UBS Group AG (UBSG) Earnings Call Transcript

Good morning, everyone, and thank you for waiting patiently. We're here at UBS today to host Cisco and have an ESG discussion about their future priorities and their viewpoints regarding this incredibly topical investment consideration right now in the marketplace. My name is David Vogt, and I'm the UBS networking analyst here. I'm joined by my colleagues, Julie Hudson, our Global Head of ESG Research; and Shneur Gershuni, Head of ESG Research in the Americas. I know I speak for my colleagues when I say we're excited to have with us today from Cisco, Mary de Wysocki, VP of Corporate Social Responsibility and Sustainability. Mary has over 15 years of experience, helping lead various ESG initiatives at Cisco, and she'll provide a great overview of Cisco's initiatives in this arena. However, before we get started, I'm required to make certain disclosures. As a research analyst, I'm required to provide certain disclosures relating to the nature of my own relationship and that of UBS with any company on which I or anyone expresses a view on this call today. These disclosures are available at www.ubs.com/disclosures. Or alternatively, please reach out to me, and I can provide them to you after the call. Lastly, to set the agenda, I'm going to turn it over to Emily Hunt from Cisco to cover some housekeeping issues on their end. Mary then will provide an overview of Cisco's ESG efforts, followed by a fireside chat with the UBS team. Please submit any questions you may have to me by e-mail at david.vogt@ubs.com, and we will do our best to incorporate as many questions as possible in the time allotted today. So at this time, I would like to turn it over to Emily Hunt from Cisco to cover the forward-looking statements. Emily?

Thanks, David. Please note, we will be making forward-looking statements, which are subject to the risks and uncertainties, which are outlined in our SEC filings, which can be found on Cisco's Investor Relations website at investor.cisco.com. Actual results or outcomes may differ from those forward-looking statements. No new material information will be discussed during this webinar. With that, I'd like to hand it over to Mary.

Thank you, Emily. I know the situation in Ukraine is weighing on everyone's mind, so I just want to acknowledge it before we get started. Cisco formally and unequivocally condemn the unjustified war being waged by Russia and the violence that has been unleashed upon innocent civilians. We are doing all we can on multiple levels to support those affected in accordance with our values. You can read about these actions on our corporate website, and they are a reflection of what we say when it comes to ESG topics. And that is really what I want to discuss with you today. Coming to that topic, I wanted to share a quick overview of how we look at ESG topics in the context of our purpose, which is to power an inclusive future for all. What you see here is where we focus. When Cisco talks about power, we're referring to the potential of our technology to transform lives. Digital technologies can change the way the world is in so many different and very positive ways, but they also introduce risks, including breaches of sensitive data and mistreatment of workers who assemble hardware products. We include safeguards to ensure data privacy and security. And we engage with our suppliers to promote safe and healthy working conditions in alignment with globally recognized human rights principles. And because we want everyone to enjoy the benefits of digitization, we work closely with customers and government partners to expand internet access worldwide. Inclusive means that we want to act boldly and deliberately to accelerate fairness, inclusion and equitable access to opportunities, both inside and outside Cisco. For employees, this means respecting one another's identities in the various roles we play inside and outside of work, empowering people to chart their own career journeys and caring about employee well-being. For our communities, this means helping underserved and vulnerable people to thrive by providing early-stage grants to nonprofits, meeting critical human needs through our crisis response program, and giving people the skills and resources to succeed in our digital economy through Networking Academy, our program, which is license-free to learning institutions worldwide. And finally, future. It's how we protect the Earth's resources and ensuring a livable planet not just today, but for generations to come. This includes everything from our efforts to reduce our greenhouse gas emissions to net zero by 2040, to how we're adapting business models to reduce the resources we consume and the waste we generate through our circular economy model. We report our progress, accomplishments and challenges in all these areas in our annual purpose report and our ESG reporting hub. These resources are accessible to the public at cisco.com/go/esg-hub. I encourage you all to explore that site. I'd like to just take a few moments to share a number of highlights from our most recent purpose report published last December for fiscal year 2021. I note that we reached 2 major environmental goals in FY '21 1 year ahead of schedule. We achieved 60% reduction in Scope 1 and 2 in our greenhouse gas emissions compared to our fiscal year 2007 baseline. To achieve this goal, we invested $45 million between fiscal year '18 and fiscal '22 to implement hundreds of energy efficiency and renewable energy projects. Also, in FY '21, we reached our goal of having 85% of our global electricity coming from renewable sources. Investment in renewable energy over the past 15 years has really helped us drive down our Scope 1 and 2 emissions. Continuing our investment in both these areas will help us reach our goal of net zero emissions across global Scope 1, 2 and 3 by 2040. I'd also note that in FY '21, we reached 3 million Networking Academy students. That means we've reached 15 million students since the inception. Networking Academy teaches IT skills like networking, cybersecurity, IoT and programming. We offer the curriculum and learning tools free of charge to learning institutions worldwide. We achieved this highest number of annual participants in the Network Academy in the history of the program. We also introduced Skills For All, a free mobile-first platform for learning technology skills. 2.9 million students who have completed our [ third rated ] courses since 2005 say Networking Academy has helped them obtain a job. Finally, I'll just note on the upper right, you see our progress towards our goal, which we set in 2016 to positively impact 1 billion people by 2025 through our social impact grants and signature programs. We have positively impacted 716 million people between FY '16 and FY '21, and have received external limited assurance of this number. It's just one example of the rigor and transparency we bring to reporting our progress on ES&G topics. Let me hand it back to the UBS team.

