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

All right, thank you, everyone for joining us. Yes, Kip, please, go ahead.

Yes, that's good.

Actually, you can sit right here, if you want as well.

That will be great.

Yes. All right. Thank you everyone for joining us. I'm Sami Badri with Credit Suisse Equity Research. We have Kip Compton, today, CTO and SVP of Strategy and Operations and specifically the enterprise networking and cloud business for Cisco. Thank you very much for joining us.

Thanks. Great to be here.

Yes. So one thing I wanted to open up with a very broad statement here a broad question is, there are several technological industry tailwinds that are currently ongoing today from 5G, WiFi 6 You name it, there seems to be a big tailwind embedded in the technology sector across all the various subsegments. Could we talk about which of these drivers are most relevant to Cisco?

Sure. So before I begin, I ought to say that I'm going to make forward-looking statements, and they're subject to the risks in our latest filings. So with that, out of the way. There are a lot of tailwinds. We're seeing networking right now is -- maybe it's cliche, but maybe more important to a lot of our enterprise customers than even it has been in the past. Three that I would highlight perhaps are IoT, hybrid work and the growth in the web scalers that we're seeing. So on the IoT side, you think of industrial IoT and some of the things, but we're actually seeing a growth in smart buildings and sensors and all kinds of things in the enterprise power of Ethernet. Lighting, for instance, is driving a lot of growth in sort catalysts for our campus business. On hybrid work, at the beginning of pandemic, a lot of people made very quick technology calls to make it so all their employees could work from home. Now they are taking much more strategic approach, and they're looking at their return to office and hybrid work and realizing pretty much every meeting is a video meeting now, even when most people are in the office, there are still people who are remote. And that's driving a really significant change in the amount of traffic and traffic patterns in the enterprise. And we think that's going to continue to be a catalyst for some time. And then on the web scalers, it's just driven by the continued incredible growth in that segment, and we're seeing new builds of AI and ML networks that are even more sort of network intensive, and that's contributing to our growth there.

Got it. And then when you think about Cisco's R&D investments, where would you say is kind of the biggest concentration?

I'll probably divide that into 2 buckets, the way I think about it. I mean there's core technology. So I mean huge investments in optical, our Silicon One ASIC strategy, our security technologies and core networking software that powers the internet. Those are the core technologies where we made huge long-term investments, and we're going to continue to do that to differentiate and lead the market. The other category I'd say is where we're increasingly investing to deliver experiences. And I think the success that we've seen with Meraki is maybe the [ primitive ] example of this. But all of our customers are looking for simpler ways to consume technology. Simplicity is winning. So we're increasingly investing in cloud management platforms that deliver simplicity, and you'll see us increasingly bring AI and ML into those platforms to make it even easier for people to run their networks.

Got it. Got it. One thing I wanted to hit or kind of discuss with you is the market share of Cisco across various product segments. Where is Cisco most resilient from a market share perspective? And over the next kind of 3 to 5 years, how would you expect market positioning to actually evolve?

Yes, this is -- I mean, it's on everyone's mind, certainly including ours. And it's a super tricky environment right now. I -- one of the conversations this morning, it's a great environment for networking for the reasons I mentioned earlier. If you're trying to track market share, it's a terrible environment. And of course, it's because of the supply chain. And market share is counted on revenue, revenue requires us to ship. Shipping is dependent on supply chain. And just to give you an idea of the diversity and lead times that we're seeing, and why this complicates, how we calculate and others track market share. We have some products that are as short as 3-week lead time right now. We have other products that are 40-, 50-plus weeks still. And there's not a lot of rhyme or reason to that. It's based on various component availability, and our competitors have a similar landscape. So I'd just say it's super difficult to track and understand market share right now. We did some internal analysis, and we actually shared on our recent earnings call a few things on our view of market share. We felt like we're holding our own in-campus switching, SP routing, wireless and optical as examples, and growing share in blade servers, telepresence and voice. So that's what we're seeing in terms of the landscape. We think as the supply chain situation continues to resolve itself that the market share accounting will become a little bit more transparent and things will normalize itself. In terms of what's resilient, I mean, I come from the engineering product development side of the house. So my view of resiliency is where we have differentiation. And there's a few examples. I mean in SP routing, a lot of it is driven by the incredible growth of our Cisco 8000 platform, fastest-growing platform in the history of the company, and that's powered by and differentiated by our second one, ASIC strategy. You see us in optical, just bringing incredible technology from Acacia and other areas and also being able to take that best-in-class technology and integrate it vertically into a networking stack, which just drives greater efficiency and simplicity for our customers. And then wireless and campus switching, Meraki is a major factor there. The simplicity and the experience that we're able to deliver with that model is winning in the marketplace and is helping to make our wireless and campus switching market shares more resilient.

