Cisco Systems Inc (CSCO) — Q1 2022 Earnings Call Transcript

Welcome everyone to Cisco's First Quarter 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 Herren, our CFO. By now, you should have seen our earnings press release. A corresponding webcast with slides including supplemental information will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements, and other financial information can also be found in the Financial Information section of our Investor Relations website. As a reminder, effective in Q1, we began reporting our revenue in the following categories: secure agile networks, hybrid work, end-to-end security, Internet for the future, optimized application experiences, other products, and services. As discussed during our Investor Day, and in our October 20th press release, this change better aligns our product categories with our strategic priorities. This change only impacts how we report revenue by product category as our reportable segments will continue to be based on geographies which consist of the Americas, EMEA, and APJC. We included quarterly reclassified revenue amounts for the last 3 fiscal years on our website. Click on the Financial Information section of the website to access these documents. 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 done on a year-over-year basis. Matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the second quarter and full year of Fiscal 2022. They are subject to the risks and uncertainties, including COVID-19, that we discuss in detail in our documents filed with the SEC. Specifically, the most recent report on Form 10-K identifies important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. I will now turn it over to Chuck.

Thanks, Marilyn. And good afternoon, everyone. We look forward to spending time with you today. First, I would like to thank those of you who joined us for our Investor Day in September, where we showcased the strong foundation we've built for helping to generate long-term, profitable growth. We're striving to maximize value creation through our focus on higher concentrations of software and subscription-based revenue streams. This gives us, and you, greater visibility and predictability into our future growth. We also highlighted our unique portfolio of market-leading franchises, which are well-positioned to drive growth in highly attractive existing and expansion markets. Lastly, we showcased the depth of our leadership team and outlined the next phase of our strategy. Moving into fiscal year '22, we were off to a great start with robust order growth of 33% and continued strong demand across our portfolio. Our teams are executing well, our ARR grew double-digits, and our momentum is accelerating, driven by digital transformation and cloud. Even with the ongoing supply constrained environment, we are solidly on track to deliver against our long-term financial targets by investing for growth while delivering breakthrough innovation. The past 18 to 24 months have no doubt accelerated the digital revolution we are all experiencing as technology is permanently changing nearly every aspect of our lives. The technology we build is powering the modern secure infrastructure that sits at the heart of this revolution, and Cisco is well-positioned to capture the opportunities ahead. Our customers want digital and cloud enabled solutions that allow them to move with greater speed, agility, and efficiency. We're already seeing the positive impact of our investments to drive accelerated innovation across high-growth areas, including hybrid cloud, web scale, cloud security, 5G, Wi-Fi 6, 400-gig, and full-stack observability. A key trend in front of us is enabling employees to work from anywhere. And this is much broader than meetings. It's about the holistic capabilities to support a highly distributed workforce that requires new infrastructure architectures, observability, and security. Many companies are in the process of defining their hybrid work strategy, which will be based on the technology we build across our networking, security, and collaboration portfolios. We're also leading the way with new innovation, including our recently expanded WebEx portfolio, purpose-built for inclusive experiences across hybrid work, workspaces, and events. Now I'd like to discuss our Q1 performance. Building on the momentum from last quarter, I'm proud to say we achieved another strong quarter in line with our expectations despite supply constraints, which I will discuss shortly. We delivered balanced revenue and non-GAAP EPS growth with healthy margins driven by a continued economic recovery, strong execution, and exceptional demand for our products. We also generated a strong quarter of double-digit growth in ARR and RPO, reflecting the ongoing success of our transformation. We have continued to operate successfully in a very dynamic environment, staying nimble in order to navigate the evolving conditions related to the Delta variant and global component shortages. Now let me discuss the performance of our customer market segments. Q1 marks the third consecutive quarter of accelerating order momentum with broad-based strength across our business. Every geographic region and 3 of the 4 customer markets grew