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

Hello, everybody. Tim Long here at Barclays, along with my colleague, George Wang. Thank you for joining us for a fireside chat with Cisco. We're very happy to have Chuck Robbins with us today, obviously, CEO of the company. He's been there a while, doing a great job over the last multiple years here as CEO, taken over for a long time leader in John Chambers. So we're going to get right into the Q&A. First, I'm going to throw it over to Marilyn Mora to go over the disclosures, and then we'll start the Q&A.

Right. Thanks, Tim. Thanks for hosting us today. So off to the safe harbor. We may be making forward-looking statements, so I'd refer you to our SEC filings, for example, our 10-K and our 10-Q, which can be found on Cisco's Investor Relations website. So back to you.

Thank you. Chuck, thanks so much for joining. I was hoping we could start out with something a little bit more on the macro side. I think Cisco, over the years, has always been a pretty good barometer of economic activity and particularly changes. So I'm curious kind of if you can just give us a quick overview of what you're seeing from the different customer constituencies now as we kind of move out of this pandemic and back towards a little bit more, hopefully, steady economic time and back-to-work environment.

Yes. Tim, first of all, thanks for having me. And I think that Marilyn coming on and doing the safe harbor is clearly a statement that I haven't done it correctly over the last few years. So anyway, it's good to be here. And I think that if you look at like the last quarter we had, as it relates to the macroeconomic environment, I think it says a couple of things. Number one, we do -- we certainly do better when the economy is doing better, and I think we're seeing economic improvement happening around the world. But I think there's a bigger thing that's going on, and that's a -- through the pandemic, I think technology has been at the heart of how we've navigated our way through it. And I think that CEOs and other C-suite executives, political leaders around the world, they experienced technology in a way that they hadn't prior. And I think what that has done is not only given us the ability to feel the impact of the economic recovery, but also, there's a huge commitment to investing in next-generation technology now because they've seen how it works. Some companies or organizations don't ever want to be caught flat-footed again, so they're moving on modernizing everything. Others realize that there's competitive differentiation that they can gain from technology, so they're moving on deploying it. They can interact with their customers differently and more efficiently than they have in the past. I think when you look at the last 2 quarters, for us, we've had product order growth in excess of 30%, which is first time in a decade that we've seen that. And last quarter, clearly, 8% revenue growth; 8% EPS growth; we've got our web scale business that grew 200%; RPO, over $30 billion; product RPO growing 18%. So not only the demand for the solutions and also the transition we've been making in the software, I think really has been accelerated as we've come out of this, if we're coming out of it.

Yes. Great. Great. Excellent. Yes. Now let's get -- let's talk about some of the businesses here. I think we should start with software. Obviously, that was one of the discussion points coming out of last quarter. We just did a big piece on it ourselves. But would love to get your perspectives here. And obviously, there's a little disappointment on the growth rate, but some of the other indicators were pretty positive. So maybe if you can first talk about how customers feel about some of these transitions. And then, second of all, maybe give us your thoughts on what investors should look at as the proof points that you guys are being successful. It's obviously not just revenue.

Right. Right. Well, thank you, Tim. I think if you -- first start with the customer side of it, and I think there are aspects of our portfolio that are transitioning to software that customers naturally expected to transition software. Security is moving in a big way towards just software solutions, cloud software solutions, in addition to high-performance hardware, but a lot of software. I think there's certainly cloud-based subscription of managed hardware, which has become more of a norm that we're seeing. And then there's things that we're -- we've actually been a leader on, which is driving subscription-based software on our enterprise networking portfolio, which we were the first to do that no one thought we could really pull off. And I think -- in that case, I think some customers have been a little mixed on it early. But then I think what they figured out is that we add more innovation to it, and they're getting more forward over time. So one simple example is we made the acquisition of ThousandEyes, which has incredible insights on what's going on in the Internet on a global basis or the private network. And we added that into the premium DNA subscription. So the customers feel like they're getting -- they are getting more value for having a subscription. We would not have done that in a prior model. So that's that piece. And then if you think about how do we think about success, I mean, we've added -- we've started disclosing ARR. We started disclosing RPO, and RPO is really a leading indicator for revenue, particularly in software and services, and it was in excess of 30%. Again, I mentioned that product RPO grew 18%. And then, the final thing I would say is the disappointment on the growth rate in software last quarter, and I think one of the questions was that supply chain doesn't have anything to do with software. And I think we need to clarify that, actually, supply chain does have something to do with some of our software. And the reason is we have hardware that it has this subscription associated with it that's sitting in backlog. So that subscription actually sits in backlog with the hardware until it flows through and the hardware shifts. And then we'll take the upfront revenue on the subscription, and then the balance of the revenue goes into RPO. So just to put it in perspective, at the end of Q4, that software that was attached to hardware sitting in backlog was $1.8 billion, and it had gone up by $900 million during the quarter. So in normal supply chain times, that would have flowed through, and our growth rate would have been somewhere in the 20s, which would have been much more of what would have been expected. So that's something that we didn't probably make as clear as we could have on the earnings call.

