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

So you brought up supply chain constraints. Obviously, it's been top of mind for over a year now. I think management on the last call talked about some early signs of relief -- and I think maybe it was Chuck or Scott, that said we don't have a demand issue. It's a supply issue. And so I'm wondering, can you talk about how your business has been affected by these constraints over the last year? And what you're seeing in terms of maybe potential loosening of some of these constraints over the last several months?

Yes. It's been quite the 12 months. I think we did see significant supply issues that most had. But what we started doing sometime late last year and certainly 6 months this year is really looking at redesigning components, which were choked, trying to remove those redesign and those redesigns take time, right? Like -- so that's why we were not able to immediately come up with and say we have solved the supply problem. But the good news is on at least -- I mean Scott mentioned this, I think the earnings on 2 of the high learning SKUs, one wireless one switching both, unfortunately, my portfolio, we have redesigned and now we see light around the corner for those few. So as these high-volume SKUs, now we have alternate supply, we do see the supply chain situation improving quite a bit. Obviously, you have learned a lesson not to -- the world's not predictable. So you don't know which other component is going to be scarce. So we can't sit here and say that it's absolutely gone away. So it's still challenging, but you see light around the corner.

Got it. Got it. And would you say customer buying behavior. I think it's been one of the other questions we get a lot from investors is our customers pulling forward plans for investment, knowing that obviously lead times are lengthening, have you seen any sort of meaningful change in customer buying behavior?

So we have seen a lot of demand. But when we look at the actual units, right, like, let's say, take switching as an example, the units right now where it is, is where it was pre-pandemic. So it's not as if folks bought 20% more switches, volume during the pandemic. What happened was there was a dip in the first 6 months of the pandemic and then it recovered. And whatever they didn't spend in those 6 months, they spent it all in the next 12, 18. So I say, we saw more of that was us true pull forward on the switching side. And then, of course, there was a lot of inflation. So those price increases we had to do. And a lot of the benefits of that price increase, we are just now beginning to see and we'll see more of that going forward. So I would say -- so possibly some pull forward. We cannot deny that. But we are not seeing an extraordinary increase in volume that we're too worried about. On the wireless side, we did see an increase in volume because almost everybody use the pandemic to upgrade, right? But I think while there's a genuine increase in demand as well, because as you need more video, you have WiFi 6E, which opened up a giga of spectrum. That's a lot of spectrum. We have AR, VR type of applications coming. So wireless is this something that should grow faster than GDP, right? Like high single, double-digit TAM. And so I think that explains some of the demand that we are seeing here. In terms of customer buying behavior, recently, what we are seeing is more of a thoughtful ask around supply chain, right? So let's say, they have 10,000 units of switches or access points. They're not asking for all 10,000. They're saying like, "Hey, I'm going to open a new building here. So I really need 1,000 of what I ordered in November. I need another 2,000 in Jan." So they're breaking their order into piece parts of their need, and we're working through them to that. So it's -- I wouldn't say it's a change in buying behavior, but a more sophisticated ask around and they're sharing their strategy more openly, right, rather than saying we order 10,000, they're like, "Hey, this is how we're going to roll out our retail branches. This is when we need," we see more of those sort of dialogue going on.

Got it. Got it. I want to ask about innovation. It's an area, obviously, Cisco, and obviously, the broader industry continue to invest in R&D to keep sort of differentiating and retain competitive advantage. Can you talk about some of the more recent innovations in your business and how that propels your segment going forward?

