Cisco Systems, Inc.
Q3 2015 Earnings Call Transcript

Published: 2 Dec 2015

[James Faucette:]

I am James Faucette, the Senior Com Systems and Apps Analyst from North America for Morgan Stanley. I am very pleased to have Cisco here today. Representing Cisco we have from Investor Relations, Emily Hunt, who is on the front row. In case anybody needs to follow-up with her, we go too far out of line up here. And then, very pleased today though that we are talking to Phil Smith, the CEO of Cisco U.K. and Ireland. He has been in that role since 2008 and joined the company in 1994. And as I hear that he leads about 5,500 people reflecting on that and it’s actually a pretty big job. I mean, the only time I ever feel like I am talking to 5,500 people is, if I make a terrible call in, all of you remind of that. So fortunately doesn’t happen that offline somewhat. But anyway, so, Phil, I guess, we will just kick off and we want to make this interactive and so as in previous -- and in previous sessions, if anybody has any questions, please raise your hand, we will get you a mic and we can kind of address the topics that are top of mind for you. But I wanted to just start-off and just talk a little bit about the market generally for Cisco and where you are operating. This time last year, you and I talked, and U.S. dollar had just begin to strengthened considerably against the euro and the pound, and that’s really a trend that persisted strongly through the first half of 2015. At this time last year just reminding you some of the things that you’d said is that, the early part, at this time last year and through the early part of 2015, you and the rest of team talked about how Europe demand was actually remaining quite resilient? That being said is whether from you or from others, we have seen to have heard that that maybe have softened a little bit of late. Nevertheless, the Cisco reported number soon to be keep trundling along, if I am right, you are up about 3% in the region during the October quarter? So what is happening? Is there softness? Isn’t there softness? Is the U.S. dollar starting to have some strength, starting to have some impact and how are you thinking about what that impact could be ultimately?

[Phil Smith:]

Okay. And well, first of all, of course, I have to make my caveat of any statements I make obviously covered by any caveat within the lodged documents, so make sure you understand that. It’s, yeah, it’s obviously, good to talk about. I mean, we had a strong quarter. I mean, there was not a strong quarter from Cisco overall, good performance both in revenue, but also in gross margin performance, in operating profit and so on. So it was a good strong quarter and I think that reflected a balance across the world. And even, when I look at my business as a micro cause that abates my business are doing really well and rest are doing not so well kind of cyclically, I am not sure across the world as well. And I think the currency and those sorts of effects are one example of that, pounds relatively stronger at moment, although, of course, we still price in dollars here. There is a couple of places around the world where we price in local currency and those had an effect and that’s even had an effect maybe a point or two of growth in the company overall. And but I think this, even though, and the guidance for this quarter was slightly lower than some expected. I think there are some specific and it feel like macro reasons for that in this quarter as opposed to any systemic issue that looks like its on the broad side. I mean, in my business we are seeing definitely a very strong demand for cloud, we are seeing a very strong demand for our solutions, generally -- if my guys generally would reflect to me that it’s actually the constraint at the moment is my ability to invest in them or my ability to get them in front of the right opportunities, because the opportunities are all there or maybe the skills through the channel and those sorts of things. And I think that broadly reflects I hear from colleagues around the rest of EMEA and in the rest of the world as well. But there are clearly some difficult areas, Russia, some parts of emerging markets, okay, definitely not just want to come the perspective but just in general trading. And so I think actually the world feels like its still very focused on kind of broad areas we talk about around things like digitization and so on, which are all sound like times that we would just use inside the technology and I actually being read back to me all the time, I mean, I was talking to Rolls-Royce a few weeks ago their senior leaders and all they wanted to talk about how they can make themselves a more digital organization and they have got some challenges at the moment.

[James Faucette:]

Yeah.

[Phil Smith:]

So they really see that as an opportunity to optimize the way they do and it’s driven many, many customers, I think, that we talked at the moment. So it feels like the claim is very positive. I think we are executing well. I think there are other bumps you get periodically, but that’s kind of the way it feels.

[James Faucette:]

So from your perspective the push for digitization and as you mentioned and roughly so, that within your region directly maybe you haven’t had as much of the currency pressures as other regions have?

