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

Thank you very much for joining us to our third day of the conference. I did notice that outside, there is a banner with the barcodes of our reports. So if you want to have our primers, we published plenty of primers on various topics. If you want to have our primer, primers are there. There is a primer coming soon about Cisco's largest segment, Secure Agile Network, and it's a bottoms-up look at their revenues and kind of all the trends, et cetera, but that's going to come up soon. So thank you very much, Greg, for joining us. Maybe we'll start with introduction and you'll do a better job at introducing yourself than me trying to make it. So if you can tell us kind of your background at Cisco and what are you -- what are your areas of responsibility today, et cetera?

All right. Thank you. Good morning, everybody. I'm Greg Dorai, I'm the SVP, General Manager for what we call as a campus connectivity business. That is basically our switching business and products like Cisco DNA Center et cetera. That's core and that's Secure Agile Networks portfolio. Peers who are on wireless and WAN and data center and those 3 or 4 is that Secure Agile Networks. And before we go forward, I'll just make the safe harbor statement. We'll be making forward-looking statements. You can refer to our 10-K for further details on that.

Perfect. I promise I'm going to hardly ask you questions about the network.

Yes, that's perfect.

So let's start. First of all, at the high level, Secure Agile Network grew last quarter, 29% almost a year before was 4.4%. Talk about your area of responsibility. What are the trends you're seeing with this kind of great growth we have seen?

Yes, we saw a pretty significant boom in certainly a switching wireless businesses that are there. And we had supply chain issues, as we all know. So now finally, we have unlocked that. And a lot of the growth, frankly, is orders that are booked during that boom. So that's not a surprise to any of you. The reason for that demand was as folks went home, the importance of technology of connectivity just hit home with CIOs, and that was an area that they decided to beef up, right? Like -- and so some of those investments are still absorbing because they, frankly, combination of supply chain plus hey, we need to invest to get our corporate offices on -- like I'll give you an example. If you are on Wi-Fi from 2 generations ago to now, it was literally 10x better, right? Like so why would as hybrid work as video conferencing becomes -- you just kind of need that. You couldn't rely on something that was built for guest access and you didn't refresh. I'm not saying all verticals were like that, but there were verticals who are in that. So we saw that. Now of course, we are seeing a little bit of recession come on top of those trends. And it's hard to know what's what, but those are all acting together.

So let's talk about kind of the current demand -- need, not demand, need, the current need for infrastructure build out. So in the last few years, there was build out, at least -- not build-out. There was demand going up. We're seeing the build-out today because of supply constraints. Is there -- put it in the historical perspective. If you look at the growth of '21, '22, '23 together, right, and average it between the years where you had supply and here, you don't have just average it. It seems to me like it's still way above the growth we have seen in the previous few years. Unless -- correct me if I'm wrong, that it wasn't in a sense that it seems like there was acceleration of demand in a campus environment. And the question is, is this acceleration sustainable? If I'm totally wrong with my observation, please correct me. It's not going to be the first one I'm wrong.

I think if you just look at '21 to '23, you're right. right? Like there was an acceleration. But if you look at from '19 to '24, right, 24 being some of which has not played out. And it's hard to say whether it's acceleration or there was a little bit of a bump. It all depends on how we see the future order recovery, right? So we are between that period. If you just take the 3 years that you mentioned, yes, right? Like there was signaling acceleration and looked like the trajectory was different. But if you then take a 5- or 6-year period, the signs that it could normalize, right? Now why do I see demand, right, like more than the numbers? I think there are the headwinds and tailwinds, right? Like which headwinds are -- there's a strong demand for security and some of the more modern gear is better to have tighter security because they have more memory, they can have agents in the infrastructure and tightly coupled with security portfolio. That's good, right? There's demand toward sustainability. Modern gear is 20% to 40% more energy efficient than gear that you got from 10 years ago, and you could go do a lot of good things with it, right? So that's good. There's demand towards smart buildings, which is people are not coming back to offices. So your offices need to be smarter. So you need to invest in IoT sensors. We see that if -- like we have invested in 3 buildings, Atlanta, 1PENN and here in San Francisco where we made it totally POE powered, et cetera. If you go that route, you need 3x more ports than just for connectivity, right? So that's -- those are all tailwinds. The headwind is that's the real estate consolidation going on right? Not everyone is coming back to office. So people are consolidating their real estate assets. And so if you shut down, right, like that's going to be a headwind. It's difficult for yet for us to say if you put netted out, what it would be it was looking like there was a total uplift. But then as you look out to the next 2 years with a softer economy, it could normalize to historical.

