Cisco Systems Inc (CSCO) — Q4 2017 Earnings Call Transcript

Thanks, Mark. Welcome everyone to Cisco's fourth quarter fiscal 2017 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 sheets, cash flow statements and other financial information can also be found in the Financial Information section of our Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis unless stated otherwise and the full year revenue and non-GAAP comparison has been normalized to exclude the divested SP video CPE business from our historical results. The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter of fiscal 2018. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on form 10-K and 10-Q which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. With that, I'll now turn it over to Chuck.

Thank you, Marilyn, and good afternoon everyone. As you know, it's only been seven weeks since we last spoke at our Financial Analyst Day and our overall outlook remains consistent with what we outlined at that time. In fiscal 2017, we continued to execute well against our vision of delivering customers a highly secure intelligent platform for their digital business. We managed our business through a dynamic environment and at the same time delivered significant innovation to further accelerate the next phase of our transformation. In Q4, we generated revenue of $12.1 billion and non-GAAP earnings per share of $0.61. For the full fiscal year, revenue was $48 billion and we delivered non-GAAP earnings per share of $2.39. We drove strong margins and record operating cash flow for the year. Our results demonstrate solid execution against our strategic priorities. Accelerating our pace of innovation, increasing the value of the network, and delivering technology in the way our customers want to consume it. In June, we announced a new era of networking with the launch of the Network Intuitive. This is an example of the industry leading innovation Cisco is providing to its customers. The Network Intuitive is a new intent-based network that creates a fully integrated intuitive system that is designed to anticipate actions, stop security threats in their tracks, and continue to evolve and learn over time. We're applying the latest technologies such as machine learning and advanced analytics to operate and define the network. From a security standpoint, the new network enables our customers to detect threats in encrypted traffic with unprecedented accuracy using Cisco's encrypted traffic analytics and intelligence from Cisco's Talos cyber intelligence unit. We have created the only network that is designed for security while maintaining privacy, solving a previously unsolvable problem. Our new Catalyst 9000 switches represent the foundation of our intent-based networking capabilities and provide highly differentiated advancements in security, programmability, performance, and lower operating cost by innovating at the hardware and software layer. This offering is also a great example of how we're moving our core business to a recurring revenue model. Customer reception to this new innovation has been incredibly positive. As we've always said, transitions of this nature are multi-year, but during the first four weeks in the market our pipeline and product orders are strong. With over 200 customers having ordered the new Catalyst 9000, the heart of the Network Intuitive platform. Our software value proposition in this portfolio is also compelling as the large majority of our customers are adopting the most advanced subscription offer available. Building on this early success, we intend to further accelerate our leadership in intent-based networking through the combination of our expertise in network infrastructure, AppDynamics visibility into applications, and the Talos automation capabilities. I believe that over the next several years, we will see continued increasing relevance of technology as customers add billions of new connections to their enterprises. The network has never been more critical to business success and we're looking for helping our customers take advantage of the insights and intelligence that are only accessible through our highly differentiated platforms. In Q4, we also announced an extension of our strategic partnerships with Apple, IBM, and Microsoft. We plan to deliver the first enterprise security application on Apple iOS and we're integrating our comprehensive security portfolio with IBM's Cognitive Security operations platform. Additionally, we're collaborating with Microsoft in two important ways. First, we're implementing a software layer on our data center switches that gives Microsoft the flexibility to run their own operating system on our industry leading hardware platforms in their Azure infrastructure. Second, we're collaborating together to enable businesses to build and host their IoT applications in Microsoft Azure while extending the power of those applications to the edge via