Cisco Systems, Inc. (CSCO) J.P. Morgan Global Technology, Media and Communications Conference

Cisco Systems, Inc. (NASDAQ:CSCO) J.P. Morgan Global Technology, Media and Communications Conference May 20, 2024 1:50 PM ET

Company Participants

Scott Herren – Executive Vice President and Chief Financial Officer

Conference Call Participants

Samik Chatterjee – Executive Director, J.P. Morgan

Samik Chatterjee

Good afternoon, everyone. I’m Samik Chatterjee, I cover hardware and networking companies at J.P. Morgan. For the next fireside chat, we have the pleasure of hosting Cisco. And I have with me Scott Herren, Chief Financial Officer. Scott, thanks for taking the time to be at the conference. Thank you to Sami as well, from Investor Relations.

Question-and-Answer Session

Operator

Q – Samik Chatterjee

Thank you. Scott, I’ll start you off with a few questions, primarily from the earnings report that you had.

Scott Herren

Sure.

Samik Chatterjee

Last week — you reported last week with an update on stable demand trends, and we are asking all of our companies to really comment about how they think about demand trends, 12 months out.

Scott Herren

Sure.

Samik Chatterjee

Just offer your insights in terms of, I know it’s a difficult question in itself to forecast demand 12 months out, but how do you think about where we would be in 12 months in relation to demand, as well as the magnitude of the change from where we stand today?

Scott Herren

Yes. First of all, Samik, thanks for having us. It’s always a pleasure to get a chance to spend time with you and with the group in the room. Yes, we just had our earnings call last week, and as a part of that, one of the things that we announced was total product order growth, which is a leading indicator, obviously, of revenue growth. Total product order growth was plus 4%. That included Splunk, because we had about six weeks of Splunk, right? That transaction closed on March 18th for us. So we had about half a quarter of Splunk.

If you net that out, product order growth on a more apples-to-apples basis was flat year-on-year. And that’s an improving trend from where we’ve been, because, remember we’ve had this disruption that hit the supply chain, and we had three consecutive quarters of 30 plus percent order growth while lead times extended and people had to buy ahead. And then as we solved those, the kind of the supply chain, the individual constraints, we actually solved it really quickly and got a lot of product shipped out in the third quarter a year ago. So, our last week earnings call was our fiscal third quarter. So tough compared to a year ago, where we shipped a lot of backlog out as we worked through those constraints, this current quarter, we also shipped a lot of excess backlog out a year ago, so tough compare.

Q1 will be the last of the tough compares, but in the wake of that, once we got all that product shipped out into the field, what we saw is now that kind of, we had this bottleneck at our level and we got it shipped out pretty quickly, and now that bottleneck just moved to the customer level. And their ability to implement everything that we had shipped to them — by the way they had ordered it all, but their ability to implement it as quickly as we would like them to was limited.

And we said on our Q1 call as we took down our expectations for the year, we thought it would take a couple of quarters. And then in Q2, it became clear to us it was actually going to be more like the end of this quarter. So, this is our fiscal fourth quarter right now. We track this pretty carefully, as you can imagine, given the impact it’s had on demand, we track it pretty carefully and it looks like the overwhelming majority of that product inventory that got shipped out as we cleared the backlog will all be implemented by the end of this fiscal quarter.

So what that’ll mean for demand, it’s obviously been a headwind. It’s like, hey, I’m busy. I’ve got to implement what you’ve already shipped me before I start the next project. Starting the next project means now I’ve got to go ahead and place the orders for that. And our lead times have been back to normal for a couple of quarters. Backlog has been back to normal really since early in our second fiscal quarter of this year.

So, I think most of the perturbances from the supply chain are through the system. But now the compare points still reflect some of those changes. I feel good about it, I mean, it’s hard to say you feel good about flat demand, but given the trend, what we’re seeing is as we were able to track product that was shipped out and we know serial number X left the loading dock on this date, when did it actually get set up and configured? And we know that especially within Meraki because there’s a cloud-based control plane from Meraki, we see those times coming back down to where they had been pre-pandemic and pre some of the supply chain issues.

So feeling good about that, where we’ve seen it recover, we’re seeing order growth return at the same time. And that’s part of what you saw during the quarter with enterprise still being modestly down, public sector growth, growth in service provider and cloud growth in our security portfolio, and growth in collaboration. So, it was — we’re really seeing a positive trend through that.

