Cisco Systems Q1 2024 Earnings Results & Report

Cisco Systems EPS Results

• Actual EPS: $1.11
• Consensus EPS: $0.91
• Beat/Miss: Beat by +$0.20
• One Year Ago EPS: $0.77
• EPS Beat Rate: 8 of last 8 quarters

Cisco Systems Revenue Results

• Actual Revenue: $14.67 billion
• Expected Revenue: $14.63 billion
• Beat/Miss: Beat by +$42.03 million
• YoY Revenue Growth: +7.60%

Cisco Systems (NASDAQ:CSCO) develops networking, cybersecurity, collaboration and observability technologies for businesses, governments and other organizations. Its products include routers, switches, wireless systems and data center infrastructure, along with security software and services that help organizations connect and protect their networks.

The company also provides collaboration tools through its Webex platform and observability capabilities through its software offerings, including technology from Splunk, which Cisco acquired in 2024. Cisco serves customers around the world and supports them with technical services and software.

Founded in 1984, Cisco helped popularize commercial internet networking. The company is headquartered in San Jose, California, and is led by Chairman and Chief Executive Officer Chuck Robbins.

Cisco Systems Q1 2024 Earnings Call Transcript

Key Takeaways

• Record Q1 results: Delivered highest-ever revenue and profitability with EPS above guidance, record non-GAAP gross and operating margins, and returned $2.8 billion to shareholders.
• Experienced a temporary order slowdown as customers focus on implementing backlog, expecting 1–2 quarters of lower orders before sequential growth resumes in H2.
• Accelerating business transformation with 85% subscription-based software revenue and 5% ARR growth to $24.5 billion, boosting margins through recurring streams.
• Announced intent to acquire Splunk to build an end-to-end data platform, enhancing AI, security, and observability capabilities while driving higher software and ARR growth.
• Strong portfolio momentum with 10% networking revenue growth, 21% observability surge, and over $1 billion in AI infrastructure orders secured for FY 2025.

Presentation

[Operator]

Welcome to Cisco's first quarter fiscal year 2024 financial results conference call. At the request of Cisco, today's conference is being recorded. If you have any objections, you may disconnect. Now, I would like to introduce Sami Badri, Head of Investor Relations. Sir, you may begin.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

Welcome, everyone, to Cisco's first quarter fiscal year 2024 quarterly conference call. This is Sami Badri, Cisco's new Head of Investor Relations, and I'm joined by Chuck Robbins, our Chair and CEO, and Scott Herren, our CFO. Having followed Cisco on the sell side for 10 years, I couldn't be more excited to join the company, and I look forward to engaging with you all in my new role. By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be available on our website in the Investor Relations section following the call. As a reminder, we have simplified how we report product and service revenue in customer markets. Starting this quarter, we are reporting revenue in the following five categories: networking, security, collaboration, observability, and services.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

We are reporting customer markets in the following three categories: enterprise, public sector, and service provider and cloud. Also, as is customary in Q1, we have made certain reclassifications to prior period amounts to conform to the current period's presentation. Income statements, full GAAP to non-GAAP reconciliation information, balance sheets, cash flow statements, and other financial information can also be found in the Financial Information section of our Investor Relations website. Throughout this conference call, we will be referencing both GAAP and non-GAAP financial results, and we'll discuss product results in terms of revenue and geographic and customer results in terms of product orders, unless stated otherwise. All comparisons made throughout this call will be on a year-over-year basis. The matters we will be discussing today include forward-looking statements, including the guidance we will be providing for the second quarter and full year of fiscal 2024.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

They are subject to the risks and uncertainties that we discuss in detail in our documents filed with the SEC, specifically the most recent report on Form 10-K, which identify important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. With respect to guidance, please also see the slides and press release that accompany this call for further details. Cisco will not comment on its financial guidance during the quarter, unless it is done through an explicit public disclosure. I will now turn it over to Chuck.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Thanks, Sami, and welcome to Cisco. I hope everyone is doing well, and thanks for joining us today. We delivered a solid start to fiscal 2024, with the strongest first quarter results in Cisco's history in terms of revenue and profitability. Our Q1 revenue was at the upper end of our guided range. EPS exceeded the high end of our guidance, driven by strength in gross margins and expense control, resulting in strong operating leverage. Our disciplined expense management and the tailwinds from our business model transformation resulted in our highest non-GAAP gross margin in over 17 years and record non-GAAP operating margin. We also returned $2.8 billion in Q1 via cash dividends and share repurchases, delivering on our capital return commitments to our shareholders.

