs included Big Bets, Collaborative
Professional Services and Business Architecture Specialists.
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CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 45 -
Defendants Knew the Consumer Business was Underperforming in 2010 and 2011
129. Information provided by CW1, subsequent statements by Cisco and others, and other
facts establish that defendants knew there were major undisclosed problems in the consumer
segment which contradicted their positive statements that: (a) there was “dramatic across the board
acceleration and sequential improvement” in the consumer segment; (b) Cisco’s expansion in to this
“market adjacency” was a success and the Company was“extremely well-positioned”; (c) Cisco’s“new
organization structure of councils, boards and working groups” was “operating very effectively”;
(d) Cisco’s “vision, strategy and execution” in the consumer segment were “in great shape and producing
results”; and (e) the Company was “hitting on all cylinders.”
130. Decline in Linksys and Valet router sales . According to CW1, the consumer
division generated $1 billion in revenues in 2009 – $800 million from Linksys (wireless routers
intended for home applications) and $200 million from the Pure Digital Flip business – and there was
a five-year plan to aggressively grow consumer division revenues to $5 billion. Confirming CW1’s
statement, as reported by CNET on April 13, 2011, during the Consumer Electronics Conference in
2009, Chambers said he expected the consumer business to generate between $5 billion and $10
billion over the next few years. He said Cisco was “really committed to this market and we’re putting
the whole company behind it.”
131. CW1 said that Jonathan Kaplan (“Kaplan”) was put in charge of the consumer division
and responsible for growing revenues in accordance with the five-year plan because of his success at
Pure Digital growing Flip revenues from nothing to $200 million in just a few years. In fact, CW1
said that Cisco acquired Pure Digital for its management team because of its proven track record in
growing that company’s revenues. However, CW1 said that actions taken by Kaplan made these
aggressive targets unattainable.
132. In August 2009, CW1 learned that within a few months of the March 2009 Pure
Digital acquisition, Kaplan had halted the development of any new Linksys products – including
products that were currently in development – and also reduced the number of existing Linksys
products already available for sale. CW1 explained that one of the criteria for deciding whether to
eliminate products already for sale was the amount of revenue derived from the product. If a product
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did not achieve a certain amount of revenue, then the Company would `kill it.” CW1 said that the
number of existing Linksys products was reduced by more than 50% in 2009 and 2010. CW1
explained that the reduced number of products meant shelf space at retailers previously dedicated to
Linksys products was empty and was almost immediately filled with products from NetGear,
Linksys’ main competitor. According to CW1, these decisions –and the ineffective communication of
these decisions to customers – caused the Linksys business to almost contract.
133. CW1 described another undisclosed problem with Cisco’s `Valet” line of routers, which
was introduced in April 2010. CW1 said the Valet router was an `awful failure” because it was
marketed as a Cisco product instead of a Linksys product. CW1 described that decision as very ill
advised because Cisco was trying to create a brand out of nothing rather than leveraging the existing
name recognition of the Linksys brand. The Valet router did not sell even after Cisco spent $15
million on TV advertising, the first time the consumer division advertised on TV.
134. CW1 said that sales of the Valet router were also poor because it was originally
marketed as a `home wireless hot spot” device instead of a router, which confused consumers and
retailers. Some retailers believed incorrectly that there might be a monthly fee charged to use the
device, and some retailers did not position the product with other routers in their stores. Shortly
before CW1 left Cisco in February 2011, Cisco changed the Valet packaging to correct these errors
and called it a router.
135. In March 2010, just before the Valet was introduced, the financial press reported that
there were bugs with the router and that it was not an improvement over cheaper alternatives. For
example, on March 30, 2010, Katherine Boehret wrote in The Wall Street Journal that, while trying
to install the Valet onto a Mac, she ran into a bug that the Company was unaware of. The same day,
it was reported in the Financial Times that there were problems setting up the Valet router and that
its `performance was unexceptional” with `no noticeable improvement in speeds or range compared to
[a] $30 802.11 b/g previous generation router.”
136. Internal reports show decline in consumer router sales . CW1 stated that 2010 was a
slow train wreck as the consumer division experienced decreasing revenues and market share.
According to CW1, Linksys’ share of the consumer home networking market declined from 52% in
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2009 to 24% in February 2011 and that the reduction in the number of Linksys products available for
sale was the biggest factor contributing to the decline. CW1 stated that Linksys’ revenue goals were
not being hit and even fell short of revenue goals that were reduced in spring 2010. CW1 said that
weekly “sell-in/sell-through” reports showed ongoing erosion of sales throughout calendar 2010,
including particularly poor sales of the Valet router. A sales operation team and new products
introduction team assembled the data needed to produce the reports that showed the weekly sales of
each product, weekly sales by each retailer and weekly sales by region. The report also showed how
many products were sold to retailers but not sold through to consumers. According to CW1, the
reports were accessible to many individuals in the consumer division and were discussed in
meetings, including quarterly business review meetings attended by virtually everyone in the
consumer division.
137. Kaplan admits problems in March 2010 . CW1 said that there was increasing
pessimism during 2010 at Cisco’s Irvine office, where the consumer division was located, based on
the poor sales performance and the growing sense that the Pure Digital management team – and
Kaplan, in particular – did not understand the business. Beginning in early 2010, CW1 spoke with
many individuals who believed Kaplan’s days were numbered because he could not successfully lead
the consumer division. Kaplan himself acknowledged the problems internally. CW1 attended a
March 2010 “skip-level meeting” in Cisco’s Irvine facility, during which Kaplan admitted to consumer
division employees that he was “too arrogant” in pushing through his plans to change the consumer
business and that he anticipated a decline in market share as a result of eliminating Linksys products.
On February 10, 2011, the day after Cisco reported a 15% decline in consumer revenues in 2Q11,
the Company announced that Kaplan was leaving.
138. Consumer revenue targets reduced in spring 2010 . According to CW1, the revenue
targets for the consumer business were reduced in spring 2010 because the existing targets were not
attainable. Chambers and Calderoni knew about the reduced revenue targets because, as CW1
explained, revenue targets could not be adjusted unilaterally but had to be approved by Cisco’s senior
executives. During business review meetings, CW1 learned that the revenue targets for fiscal 2011
were less than the revenue targets for 2010. The timing and defendants’ knowledge of the reduction
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of the consumer revenue targets described by CW1 is corroborated by Calderoni’s statements during
Cisco’s Annual Financial Analyst conference on September 13, 2011. During that conference,
Calderoni stated that Cisco executives engaged in a “planning process in the spring” where the
executives “work through various scenarios at a high level across the Company deep in with the
business leaders that have responsibility for each of the businesses.”
139. Problems with the Flip digital video recorder . When Cisco purchased Pure Digital
in 2009 for $533 million, it told investors that it was “key to Cisco’s strategy to expand our
momentum in the media-enabled home and to capture the consumer market transition to visual
networking” and that it would take the consumer business “to the next level.” Analysts questioned the
acquisition at the time, Miller Tabak & Co., LLC analyst Alex Henderson, said there was not an
analyst on the planet who thought Flip was a good acquisition for Cisco. Thus, defendants were
motivated to conceal the problems with the Flip and did so until Cisco announced on April 12, 2011
that the Flip business would be shut down.
140. CW1 said that the plan was to increase sales of the Flip digital video recorder by
expanding sales outside the United States but that sales did not meet projections. CW1 noted that
Samsung and Kodak introduced competing products; other competitors included Canon, Sony and
Panasonic. The Flip was also unsuccessful because it was expensive, lacked full HD capture and its
still image abilities were inferior to competing products. Smart phones like the iPhone 4, Droid X
and EVO included multiple functions, such as phone, e-mail, text, internet access and built-in
camcorders that produced video with the same quality as the Flip. A single-function device like the
Flip could not compete, which caused sales to decline. When Apple introduced the iPod Nano in
2009, Steve Jobs made it clear that Apple was targeting the Flip, stating that the company wanted to
get in on the budget-camera business while showing a slide of the Flip. Apple had already released
the iPhone 3GS, which offered video. As CNN reported on April 13, 2011, the slew of smart phones
with video capability made the Flip irrelevant.
141. Data from NPD, a market research firm, corroborates CW1 by showing that Flip’s
revenues and share of the mini-camcorder market declined. As reported by CNET on April 13, 2011,
NPD data showed that overall sales of the Flip increased 5% between 2009 and 2010 and then
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declined 19% in 2010. As a result, Flip’s share of the mini-camcorder market declined from 26% in
early 2010 to 17% in early 2011. During the same time period, Kodak’s market share increased from
5% to 12.8%, and Sony held just under 21% of the market.
142. Problems with Ecosystem initiative . Defendants also knew that Cisco’s Eos business,
a platform that enabled media and entertainment companies to engage online audiences with
interactive social experiences without having to develop and maintain a proprietary web platform
internally, was not meeting economic objectives. Cisco obtained Eos in 2007 when it acquired Five
Across and Utah Street Networks.
143. CW1 said that Kaplan was trying to develop an “ecosystem” venture with other vendors
like Sony whereby a Sony Blu-Ray DVD player would include a Cisco RFI V-chip that would
enable the device to connect to a Cisco network. But CW1 said that the development of this
initiative was longer than expected and missed the original deployment date. CW1 stated that
deployment of some “ecosystem” products was scheduled for the 2010 holiday season – which was
typical for all new consumer products – and meant the products needed to ship by September 2010.
CW1 said that by spring 2010, if not sooner, it was recognized that the ecosystem products would
not be deployed as originally projected. CW1 explained that there were various technical and
functionality issues with the development of chips that were more challenging to resolve than
originally anticipated. In addition, CW1 stated that it was difficult to persuade potential partners to
team up with Cisco because of the Company’s shrinking share of the consumer market.
144. Problems with Telepresence . Cisco introduced its Telepresence corporate
videoconferencing product in 2006. Telepresence was not a consumer product, although in
November 2010 the Company introduced UMI, a consumer product that turned HDTV into a big
videophone. According to CW5, Cisco’s Telepresence business was not performing well, and the
Company was giving away millions of dollars’ worth of Telepresence systems for free. CW5 stated
that Chambers decided to give away certain portions of Telepresence systems to different customers
and hoped they would purchase other portions of the system needed to utilize Telepresence
videoconferencing features. CW5 said Cisco gave Telepresence systems to Duke University and
EMC2 but did not believe those customers or other customers were purchasing additional systems.
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CW5 said that inadequate training of Cisco’s sales staff contributed to the problems with
Telepresence because there were so many products and services Cisco offered that the sales staff did
not sell products they did not understand sufficiently.
145. Defendants publicly admit problems with the consumer business . Defendants
gradually revealed that there were significant problems in the consumer business. On November 10,
2010, Cisco revealed that there was no increase in consumer sales in 1Q11. On February 9, 2011,
the Company unexpectedly announced that orders in the consumer segment declined 15% year-over-
year in 2Q11, that Cisco recorded a $155 million impairment charge in the consumer segment and
that the poor results contributed to the overall decline in gross margins, although that negative news
was overshadowed by the unexpected decline in switching sales and product gross margins.
146. Chambers also stated that higher-end consumer products got crushed, Flip sales
increased 15% year-over-year, not 30% as expected, and the consumer segment was 2% of Cisco’s
business, which meant the annual run rate was less than $1 billion, the amount of revenue generated
in FY09. Ned Hooper acknowledged that the consumer business exited some products, but no one
said anything about the ongoing erosion of Linksys and Valet router sales throughout 2010 and 2011
reflected in the weekly sales-in/sales-out reports, the decline in Linksys’ share of the consumer home
networking market from 52% in 2009 to just 24% in February 2011, the reduction of the consumer
businesses’ revenue target or the problems with various other consumer products.
147. On February 10, 2011, the day after Cisco announced disappointing results in the
consumer segment for the second consecutive quarter, the Company announced that Kaplan was
departing Cisco to pursue other opportunities. During a July 29, 2011 interview on NPR about his
new grilled-cheese-sandwich business, Kaplan stated that he understood the reason Cisco was
shutting down the Flip business was that the consumer division was only generating $1 billion in
revenues.
148. Analysts also reported that the 15% year-over-year decline in the consumer segment
was unexpected negative news. Gelblum reported that the 15% year-over-year decline, the 1%
quarter-over-quarter drag on the gross margin and the 15% year-over-year growth in Flip revenues
were significantly less than Cisco’s 30% target. Oppenheimer analyst Kidron reported that the results
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of the consumer business were a negative but noted, incorrectly, that the problems could be
mitigated relatively quickly. RBC Capital Markets analyst Mark Sue also reported that the consumer
business contributed to the gross-margin decline.
149. In an April 5, 2011 memorandum to all Cisco employees, Chambers admitted that
operational execution was unsound, management had been too slow in making decisions and Cisco
lost the accountability that had been the hallmark of its ability to execute consistently for customers
and shareholders. He wrote that Cisco had “lost some of the credibility that is foundational to Cisco’s
success” and that the Company would take bold steps and make tough decisions that would cause
disruption.
150. The financial press noted the startling admissions. On April 6, 2011, The Wall Street
Journal reported that Chambers “confessed the once highflying technology company has lost its
focus, lacks discipline and needs to overhaul its operations.” Jim Duffy reported that the Chambers
memorandum followed Cisco’s announcement of disappointing results in 1Q11 and 2Q11 and a 33%
decline in the Company’s stock price. He and The Wall Street Journal noted that some analysts
attributed the lackluster financial results over the past two quarters to its ambitious agenda of
targeting 30 market adjacencies to stimulate growth while sales of routers and switches grew
modestly and that there were calls for Cisco to divest some of the new product areas and refocus on
its traditional strengths in routing and switching. It was also reported in The Wall Street Journal that
Cisco’s problems included “ill-judged acquisitions, a byzantine management structure and lost market
share,” which “should have seasick Cisco investors asking whether their ship needs a new captain.”
151. On April 7, 2011 at a Wells Fargo Securities Tech Transformation Summit,
Chambers acknowledged that investors should expect an accelerated exit from some businesses and
changes in operational strategy. On April 12, 2011, Cisco belatedly admitted the failure of several
businesses in the consumer segment. It announced that it was discontinuing the Flip business and
laying off 550 employees, which would result in Cisco recording a pretax charge of $300 million –
more than half the price Cisco paid for the Flip business in 2009. On April 13, 2011, Dow Jones
reported that Cisco’s failure to try to sell Flip despite its generating $317 million of sales in FY10
illustrated how irrelevant the Flip product had become.
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152. In the April 12, 2011 press release, Cisco also announced that it was refocusing the
home networking business (the business CW1 said had declined substantially after Kaplan halted
development of new Linksys products and reduced the number of Linksys products available for
sale) for greater profitability and connection to the Company’s core networking infrastructure.
153. Cisco also announced on April 12, 2011 that the Company was assessing the core
video technology integration of the Eos media solutions business or other market opportunities for
Eos – the business that CW1 said was facing problems in spring 2010. The same day, Dan
Scheinman announced that he was resigning as the head of Cisco’s Eos business and wrote that the
“economics weren’t what we wanted” and were “still 2 years off.”
154. On April 12, 2011, it was reported by the Associated Press that Cisco was
discontinuing sales of UMI through retailers and folding it into the Company’s Telepresence
business. UMI was a device that Cisco started selling in November 2010 for $599 that turned
HDTV into a big videophone. Sales were immediately disappointing, and Cisco slashed prices in
March 2011, along with the monthly service fee, which dropped from $24.95 per month to $99 per
year. In fact, on April 6, 2011, it was reported in PC Magazine that UMI was an “over-priced Skype
video competitor” and “probably the grossest miscalculation in Cisco’s history.”
155. Analysts following Cisco applauded the retreat from consumer businesses but noted
that more should be done. Wedbush Morgan analyst Rohit Chopra stated Cisco could have gone
further by selling the entire consumer segment. Gleacher & Co., Inc. analyst Brian Marshall said the
move was a step in the right direction but not enough. Deutsche Bank analyst Brian Modoff
reported the moves were positive but that Cisco still needed to address fundamental and structural
issues and simplify its management structure from boards and councils to a less wieldy and more
responsive operating team/leader model. Sterne Agee analyst Shaw Wu reported that the moves
were a step in the right direction and that it appeared to be the first of many restructurings.
156. On May 5, 2011, Cisco revealed that it was moving away from many of the consumer
businesses when it issued a press release announcing “significant changes to its business structure and
operations” and a focus on five areas driving the growth of networks and internet core. On May 10,
2011, BGC Partners analyst Collin Gillis reported that Cisco’s foray into consumer products was an
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example of overreaching, which destroyed shareholder value by combining an aggressive acquisition
policy with a stifling internal operational structure.
157. On May 11, 2011, Cisco announced that product orders in the consumer segment
declined 49% year-over-year in 3Q11, and Chambers stated that the consumer business was an area
of concern that was under pressure and that the Company was taking comprehensive actions to
divest or exit underperforming businesses. COO Gary Moore stated that a comprehensive portfolio
review had begun, starting with the consumer businesses, and that decisions would be made in the
months and quarters ahead.
158. On May 13, 2011, MarketWatch reported that Cisco’s Linksys routers were
“ridiculously more expensive than the competition” and that the Company’s mid-level video-
conferencing product was extremely expensive, especially when compared with the free service
offered by Skype. On May 23, 2011, Cisco announced it was discontinuing Eos. On July 18, 2011,
the Company announced it was laying off 11,500 employees, including 5,000 who worked in the set-
top box manufacturing facility in Juarez, Mexico. After reporting consumer product orders during
the Class Period, Cisco stopped reporting consumer orders in November 2011, which reflected the
failures and the wholesale retreat from the consumer line of businesses. By the time of Cisco’s
September 13, 2011 Annual Financial Analyst conference, COO Gary Moore stated that the
Company had exited ten businesses and reduced its investment in six others.
Defendants Knew Cisco Was Masking Declines in the Cable Set-Top Box Business by Providing Customers with Huge Price Discounts to Pull in Orders from Future Quarters
159. Information provided by former Cisco employees and statements by defendants and
the Company in November 2010 strongly suggest that defendants knew Cisco was not “extremely
well-positioned” in this “key product categor[y]” and that the reported 20% increase in service provider
orders in 2Q10 was materially misleading and was not “one of the most robust positive turnarounds
[Chambers had] seen in [his] career.” Defendants knew orders for set-top boxes were caused by huge
price discounts that masked problems until November 2010, when Cisco reported a 40% decline in
cable set-top box orders in 1Q11.
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160. As Chambers stated during the November 10, 2010 conference call announcing 1Q11
results, service provider orders increased more than 20% in each of the last three quarters in FY10
and then only increased 8% in 1Q11. That decline, Chambers explained, was caused by a 35%
decline in orders for traditional set-top boxes, including a 40% decline in the North American cable
business, which accounted for a majority of the business. Chambers claimed the 35% decline was
due to reductions in consumer spending and a transition from traditional set-top boxes to IP-based
set top boxes and admitted that `we saw the transition coming.”
161. Information provided by former Cisco employees establishes that another undisclosed
reason for the decline in cable set-top box orders was Cisco’s persuading cable companies to order
more set-top boxes than they needed, which resulted in the channel stuffing and the precipitous drop
in orders in 1Q11 and 2Q11. CW3 was responsible for entering new orders into Cisco’s computer
system and stated that it was a prevailing practice at Cisco to offer customers huge discounts to pull
in orders from future quarters and to compete with Asian companies that were selling set-top boxes
for lower prices. The last month of the quarter was particularly important, according to CW3,
because there was always a major push to recognize as much revenue as possible on existing
bookings and to pull in orders from future quarters. Immediately after the end of the quarter, the
goal was to work with customers to get new orders. CW3 also said there was a `big push” to load up
customers at the end of FY10, the last quarter Cisco reported greater than 20% order growth. CW4,
the former manager of worldwide channels finance, also said Cisco provided steep discounts and
stated that various participants at weekly meetings in 2010 and 2011 expressed frustration that Cisco
had to extend large discounts to win business.