[Phil Smith:]

Yeah.

[James Faucette:]

But when you talk to kind of your co-leaders across those different regions? It sounds like you feel like, okay, in spite of maybe the strength of the U.S. dollar and how that’s making a product more expensive is that the impetus on organizations to digitize this is kind of overwhelming that?

[Phil Smith:]

Yeah. And I think there are also some good. I mean a lot of the opportunities we look at now, people are generally trying to see it cost. I mean, I guess, there’s always been a promise of IT.

[James Faucette:]

Yeah.

[Phil Smith:]

… which has opt to maybe improve its productivity, everything, we really hear in the U.K. again, issuing product and then I should leading a government group looking at the digital aspects of productivity, because its something issue for most companies not for the digital industry itself, but for all the other industries. And so I think that we have not seen massive pressure from my perspective on pricing for example because of currency fluctuations. We have not seen even as you have seen from the results not a huge pressure on margin as a result.

[James Faucette:]

Yeah.

[Phil Smith:]

So it feels to me like the balance we’re able to provide of improving productivity of driving advantage to people, maybe consolidating and those sorts of things, big cost savings, 100 data centers to four data centers saves a lot of money for people. And the committee maybe becomes not as significant within something like that.

[James Faucette:]

Got it. Goit it. So talking about digitalization in that move is that clearly a big topic and it seems to be, it’s been a big topic, I think here among U.S. companies but now seems to be spreading more to the European companies as well or those of cloud services like AWS and Azure from Microsoft. There is a perception that the European companies have been slow to move to adopt and adapt the cloud services for a variety of reasons but now it seems to be accelerating. What’s your perspective like how are the cloud services that were offered impacting your customers and the European customers generally?

[Phil Smith:]

It’s interesting because I think we in the U.K. again have probably been at the radius maybe long as often as the cases of U.S., U.K. and then maybe rest of Europe. And so we’ve seen a lot of growth in cloud. No, it’s not the direct AWS competition although fairly significant part of my business has been based on partners of ours creating infrastructure as service type, services and selling these to customers. Maybe with some of the parameters, they are now becoming more important like geographical boundaries, some issues are owned, the way that data is actually owned and managed by the customer as opposed to just kind of owe that. But a lot of the cloud business that I’m seeing apart from things like WebEx, Meraki and so on has been things like contact centers in collaboration and so on where people are saying, I kind of want to buy 10,000 agents of contact center but I don’t necessarily want to commit to a big infrastructure myself. I want to own the cloud. I have got people sitting, answering but I want to be able to burst up and down and so on. So we have seen a lot of that. But to your point more generally in Europe, I think there is a little less, probably a lag generally. In U.K., we’ve seen very strong cloud growth in my business over the last number of quarters up to the point where we’re probably some between 15% -- 15% to 20% of all my business to the end of Q4 last year was in cloud, so a big…

[James Faucette:]

Yeah.

[Phil Smith:]

It wasn’t quite as big as in another parts of Europe but I can see that now coming up and as customers becoming more comfortable with the idea that they will provide that kind of capability. However, the headwind to those of course has been the radius, challenges of privacy and security and so on which again are much more visible in other countries in --for me. So I don’t get. Obviously Germany, I’ve got some specific issues and so on and maybe very focusing on those issues. I’m not saying they are not important here where people are kind of so rationalizing that because we need to go on because it saves us money, make us more agile and so on. So I think it’s moving now. You are right in Europe, the only thing I would say is accounted to the kind of Amazon general deployment sort of model is that I think that we are seeing a lot more of our customers asking questions about well, how much cloud I’m actually doing and how am I paying for it and where it’s been accounted for? Does it hold in the security and so on? So we’ve got bunch of services, not all the others like there where people kind of audit how much clouds are you doing and you can absolutely guarantee, it’s usually somewhere between 5 and 10 times that they thought were doing because there is a little bit more people with 5, credit cards and things.

[James Faucette:]

Right. Right.

[Phil Smith:]

I know it’s been a issue from a risk management perspective but also as a cost management perspective. So that’s providing some good opportunities for us as well as we consolidate on to provide mechanisms which simplify.

