Welcome to Cisco Systems Third Quarter and Fiscal Year 2014 Financial Results Conference Call. At the request of Cisco Systems, today's call is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Melissa Selcher, Vice President of Global Corporate Communications. Ma'am, you may begin.

Thank you, Kim. Good afternoon, everyone, and welcome to our 97th quarterly conference call. This is Melissa Selcher, and I'm joined by John Chambers, our Chairman and Chief Executive Officer; Frank Calderoni, Executive Vice President and Chief Financial Officer; Rob Lloyd, President of Development and Sales; and Gary Moore, President and Chief Operating Officer. I would like to remind you that we have a corresponding webcast with slides, including supplemental information that will be available on our website in the Investor Relations section following the call. Income statements' full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statements and other financial information can also be found on the Investor Relations website. Click on the Financial Reporting section of the website to access these documents. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results. The matters we will be discussing today include forward-looking statements and, as such, are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically, the most recent reports on Form 10-K and 10-Q and any applicable amendments, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. Unauthorized recording of this conference call is not permitted. All comparisons throughout this call will be on a year-over-year basis unless stated otherwise. As we have in the past, we will discuss product results in terms of revenue and geographic and customer segment results in terms of product orders, unless specifically stated otherwise. I will now turn it over to John for his commentary on the quarter.

Melissa, thank you very much. I am pleased with our solid performance in Q3 with non-GAAP earnings per share of $0.51 on revenues of $11.5 billion. We saw strength in our non-GAAP gross margins of 62.7% and non-GAAP product gross margins of 61.4%. We also continued our disciplined management of the business with total non-GAAP OpEx down 6% year-over-year. We generated $3.2 billion in operating cash flow and returned approximately $3 billion to our shareholders through the dividend and share buyback. We are very focused on creating value for our shareholders, employees, customers and partners. Our conviction around how we're evolving Cisco is strong and resolute. You've seen us deliver incredible innovation, make bold moves in the market to capture future opportunities and disrupt our competitors and ourselves when necessary. We remain committed to doing the right thing to increase our long-term strategic value to our customers and advance Cisco toward our goal of becoming the #1 IT company. In Q3, revenue earnings per share and gross margins exceeded our guidance. Our product orders improved to be relatively flat year-over-year. Our book-to-bill was comfortably above 1. I am pleased with the progress to return to growth, and I'd like to give you an update on Q4 revenue guidance, which will allow you to frame our remarks on the business momentum. For Q4, we expect revenues to decline in the range of minus 3% to minus 1%, which would represent quarter-over-quarter growth of 4% to 6%, that is Q3 to Q4. We saw strength across a number of areas of our business and as we look across the world. From a geographic perspective, total U.S. product orders grew 7%, with U.S. commercial and U.S. enterprise both up over 10%. The momentum in U.S. enterprise and commercial remains very strong. As an…

We will, John.

As you would expect, we have added some of the best and brightest cloud talent to our team. We are also seeing our partnerships in delivering converged infrastructure, such as VCE and FlexPod, leveraging Application Centric Infrastructure and the InterCloud fabric to provide on-ramps to the InterCloud. As part of our InterCloud strategy, we do -- we'll deliver a portfolio of Cisco cloud applications and services. The Cisco cloud applications, which are already in market, namely WebEx and Meraki, continue to perform very well. WebEx revenue grew 7% with annual recurring revenues up 12%. The total number of available users was up over 26%. Meraki, our cloud networking business, grew over 150% with the customer count growing approximately 30% sequentially. We also see -- I'm sorry, we also continue to cement our position as the #1 cloud infrastructure and the #1 cloud provider, according to Synergy, delivering the innovation and platforms to fuel the world's largest cloud. That was again, the #1 cloud infrastructure and the #1 hybrid cloud provider. On the Internet of Everything, last quarter, I discussed the momentum we are seeing with our customers to translate the Internet of Everything opportunity to actual business requirements. We are making measurable progress connecting the $19 trillion value we have identified in the Internet of Everything to specific business opportunities and pipeline. Again, at Cisco Live! next week, our user conference, probably 20,000 people in person, and we hope 200,000-plus virtually, customers like Royal Dutch Shell and The Weather Channel will join us on stage to share how they are partnering with Cisco to leverage the Internet of Everything to drive innovation and business results in their own organization. Our close engagement with our customers to capitalize on the major market transitions like cloud and Internet of Everything will be a future driver of our services growth. Service revenues grew 3% this quarter with continued strong margins. Gary, nice job by you and Edzard and the team.

Thanks, John.