Cisco's leading Fog computing solutions. Now let's review other key parts of our business starting with security. We believe we are well positioned as the number one enterprise security vendor. With growing cyber-attacks and the need for our customers to protect their business-critical data and applications, we are aggressively providing security everywhere. In the network, in the cloud, and at the endpoint. We don't believe any other company can match our capabilities given the criticality of the network in our customer's security architecture. Our best of breed products in Integrated Security architecture combining analytics and automation are winning in the market. Our security business delivered a solid quarter with double-digit orders and 49% deferred revenue growth. This caps off a year in which we delivered 9% revenue growth with more than $2 billion in revenue making us the only company growing at this scale. Our leadership position in network security continues to expand driven by our next generation firewall portfolio with over 6,000 new customers added in the quarter, which is three times our nearest competitor. Bringing our total customer base to nearly 80,000. Customers continue to rapidly adopt our advanced threat portfolio. We delivered revenue growth of 9% and we added over 7,600 new customers bringing the total number of AMP customers to over 42,000. Building on our differentiated security innovations, we recently completed the acquisition of Observable Networks, which extends our Stealthwatch Solution into the cloud with highly scalable behavior analytics and comprehensive visibility. This platform expands our security, cloud security capabilities by providing greater support and compliance for applications deployed in Amazon web services as well as Microsoft Azure environments. Additionally, to combat the 90% increase in cyber-attacks against IoT devices over the last year, we launched IoT threat defense solution, an extensible, scalable security architecture created to defend devices in connected healthcare, electric utilities, and manufacturing industries. In the data center, we're helping our customers take full advantage of a multi-cloud world that has become the norm in managing their applications and hybrid cloud solutions. Our goal is to deliver the best multi-cloud platform built on an intelligent Intuitive Network enabling faster automated and highly secured delivery of applications in the cloud. We believe Cisco is best positioned to do this as everything we do in the data center is in support of modern and traditional applications both on-premise and in the cloud. Cisco has led the industry over the past four years with ACI combined with UCS to traditional cloud center and our security solutions. In Q4, we saw strong performance of our multi-cloud infrastructure portfolio combined with our cloud-based SaaS offerings including WebEx and Meraki cloud networking. For example, ACI, our fastest growing data center switching platform had a record quarter with growth of 38%. We continue to see strong customer adoption driven by our ability to accelerate data center application deployment across private to public clouds. HyperFlex our hyper-converged offering combined with cloud center is gaining traction with customers benefiting from simplicity and scalability to support their hybrid cloud strategy. You'll see us continue to strengthen our partnerships with public cloud providers as they look to Cisco to help our joint customers manage workloads across their private and public clouds. Lastly, we're delivering the right consumption models to enable continuous value and innovation for our customers. Our strong momentum continued in Q4 with 50% growth to $5 billion in deferred product revenue related to software and subscriptions which has doubled from two years ago. For the first time, over $1 billion or 11% of our product revenue came from recurring offers which grew 40% year-over-year. Overall 31% of our total revenue was recurring and revenue from subscriptions now represents 51% of our software revenue. Going forward, you should expect to see our software business benefit from the transition of our campus networking portfolio to a subscription model. To summarize our Q4 and full fiscal year results reflect a strong year of progress. We see tremendous opportunity in intent-based capabilities across our portfolio and we will continue to evolve our business to be the leading provider of highly secure software defined automated and intent-based infrastructure. Our innovation is as strong as ever, as we focus on accelerating our core networking, security, software, and cloud based businesses. While it will take time, I firmly believe our core business is better positioned for the long term as we realize the benefits from our next generation intent-based networking portfolio. Now, I'll turn it over to Kelly to walk through more detail on our financials.

