Cisco Systems, Inc. (NASDAQ:CSCO)
Q1 2017 Earnings Conference Call
November 16, 2016 04:30 pm ET
Marilyn Mora - Head, IR
Chuck Robbins - CEO
Kelly Kramer - EVP & CFO
Ittai Kidron - Oppenheimer
Vijay Bhagavath - Deutsche Bank
Pierre Ferragu - Bernstein & Company
Simona Jankowski - Goldman Sachs
James Faucette - Morgan Stanley
James Suva - Citigroup Global Markets
Jeff Lubert - Wells Fargo Securities
Paul Silverstein - Cowen & Company
Steve Milunovich - UBS Securities
Mark Moskowitz - Barclays
Tal Liani - Bank of America Securities
Jeff Kvaal - Nomura
Welcome to Cisco Systems’ First Quarter and Fiscal Year 2017 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 first quarter fiscal 2017 quarterly earnings conference call. This is Marilyn Mora, Head of Investor Relations, and I’m joined by Chuck Robbins, our CEO and Kelly Kramer, our CFO.
By now you should have seen our earnings press release. A corresponding webcast with slides including supplemental information will be available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statements and other financial information can also be found on the financial information section of our Investor Relations website. As is customary in Q1, we would need certain reclassification to acquire period announced to conform to the current periods presentation. The reclassified amounts have been posted on our 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 and we will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons throughout this call will be made on a year-over-year basis unless stated otherwise.
The matters we will be discussing today include forward-looking statements including the guidance we will be providing for the second 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 annual reports on Forms 10-K which identifies 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, fiscal 2016 on November 20th, 2015 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 Q1 fiscal 2017. As such, all of the revenue, non-GAAP and product orders 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 website to help to understand these impacts. As a reminder, the guidance we provided during our Q4 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 you Chuck.
Thank you, Marilyn. So we delivered a strong Q1 in an environment that continues to be challenging. We executed very well in the quarter with revenue growing 1% and non-GAAP earnings per share growing 3% along with continued strength in non-GAAP gross and operating margins. This quarter totaled product orders declined 2% largely due to service provider orders declining 12% which was worse than our expectations heading into the quarter.
We continue to show great progress in how we are aligning our business model to the way our customers want to consume Cisco technology. There are many strong indicators that we are driving this change including the 48% growth in our product deferred revenue related to our recurring software and subscriptions. At the same time we are delivering more innovation with simple intelligent automated solutions with industry leading security across our portfolio.
Let me review a few areas of our business where our innovation is driving momentum. First security; our security revenue grew 11% marking the 4th consecutive quarter of double-digit growth. We’re driving more subscription based recurring business resulting in deferred revenue growth of 39%. Our competitive position in security is growing stronger as our integrated architecture approach and best-of-breed portfolio resonates with our customers. In fact, we’re the only company with security product revenue exceeding $2 billion annualized run rate with double-digit growth.
I’m incredibly pleased with how the team has transformed this business from where we were just a few years ago establishing Cisco as the market leader in the most critical priority area for our customers. This past quarter, we again drove rapid adoption of our advanced threat solutions with amp revenue growing over 70% and now deployed at over 22,000 customers globally. We also see ongoing traction with our next generation firewall revenue growing over 35%, as we added 5,300 customers in Q1 bringing our total next gen firewall customer base to approximately 62,000.
Going forward we’re driving innovation as we extend our security architecture from the network to the endpoint to the cloud. Over two weeks ago at our partner summit, we launched our enhanced AMP for endpoints a SaaS based cloud managed security solution combining prevention, detection and response capabilities delivering simplified and affective endpoint security through our threat-centric architecture.
Second, our next generation data center. Our goal is to build the best private and hybrid cloud solutions for our customers. We’re investing heavily in our data center portfolio to extend our market leadership. To do this, we’re delivering software, hardware and systems at all levels of the data center stack and across delivery models. Our customers widespread adoption of Cisco ASI family of data center networking products continued in Q1 with revenue growth of 33% to an annualized revenue run rate now of $3 billion.
