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

Thanks again for joining the company here today. We've got with us today. We're excited to have Cisco Systems. With me on stage, we've got Bill Gartner, SVP and GM of Optical Systems and Optics Group. And with Bill is Sami Badri, Head of Investor Relations and Market Insights.

So I thought maybe, Bill, you were here last year, I think a lot of people were familiar with kind of your role at Cisco, but I think maybe for those, maybe a little bit less familiar, can we just start with kind of what falls under your purview, how we think about what's responsible into your business and how that fits into the Cisco portfolio?

Sure. Thanks, David. First of all, thank you for having us. I have responsibility for Optical Systems and Optics at Cisco, and let me just explain the semantics there. Optical Systems include the traditional DWDM systems, dense wavelength division multiplexing that are sold to service providers primarily and hyperscalers who are trying to get signals across the city, or across the country on a fiber optic infrastructure. And competitors in that domain would include guys like Ciena, Fujitsu, ADVA, Infinera, Huawei, ZTE. It's pretty fragmented. Big Iron, there was a chassis-based solutions with line cards and software wrapped around them. That's one business. The other business is the Optics business, which are the transceivers that we sell for use in switches and routers inside the data center or inside a Campus environment. That's a short distance optic, typically less than 10 kilometers. It's a simpler optic, in many ways, though simple as relative. And then the third business that I responsibility for is Acacia, which was an acquisition we did just about 6 years ago. And Acacia provides the underlying coherent technology that are used in optical systems and also in our -- in DCO pluggables that are used for things like DCI and scale across networking. Those are the three businesses.

We rewind the clock 12 months ago, we were here. I think it was at the cusp of this surge or tie a wave of demand from hyperscalers regarding AI and optics. So maybe we can talk about what you've seen over the last 12 months? And maybe let's start with optics, because that's, I think, a little bit more relevant. And then the Acacia piece, and what's changed over the last 9 to 12 months, if you will?

Yes. So Acacia has probably provided the most significant upside for us in those three groups that I mentioned. In that we have seen just dramatic demand primarily from the hyperscalers, increasingly from service providers as well, but primarily from hyperscalers for DCI optics, optics that help them interconnect data centers now scale across and really across all of the hyperscalers, we don't announce specific names with hyperscalers. They would actually not give us permission to do that. But we are in all of the hyperscalers and in the top service providers as well. We've seen tremendous demand. So our -- FY '25, we had significantly more demand than our original forecast for the year. In FY '26, we have -- even after first quarter, increased our forecast for the year for that business as we see just continuing growth and demand for the optics that are used across data centers.

I want to ask you a nuance question, which I wasn't going to ask you. So we talked about this last night, you have historical DCI, and now we're talking about scale across. Can you maybe help investors understand because this was maybe a nuance that I didn't quite appreciate, how scale across is different than traditional WAN? And how hyperscalers and maybe other customers are thinking about the different use cases and where the technology that you bring to bear plays into that sort of dynamic in that need case?

Right. So if you think about the traditional WAN that has a certain amount of bandwidth associated with it. If you just normalize it to one, the scale across network helps solve a problem in that, that WAN bandwidth is constrained. And if you look at the total capacity in a scale-out network, the total capacity relative to the WAN is something like 10x. And if you look at the scale-up network, it's another 10x. So there's much, much more capacity in that scale up than there is in the scale out, and there's much more capacity in the scale out than there is in the WAN. And what some of the hyperscalers were doing is trying to basically cram scale out capacity through the WAN, and that is DCI, data center interconnect. And it served as a significant source of growth for us, but it was constrained because the WAN just wasn't built for that amount of capacity. What scale across is, is that it really allows us to connect the scale out networks directly. So you're effectively bypassing the WAN and going scale out to scale out. And what it does is it really allows a service provider to scale the AI infrastructure very, very cost effectively. And given the full capacity of scale out, basically making that look like it was all within the four walls of a data center. So it is a nuanced difference between DCI and scale across. The optic doesn't change. The optical interface doesn't change, but the amount of capacity does, and it turns out there are some capabilities in the routing or switching that help with that, for instance, if you're scaling across racks in the data center, you're less worried about things like a link flap that might occur. If you're scaling across data centers, now you have a much more significant fiber infrastructure, much more subject to things like link flaps, the router or the switch now has to have things like deep buffers that can accommodate that and recover from that very quickly. And that's -- so it's those things going together that really make for an effective scale across applications.

