Q3 2021 Cisco Systems Inc Earnings Call
Welcome to Cisco third quarter of fiscal year 2021 financial results conference call at the request of Cisco Today's conference is being recorded if you have any objections you may disconnect now.
Now I would like to introduce Marilyn Mora head of Investor Relations. Ma'am, you may begin welcome everyone to Cisco's third quarter fiscal 2021 quarterly earnings conference call. This is Marilyn Mora head of Investor Relations and I'm joined by Chuck Robbins, Our chairman and CEO and Scott Herren, 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 will 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 on a year over year basis.
The matters, we will be discussing today include forward looking statements, including the guidance, we will be providing for the fourth quarter of fiscal 'twenty 'twenty..1 they are subject to the risks and uncertainties, including COVID-19 that we discuss in detail in our documents filed with the SEC specifically the most recent reports on forms 10-K, and 10-Q, which are.
Dental fly the 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.
I 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.
Thanks, Marilyn and good afternoon, and thanks for joining today.
Hope everyone is staying healthy and safe as we start to see the benefits of vaccine deployments on the continuing improvement in economic activity.
I want to start by acknowledging our employees customers and partners in India, who are experiencing a devastating surge of Covid cases, Cisco is providing critical resources. During this challenging time and our thoughts remain with all of you.
While many of US were seeing great progress in our recovery efforts, we must remain vigilant and adaptable as we manage the ongoing pandemic around the world.
Turning to the quarter, we had impressive momentum in Q3, which gives me a great sense of optimism going forward, we returned to growth with revenue up 7% driven.
Driven by an improving macro environment, the strongest product portfolio in our history and great execution by our teams we saw broad based demand across the business led by our biggest growth opportunities hybrid work digital transformation cloud and continued strong uptake of our subscription based offerings. We're also seeing early momentum and the ramping of key.
Technology cycles that are a long term growth drivers for our business such as 5 G 400 gig and edge.
The next phase of the recovery and the future work will be heavily reliant on our technology Cisco was Indian portfolio will serve as the foundation for next generation infrastructure solutions as well as cloud enabled delivery models and innovation, allowing our customers to move with even greater speed and agility.
This will require a significant investment cycle.
And reinforces the strength of our strategy, while driving greater opportunity to create a world that is more connected inclusive and secure.
We remain focused on accelerating innovation, while simplifying the adoption of our offerings with network wide automation analytics and flexible as a service consumption models all aimed at improving our customer's network performance capabilities and security, which we believe will drive tremendous long term opportunities for us.
Our Q3 performance only reinforces my confidence about the future. These.
These results reflect a return to a strong spending environment in an economic recovery that has gained momentum driven by vaccine rollouts and the easing of restrictions.
As the economy has improved customers have increased their investment across our portfolio to prepare for the upturn and returned to office in Q3, we saw 10% growth in product orders the highest growth rate since Q1 of fiscal 2012, reflecting robust improvement across all of our customer segments and geographies from.
A product revenue perspective, we saw 6% growth led by strength across our portfolio, including campus switching routing wireless security collaboration and web scale as well as from our acquisition of Acacia which closed during Q3.
We continue to aggressively shift our business to more recurring revenue streams, which we expect to grow over time as we expand our offerings.
In Q3, we achieved $3.8 billion in software revenue with 81% of our software revenue is sold as a subscription up from 76% last quarter. We also saw another quarter of double digit growth in our deferred revenue and remaining performance obligations.
Over the past 6 years, we have made significant progress and now have 1 of the largest software businesses in the industry with an annual run rate well over $14 billion Lee.
I'll touch on infrastructure platforms.
We saw strong demand across the majority of our portfolio.
Led by our next generation enterprise networking and service provider solutions as companies accelerate the modernization of their infrastructure.
This modern infrastructure delivers higher performance and faster access to data while offering the best user experience in an increasingly distributed environment.
Customers are turning to us to help them create the trusted workplace of the future with Wi Fi access points video endpoints cameras, and Iot sensors feeding data into DNA center in DNA spaces, we're enabling operations teams to remotely monitor workplace conditions for a safe return to office.
We're also working to provide visibility beyond corporate networks, which is increasingly critical.
As our customers accelerate their adoption of SaaS and cloud solutions for hybrid work.
At Cisco live we launched the industry's first enterprise wide full stack observe ability offering by integrating thousand eyes cloud intelligence with our catalyst switching portfolio and App dynamics. This provides it with visibility and actionable insights across both external and internal networks to provide a seamless digital experience for us.
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And with users more distributed than ever it is vital that they have the most efficient and secure connection to the cloud our deep partnerships with Google Amazon and Microsoft, allowing native connectivity from our SD Wan fabric to each of these cloud offerings with our technology customers can reduce deployment times and connect branch offices to cloud work.
Clothes in minutes.
And our web scale business, we delivered our sixth consecutive quarter of strong order growth, which increased over 25% in the quarter and over 50% on a trailing 12 month basis. Our web scale customers are starting their 400 gig upgrade cycles and aggressively pursuing long haul build outs, while our carrier customers are exploring new architectures to real.
Is the full potential of 5 G.
We are building the internet for the future by creating breakthrough innovation with our routing optical and automation technologies to deliver significant economic benefits.
Recently, we launched a new route at optical networking solution integrating our scalable high performance routers and Acacia is plug a hole optics, which offer significant cost savings.
