思科 (CSCO) 2014 Q3 法說會逐字稿

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  • Operator

  • Welcome to Cisco Systems third quarter and fiscal year 2014 financial results conference call.

  • At the request of Cisco Systems, today's call is being recorded.

  • If you have any objections you may disconnect.

  • Now I would like to introduce Melissa Selcher, Vice President of Global Corporate Communications.

  • Ma�am, you may begin.

  • Melissa Selcher - VP Global Corporate Communications

  • Good afternoon, everyone and welcome to our 97th quarterly conference call.

  • This is Melissa Selcher and I'm joined by John Chambers, our Chairman and Chief Executive Officer, Frank Calderoni, Executive Vice President and Chief Financial Officer, Rob Lloyd, President of Development and Sales and Gary Moore, President and Chief Operating Officer.

  • I would like to remind you that we have a corresponding webcast with slides including supplemental information that will be available on our website in the Investor Relations section following the call.

  • Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statements and other financial information can also be found on the Investor Relations website.

  • Click on the financial reporting section of the website to access these documents.

  • Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results.

  • The matters we will be discussing today include forward-looking statements and as such, 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 and any applicable amendments which identify important risk factors that could cause actual results to differ materially from those contained in forward-looking statements.

  • Unauthorized recording of this conference call is not permitted.

  • All comparisons throughout this call will be on a year-over-year basis unless stated otherwise.

  • As we have in the past, we will discuss product results in terms of revenue and geographic and customer segment results in terms of product orders unless specifically stated otherwise.

  • I will now turn it over to John for his commentary on the quarter.

  • John Chambers - Chairman & CEO

  • Thank you very much.

  • I am pleased with our solid performance in Q3, with non-GAAP earnings per share of $0.51 on revenues of $11.5 billion.

  • We saw strength in our non-GAAP gross margins of 62.7% and non-GAAP product gross margins of 61.4%.

  • We also continued our disciplined management of the business, with total non-GAAP OpEx down 6% year-over-year.

  • We generated $3.2 billion in operating cash flow and returned approximately $3 billion to our shareholders through the dividend and share buyback.

  • We are very focused on creating value for our shareholders, employees, customers and partners.

  • Our conviction around how we're evolving Cisco is strong and resolute.

  • You've seen us deliver incredible innovation, make bold moves in the market to capture future opportunities and disrupt our competitors and ourselves when necessary.

  • We remain committed to do the right thing to increase our long-term strategic value to our customers and advance Cisco toward our goal of becoming the number one IT company.

  • In Q3 revenue earnings per share and gross margins exceeded our guidance.

  • Our product orders improved to be relatively flat year over year.

  • Our book-to-bill was comfortably above 1.

  • I am pleased with the progress to return to growth and I'd like to give you an update on Q4 revenue guidance which will allow you to frame our remarks on the business momentum.

  • For Q4, we expect revenue to decline in the range of minus 3 to minus 1, which would represent quarter-over-quarter growth of 4% to 6%, that is Q3 to Q4.

  • We saw strength across a number of the areas of our business and as we looked across the world.

  • From a geographic perspective, total US product orders grew 7% with US commercial and US enterprise both up over 10%.

  • The momentum in US enterprise and commercial remains very strong.

  • As an example, in the US enterprise total deals over $1 million are up over 25% from Q3 start to Q4 start and deals over $5 million are up more than 50%.

  • As we continue to move to solutions, our enterprise customers are making more and bigger investments as they partner with us.

  • We see continued stabilization across Europe, with order strength in the UK up 7%, Germany up 5%, and Northern Europe as a whole up 4%.

  • From a product perspective, our new service provider platforms are showing good momentum.

  • As we shared with you in prior calls, it takes time when you introduce disruptive, high-end products before the growth returns.

  • This quarter we saw high end router order growth reversing a three quarter negative trend.

  • While we are pleased with these results, these numbers will continue to be lumpy.

  • The Nexus 9000 and our application centric infrastructure while still early, is gaining significant market traction.

  • In just our second quarter shipping new application centric infrastructure, i.e.

  • ACI enabled platforms, specifically the Nexus 9000, we grew from 20 plus customers last quarter to 175 customers this quarter with a pipeline approaching 1,000 customers.

  • We saw major wins including competitive wins and displacements at large financial institutions, large cloud providers, software as a service and major service providers.

  • Data center revenue grew 29%.

  • UCS continues to cement its place as a leading platform for hybrid cloud environments, big data and virtual desktop services, gaining market share for the 17th consecutive quarter since it was introduced.

  • Security revenue increased 10% and orders increased 20% as the Sourcefire integration continues to fuel growth and opportunities with customers.

  • There are several businesses that are starting to show improving trends.

  • Collaboration is the first.

  • While collaboration revenues decreased 12% in the quarter, collaboration orders increased 4%, reversing a multi-quarter negative trend.

  • Positive revenue growth of software as a service WebEx business was balanced by declines in unified communications and telepresence.

  • In this quarter, we began unveiling our next generation of collaboration solutions, specifically a new range of innovative cloud connected telepresence products at a very competitive price points.

  • Wireless.

  • Revenues grew 3% with orders up 12%.

  • We did see some weakness in the service provider customer segment and at the low end of the market, but we saw good strength in the 802.11ac ramp, with the AP3700 now the fastest ramping access point in our history.

  • There are three areas of our business which we have discussed for the last several quarters where we are managing through challenges, both macro and Cisco specific.

  • First, emerging markets from a macroeconomic perspective, continue to be challenging.

  • Orders in our emerging markets declined 7% with the BRICs plus Mexico down 13%.

  • As we've said for several quarters, we expect these challenges to continue.

  • The challenges we saw in Brazil, down 27% and Russia down 28% are consistent with those we are hearing and seeing from our peers and customers, while China declined 8%, Mexico declined 3% and India declined 1%.

  • Our strategy with emerging markets has not changed.

  • Our relationship begins with the engagement with the leadership of the countries on key priorities for the country and technology development initiatives and drives all the way to local municipalities, their service providers and private businesses.

  • Second, service providers.

  • Service provider orders were down 5%, showing improvement from the minus 12% decline in Q2 and 13% decline in Q1.

  • The weakness in emerging markets also negatively impacts the service provider customer segment.

  • SP video revenue declined 26% which had a negative impact on our SP segment numbers as we continue to manage through the transition of that business.

  • SP video orders declined 11%.

  • We are seeing some signs of stabilization in the SP business, but believe it will take multiple quarters to return to growth.

  • We will continue to make changes we need to to lead in the service provider market.

  • And third, new product transitions in high-end routing and high-end switching.

  • While we saw momentum, actually good momentum in high-end routing orders as mentioned earlier, it is still early in the transition as revenue lags orders by a quarter or so.

  • We did not see the benefit on this revenue in this quarter.

  • This slide combined with the challenges on access layer and the mobility business led to a decrease in next generation network routing revenue of 10%.

  • On the positive side, the strength of the ASR9000 continues with revenue growth of 59%.

  • It is Cisco's fastest growing and most successful high-end router since the 7500 introduced over a decade ago.

  • We did see next generation routing orders relatively flat and saw orders of the NCS6000 and the CRSX grow above our expectations, though again, it is still early in the ramp and off relatively small numbers.

  • Overall switching revenue declined by 6%.

  • We continue to manage through declines in our campus switching portfolio, specifically at the high end, with the exception of the Catalyst 3850 which is growing very well.

