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Cisco Systems, Inc. (NASDAQ:CSCO)

Company Conference Presentation

September 04, 2013, 12:00 PM ET

Executives

Kelly Ahuja - SVP and General Manager, Mobility

Analysts

Kim Watkins - Citigroup

Kim Watkins - Citigroup

Okay. Welcome everyone. I think we're going to get started. We're here for the Cisco Systems' session, so I wanted to introduce myself. My name is Kim Watkins. I'm on the communication, equipment and data networking team here at Citi. And to my left and I'm pleased to welcome Kelly Ahuja. He's a Senior Vice President and General Manager of Cisco's Mobility Business Group. Kelly has been at Cisco about 15 years and prior to his current position, he was the Chief Architect for the Service Provider business and he's very knowledgeable about the routing business, optical, mobility. And prior to that, he was the SVP and General Manager of the Service Provider Routing Group. So he's very well versed as I mentioned in routing as well.

The format of the discussion today is going to be Kelly is going to start it off with about five to 10 minutes of comments and then we're going to dig into Q&A and open it up to the audience as well. So, Kelly, welcome.

Kelly Ahuja

Great. Thank you and thank you for the opportunity for being here and speaking to the team. And it's great because I can talk and you can eat and hopefully you can keep eating and I can keep talking and you won't have too many questions for me, right? That's right. Good.

So first of all, the opportunity today is very great. I want to maybe talk a little bit about the Service Provider business that we have at Cisco and certainly we live in interesting times. If you take a look at the developments just from the weekend and what's been happening in the industry, a couple of key things point out which is one; while there is uncertainty in the macroeconomic environment, there's a lot of transitions and market dynamics that are accelerating in different parts of the world. And that's happening across the board whether it's in devices or in the operators or ecosystems.

But one thing is becoming clear and clear which is there is certain challenges in the operator's space that they want to focus on. And when we talk to the operators, we talk to them about three problems or they talk to us about three problems that they have. One is they want to be able to drive cost and capacity growth – capacity growth at a cost effective pace and they want to be able to scale their networks, scale the infrastructure but do it in a very cost effective way.

The second thing is that they want to be able to get all of their users and subscribers onto one network. Today, they've got multiple networks that each subscriber comes in on one network and then they go onto a different network whether it's a WiFi or a 3G or a fixed network, and they don't really have a single way of looking at that subscriber and offering them services or differentiated experience. So that's the second thing that's going on.

The third thing is the conversation over the last few years has shifted. If you recall a few years ago, the add-ons on television all used to be about can you hear me now? Right. Or is there an app for that or a map for that? So it was all about coverage. From coverage we move to the commercials about capacity which is how fast is my network? Or how much speed can I accommodate?

The next stage is really about services and that's where the third part of the conversation comes in from cost effective coverage and capacity to how do I get a single view of my subscriber to the third part which is how do I come up with new services, new capabilities and new ways of monetizing and optimizing that subscriber not necessarily from the subscriber themselves or perhaps from a B2B environment. So those are three areas that the operator is focused with us on.

Now many technologies smorgasbord that they talk about whether it's SDN, NFV, virtualization or other things but each one of those is really focused on solving some fundamental problems. And just a simplistic way that you should think about it is SDN is really about programmability and automation of the network, not just about data centers of the entire network. And NFV is really about virtualization which is really about separation of hardware and software whereas SDN is really about separation of control plane and management plane and data plane or folding plane. That's a distinct differentiation.

And both are required and very important for the operators, but fundamentally the thing you should be looking at is what problems do they solve for the customers? And they really help solve the problems across these three areas which is cost effective coverage and capacity, second part is really around the single view of the subscriber and the third part about how I move past, how do I create new services quickly using programmability and automation.

When we look at what we've been doing for the operators over the last few years, we've actually grown the SP portfolio dramatically. Within the company we're focused on a few growth areas; cloud, mobility, video, security, software and services are the key growth areas that we have. And as we look at some of the infrastructure components which tie into growth of capacity in the wireline and fixed context, we're investing in optical and IT and GM technologies with optical and routing across the core, the edge as well as in the backhaul areas.

In mobility we've doubled down, so to speak, in our investments and actually ramped up the investments, done a few acquisitions over the past 12 months and really focused on trying to change the definition of a mobile network from being radio-centric to being more intelligent-centric, and leveraging intelligence at each layer in the network, the radio layer, the wide area network layer, the core layer and also the services layer and stitch that together for the service provider so they can actually leverage that intelligence to be able to optimize the user's experience and then have the ability to be able to monetize that experience.