So is that what you're seeing? So obviously, last quarter, you had an incredibly strong order number for your Optics business or Acacia business. Is that what's driving the strength? I mean, we talked a little bit about it last night at dinner. I mean, it was like a surge in demand that you saw from multiple customers, multiple hyperscalers. Is that kind of the underpinning of what's driving that growth? Is the demand for scale across? Or how would you characterize kind of the driver?

We actually -- I think it's hard for us to tell at times whether that's DCI or scale across. But between the two of them, we're certainly seeing a significant ramp in the demand there across all of the hyperscalers.

And so last quarter was considerably stronger from an optics perspective than your traditional switch, AI-powered switch business. How do you think about over time your ability to be a relevant sort of mix in your AI? Because I think in the guide you've given historically 2/3 are switch, 1/3 are optics. Is that a good rule of thumb for, I think, investors to focus on as we go into fiscal '26, fiscal '27 and beyond?

I think it's a good rule of thumb based on what we know today. The mix change can make that -- at any one point in time, any quarter, we may see a difference. The last quarter was more heavily weighted towards optics. But a lot of that has to do with where customers are in the deployment cycle. They may acquire the switches first, get those switches deployed and then put the optics in. And so if they're sequencing their orders, along with their operations, we're going to see spikes in the demand for switching versus optics. I would say our best view at this point is you can think about it as about 1/3 for optics and optical versus switching. On any one given switch platform, though, you may see a very different profile. We've -- and also depending on the customer, but we've seen customers who procure a switch with -- fully equipped with 400 gig or 800 gig optics. And in that case -- not the ZR optics. And in that case, it might be 50-50 or even more heavily weighted towards optics if they're using ZR optics. So it is very much dependent on where they are in their deployment cycle and where the -- if they're sequencing orders...

You bring up a good point. So when you think about your holistic hyperscaler customer base, customers move at different paces. They have different technological road maps. There are some customers that are deploying switch and optics at 400, some may skip 800. How do you think about the evolution of your Optics business as we go from 400 to 800 to ultimately 1.6? And kind of how do we think about the timing of -- I know it's not a homogenous group, clearly, but just maybe help us kind of frame out how you're thinking about that.

So there's no question that the hyperscalers lead the demand curve here and they dominate the demand as well. But these things have very, very long tails. And I was speaking with a group just earlier, and I think 10 gig still represents a big portion of my optics business, 10 gig. And 10 gig has been around for 25 years. And the reason that, that's the case is that what we see as hyperscalers will deploy our technology. And maybe even move to the next generation before service providers start deploying that same technology. And service providers can deploy that technology for 10 years or more. And then we'll see enterprises and commercial customers deploy our technology. And so the lifespan of that technology can be very, very long. We are at the cusp right now of 400 gig transitioning to 800 gig for service providers, but we barely touched the service provider market at 400 gig. It's penetrating now. And we haven't even begun to touch the enterprise market at 400 gig. So these technologies are all going to have a very long curve, lifespan curve. We are moving today from 400 gig to 800 gig as you mentioned, David, in some of the hyperscalers. Some decided they were never going to deploy 400 gig, and they're only going to go start at 800 gig. And most of them have also decided they needed some 400 gig. So they've kind of backed off that view. We have some hyperscaler customers who have decided they're going to go from 400 gig to 1.6T. They're going to skip the 800-gig transition. A year from now, they may decide they need to deploy some 800 gig. So these things tend to be very fluid. But we are seeing right now a transition from 400 gig to 800 gig on the part of some of those hyperscalers, a pretty aggressive transition. And most of our growth right now is in 800 gig.

And maybe just to level set. So on the SP enterprise side, you mentioned that long tail of 10 gig. Is that on systems and optics?

Yes. It's on both. systems and optics, yes.

On both. So presumably, you have a long tail on optical systems as well despite the risk of -- I think the market is concerned that pluggables is somewhat cannibalistic to systems chassis and transponder business. How do we think about that sort of maybe trade-off between that long tail that you just mentioned where customers have these speeds 10, 15 years versus maybe SP and enterprise adopting a more pluggable architecture?

Yes. So the -- right now, the SPs are beginning to deploy the pluggable technology. I'd say beginning, we've got 400-plus customers that are deploying that, which is a good chunk of the market. But in terms of the total volume, I think we're early stage in deploying that technology. Enterprise customers historically have not deployed a lot of the optical systems. They rely on service providers to deliver that capacity. So that's really where our eyes are on what's happening with the service providers. The enterprises would be deploying switches locally and the optics associated with those switches, but not the long-reach optics that would span a city or a country. So these technologies will have a long life. We don't expect disruptive changes on the part of any customer, even a service provider who is moving from transponders to pluggables. We can make that a very natural transition for them. It's a cap and grow. It's not a rip and replace. And so I think we're very cognizant of how those transitions are going to take place with customers.