  • We are pleased with our momentum in data center switching, but it's still early in the high-end switching transition.

  • As a result of these transitions, it will be several more quarters before we see growth in overall switching.

  • Switching gross margins remains strong.

  • Stepping back, I am pleased with the momentum we are continuing to drive across our business, despite these challenges.

  • We will continue to take it one quarter at a time, as you would expect.

  • While competitors at times may gain share on us in a given quarter or two, we believe that our strategy of driving architectures to deliver business value will win in the long term.

  • I've met with over 100 CIOs in the last month and they understand where we're going, our strategy and our differentiation and are asking us to partner even more closely with them on their business outcomes.

  • Looking forward, we are driving the innovation and making bold moves to lead the major market transitions our customers are facing today.

  • Two transitions that I would like to highlight this quarter are cloud and the Internet of Everything.

  • On cloud, in this quarter we announced our InterCloud strategy, leveraging our application centric infrastructure together with our partners to deliver the first global open network of clouds.

  • Customers, providers and channel partners are turning to Cisco to create an open and highly secure hybrid cloud environment.

  • Cisco is unique in our ability to enable a seamless world of many clouds in which our customers have the choice to enable the right and highly secure cloud for the right workload.

  • We have already announced major global InterCloud partners such as Telstra and with more to come at Cisco Live next week.

  • Rob, I think you'll be announcing them at that time and it's getting pretty exciting.

  • As you would expect, we have added some of the best and brightest cloud talent to our team.

  • We are also seeing our partnerships in delivering converged infrastructure, such as VCE and FlexPod, leveraging application centric infrastructure and the InterCloud fabric to provide on-ramps to the InterCloud.

  • As part of our InterCloud strategy, we'll deliver a portfolio of Cisco cloud applications and services.

  • The Cisco cloud applications, which are already in market, namely WebEx and Meraki, continue to perform very well.

  • WebEx revenue grew 7% with annual recurring revenues up 12%.

  • The total number of billable users was up over 26%.

  • Meraki, our cloud networking business, grew over 150% with the customer count growing approximately 30% sequentially.

  • We also continue to cement our position as the number one cloud infrastructure and the number one cloud provider, according to Synergy, delivering the innovation and platforms to fuel the world's largest cloud.

  • That was, again, the number one cloud infrastructure and the number one hybrid cloud provider.

  • On the Internet of Everything, last quarter I discussed the momentum we are seeing with our customers to translate the Internet of Everything opportunity to actual business requirements.

  • We are making measurable progress connecting the $19 trillion value we have identified in the Internet of Everything to specific business opportunities and pipeline.

  • Again, at Cisco Live next week, our user conference, probably 20,000 people in person and we hope 200,000 plus virtually, customers like Royal Dutch Shell and The Weather Channel will join us on-stage to share how they are partnering with Cisco to leverage the Internet of Everything to drive innovation and business results in their own organization.

  • Our close engagement with our customers to capitalize on the major market transitions like cloud and Internet of Everything will be a future driver of our services growth.

  • Service revenues grew 3% this quarter with continued strong margins.

  • Gary, nice job by you and Edzard and the team.

  • Gary Moore - President & COO

  • Thanks, John.

  • John Chambers - Chairman & CEO

  • We continue to be optimistic about the future opportunity.

  • As our customers embrace cloud, mobility, social, analytics and the Internet of Everything, they are seeing Cisco as uniquely positioned to help them build and run the highly securable environments they require.

  • We are helping them design secure and optimized cloud solutions, enabling industry leading security for their mobile workforce and access data from anywhere to speed decision making, among other solutions.

  • During the past quarter, we announced our new managed threat defense service to help customers detect and prevent attacks across their extended networks, fueling our security services business opportunities.

  • We will continue to differentiate our approach to services, leveraging both technology and people to deliver business value.

  • We continue to drive our evolution to software and services and this quarter we closed a first of its kind multi-year deal to license Cisco's software portfolio to General Motors.

  • This innovative license agreement involving our software and hardware, where needed, will give GM greater speed and flexibility to drive business value.

  • For example, when GM needs to increase their collaboration solutions across the company, they have access to our full suite of products to do that.

  • Going forward, Cisco and GM will continue to partner to deliver GM's business goals up to and including the Internet of Everything.

  • We are evolving very quickly as a Company to meet the changing requirements of our customers globally and I am extremely pleased with the level of innovation and the value we are driving across the Company in both technology and business models.

  • We are leaning forward and will continue to make the moves and investments we need to ensure our leadership for the next decade.

  • I'd now like to turn the call over to you, Frank, to go into a little bit more details on the financials for the quarter and expand on our guidance.

  • Frank Calderoni - EVP & CFO

  • Thank you, John.

  • John Chambers - Chairman & CEO

  • Very welcome.

  • Frank Calderoni - EVP & CFO

  • In Q3 FY14 we executed well as we managed through the transitions in our business and markets, resulting in our financial performance above our expectations.

  • From a top and bottom line perspective, total revenue was $11.5 billion, down 5%, non-GAAP net income was $2.6 billion and non-GAAP EPS was $0.51.

  • Our GAAP net income was $2.2 billion and GAAP earnings per share on a fully diluted basis were $0.42.

  • Product revenue declined 8% and services revenue increased 3% with product book-to-bill comfortably above 1. Overall, non-GAAP operating margin was 28.1%.

  • In Q3, our total non-GAAP gross margin was 62.7%.

  • Non-GAAP product gross margin was 61.4% and product gross margin benefited from improved productivity as we had greater leverage with our cost structure, partly driven by higher revenue volume.

  • These benefits were offset by pricing.

  • Non-GAAP service gross margin was 66.8%, consistent with historical levels.

  • Our non-GAAP operating expenses were $4 billion or 34.6% as a percentage of revenue, compared to 34.8% in Q3 of FY13.

  • Operating expenses were higher quarter-over-quarter driven by investments in cloud and acquisitions as well as higher variable compensation.

  • Given the expected decline in our full fiscal year revenue, we do expect our variable compensation expense and thus total non-GAAP operating expense, to be lower than originally forecasted.

  • Our headcount decreased by approximately 230 from last quarter to 73,834.

  • In Q3, other income and expense was $100 million, reflecting realized gains on sales of publicly traded equity and fixed income securities.

  • Total cash, cash equivalents and investments were $50.5 billion, including $4.6 billion available in the United States at the end of the quarter.

  • We generated operating cash flows of $3.2 billion during the quarter.

  • During the quarter, we issued $8 billion of debt for general corporate purposes including repayment of debt and a return capital to our shareholders through our share repurchase as well as our dividends.

  • The debt repayment portion covered $3.3 billion of previously outstanding notes.

  • As you recall, our capital allocation strategy is to return a minimum of 50% of our free cash flow annually through dividends and share repurchases.

  • So far, in fiscal year 2014, we have returned approximately 140% of free cash flow to our shareholders, comprised of $8 billion of share repurchases and $2.8 billion of dividends.

  • In Q3, we returned $3 billion to shareholders that included $2 billion through share repurchases and approximately $974 million through our quarterly dividend.

  • Our diluted share count decreased by approximately 150 million shares driven by these repurchases.

  • We remain committed to this strategy.

  • Our balance sheet continued to be an area of strength in Q3, with DSO at 35 days, non-GAAP inventory turns of 11.2 and total deferred revenue growth of 4%.

  • Let me now provide a few comments on our outlook for the fourth quarter.