[James Faucette:]

So if you look at the issues that you raise like privacy and where data is stored in some of the regulations or at least suggestions that have been put in place. How are your customers architecting your cloud solutions like I mean who they are working with and how they are putting those together?

[Phil Smith:]

Well, I think the -- I think that’s where are a lot of customers are going down in the path. Well, I think what’s happened is lot of them are saying yet we want to do cloud but also there is some kind of private cloud or a variation of private cloud. Private cloud hosted by someone but it’s actually still a private cloud. But all of them I think are really focused on possession and -- we are as well in terms of what we deliver of providing some vehicle for this hybrid cloud to happen so that people can have their own -- build their own capability, potentially get the some of optimization of it being owned by or managed by someone else but it’s their cloud but then they want mechanism for same. At some point, am I going to use some cloud services or am I going to expand that particular cloud in dollars. And I think that’s really where the game is. For all of us at the moment is how you can provide that kind of capability. And into that, of course, we’ve got cloud services, WebEx, Meraki and so on. But we want to actually provide into those customers sometime through our partners. But again in Europe and certainly in the U.K., we are predominantly doing this through partners. It’s predominantly their services that we’ve enabled than they are selling to our customers.

[James Faucette:]

So does the European cloud environment end up looking differently than the U.S. because I think in the U.S. there have been this idea that there will be a lot of private cloud or hybrid cloud. And what seems -- the opinion that seems to be taking root at least over the last few months or quarters is that a lot of people are just kind of throwing up their hands. And you know what, maybe we can just do public. And AWS is doing and Azure is doing a lot to improve security and address some of these issues. But you don’t have the fragmentation of regulation and data storage and that kind of thing in the U.S. that you do in Europe. So are there differences whether it will be regulatory or just preferences such that that we will see more private and hybrid cloud usage in Europe even in the long run that we’re doing in the U.S. or how do you think that plays out?

[Phil Smith:]

I think that’s likely. I think in general, we find that the case in Europe overall which is I mean, if you look at for example, things like Managed Services, they were always much more prevalent in Europe and again in U.K. even more so than they were in the U.S. where there was much more of kind of sell stuff that bring competitors to us when we were doing lots of Managed Service in U.K., it was kind of like SPC in those days but actually to be honest, that was just sort of resale gain.

[James Faucette:]

Okay.

[Phil Smith:]

So there was definitely always been a better difference and so I can see a bit more of that prevailing in Europe and that kind of AWS, kind of, scale of AWS. I agree with you. I mean some of it is obviously is in the U.S. and is the U.S. sort of season, all those things. So, I’m not saying that it would -- it's happening here but that is definitely a different level of caution. And I think people are feeling that the opportunity of the promises around and obviously, the things when they say harbor changes recently or challenges recently, which is certainly to avoid people into disarray and so what we are going to do that and that maybe just let people step back and maybe think that contain model is a certainly more attractive model here.

[James Faucette:]

Got it. Any questions from the audience because I know this is a big topic. So if we kind of try to capitalize on this topic, what is the role in the long run for Cisco? I mean you become, I guess a campuses and services company and enable kind of this other pieces as necessary, or are you kind of a D&A, or do you help manage and that managed services becomes a much bigger part of the business? So, I’m just wondering how you are thinking about what the business looks like as a result several years hence?

[Phil Smith:]

Well, I think we’ve got really good opportunity, I think to be in many places as I guess, we’ve traditionally been. So, I think we’ve got good opportunity to be providers in Intercloud environment if it’s often close which is at the moment. And in fact even in those kinds of HyperScale guys, we’ve definitely seen, I mean we’ve, in the last quarter we grew by 20% in our sales to them. And that is partly the evolution of the way they are working because I think in the early days, they said we just want some hardware and if you can give us that, Cisco will render some outcomes with fairly black and white. I think that dialog is moved on now, with our products, the way we build and the way we deliver them is a bit closer to what maybe is needed now. So that’s an opportunity, not just for those five but obviously all the others. Again, if I talk locally, we build a lot of cloud supply capability in the U.K. So that’s good for us as a business. We are probably selling to service providers. We’ve sold and are selling. And in some cases selling through them the services, sort of WebEx and Meraki and IronPort and other types of services we can sell through them as well. So, we are going to have those services and they are going to sell through. Then there is this sort of brokering of a slightly more sophisticated cloud environment in the way we have described in Intercloud and one another’s ability to sort of connect close together. And then obviously, there is still a requirement for people to have private close or mechanisms that they want to build themselves. So, I would hope that we are still going to play in those, in all of those places. But I also think what we’ve seen as a general trend in Cisco over the years is that, as we have provided capability to deliver function directly to the customer, we will be doing that alongside partners that will be a richer component of Cisco in there, so whether that be like a WebEx, just as a simple example or it could be an analytics servers. All those sorts of things that we can still provide often in corporation with partners directly to customers. So, I still believe there are rich set of things we can do there.

