Cisco Systems Q2 2024 Earnings Call Transcript

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Provided by Quartr
February 14, 2024

Key Takeaways

  • Strong Q2 financial performance: Revenue came in at the high end of guidance, non-GAAP margins exceeded expectations, EPS beat estimates, and the company returned $2.8 billion to shareholders while raising its quarterly dividend.
  • Lowered second-half outlook: Management cited extended customer inventory digestion, heightened macro uncertainty and ongoing telco/cable weakness as reasons for resetting guidance downward for Q3 and fiscal 2024.
  • Software and recurring revenue growth: Annualized recurring revenue reached $24.7 billion (up 6%), software subscription revenue grew 5%–6%, and subscriptions now account for 50% of total revenue, bolstered by the pending Splunk acquisition adding roughly $4 billion ARR.
  • AI and innovation momentum: The new NVIDIA partnership for AI infrastructure, alongside double-digit growth in observability (16%) and AI-driven security enhancements, positions the company to capitalize on the expanding AI market.
  • Expense realignment and restructuring: A plan affecting about 5% of the global workforce and incurring $800 million in pre-tax charges aims to safeguard operating leverage and support long-term value creation.
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Earnings Conference Call
Cisco Systems Q2 2024
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Operator

Welcome to Cisco's second quarter fiscal year 2024 financial results conference call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Sami Badri, Head of Investor Relations. Sir, you may begin.

Sami Badri
Head of Investor Relations at Cisco

Welcome everyone to Cisco's second quarter fiscal year 2024 conference call. This is Sami Badri, Cisco's Head of Investor Relations, and I am joined by Chuck Robbins, our Chair and CEO, and Scott Herren, our CFO. By now you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements, and other financial information can also be found in the Financial Information section of our Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we'll discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons are made throughout this call, will be on a year-over-year basis.

Sami Badri
Head of Investor Relations at Cisco

The matters we'll be discussing today include forward-looking statements, including the guidance we will be providing for the third quarter and full year of fiscal 2024. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent report on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please feel free to see the slides and press release that accompany this call for further details. 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.

Chuck Robbins
Chairman and CEO at Cisco

Thanks, Sami, and thank you all for joining us today. We delivered a solid Q2 performance, with revenue coming in at the high end of our guidance range. Strong operating leverage across our business drove our margins, which exceeded the high end of our expectations and allowed us to deliver better than anticipated earnings per share. In Q2, we once again returned a total of $2.8 billion in value through dividends and share repurchases. We also announced today another increase to Cisco's dividend payout rate, reaffirming our ongoing commitment to returning significant value to our shareholders through consistent capital returns. Overall, our Q2 results continue to advance our strategic business transformation around driving higher levels of software subscriptions and annualized recurring revenue, or ARR, both of which showed performance gains in the quarter.

Chuck Robbins
Chairman and CEO at Cisco

Our pending acquisition of Splunk also further supports our transformation strategy by fueling stronger growth, expanding our portfolio of software-based solutions, and generating higher levels of ARR, with roughly $4 billion in additional ARR expected upon closing, and will make us one of the largest software companies in the world. Before turning to our performance in the quarter, I'd like to start by commenting on the demand environment. First, in terms of the macro environment, we are seeing a greater degree of caution and scrutiny of deals given the high level of uncertainty. As we're hearing this from our customers, it's leading us to be more cautious with our forecast and expectations.

Chuck Robbins
Chairman and CEO at Cisco

Second, as we discussed last quarter and subsequently saw in other technology provider results, customers have been taking time since the start of our fiscal 2024 to deploy the elevated levels of products shipped to them in recent quarters, and this is taking longer than our initial expectations. Third, we also continue to see weak demand with our telco and cable service provider customers. This industry has seen significant pressure, and they are adjusting deployment phasing, which is weighing on our business outlook. Given these factors, we are adjusting our expenses and investments to reflect the current environment. That said, for the product categories in which we can measure customer inventory absorption through connections to the cloud, we are seeing steady progress.

Chuck Robbins
Chairman and CEO at Cisco

However, based on conversations with customers, we still believe we are one to two quarters away from full implementation of their inventory, which, as I mentioned, is longer than we expected. We continue to track Meraki activations, which are moving slightly faster in wireless and slightly slower in switching. Using our Meraki business as a proxy for our wider enterprise networking portfolio, we expect the current implementation of shipped products to be broadly complete by the end of fiscal 2024. Looking at our wireless business as an example, we are encouraged by the number of orders of one million or more, which increased approximately 50% sequentially in Q2. This indicates that many wireless customers have finished absorbing what we've shipped to them and are preparing for larger deployments in the coming months.

