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Thomson Reuters StreetEvents Event Transcript
E D I T E D V E R S I O N

Q3 2018 Cisco Systems Inc Earnings Call
MAY 16, 2018 / 8:30PM GMT

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Corporate Participants
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* Marilyn Mora
Cisco Systems, Inc. - Director of Global IR
* Charles H. Robbins
Cisco Systems, Inc. - Chairman & CEO
* Kelly A. Kramer
Cisco Systems, Inc. - Executive VP & CFO

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Conference Call Participiants
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* Paul Jonas Silverstein
Cowen and Company, LLC, Research Division - MD and Senior Research Analyst
* Srinivas Reddy Pajjuri
Macquarie Research - Senior Analyst
* Mark Alan Moskowitz
Barclays Bank PLC, Research Division - Director
* Roderick B. Hall
Goldman Sachs Group Inc., Research Division - Equity Analyst
* Vijay Krishna Bhagavath
Deutsche Bank AG, Research Division - VP and Research Analyst
* Jeffrey Thomas Kvaal
Nomura Securities Co. Ltd., Research Division - MD
* Pierre C. Ferragu
New Street Research LLP - Global Team Head of Technology Infrastructure
* Jim Suva
Citigroup Inc, Research Division - Director
* Mitchell Toshiro Steves
RBC Capital Markets, LLC, Research Division - Analyst
* George Charles Notter
Jefferies LLC, Research Division - MD & Equity Research Analyst
* Tal Liani
BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector
* James Eugene Faucette
Morgan Stanley, Research Division - Executive Director
* Ittai Kidron
Oppenheimer & Co. Inc., Research Division - MD

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Presentation
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Operator [1]
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Welcome to Cisco's Third Quarter Fiscal Year 2018 Financial Results Conference Call. At the request of Cisco Systems, today's conference is being recorded. If you have any objections, you may disconnect.
Now I would like to introduce Marilyn Mora, Head of Investor Relations. Thank you. You may begin.

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Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [2]
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Thanks, Michelle. Welcome, everyone, to Cisco's Third Quarter Fiscal 2018 Quarterly Earnings Conference Call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO.
By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statement and other financial information can also be found in the Financial Information section of our Investor Relations website.
Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis, unless stated otherwise.
The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the fourth quarter of fiscal 2018. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Form 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements.
With respect to guidance, please also see the slides and the press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure.
With that, I'll now turn it over to Chuck.