In security and video, you're seeing some of the moves we've made with video on MDS [ph] and growing that business and capturing in the market transitions. Security; you've seen us make a move as well with the announcement of the acquisition of Sourcefire. So as you look through that, one of the things that you should be aware of and become lucent of is the way we go about these approaches is really the focus on market transitions that affect our customers and look for areas that have technology inflection points or transitions occurring as part of those market transitions and that's where we insert.

So I'm sure you're going to have lots of questions for me in many of those areas. I'll pause my commentary around this are and maybe get into some Q&A.

Kim Watkins - Citigroup

Okay. That sounds great. Thank you for that. I probably would start just talking about the general demand environment. It does look like a good place to start. The Cisco's routing business is just about flat – we'll start with routing demand environment. The routing business is about flat so far in the first half of calendar '13. Juniper's done a little bit better but I'll get to that in a minute. One of the markets that's been a little bit slower for Cisco is in APAC and specifically two markets kind of stand out for me at least, China and Japan. China orders were down 6% year-over-year last quarter. How much of this is still critical fallout from the congressional report last year? We're sitting in front of two substantial build-outs, the 100 Gig and the TD-LTE build-out on the horizon. How do you expect outlook for routing in that market?

Kelly Ahuja

Okay. So first of all, you're right. Routing predominately was flat year-over-year and if you dissect that a little bit, we've actually done really well in the Edge. So the ASR 9000, for example, grew over 60% quarter-over-quarter. The area that we actually saw a little bit of a challenge in was the core, driven predominately by the regions that you mentioned, predominately Japan where we actually had a huge build last year around this time with some of the operators there, building out capacity. Now that capacity is build out. We're helping them fill that capacity up and continue that expansion.

In China, our business in China overall as a company is about 5% of our total business and we're continuing to work with the operators. Clearly some of the geopolitical situation has created an opportunity for some of our competitors, local competitors to take some share from us. But that said, even the economic environment in China is going through some change and we're working closely with government leaders as well as the operators to understand the requirements and make sure that we leverage our footprint because we do have good footprint there in China both in the IT network side, the backbones as well as in other areas. So working through that and looking to see how that happens.

But predominately as you look at the overall business, John talked about this in the last earnings call, where inconsistency in the pace of recovery across the different geographies is what's kind of creating some of the challenges and the conditions that we've seen.

Kim Watkins - Citigroup

Okay. Specifically though on Japan given the big build with the year-ago now, when – is it the next couple of quarters and you expect a pickup in that market or what are you seeing ahead?

Kelly Ahuja

We can't really put a timeline to it because it's a function of some of the inherent growth that they're going to see in traffic and how much capacity they've build out and how they kind of build to that or absorb it I guess is the best way to put it. And the new services that they might actually roll out. And also the footprint that they might put out inside the network, so certainly I think it's an ongoing dialogue. We've got the infrastructure in place. In many of the cases what happens is something like the core, for example, is what your question was. For something like a large router like a CRS-X or CRS-3, typically we'll sell them the infrastructure which is a fabric and some of the line card chassis but then they can continue to add line card chassis in that capacity with cards as that goes with the razor and blade model. That will continue over a period of time.

Kim Watkins - Citigroup

Okay. And then you alluded to this a minute ago, on the earnings call a few weeks ago, I think one of the surprises was that Cisco made an announcement to cut 4,000 employees, about 6% of headcount and I think Frank described this as a rebalancing. What exactly does that mean and why is Cisco cutting heads just as business appears to be starting to recover? I think book-to-bill was described as being comfortably about 1. How is this option also different from the headcount reduction in 2011?

Kelly Ahuja

Okay. So first of all, we feel pretty good about where we are and on all the things that we can control, right? What we are seeing though globally is that the pace of recovery is not as consistent as it could be or should be. And just so what that means is that behaviors and patterns that we're seeing in certain parts of the geographies, particularly in the emerging areas, are not as consistent. So that combined with the pace that we're starting to see and our commitment to our investors as well as our shareholders to be able to drive growth and earnings faster than growth requires us to kind of go back and say prioritize our portfolio.

In terms of portfolio, we've identified a few growth areas as I mentioned before; cloud, mobility, video, security and software and services and we're actually shifting and rebalancing investments into those areas. Just to give you my own example, within my business and mobility, the net investment is higher than it has been in the past few years. But that doesn't mean that I don't need to go and focus on driving some optimizations and efficiencies within my own team. I've got to go do that, but at the same time the net investment is up.

Kim Watkins - Citigroup

Okay.

Kelly Ahuja

So certainly from a rebalancing standpoint that's what Frank was pointing to.