  • Let me remind you again that our comments include forward-looking statements.

  • You should review our recent SEC filings that identify important risk factors and understand that actual results could materially differ from those contained in the forward-looking statements and that actual results could be above or below our guidance.

  • The guidance we are providing is on a non-GAAP basis with a reconciliation to GAAP.

  • As John mentioned, we expect total revenue to decline in the range of minus 3% to minus 1% on a year-over-year basis.

  • For the fourth quarter, we anticipate non-GAAP gross margin to be in the range of 61% to 62%.

  • As we have said in the past, forecasting non-GAAP gross margin has always been challenging due to various factors such as the volume, product mix, cost savings, as well as pricing.

  • So as a result, non-GAAP gross margins may vary quarter to quarter by a point in either direction of our guidance range.

  • Our non-GAAP operating margin in Q4 is expected to be in the range of 27.5% to 28.5%.

  • Our GAAP tax provision rate is expected to be approximately 21% in the fourth quarter.

  • Our Q4 FY14 non-GAAP earnings per share are expected to range from $0.51 to $0.53.

  • With our Q3 performance and our current guidance for Q4, our non-GAAP EPS would be at the higher end of the full year FY14 guidance of $1.95 to $2.05 that we provided earlier this year.

  • We anticipate our GAAP earnings to be lower than our non-GAAP EPS by about $0.11 to $0.14 per share in Q4 FY14 and $0.56 to $0.59 for the full year.

  • This range includes pre-tax impact of approximately $60 million in Q4 FY14 and up to $500 million for the full year as a result of our anticipated restructuring charges related to our workforce reduction plan that we announced in the second quarter.

  • Substantially all of these charges are expected to be recognized during fiscal 2014.

  • During Q3, we recognized pre-tax charges to our GAAP financial statements of $26 million related to that announcement and $336 million through Q3.

  • Please see the slides that accompany this webcast for further detail.

  • Other than those quantified items noted previously, there are no other significant differences between our GAAP and our non-GAAP guidance.

  • This guidance assumes no additional acquisitions, asset impairments, restructuring and tax or other events which may or may not be significant.

  • 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 hand it back to John for summary comments.

  • John?

  • John Chambers - Chairman & CEO

  • Frank, thank you very much and well done.

  • Reflecting on the quarter, the dynamics in our business and market continued to play out as we said they would.

  • And we did what we said we would do.

  • Our management team is executing well and driving innovation, transformation, and discipline across the entire company.

  • We're delivering solutions, not just technology, in a way we haven't in the past and are transforming our business models toward more recurring product, software and cloud revenues.

  • As we continue to drive the business, we remain focused on shareholder value creation by maintaining the flexibility to make the right long-term strategic decisions for the business, driving efficiencies in our cost structure and returning capital through dividends and share repurchase to our shareholders.

  • In addition to the solid financial results, there are four key take-aways for how we are driving Cisco forward that were evident in this quarter.

  • First, we made good progress on our plans to return to growth despite some macro and industry specific challenges.

  • At the same time, we are innovating and investing while becoming more efficient in taking costs out.

  • As a result, we're delivering and often over-delivering on your expectations while transforming our business.

  • I'm proud of what we've done and excited about what's to come.

  • Second, we are delivering more innovation at a faster pace than any time in our history.

  • I look at the new high-end switching and routing platforms, the recently announced InterCloud strategy, new collaboration portfolio, new pervasive security offerings, new data analytics, self learning networks, services in all delivery capabilities, IOE and much more.

  • And we're not just innovating the technology.

  • The changes we are making in how we deliver value to our customers, leveraging integrated architecture, software and services to deliver their business outcomes are driving larger opportunities and deal sizes as well as more recurring revenue.

  • Third, we are disrupting the competition and when necessary, disrupting ourselves to drive our leadership position.

  • For example, we began work on application centric infrastructure over three years ago.

  • When we launched into the market in November, we laid out a road map for our customers on how we could deliver on the benefits and promises of SDN.

  • The traction we are seeing with our application centric solutions gives me great confidence that we are leading the transition to SDN.

  • We have similar disruption examples today in high-end routing, collaboration, our overall go-to-market and organization structures.

  • Finally, I believe we are positioned extremely well on the major market transitions.

  • When I look at our leadership in the Internet of Everything, our differentiated hybrid cloud strategy, InterCloud, our ability to combine SB and enterprise mobile solutions like no one else can, Cisco's unique insight into the network traffic to provide security and analytic solutions is second to none.

  • Our ability to converge the network, compute and storage from the cloud to the data center to the wide area network all the way to the edge, the network is clearly at the center of each of these transitions.

  • We are creating tremendous value for our customers when we connect the unconnected and opportunities are clearly exciting.

  • Now, Mel, let's move to the most fun part which is Q&A.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, John.

  • We'll now open the floor to Q&A.

  • We still request that sell-side analysts please ask only one question.

  • Operator, please open the floor to questions.

  • Operator

  • Thank you.

  • Our first question comes from Simona Jankowski with Goldman Sachs.

  • Simona Jankowski - Analyst

  • I just wanted to understand, John, your guidance a little bit.

  • You are guiding for better than normal seasonality in the July quarter and that's despite the continued weakness both in emerging markets and in service providers.

  • Can you just expand on what is driving that?

  • And to the extent that some of that is driven by the Nexus 9K ramp where you highlighted 175 customers, can you just dig into a little bit on how many of them are also licensing ACI and also, does that include any of the top 10 cloud providers?

  • Thank you.

  • John Chambers - Chairman & CEO

  • Got you.

  • A few questions, Simona, but you've been very patient with us over the years, so we'll do that.

  • In the future, we'll hold the questions for everybody to one.

  • In terms of seasonality, you're right, the guidance seasonality wise for Q3 to Q4 is 4% to 6% growth.

  • If you look at it, Frank, if I know these numbers right, over the last three years it's about 1.9% or 2%.

  • Over the last five years, it's averaged just 3.2%.

  • So it is above that.

  • We're going in with stronger backlog and by definition, we had a very good third month of the quarter.

  • In terms of the weakness in emerging markets and service provider, you're correct in that we anticipate those continuing for several more quarters and that's going to be heavy lifting as we work our way out.

  • Let me leave no doubts in anyone's mind.

  • We are committed to emerging markets.

  • We're going to position ourselves, as we've done before when countries have seen economic downturns, and position us for the future.

  • In regards to service provider, we're going to do whatever it takes, to get back on top there and get that to return to regular growth.

  • In terms of the areas that are growing well, you saw it in almost every product category.

  • While the revenue numbers by definition, when product revenues are down 8% if I remember, Mel, right, and product orders were relatively flat, which means plus or minus 1%, it means in almost every product category bookings grew faster, orders grew faster than the revenues and we showed that.

  • You see areas like collaboration, which we've been getting a little bit longer in terms of our products before we introduce new products and Rowan's done an amazing job there.

  • They turned from what's been a three or four quarter, three quarter I think it is, negative quarter over quarter to a 4% growth and, Rowan, I'm betting on you big time to get that growth up to at least high single digits by the end of this next fiscal year.

  • You will see new product announcements throughout this year in the collaboration area, making it easier to use and product announcement, even in Cisco Live next week where you almost want to think about it like a iMac combination with telepresence on ease to use and tremendous price performance you so you can bring this to the desktop and it can be literally a phone replacement that also has a capability on a touch screen to bring it to life.

