Operator:

Welcome to Cisco's Third Quarter Fiscal Year 2024 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 Sami Badri, Head of Investor Relations. Sir, you may begin.

Chuck Robbins:

Thanks, Sami, and thank you all for joining us today. We delivered a solid performance in Q3 with organic revenue coming in at the high end of our guidance range. Strong operating leverage across our business drove gross margins to exceed the high end of our expectations, resulting in better-than-anticipated earnings per share performance. We once again delivered good growth in annualized recurring revenue, remaining performance obligations and subscription revenue. We have transformed our business model with revenue from subscriptions now accounting for more than half of our total revenue even before the addition of Splunk. With the success of our transformation, we are well positioned to drive long-term growth powered by innovation across the organization. I want to thank the entire Cisco team as it is through their dedicated efforts that our research and development engine has never been stronger across networking and silicon, observability, security, collaboration, and AI. The strength of our core business continues to produce strong cash flows, reinforcing our ongoing commitment to delivering consistent capital returns. In Q3, we returned $2.9 billion in value to our shareholders through share repurchases and cash dividends in the quarter with a total of $8.5 billion in value returned year-to-date. Q3 was significant for us in two important ways. First, I couldn't be more excited about the successful close of our Splunk acquisition, Cisco's largest ever. Our acquisition of Splunk was completed midway through our Q3 on March 18, earlier than initially anticipated. Splunk significantly expands our portfolio of software-based solutions, contributing over $4 billion in annualized recurring revenue and adds to our position as one of the largest software companies in the world. We are thrilled to welcome the Splunk team to Cisco and are very excited about what we can deliver for our customers as we integrate our complementary security and observability capabilities. Our unified platform will revolutionize how customers connect and protect their organizations using data in new ways to enhance their entire digital footprint. Second, we introduced Cisco Hypershield, our most significant new security innovation with a groundbreaking AI-powered approach to highly distributed security, a first-of-its-kind. Combining security and networking in a way only Cisco can, Hypershield is built in the very fabric of the network, bringing the power of hyperscaler security and connectivity to the enterprise. I will talk more about these developments and our innovation momentum in a few moments. But now, I'd like to turn to our performance in Q3 and what we're seeing in terms of customer demand. The breadth of our portfolio, together with our many touch points with partners and customers around the world, provides us with differentiated insight into what's happening in our customer base. Based on activations to the cloud, which we track as well as conversations with our customers and partners, we believe that the products customers have on hand are being steadily deployed in line with the expectations we laid out last quarter, meaning we currently expect customers to complete the installation of the majority of their inventory by the end of our fiscal year in July. At a time where customers are ruthlessly prioritizing their IT investments, we saw product order growth in two of our largest product portfolios, data center switching and campus switching, as well as product order growth in our security and collaboration product categories. Overall, product orders were up 4%, and excluding Splunk, product orders were flat year-on-year. In our customer markets, public sector was strong in EMEA and APJC, but continuing resolution discussions in the U.S. temporarily impacted public sector performance in the Americas. We believe this has since cleared with the subsequent signing of the most recent U.S. Federal Government funding legislation. While our telco and cable customer demand remain muted worldwide, we are encouraged to see early signs of stabilization and improved performance in Webscale in terms of pipeline and orders. Overall, our win rates are stable, and we saw increased strength as we move through the quarter. This reflects our competitive strength and successful execution and gives us confidence in the long term. We also know that the value of our portfolio is greater than ever as evidenced by recent sell-side research IT spending surveys, which show that Cisco is expected to be the only net share gainer within large network budgets over the next 12 months. Now, let's look at our performance in Q3 in more detail. We saw revenue growth in security and double-digit growth in observability year-over-year, excluding Splunk as customers look to enhance their digital resilience with Cisco's technologies. In the past year, we've accelerated our pace of innovation in security and I'm proud of what our teams have achieved. As I mentioned earlier, last month, we introduced Cisco Hypershield, the first truly distributed AI-native cybersecurity solution, which will be built into our networking fabric. This new innovation leverages the recently closed Isovalent acquisition to facilitate deployment in software and the first shipment is scheduled for August this year. This launch furthers our vision for the Cisco Security Cloud, which is expected to deliver the industry's most comprehensive unified platform with end-to-end solutions, making it easier for our customers to protect against the threats of today and tomorrow. Our newest available security solutions, XDR and Secure Access continue to ramp quickly with strong customer feedback. Just last week at RSA, we also announced the integration of Cisco XDR with Splunk Enterprise Security, which will give our customers even more value and insights. The closing of the Splunk acquisition in Q3 will also enable us to begin driving revenue synergies in our security and observability markets. Upon closing the deal, we identified 5,000 existing Cisco customers who have the potential to become meaningful Splunk customers and our sales teams are already making those connections. We also see significant opportunities for revenue synergies by leveraging Cisco's robust partner and customer ecosystem in markets where Splunk had limited or no presence. Earlier this week, Splunk was ranked as the leader in Gartner's Magic Quadrant for security incident and event management, which is a testament to the strength of the offering and the continued business momentum that Splunk has delivered. We are working on rapid integration, investing in both product integration and go-to-market resources, starting with aligning our Cisco and Splunk sales forces and accelerating channel enablement processes for cross-selling and upselling our combined solutions. We also continue to capitalize on the multi-billion-dollar AI infrastructure opportunity. In Webscale, we continue to see momentum with three of the top-four hyperscalers deploying our Ethernet AI fabric, leveraging Cisco-validated designs for AI infrastructure. In the past two quarters, Cisco has been granted additional design awards based on our 51.2 terabit G200 Silicon One ASIC. We expect these awards to yield orders in fiscal year '25, reinforcing our confidence in our line of sight to $1 billion of AI product orders in fiscal '25. Additionally, for those leading-edge enterprise customers who seek to be the early adopters of AI, our partnership with NVIDIA will offer easy-to-deploy cloud-based and on-prem networking solutions for AI inferencing. We believe we are well-positioned to be the key beneficiary of AI enterprise application proliferation with the breadth of our portfolio and the vast amounts of data we see. Before I turn it over to Scott, I'd like to share one more update. Earlier today, we announced that Jeff Sharritts, our Chief Customer and Partner Officer, is departing Cisco and that Gary Steele, Splunk's former CEO, has been named Cisco's new President of Go-to-Market. Gary is well known for his operational excellence, and in this new role, he will work closely with me to set and execute against our strategic plans and goals for the company. He will continue to lead the Splunk team through the integration process to ensure a seamless integration into Cisco. Gary's operational mindset, combined with his intense focus on simplicity and proven ability to drive growth, position him well in this role and I look forward to working closely with him in this new capacity. I'd also like to take a moment to thank Jeff for all that he's helped Cisco achieve, which is quite a long list of accomplishments in his 24 years here. Moving back to Q3, let me briefly summarize. While our core product portfolio is trending toward normalization as we continue to see customer deployments of shipped equipment progress, we are pleased that our security and observability portfolios have continued to grow and are significantly enhanced by the acquisitions of Splunk and Isovalent. As our customers adopt and deploy AI, they need the infrastructure to power it, the data to develop it and the security to protect it. And we believe only Cisco can deliver and integrate all three. With our unified platform approach, vast global partner ecosystem and ability to support hybrid and multi-cloud environments, we will deliver innovation at an unprecedented pace and scale to organizations around the globe. I'll now turn it over to Scott to provide more detail on the quarter and our outlook.

A - Sami Badri:

Thank you, Scott. Before we start the Q&A portion of the call, I'd like to remind analysts to ask one question and a single follow-up question. Operator, can we move to the first analyst in the queue?

Amit Daryanani:

Yes. Thanks for taking my question. I have two. I'll ask them both at the same time. Chuck, it's really nice to hear about inventory digestion sort of being done and order growth getting back to flat and growing in some of the verticals. Some of your tech -- some of the tech companies, I guess, have talked about a softer macro-environment that's resulting in some positive spending. So, I'd love to understand kind of away from the inventory digestion that this seems like it's happening, what are you seeing from a macro-environment and if that's actually starting to improve as well for you folks? And then if I could just follow up on a different side, the $1 billion of AI orders that you have -- you know that you see -- that you believe you can get in fiscal '25, can you just talk about is this other wins more coming from the Silicon One side or optical or on the switching solution? Just any clue on kind of where do you expect to get these wins would be helpful. Thank you.

Sami Badri:

Thank you, Amit. Operator, can we move to the next question?

Simon Leopold:

Great. Appreciate you taking the question. I wanted to see if you could give us some metrics or some help trying to extrapolate the 5,000-customer opportunity for Splunk. And just give us a better idea of what that could mean from a dollars perspective, if you're able to penetrate it? And my follow-up is really, I'm trying to seek a little bit more clarification on this $1 billion AI pipeline because there's been a lot of debate in the investment community regarding it. So I want to see if we can get some clarification that when we talk about the context of what's in there, it's explicitly in the back-end that there's not some extrapolation to front-end data center applications. So explicitly back-end and I think, Chuck, you are saying that it is mostly switching in the back-end with some optics and some Silicon One. I really would like to clarify this because we're getting a lot of questions. Thank you.

Gary Steele:

Yes. So we're excited about the fact that basically, we've identified these 5,000 customers where Splunk traditionally has had no footprint. And the goal there is to have the Cisco sellers open the door for the Splunk team. There's also a financial incentive or spiff in place to incent the Cisco sellers to support this activity. And that's really -- that's one aspect of where we see tremendous opportunity. And then second to that, obviously, there's a lot of overlap in our customers where the Cisco team may have higher, more strategic relationships where they can extend our footprint, assist in helping extend our footprint within the existing Splunk base and we're already seeing that activity right out of the gate. So we feel like we're off to a very good start and I'm super encouraged by the level of collaboration we've seen so far.

Operator:

Thank you. Our next caller is Tal Liani with Bank of America. You may go ahead, sir.

Chuck Robbins:

Tal, thanks for the question. So on the -- let's go with the first question and I'll say on the organic Cisco Security front, you're right, revenue was up 3%, but as I said, our demand was as high -- as the highest it's been in probably a couple of years and it was high-single-digits. So we're seeing the traction on these new products. They're just ramping, right? They're new, customers are testing, they're implementing. And by the way, a lot of it is ratable. So you don't -- you take the orders and then, you know, like close to 80% of our security portfolio is ratable. So that actually impacts the time for it to transition into revenue. So that's on the security side. But I think on the security and Splunk side, I'll talk about it a little bit. We've -- and then I'll let Gary comment on some of the integration. But we announced our first integration last week at RSA. Our intent is just to continue pushing innovation out. We'll have more announcements at Cisco Live. So I think that you'll continue to see that happen. I've always said on the security front even before Splunk that we had brought in a new team, we've been building new innovation. The team has built five new products and solutions from the ground up over the last 12 months, as you alluded to, just done a phenomenal job. And I had always said that second half of '24, I expected you would see an improvement and then in '25, you'll see it get to where we really need it to be. And I think that still stands. You want to comment on the Cisco, the integration stuff, Gary?

Chuck Robbins:

Thanks, Gary. And then on your AI timing question in '25, my suspicion is that that's going to start low at the beginning of the year, and it will ramp as we get through the year. So I'll be thinking more back-half, but we'll have to see how these pilots go. We'll probably know a little more about -- we'll know more in the next 90 days on that. On your second question, first of all, I appreciate the fact that you recognize that several billion of backlog that we cleared last year because this is the last -- this is a -- '25 will be a year where we're still going to have strange comparisons because we're just still coming out of the tail end of this supply chain situation and this whole digestion issue and the inventories, shipments and everything. So '26 over '25 will be the year where you will really hopefully get back to real apples-to-apples year-over-year comparisons. And while I'm not -- we aren't giving a breakdown today of the FY '25 Cisco or Splunk contribution, we'll obviously have an Analyst Day in June and we'll go into more detail there. And Scott, do you have anything to add to that? Or is that good?

Sami Badri:

Thank you, Tal. Operator, can we move to the next question?

David Vogt:

Great. Thanks, guys, for taking my question. So maybe, Scott, I want to follow up on that line of questioning from Tal. Now I recognize that you have that backlog headwind in '24, but if I just kind of run through what Splunk should be doing versus what they contributed this year, it certainly looks like the backlog headwind is going to cause -- of course, is going to be down next year. I know you said you're going to hold off on giving numbers. Is that the right math? And so basically all of the low-single to mid-single-digit growth comes from Splunk. And then from a gross margin perspective, obviously, Splunk is going to be a much bigger part of the business. Can you maybe walk through, you gave us an operating margin framework, but sort of what do you expect from a gross margin perspective, given the strong gross margin profile of Splunk being a bigger part of the business next year versus this year? Thank you.

Sami Badri:

Thank you, David. Operator, can we move to the next question?

Meta Marshall:

Great. Thanks. Maybe first question, Chuck, if you could just kind of update where your kind of conversations with customers are around AI, either in kind of desire to invest on-premise or invest in kind of Cisco Security products for preparedness or just impact to budgets? And then maybe second question for Scott. Just as we think about kind of the OpEx investment that you guys noted for Splunk, you know, how should we think of that versus kind of original targets to have Splunk be kind of accretive one year post close? Thanks.

Gary Steele:

And then--

Gary Steele:

And in terms of the way to think about the OpEx comment that I made, you know, we talked, Meta, when we announced the acquisition of Splunk that this is much more driven by revenue synergies than cost synergies. There's no question there will be cost synergies as we work our way through this, but we will spend fiscal '25 -- from this point through fiscal '25, ensuring that we get both the product integration right, the organizational integration right, we have to do channel enablement, we have to train their sales team on Cisco, train the Cisco sales team on Splunk. There's investment that goes along with that integration and fiscal '25 is the year we'll do that. We said in the first year post-acquisition that we would be accretive in cash flow, and we will, that we'll be accretive in gross margin from Splunk and we will and that we'll be accretive in earnings per share in the second year. So that's -- think of that as fiscal '26. I know this closed a little bit early and I think there's this perception that it closed six months early. So those times ought to be accelerated. We thought the acquisition would close around the end of our fourth quarter. It closed around the middle of our third quarter. So round numbers, it was a little more than a quarter early. So I think the way to think about that is EPS accretive in fiscal '26, but still being cash-flow and gross margin-accretive in fiscal '25 as we invest in the integration.

Operator:

Thank you. James Fish with Piper Sandler. You may go ahead.

Chuck Robbins:

Yes. Thanks, Jim. On the OpEx ramp, I mean, it's -- I know we haven't -- the Spunk team didn't put out guidance for this fiscal year, but you can look at where their OpEx was headed and layer that into the OpEx that we had. There is some growth year-on-year, there's some investment. It's not -- it's not a substantial ramp-up though in the investment on integration. It's more a question of just pulling the Splunk team together with ours. As I said, there will be some cost synergies that are likely to come more in the second half of the year, but this wasn't a deal that was motivated by cost synergies. It was much more motivated by revenue synergies. I think you will -- what you said, I think is spot on. We will see those revenue synergies begin to ramp in the second part of fiscal '25 as these are not short sales cycles as we get our team ramped up on how to sell Splunk as we get the Splunk team ramped up on how to sell Cisco and as we get our channel fully enabled to sell that. So yes, you're going to see those revenue synergies, but you'll need to think about them more in the second half of the year.

Sami Badri:

Thank you, Jim. Operator, next question.

Samik Chatterjee:

Hi, thanks for taking my question. I have a couple as well if I may. I know you're talking today about the deployments with your customers, enterprise customers being higher than what you're shipping to and that implies you'll take a step-up in terms of revenue and that inventory digestion ends. I was just curious in sort of the order trends. You had mentioned you'll be back to a normal seasonality of orders, maybe more in fiscal '25, but how close are you seeing sort of order trends return on a sequential or quarterly basis to more normalized sort of seasonal trends? Is that pointing you in any direction in terms of whether that gap between deployment and your orders are starting to sort of compress? And for the second one, just on the quick follow-up on the AI order of $1 billion sort of target here. Just trying to understand if you feel like you need one or two more big wins in terms of customers or the land and expand with the existing ones should be good enough to get you to that $1 billion target that you have? Thank you.

