Q1 2025 Earnings Call Transcript

Welcome to Cisco's First Quarter Fiscal Year 2025 Financial Results Conference Call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. Now, I would like to introduce Sami Badri, Head of Investor Relations. Sir, you may begin.

Good afternoon, everyone. This is Sami Badri, Cisco's Head of Investor Relations, joined by Chuck Robbins, our Chair and CEO, and Scott Herren, our CFO. Cisco's earnings press release and supplemental information, including GAAP to non-GAAP reconciliations are available on our Investor Relations website. Following this call, we will also make the recorded webcast and slides available on the website.

Throughout today's call, we'll be referencing both GAAP and non-GAAP financial results. We will discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons will be made on a year-over-year basis. Please note that our discussions today will include forward-looking statements, including our guidance for the second quarter and fiscal year 2025. These statements are subject to risks and uncertainties detailed in our SEC filings, particularly our most recent 10-K report, which identifies important risk factors that could cause actual results to differ materially from those contained in our forward-looking statements.

With respect to guidance, please also see the slides and press release that accompany this call further for further details. Cisco will not comment on its financial guidance during the quarter unless that is done through an explicit public disclosure. Now, I'll turn it over to Chuck.

Thanks, Sami. And thank you all for joining us today. Cisco delivered a strong start to fiscal '25, delivering $13.8 billion in revenue for the first quarter, coming in at the high end of our guidance range. This was supported by solid growth in annualized recurring revenue, remaining performance obligations, and subscription revenue, which now accounts for 57% of our total revenue.

The strength of our recurring revenue streams is helping to fuel our profitability. Non-GAAP EPS of $0.91 exceeded the high end of our guidance range, driven by the highest non-GAAP gross margin we have seen in more than 20 years, which was further enhanced by Splunk. The combination of Cisco and Splunk and our team's great execution are both driving our strong operating leverage. The strength of our operating performance and free cash flow in Q1 fueled a return of $3.6 billion in value to our shareholders through share repurchases and cash dividends, delivering on our commitment to consistent capital returns.

Building on the growing demand we saw at the end of fiscal year '24, product orders grew 20% year-over-year in Q1 and were up 9% organically. This is an acceleration of the 14% product order growth we saw just three months ago and is a clear sign of normalizing demand for Cisco's innovation. Now, let me share some details on our first quarter, starting with the demand environment. Enterprise product orders were up 33%, driven by particularly strong performance in the Americas and EMEA across a broad range of customers.

We saw continued strong momentum in service provider and cloud, with product orders up 28%, driven by triple-digit growth in webscale. In Q1, our webscale customers placed AI infrastructure orders in excess of $300 million. Our AI pipeline continues to be strong. We have earned more design wins and remain confident that we will exceed our target of $1 billion of AI orders this fiscal year from webscale customers.

After a very strong Q4 last quarter, public sector orders were up 2% year-over-year in Q1. Federal spending in the U.S. was lower year-over-year due to continuing resolutions discussions, the impact of the Fiscal Responsibility Act, and the diversion of funds within U.S. federal. It's important to note that we believe the deals we are working on with U.S. federal customers are simply delayed, not lost. In both EMEA and APJC, year-over-year public sector order growth was strong. Now, let me share some data on demand through the lens of our products to provide some incremental color.

Our networking portfolio saw double-digit product order growth overall, driven by switching, wireless, and internet infrastructure. Looking at data center switching in particular, we have seen three consecutive quarters of double-digit order growth and an acceleration from Q4 into Q1. This shows our competitive strength in this key market and the power of our Nexus brand in the build out of private cloud infrastructure by our customers. We expect this momentum to continue as customers are showing significant interest in our 400 gig and 800 gig switches based on Silicon One. Security orders more than doubled year-over-year, driven by the advanced threat intelligence capabilities of Splunk.

Excluding Splunk, growth in security product orders was driven by our renewed security strategy and new product pipeline, which continues to be well received by customers and analysts. We continue to see momentum around our new security products like XDR, Secure Access and Multicloud Defense with now over 1,000 customers deploying these products thus far. In Q1, we had a marquee win for over 75,000 cloud security seats with a multinational IT services and consultancy company. The customer largely replaced an SSE competitor with our solution and moved from planning to implementation in 120 days, highlighting how fast our teams can implement our solutions at scale.

We also booked our first seven-figure Hypershield deal in Q1. Collaboration product orders grew double-digits again driven by demand for devices and our Cloud Webex Suite. Finally, in observability, orders were up high-single-digits, driven by our network assurance solution, ThousandEyes and Splunk Observability. I'd also like to highlight some of the progress we've made integrating Splunk. We now have a dozen updated data integrations between Cisco and Splunk across our security and networking portfolio, including Secure Firewall, Catalyst Center, SD-WAN and ICE.

We continue our joint selling motions between Cisco and Splunk, including a Cisco Secure Network Analytics and XDR alongside Splunk's SIEM, offering enhanced capabilities to the security operations center. We also continue to build our market-leading Observability solutions to accelerate Full-Stack Observability for the enterprise. Overall, our Q1 results highlight continued strong demand for Cisco technologies, driven by the need for modern, resilient networks as AI begins to scale. Findings from our new global AI partner study show that IT partners around the world are anticipating a transformative wave of AI technology demand driven by infrastructure, cybersecurity, and customer experience, which they expect to fuel the majority of their revenue over the next four to five years.

With the breadth of our portfolio, we are uniquely positioned to capitalize on this AI technology demand as customers are investing in their critical infrastructure to prepare for AI. In fact, there are three distinct but connected pillars to the AI networking opportunity for Cisco, which we have outlined on a slide as part of our quarterly materials. First, AI training infrastructure for webscale customers: AI networks demand scalable, programmable, low-power switches with advanced load balancing and observability. These characteristics in our products are driving hyperscalers to deploy the Cisco 8000 with Cisco's Silicon One G200 for maximum power efficiency in their back-end AI training networks.

