Cisco Systems, Inc. (CSCO) Q2 2011 Earnings Report, Transcript and Summary

Welcome to Cisco Systems Second Quarter and Fiscal Year 2011 Financial Results Conference Call. [Operator Instructions] Now, I would like to introduce Blair Christie, Senior Vice President and Chief Marketing Officer. Ma'am, you may begin.

Great, Thank you. Good afternoon, everyone, and welcome to our 84th Quarterly Conference Call. I'm Blair Christie; and I'm joined by John Chambers, our Chairman and CEO; Frank Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, Executive Vice President of Worldwide Operations; Ned Hooper, Chief Strategy Officer and Senior Vice President Consumer Business; and Padmasree Warrior, our Chief Technology Officer and Senior Vice President of our Enterprise Business. The Q2 fiscal year 2011 press releases is on U.S. high tech market wire and on the Cisco website at http://newsroom.cisco.com. I would like to remind you that we have a corresponding webcast with slides. In those slides, you will find financial information that we covered during this conference call as well as additional financial metrics and analysis that you might find helpful. Additionally, downloadable Q2 financial statements will be available following the call, including revenue by geographic segment as well as product categories. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet and cash flow statements can be found on our website in the Investor Relations section. Just click on the financial reporting section of the website to access the slides and these documents. A replay of this call will be available via telephone from February 9 to February 16 at (866) 357-4205 or (203) 369-0122 for international callers. A webcast replay is available from February 9 through April 22 on the Cisco's Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results. The financial results in the press release are unaudited. The matters we will be discussing today includes forward-looking statements and as such are subject to the risks and uncertainties that we discussed in detail and our documents filed with the SEC, specifically the most recent reports on Form 10-Q and 10-K and any applicable amendments which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. Unauthorized recording of this conference call is not permitted. And now I'd like to turn it over to John for his commentary on the quarter. John?

Blair, thank you very much. Based in part on the feedback from a number of, we are continuing to evolve the format of our quarters conference call. The objective being to share more information in a tighter format while leaving more time for Q&A at the end of the call. Please do not hesitate to give us feedback in terms of the effectiveness of this new format. We will break the call into four sections. In the first section I will put out a summary of the quarter, focusing on key financials, geographies, customer segments and products. In this Section, I will focus on what went well and areas that we would like to see improve. We will finish with general comments on business momentum exiting the quarter as well as our guidance for both Q3 and Q4 fiscal year '11 with all the appropriate caveats. In the second section, Frank will provide additional details about Q2 FY '11 as well as expand on our Q3 and Q4 guidance, investments, opportunities and challenges. In the third section of the call, I will expend on my opening comments on the second quarter as well as a discussion on how we're doing in the market, answering some of your key questions and what you can expect from us going forward. And finally, in the fourth Section, I will provide some closing comments and then wrap up with Q&A. Now beginning with the opening section, where I will cover some of the key results of the quarter in terms of highlights and challenges. First, from a financial perspective, the quarter evolved pretty much as we expected from a top and bottom-line perspective. Revenue of $10.4 billion, a 6% year-over-year increase was slightly higher than our guidance provided last quarter of 3% to 5%.…

Thank you, John. Generally, our financial results for Q2 fiscal year '11 came in as inspected. We did see several positive areas across the business as well as a few challenging areas. Total revenue for the second quarter was $10.4 billion, an increase of approximately 6% year-over-year and above our guidance of 3% to 5%. Total product revenue was $8.2 billion up approximately 3% year-over-year. Switching revenue with $3.2 billion, a decrease of 7% year-over-year. Routing revenue was $1.7 billion, up 4% year-over-year primarily driven by a 5% and 6% increase in high end and low end respectively. Mid-range routing revenue decreased slightly year-over-year. New Products' revenue totaled $3.2 billion, representing an increase of 15% year-over-year. We saw strong year-over-year growth in data center of approximately 59%, collaboration which includes TANDBERG of approximately 37% and wireless LAN of approximately 34%. Security and video connected home declined 9% and 4% respectively. Other Product revenue totaled $211 million, an increase of approximately 7% year-over-year. Total service revenue was $2.2 billion up approximately 18% year-over-year. We experienced strong, year-over-year growth of 14% in technical support services and approximately 30% in advanced services. We saw an increase in total revenue across all geographic segments on a year-over-year basis. Revenue increased approximately 9% in European markets on a year-over-year basis and approximately 4% for U.S. and Canada. Rounding out the theater, we saw year-over-year revenue growth of 8% in each of our emerging and Asia Pacific markets. Q2 FY '11 totaled non-GAAP gross margin was 62.4% down 1.9 percentage points quarter-over-quarter and down 3.2 percentage points year-over-year. For product only, non-GAAP gross margin for the second quarter was 61.1% down 2.9 percentage points from last quarter. Let me take you through the key drivers. Approximately 1% of the quarter-over-quarter decrease was driven by our consumer…