Last week, we announced our intent to acquire Sedona systems to extend our crosswalk automation platform to build on these capabilities. We also expanded our silicon 1 platform from a routing focused solution to 1 which addresses the web scale switching market.
Bring 10 networking chips, ranging from 3.2 to 25, 6 terabits per second making it the highest performance programmable routing and switching silicon on the market.
We know our customers increasingly want to consume Cisco technology in new more flexible ways at Cisco live we launched our new as a service portfolio, Cisco plus and our first offer Cisco plus hybrid cloud, combining our datacenter compute networking and storage portfolio.
Cisco plus includes our plans to deliver networking as a service.
Which will unify networking security and observe ability across access Wan and cloud domains to deliver an unparalleled experience for our customers.
Turning to security, we had a record quarter, surpassing 875 million in revenue up 13% as we expanded our reach with customers around the world.
Our security strategy is focused on delivering a simple and secure experience.
We have an unrivaled ability to provide end to end security capabilities across users devices applications and data on any network or any cloud.
This is a key reason why our customers trust us to help them proactively protect against and remediate threats.
In fact, leading customers in every industry, including 100% of the Fortune 100 are using Cisco security solutions.
These customers are increasingly deploying our zero trust and secure access service edge or SaaS architectures, along with automation authentication and analytics capabilities.
With todays distributed workforce companies must quickly deploy highly secure trusted access to critical applications everywhere without compromising performance.
Customers like Ford or using our cloud delivered security platform umbrella as they secure over 100000 of their remote team members.
And this quarter lift turned to Cisco to strengthen their security protection for all of their users accessing their applications by.
By deploying our duo portfolio lift was able to provide strong access controls as they protect their users sensitive personal and financial information, while reducing their total cost of ownership by more than 50%.
With nearly 6 billion in annual R&D investment that Cisco is making of both security and the network continues to lead the momentum across our portfolio.
With 23 consecutive quarters of double digit umbrella cloud security growth.
Nearly 7000 customers using our cloud native secure X platform.
And strong platform growth with security enterprise agreements.
We continue to expand our leadership with new innovations, including password less authentication data loss prevention observe ability cloud based malware detection and enhancements to secure X.
We're also complementing our organic innovation with assets that enable greater security efficacy.
Our intent to acquire Kinder security will bring together their risk based vulnerability management platform with secure access threat management capabilities to prioritize and more effectively manage overall risk.
Lastly, let me touch on applications.
Our collaboration business continues to perform well.
We had a record quarter and webex as we execute against our strategy to power the future of hybrid work.
Over the last 6 months, we've added more than 400, new features and devices to our Webex portfolio.
We are enabling seamless experiences through our desk camera and desktop solutions, while extending the webex suite of devices.
Including digital signage touchless calls room capacity alerts and environmental sensors to help enable a safe return to the office.
Well being is top of mind for so many right now as we face a new way of working this is why we launched people insights to help people monitor and manage their wellbeing. These.
These new features devices and capabilities combined with cloud, calling in cloud contact center to provide our customers with the most comprehensive and inclusive hybrid work platform.
Last week, we announced our intent to acquire socio labs by integrating slideshow and socio labs into our Webex platform. We will also be able to provide the most comprehensive internal and external event management solution on the market.
In summary, we had a very good quarter.
I'm. So proud of the continued success of the business transformation our teams are driving.
As I mentioned earlier, we are experiencing the strongest demand in nearly a decade.
We're also seeing similar component shortage supply issues as our peers. The good news and this is reflected in our guidance is that we are confident we will work through this as we have already put in place revised arrangements with several of our key suppliers.
We believe these actions will enable us to optimize our access to critical components, including semiconductors and take care of our customers by fulfilling their demand as quickly as possible.
Our strategy and commitment to leading with trust innovation and choice along with our continued focus and discipline.
Our positioning us well for growth and profitability.
As we accelerate the pace of innovation for our customers and partners. It's critical that we continue to support our people our communities and our planet.
I'm very proud that Cisco was recently named the number 1 best place to work in the United States by Fortune and great place to work.
This is a tremendous honor for us as it recognizes the incredible work of our people and the power of the culture, we have created.
And lastly in terms of actions, we're taking to protect the planet last month, the Cisco Foundation announced 100 million over 10 years to fund nonprofit grants and impact investing in climate solutions, we have already achieved 100% renewable energy in the U S and in many countries across Europe and this is another strong step forward.
Whether it's our deep focus on delivering the best results for our customers partners and employees.
Our commitment to making a difference in communities across the world Cisco remains committed to our purpose to power an inclusive future for all I'm quite optimistic about what's ahead and confident in our team's ability to deliver I'll now turn it over to Scott.
Thanks, John Laing.
Last quarter identified 4 key priorities that we're using to define our financial strategy.
Driving profitable growth.
Our continued disciplined focus on financial management and operating efficiency.
Setting a long term plan to maximize value creation through strategic transformation.
And examining investments both organic and inorganic.
We made progress on all these fronts in Q3 and are continuing to build our financial approach based on these core pillars, providing a strong foundation for enhanced financial performance as well as long term value creation for our shareholders.
Now, let's turn to our results.
I'll start with a summary of our financial results for the quarter, followed by the guidance for Q4.
As Chuck said Q3 was a strong quarter across the business.
