Cisco Systems, Inc.

Welcome to Cisco's second quarter fiscal year 2021 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 Marilyn Mora, head of investor relations. Ma'am, you may begin. Welcome everyone to Cisco's second quarter fiscal 2021 quarterly earnings conference call. This is Marilyn Mora, head of investor relations, and I'm joined by Chuck Robbins, our chairman and CEO. and I'm very pleased to welcome Scott Herron, our CFO. By now, you should have seen our earnings press release. A corresponding webcast with slides, including supplemental information, will be made 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 third quarter of fiscal 2021. They are subject to the risks and uncertainties, including COVID-19, that we discuss in detail in our documents filed with the SEC, specifically the most recent reports 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. With that, I'll now turn it over to Chuck.

Thanks, Marilyn. First of all, I hope that all of you and your families are safe and healthy. This year is full of promise as vaccines give us a path to healing and recovery. We are optimistic about the future and look forward to what lies ahead. This past quarter, our team delivered strong performance with revenues coming in at the top of our guidance range and non-GAAP EPS landing above the high end of our expectations, all supported by margin expansion and a further strengthening of our balance sheet. More importantly, We are seeing encouraging signs of strength across our business as the recovery takes shape with all customer segments showing improvement in year-over-year growth rates. Our employees and partners have done a remarkable job executing and innovating throughout the pandemic to help our customers connect, secure, and automate to accelerate their digital agility in a cloud-first world. We are partnering with them on core issues that are essential to their success, business resiliency, modernizing their IT environments, and embracing secure hybrid work. Over the past year, our customers have relied on our innovation to accelerate their digital and cloud capabilities while protecting them from an expanding threat environment. In my numerous conversations with customers, it is clear that our technology will be a powerful engine for their recovery and growth as their technology needs continue to evolve at a rapid pace. Building on the strength of our broad portfolio, we are focused on six strategic pillars that will deliver highly secure next-generation architectures with unprecedented insights, automation, and visibility. First, we are building networking solutions with built-in simplicity, security, agility, and automation that can be consumed as a service. Second, we are optimizing our customers' application experiences, enabling greater speed, agility, and scale of cloud-native applications and DevOps that deliver the best end-user experience. Third, with the future of work being hybrid, we're delivering highly secure access, a safer workplace, and the best collaboration experiences, no matter whether workers are at home or in an office. Fourth, with our customers and partners, we are building the Internet for the future. by transforming connectivity and efficiently meeting the ever-growing demand for low latency and higher speeds. Fifth, with security and privacy a top priority, we are building integrated, high-efficacy end-to-end security solutions that are delivered on-prem or in the cloud. Lastly, as apps and workloads move closer to users and devices, we are developing new edge capabilities for a distributed world while enhancing the developer experience and extending enterprise and carrier networks. I am confident that this is the right strategy to deliver the innovation and integrated network solutions that our customers need, no matter what the future holds. Now moving to our performance this quarter. We continue to see signs of gradual improvement led by order growth in our commercial, public sector, and service provider businesses, which together account for nearly three-quarters of product orders. The enterprise market remains soft, driven by some elongated sales cycles and a continued pause in spending among some customers brought on by the pandemic. From a product revenue perspective, we saw strength in our Catalyst 9K, data center switching, security, wireless, and WebEx portfolios. The transformation of our business to more software and subscriptions continues to show great progress as we achieve $3.6 billion in software revenue with 76% of our software revenue sold as a subscription. We also saw our sixth consecutive quarter of double-digit growth in our deferred product revenue. We continue to accelerate our pace of innovation, delivering unique solutions and digital capabilities as we invest in flexible consumption models. I am confident in our ability to capture the long-term opportunities ahead in areas such as cloud, 400 gig, 5G, security, hybrid work, and next-generation applications. Looking ahead, we are cautiously