Cisco Systems, Inc.

Welcome to Cisco's third quarter fiscal year 2023 financial results conference call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. Now I would like to introduce Marilyn Mora, Head of Investor Relations. Ma'am, you may begin.

Welcome, everyone, to Cisco's third quarter fiscal 2023 quarterly earnings conference call. This is Marilyn Mora, head of investor relations, and I'm joined by Chuck Robbins, our chair and CEO, and Scott Herron, our CFO. By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the investor relations section following the call. Income statements, full gap to non-gap reconciliation information, balance sheets, Cash flow statements and other financial information can be found in the Financial Information section of the 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 made throughout this call will be made on a year-over-year basis. The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the fourth quarter and full year of fiscal 2023. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent reports on Forms 10-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 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. With that, I'll now turn it over to Chuck.

Thank you, Marilyn, and hope you all are doing well. This was another strong quarter for us, and I'm proud of what our teams have achieved. In Q3, we delivered our strongest ever revenue, non-GAAP income, non-GAAP EPS, and operating cash flow. We also continued to successfully execute on our strategy, driving solid growth in ARR to nearly $24 billion and posting double-digit growth in subscription and software revenues. Based on our strong Q3 performance, we are once again raising our fiscal 2023 outlook for revenue and earnings per share, which Scott will cover shortly. As we look ahead to fiscal year 24, we expect to see modest revenue growth, even with the tough compare of double-digit growth in fiscal year 23. Now, before I go through our Q3 performance, I'd like to discuss three key areas that will help drive our long-term growth. First, we are pleased with continued success in our movement towards more subscriptions and recurring revenue. In Q3, we delivered 18% growth in software revenues. We also have $32 billion in remaining performance obligations, and we expect to see this momentum accelerate. Second, security continues to be an enormous opportunity for us. As you've heard me say, we've revamped our strategy, put a world-class team in place, and made this a top priority for the company. Over the coming quarters, you will see new innovations in this space building on our strong Cisco Security Cloud strategy, including at Cisco Live next month. Based on the rapid progress we are making, we are optimistic about our opportunity in this fast-growing market. And third, generative AI and cloud. At Cisco, we already use predictive AI extensively across our portfolio. In addition, our core networking technology is already powering some of the leading AI models run by hyperscalers around the world. We have also moved rapidly to leverage generative AI capabilities in our own products, which you'll hear more about in the next few weeks and beyond, starting at Cisco Live. Now let me discuss our quarterly performance. As I mentioned, in Q3, we delivered our highest ever quarterly revenue in non-GAAP earnings per share, exceeding the high end of our guidance range. We saw healthy margins and record non-GAAP net income, which reflect our strong operating discipline. All of this contributed to record operating cash flow in Q3. As we expected, the actions we took to mitigate supply constraints have continued to pay off. Price realization as a result of the actions we put in place last year helped offset inflationary pressures. Our disciplined cost management enabled us to continue to expand gross margins as well as prioritize our strategic investments to drive long-term growth. As it relates to customer demand, it is being shaped by a few factors that we believe are impacting the entire industry. First, our increase in product shipments is often leading customers and partners to absorb these shipments prior to placing new orders. Second, the significant reduction in product lead times reduces the need for extensive advanced ordering by our customers. And third, macroeconomic conditions. With this said, in our discussions with customers, such as the ones we had at our most recent Global Customer Advisory Board event earlier this month, they continue to invest in key technologies that are core to their overall strategies. As we previously shared, given the unprecedented demand for our technology during the pandemic, we believe sequential order rates are far more informative than year-over-year rates. Just like the prior two quarters, our sequentials in Q3 were in general alignment with historical ranges, coming in one point below the historical range. In addition, our order cancellation rates also remain well below historical levels, indicating the strength of our backlog and portfolio. In terms of our backlog, we continue to expect that we will end the fiscal year with roughly double our normal product backlog. Now let me share a bit more detail about some of our newest innovations. Regarding our web skill customers, they are currently consuming and implementing their prior significant technology investments. There remains a huge growth opportunity across all these customers enabled by our portfolio of hardware, software, silicon, and systems. We already see early design wins in AI infrastructure and continue to see other wins and competitive displacements leading to continued share gain in this space. In our networking business, We remain focused on building solutions that drive a higher return on investment and sustainability. In March, we introduced 800-gig capability to our Cisco 8000 platform with the industry's first 28.8-terabit line card powered by Cisco's silicon-1 ASICs and pluggable optics. This new platform can deliver up to 68% power savings and 83% space savings compared to 400-gig solutions helping to reduce operational costs and carbon emissions, as well as enabling the densification of networks to support use cases such as AIML and IoT. This continues to drive positive customer feedback, and we're excited about this opportunity. To complement our own innovations, in Q3, we closed the acquisition of VALTEX, which is aligned to our security cloud vision for providing protection across multi-cloud environments with a seamless experience. We also announced our intent to acquire two companies that further extend our capabilities in cloud, security, and full-stack observability. Before I close, I also want to share once again how incredibly proud I am that for the third year in a row, we were ranked number one in the U.S. on Fortune Magazine's 100 Best Companies to Work For and in 14 other countries around the world. We were also ranked as the number one great place to work, reflecting Cisco's position as a premier destination for top talent worldwide. To summarize, our ability to navigate uncertainty was demonstrated by our record results. Our performance remains solid and reflects the strength of our strategy and the benefits from the investments we've made over the last several years. Our operational discipline and excellence in execution are driving record earnings, cash flow, and shareholder value. As we look towards Q4 and fiscal year 24, I'd like to share a few observations. As I mentioned earlier, as of now, we see modest revenue growth in fiscal year 24 on top of our strong performance in fiscal year 23. You can also expect us to grow earnings per share at a higher rate than revenue in Q4 fiscal year 23 and full year fiscal year 24, reflecting improving gross margins and strong expense management. Lastly, we expect to continue our stock buybacks at the higher levels you've seen over the last two quarters. I'd like to thank our teams for their focus and execution and our customers and partners for the trust they placed in us. As cloud, AI, and security continue to scale, Cisco's long-established leadership in networking and the breadth of our portfolio give me the confidence in our ability to capture the many opportunities ahead. I'll now turn it over to Scott.