Scott Herren:

Yes. Well, on the enterprise deployments, we are seeing that progress, Samik. And one of the things that's been encouraging, and we've given you some of the data on this is where we see it moving more quickly. We talked about WiFi and how our wireless business is growing, where the -- if the enterprise deployments of all the product that was pushed out has progressed more quickly, we're seeing demand return. Normal seasonality, if you're talking about year-on-year growth rates is a lot tougher, right? You've got to get to a point where you actually have a normal quarter and which we're headed toward now once we get through this inventory consumption at the end of this quarter and then you have to lap it by a year. To get to a year-on-year compare, that's an apples-to-apples compare. So think of the normal seasonality in terms of year-on-year growth rates beginning much more in fiscal '26. From a sequential standpoint, you'll see that start to happen in the second half of fiscal '25.

Scott Herren:

And then on the AI, the $1 billion -- the $1 billion that we talked about, those are actually identified opportunities that our teams have a high degree of confidence. This is not like -- we didn't set a $1 billion target and tell people to go find deals. There are deals behind $1 billion and there are actual wins that we either have already won or we have a high degree of confidence that we will win. There's certainly execution that has to occur between now and whenever we get it -- when we get them done. We have to get through the pilots. There's a lot of testing that has to take place. There's power consumption testing that goes on. So a lot of that's going on. But based on what we know, this is what our teams believe today. So this is not some aspiration that we have to go find. This is -- these are opportunities that have been identified that our teams feel good about.

Operator:

Thank you. Matt Nicknam with Deutsche Bank. You may go ahead, sir.

Chuck Robbins:

Scott, you want to take the first one?

Chuck Robbins:

And Matt, on the demand normalization, based on what we see today, I think we would expect starting in Q1 and beyond, we should see that normalize. Obviously, with the caveat that there are a lot of hot spots around the world, there are a lot of potential risks out there that are happening. We've got elections all over the world and the most important one perhaps in the United States. So we're certainly going to have to see how all of this plays out. But so far, based on what we see, I think that's a decent assumption for FY '25.

Operator:

Thank you. George Notter with Jefferies. You may go ahead, sir.

Chuck Robbins:

No, we're not, George. There's very little inventory that -- in the channel that is something that we continue to own. In other words, when we ship it to the channel, it's sold at that point. There's very little stocking that happens inside our channel. So we're not seeing that benefit. What we are seeing is, of course, we've put in place the price increases to help offset the higher cost that we saw coming through the supply chain constraints and we've lapped those. But there's actually a little bit, you'll see when our Q comes out a little bit of pricing headwind back to the normal what it had been kind of pre-pandemic, but big benefits, of course, with the product mix of Splunk coming in and some one-off things that we benefited from during the quarter.

Operator:

Thank you. Ittai Kidron with Oppenheimer. You may go ahead, sir.

Gary Steele:

Yes. No, great question. There obviously is a lot of activity in this particular market. One of the things that we feel very good about and Chuck referenced in his prepared remarks earlier is our position in Gartner's Magic Quadrant where we stood out as the leader in the SIM market. We -- so we have a very strong established market position, and our pace of innovation has fundamentally changed over the last couple of years. We've continued to deliver very interesting innovative capability that we think is very high value. So for example, last week at RSA, we announced what we call Splunk Asset and Risk Intelligence. This is a critical capability to help organizations do self-discovery of assets across their environment and then understand the risks associated with those things. Coupled with that, we're now getting the broad benefit of the Cisco Security product line where we can bring in interesting capabilities like the integration with the XDR solution that we also announced. So, we feel like while, yes, it is competitive, we feel like we're incredibly well positioned to continue to drive very important innovation. And we've also taken a very different approach than our competitors and we think broadly about how do you bring together on a single platform the security capabilities that customers want broadly all the way through observability and it's very difficult across the industry to see anybody taking the position that we have and driving value. With respect to pricing, we don't have any fundamental change in our pricing strategy. We're very much focused on driving very good adoption across our customer base and ensuring that they feel like they're getting value every day. And the capabilities that we're offering are hard to match in the industry. So we're not -- we're not shifting gears from a pricing point of view.

Operator:

Thank you. Ben Reitzes with Melius Research. You may go ahead, sir.

Chuck Robbins:

Yes. I got it, Ben. And you're asking me now for fiscal '26 guide at the same time. Is that the right takeaway? Just you're thinking about it right. The underlying business, the core business of Cisco net out the benefits of the Splunk acquisition when you look at fiscal '25, but also when you take '24, net out the impact of the excess backlog that we shipped early in fiscal '24, mostly in Q1, a small amount in Q2 as well, and you get to that mid-single-digit growth of the core business that we've had. So, I think you're thinking about that right. We will talk more -- I'm not going to do it on this call, but we will talk more about fiscal '26 and beyond at our Investor Day in June in Vegas. So hopefully, I'll see you there.

Operator:

Thank you. Atif Malik with Citi. You may go ahead, sir.

Gary Steele:

You bet. And so if you look at the history with Splunk, we were very early driving capabilities with machine learning. We launched the MLTK package in 2017 and we've had a quarter of a billion -- excuse me, quarter of a million users on that. So there's been broad adoption. We then extended that when we brought Gen AI into the picture, delivering an SPL assistant, SPL being our proprietary search language, being able to use English to be able to do that. We're also bringing AI directly into the workflows. So think about SOAR as an example and how you can bring AI into the picture to drive better outcomes from a remediation point of view. So, we've been investing across the product line. You're going to hear and see more announcements from us over at Cisco Live as well as at our user conference, which follows Cisco Live. And the benefit that we're getting -- bringing it into Cisco is Cisco has made -- independently been making a whole set of investments. We get to leverage those assets in addition to the richness of data that we get. So where we benefit from Cisco is the broad rich datasets that exist across networking where you -- so think lateral movement, how can we leverage that data to do a better job from a detection point of view? And frankly, the data and insights that we have as a combined entity, I think are second to none in terms of the competitive environment. So we just basically accelerate our AI efforts as part of Cisco and the outcomes we can deliver to be really important.

Operator:

Thank you. Michael Ng with Goldman Sachs. You may go ahead, sir.

Chuck Robbins:

Okay. Michael, thanks for the question. The year-on-year, again, the -- I think what you're struggling with on the fiscal '25 look is expectations if you just added -- straight added where the run rate of Cisco spend to what your expectations are the run rate of the Splunk spend. And I'd say a couple of things to bear in mind. There are some one-time benefits that we had this year in our OpEx for the Core Cisco pre-Splunk acquisition, up frankly in our variable comp plans, which, you know, it has been a tough year and we've come up short of our plan. And so there's some savings in variable comp for this year and fiscal '24, obviously, I don't plan on repeating those in fiscal '25. So there are some -- and then obviously will do a merit increase as well. So there's some small increase that is just kind of the reset of the comp plans and ongoing merit. There is some investment as well in the integration, but it's not even approaching the number that with the quick math that you just did. So that's kind of the way to think about that piece. Now if you look at the guide for next year, kind of how would I say -- what I'd say about the guide for next year is I feel with a lot of the tailwinds that we're seeing right now, so let's just go back. Consumption of all the inventory that we shipped to customers that they were working very hard to get implemented is going in line with our expectation. We think we work our way through that headwind mostly by the end of this quarter, our fourth fiscal quarter. That's a tailwind for next year. Obviously, the AI opportunity that we've talked about and being more second half, but for the full-year -- second half of fiscal '25, but for the full-year, that's a tailwind as we look ahead. Security business is doing what we said it was going to do, right? It's -- we've launched new products there even before the acquisition of Splunk and those products are getting good traction. So that's a tailwind as we look at next year as well. So I think all-in-all, I feel like it's kind of a down-the-middle view of fiscal '25 at this point. It's not a formal guide. I just wanted to give you a sense of what that looked like and we'll do -- we'll give you a better feel for what the longer-term looks like at our Investor Day in June, and then we'll give you a more fulsome guidance when we get to our Q4 call in August.

Chuck Robbins:

Thanks, Sami, and thanks to all of you for spending time with us today. I guess I'd say I'm pleased that we're getting to the tail end of this supply chain situation that we've been navigating for the last several years, on track to get this consumption issue behind us as we enter FY '25. I feel good about the overall demand environment we saw in Q4, which supports the fact that our customers are getting this digestion done. As we look to the future, we obviously are optimistic about AI, both from an infrastructure perspective, a data perspective as well as a cybersecurity perspective. Security in general, we believe will continue to improve. And obviously, we're super excited about the Splunk integration and we're committed to deliver for both our customers and for you. I also just want to quickly thank Jeff Sharritts for everything he's done at Cisco and also they were very excited to have Gary taking on the new role here and thank you all for being with us today.

Operator:

And thank you for participating in today's conference call. If you would like to listen to the call in its entirety, you may call 1-800-391-9851. For participants dialing from outside the U.S., please dial 203-369-3268. This concludes today's conference call. You may go ahead and disconnect at this time.

Operator:

Welcome to Cisco's Second Quarter Fiscal Year 2024 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 Sami Badri, Head of Investor Relations. Sir, you may begin.

Chuck Robbins:

Thanks, Sami, and thank you all for joining us today. We delivered a solid Q2 performance with revenue coming in at the high end of our guidance range. Strong operating leverage across our business drove our margins, which exceeded the high end of our expectations and allowed us to deliver better-than-anticipated earnings per share. In Q2, we once again returned a total of $2.8 billion in value through dividends and share repurchases. We also announced today another increase to Cisco's dividend payout rate, reaffirming our ongoing commitment to returning significant value to our shareholders through consistent capital returns. Overall, our Q2 results continue to advance our strategic business transformation around driving higher levels of software subscriptions and annualized recurring revenue, or ARR, both of which showed performance gains in the quarter. Our pending acquisition of Splunk also further supports our transformation strategy by fueling stronger growth, expanding our portfolio of software-based solutions and generating higher levels of ARR with roughly $4 billion in additional ARR expected upon closing and will make us one of the largest software companies in the world. Before turning to our performance in the quarter, I'd like to start by commenting on the demand environment. First, in terms of the macro environment, we are seeing a greater degree of caution and scrutiny of deals given the high level of uncertainty. As we're hearing this from our customers, it's leading us to be more cautious with our forecast and expectations. Second, as we discussed last quarter and subsequently saw in other technology provider results, customers have been taking time since the start of our fiscal 2024 to deploy the elevated levels of products shipped to them in recent quarters, and this is taking longer than our initial expectations. Third, we also continue to see weak demand with our telco and cable service provider customers. This industry has seen significant pressure and they are adjusting deployment phasing, which is weighing on our business outlook. Given these factors, we are adjusting our expenses and investments to reflect the current environment. That said, for the product categories in which we can measure customer inventory absorption through connections to the cloud, we are seeing steady progress. However, based on conversations with customers, we still believe we are 1 to 2 quarters away from full implementation of their inventory, which, as I mentioned, is longer than we expected. We continue to track Meraki activations, which are moving slightly faster in wireless and slightly slower in switching. Using our Meraki business as a proxy for our wider enterprise networking portfolio, we expect the current implementation of shipped products to be broadly complete by the end of fiscal 2024. Looking at our wireless business as an example, we are encouraged by the number of orders of $1 million or more, which increased approximately 50% sequentially in Q2. This indicates that many wireless customers have finished absorbing what we've shipped to them and are preparing for larger deployments in the coming months. Our team is also partnering closely with customers to assist with this heightened focus on deployments of Cisco equipment on hand, contributing to our services revenue increase year-over-year. It's also worth noting that non-hardware-centric revenue in areas such as security and collaboration increased and our observability offerings grew double digits year-over-year. Finally, despite the near-term challenges, our win rates are stable and on a rolling 4-quarter basis, our market share remained steady in three of our four largest markets. Now moving on to our performance in Q2. As I mentioned earlier, our performance in the quarter was broadly in line with or better than our Q2 expectations. Given the trust our customers place in us and the criticality of our technologies to the outcomes our customers are seeking, I am confident about the foundational strength of our portfolio and our future growth opportunities. With our innovation, we deliver and enable our customers to deploy next-generation applications in a highly secure manner. As part of this, we help facilitate their growth through our products and services so that when our customers adopt new technologies, we grow alongside them. We continue to accelerate our innovation across high-growth areas. Last week at Cisco Live EMEA, we announced new capabilities in networking, furthering our vision for the Cisco networking cloud. We also announced several new capabilities across our security, collaboration and observability portfolios leveraging AI throughout. We also continue to capitalize on the multibillion-dollar AI infrastructure opportunity. This quarter, we announced the next phase in our partnership with Nvidia to offer enterprises simplified, cloud-based and on-prem AI infrastructure. This includes both networking hardware and software to support advanced AI workloads. We are clear beneficiaries of AI adoption, and this partnership further demonstrates the central role we play in AI and the overall technology ecosystem. Our combined solution will be sold through our extensive global channel with professional services and support from key partners who are committed to helping businesses deploy their GPU clusters via Ethernet infrastructure. In web scale, we continue to see momentum with three of the top four customers deploying our hyperscale Ethernet AI fabric, leveraging Cisco-validated designs for AI infrastructure. While there is tremendous opportunity ahead, we are still in the early stages of adoption of AI workloads. In security, we continue to execute against our product roadmap to deliver the industry's most comprehensive unified platform with end-to-end solutions. This quarter, we introduced Cisco Identity Intelligence, an analytics layer that pulls data from identity infrastructure and performs behavior-based assessments to help protect against identity-based attacks which are at the forefront of cyber threats today. AI is also becoming more pervasive across the Cisco Security Cloud. For example, our new AI Assistant and Secure Access lets customers create security access policies using natural language prompts, reducing errors and speeding up policy administration by 70%. Our new security solutions like XDR and Secure Access are ramping quickly after being launched this fall with now over 230 Cisco XDR customers. Over the next 6 months, you can expect more meaningful announcements across the portfolio through our accelerated organic innovation and inorganic investments. In addition, we have now extended our AI-powered ThousandEyes into Cisco Secure Access joining past integrations with AppDynamics, Webex, Catalyst and Meraki platforms. ThousandEyes allows our customers to understand the digital experience of users, applications and things through billions of daily measurements of the Internet and public SaaS, as well as thousands of enterprise customers creating best-in-class digital experiences for users. In observability, we introduced the Cisco Digital Experience Monitoring application, providing deep insights into the performance of browser and mobile applications and efficient resolution of session level issues. Our continued generative AI innovations build upon our existing platform capabilities, further enabling operations teams to focus on what matters most, minimizing tool sprawl, improving overall performance and delivering highly secure digital experiences. Going back to the pending Splunk acquisition, the combination of Splunk's complementary capabilities with ours and AI, security and observability will create an end-to-end data platform to enhance our customers' digital resiliency. We are excited that together, we will bring trusted innovation leadership, an outstanding go-to-market engine and a world-class culture that will help our customers achieve their technology outcomes with innovative products and solutions. I would also like to provide a brief update on timing. While the closing of the acquisition of Splunk remains subject to regulatory approvals and other customary closing conditions, given the positive progress to date on the required regulatory approvals, we now expect to close the transaction late in the first quarter or early in the second quarter of calendar year 2024, which is in our fiscal third quarter. Before I turn it over to Scott, let me summarize three key takeaways. First, we have reset our expectations for the second half of the year given the cautious macro environment, our customers absorbing high levels of inventory and ongoing weakness in Service Provider. Second, you can count on us to take a disciplined approach regardless of the environment. We remain committed to operating leverage, capital allocation and expense management. Lastly, our portfolio continues to get stronger and stronger every day. While we have work in front of us and despite the current environment, we remain confident in our long-term strategy. We are relentlessly focused on our commitment to driving long-term value for our shareholders and industry-leading innovation for our customers. I'll now turn it over to Scott to provide more detail on the quarter and our outlook.

Sami Badri:

Thank you, Scott. Before we start the Q&A portion of the call, I would like to remind analysts to ask one question and a single follow-up question. Operator, can we move to the first analyst in the queue.

Amit Daryanani:

Yes, good afternoon. I'll ask both my questions upfront. Chuck, when I think about the lower revenue guide for the full year by about 500 basis points versus 90 days ago. Can you just touch on how much of that do you think is the digestion getting extended versus the macro versus the telco weakness? And then how do you sort of think about getting back to a positive revenue cadence organically? And then as a follow-up, I'd love to just understand this Nvidia announcement you folks had. There's a bit of a perception that it's more about servers, less about networking. I would love for you to just flush that out, what that means for Cisco? Thank you.