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [3]
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Thank you, Marilyn. Good afternoon, everyone. We had another great quarter. We are executing well against the strategy we put in place 3 years ago. Our innovation pipeline has never been stronger, and we continue to transform our business to reflect the way customers want to consume our technology.
We delivered another quarter of accelerating revenue growth of 4%, solid margins and record non-GAAP EPS up 10%. Our performance was driven by the acceleration of our intent-based networking portfolio, continuing strong customer demand for our innovative solutions and the increasing value of the network. We also made steady progress in shifting more of our business toward software and subscriptions. This resulted in broad-based strength across our products and geographies.
As I talk with customers around the world, it is clear that the network is playing an increasingly critical role in helping them manage their complex environments. They are consuming services from multiple cloud providers, multiple SaaS applications, connecting billions of new devices which are generating massive amounts of data, and the network is pervasive across all of these environments. We have been evolving our portfolio to help our customers deal with this complexity and provide unprecedented simplicity, visibility and security across on-premise, hybrid and multi-cloud environments.
Now I'd like to review our momentum across key priority areas and share some of the innovations we're driving across our portfolio. First, let's start with Infrastructure Platforms. We are leading the network industry's transformation to intent-based networking across the campus, branch, data center and the edge. We are paving the way to help customers simplify and manage the network. Only Cisco offers an end-to-end, intent-based networking portfolio that delivers assurance, industry-leading security, policy-based automation and segmentation.
We continue to see very strong adoption of the Catalyst 9000, the fastest-ramping new product introduction in our history. This includes another quarter of high uptake of our advanced subscription offer in DNA Center, our automation and analytics platform. The Catalyst 9000 now has over 5,800 customers, up from 3,100 last quarter. This is an excellent example of how we've begun to scale our enterprise networking business into a subscription model. We've also recently introduced additional intent-based networking innovations. These include new access solutions and routing software subscriptions which expand our software-defined WAN capabilities onto any platform.
We are extending our leadership in data center and cloud by providing highly secure and differentiated offerings such as our ACI SDN solution. With growing 100-gig deployments, especially in cloud infrastructure, we remain well positioned for future growth with our data center switching and intent-based portfolio. We also announced new hybrid cloud workload management solutions with ACI Multi-Site Management and new flexible consumption models, including SaaS delivery for our Tetration platform. Whether deploying enterprise applications or containers in a multi-cloud environment, customers are increasingly turning to Cisco's unique architectural approach. This is leading to strong momentum with UCS, our compute platform; and HyperFlex, our hyperconverged offering, as customers benefit from simplicity and scalability to support their hybrid cloud strategies.
Now turning to Security, which is foundational to everything we do. Our architecture delivers highly effective security from the network to the endpoint to the cloud. This unique ability to bring together networking and security at scale gives us a huge competitive advantage. With the largest customer base in enterprise security, it is clear that our strategy is working. The strength we saw in the quarter is driven by our integrated architecture, combined with best-of-breed products.
We are also leveraging artificial intelligence and machine learning to reduce time to detection and remediation. A great example of this is our Talos intelligence platform where we block 20 billion threats every day.
We continue to rapidly innovate in security to address key areas of concern for our customers such as security in their complex data centers. We introduced a comprehensive, integrated data center security architecture that is designed to protect the modern data center by seamlessly following any workload anywhere across physical and multi-cloud environments.
Now moving to Applications. This quarter, we introduced new innovations across our collaboration portfolio with the convergence of the Cisco Spark and WebEx platforms combined with new WebEx Meetings and WebEx Teams applications. We further enhanced our AI and machine learning capabilities across our collaboration portfolio with the acquisition of Accompany, a relationship intelligence platform with robust insights and intelligence to improve meeting and team experiences. We completed this acquisition last week.
We are pleased with the consistent progress we've made to deliver on the strategy we put in place nearly 3 years ago. We have solid business momentum. We are confident in our pipeline of innovation and future growth opportunities. And our commitment to driving value for our shareholders remains as strong as ever. This is clearly demonstrated by the fact that we delivered record capital returns this quarter.
As part of our commitment to shareholders, we are also very focused on our responsibility as a company to drive impact within our communities through innovation and active engagement. It is not only the right thing to do, but a key requirement for long-term business success. We are deeply committed to our long-standing efforts around sustainability, education and disaster relief as well as other key issues such as hunger and homelessness. I could not be prouder of our achievements or more excited about the impact we will have going forward.
Now I'll turn it over to Kelly to walk through more detail on our financials.