[Chuck Robbins, Chair and CEO at Cisco Systems]

As we continue to transform our business towards more software and recurring revenue streams fueled by accelerated innovation, we remain committed to driving operating leverage and shareholder returns. Now, turning to the demand environment. After three quarters of exceptionally strong product delivery, our customers are now focused on installing and implementing these unprecedented levels of products. The bottleneck that we previously saw in the supply chain has now shifted downstream to implementation by our customers and partners. Our order lead times and backlog have largely returned to normal levels. As deliveries rose, the channel inventory we track at our distributors also steadily declined during this time. Simply put, customers are now taking time to onboard and deploy these heightened product deliveries. While the macro challenges we have discussed still exist, we believe this implementation phase is the primary reason for the slowdown in new orders.

[Chuck Robbins, Chair and CEO at Cisco Systems]

We saw it mostly with our larger enterprise, service provider, and cloud customers, and it was most pronounced in October. Based on our analysis, we believe this phase is temporary and estimate there is an additional one-two quarters worth of shipped orders in customers' hands still waiting to be deployed. This has near-term consequences for revenue and our outlook for the next couple of quarters, which Scott will discuss shortly. However, it does not change our longer-term confidence. We expect product order growth rates to increase in the second half of the fiscal year. We also remain very confident in the foundational strength of our business and future growth opportunities, given the criticality of our technologies.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Overall, our win rates are stable, cancellation and return rates remain below pre-pandemic levels, and we have gained market share, all of which are testaments to the strength of our portfolio and how it aligns to our customers' most pressing needs. As we look to enhance our capabilities in higher growth areas, in the first quarter of fiscal 2024, we announced our intent to acquire Splunk. The combination of Cisco and Splunk will create an end-to-end data platform to enhance our customers' digital resiliency with our complementary capabilities in AI, security, and observability. The combination of Cisco and Splunk also directly supports our strategic objectives around driving higher levels of growth, software capabilities, and ARR. Together, we will bring trusted innovation leadership, an outstanding go-to-market engine, and a world-class culture that will help our customers achieve their technology outcomes with innovative products and solutions.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Now let me comment on our quarterly performance. As I previously mentioned, we delivered strong revenues in Q1, which was broad-based across our product portfolio and driven by our customers' investments in generative AI, cloud, security, and full-stack observability. As expected, we continued to gain market share with the release of the calendar Q2 results, recording another quarter of year-over-year gains in three of our largest networking markets: campus switching, wireless LAN, and SP routing. In web scale, we see continued momentum in AI, with three of the top four customers deploying our hyperscale Ethernet AI fabric. We also already have line of sight to over $1 billion in orders for AI infrastructure from major cloud providers in fiscal year 2025.

[Chuck Robbins, Chair and CEO at Cisco Systems]

To help advance AI, we are working with key GPU and storage partners to create solutions, including Ethernet technologies, GPU-enabled infrastructure, and joint tested and validated reference architectures, with a commitment to open networking for AI. Collectively, we believe there is a great opportunity for a broad set of innovations in compute, GPU, networking, software, and services to support core and edge AI infrastructure. According to 650 Group, the AI switching market is forecasted to exceed $10 billion in 2027. Our scalable fabric for AI, coupled with the proven power-saving capabilities of Cisco Silicon One, put us in a strong position to build out the infrastructure needed for AI clusters, and we are laser-focused on winning in this space. Moving to security, we continue to execute against our product roadmap and strengthen our unified security platform.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Since our Cisco XDR solution became available this summer, we have added recovery to the response process, giving security teams the ability to snapshot and restore their business-critical data at the first sign of a ransomware attack. With our three new offers around XDR, Cisco Secure Access, and Multicloud Defense, we already have over $500 million in the pipeline across over 1,000 customers. We also launched our new Cisco Security Firewall solution this quarter. We are actively engaged in competitive sales with all these products and expect to see meaningful positive results in the coming quarters. In our collaboration portfolio, we recently introduced a range of truly game-changing AI capabilities spanning the entire Webex suite, as well as new devices for reimagined workspaces at our Webex One event. Before I turn it over to Scott, let me briefly summarize three key takeaways.

[Chuck Robbins, Chair and CEO at Cisco Systems]

First, as we consider where we're at today, the primary issue with demand is that customers are taking time to onboard and deploy heightened product deliveries. While we are not immune to the macro, we believe this is temporary, as our customers and partners continue to tell us that our portfolio is stronger than ever, and we have continued to see share gains in key markets. Second, we remain confident in our future. With the incremental multibillion-dollar AI infrastructure opportunity, the increasing criticality of security and observability, and what we believe Cisco and Splunk can do together for our customers is truly exciting. Lastly, you can always count on us to take a disciplined approach, regardless of the environment. We remain committed to operating leverage, capital allocation, and expense management. I'll now turn it over to Scott to provide more detail on the quarter and our outlook.

