Cisco Systems Inc (CSCO) — Q3 2016 Earnings Call Transcript

Thanks, Kim. Welcome, everyone, to Cisco's third quarter fiscal 2016 quarterly conference call. This is Marilyn Mora, Head of Investor Relations. And I am 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 sheets, cash flow statements, and other financial information can also be found on the Financial Information section of our Investor Relations website. Throughout this call, we will be referencing both GAAP and non-GAAP financial results, and we'll 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 third quarter. They are subject to the risks and uncertainties that we will 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 Q3 fiscal 2016. As such, all of the revenue, non-GAAP, and product orders 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 Q2 earnings call and today's call has been normalized in the same way. With that, I'd like to go ahead and turn it over to Chuck.

Thank you, Marilyn. We delivered strong Q3 results against the backdrop of the macro environment that continues to be uncertain. Despite this uncertainty, we executed very well, with revenue growth of 3% and non-GAAP EPS growth of 6%. We continued to generate strong operating cash flow of over $3 billion in the quarter, returning nearly $2 billion to shareholders through dividends and share repurchases. Our commitment to operating discipline continues to yield solid results in spite of the challenging environment. The operational changes we continued to make will further enable our customers to leverage a strategic role in the network as they transform their businesses to become digital. As I did last quarter, I would like to highlight our momentum in four key areas. First, in Security, we saw continued acceleration in the third quarter with revenue growth of 17% while deferred revenue grew 31% driven by our ongoing shift from hardware to more software and subscription services. Our security business is tracking as we indicated it would earlier in the year. As one of the largest IT security vendors, we believe our portfolio is the most comprehensive and effective in enabling our customers to protect their businesses. Security is and will remain one of our absolute highest priorities. Second, collaboration. Revenue accelerated by 10% and deferred revenue grew 16%. This is yet another example of a successful transition to a cloud-based platform increasing our market leadership which we expect will give us sustainable long-term differentiation. Third, our next generation data center portfolio is extremely well positioned to meet our customers' needs regardless of where they place their workloads, enabling public, private, or hybrid cloud deployments. At our partner summit, we received a very strong response to innovations as customers adopt our next generation data center solutions. Our strong position is evident in our installed base of 52,000 UCS customers and the continued success of our ACI portfolio. In March, we announced a dramatic improvement in price performance, and by this I mean 100 gig performances for 40 gig pricing driven by new A6, which provide us a time-to-market advantage of 18 to 24 months while maintaining the same margin profile. In Q3, our ACI platform grew revenue approximately 100%, while it exceeded a $2 billion annualized run-rate, far outpacing our next closest competitor in both size of business and growth rate. Our entry into the hyper-converged market with HyperFlex, as well as our acquisition of CliQr, an innovation in multi-cloud orchestration, extend our leadership position in the data center. Finally, we continue to make great progress in transitioning more of our revenue to recurring with increased emphasis on software and subscription offers. Our software subscription deferred revenue balance continues to exhibit accelerated growth this quarter, up 36%. We have a number of strong proof points of how we have executed successfully against our objective and the potential to apply the same model to the rest of our portfolio. In addition to the success I have highlighted in our security and collaboration businesses, we had double-digit revenue growth again this quarter in Meraki, which stands out as an excellent example of how we begun to scale our enterprise networking into a subscription mode. As I look to the future, you will see us expand the approach we have taken with the success of Meraki, collaboration and security, and apply it to our data center and core networking for both enterprise and service providers. Our $180 billion of installed base with by far the most widely adopted operating systems for networking makes us uniquely positioned to lead this migration. While the overall macro environment remains uncertain, we are nicely positioned to benefit from any rebound in the global economy. At the same time, we will continue to manage our business to capitalize on the key growth areas in front of us. I am very pleased with our demonstrated ability to execute operationally and strategically in virtually any environment. Now I will turn it over to Kelly to walk through more details on our financials.