Kim Watkins - Citigroup

Okay. So more specifically on the routing market, Cisco outperformed Juniper in 2012. I think Cisco was down just 1%, Juniper was down double digits. So far this year I just mentioned Cisco's revenue and routing has been about flat, Juniper's up double digits. What was happening? Can you help us understand what's occurring here competitively? Was it that Cisco was winning the head-to-head competition and now it's not, or is this more a reflection of the geographic differences in the two businesses?

Kelly Ahuja

It's interesting because if you look at the data, right, for example our Q4 earnings, ASR 9k group up 60% year-over-year. So in that sense, in Edge, I feel we're doing really well and we're continuing to take share and grow the business from others. But you've got to look at this more as a long-term historical thing because you're going to see some quarterly swings here and there anyways. Why? Because the operators' mind behaviors and patterns, where they invest, which part of the network they invest in and where they need capacity growth might shift from a quarterly basis. But you've got to look at the trajectory. And on a trajectory basis, longer term trajectory year-over-year and over the last couple of years, we're actually on a good path.

The other thing is, is that from an innovation standpoint we've continued to innovate whether it's ASR 9000 or also in the CRS portfolio. We just announced the CRS-X last quarter which has been very well received by the customers and they really like the approach that we've taken there which is providing them an evolution pack for their existing portfolio of products, leveraging some of the technologies. And if you haven't see it, I've got some show and tell with A6 and the optics module that you can come by and check out later which really allows us to kind of do some interesting things for the operators to be able to give them more capacity within the same footprint, leveraging the investment that they've already had in the line cards as well as the infrastructure that they've already developed. And that is playing out well.

Now clearly as we look ahead, the build-out of 100 Gig inside the networks is going to happen over the next little while and that's going to be where some of the trajectory from the SP investment and CapEx might go.

Kim Watkins - Citigroup

But specifically come back to the competitive environment relative to your business, Juniper's business and Alcatel Lucent recently announced a core router and has talked a lot about getting traction on products. What are you seeing in the competitive landscape and do you think that the weakness that Cisco's seen on a relative basis in the core routing side could actually indicate loss [ph]?

Kelly Ahuja

Well, I think the core routing trends that we've seen are a function of what we've seen in terms of Japan behavior and comps being pretty kind of out of norms, so to speak. But if I take a look at what we've been doing in terms of innovation on the core side, I feel pretty good about where we are. I feel that some of the things that we're doing compared to our competitors which is not just focusing on the silicon side of the house but also the optics where we're actually driving innovation and driving most cost reductions as well as efficiencies in terms of how many things you can pack into a line card or absolutely fundamental and help the operators kind of do that.

In terms of core and ALU and their insertions, I do think that the 7750 is a platform, has been out in the market for a long time and it's been deployed in many places particularly in Europe and other parts. So you would expect them to come in with a new platform and provide a migration path of their customers as well, and the 7950 allows them to do that. What we've got to do is continue to stay ahead of them on the innovation curve and we feel that the collating [ph] of layer 1 and layer 3 which is what we're driving with both the CRS-X as well as our existing portfolio allows us an opportunity to do that and do it very effectively. And some of the investments, fundamental technology investments we're making in coherent modulation schemes as well as optics modules and packaging allow us that differentiation and a long-term market textual differentiation that we can leverage.

Kim Watkins - Citigroup

Okay. Let's just talk specifically about your show and tell. I think that's just the FT module, CPAC. Why does Cisco decide to build that internally as opposed to buy from the merchant market what wasn't available in the merchant market?

Kelly Ahuja

Yes, it's a great question. So in fact if you look at historically and what's happened particularly in the optics space, most of the optics vendors that are out there want to invest in where the volume is the biggest, right? So if I was to go into an optics vendor today and we've done this before, when we went and talked to them about 40 Gig, most of the incumbent vendors weren't too keen on investing into the 40 Gig space. They wanted to continue to build 10 Gig and kind of capture that space.

The same thing happened in the 100 Gig space as well. But in the 100 Gig we said that it was going to take us a long time to get to where we needed to which is density and power levels that would allow us to put more interfaces on to a router or a particular line card on a router. So the first thing we drove was the development of the CST, which is this thing here, which is essentially a standard interface that we can get from other module suppliers to be able to plug in into any line card, which is great for us, great for the industry and we drove that. But it took us a long time to convenience the standard optics players to be able to go do this.

And we felt that we needed to kind of continue to speed up the innovation curve. So what we did is we said we need to kind of give them some incentives, so leveraging our own technologies as well as some acquisitions. We actually built a CPAC module which looks like this. Now it's about half the size, I'll show this for video, but it's about a quarter of the power, right? And that's very, very huge. Why? Because now I can take four, 10 of these and stuff them onto a line card as opposed to just two of these or three of these on a line card. And that provides me a huge advantage and at times a market advantage and also a first mover advantage in the marketplace.