Got it. And I know this is not your purview, but I'm going to ask it and maybe Sami chime in on pluggables, Acacia and silicon. So you've had this multiple vector from a technological innovation perspective in the last 5, 6, 7 years. How does sort of the road map of Acacia and the road map of Silicon One and what you're trying to do holistically with hyperscale customers kind of play together? I know in the past, it was this is the Cisco solution, take it. Now it's, we're going to go to -- we're going to meet the customer where they want to be. So maybe you could speak to how the road map from Silicon One and Acacia maybe in parallel kind of lead you to where we are today.

So I can say it was December 2019, you had about the right time frame here. December 2019 that we made an announcement that we were going to support a component business model. And what we meant by that was that historically, our business model was we would sell switches and routers as fully integrated solutions, hardware, software, services, everything is in there. And that's the only business model we had for customers. If they wanted to buy something from Cisco, they bought everything we had. It was a stack of equipment. And the hyperscalers rejected that model. The hyperscalers wanted to pick and choose the technologies or the portion of the technology that they felt was relevant for them, and they were capable of putting things together. So they largely succeeded in disaggregating the market. Hardware and software, we had SDN craze going on for a while with hardware and software separated, then even within the hardware separation of the platform from the Silicon. And hyperscalers were adamant that they wanted to pick and choose the technology. They didn't want to take everything that we had to offer. And so in December 2019, we announced a component business model that said, if you want to buy hardware from us, we'll sell you the hardware. If you want to buy software, we'll say you the software. If you want to buy a piece of the hardware from us like the silicon, will sell you that. You want to buy an optic from us. You want to buy a DSP from us. We'll sell you that. That was motivated in part by a desire to capture hyperscaler business more significantly. But it was also motivated by the fact that we were acquiring Acacia at that time, and Acacia had a component business model. They were selling components to their customers, and we had to adapt our systems and our processes to support that. That requires new ERP systems, that required rethinking the cash cycle, rethinking inventory, very different business model around components. And so we worked very closely with Silicon One. Silicon One now is part of that component business model, where if a customer wants to buy our silicon and build their own white box, they can do that. We work with Silicon One on that sort of commercial model, but also in terms of timing, things like Silicon One going from 100 gig SerDes to 200 gig SerDes. Our optics, both the short-reach optics and the Acacia optics need to match that. And so we work very closely with our Silicon One teams.

I didn't ask you this the other day, but would you be open to selling other parts of your ecosystem, whether it's SerDes technology, DSP? I know there's some chatter in the marketplace by maybe one of your competitors that they're looking at that down the road as a potential opportunity.

So we do sell our DSP today. We do sell our DSP technology. Acacia is probably the example I can give you the most detail on. When Acacia came into Cisco, Acacia was selling DSPs to some customers, they were selling embedded modules, which ultimately landed on a transponder. We still sell that to customers, including hyperscalers who want to build their own. And so we will -- for anything that's a unit that we would have today, so SerDes is more of a technology that gets embedded. But certainly for DSPs, for photonic integrated circuits, we're selling those to module makers who go build an optics module and maybe we buy that back or maybe they sell that more broadly. Yes, we'll sell anything a customer wants to buy.

So I would be remiss if I didn't ask about supply chain. Cisco typically is generally considered best-in-breed. There's a lot of discussion across the ecosystem. I know it's not a big part of your BOM but DRAM, NAND, other components are in short supply. Maybe can you just give us an update on where you sit today in the context of what you communicated a number of weeks ago from an earnings perspective for the outlook for this year.

Sami, do you want to take the DRAM question?

Sure. Our updated FY '26 revenue and EPS guide does factor in some of the latest price points, at least up until our earnings report. We have two teams internally that are running these calculations and know these numbers very closely. We have a supply chain finance team, and we just have an entire supply chain and procurement arm of the company as well. So we've accounted for all these factors into the updated guide when we reported it just a couple of weeks ago.

So it's not one of those -- well, not to say that it's not something that keeps you up at night, but it's on your long list of things that you're thinking about for fiscal '26, a little bit less relevant than maybe some of the other concerns out there?

