Uniti Group Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 15, 2023

There are 14 speakers on the call.

Operator

Welcome to Sysco's Second Quarter Fiscal Year 2023 Financial Results Conference Call. At the request of Sysco, 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.

Speaker 1

Welcome everyone to Sysco's 2nd quarter fiscal 2023 quarterly earnings conference call. This is Marilyn Mora, Head of Investor Relations and I'm joined by Chuck Robbins, our Chair and CEO and Scott Herron, our CFO. By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non GAAP reconciliation information, balance sheets, cash flow statements and other financial information can also be found in the Financial in the Q1 of 2019.

Speaker 1

Throughout this conference call, we will be referencing both GAAP and non GAAP financial results and will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be done on a year over year basis. The matters we will be discussing today include Forward looking statements, including the guidance we will be providing for the Q3 and full year of fiscal 2023. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10 ks and 10 Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details.

Speaker 1

Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. I will now turn it over to Chuck.

Speaker 2

Thanks, Marilyn. I hope everyone is doing well. With the tremendous results we delivered in the first half of the year, fiscal 2023 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're operating in remains dynamic, Cisco is better positioned today than at any time since I became CEO almost 8 years ago.

Speaker 2

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'll touch on the quarter in more detail. Our Q2 financial results were strong as we again exceeded the high end of our guidance ranges. We delivered our 2nd highest quarterly revenue of $13,600,000,000 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.

Speaker 2

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 $32,000,000,000 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.

Speaker 2

This quarter, we also achieved record operating cash flow, enabling today's dividend increase and the buyback of over 1,000,000,000 We continue to deliver on our commitment to drive returns to our shareholders.

Speaker 3

Let me

Speaker 2

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.

Speaker 2

Like I shared last quarter, As supply constraints ease and lead times shorten, we expect orders will 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're 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.

Speaker 2

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 2 of our largest customers grew their orders with us over 40% in the first half of fiscal twenty twenty three. We continue to take share in this space and over the past few years, we've grown our webscale cloud infrastructure from effectively 0 into a multibillion dollar run rate business. I'm incredibly pleased about the overall progress we've made as we are continuing to win more and more use cases within their infrastructure.

Speaker 2

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 remain stable. Looking at the broader landscape. Digital transformation and hybrid cloud remain top areas of spend, which is fueling growth across our portfolio. Many customers have told me that while their Spend levels may be slowing in some areas.

Speaker 2

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 high single digits in 2023. We're also seeing many customers moving ahead with their hybrid work, AI and ML investments, while building the modern infrastructure they need to deliver on their objectives. 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.

Speaker 2

Lastly, Cybersecurity and full stack observability remain strategic priorities where we continue to invest and innovate. From a product revenue perspective, we saw 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.

Speaker 2

Last week, we introduced a preview of our cloud native full stack observability platform, the 1st network visibility solution to support open telemetry. This platform brings together our ThousandEyes and AppDynamics capabilities for unmatched to data correlation and insights from the user to the application to the network. To simplify network Security and Policy Management, our unified SaaS solution, Cisco Plus Secure Connect, now supports integration into Cisco SD WAN fabrics using Viptela technology as well as our existing Meraki SD WAN fabric. We also introduced new flexible, more To close, I'm proud of what we achieved this quarter. We delivered a strong financial performance, innovated across our portfolio and continue to make great progress on our business transformation.

Speaker 2

In addition, the increased visibility we have from almost $32,000,000,000 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 2024, 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, to secure their environments and achieve their sustainability goals all while delivering differentiated experiences.

Speaker 2

Now, I'll turn it over to Scott.

Speaker 3

Thanks, Chuck. We delivered another strong quarter and exceeded both our top and bottom line expectations, driven by our focused execution, Continued success of our business transformation and improved availability of supply as the actions our supply chain team have taken over the last several quarters are bearing fruit. Total revenue was $13,600,000,000 up 7%. Non GAAP net income was a record 3,600,000,000 and non GAAP earnings per share also a record was $0.88 Looking at our Q2 revenue in more detail. Total product revenue was $10,200,000,000 up 9%.

