Cisco Systems, Inc. (CSCO) Earnings Call Transcript & Summary

Appreciate that, Michelle. Hello, everybody, and thanks for joining us for Cisco's quarterly earnings conference call covering the first quarter of fiscal 2021. I'm Marilyn Mora, Head of Investor Relations, and with me are Chuck Robbins, our Chairman and CEO, along with Kelly Kramer, our CFO. You should have our earnings press release in hand by this point. A webcast with slides that goes along with it, which includes supplemental information, will be posted on our website under the Investor Relations section once this call ends. As we typically do in Q1, we've applied some reclassifications to prior-period amounts so they align with how the current period is presented. You can find our income statements, the full reconciliation from GAAP to non-GAAP, balance sheets, cash flow statements, and other financial data in the Financial Information area of our Investor Relations site. On today's call, we'll refer to both GAAP and non-GAAP results, and unless we say otherwise, product results will be discussed as revenue while geographic and customer results will be discussed as product orders. Any comparison we make during this call is on a year-over-year basis. Today's discussion includes forward-looking statements, among them the guidance we'll give for the second quarter of fiscal 2021. These statements come with risks and unknowns—COVID-19 among them—that we cover thoroughly in our SEC filings, particularly the latest Form 10-K, which lays out key risk factors that might make real outcomes diverge significantly from what the forward-looking statements suggest. Regarding guidance, we encourage you to check the slides and press release provided alongside this call for additional information. Cisco won't address its financial guidance mid-quarter unless it's shared via a formal public disclosure; so with that, I'll hand things over to Chuck.

