Q2 2023 Cisco Systems Inc Earnings Call
Welcome to Cisco's second quarter fiscal year 2023 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.
Ma'am you may begin.
Welcome everyone to Cisco's second quarter fiscal 'twenty twenty-three quarterly earnings conference call. This is Marilyn Mora head of Investor Relations and I'm joined by Chuck Robbins, Our chair and CEO and Scott Herren, our CFO by now you should have seen our earnings press release, a corresponding webcast website, including supplemental information.
Patients 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 done 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 third quarter and full year of fiscal 2023.
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 forms 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 Cisco.
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.
Thanks, Marilyn and hope everyone is doing well with.
With the tremendous results we delivered in the first half of the year fiscal 'twenty three is shaping up to be very strong fueled by demand for our cloud driven networking portfolio. Our continued business transformation success.
And in an improving supply situation. Thanks in large part to our team's aggressive actions.
Before I dive into additional details on the quarter I wanted to take a moment to say how incredibly proud I am of the team here at Sysco.
The environment, we're operating in remains dynamic Cisco is better positioned today than at any time since I became CEO almost eight years ago.
We have reshaped and transform the company and our portfolio, while remaining highly disciplined both financially and operationally. This gives me great confidence that we will continue to succeed in the long term.
Now I'll touch on the quarter in more detail. Our Q2 financial results were strong as we again exceeded the high end of our guidance ranges. We delivered our second highest quarterly revenue of $13 6 billion up 7% and record non-GAAP EPS at 88 cents. We also delivered solid growth sequential non-GAAP margin.
Spansion and record non-GAAP net income in.
In terms of our business model shift we continue to make great progress with 10% growth in software revenue and with software subscription revenue up 15%.
Recurring revenue also now represents 44% of our total revenue in.
In addition, we have built up nearly 32 billion in remaining performance obligations and our backlog remains robust.
Even as we drew down backlog by 6% sequentially, our total backlog still grew year over year.
These metrics along with our increasing visibility, let us to raise our full year outlook, which Scott will address in a moment.
This quarter, we also achieved record operating cash flow, enabling today's dividend increase and the buyback of over 1 billion. We continue to deliver on our commitment to drive returns to our shareholders.
Let me also provide an update on the supply situation while components for a few product areas remained highly constrained we did see an overall improvement.
Combined with the aggressive actions our supply chain and engineering teams took to redesign hundreds of our products, we increased product deliveries and saw significant reductions in customer lead times.
As our product deliveries increased channel inventories also declined as our partners were able to complete customer projects.
Like I shared last quarter.
As supply constraints ease and lead times shorten we expect orders were normalized from previously elevated levels as customers returned to more typical buying patterns. As a result sequential quarterly order growth is a better indicator than year over year growth and in Q2, despite improving lead times our quarter over quarter order.
Growth was again in line with our historical ranges across most of our geographies and customer markets.
With that let me touch on what we're seeing with customer demand.
And our customer markets, we experienced normal double digit sequential growth in both our enterprise and commercial markets, while public sector performed better than we have seen historically.
Within our service provider business, our order rate was below recent sequential as some customers are absorbing the improved delivery of our products into their production environments.
We saw another consecutive quarter of rapid adoption of our 400 gig Cisco 8000, and silicon one platforms. This reflects the ongoing investments our customers are making and our innovative solutions and AI optimized infrastructure.
Within web scale, while we saw overall slowing due to normalizing product lead times two of our largest customers grew their orders with us over 40% in the first half of fiscal 'twenty three.
We continue to take share in this space and over the past few years, we've grown our web scale cloud infrastructure from effectively zero into a multibillion dollar run rate business.
I'm incredibly pleased about the overall progress we've made as we are continuing to win more and more use cases within their infrastructure we.
We were also still at the beginning of what we believe to be a massive growth opportunity going forward.
While we continue to closely monitor the global macroeconomic conditions. The overall demand environment remains steady and on par with Q1, and our pipeline and win rates remained stable.
Looking at the broader landscape digital transformation and hybrid cloud remain top areas of spend which is fueling growth across our portfolio.
Many customers have told me that while their spend levels may be slowing in some areas technology remains a central as it is vital to their overall business resilience competitive differentiation and success.
In fact, Gartner and IDC is most recent survey just make it clear that technology budgets are growing as they forecast it spend to increase in the mid to high single digits in 2023.
We're also seeing many customers moving ahead with their hybrid work AI and ml investments while building the modern infrastructure they need to deliver on their objectives.
Oh Gee has also been accelerating we saw record revenue growth in Q2 as customers look to connect their industrial systems in order to optimize power consumption automation and efficiency.
Lastly, cyber security and full stack observed ability remain strategic priorities, where we continue to invest and innovate.
From a product revenue perspective, we saw strong double digit growth for catalyst nine key enterprise routing wireless meraki duo and thousand eyes, reflecting the ongoing investments our customers are making to modernize their infrastructure to rapidly digitize and secure their organizations.
We are increasing our investments in our cloud management platforms that deliver the simplicity, our customers need youll see us continue to bring AI and ml into those platforms to further simplify how networks are managed for.
