Cisco Systems, Inc. (NASDAQ:CSCO) Q4 2023 Earnings Call Transcript

Cisco Systems, Inc. (NASDAQ:CSCO) Q4 2023 Earnings Call Transcript August 16, 2023

Operator: Welcome to Cisco’s Fourth Quarter and Fiscal Year 2023 Financial Results Conference Call. At the request of Cisco, today’s conference is being recorded. If you have any objections, you may disconnect. Now I would like to turn the call over to Marilyn Mora, Head of Investor Relations. Ma’am, you may begin.

Marilyn Mora: 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.

Chuck Robbins: 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. We will do this 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. Second, the acceleration of AI will fundamentally change our world and create new growth drivers for us. While AI has been an important element in our products for several years, this quarter we announced new market leading AI technologies across our collaboration and security portfolios designed to boost productivity, enhance policy management and simplify tasks. We also launched new AI scale infrastructure innovation to allow our customers to process AI workloads more efficiently.

Cisco’s ASIC design and scalable fabric for AI position us very well to build out the infrastructure that Hyperscalers and others need to build AI/ML clusters. This is a huge opportunity for Cisco and we are laser focused on leading and winning in this space. As a result of our innovation in this area, we expect Ethernet will lead in connecting AI workloads over the next five years. To accelerate this transition, Cisco became a founding member of the Ultra Ethernet Consortium, an industry wide effort to drive open large scale Ethernet based fabrics for high performance networking. In June, we launched our next generation Silicon One switching ASICs to support large scale GPU clusters for AI and ML workloads. We are seeing early success in Hyperscale Ethernet AI fabric deployments.

To-date, we have taken orders for over $0.5 billion for AI Ethernet fabrics. We are also piloting 800 gig capabilities for AI training fabrics. 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. Next, 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. For example, Goldman Sachs has been one of our early adopters of our multi-cloud defense solution.

In addition, we are working with Apple to incorporate Cisco’s secure access solution into iOS and macOS. These innovations, combined with our recent acquisitions, show how we are extending our security portfolio with deep telemetry AI and identity threat capabilities. Given our installed base of 300,000 Cisco security customers, we believe we have the opportunity to accelerate revenue growth in security over the next few quarters. 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. I also want to be very clear on our commitment to increasing shareholder returns through capital return, innovation and strong execution. Last quarter, we committed to operating leverage in Q4 and fiscal year ’24 and our guidance today reflects this.

Today, I want to confirm that this will be our long-term strategy beyond fiscal year ’24. We will also drive a high degree of consistency into our stock repurchase program and will maintain the 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 — to the success of our customers and partners. 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. I’ll now turn it over to Scott.

Scott Herren: 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%. Within product revenue, Secure Agile Networks, our largest product category was very strong, up 33%. Switching revenue had double-digit growth with strength in both campus and data center switching driven by our Catalyst 9000 Nexus 9000 and Meraki offerings. Enterprise routing declined, driven primarily by Access, partially offset by strength in our Catalyst 8000 Series SD-WAN and IoT Routing. Wireless had double-digit growth driven by our Wi-Fi 6 products and Meraki wireless offerings. Internet for the Future was up 3%, driven by growth in our core routing products, including strong growth in our Cisco 8000 offering. We also saw double-digit growth in web scale. Collaboration was down 12%, driven by declines in collaboration devices and meetings partially offset by growth in cloud calling and cloud contact center.

End-to-End security was flat with growth in our Zero Trust offerings offset by a decline in our network security offerings and optimized application experiences was up 15%, driven by growth across the portfolio, including double-digit growth in ThousandEyes and AppDynamics. We continue to make progress on the transformation of our business to more recurring revenue based offerings driven by higher levels of software and subscriptions. We saw solid performance in our ARR of 24.3 billion, which increased 5% with product ARR growth of 10%. Total software revenue accelerated to $4.6 billion, an increase of 17% with software subscription revenue up 20%. 85% of our software revenue was subscription based. Total subscription revenue was 6.6 billion, an increase of 13%.

And RPO was 34.9 billion, up double-digits at 11%. Both product and service RPO had strong growth with product RPO up 12% and service RPO up 9%. 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%. This was against a strong performance in the year ago quarter, where we delivered the second highest orders in absolute dollars in the history of the company. The aging of our backlog has continued to improve as the supply situation normalizes and as expected, increased customer deliveries reduced our year-end backlog to roughly double historical levels as we enter fiscal ’24. Order cancellation rates remain below pre-pandemic levels, which reflects the true demand and criticality of our technologies to our customers.

