Cisco Systems Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 15, 2023

There are 12 speakers on the call.

Operator

Welcome to Cisco's First Quarter Fiscal Year 20 24 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.

Speaker 1

Welcome everyone to Cisco's Q1 fiscal year 'twenty four quarterly conference call. This is Sami Badri, Cisco's new Head of Investor Relations, and I'm joined by Chuck Robbins, our Chair and CEO and Scott Herron, our CFO. Having followed Cisco on the sell side for 10 years, I couldn't be more excited to join the company and look forward to engaging with you all in my new role. By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be available on our website in the Investor Relations in the following 5 categories: networking, security, collaboration, observability and services.

Speaker 1

And we are reporting customer markets in the following 3 categories: Enterprise, Public Sector and Service Provider and Cloud. Also as is customary in Q1, we have made certain reclassifications to prior period amounts Conform to the current period's presentation. Income statements, full GAAP to non GAAP reconciliation information, balance sheets, 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 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 on a year over year basis.

Speaker 1

The matters we will be discussing today include forward looking statements, including the guidance we will be providing for the Q2 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 report on Form 10 ks, 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. I'll now turn it over to Chuck.

Speaker 2

Thanks, Sami, and welcome to Cisco. I hope everyone is doing well and thanks for joining us today. We delivered a solid start to fiscal 2024 with the strongest first quarter results in Cisco's history in terms of revenue and profitability. Our Q1 revenue was at the upper end of our guided range. EPS exceeded the high end of our guidance driven by strength in gross margins and expense control, resulting in strong operating leverage.

Speaker 2

Our disciplined expense management and the tailwinds from our business model transformation resulted in our highest non GAAP gross margin in over 17 years and record non GAAP operating margin. We also returned $2,800,000,000 in Q1 via cash dividends and share repurchases delivering on our capital return commitments to our shareholders. As we continue to transform our business towards more software and recurring revenue streams fueled by accelerated innovation. We remain committed to driving operating leverage and shareholder returns. Now turning to the demand environment.

Speaker 2

After 3 quarters of exceptionally strong product delivery, our customers are now focused on installing and implementing these unprecedented levels of products. The bottleneck that we previously saw in the supply chain has now shifted downstream to implementation by our customers and partners. Our order lead times and backlog have largely returned to normal levels. As deliveries rose, the channel inventory we track at our distributors also Steadily declined during this time. Simply put, customers are now taking time to onboard and deploy these heightened product deliveries.

Speaker 2

While the macro challenges we have discussed still exist, we believe this implementation phase is the primary reason for the slowdown in new orders. We saw it mostly with our larger enterprise, service provider and cloud customers and it was most pronounced in October. Based on our analysis, we believe this phase is temporary and estimate there is an additional 1 to 2 quarters' worth of shipped orders and customers' hands still waiting to be deployed. This has near term consequences for revenue and our outlook for the next couple of quarters, which Scott will discuss shortly. However, it does not change our longer term confidence.

Speaker 2

We expect product order growth rates to increase in the second half of the fiscal year. We also remain very confident in the foundational strength of our business and future growth opportunities given the criticality of our technologies. Overall, our win rates are stable, cancellation and return rates remain below pre pandemic levels, and we have gained market share, all of which are testaments to the strength of our portfolio and how it aligns to our customers' most pressing needs. As we look to enhance our capabilities in higher growth areas, In the Q1 of fiscal 'twenty four, we announced our intent to acquire Splunk. The combination of Cisco and Splunk will create an end to end data platform to enhance our customers' digital resiliency with our complementary capabilities in AI, security and observability.

Speaker 2

The combination of Cisco and Splunk also directly supports our strategic objectives around driving higher levels of growth, software capabilities and ARR. Together, we will bring trusted innovation leadership and outstanding go to market engine and a world class culture that will help our customers achieve their technology outcomes with innovative products and solutions. Now let me comment on our quarterly performance. As I previously mentioned, we delivered Strong revenues in Q1, which was broad based across our product portfolio and driven by our customers' investments in generative AI, cloud, security and full stack observability. As expected, we continue to gain market share with the release of the calendar Q2 results, recording another quarter of year over year gains in 3 of our largest networking markets, Campus switching, wireless LAN and SP routing.