Chuck Robbins
Chairman and CEO at Cisco

Our team is also partnering closely with customers to assist with this heightened focus on deployments of Cisco equipment on hand, contributing to our services revenue increase year-over-year. It's also worth noting that non-hardware-centric revenue in areas such as security and collaboration increased, and our observability offerings grew double digits year-over-year. Finally, despite the near-term challenges, our win rates are stable, and on a rolling four-quarter basis, our market share remains steady in three of our four largest markets. Now moving on to our performance in Q2. As I mentioned earlier, our performance in the quarter was broadly in line with, or better than, our Q2 expectations. Given the trust our customers place in us and the criticality of our technologies to the outcomes our customers are seeking, I am confident about the foundational strength of our portfolio and our future growth opportunities.

Chuck Robbins
Chairman and CEO at Cisco

With our innovation, we deliver and enable our customers to deploy next-generation applications in a highly secure manner. As part of this, we help facilitate their growth through our products and services so that when our customers adopt new technologies, we grow alongside them. We continue to accelerate our innovation across high-growth areas. Last week at Cisco Live EMEA, we announced new capabilities in networking, furthering our vision for the Cisco Networking Cloud. We also announced several new capabilities across our security, collaboration, and observability portfolios, leveraging AI throughout. We also continue to capitalize on the multi-billion-dollar AI infrastructure opportunity. This quarter, we announced the next phase in our partnership with NVIDIA to offer enterprises simplified, cloud-based, and on-prem AI infrastructure. This includes both networking hardware and software to support advanced AI workloads.

Chuck Robbins
Chairman and CEO at Cisco

We are clear beneficiaries of AI adoption, and this partnership further demonstrates the central role we play in AI and the overall technology ecosystem. Our combined solution will be sold through our extensive global channel, with professional services and support from key partners who are committed to helping businesses deploy their GPU clusters via Ethernet infrastructure. In webscale, we continue to see momentum, with three of the top four customers deploying our hyperscale Ethernet AI fabric, leveraging Cisco Validated Designs for AI infrastructure. While there is tremendous opportunity ahead, we are still in the early stages of adoption of AI workloads. In security, we continue to execute against our product roadmap to deliver the industry's most comprehensive unified platform with end-to-end solutions.

Chuck Robbins
Chairman and CEO at Cisco

This quarter, we introduced Cisco Identity Intelligence, an analytics layer that pulls data from identity infrastructure and performs behavior-based assessments to help protect against identity-based attacks, which are at the forefront of cyber threats today. AI is also becoming more pervasive across the Cisco Security Cloud. For example, our new AI assistant in Secure Access lets customers create security access policies using natural language prompts, reducing errors and speeding up policy administration by 70%. Our new security solutions, like XDR and Secure Access, are ramping quickly after being launched this fall, with now over 230 Cisco XDR customers. Over the next six months, you can expect more meaningful announcements across the portfolio through our accelerated organic innovation and inorganic investments. In addition, we have now extended our AI-powered ThousandEyes into Cisco Secure Access, joining past integrations with AppDynamics, Webex, Catalyst, and Meraki platforms.

Chuck Robbins
Chairman and CEO at Cisco

ThousandEyes allows our customers to understand the digital experience of users, applications, and things through billions of daily measurements of the internet and public SaaS, as well as thousands of enterprise customers creating best-in-class digital experiences for users. In observability, we introduced the Cisco Digital Experience Monitoring application, providing deep insights into the performance of browser and mobile applications and efficient resolution of session-level issues. Our continued generative AI innovations build upon our existing platform capabilities, further enabling operations teams to focus on what matters most, minimizing tool sprawl, improving overall performance, and delivering highly secure digital experiences. Going back to the pending Splunk acquisition, the combination of Splunk's complementary capabilities with ours in AI, security, and observability will create an end-to-end data platform to enhance our customers' digital resiliency.

Chuck Robbins
Chairman and CEO at Cisco

We are excited that together we will bring trusted innovation leadership, an outstanding go-to-market engine, and a world-class culture that will help our customers achieve their technology outcomes with innovative products and solutions. I would also like to provide a brief update on timing. While the closing of the acquisition of Splunk remains subject to regulatory approvals and other customary closing conditions, given the positive progress to date on the required regulatory approvals, we now expect to close the transaction late in the first quarter or early in the second quarter of calendar year 2024, which is in our fiscal third quarter. Before I turn it over to Scott, let me summarize three key takeaways. First, we have reset our expectations for the second half of the year, given the cautious macro environment, our customers absorbing high levels of inventory, and ongoing weakness in service provider.

Chuck Robbins
Chairman and CEO at Cisco

Second, you can count on us to take a disciplined approach regardless of the environment. We remain committed to operating leverage, capital allocation, and expense management. Lastly, our portfolio continues to get stronger and stronger every day. While we have work in front of us and despite the current environment, we remain confident in our long-term strategy. We are relentlessly focused on our commitment to driving long-term value for our shareholders and industry-leading innovation for our customers. I'll now turn it over to Scott to provide more detail on the quarter and our outlook.