162. CW3 said that the practice of lowering prices to pull in orders from future periods
risked major problems in the future if Cisco was unable to replace the orders and that the `hope” was
that Cisco’s good relationship with its customers would enable the Company to replace future orders
pulled into earlier quarters. But CW3 stated that Cisco was essentially `robbing Peter to pay Paul” by
pulling in orders through price discounts and that there was no way Cisco could continue to hide the
challenges facing the cable set-top box business. CW3 also reported that Cisco’s practice of
extending large discounts had a negative impact on the margins on sales of set-top boxes. CW3 said
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that Cisco offered even more significant price discounts after the Company reported the decline in
1Q11 orders on November 10, 2010, which caused future revenues to be even lower for customers
that placed orders. According to CW3, other customers were not submitting new orders and were
canceling existing orders.
163. The reported increases in cable set-top box orders prior to November 2010 was also
misleading because, as CW3 and CW4 explained, revenues eventually recognized on the discounted
orders were even less than the discounted amount. CW3 said that the full amount of an order was
entered if the set-top boxes would be shipped within 90 days even though the price of the order
would be reduced when the set-top boxes were actually shipped. CW3 said that Cisco tried
unsuccessfully to get customers to increase their orders given the practice of lowering prices
between the order date and the shipment date. As a result, the dollar amount of bookings exceeded
the amount of revenue that would eventually be received.
164. The reported increases in cable set-top box orders prior to November 2010 was also
misleading because, as CW3 stated, forecasted orders for all set-top boxes in FY11 were only $1.2
billion, including $475 million from Scientific Atlanta and $725 million from Classic Cisco.
Moreover, CW3 said the $475 million forecast from Scientific Atlanta was 30% higher than
revenues recognized in FY11 because of the “price erosion” between the date the order was booked
and the shipment date and that the Classic Cisco $725 million forecast was 17% higher than
revenues recognized in FY11 due to a lack of sales and new orders.
165. Information provided by CW5, the services portfolio analyst who prepared reports on
the growth of Cisco’s services portfolio, also indicates that the amount of revenue recognized on
contracts was less than the amount of the order and that there were problems at Scientific Atlanta.
According to CW5, groups within Cisco that were responsible for different elements of multi-
element contracts were individually claiming credit for an amount of revenue that collectively
exceeded the contract amount and the amount of service revenue Cisco reported. As a result, CW5
explained, the reports based on the information received from the various groups reflected growth
that was greater than actual growth. CW5 also reviewed Scientific Atlanta information obtained
from Cisco’s finance organization that CW5 said was consistently poor, did not show growth and was
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getting worse. CW5 stated that Scientific Atlanta had reported losses since Cisco acquired it in 2006
and that Cisco employees often asked why the Company purchased Scientific Atlanta when it was
consistently operating at a loss.
166. CW3 said that Cisco was lowering prices to pull in orders from future quarters when
demand for cable set-top boxes was declining as a result of consumers abandoning cable television
service in favor of alternative forms of connectivity. According to CW3, Cisco’s major set-top box
customers – AT&T, Verizon, Comcast, Time Warner, Cox Communications and Cablevision – were
all facing huge challenges due to this market transition. CW3’s customers included Comcast, Time
Warner, Cox Communications and Cablevision and CW3 said that Time Warner was having the
biggest problems followed by Comcast.
167. CW2 said that the set-top box business was declining before CW2 left Cisco in July
2009 because new competitors like Samsung, Huawei and others were entering the field that was
previously dominated by Scientific Atlanta and Motorola. Additional factors contributing to the
decline, according to CW2, were threats from new kinds of electronic entertainment media services -
including Netflix, Hulu and Apple TV – and threats from new kinds of media devices like iPhones
and other mobile devices that included video and other entertainment applications. According to
CW2 the increased competition and new kinds of media devices and services caused consumers to
cancel their cable TV subscriptions. These trends were included in the reports CW2 prepared
including one report in which CW2 wrote that the iPhone was “disrupting the entire landscape” for set-
top boxes and non-mobile technologies.
168. CW6, the Scientific Atlanta financial analyst from February 2007 to October 2010,
said that in late 2008 cable companies were reducing their capital expenditures by purchasing
products from lower-cost Asian competitors like Samsung. CW6 also said that before and during
summer 2010, cable operators were losing subscribers and discussed the decline with sales and
marketing personnel at Scientific Atlanta. According to CW6, these two trends did not improve
before CW6 resigned in October 2010. Further, CW6 confirmed that, during 2010, the Scientific
Atlanta division of Cisco provided significant incentives, such as price discounts, so customers
would accelerate and increase the quantity of their purchases. CW6 said the incentives became more
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elaborate as the year progressed, including significantly lower prices that had a negative impact on
gross margins.
169. CW7, the Commercial Finance Solutions Group employee responsible for reviewing
proposed sales transactions with cable operators, stated that cable set-top box orders declined in
2009 and 2010, in part due to lower-cost Chinese competitors like Huawei. CW7 also helped with
the management of ongoing contract negotiations and stated that several customers did not renew
their set-top box contracts, including Time Warner and Comcast, which did not renew their contracts
in 2009, and Cox Communications, which informed Cisco it would not renew its set-top box
contract in 2008. CW7 said that large orders began to decline in 2009 and that large deals that did
get done in 2009 and 2010 were very steeply discounted. According to CW7, one deal with
Cablevision that should have been priced at $500,000 was still being negotiated when CW7 left the
Company in October 2010; at that time, the Cisco salesperson was quoting a price of $75,000.
170. The steep decline in the number of deals CW7 processed over time also reflected the
decline in demand from cable operators. CW7 said that the number of deals CW7 processed
declined from about 12-15 deals per day in 2007 and 2008 to just about eight deals per week in
2010. CW7 noted that another sign of the decline in set-top box orders was the decline of personnel
at the Lawrenceville, Georgia facility, which CW7 said was nearly empty when CW7 left the
Company in October 2010.
171. Declines in cable subscribers . Reductions in cable subscriptions corroborate CW3-
CW7 and strengthen the inference that defendants knew the reported 20% increase in service
provider orders was misleading. On August 23, 2010, GigaOm reported that cable companies lost
711,000 subscribers in 2Q10, which represented the biggest quarterly loss in cable television history.
In a November 4, 2010 article titled “Big Cable Is Bleeding,” GigaOm reported that subscriptions
declined another 518,300 in 3Q10 at four of the five largest cable companies. Comcast reported a
decline of 275,000 subscribers, Time Warner a 155,000 decline, Charter a 63,800 decline and
Cablevision a 24,500 decline. The actual decline was probably higher because Cox
Communications, the third largest cable company, did not publicly disclose the change in
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subscriptions. GigaOm also reported that the trend was expected to continue because cable
companies were increasing bills at an incredible rate.
172. Analysts’ reactions to the unexpected decline in set-top box orders . Analysts’
reactions to the unexpected decline in cable set-top box orders announced by Cisco on November 10,
2010 strengthen the inference that defendants knew about the problems earlier. As Morningstar
Equity Research analyst Joseph Beaulieu wrote in a November 11, 2010 report, the question-and-
answer session between management and analysts was “fairly contentious.” The first question during
the November 10, 2010 conference call was from Sanford C. Bernstein analyst Jeff Evenson, who
noted that Cisco repurchased 110 million shares during the quarter versus the 40 million shares
defendants stated Cisco would repurchase during the May 2010 conference call, and he asked if it
indicated anything about when defendants realized the quarter was going to be weaker than they
thought three months ago.
173. The next question came from RBC Capital Markets analyst Mark Sue, who asked
Chambers how Cisco missed the cable MSO transition that caused the decline. Chambers admitted
that he and Calderoni “saw the transition coming” and had made changes in management at Scientific
Atlanta. Morgan Stanley analyst Ehud Gelblum noted that Chambers said the quarter unfolded as
expected but also said that orders were $500 million less than projected and asked if management
knew about the shortfall before or after Cisco’s September 2010 analyst day. UBS analyst Nikos
Theodosopoulos stated that significant reset related to the decline in cable orders and public sector
orders was surprising because, in the past, at Cisco such resets were typical during big macro
changes and that it was a pretty significant reset when the rest of the industry was not seeing it.
Chambers conceded that the “challenge [was] fair.”
174. After the conference call, Morgan Stanley analyst Gelblum issued a report on
November 11, 2010, in which he wrote that management attributed the set-top box shortfall to the
sluggish housing market, which was “an explanation we [found] difficult to fathom as the housing
glut has been overhanging the entire market for nearly two years now.” He also noted that Motorola
reported during its earnings call two weeks earlier that cable set-top box orders would increase the
following quarter. Oppenheimer analyst Kidron wrote in a November 11, 2010 report that
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management’s contention that the problems reported during the conference call were temporary air
pockets “will undoubtedly raise questions as to the real root cause of the weakness.”
175. In a November 11, 2010 report, Argus Research Company reported that Chambers
made conflicting statements during the conference call by stating that the quarter “proceed[ed] largely
as we anticipated” and also stating that management was surprised by the order shortfall. Jefferies
analyst William Choi wrote in a November 10, 2010 report that the lowered guidance resulting from
the problems in the public sector and service-provider businesses was “puzzling” for a company that
would “typically set guidance and [met].” Raymond James analyst Todd Koffman reported that the
sharp adjustment in cable orders was “very surprising.”
176. Magnitude of the declines in cable set-top box orders . The size of the cable set-top
box business, the magnitude of the order decline and the 20% growth in orders in the previous three
quarters also indicate that defendants knew about the order declines. As Chambers acknowledged
during the November 10, 2010 conference call, defendants knew that the U.S. service provider
business had order growth rates in the last three quarters of FY10 in excess of 20% and that the set-
top box business generated $2 billion of annual revenue.
177. After reporting the substantial declines in set-top box orders during the November 10,
2010 conference call, on February 9, 2011, Cisco reported that the set-top box business continued to
be challenged, as reflected by a 15% decline in orders and a 29% decline in cable set-top box
revenues to an annualized run rate of approximately $1.6 billion. Calderoni stated that Cisco
“provid[ed] financing to customers and channel partners, enabling incremental sales of Cisco
products, services and networking solutions,” but said nothing about the huge price discounts that
caused set-top box orders to plummet 40% in 1Q11 and 15% in 2Q11 after increasing more than
20% in 2Q10, 3Q10 and 4Q10.
178. Morgan Stanley analyst Gelblum reported that cable set-top box orders declined 15%
year-over-year; set-top box revenues declined 11% year-over-year – including a 29% year-over-year
decline in cable set top box revenues; and the annual run rate for set-top box revenues declined from
$2 billion to $1.6 billion, “barely a whisper above the $1.52B in settop box revenue that Scientific
Atlanta generated in CY 2005.” By contrast, Motorola reported a 1% year-over-year increase in set-
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top box revenues. RBC Capital Markets analyst Mark Sue reported that the 15% year-over-year
decline showed that the business continued to be challenged, and Oppenheimer analyst Kidron
reported that the orders remained weak.
Defendants Knew of the Concealed Problems with Cisco’s Businesses from Their Receipt of Internal Reports and Their Admitted Frequent Meetings with the Company’s Customers
179. Defendants also knew that switching and router sales and gross margins would
decline, that demand for cable set-top boxes had declined (but were masked by the price discounts),
and that sales in the consumer segment were substantially less than forecast from their receipt of
internal reports and their close relationship with Cisco’s customers. Chambers repeatedly stated that
he and other Cisco employees routinely met with customers. During the February 3, 2010
conference call, Chambers discussed the World Economic Forum at Davos, where he “interfac[ed]”
with and received feedback about Cisco’s business from over 100 key customers, government
leaders, and industry subject matter experts.
180. At the February 8, 2010 Thomas Weisel conference, Tony Bates, Cisco’s senior vice
president and general manager of enterprise, commercial and small business, stated that Cisco had
the largest set of customers and partners, reaching 210,000 salespeople around the world through its
global partner program, and that Cisco held an annual CIO summit where the Company’s top
executives met with the top 100 CIOs from Fortune 500 companies. At the March 10, 2010
Wedbush Morgan Securities Management Access conference, Soni Jiandani, Cisco’s vice president
of marketing in the Storage Technology Group, stated that Cisco spent an “immense amount of time
with both our medium-sized customers and our large customers.”
181. During Cisco’s May 12, 2010 conference call, Chambers stated that Cisco had
“dramatically improved customer relations as a trusted technology and business partner.” He said that
he traveled around the world to meet with Cisco’s 1800-strong partner community and recently
attended a global technical advisory session with 30 of Cisco’s largest customers, service providers
and enterprise customers and that the goal was to meet with the Company’s top 1000 customers. At
the May 18, 2010 JPMorgan Technology, Media and Telecom conference, Cisco’s Chief Technology
Officer, Bob McIntyre, stated that he spent 60 to 70% of his time with customers. During the June 9,
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2010, RBC Capital Markets North American Technology, Media & Communications conference,
Worldwide Channels senior vice president Keith Goodwin said that Cisco executives talked to
customers“every day.”
182. During the August 11, 2010 conference call, Chambers told investors that Cisco had
more “high-level relationships with CEOs and CIOs develop at a very detailed level in the last year
and a half than we have had in the entire prior decade in terms of their relationship with Cisco,”
which spoke to the “rapidly changing role of Cisco in our customer accounts.” In fact, Chambers
acknowledged he was receiving “mixed signals” from customers. He emphasized that Cisco’s
relationship with its customers was “moving from being a box player or a router or a switcher –
switching to really a key business partner, a trusted technical advisor.”
183. During the Deutsche Bank European Technology, Media and Telecommunications
conference on September 9, 2010, Phil Smith, the CEO of Cisco UK & Ireland, stated that the
Company talked to “all the big customers. We’re inside all those big customers.” According to a
November 1, 2010 article in Treasury & Risk Breaking News , Calderoni stated that Cisco leveraged
technology to “get real-time information across the company, so we can make better and faster
business decisions,” and that Cisco could “close our financials monthly and quarterly in four hours.”
184. As reported in the proxy statement filed with the SEC on November 18, 2010, Cisco
also conducted annual customer satisfaction surveys because executive compensation was based, in
part, on meeting certain customer satisfaction metrics.
185. During a CEO/CFO fireside chat on December 9, 2010, Chambers said that he
received feedback from all of Cisco’s executives and customers: “we shoot our communication to the
employees. We get their feedback. I read every one of the hundreds and hundreds of individual
comment feedbacks . . . . We do that with our executives. . . . We do the same thing with the
customers.”
186. As Calderoni explained during the February 15, 2011 Goldman Sachs Technology &
Internet conference, Chambers also required Cisco’s senior executives to meet with the Company’s
customers and kept a scorecard that tracked those meetings. Calderoni stated that he had numerous
meetings with CIOs and CFOs over the past few weeks.
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187. During the March 15, 2011 Lazard Capital Markets Technology & Media conference,
Charles Carmel, Cisco’s Vice President of Corporate Business Development, stated that “bringing that
customer feedback into the mix and stirring it around and helping inform the strategy is an important
part of what we do.”
188. Cisco’s senior executives, including Calderoni, also interacted with customers through
its “executive briefing centers.” During the April 7, 2011 Wells Fargo conference, Chambers said that
in March 2011, Cisco held a session with the top 45 CEOs in the world which gave him “the best
exposure to customers at the CEO level, at the CIO level, at the partnering level and also at the
technical engineering level that you get during the course of a year.”
189. During Cisco’s Annual Financial Analyst conference on September 13, 2011,
Calderoni disclosed that Cisco executives were “customer executives,” which meant they worked “very
close” with the customers’ executive team, including the CEO, CFO and CIO. He also said that Cisco
executives engaged in a “planning process in the spring” where the executives“work through various
scenarios at a high level across the Company deep in with the business leaders that have
responsibility for each of the businesses.”
190. The financial press also noted Cisco’s close customer relationships and how it allowed
the Company to avoid reporting surprises. In a November 12, 2010 report, Edward Zabitsky of ACI
Research wrote that Cisco “had the most sophisticated customer feedback loop I have ever seen in
any business. Part of that customer feedback loop is the sales pipeline. Another part is their
extensive C-level contacts.” It was reported in Optical Networks Daily that Cisco typically reported
quarterly sales “on the knuckle” and EPS a penny ahead of guidance because the Company had no
greater than 10% customers, a broad product line, a very wide range of customers, a reasonable
geographic distribution and a disciplined market intelligence system via its numerous channel
partners.
191. Former Cisco employees also described various reports that included the concealed
problems and meetings during which the problems were discussed. CW1 described weekly “sell-
in/sell-through” reports prepared by the Sales Operation team and New Products Introduction team
that showed the weekly sales of each type of consumer product by each retailer and region and the
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amount of each type of product that retailers had not sold. CW1 said these reports showed an
ongoing erosion of Linksys and Valet router sales throughout calendar 2010. CW1 stated the reports
were accessible to many employees in the consumer division and were discussed during quarterly
business review meetings attended by virtually everyone in the consumer division and during sales
and marketing department meetings that occurred every two to three months. CW1 also said there
was a forecast prepared for the consumer segment which was lowered in spring 2010 when it
became apparent that forecasted results would not be met.
192. CW2 prepared reports every other month that identified the future direction of the
market, actions by Cisco’s competitors and proposals for Cisco to counter its competitors. CW2 said
that the reports included projected sales and margins of Cisco’s competitors and that other reports
prepared by the Pricing Group included projected sales and margins of Cisco’s products. CW2 said
the reports were submitted to members of the Service Provider committee which was comprised of
senior vice presidents in sales, engineering and marketing and that a member of the Service Provider
committee attended Cisco’s executive committee meetings that were also attended by Chambers. The
reports prepared by CW2 disclosed that competitors, including HP, were taking market share away
from Cisco in 2009 by lowering prices and that the set-top box business was in decline in 2009 due
to increasing competition and new kinds of electronic entertainment media services and devices.
193. CW3 said there was a forecast for the set-top box business that projected $1.2 billion
of orders in FY11 which was less than the forecast for FY10. CW3 also said the forecast could not
be met because demand for set-top boxes had declined as a result of the huge discounts Cisco
provided to pull in sales from future quarters, increasing competition, the availability of new kinds of
electronic entertainment media services and devices and declining cable TV subscriptions. CW3
also said that the Scientific Atlanta division also prepared a forecast and financial reports that CW3
reviewed and that the financial data for Scientific Atlanta was merged into a consolidated set of
financial data for the entire set-top box business.
194. CW4 provided reports and analysis to the controllers for each business segment who
were the key players in developing and managing forecasts for their business segment. CW4 said
the forecasts were discussed during weekly forecast calls run by the controllers and attended by
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various members of their business segment and that the goal of the meetings was to determine how
much revenue could be achieved in the upcoming quarter. CW4 stated that various participants at
the weekly meetings in 2010 and 2011 expressed frustration that Cisco had to extend large discounts
to win business.
Contrary to Chambers’ Statements During the February 3, 2010 Conference Call, Cisco’s Organizational Structure Slowed Decision-Making and Was Ineffective
195. Defendants admit Cisco’s organizational structure is ineffective . Defendants
belatedly admitted that Cisco’s organization structure of councils, boards and working groups was not
operating very effectively, as Chambers represented. In an April 5, 2011 memorandum to all Cisco
employees, Chambers admitted that operational execution was unsound, management had been too
slow in making decisions and Cisco lost the accountability that had been the hallmark of its ability to
execute consistently for customers and shareholders. He wrote that Cisco had “lost some of the
credibility that is foundational to Cisco’s success” and that the Company would take bold steps and
make tough decisions that would cause disruption.