We executed well with strong product orders and solid growth in revenue net income and earnings per share.
Total revenue increased to $12.8 billion up 7% year on year exceeding the high end of our guidance range for the quarter.
We saw broad strength in all product areas and geographies.
We also saw continued recovery in our business and building momentum with sequential revenue growth of 7%.
Our non-GAAP operating margin was 33, 6%.
Non-GAAP net income was $3.5 billion up 4% and non-GAAP earnings per share was <unk> 83 up 5% year on year coming in above the high end of our EPS guidance range.
Now, let me provide more detail on our Q3 revenue.
Total product revenue was $9.1 billion up 6%.
Service revenue was $3.7 billion up 8%.
Infrastructure platforms has rebounded nicely with revenues up 6%.
Within that switching revenue increased overall with growth in campus driven by strong double digit growth of our catalyst 9 K products.
Routing had strong double digit growth driven by strength in the service provider market.
Wireless had strong growth driven by the continued ramp of Wi Fi 6 products and strength in Milwaukee.
Data center revenue declined driven primarily by servers as we experienced continued market contraction.
Applications were up 5%, we continue to see double digit growth in webex, driven by our product innovations and the value we bring to remote working.
We saw growth in unified Communications, Iot software and App dynamics offset by a decline in telepresence endpoints.
Security was up 13% with gross growth across the entire portfolio.
Our cloud security portfolio performed well with strong double digit growth and continued momentum of our duo and umbrella offerings.
So we continue to transform our business delivering more software offerings and driving growth in subscriptions and recurring revenue.
Software revenue was $3.8 billion and subscriptions were 81% of total software revenue up 7 points year on year.
As we continue to increase our software subscriptions, we're driving higher levels of recurring revenues in fact, the majority of our total revenue growth in the quarter came from recurring revenue streams. Additionally, the strength of our portfolio and transition to more software and services is driving growth in remaining performance obligations or our P O.
At the end of Q3, <unk> were $28.1 billion up 10%.
RVO for product was up 15% and for service was up 7%.
There was a 90 basis points positive impact on revenue growth in the quarter related to the acquisition of Acacia and IMI mobile, which both closed during the quarter.
As a reminder, these acquisitions were not factored into our Q3 revenue guide.
We had strong order momentum in Q3 with total product orders up 10%.
Looking at our geographies the Americas were up 6% EMEA was up 10% and a P. J C was up 31%.
Total emerging markets were up 13% with the Brics, plus Mexico up 31%.
And our customer segments of service provider was up 17% commercial was up 16% public sector was up 11%.
Enterprise was flat, which is a significant improvement from last quarter.
Non-GAAP total gross margin came in at the high end of our guidance range at 66% down 60 basis points year over year.
Product gross margin was 64, 9% down 90 basis points and service gross margin was 68, 7% down 20 basis points.
The decrease in product gross margin was largely driven by ongoing cost related to the supply chain challenges offset by positive product mix, which includes some software benefit.
Price erosion was relatively moderate and in line with our historical range.
On the supply chain front, we continue to manage through the constraints seen industry wide and continue to incur additional costs were.
We are partnering with our key suppliers, leveraging our volume purchasing and extending supply commitments as we address the supply chain challenges, which we expect will continue.
The quarter did include an extra week as we discussed on our last call.
Consistent with our guidance for the quarter the benefit the total revenue was approximately 3 points of growth.
Total impact on our cost of sales and operating expenses was approximately $150 million.
Operating cash flow was $3.9 billion down 8% driven by the timing of payments and restructuring costs.
We expect operating cash flow to normalize for the full fiscal year.
We ended Q3 with total cash cash equivalents and investments of $23.6 billion down 7 billion sequentially driven by $5.5 billion in payments for acquisitions as well as $3 billion in repayments of our long term debt.
From a capital allocation perspective, we returned $2.1 billion to shareholders. During the quarter that was comprised of $1.6 billion for our quarterly dividend and $510 million of share repurchases.
Year to date, we returned $6.7 billion to shareholders, which represents 64% of our free cash flow and we have $8.7 billion in capacity remaining under our current share repurchase program authorization.
We continue to invest organically and inorganically in our innovation pipeline.
During Q3, we closed 3 acquisitions, Acacia communications, IMI mobile and Dash base.
Subsequent to the end of the quarter. We also successfully closed on our acquisition of slideshow on may 4th.
These investments are consistent with our strategy of complementing our internal innovation and R&D with targeted M&A to allow us to further strengthen and differentiate our market position in our growth areas.
To summarize we had a great Q3.
We executed well with strong top line growth and profitability we're.
We're seeing returns on the investments, we're making in innovation and driving the continued shift to more software and subscriptions delivering growth and driving shareholder value.
Now, let's turn to our guidance for the fourth quarter of fiscal 'twenty 1.
This guidance is subject to the disclaimer regarding forward looking information that Marilyn referred to earlier.
Our financial guidance for Q4 is as follows.
We expect revenue growth to be in the range of 6% to 8% year on year, reflecting again the strong demand we're seeing.
We anticipate the non-GAAP gross margin to be in the range of 64% to 65%, reflecting the ongoing increase in supply chain costs. We are incurring as we protect shipments to our customers.
Our non-GAAP operating margin is expected to be in the range of 32% to 33% and the non-GAAP tax rate is expected to be 19%.