Speaker 3

Service revenue was $3,400,000,000 up 2%. Within product revenue, Secure Agile Networks performed very well, up 14%. Switching revenue grew in the double digits with strength in campus switching, driven by our Catalyst 9,000 and Meraki offerings. While data center switching declined slightly, we saw strong growth in our NEXUS 9,000 Enterprise routing had double digit growth driven primarily by strength in our Catalyst 8,000 series routers, SD WAN and IoT Routing. Wireless had very strong double digit growth with strength across the entire portfolio.

Speaker 3

Internet for the future was down 1%, driven by declines in optical and edge. We saw growth in our Cisco 8,000 offering and double digit growth in webscale. Collaboration was down 10%, driven by declines in meetings and collaboration devices, slightly offset by growth in contact center. End to end security was up 7%, driven by our unified threat management and 0 Trust offerings. Optimized application experiences was up 11%, driven by double digit growth in our SaaS based offering ThousandEyes.

Speaker 3

We made solid progress on our transformation metrics as we shift our business to more recurring revenue based offerings driven by higher levels of software and subscriptions. We saw strong performance in our ARR of $23,300,000,000 which increased 6% with product ARR growth of 11%. Total software revenue was $4,200,000,000 an increase of 10% with software subscription revenue up 15%. 84% of the software revenue was subscription based, which is up 4 percentage points year over year. We continue to have $2,000,000,000 of software orders in Product backlog.

Speaker 3

Total subscription revenue was $6,000,000,000 an increase of 9%. Total subscription revenue represented 44% of total revenue. And RPO was $31,800,000,000 up 4%, product RPO increased 7% and service RPO increased 2% and total short term RPO grew to $16,900,000,000 While total product orders were down 22 They compared against 34% growth in Q2 fiscal 2022, which is one of the largest quarters for product orders in our history. We saw year over year declines across our geographies and customer markets. Sequentially, total product order growth was in line with our historical growth rates.

Speaker 3

Within our customer markets, we experienced double digit sequential growth in both enterprise and commercial and public sector was better than we've seen historically. We continue to have very low order cancellation rates, which remain below pre pandemic levels. Total non GAAP gross margin came in at the high end of our guidance range at 63.9%, down 160 basis points and up 90 basis points sequentially. Product gross margin was 62.1 percent, down 2 20 basis points year over year and up 110 basis Point sequentially. Service gross margin was 69.1%, up 30 basis points.

Speaker 3

In our product gross margin, the year over year decrease was primarily driven by higher component and other costs. This was partially offset by our strong product mix and positive pricing the benefits of the actions we took in the prior fiscal year flowed through as we shift our backlog. Non GAAP operating margin came at the high end of our guidance range at 32.5%, down 180 basis points year over year and up 70 basis points sequentially. The The year over year decline was primarily driven by the higher component and other costs that I just mentioned. Backlog for both our hardware and software products continue to far As we navigated a complex supply environment, we were able to draw down total backlog by 6% sequentially, although it still grew year over year.

Speaker 3

Just a reminder, backlog is not included as part of our $31,800,000,000 in remaining performance obligations. Combined, our significant product backlog and RPO continue to provide great visibility to our top line. Shifting to the balance sheet. We ended Q2 with total cash, cash equivalents and investments of $22,100,000,000 We had record Q2 federal tax payments due to the IRS tax relief related to the California floods. We expect to pay these federal taxes by the end of the fiscal year.

Speaker 3

We returned $2,800,000,000 to shareholders during the quarter, which was comprised of $1,600,000,000 for our quarterly cash dividend and $1,300,000,000 of share We also ended the quarter with $13,400,000,000 in remaining stock repurchase authorization. Today, Today, we announced that we are raising our quarterly dividend by $0.01 to $0.39 per share, which represents our 13th consecutive increase. This reinforces our commitment to returning a minimum of 50% of free cash flow to our shareholders annually and confidence in the strength and stability of our ongoing cash flows. To summarize, we had a great quarter, delivering better than expected top and bottom line performance. We continue to make progress on our business model shift to more recurring revenue while making strategic investments in innovation to capitalize on our significant growth opportunities.