Speaker 2

In web scale, we see continued momentum in AI with 3 of the top 4 customers deploying our hyper We also already have line of sight to over $1,000,000,000 in orders for AI infrastructure from major cloud providers in fiscal year 2025. To help advance AI, we are working with key GPU and storage partners to create solutions including Ethernet technologies, GPU enabled infrastructure and joint tested and validated reference architectures with a commitment to open networking for AI. Collectively, we believe there is a great opportunity for a broad set of innovations in compute, GPU networking software and services to support core and edge AI infrastructure. According to the 650 Group, The AI switching market is forecasted to exceed $10,000,000,000 in 2027. Our scalable fabric for AI, Coupled with the proven power saving capabilities of Cisco Silicon 1 put us in a strong position to build out the infrastructure needed for AI clusters and we are laser focused on winning in this space.

Speaker 2

Moving to security. We continue to execute against our Roadmap and strengthen our unified security platform. Since our Cisco XDR solution became available this summer, we have added recovery to the response process, giving security teams the ability to snapshot and restore their business critical data at the first sign of a ransomware attack. With our 3 new offers around XDR, Cisco Secure Access and Multi Cloud Defense, we already have over $500,000,000 in the pipeline across over 1,000 customers. We also launched our new Cisco security firewall solution this quarter.

Speaker 2

We are actively engaged in competitive sales with all these products and and expect to see meaningful positive results in the coming quarters. In our collaboration portfolio, we recently introduced a range of truly game changing AI capabilities spanning the entire Webex suite as well as new devices for reimagine workspaces at our WebexOne event. Before I turn it over to Scott, let me briefly summarize 3 key takeaways. First, as we consider where we're at today, the primary issue with demand is that customers are Taking time to onboard and deploy heightened product deliveries. While we are not immune to the macro, we believe this is temporary as our customers and partners With the incremental multibillion dollar AI infrastructure opportunity, the increasing criticality of security and observability and what we believe Cisco and Splunk can do together for our customers is truly exciting.

Speaker 2

Lastly, you can always count on us to take a disciplined approach regardless of the environment. We remain committed to operating leverage, capital allocation and expense management. I'll now turn it over to Scott to provide more detail on

Speaker 3

the quarter and our outlook. Thanks, Chuck. We delivered solid results in Q1, driven by the prior strategic actions we took to mitigate the supply chain constraints. For the quarter, we reported strong revenue growth and a record non GAAP operating margin. Total revenue was $14,700,000,000 up 8% year over year at the high end of our guidance range.

Speaker 3

Non GAAP net income was $4,500,000,000 up 28 percent And non GAAP EPS was $1.11 up 29%, exceeding the high end of our guidance range. Looking at our Q1 revenue in more detail, total product revenue was $11,100,000,000 up 9% and service revenue was $3,500,000,000 up 4%. Networking, our largest product category, drove the increase with 10% growth. Within networking, the growth was driven by switching where campus and data center We're both up double digits on the strength of our Catalyst 9,000 and NEXUS 9,000 offerings. This was partially offset by a decline in wireless.

Speaker 3

Security was up 4%, driven by our 0 Trust and Threat Intelligence, Detection and Response offerings. Collaboration was up 3%, driven by growth in calling and contact center, partially offset by a decline in meetings. Observability was up 21%, driven by growth across the portfolio, including double digit growth in ThousandEyes and AppDynamics. We continue to make progress in our transformation to more recurring revenue based offerings and saw solid performance in our ARR of $24,500,000,000 which increased 5% with product ARR growth of 10%. Total software revenue was $4,400,000,000 a 13% increase with software subscription revenue also up 13%.