196. As alleged above, the financial press noted that the admissions contradicted
defendants’ statements during the Class Period. On April 6, 2011, The Wall Street Journal reported
that Chambers “confessed the once highflying technology company has lost its focus, lacks discipline
and needs to overhaul its operations.” Jim Duffy (“Duffy”) reported that the Chambers memorandum
followed Cisco’s announcement of disappointing results in 1Q11 and 2Q11 and a 33% decline in the
Company’s stock price. Duffy and The Wall Street Journal noted that some attributed the lackluster
financial results over the past two quarters to its ambitious agenda of targeting 30 market adjacencies
to stimulate growth while sales of routers and switches grew modestly and that there were calls for
Cisco to divest some of the new product areas and refocus on its traditional strengths in routing and
switching. It was also reported in The Wall Street Journal that Cisco’s problems included “ill-judged
acquisitions, a byzantine management structure and lost market share,” which “should have seasick
Cisco investors asking whether their ship needs a new captain.”
197. On April 7, 2011, Chambers stated that investors should expect an accelerated exit
from some businesses and changes in operational strategy. On May 5, 2011, after Cisco had
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reported unexpected negative news in two consecutive quarters, the Company announced “significant
changes to its business structure and operations” that would “streamline” its sales, services and
engineering organizations. Chambers acknowledged that the Company’s existing organization
structure was not operating effectively, stating, “it’s time to simplify the way we execute our strategy.”
198. The financial press applauded the changes and noted they were necessary. On May 5,
2011, it was reported in the Silicon Valley Business Journal that Chambers was “shaking up
management units as the company copes with slumping stock and a recent exodus of top executives.”
The same day, Dow Jones reported that Cisco was switching to a streamlined operating model “as the
struggling networking giant looks to refocus operations and simplify its oft-criticized management
structure” and that the move came “after Chambers conceded in a memorandum last month that the
company had suffered a lapse in operational execution, and had confused customers and
disappointed investors.”
199. On May 7, 2011, Bloomberg reported that Cisco was “overhaul[ing] a management
structure that investors and former employees say slowed decisions, fueled market-share losses and
led to an exodus of senior executives.” Robert Ackerman, founder of Allegis Capital, which sold
three companies to Cisco, said that Cisco had “a culture that frustrates talented people” that “feel[] like
they’re beating their head[s] against the wall.” The Bloomberg News article noted the problems
caused by the old structure that Chambers repeatedly claimed was operating very effectively during
the Class Period.
Chambers set up the councils to support his push into more than 30 new markets, including computer servers, consumer video conferencing gear and corporate social-networking software. Unlike the traditional command-and-control management structure Cisco used to have, a series of interlocking councils would have the authority to tap resources from around the company without having to wait for Chambers’ approval.
* * *
Yet by requiring employees to petition groups of people for department budgets, the councils slowed decision making, said former employees and other people familiar with the matter. It left managers without full control of units, said the people . . . .
200. Bloomberg also reported that numerous executives left the Company due to the
organizational structure, including Debra Chrapaty, Cisco’s former senior vice president of Cisco’s
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collaboration software group; Dan Scheinman, the former mergers and acquisitions chief; Nawaf
Bitar, a vice president in the security division; Mike Volpi, a senior vice president in charge of
Cisco’s router and service provider groups; Charles Giancarlo, Cisco’s development chief; and
Jayshree Ullal, the head of Cisco’s data center business. Others believed the changes did not go far
enough. In a May 6, 2011 report, Deutsche Bank analyst Brian Modoff wrote that Deutsche Bank
“remain[ed] concerned about the company’s management structure” and “should have eliminated the
‘boards and councils’ entirely and further streamlined their organizational structure.”
201. During Cisco’s May 11, 2011 conference call, Chambers again acknowledged that
Cisco was “streamlining our organization and overhauling our business model dramatically” to address
“problematic areas.” He said that Cisco had “aggressively addressed our organization and operating
model . . . by appointing a COO; second, by reorganizing major functions of sales, engineering and
services; third, moving away from a broad Council & Board structure, implementing clear decision-
making responsibilities . . . ; and finally, continuing to streamline operations across the Company.”
202. During the Company’s annual Cisco Live! convention on July 12, 2011, Chambers
said that he was overhauling the Company to make it more agile and responsive to consumers and
admitted that there were areas in which the Company must do better, that Cisco was too complex
and lost focus as it expanded into numerous other tech markets and that the sales and engineering
groups were pretty top heavy.
203. The financial press again noted that Chambers had admitted problems that
contradicted his statements during the Class Period and appeared to be ready to address them.
Seeking Alpha ’s Cameron Kaine, who recently called for Chambers’ resignation, reported on July 13,
2011 that Chambers’ promise to decisively streamline Cisco’s operations and speed up decision
making was an admission of what many had been saying all along – that it was time to cut the fat.
204. On July 18, 2011, Cisco announced that it would reduce its workforce by
approximately 6,500 employees, or 9%, and recognize a restructuring charge of $1.3 billion, as part
of its continued implementation of a comprehensive action plan to simplify the organization, refine
operations and reduce annual operating expenses. It also announced that it was selling the set-top
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box manufacturing facility in Juarez, Mexico, which would reduce the work force by another 5,000
employees.
205. On August 10, 2011, when Cisco reported its 4Q11 and FY11 results, Chambers
stated that, since the last earnings call, Cisco had “moved very rapidly on our plan to simplify
operations and focus on our operating model and align our investments . . . to reinforce our ability to
execute on our strategy.” He stated that Cisco was “simplifying and focusing our organization and
operating model” by “reorganiz[ing] our sales, engineering, services and operations organization,
providing clear line of sight, accountability, accelerating the speed of decisions, driving toward
major improvements in productivity, and driving innovation at a faster pace.” He also said that the
Company had aligned its cost structure given the transitions in the marketplace and was well into the
implementation of reducing operating expenses by $1 billion.
206. Chambers said that Cisco was divesting, cutting back or exiting underperforming
operations and had made changes across engineering to create simplified organizational structures
that allowed for faster innovation and simplicity in the decision process. He stated that Cisco would
continue to accelerate and drive through the simplification process at an even faster pace and that the
changes made and to be made were dramatic and would continue for several years.
207. COO Gary Moore stated that Cisco had taken “swift action designed to simplify the
operating models of the Company within each organization . . . sharply reduced our boards and
counsels and appointed clear and accountable leadership” and “chang[ed] our processes to reduce
duplication and increase our execution speed.”
208. At Cisco’s September 13, 2011 Annual Financial Analyst conference, Chambers said
that Cisco was in the third stage of “development simplification” and that the Company “need[ed] to
have consistency in innovation, consistency in operations.” He admitted that Cisco was “fat” with “an
extra 4 or 5 inches around the waistline” during the Class Period and that it “slowed decision making
down” and caused Cisco to “[get] away from the basics.” Chambers provided examples, stating that
there were “multiple engineering functions, multiple operating system functions, multiple groups
actually competing with each other on switching and routing” that had recently been combined. He
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stated that the 23,000-person sales force had been “realigned completely,” with 90% rather than 70%
now in the field, and that 12,700 people had exited the Company.
209. COO Moore also stated that Cisco had “gained a few inches around the waist,” had
“become fairly complex relative to allowing people to actually work with one another – get decisions
made quickly; respond to customers” and was “losing in the marketplace because of that complexity.”
He stated that Cisco had exited ten businesses, reduced its investment in six others and reduced the
time it took to approve some deals by 70%.
210. Former employees state organizational structure was ineffective . Former Cisco
employees also stated that the new organizational structure that Chambers initiated in 2007 and
touted during the Class Period was a disaster. CW1 said that decision-making in the consumer
segment was extremely slow because there were hundreds of products and virtually every decision
had to be reviewed and approved by Kaplan.
211. CW2 stated that the committee-based organizational structure at Cisco slowed
decision-making. CW2 also said that each of the Company’s main customer segments (enterprise,
commercial, consumer, public sector and service provider) had a business development manager for
sales, engineering and marketing but that it was difficult to collaborate or communicate with them.
CW2 said the lack of communication and collaboration reflected a pervasive attitude among Cisco
employees of not wanting to assist personnel outside their immediate areas of responsibility.
212. CW3 stated that Cisco management was slow in reporting internal challenges because
the Company was organized into numerous silos that often had little interaction with one another.
CW4 said that Cisco had an excessively complex and unwieldy organizational and management
structure that resulted in duplication of work, a lack of clarity about who was responsible for
different matters and slow decision making. CW4 also said that Cisco had numerous committees
responsible for different functions that greatly slowed down decision-making.
213. CW5 stated that there were multiple layers of management, high turnover amongst
vice president level managers, vaguely understood responsibilities and numerous committees
responsible for different functions. CW5 observed managers throughout the Company constantly
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fighting over getting credit and not cooperating or working together to solve problems even when it
was recognized what needed to be done.
Chambers’ Sale of $97 Million of Cisco Stock Days After the February 3, 2010 Conference Call Strengthens the Inference He Knew About the
Concealed Problems with Cisco’s Business and the Falsity of His Statements
214. Shortly after making the false positive statements about Cisco’s business on February
3, 2010, Chambers sold 4 million shares of his Cisco stock for $97 million on February 8, 2010 (2.2
million shares for $52.2 million) and March 5, 2010 (1.8 million shares for $45 million). Prior to
these sales, from January 2009 through January 2010, Chambers only sold 500,000 shares for $11.4
million (400,000 shares in August 2009 and 100,000 shares in November 2009). The dramatic
increase in Chambers’ sales strongly suggest he knew the stock price was artificially inflated by his
(and Calderoni’s) false positive statements. During 2Q10, Cisco spent $1.5 billion to repurchase 63
million shares of the Company’s stock.
215. Some individuals questioned the suspicious timing of the sales. On March 9, 2010,
Brad Reese, who wrote an “On Cisco” blog for Network World , reported that Chambers had sold 4
million shares for $97.2 million pursuant to a Rule 10b5-1 trading plan and that the SEC was trying
to determine if Rule 10b5-1 plans were used to circumvent insider-trading rules because research
showed such sales were more likely to happen before price declines. On May 13, 2010, he again
wrote about the sales and noted they came just days after he reported that Cisco’s receivables had
increased by $1.344 billion from 2Q09 to 2Q10 while sales increased just $726 million and that
Chambers “demonstrated perfect timing executing his insider Cisco stock trades.” On May 17, 2010,
he wrote that Chambers’ insider sales appeared to demonstrate his lack of true conviction that Cisco’s
stock price would appreciate in value.
C. May 12, 2010: Chambers and Calderoni Reiterate that the Game Plan Is “Hitting on All Cylinders,” Cisco Is “Gaining Market Share” and the Company’s Expansion into Market Adjacencies Is “Exceeding . . . Expectations” – Less Than a Week Later, Chambers Sells Another $31 Million of Cisco Stock
216. On May 12, 2010, Cisco issued a press release and held a conference call to report
3Q10 results, and defendants continued to mislead investors by concealing the adverse information
detailed in ¶¶79-213, falsely representing that Cisco was successfully expanding into more than 30
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market adjacencies while gaining market share in the core routing and switching businesses and that
the Company’s organization structure was operating very effectively. Defendants made the following
misleading statements in the press release:
`Our financial results were outstanding, achieving record level revenue and earnings per share results. We witnessed a return to strong balanced growth across geographies, products and customer segments that we haven’t seen since before the global economic challenges began. We emerge from this downturn gaining market share, a larger share of the total wallet spend of our customers, dramatically improved customer relations as a trusted technology and business partner, and having next generation products in almost every product category. It is clear that our game plan for how to handle economic downturns is hitting on all cylinders ,” said John Chambers, chairman and CEO of Cisco.
Chambers continued, `Our innovation and operational engines are exceeding our expectations. This applies to products, organization structures, business models, and movements into 30+ new market adjacencies. From almost every measurement perspective – revenues, earnings per share, new products, successful acquisitions, internal startups – our results in Q3 were the proof points that our strategy is working and was probably the strongest quarter in our history .”
217. During the conference call, Chambers and Calderoni misled investors by reiterating
the false statements included in the press release and making other statements that reinforced the
false impression that Cisco was successfully diversifying into new market adjacencies while still
maintaining revenue growth and market share gains in traditional areas:
There are three key takeaways , in my mind, for the quarter. First, Q3, in my opinion, is the proof point to having achieved our goals and aspirations in terms of how we handled very challenging economic times. We emerged from this downturn gaining market share, a larger share of the total wallet spend of our customers, dramatically improved customer relations as a trusted technology and business partner, and having next generation products in almost every product category .
Second, our innovation and operation engine is hitting on all cylinders. This applies to products, organization structure, business models and movements into 30-plus new market adjacencies .
And third, from almost every measurement perspective , whether revenues, earnings per share, new product introductions, successful acquisitions, leading and economic challenges, internal start-ups and many more, this quarter was probably the strongest we’ve had in our history .
In summary, our game plan for handling economic downturns hit on all cylinders . Q3 results are the proof points and was, in my opinion, the strongest across the board quarter in our history.
218. Chambers further misled investors by stating that `[o]ur new innovative, dynamic
network organization structure of councils, boards and working groups, as discussed in the last
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few calls, is operating very effectively and has been an important part of managing through the
recent downturn and then positioned us for the acceleration of results achieved in Q3. These
structures allow speed, scale, flexibility and rapid replication .”
219. Chambers also highlighted the complete enhancement of Cisco’s product lines and the
rapid growth of new technology sales, which was misleading because it concealed the fact that sales
of these newer products would cause revenues and gross margins to decline because sales of the
lower-priced and lower-margin products were cannibalizing sales of higher-priced and higher-
margin technology products:
During the last year we have completely enhanced our routing, switching, advanced technology and consumer product lines . Growth in terms of orders were all approximately 25% or better year-over-year, and the new products such as our Nexus product family, our ASR product family, new fixed-switching of the 2K[s] and 3Ks are all producing growth results at the high end of our expectations .
The details supporting the new product success is really impressive. The following is a quick summary of year-over-year growth rates for these new products. The Nexus 2000 is up 431%. The Nexus 5000 is up 315%. The Nexus 7000 is up 277%. ASR 9000 is up almost 900% . . . .
In terms of this quarterly sequential growth, . . . the ASR 5000 grew 243%, the ASR 9000 grew 110%, the ISR G2 grew 337%, the ISR 1900 grew 333%, the 2900 ISR grew 335% and the 3900 ISR grew 342%. That’s probably as fast as we’ve ever done with new products in terms of rapid ramp up for the next generation.
Obviously, both our next generation product introduction pace and rapid customer acceptance of these new products across our entire product line is extremely strong, in my opinion, in fact, the best we’ve seen in the history of our country in terms of breadth and depth of the innovation engine with solid operational execution. Again, I would not underestimate the role of the new organization structure and new business models have played in our ability to achieve the above-mentioned results .
220. Chambers also falsely represented that Cisco “ had market share gains in both
switching and routing ” and that revenue growth was “extremely strong,” when in fact market share had
declined and sales of Cisco’s newer switching products were replacing sales of higher-margin legacy
switches:
Our core switching revenue growth was extremely strong with approximately 40% year-over-year growth. Balance was also very strong between modular and fixed switching, growing 45% and 37% year-over-year, respectively. As we mentioned earlier, the new switching products were very strong . In terms of new switching products, the Nexus 7000 from a revenue perspective grew 281% and now has an annualized run rate of $1 billion. The Nexus 5000 continued with very strong revenue growth year-over-year of 425% and at a current run rate of $250
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million a year. The Nexus 2000 revenue run rate is now above $160 million on an annualized basis and achieved year-over-year revenue growth of 486% .
Our core routing products also had a very strong quarter with revenues up 23%. High-end routing, which as we currently have it classified represents about two-thirds of our total routing business, grew an outstanding 37%. In terms of new routing products we again saw very strong year-over-year growth in revenues. The ASR 9000, with an annualized revenue run rate of over $160 million, grew 740% year-over-year and 180% quarter to quarter .
* * *
The key takeaway from these outstanding year-over-year and quarter-over-quarter growth numbers for our newly introduced products is how fast they are ramping up and how fast our customer base is expanding using these new products. And it’s going across all of our new innovative product lines with this type of success. I have never seen this broad a base of new product families with as broad a balance of extremely rapid growth rates in my career of any high-tech company .
221. Chambers concluded his prepared remarks by emphasizing Cisco’s rapid expansion
into 30+ market adjacencies and stated that the Company was in the best position it had ever been to
achieve its long-term goals and aspirations.
So in summary, while there are always challenges in front of us from the economy, job creation, competition, supply chain and regulatory environment and many other factors that could be a surprise to us versus our expectations and guidance, we are, in my opinion, in the best position we have ever been to achieve our long-term goals and aspirations . . . .
The balance of this quarter, as evidenced from a country, theater, product family, customer segment and market adjacencies perspective, was probably the best we’ve seen in recent history and definitely the best, given our rapidly expanding role into 30-plus market adjacencies .
222. Calderoni also made false and misleading statements by reporting that the change in
the 3Q10 gross margin was due to higher discounts and product mix but failing to disclose that Cisco
was pulling in sales by offering huge price discounts and that the complete enhancement of the
Company’s products would cause revenues and gross margins to decline as they cannibalized sales of
higher-priced and higher-margin products.
For product only, non-GAAP gross margin for the third quarter was 65.3%, down 0.3 percentage points quarter over quarter. The decrease was primarily due to higher discounts partially offset by higher volume and cost savings . While we were pleased with our overall performance in gross margins this quarter, we do recognize the variability in product mix and other factors that will impact the gross margin . On a year-over-year basis, non-GAAP product gross margin was up 0.7 percentage points, primarily driven by higher volume, mix and cost savings partially offset by higher discounts .
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223. For the same reasons, Calderoni’s statements that the gross margin in 4Q10 “could” be
negatively impacted by product mix were also misleading:
Let me now give you some additional details on the Q4 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 component costs, customer and channel mix and competitive pricing pressures. That being said, we believe total gross margin in Q4 will be approximately 64% to 65% , 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 product mix .
224. Chambers stated that the “service provider business on a global basis in terms of
product orders in Q3 was up approximately 30% year-over-year ” but concealed that Cisco was
masking the decline in demand for cable set-top boxes by giving customers huge price discounts to
pull in orders from future quarters.
225. Analysts noted the importance of defendants’ statements and asked questions. Bank
of America/Merrill Lynch analyst Tal Liani asked how much of Cisco’s growth was coming from the
refreshing of the core switching and router products. Chambers responded that the “ core one group
of advanced technologies, if I remember right, grew at about 22% ” but failed to disclose that the
sales of these lower-margin products were cannibalizing, and would continue to cannibalize, sales of
higher-priced and higher-margin products.
226. Oppenheimer analyst Ittai Kidron followed up on Liani’s question about margins,
noted that switching and routers were the Company’s higher-margin products and asked why margins
had declined given the change in mix to higher-margin products. Chambers responded that it was
“just normal pressure ,” that there was “nothing unusual going on from competition ,” including “no
more major price competition than we’ve traditionally seen ” and that he encouraged analysts to
“model in that 64% to 65% range.”
227. Morgan Stanley analyst Ehud Gelblum also questioned defendants’ statements about
the gross margin, noting that Calderoni mentioned several times the impact of higher discounts in
various areas on Cisco’s gross margin. He asked if the discounts were higher than normal, why
Calderoni mentioned the “higher discounts,” whether the higher discounts were in certain areas and
how they impacted Cisco. Calderoni downplayed the issue and concealed both the huge price
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discounts provided to customers to pull in orders from future quarters and the fact that the complete
refresh of products was causing a decline in revenue and margins.
So when we look at margins, as we’ve talked about in prior quarters, the factors that drive margin variability have to do with the volume and the mix, the cost and then also the price, which is discounting in rebates. So what I highlighted from a product perspective is really just looking at some of the major drivers, not to identify that it was a significant amount but just the main drivers in the quarter were discounts and rebates with benefits offsetting that, what’s driven by the higher volume and cost savings. So nothing significantly unusual, it’s just some of the drivers of that that comes into play from the product side.