Got it. Got it. For my next question, I was hoping we could kind of talk about the record performance you discussed on the last quarterly call. And maybe you could talk about them by product SKU, and you kind of alluded to some of them now. The main ones that you guys called out was the Catalyst 9000, the Series 8000, Meraki, ThousandEyes and Duo. Could we kind of dissect each of these product lines and just discuss what are the key growth drivers of each of these?

Sure. No. And it's great to have -- frankly, to have quite a few products in different parts of our portfolio doing so well. The Catalyst 9000 and wireless, I'll kind of lump together because some of the drivers there are the same. And I mentioned it earlier, the return to office and the fact that every meeting is a video meeting is causing some pretty massive campus refreshes. That, coupled with the sort of traditional and ongoing more rapid refresh of wireless driven by new wireless standards. We've seen a lot of refreshes driven by WiFi 6. Recently, we see 6E on the horizon that's driving similar refreshes. And by the way, not a new phenomenon, but one of the things that we see with these WiFi 6 and 6E refreshes is that it tends to drive a switch upgrades as well because they deliver -- those wireless standards deliver more than 1 gigabit of performance. So it triggers our customers to invest in switches that are multi-gigabit or M-gig capable. On the Cisco 8000, it's driven by the webscaler growth. And as I mentioned earlier, in addition to the normal incredible growth that we see out of the webscalers, we're seeing these AI and machine learning network deployments emerging, which are bringing a greater level of network intensity and more opportunity for us. On Meraki, it's the simplicity of the Meraki dashboard along with the full stack management capability. So a customer is able to go in and manage their switches, their wireless, their routing, their cameras, their sensors, for instance, all in one unified place, and that's something that's very, very powerful. ThousandEyes was another area where we saw incredible growth. This is a really fantastic asset. This is actually the first M&A transaction that we closed virtually. It was at the beginning of the pandemic. It was the first deal we had done without in-person meetings. I think the timing worked out really well. ThousandEyes gives customers end-to-end visibility over their own networks, but also public networks as well as the cloud so they can understand the application performance that customers or employees are getting. And this actually becomes super critical when you have people working from home because they are calling the IT department, trying to figure out what's going on. And all of a sudden, it's not enough for the IT department just to be able to see their own network. So that's being driven by hybrid work and hybrid cloud in a big way. And I think last one you mentioned was Duo. That's driven by Zero Trust for the same hybrid work environment where increasingly, people are not in the office. Obviously, the security perimeter type model breaks down, and you need people to be able to work efficiently and securely from anywhere that drives a Zero Trust architecture and Duo is a leader there. So those are some of the drivers.

And then if you were to think about maybe the one technology or the one solution that seems to be, by far, the leading reason why customers are spending money, upgrading and doing what they're doing mainly to modernize or maybe even upgrade their networks. What would be that technology?

Well, I mean, I would say, first of all, the network seems to be more important even than it was in the past. Maybe it's because of remote work, maybe just the acceleration of some trends that were already in place because of the pandemic. So we're seeing people really seeing their network and their investment in the network is critical to their success. And even as they move more close to the cloud, you actually need a great network if you're going to get a great cloud experience. So I think it's -- again, it's probably a combination of the things I've talked about. The hybrid work, including the return to office and what that means is key. Hybrid cloud drives investment in networks. IoT is a factor, 5G on the service provider side and also some interest in private 5G on the enterprise side are all catalysts.

Got it. Got it. I want to shift gears a little bit and talk about Cisco's business model transition from predominantly transactional or perpetual to more subscription and software. Could we kind of talk about how this transition is going, and I know you guys released the Catalyst 9000 with a subscription offering. And I guess, the investor base is expecting this to kind of go into other product groups at some point. Could we kind of go through that path, and how the transition is actually going?