For example.
In Q2, we announced several new innovations across our cloud managed networking and security portfolios that offer greater visibility with AI driven insights enable secure connectivity and give our customers the ability to simplify their it operations.
Last week, we introduced a preview of our cloud native full stack Absorbability platform. The first network visibility solution to support open telemetry.
This platform brings together, our thousand eyes, and App dynamics capabilities for unmatched data correlation and insights from the user to the application to the network.
To simplify network security and policy management, our unified SaaS solution, Cisco plus secure connect now supports integration into Cisco SD Wan fabrics, using the <unk> technology as well as our existing Meraki SD Wan fabric.
We also introduced new flexible more powerful and energy efficient servers, which not only helped lower cost, but also help our customers meet their sustainability goals and increasingly critical area for most of our customers.
To close I'm proud of what we achieved this quarter.
We delivered a strong financial performance innovated across our portfolio and continue to make great progress on our business transformation.
In addition, the increased visibility we have from almost 32 billion and our P O a healthy backlog and pipeline and improving supply give us the confidence to raise our full year outlook.
We expect those same factors to continue into fiscal year, 'twenty, four giving us conviction in our ability to deliver on our commitments.
Modern resilient and secure networks, we are building serve as the backbone of our customers' technology strategy, Cisco is well positioned to benefit from multi year investment cycles with our market, leading hardware as well as our innovative software and services.
Together these allow our customers to digitize rapidly secure their environments and achieve their sustainability goals, all while delivering differentiated experiences now I'll turn it over to Scott.
Thanks, Chuck we delivered another strong quarter and exceeded both our top and bottom line expectations driven by our focused execution continued success of our business transformation and improved availability of supply as the actions our supply chain team have taken over the last several quarters are bearing fruit.
Total revenue was $13 6 billion up 7%.
non-GAAP net income was a record $3 6 billion and non-GAAP earnings per share also a record was 88 cents.
Looking at our Q2 revenue in more detail.
Total product revenue was $10 2 billion up 9% service revenue was $3 4 billion up 2%.
Within product revenue secure agile networks performed very well up 14%.
Switching revenue grew in the double digits with strength in campus switching driven by our catalyst 9000 and Meraki offerings.
While data center switching declined slightly we saw strong growth in our Nexus 9000 offerings.
Enterprise routing had double digit growth driven primarily by strength in our catalyst 8000 series routers.
SD Wan and Iot routing.
Wireless had very strong double digit growth with strength across the entire portfolio.
You ended up for the future was down 1% driven by declines in optical and edge.
We saw growth in our Cisco 8000, offering and double digit growth in web scale.
Collaboration was down 10% driven by declines in meetings and collaboration devices slightly offset by growth in contact center.
End to end security was up 7% driven by our unified threat management and zero Trust offerings.
Optimize application experiences was up 11% driven by double digit growth in our SaaS based offering thousand eyes.
We made solid progress on our transformation metrics as we shift our business to more recurring revenue based offerings driven by higher levels of software and subscriptions.
We saw strong performance in our IRR of $23 3 billion, which increased 6% with product they are our growth of 11%.
Total software revenue was $4 2 billion, an increase of 10% with software subscription revenue up 15%.
84% of the software revenue was subscription based which is up four percentage points year over year.
We continue to have 2 billion of software orders in our product backlog.
Total subscription revenue was 6 billion an increase of 9%.
Total subscription revenue represented 44% of total revenue.
And <unk> was $31 8 billion up 4% product <unk> increased 7% and service <unk> increased 2% and total short term RP O grew to $16 9 billion.
While total product orders were down 22% that compared against 34% growth in Q2 fiscal 'twenty, two which is one of the largest quarters for product orders in our history.
We saw year over year declines across our geographies and customer markets.
Sequentially total product orders growth was in line with our historical growth rates.
Within our customer markets, we experienced double digit sequential growth in both enterprise and commercial and public sector was better than we've seen historically.
We continue to have very low order cancellation rates, which remain below pre pandemic levels.
Total non-GAAP gross margin came in at the high end of our guidance range at 63, 9% down 160 basis points and up 90 basis points sequentially.
Gross margin was 62, 1% down 220 basis points year over year, and up 110 basis points sequentially.
Service gross margin was 69, 1% up 30 basis points.
And our product gross margin the year over year decrease was primarily driven by higher component and other costs.
This was partially offset by our strong product mix and positive pricing as the benefits of the actions we took in the prior fiscal year flowed through as we shipped our backlog.
non-GAAP operating margin came in at the high end of our guidance range at 32, 5% down 180 basis points year over year and up 70 basis points sequentially.
The year over year decline was primarily driven by the higher component and other costs that I just mentioned.
Backlog for both our hardware and software products continue to far exceed historical levels.
As we navigated a complex supply environment, we were able to draw down total backlog by 6% sequentially, although it still grew year over year.
Just a reminder, backlog is not included as part of our $31 8 billion in remaining performance obligations.
Combined our significant product backlog in our P. O continued to provide great visibility to our topline.
Shifting to the balance sheet. We ended Q2 with total cash cash equivalents and investments of $22 1 billion we.