228. Chambers followed up and again misled investors by stating that there was quick
acceptance of Cisco’s next-generation products and that product transitions could not be better, but he
concealed the huge price discounts provided to customers to pull in sales from future quarters and
the fact that sales of Cisco’s next-generation products with lower prices and lower margins would
cause revenues and gross margins to decline by cannibalizing sales of the higher-priced and higher-
margin products.
In terms of the mix on the products, we gave an unusual amount of detail which we won’t repeat in the future calls . . . because the start-ups are tremendously powerful here in terms of how quick acceptance occurs. This is about as good as you can do with a next-generation product in a single category, but to do it across every product category from the 7000 Nexus to the 5000 to the 2000, from the ASR to the 9000 to 5000 to the 1000, to be able to do it with UCS, etc., it was across the board very rapid increases .
So the best way to arrive at the number that you ask is that if you have switching improvement of 40% and its about 35% of our total products – total business and you have routing growing at 23% and it’s about 16%-17% of our total business, you can back into the numbers. But overall, the numbers were very solid, no matter how you get them – market share gains, normal transitions, good mix, etc. It doesn’t get any better on product transitions than what’s going on now, is the answer I would come away with on that .
229. During an interview with Bloomberg TV on May 13, 2010, host Margeret Brennan
stated that a number of analysts were surprised by the discounting mentioned during the conference
call and asked Chambers to explain it. Chambers stated that the 64% to 65% gross margin guidance
was“offthe charts,”included discounting and that while Cisco “face[d] a number of good competitors,”
there was “no unusual price competition.” He also stated that “we are gaining market share
versus all of our key competitors.” Chambers concluded the interview by stating “so again, we’re
on fire in terms of our growth .”
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Reasons Why Defendants Knew or Were Deliberately Reckless in Not Knowing Their Statements Were Materially False and Misleading
230. Chambers and Calderoni knew or were deliberately reckless in not knowing their
statements on May 12, 2010 were materially false and misleading for the reasons set forth in ¶¶79-
213. Specifically:
• Defendants knew that competition, the introduction of new switching and router products and customers switching from single-vendor networks to multi-vendor networks were causing revenues, product gross margins and market share to decline. Throughout the May 12, 2010 conference call, Chambers repeatedly touted the complete refresh of Cisco’s products; but neither he nor Calderoni disclosed–as they did in February 2011 and later – that they knew: (1) Cisco had never before introduced so many new products in such a short time period; (2) Cisco would need to sell two to three times the number of new Nexus switching products to generate the same amount of revenue from sales of the Catalyst switches they were cannibalizing; (3) new products always had lower gross margins; and (4) it usually took three to four years before new product gross margins reached the levels of gross margins on the products they were replacing.
• Defendants concealed the huge price discounts and cannibalization of higher-priced and higher-margin products by newer products with lower prices and lower gross margins even though they knew these issues were important to analysts and investors. Indeed, during the May 12, 2010 conference call, several analysts specifically asked what Calderoni meant when he stated that the decline in the 3Q10 gross margin was primarily due to higher discounts and product mix offset by higher volume and cost savings. Instead of answering truthfully, defendants misled investors by stating the decline in the gross margin was “just normal pressure,” that there was “nothing unusual going on from competition” and that there was “nothing significantly unusual.”
• Defendants knew there were various problems in the consumer segment, including the substantial decline in Linksys router sales, the less-than-projected Valet router sales and less-than-expected results in other businesses like Flip, Eos and Telepresence. Indeed, according to CW1, Kaplan acknowledged the problems during a “skip-level meeting” in March 2010, and the forecast for the consumer segment was reduced in spring.
• Defendants knew the reported 30% increase in service provider orders was the result of Cisco’s pulling in orders from future quarters by offering huge price discounts when consumer demand for cable television service was declining. Five former Cisco employees (CW3-CW7) said that the Company was providing cable customers huge price discounts to increase the number of orders and to pull in orders from future quarters. During the November 10, 2010 conference call, Chambers revealed an unexpected and substantial decline in cable set-top box orders, and skeptical analysts openly questioned Chambers’ stated reason for the decline – a sluggish housing market. Morgan Stanley analyst Ehud Gelblum reported that the reason was “difficult to fathom as the housing glut has been overhanging the entire market for nearly two years now.”
• Defendants knew Cisco’s organizational structure was not operating very effectively. Rather, as defendants repeatedly admitted from April through September 2011, and
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as former Cisco employees described, the organizational structure was not operating effectively, was excessively complex and slowed decision making.
231. Insider Selling . After selling 4 million shares for $97.2 million shortly after Cisco’s
February 3, 2010 earnings release and conference call, Chambers sold another 1.27 million shares
for $31.3 million on May 17 and 18, 2010. He sold the stock just one week after he and Calderoni
made the materially false and misleading statements during the May 12, 2010 conference call and
the May 13, 2010 interview with Bloomberg TV . Chambers sold the stock even though the options
he exercised did not expire for months. Further, he sold the stock at $24.61 and $25 per share
shortly after Cisco repurchased 87 million shares of the Company’s stock during 3Q10 for $2.25
billion or an average price of $25.76 per share.
D. August 11, 2010: Defendants Falsely Represent that Cisco’s 4Q10 and FY10 Results Positively Proved the Effectiveness of the Organization Structure and the Growth and Diversification Strategy, that the Company’s Success in New Markets Was Stronger than Anticipated and the Key Take Away Was that the Company’s Strategy and Vision Were Absolutely Working – Chambers Sells $5 Million of Stock a Week Later
232. On August 11, 2010, Cisco issued a press release and held a conference call to report
4Q10 and FY10 results, and defendants continued to mislead investors and the market by concealing
the adverse information detailed in ¶¶79-213, falsely representing that Cisco was successfully
expanding into more than 30 market adjacencies while gaining market share in the core routing and
switching businesses and that the Company’s organization structure was operating very effectively.
In the earnings release, defendants misled investors by continuing to falsely represent that Cisco was
successfully growing the business through solid execution of its growth strategy to aggressively
move into new areas:
“This was yet another very strong quarter with a number of record financial results for Cisco, closing the fiscal year in a tremendous position of strength – a compelling financial model, a well-tuned innovation engine and solid execution on our growth strategy ,” said John Chambers, chairman and CEO, Cisco.
Chambers continued, “Whether the global economy continues to show mixed signals or not – the strength of our financial model and profit generation serves us well. As we continue to successfully grow our business and share of IT investments, our focus is squarely on helping our customers accelerate productivity and growth. We are very confident in our strategy, and will continue to aggressively move into new areas where the network is becoming the platform, and where our customers want us to invest and innovate.”
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233. Defendants reiterated these positive statements during the conference call and falsely
stated that Cisco’s FY10 results were “extremely positive proof in terms of the effectiveness of
organization structure, business models, innovation and execution capabilities, while focusing on
over 30 major new market adjacencies at the same time”:
[T]here are a number of key takeaways from the results in Q1 FY10 and our momentum going into Q1 FY11. First, this was a very strong quarter for Cisco, and we closed FY10 in a tremendous position of strength. We have a compelling financial position, a well-tuned innovation engine, and have shown solid execution on our growth strategy .
* * *
In my opinion, these results are extremely positive proof in terms of the effectiveness of organization structure, business models, innovation and execution capabilities, while focusing on over 30 major new market adjacencies at the same time .
* * *
As we also discussed in a fair amount of detail on the last conference call, we could not be more pleased with how our new organization structure built around dynamic network organizations, combined with new business models around vision, differentiated strategy and execution, are enabling an extremely competitive structure in terms of speed, scale, flexibility and replication . . . .
Our success in both the individual market adjacencies and the inner dependencies between adjacencies had been even stronger than we anticipated. These large opportunities include key emerging countries, datacenter virtualization, cloud, video, consumer and collaboration, all of which have been an extension of current area focus.
234. Chambers also stated that “in Q4 total product orders grew about 23% year over
year,” including “growth in the high teens in service providers ,” which was false and misleading
and concealed that orders for cable set-top boxes were being pulled in from future quarters as a result
of the huge price discounts provided to cable set-top box customers. Later in the conference call, he
falsely stated that “US service providers . . . have been remarkably solid .” Moreover, in response to a
question from Sanford C. Bernstein analyst Jeff Evenson regarding Cisco’s use of marketing
programs or other incentives to drive the recovery in order rates in mid-July, Chambers falsely stated
that the orders were “just normal orders .”
235. Chambers touted the growth of Nexus switch revenues, stating that “[t]he Nexus
family with an annualized run-rate of over $2 billion grew approximately 325% year over year ,”
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but misled investors by failing to disclose that those sales were causing – and would continue to cause
– overall switching revenues and product gross margins to decline because they were cannibalizing
sales of higher-priced and higher-margin Catalyst switches.
236. Chambers stated that his “strong optimism” was balanced by “some challenges that are
contributing to an unusual amount of conservatism and even caution,” including slowing GDP
growth, job creation, the slowing pace of the recovery, customers seeing a softening of their
businesses in June and July and concerns about Europe. But he said nothing about the problems in
the consumer segment; the declining sales, market share and profitability in the switching and router
segments; or the artificially inflated orders for cable set-top boxes caused by the huge price
discounts. Further, as in previous conference calls, Chambers again stated that Cisco was extremely
well positioned on those areas that it controlled and that it was gaining solid momentum in almost all
product families and market adjacencies:
In summary, on those areas that we can control or influence, from an innovation point of view or an operational execution point of view, we feel we are extremely well-positioned. Almost all of our product families are in the early stages of their lifecycle and gaining solid momentum as we discussed earlier. Balance across geographies and customer segments remains very good. Even after four sequential quarters of growth, our Q4 results versus Q4 a year ago were above our long-term goals of 12% to 17%. . . .
So, as may of you would expect, we’re going to focus on what we can control and influence as we have done in each of the periods of uncertainty, and we’re going to be very aggressive in terms of investing resources in the new market adjacencies where we are also gaining very good momentum both from an innovation thought leadership perspective, as well as a business perspective.
237. Calderoni provided information on Cisco’s gross margins but said nothing about the
huge discounts provided to cable set-top box customers, increasing pressure from competitors and
Cisco’s newer and lower-margin switches and routers causing revenues, market share and gross
margins to decline:
Total non-GAAP gross margin for fiscal year 2010 was 65.2%, up 0.2 percentage point year over year. For product only non-GAAP gross margin of 65.1% was up 0.2 percentage point compared with FY09, primarily due to cost savings and volume, partially offset by pricing and discounts .
* * *
Q4 FY10 total non-GAAP gross margin was 64.1%, down 1.1 points quarter over quarter and down 1.2 points year over year. For product only non-GAAP gross
CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 79 -
margin for the fourth quarter was 63.6%, down 1.7 points quarter over quarter. We saw an approximate 1 percentage point impact on margins as a result of higher manufacturing-related costs due primarily to the constraints in our supply chain and its impact on our linearity, which was incremental to our typical variances.
We also saw an unfavorable mix impact driven by numerous recent product introductions . Consistent with historical experience, we expect to see positive benefit from ongoing cost savings from component costs and value engineering over time. The remainder of the decrease in product margins was driven by pricing and higher discounts, partially offset by cost savings and higher volumes .
On a year-over-year basis, non-GAAP product gross margin was down 1.1 percentage points. This was primarily driven by higher manufacturing-related costs associated with supply-chain constraints, unfavorable mix, pricing and higher discounts, partially offset by the cost savings and higher volumes .
238. Bank of America/Merrill Lynch analyst Tal Liani noted that switching and router
revenues were down in the quarter, the gross margin disappointed and the Company’s guidance was
weak and below expectations. Liani asked if these facts were specific to Cisco or more because of
the economy and signs of another dip in IT spending. Chambers disputed that switches and routers
were down, did not address the disappointing gross margin and emphasized that Cisco was doing so
well that his confidence had never been higher:
In terms of routing and switching, I respectfully disagree on the switching numbers. You have watched us both in modular and fixed both this quarter and last quarter. You are talking about growth last quarter of 40% and I think 27% this quarter. Those numbers are really good, and you add up total switching, that is hard for anybody to keep up with, and yet we have the largest position in the market.
In terms of routing, our product line is really solid, really good.
* * *
In terms of the caution that you’re hearing, so in summary, in terms of Cisco-specific, we feel really good. We are competing. We are winning. We are moving into new market adjacencies. Organization structure is working. My confidence has never been higher. And candidly when you talk to customers, you hear the exact same thing .
239. In response to a question from RBC Capital Markets analyst Mark Sue about the
conservative guidance and mixed economic signals, Chambers said that, despite the mixed signals,
he was very comfortable on things Cisco could influence:
We are not making a call on the economy. We are just sharing with you where we see it, and I know you’re asking me and leading that question to get more details out. I feel very comfortable with our ability to compete in every product category . I mean we have the best product lineup we have ever had.
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I think it is real important that the market – and all of us agree, you look at the spot price and you have got to say the market is not buying that we can go 12% to 17% consistently. And yet we are defending growing above that range when you’re comparing two year-over-year comparisons in a tough economic time, which I think is pretty darn good performance.
So in terms of the direction, on things we can totally influence, I’m really comfortable. We will get our market share gains. We have got good balance. We are not seeing any unusual pricing issues. Our gross margin issues were due almost entirely to the problems we had on supply chain and the mix issue . And I do want to repeat, if I’m here for the next several years, each of these quarter calls apologizing that we were at the high end of the 12% to 17% or over 17% growth, then I will do so.
240. Goldman Sachs analyst Simona Jankowski asked for more color on the gross
margins, noted that Chambers said component shortages were the reason for the decline and were
something Cisco had been dealing with for a couple of quarters, and asked if the decline was also
related to mix, including sales of newer switching products with lower margins. Chambers admitted
that it did, but falsely stated that it was fairly normal and that Cisco was doing well versus the
competition –when the tables in ¶¶82-83 show that Cisco’s share of the switching and router markets
had declined:
[W]hen you introduce new products, . . . we always start with lower gross margins on the new products. . . .
This is the fastest, layered and most well-balanced I can remember us being in terms of new product introductions , and that does have an impact as well.
But no, that is going to be with us for a little while until you do your typical Texas two-step in terms of price performance improvement, costing on components, etc. So this has been fairly normal in terms of the direction.
* * *
We are doing well versus our competitors. I’m very comfortable with where we are .
241. In response to a question from Ticonderoga analyst Brian White about what Cisco
was seeing in the government public sector given the big fiscal austerity programs around the world,
Chambers stated that [p]ublic sector in the US is very solid for us, both in the federal and the state
and local ,” that Public Sector Europe actually held up pretty well ,” that it did pretty well ” in emerging
countries and that Bruce Klein, the head of the public sector, was `pretty optimistic about next year .”
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Rob Lloyd, Cisco’s EVP of Worldwide Operations, added that “we feel very confident, very strong
about the forecast and a pipeline of opportunities .”
242. Robert Baird analyst Jayson Noland asked if Chambers saw Cisco “long-term
competing with HP on price, on technology or vision, and how much of a risk is HP to Cisco’s gross
margin long term.” Chambers avoided answering the question and instead misleadingly responded
that HP was a good and tough competitor and that hopefully Cisco could “take a lot of [market share]
from them.” In fact, as the tables in ¶¶82-84 show, HP’s share of the switching market had increased
while Cisco’s declined.
243. At the end of the conference call, Chambers again emphasized that the key takeaways
were that Cisco’s strategy and vision were absolutely working, that things Cisco controlled were in
great shape and that management was very comfortable with a 12% to 17% growth rate:
[I]f there is one key takeaway from this call that I would like for you all to think about, our strategy and vision is absolutely working. We are gaining [market share]. We are gaining product leadership . We are gaining architecture. Our relationships with our customers is moving from being a box player or a router or a switcher – switching to really a key business partner, a trusted technical advisor. We will win more than our fair share of jumpballs in all areas. And it is unusual a company can say that with that type of confidence. We are clearly applying in terms of our growth projections for the future very comfortable and becoming more comfortable with our long-range 12% to 17% .
So I think it is important when you think out, several years out, 12% to 17%, most of the shareholders would be very, very comfortable with. We are saying when you start comparing quarters where we have had very good growth to quarters where we have very good growth, we are very pleased that we are at the high end of that or above that.
So that is perhaps my one key takeaway. Things we control or influence are in great shape. Our growth in terms of our long-term aspirations looks very good, and we are playing actually at the high end or above on that . And our concerns are normal cautious concerns, which you would expect to see . . . .
Reasons Why Defendants Knew or Were Deliberately Reckless in Not Knowing Their Statements Were Materially False and Misleading
244. Chambers and Calderoni knew or were deliberately reckless in not knowing their
statements on August 11, 2010 were materially false and misleading for the reasons set forth in
¶¶79-213. Specifically, they knew:
• Competition, the introduction of new switching and router products and customers switching from single-vendor networks to multi-vendor networks were causing revenues, product gross margins and market share to decline. Further, as the tables
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in ¶¶82-90 show, Cisco’s share of the switching and router markets had declined, while its competitors’ share of those markets had increased. During the August 11, 2010 conference call, Chambers stated that new product introductions had never been faster and that Nexus switches grew 325% to an annualized run rate of $2 billion. But he said the decline in product gross margins was primarily due to component shortages and that the impact of new product sales on the gross margin was fairly normal. Neither he nor Calderoni disclosed – as they did in February 2011 and later – that they knew: (1) Cisco had never before introduced so many new products in such a short time period; (2) Cisco would need to sell 2-3 times the number of new Nexus switching products to generate the same amount of revenue from sales of Catalyst switches it was cannibalizing; and (3) it usually took 3-4 years before new product gross margins reached the levels of gross margins on the products they were replacing. Nor did they disclose the impact on gross margins from the huge price discounts provided to cable set-top box customers to pull in orders from future quarters.
• There were various problems in the consumer segment, including the substantial decline in Linksys router sales, the less-than-projected Valet router sales and less-than-expected results in other businesses like Flip, Eos and Telepresence. According to CW1, 2010 was a slow train wreck as the consumer division experienced decreasing revenues and market share that were reflected in the weekly “sell-in/sell-through” reports, and the revenue goals of the consumer division had been reduced back in the spring.
• The reported “high teens” growth in service provider orders was the result of Cisco pulling in orders from future quarters by offering huge price discounts when consumer demand for cable television service was declining. Thus, Chambers and Calderoni knew that Chambers’ additional statements that U.S. service providers had been remarkably solid and that they were just normal orders were also misleading. In fact, during the November 10, 2010 conference call, when Cisco reported a 35% decline in cable set-top box orders – and a 40% decline in the North American cable business – in 1Q11, RBC Capital Markets analyst Mark Sue asked Chambers how Cisco missed the cable MSO transition that caused the decline. Chambers admitted that he and Calderoni “saw the transition coming” and had made changes in management at Scientific Atlanta. Other skeptical analysts also questioned the timing of the disclosure. Morgan Stanley analyst Gelblum reported that defendants’ claim that a sluggish housing market was the reason for the set-top box order decline was “difficult to fathom as the housing glut has been overhanging the entire market for nearly two years now.” He also noted that Motorola reported during its earnings call two weeks earlier that cable set top box orders would increase the following quarter. Jefferies analyst William Choi wrote in a November 10, 2010 report that the lowered guidance resulting from the problems in the public sector and service provider businesses was “puzzling” for a company that “typically set guidance and [met].” Raymond James analyst Todd Koffman reported the sharp adjustment in cable orders was “very surprising.”
• Cisco’s 4Q10 and FY10 results were not, as Chambers stated during the August 11, 2010 conference call, “extremely positive proof in terms of the effectiveness of organization structure, business models, innovation and execution capabilities, while focusing on over 30 major new market adjacencies at the same time.” Rather, as defendants admitted from April 2011 through September 2011, and as the former employees described, the organizational structure was not operating effectively, was excessively complex and slowed decision making.