As further proof, we also won a new Super Spine AI networking use case with one of our webscale customers this quarter. Second, AI network connectivity: This quarter, we booked further platform sales with global enterprise customers who are leveraging our technology platforms to modernize and automate their network operations to prepare for large scale connectivity to AI applications. Our technology platforms across switching, routing, security, and observability will help enable our customers by leveraging cutting-edge innovations like AI-powered robotics and unmatched supply chain visibility.

Third, AI network inference and enterprise clouds: Most of the CIOs and technology leaders we talk to say that their organizations are planning full GenAI adoption within the next two years, yet only 13% of organizations say their infrastructure is ready for AI today, according to the Cisco AI Readiness Index. To help our customers prepare, we have announced two new additions to our data center infrastructure portfolio, a new Nvidia-based AI server and AI PODs, including Nvidia's AI Enterprise cloud-native software platform and managed through Cisco Intersight to simplify and de-risk AI infrastructure deployment.

Our new AI server is expected to begin shipping next month. And our AI PODs are orderable this month. In addition, HyperFabric, our fabric as a service solution, which is expected to be available in early calendar 2025, further simplifies infrastructure deployment and management while providing real-time visibility into network performance. With these solutions, we are bringing the power of open hyperscale AI networking to the enterprise.

We also continue to fuse AI capabilities into our products. Hypershield, our first truly distributed AI-native cybersecurity solution built into the fabric of the network, shows how we are delivering secure networking, making it easier for our customers to protect against evolving threats. Splunk's Asset and Risk Intelligence solution is another example of how we are providing insights to help customers understand their security maturity and demonstrate compliance with evolving regulations. In our collaboration portfolio, we recently introduced the Webex AI Agent, AI Agent Studio, and Cisco AI Assistant features for Webex Contact Center.

These solutions use advanced conversational intelligence and automation to improve overall customer satisfaction. We have seen strong initial interest from customers and we'll continue to strengthen our collaboration products, increasing AI capabilities. We are also enhancing our own productivity by using AI in our services and customer experience organization. Over 60% of our Technical Assistance Center support cases are now touched by AI-enabled automation backed by our expertise for faster resolutions, which is leading to higher customer satisfaction scores.

In addition, our internal AI assistant for TAC works alongside our engineers to improve quality and speed time to resolution, while allowing our people to work on more complex and creative problem solving. To summarize, as we look at what's occurring with AI, there are three key things happening. First, there is significant investment in back-end AI networks with hyperscalers focused on training. Second, as enterprises look to adopt and deploy AI, they need to modernize and secure their infrastructure to prepare for pervasive deployment of AI applications.

Finally, the combination of mature back-end models with enterprise AI application deployment will lead to increased capacity requirements on both private and public front-end cloud networks. Cisco is already playing a major role across all three of these significant opportunities and are uniquely positioned to win with the breadth of our product portfolio and our trusted customer relationships. I will now turn it over to Scott to provide more detail on the quarter and our outlook.

Thanks, Chuck. We executed well in Q1 with strong order momentum, margins, and operating cash flow. For the quarter, total revenue was at the high end of our guidance range at $13.8 billion, down 6% year-over-year. As a reminder, Q1 of fiscal '24 was the last quarter of significantly elevated backlog shipments.

Non-GAAP net income was $3.7 billion and non-GAAP earnings per share were above the high end of our guidance range at $0.91. Looking at our Q1 revenue in more detail, total product revenue was $10.1 billion, down 9%, and service revenue was $3.7 billion, up 6%. Networking was down 23%, primarily driven by the elevated level of shipment we saw a year ago. As Chuck said, we saw strong order growth across our networking products as customers have worked down inventory and deployed the networking products we shipped them last year. Security was up 100%, primarily driven by growth in our threat intelligence, detection, and response offerings, which includes the offerings from Splunk, network security and SASE.

Excluding Splunk, security grew 2%, and our security portfolio was particularly impacted by the delays in spending in U.S. fed. Collaboration was down 3%, driven by declines in our on-prem Webex Suite and collaboration devices, partially offset by growth in our contact center and CPaaS offerings. Observability was up 36%, driven primarily by Observability Suite and growth in Network Assurance offerings. Excluding Splunk, Observability grew 1% for the quarter.

Looking at our recurring metrics, ARR ended the quarter at $29.9 billion, which increased 22%, with product ARR growth of 42%. Total subscription revenue increased 21% to $7.8 billion, representing 57% of Cisco's total revenue. Total software revenue was up 24% at $5.5 billion with software subscription revenue up 35%. Total RPO was $40 billion, up 15% year-over-year.

Product RPO grew 24% and total short-term RPO was up 15% to $20.3 billion. Q1 product orders were up 20% year-over-year. Excluding Splunk, product orders were up 9% year-over-year. Looking at our product orders across our geographic segments, the Americas was up 17%, EMEA was up 26%, and APJC was up 25%.

In our customer markets, enterprise was up 33%, service provider and cloud was up 28%, and public sector was up 2%. Total non-GAAP gross margin came in at 69.3%, up 220 basis points year-over-year and exceeding the high end of our guidance range and reaching the highest level in more than 20 years. Product gross margin was 68.9%, up 240 basis points, driven by Splunk, favorable product mix, productivity improvements and the one-time benefit of duty drawback, partially offset by price. Services gross margin was 70.3%, up 130 basis points.

