This week Cisco announced its Q4FY20 results. They were a mixed bag of good news and bad news that resulted in the stock price being down a whopping 6% in after-hour trading. The fourth-quarter revenue for the network market share leader came in at $12.15 billion, down 9% year-over-year but still above the $12.08 billion the Street was expecting. Another positive in the quarter was that the company hit its target of having more than half its revenues come from software and services. This was a goal that CEO Chuck Robbins stated back in 2017.
Cisco’s Current Quarter Was a Mixed Bag With Conservative Guidance
With numbers like this, one would think investors would be happy and the stock would rise. However, the company’s Q1FY21 guidance showed a different story. Cisco is guiding to a revenue decline of 9% to 11% year-over-year with gross margins of 64% to 65% and EPS of $0.69 to $0.71, below the consensus estimate of $0.76.
One would assume the shift to software and services would push gross margins up, but as Robbins explained on Jim Cramer’s “Mad Money” cable news show, there are a number of supply chain and logistics issues that occurred during the quarter. Also, some pricing pressure came into play this quarter. During the Cramer interview, Robbins said, “Customers are stressed, and competition is aggressive,” so the longer COVID-19-related uncertainty drags on, the longer the pricing pressure will last. However, as Robbins noted, gross margins are way up from where they were four to five years ago. I recall a quarter, prior to Robbins assuming the CEO helm in 2015, where product gross margins dropped to under 60% for a quarter, and the Street acted like the sky was falling.
A good analogy for the quarter is a car that’s not firing on all pistons. The pistons that are related to work from home, which includes security (up double digits) or SaaS services, such as Webex (also up double digits), performed well. Products that were related to connecting tractional offices, unsurprisingly, did not do well. The one exception was the Catalyst 9000 switch, which is the backbone of most businesses' networks and a foundational component of Cisco’s Intent-Based Networking (IBN). Shifting to the Cat9K, as it’s more commonly known, enables network managers to automate more processes, which can be important when the engineers are also working from home.
Work-From-Home Technologies Continue to Perform Well
From my conversations with IT leaders, when employees were sent to work from home, IT operated as normal. We even can say an acceleration of spending for things such as VPN concentrators, firewalls, SD-WAN, etc., was happening. That money has been spent, however; people are working from home, and there appears to be no end in sight.
In fact, on the earnings call, during the Q&A, Robbins said: “I wouldn't say that we're coming out of the coronavirus right now. I think that it feels to me very much like it felt 90 days ago.” This indicates a prolonged malaise in IT spending as IT buyers sit on the sideline and wait.
Large Enterprises Are Spending With Small Businesses Watching
The one bright spot for IT spending is with large enterprises.
“The biggest, biggest premier enterprise accounts are still investing significantly, and they had very good order rates,” Cisco CFO Kelly Kramer said. “But as you go down the tiers in enterprise, it did slow down.”
Kramer then added the following about commercial accounts, which is Cisco’s designation for small- to midsize businesses: “They're waiting to see what comes out of the pandemic, and they're pausing their IT spend.”
While this makes logical sense, I do want to issue this word of caution to IT and business leaders. The COVID-19 pandemic is reshaping the world, and I believe it will reshape the business landscape. The strong will get stronger, and the weak will get weaker, creating an even larger divide.
Cisco’s former longtime CEO, John Chambers, used to talk at length about making the right investments when the markets are down, so the company can come out of it in a position of strength when things pick up.
Investments Today Will Pay Dividends Tomorrow
This is the trend that I see happening with COVID-19: Companies investing today are putting themselves in a great position to capitalize on this so-called “great reset.” Enterprises that are not investing could find themselves on the outside looking in.
There’s an expression that goes: “Some people make things happen, some watch what happens, and others wonder what happened.” Based on Cisco’s guide, it appears there are a lot of companies watching, which will lead them to wonder what happened.
The network will play a key role in a return to the office. WiFi and Bluetooth enable contact tracing; collaboration and video let companies blend virtual and physical workers; and internet of things (IoT)-connected endpoints can enable greater automation. Also, cloud-managed infrastructure lets engineers run the network from remote locations, such as home. For most companies, this will require an upgrade of the network, and that should be done ahead of a return to the office.
I do not believe the caution that CEO Robbins gave has anything to do with company structure or where Cisco is with products. The company continues to be a bellwether for IT spend, and it appears it’s not immune to the effects of COVID-19. I’m expecting this drag we are seeing on general IT spend to continue with strengths in certain pockets—particularly security and collaboration.
One final note on the quarter: During the call, CFO Kramer announced she would be retiring. Kramer has been an icon in the industry and revered as one of the top CFOs in the industry and will leave big shoes to fill. I wish her well in her post-career endeavors.
Zeus Kerravala is an eWEEK regular contributor and the founder and principal analyst with ZK Research. He spent 10 years at Yankee Group and prior to that held a number of corporate IT positions.