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [4]
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Thanks, Chuck. I'll start with a summary of our financial results for the quarter, followed by the guidance for Q4.
We were pleased with the financial performance in Q3 with broad strength across the business. We executed well with very good orders momentum, strong revenue growth and solid margins.
Total revenue was $12.5 billion, up 4%, and non-GAAP EPS was $0.66, up 10%. We continue to focus on driving margins and profitability with a strong non-GAAP operating margin rate of 31.5%.
Let me provide some more detail on our Q3 revenue. Total product revenue was up 5%, demonstrating the strength of our portfolio. Infrastructure Platforms grew 2% with strength in all businesses with the exception of routing. Switching returned to growth with revenue growth in both data center and campus. Campus growth was driven by our new switch, the Cat 9K. We saw solid growth in wireless with strength in Meraki and our Wave 2 offerings. Data center had very strong double-digit growth driven by servers as well as HyperFlex. Routing declined largely with the continued weakness in service provider.
Applications was up 19% in total with broad strength across the businesses. We saw very solid growth in TelePresence endpoints, UC infrastructure and AppDynamics.
Security was up 11% with strong performance in unified threat, advanced threat and web security. Deferred revenue grew 38% as we continue to drive more subscription-based software offers.
Service revenue was up 3%, driven by growth in advanced services as well as software and solutions support.
We continue to transform our business, delivering more software offerings and driving more subscriptions and recurring revenues. In Q3, we generated 32% of our total revenue from recurring offers, an increase of 2 points from a year ago. Revenue from subscriptions was 55% of our software revenue.
We drove good growth in deferred revenue, which was up 9% in total, with product up 18% and services up 4%. Deferred product revenue from our recurring software and subscription offers was $5.6 billion, up 29%.
We saw strong momentum in Q3 product orders growing 4% in total. Looking at our geographies, Americas grew 4%, EMEA was up 6% and APJC was up 3%. Total emerging markets was up 7%, with the BRICS plus Mexico up 12%.
In our customer segments, enterprise was up 11%, commercial grew 7%, public sector was up 2% and service provider declined 4%.
From a non-GAAP profitability perspective, total Q3 gross margin was 63.9%, down 0.5 points. Product gross margin was 62.9%, down 0.3 points. And service gross margin was 66.9%, down 0.9 points. We continue to be negatively impacted by the higher memory pricing we have discussed over the past several calls, which we expect to continue in the near term. Our operating margin was strong at 31.5%.
When we look at the impact of acquisitions on our results year-over-year, there's been 120 basis point positive impact on revenue and a negative $0.01 year-over-year impact on our non-GAAP EPS.
In terms of the bottom line, non-GAAP net income of $3.2 billion was up 6%, while GAAP net income was $2.7 billion. We grew non-GAAP EPS 10% to $0.66, while GAAP EPS was $0.56.
We delivered operating cash flow of $2.4 billion, down 28%. We paid $1.3 billion of onetime foreign taxes during the quarter related to the Tax Cuts and Jobs Act. Operating cash flow increased 11% normalized for these tax payments.
We repatriated $67 billion of our offshore funds to the U.S. and ended Q3 with total cash, cash equivalents and investments of $54.4 billion, with $47.5 billion available in the U.S.
From a capital allocation perspective, we returned $7.6 billion to shareholders during the quarter that included $6 billion of share repurchases and $1.6 billion for our quarterly dividend.
We recently announced an agreement to sell our Service Provider Video Software Solutions business. We expect this transaction to close in Q1 fiscal year '19 subject to any regulatory approvals and customary closing conditions. We are continually looking to optimize our portfolio.
To summarize, Q3 was a good quarter with solid top line growth, strong profitability and order growth. We continue to make solid progress on our strategic priorities, making key investments to drive our long-term growth.
Let me reiterate our guidance for the fourth quarter of fiscal year '18. This guidance includes the type of forward-looking information that Marilyn referred to earlier.
We expect revenue growth to be in the range of 4% to 6% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29.5% to 30.5%. And the non-GAAP tax provision rate is expected to be 21%. Non-GAAP earnings per share is expected to range from $0.68 to $0.70.
I'll now turn it back to Marilyn so we can move on into the Q&A.

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Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [5]
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Thanks, Kelly. Michelle, let's go ahead and open the line for questions. (Operator Instructions) So with that, I'll turn it to you, Michelle.

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Questions and Answers
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Operator [1]
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James Faucette from Morgan Stanley Investment Research.

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James Eugene Faucette, Morgan Stanley, Research Division - Executive Director [2]
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Great. Chuck and Kelly, I guess I wanted to ask, as you -- one of the key things that investors are looking at is the continued growth in subscriptions, et cetera. And it seems like the deferred continues to grow nicely. One of the key questions that we have though is, as you continue to show good demand for the new Catalyst 9K products and distribution expands, what are you seeing in terms of attach rates for subscriptions to that new product? Are they maintaining the levels that you had seen at the early stages of launch or are they starting to normalize back to more traditional levels? Just trying to get a little color on how well that tying strategy is working for you.

Yes, James, thanks for the message. I'll comment. And then if Kelly wants to add anything, we'll let her do that as well. I would say it's been very consistent over the last 4 quarters, I think, since we put it in the marketplace in Q4 of last fiscal year. I think we had 1 month of activity. So it's been incredibly consistent. We're really pleased with the acceptance of this product. I think adding 2,700 more customers in the quarter, if you think about that, that means we added over 40 customers per day that acquired a Catalyst 9000 for the first time. And the acquisition of that product, in my opinion, is a clear belief in the next-generation architecture with the automation platform that we're announcing, which is what the advanced subscription model requires. And so I think that's reflected in the continued high uptake that we see on the advanced subscription. Kelly?

Yes. No, I think that covers it. Vast majority is the Advantage, which has the advanced features and the higher margin profile. And then the only other thing I would add is, it is very evenly spread across commercial, enterprise and public sector in terms of the demand and where we're seeing all the business.

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Operator [5]
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Rod Hall from Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - Equity Analyst [6]
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I just wanted to try to dig under the covers a little bit on the revenue guidance. Obviously, service provider orders are weak and sounds like routing's weak, in line with that. Just wondering if you could, Kelly, maybe give us any idea how much service provider video is affecting that guide and also the routing within that guide, like what are you assuming there. Are you assuming routing continues to kind of drag that growth down? And then I have a follow-up.