Great. Thanks, Mary. That's been an incredibly helpful overview. Before we jump into the specifics, given that we have a cross-section of investors on this call, we thought it would make sense to start, maybe, at a high level.

How does driving sort of the ESG agenda that you just laid out get captured in Cisco's long-term view around returns? I.e., is it factored into investment decisions quantitatively? Or is it just qualitatively factored into sort of the road map put forth by the management team and the Board of Directors?

Thank you for that question. We know in order to mitigate the very worst impact of climate change, the global community -- the global business community, in fact, must step up in a very big way. Our customers are expecting us to do that as well. We see a dramatic increase in the number of RFPs that include at least one or more topics on ESG. The tech community has a particularly important role to play. Research shows us that the tech industry is responsible for, let's say, between 2% and 4% of greenhouse gas emissions. But if you look at certain reports, for example, one out of the UN, existing ICT solutions offer the potential to suppress 15% of current emissions. I think this means the tech industry has a really unique opportunity to contribute to society's transition to both the digital and a greenroom of living and working, and making that world inclusive as well. Therefore, when we think about our business strategy and our technology road map, sustainability, inclusion is deeply embedded. I already mentioned our commitment to reach net zero by 2040. Another example is how we're adapting our business model to really reduce the resources we consume and the waste we generate. So this really focuses in on how we design and manage our products through multiple life cycles. How do we design that in from the beginning? Enabling us to think about how our products will be reused, remanufactured, repaired, as well as upgraded. So one of the things we've done is committing to a goal where 100% of new Cisco products and packaging will incorporate circular design principles by FY '25. I think one really good example that I might bring up is our updated IR 1101 industrial router. It really allows for modular upgrades and repairs, which extends the life of the product. So modularity eliminates the need for the customer to refresh the infrastructure every few years. Instead, they can add or upgrade components as their needs and technology evolves. On top of that, this updated product really looks at how we think about the need of the customer as they think about refreshing their technology. So it's not just modular, but we also look at incorporating in idle power. Can we manage the power. So the router's, idle power, you can actually design it in where we can reduce 45% by managing the power, reducing carbon emissions and eliminating foam from its packaging. I think a great example of how we worked with a customer is with Ash Ray. It's a world-leading building standards organization. What's interesting is 20% or more of energy-related greenhouse gas emissions comes from buildings. So when we really think about innovation, technology road maps, that's one area that we're really focused in on. So Ash Ray, they wanted to move their new corporate headquarters, so they partnered with Cisco and NTT to retrofit the 43-year-old building into something that's far more secure, innovative and sustainable. So by using PoE or Power over Ethernet, creating a foundation powered by Cisco, they can now have all their systems managed over the network through an integrated building management system. So between heating and cooling optimization, on-site solar and other energy management solutions, the building consumes less power than it generates. It's these kinds of forward-looking solutions that we're building into our strategy as well as our technology road map. And speaking of power, power efficiency and capacity and capability have really become a key buying decision. And our Silicon One chipset to go quantum leap forward in both. Now, you can find Silicon One in several of our products, including the Catalyst 9000, which is the Cisco 8201 router, which drives internet data transfer across web scale and service provider networks. And what's really important is when you compare previous routers without Silicon One, the 8201 now uses 96% less energy and delivering 35% more bandwidth and uses 48% less space. So we're really looking at all of those dimensions as we think about our product and business strategy.

