Wednesday, November 19, 2014

Cisco's 1Q FY15: Looking Forward and Back.

Looking Back at Our Cisco Posts

"Cisco's 4th Quarter: A Tiger Changes Stripes," 8/16/2012
  • Credit Suisse worried about 250-300 bp erosion in the gross margin rate going forward! (the time frame is not specified)
"Cisco: The Fourth Horseman Reports First Quarter 2014," 11/13/2013
  • For the period 7/2008-2013, Cisco's shares return an average rate of 7.4% per annum, trailing both the Standard and Poors broad index (16.5%) and the Tech Index at 18%.
  • $12.1 billion in revenue increases 1% y/o/y.
  • It will take 4-5 years to transition the company away from a heavy reliance on its traditional core of switching and routing.  
  • From 2008-2013 the gross margin rate declined 800 basis points.
  • Long-term growth rates of 5-7% expected from a reconfigured Cisco. 
  • If this were combined with operating leverage on a leaner company and better supply chain efficiencies, long-run value creation would be significant.
"Cisco's 2013 Financial Analysts Conference," 12/14/2013
  • Core business growth might average 0-1% per annum over the next 3-5 years!
  • Hardware still accounts for about 30% of data center spend.
  • Servers account for 29%.
  • Software accounts for 22% of the data center spend.
  • "stock could have legs in 2014."
"Cisco's Fiscal Second Quarter 2014: Nothing New From the First," 2/13/2014.
  • "When...(a stock is) priced like a 'going out of business' sale that's the time to take a look at the risk/reward ratio." 
"Cisco's Third Quarter and Cloud Computing," 5/18/2014.
  • Customers apply 75% of their skilled labor to the management of their applications, software layers and infrastructure.  Over time, this ratio must fall to about 25% in order for them to meet the new demands on IT departments.
  • This is the opportunity for vendors like CSCO, HPQ, MSFT, and IBM.
"Cisco's 4Q: FY'14: Low Quality of Earnings Concerns," 8/14/2014
  • Concerns on the analyst call about the effects of software defined networks (SDNs).
  • Switches are 30% of the quarter's revenues
  • Acquisitions mentioned: Tail-f Systems; ThreatGRID; Assemblage, for mobile collaboration.
  • Expect the share price to be range bound between $20-25 for the balance of the year.

Coming into 1Q FY15

  • Facebook's announcement about its new data center architecture was seen as a negative for Cisco's earnings announcement and for sentiment on the stock's prospects: 
"Our previous data center networks were built using clusters. A cluster is a large unit of deployment, involving hundreds of server cabinets with top of rack (TOR) switches aggregated on a set of large, high-radix cluster switches. More than three years ago, we developed a reliable layer3 “four-post” architecture, offering 3+1 cluster switch redundancy and 10x the capacity of our previous cluster designs. But as effective as it was in our early data center builds, the cluster-focused architecture has its limitations.
First, the size of a cluster is limited by the port density of the cluster switch. To build the biggest clusters we needed the biggest networking devices, and those devices are available only from a limited set of vendors. Additionally, the need for so many ports in a box is orthogonal to the desire to provide the highest bandwidth infrastructure possible. Evolutionary transitions to the next interface speed do not come at the same XXL densities quickly. Operationally, the bigger bleeding-edge boxes are not better for us either. They have proprietary internal architectures that require extensive platform-specific hardware and software knowledge to operate and troubleshoot." [I love the unconventional use of the mathematical term 'orthogonal' in the press release]
The bears on all the Four Horsemen of Tech, especially CSCO and HPQ, would say that the mega-users are rebuilding their next-Gen data centers with their own designs, which include more software defined network architectures. (remember the concerns on the prior 4Q FY 14 call)

The 1Q FY 15 Results

  • Revenue of $12.2 billion increases 1.3% over the prior-year period.
  • The gross margin rate of 63.3% is the highest level in three years. (Remember Credit Suisse's projections from 2012)
  • The operating margin rate is 29.2%
  • Switching and routing are 47% of consolidated revenues versus earlier projections of two-thirds. (some of this might be bleeding off into new categories, but it shouldn't be that significant)
  • New product introductions are cited, including ASA with FirePOWER, an industry-first threat focused firewall.  Perhaps the latter feature came from the ThreatGRID acquisition mentioned a quarter earlier.
  • The stock price which began the year at $21.98 is at $26.59 intra-day as of this writing.  The stock indeed had legs in 2014!

What's Ahead?

  • The world won't belong to Huawei.
  • Even thought IT purchasers are taking longer to make their big purchase decisions, very few of them are going to design their own data center configurations.  Mix and matching will have its limits, as IT officers rise higher up in the executive chain with more visibility and accountability for performance and for mistakes. 
  • The succession plan for CEO John Chambers is being signaled as evolving.  The revenue growth under Mr. Chambers has been nothing short of astonishing, although some of it was riding a tech wave for sure.  
  • The next alignment of the executive team, the culture, and the ability to tell their story better will tell all about the stock's price appreciation potential.  Some board refresh would be appropriate.  
  • So far, Cisco has been doing exactly what it said in 2012, which itself is unusual for mega-cap companies.  

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