Thanks, Chuck. We delivered a record quarter that exceeded both our top and bottom line expectations, driven by focused execution, continued business transformation, and the actions we've taken over the last several quarters to mitigate supply issues. We reported our strongest ever revenue, non-GAAP income, non-GAAP earnings per share, and operating cash flow for the quarter. Total revenue was $14.6 billion, up 14% year-on-year. Non-GAAP net income was $4.1 billion, and non-GAAP earnings per share was $1, up 15%. Looking at our Q3 revenue in more detail, total product revenue was $11.1 billion, up 17%, and service revenue was $3.5 billion, up 3%. Within product revenue, secure agile networks, our largest business, was very strong, up 29%. Switching revenue had strong double-digit growth with strength in both campus and data center switching, driven by our Catalyst 9000, Meraki, and Nexus 9000 offerings. Enterprise routing growth was driven primarily by strength in our Catalyst 8000 series routers, SD-WAN, and IoT routing. And wireless also had very strong double-digit growth with strength driven by our Wi-Fi 6 products and Meraki wireless offerings. Internet for the future was up 5%, driven by growth in our core routing products, including very strong growth in our Cisco 8000 offering. We also saw double-digit growth in web scale. Collaboration was down 13%, driven by declines in collaboration devices and meetings, offset slightly by growth in calling and contact center. End-to-end security was up 2%, driven by our unified threat management and zero trust offerings. And optimized application experiences was up 12%, driven by growth across the portfolio, including double-digit growth in ThousandEyes. We continue to make progress on our transformation metrics as we shift our business to more recurring revenue-based offerings, driven by higher levels of software and subscriptions. We saw solid performance of our ARR of $23.8 billion, which increased 6%, with product ARR growth of 10%. Total software revenue was $4.3 billion, an increase of 18%, with software subscription revenue up 17%. 82% of software revenues were subscription-based. We continue to have an elevated level of software orders in our product backlog. Total subscription revenue was $6.1 billion, an increase of 11%. RPO was $32.1 billion, up 6%, with product RPO increasing 9%. and service RPO increasing 4%, and total short-term RPO grew to 16.9 billion. Total product orders were down 23%, driven by the three factors Chuck pointed out earlier. The aging of our backlog has improved significantly, and we continue to have very low cancellation rates, reflecting the quality of our past orders and critical nature of our product portfolio. Total non-GAAP gross margin came in at 65.2%, exceeding the high end of our guidance range, and down 10 basis points year-over-year. Product gross margin was 64.5%, up 240 basis points sequentially, and up 40 basis points year-over-year. The year-over-year increase was primarily driven by positive pricing and favorable product mix. This was partially offset by a higher component and other costs. Services gross margin was 67.3%, down 160 basis points year-over-year. Non-GAAP operating margin was at the high end of our guidance range at 33.9%, down 80 basis points year over year, and up 140 basis points sequentially. Backlog for both our hardware and software products continues to significantly exceed historical levels. Due to an improving supply situation and our focused execution, we were able to accelerate shipments of our aged backlog to meet customer needs, which resulted in a decline in backlog levels sequentially and year over year. we continue to expect to exit the year with roughly double our normal product backlog. And just a reminder, backlog is not included as part of our $32 billion in remaining performance obligations. Combined, our significant product backlog and RPO continue to provide great visibility to our top line as we approach fiscal year 24. Shifting to the balance sheet, we ended Q3 with total cash, cash equivalents, and investments of $23.3 billion. We had record operating cash flow for the quarter of $5.2 billion, up 43% year over year, driven primarily by strong collections and the deferral of our Q3 federal tax payment due to the IRS tax relief related to the California floods earlier this year. The federal tax payment deferral had a positive impact of approximately 20 points of growth year over year on Q3 operating cash flow. This recent IRS relief postponed our remaining current year federal income tax payment deadlines until Q1 of our fiscal 24. In line with our disciplined capital allocation strategy and commitment to return capital, we returned $2.9 billion to shareholders during the quarter, which was comprised of $1.6 billion for our quarterly cash dividend and $1.3 billion of share repurchases. We ended the quarter with $12.2 billion in remaining stock purchase authorization. Year to date, we've returned a total of $7.7 billion via cash dividends and share repurchases. This reinforces our confidence in the strength and stability of our ongoing cash flows. We continue to invest organically and inorganically on our innovation pipeline. During Q3, we announced and closed the acquisition of Vaultix, which further strengthens our security portfolio. This investment is consistent with our strategy of complementing our internal innovation and R&D with targeted strategic M&A. To summarize, we had a strong quarter delivering record top-line growth, non-GAAP profitability, and cash flow. We continue to make progress on our business model shift to more recurring revenue while making strategic investments in innovation to capitalize on our significant growth opportunities. Turning now to our guidance. For fiscal Q4, our guidance is we expect revenue growth to be in the range of 14% to 16%. We anticipate the non-GAAP gross margin to be in the range of 64.5 to 65.5%, and our non-GAAP operating margin is expected to be in the range of 34 to 35%. Non-GAAP earnings per share is expected to range from $1.05 to $1.07. As Chuck mentioned, we are yet again raising our fiscal year guidance for fiscal 23, which is as follows. We expect revenue growth to be in the range of 10 to 10.5% year on year, Non-GAAP earnings per share is expected to range from $3.80 to $3.82. In both our Q4 and full-year guidance, we're assuming a non-GAAP effective tax rate of 19%. Our guidance ranges reflect significant visibility driven by healthy backlog, ARR, RPO, and improving availability of supply. As Chuck mentioned earlier, as of now, we see modest revenue growth in fiscal 24 on top of our strong performance in fiscal 23. You can also expect us to deliver earnings per share at a higher growth rate than revenue in Q4 and in fiscal 24, reflecting improving gross margins and strong expense management. And lastly, we expect to continue our stock buybacks at the higher level you've seen over the last two quarters. I'll now turn it back to Marilyn so we can move into the Q&A.

