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

Hello, everybody, and welcome; I'm Sami Badri, and I oversee Investor Relations at Cisco. With me today are our Chair and CEO, Chuck Robbins, plus our CFO, Mark Patterson. You can find Cisco's earnings press release and supplemental information—which includes GAAP to non-GAAP reconciliations—posted on our Investor Relations website. Later, once this call ends, the recorded webcast and slides will be posted there as well. During today's call, we'll cover financial results prepared under both GAAP and non-GAAP. Revenue will be how we discuss product results, while product orders will be the basis for geographic and customer results, unless we say otherwise. Every comparison we make will be year-over-year. Keep in mind that forward-looking statements will be part of today's discussion, among them our guidance for the third quarter and fiscal year 2026. Risks and uncertainties that apply to these statements are described in our SEC filings, especially the most recent 10-K and 10-Q reports, which lay out important risk factors that could lead actual results to differ materially from what our forward-looking statements contain. Regarding guidance, further details are available in the slides and press release accompanying this call. Unless Cisco makes an explicit public disclosure, we won't comment on financial guidance during the quarter. I'll now hand things over to Chuck.

Thanks, Sami, and I appreciate everyone being here today. The second quarter came in very strong, with both revenue and earnings per share increasing at a double-digit pace and landing above the top of the guidance ranges we had provided. Q2 brought record revenue, which keeps Cisco on course for our best year ever, consistent with what our full-year guidance indicates. During Q2, total revenue growth sped up to 10% compared with a year earlier, while product revenue rose 14%, fueled by powerful demand for AI infrastructure and Campus networking solutions. That robust top line, along with operating efficiencies and dependable execution from our teams, drove non-GAAP EPS up 11%, which again outpaced revenue growth. Thanks to this performance, we returned $3 billion of capital to shareholders during the quarter, taking the cumulative value returned so far this year to $6.6 billion. We also revealed today that Cisco's dividend is going up, which shows how dedicated we are to delivering value back to shareholders via steady capital returns. Our innovation engine is running at full power, and our dedication to customers has never been greater. Cisco held its AI Summit last week, bringing together AI visionaries and geopolitical experts to examine how AI affects the economy, society and business. Although expectations around adoption and execution are clearly elevated, a significant obstacle remains. Legacy infrastructure simply wasn't built to handle what AI requires in terms of performance, speed and security. Our powerful first half of FY '26 proves both the strength of our portfolio and the essential part we play in this once-in-a-generation transition. Thanks to our industry-leading networking portfolio powered by Silicon One, AI native security solutions and operating systems, Cisco is positioned well to supply the critical infrastructure the AI era demands. I also want to talk about the sharp memory price hikes happening lately throughout the market. Drawing on our industry-leading supply chain team, we are taking proactive steps with 3 key strategies: First, price increases are already out, and we will keep watching market trends and adjust further when needed. Second, we are reworking contractual terms with channel partners and customers so they reflect changing component prices. Third, Cisco's operating scale and industry-leading position let us secure favorable terms and lock in supply to meet both current and future demand. All in all, we are confident we can handle this industry-wide situation better than our competitors. Let me now turn to the robust demand we saw in Q2. Total product orders rose 18% compared with a year earlier, even after double-digit growth in Q2 fiscal year '25. Leaving out hyperscalers, product orders increased 10% year-over-year, which shows the wide-ranging demand for our technology around the world. Enterprise product orders rose 8% year-over-year in Q2, with strength throughout our entire networking portfolio. Public sector orders climbed 11% year-over-year, with double-digit growth in every geography. Product orders from service provider and cloud customers picked up speed in Q2, rising 65%, powered by triple-digit order growth across hyperscalers. We likewise experienced ongoing