Welcome to Cisco Systems' Fourth Quarter and Fiscal Year 2016 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 Marilyn Mora, Head of Investor Relations. Ma'am, you may begin.

Thanks, Sam. Welcome everyone to Cisco's fourth quarter fiscal 2016 quarterly earnings conference call. This is Marilyn Mora, Head of Investor Relations, and I'm joined by Chuck Robbins, our CEO and Kelly Kramer, our CFO. By now you should have seen our earnings press release. A corresponding webcast with slides including supplemental information will be available on our Web site 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 financial information section of our Investor Relations Web site. Throughout this conference call we will be referencing both GAAP and non-GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons throughout this call will be on a year-over-year basis unless stated otherwise. The matters we will be discussing today include forward-looking statements including the guidance we will be providing for the first quarter of fiscal 2017. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. As a reminder in Q2, on November 20th, we completed the sale of the customer premises equipment portion of our SP Video connected devices business and accordingly had no revenue or expense from that business in Q4 fiscal 2016. As such, all of the revenue, non-GAAP, product orders and backlog information we will be discussing is normalized to exclude the SP Video, CPE business from our historical results. We have provided historical financial information for the SP Video CPE business in the slides that accompany this call and on our Web site to help to understand these impacts. As a reminder, the guidance we provided during our Q3 earnings call and today's call has been normalized in the same way. So with that, I'll go ahead and turn it over to Chuck.

Thank you, Marilyn. We executed extremely well in Q4 with revenue growth of 2% and record non-GAAP EPS which grew 9%. This was another strong quarter wrapping up a great year. We closed out our fiscal year with $48.7 billion in revenue, up 3%, and non-GAAP EPS which grew 8% to a record $2.36. Gross margins and operating margins were consistently strong throughout the year. We continue to manage our business well and these results underscore our ability to execute against our strategic priorities and our rigorous discipline on profitability. Over this past fiscal year, we experienced a challenging environment with significant volatility. Our fourth quarter was no exception. After three consecutive quarters of growth, both service provider and emerging markets turned negative. Service provider orders declined 5% reflecting the many challenges in that customer segment that you've heard from our peers. In addition, emerging markets orders were down 6%. The remainder of the business remained healthy, with orders growing 5%. While the overall macro environment remains uncertain, we are well positioned to capture the benefits of any tailwinds. At the same time, we're aggressively investing in priority areas to drive growth over the long-term, regardless of the environment. We had strong performance in security; data center switching, collaboration and services as well as continued success in the transition of our business model to software and subscriptions. We remained focused on accelerating innovation across our portfolio and we've made great progress over the past year in these priority areas where we continue to see momentum. First, security; Security is the number one priority for every customer. As the global leader in networking, Cisco is uniquely positioned to deliver security at scale with leading edge innovation as we lead the transition to cloud delivered security. Our team has done a phenomenal…

Thanks, Chuck. We executed well on our financial strategy of delivering profitable growth, managing our portfolio and strategic investments and delivering shareholder value. First, on delivering profitable growth. We had another good quarter with revenue growing 2% and non-GAAP EPS growing 9%. For the full fiscal year, we grew revenue 3% and non-GAAP EPS 8%. For the quarter and the full year we expanded both our gross and operating margins. For the full fiscal year total revenue was $48.7 billion with product up 2% and services up 5%. Let me now walk through the details for Q4. Total revenue was $12.6 billion, up 2% with growth in product revenue of 1% and services of 5%. Switching grew 2% driven by strength in data center switching with continued momentum in ACI and the next generation data center. Routing declined 6%, largely driven by the weakness we saw in service provider. Collaboration grew 6%, driven by continued strength of our TelePresence portfolio which grew in the double digits and continued solid performance of WebEx. Deferred revenue grew 13%. Data center declined 1%. Our hyper converged offering, HyperFlex, is experiencing solid early up tick by our customers led by its highly differentiated architecture. Wireless grew 5% led by growth in cloud-based Meraki partially offset by a decline in controllers. Security grew 16% with deferred revenue growth of 29%. We had strong performance in our advanced threat security and web security solutions, which grew over 80% and 50% respectively. SP Video declined 12% driven by the weakness we saw in China this quarter. Services grew 5% driven by our focus on renewals and attach. So we continue to make solid progress in our goal of driving more recurring revenue, total deferred revenue grew 8% with product up 8% and services up 9%. And as…