product orders at 30% or higher. We again experienced the strongest demand in over a decade as our customers increased their investments in digital transformation. In our enterprise and commercial businesses, we achieved our fourth consecutive quarter of accelerating order growth. We also saw solid growth in the public sector. Our service provider segment delivered its highest level of order growth in over 5 years with a 66% increase as these customers address their growing bandwidth requirements. In our web scale business, our robust momentum continues. Our performance was once again a record with order growth of over 200%. That's 120% growth on a trailing four-quarter basis. We are very pleased with the early traction of our 400-gig solutions, Cisco 8000 platform, Silicon One portfolio, and rapid growth in our Acacia portfolio of optical networking products. It's clear we are expanding our footprint as our cloud growth rate is outpacing our peers. We continue to invest in web scale innovations with differentiated customer value. Launching this quarter, the latest member of the Silicon One family, the 19.2 terabit P100 routing device. The 11th chip in the Silicon One family. In addition, Acacia marked a major milestone by unveiling the industry's first pluggable module capable of delivering 1.2 terabit capacity on a single wavelength. Our product revenue was up nearly $1 billion year-over-year, demonstrating the competitive advantages of our scale and reach, as well as our ongoing momentum. We saw broad-based demand across the majority of our product portfolio. In addition, we continue to see steady progress in our business model transition. Our focus on subscriptions allows us to deliver innovation faster to our customers while providing more predictability and visibility, leading to a more durable growth business over the long term. We delivered software revenue of $3.7 billion, with 80% sold as a subscription. Subscription revenue increased by 4% to nearly $5.5 billion, while ARR increased by 10% year-over-year to $21.6 billion. We saw strong product ARR growth of 21% and product RPO grew 18%, reflecting our rapid transformation to a software-led business model. While our revenue growth was solid, it was impacted by the supply constraints which are affecting our technology peers and nearly every other industry. Our product orders were extremely strong and balanced across our markets. But we are constrained in what we can build and ship to our customers. We have a world-class supply-chain team that works to deliver an incredibly high volume of products given our scale and reach. They continue to execute well in this highly fluid and complex environment. We have been taking multiple steps to mitigate the supply shortages and deliver products to our customers, including working closely with our key suppliers and contract manufacturers, paying significantly higher logistics costs to get the components where they are most needed, modifying our designs to utilize alternative suppliers where possible, and constantly optimizing our build and delivery plans. We are doing this at a breadth and scale that is significantly greater than most in our industry. Of course, all of these steps, while necessary to maximize our production and delivery to customers, add to our cost structure. When combined with cost increases we are seeing from many of our suppliers, these factors are putting pressure on our gross margins. While we've thoughtfully raised prices to offset this impact, the benefits are not immediate and will be recognized over the coming quarters. Our focus remains on our customers to ensure we provide them with the products they need as quickly as possible. Now, I would like to share the progress we're making on our ESG initiatives. In September, we committed to being net 0 greenhouse gas emissions for Scope 1 and 2 by 2025 and net 0 for all emissions including Scope 3 by 2040. We believe we will do this by focusing on 4 areas: Building more efficient products, accelerating the use of renewable energy, embracing hybrid work, and investing in innovative carbon removal solutions. We believe we have a deep responsibility to use our industry leadership position and our innovation to make the world a better place and look forward to continuing to do our part. In summary, I am very pleased with the start of our fiscal year. Our teams are executing on our strategy while navigating a challenging operating environment and this is reflected in our Q1 results. Demand remains strong and, with the momentum in our business transformation, we have set the stage for another year of accelerated growth in fiscal 2022. Our performance is a testament to the power of our differentiated innovation, the strength of our end markets, and our team's commitment to excellence. As our customers accelerate their digital transformation and their adoption of hybrid cloud and hybrid work strategies, we believe we are uniquely positioned to capture the opportunities ahead. We will continue to strategically invest across our portfolio to drive growth and innovation, strengthen our competitive advantage, and position Cisco for success. I continue to have great confidence in our future. I will now turn it over to Scott.