optimistic, as recent surveys of IT spending indicate year-over-year IT budget growth for calendar 2021. And Cisco remains well-positioned among CIO's top forward-looking spending priorities, including network infrastructure, cybersecurity software, as well as cloud migration and cloud infrastructure. We are also mindful and vigilant about the uncertainty of the pandemic and its influence in the market, which is not fully behind us yet. Now let me touch on infrastructure platforms. To manage the highly distributed and complex nature of modern IT environments, our customers must fundamentally change how their networks are architected. To help them achieve this, we are building a unified cloud-native platform suite to deliver secure, agile networking. A good example of this is our subscription-based, intent-based networking portfolio and is reflected in the momentum of our Catalyst 9K family, which saw another quarter of double-digit revenue growth. We are also delivering full-stack observability from the application to the infrastructure to give our customers greater insights for faster, better decision-making. We are doing this through key elements of our portfolio like Intersight, ThousandEyes, and AppDynamics, as well as our leading security innovations. As a global leader in transport network infrastructure, we are playing an important role in helping customers build their networks for the future. We continue to invest heavily to capture 5G, 400 gig, and Wi-Fi 6 transitions to enable open RAN and edge services. This is reflected in our SD-WAN portfolio, routing, 5G mobile core platforms, optics, and automation capabilities. In our web scale business, We delivered our fifth consecutive quarter of very rapid order growth, increasing to triple digits. And on a trailing 12-month basis, our orders grew over 60% as we focus on delivering routing, data center switching, and optical platforms built on Cisco Silicon 1, which has a better efficiency over other silicon on the market. While we could see our performance vary quarter to quarter due to the timing of large deals, we are incredibly confident in our ability to further strengthen our position. By building a network on silicon-1, our customers can also save up to 30% of network switching power, resulting in a meaningful reduction in their environmental footprint, as well as significant energy cost savings. Our agreement to acquire Acacia will enable us to deliver leading-edge optical technology to meet both the bandwidth requirements and the economics of next-generation networks, which is critical to providing high-speed connectivity. This is just another reason why I'm so confident we will continue to win in the web-scale space. As I've mentioned, we plan to transition the majority of our portfolio to be cloud-driven, cloud-managed, and delivered as a service. If we can deliver it from the cloud, we will. For example, we are looking at offering SD-WAN plus cloud security as a service along with creating other new solutions. We will also provide simplified end-to-end networking with security, reliability, control, and automation, plus seamless on-ramp capabilities to the cloud that no one else can deliver. Moving to security. We delivered another strong quarter of revenue growth driven by increasing adoption of our next-generation cloud-based architectures, which can enable fast, secure access to applications and data from anywhere. With the rapid growth in modern applications and more distributed work environments, our customers are adopting new security architectures as identity and data privacy are increasingly critical. The recent SolarWinds breach only highlights the urgent need for advanced threat defense. Our comprehensive security portfolio offers simplified protection for any workload on any cloud while minimizing the attack surface and automating security policies across an organization's hybrid cloud footprint. This extends to our secure access service edge framework and zero trust architecture where we have developed a best-in-class cloud-delivered stack across Umbrella, Secure Internet Gateway, Meraki SD-WAN, and Viptela. We are also delivering leading unified detection and response capabilities built on Cisco SecureX, our cloud native platform. Over 5,400 customers are already seeing the benefits of this platform since it became generally available last June. We remain committed to delivering simple, integrated, and highly effective end-to-end security solutions delivered on-prem and in the cloud. Turning to applications, which includes our collaboration portfolio. We are focused on building solutions that will enable an engaged, productive workforce and an intelligent workplace built with secure collaboration, automation, and insights. Our aim is to deliver the best collaboration experience for our customers, no matter where they are. Our strong momentum with WebEx continued, resulting in double-digit revenue growth. I'm so proud of the work the WebEx team has done to ensure our nearly 600 million quarterly