So what are the big buckets of your products. If you look at it the product basis, what are the big buckets is? Campus switching is one. What are the other ones?

If you look at it historically, right, I think it's campus switching, it's wireless, it's routing and SD-WAN and it's data center, right? And I think we may include cloud compute, right, Carol, and...

But -- no, but that's within your responsibility?

No. Within my responsibility, it is switching and then there is management layer, right, like on top of switching wireless routing, and we call that Cisco DNA Center. That's one that we have. And then we have Meraki that's not in my responsibility, but can also work on the same gear. A lot of the growth levers are software. What I spoke of before were hardware, right? Like -- so we do -- I do have software assets. One is the Cisco DNA Center. The other is what we call Cisco Spaces for smart building and then there's a security product we call Cisco ICE. So these are our growing parts of our portfolio. They work on top of the hardware, that's...

Speaking about switching is easy. I'll keep it to the end. I want to talk about the other parts you just mentioned. Can you take us through spaces through the ICE, through the other products that are software-oriented. And can you talk about it first in terms of what is the problem it is trying to solve? And second, how is it synergistic to your business? How does it help you sell other things or attract business from new customers?

Yes. So let's start with spaces. So that's a smart building offer. The premise in a smart building offer is employees when they want to come into any campus, could be carpeted, it could be retail, could be a hospital, they want a better experience, right? Part of the data that we have from our Wi-Fi access points or WebEx devices that are there, is we have very good location data on how people move around. So spaces reads all of it. So you can start doing things like, hey, this building is occupied at 60% today. So that's one. You can say, which conference rooms are actually empty. Because a lot of times people book conference rooms, they don't actually sit in the conference rooms, right? You can say that. You can do navigation to conference rooms. We -- if you think about maps, as an example, outdoor navigation, it's like brilliant, right? It's all 10 years ago, we all use it every day. But you look at indoor maps, it's actually pretty bad relative to outdoor, right? Like within a building, you don't know even now when we came in, Carol and I were searching for things, right? So actually, Cisco has maps, but it's IT maps right? And spaces can convert it into actually more physical maps, of course, need the help of the facility owner, but to say, like yes this part. And then you can start doing navigation seamlessly and if you can do that. So that's the premise of spaces. And then there's an API ecosystem on top of it, which now a vertical-specific partner can read and give more sophisticated outcomes, right? I'll give you an example of higher ed. You want to actually know students, which classes they took, are they -- especially if they're on a certain scholarship that are requirements if they attend labs that they -- and so you can actually geofence and say, like, yes, they've been spending this many hours in campus, et cetera. Now, there are privacy requirements in getting that, which is why I don't think Cisco can get in there. But a partner who's working with that higher ed university may be able to take API from spaces and deliver that more custom outcome for that vertical. So that's spaces, right? What is the opportunity in spaces? This is rough back of the envelope map, I'm not claiming that this is actual TAM. But if you look at a corporative space today and you put all that spend on infra, at least in the Cisco domain, it's probably $1 or $1 per square foot, right? So if you look at the facilities budget, how much they spend on per square foot per employee is a lot higher than that? It's hundreds of dollars, right? So the question is, can you give some outcome, both to the employee and frankly, to the facilities owner, right? Because now they know how a building is actually utilized, they can shut down buildings. Then can we get $1.50? That's a significant increase in our software TAM because we cover, gosh, I don't know...

And that's a recurring revenue basis?

That's a recurring revenue basis, right? That's what I'm saying. If we go into that model. Today, we are not in that model, but we have every one of our Wi-Fi access points covers say a 1,000 square foot, right? We probably have 20 million to 30 million installed Wi-Fi access point. So you can -- on a square foot basis, that's what we can see. And the question is, can we monetize it differently. That's the spaces of value prop.

What are the other software you mentioned a few of them.

