Cisco Systems



| Cisco Systems | (CSCO – NASDAQ) |$45.16 |

Note: More details to come; changes are highlighted. Except where highlighted no other sections of this report have been updated.

Reason for Report: 3Q18 Flash Update

Prev. Ed.: Apr 6, 2018; Changes in Estimates & News Update

FLASH UPDATE [Earnings update in progress; to follow]

Cisco Systems delivered 3Q18 non-GAAP EPS of 66 cents, increasing 10% from the year-ago quarter.

Revenues increased 4.4% y/y to $12.463 billion. Acquisitions contributed 120 basis points (bps) to revenue growth in the quarter.

Strength witnessed in company’s Security and Applications segments drove y/y growth. Order strength and improving traction of the subscription-based model were other tailwinds.

Top-line Details

Products (74.7% of total revenues) increased 4.7% to $9.30 billion.

Services (25.3%) advanced 3.4% to $3.16 billion. This was driven by growth in software and solutions services.

Almost 32% of the revenues were recurring in nature gaining 2% from the year-ago quarter.

Revenues from subscriptions represent 55% of the company’s software revenues.

Recurring software and subscriptions generated $5.6 billion deferred product revenues, which surged 29% from the year-ago quarter.

Geographically, Americas, EMEA and APJC reported revenue growth of 2%, 9% and 7% on a y/y basis, respectively. Total emerging markets grew 7% and the BRICs plus Mexico climbed 12%.

In terms of customer segments, enterprise increased 11%, while service provider dropped 4%. However, commercial and public sector rose 7% and 2%, respectively.

Total product orders increased 4%. Cisco has realigned Product segments into four distinct categories — infrastructure platform, applications, security, and other.

Wireless, Switching Witnessed Growth

Infrastructure Platforms (57.5% of third-quarter revenues) comprise Switching, NGN routing, Wireless and Data Center solutions. Revenues inched up 2% from the year-ago quarter to $7.16 billion.

The y/y increase was primarily due to robust growth across switching, wireless and data center business. Switching revenues increased witnessed strong growth across campus and data center. Adoption of new campus switch, Cat9K was impressive.

Further, wireless revenues grew on the back of company’s Wave 2 offerings and Meraki solution. Robust demand for the HyperFlex data-center solution drove data center’s double digit growth.

However, continued weakness in service provider which led a slowdown in enterprise routing business remained a headwind during the quarter.

Management stated that the subscription-based Catalyst 9000 switching platform has been adopted by more than 5,800 customers, up 2,700 sequentially. Moreover, results benefited from the continuing customer shift to 100 gig architectures. Additionally, rapid adoption of multi-cloud infrastructures was a key catalyst.

Cisco’s ACI solution continues to witness traction. The company believes that ACI customers are gaining from increased business agility owing to network automation, simplified management and improved security features of the product. Management remains optimistic on the newly introduced ACI SDN offering.

AppDynamics Drive Growth

Applications (10.5% of third-quarter revenues) consist of Collaboration portfolio of Unified Communications (“UC”), Conferencing and TelePresence, Internet of Things (“IoT”) and application software businesses such as AppDynamics and Jasper. Revenues increased 19% from the year-ago quarter to $1.31 billion.

In the quarter, Cisco integrated its Cisco Spark with Webex Platform which enhanced Webex Meeting and enabled it to introduce Webex Teams, further strengthening the company’s collaboration portfolio.

Collaboration revenues rose primarily driven by growth across AppDynamics, UC infrastructure and TelePresence endpoints.

Security Remains Strong

Security (4.7% of revenues) climbed 11% to $583 million. The results were noticeable as deferred revenues surged 38% from the year-ago quarter.

Strong growth can be attributed to solid demand witnessed by web security, unified threat and advanced threat solutions.

Cisco’s AI-driven Talos intelligence platform blocks 20 billion threats per day. The company is striving to leverage machine-learning to deploy security platforms to mitigate online risks on a real-time basis.

Others

Other Products segment (2% of revenues) contains service provider video, cloud and system management and various emerging technology offerings. Revenues fell 6% to $249 million.

A positive development pertaining to the sector is the recent divestiture of a portion of company’s previously acquired NDS video assets. This move is likely to mitigate the sluggishness persistent in this segment.

Operating Details

Non-GAAP gross margin contracted 40 bps from the year-ago quarter to 63.9%. Management claims that the decrease can be attribute to higher memory pricing. This is anticipated to persist in the near term.

Non-GAAP operating expenses during the quarter came in at $4.05 billion, up 5.7% y/y. Non-GAAP operating expenses, as percentage of revenues, expanded 40 bps to 32.5%.

As a result, non-GAAP operating margin contracted 80 bps to 31.5%.