[Scott Herren, EVP and CFO at Cisco Systems]

Thanks, Chuck. We delivered solid results in Q1, driven by the prior strategic actions we took to mitigate the supply chain constraints. For the quarter, we reported strong revenue growth and a record non-GAAP operating margin. Total revenue was $14.7 billion, up 8% year over year, at the high end of our guidance range. Non-GAAP net income was $4.5 billion, up 28%, and non-GAAP EPS was $1.11, up 29%, exceeding the high end of our guidance range. Looking at our Q1 revenue in more detail, total product revenue was $11.1 billion, up 9%, and service revenue was $3.5 billion, up 4%. Networking, our largest product category, drove the increase with 10% growth.

[Scott Herren, EVP and CFO at Cisco Systems]

Within networking, the growth was driven by switching, where campus and data center were both up double digits on the strength of our Catalyst 9000 and Nexus 9000 offerings. This was partially offset by a decline in wireless. Security was up 4%, driven by our Zero Trust and threat intelligence, detection, and response offerings. Collaboration was up 3%, driven by growth in calling and contact center, partially offset by a decline in meetings. Observability was up 21%, driven by growth across the portfolio, including double-digit growth in ThousandEyes and AppDynamics. We continue to make progress in our transformation to more recurring revenue-based offerings and saw solid performance in our ARR of $24.5 billion, which increased 5%, with product ARR growth of 10%.

[Scott Herren, EVP and CFO at Cisco Systems]

Total software revenue was $4.4 billion, a 13% increase, with software subscription revenue also up 13%. 85% of our software revenue was subscription-based. Total subscription revenue increased 10% to $6.5 billion, which represents 44% of Cisco's total revenue, an increase of 1 percentage point over last year. RPO was $34.8 billion, up 12% year-over-year. Product RPO increased 14%, and service RPO increased 11%. And total short-term RPO was up 8% to $17.6 billion. Looking at our product orders by geographic segment year-over-year, overall product orders declined 20%, with the Americas down 19%, EMEA down 13%, and APJC down 38%. In our customer markets, service provider and cloud was down 38%, enterprise was down 26%, and public sector was up slightly at 2%.

[Scott Herren, EVP and CFO at Cisco Systems]

Total non-GAAP gross margin came in at 67.1%, up 410 basis points year-over-year, and 110 basis points above the high end of our guidance range. Product gross margin was 66.5%, up 550 basis points. The increase was driven primarily by productivity improvements with lower freight, logistics, and component costs. Favorable mix and positive pricing also contributed to the year-over-year improvement. Services non-GAAP gross margin was 69%, up slightly. Our non-GAAP operating margin came in at 36.6%, up 480 basis points, and exceeding the high end of our guidance range. This improved leverage was driven by both our strong non-GAAP gross margin and ongoing disciplined cost management. Shifting to the balance sheet, we ended Q1 with total cash, cash equivalents and investments of $23.5 billion.

[Scott Herren, EVP and CFO at Cisco Systems]

We had operating cash flow for the quarter of $2.4 billion, down 40%, primarily due to the $2.8 billion tax payment related to prior quarters, which was associated with the IRS tax relief due to the California floods. This quarter, we returned $2.8 billion to shareholders, comprised of $1.6 billion for our quarterly cash dividend and $1.3 billion of share repurchases. Consistent with our capital allocation strategy, we are committed to increasing shareholder returns through greater operating leverage, maintaining a higher level of annual share repurchases, and growing our dividend. We continue to invest organically and inorganically in our innovation pipeline.

[Scott Herren, EVP and CFO at Cisco Systems]

During Q1, we announced our intent to acquire Splunk, which we expect to close by the end of the third quarter of calendar year 2024, subject to regulatory approvals and customary closing conditions, including approval by Splunk shareholders. In Q1, we also closed several acquisitions, all of which are highly complementary to our internal R&D and in line with our strategy to strengthen our position in cloud, security, observability, and AI with targeted strategic M&A. To summarize, we delivered a solid quarter, highlighted by top-line growth and increased operating leverage that resulted in stronger than anticipated earnings per share. We continue to make progress in our business model shift to more recurring revenue. We remain focused on disciplined expense management without losing sight of the strategic investments necessary to innovate and capitalize on growth opportunities.