Yes. So one of the important innovations is perhaps and you shared Chuck speak about it is the amount of subscription software business that we drive and my business also drives a lot of sort of that. And so in order for that to happen, you need to innovate on the software layer. It's no longer just about the hardware shipments, right? And that also gives you predictability of revenue, predictability and cycles that are not as long as, say, a switch renewal cycle, which is 6 years and upgrade software. So there, we have focused a lot on ARR, right? So I'll give you an example. This conference room, let's just take it, has WiFi access points. I think it's Cisco access points. But right now, we have 50, 75 people in this room. Earlier in the day, that's probably 0. Later on, there might be 200. You don't know, right? It fluctuates. I think the network can be smarter in a lot of different ways because it sort of understand and say like, okay, now I really need to tune in for high-density WiFi. Now I can possibly switch off 4 of the 5 access points and conserve power, right? You can also have HVAC systems controlled if you have that occupancy dynamically monitored. And that's a 5% to 7% savings for this casino if that works that way. So we're investing in software suite that give value to customers besides just speeds and feeds of connectivity. So that's one innovation. I spoke about cloud acceleration. Historically, we've gone to market with 2 portfolios on my product line, 1 is the Meraki, which was cloud and the other was for DNA Center, which was on-prem. And so customers have to make a choice. So now we are removing that and you're saying, we're shipping new hardware on the WiFi side, and we will on switching soon enough that actually works on both on cloud and on-prem. And so that means that investment protection for customers who today aren't quite ready, but they can buy the same hardware they're used to buying and then when they want to go the cloud journey, it's just a switch of management. So we think this will unlock some new demand, and we have been innovating at it. So those are a couple of examples.

Got it. Got it. I want to talk a little bit about your go-to-market model. Can you talk about the model for your business, whether it's direct sales, channel driven? And then maybe also one other layer to this question, I think we've seen a lot and heard a lot about the shift to as-a-service model that Cisco has been implementing. How has that impacted your go-to-market strategy?

So broadly, our go-to-market, obviously, we have I think the world's best direct selling B2B sales organization supported by our [indiscernible] partners. So that's the high-touch model. Large majority of my product line goes through that model. But obviously, we also serve the commercial and SMB segments through our distributor and VARs right? Like -- and so those are our traditional routes to market. We are investing more in e-commerce and digital routes to market, and also the managed service provider, right? Like -- and so these newer route to markets do require more innovation around as-a-service and consumption models that are required, right? Early days. And this often is not just a product innovation, right? It's sort of a whole user experience innovation, how you build, how you consume, what's the meter you're going to use. So we're going to have -- we have to retool a lot of the back-end systems, and that can, as some of you know, can take a while to get right, right? So I think that's what we are busy doing. Behind these early tip-of-the-spear products that we have, early days yet, but we see a lot of opportunity in the -- as-a-service models as we go down the future. But it really requires a complete overhaul of the user experience behind the product.

What's the response then from your channel partners in terms of the evolution to more of a subscription and consumption model?

You see, from an exact CIO level and their partners, the channel, double thumbs up. But again, it's the same retooling they also have to do right? And how you meter and how you sell. And so the integrations with Cisco. So awesome response, but in terms of actual volume passing through, we haven't crossed the [indiscernible] , early days.

Got it. Got it. I want to talk a little bit about the catalyst switching portfolio. So I think last fiscal quarter, switching overall declined, yet Cat9K still saw growth. And I think Chuck had mentioned, it was the second largest shipment quarter in the company's history for Cat9K. Can you talk a little bit about what you're seeing here that's driving some of the relative outperformance?

So I think, like I said, from a unit perspective, we are where we were pre-pandemic -- so we kind of recovered and we have come there. And then the price increases we have done, which give us a nice bump. What we are seeing is generally enterprise, especially large enterprises, have realized the importance of having a solid access network, a solid backbone that can support all of this wireless that we have, right? Like -- so compromising on that is not a great -- the outcome wasn't great, right? Like -- and so they've realized that. So the -- we've seen continuous robust demand for these Cat9K switches particularly in the higher density, right, like 10 gig, 25 gig, versus previously that was 1 gig. So the big mGIG switches seeing nice traction that's happening. So I think -- and it's driven by wireless, right? Like because you need more access point, you need more switches. It's driven by smart building and digitization. So that's another trend, sustainability, right? Like so we have all of our Cat9K switches can power up to 90 watts of PoE, which means most of the devices you have can be powered through PoE and that's more power efficient in general. And it's not just power efficient, you can also control lighting from your phone or it's more digital, right? So a smart building anecdotally, this is not something that is true every time. But anecdotally, when a building goes smart, right, so let's say, this casino, they decide to do PoE sensors and digitize, the number of ports they need is 2x to 3x the ports that they need if the building was just WiFi connectivity. So the trend that we see in switching is there's going to be a reduction in footprint as hybrid work comes because some folks, you close some buildings. A lot of people are working from home. But then the buildings that you have, you make it truly smart. So net-net, we don't see -- it's a stable port world that we see. And then, of course, you buy more premium switches, you buy more software on top of those. And so there's a nice dollar growth to be had.

