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Presentation

Cisco Systems, Inc. beats earnings expectations. Reported EPS is $0.88, expectations were $0.828.

Operator: Welcome to Cisco’s Third 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: Welcome, everyone, to Cisco’s third quarter fiscal year ’24 conference call. This is Sami Badri, Cisco’s Head of Investor Relations, and I am joined by Chuck Robbins, our Chair and CEO, and Scott Herren, our CFO. And given our recently closed acquisition of Splunk, we are also joined by Gary Steele, the former CEO of Splunk, which is now a Cisco company. 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. 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 fourth quarter and full year of fiscal 2024. 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 Forms 10-K and 10-Q, 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: Thanks, Sami, and thank you all for joining us today. We delivered a solid performance in Q3 with organic revenue coming in at the high end of our guidance range. Strong operating leverage across our business drove gross margins to exceed the high end of our expectations, resulting in better-than-anticipated earnings per share performance. We once again delivered good growth in annualized recurring revenue, remaining performance obligations and subscription revenue. We have transformed our business model with revenue from subscriptions now accounting for more than half of our total revenue even before the addition of Splunk. With the success of our transformation, we are well positioned to drive long-term growth powered by innovation across the organization.

I want to thank the entire Cisco team as it is through their dedicated efforts that our research and development engine has never been stronger across networking and silicon, observability, security, collaboration, and AI. The strength of our core business continues to produce strong cash flows, reinforcing our ongoing commitment to delivering consistent capital returns. In Q3, we returned $2.9 billion in value to our shareholders through share repurchases and cash dividends in the quarter with a total of $8.5 billion in value returned year-to-date. Q3 was significant for us in two important ways. First, I couldn’t be more excited about the successful close of our Splunk acquisition, Cisco’s largest ever. Our acquisition of Splunk was completed midway through our Q3 on March 18, earlier than initially anticipated.

Splunk significantly expands our portfolio of software-based solutions, contributing over $4 billion in annualized recurring revenue and adds to our position as one of the largest software companies in the world. We are thrilled to welcome the Splunk team to Cisco and are very excited about what we can deliver for our customers as we integrate our complementary security and observability capabilities. Our unified platform will revolutionize how customers connect and protect their organizations using data in new ways to enhance their entire digital footprint. Second, we introduced Cisco Hypershield, our most significant new security innovation with a groundbreaking AI-powered approach to highly distributed security, a first-of-its-kind. Combining security and networking in a way only Cisco can, Hypershield is built in the very fabric of the network, bringing the power of hyperscaler security and connectivity to the enterprise.

I will talk more about these developments and our innovation momentum in a few moments. But now, I’d like to turn to our performance in Q3 and what we’re seeing in terms of customer demand. The breadth of our portfolio, together with our many touch points with partners and customers around the world, provides us with differentiated insight into what’s happening in our customer base. Based on activations to the cloud, which we track as well as conversations with our customers and partners, we believe that the products customers have on hand are being steadily deployed in line with the expectations we laid out last quarter, meaning we currently expect customers to complete the installation of the majority of their inventory by the end of our fiscal year in July.

At a time where customers are ruthlessly prioritizing their IT investments, we saw product order growth in two of our largest product portfolios, data center switching and campus switching, as well as product order growth in our security and collaboration product categories. Overall, product orders were up 4%, and excluding Splunk, product orders were flat year-on-year. In our customer markets, public sector was strong in EMEA and APJC, but continuing resolution discussions in the U.S. temporarily impacted public sector performance in the Americas. We believe this has since cleared with the subsequent signing of the most recent U.S. Federal Government funding legislation. While our telco and cable customer demand remain muted worldwide, we are encouraged to see early signs of stabilization and improved performance in Webscale in terms of pipeline and orders.

Overall, our win rates are stable, and we saw increased strength as we move through the quarter. This reflects our competitive strength and successful execution and gives us confidence in the long term. We also know that the value of our portfolio is greater than ever as evidenced by recent sell-side research IT spending surveys, which show that Cisco is expected to be the only net share gainer within large network budgets over the next 12 months. Now, let’s look at our performance in Q3 in more detail. We saw revenue growth in security and double-digit growth in observability year-over-year, excluding Splunk as customers look to enhance their digital resilience with Cisco’s technologies. In the past year, we’ve accelerated our pace of innovation in security and I’m proud of what our teams have achieved.

As I mentioned earlier, last month, we introduced Cisco Hypershield, the first truly distributed AI-native cybersecurity solution, which will be built into our networking fabric. This new innovation leverages the recently closed Isovalent acquisition to facilitate deployment in software and the first shipment is scheduled for August this year. This launch furthers our vision for the Cisco Security Cloud, which is expected to deliver the industry’s most comprehensive unified platform with end-to-end solutions, making it easier for our customers to protect against the threats of today and tomorrow. Our newest available security solutions, XDR and Secure Access continue to ramp quickly with strong customer feedback. Just last week at RSA, we also announced the integration of Cisco XDR with Splunk Enterprise Security, which will give our customers even more value and insights.

The closing of the Splunk acquisition in Q3 will also enable us to begin driving revenue synergies in our security and observability markets. Upon closing the deal, we identified 5,000 existing Cisco customers who have the potential to become meaningful Splunk customers and our sales teams are already making those connections. We also see significant opportunities for revenue synergies by leveraging Cisco’s robust partner and customer ecosystem in markets where Splunk had limited or no presence. Earlier this week, Splunk was ranked as the leader in Gartner’s Magic Quadrant for security incident and event management, which is a testament to the strength of the offering and the continued business momentum that Splunk has delivered. We are working on rapid integration, investing in both product integration and go-to-market resources, starting with aligning our Cisco and Splunk sales forces and accelerating channel enablement processes for cross-selling and upselling our combined solutions.