  • Where you're leading me on other products, such as the high-end switching, the Nexus 9K, I have not missed on a customer call, and I've probably called, like I said, 100 CIOs in the last quarter on the 9000 and application centric infrastructure behind it.

  • I'm not that good a salesperson, Rob.

  • None of us are.

  • What it means is the product is really, really solid.

  • You're seeing us take leadership across the enterprise accounts.

  • When you think about it going from 20 plus customers to 175, going to 1,000 people in the pipeline and you see us with the application centric infrastructure with the simulation going on, Rob, if I remember that number right, I think it's over 50 customers that are doing that.

  • Rob Lloyd - President of Development & Sales

  • That's correct.

  • John Chambers - Chairman & CEO

  • Again, the receptivity's been extremely strong.

  • Many of you come from financial institutions, so you might have seen a small startup and VMware combine because they've been out there for five plus years.

  • We're taking almost all of those back.

  • Momentum feels very good on it and I think you'll just see us knock them off one after the other.

  • In the commercial marketplace, Alison Gleeson would say the 9K is on fire.

  • To your indirect part of your question, Simona, it will take another at least one and probably two quarters before you get high-end switching growing well.

  • They put a 9000 in, you do the ACI modeling, et cetera.

  • So it's going to take us a few quarters to extend it out, but your overall premise is right.

  • When we present our architecture strategy and our vision, the CIOs get it, they buy into it and we're in extremely good shape in enterprise, as you would guess from the 6% growth that we showed this quarter and improving.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Simona.

  • Next question.

  • Operator

  • Next question comes from Ittai Kidron with Oppenheimer.

  • Ittai Kidron - Analyst

  • Thanks.

  • And congrats again on great execution.

  • I'll also take a stab at a two-part question.

  • First of all, referring to the last page of your press release --

  • John Chambers - Chairman & CEO

  • You gave us a compliment.

  • Okay.

  • Two questions and then we've got to keep them to one.

  • Ittai Kidron - Analyst

  • I'll give you another one if I can get three questions.

  • Speaking on deferred revenue, Frank, looking at the breakdown of your deferred revenue you have a very nice increase on a year-over-year basis on the product side, but when we look at the split of that between current and non-current it seems like most of it is concentrated in the non-current area.

  • Can you talk about how the change in deferred revenue relates to the change in your business model, as far as moving more into cloud, more into, as a service type of consumption model for your customers?

  • And then for you, John, on the competitive front, from a high level standpoint, some of the switching vendors have talked about going aggressively after your cat 65 install base which is quite substantial still out there.

  • How do you feel about your ability to defend that?

  • And also with some of the clearly good progress you've been making on UCS, how do you feel against IBM and HP these days as far as going after the server footprint, both the standalone and on a converged basis as well?

  • John Chambers - Chairman & CEO

  • Got you.

  • Okay.

  • Frank, you get the easy part, deferred revenue and what's occurring there.

  • I'll probably expand on that and lead into the other questions.

  • Frank Calderoni - EVP & CFO

  • As you know, if you look at the overall deferred revenue close to $12.7 billion in the quarter, up 4%, the key driver of the growth was the product side, close to $4 billion, up 11%.

  • And within that on the question that you mentioned, the driver has been growth that we see in our subscription type business and that was up within that segment about 36% and within that segment it's the WebEx, it's security, it's Meraki and it's our collaboration, our enterprise license agreement.

  • Those are the areas that when we talked about, even back in December at the financial conference, and I was talking about some of the cloud offerings, subscription offerings, that's the piece that is showing growth and that's clearly what's driving the improvement in the deferred revenue on the product side.

  • Good performance there, I just also put into perspective as far as the contribution, still small contribution, but we do expect that to continue as we see the investments over the next several quarters in the space.

  • John Chambers - Chairman & CEO

  • What's interesting is, Ittai, you nailed it, we are seeing a number of our customers of all types begin to look at not just recurred revenue, but kind of a pay as you go or pay as you drink type of approach.

  • We've closed a number of key deals, and these are $100 million type of deals, this quarter alone that we'll see the results on over the next 3 to 5 years, but it shows very little impact in terms of this quarter and next quarter and that's something we just have to manage through.

  • We'll try to keep you in tune, what that means.

  • It obviously means, as you understood from the deferred revenue product growth, that it's 1% of our growth now, it goes into this category faster than before, per quarter, and it would not surprise me to see it at 2% to 3% by the end of next year.

  • Our key is to do that, keep our balance on profits and revenue growth and earnings per share.

  • At the same time, we build something that will introduce more continuity in our revenue streams, which I think all of you want to see.

  • It's a little bit of a balancing act.

  • It's one that we're up to.

  • Kind of fun for Chuck Robins, our head of sales, as he does this.

  • In terms of the switching, I think your comments are right.

  • The campus switching is where we're seeing some good competition, but our real issue is we have products like the cat 6K that are still going great guns and very competitive, but they are decreasing as you expect year over year by a fair amount.

  • The 3850 in that category is very price competitive, but we're competing with much lower cost products, so trying to get the total number up when the price performance may be two or three or four to one, it's a little bit of a challenge there.

  • To answer the question about, that Simona hit on the 9K, our win rate on the data center switching is really, really good.

  • Our share there is probably close to 70%.

  • We clearly built backlog this last quarter because a lot of the orders came in late in this category area and I feel very, very comfortable with our ability to win, not with the 9K alone, but how we're going to not only embrace SDN and benefit from it, but we're going to lead in SDN.

  • Rob, maybe depending on if we get some questions later, I'll give you the ball on that.

  • We're going to embrace it very tightly and bring the benefits of a virtual and physical architecture into one and then take with application centric infrastructure straight down from the cloud data center all the way to the LAN to the edge.

  • So it's a great story to tell.

  • In terms of UCS, handling our competition, IBM and HP and Dell, I feel very comfortable with us continuing to beat them pretty well.

  • Our growth of 29%, I think the three of them added together might have been negative growth in terms of blade servers.

  • Our real competition here is white label.

  • We saw this coming 3 to 4 years ago.

  • We're going to sell architectures in the white label approach as opposed to standalone products.

  • I personally believe standalone products from any company, whether it's a standalone switch or a standalone server will get squeezed pretty hard.

  • Our competition there is architecture and how you bring compute and network and storage together, how you bring that together with application centric infrastructure and bring it down the environment.

  • That, you get premium for, and we know how to sell it pretty well.

  • When I talk with our customers, most of them will say that we're the only company that's really differentiating our server architecture in a way they will pay a premium for.

  • Most of the others, they view it more as a commodity and a bid type of approach.

  • Frank, you had something to say.

  • Frank Calderoni - EVP & CFO

  • I just wanted to clarify the first part of the question on the deferred revenue.

  • I gave the balances for Q3 2013 that were growing at 11%.

  • Just to clarify, last year we had close to $4 billion, Q3 2013 going to $4.4 billion in product deferred revenue, that's up 11% and the overall total last year $12.7 billion going to $13.2 billion, up 4% total.

  • I just want to clarify that.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Ittai.

  • Operator, next question.

  • Operator

  • Next question comes from Pierre Ferragu with Bernstein.

  • Pierre Ferragu - Analyst

  • Hi.

  • Thank you for taking my question.

  • John Chambers - Chairman & CEO

  • Hey, Pierre.

  • Pierre Ferragu - Analyst

  • Can you give us some color on how your gross margin evolved sequentially?

  • You have had a very good improvement in gross margin.