[James Faucette:]

Got it. Let’s move on to the Ericsson partnership you recently announced. What is your view of the opportunity created by that partnership? I mean, both companies talked about how the intention is to use the partnership to accelerate industry growth. As you talk about the opportunity, can you talk about the mechanism by which you think you can make that happen?

[Phil Smith:]

One of the obvious things from our perspective is that we sell obviously with a number of service providers directly and that’s okay. There has been good business for us over the years. But we’ve never really had a strong channel that allowed us to get to service providers and integrate sort of FI, whatever you want to call it who could take our products at a really sophisticated level and build them into service providers. It happens actually but it is not anywhere consistent. We have some partners who have some capability but most of them find services providers a little too hard work for some reason. But basically they find a little harder work. The Ericsson clearly is kind of centering that and currently of course using Juniper and other technologies. So, I think the opportunity for them simply to be a very sophisticated integrated service is pretty interesting. There is good upside for those. And of course that integration may not just be to the service provider but could be to the bigger enterprises who are building more sophisticated networks. So, I think -- but Ericsson is quite likely to enter some of that market and perhaps have some capability to do that and then obviously in the service provider market, so that is interesting. I think that are then lots of kind of cases if you will, where there could be good things you could do together, whether it would be improvements in mobile bank card, things around Small Cell or even some of the integration of mobile and fixed into the enterprise. So it’s got some short-term. I think real attractions and we are already talking to the local guys here and seeing what the opportunities are and could we do things, immediately couldn’t have either afforded to address but didn’t have the scales to address at the skew. And then there is some future things.

[James Faucette:]

In your mind how does the Cisco Ericsson partnership line up against the proposed Alcatel-Lucent, Nokia merger?

[Phil Smith:]

Well. Yeah. And hopefully very well on the basis that I don’t think it was done necessarily as an answer to that or anything because I think we’ve had -- this is a long-term requirement, we wanted this capability. But I think if that Nokia, Alcatel-Lucent thing, which obviously like all big mergers is quite difficult. It takes time cultural integration. I think the partnership model if you can get it right, makes you more agile in doing this. And I’m hoping that we can take a lot of opportunities before even really in the Nokia, Alcatel-Lucent actually really get going. So I think it soundly because he is able to compete very strongly within, but I hope it makes it even more agile.

[James Faucette:]

So when you look at, I mean, you’ve -- a moment ago you made the case pretty well for how the Ericsson partnership should improve the opportunity San Francisco within a service provider. What does it do for the Ericsson’s opportunity set within the enterprise from your perspective? Is there anything meaningful there or?

[Phil Smith:]

Yeah. I think so. I think they are probably not particularly well known in the enterprise other than their traditional voice PDX type or although, some time ago. And I think that the ability to do some of the integration that’s needed for the more sophisticated enterprise to build cloud, build other sorts of things, they’ve got fairly good services capability that will compliment what we have. And so I think if we can build some joint solutions together, particularly when things blend with kind of SDN and cloud more now then I think there is some opportunities for them that maybe they wouldn’t have had the enterprise reputation I think it do with us jointly.

[James Faucette:]

Got it. How we’re going to judge the success? I mean this is a very atypical partnership, right. And how are we going to judge the success of the partnership? And when should we expect to start to see progress in my personal achievements?