We continued our focus on profitability and financial discipline with non-GAAP operating margin above the high end of our guidance range at 34.1%. On the bottom-line, Q1 non-GAAP net income was $3.7 billion, and earnings per share were $0.91. Shifting to the balance sheet. We ended Q1 with total cash, cash equivalents and investments of $18.7 billion. Operating cash flow was $3.7 billion, up 54%.

From a capital allocation perspective, we returned $3.6 billion to shareholders during the quarter comprised of $1.6 billion for our quarterly cash dividend and $2 billion of share repurchases. We continue to invest organically and inorganically in our innovation pipeline. During Q1, we closed two software acquisitions: DeepFactor, to accelerate innovation in the Cisco Security Cloud and augment our Secure Access offerings, and Robust Intelligence, which brings enhanced protection for AI models throughout their life cycle from development to production. Additionally, we announced our intent to acquire Deeper Insights AI to expand our Customer Experience team's technology footprint and engineering talent, accelerating innovation and momentum of Cisco's CX AI capabilities and services.

These investments are highly complementary to our internal R&D, in line with our strategy to strengthen our position in security and AI with targeted strategic M&A. To summarize, we started the fiscal year with a solid quarter, highlighted by strong order growth, margins and non-GAAP EPS. We remain focused on making strategic investments and accelerating innovation across our business to best capitalize on the significant growth opportunities we see ahead, all underpinned by disciplined expense management. It's this powerful combination that continues to fuel our strong cash flow generation, as well as our ability to return significant value to shareholders.

Turning to our financial guidance. For fiscal quarter Q2, our guidance is as follows: we expect revenue to be in the range of $13.75 billion to $13.95 billion; we anticipate non-GAAP gross margins to be in the range of 68% to 69%; non-GAAP operating margin is expected to be in the range of 33.5% to 34.5%; non-GAAP earnings per share is expected to range from $0.89 to $0.91. For fiscal year '25, our guidance is: we expect revenue to be in the range of $55.3 billion to $56.3 billion; non-GAAP earnings per share guidance is expected to range from $3.60 to $3.66. In both our Q2 and full year guidance, we're assuming a non-GAAP effective tax rate of approximately 19%.

Sami, let's now move into the Q&A.

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

Thank you. Tal Liani, you may go ahead from Bank of America.

Hello. I'll ask both my questions together. What is -- so, cloud orders, cloud and service providers grew 22% ex-Splunk. Last quarter, it was only 2%.

So, what is driving this massive growth in orders? And can you elaborate on the areas where you participate in cloud, more specifics of switching, routing, optical, et cetera, where you have strength and the extent, meaning is it all cloud providers, cloud titans, or are you focused -- like we have other vendors, are you focused on certain cloud providers and not others? And my follow-up question is on margins. Very strong gross margin, very strong operating margin this quarter.

Talk about the drivers and sustainability of these margins? Thanks.

Okay. Thank you, Tal. Thanks for being with us, and thanks for the question. So, I'll take the first one, which is service provider and specifically cloud orders.

So, if we step back and look at our service provider business, we were pleased. I think, first and foremost, starting with cable, it continues to be under pressure, but it's also the smallest portion of the business and is less impactful as it gets smaller. On the telco side, we actually saw some probably low-single-digit growth in telco, which was positive to see. We saw some real -- some activity occurring in both Europe and in APJC, which was encouraging as well.

And then, we moved to cloud or the webscale customers. That's where we had order growth in excess of 100%. And what I would tell you is that four of the six largest players were all each in excess of 100%. So, it was not concentration in one customer, it was actually four different customers all above triple-digit growth for us.

When we look at areas where we participate, you mentioned routing, switching optical, et cetera, and we participate in all of those. I did call out that we took orders in Q1 for AI and webscale in excess of $300 million, putting us well on track for the $1 billion and to exceed the $1 billion for the year. We participate -- I'll start with AI. We participate -- when we talk about AI, it's primarily -- it's systems underpinning GPUs in back-end networks.

I talked about a Super Spine win, which would be systems that are actually interconnecting clusters in the back-end. And then, we also provide both systems and optics that are providing that same connectivity as well as the connectivity required from the back-end to the front-end. So, we have a number of design wins in this space. We feel good about the progress we're making.

And I would just say that this is one of the big benefits of our strategy, which is to basically sell to our customers in the way that they would like to consume the technology, whether it's by our silicon, by our systems. And I think having our own silicon is proving to be a real competitive advantage for us. So, we're pleased with that. At the same time, I would say that the AI infrastructure represented just less than half of the total business we took from the webscale customers.

So, we still saw strength in the traditional cloud side as well, and we're pleased with the performance that we showed there. Scott, do you want to take the margin call?

Yeah. Tal, the margins were very strong. Of course, we had non-GAAP total gross margins of 69.3%, as Chuck said earlier, highest that we've had in 20 years. The product non-GAAP gross margin is 68.9%, up 240 basis points.

So, a handful of things driving that. Obviously, the year-on-year increase includes the addition of Splunk, which is favorable at the gross margin line, of course. We had other favorable product mix built into that. A nice job continues to be done by the team on what I'll call productivity enhancements.

So, continuing to drive cost out of the cost of goods sold line. The supply chain team has done a really nice job on that front. That is sustainable. We did have a one-time benefit in Q1 in the cost of goods sold line for a project that's been on flight for several years around duty drawback.

So, these are components that we imported that incurred a tariff. They were built into final product and then subsequently exported. When that happens, of course, you get the ability to get a return on that. We've been working to get a return of the tariff that you paid at the point of import.