The automation of data center networks that ACI delivers is the first step in enabling our customers to move workloads in and out of public cloud environments while maintaining enterprise security and policy. We are building on the foundation of ACI by extending our capabilities with analytics through Tetration, agnostic cloud management with CloudCenter from our CliQr acquisition and our hyper converged offering, HyperFlex. This will give our customers flexibility, agility and savings by delivering the benefits of both private and public clouds. We have a unique set of capabilities to lean in this market and address our customers’ needs for delivering business applications quickly, cost effectively and at scale.
In collaboration, we’re adding new capabilities to our collaboration and IoT offerings through organic investments acquisitions and partnerships. As a global market leader, Cisco’s collaboration business has a solid foundation to drive our roadmap of products and services that will increasingly be delivered from the cloud such as Spark our end-to-end business collaboration suite.
Over the last few months we’ve added two significant partners to our collaboration ecosystem. We announced a global strategic alliance with sales force to natively integrate Cisco’s cloud collaboration platform with Salesforce’s Lightning platform. This will deliver expanded reach and relevance as part of our cloud strategy. We also formed an alliance with IBM to further enhance the collaboration experience for our customers by combining our collaboration and analytics technologies. We are integrating our Cisco’s Spark and WebEx offerings with IBM’s cloud collaboration solutions along with cognitive computing capabilities enabled by the IBM Watson platform.
While the dynamics in service provider and emerging markets continue to present headwinds to overall growth. I’m pleased with our success in accelerating our momentum in our key investment areas and our commitment to operational discipline.
Now let me hand it over to Kelly to walk through our Q1 results and outlook in more detail.
Thanks Chuck. We executed well on our financial strategy of driving profitable growth, managing our portfolio in strategic investments and delivering shareholder value. On driving profitable growth total revenue grew 1% while our non-GAAP EPS was up 3%. We expanded our profitability year-over-year with increases in both non-GAAP gross margin and non-GAAP operating margin. Let me provide some details on revenue.
Total products revenue was down 1%, we saw switching decline 7% driven by weakness in campus partially offset by continued strong momentum in ACI, which was up 33% as Chuck mentioned. In campus, we still see a pause in enterprise spend largely driven by uncertainty in the macro environment. Routing grew 6% driven by growth in both SPCORE and Edge. Collaboration was down 3% although we did have solid order growth. The revenue decrease was driven by TelePresence and unified communications endpoint partially offset by strong growth of 10% in conferencing as we see more customers each quarter committing to WebEx. We saw good momentum again in the transition to subscriptions and SaaS offers with deferred revenue up 14%.
Data center declined 3% impacted by the market shift we’ve seen from Blade to Rack. While not significant in terms of revenue at this point, we did see our new hyper converged offering, HyperFlex has solid early uptake by our customers. Wireless declined 2% led by a decline in controllers and soft E-rate funding partially offset by strong growth in Meraki with our cloud managed product line. Security grew 11% with deferred revenue growth of 39% as we transition to more software and recurring revenue, we had strong performance in our advanced threat security up 100% as well as web security solutions which was up 60%.
Services grew 7% with our ongoing focus on renewals and attach rates. Overall we’re making progress each quarter on our goal of driving more recurring revenue. Total deferred revenue grew 12% with product up 19% and services up 8%. The portfolio of our product deferred revenue related to our recurring software and subscription businesses grew 48% to $3.8 billion. From an orders perspective total product orders declined 2% with book to bill below one.
Looking at our geographies which is the primary way we run our business, Americas was down 4%, EMEA grew 1% and APJC grew 4%. Total emerging markets declined 2% with the BRICs plus Mexico up 2%. In terms of customer segments enterprise grew 5%, commercial grew 1%, public sector was flat and service provider declined 12%. We are driving consistent profitability from a non-GAAP perspective total gross margin was 65.2% growing 0.3 points with product gross margin of 64.8%, up 0.3 points and service gross margin flat at 66.2%.