Security, right? Like so -- and of course, for security, the security portfolio, but the part for me is can we leverage the power of network and that's where Cisco ICE comes in. We actually know because one of the threats here is everyone wants to go over the top, I'm going directly to an Internet. So why do I really need horizontal campus information. The reason is because you have actually a lot of unmanaged devices, IoT devices in any campus. And we have that context because of the network and Cisco ICE is a product that knows, right? So we actually have context of all those unmanaged devices. We can do AI to profile those devices. We know if a fire alarm behaves like a fire alarm or is there some data spike. If you can share all of that to our security products. And suddenly, the security defense becomes more stronger because you're getting information from the network and you can make decisions. It's not just perimeter. Security, it's not just agent-based security. It's throughout the network. If there's any anomaly in the data flow we can do that. And I think that will help our security portfolio grow a lot faster if we get this integration tighter, better. And that's what -- there's a lot of Cisco Live announcements that was about that.

Got it. So Speaking about the campus switching, I can address it from multiple kind of angles. I want to start from the angle of how do you make money in switching, meaning a few years back, 10 years back, the way to grow in switching was either if you had more people, if you hired more people, so you need more ports. Number 2 is if there was a new technology, power of Ethernet, migration to 1 gig or 10 gig, whatever it was. Is it still the same thing? Are these the 2 drivers for growth, meaning technology evolution and more hiring? Or were you're able to change the switching portfolio to have more software content, more recurring revenue content and add more features to it that were not included in the past?

Yes...

It's a long question and a long answer.

It's a long question and long answer. I think to get back, certainly, ports to people was a driver -- it's becoming less of a driver. And as we discussed, it can even be a headwind, right, like because every desk used to have 2 ports and now the question is do you need that and you are doing consolidation. So but it is still a driver of growth. Why is it? Because it's an amazing insurance policy, right? Like it's $0.60 per port or something like that over 10 years. So why would you risk not having that, it's just nothing in the grand scheme of things. And so we think ports growing at GDP is something that you should will continue. It's not going to have like a dramatic shrink, right, like the [ third ] one. Second is -- except there is an actual physical asset consolidation, right? But second is certainly as we look at POE and if we look at mobility and video in that, you do need newer gear, right, POE-powered switches MGIG switches. The penetration of that is small today in the portfolio. So I think if buildings get smarter, that then there will be tailwind from that. But the biggest driver is the third. And we have already seen a lot of benefit from it, right? You've heard Chuck talk of numbers on what percentage of our portfolio is software, how much is ARR, being a very large portfolio that switching is the number that Chuck speaks about very close to my numbers as well. So I will not give you the specifics where it's almost like you can go say, see our investor call, that's kind of exactly where my business will be. But there's a lot of upside even from there because what we have managed right now is we took the dollar value our customers paid, and we said instead of at that time, 95% or 98% being hardware and 2% to 5% being software, we have come to where we are, which I think is between 25% and 30%, right? Like give or take, software. But still, the customer was paying more or less the same dollar amount. We just -- but then if they renew it, that was our upside, right? So that was the first thing, and it's working really well. But the second thing that I think there's more upside as we look forward is for any infrastructure that our customer buys from us, if they spend $1, they spend $4 to $5 operating that infrastructure, right? Like either it's internally or it's with partners, contractors. And if we can go and simplify, and this is where cloud and unification of the portfolio comes in, right? Like -- because the billions of the Cisco of the past was we created this ecosystem of CCIEs. And that was so sticky, but it also was -- customers have to spend because you really needed those experts to come and set up your switches or troubleshoot your switches. In this new world, I think we need something more nimble and agile. And so if we can get a certain percentage of that spend as product. And then we encourage our ecosystem to go from the world of more CCIEs and knobs to the world of APIs and do richer apps on top of it. I think it will be good for them. It will be good for us. So that's a big driver of growth.

So give me an example, if I spend $100 -- I understand from you, if I spend $100 on a switch yesterday or 10 years ago, I still spend $100, but the breakdown of software and hardware is different.

Correct.

What is -- is the 20 -- you mentioned 25% to 30% software. So again, taking this example, I assume that if I spend $100 on a switch today, 25% will be -- $25 will be the software. Is the software recurring?

Yes.

And the software 10 years ago was not recurring?

10 years ago it was less software period, and it was not recurring.

Okay. What are the big components of this recurring revenue? Meaning, you touched on a little bit on it, but what are the big components of this recurring revenue in campus switching? And why are companies willing to pay it? Because this is -- it used to be very hardware-centric, as you mentioned. How do you convince them to start paying every year on the same switch?