Speaker 3

85% of our software revenue was subscription based. Total subscription revenue increased 10% to $6,500,000,000 which represents 44% of Cisco's total revenue, An increase of 1 percentage point over last year. RPO was $34,800,000,000 up 12% year over year. Product RPO increased 14% and service RPO increased 11%. And total short term RPO was up 8% to 17,600,000,000 Looking at our product orders by geographic segment year over year, overall product orders declined 20% with the Americas down 19%, EMEA down 13% and APJC down 38%.

Speaker 3

In our customer markets, service provider and cloud was down 38%, Enterprise was down 26% and Public Sector was up slightly at 2%. Total non GAAP gross margin came in at 67.1%, up 410 basis points year over year and 110 basis points above the high end of our guidance range. Product gross margin was 66.5%, up 5.50 basis points. The increase was driven primarily by productivity improvements with lower freight, logistics and component costs. Favorable mix and positive pricing also contributed to the year over year improvement.

Speaker 3

Services non GAAP gross margin was 69%, up slightly. Our non GAAP operating margin came in at 36.6%, up 480 basis points and exceeding the high end of our guidance range. This improved leverage was driven by both our strong non GAAP gross margin and ongoing disciplined cost management. Shifting to the balance sheet. We ended Q1 with total cash, cash equivalents and investments of $23,500,000,000 We had operating cash flow for the quarter of $2,400,000,000 down 40% primarily due to the $2,800,000,000 tax payment related to prior quarters, which was associated with the IRS tax relief due to the California floods.

Speaker 3

This quarter, we returned $2,800,000,000 to shareholders, comprised of $1,600,000,000 for our quarterly cash dividend and $1,300,000,000 of share repurchases. Consistent with our cap allocation strategy, we are committed to increasing shareholder returns through greater operating leverage, Maintaining a higher level of annual share repurchases and growing our dividend. We continue to invest organically and inorganically in our innovation pipeline. During Q1, we announced our intent to acquire Splunk, which we expect to close by the end of Q3 of calendar year 2024, subject to regulatory approvals and customary closing conditions, including approval by Splunk shareholders. In Q1, we also closed several acquisitions, all of which are highly complementary to our internal R and D and line with our strategy to strengthen our position in cloud, Security, observability and AI with targeted strategic M and A.

Speaker 3

To summarize, we delivered a solid quarter, highlighted by top line growth and increased operating leverage that resulted in stronger than anticipated earnings per share. We We continue to make progress in our business model shift to more recurring revenue. We remain focused on disciplined expense management without losing sight of the strategic investments necessary to innovate and capitalize on growth opportunities. Turning to our financial guidance. As Chuck outlined, the bottleneck that we previously saw in the Supply chain has now shifted downstream to implementation by our customers and partners.

Speaker 3

Most of the supply chain constraints are now behind us and both Shipment lead times and backlog have largely returned to normal levels. Q1 product orders declined 20% as our largest Customers are implementing elevated levels of product shipments from prior quarters as we delivered orders from our historically high backlog levels. As Chuck mentioned, we believe there are 1 to 2 quarters worth of shipped orders awaiting implementation by our customers. Our Our revenue guidance assumes 1 to 2 quarters of lower revenue and then a return to more typical sequential growth rates. Consequently, for Q2, we expect revenue to be in the range of $12,600,000,000 to $12,800,000,000 We anticipate the non GAAP gross margin to be in the range of 5% to 66%.

Speaker 3

Non GAAP operating margin is expected to be in the range of 31.5% to 32.5% and non GAAP earnings per share is expected to range from $0.82 to $0.84 For fiscal year 2024, our guidance is updated as follows. We expect revenue to be in the range of $53,800,000,000 to $55,000,000,000 Non GAAP earnings per share is expected to be in the range of $3.87 to $3.93 In both our Q2 and full year guidance, we're assuming a non GAAP effective tax rate of 19%. I'd like to thank our teams for their focus and execution this quarter. We remain confident in the strength of the business and our ability to capitalize on the key growth opportunities ahead. I'll now turn it back to Sami, so we can move into the Q and A.

Speaker 1

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

Operator

Thank you. Tal Liani with Bank of America. You may go ahead, sir.

Speaker 3

Al, are you there?

