Cisco Systems, Inc. (NASDAQ:CSCO) Credit Suisse 26th Annual Technology Conference Transcript November 29, 2022 1:40 PM ET
Executives
Kip Compton – Senior Vice President, Strategy and Business Development
Analysts
Sami Badri – Credit Suisse
Sami Badri
All right. Thank you, everyone, for joining us.
Kip Compton
Yeah.
Sami Badri
Kip, please go ahead.
Kip Compton
Yeah. That’s good.
Sami Badri
Yeah. Actually, I can say right here if you want well.
Kip Compton
That would be great.
Sami Badri
Yeah. All right. Thank you everyone for joining us. I am 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.
Kip Compton
Thanks.
Sami Badri
Yeah.
Kip Compton
Great to be here.
Question-and-Answer Session
Q – Sami Badri
Yeah. So one thing I want to open up 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 sub-segments. Could we talk about which of these drivers are most relevant to Cisco?
Kip Compton
Sure. So before I begin, I want to say that, I am going to make forward-looking statements and they are subject to the risks and our latest filings. So with that out of the way, there are a lot of tailwinds. We are 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.
The three that I would highlight perhaps are IoT, hybrid work and the web — the growth in the web scalers that we are seeing. So on the IoT side, you think of industrial IoT and some of the things, but we are actually seeing a growth in Smart Buildings and sensors and all kinds of things in the enterprise Power over Ethernet lighting, for instance is driving a lot of growth and certainly a catalyst for our campus business.
On hybrid work, the beginning of pandemic, a lot of people made very quick technology calls to make it all their employees could work from home. Now that the much more strategic approach and they are 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 are seeing new builds of AI and ML networks that are even more sort of network intensive and that’s contributing to our growth there.
Sami Badri
Got it. And then when you think about Cisco’s R&D investments, where would you say is kind of the biggest concentration?
Kip Compton
I will probably divide that into two 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 are going to continue to do that to differentiate and lead the market.
The other category I’d say is we are increasingly investing to deliver experiences and I think the success that we have 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 are increasingly investing in cloud management platforms that deliver simplicity and you will see us increasingly bring AI and ML into those platforms to make it even easier for people to run their networks.
Sami Badri
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 three years to five years, how would you expect market positioning to actually evolve?
Kip Compton
Yeah. This is — I mean, this one is 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 are 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 are seeing and why this complicates how we calculate and others track our market share. We have some products that are as short as three-week lead time right now. We have other products that are 40 weeks, 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 are 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 are 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 are able to deliver with that model is winning in the marketplace and is helping to make our wireless and campus switching market share is more resilient.
Sami Badri
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?
Kip Compton
Sure. No. And it’s great to have — frankly, we have quite a few products in different parts of our portfolio doing so well. The Catalyst 9000 in wireless, I will 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 have seen a lot of refreshes driven by WiFi 6. Recently we see 6C 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 6C 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 web scaler growth. And as I mentioned earlier, in addition to the normal incredible growth that we see out of the web scalers, we are 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 is 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 become super critical when you have people working from home, because they are calling the IT department and 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 Zero — 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 Zero Trust architecture and Duo is a leader there. So those are some of the drivers.
Sami Badri
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 are doing mainly to modernize or maybe even upgrade their networks. What would be that technology?
Kip Compton
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 the — just the acceleration of some trends that were already in place because of the pandemic.
So we are seeing people really seeing their network — their investment in their network is critical to their success. And even as they move very close to the cloud, you actually need a great network if you are going to get a great cloud experience.
So I think it’s — again, it’s probably a combination of the things I have 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 of 5G on the service provider side and also some interest in private 5G on the enterprise side are all catalysts.
Sami Badri
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.
Kip Compton
Yeah.
Sami Badri
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?
Kip Compton
Sure. So I mean we feel like we are on track. I think last quarter we said 43% of our revenue is recurring and that — I think that’s aligned with the rough time line we talked about at Investor Day, I think, it was last year.
A lot of people question like do — 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 are also, though, seeing success in what I will call hardware independent recurring revenue, software businesses, SaaS businesses. In fact, we already talked about a couple of them, Duo and ThousandEyes. Our Cloud Calling business is doing extremely well as a Cisco Contact Center.
So we are able — I believe we are able to drive a balanced strategy where we drive recurring software revenue attached to hardware like the play that we are still running with the Cisco 9000, as well as businesses that are SaaS properties that are have independent.