Frank, thank you very much. At this time, I would like to provide a more detailed discussion of the second quarter of fiscal year '11. The first area that I want to cover is the strength of our business momentum in the enterprise markets with a specific focus on U.S. enterprise. This review does not include our large global financials which I will cover shortly. There was very strong order growth in U.S. enterprise accounts, growing year-over-year in the high-20s to an annualized run rate of over $2.5 billion. Customers are increasingly buying both our technology and business architecture. The large global U.S. financial organizations, as you would expect, were hit hard from the regulatory effect in retail and investment banking areas, as well as write downs on bad debt. As a result, our sales in these financial organizations decreased in the mid teens. Next, I would like to expand our discussion in the enterprising commercial segment in more detailed terms, in terms of data center, virtualization, collaboration and mobility. As discussed earlier, our strong commit to the data center strategy is playing out as we had planned with strong growth in UCS, Nexus 5000, 2000, Nexus 7000, MDS, and the VM EMC Cisco partnership. Also, the EMC Cisco VMware partnership, our joint venture, has outstanding momentum in our customers, seeing value in the high, highly innovative and fully-integrated solution. We sold to 40 new customers in this past quarter alone, doubling the number of deals quarter-over-quarter and now with a pipeline of more than $1 billion. We are very pleased with the performance and look forward to our continued partnership. In our opinion, Cisco is leading the transformation of the data center market with a network-based approach to IT infrastructure in support of rapid IT services delivery, backed by…

Thank you, John. We're now going to open up the call for questions. [Operator Instructions] So Kim, please go ahead and open the call.

Our first question comes from Tal Liani with Bank of America Merrill Lynch.

I have a question on switching and routing. Switching is down 7.5% year-over-year and routing is up 5% which is materially below the competition. The question is number one, your guidance is for total revenues to grow 5% sequentially and another 10% sequentially. So do you expect these two segments to recover materially the next two quarters? And number two, more specifically to routing, why do we see such decline, sequential declines, and low year-over-year growth in routing given that you don't have many competitors and there shouldn't be any pricing pressure in this segment?

Tal, there's always pricing pressure in every segment from a number of competitors. But if you look at where we are, if you look at switching, and you look at what we did this quarter, bookings were clearly in both our total product area comfortably above the revenues. So we clearly increased our backlog in these categories. And in terms of the momentum in the switching business, I would expect those to be positive, and while I don't want to break into segments and individual areas, if we were to do that, I would expect switching to be in the mid-single digits if I were looking out over the next couple of quarters to higher. I think what you're seeing very frankly there is, and bear with me for the audience who may not be as familiar with our product capabilities, is that 7000 might have the functionality to a salesperson of two 6000 Catalysts. And so they have to sell almost 2x to 3x the volume, the 7000 to have the same revenue scenarios. If you put a Catalyst in a wearing closet and it was a 6000 and now you can do it with the new 4000 line, while you don't lose share on that in terms of how the fuel fuse it, you do have a revenue drop on it, and you have to pick that back up. The new 2000 has the functionality of our old 3000 products. And so it's very easy to compete with the 2000 from an architectural point of view in terms of product, price performance. But we've got to learn, Rob, to sell up market in terms of the approach. So I think our challenge is to work through each of these product area and we are not going to give…

Our next question comes from Brian Modoff with Deutsche Bank.

You had this long-term kind of growth target of 12% to 17%. The question is, are you considering revisiting what you think your real growth rate is and perhaps managing the company's expense line and profitability more for perhaps a company that's a little larger and maybe a little slower growing than perhaps you previously thought.