Speaker 1

Yes. Sorry, I was

Speaker 4

on mute. Now you can hear me.

Speaker 1

Yes.

Speaker 4

What is your assumption on the growth seasonality after the next quarter? Are we back in your assumptions To normal seasonality or do you expect kind of different seasonality than previous years?

Speaker 3

Yes, Tal. It's a great question. As I said in the when we talked about 1 to 2 quarters of Basically inventory, but shipped product that's at our customers that's not yet been installed. I expect the impact to be greatest in Q2 and in Q3. But When you look at order growth, we do see a return to order growth in the second half of the year, both sequentially and year on year as we get there.

Speaker 4

So in terms of revenue recognition, you expect 3Q to the 2Q to 3Q sequentials? That was my question. Do you expect 3Q to be weaker than previous seasonality or do you expect it to be the same as previous seasonality?

Speaker 3

No. From a revenue standpoint, we don't guide bookings, Tal. But from a revenue standpoint, I do see sequential increase Q2 to Q3.

Speaker 4

Okay. Thank you. All right.

Speaker 1

Thank you, Tal. Michelle, next question.

Operator

Meta Marshall with Morgan Stanley Investment Research. You may go ahead.

Speaker 5

Great. Thanks so much. Maybe just a question on, if you see the investment categories kind of changing Maybe pre, the orders that you've seen and then when you see them come back in a couple of quarters. I guess I'm just trying to get a sense of Have much of the orders we've seen over the last year been catch up investments like campus and data center And then areas of investment will change as we come back? Or is this really just inventory digestion and the investment categories and kind of investment Prioritization will stay the same with customers.

Speaker 5

Thanks.

Speaker 2

Yes, Meta, thanks for the question. I think your latter comment is probably the Closest to the truth, we don't anticipate a big difference. Although, I think with the improvements that we've seen in our portfolio in security, we should see security accelerate. Obviously, we'll continue to update you on the AI opportunity that's out there. We think that's going to continue to be a driver over the next couple of years.

Speaker 2

But in general, I think it'll look more normal once we get through this.

Speaker 5

Great. Thank you.

Speaker 1

Thank you, Meta. Michelle, next question.

Operator

Amit Daryani with Evercore. You may go ahead.

Speaker 6

Yes. Thanks for taking my question. I guess, Chuck, one of the things I think folks will struggle to understand is the conviction you have that this is The implementation pause and not a macro demand centric weakness. So let's just understand what you can talk about and why you're so convinced this is 1 to 2 quarter implementation pause rather than enterprise demand is just getting weaker. Anything on that front would be helpful.

Speaker 6

And then I just want to clarify this part. You folks said $1,000,000,000 in AI orders, that's 2 times the number you gave last time. Is that correct? Thank you.

Speaker 2

Yes. Amit, thank you. So if you'll be patient with me, I'll give you a few data points and some context around why we think This is an inventory issue that's sitting with our customers. First of all, our customers and Sales organizations have been very clear with us over the last 90 days that this is the issue, particularly our large enterprise And our service providers, we talked about that with the service providers prior, but it shifted into the enterprise space in a big way. The other thing is we had our Partner Summit last week and some of our largest partners unsolicited began their conversations with me by talking about this very issue, which Candidly, I knew that customers had talked about it and our sales teams had talked about it.

Speaker 2

I was actually surprised to hear it so consistently at that Partner Summit. So That's sort of the subjective view. And then we've done some analysis and there's 3 things I'd point out. The first is that In certain parts of our portfolio, we actually can see the timeframe from shipment of a product until the product begins to Connect to the cloud, back to the cloud like Meraki. And what we've seen is a 1 to 2 quarter Delay versus what historically you would see when these products get shipped, how long it takes for them Be activated and connect to the Meraki cloud.

Speaker 2

So that's the first piece. The second is, we had a very strong quarter in U. S. Federal from an orders perspective. And so we looked into why big customer like the U.

Speaker 2

S. Government, Department of Defense would not have the same issue. And the reality is, is that they have special clauses in their contracts To give them most favored nation status when we're actually making shipment decisions. And certainly with the Department of Defense, we prioritized them during the supply chain crisis. So they never had a big influx.