Speaker 3

Turning now to our guidance. Our guidance ranges reflect our strong pipeline and significant visibility driven by healthy backlog, ARR, RPO and improving availability of supply as we continue to benefit from the actions our supply chain team have taken over the last several quarters. We expect those same factors will continue into fiscal 2024 giving us greater visibility and confidence in our longer term goals. For fiscal Q3, our guidance is we expect revenue growth to be in the range of 11% to 13%. We anticipate the non GAAP gross margin to be in the range of 63.5% to 64.5%.

Speaker 3

Our non GAAP operating margin is expected to be in the range of 33% to 34% and our non GAAP earnings per share is expected to range from 0.96 to $0.98 There's also a significant change to our full year fiscal 2023 revenue and non GAAP earnings per share guidance driven by these same factors. For fiscal year 2023, we are raising our expectations for revenue growth to be in the range of 9% to 10.5% year over year. Non GAAP earnings per share is expected to range from $3.73 to $3.78 In both our Q3 and full year guidance, we're assuming a non GAAP effective tax rate of 19%. I'll now turn it back to Marilyn, so we can move into the Q and A.

Speaker 1

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

Speaker 3

Yes. Before we get into Q and A, I just wanted to send Our condolences to those impacted by the earthquake in Turkey and Syria. It's been absolutely devastating to watch as the death toll has climbed We're working closely with our teams in the region to give them support and help on the ground as much as we can. And we just want to let them know that we're all thinking about them and we're here to help.

Speaker 1

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

Operator

Thank you, Marilyn. Ittai Kidron, you may go ahead with Oppenheimer and

Speaker 4

Thanks guys and nice quarter and nice guide. I guess the big question is When you think about the output 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 on 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'm just trying to gauge For how long you can kind of keep this going at above normal growth rates for yourself?

Speaker 3

Yes, Itay. Thanks for the question. And shockingly enough that was the first question I expected. So let me just summarize sort of what we're seeing and then I can give you more detail. But number 1, let's start with the fact that our demand is stable, and That's first based on the sequentials that we saw demand remains stable.

Speaker 3

And in fact, if you look out at our Q3 forecast, which we normally wouldn't give you, The current forecast in Q3 is also in line with historical ranges of sequentials. So that's the first piece. The second thing is as Scott said, while we backlog came down 6% sequentially, it was up year over year. We expect that we will end the fiscal year even with the guidance we gave you today with a backlog that's roughly double what we would normally end the year with. The other thing to take into consideration is the business transformation with 44% of our Revenue now recurring really helps a great deal and we have $23,000,000,000 of ARR which we can actually renew in the next 12 months.

Speaker 3

So if you go back 8 or 9 years ago, we might have had to take orders for 75% of our revenue in any given quarter and Now we have 44% of our revenue coming from the balance sheet and recurring revenue. So all that Said, we actually believe that we'll still be able to deliver. We're confident that we'll deliver positive growth in fiscal 2024, Obviously, with pretty significant comps based on the guidance that we gave today.

Speaker 4

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, but eating into backlog. And while your backlog is doubled, 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?

Speaker 3

Scott, you want to take that? No, not at all, Itay. But what I would say is it's Obviously, too early for us to guide fiscal 2024. 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 $17,000,000,000 almost $17,000,000,000 of RPO that's current going to turn into revenue in the next 12 months in the ARR, but I 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 2024.

Speaker 3

I think it's a bit too early given Where we are in the year, just at the end of our Q2 for us to be a little more precise on that.

Speaker 4

Okay. Appreciate. Good luck. Thanks.

Speaker 3

Thanks. Thanks.

Speaker 1

Thanks, Ittai. Next question, please.

Operator

Amit Darian from Evercore. You may go ahead, sir.

Speaker 5

Thanks. Congrats on a really good quarter from my end as well. I guess, maybe if I think about the Secure Agile Networking segment growing at 14%, that's Really notable and I don't think the industry is growing nearly close to that pace. So I'd love to understand, I mean, do you think you're starting to see some share gains Come back to its Cisco, especially the supply chain starts to improve. Is that a tailwind that you're seeing and perhaps it continues for the rest of the year?

Speaker 5

Maybe you could just talk about that and also maybe talk How is campus doing within that segment? That would be helpful.