We had record operating cash flow for the quarter of $4 7 billion up 93% year over year, driven by strong collections and we deferred our Q2 federal tax payments due to the IRS.
Tax relief related to the California floods, we expect to pay these federal taxes by the end of the fiscal year.
We returned $2 8 billion to shareholders during the quarter, which was comprised of $1 6 billion for our quarterly cash dividend and $1 3 billion of share repurchases.
Also ended the quarter with $13 4 billion in remaining stock repurchase authorization.
Today, we announced that we are raising our quarterly dividend by one penny to 39 per share, which represents our 13th consecutive increase.
This reinforces our commitment to returning a minimum of 50% of free cash flow to our shareholders annually and confidence in the strength and stability of our ongoing cash flows.
To summarize we had a great quarter delivering better than expected top and bottom line performance we.
We continue to make progress on our business model shift to more recurring revenue, while making strategic investments in innovation to capitalize on our significant growth opportunities.
Turning now to our guidance our guidance ranges reflect our strong pipeline and significant visibility driven by healthy backlog.
Our R. R P O and improving availability of supply as we continue to benefit from the actions our supply chain team have taken over the last several quarters.
We expect those same factors will continue into fiscal 2020 for giving us greater visibility and confidence in our longer term goals.
For fiscal Q3, our guidance as we.
We expect revenue growth to be in the range of 11% to 13%.
We anticipate the non-GAAP gross margin to be in the range of 63, 5% to 64, 5%.
Our non-GAAP operating margin is expected to be in the range of 33% to 34%.
And our non-GAAP earnings per share is expected to range from 96 to 98.
There is also a significant change to our full year fiscal 'twenty three revenue and non-GAAP earnings per share guidance driven by these same factors.
For fiscal year 'twenty, three we are raising our expectations for revenue growth to be in the range of nine to 10, 5% year over year.
non-GAAP earnings per share is expected to range from $3 73 to $3 78.
And both our Q3 and full year guidance, we're assuming a non-GAAP effective tax rate of 19%.
I'll now turn it back to Marilyn So we can move into the Q&A.
Thanks, Scott I'm going to turn it over to Chuck just for a few comments before we start the Q&A you.
Yeah before we get into Q&A I, just wanted to send our condolences to those impacted by the earthquake in Turkey, and Syria, it's been absolutely devastating to watch as the debt towards climbed and we're working closely with our teams in the region to give them support and help on the ground as much as we can and we just want to let them know that we're all thinking about them and we're here to help.
Thanks Chuck.
Michelle Let's go ahead and open up the queue for a question and answer.
Thank you.
Karen you May go ahead with Oppenheimer <unk> company.
Thanks, guys.
Nice quarter Nice guide.
I guess the Big question is when you think about the the outlook that you have for continued supply chain improvement.
How long would be order backlog normalization process is going to take.
In your view and maybe you can quantify and corridor itself or perhaps on the guidance. When you look at the guidance how much of that is coming from your ability to fulfill more versus the true underlying demand I'm just trying to gauge for how long you can kind of keep growing at above normal growth rates for yourself.
Yeah, Hi, thanks for the question.
And shockingly enough that was the first question I expected.
Let me, let me just summarize sort of what we're seeing and then I can give you more detail, but number one number one let's start with the fact that our demand is stable.
And.
That's first based on the sequential is that we saw demand remained stable and in fact, if you look at it our Q3 forecast, which we normally wouldn't give you. The current forecast in Q3. It is also in line with historical ranges of sequentially. So that's the first piece the.
The second thing is as Scott said, while we are.
Backlog came down 6% sequentially it was up year over year.
And we expect that it will we will end the fiscal year, even with the guidance. We gave you today with a backlog that's roughly double what we would normally in the year with.
The other thing to take into consideration is the.
The business transformation with 44% of our revenue now recurring.
Really helps a great deal and we have $23 billion of AOR, which we can actually renew in the next 12 months.
So if you go back eight or nine years ago, we might we might have had to take orders for 75% of our revenue in any given quarter and now we have 44% of our revenue coming from the balance sheet and recurring revenue.
So.
All of that.
Shed, we actually believe that we will still be able to deliver we're confident that we'll deliver positive growth in fiscal 'twenty four obviously with.
Pretty significant comps based on the guidance that we gave today.
Okay.
I guess when I think normal given your historical ranges before the pandemic.
I always think about four to six is kind of the range plus minus debt you'll run at.
Is it fair to say that from here on anything above is kind of our order book.
Eating and come backlog and while we have a backlog is double that.
Still.
It means that you can run above normal ranges for.
At least couple of years it sounds like on Leicester.
Unusual happens in like in my Misinterpreting your comments.
Scott you want take that no not at all API, but what I would say is it's obviously too early for us to guide fiscal 'twenty for what what we wanted to give you confidence as we have better visibility than we've ever had in the past both from the backlog in the <unk>.
17 billion, almost 17 billion of RP O. That's current that's going to turn into revenue in the next 12.
<unk> months in the IRR.
But.
