Cisco Systems Q2 2022 Earnings Call Transcript

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Provided by Quartr
February 16, 2022

Key Takeaways

  • Product order growth: Q2 product orders climbed 33% year-over-year—the third consecutive quarter above 30%—driving a record backlog of over $14 billion.
  • Revenue and earnings beat: Total Q2 revenue rose 6% to $12.7 billion, while non-GAAP EPS of $0.84 exceeded the high end of guidance.
  • Software and subscription momentum: ARR grew 11% to $21.9 billion, software revenue increased 6% to $3.8 billion, and subscription revenue rose 7% to $5.5 billion, bolstering revenue visibility.
  • Supply chain headwinds: Persistent semiconductor shortages and elevated logistics costs are constraining manufacturing, fueling backlog growth, and pressuring gross margins.
  • Shareholder returns: The company returned $6.4 billion in Q2 (including $4.8 billion in buybacks), authorized an additional $15 billion repurchase program, and raised its quarterly dividend to $0.38.
AI Generated. May Contain Errors.
Earnings Conference Call
Cisco Systems Q2 2022
00:00 / 00:00

There are 15 speakers on the call.

Operator

Welcome to Sysco's Second Quarter Fiscal Year 2022 Financial Results Conference Call. Now I would like to introduce Marilyn Mora, Head of Investor Relations.

Speaker 1

Sysco's Q2 fiscal 2022 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 the financial information can also be found in the Financial Information section of our Investor Relations website.

Speaker 1

Throughout this conference call, we will be referencing both GAAP and non GAAP financial results and we'll discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be made on a year over year basis. 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 2022. The SEC, they are subject to the risks and uncertainties, including COVID-nineteen, 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 CYSQ's 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 it accompanies 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

Speaker 2

Thanks, Marilyn. I hope you all are remaining safe and healthy. After the solid results we delivered last year, 2022 is proving to be an even stronger year fueled by exceptional demand for our solutions and the continued success of our transformation. In Q2, I'm thrilled to say that we delivered another great quarter with double digit ARR growth and robust product orders, Cisco, which fueled an all time high backlog and a strong pipeline. These results underscore the increasing relevance and criticality of Cisco's innovation the era of digital transformation and cloud and reinforces my confidence in our ability to deliver growth.

Speaker 2

We are focused on staying ahead of our customers' most pressing needs as they navigate a dynamic world. Our customers are moving faster than ever driven by the move to hybrid work and hybrid cloud. This requires modernized infrastructure, new security architectures and accelerated digital transformation. The breadth of our innovative solutions and services at a global scale, combined with our increasing ability to deliver more flexible consumption offerings, is driving even deeper partnerships with our customers across our entire portfolio. Now I'd like to spend a few minutes covering our results in more detail and what we are seeing in the market.

Speaker 2

We delivered solid top line growth combined with margins and earnings that exceeded the high ends of our guidance despite operating in a supply constrained and inflationary environment. The robust demand we saw in Q1 continued into Q2 with product order growth of 33%, our 3rd consecutive quarter of order growth of 30% or higher with momentum once again across all geographic regions and customer markets. For example, in our enterprise business, we delivered 37% order growth, the highest in over 12 years, as large customers prioritize investments to modernize their networks and enable new digital capabilities and resiliency. As more and more becomes digitized, we expect our momentum to continue. We believe the need for highly secure seamless connectivity, hybrid cloud and hybrid work solutions along with edge computing will drive growth for Cisco.

Speaker 2

The opportunity ahead of us is clear as demonstrated by our growing pipeline and record backlog, which more than doubled from a year ago and will convert into revenue in the coming quarters. In our webscale business, we delivered another incredible quarter. Our order growth was up more than 70% year over year, which is over 100% growth on a trailing 4 quarter basis. Cisco's portfolio, which grew over 50% fueled by the Cisco 8,000 product line, Acacia and Silicon 1. We're also seeing tremendous traction with ZR Optics as part of the routed optical network strategy.

Speaker 2

Our optical systems and Acacia businesses both saw significant double digit growth driven by our webscale customers. The innovations we've invested in over the last several years have positioned us well as the largest players in this space adopt next generation technologies. Our customers are making strategic decisions on their future roadmap Cisco and recognize Cisco's unparalleled portfolio is critical to their strategies. We believe they are still in the early phases of our next generation platform buying decisions and expect our momentum to continue. From a product revenue of we delivered another strong and balanced quarter with 9% growth with broad based demand across the majority of our product portfolio.

Speaker 2

This was led by increased customer spending to modernize their networks, securely connect their hybrid workforce and build out their 5 gs networks, All with a strong uptake of our subscription offerings. We continue to prioritize investments that will drive our long term performance and capitalize on the megatrends In large growing markets, including cloud, full stack observability, 5 gs, 400 gig, Wi Fi 6 and security. Our expertise in these areas along with the deep integration of hardware, software and silicon across our portfolio differentiates us hybrid work experience, we recently introduced new breakthrough networking innovations, including Catalyst 9000X switches built on Silicon 1, the industry's first high end WiFi 6E access points and an as a service private 5 gs offering for the enterprise, enabling communication service providers to deliver cloud based services to their customers. We are committed to also lead in a more sustainable way. An example of this is our Silicon One Catalyst 9000X switches I just mentioned, which are approximately 40% more power efficient compared to prior versions.