Well Brian, we listened to your constructive criticisms and we agree upon the points. We're going to go each quarter couple of quarters at a time and Frank and I with the team will model out what we think our growth will be over the next year, and provide expenses in line with what we think that growth will be. Then we'll let the quarter speak for themselves in terms of what the long-term growth will be in the balance. But in terms of your direct question, I would expect our expenses to be in line with orders or slightly below orders in the intermediate time period in terms of direction. So we're just going to focus on getting the results, tell you what they are, not getting our momentum ahead of our headlights, and we'll focus more in a year cycle, and then we'll see what the results take us in terms of direction. That's a nice way of saying absolutely keep expenses in line with our order growth levels as we look out over the next 12 months.

Our next question comes from Nikos Theodosopoulos with UBS.

My question is on the next couple of quarters of guidance, if you look at the sequential numbers, it's about 5% sequentially and then 9% for the fourth quarter. And I think you also mentioned, John, you thought that could be done while also improving backlog. If I look at those sequential numbers, those are at the very high end of the historical trend, especially the fourth quarter. My question is, what gives you the confidence that you'll be able to hit the high end of the historical range in the sequential revenue growth and at the same time continue to grow backlog? It seems to be a little bit of a stretch given the last couple of quarters performance.

Let's go in the order you arranged them. When you talk to executives around the world and the enterprising commercial business, well, they feel good about the market. Their optimism is starting to increase and you're seeing that in terms of our order rates in many of the areas. And while there's sometimes that lag of a quarter or two before that hits full gear, most of the enterprise customer executives, and we talk to most all of them, are more optimistic by a fair amount in terms of GDP growth in this country and around the world than they were just three or four months ago. And you did see our enterprise business as you saw hit very, very strong run rates in terms of the U.S. as an example, stripping up high end financials in the high 20s. And that's sometimes as good as we've ever done in terms of this marketplace. And they're buying our architectural approach. They're buying our ability to combine technologies across our product lines and to help them solve their business goals at a faster pace than ever before. That's a nice way of saying, probably gaining market share in those over time and definitely gaining share of wallet spend and allowing us to move into areas like collaboration data center, where we were not major areas in terms of consideration before. If you look in terms of the momentum, it feels pretty good around the world. Rob, I'm going to ask you just to comment on what you're seeing that I think we've identified the caveats pretty articulately. And I think we've been a little bit conservative in some of those. The only area that I'm major worried at the present time about is public sector spending and whatever it is, we…

Yes, John, I would just add, consistently around the world, enterprise and commercial appear to be markets we're gaining share and certainly gaining the relevance. The architectures of collaboration and data center are global markets for us and we're beginning to see those uptick even outside the United States as our momentum growth there in non-English speaking countries, which has been a focus for us. And then finally, I think the area of really driving our foundational technology is pretty critical. So emerging markets will be a growth engine for us as we capture the opportunities in Asia Pacific and emerging. I think those are the summary growth messages that we're going to continue to invest in.

Nikos, one last comment, and Blair I'll try to get the answers tighter. If you watched what we've done, if we were just a routing and switching company, that now in total is -- I'd have to look at the numbers. I think like 46% of our business is all that it is. And if you watch these new market areas that we are moving into, they are ramping at tremendous speed in terms of our video strategy, our TelePresence strategy, our media net, our collaboration and data center. We would've told you a year ago that our UCS would be growing at 700% year-over-year. That would be in many, companies that are leading edge, the preferred server technology they're using and switch technology and storage partner with our MDS growing you'd have said not a chance, John. So momentum feels very good in the data center. It feels extremely good in collaboration, we're winning in Video. Now our key is to balance all these portfolios and that's where I'm going to ask Ned to get closer and closer to me. I need help on balancing the portfolios from a strategy perspective and we need to be tougher on our focus on execution on holding people accountable for measurements. But it is these multiple growth areas that when one flows, another picks up. Now my goal is to get them all going at a faster pace in terms of their momentum and that's why I feel pretty comfortable about Q3 and Q4. It's all the appropriate caveats, because it does feel good on that.

Our next question comes from Jason Ader from William Blair. Jason Ader - William Blair & Company L.L.C.: I just had a quick question on the gross margins maybe for Frank. Frank, why would the gross margins be flat sequentially at the consumer mix which would normally be down a lot in the April quarter?