Thanks, Chuck. I'll start with a summary of our financial results for the quarter and full fiscal year followed by the Q1 outlook. This quarter played out generally as we expected and as we indicated in our guidance in our last call. We executed well, drove solid profitability, strong cash flow, and we continued to deliver on our strategic growth priorities. Total revenue was $12.1 billion down 4%. We continued to focus on driving margins and profitability with strong non-GAAP operating margin of 31.5%. Non-GAAP EPS was $0.61 down 3% and operating cash flow was strong growing 5% to $4 billion. For the full fiscal year, we had revenue of $48 billion down 2% with product down 3% and services up 3%. Non-GAAP operating margin was a record $15.2 billion expanding to 31.6% of revenue up 0.6 points. Non-GAAP EPS was also a record with $2.39 up 1% and we generated record operating cash flow of $13.9 billion up 2%. Let me provide some more details on our Q4 revenue breakdown. Total product revenue was down 5%. Switching declined 9% driven by weakness in Campus partially offset by growth in the ACI portfolio which was up 38%. We saw good initial traction of our new intent-based networking portfolio of the Catalyst 9000 family of switches. Routing was down 9% driven by weakness in enterprise access, and we did see a spending cause related to our acquisition of Viptela that we will integrate into our SD-WAN portfolio. Collaboration was down 3% due primarily to a decline in Unified Communications Endpoints partially offset by continued growth in conferencing. Deferred revenue grew 4% combined with the unbilled deferred, the two were up 16%. Data center declined 4% with the continued market shift from Blade to Rack. However, we did see solid traction of our hyper-converged offerings HyperFlex. During the quarter, we launched our UCSM5 servers bringing greater simplicity and performance for next generation data intensive workloads and applications. Wireless grew 5% with strong Meraki performance as well as the ramp of our 11AC Wave 2 portfolio. Security was up 3% with strong performance in Unified Threat, Web Security, and Advanced Threat offset by declines in our legacy Firewall products. We did see very strong order growth during the quarter. Deferred revenue grew 49% as we continued to drive more subscription-based software offers. Service revenue was up 1% driven by growth in software and solutions services partially offset by decline in hardware maintenance. We drove good growth in deferred revenue which was up 12% in total with product up 23% and services up 6%. Deferred product revenue from our recurring software and subscription offers was up 50% to $5 billion. We continue to transform our business to delivering more software offerings and driving more subscriptions and recurring revenue. In Q4, we generated 31% of our total revenue from recurring offers, an increase of almost four points from a year ago. Revenue from subscriptions increased 18% and now represents over 50% of our software revenue. In terms of orders in Q4, total product orders were flat. Looking at our geographies, Americas was down 2%, EMEA was up 3%, and APJC grew 2%. Total emerging markets declined 2% with the BRICS plus Mexico also down 2%. In our customer segments, enterprise declined 1%, commercial grew 4%, public sector was up 2%, and service provider declined 7%. Our product backlog as we ended Q4 was $4.8 billion, up 3% compared to the end of fiscal year 2016. From a non-GAAP profitability perspective, total Q4 gross margin was 53.7% down 0.9 points. Product gross margin was 61.9% down two points and service gross margin was 68.8% growing 1.8 points. While our total gross margin was solid, our product gross margin is continuing to be negatively impacted by memory pricing which we expect to continue in the near term. Our operating margin was strong at 31.5%. For the full fiscal year on a non-GAAP basis, our total gross margin was 64.3% a decrease of 0.4 points. But product gross margin down 0.9 points and service gross margin up 1.1 points. Our non-GAAP operating margin expanded to 31.6% up 0.6 points by our focus on driving cost improvement, operational efficiencies, and productivity. In terms of the bottom line, our Q4 non-GAAP EPS was $0.61 down 3%, while GAAP EPS was $0.48. For the full year, we had non-GAAP EPS of $2.39 up 1% while GAAP EPS was $1.90. We ended Q4 with total cash, cash equivalents and investments of $70.5 billion with $3 billion available in the US. Q4 operating cash flow increased a solid 5% to $4 billion with free cash flow of $3.8 billion up 7%. From a capital allocation perspective, we returned 2.6 points to shareholders during the quarter that included $1.2 billion of share repurchases and $1.4 billion for our quarterly dividend. For the full fiscal year operating cash flow grew 2% to a record $13.9 billion with free cash flow of $12.9 billion up 4%. We returned $9.2 billion to shareholders over the fiscal year through share buybacks and dividends which represented 71% of our 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 and were focused on driving operational efficiencies and profitability to drive strong cash flow enabling us to make the strategic investments to build long term shareholder value. Let me reiterate our guidance for the first quarter of fiscal year 2018; this guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue in the range of minus 1% to minus 3% year-over-year. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 29.5% to 30.5% and the non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to range from $0.59 to $0.61. Consistent with how we talk about our business at our financial analyst conference, in fiscal 2018 we will be redefining and simplifying our product reporting categories to better align with our evolving business model. We will continue to primarily run our operator business by the three geographic segments, and so this change will only impact how we report on our products. Starting in Q1 fiscal year 2018, we will realign our reporting into five distinct categories: infrastructure platform, applications, security, services, and other.