Thanks, Kelly. To wrap up, I want to summarize our priorities as we head into the year ahead and why I'm confident about our opportunities. First, we expect to continue to execute against our strategic priorities and drive profitability regardless of the market conditions. We are committed to making the necessary decisions to drive our future growth and that of our customers and our partners. Second, we believe we will transition more of our revenues to a software and subscription based model and accelerate our shift across our portfolio. Third, we remain committed to increasing our pace of innovation that will help our customers succeed. Lastly, we will continue to execute on our long-term strategy to create even greater value for our customers and shareholders while positioning Cisco for long-term success. Marilyn, I'll turn it back over to you for questions.

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

Thank you. And our first question comes from the line of Vijay Bhagavath with Deutsche Bank Securities. Your line is now open.

Thanks, Chuck, Kelly, Marilyn. My question is around demand trends, a lot of clients are asking me this since the press release came out. Help us with any color you can in terms of end markets, product categories, product cycles, anything and everything on demand trends looking into the rest of the year.

Thanks, Vijay. So I'll provide some comments and ask Kelly for anything else that she'd like to add. So when you look at in Q4 what we obviously saw was after three quarters of growth in the service provider and emerging countries, we saw those turn negative, as I said. And the rest of the business was up 5% from an orders perspective. We also highlighted the fact that enterprise was up 3, a little more color on that is that every geography around the world experienced positive enterprise growth. Commercial was up 5. Every geography around the world experienced positive growth in commercial. And then in public sector it was up 1% and I believe all except perhaps Europe were positive as well in public sector. So outside of SP and emerging, we saw fairly consistent demand and I think that pretty much summarized it. Kelly, what other comments do you have?

No. I think you summarized it well.

Okay, Sam. Let's go ahead and tee up for the next question, please.

Thank you. Our next question is from Ittai Kidron with Oppenheimer. Your line is now open.

Hey, guys. Thanks for the question. Couple things from me. And Chuck, this is the same question I asked last quarter. Your UCS, your data center business has now been stuck in range for seven quarters in a row and I understand that HyperFlex is seeing some traction, but how do we get that business back to growth again? What is the time line by which you think that could happen? And will you consider going after parts of the market that are maybe more margin sensitive? And then just another small question there, Tetration solution you introduced. Can you just remind us in what product category in the future that will be included and maybe some color on first comments from customers?

Absolutely, Ittai. Thank you very much. So on the UCS front, we talked about a couple of things. There's an overall sort of macro demand issue in that space. I think the overall blade market has been somewhat benign. But we've also had -- we've also experienced, as we talked about, a transition to rack and our teams have been working on subsequent innovation across both the blade and the rack business, as well as the introduction of the HyperFlex system. So we have -- I believe the team has a real clear plan. They've got innovation priorities outlined across all of those platforms. And we'll be executing that over the next few quarters. So, Kelly and I actually reviewed this just a couple of days ago. So I feel good about the leadership there. I feel good about their plan and now it's about execution. Kelly, any -- on the Tetration front, let me give you a little color and then Kelly you can talk about how we're going to report it. So, Tetration is -- we announced it in Q4. We're generally beginning order ability I think sometime around now. It is a combination of premise based hardware with subscription software. And so we're just very much in the early days. We have taken a couple of orders from customers. I will tell you that the general feedback from our customers is that it solves a problem that they've had for a very long time that nothing else has solved. So again, we've got that offer ready to go in a combination of premise based and subscription based solution and it is just being turned off from order ability perspective.

