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

All right. We're good to go. Welcome, everybody. I'm Meta Marshall. I lead up networking here at Morgan Stanley. We're delighted to have Greg Dorai, who is the SVP and GM of the Campus Connectivity business at Cisco. I'm going to read some brief disclosures. And I think you're going to read some brief disclosures, and then we'll get into a more exciting conversation. So for important disclosures, please see the Morgan Stanley research disclosures website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Greg, did you want to match my disclosure? \.

I will. Thank you, and good morning, everybody. It's such a pleasure to be here. I'll be making forward-looking statements, not all of which may translate into financial results. So I urge you to look at our 10-Q or 10-K for guidelines around those.

Okay. Perfect. So Greg, maybe to start, for those who may not be familiar with you, can you just kind of give a sense of your role at Cisco and just any other roles that you had kind of before stepping into this role?

Yes. So I run the -- I'm the GM for the Campus Switching business at Cisco. So that includes our Cat9k switching portfolio and all the management tools that we use on top of it. Previously, I've run the Wireless portfolio as well. So between those 2, that's sort of our largest core networking product line in the Campus portfolio.

Okay. Perfect. As you just mentioned, the Campus business is the largest business within the Cisco portfolio. Can you just talk a little bit about some of the major demand trends you're seeing within the portfolio currently?

Yes. I think if you look at the last, let's say, 4 years, you saw a big boom in demand, driven by supply chain chokes. All of us knew it. And then over the last 3, 4 quarters, we shipped out almost all of that. So there was a lot of excess shipping, if you look at our historical trend line, that we did in the last 3, 4 quarters. What we are now seeing is a softness in demand relative to that long-term trend line. And there are a couple of reasons. Chuck spoke about it in the earnings as well. One is the digestion of that supply because it takes some time for enterprises to digest it. When we look at our Meraki portfolio, which is cloud-connected and where we can see activation of all our switches we ship, we are seeing an uptick in activation, but it's not yet caught up to where we would expect it to be normal. I'd say, it's going to take until the end of Cisco's fiscal year or more to the back half of this calendar year, where we expect that digestion to normalize. The second thing we are seeing is some macro softness. There's a little bit of global softness, but the specific spikes in a few areas, like certain countries in APJC and Europe, we're seeing a little bit more softness than in the Americas. And our SP and Cloud have -- segments have been softer than our Enterprise segment. So global softness. So those are the 2 near term, I would say. Longer term, when we look at, okay, that's fine, this should go away, my expectation is that the trend line for Campus business remains close to where it was, with some upside possibilities. The headwind for that has been hybrid work. And there's this, "Oh, will be shut down offices, and therefore, the Campus ports drop?" Of course, if you're living in New York or San Francisco, like I am, you do get this real fear because return to work has been a little slower. But anywhere else in the world is actually on an uptick because people are being mandated to come in across Europe, across APJC, across smaller cities in the U.S. as well. And so we're actually seeing that headwind no longer to be true, right? Like I wouldn't say it's a tailwind, but at least going to come back to historical occupancy rates. That's one. The tailwind for us is when people do come back to work, they're going to expect a level of experience that was higher than when they left, whether it was video collaboration or whether it's IoT sensors. You, yourself and your badge said scan, no printed agenda. That means you need to have scanners in more places in this hotel, things like that, right, IoT devices. So that's a tailwind. So between those 2, I expect this to be awash and us to return to long-term trend lines.

Okay. Got it. My team wishes they were still on a hybrid work. New York is very much back in the office. So maybe just -- you mentioned kind of the softness near term being from digestion of supply or just inventory digestion. Just how are you kind of judging internally? Just what is inventory digestion versus macro headwinds? Because I think that's a question that investors have is, just how much visibility do you actually have into those?