Thanks, Chuck. We started the fiscal year with a strong Q1 performance. We executed well resulting in another quarter of more than 30% product order growth, driven by strength across our portfolio and demonstrating continued robust demand for our products and services. We also had strong results across revenue, net income, and earnings per share. Total revenue increased to $12.9 billion, up 8% year-over-year coming in line with our guidance range for the quarter. We saw strength in a number of product areas and across all geographies. Our business continues to execute well in this highly dynamic environment, but ongoing component supply constraints are impacting our ability to convert historically high demand into revenue as quickly as we'd like. Non-GAAP operating margin was 33.3%, up 60 basis points. Non-GAAP net income was $3.5 billion and non-GAAP earnings per share was $0.82, both up 8% year-over-year, with non-GAAP EPS coming in above the high end of our guidance range. Looking at our Q1 revenue in more detail, total product revenue was $9.5 billion, up 11%. Service revenue was $3.4 billion, up 1%. Secure agile networks performed very well with revenues up 10%. Switching had strong growth driven by a double-digit increase in campus switching, led by our Catalyst 9000 and Meraki switching offerings. The enterprise routing portfolio had high single-digit growth driven by Edge and SD-WAN. Wireless had a very strong double-digit increase driven by our Wi-Fi 6 products and Meraki wireless offerings. We had growth in data center switching and compute revenue declined slightly. Hybrid work was down 7% overall, driven by revenue decreases in our perpetual calling, meetings, and contact center offerings. These were partially offset by the ramp of communication platform-as-a-service and growth in our collaboration devices. Within hybrid work, our SaaS revenue continues to show growth of high single digits driven by Cloud Calling and Contact Center. End-to-End Security was up 4%, driven by growth in our cloud-based solutions, also offset by declines in our perpetual and hardware offerings. Our Zero Trust portfolio performed well with double-digit growth, with continued momentum in our Duo offerings. We also saw good growth in Unified Threat Management. Here again, our subscription portfolio performed well growing 15%, driven by our Cloud Security and Zero Trust platforms. Internet for the Future was up 46%, driven in large part by the strength of our web scale customers. We saw broad strength in the portfolio with growth in Cloud, growth in Core, in both Cisco 8000 and NCS 5500, and growth in Edge with the ASR 9000. We also saw benefits from our acquisition of Acacia. Optimized application experiences were up 18%, driven by both ThousandEyes which grew triple-digits, and Intersight which grew in the strong double digits. SaaS revenue for AppDynamics grew double digits as its revenue shifted to a greater proportion from its cloud-delivered platform. Our transformation metrics we covered at Investor Day were solid, as we continue to shift our business to more software and subscriptions. Software revenue was $3.7 billion, an increase of 1%, with the product portion up 3%. 80% of software revenue was subscription-based, which is up 2 percentage points year-over-year. Total subscription revenue was $5.5 billion, an increase of 4%, with the product portion increasing at 7%. Total subscription revenue represented 43% of Cisco's total revenue. ARR, or annualized recurring revenue, was $21.6 billion, an increase of 10%, with strong product ARR growth of 21%. Remaining performance obligations, or RPO, was $30.1 billion, up 10%. Product RPO increased 18% and short-term RPO grew 9% to $15.9 billion. As you can see, we continue to make significant progress on the transformation to increased software and subscriptions. We continue to have exceptionally strong order momentum in Q1 with total product orders up 33%, as Chuck mentioned earlier, with strength across the business. Looking at our geographic segments, the Americas was up 31%, EMEA was up 36%, and APJC was up 39%. Total emerging markets were up 37%, with the BRICS plus Mexico up 47%. In our customer markets, service provider was up 66%, commercial was up 46%, enterprise was up 30%, and public sector was up 10%. As you can see, it was broad strength across the business. From a non-GAAP perspective, total gross margins came in at 64.5%, down 130 basis points year-over-year. Product gross margin was 63.8%, down 150 basis points. And service gross margin was 66.5%, down 60 basis points. The decrease in product gross margin was primarily driven by higher costs from freight, expedite, and increased component costs related to the supply constraints. Pricing impact was relatively moderate and consistent with prior quarters, partially offset by positive product mix. 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 costs for many of these components. We're partnering closely with our key suppliers, leveraging our volume purchasing and extended supply commitments to address the supply challenges and cost impacts which we expect will continue into the second half of fiscal 2022. Our supply chain team continues to perform well in this very complex situation. We believe we're taking the right strategic actions with our suppliers and contract manufacturers to ensure we meet customer demand despite the potential risks associated with increasing our inventory and purchase commitments. When we look at the impact of acquisitions on our Q1 results, there was an approximate 250 basis point positive impact on revenue and no material impact on our non-GAAP EPS, which is in line with our expectations. Operating cash flow for the quarter was $3.4 billion, down 16% year-over-year, driven by higher supplier-related payments and timing of other payments and collections. We ended Q1 with total cash, cash equivalents, and investments of $23.3 billion, down approximately $1.2 billion sequentially, primarily driven by $2 billion in scheduled repayments of our long-term debt. In terms of capital allocation, we returned $1.8 billion to shareholders during the quarter, which comprised $1.6 billion for our quarterly cash dividend and $256 million of share repurchases. We continue to invest organically and inorganically in our innovation pipeline. During Q1, we closed the acquisition of EPSAGON and announced our intent to acquire Reflex. These investments align with our strategy of complementing our internal innovation and R&D with targeted M&A to further strengthen and differentiate our market position in key growth areas. To summarize, we had a strong Q1 in a complex, supply constrained environment. We executed well with strong top-line revenue and earnings per share as we delivered balanced, profitable growth. We continue to make great progress on our business model shift and are continuing to invest in innovation to capitalize on our significant growth opportunities. 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 Q2 which is as follows. We expect revenue growth to be in the range of 4.5% to 6.5% year-on-year. We anticipate non-GAAP gross margin 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 from 32.5% to 33.5%. Non-GAAP earnings per share is expected to range from $0.80 to $0.82. There is no change to our full-year fiscal '22 guidance. We expect revenue growth to be in the range of 5% to 7% year-on-year, and non-GAAP earnings per share is expected to range from $3.38 to $3.45, also up five to 7% year-over-year. In both our Q2 and full-year guidance, we are assuming a non-GAAP effective tax rate of 19%. I'll now turn it back to Marilyn so we can move into the Q&A.