And we're gonna roll in backlog, that's roughly double what it normally would be at the end of the year. So we have good confidence in where we're headed in fiscal 'twenty four I think it's a bit too early given the where we are in the year just at the end of our second quarter for us to be a little more precise on that.
I appreciate it good luck thanks.
Thanks, Steve next question please.
Dark Blue from Evercore you May go ahead Sir.
Hey, Thanks, Congrats on a really good quarter behind as well.
Maybe if I think about the secure agile networks segment growing at 14%. That's really notable that I don't need the industry's growing nearly close to that pace.
I mean do you think you're starting to see some share gains come back to with Cisco, especially the supply chain to improve is that a tailwind that you see and perhaps it continues for the rest of the year. Maybe you can just talk about that and also maybe talk about house campus being within.
That segment that would be helpful.
Thanks, Amit let me take the share question, because I think I've said on several calls that obviously market share is reflective of revenue and with our backlog that as we began to ship.
Certain products that we would be a gainer of market share and we certainly expect that when these numbers are digested in the new reports come out.
For Q4 that Youll see that to be the case. One example is during last quarter. Our wireless revenue was up 57% year over year and I suspect that that's going to be a share gainer.
And you know the other thing to keep in mind is it market share is inexact.
I would tell you that when we.
Ship products into the web scale infrastructure space as an example, it goes into our routing reports in many of our competitors put it in data center switching so it's very difficult in some cases to get complete apples to apples, but I do believe that as we continue to ship our backlog.
We will be gaining share you want to talk a little bit about the cat.
The campus switching.
Yes, sorry, I missed that part of the question can you repeat your question about the campus switching the second part.
Yeah, Yeah, no I was just wondering like within this context of 14% growth that you saw in that segment you know how its campus performing for you very specifically and how the supply chain kind of alleviated over there.
Yeah campus is doing well for us and the supply chain while.
I don't want to leave the perception that supply chain just got better.
Our our supply chain team and our product engineering teams have worked pretty relentlessly over the last several quarters with product redesign without with qualifying alternative components with working with our suppliers to get to their sub components to make sure. We can free this up so that the increase in supply that's leading to some of the share gains that were.
Talking about as a result of a lot of hard work by a lot of people inside the company and I think frankly, it puts us in a better position than many of our peers in the industry right now from a supply chain standpoint, but the longer answer. The short answer is that we were doing quite well in that space as we continue to deliver what we've just laid out as our our guidance.
For the second half of this year I think youll continue to see share gain grow for us.
Got it that's really helpful. And then just ask you really quick on that.
Your back half guide is obviously fairly impressive but in April quarter.
Sort of implying gross margins will be down 130 basis points year over year I think for the April quarter can you just talk about how much of a downtick you think is cyclical things like the supply chain and logistics and so on which is structural and what do you think normalized gross margin could look like for the company. It's supply chain, it's truly an herbalife.
Thank you.
The midpoint of the guide for the April quarter is about is about a 10 basis point improvement from the quarter. We just announced so we do see gross margins improving and it's largely driven by less less driven by cost we're seeing some reduction in cost around logistics in particular, but component costs are kind of staying where they are.
And in most cases it's.
It's more driven by the fact that as we shipped the backlog more and more of what we ship reflects the price increases that we put in place last year. So I think you'll see gross margins potentially continue to expand from where they are maybe as much as 50 basis points.
In Q4.
Perfect. Thank you.
Great. Thank you next question please.
Thank you Paul Silverstein with Cowen you May go ahead Sir.
Thanks, Chuck has got appreciate that you all addressed in your prepared remarks, the visibility the management issue, but so my apologies, but I'd ask you to revisit, especially in your enterprise business, including government and U S. Federal.
I'm sure you and your team are aware of what your competitors are observed I know Chuck you just addressed the market share issue.
Can you give us more color in terms of the solidity of the demand trends and the visibility that's translating into.
Well as I said, you know the our enterprise and commercial business, which is reflective of how most of our peers.
It represent enterprise.
They were that was up double digit sequentially, which is in line with our historical ranges and in public sector actually performed better.
Then it was above our historical ranges during the quarter. So.
The other thing I would point out is that our quarter. It's still from a linearity perspective was quite normal and we actually had a you know we're unique in that we had the January month.
In our Q2 and.
And one of the questions that we had was what's going to happen to budgets as we enter into calendar 'twenty three and we clearly we actually finished stronger than we started the quarter. So those are just a few data points for you and I think if you.
If you look at.
What our customers are focused on right now.
Think about some of their top priorities they've got a complete re architecture of their applications to be cloud native running in both public and private clouds.
They're having to re architect their infrastructure to actually deal with the changing traffic patterns that they that multi cloud brings to them.
They're dealing with hybrid work and how do I transform our it infrastructure for that.
They're dealing with.
Cyber security threats on a massive scale.
And they're also all focused on sustainability, which is leading to our Iot business growing significantly as we connect industrial systems for our customers. So if you think about those big five trends, we're actually in the middle of those with all of our customers. So we feel good about where we are.
And.
And the last thing I'll say is that I was in Tokyo, and Singapore last week and at the same time a lot of my leadership team were in Amsterdam for Cisco Live Europe .