We also continue to capitalize on the multi-billion-dollar AI infrastructure opportunity. In Webscale, we continue to see momentum with three of the top-four hyperscalers deploying our Ethernet AI fabric, leveraging Cisco-validated designs for AI infrastructure. In the past two quarters, Cisco has been granted additional design awards based on our 51.2 terabit G200 Silicon One ASIC. We expect these awards to yield orders in fiscal year ’25, reinforcing our confidence in our line of sight to $1 billion of AI product orders in fiscal ’25. Additionally, for those leading-edge enterprise customers who seek to be the early adopters of AI, our partnership with NVIDIA will offer easy-to-deploy cloud-based and on-prem networking solutions for AI inferencing.

We believe we are well-positioned to be the key beneficiary of AI enterprise application proliferation with the breadth of our portfolio and the vast amounts of data we see. Before I turn it over to Scott, I’d like to share one more update. Earlier today, we announced that Jeff Sharritts, our Chief Customer and Partner Officer, is departing Cisco and that Gary Steele, Splunk’s former CEO, has been named Cisco’s new President of Go-to-Market. Gary is well known for his operational excellence, and in this new role, he will work closely with me to set and execute against our strategic plans and goals for the company. He will continue to lead the Splunk team through the integration process to ensure a seamless integration into Cisco. Gary’s operational mindset, combined with his intense focus on simplicity and proven ability to drive growth, position him well in this role and I look forward to working closely with him in this new capacity.

I’d also like to take a moment to thank Jeff for all that he’s helped Cisco achieve, which is quite a long list of accomplishments in his 24 years here. Moving back to Q3, let me briefly summarize. While our core product portfolio is trending toward normalization as we continue to see customer deployments of shipped equipment progress, we are pleased that our security and observability portfolios have continued to grow and are significantly enhanced by the acquisitions of Splunk and Isovalent. As our customers adopt and deploy AI, they need the infrastructure to power it, the data to develop it and the security to protect it. And we believe only Cisco can deliver and integrate all three. With our unified platform approach, vast global partner ecosystem and ability to support hybrid and multi-cloud environments, we will deliver innovation at an unprecedented pace and scale to organizations around the globe.

I’ll now turn it over to Scott to provide more detail on the quarter and our outlook.

Scott Herren: Thanks, Chuck. Our Q3 results reflect solid execution with strong margins and a stabilization of orders. Both including and excluding Splunk, our revenue, gross margin, and non-GAAP earnings per share were at or above the high end of our Q3 guidance range. Total revenue was $12.7 billion, down 13% year-over-year. Splunk contributed $413 million in revenue in the partial quarter post-close. Non-GAAP net income was $3.6 billion, down 14%. Non-GAAP earnings per share was $0.88, down 12%. The interest cost of financing with Splunk acquisition slightly more than offset the positive operating impact of Splunk. The net effect was a negative impact of $0.1 on non-GAAP earnings per share. Looking at our Q3 revenue in more detail, total product revenue was $9 billion, down 19% and service revenue was $3.7 billion, up 6%.

Networking, our largest product category, was down 27%. We saw declines across almost all geographic segments due to the continued implementation of inventory by our customers. Bear in mind that our Q3 2023 networking revenues benefited from significant shipments of excess backlog. Security was up 36%, including the benefit received from the Splunk acquisition. Excluding Splunk, security grew 3%, driven by growth in SASE and double-digit growth in our Zero Trust offering. Collaboration was flat, driven by growth in our cloud calling and contact center offerings, offset by declines in meetings and devices. And observability was up 27%, driven by growth in ThousandEyes Network Services and the benefit from the Splunk acquisition. Excluding Splunk, observability grew 14% for the quarter.

As Chuck said, we have successfully transformed our business model. ARR ended the quarter at $29.2 billion, which increased 22% due to continued strong performance and contribution from Splunk. These factors also drove our product ARR growth of 44%. Without Splunk, ARR was $25 billion, up 5% and product ARR was up 9%. Total subscription revenue increased 12% to $6.9 billion, which now represents 54% of Cisco’s total revenue. Without Splunk, total subscription revenue was up 5%, representing 53% of Cisco’s total revenue. Total software revenue was up 5% at $4.5 billion, with software subscription revenue up 17%. Without Splunk, total software revenue was down 4% and software subscription revenue was up 6%. 91% of our total software revenue was subscription-based.

Total RPO was $38.8 billion, up 21% due to both strong performance and the Splunk acquisition. Product RPO grew 29%. Total short-term RPO was $20.1 billion, up 19%. Without Splunk, RPO was $35.3 billion, up 10% with product RPO also growing at 10%. Q3 product orders were up 4%. Excluding Splunk, product orders were flat year-over-year. We see customer product implementations progressing in line with our expectations and we expect these deployments to be largely complete by the end of our current fiscal year. Looking at our geographic segments year-over-year, the Americas was up 6%, EMEA was up 4%, and APJC was down 1%. In our customer markets, service provider and cloud was up 10%, the public sector was up 6% and enterprise was up 2%. Total non-GAAP gross margin came in at 68.3%, up 310 basis points year-over-year and above the high end of our guidance range.

