Cisco Systems Inc (CSCO) — Q4 2023 Earnings Call Transcript

Welcome everyone to Cisco's fourth quarter fiscal 2023 quarterly earnings conference call. This is Marilyn Mora, Head of Investor Relations, and I am joined by Chuck Robbins, our Chair and CEO; and Scott Herren, our CFO. By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made available on our website in the Investor Relations section following the call. Income statements, full GAAP to non-GAAP reconciliation information, balance sheet, cash flow statements, and other financial information can also be found in the Financial Information section of our Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we will discuss product results in terms of revenue and geographic and customer results in terms of product orders unless stated otherwise. All comparisons made throughout this call will be done on a year-over-year basis. The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the first quarter and full year of fiscal 2024. They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically, the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter unless it is done through an explicit public disclosure. With that, I will now turn it over to Chuck.

Thanks, Marilyn, and good afternoon, everyone. Fiscal '23 was a milestone year for Cisco. We delivered on our operational and financial goals while accelerating our transformation. We achieved record revenue and earnings per share in both the fourth quarter and the full year. We also generated strong margins, record operating cash flow, and strong shareholder value, returning $10.6 billion via share repurchases and increasing cash dividends. In FY '23, we delivered nearly $57 billion in revenue, up 11% year-over-year, the highest revenue growth rate in over a decade. Overall, customer demand also remained solid. In Q4, we achieved over 30% total sequential product order growth—the second highest in 20 years—with double-digit increases across all customer markets. As we look to build on this strong performance going forward, we remain focused on the following: first, growing market share in all key areas of our business; second, driving innovation and extending our leadership by investing in significant new opportunities for growth in AI, cloud, and security; third, delivering long-term sustainable value creation for our stakeholders; and fourth, transforming our business model by growing recurring revenue. Consistent with what we said last quarter, we expect to build on our record results delivering modest revenue growth in fiscal year '24, with the bottom line growing faster than the top line, demonstrating operating leverage. Our outlook reflects good visibility and predictability, driven by healthy backlog, ARR, and RPO. We remain deeply committed to building shareholder value and increasing returns to our investors through a long-term commitment to greater operating leverage while increasing our annual share repurchases and growing our dividend. Now, let me share additional detail on the quarter and key growth opportunities ahead for Cisco. First, one of our greatest competitive advantages is our pace of innovation. This quarter, we announced new solutions spanning generative AI, hybrid work, security, full stack observability, and sustainability. In addition, we remain focused on delivering a more unified and simpler experience for our customers. As I've stated in the past, we knew that as our backlog cleared, we would see corresponding market share gains. With the release of the calendar Q1 results, we gained over three percentage points of market share year-over-year in our three largest networking markets: campus switching, wireless LAN, and SP routing. We expect further share gains in these areas as market share numbers are released for calendar Q2. Security remains a top priority. Our AI-driven security cloud platform has comprehensive capabilities across the network endpoint and the cloud, helping to simplify security management while increasing efficacy. Our new technologies like XDR, multi-cloud defense, and cloud secure access, a secure service edge solution, are seeing rapid early adoption. Overall, Cisco is committed to helping our customers navigate this transition in a trusted and responsible way to deliver on the full promise of this technology, and we are well positioned to win. To summarize, we had a phenomenal year. Our fiscal year '23 and Q4 results demonstrate the strength of our business today and are a solid foundation for future growth. We will also drive a high degree of consistency into our stock repurchase program and will maintain quarterly levels in the range that we have over the past few quarters. Finally, I want to take a moment to thank our teams who all played an important role in delivering these record full-year results and their deep commitment to our success. With our focus on innovation and our commitment to operational excellence, I have tremendous confidence in our ability to capitalize on the many opportunities ahead.