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245. Problems in the public sector segment . Chambers’ statements during the November
10, 2010 conference call, analysts’ reactions to those statements, defendants’ admitted close
relationship with Cisco’s customers and the importance of the public sector to Cisco’s overall results
strongly suggest that defendants also knew their statements about the public sector–that the“[p]ublic
sector in the US is very solid for us, both in the federal and the state and local”; that “Public Sector
Europe actually held up pretty well”; that Bruce Klein, the head of the public sector, was “pretty
optimistic about next year”; and that management felt “very confident, very strong about the forecast
and a pipeline of opportunities” – were false.
246. Analysts’ reactions to the unexpected negative news . During the November 10,
2010 conference call, Chambers reported that orders in the public sector segment – which was 22% of
Cisco’s business – declined 25% year-over-year and 48% quarter-over-quarter and that the public
sector business would continue to be challenging for at least several quarters. Chambers claimed
management was “surprised” that Cisco missed its public sector forecast. Analysts were skeptical,
and, as Morningstar Equity Research analyst Joseph Beaulieu wrote in a November 11, 2010 report,
the question-and-answer session with analysts was “fairly contentious.” J.P. Morgan analyst Rod Hall
did not believe the decline in public sector spending was a surprise and wrote in a November 11,
2010 report, “[w]e believe that Cisco had expected a weak start to FQ1 due to aggressive selling in
FQ4’10. In our opinion, this masked developing weakness in government spending .”
247. During the conference call, Morgan Stanley analyst Ehud Gelblum noted that
Chambers admitted during the conference call that the quarter unfolded as expected and that sales
orders missed internal projections by $500 million and asked if that was known before the
Company’s September 14, 2010 analyst day. Chambers admitted he and Calderoni knew about the
shortfall throughout the quarter, stating that “the quarter was within our normal seasonality in terms
of mix for each of the three months” and was “pretty much normal.”
248. UBS analyst Nikos Theodosopoulos questioned the reassurances provided by
management during the 4Q10/FY10 earnings call on August 11, 2010 that there were not issues in
the public sector segment. Indeed, Theodosopoulos said it was a “pretty significant reset when the
rest of the industry isn’t seeing it.” Chambers admitted the “challenge [was] fair.” Jefferies analyst
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William Choi reported on November 10, 2010 that the lowered guidance resulting from the problems
in the public sector and service provider businesses was “puzzling” for a company that “typically set
guidance and [met].”
249. During a November 11, 2010 interview with Bloomberg News, host Betty Liu asked
Chambers why the decline in public sector orders was a surprise when “we’ve been talking all year
about a budget tightening among state governments.” Chambers acknowledged the skepticism by
responding, “maybe it shouldn’t,” and then tried to persuade Liu that the decline really was surprising
by noting that the feedback from analysts during the conference call was that other companies were
not seeing a decline in government spending. But the analysts making those comments were
skeptical about when Chambers and Calderoni knew about the decline in public sector orders
because they believed it was caused, in part, by Cisco’s loss of market share to its competitors.
250. Defendants’ admitted close relationship with customers . Defendants’ admitted close
relationships with its customers, and the fact that the public sector comprised 22% of Cisco’s
business also indicates defendants knew about the decline in public sector orders by August 10,
2010. As detailed in ¶¶179-189, defendants and other Cisco executives repeatedly told investors that
Company management frequently met with customers, maintained a scorecard that tracked such
meetings, surveyed customers and received feedback, all of which were utilized to form the
Company’s strategy.
251. As detailed in ¶¶191-194, former Cisco employees also described various internal
reports that tracked sales and orders from the Company’s various businesses. They also said these
reports were discussed during various meetings. Analysts and the financial press reported that Cisco
had “the most sophisticated customer feedback loop . . . in any business” and that the Company
reported results “on the knuckle” due to its “disciplined market intelligence system.”
252. Insider Selling . As alleged above, Chambers sold 5.5 million shares for $134 million
between February 8, 2010 and August 18, 2010, including the sale of 243,178 shares for $5.5 million
on August 18, 2010. The August 18, 2010 sale was just one week after Chambers made the false
statements during the August 11, 2010 conference call and after the Company repurchased 99
million shares for $2.25 billion in 4Q10. After Cisco unexpectedly reported order declines in the
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public sector and service provider businesses on November 10, 2010 that caused some analysts to
question the positive statements made during the August 11, 2010 conference call, Michael Shedlock
from Mish’s Global Economic Trend Analysis, noted the suspicious timing of the sales by Chambers
and other Cisco insiders. On November 11, 2010, he wrote that Chambers’ sales and the sales of 1.1
million shares by other Cisco insiders showed that the insiders “bailed hand over fist” and, unlike
investors, were not surprised by the adverse news reported by Cisco on November 10, 2010. He also
reported that the insider sales, Cisco’s repurchase of 1.6 billion shares for $38 billion in the five years
ending July 2010 and the failure to pay dividends despite $40 billion of cash allowed management to
“pretend it [was] increasing shareholder value while corporate insiders [got] to dump massive
numbers of shares” and was “nothing more than shareholder rape.”
253. Analysts also question share repurchases by Cisco . The first question during Cisco’s
November 10, 2010 conference call was from Sanford C. Bernstein analyst Jeff Evenson, who asked
why Cisco repurchased 110 million shares during 1Q11 when defendants said during the August 11,
2010 conference call that the Company expected to repurchase 40 million shares. He also asked
whether it “indicate[d] anything about when you came to the conclusion that things were going to be
weaker than you maybe thought three months ago.” Chambers responded that the quarter was
“shaping up very much as we anticipated for the vast majority of the quarter ” and that it “had zero to
do with purchasing in the marketplace.” Later during the conference call, he said Cisco “bought stock
because we thought it was a good price in terms of momentum for where it would be not just a
quarter out, but in one year[], and two years and three years out in terms of direction.” Those
responses, if true, contradicted Chambers’ earlier statement that management was surprised by the
reduction in public sector orders and was an admission that Chambers knew of the problems
disclosed on November 10, 2010 when he sold $5.5 million of his stock in August 2010. Indeed, if
Chambers really thought the stock price was good for Cisco to purchase, then why did he sell his
stock?
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E. November 10, 2010: Cisco’s Stock Price Declines 16.2% after Defendants Reveal Problems in the Public Sector, Set-Top Box and Consumer Businesses but Falsely Assure Investors the Problems Are Temporary Air Pockets and Continue to Make Misleading Statements
254. On November 10, 2010, Cisco issued a press release and held a conference call to
report 1Q11 results, during which defendants began to reveal some of the previously concealed
problems with Cisco’s business and acknowledge the falsity of some of their previous statements –
particularly the positive statements made during the August 11, 2010 conference call about the
public sector business and service provider business. Cisco disclosed that year-over-year revenue
growth in the U.S. was only 6% due to challenging trends in global service provider capital
expenditures and a 40% year-over-year decline in traditional set-top box orders from North
American cable operators. Chambers said that slowing consumer spending, lower-cost competitors
and cable operators transitioning from traditional set-top boxes to IP set-top boxes caused the
declines.
255. Chambers also acknowledged the falsity of the positive statements he made during
Cisco’s August 11, 2010 conference about the public sector segment – that the public sector segment
was “very solid” and that management felt “very confident, very strong about the forecast and a pipeline
of opportunities.” He unexpectedly revealed substantial declines in orders in the public sector: a 25%
year-over-year decline in orders (and a 48% quarter-over-quarter decline) from state governments in
the U.S.; a mid single digit year-over-year decline in European public sector orders caused by drastic
government budget cuts; and declines in Japan public sector orders. Chambers also said the public
sector business would continue to be challenging for at least several quarters.
256. Chambers stated that total orders in 1Q11 were $500 million less than forecasted and
that Cisco was not projecting growth as fast as management would like over the next several quarters
because of the reality in public sector spending, challenges in the service provider market and one or
two areas (that he failed to identify) where Cisco needed to improve its execution. He stated that
year-over-year growth in 2Q11 was expected to be just 3% to 5%, year-over-year growth in FY11
was expected to be 9% to 12% and it was realistic to hope for a return to the 12% to 17% growth
goals in the not-too-distant future.
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257. As a result of this unexpected adverse information, Cisco’s stock price declined 16.2%
from $24.49 on November 11, 2010 to $20.52 on November 11, 2010, compared to a 0.4% decline
in the S&P 500 and a 1.8% decline in the peer group. Analysts attributed the decline to the
unexpected disappointing results in the public sector and service provider businesses and the
resulting weak guidance. Reuters reported that investors were stunned by the unexpected bad news.
MarketWatch reported that at least four analysts downgraded Cisco and that the stock price decline
was the worst single-day drop in more than 16 years.
258. But defendants continued to mislead investors and maintain the artificial inflation in
Cisco’s stock by representing that the problems were short-term “air pockets” that Cisco was going to
“power through” and that Cisco’s execution in the areas it did control and influence reflected the
success and relevance of the Company’s strategy. As reported by The Wall Street Journal on
November 12, 2010, Chambers “took pains to refute suggestions that Cisco is losing ground to rivals
in the switching and routing hardware that are key pillars to its business.” In the press release,
Chambers misled investors by stating that the success and relevance of Cisco’s strategy was
demonstrated by management’s execution in the areas it controlled and influenced and that Cisco’s
market-share momentum positioned the Company for growth:
“Cisco delivered solid financial results, during a challenging economic environment. While we have seen capital spending moderate in some areas of our business, our execution in the areas we can control and influence speak to the success and relevance of our company’s strategy ,” said John Chambers, chairman and CEO, Cisco. “Our position in the market, including continued product innovation, market share momentum and operational excellence, positions us for growth and flexibility well into the future as we strengthen our role as a trusted business partner to our customers .”
259. During the conference call, defendants continued to mislead investors by representing
that Cisco was executing well in its core markets and market adjacencies:
From a high-level perspective there are a number of key takeaways from the results in Q1 FY’11 and our momentum going into Q2 FY’11.
First, Q1 was a solid quarter from [] Cisco from a financial, product, customer and geographic perspective. We continue to execute well with a compelling financial position, expanding innovation engines, and executed in both our core markets and market adjacencies . However, what I am most pleased about is how our business architecture and technology architecture is gaining customer acceptance.
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260. As he did in previous conference calls, Chambers touted the growth of new products,
including Nexus switches, but concealed that the sales of those lower-priced and lower-margin
products were causing revenues and gross margins to decline because they were cannibalizing sales
of higher-priced and higher-margin products, including Catalyst switches. Chambers stated that the
Company’s“new next-generation products continue very solid customer acceptance,” including
“ASR edge routers [which] grew approximately 200% year-over-year, with a current annualized
run rate of approximately $1.4 billion, ” the “ASR 9000 [which] was especially strong with over
700% growth year-over-year, with an annualized run rate of $280 million,” and the “Nexus
product family [which] also continued to be very strong, with year-over-year growth in excess of
120%, and an annualized run rate of approximately $1.5 billion. ” He also stated, the “UCS server
product family had another extremely strong quarter, with growth year-over-year of 550% to an
annualized run rate of almost $500 million.”
261. After describing the problems in the service provider and public sector businesses,
Chambers stated that Cisco continued to gain market share, was well positioned and would power
through the short-term challenges:
In summary, we continued to gain [market share] in many of our product areas in the third calendar quarter of this year . In terms of our new intermediate two- to three-year big opportunities, we are well-positioned and getting good results in video, collaboration, data center virtualization, cloud, our emerging countries, Smart+Connected Communities, as well as our new innovative products.
* * *
On the areas we control or influence from an innovation point of view, or an operational execution point of view, we feel we are very well-positioned . Almost all of our product families are in the early stages of their lifecycle and gaining solid momentum as we discussed earlier.
* * *
Our ability to enter new markets from the data center to the cloud to UCS to collaboration to video mobility to the home is gaining speed, scale, flexibility, and is becoming replicable, as we had hoped, as well as tying together from an architectural perspective .
* * *
[O]ur view is that we are going to power through in what we believe to be some short-term challenges in the next several quarters . . . .
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262. Chambers concluded his opening remarks by stating that the “key takeaway from Q1
remains that our vision of the industry’s evolution and our strategic differentiation is playing out
pretty much as we had desired. And Cisco is strongly positioned to win in these traditional
markets and new market adjacencies. . . . [I]n terms of what we can control or influence, we
continue to feel very confident. . . . I could not be more excited about how we are positionedfor
the future .”
263. Calderoni also falsely stated that the reported gross margin reflected higher cost
savings partially offset by discounts and unfavorable mix, but continued to conceal the huge price
discounts provided to cable set-top box customers and the lower gross margins on newer products
that were cannibalizing sales of higher-margin products:
For product-only non-GAAP gross margin for the first quarter was 64%, up 0.4 of a percentage point quarter-over-quarter.
For the quarter-over-quarter comparisons higher cost savings are partially offset by discounts . On a year-over-year basis non-GAAP product gross margin was down 2.3 percentage points. The year-over-year decrease was primarily driven by pricing and discounts, along with higher manufacturing-related costs associated with the carryover effect of our FY’10 supply-chain constraints, and unfavorable mix, partly offset by cost savings and higher volumes .
264. Notably, Calderoni did not provide gross margin guidance, which always had been
provided in previous conference calls. When asked why by RBC Capital Markets analyst Mark Sue,
Calderoni stated that lower sales volume and increased consumer sales in 2Q11 could negatively
impact margins, but nevertheless stated that gross margins would be in the 64% range for the rest of
the year.
265. Bank of America/Merrill Lynch analyst Tal Liani noted that the 9% to 12% increase
in FY11 revenues assumed very strong growth in 3Q11 and 4Q11 and asked what the basis was.
Chambers responded that Cisco would “adjust” to the “couple of air pockets that we hit” and that he and
Calderoni saw “good balance literally in all the segments .” In response to a question from Deutsche
Bank analyst Brian Modoff, he reiterated that Cisco “hit a couple of air pockets” but stated that Cisco
would “go right through them” and was in great shape and gaining market share:
[T]he big picture hasn’t changed. The major transitions that are going on, we are in great shape for. We are taking [market share] in most areas we are moving into.
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There may be a quarter or two where we are not, but as a whole we are really world-class in this .
* * *
We hit a couple of challenges and we will manage through those. But I think we will look back and say that they were just air pockets and good bumps, but we will go right through them .
266. Oppenheimer analyst Ittai Kidron stated that the guidance indicated switching
revenues would be down 15% in 2Q11, which raised questions of where Juniper and HP were taking
business away from Cisco. Kidron also commented that the Company’s biggest router competitor
reported 20% growth compared to Cisco’s 13%. Kidron asked if management was losing sight of its
core markets and if Cisco could still execute in these markets without dropping the ball and losing
focus, especially given all of the investment and focus on new areas. Instead of admitting that Cisco
was losing market share to competitors and that switching revenues and gross margins would decline
again in 2Q11, Chambers continued to falsely state that Cisco’s market share for various products
had actually increased (access routing up 1% to 87% market share, switching up 2% to 70%+
market share, wireless LAN up 3%, enterprise voice up 4%, UCS up 5%, SAN up 6%), that the
Company only lost market share in A&S and Labs and that Cisco was “executing very well” and that
he was “very comfortable with where we need to go .”
Reasons Why Defendants Knew or Were Deliberately Reckless in Not Knowing Their Statements Were Materially False and Misleading
267. Chambers and Calderoni knew or were deliberately reckless in not knowing their
statements on November 10, 2010 were materially false and misleading for the reasons set forth in
¶¶79-213 and ¶¶245-253. Specifically, they knew:
• Competition, the introduction of new switching and router products and customers switching from single vendor networks to multivendor networks were causing revenues, product gross margins and market share to decline. Further, as the tables in ¶¶82-90 show, Cisco’s share of the switching and router markets had declined, while its competitors’ share of those markets had increased. In fact, on February 9, 2011, Cisco reported substantial declines in switching revenues and product gross margins in 2Q11 and attributed the decline to competition and sales of newer products with lower prices and lower gross margins that were cannibalizing the sales of legacy products with higher prices and higher gross margins.
• There were various problems in the consumer segment, including the substantial decline in Linksys router sales, the less-than-projected Valet router sales and less-than-expected results in other businesses like Flip, Eos and Telepresence. In fact,
CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA - 91 -
Cisco reported a 15% year-over-year decline in consumer orders in 2Q11, which was the quarter that Cisco usually generated the most consumer orders because it included the holidays.
• Cisco’s organizational structure was not operating very effectively. Rather, as defendants admitted from April 2011 through September 2011, and as the former employees described, the organizational structure was not operating effectively, was excessively complex and slowed decision making.
268. Analysts’ questions during the November 10, 2010 conference call, the unexpected
disappointing switching and router results reported on February 9, 2011 and analysts’ reactions
to those unexpected results are additional facts showing defendants knew their statements about
the switching and router businesses were false and misleading . During the November 10, 2010
conference call, analysts openly questioned Chambers’ positive statements about the strength of the
switching, router and UCS businesses; and, as the The Wall Street Journal reported on November
12, 2010, Chambers “took pains to refute suggestions that Cisco [was] losing ground to rivals in the
switching and routing hardware that are key pillars to its business.” Oppenheimer analyst Ittai
Kidron, who asked Chambers during the conference call if Cisco was losing sight of its core markets
and dropping the ball as it focused on new areas, issued a report following the conference call in
which he wrote that Chambers’ assurances that the problems were temporary air pockets “ will
undoubtedly raise questions as to the real root cause of the weakness” and that the “key issue”
was “determining whether the issues highlighted above are the true root causes of the weakness
or if there are other issues brewing that have yet to surface that Cisco has not fully admitted or
recognized .” Kidron reported Oppenheimer’s opinion was that “the truth lies somewhere in the
middle”; “spending in Europe and the public sector [would continue to] be weak for the foreseeable
future”; Cisco was “gaining traction in the data center and collaboration with UCS and Tandberg
acquisition”; and Cisco was “losing market share in its core markets – namely, routing, switching
and security .” The Wall Street Journal reported that Kidron said he expected to see share losses for
Cisco in 2Q11 in its core markets.
269. William Blair & Company, L.L.C. (“William Blair”) analyst Jason Ader downgraded
Cisco and reported that the Company was in denial about issues that were hampering growth
prospects that went beyond the weak spending by public sector customers and U.S. cable operators.
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He reported the problems disclosed by Cisco “cannot fully explain such a big reset ” and that the
slowdown in business was also due to other factors, including “market share saturation in the core
business of switching and routing .”
270. Morgan Stanley analyst Ehud Gelblum reported, “[w]e believe the order shortfall
could be more than the ‘air pocket’ described by Chambers, and instead could be the first signal
that Cisco is losing share in several of its core markets as its focus on growth has diverted
attention from its core businesses. We can’t find one other company – big or small – that’s seeing
similar weakness .” He wrote that it appeared Cisco lost significant momentum in key growth
products in its core business, including: (a) the ASR9000, which Chambers said hit a $280 million
annualized run rate, just $5 million greater than the $275 million run rate reported in 4Q10; and
(b) the Nexus family of Ethernet switches, which Chambers said hit a $1.5 billion annualized run
rate – $500 million less than the $2 billion run rate announced in 4Q10.
271. The Street.com reported that Chambers “put a positive on the company’s numbers,
pointing to strength in areas such as switching, routing and the UCS server business.” But Goldman
Sachs analyst Simona Jankowski reported that customers’ preference for best-of-breed vendors in the
move to cloud was putting pressure on integrated IT vendors like Cisco that could be highly
disruptive for Cisco’s core switching businesses.
272. Reuters reported on November 11, 2010 that the order declines in the public sector
and service provider businesses and bleak forecast raised concerns that Cisco was neglecting its
main business as it expanded beyond the traditional network equipment into everything from video
cameras to computer servers. UBS analyst Nikos Theodosopoulos reported that Cisco might be
spreading itself too thin by pursuing too many new markets with ongoing gradual networking share
loss.