We continue to be optimistic about the future opportunity. As our customers embrace cloud, mobility, social, analytics and the Internet of Everything, they are seeing Cisco as uniquely positioned to help them build and run the highly securable environments they require. We are helping them design secure and optimize cloud solutions, enabling industry-leading security for their mobile workforce and access data from anywhere to speed decision-making among other solutions. During the past quarters, we announced our new Managed Threat Defense service to help customers detect and prevent attacks across their extended networks, fueling our security services business opportunities. We will continue differentiate our approach to services, leveraging both technology and people to deliver business value. We continue to drive our evolution to software and services. And this quarter, we closed a first-of-its-kind multiyear deal to license Cisco's software portfolio to General Motors. This innovating licensing agreement, evolving our software and hardware where needed, will give GM greater speed and flexibility to drive business value. So for example, when GM needs to increase their collaboration solutions across the company, they have access to our full suite of products to do that. Going forward, Cisco and GM will continue to partner to deliver GM's business goals up to, and including, the Internet of Everything. We are evolving very quickly as a company to meet the changing requirements of our customers globally. And I am extremely pleased with the level of innovation and the value we are driving across the company in both technology and business models. We are leaning forward and will continue to make the moves and investments we need to ensure our leadership for the next decade. I'd now like to turn the call over to you, Frank, and do go into a little bit more details on the financials for the quarter and expand on our guidance.

Thank you, John.

You're very welcome.

In Q3 FY '14, we executed well as we managed through the transitions in our business end markets resulting in our financial performance above our expectations. From a top and bottom line perspective, total revenue was $11.5 billion, down 5%; non-GAAP net income was $2.6 billion; and non-GAAP EPS was $0.51. Our GAAP net income was $2.2 billion, and GAAP earnings per share on a fully diluted basis were $0.42. Product revenue declined 8% and services revenue increased 3%, with product book-to-bill comfortably above 1%. Overall, non-GAAP operating margin was 28.1%. In Q3, our total non-GAAP gross margin was 62.7%. Non-GAAP product gross margin was 61.4%, and product gross margin benefited from improved productivity as we had greater leverage with our cost structure, partly driven by higher revenue volume. These benefits were offset by pricing. Non-GAAP service gross margin was 66.8%, consistent with historical levels. Our non-GAAP operating expenses were $4 billion or 34.6% as a percentage of revenue compared to 34.8% in Q3 of FY '13. Operating expenses were higher quarter-over-quarter driven by investments in cloud and acquisitions as well as higher variable compensation. Given the expected decline in our full fiscal year revenue, we do expect our variable compensation expense and, thus, total non-GAAP operating expense to be lower than originally forecasted. Our headcount decreased by approximately 230 from last quarter to 73,834. In Q3, other income and expense was $100 million, reflecting realized gains on sales of publicly traded equity and fixed income securities. Total cash, cash equivalents and investments were $50.5 billion, including $4.6 billion available in the United States at the end of the quarter. We generated operating cash flows of $3.2 billion during the quarter. During the quarter, we issued $8 billion of debt for general corporate purposes, including repayment of debt and a…

Frank, thank you very much, and well done. Reflecting on the quarter, the dynamics in our business and market continue to play out as we said they would. And we did what we said we would do. Our management team is executing well and driving innovation, transformation and discipline across the entire company. We're delivering solutions, not just technology, in a way we haven't in the past, and are transforming our business models toward more recurring product, software and cloud revenues. As we continue to drive the business, we remain focused on shareholder value creation by maintaining the flexibility to make the right long-term strategic decisions for the business, driving efficiencies in our cost structure and returning capital through dividends and share repurchase to our shareholders. In addition to the solid financial results, there are 4 key takeaways for how we are driving Cisco forward that were evident in this quarter. First, we made good progress on our plans to return to growth despite some macro and industry-specific challenges. At the same time, we are innovating and investing while becoming more efficient in taking costs out. As a result, we're delivering and often over-delivering on the expectations while transforming our business. I'm proud of what we've done and excited about what's to come. Second, we are delivering more innovation at a faster pace than any time in our history. I look at the new high-end switching and routing platforms, the recently announced InterCloud strategy, new collaboration portfolio, new pervasive security offerings, new data analytics, self-learning networks, services and all delivery capabilities, IoE and much more. And we're not just innovating in technology. The changes we are making in how we deliver value to our customers, leveraging integrated architectures, software and services to deliver their business outcomes are driving larger opportunities…

Thanks, John. We'll now open the floor to Q&A. [Operator Instructions] Operator, please open the floor to questions.

Our first question comes from Simona Jankowski with Goldman Sachs.

So this is one question with, perhaps, a couple of subparts. But I just wanted to understand, John, your guidance a little bit. So you are guiding for better-than-normal seasonality in the July quarter, and that's despite the continued weakness, both in emerging markets and in service providers. So can you just expand on what is driving that? And to the extent that some of that is driven by the Nexus 9000 ramp, where you highlighted 175 customers, can you just dig into a little bit on how many of them are also licensing ACI? And also does not include any of the top 10 cloud providers?