And <unk>.
No one is talking about cutting technology spending right now everybody is it seems very committed to it I think the underlying power of the technology as it relates to all over the organization strategy is just too strong right now.
Alright, Scott back on the margin question I. Appreciate you got to walk before you run, but you're now three three percentage points roughly below peak on both gross and operating in terms of the initial recovery any thoughts for how much of those three percentage points can you eventually get back to 67 grows can you get back to 35.
Operating and it's just a function of time or because of the price increases with respect assuming these or other things that's just a bridge too far.
Yeah, I mean as you talk long term there is a number of tailwind that will come into gross margin. So not not necessarily talking about our guide for fiscal 'twenty three but longer term. There are several things that are going on that are going to be a tailwind there one is.
Continuing to work our way through the backlog and reflect the price increases I think we will continue to see leverage in logistics costs. Both from a reduction in the freight cost per kilo, but also in the mix of how we ship between what has supply airfreight and what will go on the ocean. So I think we'll see some leverage there as well.
I don't see a lot of our component providers outside of commodity areas like memory lining up to reduce cost to us.
So I think that it'll be the combination of mix that'll be beneficial to us in some cost leverage in the non component areas that'll drive that north.
So you said you can't get back to 60035.
Yeah. So are you asking me for a five year forecast on gross margin Paul is that where you're going out long term long term can you get back to that model.
Long term, there's definitely leverage to push it back to where it's been historically for shorter and if not beyond.
Thanks, guys.
Thank you.
Paul next.
Next question please.
Meta Marshall with Morgan Stanley You May go ahead.
Great. Thanks.
I am assuming as you're having conversations with customers that are looking for more flexible.
Our subscription methods and part of your subscription transition has kind of been evolved in kind of the E. L. A model or kind of the subscription model you guys have had I just wanted to get a sense of where you think you are on some of the kind of subscription is Asian of.
Some of your products and you know whether you are seeing a big impact of that right now and then just maybe just some commentary about how you see the M&A environment currently thanks.
Thank you.
So we are.
We are probably I'd say still in the early innings of transitioning.
The traditional portfolio to subscription models of the team's working hard on that right now and and we'll just continue to keep you updated but I think we're several quarters away from really having.
Anything to speak about relative to the size of that business, but we're working hard on being able to deliver that and the key is to give customers flexibility that's what.
You know over the last seven years or so we we have disaggregated hardware and software and Silicon, we virtualized software to run on X 86 appliances. So we want to give all of it we want to give our customers whatever kinds of flexibility that they they would like so.
That's the first part on the on the M&A side I would say our strategy. As you would expect has not changed I think you know the market dynamics have changed and I think that the longer valuations remain somewhat muted from their peaks I think some of the companies are probably come into more.
Of a real position on what how long these valuations may exist and where the prior valuations even realistic in the first place. So we continue to stay.
Aware of what's going on and we continue to scan the marketplace, but our strategy remains the same.
Great. Thanks.
Thanks, Chuck next question please.
Thank you Simon Leopold with Raymond James You May go ahead Sir.
Thanks for taking the question I wanted to see if we could talk a little bit about the trends youre seeing in data centers.
In the prepared remarks, I think you mentioned campus was good but data center was weak.
And I guess, maybe I'm looking for not just the switching part of it but your ucs business and what are the broader trend how much of that is reflective of hyperscale slowing versus the broader market just trying to unpack that a bit. Thank you.
Yeah, I'll make couple of comments and it's got I don't know if you want give any detail, but I would say that our customers are increasingly balanced.
Around how they're thinking about private cloud versus public cloud.
And and.
And so we've seen.
Continued focus on.
Revitalizing the private data center infrastructure.
And I'll, let Scott speak to you and I'm not sure of the on the on the infrastructure side are you see us if you want to share that but the other thing I would point out Simon as I said in my comments earlier about market share everything that we sell and the infrastructure within web scale.
Those into our routing market share numbers are in our routing business. So it doesn't actually boost our datacenter switching the way we report it so it's a little bit of an apples and oranges issue I just want to make sure you understood that no. That's a really good point and on Ucs. If that's the root of your question. Simon we are seeing nice growth in ucs as well and.
Based on our calculations feel like we're gaining share there as well.
Thanks, and then just maybe a quick follow up I was a little bit surprised that the metric of hardware catch software in backlog. It is 2 billion same as it was in the prior quarter.
I would have guessed it would have come down with the the basically improvement of shipping the hard associated hardware.
Maybe maybe I don't understand that value, where you could talk a little bit to why that to bell you didnt come down with the extra shipments out of the related hardware.
Yes.
It's a great question, Simon and we actually did see if you noticed our overall software revenue grew 10% this quarter. So back back back to double digit growth in some of that growth is on the back of shifting some of the some of the backlog out both the hardware and the software that sat in backlog, but we are seeing the benefit of shipping that out at the same time as Chuck said earlier demand remains.
30.
And so our overall backlog, while it came down only.
Only about 6% sequentially. There is still a significant amount of software stuck in that backlog some of it attached to hardware.