expansion among telecom and cable clients during the second quarter, where combined orders climbed by nearly 20%. Let me now provide some detail regarding demand as viewed through our product categories. The pace of increase in networking product orders kept building, surpassing 20% in Q2 and representing our sixth straight quarter of double-digit gains, propelled by service provider routing, data center switching, campus switching, wireless, servers and industrial IoT products. Looking inside our Campus networking portfolio, demand is robust for our next-generation switching, routing and wireless offerings, and these are scaling more quickly than earlier product introductions did. Across these products we are shipping AI native capabilities, which includes embedding security throughout the network fabric and updating the operational stack for Campus networks; when these fresh capabilities are paired with an installed base worth tens of billions of dollars spanning early catalyst generations that are approaching end of support, they support the multiyear, multibillion-dollar refresh opportunity for Cisco. Demand remains powerful for our industrial IoT portfolio, which has achieved double-digit expansion for 7 quarters in a row now. This demand stems from manufacturing onshoring back to the United States, rising AI workloads at the network edge and the arrival of physical AI. Orders for AI infrastructure placed by hyperscalers reached $2.1 billion in Q2, versus $1.3 billion only one quarter earlier, and matching the entire amount booked across all of fiscal year '25, which signals yet another notable acceleration in growth throughout our silicon, systems and optics; during Q2 we shipped our 1 millionth Silicon One chip and intend to roll out our Silicon One architecture across our high-performance networking systems by fiscal year '29. Only this week at Cisco Live Amsterdam, we unveiled our 102.4 terabit per second G300 chip, placing Cisco within a select group of silicon suppliers that deliver switching speeds above 100 terabits per second; we also introduced 4 new systems that run on G300. The Cisco 8000 and Nexus 9000 102.4 terabit systems provide flexible air-cooled choices for traditional data center architectures plus a liquid cooled option built for the newest ground-up facilities. The programmability of Silicon One sets Cisco silicon apart in a class of its own, able to adapt to a broad range of use cases and network infrastructure designs. We further announced 2 new pluggable optics, a 1.6 terabit per second OSFP and an 800-gig LPO, both constructed with Cisco silicon photonics technology, which brings greater efficiency and reliability to high-performance AI infrastructure. Acacia posted its strongest quarter so far, with triple-digit growth in bookings. Every major hyperscaler is rolling out its market-leading coherent pluggable optics for data center interconnect and scale across use cases; we are seeing growth in both 400-gig and 800-gig coherent optics and transponder shipments, with 800-gig pluggables ramping considerably. Because demand is so strong for our Silicon One systems and optics, we now anticipate booking AI orders beyond $5 billion and recognizing more than $3 billion in AI infrastructure revenue from hyperscalers in FY '26. Outside of the big hyperscale players, there's another AI opening for us spanning neocloud, sovereign, and enterprise accounts. From those types of customers, we booked $350 million in AI orders during Q2, and our pipeline for the high-performance AI infrastructure lineup keeps expanding and now exceeds $2.5 billion. To seize this chance, we keep building out our strategic alliances. During Q2, we shared that we intend to create a joint venture alongside AMD and HUMAIN, aiming to supply as much as 1 gigawatt of AI infrastructure by 2030. Operations at that joint venture are expected to kick off within this calendar year, with Phase 1 calling for 100 megawatts to be built in Saudi Arabia. European customers are showing considerable enthusiasm for our sovereign critical infrastructure offering, which is built to run in air-gapped on-prem settings, so organizations gain control over sensitive data and critical infrastructure. With AI uptake speeding up, worries about privacy, data governance, and regulatory compliance sit at the top of our customers' minds, which makes sovereign solutions a vital cornerstone for establishing digital trust. Turning now to Security. Across our newly introduced and updated products, we kept seeing order growth in Q2. Those products make up about 1/3 of our security portfolio and cover Secure Access, XDR, Hypershield, AI Defense, and refreshed firewalls.

