Welcome to Cisco Systems' Third Quarter and Fiscal Year 2012 Financial Results Conference Call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Melissa Selcher, Senior Director, Analyst and Investor Relations. Ma'am, you may begin.
Thank you. Good afternoon, everyone, and welcome to our 89th quarterly conference call. This is Melissa Selcher, Senior Director of Analyst and Investor Relations, and I'm joined by John Chambers, our Chairman and Chief Executive Officer; Frank Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, Executive Vice President of Worldwide Operations; and Gary Moore, Executive Vice President and Chief Operating Officer.
The Q3 fiscal year 2012 press release is on the U.S. high tech Marketwire and on the Cisco website at http://newsroom.cisco.com. I would like to remind you that we have corresponding webcast with slides. Additionally, downloadable Q3 financial statements will be available following the call in the Investor Relations section of our website, including revenue and gross margin by geographic segments, as well as revenue by product categories. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets and cash flow statements can also be found on our website in the Investor Relations section. Click on the Financial Reporting section of the website to access the webcast slides and these documents.
An audio replay of this call will be available from May 9 through May 16 at (866) 493-8039 or (203) 369-1749 for international callers. A webcast replay is available from May 9 through July 20 on Cisco's Investor Relations website at investor.cisco.com.
Throughout this conference call, we'll be referencing both GAAP and non-GAAP financial results. The financial results in the press release are unaudited. The matters we'll be discussing today include forward-looking statements, and as such, are subject to the risks and uncertainties that we discussed in detail in 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.
I'll now turn it over to John for his commentary on the quarter.
John T. Chambers
Thank you, Mel. I am pleased to share another quarter of solid execution on our 3-year plan of continued profitable growth. For the second quarter in a row, we delivered record revenues, record non-GAAP earnings per share and record non-GAAP operating income and non-GAAP net income. We believe our vision and strategy are working. Our value proposition and mind share with our customers are very strong. One example would be our traction and relative performance with our service provider customers, which represents about 1/3 of our total business and where we believe we have taken wallet share almost across-the-board.
We remain #1 or #2 in almost every product market where we play. At the same time, we have maintained or gained share year-over-year in the majority of product categories across service provider, commercial and enterprise in the most recent quarter for which the market share data is available. Additionally, we are often named the top IP vendor by our very important channel partners.
We remain focused on our 5 foundational priorities and the role of intelligent networks in driving our customer's business. In a world of cloud, video and mobile device proliferation, the role of the network and specifically, the intelligent network, has never been greater. In all aspects of IT, we clearly are becoming more mobile, more social, virtual and visual.
As we have done for the past 20 years, we have again demonstrated our ability to capture the market transitions that matter most to our customers and have delivered the innovation and the market-leading products to enable our customer's success. The acceleration of the data center and specifically the UCS business years ahead of our competition is just one example where we grew Q3 revenue over 50% -- 57% year-over-year for the UCS business, while each of our top 2 data center competitors had flat or negative growth in their service business in the most recent quarter.
Our results from the data center over the last year are an example of our history of seeing market trends early and having the ability to react quickly, both technologically as well as operationally. We have done what we said we would do and position the company for long-term growth and shareholder value, and we continue to do the work internally to position the company going forward.
With the help of the whole company, we have put the processes, accountability and structures in place to enable Cisco's future growth and position us to remain the agile and industry-leading company our customers, partners, employees and very importantly, our shareholders, expect. We have a solid game plan, and in our view, are successfully executing against the plan even in the face of ongoing economic challenges and cautious IT spending especially in the enterprise accounts.
We believe we can continue to create value for our shareholders by balancing top line growth and the current environment with a disciplined focus on operational execution and efficiency. We remain committed to our long-term financial model as outlined to you previously.
With this call, I'll first turn it over to Frank for a discussion of the Q3 financial results. Then I'll walk through what we're seeing and where we're focused going forward. Frank will then detail our guidance, and then I'll wrap it up heading up to Q&A with Mel.
Frank, let me now turn it over to you.
Frank A. Calderoni
Thanks, John, and good afternoon, everyone. We had a solid third quarter with total revenue of $11.6 billion, up 7% year-over-year. Total product revenue was $9.1 billion, up approximately 5% year-over-year. We saw single-digit revenue growth in our overall core product businesses and double-digit growth in a number of other areas of our portfolio. John's going to cover this in more detail later in the call.
Services revenue was $2.5 billion, an increase of approximately 13% year-over-year. Total product book-to-bill for Q3 was approximately 1. Q3 FY '12 total non-GAAP gross margin was 63.1%. That was up 0.7% quarter-over-quarter and down 0.8% year-over-year. For product-only, non-GAAP gross margin for the third quarter was 62.0%, an increase of 1.1% quarter-over-quarter. The increase was primarily driven by favorable mix and cost savings, partially offset by pricing, discounts and rebates.
On a year-over-year basis, non-GAAP product gross margin decreased 1.1%. We were pleased to see the solid gross margin performance especially in our core product areas of switching and NGN routing, which on a combined basis, reflected quarter-over-quarter improvements as well as continued gross margin stability. Our non-GAAP services margin for the third quarter was 67.1%, down 0.9% quarter-over-quarter and up 0.1% year-over-year.
Turning to our geographic performance. Our year-over-year total revenue grew across all geographic regions, with increases of 3% for the Americas, 5% for EMEA and 24% for APJC. The growth in the APJC region was driven by strength in both product and service revenues across most of our customer segments led by service provider, which benefited from the completion of several large multiyear projects in the region.
Total non-GAAP gross margin by geographic region was 62.7% for the Americas, 63.9% for EMEA and 63.3% for APJC. On a quarter-over-quarter basis, Americas was flat, while EMEA decreased 0.6 points and APJC increased 5.8 points. Regarding the increase in APJC, we saw benefits from low discounts, product mix, cost savings and volume, including the multiyear projects I referred to previously.
Non-GAAP operating expenses were 34.5% of revenue or approximately $4 billion in Q3 FY '12. That was up approximately $80 million as compared to the previous quarter. Our increased G&A expenses in Q3 reflected investments in our operational infrastructure, including real estate, IT project implementations and investments related to operational and financial systems.
We are pleased to see continued stability in our non-GAAP gross margin as well as strength in our overall non-GAAP operating income, which grew 12% year-over-year and was 28.6% of revenue in Q3. We grew profits faster than revenue consistent with our overall strategic financial goals. We will continue to target non-GAAP operating margin consistent with our 3-year model, balancing investments between gross margin and operating expense.
Our Q3 FY '12 non-GAAP tax provision rate was 22%. Non-GAAP net income for the third quarter was $2.6 billion, representing an increase of 11% year-over-year. As a percentage of revenue, non-GAAP net income was 22.5%. Non-GAAP earnings per share on a fully diluted basis for the third quarter was $0.48 versus $0.42 in the third quarter of fiscal year 2011, a 14% increase year-over-year.
GAAP net income for the third quarter was $2.2 billion as compared to $1.8 billion in the third quarter of fiscal year 2011, an increase of 20% year-over-year. Earnings -- GAAP earnings per share on a fully diluted basis for the third quarter were $0.40 versus $0.33 in the same quarter of fiscal year 2011, an increase of 21% year-over-year.