And software as a total percent of revenue or product revenue that metric.
With that now.
Yeah.
Just for software it's in the 30% range overall, we're in the 44% range.
Thank you very much.
Alright, Thanks, Simon next question.
Thank you Sami Badri from Credit Suisse. You May go ahead Sir.
Hi, Thank you I had one quick one and a follow up the first one is on <unk>.
The data center switching redesign.
You guys made several mentions regarding supply and the team kind of working hard to get redesigned through but does that actually mean in the data center switching portfolio is now completed with redesign in that part of they did drive.
Our revenue guidance for the year.
So that's my first question. The other one is we've seen several companies report.
Elongated lead times, where sales cycles and extra signatures and all these other elements and I. Appreciate Chuck you did hit on the fact that you aren't seeing any kind of tech spend get cut but are you seeing some kind of resistance or slow down as far as sales cycles impacting the speed at which.
You guys have historically done business.
Take into account also I appreciate your comment regarding linearity, but just wanted to kind of ask this question to get it through.
Let me take the second one first and Scott you can talk about the data center switching redesign them.
We absolutely are seeing some elongated sales cycles, what our teams have told me is that.
In many cases they are there are extra signatures required we just seem to in general be getting them. It just takes a little bit longer so but look it's a it's a complex world right now, but if you look back at historical.
Sort of what we would consider a bit of a crisis or a complex world environment I've experienced demand falling off a cliff and we we obviously haven't seen that in the current situation.
Scott you want to talk about.
To finish up on that pipeline looks strong close rates still look good. So we're not seeing a huge difference there. There is in some cases, a slight elongation on the redesign that's absolutely contributed to the growth that we're seeing particularly in secure agile networks.
Less so from you know in terms of releasing the next.
Successor product more being able to design around problematic components that we couldn't get supply of and as we work those redesigns to build the product around components, we can get our hands on that that's what we're talking about when you talk about the redesign and so there's no question that's driven some of the growth that you saw in the quarter. We just announced we will continue to drive the.
<unk> growth that we've put out for the second half and to be clear, we will continue to see growth into fiscal 'twenty for all the trends we've talked about that are driving the uptick that.
You see in our guidance in the second half of this year those trends continue into fiscal 'twenty four and we continue to expect nice growth. There I just think it's a little too early to start to quantify that and give you a guide.
Got it thank you.
Mhm.
Next question please.
Thank you George Notter from Jefferies. You May go ahead Sir.
Hi, guys, thanks very much.
I wanted to ask about your impressions of our backlog in product orders relative to three months ago.
And I think I have this correct about three months ago, you guys were talking about.
If product orders were down 10% for the year then your product backlog at fiscal year end would be two to three times higher than the normal kind of four or $5 billion range and Chuck I think you are quick to say that.
It didn't feel like a 10% order decline was in the cards for you. So it feels now like you you are going to burn more backlog than you were thinking previously and in order to be a bit worse than previous.
I perceiving that correctly and what are your thoughts there. Thanks.
Yeah, George I'll I'll take that and then you can you can jump in.
I don't think it is burning down backlog there. We clearly are the good news is we're able to ship more of the backlog. That's good news for our customers are waiting for these components they've got projects that theyre holding up that they need to get done. It's good news for our channel in a sense that the channel is sitting on in some case partial shipments they need that last box. So they can go out and implement that in.
And relieve some of the pressure on their own working capital.
What I'm responding to the burning down backlog. This is good news our ability to ship the backlog and that's what you see reflected there.
And the in the guide down or I'm, sorry in the guide up that we have in the second half of the year. We have you know.
What you see now is a significantly higher revenue projection for the second half of the year than we had before and some of that clearly is our ability to ship backlog because of the great job. Our team has done to free up supply.
And I would say on the demand side, if I go back 90 days I would say.
In General I think there was more risk at least there felt like there was more risk and when I talk to my customers there was more uncertainty.
And even when you hear listen to the news and we talked I talked to my colleagues we were in Davos.
It feels like the longer we go without seeing some major shift than.
The better our customers are feeling so obviously, we're not immune to anything and we'll have to continue to monitor it but after traveling in.
You know Asia last week, our team being in Europe , I actually saw customers in New York, While I was here this week and.
Customers are moving forward.
Great. That's helpful. Thank you very much.
Thanks, George next question.
Thank you David So with UBS you May go ahead.
Great. Thank you guys and I apologize if you covered this my line cut out a little bit before Scott I'm, just trying to clarify the order versus the backlog comment I think I'm not mistaken your run rate backlog had been sort of you know roughly $5 billion as you exit next fiscal year.
Are you, suggesting to us that the backlog comes down by about $3 $5 billion over the next several quarters and if that's the case if I just kind of back out I think your guidance would that imply that the business is effectively flat year over year ex to backlog draw down as we exit 'twenty three into 'twenty four and then I have a quick follow up.
Yeah. So let me, let me try and walk through some of the moving parts there David It's a great question. What we said previously is we thought we would end the year with somewhere between two and three times normal backlog of normal backlog as we said last quarter is between four and $5 billion at the end of the year. While we now see is that it's still going to be roughly double what you know that St.