Thank you, Marilyn. To begin, I'd like to express my hope that all of you are staying safe and well. I'd also like to express gratitude to our staff members for their commitment to our clients and their tireless pursuit of innovation. Cisco has gotten off to a strong beginning in fiscal 2021. These results make me proud. Our teams are carrying out their work with excellence, and we keep making consistent headway in our transition toward a model driven by software and subscriptions. We feel optimistic because of indications that our business is improving as we keep dealing with the pandemic and other broad economic uncertainties. Our priority is to succeed through a distinctive innovation portfolio, achieve growth over the long term, and serve as a dependable technology partner for our clients. During the past several quarters, we have effectively adapted to fresh requirements by implementing essential modifications and adjustments in our operations. We stay tightly connected with our clients so we can give them the essential technology required to remain resilient and progress toward embracing new hybrid work approaches. Indeed, we foresee numerous excellent possibilities ahead, since every business across every sector is speeding up its digital-first approach. Our clients are reconsidering the way they assist and serve both their customers and their staff. What they require is speed, agility, and simplicity. A number of clients have told me they are squeezing years' worth of effort into merely a handful of months. That's why we are pursuing fresh innovation that assists our clients in connecting, securing, and automating their settings more quickly than at any point in the past. Equipped with the proper technology and tools, we can become even more efficient and productive, and that is precisely what we plan to provide for our clients. Looking ahead, our emphasis is on creating innovation that assists our clients and Cisco in prospering within a hybrid cloud environment. When we consider the upcoming few years, there are 6 primary areas on which we are concentrating. The first is providing optimized application experiences to our clients. For every organization, the application serves as the lifeline, and it is increasingly the means by which end users reach their products and use their services. The second is to keep providing the secure networking abilities that Cisco is relied upon for, delivered as a service, with still greater simplicity and automation. The third area centers on assisting communications providers in achieving success with major architectural shifts such as 400 gig and 5G. These will be accomplished through a blend of our software assets, silicon and optics capabilities, along with fully integrated systems. We will provide these technologies both on-prem and from the cloud. The fourth is speeding up the future of work. As numerous enterprises seek to embrace new hybrid work approaches with a greater number of remotely distributed employees than previously, our emphasis is on assisting them in providing consistent experiences, whether someone is working remotely or at the office, spanning connectivity, collaboration, and security. The fifth is aiding our clients in their mission of securing everything they do. We will keep providing the end-to-end intelligent security architecture crafted to keep their data private and their people protected. The last piece involves creating edge technologies that let app developers operate distributed applications while gaining secure access to and control over distributed data. These important segments, we think, will fuel our expansion and achievements in the years ahead; let me now go into greater detail about our Q1 outcomes. As stated before, we noticed positive indicators of progress in a few parts of our operations. A number of big clients already working on upgrading their infrastructure are carrying on with that effort, which we've observed through the sustained momentum of Catalyst 9000. Webex, alongside our security offerings and business resiliency products, likewise experienced robust growth, since customers are entrusting their most essential initiatives to us; we are making headway in reshaping our business model, with 78% of our software revenue now coming from subscriptions, and we recorded double-digit expansion in deferred product revenue. Just as I noted during the previous call, you'll observe us providing more of our technology in an as-a-service format, delivering additional options and adaptability throughout our whole portfolio. Our pipeline of new technology stays robust as we keep speeding up how quickly we innovate. During our latest Partner Summit, we rolled out several fresh technology solutions that assist customers in adapting, accelerating and streamlining their operations via new agile automation platforms. When it comes to our infrastructure platforms, our Cat 9K line of switches along with Meraki cloud-based platforms keep delivering solid results, as customers construct highly secure, resilient and scalable networks to serve as the basis for their digital strategies. More and more, our customers are operating applications spanning various cloud environments, which calls for next-generation architectures featuring automation, security and insights; we just unveiled new cloud and SD-WAN platform innovations aimed at helping customers connect, secure and automate throughout their hybrid environments, with improved visibility into their applications. We are achieving significant progress among our web-scale customers, marking our fourth straight quarter of robust double-digit growth; this demonstrates their confidence in our future direction and their continued dedication to investing alongside us in building out their forthcoming architectures. We likewise keep assisting customers in functioning within a multi-cloud setting and refining our overall cloud experience; during Q1, we broadened these abilities via Cisco's Cloud onRamp solutions, which tightly incorporate cloud services from AWS, Google and Microsoft to more effectively support end-to-end visibility and manageability of their distributed applications. On the security front, we posted yet another stable quarter of growth, propelled by our extensive cloud-native portfolio. SecureX, which delivers a streamlined security experience, experienced significant uptake, having been implemented at over 4,000 organizations since its global launch in June. With customers' staff still working from home, they seek to reinforce their current security measures using unified user and endpoint protection; we keep gaining from the move toward cloud-based security capabilities and enjoyed strong growth in our secure remote worker offering, encompassing Duo, Umbrella and AnyConnect. Additionally, our customers want highly secure, high-speed, low-latency connections to the Internet. What we're seeing is networking and security services coming together in the cloud, so that any user or device can be connected securely to any application and get the best possible experience. Recently, our security team, which is world-class, rolled out fresh innovations, among them extended detection and response, Zero Trust, and secure access services edge. When we pair our top solutions, SD-WAN and Umbrella, with the new capabilities we've added for secure Internet gateway, customers can put solutions in place that let their users reach cloud workloads and SaaS applications easily and safely. Turning to collaboration, business continuity and resiliency are still front and center for our customers. The priority for organizations is building flexible work environments that boost productivity, all while making sure employees stay safe. A hybrid model, with staff splitting time between the office and home, is what work will look like going forward, and in that space we hold the lead. As organizations and teams adjust to new models for business, healthcare, and learning, our collaboration portfolio is giving them the means to be both more productive and more secure. Anyone, anywhere can collaborate without friction thanks to what we offer, and at the same time we deliver consistent experiences for hybrid workplaces and keep up our leadership in security.

