Cisco Systems, Inc. (CSCO) Earnings Call Transcript & Summary

Hello, everyone, and welcome to the quarterly earnings conference call for Cisco's third quarter of fiscal 2022. I'm Marilyn Mora, and I serve as Head of Investor Relations. With me today are Chuck Robbins, our Chair and CEO, and Scott Herren, our CFO. You should have already seen the press release about our earnings by this point. After this call, a webcast with slides — including supplemental information — will be posted in the investor relations section of our website. You can also locate income statements, complete GAAP to non-GAAP reconciliation details, balance sheets, cash flow statements, and additional financial information in the financial information section of our investor relations website. During this call, we will refer to both GAAP and non-GAAP financial results. We'll talk about product results in terms of revenue, and geographic and customer results in terms of product orders, unless we say otherwise. Every comparison we make on this call is on a year-over-year basis. Please be aware that among the materials accompanying this call is a slide summarizing the impacts from the war in Ukraine and the extra week in Q3 fiscal 2021. Today's discussion will include forward-looking statements, among them the guidance we will give for the fourth quarter and full year of fiscal 2022. These are subject to risks and uncertainties, including COVID-19, that we describe 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. Regarding guidance, please also consult the slides and press release accompanying 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'll now hand things over to Chuck.

Appreciate that, Marilyn, and hello everyone this afternoon. Back in February when we had our conversation, we were heading into Q3, the latter half of our fiscal year, feeling optimistic even with the supply and component difficulties and other headwinds hitting us along with a lot of others in our industry. A number of the elements that drove that optimism haven't changed as of today; we're still experiencing robust demand that's producing a record backlog, our business transformation is coming along nicely, and the unique innovation we offer throughout our portfolio is assisting our customers in embracing and adopting the various technology transitions taking place; that said, two unexpected developments have occurred since the previous earnings call, and they affected how our Q3 revenue turned out. The war in Ukraine is the first. That led us to stop our operations in Russia and Belarus, and it came with a matching revenue effect, which Scott is going to cover. The second one involves COVID lockdowns in China, which started in late March. Those lockdowns caused an even worse scarcity of some critical components; because of that, we couldn't ship products to customers at the volumes we had initially expected going into Q3. A wider than typical range is built into our Q4 guidance, factoring in the revenue effect from the war in Ukraine along with the ongoing unpredictability tied to China's COVID lockdowns. With that unpredictability in mind, we're taking a sensible approach to the current environment and leaning toward caution regarding our outlook, handling things one quarter at a time. We think our revenue results in the quarters ahead hinge less on demand and more on how much supply is available in this increasingly complicated environment. Although some parts of the present circumstances are mostly beyond our control, our teams have been pursuing a number of mitigation efforts to help ease a lot of the component problems we've encountered; we think we'll start seeing the advantages of those efforts during the first half of the next fiscal year. Let me now get into the details of our third quarter results. As I noted a moment ago, a lot of the positives we've talked about across the last few quarters are still there, which has kept demand for our solutions solid. Total product orders rose 8% year-over-year, producing another record backlog of well over $15 billion, which is up 10% sequentially and up 130% year-over-year; that momentum confirms the essential part we play in our customers' futures. Our business transformation has moved forward well too. During Q3, we recorded ARR growth of 11%, finishing the quarter above $22 billion, along with product ARR growth of 18%. We also closed the quarter with more than $30 billion in remaining performance obligations, or RPO. On top of that, we delivered non-GAAP EPS at the upper end of our guidance range. Effective pricing actions and spending discipline drove