We increased our non-GAAP operating margin to 31.6% improving 0.2 points. We remained disciplined and focus on increasing operational efficiencies and productivity. In terms of our bottom line, we delivered non-GAAP EPS of $0.61 up 3%, GAAP EPS with $0.46. Moving to our portfolio and strategic investments, we completed three acquisitions in Q1 increasing our investments in key priority and growth areas including CloudLock which specializes in cloud access security broker technology which is part of our security business. ContainerX that develops enterprise class container management technology and Worklife which develops meeting software that is complementary to our collaboration business.
Moving onto shareholder value, in Q2 we delivered operating cash flow of $2.7 billion total cash, cash equivalents and investments at the end of Q1 were $71 billion with $10.4 billion available in US. We returned $2.3 billion to shareholders during the quarter that included $1 billion of share repurchases and $1.3 billion for our quarterly dividend.
To summarize, we executed well and Q1 delivering strong profitable growth. The ultimate solid progress in our transition to more software and subscription based models. We’re committed to making the key strategic moves in disciplined investments to drive long-term financial performance and deliver shareholder value.
So now let me reiterate the guidance we provided in the press release for the second quarter of fiscal year 2017. This guidance includes the type of forward-looking information that Marilyn referred to earlier. The guidance for the second quarter of fiscal year 2017 is as follows; we expect revenue to decline in the range of minus 2% to minus 4% year-over-year normalized to exclude the SP Video’s CPE business for Q2, fiscal year 2016. We anticipate non-GAAP gross margin rate to be in the range of 63% to 64% and the non-GAAP operating margin rate is expected to be in the range of 29% to 30%. The non-GAAP tax provision rate is expected to be 22%. Non-GAAP earnings per share is expected to be in the range of $0.55 to $0.57.
So I’ll now turn it back over to Chuck to summarize the call.
Thanks Kelly. I’m very pleased with the success of the investments we’ve made in priority growth areas such as security, collaboration in our ACI platform. These areas are key building blocks along with our strong franchise in switching and routing that place Cisco in a unique position with our customers as they become increasingly digital. As you’ve seen with our Meraki platform, we’ve achieved rapid adoption of cloud managed networking with enterprise security and policy delivered as a service.
Over the next several years, we will bring this automation, management and security at scale to the balance of our switching and routing portfolio as we continue to offer new consumption models aligned to our customer’s needs. While this is no small task, it’s an incredible opportunity for Cisco as we bring the successful model to the largest part of our business. As we make these investments, we also remain firmly committed to operational discipline and driving long-term value for our customers and shareholders and I’m very optimistic about our future.
Marilyn, now I’ll turn it back 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.
[Operator Instructions] Thank you. Our first question is from Ittai Kidron with Oppenheimer. Your line is open.
Chuck, I want to talk a little bit about the product that makes between the division of the, I mean the switching results are very disappointing clearly, the wireless is now declining, data center and I’ve been asking you about data centers for three quarters in a row and it’s still not delivering and you’ve had some changes in leadership over there as well, so just [ph] still not where it needs to be. I guess I’m trying to gage how much of the challenges that you’re seeing here right now in your opinion are macro driven versus perhaps portfolio driven because it seems like a lot of competitors in some of these areas are actually doing very well in switching for example Aruba in wireless, HP and then the data center is doing well, [indiscernible] clearly doing well. these are key major areas for you and we’re seeing revenue decline so help us understand kind of little bit what’s going on under the surface here and what is it, that makes you feel comfortable that there is no big problem. You’re on the flipside is there anything on the portfolio side that you think kind of turned the tide here.
Ittai, thanks for the question. So let me hit a few of those areas and let me first just acknowledge there are always areas that we can execute more effectively. So we’re working right now. The team’s been working over the last year on innovation and many of the areas that you mentioned and again I’m optimistic about the pipeline of innovation that we have right now. I think when you look at the switching portfolio for us, back in January when we saw the real market declines at that time and we called out the first pause we saw in the enterprise campus refresh, it’s just basically maintained, it stayed the same way throughout the year. So I’m pretty comfortable with our position there and as we continue to work on bringing automation and security and cloud based management to the rest of the portfolio. I think that will help our customers see the opportunity to refresh. For me it’s really about as we look at the key driver refresh over the longer term in the campus I think it’s going to be really around automation which can substantially reduce the operating expenses for our customers as well as security into the network and analytics out of the network.