[Scott Herren, EVP and CFO at Cisco Systems]

Turning to our financial guidance, as Chuck outlined, the bottleneck that we previously saw in the supply chain has now shifted downstream to implementation by our customers and partners. Most of the supply chain constraints are now behind us, and both shipment lead times and backlog have largely returned to normal levels. Q1 product orders declined 20% as our largest customers are implementing elevated levels of product shipments from prior quarters as we delivered orders from our historically high backlog levels. As Chuck mentioned, we believe there are one to two quarters worth of shipped orders awaiting implementation by our customers. Our revenue guidance assumes one to two quarters of lower revenue and then a return to more typical sequential growth rates. Consequently, for Q2, we expect revenue to be in the range of $12.6 billion-$12.8 billion.

[Scott Herren, EVP and CFO at Cisco Systems]

We anticipate the non-GAAP gross margin to be in the range of 65%-66%. Non-GAAP operating margin is expected to be in the range of 31.5%-32.5%, and non-GAAP earnings per share is expected to range from $0.82-$0.84. For fiscal year 2024, our guidance is updated as follows: We expect revenue to be in the range of $53.8 billion-$55 billion. Non-GAAP earnings per share is expected to be in the range of $3.87-$3.93. In both our Q2 and full year guidance, we're assuming a non-GAAP effective tax rate of 19%. I'd like to thank our teams for their focus and execution this quarter. We remain confident in the strength of the business and our ability to capitalize on the key growth opportunities ahead.

[Scott Herren, EVP and CFO at Cisco Systems]

I'll now turn it back to Sami, so we can move into the Q&A.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

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

[Operator]

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

[Scott Herren, EVP and CFO at Cisco Systems]

Tal, are you there?

[Tal Liani, Managing Director, Senior Research Analyst at Bank of America]

Yes, sorry, I was on mute. Now you can hear me.

[Scott Herren, EVP and CFO at Cisco Systems]

Okay, got it. Yep.

[Tal Liani, Managing Director, Senior Research Analyst at Bank of America]

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

[Scott Herren, EVP and CFO at Cisco Systems]

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

[Tal Liani, Managing Director, Senior Research Analyst at Bank of America]

So in terms of revenue recognition, you expect Q3 tothe Q2-Q3 sequentials. That was my question. Do you expect Q3 to be weaker than previous seasonality, or do you expect it to be the same as previous seasonality or even sequentially?

[Scott Herren, EVP and CFO at Cisco Systems]

No, from a revenue standpoint, you know, we don't guide bookings, Tal, but from a revenue standpoint, I do see sequential increase Q2-Q3.

[Tal Liani, Managing Director, Senior Research Analyst at Bank of America]

Okay. Thank you.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

All right. Thank you, Tal.

[Scott Herren, EVP and CFO at Cisco Systems]

Thanks, Tal.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

Michelle, next question.

[Operator]

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

[Meta Marshall, Executive Director, Senior Equity Analyst at Morgan Stanley]

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

[Chuck Robbins, Chair and CEO at Cisco Systems]

... Yeah, Meta, thanks for the question. I think your, your latter comment is probably the closest to the truth. We don't anticipate a, a big difference, although I think with the improvements that we've seen in our portfolio in security, we should see security accelerate. Obviously, we'll continue to, to update you on, the AI opportunity that's out there. We think that's going to continue to be a, a driver over the next couple of years, but in general, I think it'll, it'll look more normal once we get through this.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

Great. Thank you. Thank you, Meta. Michelle, next question.

[Operator]

Amit Daryanani with Evercore. You may go ahead.

[Amit Daryanani, Senior Managing Director at Evercore ISI]

Yep, thanks for taking my question. I guess, Chuck, one of the things I think folks will struggle to understand is the conviction you have that this is an implementation pause and not a macro demand-centric weakness. So I'd love to just understand whatever you can talk about and why you're so convinced this is a 1-2-quarter implementation pause rather than enterprise demand is just getting weaker. Anything on that front would be helpful. And then I just want to clarify this part. You folks said $1 billion in AI orders. That's 2 times the number you gave last time. Is that correct? Thank you.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Yeah, Amit, thank you. So if you'll be patient with me, I'll give you a few data points, and some context around why we think this is an inventory issue that's sitting with our customers. First of all, our customers and our sales organizations have been very clear with us over the last 90 days that this is the issue, particularly our large enterprise and our large and our service providers. We talked about that with the service providers prior, but it shifted into the enterprise space in a big way.

[Chuck Robbins, Chair and CEO at Cisco Systems]

The other thing is we had our partner summit last week, and some of our largest partners, unsolicited, began their conversations with me by talking about this very issue, which, candidly, I knew the customers had talked about it and our sales teams had talked about it. I was actually surprised to hear it so consistently at that partner summit. So, that's sort of the subjective view. And then we've done some analysis, and there's three things I'd point out. The first is that, in certain parts of our portfolio, we actually can, we can see the time frame from shipment of a product until the product begins to connect to the cloud, back to the cloud, like Meraki.