Thanks, Chuck. I am pleased with our continued execution on our financial strategy of delivering profitable growth, managing our portfolio and strategic investments, and delivering shareholder value. Starting with delivering profitable growth, total revenue was $12 billion, up 3%, with growth in product revenue of 1% and services of 11%. We did have an extra week in Q3, consistent with our guidance of the quarter. The benefit to revenue was approximately $265 million, $200 million of which was from our services, subscription businesses, and $65 million from our SaaS businesses like WebEx, as well as from our product distribution. In switching, as Chuck mentioned, we continued to see good momentum with ACI and the next-generation data center. The 3% decline in switching was mostly driven by macro-related weakness in our campus business, offset by positive growth in our data center switching. Routing experienced a 5% decline, mostly driven by the high-end. We are seeing continued strength with our web-scale customers, where our core development continued, and our sales to the top 10 web-scale customers were up 31%. Collaboration grew 10% by strength across the entire portfolio, and deferred revenue grew 16%. WebEx continued its double-digit growth with solid performance in Telepresence and Unified Communications driven by our new offerings in those areas. Data center grew 1% with the slower growth largely driven by continued macro challenges impacting customer spend. We expect that our HyperFlex offering will further expand our growth opportunities in the data center. Wireless grew 1%, led by strong double-digit growth in our cloud-based Meraki platform, partially offset by declines in our controller and access point businesses. Security grew 17%, along with continued strong deferred revenue growth of 31%. We had great performance in our advanced threat security and web security solutions, which grew over 100% and 50%, respectively. SP Video grew 18% with ongoing strength in China. Services revenue grew a very solid 11%, which includes the $200 million for the extra week I mentioned. Normalized for the extra week, the growth was 4%. We again saw very good progress against our goals of driving more recurring revenue. Deferred revenue had solid growth of 8%, with product deferred revenue of 9% and service of 7%. The portion of our product deferred revenue relating to our recurring software and subscription business grew 36%. From an orders perspective, product order grew 3% with a book-to-bill comfortably above 1. Looking at our geographies, which is primarily how we run our business, Americas grew 4%, EMEA was up 2%, and APJC grew 1%. Total emerging markets grew 4%, with the BRICs plus Mexico showing strength at up 4%, with China up 22% and India up 18%. Brazil and Russia continue to be challenging, now combining to represent less than 2% of our total product booking. In terms of customer segment, enterprise declined 2%, commercial grew 8%, public sector grew 6%, and service provider was flat. Similar to Q2, we are seeing pressure in the enterprise segment driven by the macro uncertainty. We drove strong profitability this quarter, especially with gross margins. From a non-GAAP perspective, gross margins were 65.2%, with product gross margins of 64.5% and service gross margins of 67.1%. Operating expenses were 35.2% of revenue, and operating margin was 30%. The total impact of the extra week on our non-GAAP cost of sales and operating expenses was $150 million. We are being very disciplined in this tough macro and pricing environment, focused on making the right investments while driving operational efficiencies and productivity. From a bottom-line perspective, we delivered non-GAAP EPS of $0.57, up 6%, while GAAP EPS was $0.46. Q3 non-GAAP income was $2.9 billion, up 4%, while GAAP net income was $2.3 billion. We have been very active from an M&A perspective, closing five acquisitions in Q3. Jasper Technologies making Cisco the largest cloud-based IoT service platform helping enterprises and service providers launch, manage, and monetize IoT services on a global scale. Acano, which provides on-premise and cloud-based video infrastructure and collaboration software. Synata which enables us to deliver search capabilities for collaboration cloud applications, Leaba, a fabless semiconductor company and CliQr, which defines an application-defined cloud orchestration platform which is expected to help Cisco customers simplify and accelerate their private, public and hybrid cloud deployment. These acquisitions are clearly focused on our key growth areas including IoT, software cloud and collaboration as well as continuing to strengthen our core. We have also seen solid momentum with our Ericsson partnership closing 17 deals this quarter. Moving on to shareholder value, in Q3 we delivered operating cash flow of $3.1 billion. Total cash, cash equivalents, and investments at the end of Q3 were $63.5 billion, with $6.3 billion available in the US. We returned $2 billion to shareholders during the quarter, which included $649 million of share repurchases and $1.3 billion for our quarterly dividend, which we increased by 24% in Q3. Overall, Q3 was a very solid quarter in a difficult macro environment. We focused on strong operational execution resulting in top line growth, stronger gross margins, and continued operating leverage consistent with our expectations. We are making the right investments in the growth areas of the business, balancing our decisions with sound portfolio management. Let me now reiterate the guidance we provided in the press release for the fourth quarter of fiscal year 2016. This guidance includes the type of forward-looking information that Marilyn referred to earlier. The guidance for Q4 is as follows: We expect revenue growth to be in the range of 0% to 3% year-over-year normalized to exclude the SP Video CPE business from Q4 2015. 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 $0.59 to $0.61. We anticipate our GAAP EPS to be lower than the non-GAAP EPS by $0.08 to $0.11. Further details to this range are included in the slide and the press release that accompany this call. I will now turn it back over to Chuck.