Because for a lot of our customers, just the -- what is base automation, which is onboarding a switch or updating to a later security patch, et cetera. In the past world, I'll just dumb it down and you have to up-level it because it's easier to explain. In the past, you could go and say, hey, Saturday, Sunday, I'm shutting down the network. Nobody can access e-mails. We all remember this, right? They'd get this email saying, it's important...

Still get it.

Maybe some of the -- it's impossible now, right? You cannot take down your network, you'll be more agile. So it has to be smarter, right? You cannot just say like, hey, I'm going to boot down all these boxes, it's down for 24 hours, right? So the value of software, even for basic upgrade, basic config life cycle management or a security incident, right? Like you have to react very, very quickly if you know there's some vulnerability in it, and these patches have to be pushed really well. So something like the Meraki suite, our cloud networking suite is just brilliant for that because all of that taken care of you and it's automatic. In our more enterprise on-prem suite, it has to be done by these IT teams, and that's where software like DNA Center really helps. So that's one, right? Base automation. The second area is around AIOps. This is -- let's -- I'll give you another simple example, right? Like in a building, typically, you know the network knows when the traffic is speaking. And for this hotel, if you observe over 30 days, you can actually build patterns of what's happening. And actually, your Wi-Fi onboarding time. So this is like when you connect to Wi-Fi, how quickly can you connect to the Internet? Varies basis the number of people. This is physics, right? Like -- and so the network knows that, and so it can actually start doing a baseline for this building, so that the IT person doesn't freak out if things are slow because it could be like things are slow, but there's 1,000 people in a room designed for 100. Don't worry about it, right? Like all that's happening. Yes, you may need to upgrade to better gear, but it's not like anything has collapsed. As opposed to wait a minute, there's nobody in the room and yet there's 1 person who's trying to connect, is getting 30 seconds before he's connecting. Something is wrong, right? And we're talking just within the room, right? I was presenting us today our Collab portfolio. if you do a Zoom call or a WebEx call or Microsoft Teams call, and you have an issue in the call where a few users don't -- are not able to connect, it's annoying, especially if someone is trying to present. And at the end of the call, in the previous world, you would be like it's annoying, I don't know it's a WebEx issue. But you don't know what it is. It could be the home Wi-Fi. It could be the middle mile. It could be the WebEx note or it could be some network in your campus, right? But with something like 1,000 eyes, we can actually stitch all this together, right? 1,000 eyes is a software offering that works on switches, that works on WebEx. And you can actually go into any meeting and any endpoint in that meeting, no matter where they are, right, hotel home. And then you can say, yes, it's actually the hotel Wi-Fi or it's -- no, it's the WebEx node in San Francisco that had the issue. So these things people will pay for, right? Because it's actually troubleshooting and experience well beyond the switch, right? So I think that's a second example. And these are the 2 really driving the base level of software and recurring...

Data software. Another aspect of campus switching is the relationship with wireless switching. How much Meraki is a complementary? And how much of it is cannibalistic to your business?

So you use wireless switching let's sort of -- there's wireless and the switching. And then in both we have Meraki and on-prem.

Okay.

Okay. So Meraki is the cloud management layer and DNA Center is the on-prem management player. So I have responsibility for the overall switching business. So that includes Meraki even though I don't own the management platform, and on-prem. So it may be cannibalistic between each other, but we only look at A plus B. So anything that I said when I say switching growth, I'm looking at A plus B, which means it is to my benefit to migrate things to a cloud management layer because it's actually more sticky. I get more renewals and I can give more benefits to the user if they are to the -- if I move them to the cloud management layer, right? So that way, it is cannibalistic, if you look at it that way, but we only look at it as A plus B. Wireless is very complementary, right? If there's any growth in wireless because of any trend, then they'll need more MGIG switches. And so any growth there is a boost to either of these switching portfolios.

Got it. One of the biggest trends in the industry in the last few years is competition, Arista, Juniper, right, campus switching. And I want to ask the question, but I want to start 10 years back, not now. When we saw competition in data centers and suddenly, we had Arista and suddenly, we had Broadcom with the chip that enabled Juniper and Arista, et cetera, Cisco lost share in the data centers. And these new players offered something else. At first, it was feed and speed, then it was latency and openness. And they had -- their message was different at the beginning. How do you make sure or how did you make sure that you don't run into the same competitive threat in campus as you had in data centers?