Now moving on to the balance sheet. The total of cash, cash equivalents and investments at quarter end was $48.4 billion, up approximately $1.7 billion from last quarter. Of this total balance, approximately $6.1 billion was available in the U.S. at the end of the quarter.
Our cash flow from operations in the third quarter was approximately $3 billion. Our accounts receivable balance was $4 billion at the end of Q3 FY '12. Also at the end of Q3, days sales outstanding, or DSO, was 31 days, consistent with last quarter and down from 37 days at the end of Q3 FY '11. On a year-over-year basis, the decrease in DSO was driven by continued shipment linearity, and going forward, we do expect DSO to be in the range of 30 to 40 days given the business mix, the linearity and as well as the growth of our services business.
Total inventory at the end of third quarter was $1.5 billion that was down $1.6 billion -- from $1.6 billion in Q2 FY '12. Non-GAAP inventory turns were 11.1 this quarter. That's up 3/10 compared to last quarter and up to 8/10 from Q3 fiscal 2011.
Inventory purchase commitments at the end of Q3 were $4.4 billion. That's up approximately $180 million quarter-over-quarter. Total deferred revenue was $12.6 billion at the end of Q3, an increase of approximately 8% compared with Q3 FY '11. Deferred product revenue grew $3.9 billion -- to $3.9 billion or roughly 5% year-over-year, and deferred services revenue was approximately $8.8 billion, an increase of about 10% year-over-year.
Our headcount at the end of Q3 totaled 65,223, up 1,353 quarter-over-quarter. This was driven primarily by hires in support of revenue growth opportunities in services as well as strategic engineering hiring.
In the third quarter, we returned approximately $1 billion in cash to our shareholders through our stock repurchases and dividend payments. During Q3, we repurchased $550 million of common stock under the stock repurchase program or 27 million shares at an average price of $20.28 per share. A dividend payment of $432 million, representing $0.08 per share, was also declared and paid during the quarter.
As we have stated previously, our capital allocation strategy remains committed to returning cash to our shareholders through a combination of dividends and our share repurchase program. Over the long term, we intend to continue to strongly support the dividend while assessing opportunities to increase it over time. Our flexibility is limited based on our U.S. cash position unless we see reform in U.S. corporate income tax policies.
Now let me turn it over to John for additional color on the quarter. John?
John T. Chambers
Thank you, Frank. Now for a more detailed discussion on geographic and specific product results. After the intensive work we undertook last year, the parts of our business that we can control are largely healthy. We are squarely focused on the areas of highest opportunity and growth and are executing well. However, we are still in an uncertain environment economically and in global perspective.
We continue to see the impact of the areas of concern we have discussed for the last few quarters. Those were, just to repeat them: Europe and the global economy, public sector, India and conservative IT spend as reflected in the commentary of our peers. Each of these areas has proven to be as challenging as we anticipated, and several, Europe and customer conservatism, have gotten worse.
The following geographic and customer segment growth rates are in terms of year-over-year product orders unless specifically stated otherwise. In Q3, Cisco's total product orders grew approximately 4% year-over-year.
Looking at the numbers from a geographic perspective, specifically the Americas grew product orders by 5% year-over-year. EMEA grew product orders -- I'm sorry, was flat year-over-year. We have seen the issues of Southern Europe expand. Central and Northern Europe have their own set of challenges. On the positive side, our emerging markets in EMEA grew 12% year-over-year, and Russia, as part of that emerging market group, was up 22% year-over-year.
Asia-Pacific, Japan and China grew by 7% year-over-year. As expected, we continued to see weakness in India. On the positive side, Japan continues to perform extremely well for us, with orders growing 39% year-over-year. China declined by 8% due primarily to the timing of several large deals. I do believe we can continue to drive even greater performance in the emerging markets because we have the teams focused on our programs, portfolio and sales and partner coverage in those regions.
Moving on to a customer market view. Specifically, service providers grew 5%, enterprise was down 1%, commercial grew 8%, public sector was up 3% year-over-year. While service provider CapEx budgets were very tight in the quarter, our service provider segment continued to perform well. In Q3, SP orders grew 5%, with the Americas growing 5% and within the Americas, the U.S. service provider group growing at 9%. While in Asia-Pacific, Japan and China, SP grew by 8%; and in EMEA, grew by 1%.
Cisco's architectural approach has differentiated us within the service providers and allowed us to take wallet share on a global basis, especially when you consider some of our peers like Juniper where their revenues declined in the most recent reported quarter by 6% and over -- a decline of over 20% in routing in that quarter. Huawei's SP business, as reported in their most recent documentation, was up almost 3% year-over-year even though they are in emerging markets and part of what should be the fastest-growing. And Alcatel's revenue was down 12% year-over-year.
As we discussed, our foundational priorities align almost one-to-one with our service providers’ customers' top priorities. Around the world, we are partnering closely with the aim of driving new monetization opportunities for them, and in so doing, even greater opportunity for Cisco.
As you have seen in our enterprise order growth and the trends over time, we are seeing hesitant spending environment. At this time, we are not seeing a significant downturn in the environment nor are we seeing new challenges in our own business. We are seeing larger -- longer sales cycles, more sign-off and smaller deal size. Again, what is all focused in terms of a more cautious environment and uncertainty from a CEO perspective.
Our competitive position continues to be very strong in our enterprise and commercial accounts, where a year ago, the fear was competitors gaining share. One year later, that has not happened and in many of them, we are actually getting dramatic market share versus those competitors that some people were concerned about before.
Over the past year, we've made significant changes to our company that enable us to respond and adjust to a cautious environment, and we will continue to be laser-focused on profitable execution. The following discussion on products will be in terms of revenues year-over-year unless otherwise stated.
Looking at our performance across our portfolio, we continue to see solid performance across most of our priority areas, with a few areas where we need to be improving. Product revenue grew a total of 5%, with switching up 5% year-over-year to $3.6 billion; next-generation networks, or NGN routing flat at $2.1 billion; and with services up, Gary, congratulations, 13% year-over-year.
Data center revenue continued to grow very rapidly at 67%, while collaboration revenue was flat. We did see double-digit growth in wireless at approximately 20% in terms of revenue. Service provider video grew at 12%, security was up 9%. I will quickly walk through the highlights from our 5 foundational priority areas. All these numbers, again, are in terms of revenue year-over-year growth unless otherwise stated.
First, with the core. Our customers are confident that Cisco will lead in the current and future evolutions of networking. Specifically, I am pleased with the continued performance of our switching portfolio. We saw relative strength this quarter with the modular portfolio and continued to see the ramp of the Nexus line with the Nexus 2000 and Nexus 5000 combined, growing approximately 75% year-over-year.
Our switching margins continue to be stable and at the levels of several years ago. Of specific interest, is that our Nexus 7000 is now within 6 gross margin points of the Catalyst 6500, and as you may remember 1.5 years ago, that delta was 17 points.
The transition from 1-gig to 10-gig is enabling applications in video to work across the network in ways that enable today's business demands. For Cisco, we are seeing strong transition to 10-gig E drivers driving higher ASPs and more server business, with Nexus 10-gig orders growing approximately 10% quarter-to-quarter and 40% year-over-year and Nexus ports growing at 90% year-over-year.