Speaker 2

Building technologies in this way is key towards our goal to reduce our Scope 3 emissions to net 0 by 2,040. I'm also proud of the progress of our business transformation to more software and subscription based recurring revenue as we transition more of our business to the cloud. Annualized recurring revenue or ARR of $21,900,000,000 was up 11% For RPO, which is largely software revenue that is committed but not yet recognized, was up 16%. We remain one of the largest software companies in the world. In Q2, our software revenue grew by 6% to 3,800,000,000 total subscription revenue accelerated to $5,500,000,000 up 7% year over year.

Speaker 2

It's important to note that both of these metrics the component situation. The strength in our software, RPO and ARR clearly demonstrate the value we are creating through our transformation and provides us a greater degree of visibility and predictability into our future growth. From a macro perspective, the component shortage continues to remain challenging. Our incredibly strong demand continues to outpace supply, expanding our backlog of products, software and services. Our supply chain team continues to take aggressive action through strong inventory positions, deepening supplier relationships, qualifying alternative components and increased use of expedited freight.

Speaker 2

There are still significant constraints with semiconductors preventing us from completing manufacturing of some of our products and that remains a headwind to revenue growth despite very strong demand. In addition, the constrained environment continues to drive up supply chain costs, which we have successfully passed through to help offset these increases. In summary, we continue to work through the impact of the pandemic and component shortages, and we've never felt better about the company, our position and our outlook for growth. Our Q2 results reflect healthy momentum, a clear vision and outstanding execution by our teams. Our innovation engine and pipeline have never been stronger, and we are rapidly transforming our business by accelerating our transition to more software and subscription offerings.

Speaker 2

I'm so proud of our teams and what they've accomplished during these very dynamic times. We are bringing industry leading innovation to market and further enhancing our differentiated position across the portfolio by delivering flexible consumption models for our customers. Cisco. I remain confident and optimistic about our future. Cisco was at the epicenter of massive shifts toward hybrid cloud, hybrid work and digital transformation, which we believe creates momentum for our business and positions us well to capture the significant opportunities ahead.

Speaker 2

I'll now turn it over to Scott.

Speaker 3

Thanks, Chuck. Q2 was a strong quarter across the business. We executed well, delivering our 3rd consecutive quarter of more than 30% product order growth, Total revenue increased by $760,000,000 to $12,700,000,000 up 6% year over year in line with our guidance range for the quarter. We saw strength in a number of product areas and across all of our geographies. Our business performed well in this highly dynamic and supply constrained environment, which, As Chuck said, continues to hinder our ability to convert the significant demand we have into revenue.

Speaker 3

Overall profitability in Q2 was strong, With non GAAP operating margin of 34.3 percent, non GAAP net income of $3,500,000,000 and non GAAP earnings per share of $0.84 With non GAAP earnings per share coming in above the high end of our guidance range. Looking at our Q2 revenue in more detail, Total product revenue was $9,400,000,000 up 9%. Service revenue was $3,400,000,000 down 1%, driven by delays in hardware support contracts related to the supply constraints. Within product revenue, Secure Agile Networks performed well with revenues up 7%. Switching had solid growth, driven by a double digit increase in data center switching, driven by our Nexus 9000 products.

Speaker 3

Campus switching had solid growth led by our Catalyst 9,000 and Meraki switching offerings. Wireless had very strong double digit increase driven by our Wi Fi 6 products and our Meraki wireless offerings. We also saw double digit growth in compute revenue driven by servers. Enterprise routing declined, primarily driven by access slightly offset by strength in SD WAN. Hybrid work, which is where we report just our collaboration portfolio, was down 9%, driven by declines in our collaboration devices and meetings offerings, partially offset by the continued ramp of our communication platform as a service.

Speaker 3

Beginning next quarter, the name of this category will change from hybrid work to collaboration. There will not be any changes to the components within this category. End to end security grew 7% with broad strength across most of the portfolio. Our 0 Trust Cisco's portfolio performed well with double digit growth driven by strong performance in our Duo offerings. Our subscription portfolio continued to perform well driven by cloud Security and 0 Trust.

Speaker 3

Internet for the future was up 42%, driven in large part by the strength of our webscale customers. We saw broad strength in the portfolio with growth in Edge, driven by double digit growth from our ASR 9,000 offerings and core with strength in Cisco 8,000 and optical. We also saw continued strong contribution from Acacia, our optical networking offerings. Optimized application experiences was up 12%, driven by double digit growth in both ThousandEyes and Intersight. SaaS revenue for AppDynamics grew mid single digits with the continued shift to its cloud delivered platform.

Speaker 3

We continue to make progress on our transformation metrics as we shift our business to more software and subscriptions. Software revenue was $3,800,000,000 an increase of 6% with the product portion up 9%. 80% of software revenue was subscription based, which is up 4 percentage points year over year. Total subscription revenue was $5,500,000,000 an increase of 7%. Cisco's total subscription revenue represented 44% of Cisco's total revenue.