Samik Chatterjee

Okay, yes. Let’s delve into campus switching and how orders also grew for data center switching and campus switching together in the quarter. Just give us more color in terms of what you’re seeing on those two aspects, given that, I think both were probably facing the same headwinds from the supply chain until last quarter or the prior quarter, I guess, just give us more color what you’re seeing both in relation to campus switching and data center and the drivers there, what is the customer really sort of now starting to engage in?

Scott Herren

Sure. Pretty encouraging couple of data points given where we’ve been over the last six or seven quarters to see those both return to positive growth, particularly in campus switching, I think is the one that surprised a lot of people. I think data center networking growing. We’ve all seen, you know, one of the big drivers of that, of course, are the big hyperscalers, and so I think that was probably less surprising than campus switching.

And what’s happening in campus switching, there’s a lot of excess commercial real estate. I don’t feel bad for anyone in the room that’s in that space, but there is, but what is happening, and we’re doing this at Cisco too is companies are now saying, you know what, it’s time to get back to the office. Maybe not five days a week. Maybe I don’t need the space that I needed previously, but for cultural reasons, for, frankly, the training and the growth of the early and career people, when we survey our own teams and say, what’s your propensity to want to come back to the office, the people that are most interested in coming back to the office are people like me with a lot of gray hair and the people that are early in their career.

You’re smiling, but I know it’s true. And people that are early in their career because that it not only provides a little bit of a social structure for them, but it provides a bit of an apprenticeship aspect. You know, I didn’t learn to do what I do in school. I learned it on the job and I learned it from role models that I got to sit next to and ask questions. So, more and more companies are saying, you know, what, two days a week, three days a week, we want you in the office.

And as they do that, it’s work in the office, everyone’s not going to be there on any given day. So, the network intensity of the people who are there is going up. And so it does — it seems a little bit odd that with commercial real estate having high vacancy rates that campus switching would grow, but it’s really an outgrowth of what the office needs to look like in this world where more and more companies are saying, it’s time for people to get back to the office.

Samik Chatterjee

Okay. I’ll come back to that in a bit just to parse out wireline — wired versus wireless. But since you mentioned campus switching, I think, and the recovery there, one obvious place that investors will go is how much of this is a benefit from a large M&A with some of your competitors versus actual market recovery.

Scott Herren

Yes. I think so we clearly have seen some uptick in wireless. We gave a couple of stats on the previous call. We continue to see large orders in that space grow in the Wi-Fi and particularly in the wireless access point space. I think some of that is people looking at that acquisition and trying to understand — I think what they’re going to have to do clearly is merge the control plane for those two. I can tell you because we’ve been doing this within our catalyst in Meraki lines, technically that’s super challenging to do. So it’s going to take some time and as it does, there is this which architecture is going to win out.

And so I do think it has created some opportunity for us in the wireless space. It’s certainly something that we’ve gone after with our sales team and going into those accounts that we know we’re heavy with either of those two competitors who we’ve known for a long time, we’ve competed against them pretty effectively for a long time, seeing them come together, I think has just created some more opportunity for us.

Samik Chatterjee

Okay. You didn’t talk about wireless, I’ll skip that. Now when we talk to distributors, resellers, a term that often comes up is every enterprise has a lot of technology debt that they haven’t really addressed. And some of the headwinds we’ve seen in the last couple of sort of quarters or more have actually increased that. When you think about the recovery here, how are you thinking in terms of the drivers for customers to come out and say, okay, this is what I need to address and which product areas in your portfolio does that help and maybe go beyond sort of the core networking to also help us address security and collaboration and observability within that?

Scott Herren

Yes, I think technical debt builds up in a lot of places. You probably don’t have any at J.P. Morgan, but other companies do, that have built it up. And I think where you feel it is partly in your infrastructure, whether that’s compute infrastructure, network infrastructure, just core systems infrastructure, you feel it there, you feel it in applications, lot of older applications that are not going to be retired and they’re going to have to continue to be run and that drives demand for things like observability and application performance monitoring, right?