Got you. A few questions, Simona, but you've been very patient with us over the years. So we'll do that -- in the future, we'll hold the questions right about into one. In terms of seasonality, you're right. The guidance seasonality-wise for our Q3, Q4 was 4% to 6% growth. If you look at it, Frank, if I know these numbers right, over the last 3 years, it's about 1.9% or 2%. Over the last 5 years, it's averaged just 3.2%. So it is above that. We're going in with stronger backlog. And by definition, we had a very good third month of the quarter. In terms of the weakness in emerging markets in service provider, you're correct in that we anticipate those continue for several more quarters, and that's going to be heavy lifting as we work our way out. But let me leave no doubt in anyone's mind, we are committed to emerging markets. We're going to position ourselves as we've done before when countries have seen economic downturns and position us for the future. In regards to service provider, we're going to do whatever it takes, Rob, to get back on top there and get that to return to regular growth. In terms of the areas that are growing well, you saw it in almost every product category. And while the revenue numbers, by definition, product revenues are down 8%, if I remember, Mel, right, and product orders were relatively flat, which means plus or minus 1%. It means in almost every product category, bookings grew faster, orders grew faster than the revenues, and we showed that. And so, you see areas like collaboration, which we've been getting a little bit longer in terms of our products before we introduce new products. And Rowan has done an…

Correct. That's correct.

And again, the receptivity has been extremely strong. Many of you come from financial institutions, so you might have seen some small startup and being we're combined because they've been out there for 5-plus years, we're taking most -- all of those back. Momentum feels very, very good on it. And I think you'll just see us knock them off one after the other. In the commercial marketplace, Allison Gleeson would say the 9000 is on fire. But to your indirect part of your question, Ramona -- I mean, Simona. It will take another -- at least one and probably 2 quarters before you get high-end switching growing well. They put a 9000 in, you do the ACI modeling, et cetera. So it's going to take us a few quarters to extend it out. But your overall premise is right. When we present our architecture strategy and our vision, the CIOs get it, they buy into it, and we are in extremely good shape in enterprise as you would guess from the 6% growth that we showed this quarter and improving.

Great. Thanks, Simona. Next question.

Our next question comes from Ittai Kidron from Oppenheimer.

I'll also take a stab at a 2-part question. First of all, referring to the last page of your press release...

I'm happy because give us a compliment. Okay, 2 questions then we got to keep them to 1.

I'd give you another one, if I can get 3 questions. But speaking on deferred revenue, Frank, looking at the breakdown of your deferred revenue, you have a very nice increase on a year-over-year basis on the product side. But when we look at the split of that between current and noncurrent, it seems like most of it is concentrated in the noncurrent area. So can you talk about how the change in deferred revenue relates to the change in your business model as far as moving more into cloud, more into as-a-service type of consumption models for your customers? And then for you, John, on the competitive front. From a high-level standpoint, some of the switching vendors have talked about going aggressively after your Cat 6500 install base, which is quite substantial, still out there. How do you feel about your ability to defend that? And also with the -- some of the clearly good progress you've been making of UCS, how do you feel against IBM and HP these days as far as going after the service footprint, both standalone and on a converged basis as well?

Got you. Okay. Frank, you get the easy part for revenue and what's occurring there. And I'll probably expand on that and then lead into the other questions.

Sure. So Ittai, as you know, so if you look at the overall deferred revenue, close to $12.7 billion in the quarter, up 4%, the key driver of the growth was the product side. Product side about $4 billion, close to $4 billion, up 11%. And within that, on the question that you mentioned, the driver has been growth that we've seen on subscription-type business. And that was up, within that segment, about 36%. And within that segment, it's the WebEx, it's security, it's Meraki, and it's our collaboration enterprise license agreement. So those are the areas that when we talk about even back in December, at the financial analyst conference, and we're talking about some of the cloud offerings, subscription offerings, that's the piece that is showing growth. And that's clearly what's driving the improvement in the deferred revenue on the product side. Good performance there. I'd just also put in perspective as far as the contribution, still small, contribution. But we do expect that continue as we see the investments over the next several quarters in the space.

Yes. What's interesting is, Ittai, you know that we are seeing a number of our customers of all types begin to look at not just recurred revenue but kind of a pay as you go or pay as you drink type of approach. We've closed a number of key deals, and these are $100 million-type of deals this quarter alone, that we'll see the results on it over the next 3 to 5 years. But it shows very little impact in terms of this quarter or next quarter. And that's something we just have to manage through. And we'll try to keep you in tune what that means. It obviously means as you understood from the deferred revenue product growth, that it's 1% of our growth now goes into this category faster than before per quarter. And it would not surprise me to see it at just at 2% to 3% by the end of next year. And our key is do that, keep our balance on profits and revenue growth and earnings per share. At the same time, we build something that will give -- introduce more continuity in our revenue streams, which I think all of you want to see. So it's a little bit of a balancing act. It's one that we're up to. But kind of fun for Chuck Robbins, our Head of Sales, as he does this. In terms of the switching, I think your comments are right. The campus switching is where we're seeing some good competition. But our real issue is we have products like that Cat 6000, they're still going great guns and very competitive. But they are decreasing, as you expect year-over-year, by a fair amount. The 3850 in that category is very price competitive, but we're competing with much lower…

I just want to go back to our -- just to clarify the, Ittai, first part of the question on deferred revenue. So I just -- I gave the balances for Q3 '13 that were growing at 11%. Just to clarify, last year, we had close to $4 billion, Q3 '13, going to $4.4 billion in product deferred revenue, that's up 11%. And the overall total last year, $12.7 billion going to 3 -- $13.2 billion, up 4% total. I just want to clarify that.