Thanks, Chuck. I'll start with a summary of our financial results for the quarter, then cover the full fiscal year, followed by our guidance. As Chuck said, we delivered another record quarter driven by focused execution, continued business transformation, and the actions we took during the year to mitigate supply issues. We reported our strongest ever revenue, non-GAAP operating margin, earnings per share, and operating cash flow in Q4. Total revenue was $15.2 billion, up 16% year-on-year at the high end of our guidance range. Non-GAAP net income was $4.7 billion, up 36%. Non-GAAP EPS was $1.14, up 37%, exceeding the high end of our guidance range. Looking at our Q4 revenue in more detail, total product revenue was $11.7 billion, up 20%. Service revenue was $3.6 billion, up 4%. We also saw double-digit growth in both campus and data center switching driven by our Catalyst 9000 and Meraki offerings. Total software revenue accelerated to $4.6 billion, an increase of 17%. 85% of our software revenue was subscription based. Total subscription revenue was $6.6 billion, an increase of 13%. Total short-term RPO grew to $17.9 billion. Total product orders were down 14% year-on-year but grew sequentially by more than 30%. Overall, we had a very strong quarter and fiscal year with record results. We executed well, delivering double-digit top-line growth, profitability, and cash flow. We continue to make progress on our business model shift to more recurring revenue while making strategic investments in innovation to capitalize on our significant growth opportunities.

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

Hi. Thank you. Yeah, Chuck, maybe we'll start with kind of the order backlog performance. Sounds a lot better than seasonal in Q4. Could you talk a little bit about what you attribute that to and then maybe looking into next year, doesn't look like you're baking a lot of that into either Q1 or the full year. So what's kind of the expectation for the pull-through of those orders into what you're going to see in revenues in fiscal '24? Thank you.

Thanks, Tim. So I'll provide some color, and Scott, maybe you can talk about the conversion of the orders. Look, first of all, we're obviously dealing in a world that has a lot of dynamics right now, but our teams executed incredibly well. As I've said on prior calls, with our sales organization, when you see transitions in customer buying, our teams will forecast a quarter and then by the end of the quarter, they would have dropped and/or missed. And then when it's beginning to stabilize and get better, they tend to exceed the forecast. And so what we saw in Q4 was they had their opening forecast. They nailed month one, they nailed month two, and they exceeded month three by several hundred million dollars. So it was one of those quarters that they actually over-performed what they thought they would do at the beginning of the quarter, which is a positive sign. But again, it's one quarter. We also had the largest quarter in our history of enterprise software agreements from an orders perspective, which was a positive thing. If you think about what was going on around the world, I'd say service provider continued to be weak. Enterprise improved, commercial improved. US enterprise was basically flat, which is better than we had been experiencing for sure, which is a good sign. Public sector remains steady. And verticals, we saw strength in financial services, transportation, and energy. And we saw some good strength in countries like India and Saudi around the world.

Yes. As we think about fiscal '24, we've got pretty good visibility driven by the business model shift that we've talked about. So a couple of data points that I think you already have, Tim. One is current RPO of $17.9 billion. So total RPO approaching $35 billion, of which $17.9 billion is current, meaning it turns into revenue in the next 12 months. We ended the year as we expected with roughly double our normal backlog levels. But that excess backlog will work down in the first half of fiscal '24 with the majority of that being worked off in Q1. We also have $24.3 billion of ARR that we get a chance to renew. So we entered the year with around 40% of that top line pretty much already in hand between those three categories. So feel good about the way we see the year laying out.

Yes. If I could add one more point, Tim. Regarding the sequential numbers, we mentioned that the year-over-year comparisons are challenging and don't clearly represent the situation. We have been focusing on sequential comparisons quite a bit. I noted in my opening remarks that the sequential growth from Q3 to Q4 exceeded 30%. To give you some context, the usual range is around 18% to 20%. Looking at customer segments, the enterprise sector was significantly above that, the public sector was also well above it, the commercial segment was fairly close, and the service provider segment was on the lower end. Nevertheless, it still remained above historical trends on a sequential basis.

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

Thanks a lot for taking my question. Congrats on a nice set of numbers here. I guess, maybe two things I'd love to get your perspective on. Chuck, when you talk about consistency in capital allocation, can you just expand a bit more on what this means? Are you going to think about this as a percent of free cash flow that you're going to go for buybacks or some other metric? Can you just talk about what this means? And how do you intend to deploy the capital allocation would be helpful. And then perhaps somewhat related to that, I guess, when we think about the fiscal '24 revenue guide that you folks are providing, 7% growth in Q1, I think, 1% for the full year. That sort of would imply back half will decline. So what are you assuming in the back half that gives you that kind of worry that would be helpful? Thank you.