  • I was wondering how much behind that was just a matter of having better volumes and if there was anything that you saw between this quarter and last in terms of product mix and of course, pricing as well.

  • And lastly, if you had some specific cost actions over the last three months that helped the gross margin improve.

  • Then I have just one very last question to ask on the switching weakness.

  • I was just wondering if you could give us some color, geographically, is that the overlap between your weakness in emerging markets and switching or is switching a market that is seeing a weakness much more broad-based across the globe?

  • Thanks.

  • John Chambers - Chairman & CEO

  • Okay.

  • So first on the gross margin question, Frank, keep me kind of balanced on this.

  • If I look at gross margins, this quarter we moved a fair amount of the products, Gary, that you and the team and engineering and John Kern had been working on in gross margin improvements when last quarter we didn't have as many of those products to work to our benefit on.

  • Also, the mix was to our benefit.

  • You saw set top boxes continue to decline even though orders slowed, declined a lot less than we've seen in prior quarters on it.

  • The UCS was good at 29%, but it was at 29%.

  • We had a very good mix advantage for us on that.

  • You're seeing pricing issues, but contrary to what people are worried about, I'm not seeing these pricing issues because of SDN.

  • Our win rate there is really good in our story, Rob, and bringing it to home application wise and protection wise is very, very good and you see that in the data center.

  • We are seeing some pressure on the campus switching area where there are different price points as you move into the market.

  • A little bit of it was due to volume, but I think also what you saw on this time is almost 1% above our 61% to 62% guidance.

  • You're going to see swings a point above, a point below, that guidance periodically.

  • I'd urge you not to over-react or under-react to either one of them.

  • We clearly did not give you guidance at 62.7% for this next quarter, nor is it likely it will be 61% to 62%.

  • There will be quarters when it goes below that 61%.

  • If we see a trend coming, we will tell you.

  • Right now, we're comfortable in that 61% to 62% gross margins where, actually what I worry about most is the mix and a little bit aggressive pricing out of emerging countries in an ugly market, where if you've got to win some strategic deals, you're going to discount pretty aggressively.

  • That's not a function of architecture SDN.

  • It's purely a tough market in a UCS type environment or a campus switching type environment.

  • Frank, how close was I to what you would say.

  • Frank Calderoni - EVP & CFO

  • Very close.

  • (multiple speakers)

  • John Chambers - Chairman & CEO

  • That's a good answer.

  • Sorry.

  • Frank Calderoni - EVP & CFO

  • I want to add one point.

  • John Chambers - Chairman & CEO

  • Okay.

  • Frank Calderoni - EVP & CFO

  • Just recap.

  • The mix was pretty much as you said, was to a slight benefit quarter on quarter.

  • So that helped.

  • Pricing was fairly consistent.

  • We haven't seen much change from a pricing standpoint.

  • We did get a benefit in the volume because last quarter we did talk about the drop in the volume that we had from Q1 to Q2, so volume improved.

  • We got that, and as a result of that, we were able to get a substantial amount of the cost benefit, some of which came from last quarter, that was delayed and others that we worked on this quarter.

  • Cost was a big plus for us in the quarter, which enabled us to get to the 62.7%.

  • Pierre Ferragu - Analyst

  • Got you.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Pierre.

  • Operator, next question.

  • Operator

  • Thank you.

  • Our next question comes from Jeff Kvaal with Northland.

  • Jeff Kvaal - Analyst

  • Yes.

  • Thank you very much for taking the question.

  • I would like to follow up on the gross margin question, if I could.

  • And that is to say you have a couple new products that theoretically, should be very accretive to the gross margin structure that are in the pipeline, i.e.

  • the new high-end switches and routers.

  • Why wouldn't we see the gross margins be stable if not even a little bit above where we are today as those products blend into the overall mix?

  • What are some of the offsetting forces there?

  • John Chambers - Chairman & CEO

  • So in regards to the new platforms, let's go first to switching.

  • The new products we're introducing is very much in line with our high-end switching margins.

  • They're very good.

  • We're able to protect it very well.

  • We win in terms of the architectures comfortably with it.

  • They just are not at major volume yet.

  • While 175 customers is exciting up from 20 plus, it isn't 1,000.

  • We need to move to those bigger numbers.

  • And then to have the big volume roll-out as ACI simulation moves to ACI implementation, not just across our Nexus 9000, but down through our other catalyst products as well in terms of direction.

  • The routing products again, were designed from the beginning with good gross margins as opposed to, if I had it to do over, something we've done throughout our history for almost 20 years, is we develop the products and brought them in at 50% gross margins and over a period of 2 to 3 years brought them up to their normal margins of 70% or whatever you aim for.

  • We won't make that mistake again.

  • We're bringing them in at high gross margins.

  • But, again, the volume isn't as much to that.

  • Rob, would you add anything to that?

  • Rob Lloyd - President of Development & Sales

  • No, John, I think you covered it.

  • Frank Calderoni - EVP & CFO

  • I would say our gross margins have been consistent.

  • John Chambers - Chairman & CEO

  • Yes.

  • Frank Calderoni - EVP & CFO

  • Last quarter, given the volume which we talked about, historically we've done everything we said we're going to do around gross margin, 61% to 62% plus or minus 1 or 2 every quarter.

  • John Chambers - Chairman & CEO

  • Yes.

  • Don't want to give anybody the impression we are not all over this.

  • We clearly are and don't want to give anybody the impression that we know a mix issue could put pressure on us here.

  • We're working on it hard.

  • That's one of the things we've got to execute on and continue to execute well on.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Jeff.

  • Operator, next question.

  • Operator

  • Next question comes from Brian Modoff with Deutsche Bank.

  • John Chambers - Chairman & CEO

  • Hey, Brian.

  • Brian Modoff - Analyst

  • Hey, John.

  • Question around the AC or the wi-fi [phase].

  • Wireless was, I think, up 3% year on year, orders up 12%, if my memory's correct.

  • Could you talk a little bit about what you see coming in the next quarter?

  • Do you see this AC transition that you've gone through for the last couple quarters and you expect to come out of that?

  • And when do you see wave two AC impacting the upgrade cycle in your campus switching business, the 3850 specifically?

  • Thanks.

  • If I could do a follow-on I'd appreciate that.

  • John Chambers - Chairman & CEO

  • Since I lost control earlier, Mel, we'll get it back to one next time.

  • Brian, in terms of the wireless and I'm including all wireless on it, we lost a little bit of momentum due to a combination of factors.

  • I think you're seeing us pick that back up.

  • It's the very low end that we were exposed to for a while.

  • Now with the new products coming out from Rob Soderbery's group, I think we're much more competitive there.

  • You're right that we are going to combine the fixed and the wireless products together on it.

  • I'm not sure I would venture, in fact, turn-up on that because they often take longer than we think and then when they occur, occur faster, especially at the low end on it.

  • And your second question?

  • Brian Modoff - Analyst

  • The second question is really on your license agreement with your software portfolio for GM.

  • I wanted to try to understand that a little bit more.

  • You mentioned collaboration.

  • What are you specifically licensing?

  • How is this going to play out?

  • Give us a little more color around what the agreement is and what products it might involve.

  • And how could you see expanding this as your product line becomes more software versus hardware over time?

  • Thanks.

  • John Chambers - Chairman & CEO

  • Okay.

  • So let me talk about the concept of GM and just put that to the side because that's specific to a customer and the first one.