Thanks, Ittai. Operator, next question.

Your next question comes from Pierre Ferragu with Bernstein.

Can you give us some color on how your gross margin evolve sequentially? So you've had a very good improvement in gross margin. I was wondering how much behind that was just operating leverage having better volumes? And if there was any synergies at all between this quarter and last in terms of product mix and, of course, pricing as well? And lastly, if you have some specific like cost actions over the last 3 months that helped so gross margin improved. And then maybe I have just one last question to ask here on the switching weakness. I was just wondering if you could give us some color geographically. Is like -- is there a big overlap between your weakness in emerging markets in switching, or is switching a market that is seeming like a weakness much more broad-based across the globe?

Okay. So first on the gross margin question, Frank, keep me kind of balanced on this. If I look at gross margins this quarter, we moved a fair amount of products, Gary, that you'd been -- and the team in engineering. So John Kurd [ph] had been working on in gross margin improvements. For the last quarter, we didn't have as many of those products to work our benefit on. Also, the mix was to our benefit. You saw set-top boxes continue to decline, even though orders slowed -- declined a lot less than we've seen in prior quarters on it. And the UCS was good at 29%, but it was at 29%. So we had a very good mix advantage for us on that. You're seeing pricing issues but, contrary to what people worried about, I'm not seeing these pricing issues because of SDN. We actually are -- our win rate there is really good. And our story, Rob, and really bringing it to home application-wise and production-wise, it's very, very good, and you see that in the data center. We are seeing some pressure on the campus switching area, where there are different price points as you move into the market. A little bit of it was due to volume, but I think also what you saw on this time is almost 1% above our 61% to 62% guidance. You're going to see the swings 1 point above, 1 point below that guidance periodically. And I urge you not to overreact or underreact, to either one of them. We clearly did not give you guidance of 62.7% for this next quarter, nor is it like it will be 61% to 62%. And there'll be quarters when it goes below that 61%. If we see a trend coming, we would tell you. Right now, we're comfortable on that 61% to 62% gross margins, where actually what I worry about most is the mix and a little bit aggressive pricing out of emerging countries and other [ph] market, where if you've got to win some strategic deals, you're going to discount pretty aggressively. That's not a function of architecture SDN, it's purely a tough market in a UCS-type environment or a campus switching type environment. Frank, how close was that on what you would say?

Very close. So the 61.3% from last quarter to...

That's a good answer, Frank. Sorry.

I just want to clarify one point, though.

Okay.

Just recap. The mix was pretty much, as you said, was to a slight benefit quarter-on-quarter, if that helps. Pricing was fairly consistent. We haven't seen much change from a pricing standpoint. We did get a benefit in the volume because last quarter we did talk about the drop in the volume that we had from Q1 to Q2. So volume improved, so we got that. And as a result of that, we were able to get a substantial amount of the cost benefit. Some of which came from last quarter that was delayed and others that we kind of worked on this quarter. So cost was a big plus for us in the quarter, which enabled us to get to the 62.7%.

Great. Thanks, Pierre. Operator, next question.

Our next question comes from Jeff Kvaal with Northland.

I would like to follow up on the gross margin question, if I could. And that is to say, you have a couple of new products that, theoretically, should be very accretive to the gross margin structure that are in the pipeline, i.e. the new high-end switches and routers. Why wouldn't we see the gross margins be stable, if not even a little bit above where we are today as those products blend into the overall mix? What are some of the offsetting forces there?

Got you. So in regards to the new platforms, let's go first to switching. The new products we're introducing is very much in line with our high-end switching margins. They're very good. We're able to protect it very well. We win in terms of the architectures, comfortable with -- they just turned on a major volume. And while 175 customers is exciting up from 20-plus, it isn't 1,000. And we need to move to those bigger numbers, and then to have the big volume rollout as ACI stimulation moves to ACI implementation, not just across our Nexus 9000, but down to our other catalysts products as well in terms of direction. And the routing products again were designed from the beginning with good gross margins as opposed to -- if I had to do over something, we've done throughout our history for almost 20 years, we developed the products and brought them in at 50% gross margins. And an over period of 2 or 3 years brought them up to their normal margins of 70% or whatever you're aiming for. We won't make that mistake again. We're bringing them in at higher gross margins. But again, the volume isn't as much to that. Rob, would you add anything to that?