I want to make a couple of comments before passing it over to Scott for further discussion. Regarding capital allocation and leverage, we've engaged extensively with our shareholders recently. It's become clear that they expect us to commit to and achieve operating leverage in our profit and loss statements, and while we've been making progress, we haven't made a long-term commitment to it until now. Today, we are declaring our intention to consistently provide operating leverage in our P&L moving forward. On buybacks, our goal has been to increase the buyback amount while also providing more consistency and predictability for our shareholders. The rate we've maintained over the last three quarters will serve as our target for quarterly buybacks in the future.

Yes, Amit, I think you were one of those voices that talked about capital allocation consistency at a higher level, and also being consistent. You've seen us do it already. The difference is we're verbalizing it in advance now, I guess. And on your revenue guide question, I think it's easy to get a little confused by the year-on-year growth rates when we've had the supply constraints that we've had over the last few years. The reality is some of the revenue that we ended up posting this year are orders that we took and customers wanted the product back in fiscal '22. We just couldn't get it out. So the better way to think about this is what's been the compound annual growth rate from when we started building that backlog through the end of our fiscal '24. If you do the compound annual growth rate on revenue through that time, it's right around 5%, which is in line with what we see as our opportunity longer term.

Great. Thanks, Amit. Next question.

Great. Thanks. Fantastic kind of data points around the traction with the hyperscalers. When it comes to kind of the $0.5 billion of orders you noted or even kind of the 800-gig trials. Is that with Scheduled Fabric? Is that with Silicon One? Just kind of trying to get a sense of what piece of the portfolio that is. And then just on the Security portfolio, clearly, you're rolling out a lot of new products, changing some of the sales approaches. Just when do you think we could see an inflection in that business? Thanks.

Yes, Meta, thank you. So on the Ethernet underneath the AI GPU networks, it is Silicon One for sure. For the next 12 months or so, I think we'll be doing trials. I think we'll have some opportunities, but there'll still be a lot of InfiniBand. That's why we joined as a founding member of this Ultra Ethernet coalition to guide the standards and deliver Scheduled Fabric effectively. On the Security front, yes, we've had some early traction. I mentioned Goldman in the multi-cloud defense, which is a great sign of confidence in that solution. We've taken some of our largest security orders ever, so there's some early green shoots. The early feedback from analysts and customers is positive, but we need to deliver on it. Hopefully, in the second half of this year, we'll see some real positive impact and then in '25 for sure.

Next question, please.

Hey, good afternoon. Thanks for the question. I just have two. First, it was encouraging to hear about the share gains on campus switching, SP routing, and wireless as well as the expectation to continue to grow share. I was just wondering if you could talk a little bit about the sales execution, the product roadmap there that gives you the most confidence in that continued share growth. And then second, I was just wondering if you could talk a little bit about your expectations as it relates to the trajectory of orders going forward. It sounds like if the backlog kind of gets back to normal levels in the first quarter, you should just grow along with revenue growth as we think about order growth beyond the first quarter, but just would love your thoughts there. Thank you.

Thanks, Michael. On the share gains in the enterprise networking space, we expect Q2 to be equal to or maybe slightly above the incremental gains that we see when those numbers come out based on some estimates that we have done internally. The thing that is really helping beyond great products is that we have begun to deliver monitoring and subsequent management of our Catalyst portfolio with the Meraki dashboard. This has been well received and has driven significant improvement in our renewal rates on the software side. I've been asked for a few years when we thought the software renewals in the enterprise networking space would be meaningful, and FY '24 is the first year we think it will be meaningful. We expect this year to renew enterprise networking software at close to $1 billion.

Trajectory of orders. Michael, thanks for that question. If you remember our commentary from the last call, we said there were three things going on inside product orders: 1) the lead times were normalizing, going from lengthy to returning to a normal level; 2) backlog; and 3) whatever is happening in the macro. We think those first two will normalize in the first half of fiscal '24. Lead times will finish being normalized by the end of the first half, and excess backlog will ship out during the first quarter. I expect to see more normal ordering patterns in the second half of the year.

All right. Thank you. Let's go ahead and take the next question.

Thanks, guys. High energy, I like this. Chuck, maybe you could look at RPO. Very strong performance there, especially when you look at the same metric a year ago. Maybe you can unpack this a little bit in the context of a few metrics, meaning duration of contracts customers are willing to go into now, size of deals that are willing to move into now. I'm just trying to get a little bit into the elements of this significant increase in RPO. Appreciate it.