Scott Herren
CFO at Cisco

Thanks, Chuck. Our Q2 results reflect solid execution again, with strong margins and increasing operating leverage. For the quarter, total revenue is at the high end of our guidance range at $12.8 billion, down 6% year-over-year. Non-GAAP net income was $3.5 billion, down 3%, and non-GAAP earnings per share was above the high end of our guidance range at $0.87, down 1%. Looking at our Q2 revenue in more detail, total product revenue is $9.2 billion, down 9%, and service revenue is $3.6 billion, up 4%. Networking, our largest product category, was down 12%. We saw declines across switching, wireless, and routed optical networking, driven primarily by weakness in the enterprise and service provider and cloud markets. Security was up 3%, with our zero trust offering growing double digits. Collaboration was up 3%, driven by growth in collaboration devices and calling, partially offset by a decline in meetings.

Scott Herren
CFO at Cisco

Observability was up 16%, driven by growth across the portfolio, with continued strength in ThousandEyes network services. As Chuck mentioned, ThousandEyes helps monitor and assure digital experience everywhere: on-premise, internet, and the cloud. We continue to make progress in our transformation to more recurring revenue-based offerings. We saw strong performance in our ARR of $24.7 billion, which increased 6%, with product ARR growth of 9%. Total software revenue was flat at $4.2 billion, with software subscription revenue up 5%. 88% of our software revenue was subscription-based. Total subscription revenue increased 6% to $6.4 billion, which now represents 50% of Cisco's total revenue, an increase of 6 percentage points over last year. RPO was $35.7 billion, up 12% year-over-year. Product and service RPO both increased 12%, and total short-term RPO was $17.9 billion, up 6%.

Scott Herren
CFO at Cisco

Q2 product orders declined 12%, a significant improvement from Q1 as customers continue to work down product shipments from prior quarters. Looking at our geographic segments year-over-year, the Americas was down 10%, EMEA down 8%, and APJC was down 27%. In our customer markets, service provider and cloud was down 40%, enterprise was down 6%, and public sector was down 5%. Backlog at the end of Q2 has now returned to normal levels. Total Non-GAAP gross margin came in at 66.7%, up 280 basis points year-over-year and above the high end of our guidance range. Product gross margin was 65.2%, up 310 basis points. The improvement was driven primarily by lower freight and component costs and favorable product mix, partially offset by negative impact on pricing. Service gross margin was 70.5%, up 140 basis points.

Scott Herren
CFO at Cisco

Non-GAAP operating margin came in at 33%, up 50 basis points and exceeding the high end of our guidance range. Strong non-GAAP gross margin and continued cost management drove the leverage. Further, we are realigning our investments and expenses to reflect the current environment to help maximize long-term value for our shareholders. As part of our announced restructuring plan, we expect to impact approximately 5% of our global workforce, with estimated pre-tax charges of approximately $800 million. Shifting to the balance sheet, we ended Q2 with total cash, cash equivalents, and investments of $25.7 billion. Consistent with our expectations, operating cash flow was $800 million, driven in large part by the timing of federal tax payments and the higher annual payment of the TCJA transition tax. This quarter, we returned $2.8 billion to shareholders, comprised of $1.6 billion for our quarterly cash dividend and $1.3 billion of share repurchases.

Scott Herren
CFO at Cisco

Year to date, we have returned $5.7 billion in value to shareholders, and we plan to continue our share repurchases at the current quarterly level throughout fiscal 2024. Increasing shareholder returns through greater operating leverage, maintaining a higher level of annual share repurchases, and growing our dividend is consistent with our capital allocation strategy. Given the confidence we have in our business today, we announced we are raising our dividend by one penny to $0.40 per quarter. This dividend increase demonstrates our commitment to returning a minimum of 50% of free cash flow annually to our shareholders and our confidence in the strength of our ongoing cash flows. To summarize, we executed well with continued strong margins and increased operating leverage as we help our customers complete record deployments and implementations. We continue to progress our business model shift to more recurring revenue.

Scott Herren
CFO at Cisco

We are strategically investing in innovation to capitalize on our growth opportunities and are committed to delivering long-term shareholder value. With regard to our proposed acquisition of Splunk, we continue to work through regulatory approvals and closing conditions, and as Chuck mentioned, we're optimistic that it'll close ahead of what we had originally anticipated. We have not included any impact from the Splunk acquisition in our forward-looking guidance. Turning to our guidance, as previously mentioned, we have reset our expectations for the second half of the year to account for the caution around macro uncertainty, the continued absorption by our customers of record levels of product shipments they've received from us, and the weakness of our service provider market. For Q3, our guidance is as follows. We expect revenue to be in the range of $12.1 billion-$12.3 billion.