No, John. I think you covered it.

Well, I would say our gross margins have been consistent. I mean, last quarter, given the volume, which we talked about. Historically, we've done everything we said we're going to do around gross margins, 61% to 62%, plus or minus, 1% or 2% every quarter.

Yes. But we don't one to give anybody the impression, we are not all over this. We clearly are and we don't want to give anybody the impression that we know a mixed issue could put pressure on us here. So we're working on it hard. And that's one of the things we got to execute on and continue to execute well on.

Great. Thanks, Jeff. Operator, next question.

Our next question comes from Brian Modoff from Deutsche Bank.

A question around the AC or the Wi-Fi piece. Just wireless was, I think, up 3% year-on-year. Orders up 12%, if my memory's correct. Can you talk a little bit about what you see coming in next quarter? Do you see -- is this really AC transition that you kind of gone through for the last couple of quarter and you expect to come out of that? And when do you see a way to AC impacting the upgrade cycle and your campus switching business, the 3850 specifically? And then if I could do a follow-on, I'd appreciate that.

All right. Since I loss control earlier, Mel, we'll get it back to one next time. Brian, in terms of the wireless, and I'm including all wireless on it. We lost a little bit of momentum due to a combination of factors. I think you're seeing us pick that back up. It's the very low end that we were exposed in for a while. Now with the new products coming out from upside [ph] of various groups, I think we're much more competitive there. You're right that we are going to combine the fixed and the wireless products together on it. I'm not sure how I would have ventured, in fact, turn up on that because they often take longer than we think. And then when they occur, occur faster, especially at the low-end on it. And your second question?

The second question is really on the -- your license agreement with your software portfolio for GM. I wanted to just try to understand that a little bit more. What do you -- you mentioned collaboration, what are you specifically licensing? How is this going to play out? Just a little more color around what the agreement is and what products it might involve? And how could you see expanding this as your product line becomes more software versus hardware over time?

Okay. So let me talk about the concept of GM and just put that to the side because that's specific to a customer in the first one. Think about what we are really beginning to share with our customers is an architecture in each product category we're in that combines the infrastructure with the platform, with the application, with services. And you go across all of these architectures from the Internet of Everything to cloud, to data center, to collaboration, to security, to mobility. And when you combine those together, and we bring a Cisco -- largely Cisco-powered environment to this, your operating costs drop dramatically because the customer doesn't have to do systems integration, and you get outcomes quicker. Now what's exciting about this deal, this is all about software. And you license that software all the way across everything from our IOS to the collaboration, to the security. And as you, therefore, begin to compete against products like White Label, you're able to say, "All right, you've already got a license of software. You can be very competitive on the architecture." This is something that clearly, you and Rob and I and then Chuck Robbins, who heads up sales, want to drive through our whole company and this is what we'd like to see many other customers do. If we do this well, that really gets exciting. And this is a huge move on the transition to software, being more part of our portfolio. And tying those software pieces together, just like we are beginning to tie our hardware and ASICs. Gary, you're very familiar with the GM deal. I know we have to be -- respect their rights on this one. But any other thoughts to add to this?

Well, just a couple quick ones. One, it is everything that you've said. And I do believe we've already seen high interest from our other large enterprise customers, the CIOs you met with, et cetera. But the opportunity here is to put in their catalog all of the software that Cisco has. We've added switching, we've added everything we do to this. So now they have a software catalog that they prepaid. And now all they have to do is make minor decisions relative to what products. And our products give them that end-to-end architecture. Example would be moving stuff that might be individual products in a dealership that would be controlled with a floppy disk to now, a very easy and, for them, cost-effective solutions to IP enable it and control that from a single spot and downloaded it to any dealer they have, as an example. Same thing we do with stadium business division and some of our other solutions.

Great. Thanks, Brian. Next question, Operator.

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

I have a question on 2 things. Number one is, service revenues are down. If you sum up the last 4 quarters, service revenue growth is down to 2.5%, down from 7% the same 4 quarters a year ago. So similar period, down from 10%, 11% before. I understand that there is a link between product growth and service growth. But on the other hand, you do offer -- and you mentioned it, you do offer more service-based solutions. And with other companies, we have seen longer lag between the decline in products to the decline in services. So is there any fundamental change in services? Is there any discount on services' side or difficulties to charge for services? Can you tell us anything about it beyond just the product growth?

I'll take -- Gary, you want to go first? I'll go second.