Now it's not that – this is actually quite innovative and if anybody wants to see it, you're more than welcome to and it's quite cool as well from a technology standpoint, so I like it.

Kim Watkins - Citigroup

Now the CPAC though, how does that compare to the CF-T2? Is this the next generation of the CF-T2?

Kelly Ahuja

Yes, so it's interesting because when we announced the CPAC and we'll see this year, some of the competitors came up and talked about CF-T2, and we think that they're still in the very early stages of kind of that stage. We don't think that the power levels are quite where they need to be yet, at least from what we're seeing from the vendors and we think – we're already shipping this today, right? So we're well ahead of the marketplace today. As the merchant suppliers catch up, right, we'll be happy to kind of standardize these things. We always standardize.

If you look at BSR which is what we did 10 years ago on the OC-48 [indiscernible] OC-192, the same thing will happen here. But as that happens we're going to have to innovate. And the innovation in the next space in the optics is going to be what? 400 Gig or a terabit in one of these modules, so we're going to have to continue to do that. So having this asset inside allows us to be able to drive that innovation curve because we can take that innovation curve and get the volumes and advantage that we need to be able to help the operators drive that cost.

Kim Watkins - Citigroup

And now where has CPAC been? On optical products, is it on the routing portfolio yet?

Kelly Ahuja

Yes, it's been shipping on the optical products and it was announced as part of the CRS-X as well.

Kim Watkins - Citigroup

Okay. NFV, you mentioned that earlier, touched on it briefly. How does that change our influence, Cisco's roadmap and how do you expect carrier adoption to affect the growth in the routing markets typically?

Kelly Ahuja

So NFV is an interesting topic because it's really about virtualizing network functions. And in many cases what folks first think about is the virtualizing elements in the network. Well, it is, but the first element that it's virtualizing aren't necessarily big routers like CRS-X or an ASR 9k. What it's virtualizing is functions that fit inside the network for an operator to deliver the service. So if you take a look at the first places where the operators are talking to us about complexity, in my business if you think about the network, right, there is the cell towers. Those cell towers are connected to mobile backhaul devices which go into ASR 901 or an ASR 903 connects to an IP and PLS backbone which is really 9ks or CRSs or both, which goes into a packet core which is really ASR 5000 series.

Behind that ASR 5000 series which could be a PGW or a GDSN depending upon if it's 4G or 3G or a WiFi packet core, there is a slue [ph] of appliances that sit there before your connection goes out to the Internet, and it's really those are the functions – those appliances are hosting these functions that the operators are funding quite complex. Why? Because the way it works today is each one of the sessions that you have in your mobile device that you're all using today is tied to a service chain off of a packet core. And each one of the service chains has a bunch of appliances sitting on it. And these are – they are power hungry servers and they're not virtualized, so you can't really scale up the capacity or use elasticity across them.

So in my business, NFV is coming at it from that side. And that for us is a growth opportunity. Why? Because that's not a space that we're playing in today, but what's going to happen is it's going to create an inflection point in that space where existing suppliers that have been selling hardcoded firewalls or hardcoded – or even appliances that have functions on them, that's going to create a disruption. And we can go in and leverage our technologies and not just virtualize but orchestrate and change some of these things together.

So NFV is a great opportunity for us. In fact if you take a look at some of Cisco's portfolios, we have many virtualized offerings today already, everything from a cloud services router which is really the equivalent of an ASR 1000 which is virtualized and next is 1KB [ph] which is a virtualized switch. All the quantum portfolio which includes WAN, WAN orchestration, policy all virtualized, virtual firewall, many other things like that, virtual WAN optimization and all the plane infrastructures also virtualized today.

Kim Watkins - Citigroup

So when do you think will get to the point where NFV is mainstream, it's the primary architecture used by those products?

Kelly Ahuja

So what's interesting is if you talk to the operators, a lot of work going on to understand network function virtualization, right? And from a standardization standpoint everyone thinks that there is standardization going on. The work that SP is doing is really about pulling people together and working up whitepapers that are going to be used in some standard bodies to drive this. But if you talk to the operators, they're all interested in looking at different applications for NFV inside their environments. The challenge they're finding is, is that this is actually blurring the boundary between the network and the data center and the operations models.

So what's going to happen is there's going to be slow and some insertions in certain used cases where the most pain points are for the operators over the next little while. And it's going to take them a while because they have to move to a different operational model, because a traditional operation model was more about – well, I guess there's hardware, the silicon, the software and the platform of box from one vendor.

