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| Thomson Reuters StreetEvents Event Transcript | |
| E D I T E D V E R S I O N | |
| Q4 2016 Cisco Systems Inc Earnings Call | |
| AUGUST 17, 2016 / 8:30PM GMT | |
| ================================================================================ | |
| Corporate Participants | |
| ================================================================================ | |
| * Kelly Kramer | |
| Cisco Systems Inc - CFO | |
| * Chuck Robbins | |
| Cisco Systems Inc - CEO | |
| * Marilyn Mora | |
| Cisco Systems Inc - Head of IR | |
| ================================================================================ | |
| Conference Call Participiants | |
| ================================================================================ | |
| * Tal Liani | |
| BofA Merrill Lynch - Analyst | |
| * James Faucette | |
| Morgan Stanley - Analyst | |
| * Jayson Noland | |
| Robert W. Baird & Company - Analyst | |
| * James Suva | |
| Citigroup Global Markets - Analyst | |
| * Ittai Kidron | |
| Oppenheimer & Company - Analyst | |
| * Vijay Bhagavath | |
| Deutsche Bank Securities - Analyst | |
| * Mark Moskowitz | |
| Barclays Capital - Analyst | |
| * Simon Leopold | |
| Raymond James & Associates - Analyst | |
| * Jess Lubert | |
| Wells Fargo Securities - Analyst | |
| * Simona Jankowski | |
| Goldman Sachs - Analyst | |
| * Steve Milunovich | |
| UBS - Analyst | |
| * Mitch Steves | |
| RBC Capital Markets - Analyst | |
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| Presentation | |
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| Operator [1] | |
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| Welcome to Cisco Systems' fourth-quarter and FY16 financial results conference call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [2] | |
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| Thanks, Sam. Welcome, everyone, to Cisco's fourth-quarter FY16 quarterly earnings conference call. | |
| This is Marilyn Mora, Head of Investor Relations; and I'm joined by Chuck Robbins, our 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 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 statements and other financial information can also be found on 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 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 first quarter of FY17. 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 Forms 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 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. As a reminder, in Q2, on November 20, we completed the sale of the customer premises equipment portion of our SP Video Connected Devices business, and accordingly, had no revenue or expense from that business in Q4 FY16. | |
| As such, all of the revenue, non-GAAP, product orders and backlog information we will be discussing, is normalized to exclude the SP Video CPE business from our historical results. We have provided historical financial information for the SP Video CPE business in the slides that accompany this call and on our website to help to understand these impacts. As a reminder, the guidance we provided during our Q3 earnings call and today's call has been normalized in the same way. | |
| So with that, I'll go ahead and turn it over to Chuck. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [3] | |
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| Thank you, Marilyn. We executed extremely well in Q4, with revenue growth of 2% and record non-GAAP EPS, which grew 9%. This was another strong quarter, wrapping up a great year. We closed out our fiscal year with $48.7 billion in revenue, up 3%, and non-GAAP EPS, which grew 8% to a record $2.36. Gross margins and operating margins were consistently strong throughout the year. We continue to manage our business well, and these results underscore our ability to execute against our strategic priorities and our rigorous discipline on profitability. | |
| Over this past fiscal year, we experienced a challenging environment with significant volatility. Our fourth quarter was no exception. After three consecutive quarters of growth, both Service Provider and Emerging Markets turned negative. Service Provider orders declined 5%, reflecting the many challenges in that customer segment that you've heard from our peers. | |
| In addition, Emerging Markets orders were down 6%. The remainder of the business remained healthy, with orders growing 5%. While the overall macro environment remains uncertain, we are well-positioned to capture the benefits of any tailwinds. | |
| At the same time, we're aggressively investing in priority areas to drive growth over the long term, regardless of the environment. We had strong performance in Security, Data Center, Switching, Collaboration and Services, as well as continued success in the transition of our business model to software and subscriptions. We remained focused on accelerating innovation across our portfolio, and we've made great progress over the past year in these priority areas, where we continue to see momentum. | |
| First, security. Security is the number-one priority for every customer. As the global leader in networking, Cisco is uniquely positioned to deliver security at scale with leading-edge innovation, as we lead the transition to cloud-delivered security. Our team has done a phenomenal job of capitalizing on this distinct advantage that Cisco has in the most critical area for our customers. | |
| For example, we've been rapidly shifting our model from a primarily hardware business to a software and services business. This past quarter, we delivered our third-consecutive quarter of double-digit growth, with revenue up 16% and deferred revenue growing 29% as a result of this shift. | |
| We continue to add significant features and functionality to our security portfolio, both through internal innovation and M&A, to meet our customers' most pressing needs. Such as cloud Defense Orchestrator, which provides cloud-based security policy management. Stealthwatch Learning Networks, which leverages a network infrastructure, analytics and distributed machine learning to provide visibility and security intelligence across the enterprise. | |