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

Thank you. Sam McChatterjee with J.P. Morgan, you may go ahead, sir.

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

Thanks, Samik. As I said in the In the opening comments, there are three factors really that are affecting demand. First of all, as we ship more of our backlog, our customers are digesting what they've ordered. Secondly, as our lead times come down, which our lead times have come down 40% over the last two quarters on a weighted basis. So it really eliminates the need for customers to order significantly in advance as they had been. And then obviously the macro conditions. When I talk about sequentials, as I've said, the year-over-years are just so hard to figure out that we've said the real thing we're looking for relative to whether we're seeing a momentum shift in the business is, are the sequentials in line? And as I've said the last couple of quarters, and this quarter as well, the sequentials were operating at or slightly below the low end of our historical ranges. So I wouldn't say it's robust, but it's still within the range or slightly below. And as we look at Q4, we actually expect our sequentials to be in line with what we've seen historically. So our view based on what we see today is that we can still deliver positive growth in fiscal year 24, even on top of the good growth year we had this year. I'll make one other point. If you go back to September of 21, when we had our analyst conference, we actually laid out long-term top-line growth of 5% to 7% and long-term EPS growth of 5% to 7%. If you move to the end of fiscal 24, based on what we see today, we will be in that range from a CAGR perspective, on a revenue perspective, and we'll be above that range from an EPS perspective during that same time period.

