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Cisco Systems, Inc. (NASDAQ:CSCO)
Q4 2018 Earnings Conference Call
Aug. 15, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to Cisco's fourth quarter fiscal year 2018 financial results conference call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. Now, I would like to introduce Marilyn Mora, head of Investor Relations. Thank you and you may begin.

Marilyn Mora -- Director, Head of Global Investor Relations

Thanks, Michelle. Welcome everyone to Cisco's fourth quarter fiscal 2018 quarterly earnings conference call. This is Marilyn Mora, Head of Investor Relations. I'm joined by Chuck Robbins, our Chairman and CEO, and Kelly Kramer, our CFO.

By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information will be made available on our website in the Investor Relations section following the call. Income statements, full-GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements, and other financial information can also be found in the Financial Information section of our Investor Relations website.

Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we'll discuss product results in terms of revenue, and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons made throughout this call will be made on a year-over-year basis, unless stated otherwise.

The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter of fiscal 2019. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC; specifically, the most recent reports on Form 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements.

With respect to guidance, please also see the slides and press release that accompany this call for further details. As a reminder, Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. I will now turn it over to Chuck.

Chuck Robbins -- Chairman and Chief Executive Officer

Thank you, Marilyn. Good afternoon, everyone. We had a very strong finish to a great year. We generated our highest quarterly revenue of $12.8 billion and non-GAAP EPS of $0.70, as growth accelerated for another consecutive quarter. Our momentum was broad-based across our portfolio, customer segments, and geographies. We also continued to generate solid margins, cash flow, and returns for our shareholders. Our results demonstrate a combination of strong customer adoption of our latest innovations, the ongoing value customers see in our software and subscription offerings, and excellent execution across our customer segments and geographies.

Our strategy is working and we believe that we are well positioned to capture growth across the portfolio with our pipeline of innovation. The broad adoption of multi-cloud environments is changing the very nature of how modern IT infrastructures are built and secured and Cisco is at the center of this transition. The recently announced intent to acquire Duo Security is another example of how we are extending our intent-based networking portfolio for the multi-cloud world.

Duo's SaaS delivered solution will expand our cloud security capabilities to help enable any user on any device to securely connect to any application on any network. Combining Cisco's network, end point, and cloud security platform with Duo's zero trust authentication and access solutions, we will be able to further enhance the industry's broadest and most effective security architecture in the market.

Now, I'll briefly highlight some of our innovation and the great momentum we're seeing across our key product areas. Starting with infrastructure platforms. We continue to rapidly innovate and transform our technology portfolio to drive even greater customer value. A year ago, we reinvented enterprise networking with the launch of our intent-based networking architecture. This quarter, we saw continued strength in infrastructure platforms driven by the Catalyst 9000, as customers look to us to simplify and automate their networks.

Over the last year, we introduced additional innovations across our networking portfolio, including new access, WAN, and data center offerings. In June, we announced new developer capabilities across our intent-based networking portfolio, spanning all network domains, campus switching, wireless, WAN, data center, and cloud. We are also excited that our developer program, DevNet, surpassed 500,000 registered members. As part of this program, we introduced new offerings to help developers and network engineers innovate throughout our intent-based architecture.

As we all know, the WAN is undergoing an architectural transition to a software-defined WAN to enable IT to rapidly respond to changing business needs in a digital and cloud world. Our customers are driving this transition and looking to Cisco to help them make this shift. Our SD-WAN portfolio leverages our leading networking products, automation, and robust security architecture to enable greater flexibility, increase bandwidth, and lower costs.

This quarter, we saw significant traction with Viptela, as it has now been deployed at over 800,000 customers, driven by our ability to provide higher capacity at a lower cost. We are pleased with the ongoing integration of Viptela with our core portfolio to driven even more value for our customers. As our customers move to a multi-cloud environment, we see tremendous opportunities to provide value to them by redesigning their IT architecture delivering security, and building, orchestrating, and managing applications. In Q4, we saw the production launch of our hybrid cloud solution with Google, the introduction of a multi-cloud solution with NetApp, and numerous engagements with customers redesigning their IT architectures. We continue to believe Cisco is very well positioned to benefit from the increasing adoption of multi-cloud.

Turning to security. Security continues to be our customers' No. 1 concern and it is a top priority for us. Our strategy is to simplify and increase security efficacy through an architectural approach with products that work together and share analytics and actionable threat intelligence. This architecture is supported by Talos, one of the largest commercial thread intelligence teams in the world. We identify and protect against new and emerging threats like the recent VPN filter vulnerability through our sophisticated infrastructure and unrivaled telemetry of data. Cisco is the largest network and enterprise security company and our approach of bringing security into the intent-based architecture and offering security across the network, end point, and cloud has proven to be very successful.

This quarter, we saw continued strong momentum with revenue again accelerating and growing double digits year-over-year. We continue to invest in our product and technology innovation, as we are committed to helping our customers on their multi-cloud journey. Our focus is on delivering cloud security solutions that provide ease of use, scalability, and protect end users. As I mentioned earlier, with our acquisition of Duo Security, we will further enhance how we deliver simple, automated, trusted access anywhere for our customers' environments.