Product gross margin was 66.9%, up 240 basis points, of which Splunk contributed 70 basis points. The remaining improvement was driven primarily by a favorable product mix and lower freight and other costs. Service gross margin was 71.6%, up 430 basis points. Non-GAAP operating margin came in at 34.2%, up 30 basis points, driven by our continued commitment to disciplined spend management. Operating cash flow was $4 billion, down 24%. Shifting to the balance sheet. We ended Q3 with total cash, cash equivalents and investments of $18.8 billion. Uses of cash during the quarter included a net outflow of $27.4 billion related to our acquisition of Splunk and in line with our capital allocation strategy, we returned $2.9 billion in value to our shareholders, including $1.6 billion for our quarterly cash dividend and $1.3 billion of share repurchases.

Year-to-date, we’ve returned $8.5 billion in capital to our shareholders. To summarize, we successfully completed the acquisition of Splunk, drove strong non-GAAP margins, and increased our operating leverage in the quarter. Turning to our financial guidance that includes our integration of Splunk. For Q4, our guidance is as follows. We expect revenue to be in the range of $13.4 billion to $13.6 billion. We anticipate the non-GAAP gross margin to be in the range of 66.5% to 67.5%. Non-GAAP operating margin is expected to range from 31.5% to 32.5%. Non-GAAP earnings per share is expected to range from $0.84 to $0.86. Our Q4 guidance includes $950 million to $1 billion in revenue from Splunk and non-GAAP EPS of negative $0.03 as the interest impact more than offsets the operating benefit.

In Q4, we’re assuming a non-GAAP effective tax rate of approximately 18%. For fiscal year ’24, our guidance is as follows. We expect revenue to be in the range of $53.6 billion to $53.8 billion. Non-GAAP earnings per share guidance is expected to range from $3.69 to $3.71. We’re assuming a non-GAAP effective tax rate of approximately 19%. Looking beyond Q4 and into our fiscal 2025, in addition to the top-line benefits from the Splunk acquisition, there are a few points to bear in mind as you build your models. First, we expect revenue growth to be in the low-to mid-single-digit range next year. Second is the interest impact from the acquisition, which we expect to be a headwind of approximately $350 million per quarter, including both the foregone interest from cash off the balance sheet and the additional interest payments on debt.

Third, we’re working to quickly integrate Splunk into our product offerings, go-to-market engine and expect to invest in OpEx in fiscal ’25 to drive those revenue synergies. Given these points, we expect fiscal ’25 operating margin to be in line with our Q4 guidance. We’ll give more formal guidance as we get to the next earnings call, but I want to make sure you have those three thoughts in mind. And as we’ve stated, we expect the deal to be non-GAAP earnings per share accretive in fiscal ’26 and beyond. Sami, let’s now move into the Q&A.

A – Sami Badri: Thank you, Scott. Before we start the Q&A portion of the call, I’d like to remind analysts to ask one question and a single follow-up question. Operator, can we move to the first analyst in the queue?

Operator: Thank you. Amit Daryanani with Evercore. You may go ahead.

Amit Daryanani: Yes. Thanks for taking my question. I have two. I’ll ask them both at the same time. Chuck, it’s really nice to hear about inventory digestion sort of being done and order growth getting back to flat and growing in some of the verticals. Some of your tech — some of the tech companies, I guess, have talked about a softer macro-environment that’s resulting in some positive spending. So, I’d love to understand kind of away from the inventory digestion that this seems like it’s happening, what are you seeing from a macro-environment and if that’s actually starting to improve as well for you folks? And then if I could just follow up on a different side, the $1 billion of AI orders that you have — you know that you see — that you believe you can get in fiscal ’25, can you just talk about is this other wins more coming from the Silicon One side or optical or on the switching solution?

Just any clue on kind of where do you expect to get these wins would be helpful. Thank you.

Chuck Robbins: Thank you, Amit. Appreciate the questions. So from a macro perspective, what I would say is that ironically, we saw the quarter actually slow — showed slight improvement as we move through the quarter. So the end of the quarter was actually a little stronger than the beginning. So we — and look, we obviously believe that our customers now are on track with the inventory digestion that we talked about last quarter, so that’s positive. But we saw the Americas excluding Splunk was up 2%, so that was a positive sign and Europe was flat. So that was good. And when you see campus switching and data center switching, both positive. And by the way, data center switching was in the mid-teens growth. So customers are investing in these private data centers and collaboration being positive, security being high-single-digits on the order side, it was, you know, but we didn’t see any different behavior from our customers during this quarter than we’ve seen.

They still are ruthlessly prioritizing what projects they spend money on, where they spend their IT dollars, but we didn’t see any fundamental shift in the macro. On the second question, on the $1 billion of AI, it is largely driven by the Webscale infrastructure. As I said, we had — we’ve got three out of four that are running our AI Ethernet fabric and we also had two or three more design wins during the quarter, I believe, in the back-end networks inside these Webscale players. So, it’s predominantly that. However, we are beginning to see enterprise pipeline materialize, as I said last quarter. So that’s really what it’s made up of. And it is both systems as well as optics across those customers.

Sami Badri: Thank you, Amit. Operator, can we move to the next question?

Operator: Thank you. Our next caller is Simon Leopold with Raymond James. You may go ahead, sir.

Simon Leopold: Great. Appreciate you taking the question. I wanted to see if you could give us some metrics or some help trying to extrapolate the 5,000-customer opportunity for Splunk. And just give us a better idea of what that could mean from a dollars perspective, if you’re able to penetrate it? And my follow-up is really, I’m trying to seek a little bit more clarification on this $1 billion AI pipeline because there’s been a lot of debate in the investment community regarding it. So I want to see if we can get some clarification that when we talk about the context of what’s in there, it’s explicitly in the back-end that there’s not some extrapolation to front-end data center applications. So explicitly back-end and I think, Chuck, you are saying that it is mostly switching in the back-end with some optics and some Silicon One. I really would like to clarify this because we’re getting a lot of questions. Thank you.