Sami Badri:

Thank you, Amit. Michelle, we have the next analyst.

Meta Marshall:

Great. Thanks. Maybe you've mentioned Service Provider, but I guess just getting a sense of whether you're seeing more weakness on data center or edge or if it comes to kind of the five investment priorities that you had noted that enterprises had a couple of quarters ago, or any one of those areas still getting prioritized significantly versus not getting prioritized significantly? And then just maybe as a second question, how are you seeing enterprises think about AI and think about where the budgets for AI are coming from? Just any commentary would be helpful there. Thanks.

Sami Badri:

Thank you, Meta. Michelle, can we go to the next analyst.

David Vogt:

Great. Thanks, guys, for taking my question. So maybe I just want to step back for a second, Chuck and maybe for Scott also. If I look at your guide for this year, I mean, we're basically back to fiscal '19 revenue levels. So I'm just trying to think about how your longer-term model works in the context of that 5% to 7% guide that you laid out at the investor briefing a number of years ago as a sort of investor - as sort of customer digest product. Obviously, it would suggest that maybe there's some more share loss going on in the core networking portfolio, given some of the other parts of the business has grown. So I just wanted to kind of try to get a sense for how you're thinking about the portfolio today, given we're kind of back to fiscal '19. And then from a profitability standpoint, obviously, you've done a tremendous job, and I would imagine the cost cutting goes along those lines to keep margins higher. But is there an opportunity to use margin and maybe price going forward to take back some of the share if there's a disruption in the market by a potential strategic transaction in the marketplace today? Thanks.

Chuck Robbins:

And David, on the share loss, I think if you look at the - just look at the last published reports that came out after Q...

Chuck Robbins:

Calendar Q3, the - in our four largest markets, so if you take campus switching, you take wireless and you take SP routing, we actually gained share. So I don't know where the share loss thesis is coming from. When you look at data center switching, you will see it show up as a share loss. But to be - we have to understand that one of our major competitors there reports their web scale sales into data center switching, and we report our web scale sales into SP routing. So those turn into sort of apples and oranges categories. But the others, based on the last reports that were put out, we actually have gained share if you look at a rolling four quarter even over the last 3 years.

Operator:

Thank you. Simon Leopold with Raymond James. You may go ahead, sir.

Chuck Robbins:

Yes. Thanks, Simon. So on the order trajectory, I think what - we clearly don't guide bookings. But what I would tell you is that even as our teams modified their second half outlook, the second half will still be more favorable than the first half. So your assessment of sort of the trajectory, I think, is valid, and I'll leave it at that. On the AI clusters, I think it's a good question because what you'll hear is us and competitors talking about a number of web scale players that are using our technology underneath GPUs, our Ethernet technology and our GPUs. And so I think it's important to remember, they always tend to have a dual vendor strategy. They always want two sources, and so we're both actually - the two of us are actually playing in this space today. And I'd say today, they're completely homogeneous clusters. And I think it's too early to tell whether there will be some benefit over time for them to mix those. My sense is, unless there's something that changes significantly or there's some sort of technology reason for GPUs to be mixed, which I can't speak to at this point. I don't think the underlying network will be mixed. I just don't think there's any benefit for them to do that.

Operator:

Thank you. Tal Liani with Bank of America. You may go ahead.

Chuck Robbins:

Okay. Thanks, Tal. So I think over the last few quarters, I've been pretty consistent that we thought the second half of this fiscal year, we would start to see an acceleration of security. And I can give you some highlights where we are seeing some of that - some green shoots early. Some of the new innovation like XDR and Secure Access, Multicloud Defense suites are - we're seeing good pipeline build with those technologies. XDR, we now have - we announced that in April last year, we shipped in August. And we have 230 customers, 230-plus customers on the platform today. And the important thing to remember is that it's a big platform play. And we actually typically see that as a 6 to 9-month sales cycle. So to have 230 customers already, I think, is a statement on the value that our customers are seeing. That's going to be a real important integration point with Splunk, by the way. So that we see, we see - we feel good about the pipeline. From a demand perspective, just to give you some insight, the Americas, the demand was almost double digits this past quarter, which is the highest we've seen in a while. So I think we're seeing a lot of good indicators. And if you just watch over the next 6 to 9 months, you're going to see more and more innovation that comes out. And I think you'll begin to believe and see the results around that same time frame.

Operator:

Thank you. Samik Chatterjee with JPMorgan. You may go ahead, sir.

Chuck Robbins:

Thanks. I would say on the thing that's changed from last quarter is that we do just see a little more caution with our customers. I don't want to over-rotate and say that it's a massive shift, but we definitely saw more caution. We talked with our sales leaders ahead of the call, and they indicated - we asked them point blank, was there more caution or the same caution from the prior quarter, and we heard more, a little bit more. And then we saw the push out of the forecast. So that just tells us that there is a little bit more in the system. So therefore, I think we need a couple of quarters to see it play out before we can declare what's going to happen in fiscal '25. On the Nvidia discussion, a couple of comments. We talked about the $1 billion of orders, which I know someone is going to ask me about at some point. And what I would say is that in the last 90 days, our pipeline of AI opportunities continue to grow. The pipeline is now almost three times that particular number that we gave last time, which were more orders that we see in '25. The total pipeline is now about three times that, roughly three times that. And I would say that virtually none of that is anything associated with the Nvidia partnership yet. It's all independent of that.

Operator:

Thank you. Ben Reitzes with Melius Research. You may go ahead.

Chuck Robbins:

Thanks, Ben. So I would say on the HP, Juniper deal, the one area where they have meaningful overlap is in wireless. And I don't know if there's any connection to the fact that we had a 50% increase in $1 million-plus wireless deal sequentially. So it's hard to say. But I mean there is a lot of noise in the system or in the industry about what they do there, but I can't say specifically that any customers have talked to me about it, to be honest. So I think we're - I think it's a little early for them to - for the customers to be expressing that concern. They may be asking them directly, but they're not talking to us. On the timing, yes, I think we said fiscal '25, which starts in August of this year. And I think you probably should assume most of that is probably in the second half, I would guess, but we'll see how things play out. I think customers are going to move as fast as they possibly can, but we're still in the early strategy and planning stages right now on most of it. The pipeline stuff are well-defined use cases that are already in place with certain customers, and we're actually just working through the opportunities.

Sami Badri:

Thank you, Ben. Michelle, next question.

Matt Niknam:

Hey, thanks so much. And I'll keep it to one and one follow-up. So main question, just around inventory digestion. Is that dynamic primarily affecting enterprise and commercial customers? And can you talk a little bit about the visibility you've got towards this actually resolving itself by fiscal year-end? And then a follow-up just on gross margins. You were fairly stable sequentially, and I think the guide implies more of the same. So I'm just wondering, are we now largely past a lot of the supply chain dynamics or headwinds? Or has anything changed on the supply chain front? Thanks.

Scott Herren:

Yes. What you saw in the quarter is, of course, gross margins continue to show a year-on-year improving trend, roughly flat, as you said, sequentially. There's a couple of dynamics. But to your question on where does this settle in? I think it settles in the range we're in right now in the 66% to 67% range through the end of the year. There's both the things that are happening from a freight and delivery standpoint, freight costs with what's happening in the Red Sea have gone up slightly, and we continue to see a little bit of component pressure, although in the commodity sections, we're seeing some benefit there. The scale of the services ramp up as you - obviously, services revenue trails the product revenue. We had those three really strong quarters of product revenue growth. We're seeing the tail of that now in our services revenue growth. And since a lot of the cost underneath our services are fixed, you get better leverage when that happens. So I think when you add all those together, we should settle in, in the 66% to 67% range. And the majority of, if not all of the supply chain constraints that we felt are behind us at this point.

Operator:

Thank you. Michael Ng with Goldman Sachs. You may go ahead, sir.

Scott Herren:

Michael, on the midpoint of the revenue guide, the math would lead you to what you just said. I think no one ever wants to have to reset guidance, much less have to do it twice. As Chuck just said, as we look at all the various factors coming in from the field, we see caution. And I think you should expect that there's caution in our guide at this point.

Sami Badri:

Thank you, Michael. Michelle, next question.

George Notter:

Hi, guys. Thanks very much. I guess I'm just curious about - are there any mechanisms or activities you guys are using to help accelerate the clearance of inventory from the channel? Any price discounting, any rebating stock rotation, how are you taking an active approach here? Thanks.

Scott Herren:

Yes. We absolutely are working with the field on that. In a lot of cases, it boils down to a lack of the skilled resources required at both - sometimes at our partner level, sometimes at the customer level to get that done. There's only so much you can do to accelerate it. We have put in place incentives to make that accelerate. To your other point on cancellations or stock rotation, we're seeing those continuing to be well below where they were pre-pandemic. So we're not seeing any of that - any pressure on that front.

Operator:

Thank you. Woo Jin Ho with Bloomberg Intelligence. You may go ahead.

Chuck Robbins:

Yes. I think - thanks for the question, Woo Jin. I think the way to think about it is, we put a - as you can imagine, when you built up the level of annualized recurring revenue that we have, we've put a huge amount of focus on both customer success and driving adoption and then turning that adoption into renewals. We've invested fairly heavily in that space over the last couple of years, and we're seeing renewal rates respond accordingly. When you look at where we're more software-heavy outside of networking, but in both security and collab, as you saw, we reported growth - revenue growth in both of those categories. Observability is almost exclusively software, and we posted 16% revenue growth in observability. So we are seeing that actually trend in the right direction.

Operator:

Thank you. Tim Long with Barclays. You may go ahead, sir.

Chuck Robbins:

Yes. Thanks, Tim. So on the margin growth trade-off, we're always considering that. And we're very disciplined, though. And we think that gross margins are clearly a reflection of the value that your customers see and your technology and what you deliver. And if you look at a lot of our competitors, and you look at some of the market share, I mean, some of the gross margins that they have, that tells you that they're viewed more as a commodity. And I think that our customers see real value in what we deliver to them. So while we always look at margins versus growth, we also are - we're just disciplined across both. On the AI front, Silicon One is a big play, clearly. We've delivered next-generation silicon into several of the cloud providers right now. We've got the Ethernet running in three of the four big ones, and we'll use the same silicon in the enterprise data center over time. We've got GPUs in our UCS platforms. And so it's evolving, but we have - I tell our teams unlike the original cloud transition that we talked on this call several times about how we were not prepared for the infrastructure play in the cloud world. I think we are absolutely ready and well equipped to succeed in this transition to AI. It will be a tailwind for us as we get into it over time.

Operator:

Thank you. Our next question comes from Aaron Rakers with Wells Fargo.

Chuck Robbins:

So our team measures what their use cases or franchises or however you want to think about it, there are specific areas within the infrastructure that we identify for each of the webscale players. And Scott, keep me honest, I want to say we're designed into '16 or...

Chuck Robbins:

21 of those. And so that's how I would think about it. I don't think that right now, if you looked at the growth numbers, they wouldn't be reflective of what's going on because they're just digesting inventory right now. So they're not in a position where they need to order a lot because lead times have normalized so much. So I don't think that's - it's not even relevant. I think understanding those 21 use cases. And as I said earlier, they want dual source, and they want dual source all the way down to the silicon level. In the traditional days with carriers, they wanted two vendors who would provide two different integrated systems. In this case, that may be the case with cloud, but they also look at silicon, they look at components. They're very deep on wanting to make sure that they have resiliency and optionality.

Sami Badri:

Thank you, Aaron. And Michelle, we have time for one last question.

James Fish:

Hey, guys, thanks for squeezing me in here. Scott, based on a couple of comments you made around gross margins. Just wondering, with supply chain starting to go the other way and supply more readily available, could we see the price increases enacted in the past now have to be given back? And any sense to how should we think about the annualized cost savings on these reductions, understanding there are people here and difficulty and what areas you guys expect to kind of reduce down and if some of those reductions are filled elsewhere in terms of like a net basis on headcount? Thanks, guys.

Sami Badri:

Thank you, Jim. Cisco's next quarterly conference call, which will affect our fiscal year '24 third quarter results will be on Wednesday, May 15, 2024, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. This concludes today's call. If you have any further questions, please feel free to contact Cisco Investor Relations, and we thank you very much for joining the call today.

Operator:

Welcome to Cisco's First Quarter Fiscal Year 2024 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 Sami Badri, Head of Investor Relations. Sir, you may begin.

Chuck Robbins:

Thanks, Sami, and welcome to Cisco. I hope everyone is doing well, and thanks for joining us today. We delivered a solid start to fiscal 2024, with the strongest first quarter results in Cisco's history in terms of revenue and profitability. Our Q1 revenue was at the upper end of our guided range. EPS exceeded the high end of our guidance, driven by strength in gross margins and expense control, resulting in strong operating leverage. Our disciplined expense management and the tailwinds from our business model transformation resulted in our highest non-GAAP gross margin in over 17 years and record non-GAAP operating margin. We also returned $2.8 billion in Q1 via cash dividends and share repurchases, delivering on our capital return commitments to our shareholders. As we continue to transform our business towards more software and recurring revenue streams, fueled by accelerated innovation, we remain committed to driving operating leverage and shareholder returns. Now turning to the demand environment, after three quarters of exceptionally strong product delivery, our customers are now focused on installing and implementing these unprecedented levels of products. The bottleneck that we previously saw in the supply chain has now shifted downstream to implementation by our customers and partners. Our order lead times and backlog have largely returned to normal levels. As deliveries rose, the channel inventory we track at our distributors also steadily declined during this time. Simply put, customers are now taking time to onboard and deploy these heightened product deliveries. While the macro challenges we have discussed still exist, we believe this implementation phase is the primary reason for the slowdown in new orders. We saw it mostly with our larger enterprise, service provider, and cloud customers, and it was most pronounced in October. Based on our analysis, we believe this phase is temporary and estimate there is an additional one quarter to two quarters worth of shipped orders in customers' hands, still waiting to be deployed. This has near-term consequences for revenue and our outlook for the next couple of quarters, which Scott will discuss shortly. However, it does not change our longer-term confidence. We expect product order growth rates to increase in the second half of the fiscal year. We also remain very confident in the foundational strength of our business and future growth opportunities given the criticality of our technologies. Overall, our win rates are stable, cancellation and return rates remain below pre-pandemic levels, and we have gained market share, all of which are testaments to the strength of our portfolio and how it aligns to our customers' most pressing needs. As we look to enhance our capabilities in higher growth areas, in the first quarter of fiscal '24, we announced our intent to acquire Splunk. The combination of Cisco and Splunk will create an end-to-end data platform to enhance our customers' digital resiliency with our complementary capabilities in AI, security, and observability. The combination of Cisco and Splunk also directly supports our strategic objectives around driving higher levels of growth, software capabilities, and ARR. Together, we will bring trusted innovation leadership and outstanding go-to-market engine and a world-class culture that will help our customers achieve their technology outcomes with innovative products and solutions. Now, let me comment on our quarterly performance. As I previously mentioned, we delivered strong revenues in Q1, which was broad-based across our product portfolio and driven by our customers' investments in generative AI, cloud, security and full stack observability. As expected, we continued to gain market share with the release of the calendar Q2 results, recording another quarter of year-over-year gains in three of our largest networking markets

Sami Badri:

Thanks, Scott. Michelle, let's go ahead and queue-up for questions.

Sami Badri:

Tal, you there?

Chuck Robbins:

Yes, Tal, it's a great question. As I said in -- well, we talked about one quarter to two quarters of basically inventory, but shipped product that's at our customers, it's not yet been installed. I expect the impact to be greatest in Q2 and in Q3. But when you look at the order growth, we do see a return to order growth in the second-half of the year, both sequentially and year-on year as we get there.

Chuck Robbins:

No, from a revenue standpoint, we don't guide bookings, Tal, but from a revenue standpoint, I do see sequential increase, Q2 to Q3.

Sami Badri:

All right. Thank you, Tal.

Sami Badri:

Michelle, next question.