Moving to applications. In May, we announced the launch of Webex Teams, bringing together meetings, calling, and teamwork into an integrated experience as part of the Webex platform. In Q4, we introduced major new enhancements to the platform, including a new user design for Webex meetings and a new solution with Google, combining their Contact Center AI service with the Webex platform. With more than 3 million customer service agents globally using Cisco's Contact Center software, out integration with Google will help to automate responses in our call centers by leveraging data and intelligence from AI.

We also achieved another robust quarter of growth without dynamics, underscoring the importance in value of our unique end-to-end visibility and analytics from the end user to the network, to the application.

To wrap up, 2018 was a great year. We returned to growth, invested in our core franchises, delivered new innovative platforms, and continued to shift our business to more software and subscriptions. Our record results demonstrate the strength of our business, as well as the strategic focus and execution that we have delivered over the past 12 months. I want to thank our teams around the globe for delivering these results.

We are looking forward to fiscal year '19 with a clear focus on growth, execution, and innovation. We see incredible opportunities across our business and believe we are uniquely positioned to deliver on our vision to be one of the most significance partners to our customers as they go through their digital transformation. Kelly, I'll now turn it over to you.

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Thanks, Chuck. I'll start with a summary of our financial results for the quarter, then cover the full fiscal year and the Q1 outlook.

Q4 was a solid quarter across the business. We executed well with strong orders, revenue growth, margins, EPS and operating cash flow. It was great to see accelerated momentum and product orders, which grew 7%. Total revenue was $12.8 billion, up 6%. Our non-GAAP operating margin rate was 30.9%; non-GAAP net income was $3.3 billion, up 8%; and non-GAAP EPS was $0.70, up 15%.

Let me provide some more detail on our Q4 revenue. Total product revenue was up 7%, with broad strength across the portfolio. Infrastructure platforms grew 7%, with growth in all businesses, except for routing, which was down slightly. Switching had another great quarter, with strong growth in campus driven by the ramp of the Cat 9K, at growth and data center driven by the Nexus 9K. We saw good growth in wireless, with strength in Meraki and our Wave 2 offerings.

Data center had very strong double-digit growth, driven by servers and HyperFlex. Routing declined slightly driven by weakness in SD routing. Applications was up 10% in total, with growth across all the businesses. We saw very solid growth in unified communications, telepresence, conferencing, and app dynamics. Security was up 12%, with strong performance in network security, unified threat, policy and access, and web security. Service revenue was up 3%, driven by growth in advanced services, as well as software and solution support.

We continue to transform our business, delivering more software offerings and driving more subscriptions and recurring revenues. In Q4, recurring revenue was 32% of total revenue, an increase of 1 point from a year ago. Revenue from subscriptions was 56% of our total software revenue, up 5 points year-over-year. We drove good growth in deferred revenue, which was up 6% in total, with product up 15%, and services up 1%. Deferred product revenue from our recurring software and subscription offers was $6.1 billion, up 23%. There was also a strong increase in the unbilled deferred, which is not on the balance sheet. The combined total deferred revenue plus unbilled deferred was up 28%.

When we look at the impact of acquisitions on our Q4 results year-over-year, there was a 90 basis point positive impact on revenue. We saw especially strong momentum in Q4 with total product orders growing 7%. Looking at our geographies, Americas grew 6%, EMEA was up 6%, and APJC was up 12%. Total emerging markets was up 12%, with the BRICS plus Mexico up 22%.

In our customer segment, enterprise was up 11%, commercial was up 9%, public sector was up 1%, and service provider returned to growth, up 6%. Our product backlog at the end of Q4 was $6.6 billion, up 38% year-over-year. From a non-GAAP gross margin perspective, total Q4 gross margin was 52.9%, down 0.8 points. Product gross margin was 51.5%, down 0.4 points, and service gross margin was 67.1%, down 1.7 points. Product gross margin was down 0.4 points, driven by our APJC region, related to some SP-specific deals, as well as negative product mix. Product gross margin for the Americas and EMEA were both up year-over-year.

Overall, pricing continued to have relatively modest erosion, as you have seen over the past couple of quarters, and we continued to be negatively impacted by higher component costs, which we expect to continue in the near term. In terms of the bottom line from a GAAP perspective, Q4 net income was $3.8 billion, and EPS was $0.81. The GAAP results include an $863 million benefit related to the Tax Cuts and Jobs Act. We've excluded the benefit from our non-GAAP results. We ended Q4 with total cash, cash equivalents, and investments of $46.5 billion. Q4 operating cash flow was $4.1 billion, up 2%, with free cash flow of $3.9 billion, also up 2%. From a capital allocation perspective, we returned $7.5 billion to our shareholders during the quarter that was comprised of $6 billion of share repurchases and $1.5 billion for our quarterly dividend.

