Cisco Systems, Inc. (CSCO) Earnings Call Transcript & Summary

All right. Sorry to keep everybody waiting. Let's get started here. So I'm very pleased to have Chuck Robbins, the CEO of Cisco, with us again this year. Great to always end the TMT conference with you, Chuck. So I really appreciate you coming.

Well, I appreciate the chance to be here.

Taking time out of your busy day after earnings.

Well, I would say something, but you kept me off TV this morning. So that was good.

Oh, okay. Well, that's good. So I obviously want to start off with kind of what happened in earnings. That's always the topical thing to discuss. We've been in a low enterprise spending environment now for a while. Your orders last night, total order volume, deteriorated a little bit faster than the quarter before, down 6%, down 4% the quarter before. Could you just give us kind of a couple of thoughts on where we are in this cycle? Are we getting near a bottom? Do we have any visibility?

Yes. I think if you look at where we ended up, sequential seasonality in our modeling, we ended up exactly where we expected to. That's what Kelly and I, from the first day of the quarter, that's where we expected we would finish. And a couple of comments. We have the -- all the macro issues that we've talked about, you had Brexit, you had the trade war, you've had USMCA not being signed, you've had impeachment. I can't believe the world we live in. Now we have a virus. And -- oh, by the way, I'm supposed to say -- tell you that I am making forward-looking statements, obviously, today. So please refer to our 10-Q and 10-K for a reconciliation of anything that I might say. Is that right, Carol? Good. Okay. Good. Glad I looked at you. But you had -- we've had all these things going on, and basically, what I've said is that our customers -- our pipeline's still where it normally would be. We did -- we've done an analysis like this quarter of our pipeline relative to the size of the deals. You go back a year ago, same number. They're just taking a little bit longer to close, and our close rates are down, which just means exactly what I've said, is that they're just kind of tapping the breaks. I talked to the financials. I had breakfast with a big global financial this morning before I came here, and everybody is just sort of monitoring things. But if you step back and look at all of that going on, and not an excuse, but we're also -- unfortunately, we're comparing against the strongest order growth quarter we've had in my memory in years. So all that just combined to what we announced yesterday. We actually did exactly what we said we were going to do many days ago, but we wanted to -- we're hopeful that there would be more. But if you would look at Asia without China, it grew, Europe without the U.K. grew, and then U.S. was the place that was a bit of a -- was a little more negative than it had been. And that's really 2 issues predominantly. It's service provider continuing to be weak, and it is the compute business, which with memory prices coming down, the whole market has gone down, right? So those were the 2 major contributors to that. Nothing systemic. And then when I look at the green shoots, I'll give you a few and we can talk about some of these. But the Catalyst 9000 continues to just explode. It's the fastest-ramping product. We're still super early in that transition relative to the installed base that it replaces. And again, remember, we're selling subscriptions on all of those when they go out the door. The products we announced in December, which I know we're going to talk about, this -- the 8000 series as well as our silicon, we've been talking for years that we're on a long journey to reengage with the cloud providers, and we are in strategic discussions with all of them. And we've already taken orders for both versions of what we talked about, and several of them were on stage with us at our announcement, which is a big statement for them. So that's good. We have now with 5G, we've been saying it's going to be out, out, out. We now have 30 routing franchise wins associated with 5G, 30 customers. And we saw Wi-Fi 6 begin to ramp this quarter. And the software transition continues to go well. So there's a lot of positive stuff in here. It's just we're doing this against the backdrop of some complicated times.

Do you -- just to really expand on that, I know you talk to a lot of executives. You said you had a meeting this morning, spend a lot of time on a plane talking to customers. What is the -- how has business confidence evolved in the last few months? Do you think -- do you see the virus and all this stuff driving things worse again? Or do you think we're kind of at a point where it's about as bad as it's going to get and maybe it gets better?

It feels like it's going to get better because it's been a subtle change. It hasn't been -- you don't go into these customers and have them tell you that the sky is falling. They're just -- as it relates to capital spending, they're just a little more cautious. And it's just super easy. Even though we made a lot of progress on our software transition, if you refer back to the financial analyst conference we did, we said that by the end of this fiscal year, we wanted software to represent 30% of our revenue. We wanted software and services to be 50%. We're on track to do that. But there's still a significant portion of our portfolio that is dependent upon capital spending. And it's just easy for a customer to say, "Let's just hold and see what happens on this." And they -- and we had big deals at the end of the quarter that didn't book that are already booked this quarter. So it's not a crisis. It's just a slight pause. It just -- and we just have a lot of our businesses still sold and revenued in the same quarter.