Speaker 3

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 Sure 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.

Speaker 3

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? Yes. Sorry, I missed that part of the question.

Speaker 3

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

Speaker 5

Yes. I was just wondering like within this context of 14% growth that you saw in that segment, how is campus performing for you very specifically and how is the

Speaker 3

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 sub components 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 It's 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.

Speaker 3

But the longer answer or 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.

Speaker 5

Got it. That's really helpful. And can I just ask you really quick on your back half guide is obviously fairly impressive, but in April You're sort of implying gross margins will be down 130 basis points year over year, I think, for the April quarter? Can you just talk about How much of that downtick you think is cyclical things like the supply chain and logistics and so on versus structural? And what do you think normalized gross margin could look like for the company

Speaker 3

Yes. The midpoint of the guide for the April quarter It's about a 10 basis point improvement from the quarter we just announced. So we do see gross margins And it's largely driven by it's less driven by cost. We're seeing some reduction in cost around logistics in particular, But component costs are kind of staying where they are 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.

Speaker 3

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.

Speaker 5

Perfect. Thank you.

Speaker 1

Great. Thank you. Next question, please.

Operator

Thank you. Paul Silverstein with Cowen. You may go ahead, sir.

Speaker 6

Thanks. Chuck and Scott, I appreciate that you all addressed in your prepared remarks the visibility of the management issue. So my apologies, but I'd ask you to revisit, especially in your enterprise business, including government in U. S. Federal.

Speaker 6

I'm sure you and your team are aware of what your competitors have asserted. I know Chuck, you just addressed the market share issue. But can you give us More color in terms of the validity of the demand trends and the visibility that's translating into?

Speaker 3

Well, as I said, our Enterprise and Commercial business, which is reflective of how most of our peers Represent enterprise. That was up double digit sequentially, which is in line with our historical ranges. And public sector actually performed better than it was above our historical ranges during the quarter. So the other thing I would point out is that our Quarter itself from a linearity perspective was quite normal and we actually had a we're unique in that we had the January month in our Q2. And one of the questions that we had was what's going to happen to budgets as we enter into calendar 2023.

Speaker 3

And we clearly we actually finished stronger than we started the quarter. So those are just a few data points for you. And I think If you look at what our customers are focused on right now, I mean think about some of their top priorities. They've got A complete rearchitecture of their applications to be cloud native running in both public and or private clouds. They're having to rearchitect their infrastructure to actually Deal with the changing traffic patterns that multi cloud brings to them.

Speaker 3

They're dealing with hybrid work and how do I Transform IT Infrastructure for that. They're dealing with cybersecurity threats on a massive scale And they're also all focused on sustainability, which is leading to our IoT business growing significantly as we connect industrial systems for our customers. So if you think about those big five trends, we're actually in the middle of those with all of our customers. So we feel good about where we are. And The last thing I'll say is that I was in Tokyo and Singapore last week and at the same time a lot of my leadership team were in Amsterdam for Cisco Live Europe and no one is talking about cutting technology spending right now.

Speaker 3

Everybody is it seems very committed to it. I think the underlying power of technology as it relates to all of our organization strategy is just too strong right now.

Speaker 6

Right. 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 eventually get back to 7 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.

Speaker 3

Yes. I mean, as you talk long term, there's a number of tailwinds that will come into gross margin. So not necessarily talking about Our guide for fiscal 2023, but longer term, there are several things that are going to be a tailwind there. One is Continuing to work our way through the backlog and reflect the price increases, I think we will continue to see leverage in logistics costs, both from a reduction in the freight cost per kilo, but also in the mix of how we ship between what has to fly air freight and what So I think we'll see some leverage there as well. I don't see a lot of our component providers outside of commodity areas like memory lining up to reduce cost to Right.

Speaker 3

So I think that it will be the combination of mix that will be beneficial to us and some cost leverage in the non component areas that will drive that north. So

Speaker 6

you think you can't get back to 67.35?

Speaker 3

Yes. So are you asking A 5 year forecast on gross margin, Paul, is that where you're going?