Right now since it is in the data center solution, it will be in data center switching. We expand that portfolio across we can be really able to give.

We'll call it out.

Yes.

Thanks, Chuck and Kelly. Sam, we'll go ahead and take the next question, please.

Thank you. Our neck question is from Simona Jankowski with Goldman Sachs & Company. Your line is now open.

Hi. Thank you. I just had a clarification first which is, what percent of the business right now is recurring software and subscription revenue? And then as far as my question, gross margins and operating margins were ahead of your target ranges and that's in a quarter when gross margins are typically seasonally down. So just curious, Kelly and Chuck, are you thinking about raising your target margin ranges over time? And just more broadly, how are you thinking about the tradeoff between margins and revenue growth?

Yes. So I'll start and Chuck you can jump in. But, to your first question, the portion of our business that is recurring revenue is up to 28%. And that compares to a 25% in Q4 of 2015. So we made really solid progress this year. In terms of the margins, this has been a huge focus for us all quarter long and it is really great to see that we actually had our margins -- gross margins and operating margins up year-over-year for us this year. Its part of what we're driving with our shift to software. Those businesses have great margins and its part of the overall transition. In terms of when do we change our model or our guidance, I think that will come over time as we make bigger shifts at the company level. But that is our goal as we shift to more software that have those nice, great margins.

The only other comment I'd make is that when we look at our success relative to subscription and software businesses, we have the product deferred revenue that's associated with software and subscriptions that we said was up 33%. We also have another category of total contract value that we have not recognized revenue on yet that we will be billing customers on, on a monthly basis going forward that we track both those numbers. The second one doesn't show up on our balance sheet yet. If you look at those two combined, which is really reflective of our progress here, that number was actually up 43% over the same period a year ago, just to share one more data point there.

Next question, please.

And our next question comes from the line of Tal Liani with Bank of America Securities. Your line is now open.

Hi, guys. My questions are about the restructuring program. Two things. First is, are you -- you said that you're doing it in order to increase investments in growth areas versus areas that are not growing. Are you anticipating further decline in growth rates or any issues beyond what we're seeing now in the legacy areas that prompt this kind of program? And second, when we talk about lower growth areas, these are your largest areas, so switches and routers and the question is how do you deal with -- how do you balance between the need to compete and the need to invest and maybe you can give us some colors on the restructuring and what you plan on doing. Thank you.

Yes. I'll make some initial comments and again pass it to Kelly. So, Tal, good questions. Primarily we are looking at the areas of growth that we believe will grow faster than others. So it's more of a relative statement than it is an absolute statement. At the same time, we actually are working very diligently on bringing innovation to our core. We're focused on a tighter coupling of security into the core. We're focused on policy and orchestration and cloud-based management across the entire portfolio. So there is a significant amount of innovation the teams are working on there over the next several quarters as well. So it's not that we're ignoring one in favor of another. We just want to make sure that our investments are commensurate with the growth opportunity from a relative perspective. Kelly?

No. I think you said it well. We are investing in basically every business unit we have, right. So we're investing in the core in key areas. We're looking for those pockets of where the growth is, whether it's in core routing and switching or security and collaboration. So we're being very smart about where we're putting our money and that's how we're looking at this.

We'll go ahead and take our next question, please.

Thank you. Our next question is from Steve Milunovich with UBS Securities. Your line is now open.

Thank you very much. Could you talk a bit more about the factors behind your first quarter guidance, revenue being flat is clearly below the recent growth rate and the gross margin is also down a fair amount sequentially. So what do you attribute that to?

Yes. I'll give a couple of macro comments here. So we obviously are calling out the weakness we saw from a demand perspective in Q4 relative to SP and emerging countries. We also -- obviously as we look forward, we just -- we're uncertain how to model any improvement in those two in particular going forward. And the other issue is that there is some impact from the transition in our business model. I'll give you a quick example. We restructured and drove new value and how we put together certain Cisco One software packages for our customers. And in Q4 as an example, there was about $139 million that would have been recognized as revenue that because of the way we have now structured those offers and the value the customers see in those, those are going to transition to ratable revenue recognition. So there is slight impact from that as we look forward as well. And those are the key things that led us to our guide.