Chuck Robbins: All right. Let me answer the second one first, if you don’t mind since I just went on that one. It’s a $1 billion of orders that we have line of sight to and next fiscal year is what I had said. And on one of the earlier calls, maybe last call, I think I said our pipeline was roughly three times that we see, but we believe we have good visibility to $1 billion in orders in FY ’25. That is primarily back-end, and it is a combination of systems that are based on Silicon One, potentially some standalone Silicon One, but mostly systems and then optics as well. And then there’s — we’re beginning to see some enterprise use cases, but it’s predominantly back-end in the hyperscaler space. On the 5,000 customers, we basically did an analysis of where we have — and Cisco has super strong relationships and Splunk doesn’t have a presence of 5,000 customers and we’ve now mapped those to the sales teams.

And Gary, you want to make a comment on that because you’ve been involved in that deeply.

Gary Steele: Yes. So we’re excited about the fact that basically, we’ve identified these 5,000 customers where Splunk traditionally has had no footprint. And the goal there is to have the Cisco sellers open the door for the Splunk team. There’s also a financial incentive or spiff in place to incent the Cisco sellers to support this activity. And that’s really — that’s one aspect of where we see tremendous opportunity. And then second to that, obviously, there’s a lot of overlap in our customers where the Cisco team may have higher, more strategic relationships where they can extend our footprint, assist in helping extend our footprint within the existing Splunk base and we’re already seeing that activity right out of the gate. So we feel like we’re off to a very good start and I’m super encouraged by the level of collaboration we’ve seen so far.

Sami Badri: Thank you, Simon. Operator, can we move to the next question?

Operator: Thank you. Our next caller is Tal Liani with Bank of America. You may go ahead, sir.

Tal Liani: Hi, guys. I’m going to ask my two questions also together. They’re linked. You have great motions in security with lots of new products and you have Splunk introduction to the channel and you have also the AI opportunity for Ethernet. Can you give us a sense of timing, meaning how long — security grew again only 3%, ex-Splunk and how long does it take to get all the benefits that you’re talking about in these three main areas or in general, is it something we’re going to see early in ’25 or later in ’25 or ’26, if you can give us just a sense of timing of all these initiatives? The second part is related to it. If I remove Splunk from the numbers and you gave us enough data to completely remove Splunk from ’24 and I can take consensus for ’25, then your core Cisco, meaning your initial growth expectations for ’25 is about 5% because we need to remove also the backlog contribution this year.

So, Cisco ex backlog contribution should grow 5%. It’s higher than before. So the question is, are you comfortable with Cisco growing 5% next year, give or take? And what is the contribution — what is the main component of this growth. Thanks.

Chuck Robbins: Tal, thanks for the question. So on the — let’s go with the first question and I’ll say on the organic Cisco Security front, you’re right, revenue was up 3%, but as I said, our demand was as high — as the highest it’s been in probably a couple of years and it was high-single-digits. So we’re seeing the traction on these new products. They’re just ramping, right? They’re new, customers are testing, they’re implementing. And by the way, a lot of it is ratable. So you don’t — you take the orders and then, you know, like close to 80% of our security portfolio is ratable. So that actually impacts the time for it to transition into revenue. So that’s on the security side. But I think on the security and Splunk side, I’ll talk about it a little bit.

We’ve — and then I’ll let Gary comment on some of the integration. But we announced our first integration last week at RSA. Our intent is just to continue pushing innovation out. We’ll have more announcements at Cisco Live. So I think that you’ll continue to see that happen. I’ve always said on the security front even before Splunk that we had brought in a new team, we’ve been building new innovation. The team has built five new products and solutions from the ground up over the last 12 months, as you alluded to, just done a phenomenal job. And I had always said that second half of ’24, I expected you would see an improvement and then in ’25, you’ll see it get to where we really need it to be. And I think that still stands. You want to comment on the Cisco, the integration stuff, Gary?

Gary Steele: You bet. So, one of the things I’m super excited about is the progress we’ve made from an integration standpoint. So last week at RSA, for example, we announced the integration between the Cisco XDR solution and Splunk’s Enterprise Security solution. So bring — bringing high telemetry alerts into Splunk Enterprise Security gives a Splunk customer that much more value in terms of threat detection. And this is just the start of the elements of integration that we can deliver that will ultimately drive growth for the security portfolio broadly, but also Splunk. And as we’ve described earlier, integration strategy really is a strong ground game, meaning we want to move the ball three yards at a time and we’re going to demonstrate to the industry that we can continue to innovate at a rapid pace as a combined business. And we feel like we’re on a really good track to do that.

Chuck Robbins: Thanks, Gary. And then on your AI timing question in ’25, my suspicion is that that’s going to start low at the beginning of the year, and it will ramp as we get through the year. So I’ll be thinking more back-half, but we’ll have to see how these pilots go. We’ll probably know a little more about — we’ll know more in the next 90 days on that. On your second question, first of all, I appreciate the fact that you recognize that several billion of backlog that we cleared last year because this is the last — this is a — ’25 will be a year where we’re still going to have strange comparisons because we’re just still coming out of the tail end of this supply chain situation and this whole digestion issue and the inventories, shipments and everything.

So ’26 over ’25 will be the year where you will really hopefully get back to real apples-to-apples year-over-year comparisons. And while I’m not — we aren’t giving a breakdown today of the FY ’25 Cisco or Splunk contribution, we’ll obviously have an Analyst Day in June and we’ll go into more detail there. And Scott, do you have anything to add to that? Or is that good?