For what it's worth, our Enterprise Activity Index has turned up the last couple of months, and that was the reason that we put Cisco's rating back on a neutral back in the fall.

I appreciate that because you saw it before anybody else the first time. I told my team before we were prepping for a call with you, they said, "He just downgraded us because they had this Enterprise Index thing." I said, "Well, it sounds like he's pretty smart about this."

Check's in the mail. So let me ask you about Europe a little bit. We've seen some leading indicators in Europe that looked a little worse, but then your order volume there actually was pretty good. It's stabled a little bit more than last quarter. Can you say a word or 2 about what you see going on in Europe?

Europe has been surprisingly resilient to me. The U.K. was the challenge this past quarter because public sector spending in the U.K. really drove -- just went to a halt and the new budgets, I think, with -- post the first phase of this Brexit activity, I think budgets were supposed to -- a team was telling me it finalized in March, and they will start flowing late March, April. And then you have -- we just have a large enterprise in Europe that had tapped a bit. But in general, Europe has done a good job, and they've surprised me and I think they remain fairly optimistic.

Okay. Commercial has been declining for the first time since the financial crisis really, and can you help us understand why that's happening now? We don't -- we're not in a recession as far as we can tell, and yet, commercial is as weak as it's been since the last recession.

Yes. That's the area that we probably have the most focus on. The reality is that it's predominantly compute. We sell so much compute in that space. And the last 2 quarters, it's just been tough. So that's the predominant issue and then probably a little bit of just the macro stuff, but that's mostly what it is.

What do you think is driving that compute, changing with cloud, is it HCI, those kinds of...

We saw the massive growth we saw in compute the year before. And I can't remember the exact number, but it was high double digit. I mean there was significant growth in compute, was largely attributed to price increases because of the memory increase. So now we're going through the inverse of that, and we're comparing against those massive numbers. So it just makes it look really bad.

So we're going to have to lap that memory, increase it, and once we do, that should right itself.

And then we'll probably go through it again some time. It's cyclical as usual.

No session at our TMT conference would be complete without a coronavirus question. So anything to say about that? I mean what's Cisco doing on the ground? What do you observe? How is it affecting business?

Yes. First of all, I mean, it's -- obviously, it's not fun. I mean this is -- it's a crisis. And it's -- there's so much uncertainty, and I think that's the challenge right now is we just don't know. Because you hear people compare it to the number of deaths we have in the U.S. from flu and they try to say it's not as big. But I think it's the unknown right now and the -- just is what's causing the challenges. And then we pulled out of Mobile World, and then they subsequently canceled it. We made a decision 2 days ago. We have a big conference in Australia called Cisco Live Australia, which is our big customer event once a year there. We canceled that this week, just erring on the side of caution because you just -- we just don't want to -- we don't -- we thought it would be wise to do so. We even canceled -- I bring together our top 150 leaders once a year, and that's in March. And some of our leaders from Europe and Asia were just expressing concern and saying, I'd like us to have commercial aircraft out of these regions as -- unless I just absolutely have to. So we canceled that. We're going to do some virtual stuff. So that's sort of how it's going. Now with China is, obviously, there's nothing happening in China. So as it relates to our call yesterday, I want to clarify 2 things. The demand impact in China, we've kind of built into our guide. The supply chain implications, I want to be clear because we had some questions just afterwards. Some people thought that given that we had put ourselves in a position -- a positive position on the tariff situation, that we were clear of China from a supply chain perspective. That is not the case. We are still highly dependent upon China as is most of the tech industry. And our point yesterday was simply that we don't know how that's going to play out. So we have nothing built in because we just have no visibility right now. The factories are starting back up. They started back up earlier this week, but just clearly not back at full capacity right now. So we'll have to wait and see.

Right, although a lot of the final assembly moved out of China to deal with the tariff situation.

That's right.

But a lot of those...

A lot of the components still come -- printed circuit boards, Ethernet connectors. But whatever it is will be a temporary thing and then we'll catch up. But we just don't know yet.