Speaker 6

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

Speaker 3

Long term, there's definitely leverage to push it back to where it's been historically, for sure, and if not beyond.

Speaker 4

Yes. Thanks, Gus.

Speaker 3

Thank you.

Speaker 1

Thanks, Paul. Next question, please.

Operator

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

Speaker 7

Great. Thanks. I'm assuming as you're having conversations with customers, they're 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

Speaker 1

And I just wanted to get

Speaker 7

a sense of where you think you are on some of the kind of 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 and A environment currently. Thanks.

Speaker 3

Meta, thank you. So We are probably, I'd say, still in the early innings of transitioning the traditional portfolio to subscription models. The team is working hard on that right now and we'll just continue to keep you updated. But I think we're several quarters away from Really having anything to speak about relative to the size of that business, but we're working hard on being able to deliver that. And the key is to give customers flexibility.

Speaker 3

That's what Over the last 7 years or so, we have disaggregated hardware and software in silicon. We've virtualized software to run on X86 appliances. So we want to give our customers whatever kinds of flexibility that they would like. So That's the first part. On the M and A side, I would say our strategy as you would expect has not changed.

Speaker 3

I think The market dynamics have changed and I think that the longer valuations remain somewhat muted from their peaks. I think Some of the companies are probably coming to more of a real position on what how long these valuations may exist and where the prior valuations even realistic in the first place. So we continue to stay aware of what's going on. We continue to scan the marketplace, but our strategy remains the same.

Speaker 7

Great. Thanks.

Speaker 1

Thanks, Chuck. Next question, please.

Operator

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

Speaker 8

Thanks for taking the question. I wanted to see if we could talk a little bit about the trends you're seeing in data centers. In the prepared remarks, I think you mentioned campus was good, but data center was weak. And I guess maybe I'm looking from Not just the switching part of it, but your UCS business and what are the broader trends? How much of that is reflective of Hyperscale slowing versus the broader market.

Speaker 8

Just trying to unpack that a bit. Thank you.

Speaker 3

Yes. I'll make a couple of comments and then 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're 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 you. I'm not sure on the infrastructure side or UCS if you want to share that.

Speaker 3

But other thing I would point out Simon is I said in my comments earlier about market share, everything that we sell in the infrastructure within webscale 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. No, it's a really good point.

Speaker 3

And on UCS, if that's the root of your question, We are seeing nice growth in UCS as well. And at least based on our calculations, feel like we're gaining share there as well.

Speaker 8

Thanks. And then just maybe a quick follow-up. I was a little bit surprised that the metric of hardware attached software in backlog It's $2,000,000,000 same as it was in the prior quarter. I would have guessed it would have come down with the Basically improvement of shipping the associated hardware. So maybe I don't understand that value or you could talk a little

Speaker 3

It's a great question, Simon. And we actually did see if you noticed, our overall software revenue grew 10% this quarter. So back to double digit growth and some of that growth is on Back of shipping some of the backlog out, both the hardware and the software that's had in backlog. So we are seeing the benefit of shipping that out. At the same time, as Chuck said earlier, demand remains steady.

Speaker 3

And so our overall backlog, while it came down only about 6% sequentially, There's still a significant amount of software stuck in that backlog, some of it attached to hardware.

Speaker 9

And software as a

Speaker 8

total percent of revenue or product revenue, that Where's that now?

Speaker 3

Yes. Just for software, it's in the 30% range. Overall, we're in the 44% range.

Speaker 8

Thank you very much.

Speaker 1

All right. Thanks, Samin. Next question?

Operator

Thank you. Samik Badri from Credit You may go ahead, sir.

Speaker 10

Hi. Thank you. I had one quick one and follow-up. The first one is on just the data center switching redesign. You guys made several mentions regarding Supply and the team kind of working hard to get redesign through, but does that actually mean the data center switching portfolio is now completed with redesign and that partly did drive better revenue guidance for the year.

Speaker 10

So that's my first question. The other one is, we've seen several companies report elongated lead times for sales cycles and extra signatures and all these other elements. And I appreciate, Chuck, you did hit on the fact that You aren't seeing any kind of tech spend get cut, but are you seeing some kind of resistance or slowdown as far as sales cycles impacting The speed at which you guys have historically done business and I take into account also I appreciate your comment regarding linearity. I just wanted to kind of ask this question to get it through.