Yes. And just on the only thing to add to that, again, we base it on what we see and again, we did see the additional slowdown in SP and emerging. That makes us a bit cautious. On the margins, Steve, we're going to be driving as much as we can in those margins and we'll be working that. But as of right now, this is what we see.

Next question, please.

Our next question comes from James Faucette with Morgan Stanley. Your line is now open.

Thank you very much. I just wanted a quick question, I think this ties into service provider. Routing was surprising to us that it wasn't a little bit better and I think that's probably attributable to service provider. I want to make sure that's the case. And I guess I'd like kind of your view, seems like with new products in that category that maybe that that category at some point becomes pretty spring-loaded as at least we would expect the valuation units to be shipped in and pent-up demand to develop. But I want to know if we're thinking about that correctly and kind of how we should think about the router segment going forward. Thanks.

Yes, James. You're correct in that. Over 50% of our routing business comes from service providers. So there's a direct correlation there. And I think if you look at the discussions that have taken place with our peers, you look at some of the analyst reports on SP CapEx, we actually saw exactly what the analysts have talked about. I saw one report that discussed double-digit declines outside of the United States and maybe flat to slightly up inside the U.S., which is effectively what we saw from a demand perspective. So it was very much in line with that. As far as what we see going forward, look, we certainly don't expect that these networks over time, that the traffic will decline. So I think it's a matter of timing. The video loads on the networks continue to increase. So we would think about it the same way you do, but we also know that in uncertain times that customers' tend to sweat assets as long as they possibly can.

Thanks, Chuck. Sam, we'll go ahead and take our next question, please.

Yes. Our next question is from James Suva with Citigroup Global Markets. Your line is now open.

Thanks very much. And I appreciate the opportunity. Congratulations, Chuck and Kelly to your good results. My question is just one part and pretty simple is, regarding Brexit, you're one of the first major tech companies to report that have a full month post the Brexit event happening. Can you talk about, did that influence your visibility, your spending patterns or demand orders or book-to-bill or anything like that, any push-outs, any hesitations? Chuck, you talked many times about uncertainty in economic times we're in. I was wondering has it been compounded by Brexit or was that kind of built in and actually you didn't see much of an impact. Thank you very much.

Thanks, Jim. I'll tell you after the first year in this job, I know for a fact that every month there are you new things that we face and the good news is we tend to execute well and we deal with those. As it relates to -- first off, let me just say, in the EMEA business the decline there was largely attributed to service providers. So I just want to make that clear. We would not suggest that the broad-based shift in the EMEA results was solely dependent upon Brexit. What we saw from a Brexit perspective is exactly what you would expect. In the U.K. proper, we saw customers pause. We saw them just kind of slow a bit because they're uncertain. And we also saw the impact of the currency devaluation which you would expect. But we remain very committed there. We think we'll work through this. But those are the real impacts.

Great. Thanks, Chuck. Sam, let's go ahead and take the next question, please.

Yes. Our next question is from Mark Moskowitz with Barclays. Your line is now open.

Yes. Thank you. Good afternoon. I wanted to ask a follow-up around the restructuring. Can you give us any sense, Chuck or Kelly, is there any benefit here from the early stages of the Ericsson relationship allowing you to leverage that JV so you can actually drive some of this restructuring, does that imply there could be incremental restructuring down the road? And then my question is around the cloud. We keep getting a lot of questions around what is Cisco's exposure to the cloud in terms of can you give us any sense around the percentage of revenue at least to private cloud or public cloud deployments that you're serving from an infrastructure perspective. Thank you.