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

Yes, Sammy, if you look at the last two years, we've actually grown EPS faster than revenue. And as we look to, Q4 and then beyond, it's pretty clear that with the gross margin expansion and with our expense management that we are implementing, we can still fund the investment areas that we need to fund as well as actually deliver higher EPS growth rates than revenue, which is what a lot of our investors have been asking for. And so we believe that's quite feasible for us to do now. Scott, do you have any comments on that?

No, I think you touched on the key points. We will continue to invest in growth But we also, as you've seen in the last two years, you've seen us do this, grow the bottom line faster than the top line in fiscal 22 and at the midpoint of our guide for fiscal 23. And as we look ahead, you know, it's a time to be prudent. And so we see that happening again in fiscal 24. Thank you.

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

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

Yeah, Simon, thanks for the question. That's something that you've seen us do in the past. It's more a reflection of interest rates jumping up to 5%, our customers needing to get their hands on technology to continue to advance their own strategies, and us just putting our balance sheet to work a bit. It's not more complicated than that.

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

No, not in terms of profitability or in terms of the long-term impact that's going to have. Great. Thank you very much. Thanks.

Thanks, Simon. Next question, please. Thank you. David Boyt with UBS. You may go ahead, sir.

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

I'm sorry, David. Could you repeat that second part, the numbers you had there? I didn't catch them.

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

All right, David. Thanks for the questions. So let me talk about the linearity that we saw in the quarterly. It actually was very favorable from our perspective on the orders. While we clearly see that we're operating at the low end of historical ranges on a sequential basis, we did not see it deteriorate from the beginning of the quarter to the end. In fact, our linearity was slightly better than it normally is, and April was actually sort of in line with what we'd seen, maybe even a titch better than the first two months. So we did not see that particular change. outcome. And again, what we're looking for is a change in underlying momentum. I'm not suggesting there's strong momentum. I'm just saying we're looking for a change. And the best way to do that is to really understand, do the sequentials continue to play out the way they're supposed to? And as of now, we see they are playing out very consistently in sort of the low end of the range or slightly below And then, Scott, you want to take the FY24 note?

Yeah, sure. Just on the math you're trying to do, David, I think you're in the right ballpark. What I'd say, obviously, I don't want to get into being too precise on fiscal 24 yet, since it's only our Q3 call. But bear in mind, that's growth on fiscal 24 on top of, at the midpoint of our guide for fiscal 23, 10.2% growth in fiscal 23 the last time. we had double-digit revenue growth for a full year was back in 2012 in the bounce back from the global financial crisis. So it's a very strong year this year, and we see a modest level of growth on top of that.

Great. Helpful, guys. Thanks a lot. Thank you.

Great. Thanks, David. Next question. Thank you. George Nodder with Jefferies. You may go ahead, sir.

Hi, guys. Thanks very much. I guess I wanted to ask you about the growth expectation for this year. I'm curious about your view, how much of that growth comes from price? How much comes from backlog consumption? What are the bigger factors driving that growth this year? Thanks.

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

Thank you very much.