Now I've got to move to a model where I'm going to get servers from one vendor, virtual components from a different vendor, hypervisor from a different player, so I've got to think about who do I get that from but how do I operate that environment. And many of those conversations and discussions are going on inside the operators today. Good news is we're participating with those operators right now in some of the used cases and I feel we're well positioned.

Kim Watkins - Citigroup

So you're best guess in timing, are we five years away, three years away, 10 years away?

Kelly Ahuja

You're going to start to see some implementations in the next 12 months and it will scale out into other parts of the network over the next 24 to 36 months.

Kim Watkins - Citigroup

Okay. Let's change gears a little bit here and talk about the mobility business near and dear to your heart. Cisco's mobility business has pretty much been [indiscernible], it's been growing at a clip of – about 30% in the last seven quarters. How large is Service Provider of this total WiFi business, mobility business and how has this business been growing and how sustainable do you think that growth rate is?

Kelly Ahuja

So I think John talked about it in the earnings call in terms of triple digit growth in some of the SP WiFi offerings that we have. But when we talk about the broader wireless category, includes both our enterprise and SP offerings as well, predominately let's kind of shift to the SP side. We can talk about the different aspects of the portfolio in the network. On the WiFi area we're starting to see tremendous amount of deployments globally which first started predominately here in the U.S. with MSOs, wireline operators that were looking to offer WiFi as an extension of their fixed network to be able to reduce the churn rate for their customers. And that strategy has worked really well for them.

Now they've shifted from that strategy and approach of let me just reduce my churn rate, so how do I make more money off of this infrastructure that I've created. And what they're doing is coming up with interesting models, business models where they can go and sell the service not to the subscribers because most of you probably expect WiFi to be free, right, but selling it more to a B2B model, right, selling it on the B2B side. So for example, whether it's venues, stadiums or malls or train stations or casinos or other things and trying to tie some level of intelligence and data and contextual services that they can offer that provides information relevant to the B2B side.

So we're starting to see that shift occur. While that's happening here, we're starting to see the build-out of WiFi infrastructure in other parts of the world, somewhat in the MSO space but also some of the mobile operators and fixed folks are getting into the action as well. Now the rationale from the wireline or the fixed operators expending it to the WiFi space is pretty clear. The mobile operators are also starting to see value in this. And the reason why they're seeing value in it is because most of their mobile networks, actually all the mobile networks today, were built for us moving at 50 miles per hour; in my case 75, and talking on the phone.

But most of us, in fact many of you who are sitting at the desk today and doing a lot of emails or perhaps watching some videos, that's where data consumption is high when you're nomadic and you're indoor. And the cellular network providing coverage indoor doesn't necessarily work too well. So they're starting to see WiFi as an extension of their network and an asset to be able to provide that cost effective coverage and capacity, and we can go into a lot more details if you want but let me pause there to see if that helps.

Kim Watkins - Citigroup

Okay. How far along do you think we are in this deployment, the Service Provider deployment of WiFi? And you alluded to this a minute ago, but where do you expect the greatest growth to come in the next, let's say, 12 to 24 months on a geographic basis?

Kelly Ahuja

All right. So I think we're still at the early stages in the SP WiFi space. I think we're starting to see it happen in North America but other parts of the world still fairly early stage. And the second part of your question was where do I see…

Kim Watkins - Citigroup

The strongest opportunities to grow in the next 12 to 24 months geographic basis?

Kelly Ahuja

I do think that while many of our traditional competitors, WAN competitors, call it WAN vendors, are focused on small cells more from an outside standpoint or outdoor which is they're taking the macro towers and kind of going to smaller versions of that on the outdoor front, our approach and our strategy has been starting indoor for the reasons that I mentioned earlier. So I do see that that's well aligned with many of the operators I speak to and I see that starting predominately again in North America and Europe for indoor coverage and capacity.

And you have to look at maybe two or three things for that. One is spectrum issues that operators have. Second one is coverage issues, right? So wherever you have solid buildings and difficult permits and high rents, those are the places where you're not going to be able to erect many more outdoor towers and backhaul costs are high. So you're going to find those areas and that's where you're going to see more of the growth in the small cell on the indoor front.

Kim Watkins - Citigroup

Okay. Let's delve down into Cisco's portfolio a little bit. The company's made four acquisitions in the mobility space in the last year. Ubiquisys [indiscernible] Intucell, BroadHop, Cariden, what does these acquisitions bring to Cisco and do you need to make any other acquisitions at this point to round out your portfolio?

Kelly Ahuja

Okay. So first of all, let's understand what we've acquired in line, right? My vision has been pretty straightforward. I want to turn mobility from being a radio-centric network to an intelligence-centric network. What does that mean? We want to leverage intelligence that each layer in the network and be able to leverage that intelligence to be able to program the network and automate the network and make it easier for the operator to achieve the three things that we talked about, which is cost effective, coverage and capacity, single view of the subscriber and move at web speed.

