Cisco Systems (CSCO) shares one of the few bright star in the ugly stock market on Thursday, with shares rose nearly 3% after the tech giant reported a better-than-expected fiscal second quarter.

Here are the headline numbers: Revenue increased 6% year-over-year to $12.7 billion, beating estimates on FactSet of $12.664 billion. Adjusted earnings per share was also a beat, growing 6% over a year earlier to $0.84 vs. estimates of $0.81. 

Despite pressures related to higher commodity and other input costs, Cisco’s margin performance was a big positive surprise in the quarter. Adjusted operating margin was 34.3%, above prior guidance of 32.5% to 33.5%. That’s an increase from 33.3% in the prior quarter, and stronger than the 33.08% that was expected.

Although supply chain costs also remain an issue, Cisco successfully passed through those to offset the hit. During the conference call, management cited a favorable product mix — they shipped higher margin products — as the reason for the quarterly outperformance.  

Breaking down the results

• Total Product revenue increased 9% YoY to $9.353 billion, beating estimates of $9.220 billion.

• Cisco breaks down its product revenue into five main buckets: Secure Agile Networks, Hybrid Work, End-to-End Security, Internet for the future, and Optimized Applications Experience.

• Secure Agile Networks revenue increased 7% YoY to $5.898 billion, thanks to solid growth from both data center switching and campus switching products as well as in Wireless. 

• Hybrid Work revenue fell 9% YoY to $1.067 billion due to declines in collaboration devices and meetings offerings. 

• End-to-End Security revenue grew 7% YoY to $883 million thanks to strength across most of the portfolio, especially in Zero Trust. 

• Internet for the future revenue climbed 42% YoY to $1.322 billion thanks to strength from web scale customers. 

• Optimized Applications Experience revenue increased 12% YoY to $180 million, driven by double digit growth in both ThousandEyes and Intersight. 

The reported results tell a large part of the Cisco story, but we think a better way to understand how the business is performing through its supply chain challenges is order growth. Order growth is great sign of demand.

• Total product orders increased 33% YoY, representing the third straight quarter of 30% or higher growth. 

• As for the backlog itself, management commented that its level is “well beyond” historical levels due to supply constraints.

• Cisco’s product backlog at the end of the quarter was more than $14 billion, representing an increase of more than 150% YoY. Within this amount, the software backlog doubled to more than $2 billion—this backlog is not included in the RPO as discussed below. 

• Turning to Services, revenue was about flat YoY at $3.3367 billion, short of the $3.441 billion estimate.

• Total software revenue grew 6% $3.8 billion. Of this figure, 80% was sold subscription-based, which is an increase of 4 percentage points YoY. ARR, or annual recurring revenue, increased 11% YoY to $21.9 billion.

• The Remaining Performance Obligation, or RPO, ended the quarter at $30.5 billion, up from $30.1 billion in the prior quarter. The total short-term RPO, meaning this is revenue the company expects to recognize this revenue in the next twelve months, increased 8% to $16.3 billion.  

• Why do software and these stats all matter? We focus on them because these metrics help us gauge the progress of the company’s business transition from lumpy hardware sales to higher-margin, more predictable (RPO provides visibility into future revenue) software sales. 

• Broadly speaking, we consider this business model transition as a price-to-earnings multiple expansion opportunity because investors tend to put more value on companies that have visibility into stable earnings growth and can expand margins.

Boosted cash returns 

• Cisco announced tonight it has increased its quarterly dividend by one cent, or 3%, to $0.38. This puts CSCO’s dividend yield at 2.80% (up from 2.73%) based on today’s closing price.

• Management was aggressive with its repurchase program, buying back $4.8 billion worth of stock compared to $256 million worth in the prior quarter.

• The company also said its board has approved a $15 billion increase to its share repurchase program. Management now has approximately $18 billion of buyback firepower under its authorization.  

Improved guidance

• For the fiscal third quarter, Cisco expects revenue to grow 3% to 5% YoY. This implies revenue of about $13.315 billion, in line with estimates of $13.31 billion. 

• Adjusted earnings per share are expected to be $0.85 to $0.87. At a midpoint of $0.86, this is a penny shy of the $0.87 expectation, but management can be conservative at times. 

• For the full fiscal year, management now sees revenues growing 5.5% to 6.5% YoY. This is a tightened range from their previous view of 5% to 7% growth.

• On adjusted earnings, management now sees the company earning $3.41 to $3.46 per share, representing a slight improvement from their previous view of $3.38 to $3.45. The new $3.435 midpoint is higher than estimates of $3.42.

• It’s great to see management increase their outlook. After last quarter, the market was not so sure that management would be able to deliver on its full-year outlook. 

• This beat and raise quarter should give investors the confidence that management can deliver on its growth targets. 

Bottom line 

This was a very good quarter from Cisco, especially considering there had been a growing belief in the market that supply constraints and cost pressures would force the company to lower its full-year outlook. But instead, the company did a fantastic job navigating those challenges to deliver results above expectations and get back in the habit of beat and raise.

Based on the strength of the backlog and orders growth, we think this report could potentially be the start of a rally that gets shares back to its December highs of the low-$60s. The huge RPO and backlog (explained later) give us confidence that this is only the start of a multiyear growth story, and all Cisco needs is an easing of its supply constraints (hopefully in the back half of the year) to meet what one analyst on the earnings call tonight called “the best demand environment across enterprise, carrier, and web-scale” they have seen in 26 years covering the industry. 

We would be buyers of Cisco right here, and believe shares will push towards last year's high in the 60$.