this, and together they let us counterbalance lower volumes while delivering both gross and operating margins above the top of our guidance range and hitting our bottom-line profitability target for the quarter. I'd like to restate what I mentioned previously. The core forces propelling our company remain robust. We do have certain near-term hurdles to navigate, yet that doesn't alter how we view the future, how closely we align with the toughest problems our customers face, or how strongly we believe in the enormous possibilities ahead of us. Seven days ago, we held our Global Customer Advisory Board gathering, sitting down with nearly one hundred clients. What they told us, again and again, was that technology sits at the center of their approach and now matters more than ever to every aspect of what they do. It's fueling not only their plans but their broader business transformation as well. The technology these organizations are bringing in from Cisco is fueling their business agility, enabling faster movement and giving them the power to provide distinctive experiences to the people they serve; at this point I want to walk through a few quarter highlights. Demand stays robust in multiple parts of our operations. Web scale continues to be a bright spot, since we keep assisting these clients in developing their capacity to link up with and support their own customers and end users at scale, stretching from the data center out to the edge; that translates into ongoing order momentum, with growth above 50%, and measured across the trailing four quarters, we achieved growth exceeding 100%. That represents our ninth straight quarter of healthy demand, as we land new franchises, broaden our design wins and gain share in web scale. I couldn't be more proud of how far we've come and the momentum we hold in this arena; we're likewise thrilled with how our 400 gig solutions are catching on, among them the Cisco 8,000, the quickest expanding SP routing platform in the company's history. On top of that, our Silicon One lineup, ZR and ZR plus optics, together with our Acacia family of optical networking offerings, keep delivering strong results. When it comes to product revenue, our results were powered by healthy demand throughout most of our portfolio, spanning switching, SP routing, wireless, security and SD WAN. What we achieved in those segments mirrors the continuing investments our clients are making to swiftly digitize their operations and provide distinctive experiences. Going forward, the move toward hybrid cloud, 5G, 400 gig, IoT, hybrid work and the surge in applications are all fueling greater demand for next generation networking, connectivity, security, and observability solutions. Cisco stands in a strong position to serve our clients through our end-to-end platforms and solutions. I take great pride as well in how quickly we innovate. Over the quarter, Cisco rolled out fresh innovations spanning our networking and cloud portfolios, plus technologies aimed at improving experiences and hybrid work settings; we additionally unveiled our new predictive networks, designed to help organizations learn about, anticipate and steer clear of network disruptions. There's additional innovation coming that we'll be revealing at RSA as well as at our very own Cisco Live gathering in June. Beyond that strong enthusiasm we share for innovation, everyone here at Cisco sees a distinctive chance to contribute toward improving the world, doing so via the technology we create and the mission we unite behind to drive an inclusive future for everyone. That blending of technology with purpose, I think, explains why Fortune and Great Place to Work gave us the top spot as the number one Best Company to Work For in the U.S. for a second consecutive year. To wrap up, although this quarter obviously unfolded differently than we had anticipated, demand is still solid and our business fundamentals remain strong. Our attention stays fixed on carrying out the strategy we presented at our Investor Day. We'll likewise stay unwavering in our commitment to reshaping the company for greater predictability and agility, all while delivering a strong pipeline of innovation to the market. Our confidence in long-term growth, and in the opportunities ahead of us, has not changed. I'd like to express gratitude to our teams worldwide for everything they do, carrying out their work with dedication, focus and excellence amid an extraordinarily dynamic environment. They keep concentrating on our customers with unmatched innovation, resiliency and determination. With that, I'll hand the call over to Scott now.