So what does that mean? Well, when we looked at the network we came up with an architecture that said, how do we build that intelligence at every layer in the network? In the radio access space, we leveraged Intucell to do SON and 3G in the macro and that allows us to insert small cells and by the way, the Ubiquisys acquisition allows us to accelerate our small cells plans and get them integrated inside our WiFi access points as well as build some additional access points as well. Now Cariden allows us to do the same thing which is intelligence and then in the wide area space.

Now it's important to distinguish between what we do in terms of intelligence because most of the folks – most of the competitors will take intelligence and just report that out for you and operators will take these reports and look at them on a weekly basis, et cetera. Our approach is different. We want to be able to take that network intelligence, we want to be able to analyze it and then we want to be able to – based on a policy orchestrate the network back again with some programmability and automation.

Why do you want to do that? Well, in some – I'll give the example of SON in some cases. SON is the ability to be able to reprogram the network at a very fast pace. And we've had instances where within a span of two to three hours, we've had to reprogram the network thousands of times automatically based on changing conditions compared to what an operator would typically do which is a handful of changes within that time.

And that's really huge for the operator because they can actually use their people not for reprogramming and configuring but letting the network kind of program itself and heal itself, and allows them to build the capabilities that they need to. Just like that, SON at the radio layer; Cariden at the WAN layer; BroadHop at the policy layer, not just 3GPT or PCRF but WiFi policy, fixed policy as well as 3GPT policy and tying those together is where we're focused now. So all those acquisitions come in.

Now I feel pretty good that with all those acquisitions that we made, we have a very good portfolio of things that we need. I'd always like more toys, right? Let's not be unclear about that, but those toys are really a function of watching what the market transitions are that are affecting our customers, understanding how that kind of transitions into our overall architecture and then looking at where we can actually build it ourselves because there are many things that we're building inside that we haven't talked about, partnering in some areas that we may need and then also acquiring it if we need to.

Kim Watkins - Citigroup

Okay. I'm going to ask one more question and then I'm going to open it up to the audience for questions, so start thinking about any questions you might have. A question on small cells. I feel like we've been talking about small cells in the past for years. Technology though hasn't really deployed – been deployed in scale. What's different this time around and how do you expect adoption of the small cell technology to unfold?

Kelly Ahuja

Yes. So I think several factors are driving this now than before and we can break it up into two parts. One is WiFi and then the second part is licensed small cells. The first thing is, is on the license side, spectrum, there is not enough spectrum to go around. A few years ago, networks front is loaded, spectrum really was not an issue. There was lots of it going around. But if you look at some of the traffic trends and if you have not, please look at the Cisco VNI Forecast and that will show you that traffic trends are exhausting capacity that's out there from a radio standpoint. And for operators to keep up with the demand growth and one of the models that we did show that traffic growth between – for a particular geography or country was going to grow at 24x over a particular period of time.

Within that same period no matter what techniques an operator would be able to use which is go from 3G or kind of UMTS to LTE, get the spectral gains, efficiencies that you get with LTE, be able to deploy more towers, you would only get a 6x or 4x deployment. So there was a 6x gap that was there for the operator. And that could only be covered by a tremendous amount of investment required. So that's part of the reason why spectrum but also coverage areas which are the hot spots. And the hot spots like we said earlier are not on the freeways when you and I are driving at 50 or 75 miles per hour. They're indoor, they're nomadic areas, they're in stadiums and train stations, et cetera.

So for those reasons license small cells are becoming more interesting in that deployment factor. Second thing is the indoor part, why is the indoor part becoming more interesting? If you take a look at small cells that are designed for outdoor while you have a small cell that maybe kind of lower in CapEx in a macro station, you still have to worry about permits, rents, power, space and backhaul. Those are all cost elements that you have to factor in. But if I go indoor, I don't really have to worry about that too much. So that's the second part. The third thing about WiFi, why WiFi and convergence of small cells now? WiFi in the past and even now has really been kind of an expectation that it's free network.

In fact many of you are using WiFi right now. Just open up and see how many WiFi networks you have access to. They're pretty unmanaged. There could be from a carrier standpoint, they don't really have a way of – have not had a way of managing the users experience like they can with the cellular network. And what the technologies that have come up which is RF interference management, what we've been able to do with clean air and clean tech, allows the operators to be able to have a more managed experience even in WiFi, be able to integrate that from a WiFi and a 3G and a 4G in the core network, have a common view of that subscriber and a common policy that can be applied to that user. So the WiFi network is becoming more manageable and that is also what's helping operators to shift towards that.