Yes, thanks, Ittai. We have transitioned our entire enterprise networking portfolio to a subscription model, which has contributed to our $35 billion in RPO. It's important to note that a portion of each order in our core networking portfolio contributes to RPO and isn't reported as revenue, which affects our market share. In Q4, we witnessed strong customer demand, with a notable amount of enterprise networking moving into RPO. Scott, do you have any comments on this?

Yes, you asked about duration. There's not much change in duration overall, Ittai. Q4 typically sees more large multiyear transactions. We have net RPO growth this year of $3.3 billion, with product having a net growth of $1.7 billion.

Move to the next question.

Hey, thank you for taking the question. Two-parter, if I could. First, as we think about fiscal '24, so you're forecasting 1% top line growth and about 4% non-GAAP EPS growth with a fairly strong exit rate on gross margin. So is it fair to assume the lift from gross margins may get offset somewhat by some OpEx reinvestment? Just trying to think about the puts and takes there. And then broadly, at the Analyst Day a couple of years ago, I think, Scott, you laid out a 5% to 7% target for both top and bottom line. I'm just wondering if that's evolved at all in light of the greater emphasis on operating leverage that you're talking about today. Thanks.

Yes. Matt, on your first question, I think gross margin settling, you saw our guidance for Q1 of gross margins in the 65% to 66% range. It drops down to a mid-single-digit OpEx growth number, in line with expectations given the environment of merit increases. The long-term model, look, that was opportunity-based. If you look backward, we have delivered the bottom line growing faster than the top line. The only difference you hear from us now is that we're articulating it in advance instead of once it's happened.

All right. Thanks, Matt. Michelle, let's take the next question.

Hi, everyone. I appreciate the question. Moving on to the go-to-market strategy, it seems you are considering shifting from specialist sales teams to a more cross-selling and portfolio-based approach. Are you undergoing a significant sales restructuring at this time? Can you enhance how you package solutions across various segments, particularly in the struggling growth segments, as mentioned earlier by Meta, such as security? Finally, regarding capital return, while I know the technology aspect often comes up, you have discussed strategic potential. How do you view the balance between pursuing further acquisitions in the key growth segments you identified and possibly spinning off some of those segments, similar to what other large companies are starting to do?

Thanks, Jim. That was a lot. Let me tell you a little bit of the history on the specialist model. We've moved to more of a platform approach across the portfolio, allowing for us to optimize the security specialist or actually align them more effectively. This platform strategy simplifies the selling cycle and has been well received. It's been a key driver for significant improvement in our renewal rates on the software side. We've seen a strong order growth in collaboration, and this past quarter, we had positive order growth in Security as well.

On the capital return question, Jim, I'd reiterate what I said earlier. With the consistency of buybacks now running right around $1.25 billion per quarter, we've been consistent with our dividends for the last 12 years. I would say on the M&A and spin-off part of that, we're constantly evaluating what's available in the market while also evaluating the value in our own portfolio.

All right. Next question please.

Hey, guys, thanks for the question. I wanted to double-click on an earlier question regarding hyperscalers, the $500 million in AI orders you had a briefing in June. I was wondering, have things picked up in terms of activity there? It seems like maybe it has. And I wanted to see if there's further traction that you could articulate in Silicon One. Like what kind of activity are you seeing there? And how big a business can this be?

Yes. Well, Ben, welcome and thank you for the question. We have definitely seen traction in this space, lots of discussions, lots of architectural discussions, and input from those customers on what they'd like to see in the next generation of silicon. This opportunity in AI is expected to be three to four times the opportunity size of the original cloud build-out. We are super well positioned as we go through this AI transition, and we've been working on unique silicon for our customers. We now are installed in 21 use cases across the top six providers and we expect that this momentum will continue over the next few years.

Thank you, Ben. We'll take the next question.

Yes, hi. I have one kind of big-picture question and one more specific. Maybe I'll start with the specific question. If I look at the 400-gig Ethernet market share, cloud, if I take Arista and White Boxes, it's like over 90% of the market, Cisco doesn't have much of a 400-gig market share by the data. But you're talking about growing market share in 800 gig. Can you talk about the dynamics of 400? And then why was it this way in 400 and how it changes in 800 in your expectations? Second is about the big picture. Product revenues last year were $38 billion. Product revenues this year is $43 billion. So that's $5 billion increase. The decline in backlog is about $5 billion. Your implied guidance for next year for product revenues is roughly flat plus. So without the support of backlog, how do you get to product revenues? What are the other parts that could support product revenues that compensate for the fact that backlog is going to normalize by the end of next quarter or next two quarters, maybe? Thanks.