Thanks, Kelly. So let me quickly summarize before we move to questions. First, I think the number one key takeaway is that we continue to execute well even in an obviously very tough environment. Secondly, we have proven our ability to transition certain elements of our portfolio, like we have done with Meraki security and collaboration, and we believe we can accelerate long-term growth by bringing the same approach to our core, and this process has begun. And finally, everything we do will be done through the lens of enabling our customer's success while driving value for our shareholders. Marilyn, I will turn it over to you for questions.

Thanks, Chuck. Kim, let's go ahead and open the line for questions. And while Kim is doing that, I would like to remind the audience that we ask you to please ask one question.

Hi, thank you very much. I just wanted to clarify your guidance for the July quarter. How much of the revenue comes embedded from acquisitions that closed in the last year just so we can get a sense for the organic sense in the business? And then when we think about the 3% growth in bookings in the quarter, how much of that benefited from the extra week in the quarter?

Yes, I'll answer the second part first, Simona. In terms of how much benefit we got from the extra week, we don't think there's much. What we saw this quarter was the forecast was pretty straightforward. The team saw deal closure and conversion rates drag on because especially in the enterprise segment; and quite frankly, the deals that we closed were more in line. So we don't think we had any upside from the extra week in bookings sitting there. In terms of your first question on your acquisitions, we will start to see - in the current run-rate, we have the bulk of OpenDNS and everything else. For the new acquisitions, you don't have the full quarter in a run-rate, we will get a bit of benefit from Jasper and Acano, but it's not terribly material in the overall growth rate.

Thanks, Simona. Kim, we will go ahead and take the next question.

Thanks and congrats on great execution. First question is regards to the data center. I hear your comments with regards to the macro impact on it, but it's five quarters in a row now. Our data business is stuck between the $800 million to $850 million revenue, and this business has to account for about a third of your growth in the past few years; so if you could give us a little bit more color as to why it's not moving, that would be great. And the second question is regarding the gross margins. I had to go back all the way to 2010 to find product gross margins that are equal to those you just reported. Can you just give us a little bit more maybe of a framework to think about what is really changing in the portfolio, whether it be the mix or changing the competitive environment, anything that can justify the increase in gross margins and how sustainable do you think that is?

Hey, this is Chuck, and I will answer the first one and I will give Kelly the gross margin question. So as we look at the data center business, we see a few things going on. First of all, we think that there is an impact coming from the overall macro environment that is relatively undeniable. We also saw, as our peers, some caution in the CapEx spend and the service provider space, and that was one of the segments we saw weakness this quarter even with our data center portfolio. We take data center in this context; we are talking about UCS in particular. The other thing that is going on is there is a transition going on in the data center relative to workloads. I talked a little bit about it on the last call. We see workload specific use cases being deployed on high-performance blade systems like our classic UCS; then we see also this move to hyper-converged systems, which led us to the launch of the HyperFlex platform last quarter. We also see a transition to rack-based systems, which also results in stacks that are driven by container-based architectures; and so in the last quarter, 30% of our business was from the rack portfolio, which we do have for the appropriate use cases. And you will see us continue to expand our offering so we have UCS as a blade system, we have a rack conversion of UCS, we have HyperFlex in the market, and you will see us continue to expand in our portfolio to meet the evolving use cases in the data center. I think that's what's going on right now. Kelly, on the gross margin question?