It's funny how we normalize these things and millions and millions of people are being impacted by them.

Oh, it's terrible. I mean I'm on the phone trying to find masks for our employees over there in the middle of earnings yesterday. So I mean it's...

All right. Well, let's move on to something more positive than that, Campus refresh cycle. We thought the commercial order volume decreases might be associated with Campus. It sounds like that's completely wrong, and Campus is still going great guns. And it -- I just wonder, could you comment on how far through you think the replacement cycle we are. And would you be seeing higher growth in Campus if it weren't for this enterprise slowdown? Do you think that's just happening regardless?

Yes. Yes, I think that's right. The Catalyst 9000 just had tremendous growth last quarter again. And we are still -- I mean it's so early relative to if you just look at raw percentages of the installed base that this portfolio replaces, we're like we have years to go based on what we've done so far. I mean we've had this product in the market since 2017. It was the first product. Now we built out the family since then. So that was the first product. Now we have the whole family built out. If we're 3 years in, and I know what percentage we've replaced, we have years ahead of us on this transition. That's where we are. And so it is -- continues to be the fastest-ramping product we've ever built as a company, which is pretty astonishing, I think. And so I'm optimistic, and it's -- but I do think that's just connected to the enterprise just happen to breaks a bit is my theory on that right now.

Is the previous Campus cycle, those of us who have followed them, seemed to have to peak in growth about 18 months in from when the volume products are shipping? This one seems like it. If none of this other stuff had happened, it might have been a little longer anyway.

Yes, maybe. I mean now we're obviously -- we had a tremendous year a year ago, when we were in the midst of it. And I think that -- so you also have a tough compare on that business. But I think it's -- look, we're in the middle of a refresh in the branch router, the Wi-Fi 6 platforms and a Campus Switching, and we have never, as a company, had all 3 of those going through a refresh cycle at the same time and they're all subscription-based. So we are pushing a little bit of that out of the revenue, not significant -- not as significant as it was with the accounting changes. But so I think when customers -- when they start spending again, I'm confident. When you look at the -- when we look at the pipeline and we look at the deals, they're all there. And it's just when we see our close rates do what they do, it just says they're tapping.

Yes. Okay. Let's talk about your component strategy a little bit. That was -- that's been something that's emerged in the last year or so, I guess, maybe a little bit less than that, that I think has been a positive surprise to a lot of people. The announcement of you getting back into the -- really seriously back into the networking chip business, and also optical, you're going that direction, I thought I've got a couple of detailed questions, but maybe could you say a word or 2 about your thinking strategically about these moves and how that fits into your overall strategy at Cisco.

Well, one of the key tenets that I believed in when I became CEO, and it's like ancient times now when I became CEO, almost 5 years, I feel like I just started, was that we needed to sell our technology to our customers however they wanted to consume it. And that's a great -- it's an easy thing to say, and then you have to actually do it. And back then, we were talking about would we disaggregate hardware and software, would we virtualize our solutions. And we've done both of those. We have instances where our operating systems are running on a customer's hardware. We have situations where a customer's operating system's running on our hardware. And the next phase of that was to actually sell silicon if they would like to buy silicon. And when we were in the discussions of acquiring this company called Leaba back in 2016, I met with the founders. And these are the guys who created Dune that got sold to Broadcom. That's who these guys are. And we had a session with the 2 founders and me. It was just -- that was the -- and they said, "Ultimately, we want to sell our silicon. We would like to build a business selling our silicon. Are you open to that?" And I said, "Absolutely." And here we are. A lot of it -- it's just primarily the cloud players. And for those of you who understand the service provider marketplace, you know, forever, they have always had dual-vendor strategies because they always want to have -- there's one element of it that's just a pricing strategy. But the real issue that drove them to this dual-vendor strategy, so in the core network, you have it; in your aggregation layers, you have it, and you -- is just to mitigate any issues that arise in one platform or the other. You got a problem with the platform, you have a backup platform. Well, the cloud players think that way about silicon and components. And so the other thing they always -- they wanted some silicon diversity, and we're -- primarily, we're the only at-scale networking silicon provider other than the merchant player. So now we're in deep strategic discussions with all of them. We've taken orders for both the 8000 and some silicon. And I think it's the fact, again, the fact that they were on stage with us at the announcement says that they really support it. They were involved with the strategy all along. So we're really pleased with where we are. And the optic stuff is basically just the same story, same thing.