Okay. Yes. That's great. That's interesting. Maybe sticking on kind of software-related. You mentioned security. So maybe you can talk a little bit about -- it's been a little bit disappointing as well. I know it's probably some of the same answer where there's hardware in there, and that's been a problem. But maybe more broadly, how do you feel about the software portfolio? I know it's something that you guys have added to over the years. And I think in the security end market, you kind of always need to do that. So maybe walk us through kind of where we are in transition and how you view that going forward.

Yes. There's -- so when we look at the subscription portion of our security portfolio, it grew 15% last quarter, which, at our size, it still grow -- we still would expect it to grow faster. So we got some work to do. There's a lot of work going on from an integration perspective across different aspects of our portfolio. So when I say we have work to do, it's really just integrating these things and really getting the value from having these different capabilities inside the company. But we have a drag on revenue from some supply chain issues related to on-prem and then the on-prem to cloud transition that we are experiencing there as well as in our cloud portfolio that just native pure software, just newer companies that have just a pure software, don't have a legacy in the on-prem piece, so they don't have to deal with that. So -- but the 15% subscription growth in the areas where we're investing for the future, that was a lot more reasonable. But again, I think our teams expect higher growth, and I think that's what they're focused on driving in the future.

Okay. Great. Maybe let's switch to one of the real big success stories. You mentioned the 200% order growth in cloud. I think it was probably 6 quarters ago, you weren't really giving any data points on cloud, and now the numbers are pretty large. So maybe just give us a view how you guys turn this around and how much runway you see for it. I mean these cloud customers are always going to want to do some things themselves, so -- and it's also a pretty competitive market. So kind of what were the success factors? And how does that translate into sustaining some of this?

Well, we made a very strategic acquisition probably 7 or 8 months after I became CEO, a company called LIVA, which was a next-generation silicon company out of Israel. And they had yet to actually bring any silicon -- take any silicon out. But we knew them, and we believe in what they were going to build. And they executed incredible -- incredibly well over the last 6 to 7 years. So they built next-generation silicon that is incredibly powerful but at the same time consumes a lot less power per -- for the bandwidth that you're getting. So increasing the bandwidth capacity taking power now is a good combination, particularly for the web scale players. And our teams have built great products around that silicon. But we also -- we spent the last few years, and I said this on an earnings call -- earning calls early in my tenure that we had missed the first wave, and it was going to take us a while to actually be ready to hit the next architectural transition. But if you hit it right, it's sort of a 6- to 8- to 10-year run that you get with these players, if you do things right. And so we rebuilt our relationships with them. We built great technology. And then we offered them choice. If you remember, in December of 2019, we made a big announcement around the Internet for the future, which announced these next-generation systems. But we also said we'll also sell you our software, if you want our software only; or we'll sell you our hardware, if you want our hardware only; and we'll sell you silicon or optics. And you can buy any combination of those or you can buy systems. And each one of them has a different view on how they want to consume the technology. We've won franchises across all of those models. And I think that was a big move for us where they believe if we were going to meet them where they are, then we were going to deal with them in a way that they wanted to be dealt with. And our teams have just done an astonishing job. It's -- we grew 200% last quarter, and on a trailing 4 quarter basis, I think we're up 120% on orders. And it's a meaningful number. This is not a trivial number. They represent, I'd say, over 20% of our service provider segment. So they have become a meaningful part of our business.