Speaker 2

They had a very steady flow of products Which explains why their order numbers look fairly normal. The third point I'd say is that we noticed a serious uptick in Q1 in our transactional advanced services, which is loosely translated to be implementation services, Where that grew almost 20% and the forecast for Q2 is almost double digits again. So it's clear that customers are asking us to Come help them get this done. And I'll give you one final subjective data point and then I'll talk about the AI stuff. We had one big partner tell us that they have literally hired 200 people in the last 90 days solely focused on implementing technology for their customers.

Speaker 2

So There was just so many things that we've learned over the last 90 days. Clearly, this surprised us, but I think we feel pretty good right now. I'll make a comment about why I don't think it's macro. Candidly, it might have been easier for me to say it was macro. But as we've discussed Prior, we have the traditional service provider has been tough and it remains that way.

Speaker 2

We've talked about elongated sales cycle, they remain. We've talked about in some cases the need for extra signatures, which is pretty normal. That's remained, but we didn't see it get materially worse in the quarter. And so all of that and I'm sorry for the long answer, but I wanted to be thorough. All of that is really what led us to believe this That this is a consumption issue with our customers.

Speaker 2

So I'm going to pause there and then I'm going to answer your AI question. What we gave last time was orders to date. We had taken orders for to over $500,000,000 for infrastructure to support AI networks, AI GPUs inside the cloud players. And I'll talk a little bit more about that in a moment. The numbers that we gave today is a forward looking Set of numbers, let's say, in fiscal year 2025, which is when we said we believe that the broad Ethernet build out would occur underneath GPUs.

Speaker 2

We have already seen, we have line of sight to $1,000,000,000 plus of orders that our teams feel pretty good that we're going to get and or we've been designed in already. So that's just sort of a forward looking Set of orders that we've identified for fiscal 2025, okay. I will also just cover real quickly, we are now We now have our Ethernet fabric deployed underneath GPUs in 3 of the 4 hyper scalers, major hyper We also are working very closely with AMD, Intel and NVIDIA to create solutions including Ethernet Technologies, GPU enabled infrastructure, jointly tested and validated reference architectures. And I will say even this week, yesterday, Jensen from NVIDIA and 4 of his 4 or 5 of his executives came over to see us and we spent 90 minutes together with my executive team. And we believe we have a great opportunity to actually build some integrated solutions between our technology and their technology to actually take to the enterprise.

Speaker 2

So we're beginning to see the use cases in the enterprise evolve and we think that a partnership with NVIDIA in that case With our underlying technology and our strength of go to market, we think will be a winning combination. So we're working on that as well. So there's a lot going on in the AI space.

Speaker 1

Right. Thank you, Amit. Michelle, next question.

Operator

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

Speaker 7

Thanks for taking the question. I wanted to see if maybe you'd be willing to unpack the networking segment a little bit in terms of the trends, and really what I'm trying to get at is understand sort of what's doing better, what's doing worse In that, I suspect its data center sounds to us pretty good, whereas maybe campus is a bit We are declining and hopefully during this transition to new segmentation, you could give us a little bit more color within networking. Thank you.

Speaker 3

Hey, Simon, thanks for that. I would say the bigger variance that we're seeing, I mean, right now, obviously, the demand signal is a little Because of the amount of inventory that's out in the field and that we have normalized lead times at this point. We knew that would happen sometime in the first half. It's now happened. Our lead times are back to where they were pre pandemic.

Speaker 3

And our backlog The supply chain team has done a terrific job getting product out the door. That's what's kind of moved the bottleneck from our level down to our customers level. But when you start to unpack within networking, we're not seeing at this point a huge difference between, for example, data center or campus networking. What we are seeing is a little more field based inventory on wireless access points. That's been slightly slower than what we've seen just because of the amount of product that's been shipped out than what we've seen in the rest of the networking.

Speaker 1

Thank you very much. Thank you, Simon. Yes. Thanks, Simon. All right.

