Historical Review:

From its beginnings as a start-up multi-protocol router company, through the early 2000s, Cisco thrived as a major supplier of hardware to build corporate and internet networks, both to telecom firms, large enterprise companies, universities, and government agencies (like the European Commission).

Having acquired many Ethernet switch start-ups, most notably Crescendo Communications and Grand Junction Networks, Cisco became the undisputed leader in Ethernet switching.  But that dominance faded with the rise of cloud computing and “white box” switches the big Internet companies bought for their cloud resident data centers.  Also, the competition from Arista Networks, co-founded by brilliant hardware architect Andy Bechtolsheim, depressed sales to cloud computing companies like Microsoft and Amazon.

Much of Cisco’s revenue growth has come from acquisitions. Cisco recently acquired ThousandEyes, a networking intelligence company, for about $1 billion. Cisco bought WAN companies Stratacom and Cerent for $4B in 1996 and $6.9B in 1999, respectively. Cisco acquired software maker AppDynamics for $3.7 billion in 2017.  Later that year, it bought BroadSoft for $1.9 billion.

Most of Cisco’s recent acquisitions have been software-related. In July 2019, Cisco acquired Duo Security for $2.35 billion, marking its biggest cybersecurity acquisition since its purchase of Sourcefire in 2013. Acquiring Duo Security bolstered Cisco in an emerging category called zero trust cybersecurity.

Not to be outdone by VMware, HP Enterprise and other large corporate acquirers Cisco purchased SD-WAN companies Meraki in 2012 and Viptela in 2017.  In 2019, Cisco agreed to buy Acacia Communications, a maker of 400G optical components, for $2.6 billion in cash. That deal has not closed. Earlier it bought optics device maker Luxtera for $660 million.

CFO Kramer told Reuters that Cisco will continue to acquire smaller companies to help boost revenue and that its $2.84 billion acquisition of Acacia Communications Inc remains on track. The deal was slated to close before the end of Cisco’s fiscal 2020 last month, but the company said it is still awaiting approval from Chinese regulators.

 

 

 

 

 

 

 

 

Cisco CEO Chuck Robbins

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Revenues Drop; Earnings Forecast Disappoints:

In its 4th fiscal quarter (May to July 2020), Cisco revenues fell 9% year-on-year to just $12.2 billion as enterprise customers slashed spending on network “infrastructure platforms.” Earnings declined 4% to 80 cents a share from a year earlier.  For the current quarter, Cisco expects sales to fall between 9% and 11% in the current quarter.  A 10% revenue drop would be at the midpoint of its forecast to about $11.84 billion. Wall Street analysts had expected $12.25 billion in revenue.

According to a filing with the Securities and Exchange Commission (SEC), sales of “infrastructure platforms” tumbled 16% during the quarter, to about $6.6 billion, compared with the year-earlier period.  “This is the product area most impacted by the COVID environment,” said Kelly Kramer, Cisco’s chief financial officer who is retiring.  “We saw declines across switching, routing, data center and wireless, driven primarily by the weakness we saw in the commercial and enterprise markets,” Kelly added.

Cisco’s applications unit, its second largest product segment, sells everything from unified communications products to “Internet of Things” software. It recorded a 9% drop in sales, to $1.4 billion in the last quarter.

That’s no surprise.  As companies shift business workloads to cloud computing services like AWS, AZURE and Google Cloud they spend much less on internal computer networks (aka Enterprise Networks). In addition, Cisco has lost share in several large markets, though it aims to rebound in cybersecurity.

Indeed, Cisco’s only real 4th fiscal quarter growth came at its comparatively small security business, where sales were up 10%, to $814 million.  Cisco’s huge services unit were flat YoY, generating $3.3 billion in revenues.

CFO Kramer elaborated:

“Applications (segment) was down 5% driven by a decline in unified communication and TP endpoints. We did see growth in conferencing as we saw strong uptake with the COVID-19 environment. We also saw strong double-digit growth in AppDynamics and IoT software. Security was up 6% with strong performance in unified threat management, identity and access and advanced threats. Our cloud security portfolio performed well with strong double-digit growth and continued momentum with our Duo and Umbrella offerings. Service revenue was up 5% driven by software and solution support. We continue to transform our business delivering more software offerings and driving more subscriptions. Software subscriptions were 74% of total software revenue, up 9 points year-over-year.