273. On November 10, 2010, Lazard Capital analyst Ryan Hutchison downgraded Cisco,
questioning whether competition in Cisco’s core switching and router businesses was adversely
impacting the business. Hutchinson wrote that, “[d]espite a rigorous defense of the strength of the
company’s competitive positioning, the weak outlook raises the possibility that it may in fact be
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weakening.” Zacks Equity Research reported that the lowered guidance indicated a slowdown in
several important areas, including routers and switches.
274. Analysts question why Cisco did not initially provide gross margin guidance .
During the November 10, 2010 conference call, Cisco failed to provide gross margin guidance,
which the Company had always provided in the past. Analysts noted the omission and their
concerns about what it meant. During the conference call, RBC Capital Markets analyst Mark Sue
asked why management did not provide gross margin guidance. Calderoni responded that gross
margins would be in the 64% range for the rest of the year and that, in the near term, a reduction in
revenue volume or an increase in lower-margin consumer sales – which were seasonal and higher in
2Q11 due to the holiday season – could negatively impact the gross margin. Morgan Stanley analyst
Gelblum noted that Cisco did not provide gross margin guidance for the first time in five years,
which he suspected meant that Cisco could be preparing to engage in a price war to defend market
share.
275. Analysts question full-year revenue guidance . Analysts were also skeptical of the
full-year revenue guidance of 9% to 12% year-over-year growth. Morgan Stanley analyst Gelblum
reported that Cisco gave annual guidance for the first time in three years, presumably to provide
some level of comfort “post the weak FQ2 guide,” but that the “9-12% growth requires an
unexplainably strong 11% sequential growth in 2H11 over 1H11, which would appear to be patently
unachievable given the unsettled demand environment and the clear lack of visibility that caused
orders to dry up in essentially one month last quarter.” Oppenheimer analyst Kidron reported that the
guidance was “unreasonable,” and William Blair analyst Jason Ader reported the “aggressive guidance
for the second half of the fiscal year leaves us perplexed .”
276. Analyst skepticism was also noted in the financial press. Dow Jones reported on
November 12, 2010 that the magnitude of the weaknesses and bullish comments from other suppliers
stoked concern on Wall Street that Cisco might be under pressure in the routing and switch business.
277. Analysts’ reaction to the decline in switching sales and gross margins revealed by
Cisco on February 9, 2011 . Contrary to the repeated assurances provided by Chambers and
Calderoni during the November 10, 2010 conference call, on February 9, 2011, Cisco reported
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substantial declines in switching revenues, router revenues and product gross margins; and as the
tables in ¶¶82-83 and ¶¶87-90 show, the Company’s share of the switching and router markets
declined further. Chambers and Calderoni also acknowledged during the conference call that
competition and the rapid introduction of lower-priced and lower-margin products contributed to the
decline by cannibalizing sales of the higher-priced and higher-margin products they were replacing.
While I strongly believe we are very well-positioned versus our competition, we are in the middle of a major product transition, with dramatically higher price performance from these new products and architectural advantages versus our prior generation of products and that of our competitors. I’ll go into more detail in a moment, but with this item in mind, we did see our switching revenues decline 7% in Q2.
* * *
We did experience in the quarter an overall mix shift toward the lower-end products in the portfolio. But overall we are growing our footprint and driving an architectural transition. What this means to me is that our new switching products are very strongly positioned with an architectural play, while addressing our competition from a price performance perspective. This allows us to both grow our market and to continue to improve our margins over time with these new products, as you would expect us to do.
* * *
As the transition to switching products with dramatically higher price performance capabilities, we are clearly establishing a differentiated value to our customers. And as you’d expect during this transition, we are seeing pricing pressures on our established Catalyst portfolio.
This is where our competitors are focused. And in simple terms this is where we are going to own our own evolution. And we’re going to own the next generation in this space. To be candid, these product transitions within our own product families are occurring even faster than we expected, especially in terms of the ramp of the new products in terms of growth rates.
278. Analysts were surprised and again questioned Chambers and Calderoni. Like the
conference call on November 10, 2010, the February 9, 2011 conference call was contentious. The
Street.com reported on February 9, 2011 that “Chambers was trying to contain the damage.” The next
day, Eric Jackson, founder of Ironfire Capital, reported that the question-and-answer session did not
start for 50 minutes because Chambers “wouldn’t shut up” and that his “endless droning worried analysts”
because “[i]f you keep talking about how everything is fine, it usually means everything’s not fine.”
279. Morgan Stanley analyst Gelblum’s concern that Cisco’s failure to provide gross margin
guidance on November 10, 2010 could mean that Cisco planned to engage in a price war turned out
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to be correct. On February 9, 2011, he issued a report noting that the 62.4% gross margin was the
lowest reported in nine years and indicated Cisco was trading revenue for margins. He also reported
that switching revenues declined a “startling” 11.3% quarter-over-quarter and 7.6% year-over-year and
expected Cisco’s share of the fixed Ethernet switch market to continue to decline as HP and Juniper
gained share and for margins to decline due to competition and cannibalization by Cisco’s newer
lower-end and lower-margin switches. He also reported that Cisco’s routing revenue grew just 1%
year-over-year on an organic basis compared to Juniper’s 30% year-over-year growth and 25%
quarter-over-quarter growth, which indicated that Cisco had lost share to Juniper.
280. The first question during the conference call was by Bank of America/Merrill Lynch
analyst Tal Liani, who asked for an explanation for the 7.5% year-over-year decline in switching
revenues and 5% year-over-year increase in router revenues, noting that those results were “materially
below the competition” and that there should not be pricing pressure in these segments because Cisco
did not have many competitors. Chambers responded that there “is always pricing pressure” and that
sales of Cisco’s newer Catalyst 7000 switch was cannibalizing sales of Catalyst 6000 switches
because Cisco would “have to sell almost two to three times the volume of the 7000 to have the same
revenue scenarios.” In response to a question from RBC Capital Markets analyst Mark Sue, who
asked why gross margins would not decline below 62% to 63% given pricing actions and extended
payment terms to compete and prevent market share declines, Chambers stated that new products
“always start at lower gross margins.”
281. On February 9, 2011, Oppenheimer analyst Kidron also reported the gross margin
decline reflected multiple product transitions and Cisco’s aggressive protection of its installed base.
On February 17, 2011, he reported that Oppenheimer had taken a deeper look at the underlying
transitions impacting Cisco’s switching business and believed that Cisco was facing intensifying
competitive pressures, as well as product-mix issues arising from poorly managed and timed
transitions.
282. On February 17, 2011 Auriga USA analyst Sandeep Shyamsukha reported that
conversations with industry experts suggested that Cisco’s new products like edge routers and
enterprise/data center switches continued to lack key software features and did not provide a
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seamless migration path to the existing customer base and that these product glitches would not be
fixed before 2Q12. On February 22, 2011, thejudagroup, a division of Sanders Morris Harris, Inc.,
reported that the switching product transition was “the broadest upgrade cycle we have seen in Cisco’s
switching business over the last 10 years” with “multiple product introductions across two overlapping
product families and is compounded by rapidly evolving requirements in the datacenter/cloud as well
as increased competition from HP and Juniper.”
283. RBC Capital Markets analyst Mark Sue reported that Cisco resorted to pricing action
to defend market share in key segments and that no meaningful rebound in product gross margins
was expected soon. Canaccord Genuity analyst Paul Mansky reported that material weakness in
product gross margins and the decline in switching revenues were the focus of the call and fueled
preexisting HP competition concerns. Credit Suisse analyst Paul Silverstein highlighted the
“unprecedented” product margin decline, echoing Gelblum by noting that the gross margin had not
been that low for a decade. Silverstein also reported the 4% year-over-year growth was “very
disappointing” and that Juniper’s routing business increased 90%. Wunderlich Securities analyst
Matthew Robison also noted that the product gross margin was a negative surprise and the lowest
reported since 2002. Piper Jaffray & Co. analyst Troy Jensen noted that Cisco was the only
networking company to report sequential revenue declines in a healthy IT spending environment and
was now “clearly losing share in two significant product categories, with switching sales down
sequentially for three consecutive quarters and router sales declining 8.9 percent quarter-over-
quarter.”
284. Channing Smith, managing director of Capital Advisors, reported that the
disappointing revenue and EPS guidance was “a way to cover up that they are facing competition in
their more mature business lines and that they are most likely going to use price as a weapon to hold
market share, and this is going to pressure earnings and margins.”
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F. February 9, 2011: Cisco’s Stock Price Declines 14.2% After Defendants Reveal Additional Problems in the Public Sector, Set-Top Box and Consumer Businesses, Unexpected Declines in Switching Revenues, Disappointing Router Revenues and Declines in Product Gross Margins
285. On February 9, 2011, Cisco issued a press release and held a conference call to report
2Q11 results, during which defendants began to reveal more of the previously concealed problems
with Cisco’s business and acknowledge the falsity of some of their previous statements, particularly
the assurances made during the November 10, 2010 conference call that the problems in the service
provider and public sector businesses were just “air pockets” that Cisco would “power through” and that
Cisco continued to execute well in both core markets and market adjacencies, continued to gain
market share in many products areas and was in great shape for major transitions.
286. Contrary to those assurances, Cisco reported a 7% year-over-year decline (and 11%
sequential decline) in switching revenues, a 1% year-over-year organic increase in routing orders
(i.e. , excluding orders from the Tandberg acquisition), a 7% sequential decline in router revenues,
further declines in cable set-top box orders, a decline in product gross margins and a 15% year-over-
year decline in consumer orders and that the challenges in the public sector business were expected
to worsen. Chambers acknowledged that none of it was a surprise to management, stating that “the
quarter evolved pretty much as we expected.” Calderoni also stated that Cisco’s 2Q11 financial results
“came in as expected.”
287. As alleged above, analysts were surprised and again questioned Chambers and
Calderoni during a contentious conference call. As a result of this unexpected adverse information,
Cisco’s stock price declined 14.2% from $22.04 on February 9, 2011 to $18.92 on February 10, 2011,
compared to a 0.1% increase in the S&P 500 and a 0.5% decline in the peer group. Analysts
attributed the decline to lower switching revenues and gross margins and the expectation that such
declines would continue.
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G. April and May 2011: Defendants Admit Cisco’s Move into Several New Markets Was Not Successful by Revealing that the Company Would Exit Consumer Businesses and Also Admit that the Company’s Organizational Structure Was Not Operating Very Effectively and Needed to Be Overhauled and Simplified
288. Chambers’ admissions of numerous problems to Cisco employees contradicted his
previous positive statements . On April 5, 2011, Cisco released a message Chambers sent to all
Cisco employees the previous day in which Chambers made various statements that contradicted his
previous positive representations. He admitted that: (1) aspects of the Company’s operational
execution were not sound; (2) the Company had been slow to make decisions; (3) employees had
talked to Chambers and made it very clear that Cisco must make it simpler for employees to do their
work; (4) the Company had been surprised where it should not have been; and (5) the Company had
lost the accountability that had been the hallmark of its ability to execute consistently for customers
and shareholders. He stated these problems were unacceptable and that Cisco had disappointed
investors, confused employees and lost credibility. Chambers wrote that Cisco would take bold
steps and make tough decisions to address the problems. He stated that Cisco needed to give
switching customers reasons to buy from Cisco because they were “buying across broader segments”
and because “competitors in this area are fierce.” He also stated that Cisco would “simplify the way we
work and how we focus our attention and resources.”
289. The financial press noted that Chambers’ admissions contradicted his previous
positive representations. Jim Duffy reported that Chambers’ admission that Cisco failed to execute
and had been slow to make decisions was shown by the product transition upheaval in the $15 billion
switching business. He also wrote that some believed the 33% decline in the Company’s stock price
and lackluster financial results over the past two quarters were due to “the ambitious agenda of
targeting 30 or so market adjacencies to stimulate high growth while sales of traditional routers and
switches chugs along at more modest growth due to Cisco’s massive installed base and dominance in
both markets.” Duffy reported that there were calls for Cisco to divest some of the new products it
acquired over the past decade and to refocus on its traditional strengths in routing and switching.
290. The same day, Stacey Higginbotham, a contributing writer for Giga Omni Media,
wrote that Chambers’ memorandum to employees was an admission that Cisco was in trouble, had
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screwed up and had let its eyes stray from the ball. She wrote that Cisco managed to let its market
share come under pressure from incumbent players and upstarts by not staying true to its core
networking focus and letting rivals set the agenda for the next big trend in networking, the idea of
one unified network. She noted that Cisco’s forays over the past few years into the consumer space,
video, telepresence and collaboration areas distracted it from core networking and that telepresence
was not worth the cost and hassle when Skype and Logitech’s LifeSize were cheaper and easier
videoconferencing products.
291. In an article published on April 6, 2011 in The Wall Street Journal discussing
Chambers’ memorandum, it was reported that Chambers “confessed the once highflying technology
company has lost its focus, lacks discipline and needs to overhaul its operations.” It also noted that
Cisco declined to comment beyond the memorandum or make Chambers available. The same day,
PC Magazine provided examples of missteps by Cisco, reporting that no one was buying UMI, the
home videoconferencing product, and that it was probably the grossest miscalculation in Cisco’s
history; that the Flip video recorder was expensive, lacked full HD capture and its still image
abilities did not match the competition; and that Cisco held only a fraction of the data center business
it entered in 2009 and which remained dominated by IBM, HP and Dell.
292. Others in the financial press reported that Chambers should be fired for the problems
he was now belatedly admitting. On April 6, 2011, Dow Jones reported that in a “mea culpa missive
to employees” “perennial cheerleader John Chambers now admits all is not well” and that the
Company’s problems included “[i]ll-judged acquisitions, a byzantine management structure and lost
market share [that] should have seasick Cisco investors asking whether their ship needs a new
captain.” It was also reported in the Dow Jones article that Chambers had “led Cisco so long that he
seems to be repeating mistakes,” including “a chaotic management structure including 59 internal
standing committees” that Chambers devised in 2009; acquisitions of Linksys, Scientific Atlanta and
Pure Digital; and market share declines in the core switching business. The same day, Brad Reese
wrote that Chambers was solely responsible for the problems at Cisco, that his memorandum
“audaciously and shamelessly . . . blames Cisco employees for what ails Cisco” and that Chambers
should be fired.
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293. As alleged above, on April 7, 2011, Chambers spoke at the Wells Fargo Securities
Tech Transformation Summit and admitted that: (1) Cisco introduced 85 new products in the last six
months of 2010; (2) new products “always have lower margins”; (3) it took three to four years before
new product gross margins came back to the levels of the products they replaced; (4) switching was
a challenge and a tough market because competitors with lower overall gross margins could offer
lower prices; (5) Cisco had to “dramatically change [its] speed of decision cycles”; (6) Cisco “did not
execute at the level that [it] needed to transition as a Company”; (7) Cisco would take “very bold steps,”
make “tough decisions on priorities and resources” and “cut back on the number of priorities”; and
(8) investors should expect an accelerated exit from some businesses, changes in operational strategy
and a dramatic reduction in expenses.
294. Cisco’s retreat from consumer businesses demonstrates the falsity of defendants’
previous statements . On April 12, 2011, one week after telling employees there were numerous
problems at Cisco that needed to be fixed, Cisco announced it was closing the Flip video business
and laying off 550 employees, which would result in a restructuring charge of $300 million;
refocusing the home networking business for greater profitability and connection to the Company’s
core networking infrastructure; integrating UMI into the Telepresence product line; and assessing the
core video technology integration of the Eos media solutions business or other market opportunities
for Eos.
295. The financial press again noted that the retreat from the consumer business was an
admission of a mistake but that more needed to be done. Miller Tabak & Co. analyst Alex
Henderson stated that he did not think there was an analyst on the planet who thought Flip was a
good acquisition and that Cisco’s grand vision of being in the consumer’s home network was “not
grounded in reality.” MarketWatch reported the announcement reflected a significant retreat from the
consumer market amid criticism that it had overreached in an expansion bid. CNET reported that it
reflected the view that Cisco needed to do something drastic to show Wall Street it was getting back
on track after it moved into new markets and lost market share in its core businesses. It also reported
that Cisco’s consumer strategy had largely been one failure after another, including the Linksys
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Home Audio system and UMI, which were priced too highly, and Flip, whose share of the video
recorder market had declined from 26% in 2009 to 17%.
296. Deutsche Bank analyst Brian Modoff wrote in an April 12, 2011 report that the moves
were positive but that Cisco still needed to address fundamental and structural issues around
achieving stability in its campus and data center switching businesses and develop a realistic strategy
to defend its low- and mid-range switching products from price competition from HP and
sophisticated data center plays, such as Juniper’s Qfabric, and a simplified management structure.
297. Cisco’s announcement of significant changes to its operations and organizational
structure is another admission that defendants’ previous statements were false . On May 5, 2011,
one month after Chambers admitted to employees that aspects of operational execution were not
sound, that the Company had been slow to make decisions, that employees had told him that Cisco
needed to make it simpler for them to do their work and that Cisco needed to “simplify the way we
work and how we focus our resources,” Cisco announced “significant changes to its business structure
and operations.” It reported that the Company would streamline sales, services and engineering
organizations as it focused on five areas driving the growth of networks and the internet.
298. Chambers stated that Cisco would make “transformational change[s],” including:
(1) organizing worldwide field operations into three geographic regions to drive faster decision
making with greater accountability; (2) organizing Cisco services around key customer segments and
delivery models in alignment with field operations; (3) organizing Cisco engineering functionally to
drive technology innovation, accountability and alignment across all five Company priority areas;
and (4) refining its cross-functional council structure to three councils that reinforce consistent and
globally aligned customer focus and speed to market across major areas of the business.
299. The financial press noted that the announcement contradicted defendants’ previous
representations that the Company’s organization structure was operating very effectively. Dow Jones
reported on May 5, 2011 that Cisco was switching to a “‘streamlined operating model,’ as the
struggling networking giant looks to refocus operations and simplify its oft-criticized management
structure” and after the “company has struggled to expand beyond its core business of routers and
switches, focusing attention in as many as 30 different directions.” In a May 7, 2011 article,
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Bloomberg reported that Cisco was “overhauling a management structure that investors and former
employees say slowed decisions, fuelled market-share losses and led to an exodus of senior
executives.” Robert Ackerman, founder of venture firm Allegis Capital, was quoted in the article as
stating that Cisco’s culture frustrated talented people, who felt like they were beating their heads
against the wall. It was also reported that former employees and others said the organizational
structure of councils and boards slowed decision making and left managers without full control.
300. On May 9, 2011, Dow Jones reported that the admissions of problems and changes
contradicted defendants’ previous positive statements and that the stark contrast was as hard to
explain as a Middle East dictator who overnight opted for democracy.
As we have been learning right across the Middle East these last few months, the core problem for a dictator who overnight opts for democracy is to explain what on earth he was up to during the previous decades when he was apparently castigating anybody who disagreed with him, confiscating their assets and putting them in anonymous Swiss bank accounts, and lying through his teeth about pretty well everything. Most people would accept that it is not inherently illogical for a bank manager to switch to becoming a plumber or a senator to transform himself into a painter and decorator, even though those transitions might appear a little odd.
On the other hand, overnight moral, intellectual and political conversions are quite another matter and rather more difficult to make sense of. John Chambers’ almost overnight translation from someone who talked endlessly about the superiority of his company and its staff and business methods, thought Cisco could grow at 12-17% each year when all statistical evidence was against him, spent over $60 billion of shareholders money seemingly to no purpose, and thought he had invested the greatest decentralised management system of all time, into a modest, practical manager ready to behave like a normal executive, does take some getting used to.
301. In another May 9, 2011 article, Reuters reported that it would take more than a quick
reorganization for Chambers to turn Cisco around and that Chambers had put his job on the line the
previous month when he admitted the Company had lost its way as it spent heavily to expand into
dozens of new markets. Reuters also reported that more changes were in the works and that Wall
Street analysts would grill Chambers during the May 11, 2011 conference call when Cisco reported
3Q11 results. Reuters noted that expectations were low because the Company had disappointed for
the past three quarters and that analysts wanted to hear how Chambers intended to revive the bread-
and-butter business of selling the plumbing of the internet and corporate networks after reporting
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declines in switching revenues and product gross margins. Reuters noted that competition and
customers switching to multivendor networks contributed to the decline.