We've been working on this project for some time. During the quarter, those filings were accepted. And so, we got a one-time benefit that's fairly substantial in Q1. Having said that, on the back of the great work the team has done, as I look at the next three quarters of the year and you see this in our Q2 guide, I would expect to see gross margins continue to settle into this range of 68% to 69% for the full year. And that of course, will be a tailwind to op margin as well.

Thank you, Tal. Michelle, we can go to the next question.

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

Hey, guys, thanks so much for taking the question. So, my question is mainly around macro. Just wondering maybe, Chuck, if you can speak to how the macro backdrop has evolved over the last three months? And then, maybe to double-click on that as a quick follow-up, as it relates to the election, just wondering if there's any hesitation, any impact in terms of buying behavior across different verticals, given some of the uncertainty around U.S. elections intra-quarter?

Thanks.

Thanks, Matt. So, on the macro front, I think, first and foremost, I would say that Scott mentioned the U.S. federal challenges, and that will tie into your second question. So, I'll cover a little bit of that there. I think the U.S. federal business was impacted by the continuing resolution pressure and then also the Fiscal Responsibility Act, which expires at the end of this calendar year.

Both of those put pressure on federal. I think we've heard that from some of our peers in their earnings announcements. If you normalize out or if you actually look at our product orders without Splunk, so the organic product order growth and you just remove the U.S. federal year-over-year, the rest of the world was up in the mid-to-high teens. So, what that tells you is that we saw very balanced strength around the world.

Geographically, we saw good strength in Europe, good strength in Asia. Without U.S. fed, we saw good strength in the United States. We saw really strong recovery in enterprise. We're pleased with that.

I discussed already the service provider performance that we had during the quarter. And so, I think the only real vertical I would call out is the U.S. federal issue that I just explained. I don't think there's anything else that we've seen relative to the elections at this point.

No. And the thing to think about, Matt, about the delays that we're seeing in U.S. fed is they are delays. This is not deals that were lost through that. It's pressure that's being put on by the continuing -- the funding of continuing resolution in the Fiscal Responsibility Act.

So, we do see some of those coming back as we get past the continuing resolutions. It looks like the Republicans will carry both Houses of Congress and the White House. And so, I would expect to get a budget in place relatively quickly. So, I do think we'll see.

Those aren't lost transactions. And just to emphasize a point that Chuck just said, total product order growth organically and excluding the impact of U.S. fed is up mid-to-high teens. So, I think in line with what you would have expected.

Lots of strength everywhere else.

Yeah.

All right. Thank you, Matt. Michelle, we can go to the next question.

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

Hi, good afternoon. Thank you very much for the question. I wanted to ask about security. It was encouraging to hear about the first seven-figure Hypershield deal in the quarter.

Could you just talk a little bit more about that, the nature of that deal? I think it was only recently made available. So, it feels like it's early days, but maybe you can talk about the reception to that? And then secondly, I think you had mentioned security orders had doubled year-over-year, including Splunk.

Could you just give us the organic number as well? And if you could speak qualitatively to the trends, that would be helpful. Thank you.

Yeah. Thanks, Michael. So, on your first question around Hypershield, this was a very large financial institution that was part of the early adopter planning and that's what we're seeing. This is a very high-impact solution that actually is very effective in some of the most, I'd say, advanced data centers in the world.

So, we see very large customers that have been deploying it. So, we're going to see, I think, a little -- a gradual uptick in customers adopting it. And we have a bit of a white glove program right now that we're using to help these customers get up and running. So, we're really pleased to see that because when a large bank makes a commitment like that, that tells you the technology is real.

And in many cases, they will lead the rest of the enterprise and actually deploy in these new security technologies. So, that's a good sign. On the security orders, we had a bit of the same issue that we had with U.S. federal on the overall product order growth. U.S. federal is our largest -- well, it contains our largest customer in the world and probably our largest security customer in the world.

And so, our security orders were up in the mid -- low- to mid-single digits without Splunk, the organic ones. And then -- but without U.S. federal, it tracked with the product data we gave you a few minutes ago. So, organic security orders, if you normalize out the federal year-over-year impact with the continuing resolution and the federal -- the Fiscal Responsibility Act, they were up in the mid to high-teens as well. We crossed 1,000 customers that have deployed these new technologies that we rolled out over the last 12 to 15 months.

So, we're pleased with the adoption that continues to occur there. And I think if you look -- if you listen to the analyst or follow the industry, I think there's a broad-based belief that our innovation pipeline and the technologies that we've been bringing to bear are going to be highly impactful our customers. And I would say there's more to come, so stay tuned.

Thank you, Mike. Michelle, we can move to the next question.

Thank you. David Vogt with UBS. You may go ahead.

Great. Thanks guys for taking my question. First, if I may, you mentioned -- I think, Chuck, you mentioned half of your webscale orders were AI with the other half sort of more traditional front-end. Is that sort of what drove the enterprise order growth or is there some campus recovery in that number from a product perspective?

And then, I'll just give you the second one for Scott. On gross margin, appreciate the color on sort of some of the impacts in the quarter. But from a Splunk perspective, was there anything else in the numbers? Like, we're trying to think through kind of the contribution from Splunk subscription versus term licenses and how should we think about that as we move through the balance of fiscal '25?

Thank you.

So, thanks, David. If I interpret your first question right, I think what you're asking is, was the non-AI portion of the cloud spend responsible for the enterprise growth that we saw. And so, I'm going to try to answer this. So, when we talk about the enterprise segment, we don't include any technology sold to the webscale customers regardless of what it is.

So, the enterprise segment is simply enterprise customers buying whatever they buy from us. So, that growth that we saw in enterprise was purely them. And I would also say that the majority of all of the webscale purchases from us were in the Internet infrastructure space. There was a smattering on the non-AI side that would be attributed to sort of classic enterprise technologies, but it was very small in the context of what they procured from us.