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

Hi, thank you very much for the question. First question I had was regarding your price increases that you talked about incorporating into your price sheets. Would you say that 100% of the product orders recognized in the quarter reflected the higher price increases that you guys incorporated? Or were there prior contracts in place that honored prior price sheets for some of your key customers? Could you give us maybe an idea on mix and maybe a straightforward answer on that side? And then just a second question is it looks like public sector up 10% year-on-year. I think some of your peers have reported some very strong end-market public sector trends, some of them coming from the U.S. federal government. Could you just give us an update on what's going on there? Were there things that did not get past the finish line or any holdups, or any kind of key things you're seeing that's met with some resistance on deploying more public sector or federal government activity?

Sure. I'll start by addressing the price increase question and then let Chuck comment on the public sector. The price increase we implemented took effect on September 1st. Most of what we shipped during the quarter came from RPO, which includes prior sales reflected on the balance sheet, contributing to our current revenue. We now have $15.9 billion in current RPO, and none of that would have incorporated the price increase. A significant portion of hardware shipments during the quarter came from backlog, and again, those shipments did not include the price increase. Looking ahead, the price increase is likely to have a more significant impact in the second half of the year rather than during Q2. You should expect that to play a larger role in late Q3 and Q4 as those price increases translate into orders, which will then work their way through the backlog, be processed, and delivered to customers.

Thank you for the question, Sami. Regarding the public sector, our global performance over the past few years has been quite stable. We've seen our business in this area double since 2017. There has been notable strength in the E-Rate program, as well as in state, local, and education sectors. The civilian side has also shown solid performance, and we had some Department of Defense deals that carried over into the second quarter. Overall, the public sector remains a strong area for us, and our teams are doing an excellent job. This continues to be a valuable business for us.

Thank you very much.

Thanks. Hey, guys. Chuck, I want to focus on the security business in fiscal '19, you grew 18%, that was down to 12% in '20, that was down to 7% to '21, and you are starting to year at 4% here and now. All at the same time, your large competitors like Palo Alto and Fortinet, and even Check Point for that matter are seeing accelerating growth, improving growth rates and growth rates in the tens, twenties and even thirties on a year-over-year basis. So maybe you can unpack this for me a little bit. I know you've been pleased with your security business, but it seems like it's kind of heading in the wrong direction growth-wise relative to what the peers are doing. Maybe you can go into a little bit depth into the transitions that are going within that portfolio. When do we see it turn around and perhaps Scott can comment on how much of that portfolio is perpetual in nature versus subscription in nature? Thank you.

Ittai, it's a great question. So first of all, I will say that we have room to get better in security and teams are working hard on that. There's a lot of innovative work going on. And then you called out the primary issue that Scott referenced in his opening comments, which is the on-prem sort of perpetual stuff in decline and then the subscription-based businesses grew double-digits. Zero Trust and Unified Threat Management had good growth. Overall, the subscription portfolio grew 15%. So, it's really balancing that and there's a little impact in there, Ittai, from supply chain on our hardware-based network firewall business. So, I think it's a combination of we've got some work to do which the teams are working on. We're expecting over the next 2 to 3 years for that business to continue to get better, and the teams are committed to make that happen.

And Ittai, to the second part of your question, we haven't actually broken that out for you, but I think as we talked at our Investor Day back in September, the growth areas of all of our markets, security and hybrid work included, are more in the subscription side. That's where we've focused our attention, and that's where we're investing a lot of our innovation. As Chuck said, the subscription piece of security grew at 15% during the quarter. So, I think as that becomes a more prominent part of our overall security product portfolio, that's where you'll begin to see more acceleration in the growth rates.

Maybe Scott can provide a different perspective. Can you clarify how far along we are in transitioning from perpetual to subscription? Will this transition continue to be a challenge for a long time, or do you believe we are nearing the end of it?

Yeah. Again, I'd rather not get into trying to give you guidance at that level, all the way out through time, Ittai. I do think the areas that we're focused on and the areas that we're investing in are the high-growth areas. And that's why you're seeing that double-digit growth. That mix will continue to change. It was obviously positive during Q1, it was positive in the prior quarter in Q4; it'll continue to change. And again, as that piece becomes a bigger part of the overall portfolio, that's where you'll see it flip to a faster growth.

Thank you.

All right. Thanks for your time. Next question, please.

Thank you. Maybe just to, if I could relate, on the software side a little bit decal on the growth rate. Maybe if you can talk a little bit about more broadly, the software solutions and how we can start to see growth accelerate there, I guess as we get through this transition a little further. And secondly, more granular, Chuck, maybe you can talk a little bit about renewals for Cat 9K. I think we're starting to come up against a period where we are going to see more of those. Any early indications there, and what do you think retention rates will look like, and do you think there's any software upsell opportunities as the bulk of the early customer base starts renewing? Thank you.

Yeah, sounds good. On the software revenue growth, as you said, it did slow a bit during the quarter and that's really again, the same effect that we talked about in the opening commentary. We had that transformation from selling more perpetual licenses to selling more as a subscription, and that's an area that we've put a lot of time and effort focusing on. So, it's that mix underneath the covers that's driving it where you'll see the revenue that's not yet recognized but the success of that transformation is in two of the stats that we also gave you in the opening commentary. Product RPO, products remaining performance obligations, up 18%, and product ARR growing 21%. So, a lot of the software sales that we had in the quarter are actually sitting there in RPO at this point and they'll get recognized over the future. So that's just creating an overall headwind to the reported revenue growth rate.

To add to that, our perpetual software is down year-over-year, as expected. We are shifting to recognize revenue ratably over three, four, or five years. As for the renewals on the Cat 9K, it's still early to determine the outcome, but it aligns with our expectations. The past two quarters have shown small figures, just to be clear. We are in the early stages, and our teams are making improvements. We have introduced innovative features, such as the ThousandEyes capability. The teams are engaged, and we feel reasonably confident. Our net retention rates are very positive. However, we anticipate seeing more volume in the second half of fiscal '23 to have confidence that our numbers will meet our targets.