Okay. So Tal, I think, first off, your numbers are correct as it compares to last year. If you look at where we've been each of the quarters this year, pretty consistent as we look across that. I think the core product bookings over the last 8 quarters have driven us down. What we've done, though, is start -- and we've started this some time ago, to build these other Services that have a slower contribution in '14. We'll have a bigger one in '15 and a bigger one in '16. And so, we're building those out. And those are services that we are selling today, in large part, whether it's cloud enablement and adoption services as we look at InterCloud and helping customers build that hybrid cloud, the service catalog development and how these customers are managing that services catalog, helping them move their workloads to the cloud and from one cloud to another, as well as the Security Managed Threat detection that we announced last quarter. So those are all things that have a revenue ramp that are adding to the services revenue that aren't -- that won't be as dependent on core product bookings. That said, the ability for us to continue to manage 3% growth in the quarter relative to the margins that we continue to drive, look anywhere else, I think you'll see that is a very well-run services organization that contributes greatly to our customers and that they value.

So I completely with what Gary said, Tal, especially on the profitability in the customer side that brings us. I think the technical services, what Joe Pinto has done there has been amazing. We split technical from advanced services out, okay? So it grew well. And its profitability is very good. And I think, given the product run rates that we're on, I'd give us an A in that. I think the point you're raising, Tal, is how quickly do we move in advanced services from not just bringing our products together to be able to work well or network audits or things of that type, to outcome-base. And the outcomes the Gary walked through, we're going to move through over this next year very aggressively. And only about 20% of our advanced services, if I remember right, Gary, are outcome-based today. And they're at more midlevel outcome-based as opposed to the transformation that we talked about at the GM or transformation -- hopefully, if we do our job right with diligence in a number of companies and countries. So that's where the growth has to return from, assuming that product numbers do not pick up a much more healthy rate. And I think what you're seeing is kind of -- I hate to always call it a leveling out, but I think you'll see us level out about this level, maybe one more quarter of this and then slowly start coming back up. But Tal, your constructive feedback and criticism is fair. We like where we are, we love the profits, we love the customer satisfaction but we got to make the transition here to services delivering on and those architectures and business outcomes before you're going to see the number grow well that you alluded to.

Great. Thanks, Tal. Next question.

Our next question comes from Amitabh Passi with UBS.

John, I only have one question for you. I wanted to maybe understand your sort of strategic rationale in some of the alternative areas where you're making investments. If I look at the radioactive market, you made an investment in a company, I think, called AltioStar. Your broadband access investments with the ME 4600. You're going after the converged packet optical market with the NCS 4000. When I look at each of these markets, they are large markets but they have very well-established incumbents, all of them with relatively low gross margin. So I guess, just given all the focus on gross margin, just wanted to understand how you're thinking about attacking these markets. How do you continue to sort of extract the premium, just given the fact that they're highly competitive with relatively low gross margin?

Okay. So the reason we're not in radios is because the margins are terrible, and actually almost nonexistent unless you bundle it in to total solution. We make investments in new companies and new architectures, and we make investments to see if their strategy plays out and plays out well. And if it doesn't, it's a good investment and, hopefully, you get a reasonable return on it. If it does, then we partner very tightly or acquire off of that. So we've got $2 billion underinvestment directly and probably a fair amount more indirectly through a number of our joint funds we invest in the technology. Let's use AltioStar as an example, a real good team at the top, Ashraf Dahod, he is world-class. He did a star job as you all know, a serial entrepreneur, and he usually does extremely well. And we told him if he ever wanted to come back to Cisco and work and do something exciting together, we're very interested. And he did come back to us and say, "All right, [indiscernible] and John, I would like to do this. Would you want to invest? Would you like to be a part of it?" And when we looked at his new architecture and his price points he's designed into, they got really excited. Now we have to see if it's going to work. But I like the team that's in place, and that's what you look at when you invest. I like the fact he's got a marketing transition, not building an old world radio architecture of the past, but one for the future, probably starting in emerging markets then coming in to developed. And we'll see if it works out. If it does, we'll claim victory and we would tell you we're very smart. And If it doesn't, you might not hear us talk about it again on that. But if I were going to bet on a start-up team, we've got a couple of them inside of Cisco we do well with. But Ashraf's been extremely good, and so that's the classic way to invest rather than take a big risk and an unreasonable amount of upfront capital to see if he owns the whole thing and then see if it works. You do investments, keep them as an entrepreneurship running fast, you open doors for them and accounts and go for it. Does that make sense to you, Amitabh, of what we're doing?

Okay. Great. Think we might have lost Amitabh. Operator, next question.

Our next question comes from Ben Reitzes with Barclays.

John, I wanted to ask about the pickup you saw in the U.S. and Europe. Is this it? Are things turning? And in particular, how sustainable would it be?