I'll now cover the full fiscal year. We delivered solid revenue, margins, net income, EPS, and operating cash flows. Revenue was $49.3 billion, up 3%. Our non-GAAP operating margin rate was 31.1%. Non-GAAP net income was $12.7 billion, up 5%, and non-GAAP EPS was $2.60, up 9%. Our total non-GAAP gross margin was 63.8%, a decrease of 0.5 points, with product gross margin down 0.4 points, and service gross margin down 0.9 points. GAAP net income was $110 million, and GAAP EPS was $0.02, which includes the charges related to the Tax Cuts and Jobs Act of $10.4 billion.

For the full fiscal year, we delivered operating cash flow of $13.7 billion. We paid approximately $1.4 billion of one-time foreign taxes during the year related to the Tax Cuts and Jobs Act. Operating cash flow increased 8%, normalized for these tax payments. We returned $23.6 billion to shareholders over the fiscal year, which represented 184% of our free cash flow. That was made up of $17.7 billion of share repurchases and $6 billion for our quarterly dividend.

To summarize, we had a strong Q4 and fiscal year. We executed well with strong top line growth and profitability. We're seeing the returns on the investments we're making in innovation and driving the shift to more software and subscriptions, delivering long-term growth and shareholder value.

As a reminder, we are adopting the new revenue recognition standard, ASC606, as of Q1 fiscal year '19 on the modified retrospective basis. Its primary impact will be to accelerate our revenue recognition for certain software licenses and sales to future distributors, as well as a recognition of a deferred commissions asset that will be amortized over the terms of our sales contract.

Let me reiterate our guidance for the first quarter of fiscal year '19. This guidance includes the type of forward-looking information that Marilyn referred to earlier. We expect revenue growth in the range of 5% to 7% year-over-year. This range includes the impact of ASC606, which we estimate to be a benefit of about 1%. We anticipate the non-GAAP gross margin rate to be in the range of 63% to 64%. The non-GAAP operating margin rate is expected to be in the range of 30% to 31%, and the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from $0.70 to $0.72. The guidance includes our service provider video software solutions business that we recently agreed to sell, and excludes the Duo acquisition, since both transactions have not closed. We expect the SPVSS transaction to close in the first half of fiscal '19, subject to customary closing conditions and regulatory approvals.

I'll now turn it back to Marilyn so we can move into the Q&A.

Questions and Answers:

Marilyn Mora -- Director, Head of Global Investor Relations

Thanks, Kelly. Michelle, let's go ahead and open the line for questions. As a reminder, please limit yourself to one question only. I'll now turn it over to Michelle.

Operator

Thank you. Vijay Bhagavath from Deutsche Bank Securities, you may ask your question.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Good afternoon, Chuck, Kelly. I hope you can hear me fine.

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Yes, hi, Vijay.

Chuck Robbins -- Chairman and Chief Executive Officer

We can Vijay, thank you.

Vijay Bhagavath -- Deutsche Bank -- Analyst

I'm here in New York. My question to you, Chuck and Kelly, please chime in, is it reasonable to assume you'd be extending your software subscription idea and plan across the portfolio? Give us an early glimpse as to how it's going or what were some of the challenges, what were some of the [inaudible] surprises, and would the makeup of the software subscription portfolio meaningfully change as you look to extend this model across the portfolio? Thanks.

Chuck Robbins -- Chairman and Chief Executive Officer

Thanks, Vijay. Most of you know that when we began the sale of the Catalyst 9000, that was the first attempt to sell a subscription software offering on top of a core networking product. That has gone, as we've said on prior calls, reasonably well. I'm very pleased with how the adoption has been from our customers. They understand the value. As I said early on, we knew when we started that process that we would need to deliver significant innovation that wasn't available in the traditional methodology of buying it in order for our customers to adopt it and some of those were the encrypted traffic analytics, the overarching automation capability, and then recently some assurance.

You'll see us over the next coming quarters when we bring new products to market, particularly in the enterprise networking space, but across the portfolio, we will apply that same strategy. I think that we've been pleased and our job now is to ensure that the operational infrastructure of the company is prepared and we're working toward being able to ensure that customers are deriving the value from that software, as well as obviously putting in the operational capabilities to ensure the renewals, etc. So, that's what we're focused on. Kelly, anything to add?

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

No, I think you hit it.

Chuck Robbins -- Chairman and Chief Executive Officer

Thanks.

Marilyn Mora -- Director, Head of Global Investor Relations

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

Operator

Thank you. Rob Hall from Goldman Sachs, you may go ahead, sir.

Rod Hall -- Goldman Sachs -- Analyst

Hi, guys. Thanks for the question. I'm kind of beside myself. I don't know where to start, these are so good. But let me kick off with a question on the deferred revenue, Kelly. You said including this off balance sheet, deferred is up 28%. Is that total deferred or product deferred? Can you just clarify what you meant by that. And also, maybe help us understand what the ASC606 impact on deferred was because that was, I guess, negative.