Cisco Webex experienced a notable rise in usage and strong uptake, since customers turn to us seeking a flexible work option that delivers privacy and security as well. No matter if they're at home or in the office, our customers require something that unites meetings, calling, file sharing and messaging through an easy and extremely secure user experience. During just the previous month, Webex recorded close to 600 million participants, which is almost twice what we saw in March. We introduced new return to office solutions not long ago, offering actionable workplace analytics via Webex Room Navigator and integrated collaboration device sensors, which assist in maintaining a safe working environment. Additionally, we're speeding up our innovation through fresh offerings like Webex Legislate, designed to keep essential operations of global governments going, plus features including breakout rooms, virtual huddle spaces and noise cancellation. We're rethinking all elements of the collaboration experience using built-in AI technology, security and integrated workflow applications, in order to build a smarter work environment and boost productivity. Finally, AppDynamics. Our customers are shifting toward highly distributed cloud-native applications, and those demand more observability along with insights. Through merging AppDynamics and ThousandEyes, our cloud-based networking monitoring platform, we provide full stack observability, which helps our customers manage their applications more effectively and enhance their digital experiences via end-to-end visibility, deep insights and automated action. Now, I'd like to share additional details about our CFO transition. During our previous call, I mentioned that our CFO, Kelly Kramer, had made the decision to retire from Cisco. Today, I'm pleased that Scott Herren is going to join Cisco as our new Executive Vice President and Chief Financial Officer starting December 18. Most recently, Scott held the CFO position at Autodesk. He carries an incredible background in software and was instrumental in guiding Autodesk's successful business model transformation from perpetual licenses to SaaS and subscription software. As we keep making strong progress on our business model shift and sell more of our solutions as a service, Scott's deep expertise in this area will assist us in speeding up our transition. He also possesses robust experience operating within complex global business environments at scale, plus a record of profitable business growth, focused team building and prudent financial controls. I have zero doubt that he will add to and nurture the culture we also take pride in here at Cisco. I want to thank Kelly once more for being such a wonderful partner and for the part she has played in our transition. We will definitely miss her, but we're quite excited to have Scott in this role and as a member of our team. To sum up, we are encouraged by how the year has begun. I'm proud of our progress, both in our own transformation and in how we enable customers to speed up their own digital strategies. We possess a clear vision and strategy, and I feel quite good about our portfolio and the innovation we are driving. People who buy from us are looking for dependable partners, plus options and adaptability regarding the way they buy, use, and roll out technology according to what each of them specifically requires; trust, innovation, and choice serve as foundational pillars of our identity here at Cisco. While we direct our attention toward expanding our operations, our purpose continues to steer us — powering an inclusive future for all. It's clear to us that widespread availability of technology and connectivity has a direct effect on economic growth and supports essential human requirements such as healthcare and education. We recognize that technology is capable of helping address some of the biggest problems facing the world, and our dedication to creating an inclusive future where everyone can flourish has never been stronger. At this point, I'll hand things over to Kelly.

Appreciate that, Chuck. And I'd like to offer Scott my congratulations on the new position as well. I've gotten to spend a bit of time with him, and I couldn't be more thrilled. For Cisco, I view this as very good news, and he's going to bring a lot to the team. Chuck, my thanks to you too; it has been wonderful collaborating with you throughout the years. Let me now walk through a recap of how we did financially this quarter, and then I'll give guidance for Q2. Our results in Q1 overall show solid execution, with healthy margins despite a difficult backdrop. We brought in total revenue of $11.9 billion, which is a 9% decline compared with the same quarter last year. On a non-GAAP basis, our operating margin rate came to 32.7%, a drop of 0.9 points. Non-GAAP net income reached $3.2 billion, which is down 11%, while non-GAAP EPS landed at $0.76, a decrease of 10%. Let me go deeper into our Q1 revenue. Product revenue overall fell 13%, coming to $8.6 billion. Infrastructure Platforms declined 16%. Keep in mind that this product area took the biggest hit from the COVID situation; we recorded drops in switching, routing, data center and wireless, mostly because of softness in the enterprise and commercial markets; at the same time, the Cat 9K kept growing and our Wi-Fi 6 products continued to ramp. Data center revenue went down, pulled lower by servers. Applications declined 8%; we kept seeing impressive growth in Webex given how important remote working has become. That was partly offset by decreases in Unified Communications and TelePresence endpoints. Security rose 6%. Our cloud security portfolio turned in a solid performance, growing at a strong double-digit rate, and our Duo and Umbrella offerings kept up their momentum. Service revenue grew 2%, lifted by gains in our maintenance business along with support services. We keep transforming the business, putting out more software offerings and pushing more subscriptions. Software subscriptions made up 78% of total software revenue, which is a rise of 7 points versus a year ago. Remaining performance obligations, or RPO, stood at $27.5 billion when Q1 closed, an increase of 10%. Product RPO rose 15% and service RPO rose 8%. This ongoing expansion in RPO shows how strong our software and services portfolio is; regarding Q1 orders, product orders overall declined 5%. Turning to our geographies, the Americas fell 5%, EMEA fell 1% and APJC fell 14%. Emerging markets overall declined 15%, with the BRICS plus Mexico down 19%; within our customer segments, public sector grew 5%, enterprise fell 15%, commercial fell 8% and service provider fell 5%. On non-GAAP profitability, gross margin for Q1 overall was 65.8%, a decline of 0.1 points. Product gross margin came in at 65.3%, down 0.8 points, and service gross margin was 67.1%, up 1.7 points versus the prior year. On the bottom line, from a GAAP standpoint, Q1 net income was $2.2 billion and EPS was $0.51. GAAP results reflect restructuring charges of $602 million tied to the plan we told you about in Q1. Q1 ended with total cash, cash equivalents and investments of $30 billion. Cash flow from operations came in at $4.1 billion, which represents a 14% increase. When it comes to how we allocate capital, we gave back $2.3 billion to shareholders over the quarter, made up of $0.8 billion in share repurchases along with $1.5 billion for the quarterly dividend. Let me restate the guidance we've provided for the second quarter of fiscal '21. That guidance carries the forward-looking information disclaimer Marilyn mentioned before. Revenue, we expect, will land somewhere between flat and minus 2% versus the prior year. For the non-GAAP gross margin rate, our expectation is a range of 64% to 65%. The non-GAAP operating margin rate should come in between 32% and 33%. As for the non-GAAP tax provision rate, we're expecting 19%. Non-GAAP earnings per share should fall in a range from $0.74 to $0.76. With that, I'll hand things back to Marilyn so we can begin the Q&A.