Non-GAAP earnings per share is expected to range from 81 to 83.
Looking ahead, we're excited to announce we will host a virtual Cisco financial analyst day on Wednesday September 15th 2021.
We will post event details in the coming weeks and look forward to sharing more with you at that time.
I'll now turn it back to Marilyn So we can move into the Q&A.
Thanks, Scott Michelle Let's go ahead and begin the Q&A.
Thank you Rod Hall from Goldman Sachs. You May go ahead.
Yeah, guys. Thanks for the question I wanted to start off I guess with the margin guidance and that's the thing. Most people are asking me about and I heard Scott I heard you talking about the impact from increased costs. I guess, maybe you could you give us some more color on how sustainable those impacts are and they'll also address the opex line.
You know it looks like those costs are insulated to I assume for some of the same reasons, but just the sustainability of these cost pressures and these kinds of margins you are guiding for.
As we look forward. Thanks.
Yeah, Thanks, Rod on the starting with the gross margin the impact you're seeing in the Q4 guide on gross margin is really driven by supply chain.
It has a couple of elements to it 1 is unit cost. So that you know we've got an actually it was announced today from Gardner we've got the number 1 supply chain team in the world 2 years in a row and that that team has done a great job getting ahead of the issues that everyone. In the industry is seeing so with that though we've locked in both supply.
And pricing.
With some of the key component providers that we've got going ahead.
That's what you see built into the margin guide and I think the the supply chain issues, we will stay with us at least through from what I can see at least through the end of this calendar year.
On the Opex side, it's a little bit different when you look at the where we're right on track. Let me just start by saying before you ask we're right on track with the savings associated with the restructuring that we announced earlier this year earlier this fiscal year.
We said at the time, we would reinvest some of that into the growth of the business overall.
That's what you see happening so when you look at the the year on year growth in Opex.
Driven by the integration of the acquisitions that closed during the quarter.
A little bit of a headwind from FX as the dollar has weakened.
And then the higher commissions given the robust strength of the topline commissions are up and reset of the variable comp plans, but that's that's what's driving.
And I think that the sustainability to get to your point is I expect to see some of these supply chain issues linger with us through the end of the calendar year first half of our fiscal year.
Yeah, Hey, Rod this is Chuck I, just want to add a little color to that so you know as we as we began to realize that we were going to have the incremental cost you know we had to make some decisions and.
I think obviously, we do believe these are temporary will have to see how long they they last but based on that.
And based on the fact that we are seeing such momentum in the business right. Now you know we decided to continue to invest in the business to drive the growth that we are feeling right now and when you see the the balance of the growth across all the businesses you see the regional balance it was balanced across the technology areas. It was balanced across.
[noise] segments, and then you.
You know you think about that in the context of.
Some of these real major trends that are occurring that we're on the front end of like the 400 gig transition like the success, we're having in web scale. The service provider 5 G build out the hybrid work and return to office, we talked about Wifi 6 leading to campus switching which we're seeing play out now.
And and the security business had a record quarter at a time, where most every customer is suggesting that they're going to be spending more over the next 12 months of cyber security. So we felt like it was prudent to continue to invest to meet the demand and deal with some of the short term pain and then we think we'll get to the other side of it.
Great. Okay. Thanks, a lot I appreciate it.
Thanks, Ron Thanks, Rod next question please.
Thomas <unk> from J P. Morgan you May go ahead.
Hi, Thanks for taking my questions Chuck I guess somewhat following up on drugs question here I think the macro expectation here is that he will be going through a period of higher inflation and you're seeing that somewhat in the supply chain, but also in other aspects as well, but can you just help us think through what are the levels that the company has as you know.
Get through that and particularly how are you trying to balance that against fee or is that some of your customers might be pulling ahead. All of those are putting I had demand justice a killer product from Hugh.
Yeah, a couple of great questions number 1.
What we what we do know is that if we come to the conclusion that any of these cost increases are these this inflation as you mentioned it are going to be more sustained then we will look at strategic price increases, where we have to and that work is already underway. There's already some decisions that we made so we will continue we will do that it's a pretty dynamic situation as you know.
And then on the pull ahead. This is a question that we've been asked and you know while it's impossible to.
Really quantified what that might be a it's going to be pretty obvious that if a customer has extended lead times, they're probably going to place orders sooner than they would that just makes sense, but.
But we also have proxies that we would be looking for to really reflect you know that being a major issue like order cancellations, if they're placing these orders in multiple you know.
Against multiple channels, and then canceling them when they get it out of 1 channel. We don't see that you would see more of that pull ahead from the enterprise and obviously commercial and small business you probably wouldn't see as much in those were pretty significant growth engines for us. This past quarter. So we don't see any glaring red flags, although we would we would certainly agree that there's probably some level of.
Of early ordering going on.
Thank you.
Thanks, Chuck next question.
Meta Marshall from Morgan Stanley You May go ahead.
Okay, great. Thanks, and I. Appreciate the question you know where do you think customers are on return to work planning you know are your larger customers, maybe further along than smaller customers or vice versa. And then just what are you seeing from some of the spending from the impacted industries from last year.
Great question. So first of all I think it's the inverse I think we're seeing the.
The small businesses and commercial customers moving a little faster, although we saw enterprise pick up in Asia and in Europe.
And we've done a deep analysis with our team in the U S improved and we would expect next quarter in the next fiscal year for U S enterprise to actually.