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Yeah, sure. On your question on the deferred revenue plus unbilled deferred, that was up 28%. The big driver that we had for that -- this is just purely product. It is what we mostly have in our unbilled deferred is from our collaboration, our applications business. They have a lot of periodic billing that they book month-to-month. That is a very large number. It is apples-to-apples of business that we have booked that we will recognize in the future. So, that's why we look at both.

When we do adopt ASC606 for Q1, that will be one of our disclosures showing you the combination of deferred plus unbilled, so you have our remaining performance obligations. But it is just product, that 28%. As far as the ASC606, we adopt that in Q1. So, in the results we just went through of the $6.1 billion of deferred from software and subscriptions, that is related to how we've been accounting for it under the ASC605. So, when we go in to Q1 --

Rod Hall -- Goldman Sachs -- Analyst

Can you just clarify though, would you write down, you'll write some of the deferred down in Q1 as a result of the change or not much, or?

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Yeah, I can give you some direction. You'll see that in our K. We will be writing off a portion of that balance. Of the $6 billion, we will be writing off and restating, because you basically restate your balance sheet for the new accounting rules. Like we've said over the past year, where we will have that impact is things that were term-based software licenses, things like our ELAs or Cisco 1, those will now be recognized up front, where they used to be deferred. So, the deferred revenue balance will be written down for that. So, we'll lower the balance of the deferred revenue and then as we go into Q1, we'll be recognizing any new business that we bill up front from that.

Rod Hall -- Goldman Sachs -- Analyst

Great, OK. Thank you.

Chuck Robbins -- Chairman and Chief Executive Officer

Thanks, Rod.

Marilyn Mora -- Director, Head of Global Investor Relations

Thanks, Rod. Next question, please?

Operator

Thank you. Ittai Kidron from Oppenheimer, you may go ahead.

Ittai Kidron -- Oppenheimer & Company -- Analyst

Thanks and congrats. Great quarter. Chuck, maybe you can help me figure out how you manage to navigate so well in what seems to be such treacherous waters out there, between some deceleration in economic activity in Europe; the FX movement, recently, which is not favorable to you although you price in dollars, nonetheless it makes your products a little bit more expensive internationally; poor capex metrics out of the large telcos; tariff wars globally. You seem to be moving along, sidestepping all of those things. Which of these things really bother you, concern you, you're watchful, you're preparing for? Then second question, maybe you can kind of dig in a little bit on the networking. The Cat 9K clearly good progress. Are there any customer metrics or anything you can give us there to help us solidify or get better visibility into the trend there?

Chuck Robbins -- Chairman and Chief Executive Officer

Ittai, I was feeling pretty good until you asked the first part of your question. I have said publicly I think we have been operating in what I'll call a consistent global economic scenario. There's clearly, even in the last few weeks, been things that have arisen. You've got the strengthening of the dollar that you mentioned. You've got some uncertainty in a couple of emerging countries. Those are clearly things that we'll watch. We've seen these in the past and we know how to deal with them. We obviously have the impending tariff situation, which we're watching closely. On that front, we're in deep discussions in Washington with the administration on trying to get to a favorable outcome. We'd like to see that land in a good place. Overall, all of those are things that we are actively involved with and we watch on a daily basis.

As it relates to the networking business, the Catalyst 9000, as I said previously, has been the fastest ramping product that we've ever built. So, the customer count became less of an indicator pretty quickly and it flowed through to the infrastructure systems growth that you saw this quarter. So, we didn't see it as a metric that was -- we usually use that metric on customer count when we're just trying to give you visibility to the ramp of a new product when it hasn't become real material to the revenue line. I think we exceeded that point in time with the 9K pretty quickly.

But I will tell you, just so you know -- Kelly, keep me honest on this -- I think we had roughly 9,650+ customers on the 9K as of the end of the quarter. We had a great Q4, great adoption, and we're very happy with where that product and that architecture is.

Ittai Kidron -- Oppenheimer & Company -- Analyst

Fantastic. Congrats.

Chuck Robbins -- Chairman and Chief Executive Officer

Thank you.

Marilyn Mora -- Director, Head of Global Investor Relations

Next question, please.

Operator

Thank you. Pierre Farragut from New Street Research, you may go ahead.

Pierre Ferragu -- New Street Research -- Analyst

Thanks for taking my question. I actually wanted to ask you about service providers. You returned to growth this quarter, which is fantastic. I think you mentioned as well that your routing business was weak and most of that weakness was in the service provider vertical as well. So, I was curious to understand how you grew revenues there even if routing was negative or maybe I got something wrong? Then, of course, I'm very curious to hear whether this recovery in service provider spending might be driven by 5G already?

Chuck Robbins -- Chairman and Chief Executive Officer

Let me answer the macro question about the overall situation we see and service provider and then Kelly maybe you can cover the routing and the impact, the first part of the question. Pierre, in the service provider space, we were obviously pleased. I've said a number of times over the last couple of years that this is a business that is dominated by large customers. As we've always said, when we have several of them that are slowing their spending, it looks bad and when we have several that are spending, it looks pretty good. That's just the nature of this business.