Yes, Tal, thank you for that. On the 400 gig to 800 gig, I don't know that I've seen exact reports that you're referencing, but our teams have had great success in the volume of ports that we're shipping on 400 gig. We've been rebuilding our presence in this space. On the 800 gig, we're engaged and installed. We have trust with these customers, and we are just in the game at the right time. I think from now on, it gives us an opportunity to be involved from the beginning. That also drives our expectations around revenue growth.

Tal, to your question on the math you're trying to do on product revenue, consider that some of the product revenue we delivered this year was actually demand from the prior year that we simply couldn't get out the door due to supply constraints. Our enterprise networking products continue to show traction and we are invested early in the AI space. We expect to capitalize on significant growth opportunities in the coming years.

All right. Thanks, Tal. Next question.

Hi, thanks. This is Joe Cardoso on for Samik. Just one question for me. You mentioned double-digit growth across all your customer verticals from an order perspective but also mentioned service provider continuing to be weak. I was just hoping you could touch on what you're seeing under the hood in service provider, specifically if I split it up between telco AI and non-AI cloud, how did those track compared to 90 days ago? And then just quickly, a clarification on the $0.5 billion in orders in AI. Any way you can parse it out, like how many customers are reflected in that order number? And then just quickly clarify if that's all hyperscale or if there's any Tier 2 cloud or enterprise customers in that mix. Thanks for the question.

Yes. On the service provider side, I think Q4 for the telco side was probably fairly consistent with the quarter before. It remained relatively weak. Communications service providers have been digesting a lot of the infrastructure they bought. Our team believes that orders will stabilize on the telco side in the second half of our fiscal year. The $500 million is definitely in the Tier 1 hyperscalers. We won three use cases last quarter, and we're in trials with most all of them for AI fabric orders.

All right. Thank you. Next question.

Great. Thanks, guys for squeezing me. I'm not going to belabor the point on orders, but I wanted to ask a question about AI orders specifically in terms of your ability to ship to customers and where you are in trials. The reason why I ask is we've heard from many companies that there are supply chain considerations causing commercial deployments and revenue recognition to be pushed out to 2025. So I want to get a sense for that $500 million you referenced, how does that flow through? And in the guidance Scott provided for fiscal '24, how much, if any, is AI-related this year? If not, why? And when do we start to see it in your P&L?

We do not know of any supply chain issues we have around AI. Our standard Ethernet portfolio based on Silicon One ASIC is what we are delivering today. As for the FY '24 contribution of AI, I don't have that information on top of my head.

Those orders are not all coming in the last quarter. They are orders we know are going into AI infrastructure. What you should expect is to see it show up in P&L late in the second half of this year. We expect customers to begin placing orders again for product delivery in the second half.

All right. Thanks, David. We have time for one last question.

Thanks for taking the question. I wanted to see if you could talk about your assumptions for your campus-related business, including both switching and wireless LAN. I assume that's roughly almost $15 billion of trailing four-quarter sales. And I've seen market research saying that business declines, some saying it's growing. Chuck, you highlighted that $1 billion renewal. Just trying to get my head around how material that is. What's built into the full year forecast for campus? Thank you.

I'll make two comments. First of all, we think that as you see Q2 calendar year share numbers come out, you'll continue to see us gain share in that space. The renewal number that I threw out was close to $1 billion, which is a subset of our fiscal '24 guide.

All right. So we'll go ahead and turn it over to you, Chuck, for some closing remarks.

Thanks, Marilyn. First of all, I want to thank our teams and just say how proud I am of the work that's gone into the last couple of years to deliver the record results that we did. We're incredibly proud of the share gains that we expected to gain and we are. I'm proud of the team and the new innovation that's being delivered in areas like AI and security. With our focus on innovation and our commitment to operational excellence, I have tremendous confidence in our ability to capitalize on the many opportunities ahead.

Thanks, Chuck. I'll go ahead and wrap this up. Cisco's next quarterly earnings conference call will be on Wednesday, November 15th, 2023 at 1:30 P.M. Pacific Time, 4:30 P.M. Eastern Time. This concludes today's call.