Good question. I think the U.S. is sustainable, especially in commercial and enterprise with all the appropriate caveats, my few years of law school have taught me on that. But I watch the pipeline, I watch the approach, our U.S. enterprise and commercial are usually a very good indicator of GDP slowly increasing, or GDP decreasing. And we saw our turnup in U.S. in enterprise, and commercial back in summer of 2012. And if you bought the [indiscernible] , I think you ought to understand what would happen. So that feels good. And you combine that with the CEOs I've talked to, most of us feel 2.5%, 3% for the next 9 months is very doable number. Not anything to do backflips on, but reasonable progress. Europe is still a little bit fragile, but we did see stability across the North with some growth rates for a change. And Europe in total was finally positive, not counting the emerging markets for us. And even stability in the South looks like it's occurring. Now I know they still got structural issues there, and I know some of the countries are in transformation and have some tough decisions to make. But I think they're, out of this downturn, slowly improving. And when I talked with our customers and the top financial people in New York, which I did just a week ago, most everybody else is beginning to see very similar trends. In fact, it almost [ph] was scary because when you described the world just like I did earlier, including emerging markets and the challenges in Russia and Brazil, we can finish each other's sentences regardless of industry. So I think Europe is coming back. Again, it's going to be slow and heavy lifting there because they haven't addressed some of their structural issues, but more consistency. And even the South is starting to show stability on it in terms of direction. So good about the U.S., good about Europe. Don't feel very good about emerging markets. They're still very challenged, especially the BRICS.

Okay. Thanks. Operator, next question.

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

The business is stabilizing and looking into your bookings linearity, more predictable. It feels like in a couple of quarters, the revenues may actually stop declining and then actually turn positive. Do you feel -- does it feel that you could hold this $46 billion to $48 billion annual revenue base because it's more predictable? And also how should we think about the annual OpEx? Is the $15 billion to $16 billion the right number, or should we expect some cost cutting? And then just on cash. eBay repatriated some cash. Recognizing your views on taxes, what else can Cisco do since half the market cap of Cisco is in overseas cash?

Okay. So our clear goal was to return to growth. It won't be straight up into the right and it may be a little bit bumpy because we're still way dependent, too dependent on our orders coming in and shipping in the next quarter and during the quarter on it. But you are right, looking out over several quarters, we'd expect that. How long it would take us to turn back up to mid-single-digit growth, if that's what we're going? It probably won't be immediate once you get a slight growth quarter and then the next quarter is there. But I think you will see us do that over a gradual time. We are going to continue to watch operating expenses. Gary's is our champion here along with Frank tightly, but we have to put money into InterCloud and we have to put money into sales rep coverage as we make these changes. And as we get really good on security and collaboration, they require a [indiscernible] for a period of time to run with. So we are going to put investments into the area there as we go forward a little bit into next year. But I think your premise on slowly up into the right is right. It will be probably be a little bit bumpy. It won't be just one quarter you'll finally turn the corner and then the next quarter you're there. But we're going to take it a quarter at a time in terms of our guidance. So we want you all not to get ahead of us on this. We are very pleased with this quarter. Next quarter's set up pretty well. But we got some real heavy lifting to do. And I'm sure, a couple of bumps along the way, especially in emerging markets and service provider on the lifting. Frank talk a little bit about where we are in occasion, how we've chosen a different path than some of our counterparts did, and why we chose the path we did.

So we can't comment specifically in regards to what eBay did. But I think, Mark, the key thing for us and this goes to the outreach we've had with all investors in the last couple of years is to build a capital allocation strategy that our investors are looking forward to, the combination of investing both in the buyback as well as in the dividend, which we've done in the last couple of years. And our strategy to a minimum have 50% of our free cash flow to use for that purposes. As I mentioned earlier, this year, we've been fairly aggressive with 140% of that free cash flow through the dividend and the buyback. We expect to continue that strategy going forward. We feel that based on the amount of cash that we have in the U.S., the amount of cash that we generate in the United States on an ongoing basis as well as our ability, as we did this past quarter, to leverage the debt market that we have the ability to fund both near-term and long-term the continued support of being aggressive on that capital allocation strategy.

Yes. We're pleased, I think, Frank, of what we've done here. And I think we're pleased to a pretty good extent without endangering our rating, et cetera, on it. So we just chose a different path actually, and very comfortable with the path we chose. Thanks, Mark.

Great. Thanks, Mark. Operator, next question.

Our next question comes from Simon Leopold with Raymond James & Associates.

A quick one. I wanted to see if you could talk a little bit more about the Ethernet switch business and the transitions. You alluded to the idea that the transitions do take a long time. What I wanted to see if you could talk about is any kind of compare and contrast this transition to the 9000 family versus the prior transition you experienced when you move to the Nexus family. If we could understand a little bit better about how this situation is either similar or different from the past, that might help us.