| We have also extended our cloud-based security platform through our acquisition of CloudLock, an as-a-service offering enabling the ability to secure cloud applications. Over the past year, we've demonstrated tremendous success in rapidly deploying Cisco's advanced threat solutions to our global customer base with our AMP solution, now deployed at over 17,000 customers around the world. | |
| As we have done in the advanced threat market, we are now deeply focused on winning in the next-generation firewall market. We launched our full-featured next-generation firewall in March, and we added over 6,000 customers this past quarter. | |
| Second, next-generation data center. Over the past year, we have continued to invest heavily in our data center portfolio, building upon our core networking foundation as customers look to Cisco for an open, programmable and automated infrastructure that accelerates application deployments and provides network services in an agile way. | |
| We are delivering technologies across physical, virtual and cloud-based deployments. In Q4, we launched our Tetration Analytics platform, providing complete visibility across the data center. Combining Tetration with Cisco Cloud Center, we can automate and orchestrate data center application workloads real-time between hybrid and private clouds, while enabling policy management with ACI. Our ACI family of products continued to see strong revenue growth in Q4, growing 36% at over a $2.3 billion annualized run rate. | |
| In addition, this past quarter marked our first full quarter with HyperFlex, our hyper-converged solution, and we already have approximately 500 customers, and over a quarter of these are net new to UCS. We're off to a great start, with a solid pipeline and strong customer feedback. | |
| Third, collaboration. This continues to be a consistent growth driver for us. Our strategy and highly differentiated portfolio, delivered both on-premise and from the cloud, enabled us in FY16 to grow revenue 9% to $4.4 billion. In Q4, we delivered another consecutive quarter of solid growth, with revenue growing 6%, and deferred revenue growing at 13%. | |
| Lastly, we continue to see great progress in our transition to software- and subscription-based models. I've mentioned the success we've had in this area in both security and collaboration, and overall, our product-deferred revenue related to our recurring software and subscription businesses grew 33% in Q4. Our momentum here is strong, and we'll continue to accelerate this transition. | |
| Today's market requires Cisco and our customers to be decisive, move with greater speed, and drive more innovation than we've seen in our history. Today we announced a restructuring, enabling us to optimize our cost base and lower growth areas of our portfolio, and further invest in key priority areas, such as security, IoT, collaboration, next-generation data center, and cloud. We expect to reinvest substantially all of the cost savings from these actions back into the businesses, and we'll continue to aggressively invest to focus on our areas of future growth. | |
| Now I'll turn it over to Kelly to walk you through more detail on our financials. | |
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| Kelly Kramer, Cisco Systems Inc - CFO [4] | |
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| Thanks, Chuck. We executed well on our financial strategy of delivering profitable growth, managing our portfolio and strategic investments, and delivering shareholder value. First, on delivering profitable growth. | |
| We had another good quarter, with revenue growing 2% and non-GAAP EPS growing 9%. For the full fiscal year, we grew revenue 3%, and non-GAAP EPS 8%. For the quarter and full year, we expanded both our gross and operating margins. For the full fiscal year, total revenue was $48.7 billion, with product up 2% and services up 5%. | |
| Let me now walk through the details for Q4. Total revenue was $12.6 billion, up 2%, with growth in product revenue of 1% and services of 5%. Switching grew 2%, driven by strength in data center switching, with continued momentum in ACI and the next-generation data center. Routing declined 6%, largely driven by the weakness we saw in Service Provider. | |
| Collaboration grew 6%, driven by continued strength of our TelePresence portfolio, which grew in the double digits, and continued solid performance of WebEx. Deferred revenue grew 13%. Data center declined 1%. | |
| Our hyper-converged offering, HyperFlex, is experiencing solid early uptake by our customers, led by its highly differentiated architecture. Wireless grew 5%, led by growth in cloud-based Meraki, partially offset by a decline in controllers. | |
| Security grew 16%, with deferred revenue growth of 29%. We had strong performance in our advanced threat security and web security solutions, which grew over 80% and 50%, respectively. SP Video declined 12%, driven by the weakness we saw in China this quarter. Services grew 5%, driven by our focus on renewals and attach. | |
| We continue to make solid progress in our goal of driving more recurring revenue. Total deferred revenue grew 8%, with product up 8% and services up 9%. And as Chuck mentioned, the portion of our deferred product revenue related to our recurring software and subscription businesses, grew 33%. From an orders perspective, total product orders grew 1%, with our book-to-bill comfortably above 1. | |
| Looking at our geographies, which is the primary way we run the business, Americas grew 3%, EMEA was down 3% and APJC grew 4%. Total Emerging Markets declined 6%, with the BRICs plus Mexico down 2%. India was up 20%, while we saw declines in China of 12%. | |
| In terms of customer segments, it was good to see a return to growth in enterprise of 3%, as well as a solid performance in commercial of 5%. Public sector grew 1%, and Service Provider was down 5%. Our product backlog as we ended Q4 was approximately $4.6 billion, up 1%. | |
| We drove strong profitability with expanding leverage in Q4. From a non-GAAP perspective, total gross margin was 64.6%, growing 0.7 points, with product gross margin of 63.9%, up 0.7 points, and service gross margin of 67%, up 1.1 points. We increased our non-GAAP operating margin to 31.4%, up 1.3 points. | |
| We also saw good momentum and improvement in the profitability for the full fiscal year. On a non-GAAP basis, our total gross margin for the year was 64.7%, an increase of 50 basis points, with increases in both product gross margin and service gross margin, up 0.3 points and 1.4 points, respectively. Our non-GAAP operating margin expanded to 31%, up 1.4 points. | |