NGN routing revenues were flat this quarter, with high-end routing up significantly and optical down. While our revenues at the edge of the network where our ASR 9000 were up over 80%, an area that a year ago some people considered a concern for Cisco.
We also continued to see strong performance in the core, where our flagship CRS-3 has achieved $1 billion in total orders in just 1.5 years. Key takeaway here is so in both of these key places in the network, we believe our legacy platforms are well on their way to transitioning to the new products.
In another area in Q3, we continued to bring out strong new products in security and wireless. An example of that would be the AP 3600. This flagship wireless product was launched last quarter and is off to a very good start. In the data center, our value proposition around Cisco's unified fabric combining storage, networking and processors in an architectural approach continues to resonate strongly with our customers.
There are a few additional points in the data center I would like to call out for you. We had another very strong quarter in UCS servers, with year-over-year growth of approximately 57%. This was especially pleasing given that our 2 largest data center competitors appeared to be flat or a negative growth in this area. However, as our data center business grows, and increases in penetration, we should start to more closely track regular server seasonality more than we have in our hyper growth start-up phase.
In our view, the investments we made in the unification of server, storage and computing is working as we see ongoing traction to the enterprise and private cloud with strong, integrated, win-leveraging solutions such as Vblock and FlexPod. Our strategic partnership with EMC and VMware is going extremely well. This quarter, all geographies saw strong cloud architecture growth, with the emerging countries leading the way.
And in service providers, we are now the $1 billion order run rate in terms of their cloud implementations. The key takeaway is not only that our data center business is going strong, but our industry leadership in the cloud is becoming broadly accepted across leading customers around the world.
Moving on to collaboration and video. Our Q3 performance in collaboration being flat is not where we expect it to be. And as you would expect, we are putting an aggressive action plan in place with specific focus on our sales execution. Part of this challenge is market-driven and part of it is our need to execute more effectively.
More specifically on collaboration. Increased sales of IP phones within our Unified Communication products were offset by sales decline in other products in the portfolio. Our TelePresence business, for example, has historically had tremendous success in the public sector and enterprise markets. As we saw continuous pressure in public sector and enterprise spending, we also saw the impact on our TelePresence results.
On video, pervasive video is front and center in almost every customer's mind, from the individual tablets all the way through to the fully-enabled TelePresence conference rooms. Open standards and interoperability are a must in our opinion in this video architecture.
We continue to look forward to the close of our NDS acquisition announced in March. This transaction, which remains subject to regulatory review, was significantly increased the speed with which we can help our service providers and, in broader set of media players, deploy and monetize the next-generation video experiences. Both our service provider customers and the key industry analysts understood the value of this deal immediately when it was announced. I had personally talked to over 20 of these customers about this acquisition and our video strategy of evolving in the cloud with Videoscape. Every one of them understands the importance of this move and the benefits it gives to them.
Cisco's competitive differentiation and collaboration lies with our open approach to voice, video and mobile clients. With the new collaboration offers including Jabber, which is our new software application bringing instant messaging, conferencing, voice and TelePresence video to multiple devices, the customer can deploy across any operating system, including Windows, Mac, iOS, Android and BlackBerry. This open approach addresses a market that demands interoperability, people-centric experiences, and it is our job to capitalize on this opportunity.
On architectures, many recent third-party surveys have seen and suggest strongly that we continue to gain relevance in the eyes of our customers as a partner to address their greatest technology, business challenges and opportunities. One highlight this in past quarters is our advanced services business, which has seen strong strength in both growth and margins as our customers tackle their toughest and most important technologies and business opportunities.
For example, in cloud and BYOD, we've seen strong demand for advanced service offerings. We strongly believe these professional service, whether delivered from Cisco or together with our partners, accelerate the success and time-to-market of the technology solutions and architectures driving their business and parities.
Finally, one of the biggest market transitions going on in the industry is the explosion of mobility and device proliferation. Mobility covers elements in each of our top 5 foundational priorities. The following are some interesting combining data points on Q3 order results in terms of mobility. Wireless orders grew 19% year-over-year, and again, this is from an order perspective. SP Wi-Fi is off to a strong start and achieving some early franchise wins, with orders growing 127% year-over-year. And the ASR 5000, which is our mobile packet core, grew orders well over 100% year-over-year.
As I reflect on these results, my conversations with our customers and partners and the results of our peers, I am more confident than ever in our value proposition in the market. With the work we have done over the last year, we are better able to plan for, adjust and execute in any market environment we encounter. Given that state of our markets that we've covered in this conference call, as you would expect, we are going to remain conservative with our business models and conservative with our guidance.
With that, I'll turn it over to Frank to walk us through our Q4 FY '12 guidance. Frank?
Frank A. Calderoni
Thank you, John. I would like to remind you again that our comments include forward-looking statements, and you should review our recent SEC filings that identify important risk factors and understand that actual results could materially differ from those contained in the forward-looking statements. This guidance is based on current pipeline and our view of the business trends based upon the information we have available today and actual results could be above or below our guidance.
The guidance we are providing is on a non-GAAP basis with reconciliations to GAAP. Taking into account the business climate that John already mentioned for Q4 FY '12, we expect revenue growth to be in the range of 2% to 5% on a year-over-year basis. This revenue guidance is aligned with the product order growth trends we saw in Q3, and the feedback from our customers on conservative IT spend, as well as the macroeconomic climate especially in Europe.
As we have said in the past, forecasting gross margin has always been challenging due to various factors such as volume, product mix, cost savings and competitive pricing pressures. For the fourth quarter, we anticipate non-GAAP gross margin to be in the range of 61% to 62%.
Our non-GAAP operating margin in Q4 is expected to be in the range of 26.5% to 27.5%, up approximately 1 to 2 points over Q4 FY '11, continuing our delivery of profitable growth. Our non-GAAP tax provision rate is expected to be approximately 22% in the fourth quarter.
Our Q4 FY '12 non-GAAP earnings per share is expected to be in the range of $0.44 to $0.46 per share, up approximately 10% to 15% year-over-year, our guidance model’s profits growing faster than revenue consistent with our 3-year financial model.
We anticipate our GAAP earnings in Q4 will be $0.07 to $0.11 per share lower than non-GAAP EPS. This range includes our typical differences, as well as an impact of up to $0.02 as a result of our anticipated restructuring charges.
Other than those quantified items noted above, there are no other significant differences between GAAP and our non-GAAP guidance. This guidance assumes no additional acquisitions, asset impairments, restructurings and tax or other events which may or may not be significant. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure.
Related to our July 2011 announcements on restructuring, we have incurred total pretax charges of approximately $945 million to our GAAP financial results to date. We expect the total restructuring charges to be approximately $1 billion, with the remaining charges to be incurred in the fourth quarter of FY '12.
Throughout the fiscal year, we have demonstrated our commitments to our long-term financial model of growing profits faster than revenue through areas such as selective changes to our portfolio and a strong focus on operational execution and efficiency. We believe our disciplined business management will enable us to navigate the near-term environment, provide operating leverage and continue to deliver value to our investors.
John, back to you.
John T. Chambers
Thank you very much, Frank. In summary, our results and guidance reflect the strength of our business in a cautious environment. We continue to see market trends early, and we believe we have the ability to lead quickly, both technologically as well as operationally.