Jason, the mix from a consumer standpoint does help us quarter on quarter going from Q2 to Q3. But the overall margins we saw this quarter for consumer are still lower than we had expected last year. So due to some of the things that we experienced in the quarter, primarily on the pricing and then also some of the inventories. So that's continuing. We also have the mix on the data center products with the UCS from a continuation standpoint. And then also, we're making an assumption here and of course factors can change from quarter-to-quarter. But if you look at the point that we mentioned in the script on the switching, and the transition that we're going through on multiple products within the switching that, that would also play into the back half of the year. So I'm trying to be somewhat balanced and conservative based on what we experienced in the quarter. And being also somewhat realistic over the next two quarters, so looking at a 62% to 63% range.

Our next question comes from Mark Sue with RBC Capital Markets.

Historically, network complexity drove the adoption of end to end in an architectural approach. But these days, standardization is driving a faster adoption of best-of-breed, which is resulting in something of an unbundling effect for Cisco. And if you're pricing actions and extend payment terms are a direct response to increased competition, and you don't want to give up market share, why would 62%, 63% gross margins be the floor? And likewise, if you're trying to compete with new products, which require new investments, are 23%, 24% operating margins sort of the new peak for Cisco longer-term?

A bunch of questions. Let me kind of summarize it. And then Mark, maybe follow up with you from our team on more details on it. In terms of looking at it, in a respectful way, I know you're throwing a fastball and a curve ball that you want me to address both issues. The network's role is increasing in this. It is at the center of everything from security to how you combine any device to any content, intelligent networks, virtualization of where your processes are, et cetera. And the best-of-breed is actually going the other way. Our team, Rob, and I'm going to ask you to comment specifically on this are learning to sell architectures and learning to sell the cost efficiencies of a technology architecture tying together. In terms of the floor, I wouldn't view it as necessary cash in contrary to 62% or 63%. I think we can improve it over time, or we may just even be a hair below it. But this is a basis that we're pretty good on transitions. In fairness, you're saying, "All right, John. You guys are really good at market transitions. How did you get surprised on this?" Well the two things that were surprising to me was the ramp up of the switching product line. We've never introduce all of our products in such a short time period from the core routing, edge routing, access routing, to high-end switching, data center switching, the fixed and modular component parts and we did all of them at once. Normally you have a balance going on. Now, that speaks to the innovation engine being on fair. That's why candidly, I'm pretty comfortable with our innovation engine and our vision and strategy. Now as they come out, they always start at lower gross margins and they go up. And you saw in the example, just using the Nexus 7000 as an example, seven points in five quarters that we improved on it and I think we need to do better in terms of the direction. And then as you get these in place, we'll get better and better at selling them Rob and we'll move some of the people at overlay sales and the direct sales and drive it through as well. So I actually think in the approach in terms of the model is right we are seeing growth faster in the UCS and some of the products at the low end. A good problem to have, but it does put downward pressure on the consumer units is a couple of quarter phenomenal year. And then I think we've got to strike our balance in terms of obviously expenses and cost efficiencies in the group, although this is important to us in terms of feeding our future direction and we'll spring our groups together on it. That will be the way I'll answer it. Rob, what would you add?

John, I think an example for Mark that you mentioned earlier is in the data center, we have an architecture that's selling. And when I ask our sales teams and I asked our partners, that architecture is clearly winning. The foundation of that new architecture has lower margins than the products that it's replacing. And it will be an ongoing improvement for us which is currently underway to improve the gross margins at the Nexus 7000 and equate to the gross margins of the Catalyst 6000 that it's replacing. So that's an example, where to Mark's question, we will be seeing margin improvement at that architectural approach to data center replies. And I think that's applying to several of our product transitions.

It might take as a year and a half to win the first $1 million orders in a large enterprise customer regardless of industry for the date center and those are servers, and the network, and our storage approach. Then, you ramp it after that. So you do have front end -- what I'd call getting the field ready type of activity that then ramp up on the back side. So that would be the way I'd answer it, Mark. Give us a feedback on what you agree with and what you perhaps are challenges further on.

Our next question comes from Jeff Evenson with Sansford Bernstein.

Are you doing Sean. Could you give us an update on the dividend and especially what I think are the related issues of the commercial paper that you're issuing and your expectations around repatriation?