Yes, on the gross margins, I would say, Ittai, a couple things. You are absolutely right when you go back and look historically. If you go back and normalize, the biggest thing we did was obviously when we got out of the set-top box business; that helped us quite a bit and normalized. If you go back to just Q1 of this year, we were at a $64.9 million, and we had even last year, we had a $65.1 million. So I would say it's kind of the new normal in that $63 million to $64 million range. I would say the only other thing when you go back and you update your models for the extra week, because a lot of the top one that I talked about comes off the balance sheet, and there's not incremental cost. I did get a half point benefit just from the extra week in my gross margins. So I'd say a normalized view on the gross margins would have been closer to $64.5 million.

Thanks, Kelly. Kim, we will go ahead and take the next question.

Yes, thanks. Clearly better than results, congratulations to you and your team. My question is as follows: Chuck, heading into the back half, what gets you most excited in terms of new product refreshed opportunities? And then, now that your security business is starting to turn the corner, especially versus the pure plays, would you double down on security investments both organically and in M&A? Thanks.

Yes, Vijay. I think the number one thing I am feeling very positive about right now, again, we have shown that we can drive the transition in our collaboration portfolio, which is as you see that business over the last two years, the team's done a great job of transitioning into a portfolio that is available to our customers as cloud-based services in seeing it growing double digits and also growing our deferred revenue balance of 16%. I think that's one example; and security, 46% of our business now comes from software and subscription services, which is clearly the direction that we had indicated we were going to take it, at the same time growing 17%. Our Meraki business, which really shows the evolution of networking to cloud-based management and policy, is over a billion dollars now and growing double digits. I think the thing I am most excited about longer term is we see a path to deploy that model across the rest of our portfolio, and again that work has begun. I think in the near term we see obviously a mix of pretty cautious environment still because we do see customers spending where they need to spend, but don't misunderstand, there's still a fair amount of caution in the market. But I think we have executed well this quarter; we had five of our seven product categories that were in positive growth with three of them in double digits. We had all the GOs in positive growth from an order perspective, and we saw pretty good strength across our segments. So that's the first question. The second one relative to security, the answer is yes, yes, and yes. We will continue investing both organically and any other way we see appropriate to drive that architecture. The team's done a phenomenal job.

Kim, we will go ahead and take the next question.

Thank you. Your switching and routing business, so businesses were both down. I guess how concerned are you about that? Do you think your product portfolio is yet to impact that? Do you believe your share or it's the market finally? What's the impact on your services business? In other words, how much of that is maintenance that could be impacted by declining hardware?

Let me address the first part, and then Kelly can connect it to the hardware. Regarding the switching business, I want to highlight a few points. Last quarter, we mentioned that growth in our campus switching segment is mainly due to refresh cycles, but during uncertain times, enterprises tend to stick with their existing infrastructure and refrain from upgrading. Consequently, we are witnessing a pause in that refresh cycle, which we discussed last quarter, and there hasn't been any significant change since then. However, we did observe an increase in our data center switching revenue growth. Additionally, we had indicated that we expect our new data center switching product portfolio to outpace the declines of our traditional products. Notably, our order growth rate this past quarter for that $4 billion portfolio was in the double digits, which is promising, and we are pleased with our advancement in the data center switching area. As for routing, several factors are at play. We are facing some macroeconomic challenges, and we have also noticed increased caution among service providers. There has been slow movement in the core of those networks and relatively flat activity at the edge. We have several new platforms undergoing certification with key players, and we anticipate that these will favorably impact our results in the upcoming quarters; that is our current perspective.