The portfolio we have in place today is the strongest across-the-board that we have had in our history, and our innovation engine is executing well. We are attracting top talent across many key areas of our business and are poised to drive the transitions ahead.
When I think about the many near-term drivers of opportunity, both from a growth and a profitability perspective, I wanted to highlight one and that is cloud. I am extremely pleased with the traction we have made in cloud. Cisco's CloudVerse framework integrates a unified data center with a cloud intelligent network to enable cloud services and applications for our enterprise and service provider customers.
Today, over 70% of the leading cloud providers are using Cisco's CloudVerse on their journey to the cloud, and our traction with our massively scalable data centers and Web 2.0 customers continue to be very strong. In the U.S., there are approximately 10 key MSDCs and Web 2.0 customers, and 9 of the 10 have invested in our Nexus platform to run their applications and services. When I think about the long-term emerging opportunities around the program mobility and flexibility of the network, including OpenFlow, SDN and a much broader set of related opportunities, I am very excited and confident Cisco will lead the next generation of networking.
While the impact of these trends will most likely be many years out, we have already positioned Cisco well for this evolution. As an example, from a programmability perspective, we already have approximately 5,000 customers on the Nexus 1000V. Combined with our stated commitment to drive software revenue models, we have unmatched expertise in the evolution of the network, and we plan to continue to invest in the internal innovation, partnerships and acquisitions that we believe will drive our networking leadership for generations to come.
Through every market transition, Cisco has emerged stronger and with more market share. A year ago, many of you had concerns about our competitive position, our gross margins and the state of our portfolio. A year later, our product portfolio has never been stronger, we refreshed our entire switching portfolio while increasing our profitability and pulled ahead of our competitors. These results speak for themselves, and our team should be proud of these accomplishments.
There are areas in the macroeconomic environment that we cannot control, and they may impact Cisco's near-term business. We believe our vision, strategy and associated investments continue to be focused on the right market transitions and resulting business opportunities. I want to thank our shareholders, employees, customers and partners for their ongoing commitment. We remain extremely excited about the opportunities for Cisco and for the network at the heart of every major market transition and evolution. In the near and long term, we will continue to manage the company well, delivering the value you expect from Cisco.
Now Mel, let's open it up for questions.
Thank you, John. We'll now open the floor to Q&A. We still request that sell-side analysts please ask only one question. Operator, please open the floor to questions.
Our first question comes from Tal Liani with Bank of America.
Tal Liani - BofA Merrill Lynch, Research Division
My question is about the environment. If I do the math right, you're guiding for product revenues to be down 3%, 4% sequentially, making some assumptions on services. What's the risk that the environment is just trending down given that the portfolio is in such a good shape right now? What's the risk that we're just going to have another downturn like we had 2 to 3 years ago?
John T. Chambers
Tal, it's a very fair question, obviously one that we've looked at very, very much over the last several months. When I talk to our customers, they do not see that occurring in their environment, and they traditionally, even the areas that have been going slow like service providers and also the financial services industry group, have said their plans are to spend more in the second half of the year. However, Tal, in the very next sentence they said, we are waiting to see what happens in Europe and what happens with government policy. So there's nothing that we see in this environment that indicates either on our behalf. Our product portfolio, as you said, is the most competitive ever. And we think as the new market share numbers come out, we will gain share in the majority of the market areas when they reported is in very good shape. The service providers, I think, we're in the strongest position, and I think you'll see us maintain that. And almost across every product area, we are continuing to gain share of mind and usually market share. In the commercial marketplace, if their business is good, they spend. So again, when we look at it, Rob, we saw good spending in the commercial marketplace especially in the beyond the top 2000 Fortune type of accounts. The public sector was a little bit better than we thought, but Tal, in terms of your modeling, we view it as pretty flat as you go forward. There will be segments that will be up and segments that will be down. We'll probably talk about that in Q&As a little bit later. The enterprise is one that had changed in terms of consumer IT confidence, in terms of customer IT confidence on spending versus the last quarter, and that's got a little bit tougher. When I talk to my peers in the industry, and make no mistake, I've been doing that; we can almost finish each other's sentences on what we're seeing around the globe from the enterprise customers. Again, not a view that things are turning down, but just very steady improvement and an uncertain and cautious wait-and-see type of environment from that perspective. So while we will always watch the numbers, Tal, and we do worry when you see a trend occurring that it can be an indication of a bigger issue, I think right now I'd classify it as uncertainty and looking to see more certainty on the global economy and in Europe and secondly, more certainty in terms of government policies that can have major impacts on their business. So it's a nice way of saying that we're not sure. We sure don't like the trend in the enterprise IT spending, although we think in our product areas, we control our own destiny in terms of share of market.
Our next question comes from Simona Jankowski with Goldman Sachs.
Simona Jankowski - Goldman Sachs Group Inc., Research Division
Just wanted to follow-up on the service provider business where, in particular, you cited the strength in APJC, and I think you also cited, though, several large multiyear projects in that area that are being completed or were completed. Are those being replaced? And if not, should we expect a step down in revenues in that particular area?
John T. Chambers
Well, I think the right way to look at it, Simona, and thank you because we knew there would be questions on revenue growth versus order growth, the right way to think about it is, what is your order growth in terms of the momentum. And if you watch, there will be times when there are large shipments i.e. that occurred this last quarter that bumped Asia-Pacific, Japan and China up 24% that will not occur the next quarter. So I would watch the booking order grade [ph] numbers. Now to your question, in Asia-Pacific, Japan and China, we are doing very well in the service provider market. If you look at key accounts in Japan like NTT, SoftBank et cetera, you are seeing us gain both share of wallet and dramatic share of opportunities to monetize their networks. We talked earlier about the Korean telecom, me and Rob, which the team just did an amazing job, going from the data center all the way up to smart services at the end. I was just in China and India in about, whatever a month ago, and at that time when I talked to the Chinese service providers, including content providers and even the smart grid environments, so the grid network, they understood the value of an architectural play very, very well in China. And then when I went to India, it was a shocker, and Gary, you know which account I'm talking about on this. For the first time, one of the major telcos there who has traditionally had everybody imaginable in their network and viewed their job as being the systems integrator, is now seriously looking at us, for truly an end-to-end type of architecture. So Simona, service provider very strong in Asia-Pacific, Japan and China. We'd anticipate continuing to get our share plus some in that environment. We saw service provided in the U.S. very solid with a 9% increase, and Rob, I think we're doing better in the MSOs as well as in the traditional telco group. Latin America was a little bit weaker than we'd like to see and that has to do with the some of the European service providers business in Latin America on it. Europe, we were good in our what we call our select top 5 or 6 service providers with good -- I think the growth, Rob, was almost 20% year-over-year if I remember right, but we were not near as good in the individual country service providers. They're starting to see the effect of the economic and other challenges. So Simona, it's a nice way of saying trending in terms of what's available looks good, and we believe we will continue to get our share plus some in service providers barring a major surprise.
Our next question comes from Brian Modoff with the Deutsche Bank.