Speaker 3

Let me take the second one first and Scott you can talk about the data center switching redesign. We absolutely are seeing some elongated 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.

Speaker 3

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, you want to talk about the redesign? Yes. Just to finish up on that, pipeline looks strong, close rates still look good. We're not seeing a huge difference there.

Speaker 3

There is in some cases a slight elongation. On the redesign, that's absolutely contributed to the growth that we're seeing Fesser product, more being able to design around problematic components that we couldn't get supply out. And as we work those redesigns to Build the product around components we can get our hands on. That's what we're talking about when we talk about the redesign. And so there's no question that's driven some of the growth that you saw in the quarter we just announced.

Speaker 3

We'll continue to drive the significant growth that we've put out for the second half. And to be clear, we will continue to see growth into fiscal 'twenty All the trends we've talked about that are driving the uptick that you see in our guidance in the second half of this year, those trends continue into fiscal 'twenty four and we Continue to expect nice growth there. I just think it's a little too early to start to quantify that and give you a guide.

Speaker 11

Got it. Thank you.

Speaker 1

Next question please.

Operator

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

Speaker 12

Hi, guys. Thanks very much. I guess I wanted to ask about your impressions of backlog and product orders relative to 3 months ago. And I think I have this correct. About 3 months ago, you guys were talking about if product orders were down 10% for the year, then your product Backlog at fiscal year end would be 2x to 3x higher than the normal kind of $4,000,000,000 or $5,000,000,000 range.

Speaker 12

And Chuck, I think you're quick to say that, it didn't feel like a 10% order decline was in the cards for you. So it feels now like You are going to burn more backlog than you were thinking previously and orders will be a bit worse than previous. Am I perceiving that correctly? And what are your thoughts there? Thanks.

Speaker 3

Yes, George, I'll 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're able to ship more of the backlog. That's good news for our customers. They're waiting for these components.

Speaker 3

They've got projects that they're 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

Speaker 6

of the pressure

Speaker 3

So it's not I'm responding to the burning down backlog. This is good news, Our ability to ship the backlog and that's what you see reflected there 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. And I would say on the demand side, if I go back 90 days, I would say, in general, I think there was more risk. At least there felt like there was more risk.

Speaker 3

And when I talked to my customers, there was more uncertainty. And even when you hear listen to the news and we talk I talk to my colleagues, we were in Davos, it feels like The longer we go without seeing some major shift, then the better our customers are feeling. So obviously, we're not immune to anything and we'll have to continue to monitor it. But after traveling in Asia last week, our team being in Europe, I actually saw customers in New York while I was here this week. And customers are moving forward.

Speaker 8

Great. That's helpful. Thank you very much.

Speaker 1

Thanks, George. Next question?

Operator

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

Speaker 9

Great. Thank you, guys. And I apologize if you covered it. My line cut out a little bit before. Scott, I'm just trying to clarify the order versus the backlog comment.

Speaker 9

I think, If I'm not mistaken, your run rate backlog had been sort of roughly $5,000,000,000 as you exited fiscal year. So are you suggesting to us that The backlog comes down by about $3,500,000,000 over the next several quarters. And if that's the case, if I just kind of back that out of your guidance, Would that imply sort of that the business is effectively flat year over year ex the backlog drawdown as we exit 2023 into 2024? And then I have a quick follow-up.

Speaker 3

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 2 times and three times Normal backlog and normal backlog, as we said last quarter, is between $4,000,000,000 $5,000,000,000 at the end of the year. What we now see is that it's still going to be roughly double What that same range.

Speaker 3

So there's definitely our ability to ship some out of the backlog, which is again great news for our customers and for our partners. The one piece that's missing in your equation is as we ship the backlog, remember we said there's more than $2,000,000,000 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.

Speaker 3

So there's 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're missing.

Speaker 9

Got it. And then

Speaker 5

maybe just as a quick follow-up.