Speaker 1

Michelle, next question.

Operator

Ben Reitzes with Melius Research. You may go ahead, sir.

Speaker 8

Hey, thanks. Good afternoon, everyone. I wanted to ask about your share repurchase cadence. Stock obviously could get hit here. We have been talking about $5,000,000,000 in buybacks X or so for the year.

Speaker 8

I know some of that's to offset dilution. If you guys are confident in the second half pickup, Is there any potential that you would be more aggressive in the upcoming quarter? And how are you thinking about share repo this year given current dynamics with the Splunk deal coming? Thanks.

Speaker 3

Yes. Ben, as we said on the Splunk Transaction, it's going to be outside of the transactional costs, it's going to be cash flow positive from the 1st year forward. So the Splunk transaction is not In any way, having an effect on our capital return either through the dividend or through the through share buybacks. We Expect to continue at higher level and consistent higher level of share buybacks and to continue to show increases in our dividend. We also will obviously look at the opportunity at the chance to be opportunistic on the share buyback.

Speaker 3

I'm not going to commit to that at this moment, but that is something that we'll obviously take a look at.

Speaker 1

All right. Thank you, Ben. All right, Michelle. Next question?

Operator

Samik Chatterjee with JPMorgan. You may go ahead.

Speaker 9

Hi. Thank you for taking my question. I guess if I can just clarify one thing first. I think Chuck in your prepared remarks you did say you saw the more Renounced impact on the orders in the month of October, I think that's what I heard you say. I mean, just curious, are you implying that you did see an improvement in orders in the sort of 1st couple of weeks of November itself and that's maybe part of your confidence in that it's A bit more temporary than a longer pause from the customers.

Speaker 9

And then you did mention large partners really being the ones Customers are sort of not going to face a similar issue or are you also basing that in terms of your sort of next couple of quarters of

Speaker 2

Thanks, Samik. I think my point with October was that If you go back to the end of Q4, we talked about on the last call that we had a fair amount of momentum as we exited the quarter, which It's one of the reasons we didn't expect to see this. And we had our normal year end Sales restructuring moving accounts around, moving territories around and getting sort of the sales startup process that happens in the first, Say 6 weeks of the fiscal year, which we went through. So what we tend to look for is the middle of the quarter and then into October is when we expect to see The actual quarter materialized and everything kind of come together and it just didn't. And that's what that was the comment about that it was primarily We really it was really clear to us in October that this was going to be the situation.

Speaker 2

Relative to They're the ones who are having the consumption issue because they have the most inventory. You asked how we What confidence will we have is not SMB. If you look at orders, we look at a sub segmentation within Enterprise now and within Service Provider, And SMB was fine. And in fact, the smaller the customer we had, the better their Order performance for us in the quarter was. So it just followed the trend that the consumption issue was upmarket and the small to midsize customers didn't feel it.

Speaker 9

Good. Thank you.

Speaker 3

All

Speaker 1

right. Thank you, Samik. Michelle, next question.

Operator

David Vogt with UBS. You may go ahead, sir.

Speaker 10

Great. Thanks guys for taking my question. Scott, maybe this is for you. I just want to unpack maybe one of the comments And I know you don't guide to orders, but I think in your prepared remarks, you said backlog is back at normal levels at

Speaker 4

the end of the quarter.

Speaker 10

So are we to assume that the guide for 2Q and the rest of the year doesn't include backlog conversion into revenue? And then if that's the case, To your comment about orders accelerating in the second half, I know you don't guide specifically to orders, but you did make a comment that revenue Can be up, I think sequentially in the Q3 year over year and in the Q4 sequentially and year over year. Doesn't that suggest like a pretty steep order acceleration, not just an acceleration, but significant positive order trajectory in the Q4 and the third I know it's easy comps, but just some more color there would be helpful. Thanks.

Speaker 3

Yes, David, we did say that. I do we are expecting sequential Improvement in the second half of the year in both Q3 and in Q4. And both and again, we don't guide this, but in both orders and revenues, you'd expect Backlog is normalized at this point. We knew that would happen in the first half. I think the supply chain team did a great job getting those orders in the hands of our customers.