In a couple of other areas, you mentioned I think. In UCS there’s been a fundamental shift in the data center too again we’ve talked about the Rack technology and in hyper converged we have some early success with HyperFlex and we have some new capabilities that will be coming out after the first of the calendar year that I think will help us in that space and on the wireless front, I think there are really, I think there are two key drivers there.
First of all is, the market is transitioning to a controller-less architecture so in large part our access points were actually positive, but the controller side of that business was down. Meraki was positive and then also we are pretty substantial recipient of E-rate business so as that has moved out much more slowly than expected I think, that has also impacted that business. So hopefully that gives you some color around those areas.
Thanks Chuck. Sam will go ahead and take our next question please.
Our next question is from Vijay Bhagavath with Deutsche Bank. Your line is open.
Vijay, are you there?
Yes, I’m here. I’m sorry I was talking to myself on mute. So once again, replay. Chuck, Kelly. In some sense the January quarter guide is a snapshot in time and it lags what CEO, CIOs could be thinking latest in terms of their spending intentions for the New Year. So my question for both of you is, in your latest calls with business leaders post-elections in particular has CEO, CIO sentiments here in the US in particular improved in your view and where do you think would be focus areas of spending in the context of your portfolio and then Kelly internally in the company where would invest the most in terms of the product roadmap. Thanks.
Thanks, Vijay. I think if you just look at our guidance let me be clear. It’s predominantly the SP weakness and the overall CapEx challenges that we’ve seen in SP and that business is large account driven. You can assume that we have done an account, by account, by account analysis in that space and understand what’s going on there. Right now I think there are unique set of characteristics particularly in SP space you have the overarching macro uncertainty in the economy which I think has led to the SP CapEx weakness has been reported all year by the analyst as well as you have the political and regulatory environments. They are somewhat uncertain both in the US and around the world. Some of those could turn more favorable, some of those could remain negative we’re just not going to model any improvement there and that’s the real reason for the guide, just to be clear on that.
Post-election I think that, most CEOs that I talk to we are pragmatic about the result and now we are all focused on the policy issues that matter to each of our companies and we are I think that President-elect Trump appears to be very business oriented and is very focused on driving the US economy and anytime the US economy improves, that’s certainly good for us. Kelly any comments.
No, I agree and then to address where we’re investing the most because no matter what the economy, we’re going to be investing for the future. I’d say it’s in the same areas we have been, right. We are continuing to invest heavily in security we think there is a lot of room to run there. And I think we’re benefiting and you’re seeing us benefit from having not only a best-of-breed portfolio but an integrated solution that ultimately, we do think once CIOs, start spending again we’ll see also drive some of the campus hopefully. So for sure security, data center is a focus for us and Chuck mentioned some of the innovation we have with the data center but also with the analytics around that.
And then even in the core we’re investing, right. Chuck talked about how we’re driving automation and things along those lines and so we’re putting heavily our investment there as we drive innovation that you’ll see today as well as going forward in the next few quarters.
Great thanks, Kelly. Next question.
Thank you. Next question is from Pierre Ferragu with Bernstein. Your line is open.
I just wait to dig a bit into your deferred product revenues this quarter that when increased I think by a bit more than a $1 billion year-on-year and actually $700 million or so, almost $700 million sequentially. So it’s a very impressive performance and the question I have is, how do I take that into account when I look at your overall product performance. So you have product revenues slightly down in the quarter, but I would assume that a lot of that is related to the transition towards your subscription business model. So do you have any estimate of how much this transition has impacted your number this quarter and then of course I have the same question for next quarter, your guide is very conservative. How much of this transition is actually impacting your guide for Q2 as well?