So Mary, that's a great place to leap off from. So you mentioned product improvement. You mentioned customer demands driving your thought process and strategic view of how we're going to go to market. But what we didn't touch on, which I think most people on this call want to hear from you today is supply chain. Unfortunately, everyone on this call is acutely aware of sort of the disruptions globally in the supply chain. It's been persistent for a couple of years, hasn't gotten much better. But maybe, can you touch on how ESG sort of factors into how you're thinking about supply chain going forward, not just operationally, but obviously from the ESG angle? And then ultimately, I think it's a key component on one of your pillars. How would you characterize the supply chain, given where we are today as -- how would you maybe stack rank it in terms of the importance right now, in terms of where Cisco's energy and sort of intellectual capital is being allocated at this point?

Thank you. From my perspective, it seems like the past 2 years have shown how much Cisco has really leaned into the [indiscernible]. For decades, Cisco has been working with our suppliers to promote both a safe and positive working conditions across our supply chain. But the pandemic, for the last 2 years, has really shown the importance of that particular issue and the [ fortability ] that has been designed in. One of the things I would just touch upon specifically around the last several quarters, we've really been able to manage through the supply constraints, and it's been seen industry-wide due to component shortages, which have resulted in extended lead times and higher cost for many of these components. But it's really that strong demand has continued to outpace our supply, which does expand our backlog of product software and services. And although the constraints remain challenging, we continue to partner really closely with our key suppliers to leverage our volume purchasing extend supplier commitments as we address the supply challenges and cost impact, which we expect will continue into the second half of our fiscal year 2022. But let me touch a little bit upon, really, how we think about our supply chain. And one of the things that we really focus in on is how we have developed and how we manage through our supplier code of conduct. And really, it creates the foundation for how we engage our suppliers. This code sets standards for working conditions, environmental protection and ethical practices. We assess our suppliers' conformance through on-site audits and other assessment programs. And if a supplier isn't meeting our standards, we work with them. We work with them to make sure the problems are fixed and that the impact to workers are addressed. This is a really important part of our ESG strategy. We have targeted programs to improve worker management communication. So the voices of the workers are heard. Because we already have this process in place, we've been able to really be flexible and adapt quickly to all these dramatic changes, engaging our supply based on responsible business conduct, while operating during the pandemic, as well as adapting to any disruption that has resulted. As you think about supply chain sustainability programs, really to be successful, it has to be factored into how we source and make procurement decisions. And so developing supplier scorecards really help us to measure suppliers' conformance to our social and environmental standard alongside critical KPIs from the business like cost and quality. And this is also one way that we really incentivize strong sustainability performance across our programs, whether that be responsible mineral sourcing, conformance to our code of conduct, hitting our net zero carbon and zero waste targets, pollution prevention as well as water stewardship. We've been training our teams on human rights risk in the supply chain and what steps they can take to not only identify, but address issues. In fiscal year '21, for example, we maintained a 98% completion rate of this training amongst supply chain operators and employees. I think the industry and others have really recognized our commitment to a resilient and responsible supply chain. Because in the last 2 years, 2020 and 2021, we've really been privileged to be #1 on the Gartner Supply Chain Top 25 report, which recognizes I think, the strong revenue growth, [ notched ] with the strength in ESG initiatives and our agility in the times of disruption.

So Mary, maybe, if I just quickly follow up on that point. So obviously, it sounds like you work very closely with your suppliers in terms of evaluating their performance and their adherence to sort of the standards that you've set. And granted the supply chain challenges right now are somewhat unique, hopefully, going forward. But what if some of your suppliers have difficulty or persist in difficulty in achieving sort of the milestones that you set forth? What's the fallback? So what's the option or what's the alternative? How should we think about that going forward? I think heading into this in the last 2 years, many of the investors that I've talked to never would have considered supply chain to be a gating factor for the business, more importantly, a consideration from an ESG perspective near term, at least. So I just would love to get your thoughts.