  • Think about what we are really beginning to share with our customers is an architecture in each product category we're in that combines the infrastructure with the platform, with the application, with services.

  • And you go across all of these architectures from the Internet of Everything to cloud to data center to collaboration to security to mobility and when you combine those together and we bring a Cisco, largely Cisco powered environment to this, your operating costs drop dramatically because the customer doesn't have to do systems integration and you get outcomes quicker.

  • What's exciting about this deal, this is all about software.

  • You license that software all the way across everything from our IOS to the collaboration to the security and as you, therefore, begin to compete against products like white label, you're able to say all right you've already got a license in software.

  • You can be very competitive on the architecture.

  • This is something that clearly, Rob and I and then Chuck Robins, who heads up sales, want to drive through our whole company and this is what we would like to see many other customers do.

  • If we do this well, that really gets exciting.

  • This is a huge move on the transition to software being more and more a part of our portfolio and tying our software pieces together just like we are beginning to tie our hardware and ASICS.

  • Gary, you're very familiar with the GM deal.

  • I know we have to respect their rights on this one, but any other thoughts to add to this?

  • Gary Moore - President & COO

  • Well, just a couple quickly.

  • One, it is everything that you've said and I do believe we've already seen high interest from our other large enterprise customers, the CIOs you met with, et cetera.

  • But the opportunity here is to put in their catalog, all of the software that Cisco has.

  • We've added switching.

  • We've added everything we do to this.

  • Now they have a software catalog that they prepaid and now all they have to do is make minor decisions relative to what products and our products give them that end-to-end architecture.

  • Example would be moving stuff that might be individual products in a dealership that would be controlled with a floppy disc being mailed out, to now a very easy and for them, cost effective solution, to IP enable it and control that from a single spot and download it to any dealer they have, as an example.

  • Same thing we do with stadium vision and some of our other solutions.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Brian.

  • Next question, operator.

  • Operator

  • Thank you.

  • Our next question comes from Tal Liani with Bank of America.

  • John Chambers - Chairman & CEO

  • Hey, Tal.

  • Tal Liani - Analyst

  • Hello.

  • It's my birthday so I'm also going to ask two questions.

  • John Chambers - Chairman & CEO

  • Okay.

  • Tal Liani - Analyst

  • I have a question on two things.

  • Number one is service revenues are down.

  • If you sum up the last four quarters, service revenue growth is down to 2.5%, down from 7% the same four quarters a year ago, so similar period, down from 10%, 11% before.

  • I understand that there is a link between product growth and service growth, but on the other hand, you do offer and you mentioned it, you do offer more service based solutions.

  • And with other companies, we've seen longer lag between the decline in products to the decline in services.

  • So is there any fundamental change in services, is there any discounts on the services side or difficulties to charge for services?

  • Can you tell us anything about it beyond just the product growth?

  • John Chambers - Chairman & CEO

  • I'll take a crack or Gary, you want to go first?

  • I'll go second.

  • Gary Moore - President & COO

  • Okay.

  • So Tal, I think first off, your numbers are correct as it compares to last year.

  • If you look at where we've been each of the quarters this year, pretty consistent as we look across that.

  • I think the core product bookings over the last eight quarters have driven this down.

  • What we've done, though, is start, and we've started this some time ago, to build these other services that have a slower contribution in 2014, will have a bigger one in 2015 and a bigger one in 2016 and so we're building those out.

  • Those are services that we are selling today in large part, whether it's cloud enablement and adoption services as we look at InterCloud and helping customers build out hybrid clouds, the service catalog development and how these customers are managing that services catalog, helping them move their workloads to the cloud and from one cloud to another, as well as the security managed threat detection that we announced last quarter.

  • Those are all things that have a revenue ramp that are adding to the services revenue that won't be as dependent on core product bookings.

  • That said, the ability for us to continue to manage 3% growth in the quarter relative to the margins that we continue to drive, look anywhere else, I think you'll see that it is a very well-run services organization that contributes greatly to our customers and that they value.

  • John Chambers - Chairman & CEO

  • So I completely agree with what Gary said, Tal, especially on the profitability and the customer set it brings us.

  • I think the technical services, what Joe Pinto has done there, has been amazing.

  • We split technical from advanced services out?

  • Okay.

  • So it grew well.

  • And its profitability is very good and I think given the product run rates that we're on, I'd give us an A in that.

  • I think the point you're raising, Tal, is how quickly do we move in advanced services from not just bringing our products together to be able to work well or network audits or things of that type, to outcome based.

  • The outcomes that Gary walked through, we're going to move through over this next year very aggressively and only about 20% of our advanced services if I remember right, Gary, are outcome based today.

  • They're at more mid-level outcome based as opposed to the transformation that we talked about at GM or transformation, hopefully if we do our job right, we're going to do in a number of companies and countries.

  • So that's where the growth has to return from, assuming that product numbers do not pick up at a much more healthy rate and I think what you're seeing is kind of, I hate to always call it leveling out, but I think you'll see us level out about this level, maybe one more quarter of this and then slowly start coming back up.

  • Tal, your constructive feedback and criticism is fair.

  • We like where we are.

  • We love the profits.

  • We love the customer satisfaction.

  • But we've got to make the transition here to services delivering on those architectures and business outcomes before you're going to see the number grow well that you alluded to.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Tal.

  • Next question.

  • Operator

  • Next question comes from Amitabh Passi with UBS.

  • Amitabh Passi - Analyst

  • Hi, guys.

  • Good afternoon.

  • John, I only have one question for you.

  • I wanted to maybe understand your sort of strategic rational in some of the alternative areas where you're making investments.

  • If I look at the radio access market, you made an investment in a company I think called Altiostar.

  • Your Broadband Access investments were the M4600, you're going after the converged packet optical market with the NCS4k.

  • When I look at each of these markets, they're large markets but they have very well established incumbents, all of them with relatively low gross margin.

  • Given all the focus on gross margin, just wanted to understand how you're thinking about attacking these markets, how do you continue to extract a premium given the fact that they're highly competitive with relatively low gross margin?

  • John Chambers - Chairman & CEO

  • The reason we're not in radios is because the margins are terrible, and actually almost nonexistent unless you bundled into total solution.

  • We make investments in new companies, new architectures and we make investments to see if their strategy plays out and plays out well.

  • If it doesn't, it's a good investment and hopefully get a reasonable return on it.

  • If it does, then we partner very tightly or acquire off of that.

  • So we've got $2 billion under investment directly and probably a fair amount more indirectly through a number of our joint funds we invest in the technology.

  • Let's use Altiostar as an example.

  • A real good team at the top, Aish Tahudi is world class.

  • He did the Star job, as you all know, (inaudible) entrepreneur and he usually does extremely well.

  • We told him if he ever wanted to come back to Cisco and work and do something exciting together, we are very interested and he did come back to us and say all right, Pankaj and John, I would like to do this.

  • Would you want to invest and would you like to be a part of it and when we looked at his new architecture and his price points he's designing to, they got really exciting.

  • Now, we have to see if it's going to work, but I like the team that's in place and that's what you look at when you invest.

  • I like the fact he's got a marketing transition, not building an old world radio architecture of the past, but one for the future, probably started in emerging markets, then coming into developed and we'll see if it works out.

  • If it does, we'll claim victory and we will tell you we were very smart and if it doesn't, you might not hear us talk about it again on that.

  • If I were going to bet on a start-up team, we've got a couple of them inside of Cisco we do well with, but Aish has been extremely good.