In sequence, the dividend very much on track, we will pay it by the end of this fiscal year. We will now start paying it by the end of fiscal year, Frank will determine when payments starts, obviously. The only question is, is it 1% or 2%. In terms of our country's understanding of the importance of bringing back foreign earnings into our own countries investment for jobs, for plant and equipment, even for acquisitions, I think you're now seeing political leaders at all levels understand that. And at the risk of repeating the theme, every major developed country in the world, doesn't matter if it's Japan, it doesn't matter if it's Germany, France, you go right down through the list, all of them bring back those foreign earnings of 0% to 2%. So we have a tax policy that is just broken. It's at an unreasonable high rate, and then it's the worst of all worlds. The majority of our growth, almost 70% of our market, and probably 90% of long-term growth is outside of the country and we have a policy that makes us non-competitive outside the country and then not only doesn't encourage us to bring it back, but penalizes it with double taxation. That's a nice way of saying, I think this one has well over a 60% profitability of being resolved in a positive way and I do believe that Republicans, Democrats in the administration are much more receptive to this that they were just six or 12 months ago for combinations of reasons. So that would be how I'd answer it Frank anything you'd add?

On the question about the commercial paper, as I mentioned earlier. We did announce within the last 12 weeks to 10 days about a $3 billion commercial paper offering. That clearly is focused on short term debt. Right now a very attractive rate to provide us with flexibility and liquidity, especially in the United States. I also mentioned that if you look at our balance in the United States at the end of the last fiscal year from a cash perspective, it's $3.1 billion. So this gives us a little bit more flexibility in the short-term based on kind of what John was saying before, to be able to deal with some corporate needs. The other thing that we have from a debt perspective that comes into play as well, as we stated before with some of the debt that we have in the $15 billion amount that we currently have, we have a little over $3 billion that's coming due later this month, which is at a higher rate. So to be able to manage that, in the short time frame is the reason why we're going forward with this offering.

Our next question comes from Simona Jankowski with Goldman Sachs.

Frank, on your growth and operating margin targets long term, are you still thinking of the same range as you talked about at the analyst day? 64% to 66% in 28 to 31. And if so what would it take to get back to that? Is that a level of a revenue level or is it just a number of quarters during which you expect some of these product transitions to play out? And then John, I just wanted to clarify your comment that you're seeing significant strength in your U.S. Large Enterprise business and you think that the data center architecture bet is working. But at the same time you also talked about pricing pressure and a mix shift to the low end. So I just wanted to understand how those two reconcile?

Sure. Which one of the two do you want Simona?

I'll go with the second.

So in terms of the architecture and the data center type of approach, we've got new products that have tremendous price performance. We're going to control the switching transition. The great news is we've got this in a breadth and depth we've never had before we usually would have one product and then a year later a different product area. And a year later it will be over five or six years, we would have brought out this range of products. They're all moving very well. The good news and the challenge is they have price-performance, our own price-performance competition that is dramatically better than the products that they're evolving from. So it's very easy to take a product that you use to do a given function and take a product class with this next generation one or two levels down. We've got to learn to architecturally sell that. In terms of the data center, it is playing out identical to what we expected. In terms of the market, our ability to really comment on architectural approach both in the traditional Brownfields and the Greenfields. I wouldn't cut us out of the bare meadow opportunities just for server architecture in terms of the direction. So you are seeing companies realize that they are an advantage to a major architectural play. We have advantages versus the incumbency big time in terms of we don't have an installed base to protect and we're moving very aggressively on that, and we're also doing that from an operating cost perspective. Our strategy is now being copied from an architectural perspective and people are following along I think you look back a few years from now and it will be the example of it. So it's a nice way of saying very simply, that if you look at the products what we're doing, we are providing more and more function. It will take a while for the network growth to occur to really pick that up in terms of the volume, but in terms of versus competition, we are really in good shape. Rob, just a quick comment on your sales force. I have worked everyone of them. With the exception of pressure and emerging markets, they would tell you that in terms of when they go head-to-head, their win rate is as good or better than it's ever been. General comments on that?

Yes, John. I don't think we're losing market share in any of those spaces. I think we can do a better job at articulating the architectural advantages at the lower end of our fixed portfolio, and we have some actions underway right now to look after that.

Nice way of saying we've got to learn how to sell up market as well as beat the competitors. We're beating the competitors fine, but we've got to sell up in terms of additional functionality. And then we can load the networks with that functionality, Simona, as well.

Our next question comes from Ittai Kidron with Oppenheimer & Co. Ittai Kidron - Oppenheimer & Co. Inc.: I wanted to follow up on Jason's earlier question on the gross margin. And John, specifically on the switching side, what is it about this transition that you didn't anticipate that is happening? And as we look forward for the next two or three quarters, what is it specifically, if you can provide us a little bit more detail on what changes over the next few quarters that would margin to improve in that segment?