Balance Sheet and Cash Flow

Cisco exited the third quarter with cash & cash equivalents and investments balance of almost $54.43 billion down from $67.97 billion in the prior-year quarter. Cash & cash equivalents and investments available in the United States at the end of quarter were $47.5 billion. The company generated $2.42 billion cash flow from operations down from the year-ago figure of $3.3 billion.

In the third quarter, Cisco repurchased approximately 140 million shares of common stock for $6.02 billion, translating to an average price of $42.83 per share. Furthermore, the company paid a cash dividend of 33 cents per share.

Guidance

For 4Q18, revenues are expected to grow 4-6% on a y/y basis.

Non-GAAP EPS is anticipated between 68 cents and 70 cents.

Non-GAAP gross margin is expected in the range of 63-64%, while operating margin is anticipated between 29.5% and 30.5% for the quarter.

Conclusion

With Webex Meetings, Webex Devices and Webex Teams yielding results, we believe Cisco is well poised to capitalize on the emerging AI-based enterprise applications.

The company recently closed the acquisition of Accompany for $270 million. The newly acquired company is set to join Collaboration Technology Group (“CTG”) of Cisco. Accompany’s robust enterprise AI capabilities will strengthen Cisco’s collaboration portfolio.

We believe that company’s expanding footprint in the rapidly growing security market holds promise. Security solutions of Cisco are likely to witness traction, going forward. The company’s extended partnerships with the likes of Aon, Allianz and Rackspace are likely to boost security segment growth.

However, weakness in the switching and routing is a headwind. Moreover, ongoing transition to subscription-based model will continue to hurt the top line. Arista’s recent intention of manufacturing switches that connect campus networks is likely to hurt Cisco as it holds a dominant position in that market.

MORE DETAILS WILL COME IN THE IMMINENT EDITIONS OF ZACKS RD REPORTS ON CSCO.

Portfolio Manager Executive Summary [NOTE: Only highlighted material has been changed]

Cisco Systems (CSCO), based in San Jose, CA, is a provider of data networking, networking equipment and communications products and services to enterprises, service providers, consumers and governments. Product categories include switches, routers, access equipment, optical networking, security, storage, wireless LAN and Internet Protocol (IP) telephony. Total revenues were $48 billion in FY17.

Key factors for determining an investment strategy in Cisco are as follows:

• Cisco has a strong market position with integrated product portfolio.

• Cisco’s focus on Internet of Things (IoT) is poised to drive growth.

• The company boasts a strong software defined networking (SDN) portfolio that includes Cisco ONE, Nexus 9000 and Application Centric Infrastructure.

• Cisco is one of the leading providers of network security and it continues to gain traction in the segment.

Competition: Cisco holds leading positions in many markets but lags current and potential competitors, such as Juniper, Arista, Microsoft, Huawei, and Extreme. Increased competition could erode Cisco's dominant market position and affect future market share gains.

Firms’ Opinions: Out of the 20 firms in the Digest group covering the stock, 17 firms were positive and the remaining 3 were neutral. The target price ranges from a low of $43.00 to a high of $55.00, with the average being $49.71.

Bullish (Buy or equivalent outlook) – 17 or 85.0% firms – These firms view Cisco’s progress on continued product and geographic diversification favorably. They are particularly optimistic about the product mix and its broadening portfolio. They believe Cisco continues to be a dominant player in the networking equipment and communications industry. The firms are hopeful about the newly launched Catalyst 9300 Series switches. The firms think that the Internet of Things (IoT) segment also offers significant growth opportunity. The security, data center and commercial markets also seem to be driving demand. Some firms believe that subscription and hybrid solutions are aiding Cisco in retaining its customers and should drive economic growth in the long term. The gradual transitioning to the recurring subscription-based business model is a tailwind for the long term. The growing adoption of Cisco ONE software is another positive. Additionally, improvement in IT spending is another positive for the company.

Neutral Stance (Neutral or equivalent outlook) – 3 or 15.0% firms – These firms are concerned about the company’s market share being down from the peak levels. Additionally, the firms are on the sidelines due to Cisco’s ongoing transition into a subscription-based business model that will affect the top line in the near term. This is because revenues from such activities are not upfront. Moreover, the firms are apprehensive about increased competition and adoption of white box switches. These firms are also concerned about the surge in usage of software defined network (SDN), which is a negative for traditional routers. However, introduction of Application Centric Infrastructure (ACI) by Cisco is expected to somewhat combat the situation.

Negative Stance (Negative or equivalent outlook) – 0 or 0% firms

General Long-Term Outlook: Despite some near-term concerns, the firms are positive on Cisco’s long-term fundamentals on the back of its systematic product and market diversification strategy. Also, they believe that the AppDynamics acquisition will help Cisco to further its cloud transition strategy and achieve a recurring-revenue business model. Management believes that order growth is sustainable in the foreseeable future as the company positions itself as a turnkey supplier of major new infrastructure installations.