[Chuck Robbins, Chair and CEO at Cisco Systems]

What we've seen is a 1-2-quarter delay versus what historically you would see when these, these products get shipped, how long it takes for them to be activated and connect to the, to the Meraki cloud. That's the first piece. The second is, we had a very strong quarter in federal, U.S. federal from an orders perspective. And so we, we looked into why big customer like the U.S. government, Department of Defense, would not have the same issue. The reality is, is that they have special clauses in their contracts that give them most favored nation status when we're actually making shipment decisions. And certainly, with the Department of Defense, we prioritized them during the supply chain crisis, so they never had a big influx. They had a very steady flow of products across, which explains why their, their order numbers look fairly normal.

[Chuck Robbins, Chair and CEO at Cisco Systems]

The third point I'd say is that we noticed a serious uptick in Q1 in our transactional advanced services, which is loosely translated to be implementation services, where that grew almost 20%, and the forecast for Q2 is almost double digits again. So it's clear that customers are asking us to come help them get this done. And I'll give you one final subjective data point, and then I'll talk about the AI stuff. We had one big partner tell us that they have literally hired 200 people in the last 90 days, solely focused on implementing technology for their customers. So there are just so many things that we, we've learned over the last 90 days. Clearly, this surprised us, but I think we feel pretty good right now. I'll make a comment about why I don't think it's macro.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Candidly, it might have been easier for me to say it was macro, but, as we've discussed prior, we have, you know, the traditional service provider has been, has been tough, and it remains that way. We've talked about elongated sales cycle. They remain. We've talked about the, in some cases, the need for extra signatures, which is pretty normal. That's remained, but we didn't see it get materially worse in the quarter. And so all of that, and I'm sorry for the long answer, but I wanted to be thorough. All of that is really what led us to believe this, that this is a consumption issue with our customers. So I'm going to pause there, and then I'm going to answer your AI question. What, what we gave last time was orders to date.

[Chuck Robbins, Chair and CEO at Cisco Systems]

We had taken orders for over $500 million for infrastructure to support AI networks, AI GPUs, inside the cloud players. Then... And I'll talk a little bit more about that in a moment. The numbers that we gave today is a forward-looking set of numbers that say in fiscal year 2025, which is when we said we believe that the broad Ethernet build-out would occur underneath GPUs, we, we have already seen, we have line of sight to $1 billion plus of orders that our teams feel pretty good that we're going to get and/or we've been designed in already. So that's just sort of a forward-looking set of orders that we've identified for fiscal 2025, okay?

[Chuck Robbins, Chair and CEO at Cisco Systems]

I will also just cover real quickly, we are now, we now have our Ethernet fabric deployed underneath GPUs in three of the four hyperscalers, major hyperscalers in the United States. We also are working very closely with AMD, Intel, and NVIDIA... to create solutions, including ethernet technology, GPU-enabled infrastructure, joint, jointly tested and validated reference architectures. And I will say even this week, yesterday, Jensen from NVIDIA and four or five of his executives came over to see us, and we spent 90 minutes together with my executive team. And we believe we have a great opportunity to actually build some integrated solutions between our technology and their technology to actually take to the enterprise.

[Chuck Robbins, Chair and CEO at Cisco Systems]

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

[Scott Herren, EVP and CFO at Cisco Systems]

All right. Thank you, Amit. Michelle, next question.

[Operator]

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

[Simon Leopold, Managing Director, Senior Equity Analyst at Raymond James]

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

[Chuck Robbins, Chair and CEO at Cisco Systems]

You, you-

[Scott Herren, EVP and CFO at Cisco Systems]

Hey, Simon, thanks for that. You, I would say the bigger variance that we're seeing, I mean, right now, obviously, the demand signal is a little bit tough because of the amount of inventory that's out in the field, and the... We have normalized lead times at this point. We knew that would happen sometime in the first half. It's now happened. Our lead times are back to where they were pre-pandemic, and our backlog has shipped. The supply chain team has done a terrific job getting product out the door. That's what's kind of moved the bottleneck from our level down to our customers' level. But when you start to unpack within networking, we're not seeing, at this point, a huge difference between, for example, data center or campus networking.

[Scott Herren, EVP and CFO at Cisco Systems]

What we are seeing is a little more field-based inventory on wireless access points. That's been slightly slower than what we've seen, just because of the amount of product that's been shipped out than what we've seen in the rest of the networking.

