Cisco Systems Inc (CSCO) — Q4 2018 Earnings Call Transcript

Thanks, Michelle. Welcome, everyone, to Cisco’s fourth quarter fiscal 2018 quarterly earnings conference call. This is Marilyn Mora, Head of Investor Relations, and I’m joined by Chuck Robbins, our Chairman and CEO; and Kelly Kramer, our CFO. By now, you should have seen our earnings press release, a corresponding webcast with slides including supplemental information will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance 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 made 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 fiscal 2019. 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. I’ll now turn it over to Chuck.

Thank you, Marilyn, and good afternoon, everyone. We had a very strong finish to a great year. We generated our highest quarterly revenue of $12.8 billion and non-GAAP EPS of $0.70 as growth accelerated for another consecutive quarter. Our momentum was broad based across our portfolio, customer segments, and geographies. We also continued to generate solid margins, cash flow, and returns for our shareholders. Our results demonstrate a combination of strong customer adoption of our latest innovations, the ongoing value customers see in our software and subscription offerings, and excellent execution across our customer segments and geographies. Our strategy is working, and we believe that we're well positioned to capture growth across the portfolio with our pipeline of innovation. The broad adoption of the multi-cloud environment is changing the very nature of how modern IT infrastructures are built and secured, and Cisco is at the center of this transition. The recently announced intent to acquire Duo Security is another example of how we are extending our intent-based networking portfolio for the multi-cloud world. Duo’s SaaS delivered solution will expand our cloud security capabilities to help enable any user on any device to securely connect to any application on any network. Combining Cisco's network, endpoint, and cloud security platform with Duo’s zero trust authentication and access solutions, we will be able to further enhance the industry’s broadest and most effective security architecture in the market. Now, I’ll briefly highlight some of our innovation and the great momentum we're seeing across our key product areas. Starting with infrastructure platforms, we continue to rapidly innovate and transform our technology portfolio to drive even greater customer value. A year ago, we reinvented enterprise networking with the launch of our intent-based networking architecture. This quarter we saw continued strength in infrastructure platforms driven by the Catalyst 9000 as customers look to us to simplify and automate their networks. Over the last year, we introduced additional innovations across our networking portfolio including new access, WAN, and data center offerings. In June, we announced new developer capabilities across our intent-based networking portfolio, spanning all network domains—campus switching, wireless, WAN, data center, and cloud. We're also excited that our developer program DevNet surpassed 500,000 registered members. As part of this program, we introduced new offerings to help developers and network engineers innovate throughout our intent-based architecture. As we all know, the WAN is undergoing an architectural transition to a software-defined WAN to enable IT to rapidly respond to changing business needs in a digital and cloud world. Our customers are driving this transition and looking to Cisco to help them make this shift. Our SD-WAN portfolio leverages our leading networking products, automation, and robust security architecture to enable greater flexibility, increased bandwidth, and lower costs. This