Speaker 3

Annualized recurring revenue, or ARR, was $21,900,000,000 an increase of 11% with strong product ARR growth of 20%. And remaining performance obligations or RPO fiscal 2020,000,000 up 8%. Product RPO increased 16%, service RPO increased 3% and the total short term RPO Grew 8% to $16,300,000,000 As a reminder, the short term portion will convert to revenue over the next 12 months. Relative to acquisitions, there was an approximate 200 basis point year over year positive impact on Q2 revenue growth and no material impact on our non GAAP EPS, strength across the business. Looking at our geographic segments, the Americas was up 36% and EMEA and APJC were both up 30%.

Speaker 3

Total emerging markets were up 39%, with the BRICS Plus Mexico up 48%. In our customer markets, service provider was up 42%, enterprise was up 37%, commercial was up 34%, And Public Sector was up 20%. As you can see, it was broad strength across our geographies and customer markets. From a non GAAP perspective, total gross margin came in at 65.5%, down 140 basis points year over year. Product gross margin was 64.3%, down 2 30 basis points and service gross margin was 68.8%, up 90 basis points.

Speaker 3

The decrease in product gross margin was primarily driven by ongoing higher component costs related to supply constraints as well as higher freight and logistics costs. As we've been discussing for several quarters, we continue to manage through the supply constraints seen industry wide by us and our peers due to component shortages, which have resulted in extended lead times and higher supply costs. The situation remains challenging. We continue to partner closely with our key suppliers, leveraging our volume purchasing and extended supply commitments as we address the supply challenges and cost impacts, which we expect will continue into the second half of our fiscal twenty twenty two. As I mentioned, the component supply constraints also slow the conversion of our strong demand into revenue.

Speaker 3

This has resulted in a substantial increase and continued build in our backlog levels well beyond our normal historical levels. Additionally, the ongoing supply constraints have not only impacted our ability to hardware, but also impacts our delivery of software, such as subscriptions that customers order with the hardware. That undelivered software is also included in backlog until the hardware ships, which is when we begin to recognize the revenue. Of course, this impacts our software revenue growth and other related metrics. To give you a sense of scale of our backlog, our Q2 ending product backlog was more than $14,000,000,000 an increase of more than 150% year on year.

Speaker 3

Within that amount, software backlog almost doubled to more than 2,000,000,000 Keeping in mind that backlog is not included as part of our $38,500,000,000 in remaining performance obligations. We ended Q2 with total cash, cash equivalents and investments of $21,100,000,000 Operating cash flow for the quarter was $2,500,000,000 down 17% year over year, primarily driven by advanced payments to secure future supply. These advanced payments had a negative 17% year over year impact on operating cash flow. Additionally, we made a tax payment of approximately $100,000,000 this quarter, which had been deferred as a result of the CARES Act. Capital allocation, we returned $6,400,000,000 to shareholders during the quarter, was comprised of $4,800,000,000 of share repurchases $1,500,000,000 for our quarterly cash dividend.

Speaker 3

Given the confidence we have in our business today and into the future, our Board has authorized an additional $15,000,000,000 for share the fiscal year, bringing the total to approximately $18,000,000,000 We're also raising our dividend by $0.01 to $0.38 per quarter, which represents our 12th increase. Combination of our dividend increase, additional share repurchase authorization and higher share repurchases during the quarter demonstrates our commitment to returning excess capital to our shareholders and our confidence in the stability of our ongoing cash flows. We continue to invest organically and inorganically in our innovation pipeline. We closed the acquisition of REPLEX in Q2 and Opsani in early Q3 to enhance our full stack observability offerings. These investments are consistent with our strategy of complementing our internal innovation in R and D with targeted M and A to allow us to further strengthen and differentiate our market position in our key growth areas.

Speaker 3

To summarize, we had another good quarter with robust product demand and solid execution in a complex supply constrained environment. We continue to make progress on our business model shift We're seeing progress as we drive the continued shift to more software and subscription revenue, delivering growth and driving shareholder value. Now let me provide our financial guidance for Q3. As a reminder, the Q3 of last year included an extra week, which was a benefit to total revenue of approximately 3 points of growth. The total impact on our cost of sales and operating expenses was approximately 150,000,000 For next quarter, we expect revenue growth to be in the range of 3% to 5%.

Speaker 3

We anticipate non GAAP gross margins to be in the range of 63.5% to 64.5%, reflecting the continuing increase in supply chain costs we're incurring as we protect shipments to our customers. Our non GAAP operating margin is expected to be in the range of 32.5% to 33.5%. Non GAAP earnings per share is expected to range from $0.85 to $0.87 For the full year fiscal 2022, we're tightening the range as follows. We expect revenue growth to be in the range of 5.5% to 6.5% year on year. Non GAAP earnings per share is increasing $3.41 to $3.46 up 5.9 percent to 7.5 percent year on year.

Speaker 3

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

Operator

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

Speaker 4

Thanks. Hey, guys. Nice to see the good results. I want to dig into the supply chain a little bit. Chuck and Scott, maybe you can talk about Just kind of quarter over quarter, have things gotten a little bit worse, a little bit better?

Speaker 4

And is there any timetable in mind where you think we could see a material improvement. And maybe on the back of that, Scott, when we see this improvement, Should we just expect like a period of, I don't know, 2, 3 quarters where you really have outsized growth as you fulfill this unusual backlog, I'm just trying to understand the scenario here of how all of this gets unwounded.