Great. You talked -- you mentioned the wins in both software and particularly in silicon. Could you just talk a little bit about -- is this kind of viewed -- I think it's hard to imagine the revenues from silicon sales or software sales to the cloud guys as being material enough for the entirety of Cisco. So can you talk a little bit about what it means for land and expand? Or does it help get you in the door and then you sell more 8000s and 400-gig switches? And kind of related to it, particularly with the silicon, how much of this dynamic do you think is becoming a real second source to a dominant silicon provider to the cloud guys?

So as we think about the value of selling silicon, some of these web scale players, they have a strategy to build their own white boxes and so -- in order to participate. And you're right, the size of that business would not be as big as if we were selling them integrated systems. However, from a relationship perspective, it's really -- it's very important for us to be there for them. And in some cases, they are looking for a second source just -- and that's been the case for service providers forever, right? Even the large telcos, if you go back, they would always have 2 core routing providers, and then they would sort of split the business up, just to make sure that if there was ever a severe problem with one, they can fall back on the other. So I think that has played a part of it. But I will tell you that we have won silicon wins in web scale providers that have then subsequently placed systems orders with us as well. So it's really a way of meeting them where they are but also gaining trust and just continue to build the relationship.

Okay. Great. Great. Maybe if we head to the campus for a little bit here. It's gotten more competitive, right, with Arista pushing into the campus switch market more aggressively. And it seems like Juniper has made a decent acquisition on the WiFi side. So talk a little bit about this market where you guys have long been almost a dominant player, and now you have some of these competitors of yours being a little bit more aggressive. So what's the strategy to retain and maybe take market share in that segment?

Yes. I think that if you -- as the backlog clears, I think you'll see what's been happening in this space because I remember a few years ago, we were talking about, could that even grow at low single digits? And now we've seen unbelievable growth rates in WiFi. As customers transition to WiFi 6, we've seen the Cat9k was the fastest-ramping product in the history of Cisco. I'll probably have to check and see if the new 8000 has eclipsed it. But the customers are buying into this. And I think you're -- it's a -- the transition that we've seen, we've talked about the fact that on the existing installed base and where we are on the transition to the 9K, which we launched in 2017, we're still less than halfway through that. So there's still a lot of runway left. I think that if you look at the growth rates that we're exhibiting in that part of the business, I think you would assume that we're holding our own, and probably, over time, we'll be gaining share. Now we went to a subscription model. So some portion of that upfront sale, we actually recognize over time where our competitors don't. So it's a little bit of a more murky model to really get into the classic ways of looking at market share. But I think if anyone had told me we'd be seeing the growth rates that we're seeing right now, I wouldn't care about market share. I'd be very happy as the teams are performing very well.

Yes. Okay. Great. Great. Yes. Maybe sticking on this a little bit. You mentioned the installed base, and it's -- you're still not halfway there. So is there something in the future where that will cause that transition to accelerate? Meaning will there be changes to support level for equipment that's a certain age? So can we expect that there -- other than just macro and enterprise demand, will there be something else that can help that transition accelerate here?

Well, I think that -- I think we're seeing the acceleration of the transition right now because the -- I think every customer is looking at hybrid work. They're looking at modernizing their infrastructure. They're looking at ensuring that they have safe spaces when they come back. So leveraging some of the technology we have built into our WiFi infrastructure, as an example, around DNA spaces to help understand where people are with the pandemic that doesn't seem to want to go away. And so I think it has been -- has continued to accelerate. We run our business. We do normal end of life, end of support processes like everybody does. So those things certainly will have an effect. But I think customers are just moving through the process right now of the timing that they have and what it takes to actually make these changes. And I think we're just going to work through it. But I think it's definitely moving faster than it was 12 months ago.

Okay. Great. Kind of touch on a little bit of future markets and growth and some real TAM expansion -- expansion market, adjacent opportunities. So maybe you could just hit on a few of those that you think will be meaningful. I think most investors were a little surprised by the 5% to 7% growth target longer term. So I imagine these markets are going to have to develop well for Cisco. So maybe just highlight a few of the most important ones for us there.