Most of it was Internet infrastructure systems, optical routing, switching, et cetera. Scott, the second one?

Yeah. On the gross margin, this is what I was touching on earlier, David, we did have favorable product mix in there and Splunk was a part of that, that drove the margins. There was a one-time benefit in Q1 that I just touched on around duty drawback. So, projects we've had in place for some time, getting a refund of basically import duty that we had paid, tariffs that we had paid on components that we imported, built into product and then turned around and exported, and you're allowed to get those back.

It's taken a while to get that -- all that paperwork pulled together, documented and then get it approved and actually get the refund. That happened in Q1. So, we had a one-time benefit. That's a catch up from a couple of years of those. That's not repeatable throughout the rest of the year.

There is a small tail of that, a little bit in Q2 and a little bit more in Q3 and Q4. The team has also done a really nice job continuing to drive cost out across the board. That's another thing that's driving our view now of gross margins kind of maintaining in the 68% to 69% range through the end of the year. So, think of Splunk being a benefit, that's not new news. I think what drove the outperformance in the quarter was much more about the one-time impact of the duty drawback project.

Thank you, David. Michelle, we can move to the next analyst.

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

Hi, thanks for taking my questions. If I can ask both my questions at the same time? Chuck, you mentioned in your prepared remarks, the data center switching portfolio had the third consecutive quarter of strong order growth. Just wondering how you're interpreting that in terms of enterprises are already starting to get ready for their AI deployments, or do you still believe that's largely in front of you.

Just what is that sort of order momentum indicating to you? And then the second one just on AI orders, you're sounding sort of better in relation to exceeding the $1 billion target, but is that -- is there necessarily an implication there in terms of revenue realization in the year? Is revenue realization maybe even a bit higher than you thought initially in terms of timing? Thank you.

Thank you. So, on the data center switching side, I think what it shows is that, clearly, our customers continue to be balanced between which workloads they move to the public cloud and which they move -- they build into the private infrastructure. We do see customers that are in -- that are generally modernizing their infrastructure. We talked about this last quarter.

We see enterprise customers who are -- even when they're unsure about what AI applications they may deploy six, nine, 12 months from now, they do know that they need modern infrastructure to be prepared to do so, and we're seeing them forward invest to get ready for it. But this has been the same pattern we've seen for a few quarters now. And so, I think it's, to some extent, in preparation for it, but the last part of your first question, I would say that the majority of this build out is still way ahead of us on the enterprise side. On the second question relative to AI orders and the fact that I think we're on track to exceed the $1 billion, the one comment I'd make on the orders, and I'll let Scott speak to the revenue implications.

I think that these customers, it's a very dynamic market, and they have a lot of rapidly changing requirements. And so, as we see these opportunities arise and we get designed in. So, when we get the design wins as we talk about, then, ultimately, they become bookings and then ultimately they become revenue. In many cases, a design win means that they have confidence that we can actually design a piece of silicon that they're looking for, we put it into a system, we deliver the system.

And so, the timing varies depending on what we want from them. And so that's why you're going to see this stuff show up in our guidance and you're going to see it show up as we continue to execute. And you've heard me talk about the need to continue to execute on several calls in a row in this space, but I feel really good about the job the team is doing right now. So that will lead to the answer to the revenue question, Scott, that you...

Yeah. And on the revenue question, as Chuck said, this is a bit dynamic in terms of shipments. Obviously, we don't get revenue until we ship the product out the door and there's a number of factors that goes into that, some of -- most of which are not within our control. We do see though this driving revenue consistent with what we've said in the past, Samik, driving revenue for us more in the second half of the year.

The majority of the revenue that we get from that will be in the second half.

Thank you, Samik. Michelle, we can move to the next analyst.

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

Great. Thanks for taking the question. First one is, I'd love to get maybe an update or double-click on the partnership you announced with Nvidia very early in [Technical Difficulty] I'd like to sort of get a sense of how that's progressing in terms of traction and where that fits into the pipeline. I did catch that you mentioned you've got an AI server.

Just sort of wondering if that's an outcome of that alignment. And my follow-up is pretty straightforward is you've earlier talked about the Splunk opportunities of new potential customers being introduced to Splunk. If you could update us on the progress there and sort of your line of sight to closing some of those deals? Thank you.

Yeah, thanks, Simon. So, on the Nvidia partnership, I think we're still really early on bringing these solutions to market. So, if you think back a couple of quarters back, we announced Hyperfabric, which is a fabric as a service solution to bring sort of that public cloud simplicity to AI workloads in the enterprise and that will be shipping in the first portion of calendar 2025. But we did announce this quarter two new platforms. We announced our AI compute platform that is -- the first phase of that is based on Nvidia GPUs.

And we announced AI PODs, which are also based on Nvidia GPUs. Over time, you'll see us support other GPUs as the market demands. But that partnership is still going fine. It's still early.

And I think 2025 is when we'll start to see enterprise real deployment of some of these technologies. On the second one, the Splunk customers update, I would say we continue to see good progress. If you really think about where we are with Splunk, we have -- I think we closed the acquisition in March. We're in November, so that's about eight months.

And if you ask Gary, he would tell you their average sales cycle is nine months. So, we haven't even gotten -- and we didn't start this initiative until probably into the second quarter that they were a part of us. So, I think it's still super early. What I would tell you is that we've -- the criteria that we use to identify these customers was based on certain attributes of the customer that would lead them to be a viable Splunk candidate.

And we've added about 1,500 more customers to that list. But the other thing that I think is really a positive sign is we have hundreds of Cisco partners now that have been trained on Splunk that are building out Splunk practices, in some cases, have actually gone out and made strategic acquisitions of Splunk Partners to accelerate and bring them into their business. So, on that front, we're super positive about how that's progressing as well.