Thanks, Chuck. We achieved healthy expansion in product orders, net income, and earnings per share, even with the difficulties Chuck described. Growth in product orders came from robust performance throughout the majority of our portfolio, while careful spending and supply chain oversight boosted our profitability. Revenue totaled $12.8 billion, unchanged from the prior year. Our non-GAAP operating margin reached 34.7%, an increase of 110 basis points, exceeding the top of our guidance range. Non-GAAP net income came to $3.6 billion, a rise of 3%, and non-GAAP earnings per share were $0.87, up 5%, landing at the upper end of our guidance range. During March, we halted business operations in Russia and Belarus, which hurt revenue by roughly $200 million, or two percentage points of growth. In the past, Russia, Belarus, and Ukraine together accounted for about 1% of our total revenue. This quarter's effect was somewhat greater than our typical run rate because of extra revenue charges we recorded for uncollectible receivables and other items. Also, keep in mind that last year's Q3 had an additional week, which benefited total revenue in Q3 of '21 by about three full percentage points of growth. Combined, the effect on the year-over-year total revenue growth rate from the extra week and the Ukraine war was roughly five percentage points. Examining our Q3 revenue more closely, total product revenue was $9.4 billion, up 3%. Service revenue was $3.4 billion, down 8%, due to the extra week in the prior year and the Ukraine war, which together affected our growth by about 8 percentage points. Within product revenue, Secure, Agile Networks was strong with revenues up 4%, switching expanded thanks to data center switching strength with our Nexus 9000 products, campus switching growth was led by our Catalyst 9000 and Meraki switching offerings. Wireless saw a double-digit rise from broad-based strength across our portfolio, including our WiFi-6 products and Meraki wireless offerings; we also experienced solid growth in Servers. Enterprise routing fell mainly because of Edge, and Access was slightly offset by SD-WAN strength. Internet for the Future was up 6%, from strength in Acacia, optical, optics, and core networking products including double-digit growth in the Cisco 8000. Collaboration was down 7%, due to declines in our meetings, calling, and contact center offerings, partly offset by the continued ramp of our communication platform-as-a-service. End-to-End Security grew 7% with broad strength across most of the portfolio. Our Zero Trust portfolio performed well with double-digit growth from strong performance in our Duo offering. Optimized Application Experiences was up 8%, from double-digit growth in both of our SaaS based offerings ThousandEyes and Intersight. We continue to make progress on our transformation metrics as we shift our business to more subscriptions and software. Total software revenue was $3.7 billion, a decrease of 3% with the product portion down 1%. Excluding the combined drag from the additional week in the prior-year period plus the conflict in Ukraine, total software revenue growth would have come in 6 points higher. Subscription-based offerings accounted for 83% of software revenue, an increase of 1 percentage point compared with a year earlier. We recorded $5.5 billion in total subscription revenue, which represents a 4% decline. Without the combined negative effects of the extra week in the prior year and the war in Ukraine, that total subscription revenue figure would have been 7 points higher. Cisco's overall revenue was 43% represented by total subscription revenue. Annualized recurring revenue, or ARR, reached $22.4 billion, marking 11% growth, with product ARR expanding a strong 18%; meanwhile remaining performance obligations, or RPO, stood at $30.2 billion, rising 7%. Product RPO was up 13%, service RPO was up 3%, and total short-term RPO climbed 9% to reach $16.2 billion. Q3 brought us solid product order growth of 8%, with strength seen across the majority of the business. Turning to geographic segments, the Americas rose 9%, EMEA rose 4%, and APJC rose 11%. Within our customer markets, commercial climbed 19%, service provider climbed 8%, public sector climbed 4%, and enterprise was flat. On a non-GAAP basis, total gross margin landed above the top end of our guidance range, at 65.3%, which is a decline of 70 basis points versus a year ago. Product gross margin came in at 64.1%, a drop of 80 basis points, while service gross margin was 68.9%, an improvement of 20 basis points. The product gross margin decline stemmed mainly from persistently elevated component costs tied to supply constraints, along with greater freight and logistics expenses, partly offset by a strong favorable pricing effect. We keep working through the supply constraints that are being felt across the industry by both us and our peers. To illustrate how large these shortages are, in Q4 we presently face constraints on approximately 350 critical components, among 41,000 unique component part numbers in total. Our supply chain organization is pursuing several options aggressively in order to resolve those shortages. Thanks to our solid product orders, we again experienced a substantial rise in backlog levels for hardware as well as software, far beyond what we normally see historically. As Chuck mentioned, product backlog at the end of the period climbed to well over $15 billion, and software backlog reached more than $2 billion, with both rising 10% sequentially. Also, a quick reminder: backlog does not form part of our $30.2 billion in remaining performance obligations. We closed Q3 with $20.1 billion in total cash, cash equivalents and investments. Operating cash flow during the quarter was $3.7 billion, a 6% decrease versus a year earlier, driven mainly by advanced payments made to lock in future supply. Those advanced payments had a negative 9 percentage point effect on Q3 operating cash flow year-on-year; when it comes to capital allocation, we returned $1.8 billion to shareholders over the quarter, consisting of $1.6 billion for our quarterly cash dividend plus roughly $250 million in share repurchases. So far this year, we've given back roughly $10 billion to shareholders through dividends paid in cash and buybacks of stock, and there's over $17 billion still available under the repurchase program authorized by our Board. In short, we're steering through a very complicated landscape even as we keep advancing the transformation of our business model and placing strategic bets on innovation so we can seize the considerable growth chances we have and the addressable markets that keep getting bigger. Let me now walk through what we're guiding for Q4. On the supply side, the difficulties we ran into during Q3 should carry over into Q4. Looking at the coming quarter, we're projecting revenue growth somewhere between minus 1% and minus 5.5%; non-GAAP gross margin should land somewhere in the 64% to 65% range. We're expecting non-GAAP operating margin between 31.5% and 33.5%, while non-GAAP earnings per share ought to come in somewhere between $0.76 and $0.84. Turning to the whole of fiscal '22, here's our guidance. Revenue growth should fall somewhere between 2% and 3% compared with a year earlier. For non-GAAP earnings per share, the guidance range is $3.29 to $3.37, which is a rise of 2% to 5% versus a year ago. When it comes to both the Q4 and full year outlooks, we're basing them on a non-GAAP effective tax rate of 19%. I'll hand things back to Marilyn now so we can get started with the Q&A.