quarter we saw significant traction with Viptela as it has now been deployed at over 800 customers driven by our ability to provide higher capacity at a lower cost. We are pleased with the ongoing integration of Viptela with our core portfolio to drive even more value for our customers. As our customers move to a multi-cloud environment, we see tremendous opportunities to provide value to them by redesigning their IT architecture, delivering security, and building, orchestrating, and managing applications. In Q4, we saw the production launch of our hybrid cloud solution with Google, the introduction of a multi-cloud solution with NetApp, and numerous engagements with customers redesigning their IT architectures. We continue to believe Cisco is very well positioned to benefit from the increasing adoption of multi-cloud. Turning to security, security continues to be our customers' number one concern, and it is a top priority for us. Our strategy is to simplify and increase security efficacy through an architectural approach with products that work together and share analytics and actionable threat intelligence. This architecture is supported by Talos, one of the largest commercial threat intelligence teams in the world. We identify and protect against new and emerging threats like the recent VPN filter vulnerability through our sophisticated infrastructure and unrivaled telemetry of data. Cisco is the largest network and enterprise security company, and our approach of bringing security into the intent-based architecture and offering security across the network, endpoint, and cloud has proven to be very successful. This quarter we saw continuous strong momentum with revenue again accelerating and growing double digits year over year. We continue to invest in our product and technology innovation as we are committed to helping our customers on their multi-cloud journey. Our focus is on delivering cloud security solutions that provide ease of use, scalability, and protect end users. As I mentioned earlier, with our acquisition of Duo Security, we will further enhance how we deliver simple, automated, trusted access anywhere for our customers' environments. Moving to applications, in May, we announced the launch of WebEx teams bringing together meetings, calling, and teamwork into an integrated experience as part of the WebEx platform. In Q4, we introduced major new enhancements to the platform including a new user design for WebEx meetings and a new solution with Google, combining their contact center AI service with our WebEx platform. With more than 3 million customer service agents globally using Cisco's contact center software, our integration with Google will help to automate responses in our call centers by leveraging data and intelligence from AI. We also achieved another robust quarter of growth with AppDynamics underscoring the importance and value of our unique invisibility and analytics from the end user to the network to the application. To wrap up, 2018 was a great year. We returned to growth, investing in our core franchises, delivered new innovative platforms, and continued to shift our business to more software and subscriptions. Our record results demonstrate the strength of our business as well as the strategic focus and execution that we have delivered over the past twelve months. I want to thank our teams around the globe for delivering these results. We're looking forward to fiscal year 2019 with a clear focus on growth, execution, and innovation. We see incredible opportunities across our business and believe we're uniquely positioned to deliver on our vision to be one of the most strategic partners to our customers as they go through their digital transformation. Kelly, I'll now turn it over to you.