[Phil Smith:]

I actually think we’ll see some progress quite quickly and maybe more tactical in terms of customers we’ve got into that either wide space for both of us are opportunities for either of us. And I really expect over the -- I mean, I say, we are actively in discussion with them already, although, the local guys about where opportunities are. So I’d expect in this financial year for us will be -- whether there will be delivered in this time, I don’t know, it depends on the length of the opportunity. But I’d expect to see over the next year some quite substantive deals that we’re doing together where we’re present in the market together quite strongly.

[James Faucette:]

Good. Once again any questions. So as we -- I want to turn and talk for a few minutes about product? And I mean, clearly you are product company and I saw a lot of stuff?

[Phil Smith:]

Yeah.

[James Faucette:]

CEO, Chuck Robbins just talked, at least in my mind and to my hearing increasingly, enthusiastically about the opportunity within service provider, especially with some of the newer routers that Cisco is launching, et cetera. And Cisco has been a big supplier of service provider routers for a long time? But at least, topically seems to take a backseat in the lot of peoples minds and then early investors mind, to Alcatel-Lucent and Juniper? Does -- do you think the newer router products that you’re bringing to market change that and how do you think about when those should start to ramp and contribute to your business?

[Phil Smith:]

And well, he is interesting, we have, is clearly, historically, if you and I been on this conversation 10 years ago, it would have been completely [indiscernible] entirely what we see…

[James Faucette:]

Right. Right. Right.

[Phil Smith:]

… anything else, so its kind of a shame on us that that’s not the position, no. However, I do think is partly and we see this in a couple of different areas is, if you’ve got company like Juniper, who has got a pretty singular focus on high-end routing than when they talk to you that’s what they talk about. When we talk to you, as I’ve been talking to investors today and about -- it's about larger stuff, it’s everything from Wi-Fi to IOT to everything.

[James Faucette:]

Right.

[Phil Smith:]

And maybe some of our messaging is getting a bit diluted within that, because I actually think, we still have a very strong message. And I think to pack-up the points specifically on chunks enthusiasm about the next generation of growth is. I mean, those boxes have always had some cyclical benefit. You’re half way through your cycle and somebody comes out with the next box then for the next period, they’ve got leadership technically over you, even though you may have big implementations to sell effectively. But I think we didn’t in that stage know, and if you look although we had a bit disappointing performance in high end routing in the last quarter.

[James Faucette:]

Right.

[Phil Smith:]

And the bookings number that was reported was significantly up for the high end NCS and CRS, which are the big chunky boxes in the middle. So that encouraging me that we’ve got some things that are coming in within that cycle where we could see some significant wins of those in place. So I think maybe we need to be clear about the real advantage we have in those boxes, which are incredibly powerful, incredibly capable, industrial leading boxes and right, you should excited because I think whether it be from the kind of digitization we said of the cloud or anything, ultimately what is driving is a man for more and more and more capacity and capability in the sense of the network which is where these boxes exercise.

[James Faucette:]

So on Juniper, I mean they have gone through obviously a couple of management changes. There seems to be a lot of focus on defending that territory. Sounds like you just said that you feel like this is basically a game of leapfrog and they left last and you are about to leave. I mean, is that a fair assessment or is something dynamic -- more substantial changed in that market in that competition?

[Phil Smith:]

Yeah. I think those is in our case -- so there is always the leapfrog goes on. I think also there’s a little bit of us and probably in Chuck’s domain, although he has obviously only been on board really for a quarter or maybe a couple of quarters if we take him, we overlap with John. I think, Chuck’s been very focused on simplification, putting money where we really have got advantage and so on. So, I would expect to see not only the products in the right place but all the other aspects of owned investment and go-to market and so on, maybe positioning us stronger than that. I think also when you look at those big core products and they are all part of our kind of a bigger sale. It depends we actually selling to the service provider, is up and ability for them to deploy a massive cloud infrastructures or it is just have a one-on-one argument about those. We’ve always been there so that we can talk the bigger value picture and I think we probably need to spend more time in there.

[James Faucette:]

Got it. So, on a different part of the competitive landscapes that of switching and data center switching which is one of the fastest growth segments in the market overall. I know that some of your competitors have talked about, we’re open, Cisco’s not, and this is true. I mean this seems to be like doesn’t matter who is competing with Cisco that always seems to be the story. On the flip side of it, it seems like you guys have made a case that you’re trying, maybe you’re trying to be more open or maybe you always have been but I mean what is from your perspective -- what is the difference in the openness between you and competitors? And more importantly, what is their customer response to the messaging?