Thanks, Pierre, appreciate the question. So yes, we’re very happy with the progress we’re making on it and you can see it on the balance sheet to your point. We’re up sequentially as well as over $1 billion or $1.2 billion year-over-year. I’d say it’s a couple of points for sure intact on our growth and it’s a combination of, it’s largely - been historically collaboration and security in Meraki but we’re continuing to add on our core platform with our Cisco 1 suite like I mentioned last quarter which - that is now being recognized ratably where a year ago, we would have recognized that as a perpetual license sale. So for example just using Cisco 1 as an example in this quarter it would have been point and half just on that just on that if we had recognized it, perpetually like we had a year ago.
So it’s for sure about at least two points and clearly that continues to grow and accelerate. So you can assume we’re assuming that in my guidance. And my guidance for the next quarter is as Chuck mentioned right, we definitely saw the same thing we saw last quarter with the slowdown in SP but it actually accelerated and I wouldn’t call my guidance conservative, I’d say it’s absolutely what we see right now based on all of the factors we take into account.
All right, Sam will go ahead and take our next question.
Thank you. Your next question is from Simona Jankowski with Goldman Sachs. Your line is open.
I just wanted to confirm Chuck that and the reason for the guidance being a little weaker is entirely to do with the softness you described in service provider orders and just to dig into that and understand that a little better, it looks like your routing business was I think you said up 7% in the prepared remarks, although I see it as up 17% in the numbers posted online, but regardless it looks like routing was quite strong. So what other products within that service provider vertical accounted for the weakness and when we look at the CapEx trends they definitely have been weak year-to-date, but they’re implied to improve quite a bit into year end. So just curious if you’re not seeing that.
Thanks, Simona. So I’ll let Kelly keep me honest on this, but I think our routing revenue that we reported in Q1 was 6% positive. So if that’s incorrect, we need to fix that.
And then on the guide, what I believe is that the predominant reason for the guide down is the service provider space. It’s 25% of our business roughly and it was down 12% in new orders and you guys know the content of our revenue that is from current quarter booking, so the forecast this past quarter and the performance was negative 12 and we’re not just not modeling right now any improvement. Simona, you’ve written some great stuff around the SP CapEx environment and so I think you know as well as anyone and while there is some forward-looking optimism many of those cases there is money being spent on density in mobile network scenarios that we may not be a direct recipient as well as we also know there is a lot of variability in how the actual actually play out vis-à-vis the forecast.
So we’re just making sure that we really see that, I think there is also [indiscernible] around the world relative to what’s going to happen in the political environment and just a little bit of wait and see and I think that’s going to have an impact. Could be positive, could be tough. Based on the SP CapEx, but most of the guide challenge that we have is related to SP. Kelly anything to add?
No, I think you summarized it well and I think just to add to your question, Simona. I’m not going into currency [ph] detail what else is in there besides us peak quarter routing, but obviously our enterprise routing business is in there, mobile packet core those kind of areas that we saw, that are included in the revenue and to Chuck’s point, the routing business is certainly got a lot of big deals driven and the pressure we see from the orders, you can expect to see coming in the future as Chuck mentioned.
Yes, one other comment or two. When I talked about customers that we saw just fundamentally freeze CapEx some of those did it for their own earnings requirements, some of them did it, we have examples that occurred based on currency challenges FX issues. We saw some that were connected to consolidation that’s going on in the industry. So we saw different flavors but we did see a fair number of customers around the world that just put the brakes on.
All right, thanks Chuck. Next question please.
Thank you. Your next question is from James Faucette with Morgan Stanley. Your line is open.
I wanted to ask just around the security business obviously that’s been pointed out, that it’s developing pretty well. But I’m wondering few things, first the pace of acquisitions and specifically what looked to be tuck-in acquisitions seemed to have slowed a little bit this quarter versus what it had been running. So I’m just wondering if you’re feeling like you’ve got the portfolio and the technology where you needed or should we expect to see acquisitions continue to run pretty high and perhaps those reaccelerate and my second is, on security and I think Kelly you kind of alluded to this, but at what point do we start to see incremental benefit on some of the other businesses from security footprint, it seems like a lot of the value of security can be tied to new hardware and switch to your networking etc. so should we expect to see some incremental pull through or benefit to little more traditional hardware businesses and if so, when should we expect that? Thanks.