Meta Marshall:

Great. Thanks so much. Maybe just a question on, if you see the investment categories kind of changing maybe free, the orders that you've seen, and then when do you see them come back in a couple of quarters. I guess, I'm just trying to get a sense of have much of the orders we've seen over the last year been catch-up investments like campus and data center? And then areas of investment will change as we come back or is this really just inventory digestion and the investment categories and kind of investment prioritization will stay the same with customers? Thanks.

Meta Marshall:

Great. Thank you.

Operator:

Amit Daryanani with Evercore. You may go ahead.

Chuck Robbins:

Yes. Amit, thank you. So if you'll be patient with me, I'll give you a few data points and some context around why we think this -- this is a -- an inventory issue that's sitting with our customers. First of all, our customers and our sales organizations have been very clear with us over the last 90-days that this is the issue, particularly our large enterprise and our large -- and our service providers. We talked about that with the service providers prior, but it shifted into the enterprise space in a big way. The other thing is, we had our Partner Summit last week and some of our largest partners unsolicited began their conversations with me by talking about this very issue, which candidly I knew the customers had talked about it and our sales teams had talked about it. I was actually surprised to hear. It's so consistently at that Partner Summit. So, that's sort of the subjective view and then we've done some analysis and there's three things I'd point out. The first is, in certain parts of our portfolio, we actually can -- we can see the timeframe from shipment of a product until the product begins to connect to the cloud, back to the cloud like Meraki/And what we've seen is a one-quarter to two-quarter delay versus what historically you would see when these products get shipped, how long it takes for them to be activated and connect to the Meraki cloud. So that's the first piece. The second is, we had a very strong quarter in federal, U.S. federal, from an orders perspective. And so, we looked into why big customer like the U.S. government, Department of Defense, would not have the same issue. And the reality is, is that they have special clauses in their contracts that give them most favored nation status when we're actually making shipment decisions, and certainly with the Department of Defense, we prioritize them during the supply chain crisis. So they never had a big influx, they had a very steady flow of products across, which explains why their order numbers look fairly normal. The third point I'd say is that we noticed a serious uptick in Q1 in our Transactional Advanced Services, which is loosely translated to be implementation services, where that grew almost 20% and the forecast for Q2 is almost double-digits again. So it's clear that customers are asking us to come help them get this done. And I'll give you one final subjective data point and then I'll talk about the AI stuff. We had one big partner tell us that they will have literally hired 200 people in the last 90-days, solely focused on implementing technology for their customers. So there is just so many things that we've learned over the last 90-days. Clearly, this surprised us. But I think we feel pretty good right now. I'll make a comment about why I don't think it's macro, candidly it might have been easier for me to say it was macro. But as we've discussed prior, we have -- the traditional service provider has been tough and it remains that way. We've talked about elongated sales cycle, they remain. We've talked about, in some cases, the need for extra signatures, which is pretty normal, that's remained. But we didn't see it get materially worse in the quarter. And so all of that -- and I'm sorry for the long answer, but I wanted to be thorough, all of that is really what led us to believe this -- that this is a consumption issue with our customers. So I'm going to pause there, and then I'm going to answer your AI question. What we gave last time was orders to-date. We have taken orders for over $500 million. For infrastructure to support AI networks, AI GPUs inside the cloud players. Then -- and I'll talk a little bit more about that in a moment. The numbers that we gave today is a forward-looking set of numbers. Let's say, in fiscal year ‘25, which is when we said, we believe that the broad ethernet build-out would occur underneath GPUs. We have already seen -- we have line of sight to $1 billion plus of orders that our teams feel pretty good that we're going to get and/or we've been designed in already. So that's just sort of a forward-looking set of orders that we've identified for fiscal ‘25, okay. I will also just cover real quickly, we are now -- we now have our ethernet fabric deployed underneath GPUs in three of the four Hyperscalers, major Hyperscalers in the United States. We also are working very closely with AMD, Intel and NVIDIA, to create solutions including ethernet technology's GPU-enabled infrastructure joint -- jointly tested and validated reference architectures. And I will say even this week, yesterday, Jensen from NVIDIA and four of his -- four, five of his executives came over to see us and we spent 90 minutes together with my executive team. And we believe we have a great opportunity to actually build some integrated solutions between our technology and their technology to actually take to the enterprise. So we're beginning to see the use cases in the enterprise evolve. And we think that partnership with NVIDIA, in that case, with our underlying technology and our strength of go to market, we think will be a winning combination. So we're working on that as well. So there's a lot going on in the AI space.

Operator:

Thank you. Simon Leopold with Raymond James. You may go ahead.

Chuck Robbins:

Hey, Simon, thanks for that. I would say the bigger variance that we're seeing, I mean, right now, obviously the demand signal is little bit tough because of the amount of inventory that's out in the field and that we have normalized lead times at this point. We knew that would happen sometime in the first half. That's now happened. Our lead times are back to where they were pre-pandemic. And our backlog has shipped. The supply chain team has done a terrific job getting product out the door. That's what's kind of moved the bottleneck from our level down to our customers' level. But when you start to unpack within networking, we're not seeing at this point, a huge difference between, for example, datacenter or campus networking. But what we are seeing is a little more field-based inventory on wireless access points. That's been slightly slower than what we've seen. It just because of the amount of product that's been shipped out than what we've seen in the rest of the networking.

Sami Badri:

All right. Thank you, Simon.

Sami Badri:

All right. Michelle, next question.

Ben Reitzes:

Hey, thanks. Good afternoon, everyone. I wanted to ask about your share repurchase cadence. Stock obviously could get hit here. We have been talking about $5 billion in buybacks or so for the year. I know some of that stops that dilution. If you guys are confident in the second half pickup, is there any potential that you would be more aggressive in the upcoming quarter? And how are you thinking about share repo this year, given current dynamics with the Splunk deal coming? Thanks.

Sami Badri:

All right. Thank you, Ben.

Sami Badri:

All right. Michelle, next question.

Samik Chatterjee:

Hi. Thank you for taking my question. I guess, if I can just clarify one thing first. I think, Chuck, in your prepared remarks, you did say, you saw the more pronounced impact on the orders in the month of October. I think that's what I heard you say. I mean, just curious, are you implying that you did see an improvement in orders in the sort of first couple of weeks of November itself and that's maybe part of your confidence in that? It's a bit more temporary than a longer pause from the customers? And then you did mention large partners really being the ones that are facing this sort of inventory installation problem. What gives you sort of color that SMB, the smaller customers sort of not going to face the similar issue or are you also baking that in, in terms of your sort of next couple of quarters of headwinds that you're thinking about on the revenue side? Thank you.

Samik Chatterjee:

Okay. Thank you.

Operator:

David Vogt with UBS. You may go ahead, sir.

Scott Herren:

Yes. Yes, David, we did say that. I do. We are expecting sequential improvement in the second half of the year in both Q3 and in Q4. And in both -- and again, we don't guide this, but in both orders and revenue as you'd expect. Backlog is normalized at this point. We knew that would happen in the first half. I think supply chain team did a great job getting those orders in the hands of our customers. We would now need them to implement them, but we've got the orders in the hands of our customers. So we do see sequential increases. And as you said, as you noted from a bookings standpoint, our order standpoint, the second half has easier compare points. Obviously, the reverse is true on revenue and the second half revenue will have very difficult compare points than last year.

Sami Badri:

All right. Thank you, David. Michelle, next question.

Matt Niknam:

Hey, guys, thank you for taking the question. Maybe just to dovetail one follow-up to the prior question, I have just another one on margins. Just on the prior one, is the expectation for a second-half improvement in a one-quarter to two-quarter digestion, does that vary at all across the three different customer sets you outlined? And then just on the margins, 36.6% on op income margins this quarter, I think the guide implies a 400 basis point to 500 basis point dip. Is that due to just the sheer revenue decline sequentially? Or are there other cost items we should consider on either the gross margin or OI margin line? Thanks.

Matt Niknam:

Just around the expectation for second-half improvement in orders one quarter to two quarters worth of installation, is that broad across the three customer sets? Or does it vary across service provider, enterprise and federal?

Matt Niknam:

Thank you.

Operator:

George Notter with Jefferies. You may go ahead.

Chuck Robbins:

Thanks, George. I think that the reason it's become relevant now is because if -- I mean, we really unloaded our backlog in the last six months. I mean -- and it was billions of dollars more than what we would normally ship to customers during that time period. So they -- I think it's just -- and we know that the cloud providers, as an example, had been buying ahead and they had been doing it for sure to your point. And all along, we have very sequenced purchasing cycles with those players. So we kind of know when they are going to start placing their next orders. I think on the enterprise, we're talking about the top 200 customers, right. These are the big customers who actually -- if they're doing a refresh of their infrastructure, they might order 400, 500 switches, as an example. Or they may be doing a branch rollout. And in some cases, to your point, it could be sitting with them or they could have a partner who's doing the staging, and the partner may be backed up with resources to try to get the staging done. So it varies, but it could be a -- either one of those or a combination of both.

George Notter:

Alright. Thank you.

Operator:

Michael Ng with Goldman Sachs. You may go ahead.

Chuck Robbins:

Thanks, Michael. On the AI question relative to the cloud players, I think that -- look, I think early on, we regained our footing there because we listened and we showed flexibility with our willingness to disaggregate if they wanted to do so. And we're in -- I can't even remember, but numerous use cases across the large web scale players. And I think we added over 10 new use cases last quarter alone, where we had been designed in. And I think it's -- so I think that the disaggregation and the flexibility and us listening to them and understanding what they wanted was the reason that we got back in. And now the feedback is as long as we're performing, I think they like our products, they like the power savings of Silicon One. It's a massive power -- lower -- massively lower power consumption. I think they do like silicon diversity for sure. And then as you look at the AI infrastructure that's currently primarily being supported via InfiniBand, they just want to move to more of a standard broad-based technology like Ethernet that they can actually have multiple sources. And so we think that's what's driving that now. And now it's just about performing and executing and delivering on what we tell them we're going to do. Scott, do you want to take the second?

Michael Ng:

Great. Thank you, Chuck. Thank you, Scott.

Sami Badri:

All right. Thank you, Michael, and all right. So we'll go ahead and turn it over to you, Chuck, for some closing remarks.

Sami Badri:

Cisco's next quarterly call, which will reflect our fiscal year 2024 second quarter results, will be on Wednesday, February 14, 2024 and at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. This concludes today's call. If you have any further questions, please feel free to contact the Cisco Investor Relations department, and we thank you very much for joining the call today.

Operator:

Welcome to Cisco's Fourth Quarter and 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 turn the call over to Marilyn Mora, Head of Investor Relations. Ma'am, you may begin.

Chuck Robbins:

Thanks, Marilyn, and good afternoon, everyone. Fiscal '23 was a milestone year for Cisco. We delivered on our operational and financial goals while accelerating our transformation. We achieved record revenue and earnings per share in both the fourth quarter and the full year. We also generated strong margins, record operating cash flow and strong shareholder value, returning 10.6 billion via share repurchases and increasing cash dividends. In FY '23, we delivered nearly 57 billion in revenue, up 11% year-over-year, the highest revenue growth rate in over a decade. Overall, customer demand also remained solid. In Q4, we achieved over 30% total sequential product order growth. The second highest in 20 years with double-digit increases across all customer markets. As we look to build on this strong performance going forward, we remain focused on the following. First, growing market share in all key areas of our business. Second, driving innovation and extending our leadership by investing in significant new opportunities for growth in AI, cloud and security. Third, delivering long-term sustainable value creation for our stakeholders and fourth, transforming our business model by growing recurring revenue. Consistent with what we said last quarter, we expect to build on our record results delivering modest revenue growth in fiscal year '24, with the bottom line growing faster than the top line demonstrating operating leverage. Our outlook reflects good visibility and predictability, driven by healthy backlog, ARR and RPO. We remain deeply committed to building shareholder value and increasing returns to our investors. We will do this through a long-term commitment to greater operating leverage while increasing our annual share repurchases and growing our dividend. Now, let me share additional detail on the quarter and key growth opportunities ahead for Cisco. First, one of our greatest competitive advantages is our pace of innovation. This quarter, we announced new solutions spanning generative AI, hybrid work, security, full stack observability and sustainability. In addition, we remain focused on delivering a more unified and simpler experience for our customers. As I've stated in the past, we knew that as our backlog cleared, we would see corresponding market share gains. With the release of the calendar Q1 results, we gained over three percentage points of market share year-over-year in our three largest networking markets. Campus switching, wireless LAN and SP routing. We expect further share gains in these areas as market share numbers are released for calendar Q2. Second, the acceleration of AI will fundamentally change our world and create new growth drivers for us. While AI has been an important element in our products for several years, this quarter we announced new market leading AI technologies across our collaboration and security portfolios designed to boost productivity, enhance policy management and simplify tasks. We also launched new AI scale infrastructure innovation to allow our customers to process AI workloads more efficiently. Cisco's ASIC design and scalable fabric for AI position us very well to build out the infrastructure that Hyperscalers and others need to build AI/ML clusters. This is a huge opportunity for Cisco and we are laser focused on leading and winning in this space. As a result of our innovation in this area, we expect Ethernet will lead in connecting AI workloads over the next five years. To accelerate this transition, Cisco became a founding member of the Ultra Ethernet Consortium, an industry wide effort to drive open large scale Ethernet based fabrics for high performance networking. In June, we launched our next generation Silicon One switching ASICs to support large scale GPU clusters for AI and ML workloads. We are seeing early success in Hyperscale Ethernet AI fabric deployments. To-date, we have taken orders for over $0.5 billion for AI Ethernet fabrics. We are also piloting 800 gig capabilities for AI training fabrics. Overall, Cisco is committed to helping our customers navigate this transition in a trusted and responsible way to deliver on the full promise of this technology and we are well positioned to win. Next, security remains a top priority. Our AI driven security cloud platform has comprehensive capabilities across the network endpoint and the cloud, helping to simplify security management while increasing efficacy. Our new technologies like XDR, multi-cloud defense and cloud secure access, a secure service edge solution are seeing rapid early adoption. For example, Goldman Sachs has been one of our early adopters of our multi-cloud defense solution. In addition, we are working with Apple to incorporate Cisco's secure access solution into iOS and macOS. These innovations, combined with our recent acquisitions, show how we are extending our security portfolio with deep telemetry AI and identity threat capabilities. Given our installed base of 300,000 Cisco security customers, we believe we have the opportunity to accelerate revenue growth in security over the next few quarters. To summarize, we had a phenomenal year. Our fiscal year '23 and Q4 results demonstrate the strength of our business today and are a solid foundation for future growth. I also want to be very clear on our commitment to increasing shareholder returns through capital return, innovation and strong execution. Last quarter, we committed to operating leverage in Q4 and fiscal year '24 and our guidance today reflects this. Today, I want to confirm that this will be our long-term strategy beyond fiscal year '24. We will also drive a high degree of consistency into our stock repurchase program and will maintain the quarterly levels in the range that we have over the past few quarters. Finally, I want to take a moment to thank our teams who all played an important role in delivering these record full year results and their deep commitment to our -- to the success of our customers and partners. With our focus on innovation and our commitment to operational excellence, I have tremendous confidence in our ability to capitalize on the many opportunities ahead. I'll now turn it over to Scott.

Marilyn Mora:

Thanks, Scott. Michelle, let's go ahead and queue up for questions.

Tim Long:

Hi. Thank you. Yeah, Chuck, maybe we'll start with kind of the order backlog performance. Sounds a lot better than seasonal in Q4. Could you talk a little bit about what you attribute that to and then maybe looking into next year, doesn't look like you're baking a lot of that into either Q1 or the full year. So what's kind of the expectation for kind of the pull through of those orders into what you're going to see in revenues in fiscal '24? Thank you.

Scott Herren:

Yes. As we think about fiscal '24, we've got pretty good visibility driven by really the business model shift that we've talked about. So a couple of data points that I think you already have, Tim. One is current RPO of $17.9 billion. So total RPO approaching $35 billion, of which $17.9 billion is current, meaning it turns into revenue in the next 12 months. We ended the year as we expected with roughly double our normal backlog levels. But that excess backlog will work down in the first half of fiscal '24 with the majority of that being worked off in Q1, by the way. And we've got $24.3 billion of ARR that we get a chance to renew. Now obviously, some of that will already be captured in RPO, but there's opportunity that's not already captured in RPO as well. So we entered the year with round numbers, 40% of that top line pretty much already in hand between those three categories. So feel good about the way we've -- the way we see the year laying out.