Speaker 3

We would now need them to implement them, but we've got the orders in the hands of our customers. So we do see sequential increases. And as you said, as you noted from a booking Point or order standpoint, the second half has easier compare points. Obviously, the reverse is true on revenue. The second half revenue will have very difficult compare

Speaker 10

Great. Thank you.

Speaker 1

All right. Thank you, David. Michelle, next question?

Operator

Matt Niknam with Deutsche Bank. You may go ahead.

Speaker 11

Hey, guys. Thank you for taking the question. Maybe just a dovetail, one follow-up to the prior question. I have just another one on margins. Just on the prior one, is the expectation for a second half Improvements in a 1 to 2 quarter digestion.

Speaker 11

Does that vary at all across the 3 different customer sets you outlined? And then just on the margins, so 36.6 So on op income margins this quarter, I think the guide implies a 400 to 500 basis point dip. Is that due to just the sheer revenue decline Sequentially or are there other cost items we should consider on either the gross margin or ROI margin line? Thanks.

Speaker 3

Yes. To your second question, it is just based on how the revenues are flowing through the second half of the year. I think Gross margins, we've said will settle in somewhere in this 65% to 66% range. I think at this point, it looks like it will be closer to the higher end Of that range for the 2nd part of the year. So that's the way I see the year flowing out.

Speaker 3

Remind me, Matt, what was the first part of your question?

Speaker 11

Just around the expectation for second half improvement in orders, 1 to 2 quarters worth of installation, is that broad across The 3 customer sets or does it vary across service provider, enterprise and federal?

Speaker 3

Yes, right. I think we expect I certainly would expect Service provider to continue to be difficult through the second half of the year. Within service provider, we've got both telco and cable, Which has one side of market dynamics going on. I think that will be continue to be a difficult space. On the other side, we have webscale and we do see the webscale orders.

Speaker 3

While they've got also inventory to work their way through, we do see line of sight of them beginning to increase their orders again in the second half of the year. So SP is a bit of a mixed bag, but I think it will continue to have probably the greater impact.

Speaker 11

Thank you.

Speaker 3

All right.

Speaker 1

Thank you, Matt. Michelle, next question.

Operator

George Notter with Jefferies. You may go ahead. Hi.

Speaker 7

Thanks a lot guys. Just continuing on, on that last question. If I look around the space, Companies have been dealing with excess inventories for really 3 quarters now. And I guess I'm just curious why is Is this now becoming more evident at Cisco versus a few quarters ago? And then also, you mentioned that the issue is spreading more to enterprises.

Speaker 7

We don't typically think about Prizes is, inventorying infrastructure. And so I guess the question for you is, Has something changed there or is this more distribution channel inventory? Any insight would be great. Thanks.

Speaker 2

Yes. Thanks, George. I think that the reason it's become relevant now is because if I mean we've really unloaded our backlog in the last 6 months. I mean and it was 1,000,000,000 of dollars more than what we would normally ship to customers during that time period. So they I think it's just and we know that the cloud providers as an example had been buying ahead and they had been doing it for sure to your point.

Speaker 2

And all along, we have very sequenced purchasing cycles with those players. So We kind of know when they're going to start placing their next orders. I think on the enterprise, we're talking about the top 200 customers, right? These are the big customers who Actually, if they're doing a refresh of their infrastructure, they might order 400, 500 switches as an example, or they may be doing a branch rollout. And in some cases to your point, It could be sitting with them or they could have a partner who's doing the staging and the partner may be backed up with resources to try to get the staging done.

Speaker 2

So it varies, but it could be a either one of those or a combination of both.

Speaker 3

And George, just to put some data to that, you have this data, but I'll repeat it. Our revenue growth, obviously, the quarter we're announcing now product revenue growth was 9%. But if you go back to Q4, product revenue growth was 20% and in Q3 it was 17%. So that obviously we get revenue when we can complete a shipment and get it out the door. It gives you a sense of just how much has been pushed out and as Chuck said in the last 2 to 3 quarters.