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

Thanks a lot. Chuck, could you give us your read on the macro picture from what your customers are telling you? I understand enterprise orders came in flat compared with a year ago. Are you noticing any shift in how they're behaving, whether because of broader macro conditions, or currency and inflation? That would really help. Thanks.

Sure thing, Meta. Thanks. On the demand question, a few points I'd make. First, if you set aside the 2-percentage point of orders we de-booked tied to Russia and Belarus, we posted 10% growth, against 10% growth a year earlier, so we feel good about that. At this stage our customers aren't signaling any meaningful change; that's not what we're hearing from them. We held our global customer advisory board only a couple of weeks back, with 100 of our largest customers there, and every conversation centered on projects and how strategic all of their objectives are. The final thing I'd mention is that on the enterprise side, we grew 37% last quarter. Keep in mind that our definition of enterprise is a fixed list of named customers, so it comes across as lumpier. Under the industry's definition of enterprise, you'd be looking at our enterprise plus our commercial business combined. So to give you something comparable to what's being discussed in the market, we thought we'd share that combined figure. Enterprise and commercial together grew 9%, but excluding the Russia impact, growth was actually 12%, and measured on a trailing 12 months basis it was 28%. So we remain at ease with the demand signals in front of us, and our customers aren't saying anything different at the moment.

That's great, thank you. I'll pass that along.

Let's take the next question.

Hello, and thank you for letting me ask. Chuck, I want to return to the demand topic once more — you're now steering the fiscal fourth quarter to look nearly the same as the third quarter, or perhaps a touch lower, and looking back through history, that pattern basically never shows up. I can't recall many cases like it. So does this mostly mirror the supply picture, or are there additional demand-related elements tied to the geopolitical circumstances that are playing a role? And at what point do we begin to see you move beyond some of that? Thanks.