Kim Watkins - Citigroup

Okay, that's interesting. Any questions in the audience and we got one right here in the front.

Question-and-Answer Session

Unidentified Analyst

You've done a great job competing against Juniper networking. Now we are faced with a lot more formidable opponent EMC VMware as the data center world move to SVN where they come with server utilization storage and very focused to take over the whole stack. What makes you think they can gain some – you can take your fair share or win that competition?

Kelly Ahuja

So SVN, the view of SVN is kind of interesting depending upon who you talk to. Most of our competitors look at SVN from a lens only in the data center. But I would argue that SVN – and SVN is really the network and it's not just the data center. It's the data center network, the wide area network, the local area network as well as the access network. So you have to look at SVN across the entire network.

So we feel that we have an advantage because we're looking at the overall network not just the data center network. But even if you take a look at the data center network, we have a very open architecture that is independent of any hypervisor or any application layer and we have a lot of capabilities where we can take anyone's assets in terms of applications, virtualize on top of our infrastructure and orchestrate them together.

What we're doing with the application-centric networking we feel we're taking the next stage in terms of development that's going to occur in that space and we're well aligned with many of our larger customers in that space as well. So a lot of more things are going to happen. There's going to be formidable competitors in each one of these areas, right, individually. But what we can do in terms of breadth of the overall architecture I don't think anyone else can touch us on that area.

Kim Watkins - Citigroup

Okay. Any other questions? In the back.

Unidentified Analyst

Hi. Can you talk a bit more about the growth opportunities that you see within network virtualization and also your cooperation with VMware?

Kelly Ahuja

Okay. I can certainly talk about the first. So network virtualization, right? As I was saying earlier in my space whenever virtualization is actually coming in is really where I don't play today. So I see it as an opportunity. What does that mean? So, for example, behind the packet core, the elements that the operators are looking to virtualize are video optimization, chains or perhaps firewalls or session border controllers or NATs or other things. In many of those cases these are appliances that they bought from my competitors, right?

So now I can go in and stitch that solution together for them on a dynamic basis as opposed to static things, buildings that I need to build, I can actually build them more dynamically as they need them and when they need them and virtualize those elements. As I do that, I can leverage the applications that they've already used but I also have an ability to insert my own functions, my own applications such as a firewall, such as other pieces that I can bring to the table. So I see that as a growth opportunity for us.

Kim Watkins - Citigroup

Any others? Go ahead.

Unidentified Analyst

Just from the VMware, you see that as a threat or as an opportunity because we're getting some mixed messages?

Kelly Ahuja

I think it's – not best qualified to answer that for you but I can tell you that our approach in terms of any of the applications we're building, virtual applications, because the customers are asking for this more than anything else, right? Customers are saying, hey, we want you to be open, like we want to be able to use a virtualization layer from one vendor or the other, so whether it's a KDM or VMware in terms of hypervisor or stack, we've got to work across all.

Kim Watkins - Citigroup

Thank you. Any other questions out there? Okay. I have one for you Kelly on small cells. In May Verizon announced that [indiscernible] Ericsson for small cells to supply LTE small cells. Is this at a disadvantage at all in the Service Provider mobility market because you don't have a macro cell solution, so how do you differentiate in this market against competitors?

Kelly Ahuja

Yes, it's a good question and in the sense that if you take a look at small cells, there's multiple definitions of small cells. In fact I covered two in my part today. One was SP WiFi which is really a small cell because a small cell is defined by a coverage area which is how much coverage you're getting, what the number of users is that you get on top of it. And there could be a WiFi instance, there could be a small radio instance which is called Femto for your home or a Peco [ph] for nanoPHY, or there could be an outdoor instantiation which could be something that sits out in the street. And typically what happens when you deploy a small cell is that you've got to insert it into either the existing spectrum that a carrier has or in a different carrier or different spectrum.

So let's talk about an example. Most of you are pretty technical, so if I'm going to deploy a small cell in the same carrier as my macro network is installed, yes, I need to worry about how I do that. And I need to make sure that that interference is going to be managed effectively. So their most traditional vendors, operators are kind of coming in and saying yup, I'm going to stick to my incumbent vendor in the markets that I'm in today and just use that. Why? Because there really is not much technology disruption going on in the macro space and that interference that happens in that layer fits in the same carrier is challenging and you've got to solve it.