Thanks, Chuck. I'll start with a summary of our financial results for the quarter then cover the full fiscal year and the Q1 outlook. Q4 was a solid quarter across the business; we executed well with strong orders, revenue growth, margins, EPS, and operating cash flow. It was great to see accelerated momentum in product orders which grew 7%. Total revenue was $12.8 billion, up 6%. Our non-GAAP operating margin rate was 30.9%, non-GAAP net income was $3.3 billion, up 8%, and non-GAAP EPS was $0.70, up 15%. Let me provide some more detail on our Q4 revenue. Total product revenue was up 7% with broad strength across the portfolio. Infrastructure platforms grew 7% with growth in all businesses except for routing which was down slightly. Switching had another great quarter with strong growth in campus driven by the ramp of the Cat9K and growth in data center driven by the Nexus 9K. We saw good growth in wireless with strength in Meraki and our Wave 2 offerings. Data center had very strong double-digit growth driven by servers and HyperFlex. Routing declined slightly driven by weakness in SP routing. Applications was up 10% in total with growth across all the businesses. We saw very solid growth in unified communications, telepresence, conferencing, and AppDynamics. Security was up 12% with strong performance in network security, unified threat, policy and access, and web security. Service revenue was up 3% driven by growth in advanced services as well as software and solutions support. We continue to transform our business, delivering more software offerings and driving more subscriptions and recurring revenues. In Q4, recurring revenue was 32% of total revenue, an increase of 1 point from a year ago. Revenue from subscriptions was 56% of our total software revenue, up five points year over year. We drove good growth in deferred revenue which was up 6% in total with product up 15% and services up 1%. Deferred product revenue from our recurring software and subscription offers was $6.1 billion, up 23%. There was also a strong increase in the unbilled deferred which is not on the balance sheet. The combined total deferred revenue plus unbilled deferred was up 28%. When we look at the impact of acquisitions on our Q4 results year over year, there was a 90 basis point positive impact on revenue. We saw especially strong momentum in Q4 with total product orders growing 7%. Looking at our geographies, Americas grew 6%, EMEA was up 6%, and APJC was up 12%. Total emerging market was up 12% with the BRICS plus Mexico up 22%. In our customer segment, enterprise was up 11%, commercial was up 9%, public sector was up 1%, and service provider returned to growth, up 6%. Our product backlog at the end of Q4 was $6.6 billion, up 38% year over year. From a non-GAAP gross margin perspective, total Q4 gross margin was 62.9%, down 0.8 points. Product gross margin was 61.5%, down 0.4 points, and service gross margin was 67.1%, down 1.7 points. Product gross margin was down 0.4 points driven by our APJC region related to some specific deals as well as negative product mix. Product gross margin for the Americas and EMEA were both up year over year. Overall, pricing continued to have relatively modest erosion as we've seen over the past couple of quarters, and we continued to be negatively impacted by higher component costs which we expect to continue in the near term. In terms of the bottom line from a debt perspective, Q4 net income was $3.8 billion, and EPS was $0.81. The GAAP results include an $863 million benefit related to the Tax Cuts and Jobs Act. We've excluded the benefit from our non-GAAP results. We ended Q4 with total cash, cash equivalents, and investments of $46.5 billion. Q4 operating cash flow was $4.1 billion, up 2% with free cash flow of $3.9 billion, also up 2%. From a capital allocation perspective, we returned $7.5 billion to our shareholders during the quarter that was comprised of $6 billion of share repurchases and $1.5 billion for quarterly dividend. I will now cover the full fiscal year. We delivered solid revenue, margins, net income, EPS, and operating cash flows. Revenue was $49.3 billion, up 3%; our non-GAAP operating margin rate was 31.1%; non-GAAP net income was $12.7 billion, up 5%; and non-GAAP EPS was $2.60, up 9%. Our total non-GAAP gross margin was 63.8%, a decrease of 0.5 points, with product gross margin down 0.4 points and service gross margin down 0.9 points. GAAP net income was $110 million and GAAP EPS was $0.02, which includes the charges related to the Tax Cuts and Jobs Act of $10.4 billion. For the full fiscal year, we delivered operating cash flow of $13.7 billion. We paid approximately $1.4 billion of one-time foreign taxes during the year related to the Tax Cuts and Jobs Acts. Operating cash flow increased 8% normalized for these tax payments. We returned $23.6 billion to shareholders over the fiscal year, which represented 184% of our free cash flow. That was made up of $17.7 billion of share repurchases and $6 billion for our quarterly dividend. To summarize, we had a strong Q4 and fiscal year. We executed well with strong top-line growth and profitability. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscription, delivering long-term growth in shareholder value. As a reminder, we are adopting the new revenue recognition standard ASC 606 as of Q1 fiscal year 2019 on the modified retrospective basis, its primary impact will be to accelerate our revenue recognition for certain software licenses and sales to future distributors as well as the recognition of a deferred commissions asset that will be amortized over the terms of our sales contract. Let me reiterate our guidance for the first quarter of fiscal year 2019. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue growth in the range of 5% to 7% year over year. This range includes the impact of ASC 606 which we estimate to be a benefit of about 1%. 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 30% to 31%, and the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from $0.70 to $0.72. The guidance included our service provider video software solutions business that we recently agreed to sell and excludes the Duo acquisition since both transactions have not closed. We expect the SPVSS transaction to close in the first half of fiscal 2019 subject to customary closing conditions and regulatory approvals. I’ll now turn it back to Marilyn, so we can move into the Q&A.