Yeah. Samik, good question. Let me begin with the straightforward response: nothing about demand problems is reflected in our Q4 guide — demand has zero connection to the Q4 guide. Let me walk through how we arrived there. I believe everyone needs to grasp this. Looking at our Q3 results, on the revenue side, we absorbed a $200 million hit from halting our operations in Russia plus the related revenue write-downs. Those were non-recurring. Then, as you may remember, our quarter closes at the end of April. What most others have reported covers quarters ending in March. That means we lived through a full quarter of the China lockdowns. In Shanghai, that ran from March 27 until today. Shenzhen closed too, though it reopened a week afterward, so the real focus is Shanghai; thus we had $200 million from Russia, and separately $300 million entirely due to our inability to obtain power supplies from China — that's the plain explanation for what went wrong. To illustrate, we had 11,000 PCB assemblies finished, yet we couldn't secure power supplies for them owing to the lockdown. That's simply what took place in Q3. Turning to Q4, when you consider the Shanghai lockdown and what we've been told — because Shanghai supplies many components that feed into our power supplies — we cannot obtain those components. Shanghai is now indicating reopening on June 1. We're unsure precisely what that will mean, or what it implies about when we'd begin receiving any supply. And in turn, we think that once they reopen and permit transportation logistics to resume, a significant level of congestion will follow. We think there will be considerable competition for port capacity and airport capacity. And we believe that, when you combine that with the inbound efforts—trying to bring raw materials back into the country, and so on—it's just going to be impossible, in our view, to catch up on this issue in Q4, and that's what led to the Q4 guidance. So even though these top-line numbers don't look good, there's a very simple explanation for what happened; then the follow-on part of your question is, when do we think this gets better. Well, if we assume that China does begin to open up and we do begin to get a more natural flow of the power supplies. We also have had our teams over the last 6 to 9 months working on a lot of mitigating actions, redesigning 100 products, over 100 products, to give us component diversity, and we believe that a combination of those, starting in our Q1 and in the first half of our year, will start to see the benefit of that; so, that's when we expect to see it improve to some extent. We need to get through the next 90 days, but I'm just being as transparent as I can about what we see and when we think some of that improvement will occur.

I appreciate it. I'm grateful you could take the question.

Thank you, Samik. Let's go to the next question, please.

Thank you. Hey, everyone. Chuck, I'd like to explore that topic a bit further, specifically regarding the supply chain. Your company appears to have been hit much harder than others in the sector. So I'm attempting to figure out if your exposure to China is unusually large compared to everyone else. Can you provide any detail on the proportion of your parts that originate in China, and why do you differ from a few other companies? I realize your April quarter differed from their March quarter, but they reported in mid-to-late April and none have indicated any problems. So obviously, they observed April's events and remained silent. Then, for the second part, looking further ahead, considering the geopolitical difficulties involving Ukraine and Russia, plus the dangers linked to China from a geopolitical perspective and, clearly, their COVID approach, is there any kind of long-range strategy that would sever your reliance on China for components down the road?

Yes, Ittai, thank you. Both are solid questions. Regarding the first, I believe April was the main differentiator. I've talked with counterparts who share our experience — we are disclosing the impact for the entire month, and April wasn't the problem for us. So, on a normalized basis for that question across the portfolio, every one of us designs products using various components. Thus, we might face a distinct problem with a single component we've built into a product, or we might enjoy a distinct benefit since we incorporated a particular component into a product. Those are the situations where, as I mentioned, we're reworking things when we encounter unique issues or simply issues in general, even though others might face identical issues. So we believe the exposure overall stemmed from the month of April. Additionally, we handle enormous volumes; generally, you'd consider that a massive benefit, but for context, our revenue shipped during the final week of our quarter exceeded what many of the competitors you're mentioning shipped across their whole quarter. So it's simply a matter that it appears as a larger figure for us than it otherwise would. If they faced the identical issue, it could mean a $20 million effect for us, or it could mean a $200 million — $400 million effect. That covers the first one. For the second, what I'd say is that we continuously assess our worldwide supply chain. And so it isn't about a single nation, it's about resilience. Looking at how the industry built out supply chains across the past 15 to 20 years, I believe everyone recognizes that we're now transforming those while simultaneously handling all the immediate problems on our plate. That means our teams face two tasks at once, yet geographic resilience is something we keep pushing forward on. Take this illustration: prior to COVID, regional redundancy was already in place for us, but a scenario where an entire country goes dark wasn't something we had planned for. Building that kind of geographic resilience doesn't happen overnight, though our teams are actively tackling every one of those efforts at this moment, and they'll keep at it, Ittai.

Okay, thanks.

Thanks, Ittai. Next question please.

I appreciate you fielding this. I hope what I say comes across clearly, but I'd like to try. Your gross margin came across as fairly durable this quarter and in the guidance, while your revenue went the way that we've observed the reverse of among several of your competitors. And I keep wondering whether one piece of this involves brokers being used to pay extremely steep fees for components in what I'd call the secondary or tertiary markets — is that a practice you avoided, which kept you from hitting revenue but let you post a stronger gross margin? I'm simply attempting to grasp certain of your approaches compared with your competitors that let you achieve a solid gross margin despite the softer sales. Does that question land?

