Cisco (Nasdaq: CSCO) investors are getting a lift this morning, as shares are rallying after the company boosted its profit and revenue guidance in its second quarter fiscal 2023 earnings report, released on Wednesday night.
More importantly, Cisco gave us insight on enterprise tech spending. Here’s the big surprise: There was no slowdown. In fact, things appeared to accelerate. Cisco raised its full-year revenue guidance to 9% to 10.5% growth year-over-year. The company now expects non-GAAP EPS of $3.73 to $3.78 for the year.
Now, things are a bit complicated for Cisco. The company was hit hard by China lockdowns and supply-chain issues last year, which resulted in slow revenue growth and disappointing profit margins. But the company said it had more orders than it could fulfill and correctly predicted this strong run. This order backlog is now flowing through the system with increased revenue.
For the longer term, the question that some analysts and investors will have is: What happens when the backlog dries up? That was a question that Cisco executives tagged as a 2024 question, which they were not willing to guide on.
For today, though, things look good. For its fiscal second quarter 2023 results, the company reported revenue of $13.6 billion, a 7% jump over the same quarter in the prior year. It reported income of $3.6 billion or $0.88 per share on a non-GAAP basis, which was a new record. In early trading this morning, Cisco shares traded up $2.40 (4.9%) to $50.85.
“Fiscal ’23 is shaping up to be very strong, fueled by demand for our cloud-driven networking portfolio, our continued business transformation success, and an improving supply situation,” said Cisco CEO Chuck Robbins on the quarterly conference call.
No Networking Recession, So Far
In the company’s earnings conference call and the Q&A session that followed, Robbins painted the picture of a strong technology investment year ahead.
“Technology budgets are growing,” said Robbins. “We are seeing many customers moving ahead with hybrid work, AI, and ML investments. IoT has also been accelerating as customers look to connect their industrial systems.”
And then, some more detail, from the Q&A:
“And the last thing I’ll say is that I was in Tokyo and Singapore last week and at the same time —a lot of my leadership team were in Amsterdam for Cisco Live Europe, and no one is talking about cutting technology spending right now. Everybody seems very committed to it. I think the underlying power of technology as it relates to all of our organization strategy is just too strong right now.”
In summary, Cisco’s results and Robbins’ comments indicate that the technology slowdown everybody was expecting is either quite mild or non-existent.
Uneven Segment Growth
If you want to search for bad news, it might come in uneven results across Cisco’s product portfolio.
Product revenue performance was led by growth in Secure, Agile Networks up 14%, End-to-End Security up 7%, and Optimized Application Experiences up 11%. Internet for the Future was down 1% and Collaboration was down 10%.
The weakness in Collaboration can be explained by two things: First, the remote conferencing market has slowed down as many people return to in-office work. In addition, Cisco’ Webex solution is showing its age and faces more nimble competition from the likes of Zoom Communications and Microsoft Teams.
Other shortfalls are just puzzling. For example, Cisco’s Secure Agile Networks segment, which represents enterprise networking technology, grew by 14%. However, the Internet for the Future datacenter switching business shrank by 1%. This is an area in which Cisco has been losing market share to competitors, including Arista.
Cisco executives said this inconsistency was the fact that it splits its switching and routing revenue into two segments — Agile networks and Internet for the Future. So some of the routing revenue is captured in Agile Networks. Robbins says this means market-share comparisons are often “Apples to Oranges.”
Cisco did appear to right the ship in security, which had been underperforming but grew by 7% y/y in the quarter. And its Optimized Applications Experience unit, which includes the ThousandEyes acquisition, showed strong growth.
There were, however, some concerns among analysts covering Cisco. In the earnings conference call, many analysts had questions about the sudden surge of revenue and whether that was just a temporary benefit from the strong backlog during the component shortage last year. Order growth was down in the quarter, causing some challenges for the future.
According to Sebastien Naji, a William Blair analyst, from a research note this morning:
“Though in the near term revenue growth will continue to benefit backlog drawdown, our concern is that the compounding impacts of a weakening demand environment (order growth was down 22%, though off tough comps) and an emerging demand air-pocket (as customers no longer need to put in orders 9-12 months ahead of time) will pressure real growth in fiscal 2024 and fiscal 2025.”
Cisco’s fiscal year ends in July and starts in the 3rd calendar quarter of this year.
Shift to ARR Makes Progress, Dividend Hiked
Another couple items that are likely to please investors: More software and a higher dividend.
Cisco has made progress in migrating Cisco away from its dependence on hardware to a software-based model based on annual recurring revenue.
Cisco cited 10% growth of software revenue and 15% growth in subscription revenue growth. Recurring revenue now represents 44% of the company’s total revenue, said Robbins.
Cisco also declared a quarterly dividend of $0.39 per common share, a 1-cent increase or up 3%, over the previous quarter’s dividend.
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