We’re not going to unplug this app, it doesn’t make sense to rerun — rewrite it, we’re going to continue to run it. I need to run it efficiently. You see it build up in data structures, and I think that’s one of the benefits that we ultimately — that will be a tailwind for us ultimately with Splunk is companies that have been around long enough to have technical debt probably didn’t sit down 15-years ago and say, here’s a pristine data model that we’re going to put in across the company and here’s the specific owners and the governance around that.

The data models just kind of grew as the company grew. And so there’s going to be some rationalization that needs to be done there. For us, what it means is there’s an opportunity, of course, in core networking infrastructure and campus switching, as we’ve talked about. There clearly will continue to be opportunities in security. I don’t think that’s necessarily based on technical debt within security. I think it’s based on the world we live in and some of the geopolitical stress that’s out there that seems to be getting worse, not better at this point.

That’s going to drive — continue to drive security. There is some cycles within the security business, firewalls that need to be refreshed and things like that, but I don’t view that as normal refresh as opposed to technical debt. Within collaboration, there’s no question that as people come back to the office, the way the office needs to be configured to work effectively in a hybrid world, which I think we’re all going to be in for quite some time.

There’s no question that you need better devices. You’ve got to improve what that experience is like. If you want people to take the time to drive to the office to work, you need to make the office experience one that — one of the things we talk about is having a return on commute, okay. If I’m going to spend the time commuting, what’s the return I get for that commute. And so I think there’s clearly an opportunity on the device side within collaboration as well.

Samik Chatterjee

Let’s switch gears here a bit and we are asking obviously, as you can imagine, a lot of questions to our companies are about AI, but before we delve into the product set, what we also were curious to hear from all of our companies, including yourself, is how do you adopt AI internally? What can that drive in terms of improvement and where can it be a bit more tangible for investors to also sort of think of those improvements?

Scott Herren

So, what other companies should everybody invest in around AI?

Samik Chatterjee

Or how sustainable is this?

Scott Herren

No, I think it’s a great question. And there’s a lot of use cases, obviously, just within the finance organization that we’re looking at. Everything from account reconciliations, which are pretty basic to the way you prepare and kind of self-service data, right? If you think of what happens inside the finance organization of big companies, it’s a lot of, hey, can you get me X?

All right. Yes, I got to go pull data from here and here and here and here and put it all together and then try to massage it into something that makes sense. That’s going to lend itself very clearly to AI beyond RPA, which has already helped in that space. But then if you zoom out from finance, there’s huge opportunities for us to be more efficient in the 1800 Cisco in our call center space, both on the inbound calls that we take.

One of the big advantages, I think of these large language models that have come out, I know you’ve played with it, I have too, is there’s a dialog capability to it. It’s not submit kind of a query and get an answer. There’s a dialogue and it’s back-and-forth. And I think that lends itself, as you know, very well to customer support, customer service.

We’ve just moved Liz Centoni, who was our Chief Strategy Officer, just moved into the role running our customer experience team, which includes customer success and our customer support teams. No one’s better positioned to drive AI through that space than Liz is, kind of, given her background. She has an engineering background. So I think there’s a real opportunity for us there. And of course, there is the opportunity to make sales and marketing much more efficient. I think everyone sees that as well.

Samik Chatterjee

Okay. Let’s move to then the product side and this is a big change for Cisco, particularly for the investment community where Cisco’s positioning for the upcoming cycle relative to some of the prior generations is materially different, materially improved. Talk to us about the impact you think AI will have on Cisco’s product demand, how do you think about growth beyond the $1 billion of AI orders that you’ve talked about for fiscal ’25?

Scott Herren

Yes. The $1 billion is kind of the first step, right? And just to be clear about what that number is because you’ve asked me about it a couple of times, everyone has asked me about that. That is within AI, it’s back-end, not front-end. We already have significant business in the front-end networks. It’s back-end, it’s Ethernet and optics in the back-end, driven by largely the large hyperscalers. There’s a couple of Tier-2 in there, almost no enterprise in there today and we should come back and talk about the opportunity in enterprise as well. So that’s what drives it.

The way that works is they don’t just buy off the price list, right? All of these hyperscalers have slightly different architectures. And what they do is they come and say, this is what I need. So they take their own network topology or their own network architecture and say, here’s three or four different places that I need networking gear in here. I needed at the spine. I needed at the top of rack, as example. This is exactly what it needs to look like in terms of technical specifications. We go off and build that. And sometimes you have to build the chipset that goes in it, but we build that, ship it to them, they go through a full certification process.