It's hard to discern what's what. Historically, we see our refresh cycle between 4 to 6 years, 4 years for Wireless, 6 years for Switching. And that's how we do the long-term trend line internally. And we know that it's below that trend line right now. So we kind of know that, hey, something is happening. So that, we have hard data. The activation data, digestion data, the one that we have is the Meraki product line that I spoke about, that's about 15% of the Campus business, if you will, right? Like that or thereabouts, maybe 20% in some areas. So it's a dipstick, but it's not fully representative. And so we are extrapolating using that. So it's hard to discern. What we do know is, when we talk to partners, when we talk to customers, they are not really talking about digestion as the issue why they're not spending, right? Like so they are more forward-looking. And so I'm really hopeful that whatever you're seeing is very ephemeral. And in a couple of quarters, it goes back to true demand drivers, which are going to be AI, security, and do I have the network for that. And I think we are very well positioned to ride all those trends.

So I mean you spoke about early on kind of the headwinds and tailwinds that return to the office can be. Is there a way to think of what that multiplier is if you want to make an office more technology dense? Or something that helps us get a insight into, okay, we get past some of the offices that are getting smaller, but what -- how do you determine what that longer-term upsell is?

There is a number, but I don't know if everyone will hit that number. So don't model based on that, but I'll give you the number. When we upgraded our Cisco offices -- so we did 2 state-of-the-art offices, one in New York and one in Atlanta, the number of ports those offices required -- and so this is basically everything is PoE powered, including your desk, a lot of lighting. And so it's extremely power-efficient. We saved 30% to 40% on power. We have a Cisco Spaces portfolio. This is for indoor navigation. Everything is connected, whether it's Webex, cameras. So you can know how many people are in an office room anytime. And you can have that display. You can book office rooms based on actual occupancy on video monitor, so on and so forth. So the works. So in an office like that, the number of ports is 3x the number of ports in an office by -- just for connectivity. So that's a big multiplier. Now the reason why I say I don't expect every Cisco building is going to get outfitted that way because it's really expensive. But certainly, the big collaboration centers of an enterprise or where you get customers in, they're going to get out with it that way. So that's -- so I don't know what the exact multiple will be if you blend it out, but at the upper end, it's 3x.

Okay. So you can kind of think of headquarters as most companies might get outfitted like that. But branches might kind of stay a little bit more connectivity then?

Yes. Exactly.

Okay. We naturally assume more WiFi or more video conferencing when we think about outfitting an office for hybrid work. But what are you seeing most forward-thinking organizations thinking about in terms of outfitting an office to make it more appealing or efficient to employees as they return to the office?

I mean, 2 broad themes we are seeing, again, forward-looking companies do, one is the employee experience. So in the employee experience, that's depending on when you are a born, you're going to have -- get a little bit more particular about what this experience might be. But it's like, from our quality indexes, there are groups of people who want to come into a building and they want to know what that is. All of our WiFi access points have a quality sensor that feeds into software. So you can kind of look at what's going on in different parts of the building. You can know which conference rooms and which part of the building are available when you walk in. In the hybrid work world, sometimes we find that employees who come into a building don't necessarily come in every week. So they don't really know the layout of the building. So indoor navigation, that's an experience as well. And on the other side, it's more productivity based. So if I'm running the -- I'm part of the facilities team that's running that particular office. I actually want to know what is the utilization, right? Which facilities are used more, less? I want to basically be able to control the power, so its energy. Like in our Atlanta office, we saw a 30% drop in our overall power consumptions after we digitized. And we had PoE, where you could turn things on-and-off basis, actual occupancy. And so they're looking for that. Sustainability is a big driver as well. This gentleman seems to have a question.

Sure. Do we have a mic?

I have 2 questions. First question is, when you look at the competitive landscape, you look at Juniper and Extreme and all these guys who are growing, they've doubled their business since pre-pandemic. And in the last 2 quarters, both have seen things get crushed, just like you guys have seen it. When you look at sort of the long-term competitive landscape, it feels like they both -- they basically grew because you guys couldn't deliver products in time due to the pandemic supply constraints. Number one, do you feel that way? Do you feel like you can take share back if that is the case? And number two, DNA Center. Obviously, the strategy here is to sell cheaper relative hardware, and then charge the customers for the DNA Center with all the services that you can bundle on top of that. How is that going? I mean you guys started pushing this in 2018, 2019, 3- to 5-year renewal rates. How are the renewal rates for, like, back then, it was, they called it, bronze, silver and gold. So I guess those are my 2 questions, kind of taking back market share from the competition. And two, how successful has the DNA Center strategy in terms of implanting the hardware and upselling the software going?