Yeah. The only thing I'd add to that is from just overall perspective on Splunk integration, it's progressing in line with our expectations on the topline and in the ARR in particular and actually ahead of our expectations on profitability at this point. So, Splunk overall is tracking quite well for us.

Thank you, Simon. Michelle, we can move to the next analyst.

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

Hey, guys. Scott, for you, just circling back on RPO, what was RPO and product RPO growth at Splunk? And then, Chuck, for you, how are you guys thinking about not just enterprise refresh potential, but also the campus refresh opportunity with Wi-Fi 7 availability that you guys I think even announced this week? And will that Wi-Fi 7 encourage any campus switch refresh as well? Thanks, guys.

Go ahead.

Yeah, Jim, on the RPO, we don't actually -- we're not going to continue to break out with and without Splunk. And that's partly because of what I just said. This integration is going well. We've launched several products now that are joint products of both Cisco and Splunk.

From an organizational standpoint, we've brought in all of the G&A functions and are quickly adopting or integrating across the product lines. So, it's getting harder and harder to say what's Splunk and what's not Splunk. That line is just getting blurry and blurry each quarter. So, I don't plan on breaking that out.

I would tell you, of course, without Splunk, it still is a positive growth rate that's in sync with where we've been historically, but I really want to get a way of trying to draw that line for you.

Yeah, Jim, on the campus refresh, I think, look, our overall enterprise networking business was very strong during the quarter. So, we are continuing to see that refresh. You mentioned Wi-Fi 7, that we did announce the high-end versions during the quarter. This is a big -- it's a big first step for us because it's one of the first platforms that we've had that you can deploy and run under an on-prem management system or a cloud management system with the same license and use the same hardware.

So, that's been something we've been working on for a while is hardware portability between both on-prem and cloud. But we see that -- we see customers continue -- because if you think about the AI deployment and you think about starting first in the back-end of AI, which we've seen, and then as you see these pervasive deployment of AI applications in the enterprise, that's going to have dual impact. Number one, it's going to create that front-end network pull that we talk about because the enterprises are going to be connecting back to the cloud to take advantage of their models. And then, it's also going to continue to pull the refresh in the enterprise side because they're going to need their networks modernized to be able to run edge based versions of AI, et cetera.

So, we think the refresh opportunity is real for some period of time and in large part will be driven by this AI wave.

All right. Thank you, Jim. Michelle, we can move to the next analyst.

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

Great. Thanks. Maybe circling back to Michael's question, where you answer that kind of organic security growth would have been in kind of the mid-to-high teens if you stripped out kind of U.S. federal. Just wanted to get a sense of kind of what was driving some of that strength?

Is that data center modernization, or just what products are kind of driving some of that upside? And then just second question, just on data center modernization as a tailwind, just where are you kind of seeing kind of prioritization the most kind of within the data center? Is it kind of around security or updating switching? Just kind of any commentary around kind of categories you're seeing that data center modernization take place in?

Thanks.

Thanks, Meta. I think when you look at the security performance, if you just put U.S. fed to the side, I think we're seeing the impact of these new products between XDR, Secure Access, Multicloud Defense. We've seen over 1,000 customers now deploy those new technologies that we didn't have in our portfolio 18 months ago. We see Hypershield with very positive early feedback.

And that's not a big contributor to the order side yet, but I think it will be and it creates a mindshare pull from our customers because it's so innovative that, sometimes, it leads them to look at the rest of the portfolio again. We also have completed a refresh of the low-end firewall in the most recent quarter. We've had the high -- the high-end was refreshed in 2024, in the early part. The mid-range was refreshed in the latter part of '24. So, I mean there's a lot that has been going on that I think is contributing to that energy in security.

But in general, I think the market, the analysts, the customers all believe that where we are today versus where we were three, four years ago in security is just fundamentally different. On the data center side, the data center modernization that I've been talking about was largely around switching infrastructure, but I think the Hypershield momentum that we're feeling, at least from a mindshare perspective with customers would suggest that security is a massive opportunity in that space. As we've talked about, if you start with a fundamental assumption that the bad actors are in your infrastructure, then the thing you need to do is stop the east-west traffic in the data center and that's one of the key roles that Hypershield plays.

So, I think that's a big focus area for our customers as well. But most of what we've seen happening when we talk about data center modernization and the momentum that we've seen there is fundamentally been around switching.

Thanks, Meta. Michelle, we can move to the next analyst.

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

Hey, thanks a lot. It's great to be chatting with you. Hey, Chuck, I asked this last quarter, and I was wondering if you had any update. I understand that customers are getting ready for AI and feel they need to have the latest and greatest year for it.

Are you getting a sense of what they're engaging you for? Is it they feel like there's going to be more inferencing? Is there specific applications that they're citing? I think investors would love to know what you potentially are hitching a ride to there on that comment.

And then, I had a follow-up question for you and Scott is just, these performances where the orders move around ex-Splunk given the excess backlog can be a little confusing for investors, but you said one thing at your Analyst Day where you're going to grow 4% to 6%. And I know that's next year and beyond. But is there anything happening near-term that makes you feel better about that long-term target where you're a mid-single-digit grower? Anything that happened that making you feel better or worse regarding it, that'd be great to hear.

Thanks.

Hey, Ben, thanks. So, on the first question relative to AI in the enterprise in particular, I think we're all seeing customers focus on customer experience. That's one of the big early applications that virtually every enterprise that we engage with is looking at, including Cisco and everybody else. So, everybody is focused on that.