Relative to 5G, I think I've said this on prior calls. Starting at Mobile World Congress earlier this year, we heard these customers in earnest begin and engage in discussions around what network requirements would look like for the infrastructure to support 5G. Assuming that they're going to add lots of high-speed connections at the edge, it will require high-performance networks with quality of service and slicing and all those things.

I would not say that this is a material result of the implementation of 5G, to be honest. We expect that as still a year out before many will start and probably see it in earnest into 2020, to be fair. But we're pleased with what our teams have done. It's been a tough market. Our teams have continued to battle and our engineering team continues to work on next-generation innovation and we're pleased with the results this quarter. Kelly?

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

To the point of better revenue. If you remember, the SP segment was down 4% and you're seeing that flow through the revenue this quarter. When we talked about routing overall. When I look forward, we don't talk about our guidance in the up-front by business, but some of this on the order side might play well as we go into Q1. What I will say, adding onto Chuck's comments is I do think, and as you know very well, our service provider segment is made up of very, very large customers and in any one quarter we can get big orders and that can fluctuate around. So as to the sustainability, I would say we feel good about our position, though I expect this could move around either way as we look forward.

Marilyn Mora -- Director, Head of Global Investor Relations

Thanks, Kelly. Michelle, go ahead with the next question.

Operator

Thank you. Sami Badri from Credit Suisse, you may go ahead.

Ahmed Sami Badri -- Credit Suisse -- Analyst

Thank you for the question. My first question has a lot to do with Europe and the strength you saw in the region in this last quarter and then is it safe to assume that going into next quarter on your very strong guidance, are you expecting to see the same kind of magnitude of strength in Europe again, despite all the moving pieces politically? Then the second question I really have is about the tele product launch. Are you addressing customers that are already big users, end customers of the campus products and the Meraki products to kind of upsell customers into your new tele product? Or maybe you can give us just an idea on the sales cycle and the customer base that you're addressing.

Chuck Robbins -- Chairman and Chief Executive Officer

If you don't mind, Sami, I'm going to answer the second one and then I'll give you a little qualitative color on Europe, and then Kelly will answer the specifics on the business expectations. So, on the second part of your question relative to Viptela and software-defined WAN, we have two offers. Meraki has an offer for those customers who have embraced the Meraki architecture. They have a very effective SD-WAN solution that is actually being well received in their customer base. They're using it to the extend their customer base. So, that's been very successful.

On the Viptela front, we have been working hard on the integration between the Viptela platform and Cisco's product. And so we're going to have a variety of offerings from our customers. We'll have a version that will have software running on different types of hardware. We'll have a software-only solution. We'll have our integrated ISR solution. So, we're seeing a number of those. This was a quarter where I would say we really saw the engagement level increase significantly. We got the offers into the marketplace, the first wave of those.

I said on the Q3 call that our teams were signaling us that Q4 was where we were going to see some of this come to fruition and we, in fact, did. So, we feel good about where we are right now. There's more work to do. We haven't gotten the SD-WAN integration into DNA center yet, so that will only be, I think, a positive boost when we get that done. The teams are working on that. I think it's coming in one of the upcoming releases. So, in general, we're pleased with where we are at this moment in time with Viptela.

Europe, our teams are doing really well there. Our teams are executing well. I think that they are competing very well because we have some very tough competition there. The team in Europe is always one of the early teams leading with some of these technology areas. So, they've had a lot of success in this core enterprise networking space as we move to intent-based networking. We're pleased with what they're doing. The entire global macro environment right now, there are so many dynamics that we're calling it like we see it based on what we know today. Kelly, you want to comment just on how we see that?

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Yeah, I think just to add to your point, I think the environment is very strong in Europe, despite the political things that are going on. Just as a data point, the U.K. is up double digits for us on product orders this quarter. So, again, it's like Chuck was saying, the overall environment is very favorable as of right now. So, we're hoping we see this continued strength.

Chuck Robbins -- Chairman and Chief Executive Officer

A lot of the innovation that we're bringing right now is actually targeted at helping our customers lower the expenses of running this investments. So, there's a significant play to be made. Almost as customers look at where they are economically, there's reduction of costs by going to this automation platform. There's reduction of cost by moving to SD-WAN. These are technologies that we are hopeful that will continue to be important to our customers regardless.

Ahmed Sami Badri -- Credit Suisse -- Analyst

Thank you.

Chuck Robbins -- Chairman and Chief Executive Officer

Thank you.

Marilyn Mora -- Director, Head of Global Investor Relations

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

Operator

Thank you. Samik Chatterjee, you may go ahead from J.P. Morgan.

Samik Chatterjee -- J.P. Morgan -- Analyst

Hi, Chuck. Hi, Kelly. Thanks for taking my question. I just had a question on the guide for the first quarter. You clearly have good momentum on the top line, although when I look at the operating margin guidance, it's kind of flat year-over-year or so. I just want to check, is there something that's limiting the flow-through of the solid momentum on the top line to the operating margin? Is there something that's limiting the leverage of that to the bottom line? Is that something we should hope for in the future and provides kind of a second leg to the earnings growth?