Tim Long:

Thank you. Very helpful.

Operator:

Thank you. Amit Daryanani with Evercore. You may go ahead, sir.

Chuck Robbins:

Let me make some just a couple of comments, and I'm going to hand it to Scott and let him answer probably both of these. On the capital allocation and the leverage comments, what I would say is that we've spent a lot of time talking to our shareholders over the last few months. And it's clearly important to our shareholders that we commit to and we deliver on operating leverage in our P&L, and we've been doing it, but we haven't committed to it for long term. So that's what we're basically doing today is saying that we are going to continue to commit to do -- to provide operating leverage in the P&L as we look to the future. And then on the buybacks, we had also increased -- there are two things we wanted to do was increase the amount as well as drive more consistency and predictability for our shareholders. And so the rate, as I said, that we've been running at like the last three quarters is sort of the target that we would be at on a quarterly basis as we go forward. Scott, do you want to add to that and then talk about the revenue guide?

Chuck Robbins:

I think I remember that.

Amit Daryanani:

No, that three-year CAGR is really helpful. Thank you.

Operator:

Meta Marshall with Morgan Stanley. You may go ahead.

Chuck Robbins:

Yes, Meta, thank you. So on the Ethernet underneath the AI GPU networks, it is Silicon One for sure. And I think for the next 12 months or so, I think we'll be doing trials. I think we'll have some opportunities, but there'll still be a lot of InfiniBand. And that's why we joined as a founding member of this Ultra Ethernet coalition so that we can up guide the standards and really deliver Scheduled Fabric, to your point, in a very effective way. So we think into FY '25 and beyond, this thing will begin to shift to more of an Ethernet-based infrastructure. On the Security front, yes, we've had some early traction. I mentioned Goldman in the multi-cloud defense, which is a great sign of confidence in that solution. If you look at our XDR platform, which, candidly, we just went GA with it right at the end of the quarter. And we already took a seven-figure order from a retailer in Europe. So that was positive. We took one of our largest security orders ever. We took an eight-figure security order from a Fortune 10 company in Q4. So there's some early green shoots, and the teams are executing. The early feedback and early commentary from analysts and customers, et cetera, is positive, but we've got to actually deliver on it. And hopefully, in the second half of this year, we'll see some real positive impact and then '25 for sure.

Marilyn Mora:

Next question, please.

Michael Ng:

Hey, good afternoon. Thanks for the question. I just have two. First, it was encouraging to hear about the share gains on campus switching, SP routing and wireless as well as the expectation to continue to grow share. I was just wondering if you could talk a little bit about the sales execution, the product road map there that gives you the most confidence in that continued share growth. And then second, I was just wondering if you could talk a little bit about your expectations as it relates to the trajectory of orders going forward. It sounds like if the backlog kind of gets back to normal levels in the first quarter, you should just grow along with revenue growth as we think about order growth beyond the first quarter, but just would love your thoughts there. Thank you.

Scott Herren:

Trajectory of orders, yes. And, Michael, thanks for that question. What I'd say is, if you remember our commentary from the last call, we said there were kind of three things going on inside product orders. One was the lead times were normalizing, going from being fairly lengthy to going back to a normal level, which, of course, if the lead time yesterday was 30 weeks and today it's 10 weeks means you don't have to place another order for 20 weeks. Those are mostly normalized. They will finish being normalized certainly in the first half of fiscal '24. And so that effect will be dampened. The second is backlog. And as we were still sitting on excess backlog, and we still do, but we've obviously been working our way through that and delivering product to customers. As we get their backlog orders in their hands, they can complete that project and then place the order for the next project. And so that's also been a little bit of a headwind to bookings, and then it's whatever is happening in the macro would be the third factor. We think those first two will normalize in the first half of fiscal '24. Lead times will be normalized, certainly by the time we get to the end of the first half and much of the backlog -- the excess backlog will ship out during the first quarter of fiscal '24. So I think we'll have a clearer view, and I expect to see more normal ordering patterns. Of course, we don't guide orders, but I expect to see more normal ordering patterns in the second half of the year.

Chuck Robbins:

Thank you.

Operator:

Ittai Kidron with Oppenheimer. You may go ahead.

Chuck Robbins:

Yes. Thanks, Ittai. I'll give you a little color and then I'll let Scott comment again, too. A lot of this is -- we've made this transition to -- virtually our entire enterprise networking portfolio now is a subscription model. And so that contributes. And Scott can talk about the year-over-year contribution that we've seen. But I mean we have $35 billion in RPO. And I think it's an important thing because when you think about market share and some of the concerns that people have had, you have to remember that we put a reasonable amount of each order in our core networking portfolio on the enterprise side goes into RPO and doesn't get reported as revenue. It's ratable. So it's a headwind to market share. And the other thing that I would point out is that we had a record year at $50 billion -- almost $57 billion at a time where we were building RPO to $35 billion and we have the backlog that we have. So there, we've had a lot of solid customer demand. I'd say in Q4, we certainly saw a fair amount of the enterprise networking. As we ship those products, we saw that software come out of backlog as we've talked about and moved into RPO. We saw a lot of these enterprise agreements that we did with our customers in enterprise contributed to it as well. Those were reasonably large deals. And Scott, I'll let you comment anything -- any more you want to comment on?

Ittai Kidron:

Appreciate the color. Thank you.

Operator:

Matthew Niknam with Deutsche Bank. You may go ahead sir.

Scott Herren:

Yes. Matt, on your first question, I think gross margin settling, you saw our guide for Q1 of gross margins in the 65% to 66% range. And I think it settles in there for the full year. So you can do the math with what we've projected on the top line. That drops down to a mid-single-digit OpEx growth number, so in line with expectations certainly given the environment of merit increases. It doesn't provide a lot of incremental investment, but I think that's in sync with what you've seen us do over time. So the long-term model, look, that was opportunity-based. If you look backwards, what you've seen is we have delivered the bottom line growing faster than the top line. I think the only difference that you hear from us now is, as I said, we're articulating it in advance instead of once it's happened. That's really the way to think about that.

Marilyn Mora:

All right. Thanks, Matt. Michelle, let's take the next question.

James Fish:

Hi, guys. Thanks for the question. Maybe just diving in on the go-to-market side. We're hearing you guys are looking to move more of the specialist sales teams out and more towards kind of a cross-sell more portfolio kind of motion. Are you doing a larger sales restructuring right now? And is there anything you can do to better package solutions across these multiple segments, especially on the growth segments that are kind of struggling here, as Meta kind of pointed out earlier, with even security. And lastly, on the capital return side. I know you guys get asked about the technology, but -- and you talked about potential being strategic and all of that. But how do you feel about the push versus pull of either further acquisitions in either of the key growth segments that you outlined, Chuck, versus possibly even spinning off some of those segments like some of the larger companies you're starting to see do? Thanks, guys.

Scott Herren:

On the cap return question, Jim, I'd just reiterate what I said earlier. With the consistency of buybacks now running right around $1.25 billion per quarter, so $5 billion a year, the dividend consumes another $6.5 billion. That's $11.5 billion of cap return that we're committed to. And I do expect to continue to, as you've seen us do for the last 12 years, make increases in our dividend payment as you look ahead. So that's one lens on it. I would say on the M&A and spin-off part of that, we're constantly evaluating that. We're constantly evaluating what's available in the order marketplace. You saw we closed three, albeit small kind of tech tuck-in, but three acquisitions during the quarter. The team's very active. We're constantly looking at that space as well as the value in our own portfolio. And so there's nothing new to report there, but those are constant things that we look at.

Marilyn Mora:

All right. Next question please.

Ben Reitzes:

Hey, guys, thanks for the question. I wanted to double-click on an earlier question with regard to hyperscalers, the $500 million in AI orders you had a briefing in June. I was wondering, have things picked up in terms of activity there? It seems like maybe it has. And I wanted to see if there's further traction that you could articulate in Silicon One. Like what kind of activity are you seeing there? And how big a business can this be?

Ben Reitzes:

Okay. Thanks a lot, Chuck. It's good to be back .

Scott Herren:

Thanks, Ben.

Operator:

Tal Liani with Bank of America. You may go ahead.

Chuck Robbins:

Yes, Tal, thank you for that. And so on the 400 gig to 800 gig, I don't know that I've seen exact reports that you're talking about on the 400 gig. But our teams -- the volume of ports that we're shipping on 400 gig would imply that that's a -- I don't know, we've had a great deal of success and it's been growing quite significantly. So -- but we obviously had -- over the last few years, we've been rebuilding or actually building our presence in this space. So it wouldn't surprise me to see us as a low market share player, but we've certainly won our fair share. On the 800 gig, I think it's just a matter of we're engaged there. We're installed already. We've got trust with these customers. They've seen what we can do. And I think that we're just in the game at the right time as opposed to where we started. And so I think from now on, it just gives us an opportunity to be there from the beginning as opposed to trying to catch up.

Tal Liani:

Got it. Thank you.

Operator:

Samik Chatterjee with JPMorgan. You may go ahead.

Chuck Robbins:

Yes. Thank you. So on the service provider side, the first question you asked -- let me write my notes down, hold on a second, so I don't have to ask you for the question again. On SP, I think -- I'd say Q4 for the telco side of it, the communications service provider was probably fairly consistent with what it was the quarter before. It's just relatively weak right now. We see a lot of these customers have -- are digesting a lot of the infrastructure that they bought over the next few months. We think that -- our team believes that orders will stabilize on the telco side of the business in the second half of our fiscal year. On the cloud side, we believe that they'll continue to invest. And they kind of invest in six-month cycles. And we think that in the middle of our fiscal year, we'll see growth in that investment for the first part of 2025. On the $500 million, it is definitely in the Tier 1 hyperscalers. So I'll just leave it at that. On the opportunity that we see, we still see -- we won three use cases last quarter. And I would say those were primarily non-AI. So there's still -- we're still winning new use cases in the core infrastructure. And -- but we're in trials in different discussions with most all of them relative to AI fabric.

Chuck Robbins:

Thank you.

Operator:

David Vogt with UBS. You may go ahead.

Chuck Robbins:

Yes. We do not -- Scott and I are both looking at each other. We don't know of any supply chain issues we have around our AI. It's our standard Ethernet portfolio based on the Silicon One ASIC, and we're delivering it today. So I don't think there's any supply chain issue for us on that front.

Chuck Robbins:

On the FY '24 contribution of AI, I don't have that information on top of my head.

Chuck Robbins:

Go ahead.

Chuck Robbins:

Yes. What I was going to add, David, is I think until we evolve some of the -- get some of the Scheduled Fabric technologies built out, they're certainly running -- they're running some of these on traditional Ethernet, which is what we're deploying today. But as we get Scheduled Fabric out and these customers get more comfortable moving from InfiniBand to Ethernet, I think that's when we'll start to see the real impact of AI. And maybe it's late '24, but I would suspect into '25 for sure.

Scott Herren:

Yes. Don't think of the $500 million as all coming in, in the last quarter. Those are orders to date that we know are going into AI infrastructure. That's not a Q4-specific comment.

Scott Herren:

Yes.

Marilyn Mora:

All right. Thanks, David. We have time for one last question.

Simon Leopold:

Thanks for taking the question. I wanted to see if you could talk a little bit about what your assumptions are for your campus-related business, and I'm including both switching and wireless LAN. I assume that's roughly -- almost $15 billion of trailing four-quarter sales, somewhere in that ballpark. And I've seen market research saying that business declines, some saying it's growing. And Chuck, you highlighted that $1 billion renewal. Just trying to get my head around how material that is. What's built into the full year forecast for campus? Thank you.

Scott Herren:

Yes. No, I don't think there's a whole lot else to add. We're encouraged by what we're seeing in campus. It's one of the things that that we've said all along is as the supply -- the backlog begins to be delivered, you'll start to see more and more of those customer decisions that went to us actually show up in the numerator of those market share equation. That's exactly what you're seeing. So I think the concern over the several quarters while we had supply constraints that maybe impacted us more than some of our peers. You should see those unwind as we can now deliver that backlog. The $1 billion of renewal that Chuck -- roughly $1 billion of renewal that Chuck talked about, that is a subset of our fiscal '24 guide.

Marilyn Mora:

All right. So we'll go ahead and turn it over to you, Chuck, for some closing remarks.

Marilyn Mora:

Thanks, Chuck, I'll go ahead and wrap this up. Cisco's next quarterly earnings conference call, which will reflect our fiscal year 2024 first quarter results, will be on Wednesday, November 15th, 2023 at 1:30 P.M. Pacific Time, 4:30 P.M. Eastern Time. This concludes today's call. And of course, if you have any further questions, feel free to reach out to Cisco's Investor Relations group. And we thank you very much for joining today's call.

Operator:

Welcome to Cisco's Third 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.

Chuck Robbins:

Thank you, Marilyn, and hope you all are doing well. This was another strong quarter for us, and I am proud of what our teams have achieved. In Q3, we delivered our strongest ever revenue, non-GAAP income, non-GAAP EPS and operating cash flow. We also continued to successfully execute on our strategy, driving solid growth in ARR to nearly $24 billion and posting double-digit growth in subscription and software revenues. Based on our strong Q3 performance, we are once again raising our fiscal 2023 outlook for revenue and earnings per share, which Scott will cover shortly. As we look ahead to fiscal year 2024, we expect to see modest revenue growth, even with the tough compare of double-digit growth in fiscal year 2023. Now, before I go through our Q3 performance, I'd like to discuss three key areas that will help drive our long-term growth. First, we are pleased with continued success in our movement towards more subscriptions and recurring revenue. In Q3, we delivered 18% growth in software revenues. We also have $32 billion in remaining performance obligations, and we expect to see this momentum accelerate. Second, security continues to be an enormous opportunity for us. As you've heard me say, we've revamped our strategy, put a world-class team in place, and made this a top priority for the company. Over the coming quarters, you will see new innovations in this space, building on our strong Cisco Security Cloud strategy, including at Cisco Live next month. Based on the rapid progress we are making, we are optimistic about our opportunity in this fast-growing market. And third, generative AI and cloud. At Cisco, we already use predictive AI extensively across our portfolio. In addition, our core networking technology is already powering some of the leading AI models run by hyperscalers around the world. We have also moved rapidly to leverage generative AI capabilities in our own products, which you will hear more about in the next few weeks and beyond starting at Cisco Live. Now, let me discuss our quarterly performance. As I mentioned, in Q3, we delivered our highest ever quarterly revenue and non-GAAP earnings per share exceeding the high-end of our guidance range. We saw healthy margins and record non-GAAP net income, which reflect our strong operating discipline. All of this contributed to record operating cash flow in Q3. As we expected, the actions we took to mitigate supply constraints have continued to pay off. Price realization as a result of the actions we put in place last year helped offset inflationary pressures. Our disciplined cost management enabled us to continue to expand gross margins, as well as prioritize our strategic investments to drive long-term growth. As it relates to customer demand, it is being shaped by a few factors that we believe are impacting the entire industry. First, our increase in product shipments is often leading customers and partners to absorb these shipments prior to placing new orders; second, the significant reduction in product lead times reduces the need for extensive advanced ordering by our customers; and third, macroeconomic conditions. With this said, in our discussions with customers such as the ones we had at our most recent global Customer Advisory Board event earlier this month, they continue to invest in key technologies that are core to their overall strategies. As we previously shared, given the unprecedented demand for our technology during the pandemic, we believe sequential order rates are far more informative than year-over-year rates. Just like the prior two quarters, our sequentials in Q3 were in general alignment with historical ranges coming in 1 point below the historical range. In addition, our order cancellation rates also remain well below historical levels, indicating the strength of our backlog and portfolio. In terms of our backlog, we continue to expect that we will end the fiscal year with roughly double our normal product backlog. Now, let me share a bit more detail about some of our newest innovations. Regarding our webscale customers. They are currently consuming and implementing their prior significant technology investments. There remains a huge growth opportunity across all these customers enabled by our portfolio of hardware, software, silicon, and systems. We already see early design wins in AI infrastructure and continue to see other wins and competitive displacements leading to continued share gain in this space. In our networking business, we remain focused on building solutions that drive a higher return on investment and sustainability. In March, we introduced 800-gig capability to our Cisco 8000 platform with the industry's first 28.8 Terabit Line Card powered by Cisco's Silicon One ASICs and Pluggable Optics. This new platform can deliver up to 68% power savings and 83% space savings compared to 400-gig solutions, helping to reduce operational costs and carbon emissions as well as enabling the densification of networks to support use cases such as AI/ML and IoT. This continues to drive positive customer feedback and we are excited about this opportunity. To complement our own innovations, in Q3, we closed the acquisition of Valtix, which is aligned to our security cloud vision for providing protection across multi-cloud environments with a seamless experience. We also announced our intent to acquire two companies that further extend our capabilities in cloud, security and full-stack observability. Before I close, I also want to share once again how incredibly proud I am that for the third year in a row, we were ranked number one in the U.S. on Fortune magazine’s 100 Best Companies to Work For and in 14 other countries around the world, we were also ranked as the number one Great Place to Work, reflecting Cisco's position as a premier destination for top talent worldwide. To summarize, our ability to navigate uncertainty was demonstrated by our record results. Our performance remains solid and reflects the strength of our strategy and the benefits from the investments we've made over the last several years. Our operational discipline and excellence in execution are driving record earnings, cash flow, and shareholder value. As we look towards Q4 and fiscal year 2024, I'd like to share a few observations. As I mentioned earlier, as of now, we see modest revenue growth in fiscal year 2024 on top of our strong performance in fiscal year 2023. You can also expect us to grow earnings per share at a higher rate than revenue in Q4 fiscal year 2023 and full-year fiscal year 2024 reflecting improving gross margins and strong expense management. Lastly, we expect to continue our stock buybacks at the higher levels you've seen over the last two quarters. I'd like to thank our teams for their focus and execution and our customers and partners for the trust they placed in us. As cloud, AI and security continue to scale, Cisco's long-established leadership in networking, and the breadth of our portfolio, give me the confidence in our ability to capture the many opportunities ahead. I'll now turn it over to Scott.