Sure. So I mean we feel like we're on track. I think last quarter, we said 43% of our revenue is recurring. And I think that's aligned with the rough timeline we talked about at Investor Day. I think it was last year. A lot of people question like are we just growing our recurring software because of the hardware attach? And for sure, that's growing. And we won't hesitate, frankly, to attach recurring software value to our large scale hardware businesses because that brings a lot of value to our customers. It brings an acceleration of the scale of recurring software for us as well. We're also though seeing success in what I'll call hardware independent: recurring revenue, software businesses, SaaS businesses. In fact, we already talked about a couple of them Duo and ThousandEyes. A cloud calling business is doing extremely well as is Cisco contact center. So we are able -- I believe, we're able to drive a balance strategy, where we drive recurring software revenue attached to hardware like the play that we're still running with the Cisco 9000 as well as businesses that are SaaS properties that are hardware independent.

Got it. Got it. I wanted to kind of shift gears and talk about some of the redesign efforts that you guys have been kind of going through. And I think one of the main product lines is the Nexus 9000 and you've really seen it. So how long does it normally take for product redesigns to take place? And has this kind of impacted or cost Cisco market share at least in the most recent quarters?

It's a great question. It's -- there's not a set -- I mean, as you probably appreciate, there's not a set answer for how long a redesign takes. What I would say is it really depends most of all on how -- when we're redesigning, usually, there's a product and we have one component that has a very long lead time. And of course, we can't ship the product unless you have all of the components. And so we'll redesign in an effort to remove that component from the product, so we can ship it more quickly. The length of time it takes us to accomplish a redesign is determined by a bunch of things, but how intertwined the particular component is with the rest of the product, and how similar or different the replacement or alternative component is is what drives kind of the differences in terms of how long it takes us to accomplish that. We're almost always talking about months. So I've not seen redesigns get done in a few weeks. I've not seen redesigns take an extended period of time either. We've done quite a few redesigns. It is, as you alluded to, sometimes a little bit disruptive to our innovation engine. So if we have product development teams who are focused on innovating and bringing new value to our customers, when we have to ask them to pivot and do a redesign program that can impact our road map. But it's -- it became extremely clear to us that perhaps the feature our customers needed most was to be able to actually get the product. And so I think it was the right call. That's actually given us some good results without getting into specifics. We did have one product where we executed the redesign, and we started shipping it, and we were able to immediately drop the lead time for our customers from 40 weeks to 12 weeks on that particular product. So it can have a really significant impact. And we're continuing to use targeted redesign efforts on our longest lead time products where we can make a big difference.

And then maybe just for an idea, I guess, because data center switching is going through redesign. That may potentially put into one of the more longer lead time categories, right, just because it's currently an ongoing process?

Yes. We do -- I mean, we do think that we -- in particular, from a market share perspective, we do believe that, to some degree, the longer lead times that we have right now in that product are impacting how market share is counted. I don't want to get into exactly which product you're redesigning at any particular moment in time. But those longer lead time products are exactly the candidates that we would be targeting.

Got it. I wanted to kind of go back to a couple of references that were made on the fiscal 1Q '23 call, and it has a lot to do with energy efficiency. And I think I counted it multiple times. I think I counted 3 times, right? And I guess like the big question when people talk about Cisco and the outlook of potentially like what happens in an economic downturn, what seems to be a comment made from at least the Cisco team as energy efficiency is a much bigger deal than we ever really thought, and that is kind of like the driver for why spend should be maintained. But maybe we can kind of get your take, like how front and center is energy efficiency coming up across your entire customer base versus maybe a select few that are sensitive.

Sure. I mean -- I think there's really 2 things coming together here. One is the long-term sustainability targets that almost all of our customers have, and they're trying to get to Net Zero. And that is always -- that has put a focus on energy efficiency. Obviously, the more energy the product uses, in general the more carbon it contributes. The other thing that's really come into the picture in the last year or so is just the rise in energy prices around the world, but especially in Europe. That's brought a renewed focus to energy efficiency from our customers. So it's part of their sustainability goals, but it's also now a direct economic situation. And I think we -- I think on our conference call, one of the things you're referring to, as Chuck mentioned a few technologies that he felt could help because we see this energy efficiency thing as perhaps a double-edged sword. Some people may delay projects because of the cost of the energy that they're paying on other things or that the project itself would incur. On the other hand, we're also seeing it as something that causes people to look at new technologies that could help them with their energy efficiency. And I think we mentioned power over Ethernet, Silicon 1 and IoT, as Chuck mentioned, those as 3 technologies that Cisco could help our customers with their energy efficiency needs. And briefly, Silicon 1, it's pretty obvious, it's a much more efficient, especially on a watt per gigabit-type-basis solution. On the IoT side, it's about deploying sensors and making buildings smarter so that you can save energy and even make better use of that space. On the power Ethernet side, it's about just a more efficient energy transmission. So we have a lot of customers looking at using power Ethernet for their lighting in their office buildings, for instance, and they can actually save power because the transmission of the energy is -- of the electricity is more efficient and also because the power over Ethernet infrastructure gives the much finer grain visibility and control over where that power is going. So he mentioned those 3 technologies as things that our customers are looking at from Cisco to help them. I'd also note that we have seen greater interest in sort of sustainability solutions and those include like sustainable data center solutions and smart buildings in particular. And if you're interested in this, we recently renovated our 1 Penn Plaza office in New York City and redid it with the latest smart building technologies. There's a number of videos and other materials online, if you want to check out what we're talking about here. I'd also note, in addition to these technologies, we're seeing some customers, particularly in Europe, starting to look at their equipment and considering an early refresh because they'll have equipment in place. Perhaps it's not fully depreciated, but they see their energy bill, their electricity bill and they see that newer equipment could be significantly more efficient. And in some cases, we see customers putting together business cases to move forward with an early refresh because they'd rather get to that lower energy cost than finish depreciating a less efficient piece of equipment.