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

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

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

Yeah, thanks, Meta. So the Transbyte segment, I think if you think about the three factors that I described, one is... customers needing to digest the shipments that we're shipping out. And secondly, as our lead times come down significantly, they don't need to order as far in advance. If you think about who the customers are that have the most visibility and have done most of the advance ordering, it's going to be large enterprises and service providers. and web scale providers. And so from a segment perspective, I think the predominant issue we're seeing in the service provider space, which by the way contributed to 41% of the overall year-over-year decline, came from the SP space, which is less than 20% of our total revenue. So it had an outsized impact on our overall year-over-year decline. I would say in the enterprise, there's large enterprises that are dealing with the same issues and are doing the same thing. They're digesting the equipment and they're not needing to order as far ahead. We're also seeing the same things that you've heard from others. We're seeing elongated sales cycles. We're seeing more signatures required, but in general, we're getting the signatures, but they are taking a little longer. And then as it relates to the technology trends and what our customers are focused on, the good news for us is that If you think about every customer on the planet is basically has five key priorities that we actually aligned to. One is they're re architecting for this multi-cloud world. They're trying to figure out hybrid work. They're rebuilding their entire application strategy and re architecting their applications. They're rebuilding their cyber footprint because of all this distributed nature of what they're doing now. And they're focused on sustainability and our technology plays across all of those very important areas. And we're working very hard with all of our customers in all of those spaces. And then the final one I think that's on everybody's mind is artificial intelligence or generative AI. And I would say in the web scale space, over the next five years, the market opportunity, well, the entire market opportunity for AI infrastructure is estimated to be at $8.5 billion by 27, growing at about 40% CAGR from where it was. As I said in my opening comments, we're already installed as a networking infrastructure for some of these early AI models that the web scalers are running. If you think about where we were at the beginning of the web scale build out a decade ago, I said many times on these calls that we were not prepared and we got left out. And I would say this time for this AI infrastructure from a networking perspective, I believe we are better positioned than anybody else, and our teams have done a great job getting us into this position, and we see that as a massive opportunity.

Great. Thanks so much.

Great.

Next question, please.

Thank you. Sam McBodry with Credit Suisse. You may go ahead, sir.

All right. Thank you. My question is on any kind of dynamics with the hyperscalers or cloud providers that led to any kind of product push-outs or delays of shipments or any kind of receipts that took longer to deliver, you know, anything that was shifted. Do you guys see any kind of shifting of deliveries or requests to shift deliveries in the quarter?

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

Got it. Thank you. And then one follow-up on gross margins. You talked about the modest growth in 24, and you also talked about EPS outpacing that. But maybe we could get an idea on gross margin trajectory. Is there something you should be thinking as far as a glide path or an expansion range?

Yeah, Sammy, you see the midpoint of the guide we gave on gross margin for Q4. We've seen significant progress. We've seen significant progress on gross margin through the year. I mean, the product gross margin grew 240 basis points sequentially. That said, I think we're about to the point where we're lapping some of the benefits of the price increases. So there may be a little more room in gross margin sequentially, but if you look at the average for the year next year, of course, you remember the first quarter of this year, we had a pretty significant impact in gross margin. So the average for the full year will definitely go up, right, if we keep it the same glide path through fiscal 24. All right. Thank you.

All right.

Thanks, Sammy.

Next question. Thank you, Matt Nickham with Deutsche Bank. You may go ahead, sir.

Hey guys, thank you for taking the questions. First, just to follow up on the fiscal 24, the modest growth, what sort of macro assumptions are you embedding into that preliminary outlook? And then just secondly, if I could just double click on security, if you can maybe talk about what's driving some of the softness or decelerating growth, I believe it was about 2% growth this past quarter, and what you're anticipating in terms of maybe additional backlog release and whether that can maybe help some of those trends looking forward. Thanks.

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

And then I'd say on the security front, I think I've been – we've talked about this on several calls, and we've hired a new leadership team. The team is doing a phenomenal job. We had a big announcement recently. at RSA where we launched an XDR platform that actually is one of the first that actually ingests data from our competitors and our partners across the industry. And at Cisco Live in a couple weeks, we're going to make a next wave of announcements around some new innovation. And so I think we've acknowledged that we needed to get these new technologies out. And I think that they're coming out with unique differentiation to Cisco. And I think that's over the next, you know, when you look out, Sort of the second half of next fiscal year, I think you'll see security really be accelerating into a growth driver force.

Thank you.

All right. Thank you. Next question. Thank you. Michael Nash, you may go ahead from Goldman Sachs.

Hey, good afternoon. Thank you very much for the question. I just have two. First, could you just talk a little bit about how you're thinking about inventory levels on the balance sheet? going forward. And if you have any information you could share with us around purchase commitments as well, and then I have a quick follow-up.

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

Great. Excellent. Thank you for that. And then second, it was encouraging to hear about the expectation to return to a normal seasonality and sequential orders starting next quarter. I was just wondering if you could provide a little bit more texture around those expectations. Is the absorption of early product shipments that may have impacted the sequentials this quarter going to be largely done by next? Is it just the easier comps? Any thoughts there would be helpful. Thank you very much.