Range. So there's there's definitely our ability to ship some out of the backlog, which is again, great news for our customers and for our partners.
The one piece that's missing in your equation is as we shipped the backlog remember, we said theres more than $2 billion of software in there a lot of that software is ratable as soon as we ship it it doesn't all drop into the revenue stream. It ends up dropping into deferred revenue and being recognized over time. So there's a you have to consider not just the reduction in backlog, what's the uptick.
On the revenue guide, but also how much of this is going to contribute to growth in deferred revenue that may be the piece that you're missing.
Got it and then maybe just as a quick follow up so as we enter let's say the next fiscal year.
I mean, given your excellent work on supply chain and the team's done a phenomenal job with that imply I mean, basically we could be back at normalized backlog within a quarter, maybe two at the worst case scenario if trends hold consistent where we are today is that a reasonable expectation.
I think rather than try to say, it's a quarter or two quarters I do expect that to normalize in fiscal 'twenty four.
Alright, thanks, guys.
Uh-huh.
Next question please.
Tal Leone with Bank of America, you May go ahead Sir.
Great.
He stole my Thunder with the previous question that was exactly my question, So I won't.
I understand I wanted to understand something just a clarification on what you just answered.
So at the minimum that decline in the backlog was $600 million at the minimum because at end of year is going to be $8 million to $10 million to a 6% of that in the backlog is now higher.
So that means that the minimum your backlog declined $600 million and that means that product growth.
We should take out some of the $600 million because some of it goes into deferred revenues am I am I correct with what you just answered.
Well Youre close let me, let me run through it again Palin and if it's still not clear we can catch you in the in the follow ups.
The 6% was the decline in backlog from Q1 to Q2.
Alright, So we were able to work off about 6% of the backlog that we came into the quarter with.
What we said is at the time that we gave you that Q2 guide and the full year. The previous full year guide, we expected to end the year with somewhere between two and three times, our normal backlog, we're now, saying, it's going to be roughly double the normal backlog.
Some of that obviously will ship out and will be a part of the significant guide up that we've given you in second half revenue. Some of it went instead of turning into immediate revenue will go into deferred revenue would be recognized ratably over time and show up in RVO I hope that but yes. It will show up in deferred revenue on our P. O I hope that's clear Pal if not we can follow up yet very clear so it'll make quest.
<unk> I wanted to I wanted to go back to the basics and understand last quarter, we're all concerned about environment slowing down.
We don't hear it we don't hear you, saying environment continues to slow down we didn't hear Arista, saying it we didn't hear you, saying that service providers were weak can you take us through the big customer accounts and tell us what is the situation of spending with your enterprise customers commercial customers that you spoke of.
Customers.
Did the environment further deteriorate from the previous quarter or did it stabilize and does it make you think that at least the trends. So far the year would continue to be normal on a sequential basis or you expect some more deterioration going forward.
Yeah tell so we.
On the enterprise and commercial space you know, we we saw double digit sequential growth, which is in line with what we've seen historically and as I've said.
Public sector was actually higher than historical ranges in federal was U S. Federal was extremely strong.
During the quarter from a demand perspective.
On the service provider side, I think you're seeing.
Many of our competitors and peers some of them anyway don't give order data and so I think for US those customers are the ones who did the most planning for long term ordering Suez as lead times begin to come down.
We would expect them to change their ordering patterns and they've already got six to 12 months worth of consumption line.
Lined up in the backlog so we'll see that normalize over the next few quarters I will say in the web scale space.
You know there are roughly 35 use cases are franchises within the the largest players and we've actually been designed into 18 of those at this point.
And we are very confident that we'll continue to get designed in I got a note today that we had just got notice that about a new design win today.
And.
And so we're we're still up very optimistic long term, we just think it's a short term normalization for our service provider space.
Got it.
And the economic slowdown.
My question was whether these factors you see an impact on your business on the orders or they stabilized from previous quarter.
Okay.
Well yeah.
You mean layoffs in like in our customers, yes, yes across the industry.
Yeah, well if you think about what occurred there was a lot of companies that had a massive surge in employment and we didn't.
But.
I think the.
Yeah.
The thing that we're seeing right now is that you know.
We've seen the sequential growth be in line and in some like it was towards the lower end. So it's not as it's not performing at the highest end, but I think that it's in range and if you and I also shared that in Q3. Our current forecast is also in line sequentially with historical ranges, which we normally don't give we just wanted to.
They have that visibility.
It's it's certainly an uncertain time.
And I'm not I don't want to paint a picture that we're immune and I don't want to paint a picture that you know every customer spending everywhere on everything but you know we've we've we'd been able to maintain and continue to see.
Our customers moving forward with projects and the one thing that was really.
Encouraging for me was to see January as strong as it was given or the uncertainty around 23 budgets.
Got it.
<unk>.
Thanks, Tal next question.
Tim long with Barclays. You May go ahead Sir.
Thank you somebody can get two in here one.
Could you talk a little bit about obviously the NTP.
Enterprise campus is still.