Thanks, Kelly. And thanks again to all of you for joining us today. As we've discussed many times in the past, we're working on a multi-year transition and while I'm confident with our progress, it's clear there's more for us to do. In Q4, we made ongoing progress generating 31% of our total revenue from recurring offers and growing 50% in deferred product revenue related to software and subscriptions to $5 billion. I'm optimistic about our future, the direction we're headed, and how we're transforming Cisco for the future. We are well positioned to succeed in a cloud and digital ready world where the network is one of the most strategic assets for our customers. Looking forward to fiscal 2018, as I said earlier, you can expect us to do the following: Execute against our strategy and invest in priority areas to drive profitable growth and enhance shareholder value. Leverage the power of the network to maximize our opportunities and differentiation in existing and new markets. Drive relentless focus on innovation, creating continuous customer value across every element of our portfolio and drive the right consumption models for our customers, and accelerate our shift towards more software and subscription revenue. Marilyn, now I'll turn it back to you for questions.

Thanks Chuck. Mark, let's go ahead and open the line for questions. And while Mark is doing that, I'd like to go ahead and remind the audience that we ask you to ask one question, so that we have plenty of time for others in the audience to ask their questions today.

Thank you for the insights on the software and current metrics, they are very helpful. I have a couple of questions. First, could you clarify the number of Cisco ONE customers? Also, Chuck, switching has faced some challenges, as three out of the last four quarters saw significant year-over-year declines. Looking ahead to 2018, how do you view that business? Will it be another transitional year, with your recent announcements possibly leading to a pause in progress and a learning curve? Or can we expect to see improved results in that area?

Ittai, I am shocked you asked a switching question.

Let me answer the easy one first.

I've given up on the data center business.

Well, I have an easy answer. In Cisco ONE we have over 20,000 customers now at this moment.

Perfect. That's great.

Okay. So Ittai, let me touch on the switching situation. First of all, the results we saw this quarter were not a surprise to us if you think about our guide last quarter we anticipated this and we also knew at the time that we're going to be making the announcement in June about the new platform. And so, we anticipated these results. Now anytime we do a major platform announcement particularly in switching there is a period of time where our customers pause because they want to understand what this means. So, we did see a pause and we actually anticipated it. But we saw great traction with the new platform. As I said earlier, just in the four weeks where we closed the quarter we had 200 customers that embraced this new architecture and purchased a new Catalyst 9000 platform. And as I said in the opening comments, the great majority of them also opted for the advanced software subscription that goes on top of it and we've had a lot of conversations over the last two years as to whether we could really drive a subscription business on our core switching platforms. And what we see is that at least early indications are that we can do that. So, we talked about our data center business, the ACI portfolio again a record quarter growing 38%. And then if you look at what we lost in the Campus, typically what we see is these are three-year cycles to transition these platforms. But this is also not a typical platform transition, this is not speeds and feeds only. We brought forward some incredible innovation in this platform and if you think about not only the actual product itself but the solutions that we announced around automation which really gets at the operating expenses that our customers are incurring to manage their infrastructure. You look at one of the key drivers of why customers move to the cloud, it was because of the complexity in the cost of their private infrastructure. So, the ability to drive significant cost out for our customers while managing this stuff over the next few years we think is a huge difference from a normal transition. And the other is the fact that we launched encrypted traffic analytics which is our ability to determine when there's malware inside encrypted traffic without decrypting it. And that's an innovation that only Cisco can deliver and both of those pieces of technology are what are included in that advanced subscription which is what tells us that the customer sees tremendous value in that subscription. So normally, we see three years, it's very early and we would like to believe that we can accelerate that based on the incremental innovation that's being delivered as part of the platform, but let's see how it goes over the next quarter or two.

Thanks Chuck. Mark next question please.

Hi, thanks so much for the opportunity to ask questions. It's Jim Suva here from Citi. Last quarter, I believe you gave a little bit of commentary or a bit of a pause in the federal government spending and also on Europe. It appears is that still continuing or has it taken a step up to improve or deteriorate a little bit and how should we think about that? And does Europe have any impact on Brexit? Thank you very much.