In terms of orders in Q3, total product orders were down 5%. During the quarter, there was a slowdown in April as we saw the impact of the COVID-19 environment continue. Looking at our geographies, the Americas was flat, EMEA was down 4%, and APJC was down 22%. Total emerging markets were down 21% with the BRICS plus Mexico down 29%. In our customer segments, public sector was up 1% while enterprise was down 4%, commercial was down 11%, and service provider was down 3%. Remaining performance obligations or RPO at the end of Q3 were $25.5 billion, up 11%. The portion related to product was up 25%.”

“Management does not see the Covid-19 disruption as having improved since May,” Barclays analyst Tim Long said in a note to clients. He added that Cisco’s fiscal fourth quarter saw “Data center particularly weak from reduced demand. Applications again below expectations as growth in Webex (video conferencing)  volume still to be fully monetized, and outweighed by weakness in the larger campus communications business.”

“Cisco earnings were disappointing on several levels, primarily on the news of a large restructuring and elimination of jobs as well as the forecast for a revenue decline, which shows the company is not meeting its growth forecasts,” said Scott Raynovich, founder and chief analyst of Futuriom, in an email Wednesday afternoon to FierceTelecom. “The share price looks like it will fall on Thursday based on the fact that investors were too optimistic that cloud infrastructure expansion could support Cisco’s business. The fact is that Cisco has never been a major player in the cloud, and this quarter may be proving out that point.”

Transition/Pivot to Software, Services and Security:

It’s a work in progress and not at all easy for a large company to accomplish.  In its fiscal 4th quarter, approximately 31% of revenues came from pure software vs. 51% of sales generated by software and services in the last fiscal year.  Of its software revenues, 78% now come from subscriptions, easily beating a company target of 66%.  However, the company wants to transition faster.

“We will accelerate the transition of the majority of our portfolio to be delivered as a service,” according to CEO Chuck Robbins who said on the earnings call:

“We believe the transition in our own business model through our shift to more software and subscription-based offerings is paying off. We saw continued strong adoption of our SaaS-based offerings and now have 74% of our software that is subscription versus 65% a year ago. We also believe we remain well-positioned over the long-term to serve our customers and create differentiated value aligned to cloud, 5G, Wi-Fi 6 and 400 gig. Our business model, diversified portfolio, and ability to continue to invest in key growth priorities gives us a strong foundation to build even stronger customer relationships. As we prepare for the future, we will closely partner with our customers to modernize their infrastructure, secure their remote workforce and their data through our innovative solutions that will serve as the foundation for their digital organizations.”

“I think this pandemic is basically just giving us the air cover to accelerate the transition of R&D expense into cloud security, cloud collab, away from the on-prem aspects of the portfolio. Clearly, we’ve got a lot of technology that we’re working on today to help our customers over the next three, four, five years in this multi-cloud world that they’re going to live in, and you’ll see more of that come out over the next couple of years.”

Related to security, Robbins said:

“Moving on to security, which is always at the heart of everything we do. In Q3, we saw solid growth reflecting increased demand for our robust solutions to secure the rapid growth in remote workers and their devices. Being the largest enterprise security company in the world, we are uniquely positioned to safeguard our customers wherever they work. We have the most comprehensive and integrated end-to-end portfolio in the industry across the network, cloud, applications, and endpoints.”

“As I mentioned earlier, we provided extended free licenses for key security technologies that are designed to protect remote workers including Cisco Umbrella, Zero Trust Security from Duo, industry-leading secure network access from Cisco AnyConnect and endpoint protection from our AMP technology. We are also supporting our customers on their multi-cloud journey by enabling them to secure direct Internet access, cloud application usage, and roaming users. We are only two quarters into our Secure Internet Gateway transition and we are already seeing strong adoption from existing and new customers. Building on the investments we made in innovation partnerships and acquisitions, we also introduced SecureX. This is the industry’s broadest cloud-based security platform connecting the breadth of our portfolio and our customer security infrastructure by providing unified visibility, automation, and simplified security across applications, the network endpoints and the cloud.”

SD-WAN Opportunity:

Robbins outlined the company’s SD-WAN strategy during the earnings call:

“We continue to execute on our secure cloud scale SD-WAN strategy by investing in innovation and partnerships to help enterprises accelerate their multi-cloud strategies. As an example, we are now integrating with our Umbrella secure Internet gateway to give our customers flexibility to use best of breed cloud security with our industry-leading SD-WAN solution. Our partnerships across web scale providers like AWS, Azure and our most recent announcement with Google Cloud allow us to offer a truly multi-cloud network fabric. As bandwidth and SaaS application demand increases, we are enabling our customers to securely connect branches and interconnect to different cloud providers to enable consistent application performance and user experience.”

