Telecom & Networking Equipment CISCO SYSTEMS Price: $44.33 (11/14/2018) Price Target: $59.00 (Prior $58.00) OUTPERFORM (1) Paul Silverstein 646 562 1340 paul.silverstein@cowen.com Fahad Najam 646 562 1427 fahad.najam@cowen.com Elizabeth Pate 646 562 1437 liz.pate@cowen.com Key Data Symbol NASDAQ: CSCO 52-Week Range: $49.47 - $33.75 Market Cap (MM): $200,823.2 Net Debt (MM): $(24,270.0) Cash/Share: $10.09 Dil. Shares Out (MM): 4,614.0 Enterprise Value (MM): $179,844.2 ROIC: ROE (LTM): NA NA BV/Share: $9.36 Dividend: $1.32 Yield: 2.98% FY (Jul) 2019E 2020E 2021E Earnings Per Share Q1 $0.75A $0.92 $1.06 Prior Q1 $0.73 $0.87 Q2 $0.74 $0.88 $1.01 Prior Q2 $0.73 $0.86 Q3 $0.81 $0.94 $1.07 Prior Q3 $0.80 $0.92 Q4 $0.88 $0.99 $1.12 Prior Q4 $0.86 $0.96 Year $3.17 $3.72 $4.26 Prior Year $3.10 $3.60 P/E 14.0x 11.9x 10.4x Consensus EPS $2.98 $3.25 $3.42 Consensus source: Thomson Reuters Revenue (MM) Year $52,220.4 $55,294.1 $58,144.0 Prior Year $51,894.0 $54,083.8 EV/S 3.4x 3.3x 3.1x EARNINGS UPDATE FY1Q19: CISCO TO THE RESCUE THE COWEN INSIGHT FY1Q19 further reinforced our investment thesis. Degree and breadth of strength suggests improving company-specific execution as opposed to just macro tide and concomitantly that Street forecasts remain too low. Margin structure/oper cash flow once again impressed. Ironically, greatest risks appear to be non-csco specific: macro and next round of U.S. China tariff hikes. Reiterate Outperform. Solid Operating Results and Guidance CSCO reported strong FY1Q19 results that exceeded both our and Street s respective revenue and EPS forecasts. Revenue growth accelerated to nearly 8% Y/Y. To be clear, CSCO s 5 7% Y/Y revenue outlook is normalized to exclude the Service Provider Video Software business. The midpoint of CSCO s guidance when including SP-Video translates to ~ 4% Y/Y growth or $12.36B v. our 4.7% Y/Y or $12.45B and the Street s 5.4% Y/ Y or $12.53B previous respective forecasts. CSCO guided PF GM of 63.5% - 64.5%, PF operating margin of 30.5 31.5%, and PF EPS of $0.71 0.73 for FY2Q19 v. our $12.4B/64.0%/31.6%/$0.73 and Street s $12.5B/63.7%/31.1%/$0.72 previous respective forecasts. While our nominal FY2Q19 revenue remains unchanged, CSCO s 5 7% Y/Y growth guidance compares favorably with our and Street s ~5% Y/Y growth previous respective forecasts. The superficial disconnect between the absolute dollars and growth rate in our and Street s previous forecasts relative to CSCO s guidance owe to CSCO s divestiture of its Service Provider Video Software business; i.e., the Service Provider Video Software business was included in our and Street s previous respective forecasts. Even excluding this divested business, our FY19 revenue estimate has increased, albeit slightly. CSCO s FY2Q19 revenue guidance of 5 7% Y/Y growth translates to 3 5% Y/ Y growth when including CSCO s revenue from its recently divested SP-Video business, which occurred in FY2Q19 on October 28, 2018. CSCO s PF EPS guidance of $0.71 - $0.73 was essentially in-line with our and Street's previous respective forecasts. CSCO reported FY1Q19 rev of $13.1B, PF GM of 63.8%, PF operating margin of 31.9%, and PF EPS of $0.75 v. our $12.9B/63.8%/31.1%/$0.73 and Street s $12.9B/63.5%/30.7%/$0.72 previous respective estimates. Excluding the divested SP Video Software business, revenue growth was almost 9% Y/Y. Although not specifically quantified by CSCO, we assume 100-150 bps is attributable to ASC 606 benefit. Revenue: Broad-based Strength Driven by broad-based strength across customer, product and regional markets, FY1Q19 s $13.1B and 8% Y/Y growth marks the fourth straight quarter of acceleration in Y/Y revenue growth, second straight quarter of 5%+ revenue growth and the fourth consecutive quarter of positive revenue growth following eight straight quarters of outright decline. This strength comes in the face of multiple headwinds including: what appears to be a slowing or challenging macro-economic environment and growing uncertainty in regions outside of the U.S.; challenges from recently enacted U.S. 10% China tariff; and still somewhat constrained, though easing, component supplies. The breadth of the strength was impressive--across product markets, customer markets and regions. As previously noted, the degree and breadth of the strength well beyond what country and regional GDP trends in most regions outside of the U.S. would suggest strongly suggest that improving company-specific execution across a number of fronts, as opposed to just the macro-economic, is playing a significant role in driving the improvement, which in turn suggests that the improvement is more secular than transitory in nature. Routing grew for the second consecutive quarter, driven by service provider. Please see pages 13 to 17 of this report for important disclosures.