[Simon Leopold, Managing Director, Senior Equity Analyst at Raymond James]

Thank you very much.

[Scott Herren, EVP and CFO at Cisco Systems]

All right. Thank you, Simon.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Yep, thanks, Simon.

[Scott Herren, EVP and CFO at Cisco Systems]

All right. Michelle, next question.

[Operator]

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

[Ben Reitzes, Managing Director, Head of Technology Research at Melius Research]

Hey, thanks. Good afternoon, everyone. I wanted to ask about your share repurchase cadence. You know, stock obviously could get hit here. We have been talking about $5 billion in buybacks or so for the year. I know some of that's to offset dilution. If you guys are confident in the second half pickup, is there any potential that you would be more aggressive in the upcoming quarter? And how are you thinking about share repo this year, given current dynamics with the Splunk deal coming? Thanks.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Yeah, Ben, as we said on the Splunk transaction, it's going to be outside of the transactional cost, it's going to be cash flow positive from the first year forward. So the Splunk transaction is not in any way having an effect on our capital return, either through the dividend or through share buybacks. We expect to continue at higher level and consistent higher level of share buybacks and to, you know, to continue to show increases in our dividend. We also will obviously look at the opportunity at the chance to be opportunistic on the share buyback. I don't I'm not going to commit to that at this moment, but that is something that we'll obviously take a look at.

[Ben Reitzes, Managing Director, Head of Technology Research at Melius Research]

Thank you.

[Scott Herren, EVP and CFO at Cisco Systems]

All right. Thank you, Ben. All right, Michelle, next question.

[Operator]

Samik Chatterjee with J.P. Morgan. You may go ahead.

[Samik Chatterjee, Managing Director, Equity Research at J.P. Morgan]

Hi, thank you for taking my question. I guess if I can just clarify one thing first. I think, Chuck, in your prepared remarks, you did say you saw the more pronounced impact on the orders in the month of October. I think that's what I heard you say. I mean, just curious, are you implying that you did see an improvement in orders in the sort of first couple of weeks of November itself, and that's maybe part of your confidence, and that it's a bit more temporary than a longer pause from the customers? And then you did mention large partners really being the ones that are facing this sort of inventory installation problem.

[Samik Chatterjee, Managing Director, Equity Research at J.P. Morgan]

What gives you sort of color that SMB, the smaller customers, are sort of not going to face a similar issue, or are you also baking that in in terms of your sort of next couple of quarters of headwinds that you're thinking about on the revenue side? Thank you.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Thanks, Samik. I think my, my point with October was that, you know, if you, if you go back to the end of Q4, we talked about on the last call that we had a fair amount of momentum as we exited the quarter, which is one of the reasons we didn't expect to see this. And we had our normal year-end, sales moving accounts around, moving territories around, and getting sort of the sales startup process that happens in the first, say, six weeks of the fiscal year, which we went through. So what we tend to look for is the middle of the quarter, and then into October is when we expect to see the actual quarter materialize and everything kind of come together, and it just didn't. And that's what, that was the comment about the...

[Chuck Robbins, Chair and CEO at Cisco Systems]

That it was. It was primarily, you know, we really, it was really clear to us in October that this was going to be the situation. Relative to, they're the ones who are having the consumption issue because they have the most inventory. You asked what confidence will we have that it's not SMB? If you look at orders, we look at, we look at a sub-segmentation within enterprise now and within service provider, et cetera, and SMB was fine. And in fact, the smaller the customer we had, the better their order performance for us in the quarter was. So it just followed the trend that the consumption issue is upmarket, and the small to mid-sized customers didn't feel it.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

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

[Operator]

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

[David Vogt, Managing Director, Senior Equity Analyst at UBS]

Great. Thanks, guys, for taking my question. Scott, maybe this is for you. I just want to unpack maybe one of the comments that you made, and I know you don't guide to orders, but I think in your prepared remark, you said backlog is back at normal levels at the end of the quarter. So are we to assume that the guide for Q2 and the rest of the year doesn't include backlog conversion into revenue? And then if that's the case, you know, to your comment about orders accelerating in the second half, I know you don't guide specifically to orders, but you did make a comment that revenue is going to be up, I think, sequentially in the third quarter, year-over-year, and in the fourth quarter, sequentially and year-over-year.

[David Vogt, Managing Director, Senior Equity Analyst at UBS]

Doesn't that suggest like a pretty steep order acceleration, not just an acceleration, but significant positive order trajectory in the fourth quarter and the third quarter? I know it's easy comps, but just some more color there would be helpful. Thanks.