Speaker 2

Yes, Ittai, thanks for the question. I'll start and then Scott can jump in. I would say during the quarter, supply chain didn't get materially worse and didn't really get It was pretty consistent. There were gives and takes throughout the quarter, but I think at a macro level, that's the way I'd characterize it. There were a little bit towards the end of some omicron effect with people being sick and not being able to show up in factories and some of the logistics issues that are well documented.

Speaker 2

But In general, that's what we saw. We don't have I wouldn't say we have a great the time line for you as to when things begin to improve. All we know now is we expect this to be with us through the second half of our year. Scott, would you add? Yes.

Speaker 3

No, I think that's right. That's in sync with our expectations. And Itay, to your question on how does this unwind, it's I don't believe it unwinds in a lumpy fashion. I think it will unwind as supply and demand get more imbalanced, That will just happen gradually over the course of the next few quarters. So I'm not expecting a significant bump in any given quarter.

Speaker 3

I think The supply frees up with $14,000,000,000 of backlog. We've got plenty of demand to go off and fulfill. It's really a question of when does that supply free up. And as it does free up, I think It will happen gradually over time.

Speaker 4

Got it. Maybe Scott, just to clarify this last point, is there any way for you to know how much of this backlog is Double ordering, I don't know what it means from a customer standpoint that you have all this backlog. Are customers really waiting for a long time to product and what is the risk You have some kind of double order elements in these figures.

Speaker 3

Ittai, that's something that we've been alert to and watching for since we began building the backlog after 3 consecutive quarters of demand growth in the 30% range And revenue growth only in the 6% to 8% range. We've been building substantial backlog, and so we've been looking to that. I think that it's clear that customers are responding to our lead times and our lead times have extended as the lead times for the components have extended. So there's, I'd say, some extension in there. But I think what we're seeing is real demand.

Speaker 3

I think it's a combination of pent up demand from products that didn't get done during the pandemic. I think it's the leading edge of several of these trends that we've talked about that we're investing into. And when we look at things like if There was double ordering, you probably wouldn't see that as much in the commercial and small customers, and we're still seeing strong growth in that segment. You probably also would see the pipeline build begin to slow down, and we're not seeing that either. Our pipeline is quite robust at this point.

Speaker 3

So We're looking for proxies to try to understand that better. We're not seeing anything at this point that would indicate there's double ordering in there.

Speaker 4

Excellent. Thank you so much.

Speaker 1

Thanks, Ittai. Next question, please.

Operator

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

Speaker 5

Thanks, guys. I guess, is there anything wrong with the following logic with respect to your elevated costs? At some point, logistics freight costs are going to return to normal, if not entirely back to where they were a year, year and a half ago largely. As far as the stickier component and semiconductor costs, to the extent they don't revert, your price increases eventually Before I ask the follow-up, is that is there anything wrong with that logic?

Speaker 3

I think, Paul, there's nothing wrong with the logic. I think the Expectations that I would give you are the same that I gave you last quarter. As I think about gross margin through the end of this fiscal year, I think it stays in the range we're in, in the 64% to 65% range through the end of the year. Beyond that, as you said, And I hope you're right that logistics costs begin to return to something that's more normal. Obviously, the price increases that we put in place, we've talked about this previously, we're not seeing much benefit from that today because the price increase goes in, there's offsets between the time we start it and it gets out to the field.

Speaker 3

Of the field then has to take those prices, sell it to customers. Those orders have to come into the backlog and then get fulfilled out of the backlog before we finally get the revenue credit for those price I think that we'll beginning this we will begin to see benefit from those price increases toward the end of this quarter and more into Q4, But my expectation on gross margins at this point is that they stay in the range that we're in right now in this 64% to 65% range through the end of the year.

Speaker 5

Got it. Chuck, on the revenue side, this is the best demand environment across enterprise, carrier and web scale I've seen in 26 years covering the segment. And you'd have to go back to the late '90s and of course that proved to be a bubble. We see your growth, the growth of your peers Arista, Juniper, Extreme, etcetera. How much of what's going on is pure market growth?

Speaker 5

How much of this is improved execution on the part of Cisco?

Speaker 2

That's a really good question. And I would say that it is definitely a combination of both. The markets are certainly robust, as you called out, with Seeing some of our peers who are having solid results as well. But then when you look at when I look at the incredibly well because we didn't exist there just a couple of years ago. And in some of our technology areas like Wi Fi, I mean the growth rates on the order side, Even Campus switching to gross on the order side.

Speaker 2

I think that I think there's a lot of really good I think our portfolio is in great shape and you have to remember we're on the front end of these multiyear trends that are really in our favor whether it's 5 gs, whether it's 400 gig, Wi Fi 6, hybrid cloud, hybrid work, edge compute, I mean these are all technology areas and transitions that are positive for us. So those are somewhat market related, but I think our portfolio is well positioned for those transitions.

Speaker 1

Thanks, Chuck. Next question?

Operator

Samik Badri from Credit Suisse. You may go ahead, sir.

Speaker 6

Hi, thank you very much. So I got 2 hard questions for you guys. I'll keep the second one short, but here's the first one. So So I want to congratulate you guys on the 30% plus product order growth. And I think what a lot of us really want to know is, What is the right normalized growth rate or when do you see the normalized growth rate finally starting to flow through your numbers?