Yes. So I think on the market share, if you look at the last 3, 4 quarters, in our Campus Switching and Campus Wireless business, we're actually gaining share. So the take back is happening. Whether it's real share gain or loss depends on after you average out 4 quarters, right? Like so, I would say, go look at our Campus Switching, Campus Wireless business, already, because we shipped out so much in the last 3, 4 quarters, we had healthy share gains. Now can we retain that? Is it true share? As the demand normalizes, we'll have to look at over 4 quarters. We -- so that's on market share. Just looking at the pandemic, post-pandemic, I think I finally feel confident. If it were just due to a supply chain, we will take back because our supply chain is now fully normalized.

[indiscernible]

I don't -- it depends, right? Like I think it sort of has geographic variance to it, right? In APJC, in certain markets, we couldn't really participate fully during the demand uptick, and we did lose share there. And I'm not sure that anything has changed in the geopolitical situation where we can say it will inflect. In North America and Europe, yes, I agree with that statement, right? Like if we had lost share, it was largely due to supply, unchoking at different parts, and it's not been significantly different post-pandemic. On DNA Center, which we now call Catalyst Center, it was not on cheap hardware, it was on a Cat9k switching portfolio. But we did take a bet that certain portion of it was on -- would be software versus hardware. And we are seeing significant adoption growth in Catalyst Center over the last 18 months.

[indiscernible]

Yes. So that's an early indicator of renewal rates. Renewal rates are going in the right direction. I'm not going to give you specific numbers on this portfolio, but it's going in the right direction. Adoption is looking good. Our adoption on the Meraki portfolio, which is a cloud-delivered portfolio, and renewal rates are very, very high, right, like near-perfect, if you will. And the other part of our strategy is the same Cat9k hardware can work on Meraki as well. That's the vision that we announced about 12, 15 months ago. Our WiFi 6E and up portfolio on the wireless is already that way. So you can actually use it on Meraki or this. And so we're hoping that the migration to cloud gives an uptick as well. So adoption is looking good. Our renewal rates are trended in the right direction. And we think we have upside because our hardware now can work both on cloud and on-prem.

Okay. We'll dig more into competitive landscape and software as we go throughout, but helpful introduction to that topic. Maybe sticking on Power over Ethernet for a while, whether with AI, with -- whether a lot of things, power hasn't kind of come into focus. Just how many -- where does that fit on the priority list of organizations just in terms of an upgrade, a reason to upgrade? Or what are you normally seeing? Is it still security that's kind of #1 reason that you upgrade? Is it primarily outfitting my office? Or some of these more sustainability factors kind of coming into...

If you look at reasons to upgrade, there are infrastructure-driven reasons, and then there are sort of overall solution-driven reasons. The infrastructure-driven reasons tend to be UPOE, which is the next-gen PoE, Almost all our high-end switches come with 90-watt PoE. So basically, you can power a LCD monitor for video collaboration with just PoE, if you will. And mGig, which is multi-gig throughput. So if you want high latest next-gen WiFi, like WiFi 6E or WiFi 7, you're going to need that capacity and just the ability to do more processing at lower power, like some of our Silicon One chips have, right? Like so those are infrastructure-driven reasons. Historically, that you would hit anywhere between 4 to 6 years, you would want to refresh your infrastructure if you don't want to choke. That's been the refresh cycle. It's infrastructure-driven. If it is -- and 4 years for wireless, 6 years more for switching routing, that's where we are. If it is due to solution, that's a little bit new, right? And we don't know how it will impact. But that's where security comes in. Our older switches don't have the same level of telemetry that we can put in, in our newer switches that we can then send to our security portfolio or even to a third-party vendor to be more tighter in security at the Campus. And so vulnerabilities are low if you are more modern in your infrastructure. So that's another reason to upgrade. That's a big driver for CIOs. And then the second reason is, for a lot of campuses today the #1 hurdle is complexity. Historically, in the networking space, competition was by silos: switching, wireless, data center, WAN and so on and so forth. And so that has resulted in complexity because we have different management layers in each, but fundamentally, what matters is the experience. And I think that's something that can be a driver. If we can deliver solutions that actually span that experience, and I can talk of later how we are thinking about it, I actually think that's driver enough. Just to give you an example. For every minute of downtime for this hotel, they will probably spend more than the CapEx, right? For every dollar of Cat9k switch I ship, someone is spending between $5 to $10 on operating and maintaining the switch. Therefore, there's more dollars in play in how you run the network than in the actual CapEx of what you need to build a network. So if we can tap into that and lower those expenses for this hotel, I think that's a refresh driver.