If we leave out the refreshed firewalls, more than 1,000 new customers bought these products during Q2, which works out to over 100% growth compared with the prior quarter and takes cumulative net new customers since launch to about 4,000. In addition, we've now recorded 3 straight quarters of double-digit expansion in firewall order volumes. With regard to Secure Access on its own, we booked in excess of 2.5 million users in Q2, and over 50% of the customers we added were new logos. With AI tool adoption rising and Agentic AI growing at the network edge, we anticipate sustained momentum in our SASE business, which includes both Secure Access and SD-WAN. As we noted in earlier quarters, gains from our new and refreshed portfolio keep being counterbalanced by a decrease in our prior generation portfolio. Now on to Splunk. Q2 showed us a trend much like Q1's, with ongoing acceleration toward cloud subscriptions and a smaller number of on-premise deals. Although this transition is putting a drag on revenue growth — something we expect to persist through the second half of fiscal year '26 — cloud subscriptions allow for greater adoption, expansion and quicker delivery of innovation to customers. So on the whole, this transition pleases us. Splunk likewise kept adding customers in Q2, hitting 500 new logos across the first half of fiscal year '26, and remains on pace to bring in 1,000 new logos for the full year. We're speeding up innovation throughout our offerings, both for AI and with AI. This week at Cisco Live Amsterdam, we introduced major AI defense and SASE advancements aimed at helping secure organizations as AI agents join the workforce. AI Defense is now able to scan models and repositories for vulnerabilities and deliver an AI bill of materials for centralized governance. Within Cisco SASE, we rolled out a new semantic inspection engine capable of evaluating the intent behind Agentic interactions and blocking sophisticated context-dependent threats. We're additionally establishing AgenticOps as the operating model for AI-driven IT, so as to enable autonomous troubleshooting, continuous optimization and trusted validation. We're putting AI agents to work side-by-side with human administrators inside our product dashboards, AI assistant and AI Canvas; internally, we keep advancing AI with broader use cases during Q2 in nearly every organization. As things stand, most of our product developers rely on AI coding assistant and collaborate with agents, which helps us innovate more quickly throughout our portfolio. Right now, AI and automation touch over 90% of customer experience support cases, letting us close a larger share of complex cases within 1 day and helping produce our highest customer satisfaction scores ever. Further use cases spanning sales, security and trust, supply chain and corporate functions are delivering substantial cost savings and efficiency gains too. In short, we're seeing robust demand for our solutions across every customer market and geography, which cements Cisco's part in delivering the critical infrastructure this once-in-a-generation transition requires. Silicon One illustrates the worth of our innovation, putting Cisco in position for the widest array of AI deployments, including even the most technologically demanding ones. And having earned customers' confidence for more than 40 years, along with a worldwide footprint, Cisco is dedicated to being a leader throughout the AI era—fueling breakthrough innovation, handling complexity and risk, and producing quicker business results for customers everywhere. I'll now hand things to Mark, who will share further specifics about the quarter as well as what we expect going forward.