. AT A GLANCE Our Investment Thesis Cisco is the leader in enterprise switching and service provider routing and one of the few vendors that can offer end-to-end networking solutions as well as, increasingly, end-to-end data center solutions. While growth is slowing and becoming more challenging, we see Cisco successfully transitioning to a larger, more strategic IT solutions supplier; margins holding up better than feared; and the SDN threat appears overstated. Base Case Assumptions Rev growth accelerates to ~6% in FY19 Gross margin remains relatively stable around 63-65% range Oper margin remains in the 31-32% range Price Performance $55 50 45 40 35 30 Feb-18 Source: Bloomberg May-18 Aug-18 Nov-18 Upside Scenario Rev growth accelerates to over 6% in FY19 Gross margin improves to 65+% in FY19 Oper margin improves to above 33% in FY19 Company Description Forthcoming Catalysts Growing traction for new Application Centric Infrastructure solution continues Shift to Cloud-based Security, Networking and Analytics solutions picks up momentum Data center upgrade cycle Eventual improvement in emerging markets and service provider end demand Ongoing strong traction in shift to software recurring revenue model Downside Scenario Rev growth declines below (2)% in FY19 Gross margin declines to 60% Oper margin falls below 30% Cisco sells data networking products and solutions to service providers and enterprises worldwide. Recently, Cisco has expanded its services offerings in an attempt to transition to a full information technology (IT) company from a supplier of networking equipment. Analyst Top Picks Ticker Price (11/14/2018) Price Target Rating CSCO $44.33 $59.00 Outperform II-VI Incorporated IIVI $36.20 $64.00 Outperform Ciena CIEN $32.94 $39.00 Outperform 2
Product Markets. CSCO noted strong revenue contribution and growth from across virtually all of its product segments. Total Product Revenue increased 9% Y/Y driven by broad-based strength. Revenue from Infrastructure Platforms increased 9% Y/Y, which represents the fourth straight quarter of outright and accelerating growth following eight straight quarters of virtually flat to outright decline; Applications by 18% Y/Y, which is the second strongest growth rate since F1Q16; Security by 11% Y/Y, which marks the second strongest growth in the past seven quarters; Services by 3% Y/Y, which marks the sixth straight quarter of positive growth; while Other Products declined by (38%) Y/Y. The broad-based strength extended to a product line level with CSCO noting the continued strong ramp of Catalyst 9000 campus switches; tremendous traction" with its Nexus 9K data center switches, ACI and UCS solutions; with "another solid quarter" in its collaboration business. CSCO also noted that its Network Intuitive campus switching architectural upgrade cycle remains very early. Customer Segments. FY1Q19 marked impressive, robust forward-looking order growth across all customers segments. Overall Product orders increased 8% Y/Y, which marks the strongest Product order growth over the past 27 quarters, with Product order growth in CSCO s customer markets as follows: Enterprise: 15%, which