Thanks, Kelly. Michelle, let's go ahead and open the line for questions. And as a reminder, please limit yourself to one question only. I’ll now turn it over to Michelle.

Good afternoon, Chuck, Kelly, hope you can hear me fine?

Yeah.

We can, Vijay, thank you.

My question to you Chuck and Kelly, please chime in, is it reasonable to assume you'd be extending the software subscriptions idea and plan across the portfolio. Give us an early glimpse as to how it's going, what were some of the challenges, what were some of the positive surprises, and would the makeup of this software subscription portfolio meaningfully change as you look to extend this model across the portfolio? Thanks.

So, most of you know that when we began the sale of the Catalyst 9000, that was the first attempt to sell a subscription software offering on top of a core networking product and that has gone, as we’ve said on prior calls, reasonably well. I'm very pleased with how the adoption has been from our customers; they understand the value. As I said early on, we knew when we started that process that we would need to deliver significant innovation that wasn't available in the traditional methodology of buying it in order for our customers to adopt it and some of those were the encrypted traffic analytics, the overarching analytics, I mean, the automation capability and then recently some assurance. You'll see us over the next coming quarters when we bring new products to market, particularly in the enterprise networking space but across the portfolio; we will apply that same strategy. So, I think that we've been pleased, and our job now is to ensure that the operational infrastructure of the company is prepared, and we're working towards being able to ensure the customer is deriving the value from that software as well as obviously putting in the operational capabilities to ensure the renewals, etc. so that's what we're focused on. Kelly, any?

No, I think you hit it.

Hi guys, thanks for the question. I’m kind of beside myself, don't know where to start, these are so good. But let me, I guess, kick off with a question on the deferred revenue, Kelly. You said this off but including this off balance sheet deferred, it’s up 28%, is that total deferred or a product deferred? Can you just clarify what you meant by that and also maybe help us understand what ASC 606 impact on deferred was because that was, I guess, negative.

Yeah, sure. So, on your question on the deferred revenue plus unbilled deferred, so that was up 28%. The big driver we have for that, that is just purely product, okay? So, it is - what we mostly have in our unbilled deferred is from our collaboration, our applications business. They have a lot of periodic billing that they book month to month that is a very large number. So it is kind of apples to apples of business that we have booked that we’ll recognize in the future. So that's why we look at both. When we do adopt ASC 606 for Q1, that will be one of our disclosures showing you the combination of deferred plus unbilled. So you have a remaining performance obligation. But it is just product that 28%. As far as the ASC 606, we adopt that in Q1. So, in the results we just went through of the $6.1 billion of deferred from software and subscriptions, that is related to how we've been accounting for it under the old ASC 605. So when you go into –

Can you just clarify though, would you write down some - you’ll write some of the deferred down in Q1 as a result of the change or not much or?

Yes, so yeah I can give you some direction, you'll see that in our K. So, we will be writing off a portion of that balance, so of the $6 billion, we will be writing off and restating because you basically restate your balance sheet for the new accounting rules. And like we said over the past year, where we will have that impact is things that were term-based software licenses, things like our ELAs or Cisco One, those will now be recognized upfront where they used to be deferred. So the deferred revenue balance will be written down for that and will lower the balance of the deferred revenue, and then as we go into Q1, we'll be recognizing any new business that we bill upfront from that.

Thanks and congrats, great quarter. I guess Chuck maybe you can help me figure out how you managed to navigate so well in what seems to be such treacherous waters out there between some deceleration in economic activity in Europe, the FX movement recently which is not favorable to you, although you price in dollars nonetheless makes your products a bit more expensive internationally, poor CapEx metrics, out of the large telcos; tariff wars. Globally, you seem to be moving along sidestepping all of those things; which of these things really bother you, concern you, you’re watchful, you’re preparing for. And then second question, maybe you can kind of dig a little bit on the networking, Cat9K clearly good progress, are there customer metrics or anything you can give us there to help us solidify or get better visibility into the trend there?