Brian T. Modoff - Deutsche Bank AG, Research Division
John, so kind of looking a little longer term as you kind of look at the network intelligence piece of your business and looking at the wireless as a specific area, you saw Starent -- your Starent acquisition doing well for you. Are there other elements that you see in these evolving networks that you think you need to strengthen in your portfolio to continue to see good growth in the service provider side of the business?
John T. Chambers
Sure. We're working with the service providers on a bunch of fronts, and I think, Brian, you set me up with the comment on the wireless. We commented in this session, I think, that we are at the $1 billion run rate in terms of the key wireless components together in the service provider market, as well as a $1 billion run rate in the cloud. So in terms of the areas, if you look at the key trends going on, cloud is the first one, and we are doing extremely well not just in traditional virtualization environments but we're now, Rob, beginning to get them to run their Oracle environment or their SAP environment, their core systems, on this capability. So after mobility in terms of service providers, I think cloud is going to go very well. What they're after isn't just efficiency in the data center. They see this as ability to deliver intelligent services capabilities they can charge for i.e. entertainment, i.e. small business applications, et cetera, and to move there. They are very interested in programmability and this is where you begin to see us thinking how do you combine not just software but ASICs, OpenFlow, SDN into total architectural play. And when we shared that strategy with our service providers, including the content service providers, their eyes light up as they see that we get it and they're going to, barring a surprise, transition smoothly through that. The last area that I look at in terms of real growth is video. Video, I think, is at the very front end stage, and while I love the CRS-3 numbers that we've shared with you, having reached the $1 billion run rate and they'll be up in the market in 1.5 years, video is a hog on the network. And you need intelligence underneath it, i.e. a medianet capability to make the video really usable. And then as it goes into the cloud, which all of it will, which over time will help our margins as we move out of a set-top box approach with software to a cloud approach and that will take many years to evolve, the Videoscape type of activity has to be there to manage that segment of the video. So those would be the 3 areas that came to mind. And when I talk about service provider wireless, I'm talking about both the wireless edge, SP Wi-Fi and what we're doing in wireless LANs in the service provider environment.
Our next question comes from Simon Leopold with Raymond James.
Simon M. Leopold - Raymond James & Associates, Inc., Research Division
Yes, I wanted to touch on the enterprise competitive environment. It seems as if you've had a lot of success countering HP and Juniper. But it sounds like Huawei is making a push now more towards enterprise, given the slowing growth they're experiencing from service providers. Can you discuss your plans of how you want to defend against that attack?
John T. Chambers
Sure. Let me start with some generalities and then Rob, I'm going to ask you and get prepared for it, what’s your 2-minute elevator pitch, in terms of why Cisco versus a player like Huawei in the enterprise. Let me start with the numbers. Every year that I've been here, there's either been a key large competitor, a Dell, an IBM, a Microsoft, at times even an Intel that was going to come at us and unseat us in an area, and there are always product transitions every year that people get concerned about. And for 20 years, we've come out of it stronger and in every one of those key areas. So that's not a guarantee of how it will turn out in the future, but it does mean we react very, very effectively. In terms of our enterprise customers, there's no one that has higher loyalty to Cisco, and you see in the surveys and the balance. We’ve got to earn that every day, and as we move into an architectural sale that helps them accomplish their business goals, that gets even stronger in terms of the approach. But if I could, Rob, and again I want to point out, watch Huawei's numbers. They were 11% up year-over-year, and they're getting into everything from tablets to servers to data centers to traditional networking, and we'll see if they get themselves spread too thin. But given the area that they're in with a lot of support from their government, i.e. $40 billion in loans, that was not a particularly exciting number at least from my perspective as I drug through the transcripts and had a little bit of trouble understanding their transitions from year to year to get the numbers, but that's a separate topic. Rob, in terms of your view and your 2-minute elevator pitch on how we're going to beat Huawei in the enterprise just as we've beaten other players when they come at us on our traditional business.
Robert W. Lloyd
John, I'd probably bring up 3 points, the first is a lot of customers that have now had a couple of years’ experience with Huawei are discovering that cheap at the beginning isn't so cheap after all. Their program of putting on-site resources for development is leading to lock in, and many customers who are now seeing increases in their pricing are returning to Cisco especially in the SP. One of the things that is at the heart of our customers, is looking at innovation. There's so much happening, and we clearly know that our customers view innovation from Cisco and they don't see the same from Huawei. And we would clearly say that imitation isn't innovation, and I think our customers recognize that. Finally, today's cloud-centric world, integrity is everything. The privacy of information, how data is protected, is forefront in our customers' mind in a cloud-centric world. That's not the forte of Huawei. And as they examine partnerships to enter markets around the world, this integrity gap is clearly recognized by our partners, and I think they're being -- that's being reflected in their lack of success so far in penetrating the value channels that Cisco takes to market.
John T. Chambers
If I were to draw a parallel, Simon, and Mel, you're going to kick me in a minute, I wouldn't draw the parallel to the way that HP came at us primarily on price even in the enterprise where they clearly had a very strong position. It took us, Rob, about -- I think about in 6 to 12 months to really get our act together on how to compete against them and how to say just good enough, 30% off isn't just good enough and you all have seen the win rates that we've had since then where HP switching is back to where it was when they bought 3Com. I mean this is a huge market share protection. So if we execute right, and I expect us to, I think you're going to find we are very tough versus Huawei. Not just in coming into our home turf, but watch how we did in China versus what Huawei did in China. Their growth in China was mid-single digits. Watch where we used to be on the defensive, all the time in terms of price on service provider markets in Africa and Asia and emerging countries. Now you see us going on the offensive. So I think you'll see us very confident in how to compete against them. They'll be a good tough competitor. They’ve got a lot of weakness and we're going to make them very plain to our customers.
Our next question comes from Mark Sue with RBC Capital Markets.
Mark Sue - RBC Capital Markets, LLC, Research Division
John, there's the notion that your business is becoming increasingly correlated to the global macro. So are there things Cisco can do to break free from this gravitational pull of the macro? And along the way, are there tangible proof points which may indicate that the second half of the year might be better than the first half? And I asked since the July quarter, seasonally your strongest quarter, but it's now the weakest in terms of your outlook, which implies that the October quarter, which is your weakest seasonally, might actually be worse.
