Preliminary 1Q21 Results and View into FY21

16 November 2020

Key Points

  • Chairman and CEO Chuck Robbins described the October quarter as “solid” and he is “encouraged by the signs of improvement in our business”, as the company beat consensus expectations on the bottom line and met it on the top line.
  • Cisco is widely viewed to be positioned to take advantage of both the COVID pandemic eventually ending and rising security concerns surrounding Huawei, however, its infrastructure platforms (>50% of sales) declined ~3% per year from F13 to F20.
  • The company’s focus on Applications and Security matches well with our view that networking is moving to be dominated by software. SD-WAN is just the latest software push into networking. Security should do well (it was the only segment to grow in the July quarter, and one of only two segments to grow in the October quarter), driven by its Duo and Umbrella products.
  • The Catalyst 9000 continued to be strong, but enterprise campuses are now empty, and the focus is on remote access. Some customers are taking the opportunity to upgrade their empty campuses, however there could be a pause in Catalyst 9000 revenue growth.
  • Read our initiation report HERE.

What Happened?

For the October quarter (F1Q21) the consensus non-GAAP EPS estimate was for a $0.70 EPS, which the company beat by $0.06, reporting EPS of $0.76. Revenue was $11.9bn (down 9% YoY), in-line with consensus expectations. Non-GAAP gross margin contracted 10bps YoY to 65.8%.

Guidance for F2Q21 is for revenue to be flat to down 2% YoY ($11.75bn to $12.0bn), above prior consensus of $11.7bn. Non-GAAP gross margin is expected to be between 64-65%, down from 66.4% F2Q20. Non-GAAP EPS guidance of $0.74 to $0.76, is above previous consensus of $0.73.

Our Insight

The Opportunities

Going forward the company expects clients to accelerate their digital strategies. In a post-COVID world companies are having to realign how they work, service customers, and make money; networking and communications is going to be a central element of that realignment. Cisco intends to focus on six areas:

Application Optimization – Making clients key applications run well on Cisco’s
networks was boosted by the $3.7bn acquisition of AppDynamics in 2017.
AppDynamics allows Cisco to monitor end-to-end performance of applications.
This differentiation could help Cisco hold on to large clients.

  • Security – Security has been growing for Cisco for sometime, even during weaker quarters. The company is likely to continue to see growth as the security market grows and it gains share from standalone security companies. Standalone technology companies generally perform better when a market is new. Parts of security are maturing (e.g. firewalls) and are becoming part of larger offerings.
  • Transition to 400G networking and 5G cellular – Cisco expects to be a key player in these transitions as enterprises, cloud titans, and carriers move to the new technologies for their cost and performance advantages.
  • Changing how workers work – Hybrid work models (some remote and some in office) are expected to become more popular. Cisco expects remote connectivity and collaboration will drive continued grow of its WebEx products, even after many workers return to the office.
  • Data privacy – The company expects consumers’ and workers’ data privacy needs will grow, which makes network control and monitoring even more important.
  • Distributed data and applications – Running the applications in the right location will become a real-time decision and a challenge for networks to overcome. Those companies that can deliver distributed applications will have a significant advantage. Possible locations include cloud service providers, smartphones, data center server, and industrial end-points.

The Obstacles

It is obvious, but external economic factors, elections, geopolitical issues, pandemics, etc. can all negatively impact demand for any product or service and Cisco is no different. On the August earnings call, the company said it would cut costs (more than $1 billion annualized) as COVID has impacted many customers. In FY20 the company had its first yearly revenue decline in three years (down 5%). This could make for easy year / year comparisons, but COVID could also continue to have negative impacts.

Arista has effectively owned the cloud networking market for a few years and there have been expectations that Cisco will start to make some inroads when the cloud titans move from 100G to 400G. However, multi-vendor networks may be a luxury that a post-COVID world will not support. Microsoft Azure has been on a multi-vendor path, but Microsoft was pausing network purchases even before COVID hit the US. Altogether, this may cause Cisco’s window of opportunity to shrink, if not close completely. While Cisco has grown its webscale business in recent quarters, the revenue level is still not meaningful. The cloud titans will likely continue to be a challenge for Cisco.

Management changes can be a catalyst for a stock, sometimes positive sometimes negative. The announced retirement of CFO Kelly Kramer comes at a difficult time for Cisco; the company is having revenue challenges and is going to be cutting $1bn in expenses over the next few quarters. Scott Herren will be joining Cisco as its new Executive Vice President and Chief Financial Officer beginning December 18, 2020.