Apr 5, 2018

Overview [NOTE: Only highlighted material has been changed]

Cisco Systems (CSCO), based in San Jose, CA, is the leading provider of data networking equipment to enterprise and government customers with end-to-end solutions, and is the fourth largest provider of equipment to telecommunications service providers. The company’s IP-based networking solutions are the foundation for the Internet. The company also provides networking products for transporting data, voice and video within buildings and across campuses, and offers routers that interconnect computer networks by moving data, voice and video from one network to another. Its switching systems are used to build local-area networks (LAN), metropolitan-area networks (MAN) and wide-area networks (WAN). Technology products comprise home networking products that enable users to share Internet access, printers, music, movies and games; Internet protocol telephony products for transmitting voice communications; optical networking products, which provide a path for telecommunication carriers, as well as for carriers and enterprises; and security products, which protect information systems from unauthorized use. It also offers storage networking products that deliver connectivity between servers and storage systems. In addition, the company offers wireless LAN and outdoor wireless bridging products. For further information, please visit: .

Key investment considerations as identified by the analysts are as follows:

|Key Positive Arguments |Key Negative Arguments |

|Strong Market Leadership: Cisco dominates data networking in the enterprise|Saturating Markets: Growth in the enterprise data networking market is |

|arena with end-to-end solutions. |slowing down due to market saturation and overcapacity. |

|Enterprise Spending: Investments in new technologies have paid off as new |Impact of New Technology: Growth in new technologies could have a |

|products are growing rapidly. |lower-than-expected impact on the large revenue base. |

|Revenue Opportunity: Six key areas of growth (Security, VoIP, Wireless LAN,|Increased Competition: Cisco is steadily losing market share to H-P, |

|Optical, Home Networking and Storage) have the potential to generate |Juniper, Fortinet and Palo Alto Networks. Certain channel conflicts in the |

|significant annual revenues. |server market are also resulting in share losses. |

|Internet of Things (IoT): IoT offers a lot of opportunities for the long |Pricing Pressure: The company is expected to face increased pricing |

|run. This fast growing market is expected to experience widespread adoption|pressure as a number of Asian vendors (especially from China) enter the |

|in the future. |global markets. |

|Improving Security Position: Cisco is one of the leading providers of |Integration Risks: Cisco continues to acquire a large number of companies. |

|network security and it continues to gain traction in the segment. |While this improves revenue opportunities, it increases integration risks. |

Note: CSCO’s fiscal year ends on Jul 31; fiscal references differ from the calendar year.

Apr 5, 2018

Long-Term Growth [NOTE: Only highlighted material has been changed]

Cisco has highlighted three areas that will offer tremendous growth opportunities over the next several years and optimally utilize Cisco’s technology and business architecture in its service provider and enterprise accounts. These areas — collaboration, video and data center virtualization cloud — are relatively new opportunities for both Cisco and the industry.

The long-term expected EPS growth for Cisco over a period of three to five years stands at 5.0%.

The firms believe that the rapidly expanding IoT market will open up new opportunities for Cisco in the long run. Household and automobile Internet connectivity is expected to expand at a considerable rate, thereby increasing the demand for additional networking products that Cisco could provide.

Cisco bought Jasper Technologies Inc. for $1.4 billion in 2016 to expand further into the IoT space. The firms believe that with the Jasper takeover, Cisco has further strengthened its foothold in the space. Previously, it had entered into an alliance with Fanuc America, a robotics company, which uses IoT technology to monitor robots. Positive results from these acquisitions are expected to drive growth for several years to come.

These firms are of the view that the company is very well-positioned for a transition to SDN, which will form an integral part of its core Enterprise and Commercial verticals in the long run. Cisco’s newly developed SDN portfolio includes Cisco ONE, Application Centric Infrastructure (ACI), and Nexus 9000. The firms expect this portfolio to expand in the long term, contributing significantly to the company’s growth.

According to the firms, competition could intensify across numerous end markets, particularly from large-cap IT peers like Hewlett Packard Enterprise Company, which could put pressure on both sales and margins of Cisco. Despite a strong lineup of new products (core and edge routing, switching, etc.), the firms await meaningful share gains, which may take a few quarters. While Cisco is likely to gain share in many markets like data center switching and UCS, the company may also lose shares in other markets such as service provider, public sector and enterprise. Juniper, F5, Riverbed, Aruba and Netgear have all gained share in the recent quarters and experienced stronger revenue growth.