Hi Jim. Thanks for the questions. Since you outlined, I'll just quickly cover sort of all the headwinds that we talked about in Q3, I'll give you a quick update on all that's including the two that you asked. First of all, we talked about Mexico last quarter which is generally in the same state it was last quarter. We didn't see any significant change and again that's largely driven by service provider weakness due to regulatory transitions as well as geopolitical dynamics and after renegotiation etcetera. Emerging countries were slightly better but there is still tremendous uncertainty and disparity between performance in those countries and service provider is generally the same as it was last quarter. The two that you asked about in particular, we did see some shifts in US federal. I would say in Q3, we had a real lack of clarity around budgets. In early May, we began to see obviously the clarity with the continuing resolution and the way the dollars get released in federal were in like the fourth phase based on how they prioritize release in those budget funds. So, we saw some improvement not where we'd like there to be but we saw some improvement particularly late in the quarter and obviously in federal we're going to be facing the same issue again in 90 days at the end of September as we try to get another budget resolution passed. But you can see on a global public sector perspective, you saw our orders last quarter were minus four, this quarter they were plus two and that was clearly a big part of that was the improvement we saw in the US federal business. On the UK, if you go back to Q3, we talked about it being significantly down and one of the primary drivers was the headwind created by currency. In Q4, what I'll tell you is that headwind from currency remained, it did not ease up. However, our teams did a really amazing job and we saw significant improvement in our enterprise and commercial business in the UK. And if you look at the overall performance in EMEAR, you can see that the strengthening in the UK for us actually helped achieve the result at the EMEAR level. I'll say one final thing and UK while enterprise and commercial we saw a good uptick. Service provider remained about the same.

Okay Mark, let's go ahead and take the next question.

Hi, thank you for taking my question. I'd like to get a sense for how you see like your near-term trend in the business. If I look at your revenue guide for next quarter, we have seen slightly down year-on-year, but sequentially the kind of revenue change you are guiding for is actually probably better than the average seasonality for Q1 of the last year. So am I right, thinking the environment, you see the environment, the business environment slightly improving sequentially after this quarter, this weaker quarter you were anticipating. So that's on the revenue front. And then on the margin front, I think like from the top of my mind, you probably didn't beat in your gross margin guidance range for like eight or nine quarters in a row or something like that. And your gross margin came in slightly down sequentially. You are guiding for slightly lower operating margin next quarter than what the consensus is anticipating when could you give us some perspective on what's happening at the gross margin level, relatively small movements that I am sure you can give us some visibility on where the drivers are there? Thank you.

Yes, Pierre. Let me give you a little color on the revenue question and sort of the business conditions and then I'll let Kelly talk about the Q1 guide as well as the margins. In general, I think if you just look at our order rates that we released today, we went from negative four last quarter to flat in Q4. I'm sorry from Q3 negative four to flat in Q4. So clear that we saw improvement there. I will tell you that across the customer segments, just so you have some visibility, I think we showed the high-level numbers, I'll give you a little bit of a double click. On the enterprise side, we didn't see a lot of variability around the world in the performance there. Commercial, every region around the world improved from Q3 to Q4, public sector every region improved from Q3 to Q4 and SP we had weakness everywhere. So that's just sort of a little color on the orders that we saw in Q4. Kelly, you want to talk a little bit about the revenue guide and margins?

Yes, sure. On the revenue guide, as you know Pierre, we call it like we see it and as Chuck mentioned, the bookings being much better in Q4 than Q3 it certainly helped a lot. And I'll just mention that we are starting off with a strong backlog with our backlog being up 3% and we have good momentum as we go in the quarter. So, we feel good about the revenue call for Q1. As I talk about margins, yes, our margins for Q4 were in the range, but we definitely saw our product margins go down 2 points year-over-year and it really comes down quite simply to the one, and the biggest impact by far has been the increase of memory pricing and DRAM specifically for the overall business that accounts for more than half of the two points decline. The second point that's really impacting that is an overall productivity. Whenever you have large part of the portfolio, our largest business unit down 9% like switching which is also a very profitable business. It impacts your ability to get cost savings in that quarter so that was the second biggest driver and then we just had a third driver but to a much lesser extent was a slight uptick in pricing erosion.

All right. Next question please.

Great, thank you. On the security side, you said at the Analyst Day you expect low to mid-teens growth. You did talk about strong orders today, but the revenue growth was much less. I think you cited some legacy products helping things back. Do you have confidence that the reported revenue is going to get back into the double digits consistently?

Yes, Steve. So first, I'll say on the security. I have zero concerns about the business, this is a revenue timing issue. Our orders were, they were some of the strongest, we saw some of the strongest order growth in the quarter as we've seen in the last two years. So, it's simply a revenue timing issue, it funny if you go back to Q4 2015, the first call I did there was concern about our security revenue at 4% and at the time our deferred software was growing at 26 and this time we had 3% revenue but our deferred software was growing at 49. So, the strength in the business, I'm still comfortable with. Kelly any comments on it?

I think you said it well and it's literally just timing. We expect an uptick to come back there in the next quarter.

Okay. Let's go ahead and jump to the next question please.