average users are able to stay connected and productive. In addition, we are connecting over 6 billion calls every month for our customers around the world. We are bringing incredible innovation to the collaboration market at an unprecedented pace. Our goal is to deliver a 10x better experience than just in-person interactions. At our recent WebEx One event, we introduced more than 50 new product and feature innovations, integrating security and privacy to deliver inclusive experiences. Some of the new powerful capabilities we announced include noise cancellation, real-time language translation, and our WebEx Desk Pro Series platforms. Our recently announced intent to acquire cloud-based IMI Mobile and Slido furthers our vision of building a WebEx suite of applications as we combine these technologies with our WebEx Contact Center to improve customer interactions. In summary, our strategy is clear and our business remains strong. We are executing and innovating with speed and delivered solid results with our Q2 revenue coming in at the high end and earnings coming in above our stated guidance. As we move into the gradual recovery phase, we believe our customers will continue to turn to Cisco as their partner of choice. I am so proud of what our teams have achieved. The incredible innovation and trusted partnerships we are building will serve us well in the years ahead. While the past year has highlighted far too many inequities in our society, We believe in the power of technology to drive more inclusivity and opportunity to underserved populations and communities around the world, which is why we are committed to powering an inclusive future for all. With our ongoing disciplined approach to investment and innovation, we expect to be in an even stronger position post-pandemic as our customers look to deploy their next generation networks at the heart of their organizations. I firmly believe Cisco is well positioned to capture the long-term growth opportunities ahead and win for years to come. I'll now turn it over to Scott, our new CFO, to walk through our financial results. As you know, Scott has strong experience in software and a proven track record of leading successful business model transitions from perpetual licenses to SaaS and recurring subscriptions. Scott is proving to be a powerful addition to our team, and I look forward to partnering with him as we plan the next phase of Cisco's continued transformation. Scott, over to you.

Thanks, Chuck. Let me start by saying how excited I am to join the Cisco team at such a pivotal time in the company's transformation. Before turning to our performance in the quarter, I thought I'd share my initial observations and key priorities. I'm impressed by the team here at Cisco and the progress the company has made on its transformation, achieving the goals laid out three years ago of driving 50% of our revenue from software and services. It's also clear that the leadership team is unified and focused and that the strategies Chuck laid out earlier in the call will drive our growth over the next several years. It's an exciting time to be joining the company in this role. In terms of my key priorities, they include the following, driving profitable growth, a continued disciplined focus on financial management and operating efficiency, setting a long-term plan to maximize value creation through strategic transformation, and examining investments, both organic and inorganic. I'm also committed to providing you the insight and metrics needed to understand and properly value our business longer term. Now let's turn to our results. I'll start with a summary of our financial results for the quarter, followed by the guidance for Q3. Our overall Q2 results reflect very good execution with strong margins and growth in non-GAAP net income and earnings per share in a continuing challenging environment. Total revenue of $12.0 billion came in at the top of our guidance range, flat year over year, as we see gradual recovery in several key product areas and sequential growth rate improvement in two out of three of our geographies. Our non-GAAP operating margin was 34.4%, up 70 basis points. Non-GAAP net income was $3.4 billion, up 2%, and non-GAAP earnings per share was 79 cents. coming in above the high end of our guidance range and up 3% year over year. Now let me provide some more detail on our Q2 revenue. Total product revenue was $8.6 billion, down 1%. Infrastructure platforms was down 3%. As a reminder, this is the product area most impacted by the COVID environment. Switching revenue was flat overall. We saw solid growth in data center switching with strong growth of the Nexus 9K. We also saw continued strong momentum of the CAT 9K products within campus switching. Routing decline driven by weakness in service provider. Wireless had solid growth driven by the continued ramp of our Wi-Fi 6 products and strength in Meraki. Data center revenue decline driven primarily by servers as we experienced continued market contraction. Applications was