Scott Herren
CFO at Cisco

We anticipate the non-GAAP gross margin to be in the range of 66%-67%. Non-GAAP operating margin is expected to be in the range of 33.5%-34.5%. Non-GAAP earnings per share is expected to range from $0.84-$0.86. For fiscal year 2024, our guidance is as follows. We expect revenue to be in the range of $51.5-$52.5 billion. Non-GAAP earnings per share guidance is expected to range from $3.68-$3.74. In both our Q3 and full-year guidance, we're assuming a non-GAAP effective tax rate of 19%. Sami, let's now move into the Q&A.

Sami Badri
Head of Investor Relations at Cisco

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

Operator

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

Amit Daryanani
Amit Daryanani
Senior Managing Director at Evercore

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

Chuck Robbins
Chairman and CEO at Cisco

Thank you very much. So obviously, with the lower guide, we talked about the feeling that there's some macro uncertainty. We talked to our teams in preparation for this, and they obviously submitted their forecasts. And what we really saw was what they previously told us 90 days ago relative to the second half versus what they told us a couple of weeks ago had changed materially, which means customers are pushing things out and putting a little more scrutiny on them. So that's the difference that we've seen. As far as trying to break down what percentage comes from each of those three, including the digestion issue as well as the telco and SPs piece, I think it's pretty difficult to do, honestly.

Chuck Robbins
Chairman and CEO at Cisco

However, I will say that we think that the consumption of the elevated inventory level should be we should be through that by the end of our fiscal year. We think that the SP telco and cable side of it, we're hopeful that in 2025, they will begin investing again. We originally had anticipated that they would begin to invest in the second half of this year, and we no longer believe that to be true. And so I think the consumption issue and the SP thing or the consumption issue is temporary through the end of the year. The macro thing is one that we're going to have to wait and see, and the SP telco probably similarly. And all of these things led us, obviously, to reset the second half of the year. On the NVIDIA partnership, it is definitely Ethernet.

Chuck Robbins
Chairman and CEO at Cisco

I was in the meeting when we first talked about this with Jensen, and he agreed that we would include our Ethernet technology with their GPUs and creating the stack. There will also be servers as well, and there'll be multiple versions of this over time. But it will include our Ethernet technology when they're connecting multiple clusters.

Sami Badri
Head of Investor Relations at Cisco

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

Operator

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

Meta Marshall
Meta Marshall
Managing Director at Morgan Stanley

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

Chuck Robbins
Chairman and CEO at Cisco

Yeah. Thanks, Meta. So I would say that what we do see customers investing in is clearly cybersecurity. We see observability, as you saw the 16% growth rate. We even saw collaboration positive this quarter, which was a good sign. They're at various phases of still dealing with this hybrid work situation. We had a very strong quarter with our devices, our video device businesses. We see customers investing in their customer experience through technologies like contact center. And so we see a lot of that. We see customers continuing to invest in their application rearchitecture, which leads to both observability opportunities as well as the rearchitecture of their networks to deal with the traffic flows that we've been talking about for a couple of years.

Chuck Robbins
Chairman and CEO at Cisco

I think the real issue right now is that we ship so much networking in our core business that that's where the challenge is, that they're just trying to get all that implemented right now. As it relates to the enterprise and how they're thinking about AI, what I will tell you is that over the last 90 days, we began to see the pipeline for AI use cases in the enterprise begin to emerge. And there's heavy work going on in financial services. I would say it's early in what they're trying to think through, but we are seeing opportunities arise.

Chuck Robbins
Chairman and CEO at Cisco

I think that there have been some comments not enough for me to translate this to a massive trend, but there were some comments from some of our field teams that they see customers holding budget back just to be ready to expend it on AI once they get their strategy fully baked. That's about what I could tell you at this point.

Sami Badri
Head of Investor Relations at Cisco

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

Operator

Yes. David Vogt with UBS. You may go ahead.

David Vogt
David Vogt
Managing Director and Senior Equity Analyst at UBS

Great. Thanks, guys, for taking my question. So maybe I just want to step back for a second, Chuck, and maybe for Scott also. If I look at your guide for this year, I mean, we're basically back to fiscal 2019 revenue levels. So I'm just trying to think about how your longer-term model works in the context of that 5%-7% guide that you laid out at the investor briefing a number of years ago as sort of customers digest product. Obviously, it would suggest that maybe there's some more share loss going on in the core networking portfolio given some of the other parts of the business has grown. So I just want to kind of try to get a sense for how you're thinking about the portfolio today given we're kind of back to fiscal 2019.