Okay. Okay. Perfect. We just introduced the topic, but you've had more of a subscription offering added on to the Campus networking portfolio over the past couple of years. Some of your competitors make noise about that, that they don't have kind of some of the subscription upsells on top of that. Just what does Cisco view as the appetite from the customer to kind of have at least a portion of their process being in subscription?

I think we shipped our -- as the gentleman pointed out, when we launched DNA and Catalyst 9K, which was our -- it is a current switching line, think about 6 years ago, if memory serves me right, that's when we made this big move to subscription. We are seeing very good adoption. But if you talk to a customer, the focus is less on subscription or the price of software or the price of hardware, it's more on value, right? Like so I think we get renewals where we have demonstrated value in the software, which means -- which is why I started answering with adoption. So if you don't get adoption then you can't get value. So that's one. And so the conversation, not whether it's security, whether it's AI, in the networking, not the LLM AI, but just even in networking. If you can demonstrate value that the network is 5 9s, 7 9s, because of that software, we get renewals. And that's our focus. There's also lower end of the segments, which could not invest in on-prem gear that's expensive, like DNA Center. And so adoption has been a hurdle. That is why we are pushing the Meraki line now. It works on the same hardware, and you use that same license. And we think that will be a driver of adoption and renewal for our mid-market and below segments that are on on-prem Cat9k today.

Okay. And that leads into my next question, which is just how has that line changed over time of between who is a Meraki customer and a Cisco customer?

It's blurring. So historically, we have had 2 lines and that's historical as just even 2 years ago, like, which means a lot of our customers may see us as 2 different product lines. Because we have the Catalyst line, we have the Meraki line, and you need to buy a different hardware, different software for both, right? And so they had their own segments that they're purchasing. Meraki was more mid-market, and then Catalyst was more upmarket. What we noticed was it was blurring even in the market without us doing anything, which means majority of our customers had both, right? They were deploying Catalyst Center in their Campus. They're deploying Meraki in their Branch. This was the typical deployment scenario. So they were already dabbling in both. I think the lines are going to blur even more with where we are taking a portfolio where we no longer -- if I play out 2 years from now, we are already well on our way in Wi-Fi. We're getting that with switching. But if I play out 2 years, it's going to be the same hardware, Cat9k, that you will buy, regardless of whether you want to consume Meraki or DNA Center or Catalyst Center. So that means the lines -- you're selling essentially the same thing, and you're selling the same license. And the deployment model for management is just a choice that you can make after you purchase the gear rather than before you purchase the gear. So at that point, I think we go to what we are calling the Cisco Networking Cloud, where the brands Meraki and Catalyst are less relevant and the brand Cisco is more relevant for networking.

Okay. I mean there's a number of competitors in the market, kind of to the question we were alluding to earlier, that have made noise about the Campus portfolios in the past couple of years, whether that be Juniper or Arista or Fortinet or Extreme. Just what do you think the market misses about some of Cisco's competitive advantages and why your share can be more sustainable in the market?

I think what I would say is, when you look at what most of our customers want from that experience, it's from your phone or the laptop, all the way to the app in the data center or hyperscaler, and they want to assure that experience. That is the goal. Cisco has #1 market share in campus switching, #1 market share in wireless, #1 market share in data center, #1 market share in SD-WAN Branch. So we have the ability to piece together for any enterprise this flow. And so that's what the market underestimates. The market expects us to continue working in silos, like we have historically done. And all of our competition compete with us in these silos. And we have had some share loss, gain, et cetera, but no competitor has the platform breadth and scope that we have. So if we can deliver on that, have that common management platform across all these domains with AI, with common data lakes, with AI on those data lakes that assure that. A good example of this is the ThousandEyes acquisition. That actually -- that's what I was -- it gives you a digital experience, monitoring for that complete experience. So when it was founded, it didn't integrate with any of our domains. And now what we're doing is, we're doing the integration. So we can not only save bad experience breaks down, you can go and say, it's wireless, let's share data, let's try and fix that wireless experience in this room. I think that's where we're going. And the market underestimates the power of that platform solution, we can correct.