And in terms of Steve, your question on the impact of the services business, typically for new sockets there would be a little lag for that, but I would say that our service business has been laser-focused on driving renewals. So even if enterprises are holding on to their switches and routers longer, our services team and sales team have been very focused on getting the contracts renewed. And we have seen that pay dividends with the acceleration of growth. If you normalize our service revenue for this quarter for the extra week, it still grew 4%, which is up from 3% year-over-year growth in Q2, and it was 1% in Q1, so we are really starting to get traction there.

Yes, and Steve, if I can just pile on to what Kelly just said, the team has been building out, trying to strengthen our capability around the entire software and subscription model, which requires a lot of focus on adoption and renewals. We have also taken the same approach to just sharpen our focus on our services renewal business, and we did see improvement in that last quarter, so I am happy that the team is making progress there as well.

Thanks, Steve. Kim, let's go ahead and take the next question.

Thank you and congratulations Chuck and Kelly to your team here at Cisco. One thing that stood out was the very impressive gross margins this quarter. If I calculated correctly, it looks like there is around $65.2 million, and that was meaningfully above I think your guidance was $62.5 million to $63.5 million. Can you help us understand what were the factors to drive it higher? Because I know the driving's all included in the extra week, and for the outlook, are there any types of swing factors we should be aware of and the causes of why would be lower than reported gross margins from this quarter? Again, congratulations to your team.

Yes, sure. Thanks for the question, Jim. The thing to keep in mind, true, we did guide with the extra week which came in line; but just again, a couple of things. When we guide, we tend to have a little conservatism in the gross margin rate, but take off that half point and we are still parked at the $64.5 million range. We do have normal seasonality quarter in and quarter out. So always, Q1 and Q3 are our strongest quarters, and Q2 and Q4 are weaker, and it's typically driven by our mix, especially our mix of drivers in those two quarters, so that's also a driver. Operationally speaking, again, the teams are doing a very good job from a productivity perspective in terms of driving costs out of the product. We had lots of efficiencies out of this supply chain in terms of managing our freight and our inventory management. So I would say we had a very strong quarter from an operational excellence perspective. If I look at pricing this quarter, we are being very disciplined on pricing. We are starting to see a tiny bit of a tick up, and you will see that in our queue where the impact to our gross margin rate year-to-date was 2.2%, and Q3 was 2.4%, so still strong. But we are still seeing price arise, but the strength we are seeing this quarter mostly came from just improvements in productivity.

Great, thanks, Kelly. Next question please.

Hi, good evening. Thank you for taking my question. I just wanted to come back on what you said about your hyper-scale and web-scale clients. So if I get that correctly, you had revenues of 31% there? Could you give us a sense of what made up most of this revenue and most of this growth? Was it mostly switching, routing, anything else? And then if we experienced that very strong performance in that segment, what did the rest of the enterprise look like in terms of growth? So you were down 2% overall; I assume it is higher. What scale is probably 31%, the rest of the enterprise was down quite significantly. And lastly, could you help us quantify any kind of the macro impact you mentioned with enterprise in this quarter, and in your guide for next quarter? So right on the points of revenue or whatever, do you have a sense of how much you have lost because of the uncertain macro environment? Thanks for that.

Okay. So I will start and make sure I don't forget the rest of the pieces here. Chuck, you got me covered there? Okay. So of our massively scaling debts and our customers, of that amount, more than half of it is certainly switching, and the next biggest follower is routing, so it's more than 50%, significantly more than 50% is our switching products. To your point on what you inferred, what would mean if switching overall was down three, I just want to reiterate what you are doing.

Let me just clarify the question. He believes that we will roll the we scale into our enterprise business, so he was saying we were negative two on enterprise, so our service provider segment, so now you can answer that question.

Yes, sorry about that, Pierre. These web-scale customers are definitely in our service provider segment, which was flat overall from the quarter of our bookings perspective. On the rest of the portfolio to your question of the service provider, we are seeing the slowdown from just overall; there's a lot of CapEx spend, and you're seeing it reflected certainly on our routing portfolio.