Thank you.

Next question please.

Great. Thanks. Chuck, I wanted to ask a question just on your conversations with customers, and just as you guys on, and much of the industry tries to pass on price changes, just how that's impacting demand. Maybe particularly with service providers, who just have a little less budget flexibility. And then, maybe the second question, just currently, you guys are making a lot of efforts to reconfigure products or find alternative suppliers. Just how should we think of the timeline of some of those actions coming online to help clear some of the backlog? Thanks.

Let me address your first question. It varies by customer. Most customers are understanding, though they are very frustrated with the lead times. When we encounter specific customer issues related to budgets and other factors, our teams address those directly with the customers. Generally, I believe they comprehend the situation, and many of our customers are facing similar challenges with their own clients. This reflects a broader inflationary trend across the economy. Regarding the second part, in the first half of last quarter, we observed some deterioration in the availability of our supply chain components, but it stabilized in the latter half, which was encouraging. We anticipate some slight improvement in Q3 and Q4. While we do not expect significant changes, we believe conditions will remain stable in Q2 and improve slightly in the latter half of our fiscal year, based on our current knowledge. Scott, would you like to discuss the second part further?

Sure. I believe that is the critical question. The complexity in answering it lies in the fact that multiple commodities are being constrained, requiring us to consider the limitations across all economies facing similar issues. Additionally, we must factor in the complicated logistics situation we are experiencing across all transport modes, including ocean, air, and trucking. This combination of factors complicates the answer significantly. As Chuck mentioned, there were signs of stabilization during the quarter, including improved visibility on component deliveries from some suppliers regarding delivery times and quantities. There were also fewer de-commits during the quarter, indicating stabilization. Furthermore, memory costs are starting to decline, which suggests that this market is beginning to balance out. As we look ahead to our Q2 guidance and the full year, we see promising signs of stabilization. We hold a solid position in terms of remaining performance obligations, which will contribute to our revenue in the latter half of the year. Plus, our backlog gives us clear visibility into what needs to be manufactured, allowing us to be more focused on our pursuits. Therefore, we feel secure about our position regarding both the Q2 and full-year guidance based on current insights.

The bad news is we've had obviously challenges getting things shipped to our customers. The good news is that our backlog is at an all-time high for our company. It's never been higher.

Great. Thank you.

Next question, please.

Thank you for taking the question. I wanted to see if you could maybe quantify or even guess how much of the 33% order growth might reflect pull-in, basically customers placing orders ahead of your price increases. If there's any way you could adjust to that or normalize, and what do you expect in terms of the outlook for order trends? Do you forecast this, and I assume at some point, revenue growth and order growth should begin to converge somewhat?

I wish I could provide a clear answer because I am curious about it too. What I can tell you is that we have noticed customers are placing orders further in advance than usual. This includes large carriers and cloud providers, where we saw 200% growth. These customers are engaging in detailed forecasting and planning, ordering 2 to 4 quarters ahead to ensure they have the necessary products in the pipeline in the correct order for delivery. While we have visibility into this, other segments, like commercial, which grew 46%, show less consistency. Some commercial customers are looking ahead a bit, but many order based on immediate needs, making it hard to give a precise answer. Regarding your second question, we closely monitor cancellations and have not seen any changes in our historical cancellation rates; in fact, they are lower. Our pipeline growth is strong, likely better than ever, even beyond the last quarter. Therefore, we see ongoing demand, particularly from our largest customers—enterprises, cloud providers, and major carriers—of which we have good visibility. There is some ordering ahead among other customers, but I believe most customers below that level are not doing the same.

Is it fair to imagine that you were also surprised by the improvement in order growth versus the prior quarter? Was this a surprise to you as well?

Yes, the comparison from a year ago was more challenging, which actually highlights the increased momentum. Our teams have made significant strides over the past six years to re-enter key franchises among cloud players, and this has proven to be very successful. Additionally, we're witnessing various trends such as the 5G rollout and Wi-Fi 6 adoption, along with enterprises realizing the necessity to modernize their technology to avoid being caught off guard in the next crisis. Our switching growth is occurring at a rate that would have seemed unbelievable just two years ago. While it's reasonable to expect that order rates and revenue will eventually align over time, this may not happen in a single quarter due to our evolving business model. Looking at our remaining performance obligations each quarter, it's clear that we are in a far better position than we were six years ago. Without the transitions we've undertaken, we would face a much more severe situation regarding supply chain and revenue today.

Yeah. That $15.9 billion of just current RPO, meaning it's going to create into the revenue stream in the next 12 months, gives us obviously a fair amount of visibility there, Simon. The other thing I'd say to your point that I think is relevant on the strength of the order flow during the quarter is linearity was also good. It wasn't likely the quarter started off strong and got weaker as it went on. The linearity was good throughout the quarter, so we do enter the current quarter with some pretty good momentum on that front. It actually was the opposite; it strengthened.

Yes.

Thank you very much for those insights. Appreciate it.

Thanks, Simon.