John T. Chambers
Okay. Let me start with the macro environment. One of the things that -- one of the primary reasons Cisco sees these trends so much earlier than our peers in the market is we're pretty pervasive. We're in every industry, every country, everything except the consumer in large volumes. And so we can see a hiccup in state and local spending in the U.S. perhaps 2 to 4 quarters before other people, our peers, get it on their radar screen. Now on the one hand, that is so good that 80% of your business is new every 120 days. On the other hand, many of our peers, and I have some very good friends in the software industry, would say, "John, we're a lagging indicator because our businesses is only 10% to 20% really new every quarter. And so by the time we see it, you've experienced and you might be in it for 2 to 4 quarters." I would like to be a little bit more that way. And what I'm after and what we're attempting to do, and Gary has helped us lead the charge, is moving more and more to a certain percentage of our business beyond servers, areas like software, WebEx, being chargeable by the month and looking at new business models that will allow us to get a more predictable stream of revenue base underneath of it. So it's not amplified 5 or 8 to 1 versus what our peers see in the market. So that would be question one in terms of macro. Question two in terms of macro, we want to move into areas that are not as subject to the ups and downs in this. Part of it is that business model change that we talked about that would be a gradual change over the next 5 to 6 years. Part of it is moving to areas like entertainment, video, if you will, from the home and capabilities where you actually see that pretty macro-resistant in terms of customer spend and directions on it. And then I think we need to really evaluate how we perhaps, in government or other areas, whether it's through our partners or directly, begin to provide things by the drink on a regular basis. And Gary, we're looking at that beyond just Cisco capital traditional approach. In terms of the second half of the year tangible proof, just being very open, this is really hard to read. Normally as you know, Mark, I have a real strong opinion on issues. It's hard for me to read, and when you talk to people who say, "We're going to pick up our spending the second half of the year, we feel very good about how we're positioned," and they say that, i.e. the retail banking investment group i.e. some of the service providers, et cetera, then in the very next breath they say, “But it depends on what happens on a global and macro scale.” So the tangible proof is the customer saying it, but you need to know that if the situation in Europe begins to get really hard or the global environment gets softer or some of these governments, whether it's in India or Argentina or the U.S. or in the 5 or 6 major leading countries in Europe, don't resolve some of the issues, then I think people are in this uncertain environment and when they're uncertain, unfortunately, you don't spend. So I don't think that answer surprises you, although I understand why you're asking it. You had a second point and I didn't write very plainly what it was. Was there a second part of the question that I missed?
Mark Sue - RBC Capital Markets, LLC, Research Division
Sure, John. I think the notion that if seasonality continues to be magnified, should we think the slowness that we're seeing right now is short-term, or can this actually be prolonged?
John T. Chambers
It's too early to tell. We clearly are positioned to go whichever way it goes. I'm a betting man and if I were betting, I would say you're going to see exactly what our customers said, which is just very slow, painful progress, in which case we'll do very well. If it accelerates, we are positioned well to participate in that, and if it gets tough, we will take market share in that. Our product portfolio is in the best shape. We've got new products across the board which caused us originally margin problems, and when you have 2 to 3x of price performance revenue generation problems, now work to our benefit. And Gary, the work that you and team have done on accelerating Cisco's transformation, we're ready for the next area whichever way it goes. But if I were betting, I would say it's going to be slow and gradual, some bumps along the way and uncertainty along the way. But if we can at least get some of these areas more predictable, then I think you'll see people spend at a different level. It'd be irresponsible for us to say that for this next quarter, but I would not extrapolate out the first quarter next year and second quarter next year. Barring any surprise, we should be very well on our market share numbers. So it's more what these segments grow at and then our ability to get into new areas like cloud, like mobility, like video, that we candidly have not had as big a share in as before. So I hope that begins to get part of the question out, Mark, and I understand exactly why you're asking.
Our next question comes from Rod Hall with JPMorgan.
Rod B. Hall - JP Morgan Chase & Co, Research Division
I just wanted to ask, I guess it's a difficult one, but I'll ask about cost. You guys are -- this revenue guidance number for Q4 is obviously pretty weak. I had to roll the model all the way back to I think 2002, 2003 to find flat revenues in Q4. And so I'm just wondering, you guys are still adding employees at a reasonable clip. I wonder if you could talk us through the flexibility you've got. Do you take action now and stop incremental hiring given the weak revenue development? And then at what point -- what kind of revenue level do you feel like you need to reduce cost further? I know you just reduced a lot of cost. So does it have to get -- how much worse does it have to get before you start thinking about that again?
John T. Chambers
Frank, again, we talked about this a fair amount between you, Gary, myself and Rob. Share a little bit of your thoughts on how we ended up there and then, as always, I'll reserve the right to jump in at the end and add a little bit of color.
Frank A. Calderoni
Yes, Rod. I mean clearly, it goes back to what we've talked about throughout the call today and also what we've been talking with the investment community back since September of last year, and that has to do with our long-range financial model. And I look at it from an operating margin perspective. Overall, it's growing profits faster than revenue. So if you look at the last quarter, I mean, we had operating margin of 28.6%, which was slightly improved from where we were in Q2, and our expenses were 34.5% of revenue. And if you look at how we've kind of closed the first 3 quarters of this fiscal year, if you kind of looked at the total Q3 year-to-date, we had revenue growth of about a little over 7%. We had net income growth about 9.5%. We had EPS growth about 14%. And so we've spent the last year really working on, internally, across the company, a continued focus on gross margin, and it's good to see some of the results that we've had the last couple of quarters and focusing on value engineering and focusing on features within our products to help improve the profitability, to look at the ramp for when we introduce new products. On the expense side, we've continued to look at our portfolio, making some tough calls and rebalancing where it was necessary. We've actually had a tremendous amount of attention on efficiency and productivity. That is not something that we are just, even when we had this conversation last quarter about reaching the goal of taking at $1 billion. I mean this is something that we feel is part of what we need to do over a longer period of time. So we're going to continue that. Of course, when you start looking at top line, we need to make certain trade-offs. Of course, we have to look at it from a short-term and a long-term perspective. We have experience this past year to kind of use that experience as the background to continue this effort going forward, and we'll constantly do the right thing that make sure that we're returning the right value to shareholders and balancing that profitability with the revenue growth.
John T. Chambers
Yes, I'd just add a couple of thoughts to it, Rod, and I understand why you're asking, again very fair. You will see us not underreact or overreact to this. I think if you watch us over the years, under times of pressure, we get pretty calm and pretty focused on how to handle it. Secondly, I would absolutely read into those comments that we do not see this being an economic trend is a given at all. We're going to go ahead and move through this, this quarter and watch to see, just like our customers are watching, to see what occurs because we do think we position ourselves very well. And candidly, from a productivity and leverage point, I think we have. The third element, and I forget if it's Simon or Mark asked this question, it kind of ties to this, as we gave our guidance in Q4, we build backlog and for Q1 and we would all be surprised and disappointed if we didn't continue to build a pretty fair backlog going in from Q4 to Q1 and that is built into our numbers in terms of thoughts. Gary, you might want to add something here?
Gary B. Moore
Yes, just -- I mean Frank hit it very, very well. I mean we are really well positioned from a visibility point of view, well positioned from a portfolio point of view. Getting back just to the heads, I mean it wasn't -- I mean you might look at it as a significant number of heads. A large majority of those were split between services, which are revenue-delivering people, remember the growth that we've had in revenue and services for the entire year. And then part of our original plan was to do strategic hiring back into engineering in the core areas where we want to continue to invest. So we intentionally made shifts in the workforce [ph] there in areas that we're going to deemphasize, and where we couldn't redeploy, rehires in those areas. So that's why you're seeing that.
John T. Chambers
And in your modeling, I mean, what Gary and team have done in services, we know no one else has done in terms of both the gross margins and their revenue growth rates. And doing it with a very partner-centric model, Rob, has been world class, and we are clearly modeling services growth, which is about 20% of our business in a low double-digit type of numbers, and we saw that both in our order rates in terms of the one-year contracts, Gary, as well as our revenue rates. So as you think about your models, that should also be built into it.
Our next question comes from Nikos Theodosopoulos with UBS.