Appreciate that, Chuck. We turned in another robust quarter, setting a record for revenue in Q2, while operating margin and earnings per share both landed above the top end of the guidance we'd given. Revenue for the quarter totaled $15.3 billion, a 10% increase compared with the same period a year earlier. Non-GAAP net income reached $4.1 billion, also up 10%, and non-GAAP earnings per share came to $1.04, a rise of 11%, which shows operating leverage continues to work in our favor since non-GAAP earnings per share is climbing more quickly than revenue. Let's dig into Q2 revenue a bit further. Product revenue overall came to $11.6 billion, rising 14%, while services revenue was $3.7 billion, a 1% decline versus the prior-year period. Networking once more stood out, expanding 21%, powered by AI infrastructure and campus refresh. We recorded double-digit gains across campus switching, data center switching, wireless, service provider routing, enterprise routing and compute. Security fell 4%, mirroring the same forces we described three months ago — namely, lower sales of older-generation products and our Splunk business shifting away from an on-prem deal toward cloud subscriptions — though growth in newly introduced and updated products partly made up for that. Collaboration delivered healthy 6% growth, carried by double-digit expansion in devices along with gains in CPaaS, Webex and Cloud Contact Center. Now to our recurring metrics. Total RPO came in at $43.4 billion, rising 5%. Product RPO increased 8%, and within that, the long-term piece was $11.8 billion, up 11%. Total ARR finished the quarter at $31 billion, gaining 3%, with product ARR up 6%. On subscription revenue — total subscription revenue reached $7.8 billion, which amounts to 51% of Cisco's overall revenue. Total software revenue was $5.7 billion, up 2%. Q2 product orders climbed 18% compared with a year ago. Product orders rose by double digits in every geographic segment: the Americas gained 23%, EMEA gained 11% and APJC gained 15%. Product orders also increased across every customer market, with service provider and cloud up 65%, public sector up 11% and enterprise up 8%. Total non-GAAP gross margin landed at 67.5%, a drop of 120 basis points from a year earlier. Non-GAAP product gross margin was 66.4%, down 130 basis points, mostly because of unfavorable mix and pricier memory, though productivity gains offset some of that. Non-GAAP services gross margin was 70.9%, down 70 basis points; we remain focused on lifting profitability and maintaining financial discipline, with non-GAAP operating margin at 34.6%, which is above the top end of our guidance range. Our non-GAAP tax rate for the quarter was 19%. Turning to the balance sheet. We closed Q2 with total cash, cash equivalents and investments of $15.8 billion. Operating cash flow was $1.8 billion, a decline of 19%, attributable to the final transition tax payment of $2.3 billion tied to the 2017 Tax Cuts and Jobs Act, plus ongoing investments to support rising overall demand and, in particular, AI infrastructure. On capital allocation, we gave back $3 billion to shareholders over the quarter, split between $1.6 billion for our quarterly cash dividend and $1.4 billion in share repurchases, leaving $10.8 billion available under our share repurchase program. Because of how confident we are in the business and how strong our ongoing cash flows are, we said today that we're increasing the dividend by $0.01, bringing it to $0.42 each quarter. This raise shows we're committed to giving back at least 50% of free cash flow to shareholders every year. In short, it was another quarter where both the top and bottom line beat what we expected, thanks to strong order growth and solid margins, which shows how our innovation engine powers strong top line growth and how operating leverage fuels profitability. We're still focused on making strategic investments in innovation so we can seize the big growth opportunities we see ahead. That will keep being supported by our commitment to disciplined spend management, and this powerful combination keeps driving strong cash flow and our ability to return significant value to shareholders. Now to guidance. Keep in mind, our Q3 and fiscal year 2026 guide assumes current tariffs and exemptions stay in place through the end of fiscal 2026; those assumptions are the same as prior guidance. Going forward, you should expect us to stay focused on durable growth with financial discipline driving operating leverage and continued capital returns. For fiscal Q3, here's our guidance: we expect revenue between $15.4 billion and $15.6 billion; we anticipate non-GAAP gross margin between 65.5% and 66.5%. Non-GAAP operating margin should be between 33.5% and 34.5%. Non-GAAP earnings per share should range from $1.02 to $1.04. We're assuming a non-GAAP effective tax rate of approximately 19%. Cisco is set for its strongest year ever, as shown in our guidance for fiscal year 2026, which is: we expect revenue between $61.2 billion and $61.7 billion. Non-GAAP earnings per share should range from $4.13 to $4.17. Sami, let's now move into the Q&A.

Appreciate that, Mark. <<operator_script>>. Operator, let's bring in our first analyst from the queue, please.

So, two things from me. First off, you clearly have a lot of momentum when it comes to AI, and there's that $5 billion AI goal for fiscal '26. Could you walk us through how the mix breaks down between Silicon One and Optics in that book? And then when you look at some of the newer offerings, such as the G300 and the P200 on the Silicon One side, do you view those as opening up additional markets or workloads for Cisco? Or is it more a matter of going deeper with the relationships you already have? I'd really like to get a handle on that piece. Then, maybe as a follow-up, Mark, you just mentioned the gross margin decline in April. My assumption is that it's entirely tied to memory, but I'd like to hear what's actually going on there, and whether you think that represents a trough when it comes to the gross margin and memory issues, or not.

Amit, thanks so much for asking. On the AI infrastructure front, that $5 billion figure — which we've now lifted our estimates to for fiscal 2026 — excludes any of the recently announced P200 products, and G300 as well, plus neither of the Optics solutions we unveiled this week at Cisco Live EMEA. As we discussed last quarter, the mix came in at 60% systems and 40% optics, and I'd say that's held fairly steady across the past several quarters. As for your last question about whether these create new markets, my view is they'll let us keep selling next-generation solutions throughout our current customer base, and I believe they'll keep helping us build traction with the neoclouds, the sovereign clouds, and so on, helping us achieve scale across technologies while continuing to sell these solutions both to customers we already have and to new ones. But to say it once more, P200 and G300 are not included in the $5 billion expected for fiscal '26. Mark?