David Vogt
David Vogt
Managing Director and Senior Equity Analyst at UBS

From a profitability standpoint, obviously, you've done a tremendous job, and I would imagine the cost-cutting goes along those lines to keep margins higher. But is there an opportunity to use margin and maybe price going forward to take back some of the share if there's a disruption in the market by a potential strategic transaction in the marketplace today? Thanks.

Scott Herren
CFO at Cisco

Yeah, David, I'll start, and then Chuck, you can chime in on share. The way to think about the 5%-7%, if you go back to when we gave that metric, you remember it was in 2021, actually pre all of the supply chain volatility that we've seen. And since then, of course, we've seen the supply chain set in, which caused a spike in product orders, and then a subsequent big building up of our backlog. As we cleared the backlog, we saw a spike in revenue. And so it's been difficult to look at year-on-year compares as all those dynamics were going on. What we're seeing now is as we've cleared the backlog, and we cleared it very quickly given the strength of our supply chain team, that bottleneck has just moved downstream.

Scott Herren
CFO at Cisco

So I don't think you can look at this year's revenue and try to somehow compare it to a historical because of all the moving parts underneath the covers. What underpinned that 5%-7% when we gave it to you was that's the aggregated growth of the TAM of the markets that we play in, right? And so at this point, we still see that as the longer-term where we're headed. I think looking at year-on-year growth rates, I don't think you're going to see those growth rates begin to normalize until we work through the inventory that's in the field right now, which is one of the biggest headwinds we've got, right? Then we can get back to regular ordering, and then you need to lap that, right? You need to go four quarters out to be able to compare to a more normalized point.

Scott Herren
CFO at Cisco

So I think that's the way you need to think about that longer term. But there's no change at this point. We'll update the longer-term model after we finish the acquisition of Splunk and can give you better insight into what we look like as a combined company.

Chuck Robbins
Chairman and CEO at Cisco

Yeah. And David, on the share loss, I think if you look at the last published reports that came out after Q3.

Scott Herren
CFO at Cisco

Calendar.

Chuck Robbins
Chairman and CEO at Cisco

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

Sami Badri
Head of Investor Relations at Cisco

Thank you, David. Michelle, next analyst.

Operator

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

Simon Leopold
Simon Leopold
Managing Director at Raymond James

Thanks for taking the question. I've got an easy one and a little bit harder one. I'll start with the easy one and then ask the other. It just looks like your order trajectory is getting somewhat better. So the orders this quarter down 12%, not too bad. And I know you don't forecast orders, but maybe if you can talk about when you expect orders could turn positive again given the comparison and the trend. The other question I wanted to see if you could discuss how you envision the AI clusters in terms of will the web scale operators choose multiple vendors in a single cluster, or will they designate maybe different data centers to different suppliers, or will they mix and match? How do you see the split playing out, particularly in the hyperscale opportunity?

Simon Leopold
Simon Leopold
Managing Director at Raymond James

I really mean this more longer term, 2025, 2026, not currently when we're dominated by InfiniBand, but when Ethernet starts taking more share. Thank you.

Chuck Robbins
Chairman and CEO at Cisco

Yeah. Thanks, Simon. So on the order trajectory, I think we clearly don't guide bookings, but what I would tell you is that even as our teams modify their second-half outlook, the second half will still be more favorable than the first half. So your assessment of sort of the trajectory, I think, is valid, and I'll leave it at that. On the AI clusters, I think it's a good question because what you'll hear is us and competitors talking about a number of web scale players that are using our technology underneath GPUs, our Ethernet technology under GPUs. And so I think it's important to remember they always tend to have a dual vendor strategy. They always want two sources. And so we're both actually the two of us are actually playing in the space today. And I'd say today, they're completely homogeneous clusters.

Chuck Robbins
Chairman and CEO at Cisco

I think it's too early to tell whether there'll be some benefit over time for them to mix those. My sense is unless there's something that changes significantly or there's some sort of technology reason for GPUs to be mixed, which I can't speak to at this point, I don't think the underlying network will be mixed. I just don't think there's any benefit for them to do that.

Sami Badri
Head of Investor Relations at Cisco

Thank you, Simon. Michelle, next question.

Operator

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

Tal Liani
Tal Liani
Technology Analyst at Bank of America Corporation

Hi. I have two questions. The first one is security. The market is great, and we met two years ago and three years ago, and you spoke about new strategy and going to market, but it's still only growing 3%. What is happening there, and what can you do to fix security and benefit from this market growth? And then maybe I'll ask my follow-up.

Chuck Robbins
Chairman and CEO at Cisco

Okay. Thanks, Tal. So I think over the last few quarters, I've been pretty consistent that we thought the second half of this fiscal year we would start to see an acceleration of security. And I can give you some highlights where we are seeing some of that, some green shoots early. Some of the new innovation like XDR and Secure Access, Multicloud Defense, the suites, we're seeing a good pipeline build with those technologies. XDR, we announced that in April of last year. We shipped it in August. And we have 230 customers, 230+ customers on the platform today. And the important thing to remember is it's a big platform play. And we actually typically see that as a six-to-nine-month sales cycle. So to have 230 customers already, I think, is a statement on the value that our customers are seeing.