Yes, good afternoon. Hi Chuck, Kelly.

Hi Vijay.

Yes, hi. My question is on what feedback and commentary you are hearing from your sales team, your customers, channel partners in this new model to purchase products like the Catalyst 9000 the subscription being is - hopefully you get this with security feature attached. And then the next part of the question is the demand for the subscription model primarily coming from the US market customers or are you seeing overseas demand as well for subscriptions based purchasing? Thanks.

Hi Vijay. Can you speak up a little bit, it's a bit hard to hear you.

Okay. So, I think the question is what commentary you are hearing from your customers on purchasing new products with subscriptions model. The second part of the question is the demand for the subscriptions model primarily coming from US customers or are you seeing overseas demand as well for subscriptions based purchasing? Thanks.

I’ll address the first part of your question. When we look back at our announcement from about eight or nine weeks ago regarding Network Intuitive, it has been one of our most significant launches in nearly a decade. There's a lot of positive energy among our employees, customers, partners, and sales teams about this innovation. Regarding your specific question, we knew from the start that introducing a subscription model for a switching product required us to deliver such high-value innovation that customers would readily embrace this model, and that’s what we’ve experienced. The automation platform we are rolling out will continue to evolve in the coming years, and the unique security capabilities we have—thanks to our deep understanding of networks, threat intelligence from Talos, and our silicon development—set us apart. Customers seem to be quite satisfied with the innovation so far, and we’ve noted a strong link to our advance subscriptions. Now, regarding the geographic aspect, Kelly?

Yes, I mean as far as the geographic it's following very closely with our natural split. We definitely have more in the Americas, but we have a very healthy pipeline in Europe as well as APJC. So, it's getting traction everywhere.

Thanks for the question Vijay. Mark, let's go ahead and take the next question.

Thank you. Just wanted to check in on the web scale client base. How did that trend in the quarter and you can also address the kind of the switching and routing competitive environment there, it seems like white box really not taking off with some of your competitors having good traction? So, if you could just update us on progress with that large customer base? That's great, thank you.

Yes, thanks Tim. So, we were together seven weeks ago, the story here hasn't changed significantly as I've said in the past. We have re-engaged in a very big way. I will tell you that we've had some wins, we actually had the press release that I talked about in my earlier comments with Microsoft about running their OS on our cloud silicon switches and we continue to make traction with these customers. As I've said, we're looking at each of them very individually as to what it is they need and we're also looking at broad base partnerships with them not only for their own infrastructure but as they realize that the importance of having this multi-cloud capability and the ability to run not only applications in a central public cloud but be able to run portions of those applications out at the edge of the network is leading to a very complimentary partnership that we're talking about with all of them. So, I would say that not a lot has changed in last seven weeks but we're still continuing to make solid progress and I'm optimistic.

Thanks Chuck. Let's go ahead and take up the next question.

Hi guys, I have actually two questions but it's about margin and cash. You touched on this a little bit but you knew about memory pricing when you enter the quarter I think when you gave the guidance, still product gross margin was weak. What was the delta, what was weaker than expected during the question that drove gross margin down? The second question is cash repatriation, if it doesn't happen. You already now have $70 billion in cash, but only $3 billion in US. So, do you consider plan B for bringing the cash to US or any other use for the cash?

Alright. Hi, Tal. So, on the memory, we've talked about memory for the last three quarters and now we start to see this as a headwind initially in Q2 and it's just gotten progressively worse. I think it's very much public information that the prices continue to climb and in this scarce supply environment, our supply team has done a great job securing supply for us but those prices continue to be at market at that price that goes forward. So, it's continuing to be a moving target and again, as I will say to the guide our gross margin ended up in the range of our guide. So those are just some of the variables as we go forward. As I look forward I think, we expect the memory pressure to continue on in the near term and we're taking that into account as we give you guidance going forward for Q1. On the cash, yes. We have $3 billion of cash domestically. We've been able to - we've been accessing commercial paper, we increased that a little bit this past quarter and we've been able to access and get access to capital to take out debt if we need to as we go forward because again, we are continuing to ensure we have the flexibility we need, whether it's for strategic M&A or to continue with obviously our dividend and share repurchase. So, we don't see any issues with that going forward and we'll continue to be as efficient as possible as managing our cash and any debt we need to take out.

Thanks for the question Tal. Mark, let's go and take the next question.