Yes; it certainly does, Simon. Let me begin, and after that I'll hand it to Scott so he can address it a bit. So, above all, we purchase very aggressively through the broker market. And as you'd expect, given our purchasing strength, we're the first ones they call. And so — no, none of that is related. As a matter of fact, our supply chain group has spent considerable time showing us instances where they purchased product through the broker market not long ago. So that isn't the cause, in my view. But Scott is able to walk through what actually took place there.

Yeah, that's a really good question, Simon. What I would say is, if you remember, we implemented two price hikes during this year. The first one took effect around the close of the calendar year, and the second came at the start of our second quarter. And at that point we mentioned that we believed — you keep asking about what those price increases are and when they'll appear in the top line — and we said we expected to start seeing the advantage from them near the finish of the third quarter, the one we just wrapped up, and that's precisely what took place. So although unit shipments during the quarter declined due to the problems we've discussed regarding the supply chain and component supply, we managed to counter that with fairly robust pricing. Actually, the list — we disclosed this in our Q, so you can find it there — but our pricing rose roughly 160 basis points in Q3. So even though we do face a unit effect from component supply, it got offset by certain initiatives we're undertaking in the — we are starting to capture on the pricing side. We are aggressively exploring every possible path. It has to be a qualified vendor, so we're working to qualify alternative sources concurrently. We are actively chasing that, whether via a broker, clearly straight from the vendor, but via a broker, distributor — we're going after all those channels, and that is generating a bit of a headwind for us.

Thank you.

Michelle, next question please.

Hello, and thanks. To start, I'd like a clarification regarding the product order growth figure that came in at 8%. Can you help us understand how much of that product order growth came from price increases? That's my first question. Then my second question: we're attempting to assemble an explanation for why, even once the contribution from Russia and Ukraine is factored in, enterprise would still show 0% growth, whereas a number of your competitors are posting much stronger results and trends, particularly in enterprise. Could we try to break that down a bit further to understand what's happening?

All right. To begin, I'll have Scott speak to the pricing piece shortly, but the key point is that pricing did not really move our growth much at all; we only passed through pricing at that moment to offset the added cost we were facing. And frankly, we've taken on more cost since then; so at present we haven't even passed through every cost we've absorbed. We keep getting price increases now. That covers the first answer. As for the second, the simplest way I can put it is what I mentioned before: the manner in which our competitors see and disclose, and the way the industry sees and discloses, enterprise would include both our enterprise and commercial business, and last quarter that combined would have risen 9%, and would have risen 12% excluding — or rather it rose 9%, but absent Russia it would have been 12%. So when you consider the scale of those two businesses together posting 9% growth, I feel quite confident that demand remains intact. And if you examine our commercial business, which typically serves as the leading indicator of a change in demand momentum, it rose 19% during the quarter. So I'm not worried.

Correct. And Sami, regarding what you asked initially, that 160 basis point effect on pricing we recorded during Q3 relates to revenue. Clearly, when moving from bookings into revenue, it must pass through backlog first and then be recognized; therefore, as for how this hits bookings, though we haven't put a figure on it, the effect would be somewhat greater than those 160 basis points.

Got it. Thank you.

Next question please.

Yeah, hello, and thank you for taking the question. I suppose I'd like to revisit this, since my sense is that the key thing investors will ask about after this call is those product orders, Chuck. And I realize you're telling us that taken together — I did catch everything you mentioned. My take is that when you examine how those moved quarter over quarter, that's substantially under typical seasonality. Suppose you grant 10% growth year over year on the product orders; you'd still be looking at a mid-single digits decline quarter over quarter, which is far under typical seasonality — though we recognize these product orders are coming down from record highs. So what I'd like to know is whether you can offer any sense of the trajectory for product orders as we move into the following quarter. The reason is I can picture a case in which product orders fall to roughly the July 2019 levels, and in that case you'd be down double digits, yet you'd remain in solid product order territory. If any of that tracks. So I'm hoping you might give us somewhat more detail regarding how you expect that trajectory to look and how those orders are settling down as time passes. And after that, perhaps I'll ask something else. I realize that ran long. Thank you.