Thanks, Michael. Well, when I said at Q4 we see normal sequentials from Q3, that – That just means they're in the range of the historical ranges that we've seen from high to low. So it's not like an anomaly. It's not going to be significantly higher or significantly lower based on what we see today. We think that the digestion issue and the lead time stuff, we're estimating right now that most of that stuff gets washed out by the middle of next fiscal year. So we think to really get back to where you see normalized sort of ordering patterns and normalized backlogs, We think that's probably going to be the second half of fiscal 24. Thank you very much for the thoughts.

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

Thank you. Amit Daryani from Evercore. You may go ahead, sir.

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

Yeah, so on the specific hyperscaler situation, we've been winning and displacing or becoming a second vendor in existing architectures for the last couple of years. And then we're winning new franchises around these these AI networks in many cases are brand new and we were actually winning some of them as well and so you know as you think about AI I think it's important to understand the underlying technology and just quickly today what's largely used is something called InfiniBand and we see that our the web skillers are they have a desire to move to Ethernet and And then further to this new technology that we actually have out called Scheduled Fabric. And we support both Ethernet and Scheduled Fabric. And we think we're leading in this space. And it actually increases the, I'd say, makes these networks run more effectively and more efficiently. And so those are some of the reasons we're winning. But it's a very big opportunity over the next five, six, seven years. Got it.

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

Yeah, it's interesting. You know, back four, five, six quarters ago, I said, you know, we see this huge bookings and revenues running at a much lower level. And I said, there'll be an inflection point where revenue will run much higher than bookings. But it's so it's playing out exactly as we expected. Now, there is the added dynamic of sort of the macro uncertainty that people are certainly concerned about. What we're looking for is you know, to see, again, if there's a significant shift in momentum from one quarter to the next, which is why this sequential thing we watched, we've watched it for 20 years, and it really helps us see what's going on. And, you know, I think we're just going to have to, you know, what we're telling you right now is based on what we see today. And when we look out at FY24 and the commentary we made about showing positive growth on a high growth year that we're having this year, It's based, as Scott said, on backlog, on RPO, and it's based on the visibility that our sales teams have right now and what their expectations are for orders over the next 12 months.

Yeah, just to add a little bit more to that, when you add up between what will be current RPO that will turn into revenue during fiscal 24 plus sales, the backlog normalizing, which will be a tailwind, plus the renewal opportunity of what's not in RPO today but sitting in ARR today, round numbers somewhere between 40% and 50% of that revenue for next year is contained in those three lines. It's either orders that are in-house and sitting in RPO or sitting in backlog or renewal opportunities that we have a chance to go out and renew this year. When I said it takes a lot of pressure off of macro, it's It's a strong position to be in rolling into next year with that much of it, either already in-house or sitting as renewal opportunities for us. Yeah, that's a really good data point, Scott.

And I think if you go back eight or 10 years ago, in any given quarter, we would have to take orders for as much as 75% of our revenue in the quarter. And that's certainly not the case today. So that actually helps us as we try to model out FY24.

Perfect.

Super helpful. Thank you.

Thank you.

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

Thanks, Marilyn. Hey, in closing, I want to thank everybody for spending time with us today. First of all, I'm super proud of our results. I think our teams are executing very well. I'm proud of the record results that we had this quarter. I'm also really proud that we're seeing what we also said, which is the market share gains come through that we had talked about. We've been asked on several calls about market share. And in the reports that we expect to be coming out very soon, we have meaningful share gains that I think you'll see in campus switching, SD branch routing, wireless LAN, SP routing, some of our absolute biggest markets, which reflect the relevance of our technology to our customers right now. I'm really proud that looking at FY24, we still see growth on a strong double-digit growth year and also growing earnings per share faster than we are revenue growth. And our teams are committed to delivering on our commitments. And we look forward to spending time with you 90 days from now. So thanks for being with us.

All right. Thanks, Chuck. And to close this out, Cisco's next quarterly earnings conference call, which will reflect our fiscal year 2023 fourth quarter and fiscal 2023 results, will be on Wednesday, August 16, 2023 at 1.30 p.m. Pacific time, 4.30 p.m. Eastern time. This concludes today's call. If you have any further questions, feel free to reach out to the Cisco Investor Relations Department and we thank you very much for joining the call.

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