Then, the second, I think, is largely they are building different applications that are contributing to automation and efficiency like we've talked about with robotics or supply chain management. We also see a lot of AI activity around deeper engagement with the customer. So, customer experience on the support side, but then upselling, cross-selling customers, we see a lot of focus on that on understanding purchasing trends. And in those cases, what we see customers doing and this is leading to my belief about what's happening in the AI shift right now is customers are needing to leverage the value provided by the foundational models, but they also need to be able to train their custom data and then the inferencing applications are actually making calls into both of those datasets, obviously.

And we think that's going to lead to the front-end network buildout that we've talked about a lot in addition to the back-end. It also is leading some customers to buildout some of this data center modernization in their private clouds, and it's leading them to think about modernizing their overall infrastructure for edge-based versions of that over time. So that's generally what we're seeing. I'll make a quick comment on the second one, then I'll hand it to Scott.

I would say that as we continue to see more and more success and more progress relative to the webscale customers and their acceptance of the AI solutions that we're delivering and our team is delivering and us achieving the numbers that we put out there and exceeding those numbers, then that contributes to my confidence in the next few years. Scott?

No, I think you said it right, Chuck. The way I think about that is, it is hard right now, Ben, to compare the year-on-year product order growth rates because of what happened last year with all the inventory digestion that needed to go on. So, one thing you can do right now is start to look at what the sequential -- the ex-Splunk sequential product order growth rates look like and get a better sense of the demand that we're seeing coming back into that marketplace. And as we lap these more normal -- demand is normalizing as we lap these more normal demand quarters, you'll begin to see something that fits into the pattern that is going to be easier to discern what's happening overall from demand standpoint.

I would say the investments that we're making in AI, the investments that we're making across the networking portfolio with some of the platform work that we're doing in Wi-Fi 7 that we just launched yesterday is a combined platform product, same product that can be run with either platform in the back-end to control it. Those investments are paying off. And so, I feel good about what we put out. Obviously, when we put those numbers out.

We wanted to be a little bit conservative with them to ensure that as we got to '26 and '27, we not only hit those, but had a chance to overachieve on that. And right now, I'd say the investments that we're making in that space to drive growth are paying off.

Thank you, Ben. Michelle, we can move to the next analyst.

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

Yeah, thanks for taking my question. I guess, I'll ask a question and follow-up at the same time. Scott, networking revenues were down 23% this quarter. Just talk about how did that stack up against your expectations?

And now that backlog has normalized, should we expect this business to grow sequentially for the rest of fiscal '25? Would be really helpful understand how that grows for the rest of the year. And then, Chuck, over the next three years, are you more excited about Hyperscale or Hypershield, which one is the bigger opportunity that you're [seizing] (ph)? Thank you.

Yeah. I got to say, Amit, I'll start on the first one, but there was some background noise as you were asking the question, I'm not sure I got the entire question, but it started with networking revenue being down 23%. Of course, remember, that's comparing to Q1 in '24 where we had a very substantial shipment of excess backlog. Basically backlog that had built up during the supply constraints that we cleared very quickly.

Q1 of '24 was the third of three consecutive quarters with very heavy backlog shipment into it. If you net that out, and I think we did some of that math for you on the last call, gives you a better sense of what's happening in network demand. It's trending in line with our expectations. I'd say AI has been a bright spot for us.

The bookings that we're seeing inside AI haven't yet turned into revenue, but we certainly are seeing good momentum from that standpoint. DC switching, as Chuck just pointed out, has continued to be strong for us. So, feeling good overall relative to our expectations about what we're seeing in networking. And if I missed the second part of your question, we will circle back to you afterward and get to it.

Yeah. And then, your second question relative to, am I more excited, I think you said about Hypershield or Hyperfabric. I know there are both hyper-words. So, those are probably the two you mentioned.

I am equally excited. I think from a security perspective and a strategic security perspective, our large enterprise customers are incredibly optimistic about what Hypershield means for them, but from an AI application deployment perspective, our customers are very excited about what Hyperfabric will mean to them. So, if you think about two of the most important objectives our customers have, which is east-west data center security, and secondly, how do I simplify the deployment of AI applications. These are two very core technologies to both those things that we think will be important to our customers for the next few years.

All right, Amit, thank you. Michelle, we can move to the next analyst.

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

Hi, guys. Thanks very much. I just wanted to get some more detail on the gross margin improvement. Any chance you can break out that duty drawdown impact in the quarter?

I'd be curious as to what that is. And then obviously, you also saw quite a sequential improvement in gross margin. Obviously, Splunk was in -- obviously, the quarter and last quarter as well. So, I think product mix was probably a pretty big factor here.

I'm wondering if there was a big difference in terms of the mix of UCS servers or other product lines that kind of drove the day there. Any details would be great. Thanks.

Sure. I talked about gross margin improvement during Q1, in particular, having a one-time benefit from the duty drawback because it's a couple of years of duty that we've been working through this process of not just getting the filings together, but getting it all approved and getting the cash back. I would say that was a substantial contributor to the benefit we saw in Q1, somewhere between probably 0.5 point and 1 point of improvement just driven by that. There will be a tail of those now that we've got that process in place.

It will be significantly less as we look at Q2, Q3 and Q4. On the product mix front, we definitely got a benefit from Splunk coming in, not surprisingly. As you know, they had gross margins -- product gross margins in the 80% range. That's been a tailwind to us overall. There's also favorable product mix across some other product lines inside there and that will continue.

The team has also done a really nice job driving cost out, as I said earlier, I give credit to our supply chain and our product teams on continuing to drive cost out of that cost infrastructure. So full year, I see that those gross margins settling into the range that we guided in Q2 into that 68% to 69% range. I would point out that pricing is back to the normalized trend that we had seen pre-pandemic, which is somewhere between 1 point and 2 points of headwind exactly as we saw kind of pre-pandemic. So, no change from a pricing standpoint.