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [7]
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Yes. So in general, I think the trends on both routing and service provider video, which is in the other bucket, have been consistent. And we're not assuming any improvement in either of those. So I would say our guide includes what we see. We feel really good about the rest of the portfolio, actually. And we see very good growth there, but those 2 trends are not improving. So that's basically what I have included.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - Equity Analyst [8]
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Okay. And then, Kelly, could you also comment on the OpEx to sales? It's ticking up a little bit in the guide, at least implied. And I'm wondering if you could maybe give us any color on what's moving around in OpEx for fiscal Q4.

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [9]
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Yes, sure. On OpEx, it's mainly driven by -- the increase is mainly driven by the acquisitions we've run, specifically AppDynamics. As you know, when we bought AppDynamics, very early stage. We're in heavy investment phase with them. So that's part of it as well as we've consolidated now BroadSoft. And then that also has a fairly high OpEx impact. If I back out -- if you look at my OpEx growth for the quarter, which was up a little less than 6%, 4 points of that alone is just purely the acquisitions. And that's, as I mentioned, the impact of acquisitions on my top line and it's hurting me on EPS. It's mainly in the OpEx line. So that's what's driving that. We're being very disciplined within the rest of the business to managing the portfolio. So I think it'll continue kind of in that range as we look forward to Q4, but that's kind of the underlying driver.

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Operator [10]
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Ittai Kidron from Oppenheimer & Co.

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Ittai Kidron, Oppenheimer & Co. Inc., Research Division - MD [11]
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Chuck, I had a couple of questions. First, on the Catalyst 9K, good progress, but help us understand how big is your Catalyst installed base from a customer standpoint? What percent of it do you really think the Cat 9K is relevant to? Because it's hard to gauge whether you're moving too slow or too fast. 40 customers a day sounds like a lot, but maybe for a company like Cisco it's not fast enough. So help me understand how do you think about driving that throughout your installed base especially with now Arista potentially coming to the marketplace. And then second question, I had a question about China. Clearly, relations there have not been on the good side recently. And you've been somewhat a little bit more optimistic on that country over the last year. What are you seeing out of there? And how do you take that into your outlook commentary?

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [12]
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Okay. First of all, thanks, Ittai, and thanks for the positive comments. On the 9K, I think that we have roughly 840,000 customers. And I would say that there's a very long list of customers that are still available to us to deliver this platform. If you look at -- the products that we have put in the market and the new Catalyst 9K family are sort of like -- if you stack our portfolio and you say, we have a very low-end switch and then you have the old Catalyst 3000, the old Catalyst 4000, those are kind of the platforms that the current 9K family replace. So there's still a very long tail of customers.
The other thing you have to remember is, many of these customers are buying the 9K and then it will become the standard platform. And they'll refresh the balance of their networks. The other thing I'll point out is that I think we said on one of the calls a while back that the enterprise segment, we would expect to lag the commercial segment with the 9K. And we did, in fact, see the enterprise business improve, and the 9K was part of that. So I think we still feel good about it. And this architecture has a long future for us. And there's a portfolio of products that sit within it. So I think if we're really honest, the number of customers who are making the decision to upgrade to the 9K, I would say it's not necessarily because, wow, what a new fantastic new Ethernet switch. It's really because they're buying into this automation strategy of which the entire portfolio will sit over time. And I think that's what we're banking on. And that's where we're banking on the long-term success.
So the China question, look, if you look at our China business this quarter, we actually saw strength in switching in both the enterprise and commercial segments. And overall, I think there's still uncertainty there. But I believe, and I have been optimistic, and I remain optimistic that the 2 countries will come to some closure on the trade issues and that we'll get stability there. And I think -- we still believe in it. It's going to be, obviously, the largest economy in the world in the coming decade. And we remain committed and actually, we're doing pretty well. If you look at the SP routing business in China, it continues to be stressed, like it is around the world, but much of the other portfolio elements, we're very pleased with.

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Operator [13]
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Vijay Bhagavath from Deutsche Bank Securities.