Well, one of the things, I think, when we talk about the 5% to 7% long term, I still don't think that people recognize the power of the stacking of the software revenue as we get into the renewal cycles. And so that's one piece that certainly goes into it. I have watched how we have constructed our guidance over the last couple of quarters. And seeing the magnitude of the revenue that we're taking off the balance sheet versus 6 years ago, if we have been giving guidance in some of the environments and we were still running the same place we were running 6 years ago, the numbers would have been significantly worse. So it's -- so that transition is certainly helping us with the long term, and it's given us more visibility even though we're in a very dynamic situation right now, as we all know. But I think in normal times, we're going to have a much more predictable and have a greater degree of visibility than we have -- than we did 6, 7 years ago. From a market perspective, I think one of the big areas is the application space and full stack observability is big. I think hybrid work is going to continue to be a major play for our customers going forward. And while we report collaboration and conferencing and hybrid work as a category, it's much broader than that. It's just very difficult to break it out in different parts of our portfolio. You have this -- I've said the irony of all ironies is that there was a belief that cloud was the demise of Cisco, and now cloud is actually driving our growth. Our sales to the cloud providers, frankly, the rearchitecture of the core infrastructure of every enterprise and every government, every commercial customer around the world, to deal with traffic patterns that are nowhere close to what they were when we designed these networks the first time. So we're rearchitecting all of that. That's a big play for us. The 5G transition is huge. We're just getting started on that. The 400-gig transition is huge. We're just getting started on that. And so there are -- we have probably more opportunities across aspects of our portfolio -- all aspects of the portfolio than we've seen in a very long time.

Great. Great. You mentioned 5G, I think, in your telco vertical. It's probably been overshadowed, the traditional telcos, by how good cloud has been because that's in that vertical for you guys. But we're seeing real strength across telcos as well, and it's always been an important part of your business. So maybe talk a little bit about that vertical, what is Cisco doing there? How do you see those dynamics? Most I talked to in the industry think we haven't seen a setup like this for a decade or so. So curious what you think about that end market.

I think that's a safe belief, the decade comment you made. Look, we talked about 5G for years on our calls, and we kept saying, when it goes, it was going to go consumer first, and that's sort of what we've seen at this point. But I think you'll see -- you're going to see the move to enterprise services. You're going to see the move to private 5G. We're beginning to see the telcos adapt versions of our 8000 that the web scale players are taking a certain version, that telcos are beginning to build out. That will be a platform that will be really important for the backbones of the future for 5G. We've got our packet core technology. We've got an incredible backhaul cell site routers that the teams will be building. And these providers are really looking to Cisco to partner on delivering enterprise services because that's a huge part of how they're going to recoup their investment on the infrastructure that they're going to build out. The enterprise services are what they're all looking for, and so that's a big play that we have yet to begun to see at scale. But we're working with most all of them today on how they can build out the infrastructure, what services they want to do or want to deliver. And then private 5G, private 5G services that the teams are working on as well. You're going to see a lot in that space. And I think we're also beginning to see the real acceleration of IoT, right? We've talked about it for a very long time. I think we have upwards of 180 million connected vehicles now on our connected vehicles platform. And we think that's going to expand. We're going to begin to see more and more of this connectivity. I was speaking to a government leader in Europe, who very aptly pointed out that all of the sustainability efforts, we're going to drive more and more technology consumption because we -- in order to make these environmental systems or these industrial systems more efficient or hit sustainability goals, we have to connect them. We have to drive automation, and those kinds of technologies are going to be key. And so we think there's a lot of great setup for 5G over the next few years.

Okay. Great. Great. Maybe, Chuck, one of the other things that Cisco has been known for and use part of the strategy over time is M&A. It's always been a core competency for the company. There's been some transitions. There were days where I would say it's only going to be software and services, and then you guys buy some base-level optical and semiconductor technology. So you guys have certainly pivoted where you're focused. So curious what your -- what do you think the strategy is now. Obviously, you got to fight valuations in parts of what you might be looking at. So just curious where you think the priorities. You guys obviously have really good cash position and ability to do larger deals. So maybe big, small and kind of where you think the focus areas would be.