| We remain disciplined, and focused on continuing to drive operational efficiencies and productivity. In terms of our bottom line, we delivered non-GAAP EPS of $0.63, up 9%. GAAP EPS was $0.56. For the full year, we had record non-GAAP EPS of $2.36, up 8%, while GAAP EPS was $2.11. | |
| Moving to our portfolio and strategic investments, in Q4, we announced our intent to acquire CloudLock, which has since closed, early Q1. The CloudLock acquisition will further enhance Cisco's security portfolio and build on our Security Everywhere strategy, designed to provide protection from the cloud to the network to the end point, and also aligns with our strategy to deliver more cloud-based subscription services. We continued our strategy of investing in key growth areas including security, but also cloud collaboration and IoT, and we are committed to looking at the right acquisitions at the right price, to drive our growth strategy. | |
| Moving on to shareholder value, in Q4, we delivered operating cash flows of $3.8 billion. Total cash, cash equivalents and investments at the end of Q4 were $65.8 billion, with $5.9 billion available in the US. We returned $2.1 billion to shareholders during the quarter. That included $800 million of share repurchases and $1.3 billion for our quarterly dividend. | |
| For the full fiscal year, operating cash flow grew 8% to a record $13.6 billion, with free cash flow of $12.4 billion. We returned $8.7 billion to shareholders through share buybacks and dividends, which represented 70% of our total free cash flow. We are firmly committed to continuing our capital allocation strategy of returning a minimum of 50% of our free cash flow to shareholders annually. | |
| To summarize, in Q4 and for the full fiscal year, we executed well, despite a volatile environment. We focused on consistent, solid execution, driving profitable growth, cash generation and operating leverage. We're making the tough decisions and key investments to drive strong financial performance over the long term, and continuing our firm commitment to delivering shareholder value. | |
| Let me now reiterate the guidance we provided in the press release for the first quarter of FY17. This guidance includes the type of forward-looking information that Marilyn referred to earlier. The guidance for the first quarter of FY17 is as follows. We expect our revenue growth to be in the range of minus 1% to plus 1% year over year, normalized to exclude the SP Video CPE business from Q1 FY16. | |
| 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% to 30%. And the non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to range from $0.58 to $0.60. | |
| The restructuring action Chuck discussed earlier will impact up to 5,500 employees, representing approximately 7% of our global workforce. We will take these actions starting in Q1 of FY17, and estimate that we will recognize pretax charges to our GAAP financial results up to $700 million. We expect that approximately $325 million to $400 million of these charges will be recognized during the first quarter of FY17, with the remaining amount recognized during the rest of the fiscal year. | |
| I'll now turn it back to Chuck to summarize the call. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [5] | |
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| Thanks, Kelly. To wrap up, I want to summarize our priorities as we head into the year ahead, and why I'm confident about our opportunities. First, we expect to continue to execute against our strategic priorities, and drive profitability regardless of the market conditions. We are committed to making the necessary decisions to drive our future growth and that of our customers and our partners. | |
| Second, we believe we will transition more of our revenues to a software- and subscription-based model, and accelerate our shift across our portfolio. Third, we remain committed to increasing our pace of innovation that will help our customers succeed. Lastly, we will continue to execute on our of long-term strategy to create even greater value for our customers and shareholders, while positioning Cisco for long-term success. | |
| Marilyn, I'll turn it back over to you for questions. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [6] | |
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| Thanks, Chuck. Sam, let's go ahead and open the line for questions. And while Sam is doing that, I would like to remind the audience that we ask you to please ask one question. | |
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| Questions and Answers | |
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| Operator [1] | |
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| Thank you. And our first question comes from the line of Vijay Bhagavath with Deutsche Bank Securities. Your line is now open. | |
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| Vijay Bhagavath, Deutsche Bank Securities - Analyst [2] | |
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| Hi, thanks, Chuck. Kelly, Marilyn. My question is around demand trends. A lot of clients are asking me this since the press release came out. Help us with any color you can in terms of end markets, product categories, product cycles -- anything and everything on demand trends looking into the rest of the year? Thanks. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [3] | |
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| Thanks, Vijay. So I'll provide some comments and ask Kelly for anything else that she'd like to add. So when you look at, in Q4, what we obviously saw was, after three quarters of growth in the Service Provider and emerging countries, we saw those turn negative, as I said. And the rest of the business was up 5%, from an orders perspective. We also highlighted the fact that enterprise was up 3%. A little more color on that is that every geography around the world experienced positive enterprise growth. | |
| Commercial was up 5%. Every geography around the world experienced positive growth in commercial. And then in public sector, it was up 1% and I believe all except perhaps Europe were positive as well, in public sector. So outside of SP and emerging, we saw fairly consistent demand. And I think that pretty much summarizes it. Kelly, what other comments do you have? | |