Appreciate that, Kelly. As the operator gets the queue ready for Q&A, I want to give the same reminder I share each quarter: please limit yourself to a single question, so there's enough time for us to get to as many of you as we can. Michelle, over to you.

Hi, everyone. It's nice to see the business holding steady. I suppose I have a few items for you. Chuck, given that enterprise orders have fallen quite a lot, should we take from how you sound that you believe that will turn around? Where do order patterns bottom out? And looking across the remaining part of the fiscal year, is that the sequential gain you're anticipating? Then, Kelly, a quick clarification about RPO. Could you let us know whether duration — how is duration shifting? It's tough to square this if duration moves between quarters.

Hi, Ittai, I appreciate the remarks and the questions. So, regarding the enterprise side, honestly I'm not overly worried about it. We had — we did face some fairly large year-over-year comparisons, and that played a part. But what I'd point to is that we saw a fairly big gain in our commercial orders. Last quarter, in the middle of the entire SMB collapse that we were aware was happening, I believe we were minus 23, and this quarter it was minus 8. And I'll tell you, in the US, the improvement from that was even larger. So that leaves us with a decent amount of optimism. I believe the enterprise situation will be OK. There is — once more, we simply — we had some comparison problems that I think just showed up in the numbers, but I don't see anything there that worries me.

Regarding RPO, Ittai, the length of time involved really hasn't shifted a great deal since we first began disclosing this figure more than a year back. Roughly 50% — a bit over 50% — of the overall balance is going to be recognized within the coming 12 months, while what remains sits further out.

That's great. And it's truly been a joy working with you, Kelly. Best wishes for whatever comes next.

Thanks, Ittai — I really value that.

Let's take the next question.

To start, Kelly, I simply wanted to express my thanks for everything you've done across the years and to wish you well in whatever comes next. Now for my questions — first, Kelly, could you bring us up to date on the pricing landscape as you see it? Then the larger issue, Chuck, concerns those remarks you just offered about gains in commercial and enterprise. For some time you've clearly been discussing the upside from remote work, plus the offsetting difficulty posed by — if we assume a return to the 21st century, some organizations will keep a certain percentage of their workforce at home, with fewer or smaller offices, headquarters, branch locations, and remote workers in those offices, which one would expect creates a hurdle for switching, enterprise routing, and wireless LAN access points. Can you share any perspective on that dynamic over the longer term?