Apr 5, 2018

Target Price/Valuation [NOTE: Only highlighted material has been changed]

Provided below is the summary of valuation and target price as per Zacks Digest:

|Rating Distribution |

|Positive |85.0%↑ |

|Neutral |15.0%↓ |

|Negative |0.0% |

|Avg. Target Price |$49.71↑ |

|Digest High |$55.00 |

|Digest Low |$43.00↑ |

|Analysts with Target Price/Total |17/20 |

Impediments to target price achievement include competitive pressure, a prolonged IT spending recovery period, geo-political risks, margin contraction due to increased competition in switching business, integration risks, deterioration in current economic condition, virtualization of networking infrastructure, pricing pressure in key segments and failure of new products to deliver expected revenue growth.

Recent Events [NOTE: Only highlighted material has been changed]

On Mar 28, 2018, Cisco announced that Gerri Elliott will be executive vice president and chief sales and marketing officer. Maria Martinez will be executive vice president and chief customer experience officer.

On Mar 16, 2018, Cisco collaborated with Verizon to accelerate adoption of Hybrid Information-Centric Networking (ICN), to simplify futuristic network architecture.

On Mar 8, 2018, Cisco unveiled NCS 1004 and NCS 1010 modular platforms to aid providers leverage their fiber investment by enhancing automation capabilities.

On Mar 07, 2018, Cisco introduced Cisco SD-WAN vAnalytics and Cisco Meraki Insight to bring visibility to wide-area network (WAN).

On Mar 05, 2018, Cisco and Teradata collaborated to leverage on IoT with a view to digitally transform cities. Integration of Cisco’s Kinetic IoT data platform with Teradata Analytics Platform enhances support for public safety and will aid in creating smart city framework.

On Mar 02, 2018, Cisco signed a memorandum of understanding with the Government of Portugal to accelerate country’s digitization.

On Mar 01, 2018, Cisco and UAE-based telecom company `du, ` announced collaboration. Cisco will support du`s transformation into a digital service provider.

On Feb 27, 2018, at Mobile World Congress (MWC), companies like Reliance Jio, Telenor, SFR (a subsidiary of Altice) and Saudi Telecom Company collaborated with Cisco such that their initiatives are accelerated.

On Feb 26, 2018, at MWC, Airtel, TIM and Vodaphone collaborated with Cisco to boost their development in respective fields.

On Feb 25, 2018, Cisco announced 5G Now portfolio to aid global service providers and thereby mobile operator customers globally by advancing their 5G plans. At MWC, Cisco announced plan to form a multi-vendor ecosystem to accelerate adoption and viability of Open vRAN solutions.  

On Feb 23, 2018, Cisco collaborated to deliver Rackspace customers protection against evolving sophisticated threats such that their multicloud journey is secured.

On Feb 20, 2018, Cisco introduced its new Cisco Crosswork Network Automation software portfolio, which will improve the efficiency of its large-scale networks.

On Feb 14, 2018, Cisco announced 2Q18 results. The quarter’s highlights are as follows:

• Total revenue increased 3% y/y to $11.88 billion.

• Non-GAAP EPS was 63 cents, up 6 cents y/y.

On Feb 8, 2018, Cisco announced its selection by NBC Olympics as a provider of IP video and networking solution for the XXIII Olympic Winter Games.

On Feb 5, 2018, Cisco collaborated with the likes of Apple, Aon and Allianz to introduce a new cyber risk management solution for businesses.

On Feb 2, 2018, Cisco announced that it has completed the acquisition of Broadsoft.

On Jan 31, 2018, Cisco announced its Container Platform, production-grade software for the management of Containerized applications across the cloud environment.

On Jan 25, 2018, Cisco announced enhancement of its HyperFlex platform with the 3.0 software release allowing for dynamic deployment and management capabilities of its cloud services.

On Jan 24, 2018, Cisco was selected by Ameritas, a large insurance company, for upgrading the latter’s data centers.

On Jan 9, 2018, Cisco along with Hyundai Motor Company announced the production of a next-generation, hyperconnected car.

On Jan 8, 2018, Cisco announced a new, highly flexible DOCSIS licensing plan for its Converged broadband router (cBR-8) platform to deliver high-speed broadband, voice services and video.

On Jan 8, 2018, Cisco announces deployment of its Intent-Based Networking by Felix Platter Hospital to create the foundation of the hospital’s digital operations.

Revenues [NOTE: Only highlighted material has been changed]

According to the press release, revenues increased 3% year over year to $11.887 billion. Acquisitions contributed 80 basis points (bps) to revenue growth in the quarter. Security, Infrastructure Platforms and Applications revenues increased in the quarter.

Provided below is a summary of revenue as compiled by Zacks Research Digest:

|Revenue ($ in m) |2Q17A |

|Copy Editor | |

|Content Ed. |Awantika Poddar |

|QCA/ Lead Analyst |Aniruddha Ganguly |

|No. of brokers reported/Total | |

|brokers | |

|Reason for Update |3Q18 Flash Update |

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May 16, 2018

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