With SD-WAN, companies have less need for costly private data networks leased from telecom companies. Cisco competes with VMware, startup Aryaka, Fortinet and CloudGenix in the SDN market. Palo Alto Networks recently bought CloudGenix.

Will 5G/WiFi 6 Drive Demand for Routers and 5G Core Products?

“In our view, headwinds have mostly played out, and we see smoother sailing ahead with easier comps and better growth cycles that are related to new product cycles,”  Bank of America analyst Tal Liani said in a note. “5G could drive demand for routers, especially access and aggregation routers, 400G  switching could drive demand for data center switching to recover, and Wi-Fi 6 (IEEE 802.11ax) could drive up another upgrade cycle.”

CEO Robbins on 5G growth:

“So I think what we see happening with 5G is a little bit mixed, but generally there is a tendency for our customers to want to sort of put their foot on the accelerator. I think you heard some of our customers that are looking for permits and with regional governments around the United States and other places that they are not sure they’re going to be able to get that done (permits to mount small cells on public infrastructure) during this pandemic. You got other customers who are saying that they actually are not having a problem, but it’s — so we think generally there is going to be an acceleration, particularly as our service provider customers also realize that some element of this work from home scenario will not go away and so we’re going to be continuing in the future to work in these very hybrid worlds where we’re going to have even a much broader distribution of where their users will be working from and I think that’s the reason that they want to continue to accelerate the deployments and the strategies around 5G.”

CEO Robbins on WiFi 6 mixed customer feedback:

“I’d say in Wi-Fi 6, I don’t see any big significant shift. I’d say on the cloud, I’ve had mixed feedback from customers. I think that in general, it’s probably a tailwind to cloud, but there are some customers that believe they have a cloud strategy and this doesn’t — they don’t understand why this would change how they go about it, but it will, as it relates to our strategy. We are going to continue to accelerate those technologies that help our customers use the cloud more effectively. We are going to — as our customers, some of our customers are going to need opex offers in the future given capex restraints. So we’re working on a balance of our portfolio to be delivered in both op capex models to give customers the flexibility that they need and we’re definitely going to continue to accelerate the development and work around our security portfolio as it relates to remote work and cloud connectivity because we think that’s only going to accelerate as well.”

Cost Cutting including Layoffs Coming:

Cisco’s restructuring plan started in the current quarter and is expected to recognize a related one-time charge of about $900 million. CEO Robbins plans to cut costs and shrink the payroll. “Over the next few quarters, we will be taking out over $1 billion on an annualized basis to reduce our cost structure,” he said on the earnings call.  CFO Kramer said operating costs would fall by around $800 million, about 4.4% of the annual total.

Costs have already been reduced substantially. In the 4th fiscal quarter opex fell 9%, to about $4.4 billion. Yet with those cuts, operating profit dropped 11%, to $3.3 billion. It was only due to lower tax payments via the 2017 GOP tax bill (which benefited companies at the expense of the middle class) that net profit rose 19%, to roughly $2.6 billion.

While older Cisco workers were getting buy-out deals to retire, headcount at the firm has grown for the past four years, rising from 71,833 employees in 2015 to 75,900 last year.  That latter number will surely decline in the months ahead.   Note that Cisco does not provide details of staff numbers or layoffs in quarterly earnings updates.

CEO Robbins did not disclose any details about possible job cuts. According to Reuters: “Cisco’s restructuring, which includes a voluntary early retirement program and layoffs, will begin this quarter, the company said, adding that it expected to recognize a related one-time charge of about $900 million.”

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References:

https://www.fool.com/earnings/call-transcripts/2020/05/13/cisco-systems-inc-csco-q3-2020-earnings-call-trans.aspx

https://www.lightreading.com/opticalip/routing/cisco-plans-hefty-cuts-as-virus-pain-deepens/d/d-id/763213?

https://www.reuters.com/article/us-cisco-systems-results/ciscos-first-quarter-forecast-disappoints-shares-fall-idUSKCN2582Q6

https://www.fiercetelecom.com/telecom/cisco-implements-restructuring-plan-including-layoffs-as-stock-tumbles-after-hours