So, on the Ericsson front, I'll tell you that the partnership continues to move forward and there was really no correlation or discussion of the Ericsson partnership as it related to the decision on restructuring. We think that, again, the original benefits that we saw with that partnership with their global scale for services, their OSS capabilities, their radio expertise combined with our IP expertise and data center and security and other capabilities as well as the enterprise and IoT were really the drivers there. So, we see that continuing. As it relates to the cloud impact, I think when we look at sort of next generation data center build out in the private cloud, we look at our ACI portfolio and we saw a $2.3 billion annualized business that grew 36%. So we feel like customers continue to move towards a hybrid cloud environment. The orchestration capability that we talked about with cloud center, which is from the CliQr acquisition, combined with the knowledge that we're going to be able to provide the customers through Tetration. So think about Tetration providing analytics about what's going on, CliQr and ACI then being able to deploy policy and move workloads between public and private cloud and that's what we think customers are going to look for and we think we're in a pretty good spot there.

Sam, let's go ahead and take the next question, please.

Yes. Our next question is from Mitch Steves with RBC Capital Markets. Your line is now open.

Hey, guys. Thanks for taking my question. So my first part is kind of on the product gross margin. So looks like it was actually down sequentially in July. And I think that's primarily due to selling more switching and routing. So does that mean in October quarter you think that the mix is going to shift more to legacy kind of routing and switching versus the remaining I guess call it advanced portfolio? And then just one small one. What was the total acquisition revenue you guys got from all the acquisitions this quarter?

Yes. So I'll take that. So on the gross margins, we do have seasonality of when different mix of our products are bigger. For example, data center and services are bigger in Q2 and Q4. So, you can see that normal seasonality in there. As I said to the earlier question, I think from an overall perspective we feel great about our gross margins. We are being smart about the tradeoff on top line and bottom line. And the teams continue to do great work in terms of driving productivity and costs out of the products that allow us to do that. From a pricing perspective, our price -- ASP price erosion that we saw in Q4 was basically in line with what we saw in Q3. Actually, 20 basis points better. So we're still in that same range. We're not seeing any change there. In terms of acquisition revenue, we don't typically disclose that but I can tell you it was roughly less than a point.

Next question, please.

Thank you very much.

Yes.

And our next question is from Jeff Lubert with Wells Fargo Securities. Your line is now open.

Hi, guys. I was hoping you could touch upon the activity you saw from some of your top cloud customers, to what degree you're continuing to see strength in that vertical. And then on the switching business, which saw a return to growth following several soft quarters, I was hoping you can help us understand to what extent ASI revenues are now greater than some of the legacy data center offerings and presuming the mix of legacy and the data center is now smaller than ASI. Would you expect the switching business overall to grow moving power or their offsets that could cause that bad going forward?

Thanks Jeff. So, on the WebSkill players, what we reported in the last couple of quarters was our -- our top ten WebSkill customers and that business was up 2% this quarter. But, it is a -- when you have 10 customers in sort of a reporting segment like that, it's highly dependent upon ordering cycle. So, I'm not concerned about our relevance or anything relative to that. On the switching business, I think it's important to understand a couple of things, number one, your question relative to the ASI portfolio and has it exceeded the traditional portfolio, I think we -- the answer to that is, yes. And our orders there were, I think grew in the data center switching business where up mid-single digits.

Yes. In the revenue side.

On the revenue side. And so, that transition continues to go well and we see customers that are investing in new cloud-ready architectures are choosing the ASI platforms which is shown in the results. When you look at our overall switching portfolio, it's just important to understand the math on what percentage of what business is still attributed to our campus portfolio and as we said, anytime we have these macro -- these environments where customers have any level of uncertainty that tends to an area that they will continue to sweat, if they can. And our job over the next several quarters is to drive innovation in that portfolio, integrate security more tightly. And again, focus on orchestration policy and helping our customers lower their costs and that's what we are trying to do.

Thanks Chuck. Next question please.