So Cat9K was one of the first products I think that was sold with the subscription starting in 2017. So how do we think about renewal cycles? Any early color you can share in terms of what you're seeing on that front?

So we did ship our first Cat9K in 2017, but it was 2020 when I'd say 90% of the portfolio was Cat9K. So what that means is a lot of the renewal dollars that meaningful volume of renewal is probably 2023, 2024. So early days. We see a lot of upside, obviously, and we are working towards that. But the renewal that we are hitting right now is too small to comment on that.

I'm going to pause for a second. If anybody has any questions, just raise your hand, somebody with a mic should walk around, bring it to you. Any questions? Okay. A couple more in the time we have left. You mentioned also the networking aspect, the security aspect. I'm wondering how do your enterprise networking solutions interact with the security portfolio? And I guess more importantly, does one pull through the other?

I think it's more complementary. I won't use the word pull-through. If both work together, I think we give a better security solution for our customers. However, no one is going to compromise on security. So it's not like the better together is going to be -- I mean you have to have security, you have to have. But if it works together, it can actually give you better security. I'll give you an example. We have an application that we call Endpoint Analytics. So what that does is a lot of times, IT teams don't have control over what endpoints you connect to the network, WiFi, right? So you could come in with a fire alarm, you could come in with a camera, et cetera. And maybe it's well intended, right? Like so a fire alarm, let's take, right? It's connected as wireless, but then somebody hacks into it, and then that's the starting point of a breach. So what we can do networking side, right? It's like we can look at the network pattern that's coming from a fire alarm. And we can classify that and say, hey, this looks like a fire alarm. This looks like a camera. This looks like -- and that's what we call Endpoint Analytics. So we can classify for this enterprise, let's say, wind resorts, type of endpoints that are connecting to their network, and they can look at it and say, "Yes, this makes sense." Not only that, we can give a trust for, "Hey, this camera is behaving like a camera should." So it's a high trust cost. So you don't need to quarantine it. So you can give this rich information about how -- what devices connect. And imagine this information is fed to the security app or the firewall or its policy engine, they can make much better and smarter decisions around that. When we did Endpoint Analytics for a hospital, early trial, that hospital realized that they didn't have visibility to 70% of the devices that connected. They were only managing 30%, which they thought their devices, right? There was 70% either an employee brought in or a patient brought in. And we could tell them these are the types of devices that are connecting. And then when these work together, imagine the benefits you can get with the comprehensive security, that's what we're working on.

Open-ended question, high-level question. What would you say are 1 or 2 of the most underappreciated growth opportunities for Cisco, and it doesn't have to be under your purview it could be broadly as well?

Yes. I would say the area where I think we can see a lot of growth that a lot of you may not be seeing is on IoT right? As more sensors, more factories go digital, the types of software and hardware solutions that they need is a nice increment over the basic speeds and feeds, connectivity that you normally associate Cisco with, right? Like MGM resorts, for example, they are trying to go with smart keys, an app and BLEs. What you don't know is that BLE network is probably run through the WiFi access points. And so the -- a huge element of providing that software that takes all of these information from sensor, cameras and feeds that application. That's one example. Similar in the slide. So we are seeing -- and Meraki has Meraki cameras that fit into Meraki dashboard. So these are examples where we've seen tremendous growth over the last 3, 4 years. And so that's an area that I think there's more growth to be had.

Got it. And then last question, I see we're coming up on our time. If we're sitting here a year from now, what would you say you would have liked to achieve in the next 12 months?

I think being part of this redefinition of hybrid work and Cisco is squarely the center of it. And like I said, our security or Chuck said that area of focus, nailing that and using our portfolio and driving forward solutions that meet our customer demand. But ultimately, it's all about the customer experience. We want to help our customers to transform that experience. So a year from now, that's what I would say. If they're going after hybrid work, did we help transform their experience? If they're going after next-gen security, did we deliver that? That'd be our win.

Excellent. All right. I think we'll end it there. Thank you so much, Greg. Appreciate it.

Thank you.