marks the highest growth since October FY4Q11 and the fourth straight quarter of outright positive growth after three straight quarters of decline; Public Sector: 8%, which marks significant acceleration following two consecutive quarters of low single-digit growth; Commercial: 8%, which marks a fifth straight quarter of high-single digit or double-digit growth following lowsingle digit growth over the preceding four quarters; and Service Providers: 2%, which marks the second consecutive quarter of growth following eight straight quarters of outright decline. Regions. CSCO posted strong growth both reported rev and forward looking product order book--across all geographies. In terms of forward looking order growth, overall Product orders increased 8% Y/Y, which marks the strongest Product order growth over the past 13 quarters, with regional Product order growth as follows: Americas: 8%, which marks the strongest growth rate since FY1Q12; EMEA: 6%, the fifth consecutive quarter of Y/Y growth and fourth straight quarter of > 5% Y/Y growth; APJC: 12%, the second consecutive quarter of double-digit growth following five consecutive quarters of low single-digit growth; and Emerging Markets: 16%, which marks the strongest growth rate in the past 12 quarters, including 19% Y/Y aggregate growth for BRICS plus Mexico. FY1Q19 reported rev increased Y/Y as follows: Americas 6%; EMEA 11%; and APJC 12%. Shift to Recurring Revenue Model: Solid Ongoing Progress The quarter marked further progress in CSCO s transformation to a recurring rev model, with CSCO noting it is on track to achieve its goal, laid out at its June 2017 Analyst Day, of driving software revenue to 30% of its total revenue by FY20. Offering support for its view, CSCO highlighted that Software Subscriptions as a percentage of Software Revenue increased to 57%, up from 56% in the preceding quarter and 52% in the year ago quarter. Given CSCO s adoption of the new ASC 606 accounting standard, CSCO noted that the most meaningful metric going forward is software subscriptions as a percentage of total software revenue, as an indicator of how well its software revenue is performing. In growth terms, given the switch to ASC 606 accounting standard in FY1Q19, total Deferred Revenue decreased over (9%) Y/Y to almost $17B, of which CSCO noted it wrote-off $1.3B in deferred revenue from its balance sheet. Offering an explanation of the impact of ASC 606 on CSCO s revenue recognition policy, CSCO noted that we've talked in the past where we used to sell the previous switch, say it sold for $100, and we recognized that $100 up front. Before ASC 606, we sold that Cat 9k for $100, but 25% of it was deferred and we recognize that 25% over say a three-year term, and then they would renew it for another three-year term. With ASC 606, that 25% that was deferred, about 12% is now deferred and the other 11% is recognized up front. But that full 25% is what we renew, and so that's why when you look at the software, that's still subscription software. That's why we think that's the relative metric. 3