  • So that's the classic way to invest, rather than take a big risk and an unreasonable amount of upfront capital to see if you own the whole thing and see if it works.

  • You do investments, keep them as an entrepreneurship running fast, you open doors for them and accounts and go for it.

  • Does that make sense to you, Amitabh, on what we're doing?

  • Melissa Selcher - VP Global Corporate Communications

  • Okay.

  • Great.

  • I think we might have lost Amitabh.

  • Operator, next question.

  • John Chambers - Chairman & CEO

  • I got it.

  • My answer is shorter, Mel.

  • I got you.

  • Operator

  • Next question comes from Ben Reitzes with Barclays.

  • Ben Reitzes - Analyst

  • Hey, John.

  • I wanted to ask about the pickup you saw in the US and Europe.

  • Is this it?

  • Are things turning?

  • And in particular, how sustainable would it be?

  • John Chambers - Chairman & CEO

  • Good question.

  • I think the US is sustainable, especially in commercial and enterprise with all the appropriate caveats my few years of law school have taught me on that.

  • I watch the pipeline.

  • I watch the approach.

  • Our US enterprise and commercial are usually a very good indicator of GDP slowly increasing or GDP decreasing.

  • We saw our turn-up in US in enterprise and commercial back in summer of 2012 and if you bought the DOW then, I think we all understand what would happen.

  • That feels good.

  • You combine that with the CEOs I've talked to, most of us feel 2.5%, 3% for the next nine months is a very doable number, not anything to do back flips on, but reasonable progress.

  • Europe is still a little bit fragile, but we did see stability across the north with some growth rates, for a change, in Europe in total was finally positive, not counting their emerging markets, for us and even stability in the south looks like it's occurring.

  • Now I know they've still got structural issues there and I know some of the countries are in transformation, have some tough decisions to make, but I think they're out of this downturn, slowly improving and when I talked with our customers and the top financial people in New York, which I did just a week ago, most everybody else is beginning to see very similar trends.

  • In fact, it almost was scary.

  • When you describe the world just like I did earlier, including emerging markets and the challenges in Russia and Brazil, we can finish each other�s sentences regardless of industry.

  • I think Europe is coming back.

  • Again, it's going to be slow and heavy lifting there because they haven't addressed some of their structural issues, but more consistency and even the south is starting to show stability on it in terms of direction.

  • So good about the US.

  • Good about Europe.

  • Don't feel very good about emerging markets.

  • They're still very challenged, especially the BRICs.

  • Melissa Selcher - VP Global Corporate Communications

  • Operator, next question.

  • Operator

  • Next question comes from Mark Sue with RBC Capital Markets.

  • Mark Sue - Analyst

  • The business is stabilizing and looking into your bookings linearity, more predictable.

  • It feels like in a couple of quarters the revenues may actually start declining and then actually turn positive.

  • Does it feel that you can hold this $46 billion to $48 billion annual revenue base because it's more predictable?

  • Also, how should we think about the annual OpEx?

  • Is $15 billion to $16 billion the right number or should we expect some cost cutting?

  • On cash, eBay repatriated some cash.

  • Recognizing your views on taxes, what else can Cisco do since half the market cap of Cisco is in overseas cash?

  • John Chambers - Chairman & CEO

  • So our clear goal was a return to growth.

  • It won't be straight up and to the right and it may be a little bit bumpy because we're still way too dependent on our orders coming in and shipping in the next quarter and during the quarter on it.

  • But you are right, looking out over several quarters we'd expect that.

  • How long it will take us to turn back up to mid single-digit growth, if that's where we're going, it probably won't be immediate once you get a slight growth quarter and then the next quarter is there, but I think you will see you us do that over gradual time.

  • We are going to continue to watch operating expenses.

  • Gary's our champion here along with Frank, tightly, but we have to put money into InterCloud and we have to put money into sales rep coverages as we make these changes and as we get really good on security and collaboration, they require specialists for a period of time to run with.

  • So we are going to put investments into the area there as we go forward a little bit into next year.

  • But I think your premise on slowly up and to the right is right.

  • It will probably be a little bit bumpy.

  • It won't be just one quarter as you finally turn the corner and the next quarter you're there.

  • But we're going to take it a quarter at a time in terms of our guidance.

  • We want you all not to get ahead of us on this.

  • We're very pleased with this quarter.

  • Next quarter's set up pretty well, but we've got some real heavy lifting to do and I'm sure a couple bumps along the way especially in emerging markets and service provider on the listing.

  • Frank, talk a little bit about that, where we are on the cash and how we've chose a different path than some of our counterparts did and why we chose the path we did.

  • Frank Calderoni - EVP & CFO

  • We can't comment specifically in regard to what eBay did, but I think, Mark, the key thing for us, and this goes to the outreach we've had with all investors over the last couple years, is to build a capital allocation strategy that our investors are looking for, which is a combination of investing both in the buyback as well as in the dividend, which we've done the last couple of years, and our strategy to, at a minimum, have 50% of our free cash flow be used for that purposes.

  • As I had mentioned earlier this year, we've been fairly aggressive with 140% of that free cash flow to the dividend and the buyback.

  • We expect to continue that strategy going forward.

  • We feel that based on the amount of cash that we have in the US, the amount of cash that we generate in the United States on an ongoing basis, as well as our ability as we did this past quarter, to leverage the debt markets, that we have the ability to fund both near term and long term, the continued support of being aggressive on that capital allocation strategy.

  • John Chambers - Chairman & CEO

  • We're pleased I think, Frank, with what we've done here.

  • I think we've pushed it to a pretty good extent without endangering our rating, et cetera on it.

  • We just chose a different path.

  • I actually am very comfortable with the path we chose.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Mark.

  • Operator, next question.

  • Operator

  • Next question comes from Simon Leopold with Raymond James and Associates.

  • Simon Leopold - Analyst

  • Thank you very much.

  • Hello.

  • Quick one.

  • I wanted to see if you could talk a little bit more about the ethernet switch business and the transitions.

  • You alluded to the idea that the transitions do take a long time.

  • What I wanted to see if you could talk about is any kind of compare and contrast this transition to the 9K family versus the prior transition you experienced when you moved to the Nexus family?

  • If we could understand a little bit better about how this situation is either similar or different from the past it might help us.

  • Thank you.

  • John Chambers - Chairman & CEO

  • Sure.

  • I'm going to put on the back end of that, Simon, I'm going to ask Rob to tie through where this fits on InterCloud and ACI throughout our whole family of Nexus products.

  • So to answer the question very directly, when we moved to the -- remember the 9K is a Nexus line and we are going to take many of the capabilities on the 9K including ACI and move it down through our other Nexus products.

  • The 7K was a slow startup and it took us a long period of time and candidly, we had tough gross margins on it when we designed it, et cetera and it took us a while to add the features that we needed.

  • Now I like very much where the 7K is.

  • You're going to see it have very continuous, very good growth opportunities.

  • It will be the 9K and the 7K together and then I'll kind of judge the total growth there at the high-end switching on in terms of the capability.

  • I think the 9K will probably ramp quicker once you get a number of lighthouse accounts and they get their two and three and four systems working well on it.

  • Remember, this is the engineering team that did the UCS where people said this is going to have a very slow ramp and it will take time to achieve that goal and while it took us a little while to get the attention of the market on UCS, the numbers went up very quickly.