I mean as Cisco Live last year, you made a big deal about these kind of solutions that you're going to sell versus kind of the previous silos. Just where do you feel like the channel is on being able to kind of sell these solutions? Where do you feel like customers are on being able to think about their needs in terms of solutions versus kind of just profile?

Early days. Early days, right? I think there's a vision what I said is not something new. Historically, any vendor, including Cisco, has struggled to execute this. So the market will look for proof points. We are about 25% of the way there. Like I said, my expectation in the next 18 months will be well on our way there. So where the market channels, they love the vision. In fact, we had a partner summit last week in Americas. And the only thing they could say is go faster to that endpoint because it gives certainty you know what to buy, et cetera. So there's a very good reception. But in terms of are we actually seeing product shift towards [indiscernible] not yet what we expect to.

Okay. I want to maybe jump into questions a little bit sooner. I have plenty of questions. But just in case there's kind of any questions from the audience? Maybe one from you, sir?

You mentioned the platform story. I want to get a sense of you look at the margins that Juniper and Extreme and HPE have, they're 6 handle and below. Meraki and Cisco is 7 handle and a plus. So you guys have much better margins than they do. Is that too much? Should you guys get more aggressive to take share? Or do you think that, with this platform story, you can maintain your margins, maintain share?

I think it's a value game. I think in certain segments, what you're seeing is our overall average. And certain segments, absolutely, are more price competitive. I would say, mid-market and below in Europe, in Asia Pacific are more price competitive. And that -- it's question of trade-offs. And sometimes we have trade -- we have not gone after those shares because we didn't -- we felt there's more value elsewhere. But in those segments, if you do want to gain share, and that's your strategy, you have to be price competitive. But there are other segments where the game is not price, its value, like I spoke of, right? Like if a downtime costs you so much dollars relative to the CapEx cost, then they're going to want the software value to be high, and that's what we are seeing. So that, I don't think you -- that the value is on, are you really providing the software that can truly reduce operational costs? And if you are, they'll pay for it. So I would say it depends on and which segment you are doing. We tend to focus more upmarket, and that's why our margin profile is higher. But if you do need to gain share like in certain segments, price, you don't need to give up on some price. Always, we have a balance. So in some periods, we have to do more. Some periods, we focus on value. So that's all I can say, but yes.

Any other questions from the audience? All right. Perfect. I'll jump back into questions. We hear a lot on our CIO calls about smarter manufacturing floors, IoT kind of becoming a bigger driver for networking investment. Just what way do you feel like Cisco is positioning itself to kind of take advantage of those opportunities?

Most certainly. I think we are seeing a big trend to factories of the future, where the factory flows are being automated. And there's this convergence of what I call OT and IT, right? When you do this automation and machines talking to each other, you're going to need high-speed connectivity, that's where the IT and networking comes in. But it's often machine-to-machine, so it's OT. So you need to work closely with the OT ecosystem to integrate the data flows correctly. We have an industrial IoT portfolio that -- particularly around IoT switching that has been doing very well historically. And so we feel very well positioned. The key trends as you automate the factory, stocking to a German auto car manufacturer, they -- you can guess space is what I say. But like there are plenty that are doing the same. In their all-electric plants, what they want to do is, they really want to go to a model where they can, if required, remote operate these plants and robots, even from a different time zone. They're not bad at all. But remember -- so you really need this high-speed connectivity that's set up. But historically, that plant is owned by the OT team. And for -- I think for -- they said for every minute of downtime during the main shift, it's like $12 million loss for this particular because 8 cars fewer are produced. So it's a real meaningful impact. If you connect everything and something happens and the network is down, right? Like -- and we are well positioned because IP, we truly understand. And we have been, for the last 5 years, working with some of these OT vendors who supply these machines to those factories. And I think I feel we're well positioned, but it's a huge trend with these factories of the future.