302. Other reports pointed to Chambers’ admission that Cisco had “lost its way following a
series of disappointing results” and questioned whether the recently announced changes in the
bureaucratic management structure would be enough for the Company to reclaim the market position
it had had just a few years earlier. Wunderlich Securities analyst Matthew Robison reported that he
did not expect Cisco to deliver jarring news. Sterne Agee reported that the quarter appeared to be on
track, and Deutsche Bank reported that it expected results better than many feared.
H. May 11, 2011: Cisco’s Stock Price Declines 4.8% after the Company Reports Additional Problems with the Switching and Consumer Businesses and Plans to Reduce Expenses by $1 Billion; Chambers Reiterates that Cisco Will Streamline the Organization and Overhaul Its Business Model Dramatically
303. Despite the low expectations, on May 11, 2011, Cisco again disclosed unexpected
negative news that revealed more of the Company’s true financial condition. Cisco disclosed a 9%
year-over-year decline in switching revenues, a 49% year-over-year decline in product orders in the
consumer segment and an 8% year-over-year decline in public -sector orders. The Company also
reported that 4Q11 “will continue to show weakness” and that revenues were only expected to grow
2% year-over-year, below Cisco’s previous 8% to 11% forecast. Regarding Cisco’s 12% to 17%
annual growth target, Chambers said, “we clearly are taking 12% to 17% off the table.”
304. Chambers stated that Cisco was a very strong company in a healthy market but
acknowledged “a few problematic areas” Cisco was “taking comprehensive action to address,” including
“simplifying actions” and “focus[ing] on our organization and operating model.” He reiterated the May
5, 2011 announcement that Cisco was “streamlining our organization and overhauling our business
model dramatically.” He announced that Cisco would reduce expenses by $1 billion and divest or
exit underperforming businesses. He assured investors that Cisco was “moving quickly and will
continue to implement our action plan to fix what is broken and solidify our foundation for the
future.” He said that 4Q11 “will continue to show weakness, while we do the hard work behind the
scenes to be able to execute these changes.”
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305. Chambers acknowledged problems, stating, “we have had several areas of our business
come under pressure – consumer, traditional set-top box, switching and our public-sector customer
segment.” Regarding the switching market, Chambers admitted that competition and cannibalization
negatively impacted revenues and gross margins:
The switching market is in the midst of a significant transition. Across the industry, prices at each speed have been driving down price per port, along with significant transitions from 1G to 10G where we are at the forefront of this innovation. This is good for our customers as it will enable faster and more efficient infrastructure long-term and will enable even faster adaptation of cloud-based solutions.
As we have said previously, in the short term, this has placed pressure on our revenue opportunities across the market as customers have begun to adopt these new technologies. Specific to Cisco, our gross margins have come under pressure due to the transition of our own products at the high end of our switching portfolio as customers adopt the Nexus 7K.
306. Chambers also revealed that modular switching orders declined 10% and
acknowledged Cisco had some “share challenges in a few areas.”
307. Chambers also reported continued problems in the public sector segment, stating that:
(a) Cisco was “seeing a broad focus on cost reductions and public spending in almost every developed
market around the world”; (b) Cisco was “in almost every sector of government, every category of
public sector, and with the vast majority of our business being new every quarter, we tend to
experience challenges and opportunities quicker than others”; (c) “routing and switching represent
[the] largest market share in this segment”; and (d) order growth had declined from 30% to 8%.
308. As a result of this unexpected adverse information, Cisco’s stock price declined 4.8%
from $17.78 on May 11, 2011 to $16.93 on May 12, 2011, compared to a 0.5% increase in the S&P
500 and a 0.6% decline in the peer group.
309. MarketWatch reported that investors “heard a different tone from the usually exuberant
Chambers, one that was more grounded in the Company’s new reality” of losing market share in its
core routing and switching business to rivals like HP and Juniper. MarketWatch reported that
Chambers’ admission that Cisco was having some “share challenges” was his “first official
acknowledgement of that new reality,” as was his statement that Cisco was no longer expecting
annual revenue growth of 12% to 17%. MarketWatch also reported that the plan to slash expenses
by $1 billion was Cisco’s “strongest signal yet that the party was over.” Dow Jones reported that
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Chambers acknowledged that the switching business continued to face challenges, with competitors
like HP and Huawei hitting the Company hard on price. Deutsche Bank analyst Brian Modoff
reported that he was “struck by the highly cautious tone” of the call, which focused on the switching
business and the revenue and margin declines caused by competition and cannibalization. He
reported that Cisco highlighted three areas of concern – the consumer business, the public sector
business and the switching business.
310. Evercore Partners analyst Alkesh Shah reported that Chambers stressed Cisco would
lower its cost base to address the competitive challenges in switching, reduce expenses by $1 billion
and move away from the consumer business. William Blair analyst Jason Adler reported that the
focus of the call was on the plan to fix problems in the switching, consumer and public sector
businesses and that management stated gross margins on Nexus 7000 switches were 18% lower than
Catalyst switches. Barclays Capital analyst, Jeff Kvaal, warned that it could take years for Cisco to
reverse recent declines in profit margins that were once the envy of the industry. Gleacher & Co.
reported that Cisco was “a tanker ship that will require multiple quarters to fix its long term financial
model.”
311. The same day that Chambers acknowledged Cisco was losing market share to HP and
Juniper, Dave Donatelli, HP’s EVP and GM for networking products, called Cisco out for its lack of
innovation, echoing the findings in the Gartner report that a single-vendor network was not the best
way to go. He said Cisco’s legacy network was at the breaking point and that its management tools
were a“joke”and“just crap.” Subhodeep Bhattacharya (“Bhattacharya”), HP’s Director of Networking,
said that Cisco’s market share declined 3.8% in 3Q11, while HP’s increased 2.3%. Bhattacharya
explained that Cisco had failed to integrate its acquisitions and HP offered solutions at lower prices.
312. In addition to the critical reports issued by numerous analysts, many others criticized
Chambers after Cisco reported 3Q11 results on May 11, 2011. In a May 13, 2011 article titled “The
Truth About Cisco: John Chambers Has Failed,” Henry Blodget wrote that Chambers’ growth and
diversification by acquisition strategy had failed and that the Company’s decision to abandon the
byzantine and bureaucratic management structure confirmed that structure was also a failure, that
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Chambers had lost his mind, as Blodget had reported two years earlier, and that Chambers should be
fired:
For more than a decade, John Chambers has failed.
Chambers’ shareholder-value-creation strategy has failed. His growth strategy has failed. His management structure has failed. And the result is that Cisco’s stock has been dead in the water for more than a decade, even when measured from the bottom of the NASDAQ bust.
Ten years is a long time – plenty of time to evaluate a CEO’s performance. And based on Chambers’ performance, as Cisco begins its latest re-organization and rebuilding, it’s time for Cisco’s board to seriously consider giving John Chambers his walking papers.
313. After Cisco hosted several webinars on June 7, 2011 to introduce several new edge-
routing platforms, Jefferies analyst George Notter reported that Cisco was still roughly two years
behind Juniper and Alcatel-Lucent in the edge-routing space. One week later, RBC Capital Markets
analyst Mark Sue downgraded the Company and reported that Cisco was preoccupied with
reorganization and restructuring but not on reclaiming lost market share, expanding product
development and improving its financial model. He wrote that the root cause of many of the
challenges facing Cisco were driving towards an unrealistic growth target of 12% to 17%, assuming
a layered bureaucratic structure and moving into the entrenched server market.
314. On June 20, 2011, Sterne Agee analyst Shaw Wu issued a report in which he wrote
that Cisco needed to take more dramatic steps to turn the Company around, that its switch prices
were too high given the competition and that Cisco would therefore likely have to take the bitter
medicine of lower gross margin for the longer-term good. One week later, Auriga USA analyst
Sandeep Shyamsukha issued a report reducing the Company’s stock price target from $19 to $16 per
share because Auriga USA expected additional growth and margin pressures from commoditization
trends in switching and intensifying competition in routing. The same day, a Cowen & Co. analyst
downgraded Cisco for the same reasons and because of uncertainty about how Cisco would
restructure. The thejudagroup reported that Cisco was likely to report a significant restructuring in
July that would include a 5% to 10% headcount reduction and exiting several additional market
adjacencies.
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315. On June 27, 2011, TheStreet.com reported that consumer advocate and Cisco
shareholder Ralph Nader had launched an attack on Cisco and Chambers, demanding that the
Company pay a special $1 per share dividend and increase its annual dividend from $0.24 to as
much as $0.50 per share. In a June 13, 2011 letter to Chambers, Nader wrote that Cisco’s
management was oblivious to building or maintaining shareholder value and that the Company could
easily pay the special $1 per share dividend because there were 5.5 billion shares outstanding and the
Company was sitting on $43.5 billion of cash.
316. On July 1, 2011, Nader published an update for upset Cisco shareholders, in which he
wrote that many shareholders had written him and were properly critical of top Cisco management
and often urged that Chambers and the Board be replaced. He noted the e-mails “provided
documentation signifying that a shareholder revolt will focus on the details of mismanagement; and
executive self-enrichment that fostered this climate of leaving the shareholders behind.” He
concluded the update by writing that top management had turned the wide-open business judgment
rule into an anti-shareholder force field and had to realize that that the trove of money was not theirs
but the shareholders’.
I. July 18, 2011: Cisco Announces that 11,500 Employees Will Be Laid Off as Part of Its Continued Implementation of a Comprehensive Action Plan to Simplify the Organization, Refine Operations and Reduce Expenses
317. On July 11, 2011, Bloomberg and other news outlets reported that Cisco was gearing
up to announce layoffs that could eliminate 5,000 employees and that the Company’s 5,000-employee
set-top box manufacturing facility in Juarez, Mexico was for sale. During the Company’s annual
Cisco Live! convention on July 12, 2011, Chambers did not provide any information about layoffs or
divestitures but did admit numerous problems. He said that he was overhauling the Company to
make it more agile and responsive to consumers and admitted that there were areas in which the
Company must do better, that Cisco was too complex and lost focus as it expanded into numerous
other tech markets and that the sales and engineering groups were pretty top-heavy.
318. The financial press again noted that Chambers had admitted problems that
contradicted his statements during the Class Period and appeared to be ready to address them.
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Seeking Alpha ’s Cameron Kaine, who recently called for Chambers’ resignation, reported on July 13,
2011 that Chambers’ promise to decisively streamline Cisco’s operations and speed up decision
making was an admission of what many had been saying all along – that “it was time to cut the fat.”
The next day, Sterne Agee analyst Shaw Wu reported that layoffs were a necessary step for Cisco to
right-size its cost structure to be more competitive with pricing in the market, particularly the
switching market. On July 15, 2011, Network World ’s Jim Duffy reported that “Chambers’ keynote
was almost contrite in tone as he sought to reassure customers that Cisco will come through its
current challenges stronger and more resolute – in every aspect of the company.”
319. On July 18, 2011, Cisco announced that it would reduce its workforce by
approximately 6,500 employees or 9%, and recognize a restructuring charge of $1.3 billion, as part
of its continued implementation of a comprehensive action plan to simplify the organization, refine
operations and reduce annual operating expenses. It also announced that it was selling the set-top
box manufacturing facility in Juarez, Mexico that would reduce the work force by another 5,000
employees.
320. Analysts applauded the move but also noted that more needed to be done, particularly
as it related to the core switching and router technologies, where Cisco revenues, market share and
gross margins had declined while defendants repeatedly and falsely told investors that Cisco was
maintaining revenue and market share growth while expanding into 30+ market adjacencies. In a
July 18, 2011 report, Deutsche Bank analyst Brian Modoff wrote that the layoffs were a step in the
right direction, particularly the large number of managerial jobs that were cut, but contributed little
to Cisco’s larger problems of sustainably growing revenues, exiting underperforming product areas
and surgically refocusing the business. Similarly, J.P. Morgan analyst Rod Hall reported that J.P.
Morgan remained concerned that the larger problems for the Company related to revenue pressure in
enterprise switching driven by competition, as well as share losses in edge routing.
321. Enderle Group analyst Rob Enderle reported that “Cisco won’t pull out of this by laying
off thousands, because getting better requires making better decisions.” He noted that Cisco’s
problems were “go[ing] to war with one of their larger partners, HP, and HP came back at them hard,
taking margin and share in the process,” and making “some horrible mistakes in the consumer market.”
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On July 21, 2011, Stephen D. Simpson, CFA reported that investors should not get too excited about
the layoffs because they did not address the Company’s significant competitive deficiencies, noting
that the once pioneering Cisco was now “the entrenched old warhorse that others target for market
share gains.”
J. August 10, 2011: Defendants Report that the Switching Business Is Still Under Pressure Due to Increased Competition and Cisco’s Rapid Introduction of New Products and that Cisco Was Still Simplifying the Organization to Accelerate the Speed of Decision Making
322. In August 2011, before Cisco reported 4Q11 and FY11 results, analysts reported that
they expected the Company to report results in line with guidance but, as RBC Capital Markets
analyst Mark Sue reported on August 1, 2011, that things were “still under disarray internally as
Cisco works to stem [market share] loss and reorganize, while laying off employees by the
thousands.” Others, like Cowen & Co. analyst John Marchetti, reported that items to watch included
additional information on the restructuring, headcount reductions, outlook for the remaining
consumer businesses and progress on product transitions, especially switching. In fact, Jefferies
analyst George Notter reported on August 8, 2011 that it expected the Company’s restructuring
efforts to be the major focus for investors.
323. The day before Cisco reported 4Q11 and FY11 results, The Business Insider quoted
Gleacher & Co. analyst Brian Marshall, who reported that Cisco “largely has itself to blame for its
current woes” and was “a victim of its own doing [by] focusing on non-core businesses like consumer,
and migrating off the path which made the company a tech bellwether such as innovative switching
and routing products.” The article emphasized the Company’s late recognition of the rapid shift to
lower-cost switches for the Company’s problems, which defendants revealed in February 2011 and
afterward resulted in Cisco’s introduction of 85 new products with lower prices and lower margins
that they knew would cannibalize sales of higher-priced and higher-margin products:
Given the way the market was saturated with its networking gear, it was smart of Cisco to seek out fresh sources of revenue. Less forgivable, however, is Cisco’s apparent blind-siding by the market’s rapid shift towards lower-pricing switches; switching accounts for almost a third of its overall revenue, and Cisco prides itself on exploiting major market transitions. If the company had paid more attention to switching – and less to consumer products – analysts say it would be in a much more favorable position today.
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324. The article also reported that 65% of TheStreet’s readers said that Chambers should
step down from the Company because he was instrumental in Cisco’s expansion into alternative
markets.
325. When Cisco reported 4Q11 and FY11 results on August 10, 2011, Chambers and
Calderoni revealed additional information contradicting their Class Period statements that Cisco was
successfully diversifying into 30+ market adjacencies while maintaining revenue and market share
growth in routing and switching and that the Company’s organizational structure was operating very
effectively. The Company reported a 4% year-over-year decline in switching revenues, a 3% year-
over-year decline in router revenues (and a 7% quarter-over-quarter decline in router revenues) and
another decline in product gross margins to 61.2%. Chambers stated that the switching business was
still under pressure, with declines in average selling prices and gross margins caused by increased
competition and the “rapid introduction by Cisco of new products almost across the board,” including
“the largest switching portfolio refresh in our history.”
326. Chambers reported that, since the last earnings call, Cisco had “moved very rapidly on
our plan to simplify operations and focus on our operating model and align our investments . . . to
reinforce our ability to execute on our strategy.” He stated that Cisco was “simplifying and focusing
our organization and operating model” by “reorganiz[ing] our sales, engineering, services and
operations organization, providing clear line of sight, accountability, accelerating the speed of
decisions, driving toward major improvements in productivity, and driving innovation at a faster
pace.” He also said that the Company had aligned its cost structure given the transitions in the
marketplace and was well into the implementation of reducing operating expenses by $1 billion.
327. Chambers said that Cisco was divesting, cutting back or exiting underperforming
operations and had made changes across engineering to create simplified organizational structures
that allowed for faster innovation and simplicity in the decision process. He stated that Cisco would
continue to accelerate and drive through the simplification process at an even faster pace and that the
changes made and to be made were dramatic and would continue for several years.
328. COO Gary Moore stated that Cisco had taken “swift action designed to simplify the
operating models of the Company within each organization . . . sharply reduced our boards and
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counsels and appointed clear and accountable leadership” and “chang[ed] our processes to reduce
duplication and increase our execution speed.”
K. September 13, 2011: Defendants Admit that Cisco’s Organization Structure Was “Fat” During the Class Period and that It “Slowed Decision Making Down” and Caused the Company to “Get Away from the Basics”
329. A month later, at Cisco’s September 13, 2011 Annual Financial Analyst conference,
Chambers, Calderoni and other Cisco executives made statements that contradicted the positive
statements defendants made during the Class Period. Chambers and Calderoni slashed annual
revenue growth from the 12% to 17% represented for most of the Class Period to 5% to 7% for the
next three years, including just 2% to 4% growth in the switching business and 5% to 7% in the
router business. Chambers acknowledged competition from HP in the switching business and
Huawei in the routing business, stating that Huawei was “a very tough long-term competitor.”
330. Chambers said that Cisco was in the third stage of “development simplification” and
that the Company “need[ed] to have consistency in innovation, consistency in operations.” He
admitted that Cisco was “fat” with “an extra 4 or 5 inches around the waistline” during the Class Period
and that it “slowed decision making down” and caused Cisco to “[get] away from the basics.” Chambers
provided examples, stating that there were “multiple engineering functions, multiple operating system
functions, multiple groups actually competing with each other on switching and routing” that had
recently been combined. He stated that the 23,000-person sales force had been “realigned completely,”
with 90% rather than 70% now in the field, and that 12,700 people had exited the Company.
331. COO Gary Moore also stated that Cisco had “gained a few inches around the waist,”
had “become fairly complex relative to allowing people to actually work with one another – get
decisions made quickly; respond to customers” and was “losing in the marketplace because of that
complexity.” He stated that Cisco had exited ten businesses, reduced its investment in six others and
reduced the time it took to approve some deals by 70%.
332. Calderoni stated that growth of switching revenues was “flat” in FY11 primarily
because of the switching product transition, “especially earlier in the year.” As he and Chambers
admitted previously, Calderoni said that gross margins declined because “pretty much the entire
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portfolio in our switching market was going through a refresh” and because of “more competition,
especially as you look at Asia and the emerging markets” in the router market. He also stated that
gross margins would continue to be in the 60% to 62% range in FY12, further demonstrating the fact
that it took two to three years for gross margins to recover on new products. He stated that the
slashed annual revenue growth guidance of 5% to 7% reflected “realistic goals that we can achieve.”
VI. SUMMARY OF CHAMBERS’ INSIDER SELLING
333. As shown in the following table, at the time defendants misled investors about the
state of Cisco’s business, Chambers sold 5,515,451 shares of Cisco stock for $134 million.
Date Shares
Sold Price Proceeds 2/8/10 2,200,000 $23.73 $52,206,000 3/5/10 1,800,000 $25.00 $45,000,000 5/17/10 1,250,000 $24.61 $30,762,500 5/18/10 22,273 $25.00 $556,825 8/18/10 243,178 $22.50 $5,471,505 Total 5,515,451 $133,996,830
334. Chambers’ sales constituted 83% of the Cisco shares he owned and 35% of his shares
and vested options. The sales were at prices that were substantially higher than the $16.93 price to
which the stock declined on May 12, 2011, the day after the end of the Class Period.
335. Chambers’ sales were also suspiciously and dramatically higher than his sales before
the Class Period. The 5.5 million shares sold during the Class Period was more than 11 times the
500,000 shares he sold before the Class Period, and the $134 million of proceeds was almost 12
times the $11.4 million Chambers received from his pre-Class Period sales.