James, thanks. This is Chuck. So as it relates to the first part of your question, on the acquisition capabilities. I think what you’ll find with this team is that, there is a ton of internal innovation that’s occurring. We again at the partner summit launched AMP or Endpoints which is to bring the endpoints into the consolidated architecture. You can assume that we’re actively continuing to scan the landscape relative to acquisitions that fit within the architecture to bring new capabilities. I think that when I took the role I would probably suggest that there was a little bit of pent up demand around some companies that seems wanted to move on and we moved relatively quickly in the first year or so, but I wouldn’t assume that suggest that there is no more activity that we will see there, I think we will.
As I relates to the core networking platforms and at what point we will see security pulling through, I think we have had some examples over the last few years where we’ve seen particularly security portfolios integrated into routing platforms as the teams have done, that we have seen as we sell those as licenses that run on top of routers assuming the routers have the right horsepower they’re fine if they don’t and [indiscernible] refresh, there’s some capabilities that teams are working on that actually provide security at the packet level inside the network, our intent over the next several quarters is to bring some of that technology to market and give our customers greater visibility and give them another yet another source of contributing to the threat landscape out of the network itself, so we’ll have to wait and see, how successful we are, that’s our plan.
All right, thanks James for the question. Next question please. Sam.
Next question is from James Suva with Citigroup Global Markets. Your line is open.
Great thanks very much. Chuck and Kelly when you mentioned the putting the brakes on, for some of the demand. Can you clarify a little bit, was that mostly due to like the uncertainty around the election or just more uncertainty global demand. And now that the election is over, does the political uncertainty about how the tax and policy changes, what happens because those breaks to last in your opinion like how long or how - when did the breaks come off? Thanks.
Well Jim thanks. I think there is not one answer to that question honestly, as I said earlier there are some customers that are looking at consolidation that lead them to take a pause. There are some that are focused on density of their mobile networks as opposed to their core routing platforms or their edge routing platforms. There are some that outside the United States who faced incredible currency headwinds and just decided to stop their CapEx spend until they had better clarity around the currency situation and then there are some providers around the world not necessarily in the US even that have that are dealing with political dynamics and potential regulatory issues that just aren’t clear. And so I think it’s a little bit of all of that, my assessment of when those issues are resolved is dependent upon the issues themselves and we’re going to have to wait and see, how they play out.
I have not heard a lot say US based service providers who have directly related to the election, but I do believe that the regulatory environment in the US is obviously in flux now around the telecom environment and that could have implications for the service providers and some of the may wait and see how that plays out.
Next question, please.
Thank you. Your next question is from Jeff Lubert with Wells Fargo Securities. Your line is open.
I was hoping you could update on what you saw on the cloud vertical last quarter, you saw some weakness there. Saw straight or that bounce back what products you’re seeing success with, with this customer sad and where you are in your process to drive share with these operators? Thanks.
Yes, Jeff so what we talked about last couple quarters is just the top 10 that we have and they were roughly flat this quarter, but I’ll tell you we had some performances that were incredibly strong within that at an account level and some that were pausing some various reasons. I think that each account is different and I think over the last couple of years what we’ve been talking about is a deep engagement at the individual customer level and where we’ve done that we have begun to see success and you can assume that we are having discussions with each of them individually and we also are, I think uniquely positioned where in many cases these companies or markets have won and we have the ability to assign dedicated engineering teams to really line up our offerings against their specific requirements and those are the discussions, we’re having right now.
All right. Thanks Jeff for the question. Sam, go ahead and take the next question please.
Thank you. Our next question is from Paul Silverstein with Cowen & Company. Your line is open.
Kelly a clarification and a question. The question is, what’s the pricing environment look like has there been any change? And I was hoping I don’t know if you gave the number earlier but not, what was software as a percentage of total revenue. And can you remind us, I think it was 29% last quarter, but if you could remind us what it was, what it was this quarter? Thank you.