Yes. Thank you. I think the pandemic really -- it just has reinforced all the focus and programs that we had in place. And it really showed how critical it is to continue to engage our suppliers on improving working conditions and worker safety. So over the past years, we've really worked to create that flexibility and adaptation. And I think one of the ways is how we monitor the development of response plans, whether that be to minimize workers' exposure to the virus, for example. So because it's top of mind, we've offered a number of programs to our suppliers to improve that worker management communication. For example, in the most recent fiscal year, we help sponsor 4 suppliers to participate in a program, a partnership with the social accountability International [ Tensar ] program. This is a workplace engagement program, which really seeks to unite workers and managers to identify workplace challenges that they can collaborate on to solve over the course of 100 working days. So through this program, participants, they really learn strategies for problem solving, communication and leadership that they can apply to future challenges, both the current and future. Another topic that is really critical is how do you reduce forced labor and you protect the most vulnerable of our workers. And we know certain populations of workers are more vulnerable to exploitation such as migrants from other countries or student workers. So we assess these risks to these vulnerable workers and its supply chain. And if an issue is uncovered, we are sure that the workers are made whole. So for example, migrant workers sometimes have to pay these recruitment fees in order to get a job in another country. And then they must pay it back, those fees over time, which is really considered a risk of debt bondage or a form of forced labor. These fees can be 150% or more of their monthly salary. So in FY '21, we oversaw the reimbursement of $200,000 to more than 4,000 workers in our supply chain who had been impacted by a health check or recruitment fees. How is this done? It really is a part of our supplier code of conduct, and that covers labor, health, safety, environment, ethics and management systems. And we get -- we monitor the adherence. And so when we do this evaluation on an annual basis, whether it's a social or environmental risk factor, we then take a look at how do we work with those partners. We've adopted the Responsible Business Alliance, the standards of accountability and many of their assessment tools. So for example, RBA has a self-assessment questionnaire, which help suppliers understand and create insights on their own performance. And it also helps us at Cisco develop leading indicators for risk that can be addressed during our audits, or other due diligence initiatives. So we do conduct announced on-site third-party audits of prioritized suppliers to assess their conformance to the code. We require regular audits of manufacturing partners every 2 years. And every year, we audit at least 25% of component supplier facilities that are deemed high risk according to our annual risk assessment process. These audits cover more than 200,000 workers in our supply chain each year. Now, if a supplier doesn't meet those standards, we hold them accountable. But we work with them to ensure these issues are adequately addressed and closed. We really want to understand where they are. Not just corrective actions, but really, understand the issues, how do we improve understanding and performance over time. Now, we have published the aggregated findings of our audits each year in Cisco's ES&G reporting hub. There you can find analysis of our top findings, various case studies, information on how we train suppliers to promote that healthy and environmentally responsible workplace. As I mentioned earlier, this supplier scorecard, that helps inform us of what are the decisions and the path forward to work with our suppliers. Audit performance and closing nonconformance in a timely manner are proven measures that really factor into those scores.

Great. No. Thanks for that clarity. And I think I don't want to belabor the point and go through all of the nonconformance data that you provided on your -- on the hub. So maybe, I'll just stop there and just pivot over to my colleague, Shneur. He has some questions, and I'll just turn it over to him.

Great. Thank you, David, and thank you, Mary, for being here today. Really enjoyed the presentation. Maybe, just a few questions from my end. Just first off, on the governance side. In my catch-ups with David, he's talked about how he's starting to receive questions from investors across the technology landscape we're seeing in other sectors as well, too, about the splitting of the Chairman and CEO role as being considered a best practice. I understand when Chuck Robbins was appointed Executive Chairman in 2017 following John Chambers' departure, the role has kind of combined at this point right now. But you have some industry peers like Juniper and [indiscernible] have split the roles. What are your thoughts about it? Where do you see Cisco going with that on a go-forward basis? Is it something that's under discussion?

Yes. Thank you. Cisco is, I'd say, large and more complex than many of our competitors. And our Board of Director, we believe that the Board Chair and CEO role, together, with the role of the lead independent director and Cisco's other strong corporate governance policies and practices, it really provides an appropriate balance of leadership. The lead independent director really helps to ensure a strong, independent and active Board of Directors, providing overall meetings when the Chairman is not present and serves as a principal liaison between the independent directors and the Chairman and CEO. Our lead independent director is elected by and from the independent Board members, and we do conduct an annual review of this role.

Great. I appreciate that. Thank you. Maybe, just to pivot to another one of the pillars in the ESG framework, specifically about the future. Kind of wanted to narrow down a bit the scope, specifically to the climate change and energy efficiency side. In 2020, 99% of your GHG emissions resulted from Cisco products and supply chain. I was just wondering if we can sort of talk about the product energy efficiency. You sort of gave an example about building in your prepared remarks. Wondering, first of all, if you have any breakthroughs or innovations on pooling our high-efficiency conversion technologies? What's being done to reduce [ friction between ] Cisco products, but other systems as well, too. I believe, there was an example in your purpose report as well, too, about working with utility in Italy [indiscernible] about potentially managing their system. And so I was just wondering, one, if we can talk about potential innovations? And then number two, is that a potential revenue stream that you're marking upon today that could manage itself into something more material on a go-forward basis?