Nikos Theodosopoulos - UBS Investment Bank, Research Division
John, I didn't hear you talk about linearity during the quarter. Did the caution in the enterprise spending intensify as the quarter progressed, or was it a constant issue throughout the quarter? And I guess as part of that, if enterprise carrier customers are telling you they're going to spend more in the second half but they're waiting for clarity in Europe and U.S. government policy, those don't seem to be likely to be resolved in the next quarter or 2. I mean, those probably don't get resolved till late year, early next year. So having a hard time understanding why they're pointing to those 2 things and suggesting they might not spend strong in the second half when those clearly aren't going to be resolved anytime soon.
John T. Chambers
So series of good questions. Let me start with the latter. Our customers as a whole in the enterprise market are in the best shape I've ever seen them during any type of economic, even hiccup. Their cache is very, very good. Even the financial institutions outside of Europe are really focused on getting the profitability back in line, getting their occasion positioned. So clearly, they're keeping their powder dry as opposed to saying we have a problem with any powder that we can take action on. In terms of the linearity during the quarter, the linearity was unfortunately very much how we gave the guidance. It was pretty similar month 1, month 2, month 3. Whenever you have a world-class sales group, which Rob, I think you've built and done a great job on, they always close the last week hard. So that always will happen, and that would've bothered me a great deal if we hadn't had a very strong last week close. But that's not indicative that things are necessary changing, but it is indicative that it was not worsening at that point in time. In terms of the caution, I'm just saying what the customers say to us, and we kind of fit in that model right now. If I was betting, I'd bet the second half of the year will be better for us and our next quarter that we're signaling. But we're going to wait and see, and we purely are going to spend per, I think it was Rod's question, very carefully as we go into this and to position ourselves to win either way. We have, we think, our competitors, including the Asian competitors, in a very vulnerable spot where we've made the changes now that they've not made and we've moved into the market growth areas that are really instrumental to our customers in terms of their success when our peers have not. Lots of them are still providing individual products and are either not capable or not trusted to be able to provide this at a much larger level. The nice way of saying whatever is there, I think we have a very high probability of doing very well with no one really knows. I do want to reemphasize though. This is an issue when I talk to our customers and our peers, and our peers especially, they can finish my sentences even though they don't have as much, dependent upon the quarter, new businesses, we do. So this is one that I think is an industry phenomena, and you saw that in Gartner dropping their IT expenditure expectation down to, I think it was 2.2%, now, et cetera. Having said that, usually by the time the majority sees it, it might be already heading another way and we'll see if that way is more up, and I'd love to be apologizing after the next quarter that we were a little bit too conservative. But that's our philosophy, and that we think is the right way to run the business.
I think, about 2.5%.
And your next question comes from Ehud Gelblum with Morgan Stanley.
Ehud Gelblum - Morgan Stanley, Research Division
First of all on gross margin, you've now beaten gross margin guidance several times, several quarters in a row. We see at Asia-Pac, Japan, China gross margins back up again after being hit last quarter of the China deals and that was off of a strong revenue in that area. So I'm guessing China was a not particularly strong for you this quarter. So you're actually getting a lift out of your APJC for gross margin. Your entire gross margin is about 63%. Frank, why do you keep guiding into the 61% to 62%? What is this bear case that you keep kind of I guess in the back of your mind when you guide so that it looks as though gross margin keeps going back down again yet you keep beating each time. I was worried mostly about APJC. Now that's not a worry anymore, I'm just curious as to what you're worried about. And then just clarification, I calculated that UCS was down quarter-over-quarter based on a 57% year-over-year that you gave, want to make sure that's right. And then John, when you said that second half of the year is stronger, October is obviously a fiscal Q1, usually that's weaker. Should we now be looking at something that's not seasonal for you guys as we start modeling?
John T. Chambers
Okay. We'll go in the quarter in the sequence that you raised it. Frank, on the gross margins?
Frank A. Calderoni
Ehud, if you -- Q3 of course, just to kind of go through, 63.1% total margin for the quarter. That was up 7/10 quarter-on-quarter and specifically on the product side, 62.0%, up 1.1% quarter-on-quarter. As I mentioned earlier, a lot of positive impacts on margin primarily because of the cross-company major initiatives that we've been driving since the beginning of the fiscal year on many things I highlighted in value engineering and so forth. This is an approach that goes not only from a engineering perspective and the business units that support within engineering, but all the way up to sales organization. We even have compensation tied to improvement in margin. So all that is goodness, and I think as a result, we've had some improvement throughout the year especially in switching. John highlighted a couple of key things if you look at the switching margins. They're back to where they were about 2 years ago. The Nexus 7 actually improved 9 points since Q1 '11 when we were having all those discussions around switching margins. Now it's within 6 points of the Cat 6500 that John mentioned, and that's where it was 1.5 years ago, it's up 17 points. So a lot of goodness there. The other thing that I highlighted as far as Q3 performance specifically is we did have a benefit in the quarter from favorable product mix and cost savings, and I emphasize the product mix. And that does change from quarter-to-quarter as we've seen throughout FY '12, if you look at the margins from Q1 to Q2 and then Q2 to Q3. So looking at that mix of product and taking that into consideration with the lower revenue base in Q4 from a growth perspective is why the range is in that 61% to 62%. So we're going to continue to focus on the many things that we have, as I said, before ongoing not only Q4 but as we go into next year. And as we see more opportunity, that helps us offset some of the mix dynamics both geographic as well as from a product standpoint.
John T. Chambers
I'm going to go in reverse order and then, Gary, after I do this, just to give you heads up, I'm going to ask you to talk about some of the things we're doing to continue the focus on gross margin improvements, a little bit deeper than Frank went because you've got us, the whole company, focused on that now in a very effective way. But let me go to the numbers, and I wanted to check before I respond to it, Ehud. The math would be no, from -- no, actually your math is right, looking at Q2 to Q3. And I think that's more a function of several factors. Most important, I think Romley played an issue with us and I think all of our peers saw it. To the indirect part of your question, we would expect, and I'd be very disappointed if UCS sales, Rob, were not up dramatically versus Q3 and Q4. So to your indirect part of your question, we would be shocked and not have Rob apologize, with me close behind him, if we're on Q4 and we aren't looking well above what the Q3 numbers actually were. To the second part of Asia-Pacific, Japan and China, it's good news and a little bit of a challenge. We have to start building products that are designed for those markets at that price point, and you don't have to have all the capabilities. Today, what we do is maybe inhibit the capabilities but still give the basic cost structure in our bids over there and you see that in terms of its impact. So I think you will see periods of time where there will be margin pressure from Asia-Pacific, Japan and China when we get very large router deals in the emerging markets. However, we're starting to do a pretty good job, Gary, in engineering, beginning to develop set-top boxes in Asia to come in at $25 and $47 per set-top box with much better margins that we get today. And candidly, if we execute well, they should result in a lot more revenue for us in countries like India at much better margins as we move forward on it. We also have done a project like Sunbird, which is a real nice controller capability out of China that has the potential to go into a huge number of -- I'm talking hundreds of thousands of opportunities in the education system and then expand beyond. So we're beginning to do a better job of designing in emerging product -- into emerging countries with products that can meet their average cost per box type of approach and without all the capabilities, not dumbing down our current product down. Gary, maybe just a couple of comments in terms of ongoing focus on margins and what you have us all focused on including the sales force.