336. The timing of the sales was particularly suspicious. The 4 million shares sold on
February 8, 2010 and March 5, 2010 occurred shortly after Cisco’s February 3, 2010 2Q10 earnings
release and conference call, during which Chambers made numerous positive – but false – statements
about Cisco’s business, including that Cisco was able to “catch market transitions and move into new
market adjacencies . . . while still maintaining revenue growth and market share gains in . . .
traditional areas” and that the Company’s “new organization structure of councils, boards and working
groups . . . [was] operating very effectively.” Moreover, the earliest expiration dates for the options
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Chambers exercised and sold were May 14, 2010 and August 21, 2010. If Chambers really believed
his statements, then he would not have sold the shares.
337. The sale of 1.27 million shares on May 17, 2010 and May 18, 2010 occurred just days
after Cisco’s May 12, 2010 earnings release and conference call, during which Chambers claimed
that “our game plan for handling the economic downturns hit on all cylinders. Q3 results are the
proof points and was, in my opinion, the strongest across the board quarter in our history.”
338. In March and May 2010, Brad Reese, a market participant who reports on Cisco,
wrote that Chambers’ sales were “curious” and demonstrated “perfect timing” because the options
Chambers exercised did not expire for months, and the sales occurred when it appeared the
Company’s stock price had peaked and as Chambers was boasting that Cisco’s game plan was “hitting
on all cylinders.”
339. On November 11, 2010, Michael Shedlock from Mish’s Global Economic Trend
Analysis wrote that Chambers’ sales, and sales by other insiders, showed that the insiders “bailed hand
over fist” and, unlike investors, were not surprised by the adverse news reported by Cisco on
November 10, 2010. He also reported that the insider sales, Cisco’s repurchase of 1.6 billion shares
for $38 billion in the five years ending July 2010 and the failure to pay dividends despite $40 billion
of cash allowed management to “pretend it [was] increasing shareholder value while corporate
insiders [got] to dump massive numbers of shares” and was “nothing more than shareholder rape.” On
February 9, 2011, after Cisco reported unexpected declines in switching revenues, consumer
revenues and product gross margins, disappointing router revenues and additional problems in the
public sector and set-top box businesses, Shedlock again reported that Chambers sold 5.5 million
shares for $134 million since February 2010 and that “Chambers has not done a damn thing for
shareholders for 10 years, cashing out hundreds of millions of dollars along the way. From the
perspective of a shareholder of a publicly traded company, Chambers is not worth a damn cent.”
340. It was reported in the Forms 4 filed by Chambers with the SEC that the sales were
made pursuant to a 10b5-1 trading plan adopted on June 16, 2008. But the plan did not establish
regular sales of the Cisco stock Chambers owned. Rather, the plan stated that between November
2008 and January 2011, Chambers could sell: (a) up to six million shares acquired via stock options
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granted in 2001 and 2002 and set to expire between May 2010 and January 2011; and (b) up to 1.2
million shares from other shareholdings.
341. Business Week reported that regulators are trying to determine whether 10b5-1 plans
are being used by corporate executives to circumvent insider-trading rules, that research shows
trades by 10b5-1 plans have beaten the market and that they are more likely to happen before, rather
than after, price declines. All of Chambers’ sales happened before, rather than after, Cisco’s stock
price declined.
VII. LOSS CAUSATION
342. As detailed above, defendants’ materially false and misleading statements and
omissions caused Cisco’s stock to trade at artificially inflated prices and operated as a fraud and
deceit on Class Period purchasers of Cisco’s securities. From February 3, 2010 to November 9, 2010,
Cisco’s stock price traded between $20 and $28 per share as defendants made false positive
statements about Cisco’s business and concealed the problems with the consumer business, the
decline in sales, market share and gross margins in the switching and router business, the decline in
demand for cable set-top boxes and huge price discounts that masked the decline and the problems in
the public sector segment. The Company’s stock price closed at $24.35 on November 9, 2010. On
November 10, 2010, Cisco began to reveal some of the previously concealed adverse facts and
revealed additional adverse facts on February 9, 2011 and May 11, 2011. As a result, Cisco’s stock
price declined 39% from its Class Period high of $27.57 to $16.93 as the artificial inflation was
removed from the Company’s stock price. Class members who purchased Cisco stock during the
Class Period suffered economic loss, i.e. , damages, under the federal securities law.
343. After defendants made false positive statements about Cisco on February 3, 2010, the
Company’s stock price increased $0.63 or 2.7% from $23.07 on February 3, 2010 to $23.70 on
February 5, 2010. By comparison, the S&P 500 declined 2.8%, and the S&P Information
Technology index declined 1.8%.
344. After Cisco reported its 3Q10 results on May 12, 2010 and defendants continued to
make false and misleading statements about the Company’s business and concealed the problems
alleged above, the price of Cisco’s stock declined 4.5 % from $26.74 on May 12, 2010 to $25.53 on
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May 13, 2010. By comparison, the S&P 500 declined 1.2% and the S&P Information Technology
index declined 1.4%. Analysts attributed the price decline to cautious guidance that reflected
significant slowing of quarter-over-quarter revenue growth, the second consecutive quarter of
declines in the gross margin and questions about price discounts. Cisco’s stock, however, continued
to trade at artificially inflated prices because of defendants false and misleading statements and
omissions about the Company’s business.
345. After Cisco reported its 4Q10 and FY10 results on August 11, 2010, the Company’s
stock price declined 10% from $23.73 on August 11, 2010 to $21.36 on August 12, 2010. By
comparison, the S&P 500 declined 0.5% and the S&P Information Technology index declined 1.7%.
Analysts attributed the decline to Chambers’ comments that Cisco was receiving mixed signals from
customers who were nervous about the wobbly global economy and the Company’s conservative
forecast for 1Q11. Cisco’s stock continued to trade at artificially inflated levels due to the false and
misleading statements made by defendants during the August 11, 2010 conference call and the
continued concealment of the problems with the Company’s business.
346. On November 10, 2010, Cisco reported its 1Q11 results and revealed some of the
previously concealed information including the decline in cable set-top box orders and public sector
orders. Reuters reported that investors were stunned by this unexpected negative news and the
Company’s stock price declined 16.2% from $24.49 on November 10, 2010 to $20.52 on November
11, 2010. By comparison, the S&P 500 declined 0.4% and the S&P Information Technology index
declined 1.8%. Cisco’s stock price continued to trade at artificially inflated prices because
defendants continued to conceal adverse information about the magnitude of the problems in the
cable set-top box business, problems in the switching and router business, and problems in the
consumer business. Indeed, they assured investors the problems were short term air pockets that
Cisco would power through and that Cisco was not losing ground to rivals in the switching and
router business.
347. On February 9, 2011, however, Cisco reported 2Q11 results and revealed more of the
previously concealed information, including lost ground to rivals in the switching and router
business. Cisco reported sequential declines in switching and router revenues, declines in product
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gross margins to levels not seen in more than ten years, further declines in cable set-top box orders, a
15% year-over-year decline in consumer orders and that the challenges in the public sector business
were expected to worsen. In response to this unexpected negative news, the Company’s stock price
declined 14.2% from $22.04 on February 9, 2011 to $18.92 on February 10, 2011. By comparison,
the S&P 500 increased 0.1% and the S&P Information Technology index declined 0.5%.
348. On May 11, 2011, Cisco reported 3Q11 results and revealed more of the previously
concealed information, including year-over-year declines in switching revenues, the Company’s stock
price declined 4.8% from $17.78 on May 11, 2011 to $16.93 on May 12, 2011. By comparison, the
S&P 500 increased 0.5% and the S&P Information Technology index increased 0.6%.
349. The declines in Cisco’s stock price following the partial disclosures compared to the
changes in the S&P 500 and the S&P Information Technology index negates any inference that the
losses suffered by class members were caused by changed market or industry conditions or
Company-specific facts unrelated to the fraudulent conduct.
VIII. CLASS ACTION ALLEGATIONS
350. Plaintiffs bring this action as a class action pursuant to Rule 23 of the Federal Rules
of Civil Procedure on behalf of all persons who purchased Cisco common stock on the open market
during the Class Period and were damaged thereby (the “Class”). Excluded from the Class are
defendants, directors and officers of Cisco and their families and affiliates.
351. The members of the Class are so numerous that joinder of all members is
impracticable. During the Class Period, there were an average of 5.6 billion outstanding shares
owned by thousands of persons and institutions. Thus, the disposition of their claims in a class
action will provide substantial benefits to the parties and the Court.
352. There is a well defined community of interest in the questions of law and fact
involved in this case. Questions of law and fact common to the members of the Class that
predominate over questions which may affect individual Class members include:
(a) Whether the federal securities laws were violated by defendants;
(b) Whether defendants engaged in a fraudulent scheme and omitted and/or
misrepresented material facts;
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(c) Whether defendants’ statements omitted material facts necessary to make the
statements made, in light of the circumstances under which they were made, not misleading;
(d) Whether defendants knew or recklessly disregarded that their statements were
materially false and misleading;
(e) Whether the prices of Cisco common stock were artificially inflated;
(f) Whether defendants’ fraudulent scheme, misrepresentations and omissions
caused Class members to suffer economic losses, i.e. , damages; and
(g) The extent of damages sustained by Class members and the appropriate
measure of damages.
353. Plaintiffs’ claims are typical of those of the Class because plaintiffs and the Class
purchased Cisco common stock during the Class Period and sustained damages from defendants’
wrongful conduct. Plaintiffs will adequately protect the interests of the Class and has retained
counsel who are experienced in class action securities litigation. Plaintiffs have no interests that
conflict with those of the Class.
354. A class action is superior to other available methods for the fair and efficient
adjudication of this controversy. A class action will achieve economies of time, effort and expense
and provide uniformity of decision to the similarly situated members of the Class without sacrificing
procedural fairness or bringing about other undesirable results. Class members have not indicated an
interest in prosecuting separate actions as none have been filed. The number of Class members and
the relatively small amounts at stake for individual Class members make separate suits
impracticable. No difficulties are likely to be encountered in the management of this action as a
class action.
355. In addition, a class action is superior to other methods of fairly and efficiently
adjudicating this controversy because the questions of law and fact common to the Class
predominate over any questions affecting only individual Class members. Although individual Class
members have suffered disparate damages, the fraudulent scheme and the misrepresentations and
omissions causing damages are common to all Class members. Further, there are no individual
issues of reliance that could make this action unsuited for treatment as a class action because all
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Class members relied on the integrity of the market and are entitled to the fraud-on-the-market
presumption of reliance.
356. The market for Cisco’s common stock was open, well developed and efficient at all
relevant times. Cisco’s stock met the requirements for listing, and was listed and actively traded, on
the NASDAQ, a highly efficient and automated market. As a regulated issuer, Cisco filed periodic
public reports with the SEC. Cisco regularly communicated with public investors via established
market communication mechanisms, including through regular disseminations of press releases on
the national circuits of major newswire services and through other wide-ranging public disclosures,
such as communications with the financial press and other similar reporting services.
357. The change in the price of Cisco’s stock – compared to the changes in the peer group
and S&P 500 – in response to the release of unexpected material positive and negative information
about the Company shows there was a cause-and-effect relationship between the public release of
the unexpected information about Cisco and the price movement in the Company’s stock. The
average weekly trading volume of Cisco’s stock during the Class Period was approximately 313
million shares, or 5.6% of the average total outstanding shares. Numerous analysts followed Cisco,
attended the Company’s conference calls and issued reports throughout the Class Period. The
Company was eligible to register securities on Form S-3 during the Class Period. The average
market capitalization of Cisco was $122.2 billion. Institutional investors owned between 3.4 billion
and 4.0 billion of Cisco’s shares or between 60% and 71% of the average total outstanding shares.
The “float” or shares not owned by insiders comprised most of the shares as insiders owned about 4
million shares. The bid/ask spread ranged from zero to $0.02.
358. As a result of the foregoing, the market for Cisco common stock promptly digested
current information regarding Cisco from all publicly available sources and reflected such
information in the Company’s stock price. Under these circumstances, all purchasers of Cisco
common stock during the Class Period suffered similar injury through their purchases of Cisco
common stock at artificially inflated prices and the subsequent revelations concerning declines in
price, and a presumption of reliance applies.
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1 FIRST CLAIM FOR RELIEF
For Violation of Section 10(b) of the Exchange Act and Rule 10b-5 (Against Defendants Cisco, Chambers and Calderoni)
359. Plaintiffs repeat and reallege the above paragraphs as though fully set forth herein.
360. During the Class Period, defendants engaged in a scheme and fraudulent course of
conduct to misrepresent Cisco’s true financial condition; approved or furnished false information
underlying the false statements specified above, which they knew or recklessly disregarded were
misleading in that they contained misrepresentations; and failed to disclose material facts necessary
in order to make the statements made, in light of the circumstances under which they were made, not
misleading.
361. By engaging in the acts, practices and omissions previously alleged, each of the
defendants violated §10(b) of the Exchange Act and Rule 10b-5 by:
(a) employing devices, schemes and artifices to defraud;
(b) making untrue statements of material facts or omitting to state material facts
necessary in order to make the statements made, in light of the circumstances under which they were
made, not misleading; or
(c) engaging in acts, practices and a course of business that operated as a fraud or
deceit upon plaintiffs and others similarly situated in connection with their purchases of Cisco’s
publicly traded securities during the Class Period.
362. During the Class Period, defendants made, disseminated and/or approved each of the
statements specified above.
363. Each of the statements specified above were materially false or misleading at the time
they were made because they contained misrepresentations of fact or failed to disclose material facts
necessary to make the statements not misleading in light of the circumstances in which they were
made.
364. The statutory safe harbor conditionally provided by 15 U.S.C. §78u-5 for certain
forward-looking statements does not apply to any of the statements alleged herein to be materially
false or misleading because:
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(a) the statements were not forward-looking or identified as such when made;
(b) the statements were not accompanied by meaningful cautionary language that
sufficiently identified the specific important factors that could cause actual results to differ
materially from those in the statement; or
(c) the statements were made by defendants with actual knowledge that the
statement was false or misleading.
365. Defendants made, disseminated or approved the statements specified above while
knowing or recklessly disregarding that the statements were false or misleading or omitted to
disclose facts necessary to prevent the statements from misleading investors in light of the
circumstances under which they were made.
366. Plaintiffs and the Class purchased Cisco securities in reliance upon the truth and
accuracy of the statements specified above and the other information that was publicly reported by
defendants about Cisco and its operations and without knowledge of the facts, transactions,
circumstances and conditions fraudulently misrepresented to or concealed from the market during
the Class Period, as specified above.
367. Plaintiffs and the Class have suffered damages because they:
(a) paid artificially inflated prices for Cisco’s publicly traded securities;
(b) purchased Cisco securities on an open, developed and efficient public market;
and
(c) incurred economic loss when the prices of the securities declined as the direct
and proximate result of the public dissemination of information that was inconsistent with
defendants’ prior public statements or otherwise alerted the market to facts, transactions,
circumstances and conditions concealed by defendants’ misrepresentations and omissions or the
economic consequences thereof.
368. Plaintiffs and the Class would not have purchased Cisco’s publicly traded securities at
the prices they paid, or at all, if they had been aware that the market prices had been artificially and
falsely inflated by defendants’ fraudulent conduct and misleading statements.
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1 SECOND CLAIM FOR RELIEF
For Violation of Section 20(a) of the Exchange Act (Against All Defendants)
369. Plaintiffs repeat and reallege the above paragraphs as if fully set forth herein.
370. Defendants and/or persons under their control violated §10(b) of the Exchange Act
and Rule 10b-5 by their acts and omissions described above, causing economic injury to plaintiffs
and other members of the Class.
371. By virtue of their positions as controlling persons, defendants are each liable pursuant
to §20(a) of the Exchange Act for the acts and omissions of their co-defendants in violation of the
Exchange Act.
372. Each of the defendants acted as a controlling person of some or all of their co-
defendants, as set forth below, because they each had the capacity to control, or did actually exert
control, over the actions of their co-defendants in violation of the federal securities laws.
373. Chambers controlled Calderoni and Cisco through his position of power and control
and his responsibilities as Cisco’s Chairman and CEO; his power to hire and fire and his supervisory
authority over Calderoni and other members of Cisco’s senior management; his power and
responsibility to manage the day-to-day operations of Cisco, including those relating to growth and
diversification strategy pursued by Cisco; and his ability to control the contents of Cisco’s press
releases, conference calls, SEC filings and other public statements.
374. Calderoni controlled Cisco through his position of power and control and his
responsibilities as Cisco’s CFO; his power to hire and fire and his supervisory authority over other
members of Cisco’s senior management; his power and responsibility to manage the day-to-day
operations of Cisco, including those relating to growth and diversification strategy pursued by Cisco;
and his ability to control the contents of Cisco’s press releases, conference calls, SEC filings and
other public statements.
375. The Company had the power to control and influence Chambers and Calderoni by
virtue of its power to hire, fire, supervise and otherwise control the actions of its employees,
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including Chambers and Calderoni, and the salaries, bonuses, incentive compensation and other
employment consideration and arrangements provided to them.
376. Each of the Individual Defendants had direct and supervisory involvement in the day-
to-day operations of Cisco and, therefore, is presumed to have had the power to, and did , control or
influence the business practices or conditions giving rise to the securities violations alleged herein
and the content of the statements that misled investors about those conditions and practices as
alleged above. By virtue of their high-level executive positions, ownership of and contractual rights
with Cisco, participation in or awareness of the Company’s operations and intimate knowledge of the
matters discussed in the public statements filed by the Company with the SEC and disseminated to
the investing public, defendants had the power to influence and control, and did influence and
control, directly or indirectly, the decision making of the Company, including the content and
dissemination of the false and misleading statements alleged above.
IX. PRAYER FOR RELIEF
WHEREFORE, plaintiffs pray for judgment as follows:
A. Declaring this action to be a proper class action pursuant to Rule 23;
B. Awarding plaintiffs and the members of the Class damages, interest and costs; and
C. Awarding such other relief as the Court may deem just and proper.
X. JURY DEMAND
Plaintiffs demand a trial by jury.
DATED: December 2, 2011 ROBBINS GELLER RUDMAN & DOWD LLP
CHRISTOPHER P. SEEFER
/s/Christopher P. Seefer CHRISTOPHER P. SEEFER
Post Montgomery Center One Montgomery Street, Suite 1800 San Francisco, CA 94104 Telephone: 415/288-4545 415/288-4534 (fax)
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ROBBINS GELLER RUDMAN & DOWD LLP
SAMUEL H. RUDMAN 58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631/367-7100 631/367-1173 (fax)
ROBBINS GELLER RUDMAN & DOWD LLP
MAUREEN E. MUELLER 655 West Broadway, Suite 1900 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax)
Lead Counsel for Plaintiffs
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1 CERTIFICATE OF SERVICE
I hereby certify that on December 2, 2011, I authorized the electronic filing of the foregoing
with the Clerk of the Court using the CM/ECF system which will send notification of such filing to
the e-mail addresses denoted on the attached Electronic Mail Notice List, and I hereby certify that I
caused to be mailed the foregoing document or paper via the United States Postal Service to the non-
CM/ECF participants indicated on the attached Manual Notice List.
I further certify that I caused this document to be forwarded to the following Designated
Internet Site at: http://securities.stanford.edu .
I certify under penalty of perjury under the laws of the United States of America that the
foregoing is true and correct. Executed on December 2, 2011.
/s/Christopher P. Seefer CHRISTOPHER P. SEEFER
ROBBINS GELLER RUDMAN & DOWD LLP
Post Montgomery Center One Montgomery Street, Suite 1800 San Francisco, CA 94104 Telephone: 415/288-4545 415/288-4534 (fax) E-mail: [email protected]
CONSOLIDATED COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS – C 11-1568-SBA
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