Once that happens, you hear us talk about design wins. Once that happens, they say you are designed in on this use case. It doesn’t mean we’re the only ones designed on in this use case, but you’re designed in on that use case. And then as they look to scale-up whatever the — however data centers they’re looking to scale up, they look at those particular use cases for networking gear as an example and say who’s qualified at each of these, and then what they want to do is have more than one viable supplier at each place, right.

No one wants to have — I don’t want to have it at Cisco, but particularly the hyperscalers because of the magnitude of what they buy, they don’t want to have single-vendor dependency at any level across the board. And so if you’re designed in at that level, then you get an allocation of the demand that they’re looking for in that space.

What drives the $1 billion then is a clear line-of-sight to use cases where we’ve got design wins and with conversations with the hyperscalers knowing what that’s going to look like for fiscal ’25. So our fiscal ’24 ends at the end of July, fiscal ’25 starts at the beginning of August, we see that $1 billion in orders coming in during fiscal ’25, more towards the second-half than the first-half, right, as they’re working their way through.

And of course, there’s a lot of things that go into that. It’s not just the networking gear, they need GPUs, they need electricity, they need facilities, et cetera. So the delivery is what will drive the revenue side of that, but those orders we see coming in fiscal ’25 largely. I think the enterprise opportunity then for AI is on top of that. So that’s the — that’s our AI opportunity to sell into the AI infrastructure build-out, which is a significant opportunity. It’s well beyond the $1 billion that we’ve talked about.

By the way, our pipeline is significantly bigger than that. That’s not total pipeline. We talked about pipeline being about 3 times that number, $1 billion is where we have a clear line-of-sight to those orders. The enterprise opportunity is much more nascent at this point. I guess we’ll come back and touch on that.

Samik Chatterjee

Yes, yes. Maybe before we get to the enterprise, so you talked about the pipeline being 3 times, how much of that pipeline is hyperscaler versus the Tier-2 cloud?

Scott Herren

It’s the majority, the large majority. I don’t want to give you a percentage on that, but it is the large majority of that total pipeline, not just…

Samik Chatterjee

And you’ve talked about wins with three out of four hyperscalers, but the way you’re building up to that visibility into the $1 billion of orders also suggests you have a fair allocation or a fair view into what allocation or share you’re being sort of promised. So, in terms of visibility into that $1 billion of orders, how much more sort of new customer wins do you need versus you already have a line-of-sight that this is what’s ramping, we have the share. We’re going to get to it easily.

Scott Herren

Yes, they — well, yes, you’re getting to it easily. It’s $1 billion at the end of the day, but it’s clearly — it’s more the former, it’s more — we understand the demand. We understand what our allocation is going to look like. We understand what they need to buy, when they need to buy it. We understand our ability to deliver at those levels. So, it’s that new customers that’s where you talk about the $3 billion pipeline as opposed to the $1 billion that we have line of sight to.

Samik Chatterjee

And before we go any further, what’s changed in that whole sort of landscape, because it’s not a surprise to anyone that Arista did have major share gains in this area in the prior generation. What if you had to identify, is this saying, okay, we now cloud customers are more aware that they need to have two sources versus one or is this just the product portfolio that is making sure that you have your fair share? Just walk us through that.

Scott Herren

I’d say it’s all the above. So if you go back to the original build out of the big compute and storage infrastructure, so a decade, 15-years ago, as that was being built out and this was under our previous CEO, but we — the Cisco kind of had the mindset of no one knows more about networking than we do. So, buy what’s on the truck kind of mindset. And the hyperscalers kind of said, that’s not the way this is going to work, right. We’ve got our own designs, we’ve got our own architecture. We’re going to build our own control layer on top of it. This is specifically what we need from you.

Scroll forward, so we missed that initial wave of build-out, scroll forward, Chuck becomes CEO, we acquired a company called Leaba. We started the Silicon One strategy of building our own chipsets inside there and really went back to the hyperscalers and said, look, we’ll meet you where you are. So, if what you want to buy from us is the chipset and you want to build all of the rest of the switch infrastructure around it, we’ll sell you just the chipset. If you want to buy a white box, we’ll sell you the white box, we want to buy full systems.