Scott Herren: No, I think you said it right and Cal, the fact that you’ve recognized the backlog work off it, it clearly is a headwind on just the core Cisco when you look at year-on-year growth rate into fiscal ’25. Bear in mind too, obviously, Q3 was a tough compare. If you remember that we had those three consecutive quarters of revenue growth in the mid-to-upper teens, Q3 of ’23 that we’re comparing to now, Q4 and then Q1 of this year. And so in addition to doing the year-on-year growth rates the way you’re doing it, you need to think of the backlog impact on the year-on-year growth rates in both this quarter, next quarter, and again a tough compare in Q1 of ’25.

Sami Badri: Thank you, Tal. Operator, can we move to the next question?

Operator: Thank you. David Vogt with UBS. You may go ahead, sir.

David Vogt: Great. Thanks, guys, for taking my question. So maybe, Scott, I want to follow up on that line of questioning from Tal. Now I recognize that you have that backlog headwind in ’24, but if I just kind of run through what Splunk should be doing versus what they contributed this year, it certainly looks like the backlog headwind is going to cause — of course, is going to be down next year. I know you said you’re going to hold off on giving numbers. Is that the right math? And so basically all of the low-single to mid-single-digit growth comes from Splunk. And then from a gross margin perspective, obviously, Splunk is going to be a much bigger part of the business. Can you maybe walk through, you gave us an operating margin framework, but sort of what do you expect from a gross margin perspective, given the strong gross margin profile of Splunk being a bigger part of the business next year versus this year? Thank you.

Chuck Robbins: Yes. Thanks, David. You remember Q4 — Q1 of this current fiscal year of fiscal ’24 was really the last quarter where we shipped a lot of, I’ll call it excess backlog, right? There’s always an ambient level of backlog where we had a lot of excess backlog that built up during the supply constraints. So when you think about the growth rate from ’24 to ’25, clearly Splunk is a positive on that, obviously adding that to it. But you also have to think of this year, fiscal ’24 having a non-repeatable bit of excess backlog that was shipped in the first quarter of this year. Remember first quarter this year, we grew in the mid-teens on revenue. So if you net that out and that’s the math that Tal was doing to say the core business is actually growing in those mid-single digits in fiscal ’25.

And where we can walk through, I know there’s a lot of moving parts there. David, we can walk through that if you want. On the gross margins, I think the way to think about that, we had some benefit in the quarter. Splunk itself is a benefit, of course. We had some benefits in the quarter on product mix and some cost savings that I don’t think are repeatable longer-term. So I talked about the guide for Q4 being gross margins in the 66.5% to 67.5% range for Q4. I think that’s the right range as you think about fiscal ’25 as well.

Sami Badri: Thank you, David. Operator, can we move to the next question?

Operator: Thank you. Meta Marshall with Morgan Stanley. You may go ahead.

Meta Marshall: Great. Thanks. Maybe first question, Chuck, if you could just kind of update where your kind of conversations with customers are around AI, either in kind of desire to invest on-premise or invest in kind of Cisco Security products for preparedness or just impact to budgets? And then maybe second question for Scott. Just as we think about kind of the OpEx investment that you guys noted for Splunk, you know, how should we think of that versus kind of original targets to have Splunk be kind of accretive one year post close? Thanks.

Chuck Robbins: Thanks, Meta. I would say the conversations, I think the webscalers is pretty well understood. So I’ll talk about the enterprise. And I think most enterprises, there are some that are certainly running pilots that are doing some work today and we actually have had some — we had a handful of wins in the enterprise space for infrastructure that was supporting AI build-outs, I’d say they’re still very, very, very early. We had our Global Customer Advisory Board last week in Canada and I think we had about 60 customers there and they’re all still trying to figure out exactly what their use cases are and how the architecture is going to play out. So I would say it’s still super early on the enterprise side.

Gary Steele: And then–

Chuck Robbins: Sorry, did you want to add something, Gary? Go ahead and start.

Gary Steele: And in terms of the way to think about the OpEx comment that I made, you know, we talked, Meta, when we announced the acquisition of Splunk that this is much more driven by revenue synergies than cost synergies. There’s no question there will be cost synergies as we work our way through this, but we will spend fiscal ’25 — from this point through fiscal ’25, ensuring that we get both the product integration right, the organizational integration right, we have to do channel enablement, we have to train their sales team on Cisco, train the Cisco sales team on Splunk. There’s investment that goes along with that integration and fiscal ’25 is the year we’ll do that. We said in the first year post-acquisition that we would be accretive in cash flow, and we will, that we’ll be accretive in gross margin from Splunk and we will and that we’ll be accretive in earnings per share in the second year.

So that’s — think of that as fiscal ’26. I know this closed a little bit early and I think there’s this perception that it closed six months early. So those times ought to be accelerated. We thought the acquisition would close around the end of our fourth quarter. It closed around the middle of our third quarter. So round numbers, it was a little more than a quarter early. So I think the way to think about that is EPS accretive in fiscal ’26, but still being cash-flow and gross margin-accretive in fiscal ’25 as we invest in the integration.

Sami Badri: Thank you, Meta. Operator, next question.

Operator: Thank you. James Fish with Piper Sandler. You may go ahead.