Understood, Rod, and in fact you're approaching this correctly. Your thinking matches mine exactly. So the first point I'd make is that I believe seasonality of any kind has gone out the window given where things stand today and given what order demand has shown us. With particular customers, we were planning over an 18-month horizon. And if they submitted 18 months' worth of orders in the prior quarter and now they intend to pause, and perhaps we'll be doing that with three fewer customers in the current quarter. So I mean it's simply — it's really hard to wrap your mind around; so there are two items I focus on. First, what's our quarterly growth rate relative to a year earlier, to see — because I consider the momentum of demand from one quarter to the next sort of — you need to examine that delta, correct. Since if you grow 30% on 1% and afterward you grew 30% on 15%, then that would signal demand momentum is weakening. That's how I approach the math, right; so that's one item we monitor. But the second item is, I think, speaking to your point, I've been discussing it with the team — once we begin comparing against those 30% quarters, I think we must look back two years and make a genuine assessment, because we know those figures included pull ahead. How much, we don't know, as we've discussed, but I think you're right. We need to examine the data going back 2 years to get a real sense of what's actually happening today, and that's going to be tough for us to handle, since the way we've traditionally interpreted these metrics simply isn't relevant at this moment. And I believe after we've gone through 1 year, another 4 quarters of this, perhaps we arrive at a normalized — a normalized perspective. Like I've mentioned, we're entering a period in which growth in our order demand is going to trail the growth in our revenue, and then ideally we reach a stage where those 2 return to being more of a predictive model, and we just have to get there.

All right, that sounds excellent. And Chuck, I suppose, regarding that topic, I'm aware you've spoken with numerous CIOs and CEOs — what's on people's minds at this point? It feels as though bad news is everywhere you turn, and it's tough to imagine folks are eager to open their wallets, but I'm intrigued — demand still appears fairly solid, so I'm wondering what you're picking up from people, and how would you describe the tone of those conversations?

My view is that COVID transformed every aspect of the way our customers approach technology. Before COVID, I believe many customers, whenever they began cutting back, would halt their technology investments; and I believe COVID made them experience the consequences of those choices. And they aren't — they will exercise a lot of prudence before halting critical initiatives that deliver customer differentiation capabilities, or infrastructure modernization, or enable hybrid work, or keep them from trailing their rivals. I mean, the day-to-day is simply not the same when it comes to how CEOs, public sector leaders, view technology and its significance. Even if they believed it mattered greatly 3 years ago, what they grasp today is far different. So I'm not claiming they won't make those calls. I simply believe the bar they must clear to make them is higher.

Great, thank you very much.

Next question please.

I'm still finding it hard to build a model for next year, since we haven't even begun to lap the strong order growth rates. Right now we're still measuring 10% against 10% from a year ago. Next quarter, you reach 30%. And there are several quarters at 30%. At that point, revenue growth ought to speed up simply because supply chain conditions begin — they're expected to improve at some point, or because of your own actions, yet what we see is order growth slowing rather than speeding up. When we consider the coming quarters, is it possible that both things happen at once: order growth falling significantly, perhaps even turning negative, while revenue growth also turns negative? I'm basically trying to figure out how to think about the next few quarters. Thanks.

Do you want to handle that, Scott?

Yeah, Tal, I think the way to look at it is to go back to a stat we shared with you initially last quarter and then once more this quarter. Product backlog currently exceeds $15 billion. And inside that figure, software in backlog accounts for over $2 billion. If you combine that with the $30 billion plus of RPO that we have, we're looking at roughly $45 billion in sales we've already closed that haven't yet flowed into the revenue line. So I think as you consider how you'd like to model out the coming year, the rate and pace of revenue growth needs to be viewed as tied to supply rather than tied to growth in in-quarter bookings. And that's definitely how I look at it.