Improved significantly from where we are today.
And I think on the on the industry front as we were doing the review in the U S and we've actually seen double digit growth in hospitality and health care and retail and we've even seen the cruise lines, making significant purchases as they prepare to go back out so we think that.
It is a definitely a sign that we're on the road to recovery.
And I would say that the other thing I would highlight is <unk>.
As our customers think about hybrid work and they think about the return to office.
We've talked about the the prevalence of Wi Fi 6 we saw continued strength in Wi Fi and we said once that begins to happen that we believed there would be a campus switching upgrade follow and you know the cat 9 K has had 4 quarters of increasing growth in double digits. The last few quarters from a demand perspective.
So we've seen that happen as well.
So I think that overall I think it's happening as we as we thought it would and perhaps even at an accelerated pace.
Great. Thank you.
Kelly Ani from Bank of America, you May go ahead.
Hi, guys.
I have 2 questions are related enough related first question is the pricing environment, we see price increases across the board, we see component shortages.
Does it impact the pricing of your products and is there any plan or have you already adjusted prices for that that's number 1.
Bob.
The second 1 I'm trying to understand the year over year trends.
In the context of a easy comps versus real growth and I know, it's hard to say, but it's hard to quantify but can you at least qualitatively speak about the fact of when Youll grow 7%, then we deduct the acquisition impact et cetera.
What's the what's the impact of the environment really improving and your comments versus just easy comps because last year was so weak because of COVID-19.
Yeah tell us great I'll I'll I'll comment on the first 1 I'll comment on both of them and then Scott can add onto it so on the pricing front. It says I've said, a few minutes ago I think.
We have made some decisions on certain products that we will do we will be making price increases on and we're looking surgically at the rest of the portfolio based on where we have a cost that we believe are gonna be sustained.
But you know we we are we're erring hard right now on taking care of our customers and try to get you know optimize our ability to deliver to them right now because we think that improves our relationships and it improves our position over the long term with these customers. So that's that's what we're doing on a year over year trends I think that well.
What I would point to is.
The real thing that I think is as substantive as is the is the demand side of what we've seen and because you're right. You can do some math that gets at the revenue in Q3, but I think that based on what we see and the demand that we see we do believe this is a it's certainly a it's it's.
A positively evolving marketplace for us and I think the work we've done over the last year.
You know, we pivoted our strategy a year ago based on what we thought would happen post pandemic. The teams have been executing really hard and it's great to see the customers embracing the the solutions that we're delivering out there. So we feel like it's sustainable and.
Yeah, I think tell when you when you look at the year on year I think the context, you need to put around that is the improving trend that we've seen right and we've seen 4 to 5 now consecutive quarters of quarter on quarter improvement and really the improvements across the board. It's in each G O.
And each product line. So we're seeing continued improvement in that that obviously bodes well for looking out at Q4 it into the future I think the other thing that we've talked about the robust demand that we've had and you see the revenue that we printed in Q3, what you didn't see US. We also have built up a healthy backlog at this point and so I think that coming into Q.
For not only do we have a very high percentage of recurring revenue as you know.
That we know will come into the revenue stream. During Q4, we've got a sizable backlog at this point of orders to fulfill and we know exactly what's in the pipeline. So really feel good about the sequential trend that we're seeing across the business. Yeah. I think trial. It's a really good point Scott makes I mean, there is a revenue headwind that we're facing based on.
Our supply chain, so notwithstanding what's going on in the supply chain or our revenue guide would have been higher which could have probably flowed through to improving EPS as well. So it's a it's a complicated thing that we're navigating through right now, but I'll tell ya notwithstanding that it's the best I've felt about the business and our momentum and where we are in quite a while.
Yeah.
Great. Thank you.
Next question please.
It's high Kid Ron from Oppenheimer, You May go ahead Sir.
Oh, Thanks, a couple of questions for me Chuck I do want to follow up again on the on the demand side I'm trying to.
Gauge how much of what you're seeing right now is things that were delayed during COVID-19 is that they're being fulfilled now versus acceleration of future plants into now.
I'm just trying to think of that it was sort of what is that normalized demand patterns for you.
Once you know the noise of Covid or worse last year for better and right now kind of goes away. Maybe you can help us think about that and then for Scott on the growth guidance for next quarter. It can you call out specifically the impact.
The acquisitions, what is the growth guidance without Acacia IMI dash base and flight or that you just closed on.
Yeah, I think so I'll I'll try to do what you I'll try to answer what you asked but I think it's a difficult 1 to to really.
B be definitive about but I think theres a couple of Theres a couple of aspects going on I certainly.
I believe there are projects that customers put on hold that they're now accelerating now that they have better visibility into what the return looks like definitely think that's happening also think your second point is happening I think that there.
Every customer is looking at modernizing their infrastructure because no 1 wants to be caught flat footed by the next crisis.
And everyone has realized the power of technology. During this timeframe and so I think there's an element of increased investments that we'll see across all of the technology areas as well as obviously cyber security et cetera, but the other thing I think that's really important is that we've been investing for a long time against a lot of these big market transitions that are starting.
To come to life I mean, you remember he Todd we we didn't play in the web scale space 5 years ago, we didn't play.
And now we're seeing you know that was almost a quarter of our service provider business again this quarter.