James Fish: Hi, guys. Did want to double-click on Meta’s question here because it’s a serious ramp on the OpEx side to get really earnings going down again in ’25, if my math is right, somewhere around $3.50 a share. Can you elaborate a little bit further as to why it’s going to go — be that much? Do we — should we be expecting revenue synergies starting in fiscal ’25 with that initial kind of low- to mid-single-digit growth rate or is that just going to take too much time, another year or so to really get? And just not to layer on the question here, but is some of the OpEx ramp due to the conversion of stock-based comp of Splunk to cash comp because historically, Splunk and Cisco have had two totally different philosophies on compensation?

Chuck Robbins: Yes. Thanks, Jim. On the OpEx ramp, I mean, it’s — I know we haven’t — the Spunk team didn’t put out guidance for this fiscal year, but you can look at where their OpEx was headed and layer that into the OpEx that we had. There is some growth year-on-year, there’s some investment. It’s not — it’s not a substantial ramp-up though in the investment on integration. It’s more a question of just pulling the Splunk team together with ours. As I said, there will be some cost synergies that are likely to come more in the second half of the year, but this wasn’t a deal that was motivated by cost synergies. It was much more motivated by revenue synergies. I think you will — what you said, I think is spot on. We will see those revenue synergies begin to ramp in the second part of fiscal ’25 as these are not short sales cycles as we get our team ramped up on how to sell Splunk as we get the Splunk team ramped up on how to sell Cisco and as we get our channel fully enabled to sell that.

So yes, you’re going to see those revenue synergies, but you’ll need to think about them more in the second half of the year.

Gary Steele: Yes. And I think the revenue synergies that we’re focused on really are driven around the 5,000 accounts that we talked about earlier. The sales cycles on those are six to nine months. And so you’re not going to see that immediately, but that work is happening. And we’re also seeing tremendous collaboration across the organization where sales teams are working together to more broadly penetrate accounts. I think you start to see that in the first half, but it’s going to layer in, you’re going to see more momentum as we get to the middle part of the year.

Sami Badri: Thank you, Jim. Operator, next question.

Operator: Thank you. Samik Chatterjee with JPMorgan. You may go ahead, sir.

Samik Chatterjee: Hi, thanks for taking my question. I have a couple as well if I may. I know you’re talking today about the deployments with your customers, enterprise customers being higher than what you’re shipping to and that implies you’ll take a step-up in terms of revenue and that inventory digestion ends. I was just curious in sort of the order trends. You had mentioned you’ll be back to a normal seasonality of orders, maybe more in fiscal ’25, but how close are you seeing sort of order trends return on a sequential or quarterly basis to more normalized sort of seasonal trends? Is that pointing you in any direction in terms of whether that gap between deployment and your orders are starting to sort of compress? And for the second one, just on the quick follow-up on the AI order of $1 billion sort of target here.

Just trying to understand if you feel like you need one or two more big wins in terms of customers or the land and expand with the existing ones should be good enough to get you to that $1 billion target that you have? Thank you.

Chuck Robbins: Scott, you want to take the sequential one?

Scott Herren: Yes. Well, on the enterprise deployments, we are seeing that progress, Samik. And one of the things that’s been encouraging, and we’ve given you some of the data on this is where we see it moving more quickly. We talked about WiFi and how our wireless business is growing, where the — if the enterprise deployments of all the product that was pushed out has progressed more quickly, we’re seeing demand return. Normal seasonality, if you’re talking about year-on-year growth rates is a lot tougher, right? You’ve got to get to a point where you actually have a normal quarter and which we’re headed toward now once we get through this inventory consumption at the end of this quarter and then you have to lap it by a year.

To get to a year-on-year compare, that’s an apples-to-apples compare. So think of the normal seasonality in terms of year-on-year growth rates beginning much more in fiscal ’26. From a sequential standpoint, you’ll see that start to happen in the second half of fiscal ’25.

Samik Chatterjee: Yes.

Scott Herren: And then on the AI, the $1 billion — the $1 billion that we talked about, those are actually identified opportunities that our teams have a high degree of confidence. This is not like — we didn’t set a $1 billion target and tell people to go find deals. There are deals behind $1 billion and there are actual wins that we either have already won or we have a high degree of confidence that we will win. There’s certainly execution that has to occur between now and whenever we get it — when we get them done. We have to get through the pilots. There’s a lot of testing that has to take place. There’s power consumption testing that goes on. So a lot of that’s going on. But based on what we know, this is what our teams believe today. So this is not some aspiration that we have to go find. This is — these are opportunities that have been identified that our teams feel good about.

Sami Badri: Thank you, Samik. Operator, next question.

Operator: Thank you. Matt Nicknam with Deutsche Bank. You may go ahead, sir.

Matt Nicknam: Hi, guys. Thanks so much. One question, one small follow-up, and I think this has been the theme most of the call. On the main question, actually for Scott, you’ve got leverage now that sits just under one turn, but the business now has a greater mix of recurring revenue, more visibility that that naturally lends itself to. So I’m just wondering how you think about optimal leverage for the business and uses of excess cash from here. And then just on the follow-up, as we think about low-to mid-singles growth next year, well aware of the backlog and the tougher comp that that creates in fiscal 1Q of next year. Just as we unpack the networking assumptions, are you assuming normal demand and purchasing cadence returns next year once inventories have been digested? Or is there any incremental caution that’s embedded there from a macro perspective? Thanks.

Chuck Robbins: Scott, you want to take the first one?

Scott Herren: Yes, I’ll talk about cash first, Matt. And yes, we moved obviously with the acquisition of Splunk, and this beta is out there. We raised about $13.5 billion of term debt that’s out there, and we actually funded a lot of it with some cash off the balance sheet, but also with commercial paper with the expectation that as rates come down, obviously, commercial paper is a more real-time reflection of those lower rates. So it’s a way of saving money on that. Moved to a net-debt position for the first time and certainly in my career, probably in the first time in the — here at Cisco, probably the first time in the last two decades here at Cisco. The use of cash though, like we talked about Splunk being cash-flow accretive in its very first year, which is highly unusual for a transaction of this size, it will be.