Yes, a couple of comments. I don't think we have exposed over half that business is coming from switching, so clearly there is value in our switching portfolio; the web-scale players are seeing that. I also think that there is still a small percentage of the overall SP business as it relates, which is why you will see flat when this segment goes up 31%, given the size of that business. But obviously, you could have done the math. But I do think that our teams have done a good job here. Kelly, the third portion of the question was that relative to any revenue impact in Q4 that we have built into the guidance, relative to the macro environment. Just generically, we are not modeling any improvements; I think is the safest way to say it. We do see a continued amount of uncertainty out there, and we are not modeling any improvement into Q4.

Great, thanks Chuck. Next question please, Kim.

Thank you for taking the question. Chuck, I wanted to follow up on services revenue. I get there was a clear benefit of an extra week, but this down marks, I think, the second quarter in a row of upside coming from the services segment. I imagine most of the return is double-digit growth was the extra week. I guess my question is, are you seeing a broader increase in services driven by solution selling trends? And if so, do you expect the services kind of recovery to potentially be a leading indicator for a future product recovery?

Thanks for the question, Brent. Let me say that over the last few quarters, Joe Cozzolino and his team have been incredibly focused on driving the operational excellence around the P&L element of that, which is what you are seeing with the gross margins. I think some of the discussion I had earlier around the focus on the renewal capability, I think we are seeing general improvement in the execution there. We see advanced services obviously doing reasonably well; security services doing reasonably well; and as I mentioned earlier, the renewal activity, our teams did a better job this past quarter. So I think a lot of what you are seeing is operational discipline and execution, to be honest. However, I think there is an opportunity, and more of our customers are asking us to help them as they look at their strategies to take advantage of this digital transition that's occurring. I am not sure I am in a position where I will give you any sort of tangible connection between it and future part of the growth, but we definitely see that as a required service we are going to provide to our customers because they are looking to us as one of the few large capable financially viable partners that really understand this transition.

Great, thanks Chuck. Next question please, Kim.

Yes, thanks, good afternoon. Just want to see if we can talk a little bit more about the cloud ACI momentum. How should we think about the mix of this cloud revenue for Cisco in terms of how much is going into public cloud vs private cloud as the run-rate improves? And then, is there any change in the public cloud versus private cloud related to a margin either from a gross margin or operating margin perspective we should be aware of? Thank you.

Thanks, Mark. So I will let Kelly tackle the second question. If you look at where we declared when we stated our strategy around cloud, it really is focused on enabling what we believe to be the long-term desire of customers to operate in a hybrid cloud model, and we said that we were going to do three primary things. We were going to make sure that we provide the infrastructure to the cloud providers, and we have done that, SPs and we have done that obviously with the top ten web-scale providers given the business was up 31%. We also said that we were going to transition our portfolio to be cloud delivered and as a service, which we are going to make sense over time across the entire portfolio, and you have seen us do that with our continued growth in Meraki in collaboration and security, and now the plans are actually underway on the project to deploy that across the rest of our portfolio, although it's early days. But I think when you look at that deferred revenue of 36% on the balance sheet, that says we are being successful in the second pillar. And then the third pillar was to help our customers with the infrastructure needed to actually take advantage of both private and public clouds or enabling hybrid. When you look at the data center switching portfolio on an annualized $4 billion business with new orders growing in double digits, I think that customers are driving both and the three pillars of that strategy are working. As far as gross margins when we sell to private cloud versus public cloud providers, Kelly, any comment there?

Yes, I would say we obviously have different margin profiles within both, but I will say whether it's campus versus data center or whether it's to the service providers versus enterprises, both margin profiles are well above the Cisco average gross margin rate, and between campus and data center side, we are within 5 to 6 points of gross margin, so the differentiations not much there. We can have variations within that. We can have some public cloud customers on some deals that might have better or worse margins, but overall the portfolio is within those ranges and again way accretive to the overall system of the margin.