Speaker 6

And We look at the 30% and think this is a thematic trend, but at some point needs to come back down a little bit. When do you see the normalization of that product order growth actually happened. So that's the first question. My second question is a $20,000,000,000 question. Are you guys buying Splunk?

Speaker 6

And if not, what have been the internal considerations for not doing the deal?

Speaker 2

So Let me answer, I guess, both of them. So on the first one, I think that next quarter, Q3, the compares definitely get tougher from a year ago, particularly because we had an extra week of order as well. And then in Q4, obviously, that was the Q1 that we experienced the 30% plus fiscal year. So certainly those will be good quarters for us to sort of On your second question, first of all, we don't comment on rumors or speculations or stories. What I will tell you is that we are constantly evaluating potential opportunities.

Speaker 2

Scott and I were talking and we think for every deal we do, we probably look at 10 to 15 companies. We base our decisions on 1st and foremost, strategic fit secondly, cultural fit and equally as important, the financial and the valuation fit. And we are always disciplined and we continue to focus on both inorganic and organic opportunities. But I will tell you that you should expect us to continue to be very, very disciplined as we go forward as well.

Speaker 6

Got it. Thank you.

Speaker 1

Next question please.

Operator

Brad Hall from Goldman Sachs, you may go ahead.

Speaker 7

Great. Thanks, guys. I wanted to come back to gross margins for the quarter. You guys substantially beat the top end of your guidance range. And I wanted to see if you could just comment on what were the positive surprises within that gross margin line.

Speaker 7

And then my second question, Maybe kind of a non sequitur, but I was really surprised, Chuck, on the public sector orders. Those were really strong. And I wonder if you could maybe dig into that a little bit and comment on some of the dynamics there in the public sector. Thanks.

Speaker 3

I'll take the first one. On the gross margin, Rod, it really came down to product mix That we had the components for that we could build and ship out during Q2. As I said earlier, our expectations on gross margin for the year are unchanged. We had favorable product mix in Q2 that drove us above, as I'm sure you're aware, above the high end of our guidance range. I think it's a bit of a headwind for us as we look at gross margins in Q3, but it equals out for the year.

Speaker 3

And so our expectations for the full year on gross margin are unchanged.

Speaker 7

Scott, can you comment on specifically what types of products mixed in positively there? Just give us a little more color.

Speaker 3

It's always a mix. When you go across product lines and across customer size, both of those things have an effect. Rather than kind of go through and parse product by product, it's We had a quarter where the supply we had just allowed us to ship higher margin product. And again, given the visibility we have with $14,000,000,000 of backlog, we have pretty good visibility into what we need to build and a pretty good feel for what that's going to look like In the quarters ahead. So feel confident that we're going to stay in this range through the end of the year.

Speaker 2

And on the Public Sector question, I think It's a good catch on your part because a lot of people look at the 20% and see it as being below the other customer markets And we'd look at that negatively, but the reality is, is it's been the most consistent for the last couple of years. And we saw broad based strength And whether it was in our government business, which has been I think we've had some looking at some data here, 6 consecutive quarters of positive growth and 3 of the last 4 strong double digit growth. If you look at Education, we've had 5 straight quarters or 6 straight quarters there as well, and it's been particularly strong in the last 5 quarters. And so it was very broad based across the public sector.

Speaker 7

Great. Okay. Thank you.

Speaker 1

Thanks, Rod. Next question?

Operator

Tim Leung from Barclays, you may go ahead.

Speaker 8

Thank you. Yes, just wanted to ask on the software side, Decent year over year growth in the quarter. I understand it's still being hampered a little bit, but maybe just Talk a little bit, Chuck, about when you think we'll start to see that accelerate a little bit more than the overall revenues. Is it CAT 9 ks? Is it some other products moving To more software, is it recovery in some of the other businesses?

Speaker 8

And then the follow-up is on the cloud business. You talked about the strong orders again. Could you just give us a little color kind of what's driving that? And then more than just a product basis, are you seeing competitive wins, new use cases, new customers, what's really driving that 70% year over year and 100% over the last 4 quarters. Thank you.

Speaker 2

I'm pulling out some data here. So Tim, on the first one, On the software front, I think you have a really good question. I think Scott called out in his section that our product software revenue growth was 9%. You got to get behind that to understand what's going on. And our old perpetual software, which we've been in transition from 2 subscriptions, perpetual was down 12 and subscription was up 17.

Speaker 2

So the transition is actually happening the way we expected. That's the reason you're seeing some of the because the subscription stuff obviously is recognized over time and you're taking a 12 on a one time piece of software from the way we used to sell it. So you've got that dynamic that just has to continue to play out. You have the renewals that you mentioned starting to come through on some of the D and A stuff in earnest in 2023 and then 2022 beginning to ramp, but and then you've got over $2,000,000,000 of software sitting in backlog That is not an RPO yet because it's connected to a piece of hardware that hasn't shipped. And we recognize a bit of that upfront and then the rest over time.

Speaker 2

So we've got all of those variables in play right now. All that being said, I think you should expect When we get to a normalized world, I would expect that once we get this supply chain and the backlog clear, in a normal world, I would expect you would see software revenue growth Going faster. But right now, with our backlog so big, that may not happen for several quarters.