Thanks for your response. Scott, I apologize if you've already addressed this, but I didn't catch your answer. Can you provide the number for how much revenue might have been impacted and what margins were affected due to the supply chain constraints? If you didn't mention it, could you share those figures with us?

We cannot provide a specific number because it's difficult to calculate. However, looking at last quarter's product growth of 31% and this quarter's growth of 33%, the remaining performance obligations will significantly increase. This is the largest backlog we've ever had in the company's history. So, it's challenging to specify an exact figure. Scott, do you have anything to add?

Paul, the main constraint we're facing right now is component supply, following two consecutive quarters of 31% product order growth in Q4 and 33% in Q1. The challenge hindering faster revenue growth is simply the supply of components. That backlog will eventually convert into revenue, but it will take some time. So, while it's difficult to quantify precisely, we can expect it to reflect in our revenue stream.

What I would say is that while short-term this doesn't feel great, I think what we're seeing is the customers have decisions they're making right now, and they're choosing our technology across the board. They're choosing the innovation that our teams have built. And I think that's going to bode well, and that's a great indicator for us in the future. The fact is that with that RPO and the backlog that we have, that stuff's going to ship. So, there's going to be some short-term issues, but it's going to catch up.

Chuck, it seems that there are two main factors impacting our revenue, specifically a shift towards software and contractually obligated revenue, along with supply chain constraints that complicate our understanding of demand. I'm not sure how insightful that is. Can you tell us about the growth in backlog and the book-to-bill ratio?

I'm not sure that book-to-bill is relevant anymore. It was significant years ago when we were primarily a hardware company, and everything was on a net 30 basis. We haven't considered that in a long time. I believe it might still be on an old spreadsheet, but I would ask Scott how he would describe the backlog.

Without providing the exact figure, Paul, I suggest examining the revenue growth rates, specifically the differences in those rates from the last two quarters, Q4 and Q1, to understand what's accumulated in that backlog.

We have clear visibility into what we need to produce and deliver, which is why we are taking steps to increase our inventory and make long-term purchase commitments that are reflected in our filings. We are doing everything possible to support our customers and expedite product shipments. You can gauge the growing backlog by comparing our bookings with the revenue we are able to generate.

Chuck, are there any product markets where you're concerned about share loss not keeping up with market growth?

Yes. We worry about it every day, and so do our competitors. And so, it's everybody trying to fulfill what customers need and I guess the silver lining is this is not necessarily unique to us, but it's certainly frustrating.

All right. Thanks, Paul.

Thank you.

Next question.

Thanks a lot, and thanks for taking my questions out. I think suppose one new your revenue guide for John Paul is obviously below the street was modeling. I'd love to get a sense on the guide that you gave, how does that stack up to what you thought John product could look like maybe 90 days ago. And to the extent you could talk about the decent ratio we're seeing from October to Jan on a year-over-year basis. Would that have occurred if you had no supply-chain issues?

The guidance for Q2 is certainly affected by the supply chain issues, particularly the problems with component supply that are hindering our ability to deliver products. However, our full-year guidance from last quarter remains at 5% to 7% growth for both revenue and net income. With strong demand and a substantial backlog along with the increase in remaining performance obligations, we have a clear understanding of what we need to achieve to meet those targets. Despite the supply challenges, we are still confident in reaching these goals by the end of the year. While the trajectory of the year may change due to these supply issues, the overall outlook is consistent with what it was three months ago.

I would say there's a couple of things on the revenue guide. I think for us, we're looking at what we see in the demand that we've witnessed and knowing that we have a backlog that's at an all-time high. I've got a high degree of confidence in that guidance. As Scott mentioned, it could very well look different from a quarterly perspective because of the supply chain bottlenecks, but I think the full year's guide is still stable. We stand by what we said in our previous call. As Scott mentioned, we stood behind the assumption of the guidance that we gave for the full year of 5% to 7% when we released the numbers from Q4.

Got it. And if I just follow-up, you had a really nice win with Facebook on Silicon One condition I think recently. Could you just talk about as you think about Silicon One offering, where is this resonating with customers? And Chuck, I'd love to understand what are the 2 or 3 reasons beyond this is alternative to what Broadcom that customers are gravitating to Silicon One for?

I would say there are a few important points. First, the performance of the Silicon One architecture is remarkable. In an era where sustainability is a major concern for everyone, its performance-to-power consumption ratio is industry-leading. When you consider the speed, number of ports, and the performance we deliver with lower power consumption, it is very significant. Not only is it advanced technology, but it also operates at a considerably lower power consumption, and I believe these are key reasons for its appeal.

Next question please.

Hi, guys. Thanks for the question. I wanted to come back to the service provider orders. We would calculate that's the best number you've done on absolute orders and service provider in 10 years. It's an insanely good number. I wonder if you could talk a little bit about what's in there. I know that you believe that orders are coming forward 3 or 4 quarters. I think like you said, Chuck, 2 to 4, but what is driving that? Can you dig into the products inside of that? And can you maybe link it back to some of these very large CapEx programs we've seen some of the hyper-scalers and so on, and how all this fits together for you from a product point of view in a market point of view, and I've got a follow-up.