And so our capital allocation process is not going to change. And just to reiterate what it is, first and foremost, it’s support growth, right behind that. If that’s one, 1A is, of course, continuing to support the dividend and you see we’ve continued to grow the dividend on a year-on-year basis. Return cash to shareholders through share buybacks. That’s been at a steady $1.25 billion per quarter for the last now several quarters. We’ll continue to do that. And to the extent that we’ve met those three and there still is excess cash, we’ll determine whether it makes sense to take that cash and delever or if it makes more sense to return that to shareholders at that time.

Chuck Robbins: And Matt, on the demand normalization, based on what we see today, I think we would expect starting in Q1 and beyond, we should see that normalize. Obviously, with the caveat that there are a lot of hot spots around the world, there are a lot of potential risks out there that are happening. We’ve got elections all over the world and the most important one perhaps in the United States. So we’re certainly going to have to see how all of this plays out. But so far, based on what we see, I think that’s a decent assumption for FY ’25.

Sami Badri: Thank you, Matt. Operator, next question.

Operator: Thank you. George Notter with Jefferies. You may go ahead, sir.

George Notter: Hi, there. Thanks very much. I guess I wanted to ask about gross margin impacts from the inventory digestion. As we look around the space, we’ve seen companies use tools like stock rotation or rebates to try to push inventory through the channel. Sometimes that can certainly have an impact on margins. Are you guys seeing any of that in the gross margin results right now? Thanks.

Chuck Robbins: No, we’re not, George. There’s very little inventory that — in the channel that is something that we continue to own. In other words, when we ship it to the channel, it’s sold at that point. There’s very little stocking that happens inside our channel. So we’re not seeing that benefit. What we are seeing is, of course, we’ve put in place the price increases to help offset the higher cost that we saw coming through the supply chain constraints and we’ve lapped those. But there’s actually a little bit, you’ll see when our Q comes out a little bit of pricing headwind back to the normal what it had been kind of pre-pandemic, but big benefits, of course, with the product mix of Splunk coming in and some one-off things that we benefited from during the quarter.

Sami Badri: Thank you, George. Next question.

Operator: Thank you. Ittai Kidron with Oppenheimer. You may go ahead, sir.

Ittai Kidron: Thanks. I had a question for Gary. I guess, off the press, Palo Alto just announced its acquisition of the SIM business from IBM. Exabeam this morning announced the merger with LogRhythm. So it seems like the market you’re operating in is moving at a very fast pace at consolidation. Maybe you can talk about the competitive landscape for your business and why should we not assume that pricing pressures are going to significantly rise in this environment as everybody is trying to fight for footprint?

Gary Steele: Yes. No, great question. There obviously is a lot of activity in this particular market. One of the things that we feel very good about and Chuck referenced in his prepared remarks earlier is our position in Gartner’s Magic Quadrant where we stood out as the leader in the SIM market. We — so we have a very strong established market position, and our pace of innovation has fundamentally changed over the last couple of years. We’ve continued to deliver very interesting innovative capability that we think is very high value. So for example, last week at RSA, we announced what we call Splunk Asset and Risk Intelligence. This is a critical capability to help organizations do self-discovery of assets across their environment and then understand the risks associated with those things.

Coupled with that, we’re now getting the broad benefit of the Cisco Security product line where we can bring in interesting capabilities like the integration with the XDR solution that we also announced. So, we feel like while, yes, it is competitive, we feel like we’re incredibly well positioned to continue to drive very important innovation. And we’ve also taken a very different approach than our competitors and we think broadly about how do you bring together on a single platform the security capabilities that customers want broadly all the way through observability and it’s very difficult across the industry to see anybody taking the position that we have and driving value. With respect to pricing, we don’t have any fundamental change in our pricing strategy.

We’re very much focused on driving very good adoption across our customer base and ensuring that they feel like they’re getting value every day. And the capabilities that we’re offering are hard to match in the industry. So we’re not — we’re not shifting gears from a pricing point of view.

Sami Badri: Thank you, Ittai. Next question.

Operator: Thank you. Ben Reitzes with Melius Research. You may go ahead, sir.

Ben Reitzes: Yes, hi. Thanks for the question. I — in the spirit of the two, I wanted to ask, if we take, let’s say, $1 billion to $2 billion of the hit from inventory in 2025 and from the prior question, I just want to make sure that I heard it right that you — do you underwrite that the real industry growth is about — or the real networking growth is in that mid-single-digit range that was mentioned in a prior question. And then if that’s the case, I guess this is the second one, then does it mean at your Analyst Day, we’ll hear more about how 2026 could be a higher single-digit growth business for Cisco overall? I mean, you’re mixing towards Splunk and software and therefore, the math would — therefore have you guys on a normalized basis after, you know, after the organic growth is very muted in 2025, accelerating by several hundred basis points to the higher single-digits in 2026, if that’s true.

Be happy to repeat any of this, but hopefully, you were able to follow that. Thank you.

Chuck Robbins: Yes. I got it, Ben. And you’re asking me now for fiscal ’26 guide at the same time. Is that the right takeaway? Just you’re thinking about it right. The underlying business, the core business of Cisco net out the benefits of the Splunk acquisition when you look at fiscal ’25, but also when you take ’24, net out the impact of the excess backlog that we shipped early in fiscal ’24, mostly in Q1, a small amount in Q2 as well, and you get to that mid-single-digit growth of the core business that we’ve had. So, I think you’re thinking about that right. We will talk more — I’m not going to do it on this call, but we will talk more about fiscal ’26 and beyond at our Investor Day in June in Vegas. So hopefully, I’ll see you there.