Speaker 3

Yes, that $2,000,000,000 of software, it's a little bit more than $2,000,000,000 sitting in our backlog right now. That's almost double where it was just a year ago, Right. So there's always some that will sit in backlog, but it's almost double. And of course, most of that software is recognized ratably. So the ramp, once we can get it the backlog and shift, we're still going to have a ratable ramp on that.

Speaker 3

So longer term, if you remember what we said in September, we said the recurring revenue parts of our product business, we the fiscal year, we expect to grow at a compound annual growth rate of 15% to 17%. That's what we just put up, all right? The product subscription piece in our software business Grew 17% in the quarter. So I think we're right on track in that space.

Speaker 2

I'm trying to find that breakdown of the different franchises in Webscale, where was that? Do you remember?

Speaker 1

Yes. Let me get it for you.

Speaker 2

Okay. On the cloud side, I think I just

Speaker 3

No, I

Speaker 2

don't have it in front of me. On the cloud side, here's what I would tell you is that we are winning continuing to win new use cases around with our integrated systems, the Silicon One systems, As well as we have won, use cases where they're simply buying our hardware, meaning a switch that they're running their operating system on. We have certain customers that are running multiple consumption models where one may be buying silicon and they also buy the hardware switch, 1 may be buying an integrated system and silicon. And so it's a variation of All of those and we are winning new competitive use cases and I don't think that's not what I was waiting for. Okay.

Speaker 2

So it's a sorry, I was just Marilyn was trying to find it, but I was going to tell you number of customers and what which how many franchises we've won inside each, but I don't have that in front of me right now and we'll try to get But in general, we are definitely winning the use cases.

Speaker 8

Okay, great. Thank you.

Speaker 1

Next question, please.

Operator

David Vogt from UBS, you may go ahead.

Speaker 9

Great guys. Thanks for taking my question.

Speaker 5

I just want to go

Speaker 9

back to capital allocation for a second. Over the last 5 years, you've been pretty consistent in deploying free cash flow to dividends, buybacks, although that materially accelerated in the quarter and acquisitions. Can you kind of expand on your philosophy over the next several years with respect to potential uses going forward, given the recent increase in the buyback today? And has your position around leverage and the use of leverage changed? And ultimately, what amount of cash flow would you be comfortable with on the balance sheet To run the business given the order strength that you're seeing, the working capital needs and supply chain uncertainty.

Speaker 10

There's a

Speaker 3

lot in there, David. What I'd start by saying is the buyback that you saw the additional buyback that you saw in Q2 And the add to our outstanding authorization to take it up to just short of $18,000,000,000 and the $0.01 increase in dividend, those are all signs of the confidence we have in our business and the growth we see ahead. Since 2018, we have returned, as you alluded to, we've returned $76,000,000,000 in capital to shareholders just since 2018. There's no change in our overall cap allocation policy to answer that question for you. It starts with 1st and foremost supporting the growth of the business of our equity plans and beyond that, return excess cash to shareholders as you saw us just do.

Speaker 3

There's no change in our overall policy. In terms of working capital, we've got, I would wager to say the strongest balance sheet in the industry. Certainly, amongst our peers, we've got the strongest balance sheet out there. So it's not I don't feel like we're constrained at all by the amount of cash we have to keep on the balance sheet to support operations.

Speaker 9

Maybe just as a quick follow-up to that along the same lines, obviously, you talked about culture, tech fit and ultimately making it work Financially, if there is an M and A opportunity on horizon, I think historically, you haven't really used your balance sheet as aggressively using leverage to do a transaction. I mean does that fit with how you're thinking about the business going forward? Is that a consideration? Or should we expect to be In sort of the same range as from a leverage perspective, whether it's measured on gross or net debt perspective or cash perspective in your case.

Speaker 3

Yes, I don't actually think of it in those terms as it relates to M and A. It's more back to what Chuck said earlier. It's, is it a strategic fit? Is that a cultural fit? Does the valuation make sense?

Speaker 3

Those are the kind of considerations that come into play as we're thinking about M and A versus What's the strength of the balance sheet? Again, I would stack our balance sheet up against anyone.

Speaker 9

Great. Thanks, Scott.

Speaker 2

I'm going to jump back in real quick and answer Give Tim the double click that I was looking for on the use cases. So we have 5 players who use our customers who use Silicon One and Cisco 8000 systems. We have 2 the use Silicon One with the 8,000 series routers with their own operating systems. We have 2 that use Silicon One embedded in their own white box hardware And we have 3 that use at least 2 of the flexible consumption modes simultaneously. So that's the data that I was trying to get to Tim.

Speaker 1

Thanks, Chuck. Next question?

Operator

Meta Marshall from Morgan Stanley. You may go ahead.

Speaker 11

Great. Thanks. Maybe just a question on passing through pricing to customers, just What those conversations are like maybe by category of customer and just whether you're seeing larger orders in an attempt to kind of offset some of those pricing increases. And then maybe a second question for you, Chuck. Just as you're starting to see customers move towards more architecture modernization versus just kind of catch up spend and maybe more specifically by enterprises, are there what are some of the strongest themes that you're seeing in terms of that modernization?

Speaker 11

Thanks.