Kim, next question please.

Great, thank you very much. I just had a clarification. You talked about ACI hitting about a $2 billion annualized run-rate, and I think our notes have suggested it was at a similar level the last couple of quarters at least you gave us similar level. I just wanted to make sure our notes were right there. And then really my question is around acquisitions. You guys have clearly been quite active doing acquisitions and doing a lot of what looked to be pretty promising technology-related acquisitions. Should we expect the current pace to persist, or are we going through an accelerated period that you expect we will be going down from? Thanks.

I will take the first one. So on the first one, yes, we are being rounded. It's actually closer to $2.2 billion run-rate and sequentially I am certainly up from what I was last quarter.

Yes, I think when we hit it last quarter, it was probably roughly $2 billion; now it's closer to $2.2 billion or $2.5 billion on the ACI portfolio, and then on the acquisition front, what I would say is that given the valuations and the movement in the tech industry, there will continue to be opportunistic. We are in a good position as a strategic buyer with some of the challenges in the public market and some other valuations becoming a little more realistic. What I would suggest to you is over the next 12 months, we will be quite as active as we have been in the past; I wouldn't expect it to be quite as fast-paced as it has been, but we will continue to be opportunistic around the areas of growth important to our future.

Kim, next question please.

Thanks very much. Going back to the question about the top ten webs, I don't think you have ever broken it out or at least my memory. Routing is 15% of your total revenue, and service providers, if I typically remember the numbers correctly, were 80% routing; that would suggest that the web guys were somewhere in the range of 15% of total revenue if looking at the current numbers correctly. Is that the ballpark?

Yes, Paul, we haven't been disclosing that, so we just don't disclose that.

Isn't that 15% range?

Again, Paul, it's not something we give out. I apologize, but it's not…

No worries, all right, let me ask you a simple question, and I think you mentioned it before, but can you give us any insight on the linearity of the quarter?

Yes, I'd say it wasn't that crazy. I mean, obviously, our extra week went actually filled in from a calendar perspective was in February. But again, because the way the teams were forecasting, I'd say the linearity in terms of what we see usually coming through was in the normal ranges.

Thanks, Paul. Hey Kim, we'll go ahead and take the next question.

Hi, hopefully, you can hear me. I have just one clarification; the tone of the previous conference call was very different. It was about a very weak environment, and we didn't speak about the growth trends. The tone of this conference call is so much more positive in a very similar business environment. So what happened in the last three months that makes you so much more positive about everything you've done? Basically, also before, very little is new now. What makes you so much more positive now versus three months ago in a similar environment unless maybe the environment gotten better?

It's a good question, Tal. I'm just having a better week this week. No, I'm kidding. I think the difference is that when we ended our last quarter in late January, the stock markets were experiencing extreme volatility, which caused our customers to significantly halt their orders. As a result, the closing weeks of that quarter were challenging for us from an orders perspective, particularly with our enterprise customers who were very hesitant due to uncertainty about future developments. This cautious atmosphere contributed to our more reserved tone at that time. While we are optimistic and satisfied with our execution now, we still find ourselves in a fairly uncertain environment. We have Brexit approaching, the vote in June, recent news from the Fed, ongoing election dynamics, issues in Brazil, and various geopolitical factors. There remains a wide array of unknowns, but I believe that the stock market volatility and the timing at the end of the last quarter are key factors that differentiate our current outlook.

Thanks Chuck, I think that was really helpful. Operator, we'll take another question please.

Great, thank you. I wanted to go back to the web-scale vertical a bit. I know that's beating the dead horse a little on this call, but I wanted to see if you could talk about the bigger trend around the white box competitive threat, because it seems apparent that there is not the dramatic shift to white box that many had feared, but maybe it's yet to happen. So if you could talk about how you're countering the threat or the substitution effect of those web-scale customers building or buying unbranded switches rather than your products? Thank you.