Speaker 9

So as we enter, let's say, the next fiscal year, I mean, given your excellent work on

Speaker 6

supply chain and the team's

Speaker 5

done a phenomenal job,

Speaker 9

would that imply, I mean, Would that imply, I mean, basically, we could be back at normalized backlog within a quarter, maybe 2 at the worst case scenario if trends hold Consistent where we are today, is that a reasonable expectation?

Speaker 3

Rather than try to say it's a quarter or it's quarters. I do expect it to normalize in fiscal 2024.

Speaker 9

Great. Thanks, guys.

Speaker 1

Next question, please.

Operator

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

Speaker 9

Great. He stole my thunder with the previous question. That was exactly my question. So I want to understand something, just clarification on what you just answered. So at the minimum, the decline in the backlog was $600,000,000 at the minimum, because if end of year is going to be $8,000,000 to $10,000,000 Take 6% of that and the backlog is now higher.

Speaker 9

So that means that the minimum year backlog declined $600,000,000 and that means that product growth, We should take out some of the $600,000,000 because some of it goes into deferred revenue. Am I correct with what you just answered?

Speaker 3

Yes. Well, you're close. Let me run through it again, Hal, and if it's still not clear, we can catch you in the follow-up. The 6% was the decline in backlog from Q1 to Q2, right? So we were able to work off about 6% of the backlog that we What we've said is at the time that we gave you that Q2 guide and the full year, the previous full year guide, We expected to end the year with somewhere between 2 and 3 times our normal backlog.

Speaker 3

We're now saying it's going to be roughly double the normal backlog. Some of that obviously will ship out and will be a part of the significant guide up that we've given you in second half revenue. Some of it instead of Turning into immediate revenue will go into deferred revenue and be recognized ratably over time. It will show up in RPO. I hope that's clear.

Speaker 3

Yes, it will show up in deferred revenue and RPO. I hope that's clear, pal. If not, we can follow-up.

Speaker 9

Yes, very clear. So my question, I want to go back to the basics and understand. Last quarter, we're all concerned And about environment slowing down. We don't hear it. We don't hear you saying environment continues to slow down.

Speaker 9

We didn't hear Arista saying it. We did hear you saying the 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 trend so far, The year would continue to be normal on a sequential basis or you expect some more deterioration going forward?

Speaker 3

Yes, Tal. So we on the enterprise and commercial space, we saw double digit sequential growth, which is in line with what we've seen And as I said, public sector was actually higher than historical ranges and federal was U. S. Federal was extremely strong during the quarter from a demand perspective. On the service provider side, I think you're seeing many of our competitors and peers, Some of them anyway don't give order data.

Speaker 3

And so, I think for us, those customers are the ones who did the most planning for long term ordering. So as lead times begin to come down, we would expect them to change their ordering patterns and they've already got 6 to 12 months' worth of consumption lined up in the backlog. So we'll see that normalize over the next few quarters. I will say in the webscale space, there are roughly 35 use cases or franchises within The largest players and we've actually been designed into 18 of those at this point. And we are Very confident that we'll continue to get designed in.

Speaker 3

I got a note today that we had just got noticed about a new design win today. And so we're still very optimistic long term. We just think it's a short term normalization for our service provider space.

Speaker 11

Got it.

Speaker 9

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?

Speaker 3

Well, you mean layoffs in like in our customers?

Speaker 9

Yes, yes, across the industry.

Speaker 3

Yes. Well, if you think about what occurred, there was a lot of companies that had a massive surge in employment And we didn't, but I think the thing that we're seeing right now is that We've seen the sequential growth be in line and in some like it was towards the lower end. So It's not performing at the highest end, but I think that it's in range. And if you and I also shared that in Q3, our current forecast is also in line sequentially with historical ranges, which we normally don't give. We just wanted you guys to have that visibility.

Speaker 3

So look, it's certainly an uncertain time. And I'm not I don't want to paint a picture that we're immune and I don't want to paint a picture that every customer is spending everywhere on everything, but We've been able to maintain and continue to see our customers moving forward with projects. And the one thing that was really Encouraging for me was to see January as strong as it was given our the uncertainty around 2023 budgets.

Speaker 11

Got it. Thank you.

Speaker 1

Thanks, Paul. Next question?