Speaker 2

Thanks, Meta. So I think that clearly, we have customers who are definitely trying to buy ahead of price increases and the conversations are, they've gone from, I'd say, being generally understanding to being a little more frustrated Primarily because of the length of time it's taken to get the product. And so they're running out of patience as we all are, but of everybody generally understands because candidly most of our customers are probably doing the same thing to their customers in whatever business they're in, in given the inflationary pressure that we see everywhere. So that's the first one. Then the second one on the architectural transformations that we see out there.

Speaker 2

There's a massive one that is really being driven by hybrid work. So re architecting your entire network the infrastructure to deal with distributed applications, distributed users, distributed data, a new security architecture to accommodate it, that's one. Obviously, within that is hybrid cloud, where you have applications running in multiple cloud providers as well as in private data centers. I mean, the demand we saw the data centers as well. So that creates traffic patterns that are not aligned with the architectures that our customers built over the last 15 years.

Speaker 2

So that's the first one. And then there are these transitions that I talked about earlier. You've got customers upgrading to 400 gig, we're almost at 700 customers now who have 400 gig ports. We've now taken orders for 737,000 ports. We had 200 plus 1,000 ports booked in the quarter, which is almost 1500% growth.

Speaker 2

So we the 400 gig has certainly taken off. The WiFi 6 transition has been pretty significant, and those are just some of the things we see. And then in the service provider space, You see 400 gig, you see the 5 gs transition and you see them building out enterprise services based on 5 gs. So those are some of the major transitions that we see.

Speaker 11

Great. Thanks.

Speaker 1

Next question please.

Operator

James Suva from Citigroup, you may go ahead.

Speaker 12

Thank you. Scott, you had mentioned margins and I think you had mentioned at this levels through the rest of the year. I just want to qualify, was that for the calendar year or fiscal year and a little bit of color because my understanding is as you put through product price increases, customers who may have already booked things prior to those increases, we'll still get the product, but you're still paying higher shipping costs and potentially component costs. So I wonder if in the second half of calendar year twenty twenty three, if actually margins could expand or maybe they just offset each other? Thank you.

Speaker 3

Yes. I think you're thinking about it the right way, Jim. It's not a most a lot of what we have in the backlog were products that were ordered Pre the price increase, certainly the latest round of price increases. Logistics costs are still with us. But as I said earlier, I think that If you remember, we've had a couple of rounds of price increases, and I think we begin to see the benefit of that first one toward the end of Q3 and expect to see it again in Q4.

Speaker 3

With the level of visibility we have, both $16,000,000,000 of short term RPO, dollars 30,000,000,000 of total RPO And add to that $14,000,000,000 of backlog. We have better visibility than we've ever had as I look ahead. So feel good that the gross margins will stay in that 64% to 65% range through the second half, and that is of the fiscal year is what I'm talking about, the second half of our fiscal year.

Speaker 12

Thank you so much for the details and congratulations.

Speaker 3

Thank you.

Speaker 1

Thanks, Jim. Next question?

Operator

Sathal Liani from Bank of America. Please go ahead.

Speaker 13

Hi, guys. I have questions on 2 of your the first one is on security. Your trends are kind of not correlated with the industry trends. The previous two quarters you slowed down materially, but now you're accelerating again and there was acceleration over the last two quarters. Can you explain why you're seeing these trends?

Speaker 13

Why we see acceleration as much as why we saw deceleration before? And second is the service revenues. This is the Q4 of deceleration. We got to negative territories for growth now. Can you speak can you also explain services and how should we model it going forward?

Speaker 2

Yes, Tal, thanks for the question. I'll take security and I'll let Scott talk about services because I know he did some work on that. On the security front, I would say that we have strengthened several areas of that portfolio, particularly in a lot of the SaaS the elements that we have in the portfolio, we do have some supply chain issues that are continuing with the firewalls. But again, the SaaS and software components grew at a healthy rate. The teams are working on a next generation strategy right now.

Speaker 2

And I feel confident that over the next 12 to 18 months, you should continue to see improvement in that business. But We also need to get supply chain issues dealt with on the firewall front. Scott, you want to talk about services?

Speaker 3

Yes, Tal, on the services piece, what you have to bear in mind is Two things, most of that's ratable and most of that is the support services we sell attached to hardware. So there's always a lag, right? When you build up a big ratable revenue base, it takes time to build it up. So it takes it a while to ramp up to speed, But it also takes time for it to come back down. And if you look at our product revenue rates, go back 12, 18 months During the midst of the pandemic, of course, our product growth rates were quite low.

Speaker 3

And the echo effect of that is We sold fewer services contracts when we're selling less revenue. It takes time for that to show up in the revenue stream because So much of that's ratable and it builds up in deferred revenue and bleeds out over time. So what we're dealing with now is just the tail of services that would have been attached to the hardware at a time when hardware sales, if you go back 12 to 18 months ago, were fairly low. The flip side is look at the growth of our RPO at $30,500,000,000 growing 8%, obviously the ratable services fit inside there And the short term at $16,300,000,000 growing 8%, gives you a sense of what the path ahead looks like. That's both services and software, but it gives you a sense of

Speaker 6

Thank you.

Speaker 1

Thanks, Tal. Next question?

Operator

Amit Dharani from Evercore. Please go ahead.