Thanks. Just two clarifications from Kelly and then a question. The clarifications being, Kelly you mentioned the tick up in price erosion. Does that mean below 3%? And then the other on the switching commentary can you give us a data center switching growth all in beyond just the ACI portfolio and what the Campus switching was? And the real question is looking at the drag and growth from the shift to subscriptions what was…

Paul? Are you on mute? Yes, let's go ahead and take the next question.

Yes, hi guys thanks for the question. I wanted Kelly maybe, get you to comment on the inventory movement. The inventory is up quite a bit this quarter. I am assuming that might be forward purchasing in memory and then I assume that might protect your margin looking forward. But I wonder could you confirm that and if it is the case, that it's memory how long are you protected and how long are you hedged? And then also Chuck maybe going back to that carrier order volume. Could you just maybe dig into where you're seeing weakness in orders in the network? Can you help us pinpoint that or is it more broad and related to product slowdown that's kind of generally from a part of the network where is that sluggishness materializing? Thanks.

Yes. Rod, regarding the inventory, you are correct. A significant part of the inventory increase is due to advanced purchases of memory. This helps us secure a large portion, but we have also been making commitments for additional supply, which will ensure we have access to it, even if prices rise. The main contribution to the $400 million increase in inventory is memory, along with some additional inventory build-up as we continue to achieve our revenue targets in the first quarter.

Hi Rod on the second part. Thanks for asking about the service provider business. I think we have characterized it as, it's less about different portions of the network and it's really about the disparity across large customers. As I said in the last couple of calls, we literally had some very big customers that were growing double-digits and others that were on the opposite side of that. So, it really is more of a customer variability issue than it is a single place in the network infrastructure that is causing a problem. And that's what we've seen for several quarters and again some of it is based on regulatory issues and geopolitical dynamics, others are based on consolidation going on in a certain part of the industry. So that's kind of the color as to how I see it. Hopefully, that's helpful.

Okay. Thanks Chuck. Next question please.

Chuck, Kelly, Marilyn can you hear me?

Yes, we can hear you now.

It is a good telephone, just in the interest of full disclosure.

We thought your question was going to be hard and you came back.

No. Go ahead.

So, let me ask a question and two clarifications. The question being what was the drag on growth from the shift of subscriptions this quarter and can you talk about what your product segment growth will look like on a normalized basis i.e. adjusting for the shift in subscriptions. I am aware that wireless win and collaboration have been the two places where insecurity where it's been first implemented but can you talk to us about what the growth will look like on a product line basis correcting for that? And the clarification, Kelly you mentioned that took up in price erosion; was it still below 3% and can you tell us what the decline in campus switching was? What was the all-in growth rate of data centers, not just ACI but taking account the 7,000 or whatever are the products in that? Thanks a lot.

Yes, of course. Regarding the shift, it remains relatively consistent with what we previously communicated, amounting to about 2%, between 1.5% and 2%. Security is most affected, and collaboration has always been influenced by this. If the security aspect changes, it could also have a significant impact on wireless. With fiscal one gaining momentum and hundreds of millions being added to the balance sheet, that will have an effect. This is the area that will see further acceleration as we gain traction with the Catalyst 9000 switches platform. Overall, in terms of the data center, if I examine switching, it was down by 9%, primarily due to campus switching, which saw a decline of over double digits and was the largest factor. Data center switching remained mostly flat. And price decline? Yes, you're talking about a year-over-year rate impact? Yes, so it is below the 3% and you can see that in the K.

Thank you. Thanks, Paul. Let's go ahead and take the next question.

Great, thanks for taking my question. I wanted to see if we could maybe double click down on the security business in light of the headlines we've heard in the security space over the last couple of months in terms of attack. I think of the case of nuance highlighted employing Cisco and I recall your discussions in the past about the need for security to be an architectural solution and not a point solution. So it sounds like the market is moving towards the pitch you've made and it's made sense for a long time, I'm just trying to see if you can help us quantify the outlook for your security business if you see an inflection point of the business moving more towards the solution sales and point products versus what we've seen in the past. Thank you.