[Scott Herren, EVP and CFO at Cisco Systems]

Yeah, yeah, David, we did say that. We are expecting sequential improvement in the second half of the year in both Q3 and in Q4. And it both, and again, we don't guide this, but in both orders and revenues, you'd expect. Backlog is normalized at this point. We knew that would happen in the first half. I think the supply chain team did a great job getting those orders in the hands of our customers. We would now need them to implement them, but we've got the orders in the hands of our customers. So we do see sequential increases. And as you said, as you noted from a booking standpoint or order standpoint, the second half has easier compare points. Obviously, the reverse is true on revenue. The second half revenue will have very difficult compare points the last year.

[David Vogt, Managing Director, Senior Equity Analyst at UBS]

Great. Thank you.

[Scott Herren, EVP and CFO at Cisco Systems]

Mm-hmm.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

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

[Operator]

Matt Niknam with Deutsche Bank. You may go ahead.

[Matt Niknam, Director, Equity Research at Deutsche Bank]

Hey, guys. Thank you for taking the question. Maybe just to dovetail, one follow-up to the prior question. I have just another one on margins. Just on the prior one, is the expectation for a second half improvement in a one- to two-quarter digestion, does that vary at all across the three different customer sets you outlined? And then just on the margins, so 36.6 on op income margins this quarter, I think the guide implies a 400-500 basis point dip. Is that due to just the sheer revenue decline sequentially, or are there other cost items we should consider on either the gross margin or OI margin line? Thanks.

[Scott Herren, EVP and CFO at Cisco Systems]

Yeah, to your second question, it is just based on, you know, the how the revenues are flowing through the second half of the year. I think gross margins, we've said, will settle in somewhere in this 65%-66% range. I think at this point, it looks like it'll be closer to the higher end of that range for the second part of the year. So that's the way I see the year flowing out. Remind me, Matt, what was the first part of your question?

[Matt Niknam, Director, Equity Research at Deutsche Bank]

Just around the expectation for second half improvement in orders, 1-2 quarters' worth of installation. Is that broad across the three customer sets, or does it vary across service provider, enterprise, and federal?

[Scott Herren, EVP and CFO at Cisco Systems]

Yeah, right. I think we expect, I certainly would expect service provider to continue to be difficult through the second half of the year. Within service provider, we've got both telco and cable, which has one set of market dynamics going on. I think that'll continue to be a difficult space. On the other side, we have web scale, and we do see the web scale orders. While they've got also inventory to work their way through, we do see line of sight to them beginning to increase their orders again in the second half of the year. So SP is a bit of a mixed bag, but I think it'll continue to have probably the greater impact.

[Matt Niknam, Director, Equity Research at Deutsche Bank]

Great. Thank you.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

All right. Thank you, Matt. Michelle, next question.

[Operator]

George Notter with Jefferies. You may go ahead.

[George Notter, Analyst at Jefferies]

Hi, thanks a lot, guys. Just continuing on, on that last question. You know, if I, if I look around the space, you know, companies have been dealing with excess inventories for, you know, really three quarters now. And I, I guess I'm just curious, you know, why is this now becoming more evident at Cisco versus, you know, a few quarters ago? And, and then also, you know, you mentioned that, the issue is spreading more to enterprises. We don't typically think about enterprises as, you know, inventorying, you know, infrastructure. And, and so I guess the question for you is, you know, has something changed there, or is this more, you know, distribution channel, inventory? Any insight would be great. Thanks.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Yeah. Thanks, George.

[Chuck Robbins, Chair and CEO at Cisco Systems]

I think that the reason it's become relevant now is because, I mean, we really unloaded our backlog in the last six months. I mean, and it was $ billions more than what we would normally ship to customers during that period. So, I think it's just. And we know that, you know, the cloud providers, as an example, had been buying ahead, and they had been doing it for sure, to your point. And all along, we have very sequenced purchasing cycles with those players, so we kind of know when they're going to start placing their next orders. I think on the enterprise, we're talking about the top 200 customers, right?

[Chuck Robbins, Chair and CEO at Cisco Systems]

These are, these are the big customers who actually, you know, if they're doing a, if they're doing a refresh of a, of their infrastructure, they might order 400, 500 switches as an example, or they may be doing a branch rollout. And in some cases, to your point, it could be sitting with them, or they could have a partner who's doing the staging, and the partner may be backed up with... you know, resources to try to get the staging done. So the, it, it varies, but it could be a com-- either one of those or a combination of both.