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| Kelly Kramer, Cisco Systems Inc - CFO [4] | |
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| No, I think you summarized it well. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [5] | |
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| Okay, Sam. Let's go ahead and tee up for the next question, please? | |
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| Operator [6] | |
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| Thank you. Our next question is from Ittai Kidron with Oppenheimer. Your line is now open. | |
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| Ittai Kidron, Oppenheimer & Company - Analyst [7] | |
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| Hi, guys. Thanks for the question. Couple things from me. And Chuck, this is the same question I asked last quarter. Your UCS, your data center business, has now been stuck in range for seven quarters in a row. And I understand that HyperFlex has seen some traction, but how do we get that business back to growth again? What is the time line by which you think that could happen? And will you consider going after parts of the market that are maybe more margin-sensitive? | |
| And then just another small question there. The Tetration solution you introduced, can you just remind us in what product category in the future that will be included, and maybe some color on first comments from customers? | |
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| Chuck Robbins, Cisco Systems Inc - CEO [8] | |
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| Absolutely, Ittai, thank you very much. So on the UCS front, we talked about a couple things. There's an overall sort of macro demand issue in that space. I think the overall blade market has been somewhat benign. But we've also had -- we've also experienced, as we talked about, a transition to rack, and our teams have been working on subsequent innovation across both the blade and the rack business, as well as the introduction of the HyperFlex system. | |
| So we have -- I believe the team has a real clear plan. They've got innovation priorities outlined across all of those platforms, and we'll be executing that over the next few quarters. Kelly and I actually reviewed this just a couple days ago. So I feel good about the leadership there. I feel good about their plan, and now it's about execution. | |
| Kelly, any -- on the Tetration front, let me give you a little color, and then Kelly, you can talk about where we're going to report it. Tetration is -- we announced it in Q4. We're generally beginning orderability, I think, sometime around now. It is a combination of premise-based hardware with subscription software. | |
| And so, we're just very much in the early days. We have taken a couple of orders from customers. I will tell you that the general feedback from our customers is that it solves a problem that they've had for a very long time, that nothing else has solved. So again, we've got that offer ready to go in a combination of premise-based and subscription-based solution, and it is just being turned off on an orderability perspective. Where will we report that? | |
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| Kelly Kramer, Cisco Systems Inc - CFO [9] | |
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| Right now, since it is in the data center solution, it will be in data center switching. As we expand that portfolio across we can (inaudible). | |
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| Chuck Robbins, Cisco Systems Inc - CEO [10] | |
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| We'll call it out. | |
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| Kelly Kramer, Cisco Systems Inc - CFO [11] | |
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| Yes. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [12] | |
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| Thanks, Chuck and Kelly. Sam, we'll go ahead and take the next question, please. | |
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| Operator [13] | |
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| Thank you. Our next question is from Simona Jankowski with Goldman Sachs & Company. Your line is now open. | |
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| Simona Jankowski, Goldman Sachs - Analyst [14] | |
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| Hi, thank you. I just had a clarification first, which is, what percent of the business right now is recurring software and subscription revenue? And then as far as my question, gross margins and operating margins were ahead of your target ranges, and that's in a quarter when gross margins are typically seasonally down. So just curious, Kelly and Chuck, about raising your target margin ranges over time? And just more broadly, how are you thinking about the tradeoff between margins and revenue growth? | |
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| Kelly Kramer, Cisco Systems Inc - CFO [15] | |
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| Yes, so I'll start, and Chuck, you can jump in. But to your first question, the portion of our business that is recurring revenue is up to 28%, and that compares to 25% in Q4 of 2015. So we made really solid progress this year. | |
| In terms of the margins, this has been a huge focus for us all quarter long, and it is really great to see that we actually had our margins -- gross margins and operating margins -- up year over year for us this year. It's part of what we're driving in our shift to software. Those businesses have great margins, and it's part of the overall transition. In terms of, when do we change our model or our guidance, I think that will come over time as we make bigger shifts at the Company level. But that is our goal, as we shift to more software that have those nice, great margins. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [16] | |
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| The only other comment I'd make is that when we look at our success relative to subscription and software businesses, we have the product-deferred revenue that's associated with software and subscriptions, that we said was up 33%. We also have another category of total contract value that we have not recognized revenue on yet that we will be billing customers on, on a monthly basis going forward. | |