Margins: Remain Resilient; We Still See Longer-Term Upward Bias Results, outlook and commentary all indicate ongoing margin resiliency with little evidence of secular downward pressure and we continue to see a positive longer-term upward bias. Price erosion of (190) bps and remained what remains a remarkably benign range of ~ (130) (300) bps Y/Y over the past four years. 63.8% Total PF GM marked 13th straight quarter of ~ 63 65%. CSCO noted that looking forward it expects to see [memory pricing] go from a headwind to a tailwind starting in the second half of our fiscal quarter. Product GM increased almost 60 bps Y/Y and marked the 15th straight quarter of over 61% GM. On a regional basis, the Americas Product GM increased ~120 bps Y/Y and 130 bps Q/Q, EMEA increased ~100 bps Y/Y and 50 bps Q/Q, while the APJC Product GM declined ~(490) bps Y/Y and (50) bps Q/Q. PF Opex came in at 31.9% of total revenue, the lowest level since the 2000 Telecom Bubble. We continue to see the following longer-term upward drivers: ongoing business model transition; higher revenue volume; increased contribution from AppDynamics, Broadsoft, DuoSecurity, and other recent software-centric acquisitions; and the looming reversal elevated memory pricing; and opportunity for incremental, albeit modest, improvement in Opex/Revenue ratio. Exiting from the SP-Video business removes (30-80) bps of GM headwind. As a result, we have increased our GM forecast by almost 50 bps in each of FY19, FY20, and FY21. Tariffs: No Material Impact Thus Far CSCO helped ease investor concern regarding the potential impact on its business from the U.S. imposition of tariffs on certain products sourced from China, indicating that CSCO s pass-through to its customers in the form of a price increase of the unmitigated cost of the current 10% tariff had no material impact on demand. The price increase negates an adverse margin impact. And CSCO cited two datapoints that argue nor was there an adverse impact on demand. CSCO noted that demand was unchanged from the week after, relative to the week before, the price increases. Additionally, CSCO noted that linearity in the quarter was identical to the linearity in the year ago quarter, supporting management s assertion of no order pull-ins tied to the tariff/price increase. There obviously is greater risk to CSCO s margin and/or revenue if and when the tariff increases to 25%. CSCO appears to downplay the risk, asserting that it can mitigate much of the impact through additional supply chain actions. That said, CSCO indicated that the full impact of an increase to 25% would not be felt until FY3Q19. On a positive note, CSCO expects the headwind from rising DRAM and NAND memory prices to continue to ease and become a tailwind in FY3Q18, representing a cost offset to potential demand fluctuations resulting from any tariff-related price increases. Valuation We have increased our 12-month price target to $59 ($58 previously), which is based on applying an unchanged 18x multiple to our increased FY19 PF EPS (ex-esc) estimate of $3.17 (previously $3.10), stripping out interest income and adding back net cash per share of $3.69. We continue to see upside to shares from improvement in the operating model above Street expectations, which in turn should translate into multiple expansion. 4