Marilyn Mora:

Thanks, Scott. Michelle, let's go ahead and tee up the queue for questions.

Samik Chatterjee:

Hi. Thanks for taking my question. I guess maybe if I can start with a clarification on the orders. I think, Chuck, I heard you say orders were sequentially 1 point below seasonality. But if you can clarify whether on a quarter-over-quarter basis, they were up or down, and I'm not sure if you gave a year-over-year. But maybe more broadly, as you think about your guide for next year as well, what are you assuming for orders in that? And I have a follow-up. Thank you.

Samik Chatterjee:

Okay. Got it. And for my follow-up, I think I wanted to sort of touch on that expense control that you talked about and EPS growing faster than revenue. Is that sort of a change of thinking from the Analyst Day in terms of – I think at the Analyst Day, you were talking about sort of limited operating leverage and growing earnings more in line with revenue. It seems to be that outside of the gross margin, you're thinking about being a bit more disciplined and pulling back on expenses, but maybe confirm if that's sort of how you – if you are integrating that right. Thank you.

Scott Herren:

No. I think you touched on the key points. We will continue to invest in growth. But we also – as you've seen in the last two years, you've seen us do this, grow the bottom line faster than the top line in fiscal 2022 and at the midpoint of our guide for fiscal 2023. And as we look ahead, it's a time to be prudent, and so we see that happening again in fiscal 2024.

Marilyn Mora:

Thank you. Next question, please.

Simon Leopold:

Thanks for taking the question. At the beginning of May, Cisco announced a Capital Business Acceleration Program as a part of Cisco Capital. This is a topic we haven't talked about much on recent calls. I'd just like a little bit better understanding as to what's the strategy, thought process and rationale for implementing that program? Thank you.

Simon Leopold:

And no real effect on your financial model, I assume then?

Simon Leopold:

Great. Thank you very much.

Marilyn Mora:

Thanks, Simon. Next question, please.

David Vogt:

Great. Thanks, guys, for taking my question. Maybe just more qualitative and maybe as a follow-up to Simon's question. Can you kind of give a little bit more color on what you saw, let's say, in March into April and what you're seeing today from a macro perspective? Because it certainly sounds like from our conversations with partners and other industry folks that March was a bit softer than people had anticipated, and it didn't improve in April. Just love to get your perspective there. And then I'll give you my follow-up real quick. So if I kind of take your comment about the three-year plan, it certainly would imply kind of revenue growth next year in kind of the 2%, 3% range and EPS in the 5% range. Is that kind of what you're trying to communicate from a back-of-the-envelope perspective next year given the macro headwinds? Thanks.

David Vogt:

Yes. If I just kind of take the back of the envelope math on your 5% to 7% three-year target, that would imply revenue growth next year in the 2% to 3% range and EPS maybe 5% to 6% range. Is that kind of what you're trying to message here? Just so we have a sense for how you're thinking about the macro. Thanks.

Scott Herren:

Yes, sure. Just on the math you're trying to do, David, I think you're in the right ballpark. What I'd say, obviously, I don't want to get into being too precise on fiscal 2024 yet since it's only our Q3 call. But bear in mind, that's growth on fiscal 2024 on top of at the midpoint of our guide for fiscal 2023, 10.2% growth in fiscal 2023. The last time we had double-digit revenue growth for a full-year was back in 2012 in the bounce back of the – from the global financial crisis. So it's a very strong year this year, and we see a modest level of growth on top of that.

Chuck Robbins:

Thank you.

Operator:

Thank you. George Notter with Jefferies. You may go ahead, sir.

Scott Herren:

Yes. I guess where I'd start is the biggest factor driving the growth for this year is the huge amount of demand we've had from our customers that's been sitting in backlog as we've worked our way through some of the supply issues. If you ask what's driving the growth, it's that, it's end-user demand. When you start to peel back to the mechanics of how that got put together, a lot of it is our ability to – based on a lot of hard work actually from both the engineering team and the supply chain team to free up some of the component supply issues that we've had that's allowed us to work through some of the backlog. We're not finished. There's still supply constraints. We think we end the year. Just like we said last quarter, we end the year with still with roughly double what our normal backlog would be, but we've made great strides on that front. Price has been a positive for us. As we said earlier, there's a – as we work our way through the backlog, more of the orders that we received prior to those price actions that we took last year have been delivered now. And so we are seeing – you'll see this when we publish our Q, about one point of benefit from price.

Marilyn Mora:

Let's go ahead and move to the next question, Michelle.

Meta Marshall:

Great. Thanks. I was wondering if you could just kind of speak to the trends you're seeing within enterprise commercial service provider. You noted kind of seeing some digestion on the webscale, but just wanted to kind of get a sense if there's any different trends that you're seeing within those customer types. And then maybe just as a follow-up question. Obviously, your customers have been going through cloud optimization efforts and kind of looking towards long-term architectures. Is there any changes kind of you distinguish from customers just on the outcomes or ways in which Cisco can kind of better help customers on that journey? Thanks.

Meta Marshall:

Great. Thanks so much.

Operator:

Thank you. Sami Badri with Credit Suisse. You may go ahead, sir.

Chuck Robbins:

No, we did not see any of that. In fact, we've been fulfilling all the request. There are certain projects that our teams have been working on that they have delayed, but those are around new orders, not around what's in the backlog. I think a lot of that is because there's so much focus now on building out the AI infrastructure for each of them, and so that's really what we see happening, and it's an area that we've had lots of design wins. We continue to get design wins, and it's an area where we believe that we'll continue to gain market share.

Scott Herren:

Yes, Sami, you see the midpoint of the guide we gave on gross margin for Q4. We've seen significant progress on gross margin through the year. I mean the product gross margin grew 240 basis points sequentially. That said, I think we're about to the point where we're lapping some of the benefits of the price increases. So there may be a little more room in gross margin sequentially. But if you look at the average for the year next year, of course, if you remember the first quarter of this year, we had a pretty significant impact in gross margin. So the average for the full-year will definitely go up, right, as we say, if we keep it this same glide path through fiscal 2024.

Marilyn Mora:

All right. Thanks, Sami. Next question.

Matthew Niknam:

Hey, guys. Thank you for taking the questions. First, just a follow-up on the fiscal 2024. The modest growth, what sort of macro assumptions are you embedding into that preliminary outlook? And then just secondly, if I could just double click on security. If you can maybe talk about what's driving some of the softness or decelerating growth. I believe it was about 2% growth this past quarter and what you're anticipating in terms of maybe additional backlog release and whether that can maybe help some of those trends looking forward? Thanks.

Scott Herren:

Yes. If we start on fiscal 2024. I think there's a few things, Matt, to keep in mind before we start talking about macro. We're rolling into the year with a backlog that's roughly double what would be normal. And that's really just a function of kind of the continuing supply constraints that are definitely improving, and that's why you see some of the strength that we've shown in this quarter and in our guide for next quarter, but they're not done. I do see those normalizing sometime midyear. By the second half of the year, we should be through most of the backlog. The second is the absorption factor. We think that with the lead times normalizing and working through the backlog, the absorption factor also probably gets itself work through to next year by around midyear of next year. So – but when you roll into the year with $32 billion of RPO, which is where we are today, $17 billion of that being current with almost $24 billion of ARR, which drives a huge renewal opportunity for us next year and with backlog, it takes a lot of pressure off of what needs to happen from a macro standpoint.

Matthew Niknam:

Thank you.

Operator:

Thank you. Michael Ng, you may go ahead from Goldman Sachs.

Scott Herren:

Sure, Michael. If you look at – you really have to look at the sum of those two collectively because purchase commitments are there, they're firm commitments that we've made to take on inventory. So the line between what's in purchase commitments and what's actually on our balance sheet is pretty great. When you add those two together and look back over the last three quarters, we've worked down about $3 billion worth of the combination of inventory on hand and the purchase commitment. So I think the team has done a really nice job balancing, ensuring we have supply to continue to work our way through the backlog, and at the same time, minimizing the risk that we have too much inventory.

Chuck Robbins:

Thanks, Michael. Well, when I said that Q4, we see normal sequentials from Q3, that just means they're in the range of the historical ranges that we've seen from high to low. So it's not like an anomaly. It's not going to be significantly higher or significantly lower based on what we see today. We think that the digestion issue and the lead time stuff, we're estimating right now that most of that stuff gets washed out by the middle of next fiscal year. So we think to really get back to where you see normalized sort of ordering patterns and normalized backlog, we think that's probably going to be the second half of fiscal 2024.

Marilyn Mora:

All right. Thanks, Michael. I believe we have time for one more question.

Amit Daryanani:

Perfect. I’m glad I sneaked in here. I guess I have two as well. Maybe first on the hyperscale side. Chuck, you talked about seeing gains on the AI infrastructure side. Can you sort of touch on where are you seeing these wins? Is it sort of data center switching or Silicon One or something else? And then are these sort of net new applications getting deployed are these displacements? Just any color there would be helpful.

Amit Daryanani:

Got it. And then if I could just maybe go back to this order discussion. I think everyone seems to be surprised on orders being down 22% despite the compares getting easier, and I get your sequential commentary fairly well. But perhaps you can just talk about – you compared that you get really easy for the next few quarters. So do you feel like the down 22% is the trough and the declines may still be there but they sort of ease up until you get to the back half? Or how do you think about the order trajectory over the next few quarters and maybe the magnitude of it?

Scott Herren:

Yes. Just to add a little bit of that, Amit, a little bit more to that. When you add up between what will be current RPO that will turn into revenue during fiscal 2024, plus the backlog normalizing, which will be a tailwind, plus the renewal opportunity of what's not in RPO today, but sitting in ARR today, round number is somewhere between 40% and 50% of that revenue for next year is contained in those three lines, right? It's either orders that are in-house and sitting in RPO or sitting in backlog or renewal opportunities that we have a chance to go out and renew this year. So when I said it takes a lot of pressure off of macro, it's a strong position to be in, rolling into next year with that much of it either already in-house or sitting as renewal opportunities for us.

Amit Daryanani:

Perfect. Super helpful. Thank you.

Marilyn Mora:

All right. Great. And Chuck, I'll turn it over to you.

Marilyn Mora:

All right. Thanks, Chuck. And to close this out, Cisco's next quarterly earnings conference call, which will reflect our fiscal year 2023 fourth quarter and fiscal 2023 results will be on Wednesday, August 16, 2023 at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. This concludes today's call. If you have any further questions, feel free to reach out to the Cisco Investor Relations department, and we thank you very much for joining the call.

Operator:

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.

Chuck Robbins:

Thanks, Marilyn. I hope everyone is doing well. With the tremendous results we delivered in the first half of the year, fiscal ‘23 is shaping up to be very strong, fueled by demand for our cloud-driven networking portfolio, our continued business transformation success and 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 Cisco. While the environment we are operating in remains dynamic, Cisco is better positioned today than at any time since I became CEO almost 8 years ago. We have reshaped and transformed 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 will 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 $0.88. We also delivered solid ARR growth, sequential non-GAAP margin expansion and record non-GAAP net income. 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 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, led 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 remain 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 would normalize from previously elevated levels as customers return 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 are seeing with customer demand. In 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 sequentials 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 in 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 ‘23. We continue to take share in this space. And over the past few years, we have grown web-scale cloud infrastructure from effectively zero into a multibillion dollar run-rate business. I am incredibly pleased about the overall progress we’ve made as we are continuing to win more and more use cases within their infrastructure. We are 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 remains 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 maybe slowing in some areas technology remains essential as it is vital to their overall business resilience, competitive differentiation and success. In fact, Gartner and IDC’s most recent surveys 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 are 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. IoT 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, cybersecurity and full stack observability remains strategic priorities where we continue to invest and innovate. From a product revenue perspective, we saw strong double-digit growth for Catalyst 9000, enterprise routing, Wireless, Meraki, DUO and ThousandEyes, 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. You will see us continue to bring AI and ML into those platforms to further simplify how networks are managed. 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 our cloud-native full stack observability platform, the first network visibility solution to support open telemetry. This platform brings together our ThousandEyes and AppDynamics 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 SASE solution, Cisco+ Secure Connect, now supports integration into Cisco SD-WAN fabrics using Viptela technology, as well as our existing Meraki SD-WAN fabric. We also introduced new flexible, more powerful and energy-efficient servers, which not only help lower cost, but also help our customers meet their sustainability goals, an increasingly critical area for most of our customers. To close, I am 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 in RPO, 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 ‘24, giving us conviction in our ability to deliver on our commitments. The modern, resilient and secure networks we are building serve as the backbone of our customers’ technology strategy. Cisco is well-positioned to benefit from multiyear 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 will turn it over to Scott.

Marilyn Mora:

Thanks, Scott. I am going to turn it over to Chuck just for a few comments before we start the Q&A.

Marilyn Mora:

Thanks, Chuck. Michelle, let’s go ahead and open up the queue for questions and answers.

Ittai Kidron:

Thanks guys and nice quarter, nice guide. I guess the big question is when you think about the outlook that you have for continued supply chain improvement, how long would the order backlog normalization process is going to take in your view? And maybe you can quantify in the quarter 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 am just trying to gauge for how long you can kind of keep this going at above normal growth rates for yourself?

Ittai Kidron:

Okay. I guess when I think normal, given your historical ranges before the pandemic, I always think about 4 to 6 is kind of the range plus/minus that you run at. Is it fair to say that from here on anything above is kind of order – eating into backlog? And while your backlog is double, that can still mean that you can run above normal ranges for at least a couple of years, it sounds like, unless something unusual happens. Am I misinterpreting your comments?

Scott Herren:

No, not at all, Ittai. But what I would say is it’s obviously too early for us to guide fiscal ‘24. What we wanted to give you confidence is we have better visibility than we’ve ever had in the past, both from the backlog and the $17 billion – almost $17 billion of RPO that’s current, that’s going to turn into revenue in the next 12 months in the ARR. But – and we’re going to 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 ‘24. I think it’s a bit too early given where we are in the year just at the end of our second quarter for us to be a little more precise on that.