Chuck Robbins
Chairman and CEO at Cisco

That's going to be a real important integration point with Splunk, by the way. So that we see. We feel good about the pipeline. From a demand perspective, just to give you some insight, the demand was almost double digits this past quarter, which is the highest we've seen in a while. So I think we're seeing a lot of good indicators. And if you just watch over the next six to nine months, you're going to see more and more innovation that comes out. And I think you'll begin to believe and see the results around that same time frame.

Sami Badri
Head of Investor Relations at Cisco

Thank you, Tal. We'll get to your other question at some point after the call. Michelle, can we move to the next speaker?

Operator

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

Samik Chatterjee
Samik Chatterjee
Managing Director and Equity Research Analyst at JPMorgan Chase & Co.

Hi. Thanks for taking my question. Chuck, I'm going to, for my first question, ask you to go back to sort of the drivers of demand that you're seeing here. We walked away from the call last time sensing a sense of optimism about a sharp rebound when you see the inventory digestion complete. But I guess what I'm hearing from you today is even as that inventory digestion ends in fiscal 2024, you're seeing a bit more of a macro impact on your customer demand. And are your expectations still sort of intact in terms of thinking about a more sharp rebound as you go into fiscal 2025? If you can share what you're seeing from customers there.

Samik Chatterjee
Samik Chatterjee
Managing Director and Equity Research Analyst at JPMorgan Chase & Co.

For my follow-up, the NVIDIA partnership, how should we think about the impact of that on your AI order target of $1 billion, or is it really most of that partnership materializes beyond that sort of target window, target time frame? Thank you.

Chuck Robbins
Chairman and CEO at Cisco

Thanks. I would say on the thing that's changed from last quarter is that we do just see a little more caution with our customers. I don't want to over-rotate and say that it's a massive shift, but we definitely saw more caution. We talked with our sales leaders ahead of the call, and they indicated we asked them point blank, "Was there more caution or the same caution from the prior quarter?" And we heard more, a little bit more. And then we saw the push out of the forecast. So that just tells us that there is a little bit more in the system. So therefore, I think we need a couple of quarters to see it play out before we can declare what's going to happen in fiscal 2025. On the NVIDIA discussion, a couple of comments.

Chuck Robbins
Chairman and CEO at Cisco

We talked about the $1 billion of orders, which I know someone's going to ask me about at some point. And what I would say is that in the last 90 days, our pipeline of AI opportunities continued to grow. The pipeline is now almost three times that particular number that we gave last time, which were more orders that we see in 2025. The total pipeline is now about three times that, roughly three times that. And I would say that virtually none of that is anything associated with the NVIDIA partnership yet. It's all independent of that.

Sami Badri
Head of Investor Relations at Cisco

Thank you, Samik. Michelle, next question.

Operator

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

Ben Reitzes
Ben Reitzes
Managing Director and Head of Technology Research at Melius Research

Hey. Thanks for the question, guys. Hey, Chuck. Hey, Scott. Wanted to ask about the HP Juniper deal. Are you seeing any uncertainty in the market near term, and how do you think that helps you long term? And Chuck, if you don't mind, just with regard to that last AI comment, one of your competitors, obviously, is expecting quite a big pickup next year, next calendar year. Do you feel like that AI $3 billion in pipeline or so kicks in next year, next calendar year, or what's your timing on that? Thanks so much.

Chuck Robbins
Chairman and CEO at Cisco

Thanks, Ben. So I would say on the HP Juniper deal, the one area where they have meaningful overlap is in wireless. And I don't know if there's any connection to the fact that we had a 50% increase in a million-dollar-plus wireless deals sequentially. So it's hard to say. But I mean, there is a lot of noise in the system or in the industry about what they do there, but I can't say specifically that any customers have talked to me about it, to be honest. So I think it's a little early for the customers to be expressing that concern. They may be asking them directly, but they're not talking to us. On the timing, yeah, I think we said fiscal 2025, which starts in August of this year.

Chuck Robbins
Chairman and CEO at Cisco

And I think you probably should assume most of that's probably in the second half, I would guess. But we'll see how things play out. I think customers are going to move as fast as they possibly can, but we're still in early strategy and planning stages right now on most of it. The pipeline stuff are well-defined use cases that are already in place with certain customers, and we're actually just working through the opportunities.

Scott Herren
CFO at Cisco

Yeah. But, Ben, our expectation is the majority of that $1 billion in orders will turn into revenue in our fiscal 2025, just to be clear.

Sami Badri
Head of Investor Relations at Cisco

Thank you, Ben. Michelle, next question.