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Vijay Krishna Bhagavath, Deutsche Bank AG, Research Division - VP and Research Analyst [14]
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Chuck, Kelly, these are solid results here. You beat on all major categories. A quick question for you. A bigger-picture question actually, Chuck and Kelly as well which is, as your software subscription attach rate sees strength, could we see the sales OpEx, for example, start to trend down? Are you already seeing that impact to your sales OpEx line? And then just a quick tactical question in terms of, approximately, what was the run rate of the SP Video business you've sold to Permira? Because that would help us to inflate your July quarter guidance if it wasn't sold so that it helps us in kind of this if-what scenario basis.

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [15]
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Yes. Let me give some color around how we see the sales model evolving. And then I'll let Kelly answer the financial side of those questions for you. Vijay, I think what you're going to see is that we're actually building a traditional -- I'll say a traditional software model where we have a customer success organization that over time will take on more responsibility for all of the functions in the software company, the whole adoption expansion and particularly, the renewal space, which will allow us to renew a lot of these offers over time. It's a multiyear renewal window. But renewing over time at a much lower cost of sale, I would suggest that, that may give us either some, obviously, operating leverage or it may give us the ability to invest in more R&D or other areas. But that's the model. That's one of the key reasons that we brought in Maria Martinez, who is now our Chief Customer Experience Officer, who is helping us build out that capability, who has a long experience of doing that in several software companies. So that is one of the major efforts that we have underway right now to not only increase our ability and our rates of renewal, but also to do that at a much different cost structure going forward. Kelly?

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [16]
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Yes. And just on the SPVSS business, we will -- it is in my guidance right now because we're going to -- obviously, we continue to run this business until the deal closes. It is the majority of what's in the other bucket, Vijay. So it's the bulk of that. But like we did when we divested the set-top box business, once we closed the transaction, we'll give you all the history so we can adjust the model and go forward from there. So you'll have complete visibility all the way through the P&L once we close the transaction.

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Operator [17]
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Pierre Ferragu from New Street Research.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [18]
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I just wanted to...

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Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [19]
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Pierre, can you speak up just a bit?

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [20]
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Yes. Okay. Is it better now?

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [21]
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Yes.

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [22]
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Yes.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [23]
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So on the gross margin, so you still suffer from these DRAM prices. Has it like improved or is that -- has the pressure like increased sequentially compared to last quarter? And then we've had this pricing for some time now in the market, and I was wondering if -- how are you going to reflect that in your pricing strategy? And when should we expect you to start like passing on these extra costs to your client? And then lastly on the gross margin, I assume that you're still like increasing very fast your share of software and subscription services in your revenue mix. So it should have a positive impact on gross margin. If you can comment on that as well that would be great.

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [24]
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Sure. So I'll take that. So first, on the memory. So yes, memory is still hurting us year-over-year. In my product gross margin, it hurt us to the tune of about 60 basis points year-over-year. So more than what we were down year-over-year. It is marginally less bad than it was last quarter, which was marginally less bad than it was a quarter before then. So the slope of the increases are getting less, though it's still increasing year-over-year. So it was about 60 basis points.
I would say, in terms of pricing, we had another very, very good quarter for price. We always have price erosion. But like you saw last quarter, our price erosion was at the very low end of what we've seen over the last 3 years, and that continues. And part of that reason of why that continues is, we have been passing on the memory DRAM cost increases through price increases on our servers, like we have been as well as a lot of our peers as well as our product managers in other parts of the portfolio have been really -- being very disciplined about looking at where we have some price elasticity and have been selectively and surgically looking for areas that we could take advantage of price elasticity. So I feel really good about where our price index was this quarter, much in line where it was last quarter.
And then to your third point on the software being a benefit, that is true, though, I will say, a portion of that is getting offset now that we're ramping the Catalyst 9K so quickly. And as you know, a portion of that gets deferred because it's a subscription. That has a negative impact on our rate as well. So this quarter, it was about 30 basis points alone just for the Cat 9K alone now becoming bigger in the revenue contribution and impact on our rate.
So again, the 3 things are: 60 basis points on memory, 30 basis points on the Cat 9 impact and then we had pretty strong price and some favorable mix coming through from software. The only other last point I will make, we had a very, very strong quarter on our UCS, our server business. And that has a little bit of negative mix for us as well, okay?

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Operator [25]
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Paul Silverstein from Cowen and Company.

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Paul Jonas Silverstein, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [26]
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Against my better judgment, I'm going to ask you a wide-open question, which is for either or both of you, Chuck and Kelly. What are you most excited about in terms of upside opportunity, whether revenue or margin? And what are you most concerned about in terms of downside risk?