I was feeling pretty good until you asked the first part of your question. I have said publicly I think we're operating in a - we have been operating in what I would call it's been a very consistent global economic scenario; there's clearly even in the last few weeks been things that have risen; you’ve got the strengthening of the dollar that you mentioned, you've got some uncertainty in a couple of emerging countries. So those are clearly things that we'll be watching. We've seen these in the past and we know how to deal with them. We obviously have the impending tariff situation which we're watching closely and, on that front, we're in deep discussions in Washington with the administration on trying to get to a favorable outcome. We like to see that land in a good place, but overall all of those are things that we are very actively involved with and we watch on a daily basis. As it relates to the networking business, the Catalyst 9000, as I said previously, has been the fastest ramping product that we've ever built. So the customer count became less of an indicator pretty quickly and it flowed through to the infrastructure systems growth that you saw this quarter. So we didn't see it as a metric that was we usually use that metric on customer count when we're just trying to give you visibility to the ramp up of new product when it hasn't become real material to the revenue line and I think that we exceeded that point in time with a 9K pretty quickly. But I will tell you just so you know, I think Kelly keeps me honest on this, I think we had roughly 9,650 plus customers on the 9K as of the end of the quarter, we had a great Q4, great adoption, and we're very happy with where that product and architecture is.

I actually wanted to ask you about service provider, you returned to growth this quarter, which is fantastic. And I think you mentioned as well that your routing business was weak and most of that weakness was in the service provider vertical as well. I was curious to understand how you grew revenues even if routing was negative or maybe I got something wrong. And then, of course, I am very curious to hear whether this recovery in service provider spending might be driven by 5G already.

Let me answer the macro question about the overall situation we see in service provider and then Kelly maybe you can cover the routing and the impact of the first part of the question. So, Pierre, in the service provider space, we were obviously pleased. I've said a number of times over the last couple of years that this is a business that is dominated by large customers. And so, as we've always said, when we have several of them that are slowing their spending and it looks bad, and when we have several that are spending, it looks pretty good, and that's just the nature of this business. Relative to 5G, I will tell you that I think I've said this on prior calls, starting at Mobile World Congress earlier this year, we really heard these customers in earnest begin and engage in discussions around what network requirements would look like for the infrastructure to support 5G assuming that they're going to add lots of high-speed connections at the edge; it will require high-performance networks with quality of service and slicing and all those things. So I would say that, I would not say that this is a material result of the implementation of 5G to be honest. We expect that this is still a year out before many will start and probably see it in earnest into 2020, to be fair. But we're pleased with what our teams have done; it has been a tough market, our teams have continued to battle, our engineering team continues to work on next-generation innovation, and we're pleased with the results this quarter. Kelly?

And to the point of, will I have better revenue, if you remember last quarter, the SP segment was down 4%, and you're seeing that flow through the revenue this quarter when we talked about routing overall. So, when I look forward, we don’t talk about our guidance in the upfront by business, but some of this on the order side might play well as we go into Q1. What I will say, adding on to Chuck's comments, is I do think, and as you know very well, our service provider segment is made up of very, very large customers, and in any one quarter we can get big orders, and that can fluctuate around. So, it adds to the sustainability. I would say we feel good about our position, though I expect this could move around either way as we look forward.

Thank you for the question. My first question has a lot to do with Europe and the strength you saw in the region in this last quarter. And then is it safe to assume that going into next quarter and your very strong guidance, are you expecting to see the same kind of magnitude of strength in Europe again despite all the moving pieces politically? And then the second question I really have is about the Viptela product launch. Are you addressing customers that are already big users and customers of the campus product and the Meraki products to kind of upsell customers into your new Viptela product, or maybe you can give us just an idea on the sales cycle and the customer base that you're addressing?