Sami Badri
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 have 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?
Kip Compton
It’s a great question. It’s — there’s not a setting, 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 are redesigning usually, there’s a product and we have one component that has a very long lead time that, and of course, we can’t ship the product, we will expect all of the components and so we will 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 are almost always talking about months. So I have not seen redesigns get done in a few weeks. I have not seen redesigns take an extended period of time either. We have 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. We have to ask them to pivot and do a redesign program that can impact our roadmap. But it’s — it became extremely clear to us that, perhaps, the feature our customers need it 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 a 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 are continuing to use targeted redesign efforts on our longest lead time of products where we can make a big difference.
Sami Badri
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?
Kip Compton
Yeah. We do — I mean, we do think that — we — in particular, from a market share perspective, we do degree — 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 will be designing at any particular moment in time. But those longer lead time products are exactly the candidates that we would be targeting.
Sami Badri
Got it. I wanted to kind of go back to a couple of references that were made on the fiscal 1Q 2013 call and it has a lot to do with energy efficiency. And I think I counted it multiple times.
Kip Compton
Yeah.
Sami Badri
I think I counted 3 times, right? And I guess like the big question when people talk about Cisco and the outlook on potentially like what happens in an economic downturn, what seems to be a comment made from at least the Cisco team is energy efficiency is a much bigger deal than we ever really…
Kip Compton
Yes.
Sami Badri
… 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 center’s energy efficiency coming up across your entire customer base versus maybe a select few that are sensitive?
Kip Compton
Sure. I mean, it’s — I think there’s really two things coming together here. One is the long-term sustainability targets that almost all of our customers have and they are 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 are 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 are paying on other things or that the project itself would incur.
On the other hand, we are 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 One and IoT.
As Chuck mentioned, there are those three technologies that Cisco could help our customers with their energy efficiency needs. And briefly, Silicon One, 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 over Ethernet side, it’s about just a more efficient energy transmission. So we have a lot of customers looking at using Power over Ethernet for their lighting in their office buildings, for instance, and they can actually save power, because the transition 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 three 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 are interested in this, we recently renovated our One 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 are talking about here.
I’d also note, in addition to these technologies, we are seeing some customers, particularly in Europe, starting to look at their equipment and considering an early refresh, because they will 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 would rather get to that lower energy cost than finish depreciating a less efficient piece of equipment.
Sami Badri
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 there ever really been as important as this time today or has there always kind of been a top criteria for customers and their solution set deployments?
Kip Compton
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 confluence — 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 two things are coming together in a different way right now than I have seen in the past.
Sami Badri
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?
Kip Compton
Sure. So Enterprise, it’s a lot of things I have 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 are really well positioned there with solutions.
On the service provider side, we are seeing solid demand, frankly, led by the web scalers, 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 are expecting to see things pick up, and perhaps, a tailwind from the investments in the Inflation Reduction Act.
Sami Badri
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?
Kip Compton
Oh! I don’t know how to quantify that. I mean, like, I said earlier, we are focused on growing recurring revenue software. And we will have a balanced strategy where it makes sense and there’s value to the customer to attach that to our hardware base, like, we have done with the Catalyst 9000, or frankly, like, is inherent in the Meraki business model. We are absolutely pursuing that.
And we are seeing some high-quality results there. Meraki, for instance, if a customer doesn’t renew their Meraki subscription, the hardware that they have bought becomes unusable. So that tends to drive a very, very high quality renewal rate on that business. So we are very pleased with the results there.
But then we are driving the growth and I think I mentioned Duo, ThousandEyes, Cloud Calling and Contact Center, as examples. We are 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 had numbers. But we are 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.
Sami Badri
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…
Kip Compton
Yeah.
Sami Badri
How would you characterize what keeps you up at night?
Kip Compton
Actually, I don’t see badly.
Sami Badri
Okay.
Kip Compton
But in terms of what’s top of mind. Lately, what I have been pondering is, given all of the change, it feels like a much more dynamic world. I mean the panic certainly herald in a new level of uncertainty, but now, obviously, geopolitically and in other ways, it feels like a much more dynamic environment than we have had in the past and I think that’s here to stay.
So thinking a lot about how we strike the balance as we are 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 going forward, because I think, we are 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.
Sami Badri
Got it. Got it. Well, I appreciate your time. We went through the question list and thank you very much for joining us today.
Kip Compton
Thank you.
Sami Badri
Absolutely. All right. Great. Thanks.
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