Operator

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

Matt Niknam
Matt Niknam
Director of Equity Research at Deutsche Bank

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

Chuck Robbins
Chairman and CEO at Cisco

Yeah. So I'll take the first, and Scott, you take the second. On the inventory digestion issue, I think I would say it's largely an enterprise and a service provider issue. And particularly the cloud providers, we think they've got probably an excess of 20+ weeks of inventory that they're working through right now as they built up when the lead times were so long. We have a lot of our enterprise products that are tethered to the cloud from management perspectives. And so we see the lag between when we ship it to the customer and when they connect it. I gave the Meraki example in my prepared remarks. And so we do have visibility, and we can actually see on some aspects of the portfolio how the time frame between shipments and connectivity is shrinking.

Chuck Robbins
Chairman and CEO at Cisco

It's not shrinking as fast as we thought it would, which leads us to believe this is going to extend through the end of 2024. That's where we are. Scott, gross margins?

Scott Herren
CFO at Cisco

Yeah. What you saw in the quarter is, of course, gross margins continued to show a year-on-year improving trend, roughly flat, as you said, sequentially. There's a couple of dynamics. But to your question on where does this settle in, I think it settles in in the range we're in right now, in the 66%-67% range through the end of the year. There's both the things that are happening from a freight and delivery standpoint. Freight costs with what's happening in the Red Sea have gone up slightly. We continue to see a little bit of component pressure, although in the commodity sections, we're seeing some benefit there. The scale of the services ramp up. Obviously, services revenue trails the product revenue. We had those three really strong quarters of product revenue growth. We're seeing the tail of that now in our services revenue growth.

Scott Herren
CFO at Cisco

Since a lot of the cost underneath our services are fixed, you get better leverage when that happens. I think when you add all those together, we should settle in the 66%-67% range. The majority of, if not all of, the supply chain constraints that we felt are behind us at this point.

Sami Badri
Head of Investor Relations at Cisco

Thank you, Matt. Michelle, next question.

Operator

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

Michael Ng
Michael Ng
Managing Director of Global Investment Research at Goldman Sachs Group, Inc.

Hey. Good afternoon. Thanks for the question, Chuck and Scott. I just have two. First, just on the revenue guidance, I think based on the midpoint of it, the implied fiscal 2024 revenue guidance only implies about +1% quarter-over-quarter. Given that we're back to a normal backlog, what's preventing that from going back to a more normal level of seasonality? And then as a follow-up to Amit's question earlier on the NVIDIA AI deal, I just wanted to clarify. I understand that it's Ethernet, but will it be both NVIDIA's Spectrum-X as well as Cisco's Ethernet, and how will that be sold together if that's the correct assumption? Thank you.

Scott Herren
CFO at Cisco

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

Chuck Robbins
Chairman and CEO at Cisco

On the NVIDIA front, I think, look, one of the key benefits that they see is leveraging our enterprise go-to-market and our global ecosystem and partner community. And therefore, when these solutions are flowing through our channels and our sales teams and our partners, it will be Cisco Ethernet.

Sami Badri
Head of Investor Relations at Cisco

Thank you, Michael. Michelle, next question.

Operator

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

George Notter
George Notter
Managing Director of Equity Research at Jefferies

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

Chuck Robbins
Chairman and CEO at Cisco

I'll make one quick comment. I think I said this in my prepared remarks as well. We've deployed a lot of transaction services for some of our larger customers just to help them do that. And I know that our sales teams were talking this week. Scott, maybe you remember or you have some more detail on looking at some partner incentives to help.

Scott Herren
CFO at Cisco

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

Sami Badri
Head of Investor Relations at Cisco

Thank you, George. Michelle, next question.

Operator

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

Woo Jin Ho
Senior Networking and Semiconductor Analyst at Bloomberg Intelligence

Great. Thank you for taking my question. Given that most of the weakness is going to be on the networking side, could you just talk a little bit more about the future software subscription renewal rates? You did a good job this quarter with software subscriptions going up 5%. But given that networking is poised to be down, I'm curious where that's heading going forward.

Scott Herren
CFO at Cisco

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

Sami Badri
Head of Investor Relations at Cisco

Thank you, Woo Jin Ho. Michelle, next question.

Operator

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

Tim Long
Tim Long
Managing Director at Barclays

Thank you. Yeah. One question, one follow-up. So first, maybe Chuck, can you talk a little bit - excuse me - about the kind of margin growth trade-off with the headcount reduction, obviously protecting margin here, but how do you think about that trade-off given the challenging growth we've seen? And then just on a follow-up with all of the AI comments, Chuck, could you just remind us kind of where we are from a product standpoint? Are you seeing more traction for Silicon One or software or the full-system products? If you could just give us a little color on kind of where you're seeing that pipeline growing. Thank you.