Yes. I mean we do have -- we always have supply chain gaps. We've got an army of people who spend their lives, making sure that we've got those covered. But there's nothing that's keeping me up at the moment.

So I want to ask you since you tend to be very balanced. And I don't want to cynical, but we've got this question all the time, I'm sure you get this question, and I got this at breakfast this morning. When you ship orders, when you're taking a purchase order and you ship, I think it's been publicly stated is that, that turns into a data center deployment almost immediately. How are you thinking about what hyperscalers are ordering, buildup of inventory versus deployment of said product in the context of when the market is generally concerned about maybe not a repeat of '99 and 2000, I know you lived through that as well. And maybe just kind of share with us how you're thinking about that and how you guys internally frame it and kind of hope to triangulate the dynamic.

Yes. So I lived through the '99, 2000 era. That was not a place I would want to return to. But I think a couple of differences. One is that the buyers have money. And so that's a big difference for us. The other is that -- and you alluded to this, they are deploying this capacity as we ship it. So it's not sitting in a warehouse somewhere. We still deal with very compressed cycles from order to shipment. We're not seeing -- for instance, we don't get a year of lead time with a customer. They will give us an order and expect it to be delivered within 90 days typically. And so I would say the intervals that we're managing here are relatively short still. We have significant backlog that we have to work down. But generally speaking, customers are looking for orders to be delivered within that 90- to 120-day period.

And is the backlog related to...

Sorry, let me just also add something. So in FY '25, we were in the state of ramping up the entire AI infrastructure motion and customer engagement. And in FY '25, we recognized $1 billion of AI infrastructure revenues. We took in a bit of over $2 billion. So let's just say, 50%, right, immediate conversion. And FY '26, that exact percentage based on what we've given is more like 75%. So that's based on the $3 billion plus of revenues expected in FY '26 to ship. And then roughly double the AI orders to be taken in and that's like the at least double FY '25. So our ratios are tightening up quite a bit, and that's just one big change in FY '26 versus FY '25.

Just so -- that's a great clarification. Just to be clear. So when I think about your backlog that's both on systems and Acacia, and that is a reflection of the strength in orders from AI in '25, but there's no excess backlog in other parts of the business. It's not your purview, but there's no excess backlog sitting in routing, I doubt that, right, or Campus, right? Campus is about to go through a refresh. So this is strictly an AI-related backlog.

Yes. I'd say that's true.

Yes. And then also, where we're really building up supply to make sure we're ready and we're really building supply for our internal demand is Silicon One. So in Q4 FY '25 and Q1 FY '26, you'll see an advanced purchase commitment disclosure. Those numbers were up around 50% year-on-year in each of those quarters, and that's really a component going into our main systems. And you'll see our inventory levels haven't actually moved up as materially as those growth rates.

Maybe one more for you, Bill. When you think about what your competitors are doing with ZR, there's a lot of noise in the marketplace. A lot of investors, I think, struggle with competitive positioning, market share how to think about the growth in the underlying market, bandwidth growth, ASP offset. Maybe help level set, obviously, I think from our checks, I think Cisco Acacia has probably the biggest market share in pluggables. Correct me if that's not correct. But how are we thinking about your position with the hyperscalers? I know I think we've talked about that there's multiple hyperscalers, you sell to everyone. Maybe kind of level set like how you see the competitive landscape.

So first of all, I don't discount competitors that are -- like meaningful competitors, Ciena, Infinera, Marvell, I would consider meaningful competitors. Cisco has been, I think, leading the charge on pluggables since we did the Acacia acquisition. And for the most part, our competitors in the optical space discounted that dynamic and said, no, no, no, this pluggable thing is just going to be a niche market. We're not going to have to worry about that. Our view was and remains that pluggables are going to dominate the deployment models for hyperscalers and for service providers as we go forward, and we'll see it diminishing role for transponders. It won't be 0, but there'll be a diminishing role. And I think that's largely played out. And now we see others sort of embracing that model, I think, more reluctantly in some cases. But out of necessity, embracing that model. We're very comfortable with the fact that we've got significant share at all of the hyperscalers. We, again, do not announce specific names, but I would say, join the club. We've been there. We're doing that right now. Others may have a need to make a more public announcement with or without the hyperscalers' permission. But we are in all the hyperscalers at this point. And as I mentioned, we're in 400 service providers as well. So including publicly announced Lumen, Lumen has announced a new Metro network that they're building for AI, servicing AI needs and basically serving the needs of hyperscalers and carrying capacity across the country. Our architecture using pluggables is routed optical networking or RON, and Lumen called their next-gen Metro network, MetRON, which is a combination of Metro and RON. So they have fully embraced the idea of using pluggable optics for their optical infrastructure.