Yes. Our next question is from Jayson Noland with Robert Baird. Your line is now open.

Okay, great. I wanted to ask about long-term revenue growth. I think Kelly 3 to 6 has been -- 3% to 6% has been discussed in the past. But, with shift to software and subscription and service provider uncertainty that seems like a stretch, I'm not asking for specific guidance. But, is there some direction that you would suggest for a long-term models?

Yes. I think that's a great question Jayson. If you back to -- I think that was back in June of 2015 with our last financial analyst conference. They have changed quite a bit. Our transition has accelerated with -- that we have been accelerating. And I would say the other major change from that long-term guidance was certainly our expectation the data center business in that market has changed. So, I would say, there is no long-term model change per se right now. But, we are in the process of planning an analyst conference hopefully at the end of the calendar year here. And we will update that. But, I would say those are the two major assumption changes since we did that.

Thanks Kelly. We have one more question. Time for one more question.

Yes. And our last question comes from Simon Leopold with Raymond James. Your line is now open.

Great. Thank you very much. I wanted to see if we can talk a little bit about the longer term on the routing business specifically. What you laid out sounds like very much the cyclical challenges facing your peers as well as weaker CapEx. But, if you could help us understand some of the longer term themes around what's going on in routing and how that sector may grow and your business may grow. I'm pondering the implications around sort of FDN as well as some of the architectural shifts of pretty more over the burden into the optical space. Thank you.

Yes. Simon, thanks for the question. So, when I think about routing, I actually think about it in several different ways. Number one, you got SP traditional portfolio with edge access and core, which we discussed earlier which is largely just a consumption driven cycle that we go through. In the enterprise space, we have this transition to software defined wide area networking, which we are very well positioning right now with our IWAN portfolio and we are actually working on -- a key differentiator for us which I think is -- as our teams have built out the ability to really drive the next generation secure edge with our cloud security capabilities, the combination of dynamically provisioning those branch solutions with the ability to have robust cloud security and edge security is going to be a real differentiator for us. So we see that being another opportunity for us going forward in the routing space. And then, finally, when we talk about the security and the security driven refresh of our core, in Q4, we actually had a couple of customers, I talked earlier in the opening comments about stealth watch learning networks, which is effectively a machine learning algorithm that runs at the edge of the network in the branch. And it actually does machine learning and a little of AI to determine normalcy for customers, and then, flag for them, when they see abnormal behavior going on. And we saw a couple of customers that actually made the decision to do a branch router refresh based on that capability, which we just launched in July. So we believe that there is innovation that we can bring that will lead us to a refresh opportunity in the core and we think that's largely going to be driven around security. And we are seeing some real early examples. We need to see how it plays out. But, we are seeing some early examples there.

All right, Marilyn. Thank you very much. In wrapping up, I just want to summarize our priorities again as we think about the year ahead. First off, we're committed to executing against the financial model and against our priorities, regardless of the conditions of the market and we're committed to making the decisions that are necessary to drive our growth and also to fulfill the commitments and obligations that we made to our customers, partners and shareholders. We also are pleased with where we are on the transition to software and subscription models and you can assume that we'll continue to accelerate that over the next year. We also, I believe will drive a greater pace of innovation than you've seen in the last several years from Cisco. Our teams are very excited. There's a lot of things going on. So we're very committed to driving innovation. And then finally, just to reiterate, our long-term strategy to create greater value for our customers and our shareholders while ensuring that we're also making the decision for Cisco's long-term success will remain at the forefront. So I want to thank everyone for spending time with us today. And we'll look forward to talking to all of you soon. Marilyn?

Thanks, Chuck. Cisco's next quarterly call which will reflect our fiscal year 2017 first quarter results will be on Wednesday, November 16, 2016, at 1:30 PM Pacific time, 4:30 PM Eastern time. Again, I'd like to remind the audience that in light of Regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, please feel free to contact any member of the Cisco Investor Relations department and we thank you very much for joining today's call.

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