Thank you for your question, Simon. The short answer is yes. Our customers are building their IT infrastructure in a highly distributed manner, managing technology assets that range from the public cloud to connected vehicles and mining operations, all the way back to their private data centers and SaaS applications. The approach of centralizing everything is not sustainable. As a result, our customers are transitioning to a new architecture that is supported by the network, which is why they are adopting a security architecture. Our strategy involves deploying security everywhere—at the endpoint, in the network, and in the cloud. Regarding recent attacks, I don't recall the exact number from last quarter or the previous one concerning our new threat customers, the Amp customers, but I believe the 7,600 we mentioned this quarter represents a significant increase compared to previous quarters. This increase is likely related to both the architectural decisions our customers are making and the resilience of our solution during recent ransomware attacks.

Okay Mark, let's go ahead and take the next question.

Yes, thank you very much. And I would like to dive into the service provider outlook a little bit if we could. It sounds as though we understand that things aren't perfect around the world for you. My question is how much of where we are in service rider, do you consider to be cyclical? And how much of this is structural? I mean do you think that we should see the service provider orders be in that 1% to 3% growth range that you've highlighted for the overall business? Thank you.

Let me break this down into three qualitative areas that we believe can enhance service provider performance over the next three to seven quarters, and over the next two years. First, we have strengthened our relevance among the web scale cloud providers we’ve discussed. Second, we are working on innovations which we previewed at the financial analyst conference, expected to emerge in a few quarters, presenting transition opportunities in various platforms. Finally, I would say there is a mix of macroeconomic factors and technology transitions. We're beginning discussions with customers who are considering 5G. Although we are not involved in the macro radio space, a critical factor for them is the impact of adding numerous new devices that operate at higher speeds and lower latency at the network's edge on the performance required in the network core. As we hope geopolitical dynamics stabilize—though that is uncertain—the ongoing 5G trend and its transition could benefit us in the coming years.

Thanks, Chuck. Let's go ahead and take the next question.

Thanks and good afternoon. I want to follow up on the question about gross margin, which has garnered a lot of attention today. How should investors expect potential margin fluctuations over the next one to two years concerning the shift to the appealing subscription model? Also, Kelly, could you provide insights on Revenue ASC 606 and when we might see Cisco offer guidance on that? Thank you.

Sure. Regarding the gross margin, we anticipate an impact from memory in the coming quarters. While some believe supply may have eased, it's difficult to determine, and that's likely to be a headwind for us. Other aspects of gross margin are being managed effectively, as we typically do with cost savings and pricing. The main uncertainty is related to memory. We will provide more details on the RevRac changes due to ASC 606 in our 10-K, outlining the implications and quantifying the impact on revenue and profitability. Additionally, I previously included a slide in the analyst conference deck that details which of our offers will be affected, which should assist in understanding the situation. We will share more updates starting with RK in the coming weeks.

Thanks, Kelly and thanks Mark for the questions. Chuck why don't I turn it over to you to wrap it up.

Thank you, Marilyn, and thank you everyone for joining us today. I have four key points to share. First, the launch we announced about eight weeks ago marks the beginning of a continuous cycle of innovation that we aim to maintain. The response from the press, analysts, customers, partners, and employees has been very positive. As I mentioned when I took this position, we are committed to accelerating our innovation, and this is just the first wave you'll see from us. Specifically, we introduced innovations in automation, our new platform, and enhanced security capabilities that will shape our future offerings. Second, in today's environment, our customers find that networks are more critical than ever. They are expanding their infrastructures in highly distributed ways, managing hundreds of thousands of devices, and preparing to handle a million or more by 2020. This underscores the importance of the automation and analytics capabilities, along with security integrated into the network. Third, our customers continue to seek our support in building a secure, intelligent platform that encompasses their multi-cloud environments for digital business. The growth in our security results and the influx of new customers adopting our technology reflect their investment in this new architecture. Finally, I believe we are executing our strategy effectively. We're navigating the transition well. Looking back on the past year, we achieved record earnings per share and cash flow while increasing our software and subscription deferred business by 50% to $5 billion this past quarter. I am very pleased with our teams’ performance, our execution, and the innovation we’ve delivered in response to customer needs. We look forward to speaking with you again next quarter. Thank you for being with us today.

Thanks, Chuck. I'm going to go ahead and provide some last closing remarks here. Cisco's next quarterly earnings conference call which will reflect our fiscal 2018 first quarter results will be on Wednesday, November 15, 2017, at 1:30 P.M. Pacific time, 4:30 P.M. Eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, feel free to reach out to the Investor Relations Team at Cisco. And we thank you very much for joining today's call.