And it's still growing robustly I mean, it grew over 25% this quarter against the quarter a year ago that was in excess of 70% growth. So it's not you know, it's it's still accelerating.
And then you got 5 G. That's starting to play out the way we as we've all been waiting for it to play out.
You've got this return to office in hybrid work with Wi Fi 6 and the campus upgrades that we've talked about and you've got the cyber security concern that.
It was only exacerbated by everything we see in the press by all the continuing attacks and you know at a time, where we had record revenue. So we I think all of those things are playing into it.
And and and that's what leads us to feel pretty good about where we are right now.
Any tie on your second question about the impact of acquisitions. We've said in the opening commentary that for Q3. It was about 90 basis points of growth and that was not part of our Q3 guide those they each closed during the quarter. So when you look ahead to Q4.
Of the of the revenue growth that we've laid out there about a point and a half is driven by the acquisitions, mostly driven by Acacia, but 2 other things you touched on that particular question that I wanted to point out if you don't mind the.
The first is we see a revenue headwind from.
The supply chain issue in Q4 as I said earlier, if we didn't have the supply chain challenges, we would've been guiding higher on revenue.
Which is reflected what Scott mentioned about the backlog coming into the quarter.
The second thing is.
You know this business transformation that we have been.
Working on for the last 5 or 6 years.
If we go back to the first quarter I was CEO and then we look at the quarter that were entering into the.
The recurring revenue that we're pulling off the balance sheet that we have visibility to today that will be part of Q4 revenue is up 64% during that time frame.
So we have a lot more visibility in it and it just says that the whole rationale for why we've been driving as business model transformation, which is a big complex change to get to.
But that has helped us in a big way and allowing us to actually deliver the revenue we're talking about next quarter. So the benefits that we believed were there for the business model I think this is probably the quarter, where we're feeling the positive.
Impact of that more than any other quarter.
That's great. Thanks appreciate it.
Thanks <unk> next.
Next question please.
Simon Leopold from Raymond James You May go ahead.
Thank you I appreciate it.
Yeah.
Simon.
Yeah.
Sounds like we lost last year Simon.
Are you there Simon.
Well go to the next question Simon can queue back up again by pressing star 1.
Hi, Mike Dairy Ani from Evercore you May go ahead.
Perfect. Thanks for taking my questions I have a question and a follow up.
Just when I think about your diet and the gross margin dropped 150 basis points.
I'm curious what do you attribute the entire dropped any supply chain issues or is there anything else at play as well.
1 and the second question was really hoping you could unpack the service provider growth, which accelerated a fair amount and can you just talk about the trends you're seeing in the traditional service provider worsened the web scale business and where that exploration is coming from would be helpful. Thank you Scott.
Gross margin yes.
It is driven by supply chain. It comes in a couple of flavors, having done the work that we've done to protect shipment to our customers, where our unit price increases unit cost increases on certain components. That's built into it but there's also increased expedite fees again to ensure that we can that we get the components in and we can get the product.
Back out the door and a slight increase in freight so it really is all tied to supply chain yet.
And then Amit on the service provider growth I'm glad you asked the question because I should have pointed it out.
We saw double digit growth across all of the sub segments of service provider. So cable carrier as well as web scale. So it was very balanced across the 3 and it's not 1 segment carrying at which.
Which is why you know another reason that we're optimistic.
The demand side, we saw was so consistent across all of our customers and so consistent across geographies.
And so consistent across our product portfolio, but in the SP space. It was a double digit across all of those segments.
The next question please.
Simon Leopold from Raymond James You May go ahead.
Sorry about that can you hear me now we can yes, we can.
I Airpods decided they wanted to stop working.
Jim.
Sorry about that so I was looking to see if maybe you could help bridge the gross margin headwinds in terms of the supply chain in that we we know there are multiple aspects. It's not just the chip shortages, but things like airfreight, and then having to add maybe extra hours and paying over time.
When things come later because of the shortage is so if there was some way to to maybe bridge that components that would help us understand how the recovery might manifest itself.
Yes, Simon when your Airpods went out amid was on the same wavelength as you ask the exact same question. So I'll give the same answer but it really is kind of 2 or 3 aspects that are driving it all related to supply chain unit costs are up and that's you know based on the.
The work that our supply chain team has done to ensure that we can get supply.
And so that such that we can deliver for our customers the gear that they need to get from us they've all got significant transformation underway as well within their shops to support the new hybrid work environment and so we're working as hard as we can to make sure. We can deliver product to them. The unit costs are slightly higher and thats that means that's memory and it's set in certain.
Other smaller commodities across the board.
The second is freight costs are higher.
And as as freight costs go up obviously that that hits gross margin and finally expedite fees as we as we're getting product in the door. So it's all tied to various elements of supply chain.
Thanks, Simon So all you have to repeat yourself no.
No problem no. It's okay, it's all right.
Alright shall tee us up for the next question.
Thank you Pierre <unk> from New Street Research you May go ahead.
Hey, guys. Thank you for them.
Thank you for taking my question.
I have to say that if I may the first 1 so if I look at your self drive revenue sequentially. Each month from 3.6 to 3.8 billion. So that's rounded numbers suggest you have like you know what kind of mid single digit sequential gross amount.
In software, which is very gate, but it's very exciting is that the kind of right run rate level run rate level of growth. We should expect for your for your software business.