Yes, Simon, it's a great question, and I believe there's a misunderstanding about the perception that all customers want to purchase white box switching. It's similar to the notion that everything is centered around the cloud, SDN, or white boxes. Customers are not simply pursuing a technology trend; there are fundamental business drivers pushing them toward specific solutions. Therefore, we are concentrating on addressing these business drivers rather than the technology trends that are often covered in the media. For instance, web-scale players are primarily interested in substantial automation and the capacity to operate large data centers cost-effectively, emphasizing automation that I believe will eventually become standard across all customers. There is a strong emphasis on reducing operational expenses, focusing on automation and programmability, which aligns with our core platforms and the needs of enterprises. We have developed some very competitive products, including the A6 enhancements that provide us with an edge in price and performance, enabling our portfolio to integrate smoothly into their operational environments. These considerations have been crucial for us. Customers are not solely fixated on white box solutions; instead, they are focused on solving their challenges. We're dedicating more time to understanding their needs and determining how we can meet those requirements, and you'll see us continually evolve our portfolio to ensure we remain relevant in this space.

Kim, next question please.

Chuck, I'm wondering if you could walk us through what you've seen so far with the Inspur relationship in China. I see China revenue decelerated, but it still grew very strongly at 22%. And also, the Ericsson relationship, it sounds like you got some big deals from the quarter or a few deals in the quarter. Maybe just highlight if you feel like that relationship is still on track for this $1 billion by 2018. The reason I ask, obviously, Ericsson had a very soft March quarter. Thank you.

Brian, it's a great question. I actually didn't expect anyone to highlight the fact that our China revenue was decelerating as our third quarter was really solid growth in China. Now I'll point out that that is across the board; it's across the portfolio. The team has done an amazing job there, and I've spent a fair amount of time over there, and I think that we're really pleased with where we are in China right now, in the midst of the uncertainty that's been discussed in the marketplace. On the Inspur partnership, in September we signed the MOU, which was basically a letter of intent to formulate the venture, and I was over three weeks ago, where we formalized the term sheet basically, and we're in the final stages of getting that one put together. I would expect it will be in the market sometime in the fall with some of the early products and solutions with them. We're spending a lot of time with them right now. So I think sort of late this year is when we'll begin to see some early results from that. I think on the Ericsson front, anytime you do these really large partnerships, they always take a little longer probably than we would all hope, but we're very optimistic. We just spend a ton of time together; I think on the last call we talked about the number of joint solutions within the first 100 days that we actually had on display together at Mobile World Congress, which was pretty amazing. And then this past quarter, we saw 17 transactions close between our teams, which in the midst of a time when HANS was doing a pretty significant organizational restructuring, and our teams are getting to know each other. So we think that we'd all wanted to go faster, but we're pretty pleased with where that partnership is right now.

All right, Chuck, I think that was our last question. Now I want to go ahead and turn it over to you to close it up.

All right, thanks, Marilyn. First of all, I want to thank everybody for spending time with us today, and I want to thank you for your questions. I would just go back to the three things that I stated earlier. I'm really proud of what we've done; I'm proud of the way the teams have executed. It is a challenging environment out there, and I think that our teams have proven that we continue to execute regardless of the environment we face. As I said last call, we're running the company on two fronts; we're focused on the execution and the operational excellence, and at the same time, we're focused on transitioning our business and investing in the future, which I think was displayed by our progress in the different areas that I highlighted during the call today. I think that again, if you look at our success and security, collaboration, next-gen data center, the Meraki cloud networking platform, and overall on our transition to software and subscription, I think we're on that journey. We've proven that we can transition elements of our portfolio, and we're going to apply that same approach again to the rest of our business. We're in the early days in the front end of a long journey, but I'm pleased with where we are. So I want to thank all of you for spending time with us today, and I will look forward to talking about to you soon. Marilyn?

Thanks, Chuck. Cisco's next quarterly call, which will reflect our fiscal 2016 fourth quarter and annual results, will be on Wednesday, August 17, 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 the Cisco Investor Relations department. We thank you very much for joining the call today.