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Hi, thanks for the question. No, I don't think you need to read anything different of what's happening on the margin. If I look at the puts and takes that we have to our margin, I spoke a little bit about, we have a little margin pressure this quarter on some specific deals in APJC, but otherwise our margin is driven by the same things. Our pricing is very robust. We're being very disciplined. The price that you've seen in the last couple questions is in a range that's very, very strong. So, that's good. We are still facing component headwinds and even though it's less of a headwind, it's still higher year-over-year. The prices are up. Again, just the slope is less, but that's part of what we see both in Q4 and the guide. And then everything else kind of balances out. So, right now, this is what we see. We obviously are going to be driving for as much as we possibly can, but it's really the same dynamics.

Samik Chatterjee -- J.P. Morgan -- Analyst

Okay. Thank you.

Marilyn Mora -- Director, Head of Global Investor Relations

Thank you. We'll go ahead and take the next question.

Operator

Thank you. Paul Silverstein from Cowen, you may go ahead.

Paul Silverstein -- Cowen & Company -- Analyst

Thanks. I appreciate you taking the question. A clarification and question. Kelly, just in your previous response, I trust you expect D-RAM at a minimum to moderate come next year and I'm wondering if you have any thoughts on the impact. The larger question, I recognize this has been asked and answered in various forms, but Chuck and Kelly, my takeaway from your comments in that there's an awful lot of things going right and my simple question is, how much of this do you attribute to the macro? I recognize even in that portion it's not simple in terms of different moving pieces globally, but how much of the strength is macro-related and how much of it is better execution in various areas like campus switching, etc.?

Chuck Robbins -- Chairman and Chief Executive Officer

You want to take the clarification?

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Sure. On the component stuff, D-RAM is loosening, though again, as I said, the prices still are up whether you look on quarter-over-quarter or year-over-year. But we are optimistic that both on the demand side, which is also driving some of that price and we expect that to get better through '19. I don't know if you want to hit the other --

Chuck Robbins -- Chairman and Chief Executive Officer

Paul, it's virtually an impossible question to answer, although I'm pragmatic enough to know that it's a combination of both. I will say that I think that clearly the economic has been pretty consistent and the markets have been positive. So, that has certainly helped. I think correspondingly, this new architecture and the new technology that we brought out first, four quarters back, actually, right at the end of Q4 from a year earlier, has clearly been adopted at a record pace for us. So, I could never possibly give you any sort of split on what that looks like. The best I can do is acknowledge that it's a bit of both. There are a lot of things going right now. But there's also, as we said earlier, and Ittai asked the question, there's a lot of dynamics out there that we're watching very closely. So, sorry that I can't give you a better, more specific answer, but I think that's as honest as I can be.

Paul Silverstein -- Cowen & Company -- Analyst

I appreciate it. Thank you.

Marilyn Mora -- Director, Head of Global Investor Relations

Thanks, Paul. Next question, please?

Operator

Thank you. James Fish from Piper Jaffray, you may go ahead.

James Fish -- Piper Jaffray -- Analyst

Hi, Chuck and Kelly. Thanks for the question. It's been a while since we got a security metric update. Can you just kind of walk through some of the past metrics you've given or what you're willing to give today? I know in the past you've given deferred revenue growth, as well as penetration of certain products, like Fire RAM. Then secondly, HyperFlex [inaudible] was released, I believe, recently. Can we get an update as to how we should think about the sizing of that business or any metrics around hyperconverged infrastructure and how it's competing against the Nutanixes of the world? Thank you.

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Like I said in the prepared remarks, on the security side, they continue to have, they're over 60% of their business is software. And so, obviously, they have a lot of their business going through deferred revenue and they continue to grow in high double digits. So, we feel good about that. They had a very strong Q4. Like I said, from a revenue perspective, it was broad-based this quarter driving that 12% up on revenue. It was across all of their sub-segments. So, I'd say it's continuing to grow very quickly. With this addition of Duo, it really just rounds out the portfolio very well.

In terms of HyperFlex, that's growing very strongly for us. I think this new release has been well received. Again, we find ourselves in a lot of head-to-head deals and winning against Nutanix, which is obviously a really tough competitor out there. But we feel good about the offer we have. Now, it's fairly small compared to the broader data center business that has all of our servers in there. But we're pleased with how it's ramping and how we're competing.

Chuck Robbins -- Chairman and Chief Executive Officer

The answer is exactly right.

James Fish -- Piper Jaffray -- Analyst

Thank you.

Marilyn Mora -- Director, Head of Global Investor Relations

Thank you. Next question, please.

Operator

Thank you. Simon Leopold from Raymond James, you may go ahead.

Simon Leopold -- Raymond James -- Analyst

Thank you for taking my question. I wanted to see if maybe we could talk a little bit longer term trending, big picture around the concept of multi-cloud, which you talked about at Cisco Live and on a number of other occasions. Within the answer, what I'm looking for is how does this help the evolution and transformation and importantly, how does this help Cisco do more business with the web scale customers? Thank you.