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [27]
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So I'll start, Paul, and thank you for that -- the opportunity. Listen, I think that what I am most optimistic about is the renewed innovation that we have brought and will continue to bring in our enterprise portfolio, particularly into our core franchises, which was one of the things -- when I spoke to many of you when I became CEO 3 years ago and even when we were on the road last year, I said the #1 priority for us right now. Obviously, we're going to continue the business model evolution, but the #1 priority was to get the enterprise portfolio and particularly the switching business stabilized, which our teams have done a great job.
And even if you look at the security portfolio with the team, and then I will tell you on the enterprise routing space, Kelly talked a little bit about the overall routing business. But SP routing is about half. And the enterprise routing, I will tell you that our teams have been working hard on the integration with the Viptela acquisition into our enterprise routing portfolio. And I actually feel really good about how that's coming along, and I'm optimistic about where that goes in the future. And I'm very optimistic about the overall innovation within the intent-based networking portfolio that we're going to bring forward over the next months, quarters and years.
I guess if I had to say what I would be most concerned about in general, it's just sort of the macro and/or some geopolitical risk. I mean, you've got -- you've obviously got lots of trade discussions, which I remain optimistic on. But as long as there's uncertainty, then we wait and see. Obviously, the dollar rising, while we had a good quarter in emerging countries, and we're pleased with our execution there, the rising dollar obviously is another macro issue, but I'm very pleased with what the teams are executing on right now. And that's how I'd leave it. Kelly, any comments? Good.

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Operator [28]
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Jeff Kvaal from Nomura Securities International.

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Jeffrey Thomas Kvaal, Nomura Securities Co. Ltd., Research Division - MD [29]
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You spoke about your progress in the data center switching side of things. I'm wondering if you could help us understand how things are going in the enterprise data center market and how your relationships are progressing in the web-scale data center market or just web-scale in general would be helpful to us outside of data center switching.

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [30]
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Thanks, Jeff. So I'm very happy with what our teams are doing in the data center switching market. In general, I think that the 100-gig transition, we're pleased with the return to growth in both the data center and the campus from a switching perspective.
On the web-scale side, I would say the story continues to remain as I've articulated it. We continue to make progress. You've seen the announcement we made, obviously, with Google. We continue to work and execute on the details of those solutions that we announced with them. You'll see more coming out later this year from us there. We continue to engage deeply with all of these players. We've had continued progress with several of them and continued favorable discussions. But these are -- as I've said repeatedly, some of these are multiyear architectural decisions, and they take a while. But again, I'm optimistic and pleased with where we are right now.
And I think the other thing I'd point out is that, this environment that our enterprise customers are facing right now where, literally, 4 or 5 years ago, they thought they were going to move to the public cloud and have a much simpler IT world. They now find themselves with 3 or 4 public cloud providers that they're consuming services from. They have 50, 60, 100 SaaS providers. We're beginning to see this real explosion of IoT devices at the edge. They still have their private data centers. Those have not gone away. You've got all of the mobility in customers and suppliers. And so the network is so fundamental to making all that work. And the web-scale providers know that as well, which has really enabled us to build these broad relationships that extend well beyond just the data center. So we're still pleased with where we are and we have a long way to go.

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Operator [31]
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George Notter from Jefferies.

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George Charles Notter, Jefferies LLC, Research Division - MD & Equity Research Analyst [32]
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I wanted to circle back to a conversation from prior earnings calls. You guys had talked about the revenue headwind associated with the move to more subscription-oriented models. And Kelly, I'm wondering if you can give us an update there. Is that still a headwind this quarter? And how do you see that progressing going forward?

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [33]
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Yes, sure. Thanks. And so yes, the headwind is still there because we are very much increasing the number of offers that we have as well as the revenue dollar that we're putting on the balance sheet. So the headwind is increasing. And just as we had talked in the past, now that the enterprise portfolio with the Cat 9K is starting to hit revenue, the headwind is increasing. So we said in the past it was 1.5 to 2 points. It definitely now is approaching the 2 to 2.5. And as we ramp more and more of the portfolio, we'll continue to see that.

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Operator [34]
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Srini Pajjuri from Macquarie Capital.