Sure, I'll address that part first, and then Kelly can speak to pricing. Paul, my sense is that with commercial, much of the rebound came from collaboration and security worldwide. That leaves us feeling positive. We also mentioned how the Cat 9K kept demonstrating momentum, with demand growth in double digits, and so what we anticipate is that as customers return, they will want to make sure their infrastructure is robust. They will have to handle social distancing concerns. Within our cloud < > portfolio, we believe you'll see customers installing high definition video in every conference room; we've developed technology — I actually watched it operate this week — where sensors sit inside the units, so beyond having high definition video, those sensors inside the units track how many individuals occupy a room, and you receive warnings whenever you surpass whatever capacity the company has set for that room. Thus we believe the safety dimension will prove beneficial as well. My view is that what truly unfolds here remains TBD, since I think 90 days to 120 days ago, the prevailing assumption was that every headquarters building across the globe would close. Today, though, I think people recognize that going back will involve a balance. So we have the Cat 9K and Wi-Fi 6 — the future modern platforms the Company has been transitioning toward that keep showing strength. And so, though we must wait and see, we're optimistic about it.

And what about pricing, Kelly?

Yes, absolutely. Regarding pricing — and thank you for those kind remarks, Paul. I appreciate that. When it comes to pricing, I would say our Q1 pricing falls within the typical range when you look at a product gross margin walk. As for the rate impacts, the figure we typically reference, it was down 1.8 points, which, as you're aware, sits within our usual operating range. And just to remind everyone, we've annualized every price increase we implemented a year ago for the list related to tariffs; so at this point, this is essentially where we stand. But I'm glad to see where we are this quarter on pricing; and even on a sequential basis from Q4, it's improved. So we're stable.

Thanks again.

Thank you.

Thanks, Paul. Michelle, let's take the next one.

Appreciate you taking it. I'd like to begin with what looks like a disconnect, I suppose, between the order rate and the guidance. Revenue comes in flat even at the high end of the guide, yet orders fell 5%; so could you folks basically draw that line between the two for us, and explain what's behind it; and then, Chuck, I realize you mentioned the enterprise orders don't worry you much. They did worsen fairly significantly. Might you elaborate a bit further on that? What's going on there — despite that deterioration, is your view that it's merely a near-term thing, or what exactly is happening inside that enterprise segment, that would be helpful? Many thanks.

Yes, regarding orders against revenue, it truly comes down to the timing of when things land and so forth. That's the same as what I typically walk through; we're aware of what leaves the balance sheet with all the software. We're aware of what sits in our backlog. So it truly comes down to the year-over-year comparisons. Thus, I'm comfortable with the guide, and you can see that reflected in it.

Okay, so regarding the enterprise side of things, what I'd really highlight is that there were only a handful of notable deals; and what we're seeing — in our pipeline right now, we're seeing a strong pipeline. We're seeing big deals reappearing in the funnel once more, which is encouraging. So if you look across core infrastructure, companies are going to refresh that core infrastructure. They're going to construct a solid on-prem collaborate — by on-prem I mean hardware video units for when employees return to offices, since everyone — every meeting will include remote participants, and you'll need that in practically every conference room. So that's encouraging. Everyone is shifting toward this WAN re-architecture involving SD-WAN and cloud security. So I think — to put it briefly, Rod, it was mostly a few large deals a year ago, and we're seeing the funnel get stronger; so that's — that's what makes me optimistic going forward.

All right, thank you, everyone. It's been a pleasure collaborating with you, Kelly.

Appreciate it, Rod.

Let's take the next question.

Thanks a lot, Chuck. What I'd like to know is how the quarter trended in terms of linearity? On that earlier earnings call, right before fiscal Q1, you sounded rather gloomy. When exactly did that improvement begin to show up? Also, do customers have to be physically present in the office before they consider placing orders, or have they simply adjusted and begun ordering even while working remotely? Thanks.

Yeah. Looking back at our previous earnings call, demand had actually been solid during the opening 2 weeks of that quarter, though obviously that's only 2 weeks. Because of that, we — nothing there was enough to establish a trend. Still, once the quarter got underway, it remained — the pattern was highly linear. It wasn't — we delivered reasonable results right from the start, and that held fairly steady all the way through. So for us, that felt encouraging. And the — pardon me, what was the other question?

Regarding whether individuals had to actually be present at the office before they could begin considering orders.