Very strong, but I think traditionally it's kind of a GDP ish type of business and it's been running above that and it sounds like your comp to next year, it's pretty strong as well so.
Maybe Chuck any insights like what's kind of different there or are we starting to decouple from like macro GDP for that campus network Bts any thoughts there would be great and then second.
Obviously, a lot of excitement out there about AI chat GTT, all that all that stuff.
Just curious what you think or your data center and cloud businesses.
What kind of impact.
There's kind of more of an arms race with big customers around AI, what that would mean or switching and routing business for you guys. Thank you.
Thanks, Tim So first one on enterprise campus I do think that.
The pandemic was was a great educator for our customers about the need to maintain modernized infrastructure because moving into the pandemic I think it became quite obvious to many of our customers that they had they.
They had not been updating and they had they were sweating assets a little longer. So that's one thing that's shifted the second is <unk>.
We're really seeing.
These trends have multi cloud the trend of hybrid work.
And.
The overall.
Re architecture of the networks. If you if you really think about how we built networks for 20 years.
We built it on a.
The premise that we have branches and we have a private data center and all the traffic flows are very understood now I have to upgrade my entire infrastructure to deal with this brand new world that I live in supporting hybrid work supporting hybrid cloud etcetera. So I think they're there that's been driving a lot of this as well as safety in the office Iot, creating new experiences.
<unk> to get our employees back to work et cetera.
So that's what I think has been driving a lot of the enterprise campus stuff as it relates to your second.
Question around the AI play.
I think that.
Look these AI networks that are being built whether it's in web scale or whether we have some of our largest enterprise customers that are building AI networks and and training AI algorithms. These are.
Like in the web scale space there like.
Bigger than the core infrastructure networks that they're running which which was astonishing to me when I learned that.
And the network performance required is three to four times, what they've historically needed and so this is a massive opportunity for us and we're in active discussions with large customers around it. So we do think that this shift is going to create.
A good opportunity for us in the future.
Okay. Thank you very helpful.
Thanks, Chuck next question.
Thank you gentlemen, chatterji with Jpmorgan you May go ahead Sir.
Yeah, Hi, Thanks for taking my questions and.
Congrats on the strong guide maybe if I can just quickly hit on two of the product areas. Firstly security what sort of benefits are you seeing given your broad portfolio. There in terms of customers looking to maybe some level of window consolidation.
And given your positioning.
Broader security portfolio supply or and what sort of benefits as supply eases, maybe on the firewall side should we expect greater revenue growth and a similar question I intended future entitled the future segment seems like a bit more supply constrained than other segments, but what sort of are you seeing.
What are you seeing on the supply side there. Thank you.
Okay, I'll take security and you can take the supply side.
So I think that look all of our customers definitely want to consolidate their security and.
Infrastructure, they they've got 40 or 50 different vendors and trying to correlate. These threats is very difficult and it just you can't add enough people. So.
Our teams right now.
Our heads down working on some new capabilities that we're gonna be bringing out over the next 12 to 18 months and in some of that is focused on exactly that how do we consolidate and how do we create the ability to correlate threats in real time, much more effectively and so we think that you're probably going to start seeing the benefit of that three or four quarters.
So team's got work to do we've hired a significant amount of outside talent. We've invested heavily in this space. So while we may see you know.
We may not see the growth that you want to see in the near term, but you will see this begin to accelerate in FY 'twenty four I think it will where we're playing the long game here and really believe that there's a lot of consolidation that we can drive over the next few years Scott Yeah on internet for the future to make it.
It is one of the spaces.
We've worked so hard and done so much across our entire product portfolio and we've made great progress.
In many cases I would say internet for the future is one of the spaces, where we're still we've improved lead times, there, but we're still not back to more normal lead times in that space.
What I'd also say, though as you know we have already picked up orders are just in the last several weeks from some of our peers that are also selling into that same space, who couldn't meet demand and in those orders came to us instead, so while it's a space. We continue to work on and while were seeing improvement its not where.
We want it to be I feel like we're a we're performing pretty well on the supply side and internet for the future.
Thank you.
Hum.
Alright that wraps up our Q&A and I'll turn it over to Chuck for some closing remarks, well first off I just want to thank everybody for spending time with us today and also really thank our teams. They delivered on very strong results I want to thank the supply chain and our engineering teams.
For quarter after quarter after quarter of hard work and Redesigns over 100 product redesigns aggressive actions to get us to the position. We're in today the entire company for the progress we've made on our business transformation and I'll. Just leave you with are feeling that our demand has remained stable the business transformation is contributing significantly.
<unk>.
Our backlog all of those give us the visibility and confidence in the future.
I think the relevance of our portfolio given the most pressing needs of our customers is a is that are as high as it's been in a very long time and I'm Super proud of what our teams have accomplished so look forward to talking to you in the future and thanks for joining us today.
Thanks, Chuck Cisco's next quarterly earnings conference call, which will reflect our fiscal 2023 third quarter results will be on Wednesday may 17th 2023 at 130 P. M Pacific time 430 P. M. Eastern time. This concludes today's call. If you have any further questions feel free to reach out.
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