| We track both those numbers. The second one doesn't show up on our balance sheet yet. But if you look at those two combined, which is really reflective of our progress here, that number was actually up 43% over the same period a year ago, just to share one more data point there. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [17] | |
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| Next question, please? | |
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| Operator [18] | |
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| And our next question comes from the line of Tal Liani with Banc of America Securities. Your line is now open. | |
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| Tal Liani, BofA Merrill Lynch - Analyst [19] | |
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| Hi, guys. My questions are about the restructuring program. Two things. First, are you -- you say that you're doing it in order to increase investments in growth areas versus areas that are not growing. Are you anticipating further declining growth rates, or any issues beyond what we're seeing now in the legacy areas, that prompt this kind of program? | |
| And second, when we talk about less lower-growth areas, these are your largest areas, so switches and routers. And the question is, how do you deal with -- how do you balance between the need to compete and the need to invest? And maybe you can give us some color on the restructuring and what you plan on doing? Thank you. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [20] | |
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| I'll make some initial comments and again pass it to Kelly. Tal, good questions. Primarily, we are looking at the areas of growth that we believe will grow faster than others. So it's more of a relative statement than it is an absolute statement. At the same time, we actually are working very diligently on bringing innovation to our core. We're focused on a tighter coupling of security into the core. We're focused on policy and orchestration and cloud-based management across the entire portfolio. | |
| So there is a significant amount of innovation the teams are working on there over the next several quarters as well. So it's not that we're ignoring one in favor of another. We just want to make sure that our of investments are commensurate with the growth opportunity from a relative perspective. Kelly? | |
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| Kelly Kramer, Cisco Systems Inc - CFO [21] | |
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| I think you said it well. We are investing in basically every business unit we have, right? So we're investing in the core and key areas. We're looking for those pockets of where the growth is, whether it's in core routing and switching or security and collaboration. So we're being very smart about where we're putting our money, and that's how we're looking at this. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [22] | |
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| We'll go ahead and take our next question, please. | |
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| Operator [23] | |
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| Thank you. Our next question is from Steve Milunovich with UBS Securities. Your line is now open. | |
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| Steve Milunovich, UBS - Analyst [24] | |
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| Thank you very much. Could you talk a bit more about the factors behind your first-quarter guidance? Revenue being flat is clearly below the recent growth rate, and the gross margin is also down a fair amount sequentially. So what do you attribute that to? | |
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| Chuck Robbins, Cisco Systems Inc - CEO [25] | |
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| I'll give a couple of macro comments here. So we obviously, are calling out the weakness we saw from a demand perspective in Q4 relative to SP and emerging countries. We also -- obviously as we look forward, we're just uncertain how to model any improvement in those two, in particular, going forward. | |
| And the other issue is that there is some impact from the transition in our business model. I'll give you a quick example. We restructured and drove new value in how we put together certain Cisco One Software packages for our customers. And in Q4, as an example, there was about $139 million that would have been recognized as revenue that, because of the way we have now structured those offers and the value the customers see in those, those are going to transition to ratable revenue recognition. So there is a slight impact from that as we look forward as well. And those are the key things that led us to our guide. | |
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| Kelly Kramer, Cisco Systems Inc - CFO [26] | |
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| Yes, and just on -- the only thing to add to that -- again, we base it on what we see, and again, we did see the additional slowdown in SP and emerging. That makes us a bit cautious. On the margins, Steve, we're going to be driving as much as we can in those margins, and we'll be working that. But as of right now, this is what we see. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [27] | |
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| Next question, please? | |
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| Operator [28] | |
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| Our next question comes from James Faucette with Morgan Stanley. Your line is now open. | |
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| James Faucette, Morgan Stanley - Analyst [29] | |
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| Thank you very much. I just wanted a quick question. I think this ties into Service Provider. Routing was surprising to us, that it wasn't a little bit better, and I think that's probably attributable to Service Provider, and I want to make sure that's the case. | |