Great. Sami, I have to ask some financial questions. So fiscal '26, we're off to a good start in terms of your outlook. Maybe can you help us understand how you're thinking about, how Cisco is thinking about fiscal '26? What are the drivers? Because we get questions and we got a question in the room. If I look back at Cisco over the last 3, 4, 5 years, there's been great technological innovation, but growth has been a little bit maybe more difficult to come by. So how do we think about where we sit today as we think about '26 and '27, what kind of underpins your confidence next year?

Yes. The most incremental driver really to the whole company is AI infrastructure. And then behind that, there are a couple of drivers, new use case wins, working with all the hyperscale there's kind of like what Bill discussed, but also the Silicon One program. For example, we took a $1.3 billion of AI orders in Q1 FY '26, but none of those orders included P200 use case wins. And the P200 is our scale across silicon chip that's also going to go head to head with some of our peers. So there are just incremental big drivers that are coming in an area that we didn't oftentimes play in, and now we're starting to show up. If I exclude AI infrastructure, and I look at the core, the core is really right now being driven by our Campus cycle. So about 1 quarter into the Campus cycle. That is a fairly sizable business because that includes Campus switches, SD-WAN and WiFi access points. That also will pull in security or it will pull in services. And we are 1 quarter in. And if you look at the last Campus cycle, that was around calendar year 2017 and 2018. And you saw a couple of years of very obvious cycle growth. But Campus and specifically Catalyst order growth from that original cycle going back 8 years ago, orders still grew in Q4 FY '25 and in Q1 FY '26. And now that we've introduced the new Campus smart switches as well as new access points, we are seeing adoption of the new platforms actually outpaced prior new announcements of products of the new platforms. So the core of the company is executing and you saw some accelerated disclosures in Q1, and we just started, right? And there's also an installed base of Cat4k and Cat6k switches that we are going to eventually end of service and eventually address with the new product. So on balance, the core is actually positioned well and we have some incremental growth coming in from AI infrastructure as well.

You just touched on it briefly, but I think either Chuck or Jeet mentioned that the Campus refresh cycle is measured in years, not quarters. Is that how we should think about? So it's not going to be this rev rec spike in '26, but it's going to be more durable in '26, your fiscal '26, fiscal '27 and beyond. Is that kind of an underpinning for the next 2 to 3 years. Campus is a more -- not muted but a more balanced growth vector than the spike that people anticipate.

If we were to compare and contrast this cycle versus the last cycle, when the Cat9k was announced, that was a fairly large upgrade versus the predecessors. So you did see somewhat of a hockey stick type reaction in the order activity. This is going to be much more gradual or more harmonized is probably the better way to put it. And yes, it is a multiyear, multibillion dollar refresh. And we also believe that, everyone keeps talking about large language models that are being developed, applications that are going to be consumed on the end user side. All of this needs to go through some form of connectivity and networking. We are one of the few companies that have the chips, the data center, the security, the software, the services to enable and deploy all these capabilities. And Cisco's product portfolio was also holistically refreshed within the last 12 months. So this is a very unique positioning for the company that we really believe in.

So I've got like another 10 questions, but I'd rather ask maybe Bill or Sami, what do you think the market is misjudging or what the misperception is, Cisco has gone through an evolution in the last decade, right? To your point, 6 years ago, we went to a completely new model effectively, if you will. So what is the market missing today? I know you've executed extremely well for the last couple of years, but what hasn't resonated maybe with investors from your perspective?

Well, one thing I think is that Cisco is in my view, the candidate to basically provide -- aside from NVIDIA. NVIDIA is going to have their proprietary stack. I think Cisco brings all of the pieces together with AMD partnerships and other partnerships, our networking, our optics to really be the open stack for AI. And I think customers are going to be looking for an open solution, not necessarily a closed proprietary solution, but an open solution. And I think Cisco is the best company that's positioned to support that need that is definitely growing in the market. We've seen other examples, Broadcom is probably one, where customers sort of revolted against what looked like a monopolistic behavior. And customers are going to look for an open solution, and I think Cisco is best positioned to serve that need.

Great. I think we're about out of time. So thank you, everyone. Thank you, Bill. Thank you, Sami.

Thanks, everybody. Thank you, David.

Thanks, everyone.

Thank you, David.