Speaker 14

Yes. Thanks for taking my question. I guess the first one I have is really on the campus side, On the campus solutions side, I'd love to understand how do you think that segment or product portfolio stacks up as we go through the rest of the year and we get back to some form of hybrid work? And also on campus, I think a lot of your peers, it's not every one of your peers has talked about picking up market share. You have the dominant position there.

Speaker 14

So I'd love to understand What you see in the marketplace and by the ability to defend share given everyone's talking about it.

Speaker 2

Amit, I could not understand the first part of your question. Would you like to ask me that one?

Speaker 14

Yes. Chuck, I was just trying to understand on the campus the side, how do you think that segment stacks up for the year as we go back into some hybrid work and then competitively a lot of your peers have talked about picking up shares. So how do you see that

Speaker 2

Got it. Okay. So what we believe we're seeing is This is pure modernization that's occurring. We see densification of Wi Fi networks in particular. So we're seeing more and more access points per workspace than what was pre COVID We believe customers are preparing for putting more and more video units into conference rooms, which will be hardwired, which drives more switch ports.

Speaker 2

We have more security cameras that are IP based that are going in. IoT is beginning to expand, connecting building automation systems and all of those things just Require an incredibly robust and resilient campus network. So we think that's what's going on. And on the second question, Market share is a funny thing and it's certainly it's obviously based on revenue. And I can tell you that Based on the growth rates from an orders perspective and how much of that is sitting in our backlog, I'm not concerned.

Speaker 2

I cannot imagine that the market is growing faster than the order growth that we've seen over the last three quarters. It just needs to be faster than revenue.

Speaker 14

Fair enough. Chuck, if I could just ask you a quick one. What scenario would it take for Cisco to start doing buyback about just And maybe the inverse of this capital allocation question, how much cash is too much on your book that you may have to do more aggressive buybacks?

Speaker 3

Yes, Amit, I mean, you saw we went pretty aggressive into the buyback during Q2, $4,800,000,000 in the quarter, that's obviously well beyond what's required just to offset dilution. And I think historically, If you look back, you'll see we've been pretty aggressive on share buybacks over the last several years with the dividend and share buybacks Returning $76,000,000,000 since 2018. So I don't think there's a change in stance or a change in demeanor as we look at that. We were constantly evaluating where we are from a cash standpoint, what our needs are. I told you the priority of our cap allocation policy has not changed.

Speaker 3

I think that's the way you need to think about it going forward. There's no real change in policy, but you saw us get pretty aggressive in the first half of Q2.

Speaker 14

Perfect. Thank you and congrats on the quarter.

Speaker 3

Thank you.

Speaker 1

Next question?

Operator

Samik Chatterjee from JPMorgan. Please go ahead.

Speaker 10

Yes. Hi, thanks for taking my questions. I have 2 quick ones. Chuck, you talked about the strength that you're seeing with webscale customers within the service provider customer segment. Maybe if you can give us some details about what you're seeing from telcos and cable and the strength as well as what visibility they are providing you at this point?

Speaker 10

And then for my follow-up, I just want to go back to orders again. And your enterprise orders did accelerate from 30% to I think 37% From Q1 to 2nd, just is there a composition of early orders that's driving that acceleration? Or Are you seeing an underlying acceleration? Can you just kind of help us think through that? Thank you.

Speaker 2

Yes, Samek. So on the service provider space, I'd say just To give you a general sense, I gave you the webscale numbers at over 70%, I'd say, And the overall service provider segment was 42, and cable was roughly flattish, give or take a point or 2. And the telco space was incredibly strong, incredibly strong for us. So both the webscale and the telco space of We're the key contributors to that 42% growth. And then on the second question, What was the second question?

Speaker 2

Enterprise Growth. Enterprise Growth. Thank you. Yes, when you look at it across I mean, whether you look at it across the geographies or you look at it across Generally across our product portfolio or even across verticals, it was just super consistent. I mean, it was every customer seems to be moving right And so I don't think there's not one specific thing to call out.

Speaker 2

It was pretty broad based.

Speaker 1

And I think that was our last question for the call. And Chuck, do you want to close with some closing remarks?

Speaker 2

Yes, I do, Marilyn. Thank you. First of all, I'm proud of what we were able to accomplish in Q2 despite the ongoing component demands or component dynamics, the product order growth, the revenue of EPS, the ARR growth, the RPO growth, the balanced growth across the world, Really pleased with our continued success in webscale and just happy that our customers are choosing our technology as they continue down this digital transformation path. I think it speaks to the relevance and criticality of what we're building and what our teams have built. And I want to just take a minute to thank all the Sysco employees because it's been an incredibly difficult couple of years.

Speaker 2

I think the team has showed a great deal of resiliency, delivered breakthrough innovation Cisco and really doing everything we can to take care of our customers. So thanks for spending time with us today and we'll talk to you next time.

Speaker 1

Great. Thanks Chuck. Cisco's next quarterly earnings conference call, which will reflect our fiscal 2022 Q3 results, will be on Wednesday, May 18, 2022, at 1:30 pm Pacific Time, 4:30 pm Eastern Time. This now concludes today's call. If you have any further questions, feel free to reach out to the Cisco Investor Relations Group.

Speaker 1

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 888-five 680332. For participants dialing from outside the U. S, please dial 203-369-3905. This concludes today's call.

Operator

You may disconnect at this time.

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