Yes. Thank you, Amit. I'll address the gross margin inquiry. When examining our Q3 guidance, two main factors are at play. The first involves mix, while the second concerns memory pricing, which you brought up. To begin, I'd like to recognize the considerable expansion in hardware that we're observing throughout both our current and newly launched platforms, along with the reality that these are ramping up at a much quicker pace than earlier rollouts. Next, regarding memory, our approach is to manage whatever falls within our influence. Chuck mentioned briefly that we've already made price increase announcements. We intend to monitor that situation closely and make adjustments down the line as necessary. In addition, certain terms and conditions with our partners and customers will be modified so that our standing is genuinely strengthened. The third element involves capitalizing on our robust financial position and exceptional supply chain. The proof shows up in our forward purchase commitments, which over just the past 90 days have climbed by $1.8 billion. On a year-over-year comparison, that figure has risen roughly 73%. A substantial portion of this relates to memory. Finally, when it comes to concentrating on matters within our control, our attention is directed at financial discipline and profitability. We're also aiming to expand EPS at a quicker rate than revenue. That was evident in Q1 and again in Q2. It's reflected in our full year FY '26 guidance too. And while we don't provide Q4 guidance, if you work backward into the implied Q4 guide, you'll find it present there as well.

There are two things I'd like to ask. First, looking at how product revenue expanded, all of the beat came out of networking, up 21.1%. Could you break that down for us — during the prepared remarks you mentioned orders. Could you discuss revenue growth instead? In what way did each of the networking segments perform? And what was the source of that outperformance? Second, I'm able to derive your 4Q guidance. Looking at the quarter-over-quarter increase from Q3 to Q4, it comes to just 1.4%. Typically, that figure sits at 5%, 6%. This tends to be a seasonally strong period. So what explains such a low number? Is that simply conservatism? Or does it reflect — is growth bunched up over the following 2 quarters?

Yes. Thanks, Tal. Honestly, throughout networking, we're witnessing strength across essentially the whole portfolio, spanning the Campus, the data center, and the manufacturing floor with regard to our IoT offerings too. So the growth you're seeing is quite strong. Once more, we noted data center switching has posted double-digit growth in 6 of the last 8 quarters. This quarter it delivered double-digit growth as well. You're also seeing the campus strengthen further, along with a shift onto these new platforms happening more quickly than with earlier launches. And I believe the second portion of your question concerned seasonality specifically. Is that correct?

Yeah, quarter-to-quarter seasonality.

Right, quarter-to-quarter. When you examine it, normally our product revenue declines by mid-single digits from one quarter to the next, yet ours rose 5%. Then turning to Q3, the usual pattern tends to be low single digits. That's exactly where we stand, even though Q2 was enormous for us in year-over-year growth at 14%, plus Q2 is typically quite a powerful quarter too. So our confidence in Q3 is fairly high.

Yeah, and Tal, one more thing I'd add there: because the hyperscaler business moves in such a nonlinear way, it does introduce some uncertainty compared with the historical figures you're accustomed to seeing.

I'd like to approach the gross margin question from another angle. If we work backward from the EPS guidance, it appears that in the fourth quarter, earnings per share come in somewhat above where the Street stands, perhaps by a couple of pennies. Does that suggest gross margin is anticipated to hit its low point and then recover? Or does operating margin alone account for it? And then I wanted to know whether you might speak to that. I believe the trough was the subject of the first question. But looking at the guidance that way, on the operating margin line, something is improving somewhat. In the fourth quarter, does that come from cost reductions or from gross margin? And then I have a follow-up.

Yes. Thanks, Ben. So regarding gross margin, certainly, much of what we discussed concerning what is within our control and some of the memory price increases that we've observed, some of that is simply a matter of timing. So we believe that, that will get better as we go forward. And then certainly, we're not here to discuss FY '27. But as you enter FY '27, we believe that software growth will get better as well, and that will certainly be a help to us.

You had a second question, I think, Ben. Okay.

Ben, we can catch up with you afterward.