So, you tell us how you want to buy. And that’s what led to the pretty rapid growth that we had a little more than a year ago within our service provider business, right. If you remember, we kept giving you those statistics on the calls. So, we actually ended up — we were late to the game but ended up making pretty good strides in that space.

Now the AI infrastructure build-out is beginning. We already have the relationships. We already have a very effective chipset that’s designed for low power consumption. We have the, we’ll meet you where you are, set of business model. So we are far better positioned to catch the initial wave and then obviously the subsequent waves of the build-out of the AI infrastructure than we were when the initial compute infrastructure got built out.

Samik Chatterjee

Got it. Okay. Let’s move over to talking about the enterprise AI opportunity. And as much as I want to sort of give you in that open-ended question of tell me how do you think about enterprise AI in itself, also what’s interesting to me is NVIDIA, you announced the partnership with NVIDIA, to me, it read like NVIDIA wants your expertise in accessing the enterprise market. So help me think if I’m interpreting this correctly is basically your expertise in managing enterprise networks is what’s being valued and the partnership is — that’s what you bring to that partnership as well.

Scott Herren

Yes, that’s right. It’s their GPUs at the core, but it’s built in a chassis — and by the way, we’re working through the architecture. So watch the space. We have our Cisco Live, our big end-customer event coming up in the first week of June in Las Vegas. So, kind of watch the space. But the architecture that we’re working on, of course, has their GPUs at the middle, but they’re built on to servers that are sitting our chassis with the inner side, which is our — inside the rack control system and our top-of-rack Ethernet switches on-top of it. So, kind of, pre-configured, if you’re an enterprise and you’re looking for inferencing or low-level training, this is what you need, AI in a box for you.

NVIDIA came to us for a couple of reasons on that. One is what you just said, our expertise in managing enterprise networks and the significant footprint we have on the front-end of all those, but also because of the reach that we have, the enterprise reach that we have from a sales standpoint made it attractive to them. So that’s — I think that’s a — today, nascent, but a pretty substantial opportunity over time as the sensitivity of the data that companies use is going to drive them to — I can do some training up in the cloud, but if I ship my data up and train my model, others can leverage that same data and train their model on my data. I don’t want that.

It’s not that it exposes your data as much as it allows other people to train on your data, the data becomes a source of competitive advantage over time. So I think you’ll see — more and more you’ll see, particularly if there’s sensitive data, you’ll see those being run inside the enterprise, potentially even at the edge within the enterprise.

Samik Chatterjee

How do you think about the AI demand on enterprise — from the enterprise segment carrying over to your campus products as well outside the data center?

Scott Herren

Yes. Well, I think there’s — I think it’s pretty clear that in a world where you’re using a lot of AI to drive your business in whatever way, whether that’s to drive your sales and marketing team or to drive your customer support desk or your finance team, however, you’re using that internally, there’s a lot of data that has to move. There’s a lot of network intensity involved in leveraging AI to drive your business. So, I don’t think there’s any question that network intensity accretes to a stronger growth segment for us in campus and in the enterprise.

Samik Chatterjee

Let me take a pause here and see if there’s a question. Just wait for the mic.

Scott Herren

Just need to get a mic. But while they’re walking the mic up, the opportunity that we haven’t talked about yet is internally we’ve had AI capabilities built into our products for quite some time. So there’s the, sell the infrastructure, there’s also, make our products better and more competitive by building AI capabilities into our own products. And in particular in security, I think it’s an obvious use case to apply. Much like it is in customer support, it’s obvious to apply that in security.

We’ve been doing that for some time, but that we’ve doubled down on that as you look ahead and now with the advent of easily usable large language models, it makes it even easier to go off and do that. That’s a space where having Splunk on board and the data that Splunk brings will be a significant advantage for us.

Unidentified Analyst

Hi, I have a question on the data center switching, especially the back-end for AI networking. You guys have lost a tonne of share to Arista. I mean, you just look at the market share now, Arista is now number-one and in particular, they dominate 200 and 400 gig and probably going to be 800 gig as well. I was at Cisco when that acquisition of Leaba happened and Leaba is supposed to be the one that puts the stop to that. But you guys just recently changed leadership from Eyal to Martin. Martin is fantastic because of Broadcom days. When do we start to see that turnaround and where does your fully scheduled fabric, which is what [Indiscernible] had been pushing for a long time, play a role.