flat overall. We continue to see strong double-digit growth in WebEx driven by our continuing product innovations and the criticality of remote working. This was offset by declines in unified communications and TPN points. Security was up 10%, with growth across the portfolio. Our cloud security portfolio performed well, with strong double-digit growth and continued momentum of our Duo and Umbrella offerings. Service revenue was up 2%, driven by growth in our maintenance business as well as solution support. And we continue to transform our business, delivering more software offerings and driving more subscriptions. Software subscriptions were 76% of total software revenue, up four points year over year, as Chuck mentioned earlier. Remaining performance obligations, or RPO, at the end of Q2 were $28.2 billion, up 13%. RPO for product was up 17% and for service was up 10%. The continued growth in RPO demonstrates the strength of our portfolio of software and services and is another indicator of the broad recovery we see happening. In terms of orders in Q2, total product orders were up 1%, a significant improvement from Q1. Looking at our geographies, the Americas was down 1%, EMEA was up 7%, and APJC was down 5%. Total emerging markets were down 14%, with the BRICS plus Mexico down 11%. In our customer segments, public sector was up 10%, service provider was up 5%, and commercial was up 1%, enterprise down 9%. Non-GAAP total gross margin was 66.9%, up 50 basis points. Product gross margins were 66.6%, up 70 basis points. And service gross margin was 67.9%, up 20 basis points year over year. The growth in product gross margin was driven by positive product mix, including some software benefit and productivity improvements, partially offset by pricing. In terms of the bottom line from a GAAP perspective, Q2 net income was $2.5 billion, and earnings per share was $0.60. We ended Q2 with total cash, cash equivalents, and investments of $30.6 billion, up $600 million sequentially. Operating cash flow was $3 billion, down 22% as expected, driven by a lower beginning receivables balance for the quarter, timing of payments, and the restructuring payments. We expect operating cash flow growth to normalize over the course of the fiscal year. From a capital allocation perspective, we returned $2.3 billion to shareholders during the quarter. That was comprised of $1.5 billion for our quarterly dividend and $800 million of share repurchases. Year-to-date, we've returned $4.6 billion to shareholders, which represents 69 percent of our free cash flow. And today we announced a one cent increase to the quarterly dividend to 37 cents per share, up 3% year over year. This dividend increase reflects the 10th consecutive year of increasing our dividend and reinforces our commitment to returning capital to our shareholders and our confidence in the strength and stability of our ongoing cash flows. We continue to invest organically and inorganically in our innovation pipeline. During Q2, we announced an amendment to the definitive merger agreement under which we previously agreed to acquire Acacia Communications. We expect to complete the Acacia acquisition in our fiscal Q3, subject to closing conditions, including Acacia stockholder approval. In addition, we announced our intent to acquire IMI Mobile, a cloud communications software and services company, and Slido, a provider of SaaS-based solutions, to enhance our WebEx platform and our new cloud-native contact center offerings. These investments are consistent with our strategy of complementing our internal innovation and R&D with targeted M&A to allow us to further strengthen and differentiate our market position and our focus growth areas. To summarize, we executed well with strong margins and growth in non-GAAP net income and earnings per share growth. We're seeing returns on the investments we're making in innovation and driving the continued shift to more software and subscriptions, delivering long-term growth and shareholder value. Now let me reiterate our guidance for the third quarter of fiscal 21. This guidance is subject to the disclaimer regarding forward-looking information that Marilyn referred to earlier. Q3 does include an extra week, which occurs every five to six years. We've factored this extra week into our guidance for both revenue and expenses. Although it's difficult to forecast the impact of the extra week, we have assumed roughly 2% to 3% year-over-year impact on total revenue growth, along with approximately $185 million of incremental cost of sales and operating expenses. The guidance for Q3 is as follows. We expect revenue to be in the range of 3.5% to 5.5% growth year over year. We anticipate the non-GAAP gross margin to be in the range of 65% to 66%. The non-GAAP operating margin is expected to be in the range of 33% to 34%. and the non-GAAP tax provision rate is expected to be 19%. Non-GAAP earnings per share is expected to range from 80 cents to 82 cents. I'll now turn it back to Marilyn so we can move into the Q&A.