If you don't mind, Sami, I'm going to answer the second one, and then I'll give you a little qualitative color on Europe, and then Kelly will answer the specifics on the business expectations. So, on the second part of the question relative to Viptela and software-defined WAN, we have two offers. We have - Meraki has an offer for those customers who have embraced the Meraki architecture; they have a very effective SD-WAN Solution that is actually being well received in their customer base and they are using it to extend their customer base. So that's being very successful. On the Viptela front, we have been working hard on the integration between the Viptela platform and Cisco's product. And so we're going to have a variety of offerings for our customers; we’ll have a version that will have software running on different types of hardware, a software-only solution; we will have our integrated ISR solution, and so we're seeing a number of those. This was a quarter where I would say we really saw the engagement level increase significantly. We got the offers in the marketplace, the first wave of those; and I said on the Q3 call that our teams were signaling us that Q4 was where we're going to see some of this come to fruition, and we, in fact, did. So we feel good about where we are right now. There's more work to go. We haven't gotten the SD-WAN integration into DNA center yet, so that will only be a positive boost when we get that done, and teams are working on that; I think it's coming in one of the upcoming releases. So, in general, we're pleased with where we are at this moment in time with Viptela. Europe, our team is doing really well there; our teams are executing well, I think that they are competing very well because we have some very tough competition there. We have - the team in Europe is always one of the early teams leading with some of the new technology areas, so they've had a lot of success in this core enterprise networking space as we move to intent-based networking. So, we're pleased with what they're doing. We feel the entire global macroenvironment right now; there are so many dynamics that we're calling it like we see it based on what we know today. And Kelly, you want to comment just on how we see the –

Yeah. I mean, I think just to add to your point, I think the environment is very strong in Europe despite the political things that are going on, and just as a data point, the UK is up double digits for us on product orders this quarter. So again, it is, I think, like Chuck was saying, the overall environment is very favorable as of right now. So we’re hoping we see this continued strength.

And a lot of the innovation that we’re bringing right now is actually targeted at helping our customers lower the expenses of running this infrastructure. So, there is a significant play to be made, almost like as customers look at where they are economically, there is reduction of cost by going to this automation platform. There is reduction of cost by moving to SD-WANs. So, these are technologies that we are hopeful will continue to be important to our customers regardless.

I just had a question on the guide for the first quarter. You clearly have good momentum on the top line, although when I look at the operating margin guidance, it’s kind of flat year-over-year. So I just wanted to check, is there something that’s limiting kind of the flow through of the solid momentum on the top line to the operating margin? Is there something that’s limiting the leverage of that to the bottom line? And is that something we should hope for in the future and provides kind of a second leg to the earnings growth?

No. I don’t think you need to read anything different of what’s happening on the margin. I mean if I look at the puts and takes that we have to our margin, I spoke a little bit about, we can have – we have a little margin pressure this quarter and some specific deals in APJC, but otherwise, our margin is driven by the same things, right. Our pricing is very robust, we’re being very disciplined. The price that you’ve seen the last couple of quarters is in a range that’s very, very strong. So that’s good. We’re still facing component headwinds and even though it’s less of a headwind, it is still higher year over year. The prices are up, it’s again, just as last, but that’s part of what we see both in Q4 and the guide, and then everything else kind of balances out. So right now, this is kind of what we see. We obviously are going to be driving for it as much as we possibly can, but it’s really the same dynamics.

A clarification question. Kelly, just in response to your previous response, I trust you expect DRAM at a minimum to moderate come next year, and I'm wondering if you have any thoughts on the impact. And the larger question, I've recognized this has been asked and answered in various forms, but Kelly, my takeaway from your comments is that there's an awful lot of things going right, and my simple question is how much of this do you attribute to the macro and I recognize even in that portion, it’s not simple in terms of different moving pieces globally, but how much of the strength is macro related, how much of it is better execution in various areas like campus switching etc?

Do you want to take the first clarification on?

Yeah. Sure. So on the component stuff, yeah, DRAM is loosening though. Again, as I said, the prices still are up whether you look quarter-on-quarter or year-over-year, but we are optimistic that both on the demand side which is also driving some of that pricing mix will back that to get better through ’19. And I don’t know if you want to hit the other –

Paul, it's a virtually impossible question to answer, although I’m pragmatic enough to know that it's a combination of both. I will say that I think that, clearly, the economy has been pretty consistent and the markets have been positive. So that has certainly helped, and I think correspondingly, this new architecture and the new technology that we've brought out first about four quarters back actually right at the end of Q4 from a year earlier has clearly been adopted at a record pace for us. So I could never possibly give you any sort of split on what that looks like. The best I can do is acknowledge that it's a bit of both and there are a lot of things going right right now, but there's also, as we said earlier, Ittai asked the question, there's a lot of dynamics out there that we're watching very closely. So sorry I can't give you a better more specific answer, but I think that's as honest as I can be.