Chuck Robbins -- Chairman and Chief Executive Officer

Simon, that's a really good question. I think the key message for us that we're trying to get across is that this transition to this multi-cloud world actually is changing the way our customers look at building their IT infrastructure and how they secure it. So, if you just think very simply, look back over the last 5-10 years, a great majority of the traffic in our enterprise customers' networks was terminating in their private data centers. So, networks were architected and security architectures were built to deal with that reality.

Now, we're moving into a world where there is still some percentage, depending on customer, of their traffic that is obviously terminating in a private data center. Then they have traffic terminating in SaaS applications in multiple public cloud providers. They have this whole IoT, edge, data aggregation issue. So, what's happened is the traffic flows and the way data is moving across their networks and across their infrastructure is much more complex than it was 5-7 years ago, where it was all very predictable. Which leads us to, when you think about ultimately our customers are just going to need to build a world where you look at the user, you look at the application, you look at their policy, and you look at the destination, and then you have technology in the network that actually provides policy routing quality security in that world.

That's the role that we're playing with our customers because they need to rearchitect their networks to accommodate a massively diverse traffic flow scenario that they're going to deal with. So, I'll stop with that right now. But that's why it's so important. You asked what does that do to our partnerships with the web scale providers. Well, they understand this dynamic that is going on and so you're seeing some of the early work we're doing with some of the web scale providers to ensure that we have integrated hybrid cloud solutions so that we can provide security and policy, whether applications or in the private data center or in the public. They're interested in our ability to process data at the edge, as customers are building out IoT applications. They're interested in us helping define security architectures that make it simple for our customers to take advantage of their services.

So, it's emerging as a really attractive partnership because of the reality that everybody sees in the marketplace today. Hopefully that was clear. If not, we can have some folks talk to you afterwards.

Simon Leopold -- Raymond James -- Analyst

Great. I appreciate it. I understand. It's obviously a complex topic. Just trying to figure out how to bake it into a model.

Chuck Robbins -- Chairman and Chief Executive Officer

I'll let Kelly talk to you about that one.

Marilyn Mora -- Director, Head of Global Investor Relations

Thanks, Chuck. Next question, please?

Operator

Thank you. James Suva from Citigroup Global Markets, you may go ahead.

James Suva -- Citigroup Global Markets -- Analyst

Thank you very much. A quick question, Chuck. Earlier in your remarks, you mentioned with service provider strength coming back that you don't believe it's 5G related, that it's more of a 2020 phenomenon. Can you give us a little bit about a history lesson of back in 3G or 4G or 2G uptakes, was there a linear into the build that happens? Is there a pause before the positive end happens or is it just more of a steady as you go? Because as we look ahead more longer term, is strategically to 5G an impact to Cisco?

Chuck Robbins -- Chairman and Chief Executive Officer

Jim, that's a good question. I think if you go back and look at the earlier transitions in this space, they have largely been around delivering -- I don't want to say incrementally better, but a better performance for mobile devices that are connected to the network already. So, when you go from 3G to 4G, you get better data performance, you're happier with your apps on your phones, etc. This is a step level difference because we're talking about the latency dynamics of 5G and the belief that this will actually enable them to deliver real-time business applications to small offices or remote branches over 5G networks. That's a completely different dynamic.

And so, I would tell you that we don't know yet, but I think if you operate under the assumption that it lives up to its billing, then it is going to create a significant demand on the core networks of the service providers. I can't say that there is a huge historical example for us to learn from, but I think what you're going to see is just between now and when they start building these things out, they're going to be working on design and then we're just going to see them begin to gradually build out. As they open up a certain market, they're build out bandwidth and backbone capacity. That's how we're thinking about it. We'll be able to give you guys updates on upcoming quarters as to how we see this thing emerging. It's not going to happen overnight.

James Suva -- Citigroup Global Markets -- Analyst

Thank you so much for the details.

Marilyn Mora -- Director, Head of Global Investor Relations

All right. Thanks, Jim. Next question, please.

Operator

Thank you. Tal Liani from Bank of America Securities Merrill Lynch, you may go ahead, sir.

Tal Liani -- Bank of America Merrill Lynch -- Analyst

Hello. I wanted to ask about the routing. Just again, it's repeatedly under pressure. You gave an answer before about Viptela, saying that it's going according to the plan. I'm wondering if there's a link between the two yet or that the pressure in routing has to do with other things, not to do with SD-WAN? That's the first question. Kind of to understand. Or maybe you can provide different explanation to understand the pressure on routing and what's the outlook for recovery or is it like Nokia and others are saying that maybe there is a long-term pressure on this market? Second question, just a follow-up on 606. What's the impact on operating margin? If you provide this information. Thanks.