Sure. And then I'm going to put on the back end of that, Simon, I'm going to ask Rob to kind of tie it through where this fits on InterCloud and ACI throughout our whole family of Nexus products. So to answer the question very directly, we moved to the -- remember, the 9000 is a Nexus line, and we are going to take many of the capabilities on the 9000, including ACI and move it down through our other Nexus products. The 7000 was a slow startup, and it took us a long period of time. And candidly, we had tough gross margins on it, where you design it, et cetera, and it took us a while to add the features that we needed. Now I like very much where the 7000 is. You're going to see it have very continuous, very good growth opportunities. With the 9000 and the 7000 together, then I'll kind of judge the total growth there at the high-end switching on in terms of the capability. I think the 9000 will probably ramp quicker once you get a number of lighthouse accounts and they get their 2 and 3 and 4 systems working well on it. Remember, this is the engineering team that did the UCS where people said, "This is going to have a very slow ramp, and it will take time to achieve that goal." And while it took us a little while to get the attention of the market on UCS, the numbers went up very quickly. And I just talked with Allison Gleeson, who heads up our Commercial Group, and what she and Tony are doing on focus on the market. And they're actually on pace for the number of customers in the pipeline that they had for UCS, which is amazing in the commercial market where, clearly, some of the commercial accounts won't be reaching to the 9000. So I think the ramp, once it goes, will probably be quicker. But it will be 7000 and the 9000 together. And Rob, bring this together, maybe a quick snapshot of this next week with where we are in InterCloud and how this move ties the where we're going with our switching architectures.

Sure, John. And I think just to continue on the comment you made at the 9000, it's a continuation of the Nexus family, running in standalone mode, using the same operating processes our companies rely -- our customers rely on, as well as in APIC mode where we begin to deploy the controller, that is the fundamental building block of our ACI architecture. When you think of the differences across not only our catalyst switch and our routers and access technology, the vision of ACI is to use a construct of a unique application policy, which no one else is talking about in SDN, and move that policy not only across both physical and virtual networks in the data center, but as well to the wide area into the access. So when we now begin shipping that technology in the next few months, the trials turn to production, you will start to see the idea of an end-to-end application policy evolve. And the really neat thing here is that same policy could run in my private cloud, on a UCS, or even now on a Vblock or a FlexPod, but as well, in a public cloud instance. And we'll be showing examples of how that policy can flow between private, managed and public clouds at Cisco Live! next week. So there's a lot of difference. We really do both physical, virtual, end-to-end across the network in terms of moving policies. We are starting to see that at scale. Earlier we were asked about public clouds deploying, we'll be announcing 2 partners that are deploying ACI in their public cloud environment. One of them is in the Gartner top quadrant, one of them is midsize. I think it's really catching on. And it is really different in terms of deploying the model our customers of which are embracing today, which is hybrid cloud. And I think we've really hit the nail on the head with ACI.

Great. Thanks, Rob. Operator, next question.

Our next question comes from Inder Singh with SunTrust.

So a good quarter. And you sound decidedly upbeat, especially after the past couple of quarters. It sounds like the demand side has picked up for you. But also the product upgrades are starting to kick in. And I think you've spent quite a time on the switching side of it. I wanted to ask you about routing as well. Clearly, the company made a big bet with the CRS-X. And I think you alluded that you're seeing above expectations in terms of the demand for that. But can you provide some more color on that? And then just the other part of the question around the security business, same thing. We've seen all these networks come under threat. Clearly, perimeter security hasn't been working on networks. What are you doing differently here where the security business is starting to show growth for you now?

Got you. So on that sequence. I'm usually pretty realistic where our competitors are, even though we know how we're going to beat them. At the high-end routing, we're by ourselves. And some people might have a product that might compete with a ASR 9000, say, that's high-end router product, it's really not. So on the CRS-X and NCS, they're both world-class, by themselves, type of capability. The ramp was actually good. But these tend -- they tend to buy a pallet, 10 by 10. And so you will see those numbers bounce a little bit in terms of quarter-to-quarter based on one big deal or 2, and Mel allows me to use the word lumpy now in terms of direction. In terms -- so I really like these products and, candidly, I've not had a customer concern on the ones we've put them in so far, which is unusual with new products. In terms of security, you're right. The market security, you tend to have a hot product company of 1 or 2 product areas. And as long as that product is hot, i.e. malware or firewall or whatever they're doing, intrusion protection, prevention, it tends to be a very good growth. The bad guys, as you alluded to, just go right around that and found weaknesses. And so, we're going to play in terms of security. You will see security go across the whole architecture from our [indiscernible] capability with InterCloud down through individual private clouds, down through the data centers, down through the LAN, down the access point. And this is where we're going to use both our merchant but also our customer ASICs. You will see us place security at each node throughout that environment in a way that nobody else can. And you will see…

Great. Thanks, John. Cisco's next quarterly call, which will reflect our FY '14 fourth quarter and annual results will be on Wednesday, August 13, 2014 at 1:30 p.m. Pacific, 4:30 p.m. Eastern. Again, I would like to remind you that in light of Regulation FD, Cisco plans to retain its long-standing policy to not comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. Please call the Investor Relations department with any follow-up questions from this call. Thank you for your participation and continued support. This concludes our call.

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