Operator

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

Speaker 13

Thank you. So if I can get 2 in here. 1, could you talk a little bit about obviously the Enterprise campus is still very strong. I think traditionally, that's kind of a GDP ish type of business and it's been running Above that, and it sounds like the confidence for next year is pretty strong as well. So maybe Chuck, any insights Like what's kind of different there?

Speaker 13

Are we starting to decouple from like macro GDP for that campus network VCs? Any thoughts That would be great. And then second, obviously a lot of excitement out there about AI, chat, PPP, all that stuff. Just curious what you think for your data center and cloud businesses, what kind of impact, There's kind of more of an arms race with big customers around AI, what that would mean for switching and routing business for you guys. Thank you.

Speaker 3

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 were sweating assets a little longer. So that's one thing that shifted. The second is We're really seeing these trends of multi cloud, the trend of hybrid work and The overall rearchitecture of their networks, if you really think about 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.

Speaker 3

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 webscale 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're like bigger than the core infrastructure networks that they're running, which was astonishing to me when I learned that.

Speaker 3

And the network performance required is 3 to 4 times what they've historically needed. And so this is a massive opportunity for us and we're 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.

Speaker 13

Okay. Thank you. Very helpful.

Speaker 1

Thanks, Jeff. Next question?

Operator

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

Speaker 11

Yes. Hi. Thanks for taking my questions. Congrats on the strong guide. Maybe if I can just quickly hit on 2 of the product areas.

Speaker 11

Firstly, security, what sort of Benefits are you seeing given your broad portfolio there in terms of customers looking to maybe some level of vendor consolidation Just given your position as a broader security portfolio supplier, and what sort of benefit as Supply eases maybe on the firewall side, should we expect greater revenue growth? And a similar question on Internet for the future Internet for the future segment, seems like a bit more supply Other segments, but what sort of what are you seeing on the supply side there? Thank you.

Speaker 3

Okay. I'll take security and you take So I think that, look all of our customers definitely want to consolidate their security Infrastructure. They've got 40, 50 different vendors and trying to correlate these threats is very difficult and it just you can't add enough people. So, our teams right now are heads down working on some new capabilities that we're going to be bringing out over the next 12 to 18 months and some of that is focused on exactly that, how do we consolidate and how do we create The ability to correlate threats in real time much more effectively. And so we think that you're probably going to start seeing the benefit of that 3, four Quarter is out.

Speaker 3

So team's got work to do. We've hired a significant amount of outside talent. We've invested heavily in this space. So while we may see we may not see the growth that you want to see in the near term, but you will see this begin to accelerate in FY 'twenty four and I think it will We're playing the long game here and really believe that there's a lot of consolidation that we can drive over the next few years. Scott?

Speaker 3

Yes, on Internet for the future, Sameek, it is one of the spaces we've worked so hard and done so much across our entire product portfolio. We've made great progress in many cases. I would say Internet for the future is one of the spaces where we're still we've improved Lead time is there, but we're still not back to more normal lead times in that space. What I'd 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're seeing improvement, it's not where we want it to be.

Speaker 3

I feel like we're performing pretty well on the supply side and Internet for the future.

Speaker 11

Thank you.

Speaker 1

All right. That wraps up our Q and A. I'm going to turn it over to Chuck for some closing remarks.

Speaker 3

Well, first off, I just want to thank everybody for spending time with us today and also Really thank our teams. They delivered on very strong results. I want to thank the supply chain and our engineering teams for quarter after quarter after quarter Hard work and redesigns, over 100 product redesigns, aggressive actions to get us to the position we're in today, the entire company for the progress we've made on our business transformation. And I'll just leave you with our feeling that our demand has remained stable. The business transformation is contributing significantly.

Speaker 3

Our backlog, all of those give us visibility and confidence in the future. I think the relevance of our portfolio given the most pressing needs of our customers is at its highest it's been in a very long time and I'm super proud of what our teams have accomplished. So look forward to talking to you in the future and thanks for joining us today.

Speaker 1

Thanks, Chuck. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2023 Q3 results, will be on Wednesday, May 17, 2023, at 1:30 pm Pacific Time, 4:30 pm 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

Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call

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