Thank you, George. Michelle, can we move to the next analyst?

Thank you. Aaron Rakers with Wells Fargo. You may go ahead.

Yeah, thanks for taking the questions. I'll keep two right together here. So, on this AI opportunity and as we kind of focus on the backlog converting into revenue, I'm curious of how you see the AI back-end possibly leading into front-end opportunities. Have you seen that at all with any of these hyperscale customers?

Any kind of color on that front would be great. And then kind of sticking to the AI networking theme, I'm curious as we move forward, how you would characterize the competitive positioning of Nvidia in the Ethernet back-end network side. Thank you.

Thanks, Aaron. So, on the back-end to front-end topic, which has been pretty popular lately, the way I think about it is that there's meaningful investment today going into the back-end training models as we all know. And then, I think that the enterprise is actually looking at two different things that are going on there. Number one, they're updating their infrastructure to prepare for AI, and then they're preparing for pervasive deployment of AI applications.

And I think that what that will do in my opinion is that will then subsequently drive a lot of the front-end capacity need because those customers will be leveraging both the back-end and the front-end capacity of the cloud infrastructure to actually deliver their own AI apps. And so, I think we're continuing to see investment in the front-end. Customers continue to make those decisions where they want to run workloads in the cloud. They haven't stopped moving workloads to the cloud.

So, we still see that happening. And -- but I do think that enterprise AI pervasive deployment will be the most meaningful driver of the increased capacity demand on the front-end networks. When you look at the competitive positioning of Nvidia, I think, look, we live in a world where we have great customers, great partners that we also compete with. There are several examples that are out there.

Nvidia, we have partnered with meaningfully. I talked about it earlier with the products that we built that includes their technology, not only GPUs, but in some cases, their software layer. But obviously, with Spectrum-X, there are areas where we're going to compete. And I think that, look, we got 40 years of building a highly-featured ethernet and a lot of experience with our customers using it.

We're seeing the success in the back-end networks. I think the other thing that many of our largest customers also want is vendor diversity. And so, I think all of those things combined with our own silicon and our ability to bring our own intellectual property up and down the entire stack puts us in a pretty good position competitively.

Thank you, Aaron. Michelle, we can move to the next analyst.

Thank you. Karl Ackerman with BNP Paribas. You may go ahead.

Yes, thank you. I have two as well, if I may. Scott, I want to focus first on the January quarter outlook, which implies that OpEx is down about $90 million. I think mostly -- most of the roughly 10% workforce realignment this calendar year has been completed.

And so, I was hoping you could address which areas of your business do you believe you need to accelerate investment to drive growth into '25 and '26 versus having some excess cost savings passed on profitability. And I have a follow-up.

Good. Do you want to go ahead and ask your follow-up now, Karl?

Sure. Yeah. In terms of follow-up, just you spoke about four cloud hyperscalers growing orders triple-digits, which is quite amazing and great. But I guess, are these product orders all four top of rack switches, or is the growth in AI networking hardware primarily driven by one hyperscaler today, which now appears to be across silicon and switches? Thank you.

Yeah, I'll start with the OpEx, and then Chuck, let you talk about the cloud partners that are growing triple-digits. On the OpEx, there is growth. Of course, you got to remember, Q2 of this year will compare to Q2 of last year when we did not have Splunk as part of the company. We closed Splunk in the middle of our Q3. So, a lot of what you see driving the year-on-year growth rate in OpEx is simply the addition of Splunk.

We talked about when we did the restructuring that it was not necessarily about driving cost savings. There are some cost savings coming out of it, but that was not the motivating factor. It was more about finding efficiencies across the company and turning around and reinvesting those in the fastest growing parts of our business, namely AI and security, and you see some of the great results coming out of that. So, think about those as the two areas we're investing, but the year-on-year growth rate and OpEx being driven mostly by the addition of Splunk.

And then, on your second question, Karl, I think we are pleased that four out of the six largest were all in excess of 100% growth year-over-year. And I would say that it was not just one customer on the AI infrastructure front, it was pretty balanced across all of them. So, we'll continue to keep plugging away, but it was pretty balanced, and we're pretty happy with the distributed nature of the business in that segment.

All right. Thank you, Karl. I'm going to hand it over to Chuck for some closing remarks.

Yeah, I just want to thank everybody again for joining us. And I want to particularly thank the Cisco teams for the innovation that our teams are delivering as well as the strong execution that we've seen in the first quarter of this year really got us off to a strong start. I think that as we talk about this whole AI transformation that's happening, I think, again, there are three big areas that we're focused on. Number one is the infrastructure required in the back-end networks to help our customers continue to build these training models.

I think the second is, we look at the enterprise space. And again, we see upgrades and refresh opportunities for customers who are preparing for AI, and then we see the ability to work with them in their data centers with this simplistic deployment of AI applications that we're going to enable. And then, the final area is continuing to work with the cloud providers and the enterprise customers on private data center and the front-end requirements that we see happening in the cloud side to support this AI transition as well. We think that the breadth of our portfolio gives us a great opportunity.

We also think that our continued momentum in security, notwithstanding what happened in U.S. federal this quarter, gives us a high degree of confidence. And we look forward to talking to all of you again next quarter. Thank you.

Cisco's next quarterly call, which will reflect our fiscal year 2025 second quarter results, will be on Wednesday, February 12, 2025 at 1:30 P.M. Pacific Time, 4:30 P.M. Eastern Time. This concludes today's call. If you have any further questions, please feel free to contact the Cisco Investor Relations department. And we thank you very much for joining the call today.

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