And then he skirts just to confirm you didn't get moving mix.
In rugged and you need some product portfolios a situation in which the supply chain, where I'm not the strategy. We could have expected some tiny sequential improvement in gross margins right.
Yeah, that's right mix is definitely as we continue to add more recurring revenue, particularly around software as you pointed out but also our tech support services. Those are higher gross margins that those long term will be a tailwind to our gross margins are the supply chain issues, obviously more than offset that.
In terms of your question on software growth are the numbers that you're using or are a little bit rounded, but you're on the right thread, we're seeing nice growth in software and in fact mentioned that 81% now of that is driven by our subscription and recurring revenue. So 7 point improvement in the amount of that software revenue that is recurring that.
Is great news longer term as you know with recurring revenue, particularly when it's ratable.
You see less of the impact upfront. So there's a there's a bit of a a bow wave and you see it in the growth of our Rps and the growth of our deferred revenue on products. So each of those are growing that's also a sign of the growth within our software product set.
We're now when you just do the quick math right. We're now 1 of the biggest software companies in the World right North of 14 billion in software revenue and I don't I don't think anyone thinks of Cisco in those terms.
Thanks, and if we put out before you check if I. If I may you have an intriguing sentence first sometimes in your press release, you're talking about the next uptake of video subscription base David.
So could you give us a sense off it almost sounds like Youre seeing you all on the on an inflection point, though on the turning point on the on that phone.
Or are you expanding your portfolio in terms of software subscription based offering.
At the moment until all you expect actually expecting.
The uptake of these products to Reaccelerate on the back of the pandemic what did you mean exactly.
Yeah. So parents I think theres a couple of things going on number 1 we have seen just over the last few years continued acceleration in our software business every acquisition. We do that's the business model. So from that perspective. It comes in from an organic perspective, we're building more software assets were delivering more software solutions, and then where were actually Lou.
Looking now we announced Cisco plus at.
At Cisco live, which is how do we deliver virtually anything that we built as a service should our customers want to consume it that way. So we're just embarking on that which is another big part of our portfolio, which will create more recurring revenue for the future. So that's our that's what I'm talking about.
Okay that makes sense. Thank you very much.
Next question.
Paul Silverstein from Cowen you May go ahead.
I appreciate you taking the questions 2 quick questions..1 Chuck I think it's been a long time since you all have disclosed what the size of your various customer segments.
Given the impacts are what I would expect would be the impact of U S federal stimulus.
What's going on in service providers enterprises of different trends can you update us on how big those sectors are including U S. Federal.
And then the other question would be your services business you had a great quarter. It was extremely strong up 8% is that is there are 1 offs in that or is that indicative up from what had been low single digit growth.
Oh, the number any insight you can share of what we should expect going forward.
And what's driving.
Yeah, Paul I don't have the percentage of because we haven't given that information out on the percentage of segments for a while I would say if we could couch that until perhaps September.
When we do our analyst meeting unless you have some no. The only thing I would add is when you compare us to some of our peers, when we where we break out enterprise versus commercial many of them combine those 2 together. So most of them do yeah. Yeah. So just bear that in mind as Youre trying to compare us across the board, Yeah, and Scott I'm aware, Scott I'm aware of.
But if I may I mean, obviously with the magnitude of the U S. Federal stimulus that's already been passed in the various additional progress that's been proposed in the thought arises that.
And with that impacted public sector, but it's also could impact enterprise not just for you, but for a lot of folks it'd be great. If you updated us at some point, where those numbers that'd be Scott that makes sense I got it.
And what was the second question Paul.
The services grow the services the services growth what's driving it.
As you know the new norm or.
Overall, obviously quite pleased with the progress on our services business. There is in the in Q3, though remember there was an extra week.
There's a lot of services a lot of that is ratable that extra week turns into an extra week of revenue during the quarter. So there is there is a a 1 off anomaly that's driving that outsized growth in Q3, and then once you normalize that out you should think about the same normal rates you've been seeing.
Alright I appreciate it thank you.
Next question please.
Thank you Tim long from Barclays. You May go ahead.
Thank you 2 questions for me to both on gross margins actually I'm just kidding.
Gotcha.
First 1 here excuse Todd.
A little bit about kind of your visibility so some of your peer companies and others in the industry.
Given you know given what's gone on with lead times, you know you obviously have.
Our revenue and a cost impact here, but what has that done to kind of how far out you can see and plan and kind of you know the whole backlog versus book and ship for the business for the next few quarters.
And then second if you could just touch on the cloud vertical it sounded like it was pretty strong again could you just give us a little color of kind of what is driving that I think there had been some campus strengths with those customers, but can you talk to us a little bit about <unk>.
The breadth of product that that's driving that is it a lot of 8-K, a starting to see software and silicon I'm starting to contribute a little bit so any color there would be great. Thanks, Jim. Thanks Al I'll make 1 quick comment on the visibility thing and I'll, let Scott comment and then I'll take the cloud 1 I would say that the thing that I would tell you Jim.
We were in the middle of Q3, I can tell you that our supply chain team.
Was was a little.
I guess concerned about what they could see for the next 2 months at that time.
And when we started building the guide and working through what we thought they could deliver and build in Q4. They had a reasonable degree of confidence. So what that says to me is theyre getting better visibility.
And so I think it's just going to improve from here.