| And I guess I'd like kind of your view -- it seems like with new products in that category, that maybe that, that category at some point becomes pretty spring-loaded, as at least we would expect the valuation units to be shipped in and pent-up demand to develop. But I want to know if we're thinking about that correctly, and kind of how we should think about the router segment going forward? Thanks. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [30] | |
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| Yes, James. You're correct in that over 50% of our routing business comes from Service Providers. So there's a direct correlation there. And I think if you look at the discussions that have are have taken place with our peers, you look at some of the analyst reports on SP CapEx, we actually saw exactly what the analysts have talked about. I saw one report that discussed double-digit declines outside of the United States, and maybe flat to slightly up inside the US, which is effectively what we saw from a demand perspective. So it was very much in line with that. | |
| As far as what we see going forward, look, we certainly don't expect that these networks over time, that the traffic will decline. So I think it's a matter of timing. The video loads on the networks continue to increase. So we would think about it the same way you do, but we also know that in uncertain times, that customers tend to sweat assets as long as they possibly can. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [31] | |
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| Thanks, Chuck. Sam, we'll go ahead and take our next question, please. | |
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| Operator [32] | |
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| Yes, our next question is from James Suva with Citigroup Global Markets. Your line is now open. | |
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| James Suva, Citigroup Global Markets - Analyst [33] | |
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| Thanks very much, I appreciate the opportunity. And congratulations, Chuck and Kelly, to your good results. My question is just one part and pretty simple. Regarding Brexit, you're one of the first major tech companies to report that have a full-month post of the Brexit event happening. Can you talk about, did that influence your visibility, your spending patterns or demand orders, or book-to-bill, or anything like that? Any push-outs, any hesitations? | |
| Chuck, you talked many times about uncertain economic times we're in. I was wondering, has it been compounded by Brexit, or was that kind of built in and you actually didn't see much of an impact? Thank you very much. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [34] | |
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| Thanks, Jim. Well, I'll tell you, after the first year in this job, I know for a fact that every month there are new things that we face. And the good news is we tend to execute well and we deal with those. As it relates to -- first off, let me just say, in the EMEA business, the decline there was largely attributed to Service Providers. So I just want to make that clear. We would not suggest that the broad-based shift in the EMEA results was solely dependent upon Brexit. | |
| What we saw from a Brexit perspective is exactly what you would expect. In the UK proper, we saw customers pause. We saw them just kind of slow a bit because they're uncertain. And we also saw the impact of the currency devaluation, which you would expect. But we remain very committed there. We think we'll work through this. But those are the real impacts. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [35] | |
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| Great, thanks, Chuck. Sam, let's go ahead and take the next question, please. | |
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| Operator [36] | |
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| Yes, our next question is from Mark Moskowitz with Barclays. Your line is now open. | |
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| Mark Moskowitz, Barclays Capital - Analyst [37] | |
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| Yes, thank you, good afternoon. I wanted to ask a follow-up around the restructuring. Can you give us any sense, Chuck or Kelly, is there any benefit here from the early stages of the Ericsson relationship, allowing you to leverage that JV so that you can actually drive some of this restructuring? And does that imply there could be incremental restructuring down the road? | |
| And then my question is around the cloud. We keep getting a lot of questions around what is Cisco's exposure to the cloud in terms of, can you give us any sense around the percentage of revenue, at least to private cloud or public cloud deployments that you're serving, from an infrastructure perspective? Thank you. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [38] | |
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| On the Ericsson front, I'll tell you that the partnership continues to move forward, and there was really no correlation or discussion of the Ericsson partnership as it related to the decision on restructuring. We think that, again, that the original benefits that we saw with that partnership, with their global scale for services, their OSS capabilities, their radio expertise, combined with our IT expertise in data center and security, and other of capabilities, as well as the enterprise and IoT, were really the drivers there. So we see that continuing. | |
| As it relates to the cloud impact, I think when we look at sort of next-generation data center build-out in the private cloud, we look at our ACI portfolio, and we saw a $2.3 billion annualized business that grew 36%. So we feel like customers continue to move towards a hybrid cloud environment. The orchestration capability that we talked about with cloud center, which is from the CliQr acquisition, combined with the knowledge that we're going to be able to provide the customers through Tetration. | |
| So think about Tetration providing analytics about what's going on, CliQr and ACI then being able to deploy policy and move workloads between public and private cloud. And that's what we think customers are going to look for, and we think we're in a pretty good spot there. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [39] | |