Got it. One quick follow-up on something you said earlier is, if you were to look in history, right, the last time customers really were very sensitively focused on energy efficiency for the equipment, right? Has it ever really been as important as this time today? Or has always kind of been a top criteria for customers and their solution set deployments?

I mean it's always been a criteria. I mean I would say, qualitatively, to me, it's coming up more right now? I think the -- I think what I haven't seen before is the confluence or the intersection of the energy costs and the sustainability targets that companies have. And I think those 2 things are coming together in a different way right now than I've seen in the past.

Got it. Got it. I wanted to touch on specific demand drivers in customer verticals, right? If we look at from public safety or the public sector to commercial, to enterprise, how would you kind of characterize drivers specifically to those verticals?

Sure. So enterprise, it's a lot of things I've mentioned, hybrid cloud, 5G, 400G and beyond, IoT and hybrid work are all top of mind with our enterprise customers and driving interest and demand. We think we're really well positioned there with solutions. On the service rider side, we're seeing solid demand, frankly, led by the webscalers again. And that's something that we see continuing. On public sector, in the U.S., we saw a little bit of a pause with the election, but we're expecting to see things pick up and perhaps a tailwind from the investments in the Inflation Reduction Act.

Got you. Got you. I wanted to go back to a question I actually overlooked on my list, but it has to do with software attached to hardware. When you think about Cisco over the next couple of few years, is software growth becoming more independent or more dependent on hardware shipments and hardware growth?

Oh, I don't know how to quantify that. I mean like I said earlier, we're focused on growing recurring revenue software. And we'll have a balanced strategy where it makes sense, and there's value to the customer to attach that to our hardware base, like we've done with the Catalyst 9000 or frankly, like is inherent in the Meraki business model, we're absolutely pursuing that. And we're seeing some high-quality results there. Meraki, for instance, if a customer doesn't renew their Meraki subscription, the hardware that they've bought becomes unusable. So that tends to drive a very, very high-quality renewal rate on that business. So we're very pleased with the results there. But then we're driving the growth. And I think I mentioned Duo, ThousandEyes, cloud calling and contact center as examples. We're building and buying and growing hardware independent SaaS businesses as well. So I don't know, I'd have to go look at our models and see if we have numbers, but we're less focused on like a percentage here or there and more like, well, okay, recurring software, how do we grow that? How do we find opportunities to bring that kind of ongoing value to our customers and get that predictability for Cisco.

Got it. Got it. I wanted to kind of close out the final question with what keeps you up at night as a CTO just because the world is obviously changing very fast, and there are multiple technologies and probably multiple opportunities for certain technologies to either be displaced or to be adopted. So how would you characterize what keeps you up at night?

Actually, I don't sleep badly. But in terms of what's top of mind. Lately, what I've been pondering is given all of the change, it feels like a much more dynamic world. I mean the pandemic certainly heralded in a new level of uncertainty, but now obviously, geopolitically and in other ways, it feels like a much more dynamic environment than we've had in the past. And I think that's here to stay. So thinking a lot about how we strike the balance as we're responding to things that come up now, like the supply chain things that we talked about. How do we strike a balance there in responding to those things in ways that give us more resiliency and flexibility are going forward? Because I think we're in a different period with a lot of change, and we have a very large and complex business. So it's important for us to think about that.

Got it. Got it. Well, I appreciate your time. We went through the question list, and thank you very much for joining us today.

Thank you.

Absolutely. All right. Great.