It’s been a while since we got a security metric update. Can you just kind of walk through some metrics you’ve given or what you’re willing to give today? I know in the past you’ve given deferred revenue growth as well as penetration of certain parts like buyer ramp. And then secondly, HyperFlex version 3.0 is released, I believe, recently. Can we get an update as to kind of how we should think about the sizing of that business or any metrics around it, hyper-converged infrastructure and how it’s competing against Nutanix?

Sure. As mentioned in the prepared remarks, the security side continues to excel, with over 60% of their business coming from software. This segment is seeing significant growth in deferred revenue, which is increasing at a high double-digit rate, giving us confidence in its performance. They had a very strong fourth quarter, and revenue growth was broad-based this quarter, with a 12% increase across all subsegments. Overall, this area is expanding rapidly, and the addition of Duo enhances the portfolio effectively. Regarding HyperFlex, it is experiencing strong growth. The new release has been well-received, and we find ourselves winning head-to-head deals against Nutanix, which is a tough competitor. While HyperFlex is still relatively small compared to the larger data center business, we are pleased with its growth trajectory and our competitive standing.

I wanted to see if maybe we could talk a little bit longer term trending big picture around the concept of multi-cloud, which you talked about at Cisco Live and on a number of other occasions. Within the answer, I think what I'm looking for is how does this help the evolution, transformation, and importantly, how does this help Cisco do more business with the web-scale customers?

Simon, that's a great question. The main point we want to convey is that the shift to a multi-cloud environment is fundamentally altering how our customers approach building and securing their IT infrastructure. If you reflect on the past five to ten years, most of the traffic in our enterprise customers’ networks used to end in their private data centers. Networks and security systems were designed for that context. Now, we're entering a new phase where a portion of customers' traffic still goes to private data centers, but there is also traffic going to SaaS applications across various public cloud providers, along with considerations for IoT Edge data aggregation. The way data flows through their networks is now much more intricate than it was five to seven years ago when it was relatively straightforward. As a result, our customers need to create environments that consider the user, the application, their policies, and the destination, with technology in place to ensure quality and security through policy routing. We're assisting our customers in re-architecting their networks to manage the significantly varied traffic flows they will experience. Regarding our partnerships with web-scale providers, they recognize this shift in dynamics. We're initiating early collaborations with some of these providers to deliver integrated hybrid cloud solutions, enhancing security and policy regardless of whether applications are hosted in private data centers or public clouds. They are focused on our capacity to process data at the edge as customers expand their IoT applications. Additionally, they appreciate our role in helping to shape security frameworks that simplify access to their services. This partnership is becoming increasingly promising due to the current market realities. I hope that was clear, and if there are further questions, we can arrange discussions afterward.

A quick question, Chuck. Earlier in your remarks, you mentioned with service provider stream coming back that you don't believe it's 5G related. That’s more of a 2020 phenomenon. Can you give us a little bit about a history lesson here of, back in 3G or 4G or 2G uptakes? Was there a linear into the build that happened? Is there a pause before the positive happens or is it just more of a steady as she goes as we kind of look ahead, more longer-term strategically to 5G's impact on Cisco?