Thank you, Rod. You might be right; I'm not sure if it goes back a decade. I haven't reviewed that, but it was significant. I believe it's a mix of the factors we've discussed. For three years, we've been questioning when 5G would become a reality, and it's happening now. We're selling site routers for backhaul, which is crucial, along with packet core systems. As we engage with cloud providers, we have standalone silicon, standalone software, and integrated systems, with a growing focus on integrated systems, which has been advantageous. The Edge with the ASR 9K is performing well, and the Cisco 8000 is also proving to be very successful. The NCS product line and optical solutions from Acacia are doing exceptionally well. All these technologies are aligning. To summarize, I would highlight three major trends: our move towards the 400-gig build-out in the cloud, the 5G expansion in the service provider sector, and a restructuring occurring in the service provider space aimed at flattening and simplifying the routed optical network strategy we’ve discussed. These are the key drivers. Now, what was your second question, Rod?

Yeah. I wanted to come back to the backlog and maybe see if Scott, if you have aged out at all. Could you give us any idea? I know it's within the RPO, but could you give us any idea on aging on that just so we could try to reconcile. Obviously, the stock's down, reason it probably down is because the growth rate here just doesn't match the word of growth, and people are going to try to reconcile that. I thought, well, maybe you could give us some aging that would help us to make some progress on that. So, I'm just curious if you can help with that. Thanks.

Thank you for your question, Rod. Our supply chain team is working tirelessly to address this issue. We have a good understanding of the backlog. What we're currently focused on is establishing a prioritization system to ensure we ship products to our customers efficiently and quickly. There is some aging in the backlog, but instead of trying to provide specific numbers, I want to emphasize that our team is dedicated to resolving this matter.

Okay. Great. Thank you.

By the way, if it's sitting in the backlog, obviously it's not an RPO yet. It's not an RPO, so it's incremental to RPO. Right.

Yeah, I misspoke. Sorry about that.

Yeah.

All right. Thanks, Rod. Next question.

Thank you for taking my questions. I have two. First, regarding gross margins, your guidance for next quarter suggests a decline of about 50 basis points at the midpoint, even with the seasonal increase typically seen in Fiscal 2Q. I'm curious if this is solely due to worsening supply chain constraints or if there are other factors at play. Secondly, on capital allocation, during the Analyst Day, you mentioned continuing to use the buyback to offset dilution from stock options, but you have $23 billion in cash. Are there any updates on your strategy regarding this? Additionally, what opportunities are you seeing in terms of larger scale, transformational M&A? Thank you.

Okay, you mentioned three points, Matthew. I'll begin with the gross margin question. The guidance we provided for the quarter, ranging from 63.5 to 64.5, is the same as what we presented in Q1 and is influenced by the same factors. There are several competing elements affecting the gross margin. We have price increases coming into effect later in the year, primarily in the second half, especially towards the end of Q3 and into Q4, which should positively impact the gross margin. However, we also face cost increases, not only in component costs but also in logistics costs, which have risen across the board. These factors are intertwined with the supply constraints we're managing. Regarding capital allocation, which I believe was your second question, our policy remains unchanged. As we stated at Investor Day, our primary focus is to support business growth. Additionally, we aim to protect dividends over time and offset dilution from our equity plans, which we implemented during the last quarter. In the long run, we plan to return excess cash to our investors in the most tax-efficient manner possible. This evaluation is ongoing, not just a quarterly task. As for the M&A question, it might be best not to delve too deeply into that. M&A has been a strategic element for us. We've mentioned a couple of recent acquisitions—EPSAGON, which was completed last quarter, and Reflex, which we announced but has not yet closed. You can expect us to pursue more build-by acquisitions, as they enhance our innovation efforts. This focus on M&A has been part of our strategy for a significant period.

That's great. Thanks, Scott.

Let's go ahead and move to the next one.

Hi. Hopefully you can hear me. Chuck, I have a high-level question. If I analyze your growth, you grew $1 billion year-over-year. But when I look at the components, it all hardware. Switches and routers or Secure, Agile Networks is about 55% of it, and the rest of it is the optical stuff, the Internet for the future. And the question is twofold. Number one, strategically, what can you do to expedite the growth of your focus areas, meaning software recurring revenue, SASE, anything that the other side of hardware? And the second question is, even if I look at the hardware side on these 2 areas, there was a major increase year-over-year in the growth rate. Meaning from -16% to +10%, for example, in securing that network, even higher on the optical side. So, what about sustainability, if that's the driver going forward, the hardware piece or the legacy pieces, how sustainable is the high growth we are seeing today versus a year-ago?

Thanks, Tal. First of all, I believe that the RPO numbers Scott mentioned indicate a significant portion of our revenue recognized each quarter comes from sources other than hardware. The RPO we expect to recognize over the next four quarters is nearly $16 billion right now, and it should increase as the year progresses. The product RPO growth for the quarter was up 18%, which shows that we are performing well. The hardware segment of the business faced challenges last year, but it is rebounding strongly. I also think we are making excellent strides on the software side, so I'm not worried about it. While I would prefer faster progress, when I compare our current balance sheet and revenue to where we were six years ago, the improvement is quite significant.