Sure. So I’ll answer that one first. So the recurring revenue number I think it’s what you’re talking about which is a combination of our product recurring revenue from the software and SaaS businesses plus the recovering revenue from service. So this quarter that was 29% and we continue to make progress of product that has grown to be 9% up from 6% of our product revenue in Q1, 2016 so we continue to make progress there, so that’s up to 29% versus it was 28% in Q4 and 25.5% in Q1. So making a progress there. On the pricing question Paul, we’re definitely in the same ranges that we normally have been. It’s actually year-over-year slightly better than we were last quarter which is largely driven by the mix of what we saw. So I would say it’s a normal ranges but how we’re driving that internally is of course we’re very disciplined around pricing that we’ve talked about but we empower ourselves sales leaders and country leaders to, we measure them on three things, we measure on revenue growth, we measure them on operating margin growth and we measure on them on driving market share and they’re empowered to make tradeoffs between those and if they need to give more price to win the franchises want to win, they will do.
So good news is, they’re again continuing to be very disciplined, making those tradeoffs and the pricing is staying in the normal ranges.
Okay, thanks Kelly. Sam will take the next question.
Our next question is from Steve Milunovich with UBS. Your line is open.
Chuck, we just wrapped up our tech conference and we had a panel on folks who helped companies moved to the cloud and the general consensus was that private cloud implementations generally are not working and many companies that begin on a private cloud path end up going down a public cloud path. So obviously there is still a lot of legacy and so forth, but if in fact private cloud is not going to do very well, you and others are very focused on that business and the risk is at on-prem pie is declining. Are you seeing something different and do you believe that the on-prem businesses is going to grow for Cisco?
Thanks Steve. So I think that over the next year to two years that a lot of the complexity in building out private infrastructure and private clouds for our customers will be alleviated. All right, I think the entire industry is going to focus on much like we talked about even in the networking systems of how we bring automation and operational relief to our customers and give them the ability to automate policy and security and manage all of these devices from their private cloud or from the cloud. I think that level of simplicity and those capabilities will improve. I think what we see is, best represented by our ACI portfolio when you look at our customers who are building out modern data center infrastructure I think those are representative of the customers who believe that they’re going to have a hybrid environment and that piece of business grew 33% is up to $3 billion run rate. So I think your observations are probably valid particularly if you look at like the lot of OpenStack, early OpenStack implementations. But I do think that customers are going to want to have that capability and I think we as an industry will continue to work on simplifying how that operational capability shows up within our customer base.
Great, thanks Chuck. Next question please.
Thank you. Your next question is from Mark Moskowitz with Barclays. Your line is open.
Chuck and Kelly, I want to get a sense of your, if there’s going to be change [indiscernible] related to how the teams are incentivized around margin, just given the company continues to outpace the guidance on the gross margin line, is there something wrong [indiscernible] or it’s just all just because mix due to the broader macro weaknesses. Thank you.
Sure, I mean I think this has been a multi-year thing that we have been driving. I’d say that we in sense like I mentioned the leadership at the higher levels at a margin level and then they have also controls at certain discount level so they can also manage that within their region. So it is definitely part of the focus, we have tools that are set up that when a sales person puts a deal in, it’s easy to see how that deal falls in from a margin perspective to help them, make good deals if you will. So the incentives haven’t changed at all this year. I think it’s just the sales teams are incredibly disciplined around it and I’d say the whole company understands the trade-off of that, right I mean we are all focused on making the tradeoffs so we can optimize and drive as much growth as possibly can and go after every point of market share that we can, but they also understand the power of the margins and that helps drive it.
I’d say, only the other thing to think about is, with the acquisitions that we have been doing that have been largely software related whether it’s in security or cloud, those SaaS businesses certainly have very high margins that just help add to the mix and again as we continue to do that, you’ll continue to see a positive buyers in our margin.
Just one comment, Mark. Kelly and I have worked with the teams and from a leadership team perspective we have three measurements that they’re held accountable for revenue, margins and market share and that’s how we just try to keep people focused on a healthy balance.
And this is not just, this is at all levels of the organization. And our Head of Sales and our Head of Partner Sales they are all part of this pricing council that we have that, we try to be very agile when we make pricing either new product pricing or changes to product pricing to take advantage of where any elasticity is.