Chuck Robbins:

Thanks.

Operator:

Amit Daryanani from Evercore, you may go ahead, sir.

Chuck Robbins:

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 and the new reports come out for Q4, that you’ll 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 the other thing to keep in mind is that 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 and 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 that we will be gaining share. Do you want to talk a little bit about the campus switching?

Chuck Robbins:

Amit, can you repeat your question about the campus switching, the second part?

Scott Herren:

Yes. 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 supply chain team and our product engineering teams have worked pretty relentlessly over the last several quarters with product redesign, with qualifying alternative components, with working with our suppliers to get to their subcomponents to make sure we could free this up so that the increase in supply that’s leading to some of the share gains that we’re talking about is the 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, yes, we’re doing quite well in that space. And as we continue to deliver what we’ve just laid out as our guidance for the second half of this year, I think you’ll continue to see share gain grow for us.

Scott Herren:

Yes. The midpoint of the guide for the April quarter 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 – it’s less driven by cost. We’re seeing some reduction in costs around logistics, in particular, but component costs are kind of staying where they are in most cases. It’s more driven by the fact that as we ship 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.

Marilyn Mora:

Great. Thank you. Next question, please.

Paul Silverstein:

Thanks. Chuck and Scott, I appreciate that you all addressed in your prepared remarks the visibility demand trend 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 have served. I know, Chuck, you just addressed the market share issue. But can you give a bit more color in terms of validity of the demand trends and the visibility that’s translating into.

Paul Silverstein:

Right. And Scott, back on the margin question. I appreciate you got to walk before you run, but you’re now 3 percentage points roughly below peak on both gross and operating in terms of the initial recovery, any thoughts for how much of the 3 percentage points? Can you visually get back to 67 gross? Can you get back to 35 operating and it’s just a function of time or because of the price increases with respect to semis or other things, that’s just a bridge too far?

Paul Silverstein:

So you think you can get back to 67, 35?

Paul Silverstein:

Yes, long-term. Long-term, can you get back to that model?

Paul Silverstein:

Thanks, Scott.

Marilyn Mora:

Thanks, Paul. Next question, please.

Meta Marshall:

Great. Thanks. I’m assuming as you’re having conversations with customers, they are looking for more flexible subscription methods and part of your subscription transition has kind of been evolving kind of the ELA model or kind of the subscription model you guys have had. And I just wanted to get a sense of where you think you are on some of the kind of subscriptionization of some of your products and whether you are seeing a big impact to that right now and then just maybe just some commentary about how you see the M&A environment currently? Thanks.

Meta Marshall:

Great. Thanks.

Operator:

Thank you. Simon Leopold with Raymond James, you may go ahead, sir.

Chuck Robbins:

Yes, I’ll make a couple of comments, and Scott, I don’t know if you want to give any detail. But I would say that our customers are increasingly balanced around how they are thinking about private cloud versus public cloud. And so we’ve seen continued focus on revitalizing the private data center infrastructure. And I’ll let Scott speak to – I’m not sure on the infrastructure side or UCS, 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 in the infrastructure within web scale flows into our routing market share numbers and our routing business. So it doesn’t actually boost our data center 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.

Simon Leopold:

Thanks. And then just maybe a quick follow-up, I was a little bit surprised that the metric of hardware attached software in backlog is $2 billion, same as it was in the prior quarter. I would have guessed it would have come down with the basically improvement of shipping the hard – associated hardware. So maybe I don’t understand that value or you could talk a little bit to why that $2 billion didn’t come down with the extra shipments of the related hardware? Thanks.

Simon Leopold:

And software as a total percent of revenue or product revenue, that metric, where is that now?

Simon Leopold:

Thank you very much.

Operator:

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

Chuck Robbins:

Let me take the second one first, and then Scott, you can talk about the data center switching redesign. We absolutely are seeing some elongated sales cycles. What our teams have told me is that, in many cases, 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 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 obviously haven’t seen that in the current situation. Scott, do you want to talk about the redesign?

Sami Badri:

Got it. Thank you.

Operator:

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

Scott Herren:

Yes. George, I will take that, Chuck, and then you can jump in. I don’t think it is burning down backlog. We clearly are – the good news is we are able to ship more of the backlog. That’s good news for our customers. They are waiting for these components. They have got projects that they are 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 and relieve some of the pressure on their own working capital. So, it’s not – I am responding to the burning down backlog. This is good news, our ability to ship the backlog, and that’s what you see reflected there in the guide down – or sorry, in the guide up that we have in the second half of the year. We have – 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.

George Notter:

Okay. That’s helpful. Thank you very much.

Operator:

Thank you. David Vogt with UBS, you may go ahead.

Scott Herren:

Yes. So, 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 2x and 3x normal backlog. And normal backlog, as we said last quarter, is between $4 billion and $5 billion at the end of the year. What we now see is that it’s still going to be roughly double what that same range. So, there is definitely our ability to ship some out of the backlog, which is again, great news for our customers and our partners. The one piece that’s missing in your equation is, as we ship the backlog, remember, we said there is more than $2 billion of software in there. A lot of that software is ratable. So, 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 is a – you have to consider not just the reduction in backlog, what’s the uptick in 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 are missing.

Scott Herren:

Rather than try to say it’s a quarter or it’s two quarters, I do expect it to normalize in fiscal ‘24.

Marilyn Mora:

Next question please.

Tal Liani:

Great. He stole my thunder with the previous question. That was exactly my question. So, I want to – I want to understand something just a clarification on what you just answered. So, at the minimum, the decline in the backlog was $600 million at the minimum because end of year is going to be $8 million to $10 million. Take 6% of that and the backlog is now higher, so that means that the minimum year 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 revenue. Am I correct with what you just answered?

Chuck Robbins:

And show up in RPO.

Tal Liani:

Yes. Very clear. So, my question – I want to go back to the basics and understand, last quarter, we were all concerned about environment slowing down. 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 account and tell us what is the situation of spending with your enterprise customers, commercial customers, service provider 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 do you expect some more deterioration going forward?

Tal Liani:

Got it. Layoffs and the economic slowdown, my question was whether these factors you see an impact on your business on orders or they stabilized from previous quarter?

Tal Liani:

Yes, across the industry?

Tal Liani:

Got it. Thank you.

Operator:

Thank you. Tim Long with Barclays, you may go ahead sir.

Chuck Robbins:

Thanks Tim. So first one, on enterprise campus, I do think that the pandemic 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 not been updating, and they had – they were sweating assets a little longer. So, that’s one thing that’s shifted. The second is we are really seeing – these trends of multi-cloud, the trend of hybrid work and the overall re-architecture of their networks. If you really think about what – how we built networks for 20 years, we built it on a 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 that’s been driving a lot of this as well as safety in the office, IoT, creating new experiences to get our employees back to work, etcetera. 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 training AI algorithms, these are – like in the web scale space, they are like bigger than the core infrastructure networks that they are running, which was astonishing to me when I learned that. And the network performance required is 3x to 4x what they have historically needed. And so this is a massive opportunity for us and we are in active discussions with lots of customers around it. And so we do think that this shift is going to create a good opportunity for us in the future.

Marilyn Mora:

Thanks Tim. Next question.

Samik Chatterjee:

Yes. Hi. Thanks for taking my question. Congrats on the strong guide. Maybe if I could just quickly hit on two of the product areas mostly security, what sort of benefits are you seeing given your broad portfolio there in terms of customers looking to maybe some level of – consolidation just given your position as a more broader security portfolio supplier. And what sort of benefit does supply eases, maybe on the firewall side, should we expect revenue growth? And a similar question on Internet for the Future segment seems like a bit more supply constrained than other segments. But what sort of are you – what are you seeing on the supply side there? Thank you.

Scott Herren:

Yes. Internet for the Future, Samik, it is one of the spaces. We have worked so hard and done so much across our entire product portfolio. So, we have made great progress in many cases. I would say Internet for the Future is one of the spaces where we are still – we have improved lead times there, but we are still not back to more normal lead times in that space. What I would also say though, is we have already picked up orders 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 those orders came to us instead. So, while – it’s a space we continue to work on. And while we are seeing improvement, it’s not where we want it to be, I feel like we are performing pretty well on the supply side and Internet for the Future.

Marilyn Mora:

Alright. That wraps up our Q&A. I am going to turn it over to Chuck for some closing remarks.

Marilyn Mora:

Thanks Chuck. Cisco’s next quarterly earnings conference call, which will reflect our fiscal 2023 third quarter results, will be on Wednesday, May 17, 2023 at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time. This concludes today’s call. If you have any further questions, feel free to reach out to the Cisco Investor Relations group, and we thank you very much for joining today’s call.

Operator:

Welcome to Cisco's First 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.

Charles Robbins:

Thank you, Marilyn, and thank you all for joining us today. We are off to a good start in fiscal 2023, delivering strong results, exceeding the top end of our guidance range for both revenue and non-GAAP EPS. We delivered the largest quarterly revenue in our history, driven by excellent execution and the actions our team took to remediate our supply challenges. Given these results, along with the strength of our orders, our visibility, and easing supply constraints, we are raising our full year outlook, which Scott will cover later.

Marilyn Mora:

Thanks, Scott. Michelle, let's go ahead and queue up the Q&A.

Meta Marshall:

Congrats on the quarter. Chuck, I was just wondering if you could dive a little bit into -- more into kind of the commentary that you gave about Europe and just also kind of what you're seeing in terms of level of activity or level of approvals needed within the U.S., that would be helpful.

Tal Liani:

Great quarter, and I see that the numbers are going up, but the question is how much of it is backlog flush and how much of it is the environment? Meaning, I look at your product growth -- product orders. It's down 14%. Last quarter, it's down 6%. And the question is how is the environment itself? Is the environment weakening from an orders bookings, backlog? Is the environment weakening and what we're seeing is acceleration because of supply constraints that are easing? Or is the environment holding up? And maybe you can refer to some kind of -- some of your big product categories to see how the trends are.

Operator:

David Vogt from UBS.

Marilyn Mora:

David, I think we may have lost you.

Marilyn Mora:

Now we can.

Richard Herren:

Sure. Yes. The backlog came down about 10%, leaving us with an ending backlog at the end of Q1 that was the second highest in our history and higher than what we had seen at the end of Q3. So we took a spike up a little more than 10% in Q4 and came back down in Q1. What Chuck was talking about on the sequentials is really about the overall product bookings that came in versus where we're standing in backlog. So the flow-through of orders come in, drop in the backlog, that backlog then converts into revenue. The way you got to think about it is less about does the change in backlog convert to revenue growth and more of does the change in backlog convert to build.

David Vogt:

Got it. And maybe just one final thing on profitability. When software comes out of backlog, I would imagine that would have been a tailwind for gross margins in the quarter. Can you kind of quantify what that might have been in the quarter, given obviously, there's some supply chain pressure and logistics pressures on margin?

Operator:

Ittai Kidron from Oppenheimer.

Charles Robbins:

Yes, Ittai. We've actually modeled out various bookings scenarios for the year, and it would have to be significantly worse than what I told you for it to be concerning. Scott, do you have any other comments?

Operator:

Tim Long from Barclays.

Operator:

Paul Silverstein with Cowen and Company.

Richard Herren:

Yes, 50 to 75 off the current quarter, that's right, by the time we get to Q4.

George Notter:

I wanted to ask about the impact of foreign exchange. Obviously, U.S. dollar at 20-year highs. Maybe you can talk about how you're broaching that conversation with customers internationally. Are you seeing any diminishment of demand? What's the picture?

Amit Daryanani:

I guess, maybe the first one, I was hoping you could touch on the service provider market. I think you said orders were down 23%. That seems a bit more severe than the rest of the portfolio. What's happening there in any newly service provider versus web scale would be helpful.

Marilyn Mora:

Can you repeat the question?

Charles Robbins:

Yes. Amit, thank you for that. And I think the reality around that one is simply if you go back a year ago, that segment grew 65%. I think that's the fundamental issue. I don't think there's anything else going on.

Charles Robbins:

No, there's nothing that's giving us pause in that. I mean, we guided up the full year in revenue from what had been a guide of 4% to 6% growth to 4.5% to 6.5%. That effectively rolls forward the outperformance that we had in Q1 into the full year. There's no change in the way we're looking at the second half of the year either plus or minus. But it's a prudent view of what we expect in the next 3 quarters.

Simon Leopold:

I wanted to see if there was some way you could characterize your own lead time. So if you had customers placing orders today from Meraki products or campus switches or data center gear, what are the lead times for getting the product for your customers? And how does that compare to the prior quarter and prior year?

Simon Leopold:

And just as a quick follow-up. As you're showing improvement, do you see that affecting your ability to maintain or take market share where perhaps you were more vulnerable when the lead times were more extended?

Operator:

James Fish with Piper Sandler.

Charles Robbins:

Yes. So we're actually speaking to our employees tomorrow about this. So I'd be reluctant to go into a lot of detail here until we're able to talk to them. I would say that what we're doing is rightsizing certain businesses. We're really focused on resources moving into like in the enterprise networking space, accelerating our platform strategy. We'll be making significant investments in security and beefing up our team there and the capacity to continue to innovate there. Those are important areas.

Charles Robbins:

But we do have a -- if you look at the number of jobs that we have opened in the areas that we're trying to invest, it is just slightly lower than the number of people that we believe will be impacted. We're going to be working really hard to help match our employees to those roles to the extent there's a skill match. So we're going to work really hard at that.

Richard Herren:

Yes. It's really not motivated by cost savings. So the net -- by the time we get to the end of the year, our expectation is we have about the same headcount that we had at the beginning of the year. But there's 2 pieces to this. One is what we've been speaking about just now about the headcount impact. There's a second piece of this that's really about rightsizing our real estate portfolio. And we've got a long tail of small offices distributed around the world that are significantly underutilized and, in fact, unused in some cases.

Operator:

Samik Chatterjee with JPMorgan.

Charles Robbins:

Yes, Samik, it's a good question. And I would say -- the first thing I would say is that Gartner recently came out with a survey of executives in our customer base, and they've -- almost half of them said that their technology investments will be the last thing they cut. So that's just a backdrop for, I think, how important customers view their technology investments these days.

Operator:

Sami Badri with Credit Suisse.

Charles Robbins:

You mean if all our backlog was actually shipped and reported?

Charles Robbins:

Yes. I think that will be true. I mean, look, we operate in lots of different markets. So is it true 100% of the markets? That would be difficult for me to say. But I believe that as we ship out the -- particularly our Secure Agile networks, our enterprise and networking products, that's certainly going to help. As we catch up on our data center infrastructure, I think that's going to help.

Ahmed Sami Badri:

Got it. Just to be clear, that is Cisco gain share? I don't know, just to make sure I heard you correctly.

Richard Herren:

In the bigger markets.

Ahmed Sami Badri:

Got it. And then one question just for Scott. So Scott, maybe you could tell us where in fiscal 1Q of '23 did shipments begin to start accelerating just because we want to kind of understand the trend here going from now through fiscal 4Q and putting into that product gross margin comment into perspective. What I'm really trying to understand is, as shipments start to accelerate, how much will software attach to those shipments just so I can understand the glide path here, what happens in some of the other segments outside of just secure network, agile networks, et cetera, right? I'm just trying to get this kind of like this pull dynamic that may occur from the other segments related to shipments going out the door.

Charles Robbins:

Thanks, Marilyn, and thank you all for joining us today. I just want to reiterate it, we feel like we had a very strong quarter, largest quarterly revenue in history. As I said earlier, the orders, the visibility, the easing of supply chain gives us the confidence to raise the year, obviously. We're very focused. We're managing the business for growth. We are going to go through this process of reinvesting into strategic areas. And the people impact is difficult. And I just want our employees who are listening in today to know that this afternoon and tomorrow, we'll be communicating about how we're going to go about this. It's always a difficult decision, but we have a lot of opportunity.

Marilyn Mora:

Thanks, Chuck. Cisco's next quarterly earnings conference call, which will reflect our fiscal year 2023 second quarter results will be on Wednesday, February 15, 2023, at 1:30 p.m. Pacific Time, 4:30 p.m. Eastern Time.

Operator:

Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call (800) 835-5808. For participants dialing from outside the U.S., please dial (203) 369-3353. This concludes today's call. You may disconnect at this time.