Figure 1 Cisco Results v. Cowen s and Street Consensus s Estimates, Thomson Reuters Figure 2 Cowen Estimate Changes Cisco CSCO 1FQ2019 Reported Cowen Reported Street Cowen in millions USD Estimate v. Cowen Consensus v. Street Revenues $13,072 $12,922 $150 $12,867 $54 Q/Q 1.8% 0.6% 1.2pp 3.2% -2.6pp Y/Y 7.7% 6.5% 1.2pp 6.0% 0.4pp Gross Profit $8,341 8,248 93 8,168 80 Gross Margin 63.8% 63.8% 0.0pp 63.5% 0.4pp Operating Expense $4,174 4,225 (51) 4,219 7 % of Revenue 31.9% 32.7% -0.8pp 32.8% -0.1pp Operating Profit $4,167 4,023 144 3,949 73 Operating Margin 31.9% 31.1% 0.7pp 30.7% 0.4pp EPS $0.75 $0.73 $0.02 $0.72 $0.01 EPS (incl-esc) $0.77 $0.66 $0.11 n/a n/a Fiscal Year 1Q19 2Q19E 3Q19E 4Q19E 1Q20E 2Q20E 3Q20E 4Q20E 1Q21E 2Q21E 3Q21E 4Q21E FY19E FY20E FY21E In millions, except EPS Revenues Revenue (New estimates) $ 13,072 $ 12,494 $ 13,124 $ 13,531 $ 13,844 $ 13,224 $ 13,895 $ 14,331 $ 14,595 $ 13,937 $ 14,576 $ 15,035 $ 52,220 $ 55,294 $ 58,144 Revenue (Old estimates) $ 12,922 $ 12,446 $ 13,060 $ 13,466 $ 13,462 $ 12,968 $ 13,615 $ 14,038 $ 14,031 $ 13,516 $ 14,197 $ 14,639 $ 51,894 $ 54,084 $ - Change in Revenue Estimates $ 150 $ 47 $ 64 $ 65 $ 381 $ 256 $ 280 $ 293 $ 564 $ 421 $ 379 $ 397 $ 326 $ 1,210 $ 58,144 Gross Profit 8,341 8,042 8,528 8,816 9,039 8,647 9,085 9,373 9,549 9,132 9,550 9,854 33,726 36,144 38,084 Gross Profit (Old) 8,248 7,963 8,389 8,672 8,709 8,423 8,846 9,129 9,133 8,817 9,264 9,562 33,272 35,108 - Change in Estimates $ 93 $ 79 $ 139 $ 143 $ 329 $ 224 $ 239 $ 244 $ 416 $ 315 $ 285 $ 293 $ 454 $ 1,036 $ 38,084 Gross Margin 63.8% 64.4% 65.0% 65.2% 65.3% 65.4% 65.4% 65.4% 65.4% 65.5% 65.5% 65.5% 64.6% 65.4% 65.5% Gross Margin (Old) 63.8% 64.0% 64.2% 64.4% 64.7% 65.0% 65.0% 65.0% 65.1% 65.2% 65.3% 65.3% 64.1% 64.9% 0.0% Change in Estimates -2 bp 39 bp 75 bp 75 bp 60 bp 44 bp 41 bp 37 bp 33 bp 29 bp 26 bp 22 bp 47 bp 45 bp 6,550 bp Operating Expense $ 4,174 $ 4,060 $ 4,226 $ 4,330 $ 4,444 $ 4,298 $ 4,474 $ 4,557 $ 4,641 $ 4,474 $ 4,650 $ 4,721 $ 16,790 $ 17,773 $ 18,486 Operating Expense (Old) $ 4,225 $ 4,033 $ 4,179 $ 4,282 $ 4,362 $ 4,163 $ 4,343 $ 4,464 $ 4,574 $ 4,325 $ 4,529 $ 4,641 $ 16,719 $ 17,332 $ - Change in Estimates $ (51) $ 28 $ 47 $ 48 $ 82 $ 135 $ 131 $ 93 $ 67 $ 149 $ 121 $ 81 $ 71 $ 441 $ 18,486 Operating Profit $ 4,167 $ 3,981 $ 4,302 $ 4,486 $ 4,595 $ 4,350 $ 4,610 $ 4,816 $ 4,907 $ 4,658 $ 4,900 $ 5,133 $ 16,936 $ 18,371 $ 19,598 Operating Profit (Old) $ 4,023 $ 3,930 $ 4,210 $ 4,390 $ 4,348 $ 4,261 $ 4,503 $ 4,665 $ 4,559 $ 4,491 $ 4,735 $ 4,921 $ 16,553 $ 17,776 $ - Change in Estimates $ 144 $ 51 $ 92 $ 96 $ 247 $ 89 $ 108 $ 151 $ 349 $ 166 $ 164 $ 212 $ 383 $ 594 $ 19,598 Operating Margin 31.9% 31.9% 32.8% 33.2% 33.2% 32.9% 33.2% 33.6% 33.6% 33.4% 33.6% 34.1% 32.4% 33.2% 33.7% Operating Margin (Old) 31.1% 31.6% 32.2% 32.6% 32.3% 32.9% 33.1% 33.2% 32.5% 33.2% 33.4% 33.6% 31.9% 32.9% 0.0% Change in Estimates 75 bp 29 bp 55 bp 55 bp 90 bp 4 bp 11 bp 37 bp 113 bp 19 bp 26 bp 52 bp 53 bp 36 bp 3,371 bp Earnings Per Share Ex-FAS123R EPS Ex-ESC (New estimates) $ 0.75 $ 0.74 $ 0.81 $ 0.88 $ 