Fair question, Ittai. It's probably one that a number of your peers have. And I know we can ask it in different ways. In terms of what has always occurred -- and bear with me, I'm going to take a step back. When we originally entered the switching market, with the team from [indiscernible], everyone was convinced that you cannot get gross margins higher in switching than high-40s, at best low-50s. And yet every generation products we brought out we’d bring out a product at a given gross margin level then would do what I call a Texas two-step which is price performance improvements with better margins, price performance improvements with better margins as you go through it. We know how to do that, I just think we have to do it at a faster pace in terms of the approach. And if you watch even the 7000 just as a proof point that's exactly what we did over the last five quarters. Now with the 2000, 3000, they're new. We've got to do the same things there in terms of the approach. And as you would expect, we have working groups in each category. Now the two things that challenge us here, that have never challenged us before, I have never been fortunate enough to have all new products across all of our product portfolios at the same time. Normally you have two or three new products per year and it takes you four or five years to have that generation of products evolved that we have today. This is tough to compete against. I mean, the innovation engine is doing really well. The speed of take up, I did not anticipate. How quickly the ramp occurs and the trade off, our ability Rob to fill the higher end…

Your next question comes from Richard Gardner with Citigroup.

it's actually John Slack for Rich. My concern is on the consumer side. Clearly down 15% year-over-year, a gross margin drag. What's the ongoing strategy there, how important is the Consumer business to Cisco? Any sort of color you can give us on that, and what you can do to kind of turn the direction there?

When I asked Ned to lead it for me and we brought in Jonathan to be the lead of the Consumer specifically, we knew going in it was going to be tough. And we based our strategy on being able to sell added value on an architectural play in the home. As you saw in the most recent Christmas holiday season, value add higher end products got crushed and the ability to move was mainly on lower SKUs and lower balance within it. And so it turned out to be a tougher market than we anticipated and this last six months in particular, the things that are most important to Cisco than being able to sell are key, were not what the customers were buying within the category. Flip was up 15% year-over-year, but that wasn't the kind of growth that we wanted. We were looking more in the 30s in terms of the growth for the Flip architecture. So let me flip to you Ned a little bit of what you found. And then let me come back come around to talk about where we're going to go-forward and jump into it any way you want.

Sure, thanks John. And you know, John Slack, what we have focused on as a strategy is bringing together the convergence of video and networking to be able to deliver high-value products and to be able to deliver experiences for our customers both directly to consumers and through partners through service providers as they deliver consumer applications. A part of the strategy we've executed over the last year has actually been to exit some of the commodity products and commodities SKUs that we were selling in the U.S. and to exit low-volume global markets where we were sub-scale. So as we looked at what happened over the last quarter, the combination of the market’s overall focus on deeper discount and lower priced products and the exit of those SKUs and markets is what caused us to underperform our expectations on both revenue and gross margin. And as John said, we're focused now very much on making sure we're very efficient in our investment bringing our resources together and driving the operational improvement. So in the short term, we do expect the consumer market to stay focused on lower value products. But we believe the opportunity for Cisco is to create those premium experiences and premium products and we're going to stay focused on that and driving that both with our retail and service provider partners.

It's 2% of our business, John, to answer the question very directly, we get a lot of creative ideas and potential architectural plays here, and we have some plays coming in terms of Smart Grid and how that ties to every device in the home up and how you make the home architectures work better. We clearly will be very careful on spending this area and make sure we catch the market transitions if we ramp up expenses in the way. We will be combining resources in a constructive way to help on expenses as well.

Our next question comes from Ehud Gelblum with Morgan Stanley.

First of all, John, you've given out some numbers since last quarter. I just want to see if you can update them on the size of the run rates of the Nexus family in total by revenue and the three different ASRs so to see how they're doing just on a comparable basis. I think you also gave the ISR G2. Just anything you can fill in there would be helpful in a comparable basis, the ones you gave out last quarter.

Go ahead, ask the question, because I'm looking for a little bit of data because I'm going across a number of these at the same time. Go ahead and get the second part and I'll combine the two.