So that's sort of what we've been doing over the last couple of months Scott you want add anything yeah from a from a reported revenue standpoint, which I think is probably at least part of your question. Tim. We've got we've got good visibility at this point given the size of our backlog that we roll into Q4 with.
As well as the amount of revenue. That's now recurring are that that will come off the balance sheet. So you add those 2 together and then look at the you know we have a good feel obviously for what's in the pipeline at this 0.2, we have we have pretty good visibility at this point, yeah, and then on the cloud vertical I would say that.
1 of the 1 of the customers we have had a very strong sort of enterprise networking portfolio relationship with.
But beyond that all of it is really being driven by infrastructure going into their cloud assets.
And so we are we have sold a significant amounts of 8-K's into that infrastructure, but we do we have sold silicon standalone as well.
We have a we have our software running on 1 of their pieces of hardware and in some case, we have their software running on our switching hardware and we're working on white box ODM with a couple of them relative to our silicon. So we have all the variations that we announced in December of 2019, we were actively in.
<unk> in right now and the good news is there's a lot of systems desire as well.
Hey, Thank you just just as a.
Add on to that last time, we talked about 400 gig and Theres always seems to be a question about 400 gig in our customer count on 400 gig went up by 50% during the quarter. So we did see.
Our continued uptake on that technology, that's super early as you know.
Great. Thank you.
Next question please.
Jim Suva from Citigroup investment Research you May go ahead.
Thank you so much for all the details and clarification I just had 1 question.
Can you give us some commentary on like your Hyperscale transit AR traction it appears service providers bouncing back pretty strong and for a while it seemed like you know the hyperscale wasn't quite as strong as you had hoped and you are putting more effort into it and it seems like now your commentary as well.
Write a bit more positive is that something new.
Product win some share gains tournament seeing traction of it but any commentary on that would be greatly appreciated. Thank you.
Yeah, Jim So we we've had.
6 consecutive quarters of very strong double digit growth ranging from mid teens to triple digits and.
And that's in the web scale vertical and it's been a combination. It certainly has been share gains because we didn't have any presence before so as I've joked on calls before it's 1 of the few markets, where we actually have the opportunity to go gain share and and so that's been positive. We are we've worked hard on these relationships in.
So that has expanded.
We had a 2 day customer briefing with 1 of the.
1 of them 2.
2 weeks ago. When it was that that particular briefing was all about our enterprise portfolio. So we're seeing both sides, but we are definitely seeing the success that I just mentioned when with Tim's question around the cloud vertical in the cloud infrastructure.
Thank you so much.
Thanks, Jim.
And we have time for 1 more question.
Thank you Jeff Qual from Wolfe Research you May go ahead Sir.
Oh. Thank you it was nice he said.
My question is actually on the margin side.
It sounds as though you are getting better visibility on the component availability. So I guess I'm wondering should we be expecting that the margin headwind would would abate through the year and then as as part of that has anything changed in terms of what you expect to happen to the margin structure.
Overtime as we get past these constraints. Thank you.
Yeah.
Jeff as we talked about earlier I think some of the supply chain issues. We have are that we're seeing certainly from a supply standpoint are going to be with us through the end of the calendar year, but there's no question. We've also got some good tailwind and the and the gross margin line. When you think of the amount of the faster growth rate of services and the right ability of that.
Which contributes significantly now to the <unk> to the revenue line, that's at a higher margin and our software business, which you know year on year grew at 13% and is now you know on a on a run rate of about $14 billion per year software business that obviously comes at a higher margin too. So while we do have supply chain headwinds. We've also got some some now.
Tail winds that are coming in.
Okay and then the concept is that once we get past these fairly ephemeral in 1 grand scheme of things our supply challenges and we should expect gross margins to reflect a mix shift to software and drift higher that's the right way to think about it yes. Okay.
Excellent and then I'm, sorry did you give us a number on how much you might've ships had you not had supply chain constraints.
Uh huh.
Yeah that's.
We talked about that in the last day, or so and it's really difficult to get a number I'd say it had been a point or 2 I mean, particularly in the guide front I think that's a reasonable thing to think about it it's a.
I mean, our guys were stressed and and in Q4, they they are very little.
Yeah, they're they're committed to what they think they can build but it's a it's it's tough it's tough right now.
So you can you can extrapolate what the growth rate, we saw on the product side and then with the with the corresponding guide that where our backlog is certainly increasing so if we had the capacity to ship, we would but we just don't have it so.
Okay. All right. Let me, let me just wrap up by our first and foremost thanking all of you for spending time with US today and you know despite the the the predominant discussion point here, which has been around gross margins relative to the supply chain.
I hope our confidence came across and that we feel really good about the portfolio. We feel really good about you know the reopening.
We feel good about our teams I'm really proud of what they've accomplished a look I'm really pleased that our customers are choosing to to spin.
Their dollars with us as they come back I think that's a that's a great statement of confidence and I think that it also proves that we are gonna be critical to the rebound in the recovery and the return to office. So thanks for being with US and we look forward to spending time with you all and I'm going to kick it back to Maryland.
Thanks, Chuck Cisco's next quarterly earnings conference call, which will reflect our fiscal 2021 fourth quarter and annual results will be on Wednesday August 18th 2021 at 130 P. M Pacific time, 430 PM Eastern time as a reminder, we will be presenting and hosting meetings at several conferences.
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Yeah.