Chuck Robbins -- Chairman and Chief Executive Officer

Okay, Tal. Let me make a comment on the first one and then Kelly can add to it and she can give the 606 answer as well. When you look at our routing business, first of all, Kelly, half of it, 50%-60% of it's SP, right? So, it's significant impacted by the SP. Some of the players you mentioned, probably a much higher percentage of their routing business is coming from service providers would be my guess. So, that's just sort of couched in the discussion on 5G and everything that we've said so far about SP I'd say is the answer on that piece of it.

From an enterprise perspective, Tal, I think over the last couple of years, we've just seen a classic architectural stall in the marketplace as we've talked about historically, when there's a big architectural transition. And you said that we believed Viptela was going according to plan. I think the way I would characterize it we've begun to see customers actually move forward with deployments, but it's early. We like where we are and we like what we see. So, I think we'll see the enterprise continue to improve relative to this architectural clarity. I'll let Kelly answer how you think about the overall routing or the 606 question.

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

On 606, Tal, just to kind of ground everybody on how we're impacted on 606. The one thing I will say is operationally, nothing has changed. We've made no changes to our offers. We've made no changes to our contracts or any changes to our cash conversion cycles. So, it is literally just an accounting change. Now, what the implications are to us, like we've said, it's going to accelerate some of our term-based licenses. We will have to write off some of our deferred revenue. We won't see that revenue, but we will offset that with acceleration of those offers when we book new orders and bill new orders.

Net-net, we think it will be a net positive for us of approximately 1%. That's the impact on the revenue. It will fall through down through margin, so on operating margin, half a point to 70 basis points, roughly, of goodness falling through there. As we go into the new rev standards, as part of our disclosures, we'll be laying out very clearly for everybody, since we are adopting the modified retrospective approach, we'll lay out very clearly the implications of the new accounting versus what it would've been under the old accounting. So, hopefully that answers your question.

Tal Liani -- Bank of America -- Analyst

Great. Thank you.

Marilyn Mora -- Director, Head of Global Investor Relations

Thank you. Well take our next question, our last question.

Operator

Thank you. George Notter, you may go ahead from Jefferies, LLC.

George Notter -- Jefferies -- Analyst

Hi, guys. Thanks a lot for squeezing me in here. I guess, Kelly, I was curious about the revenue headwind that you're seeing from the subscription transition. You've talked about that in the past. I'm just curious about what that might have looked like in the July quarter and then what do you think that would look like for the October quarter?

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

That's a great question, George. There's good news. There's good news there, I would say. Like we anticipated, as we are so rapidly ramping the Cat 9K, and as we are blowing out DNA across not only that but also our Viptela offerings and across wireless, the revenue headwind is getting more, closer to 2.5 to 3 points. Now, the good news on this is with the new revenue standard going forward, because it's accelerating some of these offers that we did have previously deferred, that headwind will become less of a headwind, OK? So, as opposed to the 2.5 to 3 points under current accounting standards, that will be much less, closer to like 1.5 points or so, if I had to guess roughly. Again, this will all flush out as we go through it, but it'll become less of a headwind because we have such a big portion of things that we will now be recognizing up front.

Chuck Robbins -- Chairman and Chief Executive Officer

You said that it was 1% increase on the other side.

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

On the revenue, exactly. The good thing about this accounting standard is it does normalize some of the natural headwinds we've had on revenue and margin because of it is now going to kind of come back and benefit us.

George Notter -- Jefferies -- Analyst

Thanks.

Chuck Robbins -- Chairman and Chief Executive Officer

All right. I think that what's the last question, Marilyn? So if I could, just thank everybody for spending time with us today. Thanks for the questions and the dialogue. Marilyn, I'll turn it back over to you.

Marilyn Mora -- Director, Head of Global Investor Relations

Thanks, Chuck, and thanks, everyone. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2019 first quarter earnings results will be on Wednesday, November 14th, 2018, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. Again, I'd like to remind the audience that in light of regulation FD, Cisco's policy is not to comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. We now plan to close the call. If you have any further questions, please feel free to contact the Cisco's investor relations department. We thank you very much for joining the call today.

Operator

Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 888-417-5767. For participants dialing from outside the U.S., please dial 203-369-0735. This concludes today's call. You may disconnect at this time.

Duration: 52 minutes

Call participants:

Chuck Robbins -- Chairman and Chief Executive Officer

Kelly A. Kramer -- Executive Vice President and Chief Financial Officer

Marilyn Mora -- Director, Head of Global Investor Relations

Vijay Bhagavath -- Deutsche Bank -- Analyst

Rod Hall -- Goldman Sachs -- Analyst

Ittai Kidron -- Oppenheimer & Company -- Analyst

Pierre Ferragu -- New Street Research -- Analyst

Ahmed Sami Badri -- Credit Suisse -- Analyst

Samik Chatterjee -- J.P. Morgan -- Analyst

Paul Silverstein -- Cowen & Company -- Analyst

James Fish -- Piper Jaffray -- Analyst

Simon Leopold -- Raymond James -- Analyst

James Suva -- Citigroup Global Markets -- Analyst

Tal Liani -- Bank of America -- Analyst

George Notter -- Jefferies -- Analyst

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