I hate to bring back gross margins, but taking a look at that in terms of what UCS is doing, so far UCS appears to be somewhat on track doing the run rate of $650 million of revenue. I believe in the past you said it would be $1 billion run rate by the end of this year. So it seems to be doing nicely and on track and yet it's detracting from gross margin this quarter half a point. Going forward, as UCS continues to get larger I'd imagine it will continue to detract from gross margin. First of all, can you give us a sense as to where the gross margin on UCS stands today, and so we can do our own calculations depending on how large UCS gets, what the impact is on gross margin and how low will it take gross margins down? Could it get into the 50s before we get this turnaround and it starts bouncing back up again. And then leave a comment on services as it keeps getting larger as a percent of revenue where that kind of tops out will be great as well.

A lot of questions and I might do the services as wild card at the end, because that's something I think many people do not realize how much a differentiator is for us. 67% gross margins. I mean, it's off the charts. And what is even more interesting, as you invest in services, your customer satisfaction goes up, your win rate goes up, your architectural plays goes up and the customers are able to implement their solutions to achieve their business goals at a faster pace. It's nice if saying well, Gary, Joe, you guys are getting a home run at this and it's becoming literally a think about it, it's 21% of our business today and growing at a rate probably five points faster than the rest of the business and yet it pulls all the rest of the business through in terms of direction. To answer your question both directly and indirectly including keying off with a question you asked last quarter, in terms of comparing apples to apples, the Nexus product lines respectively, the Nexus 2000 grew at about from a revenue perspective about 160% the 5000 close to 60% not quite there, the 7000 about 97%. To go back to the Nexus approach in the 5000, these are all pretty good shape, the ASR 1000 grew about 7% the ASR 5000 grew as I said well over 100% but to your point, if you're comparing the ASR 5000 and going back to [indiscernible] based on that and look forward about the stair in improvement you're seeing growth in this product category at about 30%. The ASR 9000 grew at about almost 500% in terms of the ramp. And the ASR 9000 as you all know is so important, Rob, to us at the edge of the…

Our last question comes from Simon Leopold with Morgan Keegan. Simon Leopold - Morgan Keegan & Company, Inc.: John, during the course of the call, you mentioned market share a number of times spread out for the call. I'm hoping you could kind of go back and simply address maybe the gap between perception and reality and just clarify one element I think I heard you saying, or at least suggesting was that in the Switching business you're going to fight back with pricing. I want to make sure that that's -- that I heard that correctly. And in general, what are you doing in terms of the real fundamental aspects around market share. If you could summarize that.

Sure. Well first let me start with a 10,000-foot view in reiterate, we are a portfolio play at Cisco. And if we have our top 15 product families, and we're gaining share in 10 and losing share in five, that's what I would consider, Ned, a reasonable balance. That doesn't mean there won't be quarters where we do 13 and quarters where we do eight, but it is that consistent balance overall, especially for the high-end segments of the product areas. According to our cuts on what the industry analysts are providing, if I look at year-over-year growth through the end of the calendar year, there are three categories that we lost share in. If you look at quarter-to-quarter and anticipating what's going on, there might be five within that group. If you look at where we are on LAN switching, I clearly am very comfortable with our product issue here. I think we've corrected the port scenario. And I think that we do our job right you see us pick up on revenue and approach. I want to say very specifically we are not fighting back with pricing. I wanted to say that very specific. This is not a price game. This is a price-performance game with our new products coming out at dramatically better price performance than our prior once. And as you'd expect, our customers will move to a product that has ramps twice the performance at half the price. That's just a logical evolution of where the markets going in terms of direction. On service provider routing, although we might lose something on the edge for a period of time this quarter. I really like where we are. And with ASR 9000, ASR 5000, we're going to be fine in terms of service providing the edge…

That's okay, John. You are the CEO. Why don't we go ahead and just close the call at this stage. Cisco's next quarterly conference call, which will reflect our third quarter fiscal year 2011 results, will be on Wednesday, May 11, 2011, at 1:30 p.m. Pacific Time; 4:30 p.m. Eastern Time. And additionally downloadable Q2 FY '11 financial statements will be available following the call including revenue segments by product and geography, income statements, full GAAP to non-GAAP reconciliation information, balance sheets and cash flow statements can be found in our website in the Investor Relations section. Click on the Financial Reporting section of the website to access the webcast live and these documents. Again, I'd like to remind you that in light of regulation fair disclosures, 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 on this call. And thank you for your participation and continued support. This concludes our call.

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