Total non-GAAP gross margin came in at 65.9%, exceeding the high end of our guidance range and up 260 basis points. Product gross margin was 65.5%, up 420 basis points. The increase was primarily driven by positive pricing and product mix, as we realized the benefits from the actions we took in the prior fiscal year. We also drove productivity improvements with lower freight and logistics component and other costs. Services gross margin was. 67.5%, down 150 basis points year-over-year. Non-GAAP operating margin came in at 35.4%, exceeding the high end of our guidance range and up 300 basis points. This improved leverage was driven by both our strong non-GAAP gross margin and ongoing cost management. Shifting to the balance sheet. We ended Q4 with total cash, cash equivalents and investments of 26.1 billion.

We had record operating cash flow for the quarter of 6 billion, up 62%, driven primarily by strong top line performance and the deferral of our Q4 federal tax payment. Consistent with our prior commentary, the IRS tax relief related to the California floods postponed our current year federal income tax payment until Q1 of our fiscal ’24. Consequently, in Q1 of fiscal ’24, our federal income tax related cash outflows will include an incremental 2.8 billion of payments for these prior quarters. This quarter, we returned 2.8 billion to shareholders comprised of 1.6 billion for our quarterly cash dividend and 1.3 billion of share repurchases. Consistent with our capital allocation strategy that we outlined last quarter, we are committed to increasing shareholder returns through a greater operating leverage while increasing our annual share repurchases and growing our dividend.

Turning to the full fiscal year, we delivered record results in revenue, net income earnings per share and operating cash flow. Revenue for the year was 57 billion up 11% and non-GAAP earnings per share was $3.89, up 16%, demonstrating again the operating leverage that we’ve been driving. In terms of our software metrics, total software revenue for the full year was up 12% at 17 billion, with the product portion up 14%. 84% of software revenue was subscription based, which is up two percentage points. Total subscription revenue was 24.6 billion, an increase of 10%. Total non-GAAP gross margin was 64.5%, down ten basis points. On the bottom line, non-GAAP net income was 16 billion, up 13%. We delivered record operating cash flow of 19.9 billion, up 50% compared to fiscal ’22, driven primarily by strong results, linearity, collections and the federal tax deferral as noted previously.

We returned 10.6 billion in value to our shareholders via cash dividends and stock repurchases. This is comprised of 6.3 billion in quarterly cash dividends and 4.3 billion of share repurchases. We increased our dividend for the 12th consecutive year in fiscal 2023, reinforcing our confidence in the strength and stability of our ongoing cash flows. We continue to invest organically and inorganically in our innovation pipeline during Q4. We closed the acquisitions of Lightspin Technologies, Smartlook and Armorblox. These investments are consistent with our strategy of complementing our internal innovation and R&D with targeted strategic M&A. To summarize, 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. Turning now to our guidance. For fiscal Q1, our guidance is, we expect revenue to be in the range of 14.5 billion to 14.7 billion. We anticipate the non-GAAP gross margin to be in the range of 65% to 66%. Our non-GAAP operating margin is expected to be in the range of 34% to 35% and non-GAAP earnings per share is expected to range from $1.02 to $1.04. For fiscal year ’24, our guidance is as follows. We expect revenue to be in the range of 57 billion to 58.2 billion. Non-GAAP earnings per share is expected to range from $4.01 to $4.08. In both our Q1 and full year guidance we’re assuming a non-GAAP effective tax rate of 19%.

I’ll now turn it back to Marilyn so we can move into the Q&A.

Marilyn Mora: Thanks, Scott. Michelle, let’s go ahead and queue up for questions.

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Q&A Session

Operator: Thank you. Tim Long with Barclays. You may go ahead. Tim?

Tim Long: 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 kind of the pull through of those orders into what you’re going to see in revenues in fiscal ’24? Thank you.

Chuck Robbins: 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 sort of customer buying, if it’s getting worse, what we see is that 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 actually 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. So we had a lot of big customers making big commitments, which was a positive thing. If you think about what was going on around the world, I’d say service provider just continued to be weak. Enterprise improved, commercial improved. US enterprise was basically flat. So that was 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. So it’s one quarter, but if you compare it to the prior few quarters where the teams had opening forecast that they generally missed by the time we got to the end of the quarter, this was one where I’d say that it was much more stable as we went through the quarter. Scott, do you want to talk about the order conversion?

Scott Herren: Yes. As we think about fiscal ’24, we’ve got pretty good visibility driven by really 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, by the way. And we’ve got $24.3 billion of ARR that we get a chance to renew. Now obviously, some of that will already be captured in RPO, but there’s opportunity that’s not already captured in RPO as well. So we entered the year with round numbers, 40% of that top line pretty much already in hand between those three categories. So feel good about the way we’ve — the way we see the year laying out.