Yes. Well, first of all, I joke internally all the time that while we're making a transition to a much greater percentage of our portfolio coming from pure software, we also are going to build the best high-performance hardware in the world because the Internet needs us to. And acquisitions like Acacia, Luxtera, those kinds of acquisitions have been really core to our future. And if you look at some of these higher speeds -- just to give you a little rationale for that. If you look at these higher-speed ports that we're going to be delivering in the future, the profit is shifting and the cost is shifting hard from the port itself to the optics. So it's really important for us to protect our future revenue by doing that. And it helps us -- it just gives us more strategic value with a lot of the web-scale players and others. So those were really important from that perspective. The -- on the rest of the M&A front, I think you'll continue to see us look for opportunities in security. Full stack observability is an area that's going to be super important for us. I think there's opportunity that are going to arise with new technologies at the edge as we look to the future. But we'll look across the entire portfolio. And we'll continue to -- we've never had like a stated like we'll only buy companies that are this size or smaller. We just -- we've always looked for strategic fit, for proper valuation, for cultural fit, and we still look for all those things. So that's going to drive how we think about it as we go forward. From a valuation perspective, it is what it is, right? I mean it's -- they are where they are. We've had -- I've talked to our team, and I say, you either sit around and wish they were lower priced or you decide if there's -- if it's strategic enough at whatever price you would have to pay, and that's what drives your decisions. And that's how we'll think about it going forward.

Right. Right. Okay. Great. Great. I did want to ask one little bit more financial question here. I think before you've gotten to your CEO role, Chuck, the company was pretty steady 28% op margin and since you guys have done a really good job of expanding the profitability. So I'm curious how you're thinking about profitability relative to growth over time. Of course, at the Analyst Day, you gave the same EPS growth as revenue growth. So it was probably a little bit of a surprise. There wasn't more of a gap there. So maybe if you can just talk about the trade-off between growth and investment and move to software should help. So there's a lot of moving pieces in there.

Yes. So we had someone tell us after the Analyst Day that we would have been better off giving a 3% to 5% revenue estimate with a 5% to 7% EPS estimate. People would have liked that better, which is hard to get my head around. But look, I think that -- Scott and I have had long conversations about this. And I think if you look at the growth rates that we're seeing -- and granted there's an element of customers ordering into the lead time window that they have to deal with. So we're not confused that there's some of that going on. But I think the overall demand is being really driven by this recommitment to the importance of technology and this new understanding at some level of the power of technology. And so we just -- we believe it would be irresponsible for us not to be investing to drive the innovation that's going to protect the growth 3 years from now. And so that's the decision we've made right now. I think from a profitability perspective, over time, you'll continue to see the -- as the software continues to become more and more a higher percentage of the revenue, you would expect to continue to see improvement. But right now, what we gave at Analyst Day is what we're going to execute against. And we see so much opportunity right now. And it's very difficult, over the long term, to run a company that -- where you're driving EPS at a significantly higher rate than your growth because you just -- over time, you're not going to be able to invest to be competitive. And so it feels good for a couple of years. But over time, I just think it's going to be a painful thing to reckon with. So that's the decision we've made, and we'll continue to work to try to drive leverage. That's what we do. But I feel very good about the opportunities right now. We don't want to miss them.

Okay. Maybe just -- I'll sneak in, we had 1 minute, 1.5 minutes. But yes, I think I asked this on the call about the Cat9k renewals. I think we're coming up on 3 years of kind of the big part of the initial phase of deployment. So do you think the next year, when these bigger base of these come in, is there a lot of risk on will they re-up the software and/or does the hardware go back out to bid? Or do you think it's more likely -- we're hearing most are just going to re-up on the software. So do you think it's going to be a nonevent? Or do you think there's a potential disruption here?

I don't think there'll be a disruption. I think that -- I think we've got -- early numbers have been positive, but they're small, to your point. In the second half of this fiscal year, they get a little bigger, but really, it's fiscal '23 when we see the volume, and the teams have great plans in place that they're executing against. So we'll have to see. I don't think there's going to be a disruption, though, because the -- there's lots of alternatives that customers have to keep running the stuff. And so our job is to make sure that they are seeing enough value from the new capabilities of the subscription that they're going to renew, and that's what the teams are focused on.

Great. Great. Awesome, Chuck. I really appreciate the time. You're always very succinct and value-added in your answers, so we really appreciate that. Thank you so much.

Thanks, Tim. Appreciate it, buddy.

Have a good day. Let's talk -- look forward seeing you in-person.

You, too.

Okay. Bye.

For sure.