Okay. All right. We'd be remiss, the whole session today, without talking about AI. How is Cisco bringing more AI into the Campus portfolio, either through improved security or just better automation of the network?

So I want to start first, which is not very relevant to Campus, but it's very relevant to how Cisco would participate is the AI for infra. So you look at high-speed switching with low latency that's required for the LLM models. Ethernet-based switching, it's, today, has low share. It's something that we expect will gain share and, Cisco should gain share with that. This is what Chuck spoke about in the earnings call of your visibility to a $1 billion of orders. So that, with the Silicon One-based switches, I think that's one area. But let's park that, it's outside Campus. We have the NVIDIA partnership that we recently announced that's on the compute. That's, again, outside Campus, but a little closer. Because as these learning models scale to enterprises, they would need GPU capacity. And so this partnership helps NVIDIA and Cisco give that to our enterprise customers. Now in the Campus portfolio, it's less learning models, but it's more inference models and how that's going to come into play. So we'll see. It's too early to call. It's too early to call what sort of applications will that and what impact is that -- it has on network connectivity. Aside from that, AI for how we operate the network is a huge deal, AIOps of the network, right? And so this is really getting all of the data that Cisco sees and mining it, whether it's for security or for better ways of operating the network. For security, the example that I'll give you is, we can actually see the data that's coming from all the IoT devices and know enough about those traffic pattern to classify those devices for our customers, right, automatically through AI. And then we can also see like, okay, that is a fire alarm. It connected as a fire alarm, but its behavior in the last 2 weeks is different from what we'd expect a fire alarm to behave. And so we can quarantine. We can do that by sharing with our security portfolio. The Splunk acquisition plays really nicely into how we can grow the story. And then on the network operations side, it's when there's a breakdown. Every minute of breakdown is expensive. So you don't know today where the breakdown is in, which domain. Wireless in the Campus Switching or is it in the van or in the Data Center? I think with a product like ThousandEyes, you can quickly identify it and then you can do some AI models to correlate hey, you did a config change in the switch 3 days ago. And that's correlated to this problem we are seeing here. So you should go and undo that change. Today, we don't do things like that, but with ThousandEyes integrated closely with our Meraki portfolio, we can. So I see us playing AI there. But fundamentally, the one thing that we don't talk enough about is Cisco as a trusted partner. In all of these models, sometimes, trust is huge. Trust in, can you keep the data secure and private? Because the data that I'm talking about is extremely sensitive data. It's literally all of the traffic. And Cisco has earned their trust. So as we do AI, I hope that plays out with our customers as well.

Got it. Maybe just circling back to macro for a second. You laid out kind of the -- how you're evaluating what the macro headwinds are currently and maybe how they differ by geography. Just as you think about recovery within the portfolio, is it campus switching first and then WiFi? Is it WiFi? Like is there any kind of staging to the recovery or staging to the geographies?

We have some sort of intelligent guesses, I would say, because a little bit forward-looking. Americas is recovering a little faster than Europe or APJC is. So that's 1 that's early evidence. So just that American within that enterprises are seeing recovery a little faster than public sector and state governments are. So that's sort of a trend. I would say, in terms of within domains, too early, but wireless likely leading the recovery and then switching will follow.

Okay. And then maybe just last question for me. How is the Cisco portfolio kind of responding to the desire for more SASE architectures? I think sometimes we have the networking investors and security investors but -- or and networking buyers and security buyers. But increasingly. Kind of how are you blending kind of what is the networking and security portfolio?

Yes, we're working very, very closely to integrate our secure networking product suite with Meraki and our security portfolio, spending a lot of time integrating. We are working on things like common policy, so we can share policy across these portfolios. We share data across these portfolios, and we are coming up with asset service models where our customers don't need to worry about what are the individual products, firewall, router, SD-WAN, and we can -- we get them consume that service. And behind the scenes, we take care of bringing these portfolios together. It's a big area of investment for us.

Okay. Okay. Perfect. Well, with that, Greg, this has been a super helpful session. Appreciate you being here.

Thank you.