The way we look to solve that was through SON, right, because SON allows us to be able to sit behind an ALU radio and an Ericsson radio, an NSM radio and whoever else and normalize that. So then we can insert small cells into it. However, our approach on small cells as I said before is not going after those outdoor ones because that has the association of I got to worry about permits, I got to worry about rents, I got to worry about power and backhaul. We're going indoor, right? So yes, we can deploy SON in those networks that are actually being deployed with either the same vendors and the same carrier. The other approach that operators are taking is they have a different carrier or frequency or spectrum that they're going to deploy their small cells in. In those areas, we're very well positioned.

Kim Watkins - Citigroup

Okay, great. Any other questions out there?

Unidentified Analyst

John Chambers on the conference call talked about macro being weak. Is that internally when you talk to troops [ph] is you sort of have to be more careful with spending this and that or is it full speed ahead and it's just something you want to be cautious?

Kelly Ahuja

So I think you heard, one, John talk about the inconsistency and the recovery that we're seeing and across the different markets. And his message is pretty consistent outside and inside. And he's talked about how we need to rebalance some of the investments because we're not seeing all of the geographies kick in at the same time, and that messaging is also very consistent both outside and inside to the employees. And clearly we're rebalancing the investment so he's talking about how we need to focus on the right growth areas; clouds, security, video, mobility and software and services as opposed to some of the other areas that we need to go invest in. So he's very consistent both externally about those messages as well as internally about those messages. Internally, we're getting our targets. Our new fiscal year has started. We've got our targets for this fiscal year and we've got a sure plan to how do we hit those targets.

Kim Watkins - Citigroup

Any other audience questions? Okay, just one more. [Indiscernible] describers Service Provider WiFi market as low margins, do you believe this is true? And how do you just get Service Provider WiFi margins comparing the enterprise WiFi margins?

Kelly Ahuja

Okay. So if you're only building access points, right, then yes, margins will be low because it's a commodity business. What you need to do with SP WiFi, is what we call it, is a very different architectural approach because the access point is only part of the equation. It's that endpoint which needs to be intelligent, it needs to have capabilities like clean air and clean tech which through our interference management or SON in WiFi to be able to do that stuff. But the bigger challenge and the opportunity is really how do you tie it to the core network and that's where you – actually that linkage is what helps you drive differentiation but also runs the business at our typical margins that we would.

So what we do in the core is really how do you take the mobility management across different WiFi access points, at a wireless LAN controller, how do you take the intelligence or the MSC or the analytics for that and be able to tie that into and integrate that into a 3G or 4G packet core network and use the common view and policy of that subscriber. Those are the elements. Unless you're going to do all those pieces, you are going to be in a commodity space and you're not probably going to benefit from that.

Kim Watkins - Citigroup

Okay, interesting. I think we have time for one more question. Anyone in the audience if not all. Okay, we've got a couple.

Unidentified Analyst

The U.S. is unique in heavy carrier spending within the networks. What's the catalyst for carriers in other parts of the world; Europe, South America, India, et cetera? Do they invest more aggressively in their networks and drive faster service provider spending and potential growth for Cisco?

Kelly Ahuja

So it depends. Maybe I'll talk about my business and relate that to you in the mobility space, right? So the catalyst typically is a market moving event. What that might mean is in some places there's competitors. Let's talk about France, for example, somebody asked the question earlier today about Free. Free was a fourth operator that the regulator actually provided a license to and they were able to enter the market at a very different pricing model or tariff for their service.

Now that created an opportunity but also created a catalyst in terms of other operators building out their strategy in terms of what they need to do from a customer standpoint but also from a network standpoint, but much of same way GDP growth, right? It could be regulatory environment, it could be competitive dynamics or it could be new services or new capabilities that the customer base is looking for.

One of the key things that's starting to happen is we're talking about Internet of everything along. We think that that's a big catalyst for driving productivity and growth not just for the service providers but for the entire industry. And we see that happening and being a catalyst for many years to come because it's going to create a tremendous amount of opportunities for all of us as we look ahead. So that's another catalyst to be able to look at.

Kim Watkins - Citigroup

Do I see another hand up? Do we have time to take that question? Not. Okay. Did you want to ask your question?

Unidentified Analyst

With the Vodafone purchase – Verizon purchased some wireless from Vodafone, is there any change in spending patterns expected from Vodafone and Verizon?

Kelly Ahuja

I've heard the same news you have on the articles, so it's too early to tell right now. I'm sure we'll absorb that information. And as they kind of settle in into what they do, we'll kind of align with them. The good news is that whether it's Vodafone or Verizon, we're very well positioned in both those customers in the mobile part of their network and also other parts of their network whether its data center or the backbones on the routing portfolio, et cetera.

Kim Watkins - Citigroup

Okay. Thank you everyone for coming and thank you very Kelly for being with us.

Kelly Ahuja

Thank you.

Kim Watkins - Citigroup

Okay.

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