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| Sam, let's go ahead and take the next question, please? | |
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| Operator [40] | |
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| Yes. Our next question is from Mitch Steves with RBC Capital Markets. Your line is now open. | |
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| Mitch Steves, RBC Capital Markets - Analyst [41] | |
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| Hi, guys, thanks for taking my question. So my first part is kind of on the product gross margin. So it looks like it was actually down sequentially in July, and I think that's primarily due to selling more switching and routing. So does that mean in October quarter, you think that the mix is going to shift more to legacy kind of routing and switching, versus the remaining, I guess, call it, advanced portfolio? | |
| And then just one small one. What was the total acquisition revenue you guys got from all the acquisitions this quarter? | |
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| Kelly Kramer, Cisco Systems Inc - CFO [42] | |
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| Yes, so I'll take that. So on the gross margins, we do have seasonality of when different mix of our products are bigger. For example, data center and services are bigger in Q2 and Q4, so you can see that normal seasonality in there. | |
| As I said to the earlier question, I think from an overall perspective, we feel great about our gross margins. We are being smart about the tradeoff on top line and bottom line, and the teams continue to do great work in terms of driving productivity and costs out of the products that allow us to do that. | |
| From a pricing perspective, our price ASP price erosion that we saw in Q4 was basically in line with what we saw in Q3 -- actually, 20 basis points better. So we're still in that same range; we're not seeing any change there. In terms of acquisition revenue, we don't typically disclose that, but I can tell you it was roughly less than a point. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [43] | |
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| Next question, please. | |
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| Mitch Steves, RBC Capital Markets - Analyst [44] | |
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| Thank you very much. | |
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| Kelly Kramer, Cisco Systems Inc - CFO [45] | |
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| Yes. | |
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| Operator [46] | |
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| And our next question is from Jess Lubert with Wells Fargo Securities. Your line is now open. | |
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| Jess Lubert, Wells Fargo Securities - Analyst [47] | |
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| Hi, guys. I was hoping you could touch upon the activity you saw from some of your top cloud customers, to what degree you're continuing to see strength in that vertical? And then on the switching business, which saw a return to growth following several soft quarters, I was hoping you could help us understand to what extent ACI revenues are now greater than some of the legacy data center offerings? | |
| And presuming the mix of legacy in the data center is now smaller than ACI, would you expect the switching business overall to grow moving forward? Or are there offsets that could cause that to vacillate going forward? | |
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| Chuck Robbins, Cisco Systems Inc - CEO [48] | |
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| Thanks, Jess. On the web scale players, what we reported in the last couple of quarters was our top-10 web scale customers, and that business was up 2% this quarter. But it is a -- when you have 10 customers in sort of a reporting segment like that, it's highly dependent upon ordering cycles. So I'm not concerned about our relevance or anything relative to that. | |
| On the switching business, I think it's important to understand a couple things. Number one, your question relative to the ACI portfolio, and has it exceeded the traditional portfolio, I think we -- the answer to that is, yes. And our orders there were -- I think grew in the data center switching business, were up mid single-digits. | |
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| Kelly Kramer, Cisco Systems Inc - CFO [49] | |
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| Yes, in the revenue, on the revenue side, yes. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [50] | |
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| On the revenue side. And so that transition continues to go well, and we see customers that are investing in new cloud-ready architectures, are choosing the ACI platforms, which is showing in the results. When you look at our overall switching portfolio, it's just important to understand the math on what percentage of that business is still attributed to our campus portfolio. | |
| And as we said, any time we have these macro -- these environments where customers have any level of uncertainty, that tends to be an area that they will continue to sweat, if they can. And our job over the next several quarters is to drive innovation in that portfolio, integrate security more tightly, and again, focus on orchestration policy and helping our customers lower their costs. And that's what we're going to try to do. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [51] | |
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| Thanks, Chuck. Next question, please? | |
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| Operator [52] | |
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| Yes, our next question is from Jayson Noland with Robert Baird. Your line is now open. | |
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| Jayson Noland, Robert W. Baird & Company - Analyst [53] | |
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| Okay, great. I wanted to ask about long-term revenue growth. I think, Kelly, 3% to 6% has been discussed in the past, but with the shift to software and subscription, and service provider uncertainty, that seems like a stretch. And I'm not asking for specific guidance, but is there some direction that you would suggest for our long-term models? | |