How -- the silicon, I know it's aimed at the data center initially. How leverageable is that silicon design across all the scale Cisco has?

Yes. That's a great question. This is -- it's going to run across every product we build. And this is a big deal for us from an operational perspective and a cost and a speed to innovate because for years, we've had different pieces of silicon in all the different products, which means you're writing different operating systems and they're somewhat static. And so having this silicon and being able to leverage it, it will take cost out of our development. It will take time out of our development cycles. And it, being programmable, gives us the ability to run it with any operating system we want to run it on. And we've been consolidating operating systems as well. So this has been part of our strategy since -- we have today, one operating system running across routing, wireless and Campus Switching for the first time in the history of the company. I know it's hard to believe, but I mean, we've got into those businesses through acquisition and just kept maintaining those operating systems. So I probably talked about it in the last year or 2. We had a few thousand engineers that for 3 years did nothing but rewrite a new operating system all across this platform. So we've been trying to get to consolidating operating systems. There's more we're going to do in that space and then consolidating the silicon. It just really takes down the -- it takes our speed to innovation and the cost of innovation down significantly. So it just takes a long time. This stuff we announced in December basically was a 5-year initiative. I know we focus only 90-day windows. We've been building these products for 5 years. So it's -- there's a long-term play.

The -- that SAI decision that you made to make it programmable, that's something that other big networking silicon people, naming no names, has not been as willing to do. Can you say a word about that decision and how that may enhance your ability to enter some of these opportunities?

Well, it was pretty simple. The customer said, "I'd like to buy your silicon." And we said, "Okay." It's -- I mean it was very simple for me. The reality is that what I found over the last 4 or 5 years is when our customers ask us if we'd be willing to do something and we say yes, that makes them more comfortable buying the way we sell today just because they feel like they got a hedge if they decide they want to do it in the future. I had a large financial institution that asked me in one of my first sessions, standing up in front of customers as CEO, "Would you be willing to disaggregate your hardware and software if we asked you to?" And I said, "Sure." And he jokingly looked at me and smiled and said, "Let me ask that question one more time because I'm not sure you understood it." I said, "Of course." And that customer has never asked us to disaggregate, but they're a very huge, very loyal customer. And what we believe is that when we engage in only silicon discussions, 1 of 2 things will happen. Once they buy into the silicon -- and at the end, they'd have to make a box decision, and it's somewhat irrelevant to us whether they want us to build the system or whether they want us to partner with a manufacturer to build an ODM white box. And so we'll go either route. So a lot of them are making the silicon decision, and then it turns into they want to buy the 8000 from us or they want to buy an integrated system. And some would want to go the white box route, and we can do either one.

With your scale, my understanding has always been that it would be tough for a white box assembler to match your cost. Is that the right way to think about it, or if your silicon is going to be in there anyway?

Well, yes, I think that when you go -- have to go buy everything, there's margin-stacking that has to occur at some point along the way. So they have to get their silicon from somewhere. So to them, it's irrelevant whether they get it from us or somewhere else. And now that we're like, we're quite happy to, we can actually work with the manufacturer on behalf of the customer to actually get those products delivered, or we can sell them silicon and they can take the lead and go do that, whichever they prefer.

Along this theme, another thing that you've said is that you're willing to sell your optics into white boxes. You -- we were a little bit surprised by that just as that customer was. So could you say a word or 2 about that? I mean I guess, it goes along the same...

It's the same story. I mean the optics situation today is that when -- the reason we felt like we needed to control the optics is as you -- today, there's pluggable optics, but the optics are going to get integrated onto the silicon because at the speeds that we're going to be building over the next few years, you're going to have to wipe out the copper and go straight from the CPU onto glass because of the speed. So that was one of the big reasons we wanted to have it. But we -- if customers want to buy the optics, I mean, we certainly want to just keep selling it to them.

Okay. Web scale, since you're starting down that path now, how big a market do you think that might be in the next 2 or 3 years for Cisco? Like how -- we know how big the overall market is. What are your aspirations in terms of tier? What do you think is achievable? Minus 50%, just to be sure of it, or is that too high a hurdle?