Now, regarding how orders are trending — orders are measured in dollars, yet different products don't move the same way. A few of them carry a lot of weight when it comes to contribution, such as the service provider side and so on. My assumption would be that things look stronger there than they do in enterprise and similar areas. So does that mean the order figures you give — could you go a bit deeper than just one aggregate orders number and walk us through which parts are seeing stronger order growth and which parts are actually seeing weaker order growth?

Yeah, a portion of that can be found in the slides we'll post online; it might be in the press release too; we discussed enterprise. For the quarter, enterprise orders came in flat, though you need to adjust for the effect of Russia and Belarus — the choice to halt operations in Russia and Belarus — which would bring it to 3% order growth; that comes after a quarter in which enterprise rose 37%, and the quarter prior to that it rose 30%. So given these — the way we classify enterprise, as Chuck mentioned, it's our largest customers. That business, by its nature, will be somewhat lumpy. Yet measured on a trailing 12 months, it's genuinely fairly strong. We keep seeing solid growth in SP, especially in web scale; we shared a few of those figures with you on this call too. Those are performing well. Public sector is still holding up. For us, public sector demand has remained fine; and commercial — you recall we brought this up when we initially entered the pandemic, that commercial dipped before the rest of sales dipped. Then when things started recovering in late fiscal '20, we saw commercial turn upward. For us it tends to serve as a leading indicator; and commercial growth product, order growth, rose 19% in the last quarter. So we aren't seeing — if that leading indicator holds, and it certainly has for us, we aren't seeing any softness in demand right now.

Got it. Thank you.

Thanks, Tal. Next question.

Folks, may I get a couple of points cleared up? To start, I believe I caught you mentioning the $300 million figure as roughly the thing driving a big revenue hit in Q3. What I didn't catch was any statement about how much revenue impact you anticipate in Q4. Could you give us that number?

Hello, Paul. Appreciate it. Sure — during Q3, telling you the number was quite straightforward, since we had full clarity on our expectations and all the rest. Once we get to Q4, we simply can't tell when things will genuinely start moving and how much we'll actually receive, and so on, and that's why we set the range the way we did. We're simply taking a realistic view of what we think we can ship, though pinning it specifically to power supplies is rather hard. That said, the bulk of what's troubling us at this moment — the real worry — is getting that door open: getting China reopened, getting product moving, and we have to see that happen. So, Scott, anything you'd like to add?

Yeah, and what I would tack on there is the reason we bring up power supplies as the illustration is that it was a bottleneck during Q3, and one piece of what went wrong for us in Q3 is that this bottleneck emerged extremely late in the quarter. Once Shanghai was locked down, we didn't see the impact right away. It mostly landed closer to the latter portion of April, which obviously fell inside our quarter; it did not fall inside the quarter for a lot of our competitors; and there simply wasn't enough runway to bounce back from it. But please don't reduce this to something overly simple, and I'm hoping I'm not steering you that way; power supplies aren't the only thing. We are dealing with problems across quite a few different spots. I attempted to convey a sense of magnitude since I'm aware it's 41,000 unique components, and what we've communicated is that roughly 350 currently carry possible supply worries. We grind on those daily, and daily a portion of them get fixed while daily another handful will get added to that list; so it isn't — sadly, it would be nice if only a single item or two were involved and we could point out precisely which ones. This is an extremely fluid set of circumstances. And the thing we're attempting to do, if you pull back to a higher view and put it this way, is we aren't presuming things improve or deteriorate as we move through Q4, and that is what's baked into the guidance.

But Chuck and Scott, the clear thing to ask about is that $1 billion, more than $1 billion gap in guidance brought down to Street expectations — does that capture everything about the limited visibility you have, the worry — the reasonable worry we all have regarding supply? Does all of it sit in the supply side of things? Returning to the numerous questions that have come up concerning your order book, the deceleration in orders, and demand quality, does any piece of that guidance shortfall stem from worries about demand, or does it all belong to supply?

Zero. Demand has no effect on our Q4 guide.

It's a 100% supply.