And what about sustainability?

You see a fraction of it in a given quarter.

Yeah. Thanks. And what about sustainability of these areas that are growing now? How sustainable is the high growth that we're seeing now?

We discussed this during our Investor Day, where we addressed the long-term growth of the total addressable market. In the areas we're currently operating in, we're already selling and investing in products that contribute to a total addressable market of up to $400 billion by fiscal '25. These markets are expected to grow at a rate of 5% to 7%, in line with our projected growth rates. Notably, the fastest growth is occurring in subscription models, which is reflected in our numbers. We are seeing an 18% increase in product remaining performance obligations and a 21% increase in product annual recurring revenue. We are successfully making the transition to a more recurring revenue model. However, these metrics may not immediately translate into reported revenues. It’s important to factor in the growth we're building in RPO and ARR, as this will drive our long-term growth.

Tal, we're experiencing significant franchise wins with the cloud web-scale players, which create recurring revenue models as we remain engaged until the next transition. This is another reason to consider that as we increase the software's contribution to total revenue, I believe software will continue to grow, and we aim to advance in both areas, to be honest.

Thanks, Tal. Next question.

Thank you. And I just have one question and that is, can you give us some more details around your prepared comment where you mentioned about your integration and Acacia is going on really well, what are some examples or proof points or milestones or items that you can maybe help us as outsiders understand about how Acacia is fitting in with Cisco? Thank you.

That's a great question. First, I believe they are performing better than we anticipated in terms of numbers. That's the main point. Additionally, the teams are making significant progress in delivering innovation, with ongoing collaboration between the silicon and optics teams. We are acquiring new franchises, and overall, the partnership has been excellent since their joining. Scott, do you have anything to add?

No. Other than just reiterating what you said in the opening commentary which is, and this is a pretty major milestone for the industry, first pluggable module capable of delivering 1.2 terabit capacity on a single wavelength. That's a sign of not just executing on the financial performance, but also continuing to innovate at the rate and pace that we'd expect from them.

Hi. Thanks for squeezing me in here. Chuck, I guess just wanted to follow up, you have based strong order trends across all the customer verticals. But you did mention the impact that you're monitoring the Delta variant and the uncertainty around it, and we've heard the same from some of the channel partners in terms of a risk to monitor, particularly for the commercial space. Are you seeing anything weaken on the margin there or is there a bit more uncertainty and risk created because of it? And then as a quick follow-up for Scott. Scott, I do realize the supply chain constraints that you're highlighting here, but you're reiterating the full-year revenue guide of 5 to 7. Does the high end look a bit more unreachable at this point, just given the supply constraints are bidding into the second half, which probably was not expected when you give that guidance earlier? Thank you.

Yes, Samik. My answer is quite brief. We're not experiencing any impact from it, but we are closely monitoring the situation. We are currently in such a dynamic world. You can see what's happening in some regions of Europe, yet we've actually observed acceleration over the last 90 days.

You highlighted the commercial aspect, Samik. One key point Chuck mentioned earlier is that product orders in the commercial group increased by 46% this quarter, indicating significant growth. Regarding your second question, it's challenging to provide a clear answer. I previously discussed the complexities involved, but I'll reiterate that earlier in the year we stated that if the supply chain and component supply constraints begin to improve in the early part of the second half, we could lean towards the high end of our guidance. If the improvement comes later in the second half, we may fall towards the low end. The real challenge lies in determining when exactly in the second half these issues will start to ease. We have noticed some stabilization after a decline earlier in the first quarter. As the quarter progressed, we saw signs of stabilization, and we have excellent visibility from our RPO, which will contribute to our revenue in the second half, along with a clear understanding of our backlog. We know precisely which components we need to pursue to fulfill our plans. Based on what we see now, we feel confident about our Q2 and full-year guidance.

Thank you.

All right. Thank you.

Let me conclude by expressing my gratitude to everyone for joining us today and to highlight how proud I am of our teams' achievements. The current environment is quite complex. We've achieved 8% revenue growth and 8% non-GAAP EPS, with product bookings exceeding 30% across all three regions. Our ARR has grown to $21.6 billion, maintaining double-digit growth, and our RPO stands at $30.1 billion, also in double digits. I'm truly satisfied with what the teams have accomplished. It has been a strong quarter despite the challenges. We have a significant backlog in our history, which will be shipped and combined with our RPO as we feel confident about our direction. We will continue to plan diligently and address the component issues, and our supply chain team is committed to working tirelessly on this. We remain optimistic about our annual guidance and I have strong confidence in our innovation and the overall state of the Company. Thank you for your time, and I look forward to our next conversation.

Thanks, Chuck. Cisco's next quarterly earnings conference call, which will reflect our Fiscal 2022 second-quarter results, will be on Wednesday, February 16th, 2022, at 1:30 PM Pacific Time, 4:30 PM Eastern Time. This concludes today's call. If you have any further questions, please feel free to contact the Cisco Investor Relations group and we thank you very much for joining today.