[Phil Smith:]

Yeah. It’s interesting. Because I think as you arrive, it kind of easy to drive at Cisco over the years in many areas but particularly, right now, I think in that kind of world of SDN program of the infrastructures, what we call ACI. All of that is entirely built on open, isn’t entirely open as open source, part of that and they are certainly open protocols and open standards. So, I would argue that with the most open of all of those implementations. But I think -- I again, a little bit of the messaging as seen before. If you are talking to someone who just talks about that area, they talked about that and we are the guys to hitting that case and that’s fine. But I think maybe our messaging isn’t as clear, because I think genuinely, we happily stand up and defend the openness of everything we do that are abundant to phases that burn into -- burn stream into phases, the way that we actually provide us and even the work we do all this time. We are leading most of these standard bodies in this area to try and standardize things. It’s an open and the history of that always been. I have been in the network for a long time. If you look at things at MPLS, which is like defect your backbone. It came, I agree, I think all the tax switching, which initially we implemented because that wasn’t a standard but we implemented it. We rightly stands as body as soon as MPLS was out, we implemented MPLS everywhere. So you can go attack. That was obviously nothing else and a bit light certainly in this environment. So, if you do things wherever you typically implemented the phones were the same. There is some standards. You then got some proprietary. You then go to standards you implement the standards and that said. And now you think that is definitely true. So, I think people who say we’re now open, are being happy to stand up and defend anywhere where people say we are open in that area. I think we are more open in that area.

[James Faucette:]

What’s the customer response to that?

[Phil Smith:]

Yes. So the customer responses to that in general has been very pivotal because I think most customers like they would do in most aspects of networking nowadays want to be open, because they do want an opportunity to integrate with other things. And I think we would struggle to even respond to other piece. Sometimes if we run open as we are. And I think the response has been very strong. As you’ve seen now, our business and that kind of competitive business do to our biggest competitors in that kind of switching space has being growing at double the speed they are, which suggest that customers are listening to us.

[James Faucette:]

Got it. Last one and I think we’ve been spend a lot of time on that. We have just about a minute left. I think, I just want to ask you a quick question on that business come up with different investors is that we have had Chuck Robbins come in as a CEO, John Chambers remain as a Chairman. He still seems to be quite active. He was here in Europe with the announcement with Ericsson and he spent some meeting with Hans from Ericsson, et cetera. So, what is the role of John today on kind of division of labor?

[Phil Smith:]

Yeah. I mean, clearly, it’s only being really a quarter.

[James Faucette:]

Right.

[Phil Smith:]

So, I think we have to recognize. He knows sales meeting at the end of year. John was still around. But I did feel like his so and so in front of the sales force. So, John -- and he has been in the business for 20 years. He has been the CEO for 20 years. So he doesn’t lie down in values. He never is going to. And I think he is going to -- while we said, one is the level of consistency and assurance that there is someone there who understands the dynamics of what we’ve done over the last 20 years. But also I think, John as Executive Chairman, he has got lot of opportunities. I think we will see him here in U.K. and other places because he is very committed to serve the country, digitization and those sorts of areas. So, I think there will be a little bit of transition. But Chuck is very clearly -- John said it and certainly you see him in internal analyst kind of meetings. Chuck is the man I suppose and he is making the decisions. And Chuck changed most of the management team, fill his own, his own royalty, he is very visible to us. We really don’t see John as much now internally and I think that sort of equation we’ve got. But as an Executive Chairman and as any Executive or any Chairman or for that matter, often big relationships can still be only about that person and other within that role whether it would be Bill Gates or whatever, you still saw them in some of those big relationships and that’s probably a valid thing to do while Chuck runs the business everyday today.

[James Faucette:]

That’s great. That’s all the time we have, Phil. Thank you so much for your time.

[Phil Smith:]

Thank you so much.

[James Faucette:]

Great conversation. Have a good day.

[Phil Smith:]

Thank you.