Next question please.
Thank you. Next question is from Tal Liani with Bank of America Securities. Your line is open.
I have a macro question and I want to ask you in the context of switching. There is a very big gap between the next quarter guidance year-over-year growth rate and your long-term growth. And the question that I have is, what part of the difference is macro, so if the macro slightly improves can you get there or is there anything that you can do on the product side that we’ll get too closer and I want to ask it in a context of switching given that you had a major overhaul or major upgrade to your switching in the last few years, but we haven’t seen the growth rates improving that dramatically, so what can you do and what is macro?
Yes, I know I think Tal that’s a great question. I’d say let’s just talk about switching. I’d say for campus switching which is two-thirds roughly of our entire switching business which is our biggest business unit. I’d say most of that is macro, right. I mean it is the one area and I think we’ve talked about this before, it’s one area that people can put off doing a refresh, if there is any macro concerns and that’s what we typically see anytime you see any economic pause or macro event. So I do truly feel that if the optimism we’ve seen this week in the stock market continues giving that feeling of optimism in the economy I would expect that to raise all boats in our campus switching side. I’d say in the data center side you understand the dynamic there, right for - to your point, we launched a fantastic product couple years ago but we had to manage through the transition of a very sizable legacy business data center portfolio declining is that, accelerated and so we managed through that and again that business we know has continued to grow as we go through that intersection and cross through now as legacy piece we’ve worked largely through. So I’d say that’s why I say it’s largely macro especially on the campus side.
All right, thanks Kelly. We’ll take our next question.
Thank you. Our next question is from Jeff Kvaal with Nomura. Your line is open.
I wanted to shift gears little bit and talk about the balance sheet, if I could. Obviously you and many other companies in tech space have been advocating the repatriation - decade, a very long time. Could you help us understand or remind us what, where you would like to take that money should you bring it back to the US? And then the second part of that question is, look there is some sentiment that interest rates will start heading north again, do you take that into account when considering your dividend policy. Thank you.
All right, Jeff. So great question I love balance sheet questions, actually. So yes, I mean again we have talked about tax reform for a very long time and I can say that what’s encouraging is with the incoming administration, this is one of their top priorities that they said they’re going to prioritize in their first 100 days, so we’re encouraged that something will happen now, it’s very early and we don’t really know the details besides what his platform was during his campaign. So we’re going to watch it very closely and look forward to as the details flush out there. But just high level, as you could imagine we have many, many scenarios of what we would do when repatriation comes, which is a combination of obviously we would ring sense in our debt and then we would have a blend of actions we can certainly take with our dividend as well as our share buyback, as well as within flexibility for us to be able to do M&A and strategic investment. So it would be a combination of all those things, obviously we’re looking very closely to our shareholders and how we want to do that and we recognize it will certainly give us a lot more flexibility.
I’m sorry, I apologize. On the interest rates, yes. On the interest rates would affect our dividend policy again we’ve been committed to growing our dividend with our earnings and again driving that to great yield as our EPS grow. So interest rates go up, they go down we’re committed to growing as our earnings grow.
A - Marilyn Mora
Great thanks Kelly. I believe that is our last question. I’ll now turn it over to Chuck to wrap it up.
Thanks Marilyn. So just in summary once again we delivered a strong quarter in an environment that obviously continues to be challenging. I’m very pleased with the success that we’ve seen in security, [indiscernible], ACI, our deferred product revenue from software and subscription and we remained focused on executing against the things that we control and to that extent I think the teams have done a very good job. We’re obviously focused now on continuing to execute in those areas as well as I talked about earlier bringing automation management and security at scale to the balance of our switching and routing portfolio and aligning with our customer’s desires and how they consume our technology.
And finally, we will obviously remain very committed to operational discipline and long-term value for our customers and our shareholders and we thank you all for spending time with us today and Marilyn and kick it back to you.
Thanks Chuck. Cisco's next quarterly call which will reflect our fiscal year 2017 second quarter results will be on Wednesday, February 15, 2017, 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 the Cisco Investor Relations team and we thank you very much for joining the call today. Thank you.
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