So I guess my question is, how does Leaba stop the share gains from Arista and where does the fully scheduled fabric play a role? Because I think your big deployments with Meta with the Wedge 400C, but I haven’t heard anything about fully scheduled fabric. So, those two questions. Thanks.

Scott Herren

Yes. So we’ve made great progress. So first of all, you obviously know a lot about that space. I assume you were in that semiconductor space inside Cisco when you were there. We’ve made great progress, as you know, with Silicon One and it now underpins not just data center networking. So, you remember, the vision isn’t just to support the hyperscalers with it, it works its way across the catalyst line, across the Meraki line through the wireless devices. So, we’ve made good progress on that front.

Honestly, I think Arista has done a nice job in the — with the two big customers that drive the — almost the majority that drive 40%-plus of their of their revenues out of those two customers.

Unidentified Analyst

[Technical Difficulty]

Scott Herren

We — yes, I can’t use their names, but we might be in both of them, it’s a possibility, yes, exactly. So I think there’s a great opportunity for us to — as we continue to build out that line to actually drive more and more of that allocation away from — I shouldn’t say away from — to us, more and more of that allocation even in those accounts will come to us, but the big win for Silicon One is going beyond just using it inside hyperscalers, but using it across the rest of the product line.

And it’s very simple. This will — this I think will appeal to you, more and more of the real value if you say, hey, here’s a switch or here’s a router, what’s driving the value of that, it’s that core chipset, right? And owning that core chipset allows us to own that value-add, instead of having to buy it from a third party and pay them a profit on top of it and then encapsulate it, the added value of the encapsulation gets smaller and smaller through time. So, I think it’s a longer-term play for us to drive that kind of value.

Unidentified Analyst

[Technical Difficulty]

Scott Herren

Yes, well, I think we’re going to drive more and more allocation across the board and within the hyperscalers.

Samik Chatterjee

Go ahead.

Unidentified Analyst

Thank you. Just to clarify one thing you said before, in terms of the backlog, they went from you after the glut of…

Scott Herren

Yes, we had a bunch.

Unidentified Analyst

Yes, it went into the carriers now sits there. Do you say probably two quarters and from now you think that will be a normalization in terms of their throughput, putting it, green-lighting those devices and then the order patterns matching more demand?

Scott Herren

Yes. So, it wasn’t just the carriers, by the way, it was across the board. It was enterprise actually probably more so in enterprise than it was in Telco where they had placed orders because our lead times went from two to four weeks to 40 and 50 weeks. So anything you needed for 40 weeks all got pulled back. And you remember we had those three quarters of 30%-plus product order growth while lead times were extending. And then we had to deliver it all. And our customers were all over. It’s like I need this, you’ve got to get me this security you got — so we did a lot of work, product redesign work, looked for alternatives where we could around particular supply constraints.

And then we’re able to clear that, the vast majority of that backlog cleared within three quarters, Q3 of last year, Q4 of last year and Q1 of this year. A lot of that shipped out the door. And to your point now, so that the big bottleneck that we had at our level became their bottleneck in terms of implementing and that became a headwind to demand.

What we said on the last call, on the call that we just had, actually, if you go back to our second-quarter call, we said we think it takes two quarters. So Q3, the one we just closed in Q4 to work through most of that inventory being consumed by our customers. We reiterated that message on our call last week that looks like by the end of this current fiscal quarter, which ends for us at the end of July, the vast majority of that will be consumed by our customers. And so that will stop being a headwind.

Samik Chatterjee

It sounds like on the carrier side, maybe a longer-tail though compared to other segments.

Scott Herren

We actually — and we talked about this on the most recent call, we actually had some nice green shoots in telco last quarter. I mean, so we talk about our service provider segment. There’s three things inside there. There’s cable, telco, and then the big hyperscalers are all in there. And there’s a very different set of dynamics, frankly, around all three of those, right. But we saw some good green shoots and orders even in telco last quarter. I think it’s been — no secret, it’s been a tough run for the telcos.

It wasn’t as much about inventory with them as it was about, hey, we invested a lot in 5G and now we’ve got to find a way to load these networks because there’s no competitive advantage. If everyone’s got 5G, you’re back in a race to the bottom on pricing. And so I think what they’ve been working on is, how do I consume all the added capacity that I’ve got in 5G? Saw some nice green shoots on that last quarter.