Chuck Robbins
Chairman and CEO at Cisco

Yeah. Thanks, Tim. So on the margin growth trade-off, we're always considering that. We're very disciplined, though. We think that gross margins are clearly a reflection of the value that your customers see in your technology and what you deliver. If you look at a lot of our competitors and you look at some of the market share, I mean, some of the gross margins that they have, that tells you that they're viewed more as a commodity. I think that our customers see real value in what we deliver to them. So while we always look at margins versus growth, we also we're just disciplined across both. On the AI front, Silicon One is a big play, clearly. We've delivered next-generation silicon into several of the cloud providers right now. We've got the Ethernet running in three of the four big ones.

Chuck Robbins
Chairman and CEO at Cisco

We'll use the same silicon in the enterprise data center over time. We've got GPUs in our UCS platforms. And so it's evolving. But we have, I tell our teams, unlike the original cloud transition that we talked on this call several times about how we were not prepared for the infrastructure play in the cloud world, I think we are absolutely ready and well-equipped to succeed in this transition to AI. It will be a tailwind for us as we get into it over time.

Sami Badri
Head of Investor Relations at Cisco

Thank you, Tim. Michelle, next question.

Operator

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

Aaron Rakers
Aaron Rakers
Managing Director and Technology Analyst at Wells Fargo & Company

Yeah. Thanks for taking the question. I'll stick to one. Just building on that last question, I know over periods of time, you've talked a little bit about how large your web-scale business is. Can you just remind us again the presence you have in some of the web-scale opportunities, either from a size and maybe ex the AI discussion, what kind of growth rates you're seeing, particularly with those web-scale customers right now?

Chuck Robbins
Chairman and CEO at Cisco

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

Scott Herren
CFO at Cisco

21.

Chuck Robbins
Chairman and CEO at Cisco

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

Chuck Robbins
Chairman and CEO at Cisco

They're very deep on wanting to make sure that they have resiliency and optionality.

Scott Herren
CFO at Cisco

Aaron, the only thing I'd add is, and we said it earlier. There's no question that over time, given the way we're positioned, both from a complete box, a white box, and a silicon standpoint, there's no question that AI is the tailwind for us longer term.

Sami Badri
Head of Investor Relations at Cisco

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

Operator

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

James Fish
James Fish
Managing Director and Senior Research Analyst at Piper Sandler

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

Scott Herren
CFO at Cisco

Yeah. On the price declines, you got to remember to go back to why we put the price increases in to begin with. That was really to offset the higher cost that we were seeing from many of our suppliers as everyone was dealing with constraints. Supply demand's pretty straightforward. What we haven't seen in the wake of this, some of the commodities, the prices have come down. Memory is a good example. What we haven't seen broadly is cost decreases coming in from our providers at this point. And so with that, you see that reflected in our gross margins, which have returned to a more normal range but are still sitting in that 66%-67% range.

Scott Herren
CFO at Cisco

So I'm not anticipating at this point price declines pending significant cost declines coming into us. On the cost savings, you can see where we are year to date. We've got, if you just look at operating expenses for a minute, year to date, operating expenses are modestly up. After working our way through the restructuring that we discussed today, for the full year, we think they'll be modestly down. I think that's probably the right way to think about it as you're looking to build your model.

Sami Badri
Head of Investor Relations at Cisco

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

Operator

Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 800-876-5258. For participants dialing from outside the U.S., please dial 203-369-3998. This concludes today's call. You may disconnect at this time.

Analysts
    • Aaron Rakers
      Managing Director and Technology Analyst at Wells Fargo & Company
    • Amit Daryanani
      Senior Managing Director at Evercore
    • Ben Reitzes
      Managing Director and Head of Technology Research at Melius Research
    • Chuck Robbins
      Chairman and CEO at Cisco
    • David Vogt
      Managing Director and Senior Equity Analyst at UBS
    • George Notter
      Managing Director of Equity Research at Jefferies
    • James Fish
      Managing Director and Senior Research Analyst at Piper Sandler
    • Matt Niknam
      Director of Equity Research at Deutsche Bank
    • Meta Marshall
      Managing Director at Morgan Stanley
    • Michael Ng
      Managing Director of Global Investment Research at Goldman Sachs Group, Inc.
    • Sami Badri
      Head of Investor Relations at Cisco
    • Samik Chatterjee
      Managing Director and Equity Research Analyst at JPMorgan Chase & Co.
    • Scott Herren
      CFO at Cisco
    • Simon Leopold
      Managing Director at Raymond James
    • Tal Liani
      Technology Analyst at Bank of America Corporation
    • Tim Long
      Managing Director at Barclays
    • Woo Jin Ho
      Senior Networking and Semiconductor Analyst at Bloomberg Intelligence
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