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Srinivas Reddy Pajjuri, Macquarie Research - Senior Analyst [35]
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I guess my question is on the recurring revenue. It dipped a little bit to 32%. If you could give some color on that. And also, I think your target long term is exceeding 37% in fiscal '20. Is that primarily a function of Cat 9K ramping in volume? Are there any other products that could contribute to that? And also, I'm wondering if you need to expand the subscription model to other products to achieve that goal.

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [36]
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Yes. So thanks for the question. So yes, on the recurring revenue, it's basically in the rounds. If I look at our product recurring revenue, again, it continues to grow over 30% to over 30% of our total product revenue. And overall, total recurring revenue is again growing in the double digits. So it's really the math and a little bit of the mix now that we have product revenue growing so much faster than services that's driving kind of just the pure math of the round from 33% to 32%. But we feel great about how it's progressing.
Yes, if you go to our Financial Analyst Conference, we feel we're right on track of what we projected as that goes out to fiscal year '20. The only caveat I'll give you on that is, when we go into our fiscal year '19, we have to adopt the new revenue standard, which will have some implication on some of the products that are included in this. So we plan to have a call where we can go through the anticipated area that will be impacted to give you guys more clarity. And then we'll adopt that Day 1 of our fiscal year '19. But overall, we feel great about the traction. We're executing very well. And we're on track, if not slightly ahead, of what we expected when we talked at the Financial Analyst Conference.

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [37]
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And Srini, just one last comment on the part of your question where you asked if we would need to extend this to other parts of our portfolio. I mean, we will. If you look at the new enterprise routing, some of the comments I made in my opening was that we're extending our software and subscription business in the routing space. Many of those are software solutions. So we'll continue to evolve. And frankly, it's driven by how our customers want to consume the technology, which is great. And as Kelly said, it will create a short-term headwind, but we think long term for the business it's absolutely the right thing to do.

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Operator [38]
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Jim Suva from Citigroup Global Markets.

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Jim Suva, Citigroup Inc, Research Division - Director [39]
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I have a brief question for Chuck and then Kelly, more of a clarification one. But Chuck, there wasn't any mention yet, at least on the Q&A, about competitors going into the campus side of things with Arista making an announcement. How do you look at that? I know competition isn't anything new. But do you need to step up your sales efforts? Or how should we think about that? And then Kelly, for the CFO question. How should we think about, you've got time now to think about the tax law, sort through all the changes. Is your outlook kind of 21% outlook long term? And stock cadence, you did a lot more stock buyback this quarter than normal with your new announcement. How should we think about those financial metrics?

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [40]
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Yes. So let me hit the first one. Relative to the competition in the campus, what I would say is that, look, we launched this architecture last June. And I think our customers have been incredibly excited about it. One of the very important things that we did is we made the architecture and DNA Center backwards compatible with at least one generation of our wireless products, our switching products, our routing products, et cetera. And I think that taking a look at all of those products is incredibly important because our customers don't want to have an automation platform that handles switching. They want an automation platform that handles the enterprise -- at a minimum, the enterprise network. And then over time, as we integrate our automation platform in the data center and the campus, you'll be looking at the ability to automate from the data center to the campus to the wireless network to the routing and frankly, the security architecture. And we think that is a unique architecture that we can deliver. We are leading right now. We see incredible acceleration of the Cat 9K and adoption by our customers. And we're very comfortable with where we are in this transition.

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [41]
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And on the tax question. So again, we feel really good about where we stand in terms of that. As we said in the call, we brought back $67 billion from overseas. And we -- like we said in last quarter's earnings, we announced a big increase to our share buyback authorization. So we have $25 billion remaining in our share buyback. And we anticipate using that in the next, basically, 18 to 21 months. So we're being very aggressive there, like we had stated we would be once we got our cash back. So that's going well. As far as the tax rate, we also stated in Q2 that we expect our tax rate to be in the 21% for fiscal year '18. And we expect it to go down to 20% in fiscal year '19 when we get the full benefit of the U.S. -- the new U.S. federal rate. So overall, we feel great about the tax law and the implications for us.

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Operator [42]
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Mitchell Steves from RBC Capital Markets.

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Mitchell Toshiro Steves, RBC Capital Markets, LLC, Research Division - Analyst [43]
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I actually wanted to circle back a little bit and poke at the recurring revenue piece. And now that it's 32%, and you're noting that you got 120 basis points from acquisitions. Can you help me understand what really drove the decline Q-over-Q from 33% to 32% given that the acquisitions you guys had done have been software in nature?