[Scott Herren, EVP and CFO at Cisco Systems]

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

[George Notter, Analyst at Jefferies]

Thank you.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Mm-hmm.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

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

[Operator]

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

[Michael Ng, Managing Director, Global Investment Research at Goldman Sachs]

Hey, good afternoon. Thanks for the question. I just have two. First, on the AI orders, $1 billion, what's the feedback from the hyperscalers on your improving position with these customers relative to a few years ago? Is it, you know, selling in a more disaggregated fashion with Silicon One? Is it a desire for silicon diversification? And then the second question, just as a follow-up on the order slowdown, was that, you know, more concentrated in the campus with, you know, wireless LAN and wired, or data center, or both, just within enterprise specifically? Thank you.

[Chuck Robbins, Chair and CEO at Cisco Systems]

Thanks, Michael. On the AI question, relative to the cloud players, I think that... Look, I think early on, we regained our footing there because we listened and we showed flexibility with our willingness to disaggregate if they wanted to do so. And you know, we're in numerous use cases across the large web scale players, and I think we added another over 10 new use cases last quarter alone, where we had been designed in. And I think it's so I think that the disaggregation and the flexibility and us listening to them and understanding what they wanted was the reason that we got back in.

[Chuck Robbins, Chair and CEO at Cisco Systems]

And now the feedback is, as long as we're performing, I think they, they like our products, they like the power savings of Silicon One. It's a massive power, massively lower power consumption. I think they do like silicon diversity, for sure. And then as you look at the AI infrastructure that's currently, you know, primarily being supported via InfiniBand, they just wanna move to more of a standard, broad-based technology like Ethernet, that they can actually have multiple sources. And so we think that's what's driving that now. And now it's just about performing and executing and delivering on what we tell them we're gonna do. Scott, you wanna take the second?

[Scott Herren, EVP and CFO at Cisco Systems]

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

[Michael Ng, Managing Director, Global Investment Research at Goldman Sachs]

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

[Chuck Robbins, Chair and CEO at Cisco Systems]

Mm-hmm.

[Scott Herren, EVP and CFO at Cisco Systems]

Thank you.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

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

[Chuck Robbins, Chair and CEO at Cisco Systems]

Yeah, thank you, Sami, and welcome again. Listen, we're proud of the team for the performance in Q1. Obviously, a very solid quarter, with the exception of this demand issue that we talked about. We'll always try to be transparent with you and share with you exactly what we're seeing. We know what's going on, we're on top of it, and we do feel that it's temporary. At the same time, we're very confident in our opportunities long term. We're confident in the AI opportunity. We're very encouraged by our improving position in security, observability, and we're also very encouraged by the opportunities that will come with the Splunk acquisition.

[Chuck Robbins, Chair and CEO at Cisco Systems]

I think, many of you know that on Monday night, the waiting period for review under the Hart-Scott-Rodino Act in the U.S. expired, meaning that we've effectively passed the antitrust review period in the United States. We're excited about that. At our partner summit last night or last week, the feedback on our portfolio right now was probably as good as it's been in a long time. And I also just wanna reiterate our commitment to delivering value to you and our shareholders with via operating leverage, capital allocation, and obviously managing our expenses in times when we, when we see challenges like we have right now. So thank you for joining us today, and I'll turn it back over to Sami.

[Sami Badri, VP, Head of Investor Relations & Strategic Finance at Cisco Systems]

Cisco's next quarterly call, which will reflect our fiscal year 2024 second quarter results, will be on Wednesday, February 14th, 2024, at 1:30 P.M. Pacific Time, 4:30 P.M. Eastern Time. This concludes today's call. If you have any further questions, please feel free to contact the Cisco Investor Relations department, and we thank you very much for joining the call today.

[Operator]

Thank you for participating on today's conference call. If you would like to listen to the call in its entirety, you may call 1-800-834-5839. For participants dialing from outside the U.S., please dial 203-369-3351. This concludes today's call. You may disconnect at this time.

Participants

Executives

• Chuck Robbins, Chair and CEO
• Sami Badri, VP, Head of Investor Relations & Strategic Finance
• Scott Herren, EVP and CFO

Analysts

• Amit Daryanani, Senior Managing Director at Evercore ISI
• Ben Reitzes, Managing Director, Head of Technology Research at Melius Research
• David Vogt, Managing Director, Senior Equity Analyst at UBS
• George Notter, Analyst at Jefferies
• Matt Niknam, Director, Equity Research at Deutsche Bank
• Meta Marshall, Executive Director, Senior Equity Analyst at Morgan Stanley
• Michael Ng, Managing Director, Global Investment Research at Goldman Sachs
• Samik Chatterjee, Managing Director, Equity Research at J.P. Morgan
• Simon Leopold, Managing Director, Senior Equity Analyst at Raymond James
• Tal Liani, Managing Director, Senior Research Analyst at Bank of America