I suppose I'd like to dig deeper into the architecture side of things, Chuck. When we consider the opportunity in AI networking and the momentum you've been witnessing, I'm interested in your latest perspective on scale up as a potential opportunity for Cisco. What efforts have you been making? At what point might that begin to perhaps take shape, if you regard it as a significant opportunity? Then for my second question, I'm interested, with the momentum you're observing among the neoclouds and sovereign opportunities, perhaps just an update on the relationship, the engagement you've had with NVIDIA and how much that has started to perhaps become a driver beyond the hyperscalers?

Yes. Thanks, Aaron. So no announcements have been made by us regarding scale up. I believe previously, I've mentioned that we do intend to take part in it, and we anticipate having products and revenue from scale-up down the road, but nothing has been announced. So I'd say keep watching for news on that front; regarding the enterprise, sovereign and neocloud space, the first thing I'd note is that on the sovereign side, there's really no genuine requirement nor anticipation for a meaningful impact in FY '26. And so for the guidance we've given, we don't need that to actually accelerate. It's entirely upside. And then for the neoclouds, I'd say, are largely the same; we anticipate the ramp starting in the second half, but really being FY '27. As for NVIDIA, I think we had a quarter in which we truly started to witness the acceleration of the engagements. We monitor the quantity of engagements we have in the field with NVIDIA. And although it wasn't a huge number beforehand, we grew it by 70% from — sequentially; and so those engagements we see continuing to rise. We had — clearly, Jensen was recently with us at our AI Summit and spoke about the strength of their GPU and compute combined with our networking and security, which exemplified the relationship and the reason we're doing it. So some early, early success is starting to be seen there, and I believe it will only ramp from here.

Perhaps I could follow up on what was just asked. Coming away from that AI Summit, we've obviously been speaking with many customers. So where exactly are you observing enterprise willingness to spend, and how far along is it? Or when do you expect that enterprise AI narrative to really gain momentum? Then maybe a second thing — regarding the price increases, did you notice any clear shift in demand or in forward orders because of them?

I'll handle the first one. You handle the second. Okay. So when it comes to AI, I'd say first, with respect to the AI Summit, if you saw the roster of representatives we had present, I believe that reflects the partnerships we've established and the part that the whole ecosystem believes we will play within it. So that had us quite enthusiastic, and we received plenty of favorable responses. Regarding enterprise, what we're observing is early-stage applications in areas such as quant, fraud detection, and video analytics. We're seeing this in financials, manufacturing, and pharmaceuticals. I also see instances in retail where — they're using agents on mobile devices in retail so their employees can engage their customers more effectively. And I believe the way this is unfolding is visible: we're witnessing a mix of investment in cloud-based architectures and also on-prem. If you consider our data center switching business, which is enterprise focused, we've achieved double-digit order growth 6 out of the last 8 quarters, and we still had positive growth in the other 2; so we keep seeing significant investment in private data centers to support these applications.

Yes. Meta, regarding your second question, on the subject of pull forwards, nothing we observed during the quarter gave us reason to believe any meaningful pull forwards occurred. We examined the usual indicators, such as linearity across the quarter; honestly, we enjoyed solid double-digit growth throughout the whole period; we checked whether any pipeline had been pulled forward from upcoming quarters, and that didn't appear to be the case, we reviewed software activations, naturally, along with channel checks and similar items; and what we actually found was the pipeline starting to build in the later quarters instead of being pulled forward. So we feel good about that; and as for the price increase and whether it's landing well with customers, I'd say from your conversations with customers, they seem to get it; they recognize this is happening across the industry. And I don't — I haven't spoken with any customers who are really prepared to delay or postpone any strategic technology investments they're making. And I think we've seen no cause for concern there at all so far.

Let me just tack something on there, Mark. Yesterday, right here at our campus, Mark and I sat down for lunch with one of our very largest customers, and we went deep into the various forces at play in this area as well as the pressure on pricing; and they grasped it fully and will collaborate with us so that the whole partnership genuinely keeps benefiting both sides. So my take is that customers — this is something the whole industry faces. Customers grasp it; and even if it isn't something they enjoy, they recognize it's a reality all of us are navigating.