Yes. Thank you. That is a really great question. Use of sold products accounts for the largest share of our greenhouse gas emissions. So increasing our product energy efficiency is going to be a critical element to reaching our goal to be net zero across all scopes by 2040. Power efficiency and capacity, it has been a key factor in our customers' buying decisions, always. And as I mentioned, right, the Silicon One chip set, that took a quantum leap forward in both. So when we think about reaching net zero, it will require that product energy efficiency. It will also require adoption of more low-carbon energy throughout both public and private sector. One of the other things, as you mentioned, is we're going to require innovation. Innovation in our product, innovation, the continued innovation in our chipset, innovation in areas such as cooling, you mentioned that. In last fiscal year, we released the M6 generation of our Unified Computing System, UCS and the [indiscernible] data center server products with new technology enhancements, including a new zone-based cooling feature. So zone-based cooling allows the chassis to provide targeted outflow, while leaving other zones at lower fan speeds, which reduces system energy consumption. This technology improvement, along with the use of 80-plus titanium rated power supplies, can reduce the energy consumption of a fully loaded chassis by 11% over the previous design. So innovation across the board role is a high [indiscernible] traditional capabilities that we are [indiscernible] on, whether that is performance, security. But now, sustainability and [indiscernible] as well. But you also brought up business models. I think that, that's an area that we have and we'll continue to lead on as we think about not only how we operate Cisco, but how our customers and partners do as well. As I mentioned, sustainability is probably the #1 topic, ES&G topic that we see in our off-piece, so we know our customers care about it and want us to provide more solutions. It is that kind of thinking that you saw with Silicon One. How do we dramatically reduce energy consumption at the same time, meeting and maximizing the bandwidth, because that is also a strong customer demand. But even with energy and thinking about the criticality of that, it also means that we need to design, in circularity. Think about those multiple life cycles of the product, and think about modularity. How can we also help our customers understand that there may be new ways of working. What is the impact of hybrid working that we've all come accustomed to over the last 2 years. How do we enhance employee and worker well-being, maximizing often productivity, but also, responsibly managing our environmental footprint, whether that is in the home or the workplace.

Great. We really appreciate the color there. Maybe just one final question for me before I turn it over to Julie. I want to start off first by acknowledging that you actually came in a year ahead of schedule on reducing GHG's emissions based on the targets that you had said, that you've reset your targets for 2025 for Scope 1 and Scope 2. In the unlikely event -- I'm not suggesting that you're headed down that path -- but you're unable, let's say, to meet those objectives in 2025, or maybe it takes a year longer, how do you plan to address that? Would you sort of reset the target? Or would you look to buy credits in the voluntary carbon markets to offset? I'm just kind of curious how, unlike in the scenario that happens at -- how does Cisco address that?

Well, thank you. when we set the net zero goal in September of 2021, as you mentioned, on some of our targets, we were a year ahead of time. What we've also done is submitted our net zero goal to the science-based target initiative, SBTI, which we believe is a recognized standard setting body for corporate net zero commitments. In order to meet the SBTI standard, our emission reduction plans must be in line with what is needed to limit global temperature rise to 1.5 degrees Celsius compared to preindustrial times. And must focus on deep decarbonization versus a reliance on offsets. In our net zero reporting, Cisco has not yet used offsets. We've really relied on energy efficiency, renewable energy procurement strategies to meet those reduction goals. And we're really just getting started on our net zero journey. And our focus will first be on how do we absolutely reduce emissions as much as possible, before we incorporate offsets. One of the things that we are looking to do is our modeling does show we may need to bring offsets. In with SBTI as part of their calculation, there is an ability to use 10% of offsets. Our approach would be to leverage offsets, which really focus on carbon removal projects and ones that we can conduct due diligence to ensure the offsets have a proven carbon removal track record and also, provide positive social benefit to the communities where they are implemented. It is really important to note that for the world to achieve net zero, the public and private sectors must invest in innovative and effective nature-based and technology-based solutions to remove carbon. The Cisco Foundation is investing in these types of solutions, having made a $100 million commitment over 10 years to fund impact investing and nonprofit grants aimed at carbon reduction and sequestration.

Perfect. Maybe, I'll pass it on to Julie. I don't want to hog all the time here.