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [44]
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Yes. I mean, again, I think, basically, AppDynamics has been in the numbers as we go along. I would say, BroadSoft has a mix of both perpetual and recurring, so it is not all recurring. I would say the bigger impact on the numbers, and again, it's really just the mix of the products. When we have product revenue growing 5%, services growing 3%. And within that product revenue, we had very, very strong server revenue growth, which has a very low software recurring proponent of it. That's what's really driving it. As I said, overall, the growth of product recurring revenue was over 30%, like it has been for the last 5 quarters. So that just continues to grow. It's really more the denominator of total revenue that's driving just the slight round down to 32%.

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Operator [45]
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Tal Liani from Bank of America.

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Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [46]
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Security was up 11%, which is an acceleration from previous quarters -- the previous 2 quarters. Can you talk about what went right and what went wrong with security this quarter? And what are the things that are driving this acceleration?

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [47]
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Yes. Thanks, Tal. So look, we remain confident in the security architecture that we built, even when we had some deviation in the revenue run rate over the last year. And I think that as you look at the architecture that we have, which extends from e-mail to endpoints to the network to the cloud and then has this massive state machine where we can correlate threats and then dynamically defend, it's a unique proposition. And we say that we have this integrated architecture but also best-of-breed products. So where we are convincing customers that the architecture is right, then we're winning. And I think that our teams are doing a really good job. I think that the engineering teams have continued to add new features and new capabilities that our customers are adopting. And I think it's as simple as that. It's just -- it's we have reasonably good traction in the field right now.

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Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [48]
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And can you share with us maybe the areas where you think you need to strengthen your portfolio?

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [49]
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Well, I mean, we have -- the great thing about this architecture when we build it is that you can continue to add virtually any source of threat intelligence to this because it's built to digest massive amounts. I mean, we see 20 billion threats every day. So you can assume that we can add any sort of capability that we like. That includes threat sources and frankly, the same thing from a defense perspective. So within the portfolio, I think there's always an opportunity for our teams to continue to improve and continue to add features. And there's a lot of good competition in the space. It's very fragmented. So we just continue to execute against delivering that architecture.

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Operator [50]
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Mark Moskowitz from Barclays Capital.

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Mark Alan Moskowitz, Barclays Bank PLC, Research Division - Director [51]
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Just one more revenue question for me. Kelly and Chuck, how should we think about the second half of calendar '18 relative to your fourth quarter revenue guidance in terms of the 4% to 6% goalpost year-over-year? Is there any inflection point with respect to the selling cycle? We've heard anecdotally from some of our checks that it is a slightly longer selling cycle as customers try to understand more the subscription element. And as they do become more receptive, could you actually see accelerating revenue growth maybe closer to that 6% or better as you go into the October, January quarters?

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Kelly A. Kramer, Cisco Systems, Inc. - Executive VP & CFO [52]
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Mark, so as you guys know, we really do just give guidance one quarter in advance. And we feel very good about the guidance we gave of the 4% to 6% growth. As we look forward though, just to give you some color, context, in the Cat 9K, the demand is great. We have fantastic demand. We are taking orders like crazy. And there's great adoption out there by our customers that we don't see slowing down. So we feel great about that. But again, there's a lot of moving parts, and we'll take it one quarter at a time. The only other thing I just want to remind you is, we do have -- when our fiscal year starts in August for '19, we do have the tweak on the new revenue standard that we'll take you through any implications of. So feel really good about the Q4 guide, and we're just going to take it one quarter at a time.

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Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [53]
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All right. Good.

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Charles H. Robbins, Cisco Systems, Inc. - Chairman & CEO [54]
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So I want to just thank everybody for joining us today. We appreciate you spending time with us. Appreciate the opportunity to answer your questions. And Marilyn, I'll kick it back to you for the details on the next call.

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Marilyn Mora, Cisco Systems, Inc. - Director of Global IR [55]
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Great. Thanks, Chuck. Cisco's next quarterly earnings call, which will reflect our full year 2018 fourth quarter and annual results, will be on Wednesday, August 15 at 1:30 p.m. Pacific time, 4:30 p.m. Eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through explicit public disclosure. We now plan to close the call. If you have any further questions, feel free to contact the Cisco Investor Relations department, and we thank you very much for joining the call today.

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Operator [56]
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And thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (888) 568-0890. For participants dialing from outside the U.S., please dial (402) 998-1566. This concludes today's call. You may disconnect at this time.

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