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| Kelly Kramer, Cisco Systems Inc - CFO [54] | |
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| Yes, you know, I think that's a great question, Jayson. If you go back to -- I think that was back in June of 2015, was our last financial analyst conference, it has changed quite a bit. Our transition has accelerated, that we've been accelerating. And I'd say the other major change from that long-term guidance was certainly our expectation of the data center business, and that market has changed. | |
| So I'd say there is no long-term model change per se right now, but we're in the process of planning an analyst conference hopefully at the end of the calendar year here, and we'll update that. But I would say those are the two major assumption changes since we did that. | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [55] | |
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| Thanks, Kelly. We have one more question, time for one more question. | |
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| Operator [56] | |
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| Yes, and our last question comes from Simon Leopold with Raymond James. Your line is now open. | |
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| Simon Leopold, Raymond James & Associates - Analyst [57] | |
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| Great, thank you very much. I wanted to see if we could talk a little bit about longer term on the routing business, specifically. What you laid out sounds like very much the cyclical challenges facing your peers, as well as weak carrier CapEx. But if you could help us understand some of the longer-term themes around what's going on in routing, and how that sector may grow and your business may grow. And I'm pondering the implications around sort of SDN, as well as some of the architectural shifts of putting more of the burden into the optical space. Thank you. | |
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| Chuck Robbins, Cisco Systems Inc - CEO [58] | |
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| Yes, Simon, thanks for the question. When I think about routing, I actually think about it in several different ways. Number one, you've got the SP traditional portfolio with Edge access and core, which we discussed earlier, which is largely just a consumption-driven cycle that we go through. | |
| In the enterprise space, we have this transition to software-defined wide-area networking, which we're very well-positioned in right now with our IWAN portfolio. And we're actually working on a key differentiator for us, which I think is, as our teams have built out the ability to really drive the next-generation secure Edge. With our cloud security capabilities, the combination of dynamically provisioning those branch solutions, with the ability to have robust cloud security and Edge security, is going to be a real differentiator for us. So we see that being another opportunity for us going forward in the routing space. | |
| And then finally, when we talk about the security and the security-driven refresh of our core, in Q4 we actually had a couple of customers -- I talked earlier in the opening comments about Stealthwatch Learning Networks. Which is effectively a machine-learning algorithm that runs at the edge of the network in the branch, and it actually does machine learning and a little bit of AI to determine normalcy for customers, and then flag for them when they see abnormal behavior going on. And we saw a couple of customers that actually made the decision to do a branch router refresh based on that capability, which we just launched in July. | |
| So we believe that there's innovation that we can bring that will lead us to a refresh opportunity in the core, and we think that's largely going to be driven around security. And we're seeing some real early examples. We need to see how it plays out, but we're seeing some early examples there. | |
| All right, Marilyn. Thank you very much. In wrapping up, I just want to summarize our priorities again as we think about the year ahead. First off, we're committed to executing against the financial model and against our priorities, regardless of the conditions of the market. And we're committed to making the decisions that are necessary to drive our growth, and also to fulfill the commitments and obligations that we made to our customers, partners, and shareholders. | |
| We also are pleased with where we are on the transition to software and subscription models, and you can assume that we'll continue to accelerate that over the next year. We also -- I believe we'll drive a greater pace of innovation than you've seen in the last several years from Cisco. Our teams are very excited. There's a lot of things going on. So we're very committed to driving innovation. | |
| And then finally, just to reiterate, our long-term strategy to create greater value for our customers and our shareholders, while ensuring that we're also making the decisions for Cisco's long-term success, will remain at the forefront. So I want to thank everyone for spending time with us today, and we'll look forward to talking to all of you soon. Marilyn? | |
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| Marilyn Mora, Cisco Systems Inc - Head of IR [59] | |
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| Thanks, Chuck. Cisco's next quarterly call, which will reflect our FY17 first-quarter results, will be on Wednesday, November 16, 2016, at 1:30 PM Pacific Time, 4:30 PM 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 an explicit public disclosure. | |
| We now plan to close the call. If you have any further questions, please feel free to contact any member of the Cisco Investor Relations department. And we thank you very much for joining today's call. | |
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| Operator [60] | |
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| Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1-888-566-0452. For participants dialing from outside the US, please dial 1-203-369-3048. This concludes today's conference. You may disconnect at this time. | |
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