Yes. I think, first of all, if you are a competitor, you do have to find something different, right? So this is -- so I think one thing that I'll say from 10 years to now is that the game is more software, right? And software by definition is more unified experience. It's not within a domain. What our competitors do is that they spike in a domain because they focus and then they figure out some gap could be speeds and feeds or could be in that domain I can -- I'm going to do software better and it's a best-of-breed approach. And we have to get that right as well. But I think the big opportunity for Cisco to hold back competition is to deliver and experience across domains, right? Because we have the market share that none of them have in each of these domains. And our customers, frankly, look at as a Cisco and not as Cisco switching, Cisco wireless, Cisco data center, right? So when we have the share and then we can simplify and converge and get unified experience, that is the stickiest way to do it because troubleshooting is easier. If you can do automation in 1 domain, it's more or less the same in another domain. It's sort of like Microsoft Office suite, right? With the platform suite, you get used to one, you're going to use the other. And I think that is -- but of course, you need to have a best product in each domain. And I think we'll do that. But competing within a domain is not a recipe for success for Cisco. We need to be really good in the domain, but the competition, we need to lift it up to be across domains, and it's very sticky. I'll give you an example, again, of our Meraki cloud portfolio, extremely loyal towards the platform. You get -- and they have switched out wireless. They don't have data center yet today. But if somebody buys wireless, the likelihood that they'll buy switching on Meraki is very high, the likelihood. So I think that's where we want to get to is to this platform approach with a unified experience. And then we think -- it's very, very hard, right? Like Arista doesn't have enterprise strong wireless footprint at all, right? Like Juniper's SD-WAN, they just acquired. And so I think there are very early stages in certain domains, but if you look at data center, yes, Arista is more mature. If you look at Juniper, they are matured in wireless and switching. But if you put together 5 or 6 domains I think the gaps are huge. And that's how...

Do you feel any pricing pressure because we have more competition from these companies?

We always feel some pricing pressure, but I don't think the game is pricing in enterprise segments. Maybe in emerging regions and the lower market, it's pricing, but the competition is different. It's not the ones you spoke about that. I think where we have is -- it's the operational simplicity and lower cost pressure versus the pricing pressure. So if it's simpler, I think at the end of the day, our customers are going to save more, and then they'd go with that solution even if it's actually slightly more expensive to get for that, pay for that.

So we have a minute left, and I want to finish with the last question on spending. And do you think if you look at the entire kind of -- if you look at all your Cisco's target markets, right, you have cloud, you have service providers, you have campus, you have data centers. Do you feel -- or do you share the view that campus is going to be the most vulnerable to any economic slowdown out of the others or is it the opposite?

Well, I think if you view the campus as how it is today, it could see a slowdown, right? But I don't think that's how we should view it. The office of the future is very different than today, right? Like you should view the campus as an office of the future. So next-gen factory, as a campus. next-gen hospital is a campus. A worker who works at branch, a large branch or comes into a collaboration center comes in, it's a campus. And so I think if you broaden this to a discussion around offers of the future or a campus of the future. I think the opportunities are tremendous in the levers that I spoke about, right? Actually, going slightly up than just the plumbing and then going into POE-powered outcomes, going into experiences, going into security, there's so much opportunity because in this future, it's very, very different than today. So I think that's how Cisco is viewing it. That's how I'd say anybody has to view it. I'll give you one example to hit this home, hospitals, right? Like the -- if you go into an ER room historically, there was a triaging area where you waited because they were just triaging for the stroke patients first. And if you are a luggage and you waited 2 hours, And then you went in another room and you waited it. I know some of you because they had put you -- they take all that with good network and hybrid experience now in Stanford here in the Silicon Valley, the triaging starts little in the parking lot, right? Like you don't really need to go into that small room. They can move around, they can do this and doctors can be hybrid, right, with the WebEx Mini Pro, some part of your discussion can go. So you can actually scale up your staff up and more. And so this whole ER experiences can be changed if you invest in it with the futuristic view, huge upside for Cisco.

Got it. Great. Greg, thank you very much. We ran out of time, but it was extremely insightful.