Speaker 1

Great. Thank you. Thank you, George. And then Michelle, we have time for one last question.

Operator

Thank you. Michael Ng with Goldman Sachs. You may go ahead.

Speaker 8

Hey, good afternoon. Thanks for the question. I just have 2. First on the AI orders of 1,000,000,000 What's the feedback from the hyperscalers on your improving position with these customers relative to a few years ago? Is it Yes, selling in a more disaggregated fashion with Silicon One, is it a desire for silicon diversification?

Speaker 8

And then the second question, just as a follow-up on the Order slowdown. Was that more concentrated in the campus with wireless LAN and wired or Data center or both just within enterprise specifically? Thank you.

Speaker 2

Thanks, Michael. On the AI question relative to the cloud players, I think that look, I think early on, We regained our footing there because we listened and we showed flexibility with our willingness to disaggregate if they wanted to do so. And we're in I can't even remember, but numerous use cases Across the large webscale players and I think we added another over 10 new use cases last quarter alone where we had been designed in. And I think it's so I think that the disaggregation and the flexibility and us listening to them and understanding what Wanted was the reason that we got back in. And now the feedback is as long as we're performing, I think they like our products, they like the power savings Of Silicon One, it's a massive power lower massively lower power consumption.

Speaker 2

I think they do like silicon diversity for sure. And then as you look at the AI infrastructure that's currently primarily being supported via InfiniBand. They just want to move to more of a standard broad based technology like Ethernet that they can actually have multiple sources. And so we think that's what's driving that now. And now it's just about performing and executing and delivering on what we tell them we're going to do.

Speaker 2

Scott, you want to take the second?

Speaker 3

Yes, Michael. I think I touched on this earlier As the question came up, I think the way to think about it is, first of all, if you're trying to generalize The trend more broadly across the industry, it may be a little difficult because we've cleared our backlog I think significantly faster than others have. But where we saw a differentiation was less between say data center infrastructure and campus networking and more between Networking and wireless. We did see because we've shipped an enormous amount of wireless access points out, We did see that take a little bit more of an impact just because it's said that our customers are sitting on more inventory on hand of that that they're looking to get installed.

Speaker 8

Great. Thank you, Chuck. Thank you, Scott.

Speaker 1

Thank you. All right. Thank you, Michael. And all right, so we'll go ahead and turn it over to you, Chuck, for some closing remarks.

Speaker 2

Yes. Thank you, Sami, and welcome again. Listen, we're proud of the team for the performance in Q1. Obviously, very solid quarter With the exception of this demand issue that we talked about, we'll always try to be transparent with you and share with you exactly what we're seeing. We know what's going on.

Speaker 2

We're on top of it and we do feel that it's temporary. At the same time, we're very confident Tuni's long term, we're confident in the AI opportunity. We're very encouraged by our improving position in security, Observability and we're also very encouraged by the opportunities that will Come with the Splunk acquisition. I think many of you know that on Monday night, the waiting period for review under the Hart Scott Rodino Act in the U. S.

Speaker 2

Expired, Meaning that we've effectively passed the antitrust review period in the United States. We're excited about that. At our Partner Summit last night or last week, the feedback on our portfolio right now was probably as good as it's been in a long time. And I also just want to Reiterate our commitment to delivering value to you and our shareholders via operating leverage, capital allocation and obviously managing our expenses in times when we see challenges like we have right now. So thank you for joining us today, and I'll turn it back over to Sami.

Speaker 1

Cisco's next quarterly call, which will reflect Our fiscal year 2024 Second Quarter results will be on Wednesday, February 14, 2024 at 1:30 pm Pacific Time, 4:30 pm 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 And

Operator

thank you for participating on today's conference call. If you would like to listen to the call In its entirety, you may call 1-eight hundred-eight thirty four-five Participants dialing from outside the U. S, please dial 203-369 3,351. This concludes today's call. You may disconnect at this time.

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Earnings Conference Call
Cisco Systems Q1 2024
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