Sami Badri: Thank you, Ben. Next question.

Operator: Thank you. Atif Malik with Citi. You may go ahead, sir.

Atif Malik: Hi, thank you for taking my questions. The first one is for Gary. Gary, Splunk has been using AI/ML for the last year and a half with natural language assistant SPL and also event detection and response. Can you big-picture talk about how Cisco data will improve your AI capabilities?

Gary Steele: You bet. And so if you look at the history with Splunk, we were very early driving capabilities with machine learning. We launched the MLTK package in 2017 and we’ve had a quarter of a billion — excuse me, quarter of a million users on that. So there’s been broad adoption. We then extended that when we brought Gen AI into the picture, delivering an SPL assistant, SPL being our proprietary search language, being able to use English to be able to do that. We’re also bringing AI directly into the workflows. So think about SOAR as an example and how you can bring AI into the picture to drive better outcomes from a remediation point of view. So, we’ve been investing across the product line. You’re going to hear and see more announcements from us over at Cisco Live as well as at our user conference, which follows Cisco Live.

And the benefit that we’re getting — bringing it into Cisco is Cisco has made — independently been making a whole set of investments. We get to leverage those assets in addition to the richness of data that we get. So where we benefit from Cisco is the broad rich datasets that exist across networking where you — so think lateral movement, how can we leverage that data to do a better job from a detection point of view? And frankly, the data and insights that we have as a combined entity, I think are second to none in terms of the competitive environment. So we just basically accelerate our AI efforts as part of Cisco and the outcomes we can deliver to be really important.

Sami Badri: Thank you, Atif. Michelle, can we move to the last question?

Operator: Thank you. Michael Ng with Goldman Sachs. You may go ahead, sir.

Michael Ng: Hi, good afternoon. Thanks for squeezing me in. I just have two as well. First, I think that the guidance this year implies 34% EBIT margins. You commented that fiscal ’25 can look like the guide for fiscal 4Q. I mean I think it’s about $1 billion of OpEx investments. I was just wondering if you could kind of qualitatively talk about where most of those OpEx investments will lie? And then secondly, last quarter, you characterized the fiscal ’24 guidance as conservative, I believe. How would you characterize your initial financial outlook for fiscal ’25? Thank you.

Chuck Robbins: Okay. Michael, thanks for the question. The year-on-year, again, the — I think what you’re struggling with on the fiscal ’25 look is expectations if you just added — straight added where the run rate of Cisco spend to what your expectations are the run rate of the Splunk spend. And I’d say a couple of things to bear in mind. There are some one-time benefits that we had this year in our OpEx for the Core Cisco pre-Splunk acquisition, up frankly in our variable comp plans, which, you know, it has been a tough year and we’ve come up short of our plan. And so there’s some savings in variable comp for this year and fiscal ’24, obviously, I don’t plan on repeating those in fiscal ’25. So there are some — and then obviously will do a merit increase as well.

So there’s some small increase that is just kind of the reset of the comp plans and ongoing merit. There is some investment as well in the integration, but it’s not even approaching the number that with the quick math that you just did. So that’s kind of the way to think about that piece. Now if you look at the guide for next year, kind of how would I say — what I’d say about the guide for next year is I feel with a lot of the tailwinds that we’re seeing right now, so let’s just go back. Consumption of all the inventory that we shipped to customers that they were working very hard to get implemented is going in line with our expectation. We think we work our way through that headwind mostly by the end of this quarter, our fourth fiscal quarter.

That’s a tailwind for next year. Obviously, the AI opportunity that we’ve talked about and being more second half, but for the full-year — second half of fiscal ’25, but for the full-year, that’s a tailwind as we look ahead. Security business is doing what we said it was going to do, right? It’s — we’ve launched new products there even before the acquisition of Splunk and those products are getting good traction. So that’s a tailwind as we look at next year as well. So I think all-in-all, I feel like it’s kind of a down-the-middle view of fiscal ’25 at this point. It’s not a formal guide. I just wanted to give you a sense of what that looked like and we’ll do — we’ll give you a better feel for what the longer-term looks like at our Investor Day in June, and then we’ll give you a more fulsome guidance when we get to our Q4 call in August.

Sami Badri: Thank you, Michael. I now want to hand it over back to Chuck for some closing remarks.

Chuck Robbins: Thanks, Sami, and thanks to all of you for spending time with us today. I guess I’d say I’m pleased that we’re getting to the tail end of this supply chain situation that we’ve been navigating for the last several years, on track to get this consumption issue behind us as we enter FY ’25. I feel good about the overall demand environment we saw in Q4, which supports the fact that our customers are getting this digestion done. As we look to the future, we obviously are optimistic about AI, both from an infrastructure perspective, a data perspective as well as a cybersecurity perspective. Security in general, we believe will continue to improve. And obviously, we’re super excited about the Splunk integration and we’re committed to deliver for both our customers and for you.

I also just want to quickly thank Jeff Sharritts for everything he’s done at Cisco and also they were very excited to have Gary taking on the new role here and thank you all for being with us today.

Sami Badri: As a reminder, we will be hosting our 2024 Investor Day as part of Cisco Live on June 4, 2024. Cisco’s next quarterly call, which will reflect our fiscal year 2024 fourth-quarter and full-year results, will be on Wednesday, August 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. We thank you very much for joining the call today.

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