What I believe took place is that I think buyers have accepted the reality that this situation will remain with us for a certain length of time. Clearly, we share the same optimism as everyone else that a few of the vaccines along with a few of the therapeutics and everything else will eventually be of assistance. We are of course weighing that against the spikes we are currently witnessing across the globe. Yet I think buyers simply stated, we do not know when things will improve, but improve they will. And I cannot just sit idle without doing anything. What I had somewhat hoped would occur, and I think we did observe it, is that we had buyers who were intensely focused on enabling their staff to work from home efficiently and on getting their security established. I think everybody hurried to accomplish that. After that, I think they halted, which is what we experienced in our orders during the prior quarter; and following that, I think they rearranged their priorities regarding where their money would go, and I think we began to witness a portion of that returning. And it is more or less precisely what I anticipated, though we had to observe it and we will find out whether it persists. However, all of us are contending with the identical macro environment, everyone is, in relation to this virus, yet that is roughly how matters unfolded. Any thoughts, Kelly, regarding the linearity?

Yes, the progression was really consistent.

Wonderful, thank you; it's been a pleasure collaborating with you, Kelly.

Appreciate it.

Thanks, Chuck. Thank you, Kelly. Who's up next?

Appreciate it. Best of luck to you as well, Kelly. My question is about the cloud vertical. Chuck, you mentioned that Q4 was strong. Could you share which products are performing well in that area and how widespread that strength is among those customers? Then a quick follow-up, if possible, regarding the public sector increase. Is there something particular or more lasting about that vertical ranking among the better performers? Thanks.

Thank you, Tim. Regarding the cloud segment and hyperscale customers, my past comments have noted that we were working to restore those connections, and afterward we started seeing those clients purchase more from our wider product lineup. That happened because they gained confidence on two fronts: first, they trusted that we would remain a committed partner, and second, they saw us putting money into technology designed around their preferred consumption model and matched to the system designs they intended to create. As for where things stand today, this past December we held a launch event where we described separating our software from our hardware, and we explained that our silicon, our optics, and our software would each be offered on a standalone basis. Our approach was to offer complete, integrated systems tailored to whatever the customer requested. And I can share that at this point, we've secured wins in the web scale segment across all of those dimensions. As a result, the progress has been quite encouraging. I'd add that certain new technologies we developed, which we'd been trialing and positioning, are now performing really well within those accounts. So that's something we're quite happy about. Additionally, the pipeline appears very robust. In fact, one point worth noting: within the US, service provider came in flat, and much of that reflected momentum in the MSDC web scale area. Turning to Europe, we recorded growth in the high teens, and MSDC web scale performance there was quite strong too. As for the public sector, results were fairly steady across different regions, driven largely by the substantial stimulus numerous governments worldwide injected into the economy. Spending at the federal level in the US came in strong; we also observed considerable infrastructure being deployed across K through 12 while students were absent. E-rate performed well, no question about it, and our expectation is that it continues doing so. Beyond that, we picked up on certain outlays tied to the CARES Act coming from local and municipal government entities. That said — the teams, we devoted a portion of this week to time with the leader, especially within the US, and my read is that he stays rather optimistic.

Thank you.

Next question, please.

Thank you. Kelly, you will truly be missed—please keep in touch. To Chuck or Kelly: can you help us bridge or reconcile the difference? Public sector orders increased by 5%, while enterprise dropped 15%. Why is one so much stronger? Looking at year-over-year comparisons, twelve months ago enterprise orders were down 7% and public sector was roughly flat, so those comps don't account for it either. Could you clarify—are purchasing decisions diverging because COVID has impacted everyone globally? If you could help us square that, it would be great.

Honestly, much of that comes down to the factors I already mentioned. Governments everywhere received substantial stimulus funding. Here in the US specifically, things looked strong — we benefited from both Department of Defense budgets and spending at the city and town level. State governments were a bit soft, though the federal side performed well, and local was solid too. E-rate funding came through — that new E-rate initiative got underway, Jim, and once it ramps up it adds quite a bit. We're really just at the start of its next cycle. Beyond that, Germany's public sector also showed strength. So overall, I'd say it was mostly a matter of steadier performance. Beyond America, clearly, there's a fair amount of healthcare. Within America as well, a significant portion of that involves healthcare within the public sector, especially beyond America.

Chuck, I really appreciate all the specifics and the clarifications. And Kelly, farewell. Thanks a lot.

Thank you, Jim.

Thanks, Jim.