Jim, that's a great question. If you look back at earlier transitions in this field, they were mainly focused on improving performance for mobile devices already connected to the network. For instance, moving from 3G to 4G improved data performance, making users more satisfied with their apps. However, this transition to 5G represents a significant difference because it involves new latency dynamics, enabling real-time business applications for small offices or remote branches through 5G networks. This creates a different situation altogether. While we don't have a clear historical example to draw from, if 5G lives up to its expectations, it will create substantial demand on the core networks of service providers. We anticipate that as they prepare to build these systems, they will focus on designs and gradually expand as they open up specific markets, increasing bandwidth and backbone capacity accordingly. We will provide updates in the coming quarters about how this development unfolds, though it's important to note that progress won't happen instantly.

I wanted to ask about the routing, just again, it's repeatedly under pressure and you gave an answer before about, you were saying that it's going according to the plan. I'm wondering if there's a link between the two yet or that the pressure in routing has to do with other things and not to do with SD-WAN. That's the first question kind of to understand or maybe you can provide a different explanation to understand the pressure on routing and what's the outlook for recovery or is it like Nokia and others are saying that maybe there is a long-term pressure on this market? The second question, just a follow-up on 606. What's the impact on operating margin, if you've provided this or you provide this information?

Okay. Tal, I'll start with a comment on the first question, and then Kelly can add her insights and address the 606 question as well. When we look at our routing business, a significant portion, around 50% to 60%, is driven by service providers. This means our business is heavily influenced by the service provider segment. Some of the companies you mentioned likely rely even more on this segment for their routing revenues. This context is relevant to our discussions about 5G and what we've previously communicated. I would attribute the current dynamics largely to the service provider side. From an enterprise viewpoint, over the past few years, we've experienced a typical slowdown in the marketplace during significant architectural shifts, which we've discussed previously. You mentioned it was unfolding as planned; I would frame it as we are starting to see customers making progress with their deployments. It's still early, but we are optimistic about our position and the developments we're witnessing. I believe the enterprise segment will continue to enhance as we gain more clarity on the architecture, and I'll turn it over to Kelly to elaborate on the overall routing aspect or the 606 inquiry.

On the topic of 606, I want to clarify how it affects us. Operationally, nothing has changed. Our offers, contracts, and cash conversion cycle remain the same; it's solely an accounting shift. The impact is that it will likely speed up some of our term base licenses, resulting in a write-off of some deferred revenue. Although we won't see that revenue, it will be balanced by the acceleration of offers when we receive and build new orders. Overall, we expect this to be a net positive of around 1%. This will influence our revenue and flow through to our operating margin by roughly half a point to 70 basis points. As we transition to the new revenue standard, we will clearly outline the implications of the new accounting versus the previous one, given our adoption of the modified retrospective approach. I hope that answers your question.

I guess Kelly, I was curious about the revenue headwind that you're seeing from the subscription transition. You've talked about that in the past. I'm just curious about what that might have looked like in the July quarter and what do you think that would look like for the October quarter?

Yeah. That's a great question, George. So, there's good news; there's good news there I would say. So like we anticipated, as we are so rapidly ramping the Cat9K, and as we're blowing out DNA across not only that but also our tele offerings and across wireless, the revenue headwind was getting closer to 2.5 to 3 points. Now, the good news on this is, with the new revenue standard going forward, because it's accelerating some of these offers that we did have previously deferred, that headwind will become less of a headwind. So as opposed to the 250 to 300 current accounting standards, that will be much less, closer to like a point and half or so if I had to guess roughly. I mean, again, this will all flush out as we go through it, but it will become less of a headwind because we have such a big portion of things that we will now be recognizing upfront.

All right. I want to – I think that was the last question, Marilyn. So if I could just thank everybody for spending time with us today. Thanks for the questions and the dialog, and Marilyn, I’ll turn it back over to you.

Thanks, Chuck, and thanks everyone. Cisco’s next quarterly earnings conference call which will reflect our fiscal 2019 first quarter earnings results will be on Wednesday, November 14th, 2018 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’re now planning to close the call. If you have any further questions, please feel free to contact Cisco’s Investor Relations department. And we thank you very much for joining the call today.