Cisco’s Q2 2023 Earnings Call – Is 2023 Going To Be A Record Year?

Cisco (NASDAQ:CSCO) recently released its Q2 2023 results – the highlights of which included the following:

  • Revenue: up.
  • Earnings: up.
  • Recurring revenues: up.
  • Guidance for the full year: up.
  • An upbeat statement from the CEO.

Is there anything not to like about Cisco’s second-quarter earnings?

Revenues and earnings beat guidance to hit quarterly records

It’s been another record quarter for CSCO, on top and bottom lines. Not only did revenues and earnings reach quarterly highs, beating CSCO’s own guidance.

Product and service revenues both improved (by 9% and 2% respectively):

  • Product revenue $10.155 billion v $9.353 billion Q2 2022
  • Service revenue $3.437 billion v $3.367 billion Q2 2022
  • Gross margin $8.427 billion v $4.671 billion Q2 2022

Year-on-year, revenues improved in each of the company’s geographical segments, too.

CFO Scott Herren summed up the quarter’s performance as follows:

We delivered another strong quarter and exceeded both our top- and bottom-line expectations driven by our focused execution, continued success of our business transformation, and improved availability of supply as the actions our supply chain team have taken over the last several quarters are bearing fruit.

Margins down from a year ago, but improving

Compared to a year ago, margins have fallen. However, the company is working to gain better control over its costs, and as supply chain issues have eased, margin erosion appears to have halted, with strong signs of a reversal.

At 62.1%, product gross margin was down 220 basis points on the respective quarter 2022. However, this is up 110 basis points from the Q1 2023. Service gross margin was 69.1%, up by 30 basis points year-on-year.

At the operating level, margins were at the top end of guidance. Here’s Scott Herren again:

“Non-GAAP operating margin came in at the high end of our guidance range at 32.5% down 180 basis year-over-year and up 70 basis points sequentially. The year-over-year decline was primarily driven by the higher component and other costs that I just mentioned.”

Growth is fueled by global digital transformation and hybrid cloud

What has spurred CSCO’s record quarter?

In a nutshell, customers may be cutting back on many areas of expenditure, but technology is not one of these. CSCO is experiencing stable and robust demand for its products and services, as businesses around the globe seek to boost productivity, sales, and security using technology.

Chairman and CEO commented:

Many customers have told me that while their spend levels may be slowing in some areas, technology remains essential as it is vital to their overall business resilience, competitive differentiation, and success. In fact, Gartner and IDC’s most recent surveys make it clear that technology budgets are growing as they forecast IT spend to increase in the mid- to high single digits in 2023. We’re also seeing many customers moving ahead with their hybrid work, AI, and ML investments while building the modern infrastructure they need to deliver on their objectives.

IoT has also been accelerating. We saw record revenue growth in Q2 as customers look to connect their industrial systems in order to optimize power consumption, automation, and efficiency. Lastly, cybersecurity and full-stack observability remain strategic priorities where we continue to invest and innovate.”

CSCO is ahead of the AI play

One of the most talked-about advances this year is AI – for example, ChatGPT has taken the world by storm. So, it’s great to hear that CSCO is ahead of the game in its employment and deployment of artificial intelligence and machine learning in its product and service mix.

We are increasing our investments in our cloud management platforms that deliver the simplicity our customers need,” says CEO Chuck Robbins.“You will see us continue to bring AI and ML into those platforms to further simplify how networks are managed. For example, in Q2, we announced several new innovations across our cloud-managed networking and security portfolios that offer greater visibility with AI-driven insights, enable secure connectivity, and give our customers the ability to simplify their IT operations.

Transformation to the recurring and subscription model continues

When each dollar of revenue must be won from new sales, a business is always at risk of a sudden downturn. New sales cost more. They are harder work to achieve. CSCO understood this several years ago, and has been directing its business to a recurring and subscription model. This strategy is paying dividends.

This quarter, 84% of the software revenue was subscription-based. That’s an increase of four percentage points from the same quarter in 2022. Total subscription revenues of $6 billion (up 9%) now represent 44% of total revenues.

This model also makes it easier for CSCO to visualize the future.

We have $23 billion of ARR, which we can actually renew in the next 12 months,” says Robbins. “So, if you go back eight or nine years ago, we might have had to take orders for 75% of our revenue in any given quarter. And now we have 44% of our revenue coming from the balance sheet and recurring revenue.”

Cashflow is at record levels, too – great news for shareholders

CSCO is committed to returning a minimum of 50% of free cash flow to its shareholders each year. So positive news in this area is also very welcome.

Compared to Q2 2022, operating cash flow increased by 93% to $4.7 billion. This improvement was driven by several factors, including strong collections and the deferral of Q2 federal tax payments due to the IRS tax relief related to the California floods (which it expects to pay by the end of the fiscal year).

Dividends ─ and share purchases ─ raised modestly

During the second quarter 2023, CSCO has returned $2.8 billion to shareholders. This comprises $1.6 billion in dividends and $1.3 billion of share repurchases.

With its earnings report, the company has announced it will increase the quarterly dividend by 1 cent to $0.39 per share. This is the thirteenth consecutive year that it has increased the dividend. CSCO also has existing authorization for a further $13.4 billion in share repurchases.

Guidance improves

CSCO has increased its guidance for the remainder of 2023. It expects revenues to grow further, margins to improve, and the bottom line to increase. For Q3 2023, it is forecasting:

  • Revenues to grow 11% to 13%
  • Non-GAAP gross margin to be in the range of 63.5% to 64.5%
  • Non-GAAP operating margin in the range of 33% to 34%
  • Non-GAAP earnings per share to range from $0.96 to $0.98

There’s also a significant change to our full-year fiscal ‘23 revenue and non-GAAP earnings per share guidance driven by these same factors,” says Herren. “For fiscal year ‘23, we are raising our expectations for revenue growth to be in the range of 9% to 10.5% year-over-year. Non-GAAP earnings per share is expected to range from $3.73 to $3.78.”

The bottom line for income investors

CSCO has had a great quarter. There is no denying this. Its order book is strong, and the subscription-based business model puts the company on a much firmer footing than it has been in the past.

Chuck Robbins says, “While the environment we’re operating in remains dynamic, Cisco is better positioned today than at any time since I became CEO almost eight years ago. We have reshaped and transformed the company and our portfolio while remaining highly disciplined, both financially and operationally. This gives me great confidence that we will continue to succeed in the long term.”

At the time of writing, CSCO is trading at around $48.50. Its dividend yield is around 3.20% (a little more than double the S&P average). The dividend payout ratio is around 54%.

The bottom line? Trading at a PE ratio of 17.5, CSCO shares seemed like a good value play for long-term income investors.

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