Samik Chatterjee

Scott, let’s get to a couple of questions on the fiscal ’25 guide that you shared I think one…

Scott Herren

No, they said — they thought I would not do that.

Samik Chatterjee

Thank you and sorry. Let’s — I mean, it’s fair to say your view for revenue growth was optimistic relative to the investor view heading into the print itself, but margins appeared less optimistic in terms of your target there. So maybe start with the revenue outlook, low-to mid-single-digit growth, what is embedded in the revenue guide for Splunk and the core business separately?

Scott Herren

Yes. Splunk, the last-time they announced results publicly was their fourth quarter, which ended at the end of January. And what they said then is the revenue was just north of $4 billion and had grown in the quarter at about a 15% rate, right. They continue to drive that revenue stream forward. That’s $4 billion was their ARR. It wasn’t just the fourth quarter number obviously. So, you think about that kind of continuing as we look into fiscal — our fiscal ’25.

The second is we’ve got — I just talked about it as I talked about inventory consumption. We’ve got — we had a tough compare in revenue for the quarter we just announced, our third quarter, because of the way we cleared backlog a year ago, we have that same tough compare in this current quarter. Again, lots of excess backlog shipped out a year ago. Q1 is the last of those three quarters with a lot of excess backlog shipped out. You don’t get to do that every year, right? Once we’ve shipped out the excess backlog, it’s out there. And that’s a significant number, that was a significant tailwind to our Q1 results.

So, if you think about the core business versus Splunk now as you go to fiscal ’25, we see Splunk continuing to grow nicely as they have been and in fact, accelerating that growth with access to our channel, with our own sales, we talked about the 5,000 accounts where we have good relationships and they have no Splunk footprint today. Like there’s a real opportunity for us to accelerate them through our sales organization, our customer contacts, and our channel ultimately.

So there’s — I think that is Splunk side of the equation on the core networking piece, if you net it out the inventory or the backlog that we shipped out in Q1 of this year of fiscal ’24 and said what’s fiscal ’24 without that excess backlog compared to what’s implied in the guide I just gave, you see the core business growing in kind of that low-to-mid-single-digit range. All of that is built into — so, you’ve got the upside of Splunk in terms of year-on-year growth rates, but you got the downside of we had a lot of excess backlog clearage in fiscal ’24.

That’s what nets to the number on the top line. In terms of margins, Splunk is accretive to our gross margins already and we saw that in the quarter that we just shipped. Gross margins were well ahead of expectations. There are several one-off, kind of, benefits inside there, but they’ll be accretive to gross margins from the start, not so at the op margin line, right.

And so that’s — so there’s — their numbers again go back to their Q4 and say what was their OpEx line, and Gary Steele, who came into Splunk has done a really nice job, kind of, taking control of the company and shaping things up, but they’re — and they’re running an OpEx number that’s about $600 million per quarter. That’s what they announced with their Q4 results. So, if you think of that for 4.5 months of fiscal ’24, but obviously for 12 months of fiscal ’25, that’s part of what’s built into the op margin range.

I think the second is, and this is one that not a lot of people had visibility to because we don’t talk about it publicly a lot, it was a tough year for Cisco. And all — a big chunk of our employee base, everyone who is not hourly, has some element of variable compensation built into their comp plan for the year. And when you have a tough year and don’t perform up to the operating plan, the metrics that drive that are largely financial metrics based on our operating plan.

When you have the kind of year that we had, there’s big savings in our OpEx for this year, driven by the underperformance of our variable comp plans. You have to reset that when you get to next year. So that’s what underpins kind of the high-level guidance that we gave you.

Samik Chatterjee

Before we wrap up, last question for you, what should investors expect on the June 4th Investor Day?

Scott Herren

I think come to Las Vegas and see what we have to say. The goal will be to spend a little more time than you can do on an earnings call and talk about our products, the markets that we’re serving, the products, what that future looks like for those products, how we come together with Splunk and what the next wave of that looks like and then of course, to give you some of the financial metrics that talk about the combined company.

Samik Chatterjee

Great. Thank you. Thank you for being in the conference. Thank you to the audience as well.

Scott Herren

Thank you.