Operator:

Welcome to Cisco's Fourth Quarter and Fiscal Year 2022 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.

Chuck Robbins:

Thank you, Marilyn, and thanks to all of you for joining us today. I'm very proud to share that we had a strong end to our fiscal year in the midst of an incredibly dynamic environment. In fact, we set several records with our performance this year. Let me first touch on those. For the full year of fiscal 22, we delivered record non-GAAP EPS of $3.36. Record product orders, which fueled our backlog to the highest level ever recorded, as well as our second strongest year of revenue in the history of the company at $51.6 billion. We continue to see strong customer adoption of our software and subscriptions, driven by the targeted investments we've been making. We also had record net income, which reflects our operating discipline, despite external challenges, including supply chain and inflation. Our ongoing business transformation continues to show progress across our KPIs, with annualized recurring revenue, or ARR, and remaining performance obligations, or RPO, both setting record highs. These important metrics illustrate the increasing recurring nature of our revenue streams. This, combined with our record backlog, provides us with enhanced visibility into our business looking forward. While this was certainly a complex year, we executed well. I want to thank our teams for their perseverance, determination and unwavering commitment to our customers and our partners. Our team's commitment to accelerated innovation has put us in a unique position of strength for fiscal 2023 and over the long term. Now, I want to be clear on our outlook for fiscal 2023. We expect strong performance across our portfolio, driven by our continued focus on innovation and easing of supply constraints to drive solid top line growth and profitability. While we anticipated some moderation from the unprecedented product order growth of last year, demand signals remain solid. We do expect to continue to experience higher costs in the short term, driven primarily by higher component, freight and logistics costs, which is reflected in our Q1 guide. However, as you'll see in our annual guidance, we expect this margin pressure to begin to ease as the year progresses. Long term, there are many multi-year growth opportunities ahead of us, that gives me confidence in our future. There are currently more technology transitions occurring concurrently than I've seen in 20 years. Long-term megatrends like hybrid cloud, hybrid work, security, IoT, 400 gig and beyond, 5G and Wi-Fi 6 as well as the move towards application observability will likely provide tailwinds to our growth. With our portfolio in such a strong position to help our customers, I'm quite optimistic about what's ahead. Before we discuss the quarter in detail, I want to provide some additional color on the supply situation and how we continue to build greater resiliency. After a challenging April due to the COVID-related shutdowns in Shanghai, and the impact on semiconductor and power supplies, overall supply constraints began to ease slightly at the back half of the fourth quarter and continuing into the start of Q1. While the component supply headwinds remain, they have begun to show early signs of easing. The decisions we made and the multiple actions we have taken over the past two years are helping to improve our resiliency and will help offset cost inflation. These include adding new suppliers, leveraging alternative suppliers, redesigning hundreds of products to use alternative components with similar capability and targeted price increases, all of which position us for the future. These actions along with the tremendous efforts by our supply chain team and the investments we've made in building capacity to meet growth have the potential to drive momentum into fiscal 2023. Moving to performance highlights in the quarter. We delivered revenue above the high end of our guidance range, and non-GAAP EPS came in at the high end of our guidance range. We achieved healthy operating margins and generated solid cash flow and returned nearly $4 billion to Cisco stockholders through cash dividends and share repurchases. With annual product order growth of 14% for the fiscal year, we exited the year with record product backlog. In addition, our RPO totaled more than $31 billion, and when combined with low cancellation rates, which remain below pre-pandemic levels, this sets the stage for increased visibility and strong revenue growth as we head into fiscal 2023. In terms of our product orders this quarter, we delivered the second highest orders in absolute dollars in the history of the company. It was second only to our performance in Q4 of fiscal 2021 and on a sequential basis it was up greater than 15% with strong growth in enterprise, commercial and public sector. From an annual growth rate perspective, we clearly faced some very tough comparisons from the record orders we saw in Q4 last year, where we had over 30% growth. Based on that, the year-over-year decline was not a surprise nor is it concerning. It's important to keep in mind that in the near term, the rate and pace of our revenue growth is much more a function of component availability than on our quarterly product order growth. With RPO of over $31 billion, almost $17 billion of which will be recognized as revenue over the next 12 months and a record backlog, we have great top line visibility. Thanks to the relentless effort of our entire organization, the business remains stronger than before the pandemic. From a demand perspective, we continue to experience solid customer activity beyond our ability to deliver as is reflected in the growth of our backlog that we saw throughout the quarter. While our business is not immune to macro trends, we will remain disciplined in our operations, while benefiting from robust multiyear investment trends and the technology transitions I mentioned earlier. Our innovation is helping our customers and partners navigate an increasing amount of complexity, and there is a greater sense of urgency to leverage leading-edge technologies to deliver on their strategic objectives. This is leading them to consistently look to Cisco and our unique and differentiated innovation to help them advance their most pressing business priorities. We recently held our Cisco Live customer event in-person for the first time in three years and had over 15,000 in attendance, including thousands of our largest customers and many more participating virtually. Our discussions with them focused on strategic projects, supply assurance and the critical role Cisco can play to support their long-term technology road maps. They did not indicate any fundamental shift in their commitment to technology investments. Regardless of what the coming quarters may bring, we have a proven track record of being able to adjust in difficult environments. Our value proposition to our customers remains as strong as ever. In our web scale business, we continue to see momentum even as the business becomes larger, as product orders were up more than 50% on a trailing four-quarter basis. We see significant opportunity ahead as these customers build out massively scalable cloud networks and increasingly turn to Cisco to help them meet accelerating demand for cloud services. Our leadership in silicon, optics, software and systems enables us to win as hyperscalers value industry-leading performance and innovation. We are expanding our footprint, driven by data center build-outs with our Silicon One-based Cisco 8000 routers, the fastest-growing platforms in Cisco's history. Together with optics from Acacia, we have a strong foundation for 400-gig and beyond to rearchitect the Internet with routed optical networking. In addition, we recently booked and shipped our first 800-gig systems to one of our web scale customers. On the IoT front, we also now have more than 200 million connected things on our cloud platform with growth driven by connected car. We finished fiscal 2022 with product orders in excess of $1 billion and growing double digits. We continue to make progress on our transformation to more software and subscription-based recurring revenue. ARR of approximately $23 billion was up 8% with product ARR increasing by 13%. We had strong subscription revenue this quarter, driven by our growing portfolio of recurring offers. While our software revenue was down slightly, once supply constraints improve and we begin to increase product shipments, we expect to see an improvement in software, subscription and services that are attached to hardware products in our backlog. The investments we've made in innovation are paying off as our competitive position is very strong. In Q4, we introduced several new cloud delivered innovations across our portfolio to help organizations drive productivity and resiliency. We launched Nexus Cloud, a platform to help our customers deploy, manage and operate their data center networks from the cloud. In addition, we introduced Calisti and Panoptica, two new cloud native API-first tools for faster and better application development. We also announced AppDynamics Cloud, a next-generation version of our observability platform for cloud native applications. In addition, we shared our strategy to help our customers connect their entire security architecture with our new platform, Cisco Security Cloud, which will be a game changer for them as they look to secure their multi-cloud environments with a single cloud-delivered security platform. This is just one part of our broader security innovation cycle. Building on the double-digit growth we saw in security this quarter, we are investing across our security business, focusing on cloud based offerings, best-in-class AI driven threat detection and end-to-end security architectures. These innovations position us well for leadership in the security market. In summary, we executed well on our strategy and transformation during what remains a very dynamic time. This led to a strong close to our fiscal year, setting several records across our business, thanks to the solid execution from our teams, our market-leading innovation and our continued growth of recurring revenue. We also took decisive actions to help offset inflation and build resiliency in our supply chain, while investing in our business to position us well for long-term growth. The power of our technology continues to be a critical driver of economic growth and productivity. Our results and outlook demonstrate the critical role that Cisco plays as a leader in bringing innovative technology solutions to customers today and into the future. As we move into fiscal 2023, we remain guided by our purpose-led culture and deeply committed to delivering value for our customers, partners and investors, as well as continuing to be an amazing place to work for our employees. I will now turn it over to Scott.

Marilyn Mora:

Thanks, Scott. Michelle, let's go ahead and queue up the list of Q&A.

Sami Badri:

Hi. Thank you. I actually had two questions. First thing is for fiscal year 2023 your revenue growth expectations came in a bit stronger than most Street expectations. And maybe you could just walk us through the composition of the segment and what's driving the strength and maybe which segments may potentially lag some of the stronger segments? And then my other question is, maybe you could just give us some color on the composition of gross margin regarding pricing and productivity in fiscal 4Q of 2022, that would be helpful.

Sami Badri:

Got it. Thank you.

Operator:

Tim Long with Barclays. You may go ahead.

Chuck Robbins:

Thanks, Tim. So let's start with the software. And you're right, the software is flattish. There's two things that I would point out. We have -- we, obviously, have been transitioning from perpetual software model, which is in decline, and that's by design. We want to decline our perpetual software and increase our subscription software. And the way I think about it is, our perpetual was down roughly 14% during the quarter. And we also, as Scott said, have over $2 billion, and it's actually a higher number exiting Q4 than it was in Q3 of software in backlog, as you said, connected to hardware. So those are two contributing factors, which is why we really should be thinking about the ARR situation because that's reflective of the ACV that we basically had exiting the quarter. And it's -- so that's an indicator of future software revenue. So we're comfortable with it. And I think once we get through some of the supply chain stuff that we'll start to see that be a little more reflective of what we've been planning on. On the cloud vertical, we continue to win new insertions. That business is approaching 3 billion annually now after just two or three short years ago, it was pretty close to nothing. And so the teams have done a fantastic job. It is, obviously, over the last four quarters, it's grown 50%. From a revenue perspective, it's very supply chain dependent. So I wouldn't get too wrapped up about the revenue versus the orders right now. I think we'll work our way through that over the next four to five quarters. But overall, really pleased with where we are.

Marilyn Mora:

Thanks Tim. Next question, please.

Rod Hall:

Yeah. Hey guys, thanks for the question. I guess, I wanted to dig into this order growth a little bit. Obviously, very strong numbers there, but somewhat inconsistent with the way that we would have expected them to come out? And I just wanted -- and the thing that's inconsistent is you guys are saying up over 15% in the quarter, but then down 6% on a year-over-year basis, we would have calculated closer to flat, like minus 1. So we're just curious whether there was any restatement of the July quarter last year. You guys had called out 31% order growth there or anything else going on with the dynamics of these orders that might help us to understand that discrepancy at least in our numbers. And then I've got a follow-up.

Scott Herren:

Yes, Rod, so there was not - to be clear on your question, there was no change in the way we report year-on-year. It's exactly the same. The only other thing that I would add, too, to the comments that Chuck just made, linearity in the quarter was quite strong. In fact, the last week of the quarter was actually the same size as it had been in the prior year and the month-to-month linearity was exactly in line with last year and with prior year's expectations. So we saw strength right through the end of Q4.

Scott Herren:

Yes. What's sitting in inventory, Rod, is the rest of the parts that aren't under constraint, so that as the ones that are constrained free up, of course, we can square the set and get the product shipped out the door to our customers. So it is growing. It's up about $1 billion year-on-year, sitting at $2.5 billion. Our advanced payments are up as well. Both of those are a bit of a headwind to cash flows, as you saw. But yes, it's much more a statement of making sure we've got everything we need, so that as those constrained parts clear up, which we saw a little bit of that towards the end of Q4, we can square the sets and get it out the door and in the hands of our customers.

Marilyn Mora:

All right. Next question, please.

Amit Daryanani:

Yes. Thanks for the taking my question. I have two as well. The question I have is just on gross margins or maybe when I think about the EPS guide of 4% to 6% for fiscal 2023. How are you thinking about gross margins in that backdrop? And then are buybacks embedded in that guide as well?

Amit Daryanani:

And then, if I could just follow up, there’s been a firm amount of fear that higher interest rates looks like impact enterprise spending across the board, your print, your guide doesn’t seem to suggest you’re seeing any signs of that. But, I’d love to get your perspective. What are you hearing from your customers as the macroenvironment is changing? And really related to that, are you seeing any shift in how they procure or what they want to buy from you as the macroenvironment changes?

Amit Daryanani:

Perfect. Thank you. Congrats on a nice print.

Scott Herren:

Thanks, Amit.

Operator:

Thank you. Meta Marshall with Morgan Stanley Investment Research. You may go ahead.

Chuck Robbins:

Thanks, Meta. So on the first one, I'd say, that it's a combination of both of those. We -- as we said earlier, we saw increased volumes in the broker network during the quarter, which candidly was an opportunity we took advantage of, which is why you saw the higher top line, we were able to get more products shipped to our customers, which we obviously were very happy about, but we had to pay more for those components, and we think that will continue probably over the next 60 to 90 days. And then, we think, some of those purchases will begin to become available from the same suppliers that have put the excess inventory into the marketplace. At the same time, we have – and I think I said this on our last call, we've had hundreds of product design – redesigns going on. And two of our high volume products that also have good margins will begin to ship in the redesigned space sort of towards the latter into Q1, and then into the balance of the year, which we think will be helpful as well. So it's a combination of both of those things. And that's what gives us a little bit of optimism that things will continue to improve during the year. On the second question, on the valuations, I've had this one a few times, and I've been asked, if our M&A strategy has changed because of the valuations. And I've said that, our strategy hasn't changed, but the openness to talk to us from some of the – the companies that thought they had different strategic exits might have changed. And so we haven't changed our strategy. We just think that, it potentially creates more opportunity for us with companies that might not have been willing because they thought there was a high-flying IPO, ahead of them that they may not believe is the case right now. And the market is obviously taking a much different view on profitability versus just growth.

Marilyn Mora:

Thanks, Chuck. Next question, please.

Tal Liani:

Hi, guys. I'm trying to distinguish between the growth next year, which is probably a function of better supplies and backlog, very high backlog in between the spending environment, and you started touching on it when we asked about the enterprise. So let me maybe expand the question about the environment. When you go through your various, what you call, use of coal theaters and you go through cloud and service providers and enterprise, et cetera. Can you take us through your expectations for the spending environment and maybe how long it takes to close deals versus before when you look into the next few quarters? I'm trying to understand, if the environment as you see it today, whether it deteriorates or not at all, or which are the areas where we see a slowdown or not? And I have a second question, just if you can touch on security. Security was good again. It was good, actually much better, and there is improvement throughout the quarter, if you can touch on your position in security?

Scott Herren:

Yeah. Probably the only thing I'd add is as you look at that 4% to 6% growth that we've forecasted now for fiscal 2023, it is absolutely supply constrained. So while the supply situation we saw late in our fourth quarter that we just closed, there were some easing. Easing doesn't mean it's over. We're going to have supply constraints throughout fiscal 2023 and just a few areas were it not for those, we would be growing much more quickly. It's not a case of demand. We're not demand constrained. We were supply constrained in fiscal 2023.

Chuck Robbins:

No, we don't see anything. What I would tell you about the service provider business is that because of the long lead times, we started a process of doing long-term planning with them that I've talked about before. And so we actually have deferred bookings that don't show up anywhere right now, approaching $0.5 billion, that because they're outside of our standard shipment window when they would like to get those. So we've got orders out quarters from now from them that are all non-cancelable because of the contracts that we've done. So we feel good about that momentum. We think that those customers will continue to spend in all of the trends that we've talked about. And given that we just shipped our first 800-gig system to one of the web scale players, we can continue to see them take advantage of these higher speed platforms.

Chuck Robbins:

Now, Tal, you also asked about security?

Chuck Robbins:

So we saw -- I think Scott mentioned this in his -- we had some really good growth and some backlog movement, to be honest, on the firewall side. So we had a really solid quarter on shipments from a firewall perspective. But we also had strength in our endpoint business. We had strengthened our Zero Trust business. And we're continuing to -- that is the number one investment area for the company this year, and it is -- we're continuing to drive, I think, greater innovation there and evolve that portfolio as we've described strategically. So I think we'll just continue to see improvement. But this quarter did get a boost from us clearing some backlog in the firewall space.

Chuck Robbins:

Thanks.

Operator:

Samik Chatterjee with JPMorgan. You may go ahead.