Gary B. Moore
Yes. Thanks, John. So at the highest level, everyone in the company is focused on value engineering and driving efficiency, efficiency across the entire portfolio. And that means efficiency not just in the product portfolio but across our people, across everything that we're doing to include our real estate, our contingent labor forces and we've done significant things there already to drive value. In addition though to the things that we've talked about before, like value engineering, our supply chain procurement group is absolutely world-class, and they are driving tremendous value. As I look at what occurs from quarter-to-quarter as we look at the pricing there and the value that will bring longer term, it just kind of compounds on itself. So I'm very comfortable that we can continue to watch the top line in a way that we do, manage the bottom line and the gross margins to stay extremely competitive in the market and return to the shareholders the value that they're expecting. So I'm very comfortable with those things, but there's many, many programs across the entire company: real estate, product portfolio, workforce, et cetera that we're driving.
Our next question comes from Matt Robison with Wunderlich Securities.
Matthew S. Robison - Wunderlich Securities Inc., Research Division
Sort of on the same topic, the mix implied and the guidance for margin. Your orders in China were down, but it sounds like the kind of mix you're talking about was, given the products for the right price points, is still the kind of thing that you're -- where you're seeing more strength in that part of the world. And just kind of wondering if maybe are we thinking about that because you still have quite a bit of backlog from past periods that's causing you to have another strong APJ quarter -- APJC quarter, or is there something else that we should be thinking about in the mix?
John T. Chambers
I would think that the guidance we're giving you is what we really believe on that. Mix will always be a huge determining factor. APJC, and the fact if I we're betting on a theater to have the best growth, that's clearly the one where we would be, barring a surprise in China. And the team out there and then it starts executing extremely well in China. Japan is not going to cover off the ball. Going through China just a little bit over a month ago, I did not see warning signals of major issues in the economy, and we did have a couple of large orders roll over. However, you will see when large orders come, pressure on margins with those type of opportunities. The designing with the margins, the right price points have to be from scratch up. You can't take an existing product and hollow it out. And we've tried that, and it just doesn't work. So we will design from the bottom up in terms of made in China, for China and beyond, made in India, for India and beyond, made in Brazil, for Brazil and beyond. But that takes a multiyear effort, and I don't want to mislead anyone. We're just getting started. Early successes have been pretty good, Gary, in what we've done there and, Rob, pretty effective from the sales side. But I would not look for them to help us out in the next 1 to 2 quarters in terms of the direction. So guidance is mainly a mix issue, Frank, is that fair, and a little bit on the geography side of the house.
Our next question comes from Jayson Noland with Robert Baird.
Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division
I wanted to ask about Cisco Capital. We're hearing more about favorable financing terms for customers, and John, you mentioned, “by the drink.” Could you talk about that approach and the impact it may have to the balance sheet?
Thanks, Jason. This is going to be our last question, John.
John T. Chambers
Okay. If this is the last, we might several of us jump in. Gary, why don't you start us off?
Gary B. Moore
Yes, so Cisco Capital, I think, provides a lot of opportunity for us that we didn't leverage as well as we could have before, just to be open about that. It provides not only the innovative solutions to our customers but also to our channel solutions, and it's going to allow Rob and the sales force have a lot more incremental sales based on the way we're going to focus. I think the fostering of those long-term relationships and the installed base also gives us a strong competitive differentiator, and we're really starting to leverage our balance sheet with them. I think we're really pleased with the growth that they've had. Kristine Snow and her team have done just an outstanding job of positioning people in the regions so that we could move quickly on decisions and where we needed to make moves, be there as a partner to the sales force. So you will see us do more there, but on the other hand, we will be making sound economic decisions and risk. So Frank manages the risk here extremely well, but we've given Kris the charter to really step it up, and she's performing extremely well with her team.
Frank A. Calderoni
And Gary, as the volumes have been increasing as we've also been able to bring this out to the marketplace as a more comprehensive offering to our customers, we're also, on your point about the credit quality, we've seen our portfolio improve actually.
John T. Chambers
Yes. It's a really a nice job, Frank, by you and by Kris and team in the field. Rob, a little bit on the value to the field?
Robert W. Lloyd
Well John, we've actually spent some time on this, and we have seen that we've had larger deal sizes. We've had a margin protection, and in many cases margin enhancement and it does give us an ability to leverage our massive install base and actually churn it much more regularly. So we are going to be out there leveraging our assets and Cisco Capital is a big one of them, and I think we're moving forward as one team.
John T. Chambers
I think in many ways, that's a very good question to end on, Jayson. If you think about what we're saying, this is about innovation and we tend to think of innovation as just engineering of products. What we're doing as a company is innovation across-the-board, and that really is what we're talking in reinventing Cisco. We obviously had a very firm base 12 to 18 months ago where we wouldn't have recovered as quickly as we did in terms of market transition, architectural plays. But we got ourselves much more effectively organized for how customers could buy in the future. We've gotten really fast, and Gary, you and I've got another couple of inches to take off. But our weight is getting back down to a much leaner type of basis as we move forward. But it's innovation in everything we do. I like the innovation that you've seen out of service provider, and I like how we've literally tied those together with not only world-class products but world-class products that work together from the data center to anybody's end-user device, fixed or mobile, very effectively. I think we've got to continue to do that across the other segments at Cisco and build on our strengths in the enterprise, et cetera. And I think what you're seeing from Kris Snow is just one example in terms of innovation. We needed to be a more out of box as our emerging markets grew in terms of our credit policy with our partners, and what was is occurring in our channel partners in the field and Rob, we needed to teach the field how to use this type of innovation in a very effective way, tied to finance in terms of a partnership. And so our goal is to be innovative across the board. We've got spots we got to fix, I think we all know that. I wish we could've given you a more direct answer about the second half versus the fourth quarter. We will always try to tell you what we truly see. And good news and bad news just because there's so much volume being new every 120 days, we do tend to see things much before our peers and almost always, unfortunately, fairly accurate in terms of at least the short-term trend. I do want to end on the note, though, everything that we talked about today, almost without exception, is completely under our control, and our momentum feels very good in the areas that we control and influence. Couple areas we need to be better, we're going to be all over those, and we think we're very well positioned whichever the way this goes. But if I listen to my customers, that's usually where I go, I think we will muddle through this with a little bit of bumps along the way and we'll see if the second half develops the way we hope. But our guidance will be conservative in what we see in the short term.
Mel, with that, let me turn it back to you.
Great. Thanks, John. Cisco's next quarterly call, which will reflect our FY '12 Q4 and annual results, will be on Wednesday, August 15, 2012, at 1:30 Pacific Time, 4:30 Eastern Time. As we mentioned in last quarter's earnings call, Cisco is implementing enhanced planning and reporting processes and as a result, future quarterly earnings calls will take place one week later than our historical schedule.
Downloadable Q4 -- Q3 FY '12 financial statements will be available following the call, including revenue and gross margin by geography and revenue by 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. Click on the Financial Reporting section of the website to access the webcast slides and these documents.
Again, I would like to remind you that in light of Regulation FD, Cisco plans to retain its long standing policy to not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. Please call the Investor Relations department with any follow-up questions from this call. Thank you for your participation and continued support. This concludes our call.
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