  • We always talk with Alison Gleeson, who heads up our commercial group and what she and Sony are doing on focus on the market and they're actually on pace for the number of customers in the pipeline that they had for UCS, which is amazing in a commercial market where clearly, some of the commercial accounts won't be reaching to the 9K.

  • I think the ramp, once it goes, will probably be quicker, but it will be the 7K and the 9K together.

  • Rob, bring us together, maybe a quick snapshot of this next week with where we are in InterCloud and how this really ties to where we're going with our switching architectures.

  • Rob Lloyd - President of Development & Sales

  • Sure, John.

  • I think to continue on the comment you made, is the 9K is a continuation of the Nexus family running in standalone mode using the same operating processes our customers rely on, as well in APIC mode, where we begin to deploy the controller that is the fundamental building block of our ACI architecture.

  • When you think of the differences across not only our catalyst switch and our routers and access technology, the vision of ACI is to use the construct of a unique application policy, which no one else is talking about in SDN and move that policy not only across both physical and virtual networks in the data center, but as well to the wide area and to the access.

  • When we now begin shipping that technology in the next few months, the trials turn to production, you will start to see the idea of an end-to-end application policy evolve and the really neat thing here is that same policy could run in my private cloud on a UCS or even now on a Vblock or a FlexPod, but as well in a public cloud instance and we'll be showing examples of how that policy can flow between private, managed and public clouds at Cisco Live next week.

  • So there's a lot of difference.

  • We really do both physical, virtual, end-to-end across the network in terms of moving policies.

  • We are starting to see that at scale.

  • Earlier we were asked about public clouds deploying.

  • We'll be announcing two partners that are deploying ACI in their public cloud environment.

  • One of them is in the Gartner top quadrant, one of them is mid-size.

  • I think it's really catching on and it is really different in terms of deploying the model our customers are embracing today, which is hybrid cloud and I think we've really hit the nail on the head with ACI.

  • Melissa Selcher - VP Global Corporate Communications

  • Thanks, Rob.

  • Operator, next question.

  • Operator

  • Next question comes from with Inder Singh with SunTrust.

  • Inder Singh - Analyst

  • Hi, John.

  • How are you?

  • John Chambers - Chairman & CEO

  • Good.

  • Inder Singh - Analyst

  • Good quarter.

  • You sound excitedly upbeat, especially after the past couple of quarters.

  • It sounds like the demand side has picked up for you, but also the product upgrades are starting to kick in.

  • I think you've spent quite a time on the switching side of it.

  • I wanted to ask you about routing as well.

  • Clearly the company made a big bet with the CRSX and I think you alluded that you're seeing above expectations in terms of the demand for that, but can you provide some more color on that?

  • And then just the other part of the question around the security business, same thing.

  • We've seen all these networks come under threat.

  • Clearly, perimeter security hasn't been working on networks.

  • What are you doing differently here where the security business is starting to show growth for you now?

  • John Chambers - Chairman & CEO

  • So on the sequence, I'm usually pretty realistic where our competitors are, even though we know how we're going to beat them.

  • At the high-end routing, we're by ourselves.

  • Some people might have a product that might compete with ASR9000, say that's a high-end router product, it's really not.

  • So on the CRSX and NCS, they're both world class, by themselves type capability.

  • The ramp was actually good, but these tend to, they tend to buy a pallet, and 10 buy 10, and so you will see those numbers bounce a little bit in terms of quarter to quarter based on one big deal or two and Mel allows me to use the word lumpy now in terms of direction.

  • I really like those products and, candidly, I've not had a customer concern on the ones we've put them in so far, which is unusual with the new products.

  • In terms of security, you're right, the market in security you tend to have a hot product company, you have one or two product areas and as long as that product is hot, i.e.

  • malware or firewall, or whatever they're doing, intrusion protection, prevention, it tends to be a very good growth.

  • The bad guys, as you alluded to, just go right around that and found weaknesses.

  • Where we're going to play in terms of security, you will see security go across the whole architecture from our literally, capability with InterCloud, down through individual private cloud, down through the data centers, down through the LAN, down to the access point.

  • This is where we're going to use both our merchant, but also our custom ASICs.

  • You will see us play security at each node throughout that environment in a way that nobody else can.

  • And you will see us evolve to something we'll talk about next week on self learning networks to where it's very good for load balancing or the Internet of Everything and you have you to have that, given how unpredictable the Internet of Everything, 50 billion devices are going to be on loads and prioritization of applications.

  • Its ability to handle [distributive analysis] service attacks and other things becomes very exciting.

  • And it was a gleam in our eye 15 months ago.

  • We put the team on it and now it looks like this is really going to hunt and I want to see a couple big lighthouses moving from beta to growth.

  • But that begins to change the competitive environment and I think that's what you're going to see us do in security.

  • You'll see us move on multiple fronts on security, bringing those products together in architecture and then providing what Gary alluded to and what Brian Palmer is leading for us in terms of a consultancy group that really helps you before, during and after and does this virtually and physically together.

  • We're betting on this big time.

  • I think the market's already figured out it's got to be an architectural player that wins here.

  • If you don't have the ability to see what's going on in the network, you're playing with one arm behind your back no matter how good your products are in terms of direction.

  • Now, this is heavily lifting and it takes multiple steps to do it and you get up one step and then you plateau out, then you get up the next step.

  • I'm counting on Chris Young executing well here.

  • I think that's a good question, Mel, to end on.

  • Key take away is what you all ask us here at the end, is this innovation engine has never been better and think about it.

  • We talked probably about 10 major product innovation areas today from InterCloud to what we're doing in high-end routing and switching to self learning networks, the collaboration portfolio with the refresh on it, how we're moving to software architectures on it, where we're going with security and it's moving very well.

  • The one area that we didn't spend as much time on was collaboration and each of our enterprise customers will tell you what the CEO wants is first, operating cost reductions, and second, revenue growth and that has changed over the last six months.

  • The collaboration has been good from us and maybe one other peer, but it doesn't get the productivity at 5%, 7%, Gary, that we need inside Cisco and others.

  • Watch what Rowan and team brings out this next year on products, ease of use, capability, creativity and just to level set, when Rowan came here and we finally brought our three product areas together with WebEx, which had been separate too long and with telepresence and with Jabber and then he took a small team to move very rapidly.

  • It took him 6 months to develop his plans, 12 months to implement it, he hit every milestone along the way.

  • Now you're finally starting to see products start to come out which are really world class and something called Red Dots, which might not mean much to people in this audience but Red Dot is like the Oscars in this industry.

  • We've won six in our history as a company.

  • We won six this last year, all in this collaboration product group on product design and direction.

  • So we're getting back to ease of use, think of it like an Apple and telepresence combined in ease of use and implementation and I encourage you to look at it at Cisco Live next week.

  • Innovation's going well.

  • We've got a lot of challenges in front of us.

  • We're not underestimating those, but I think this is a very good step back to not only growth but innovation and disrupting ourselves which I know is painful at times for our shareholders.

  • Melissa Selcher - VP Global Corporate Communications

  • Cisco's next quarterly call, which will reflect our FY14 fourth quarter and annual results, will be on Wednesday, August 13, 2014 at 1:30 PM Pacific, 4:30 PM Eastern.

  • Again, I would like to remind you that, in light of regulation FD, Cisco plans to retain its long-standing policy to not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure.

  • Please call the Investor Relations department with any follow-up questions from this call.

  • Thank you for your participation and continued support.

  • This concludes our call.

  • Operator

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