0.92 $ 0.88 $ 0.94 $ 0.99 $ 1.06 $ 1.01 $ 1.07 $ 1.12 $ 3.17 $ 3.72 $ 4.26 EPS Ex-ESC (Old estimates) $ 0.73 $ 0.73 $ 0.80 $ 0.86 $ 0.87 $ 0.86 $ 0.92 $ 0.96 $ 0.99 $ 0.98 $ 1.03 $ 1.08 $ 3.10 $ 3.60 $ - Change in EPS (Ex-FAS 123R) Estimates $ 0.02 $ 0.01 $ 0.02 $ 0.02 $ 0.05 $ 0.02 $ 0.02 $ 0.03 $ 0.07 $ 0.04 $ 0.04 $ 0.05 $ 0.07 $ 0.12 $ 4.26 New shares outstanding 4,614 4,514 4,414 4,314 4,214 4,194 4,174 4,154 4,054 4,034 4,014 3,994 4,464 4,184 4,024 Old shares outstanding 4,622 4,522 4,422 4,322 4,222 4,202 4,182 4,162 4,062 4,042 4,022 4,002 4,472 4,192 - Change in shares outstanding (8) (8) (8) (8) (8) (8) (8) (8) (8) (8) (8) (8) (8) (8) 4,024 Source: Cowen and Company, Cisco 5
Figure 3 Cisco Gross Margin Analysis Cisco Fiscal Year 2Q18A 3Q18A 4Q18 1Q19 In millions USD, non-gaap Gross Profit 7,685 7,970 8,082 8,341 Gross Margin 64.7% 63.9% 62.9% 63.8% Q/Q change in bps 99-70 -102 88 Product Gross Profit 3,200 3,448 3,709 3,639 % of Total 41.6% 43.3% 45.9% 43.6% Product Gross Margin 63.3% 62.9% 61.5% 63.2% Q/Q change in bps 26 bp -32 bp -141 bp 168 bp Service Gross Profit 2,176 2,114 2,149 2,090 % of Total 28.3% 26.5% 26.6% 25.1% Service Gross Margin 68.5% 66.9% 67.1% 65.7% Q/Q change in bps 286 bp -155 bp 19 bp -143 bp Figure 4 Cisco Operating Margin Analysis Cisco Fiscal Year 2Q18A 3Q18A 4Q18 1Q19 OpEx as a % of Sales 32.9% 32.5% 32.0% 31.9% Q/Q change in bps -39 bp -45 bp -46 bp -6 bp Operating Margin 31.7% 31.5% 30.9% 31.9% Q/Q change in bps 138 bp -26 bp -56 bp 94 bp 6
Figure 5 Cisco Geographic Order Growth Product Order Growth--Geography 2Q18A 3Q18A 4Q18 1Q19 Y/Y Growth Rate Americas 6.0% 4.0% 6.0% 8.0% EMEA 6.0% 6.0% 6.0% 6.0% APAJC 0.0% 3.0% 12.0% 12.0% 7
Figure 6 Cisco Product Revenue Breakdown Product Revenue Mix Fiscal Year 2Q18A 3Q18A 4Q18A 1Q19A Cowen Difference Difference In millions Estimate $ % Total Sales 11,887 12,463 12,843 13,072 12,935 (137) 1.1% % Q/Q growth -2.1% 4.8% 3.0% 1.8% 0.7% (1) % Y/Y growth 2.7% 4.4% 5.9% 7.7% 6.6% (1) PRODUCTS Infrastructure Platforms 6,694 7,163 7,443 7,642 7,493 (149) 2.0% % Total sales 56.3% 57.5% 58.0% 58.5% 57.9% % Q/Q growth -4.0% 7.0% 3.9% 2.7% 0.7% (2) % Y/Y growth 2.3% 2.4% 6.8% 9.6% 7.5% (2) Applications 1,184 1,309 1,339 1,419 1,372 (47) 3.4% % Total sales 10.0% 10.5% 10.4% 10.9% 10.6% % Q/Q growth -1.6% 10.6% 2.3% 6.0% 2.5% (3) % Y/Y growth 6.1% 19.0% 10.1% 18.0% 14.1% (4) Security 558 583 627 651 644 (8) 1.2% % Total sales 4.7% 4.7% 4.9% 5.0% 5.0% % Q/Q growth -4.6% 4.5% 7.5% 3.8% 2.6% (1) % Y/Y growth 5.7% 10.6% 12.4% 11.3% 10.0% (1) Other Products 273 249 232 178 252 74-29.3% % Total sales 2.3% 2.0% 1.8% 1.4% 1.9% % Q/Q growth -7.8% -8.8% -6.8% -23.3% 8.4% 32 % Y/Y growth -9.6% -6.4% -18.3% -39.9% -15.0% 25 Services 3,178 3,159 3,202 3,182 3,174 (8) 0.2% % Total sales 26.7% 25.3% 24.9% 24.3% 24.5% % Q/Q growth 3.1% -0.6% 1.4% -0.6% -0.9% (0) % Y/Y growth 2.9% 3.4% 3.1% 3.2% 3.0% (0) 8
Figure 7 Cisco Geographic Revenue Breakdown Geographic Revenue Fiscal Year 2Q18A 3Q18A 4Q18A 1Q19A Cowen Difference $ Difference % In millions Estimate Total Sales 11,887 12,463 12,845 13,072 12,908 164 1.3% % growth Q/Q -2.1% 4.8% 3.1% 1.8% 0.5% 1 % growth Y/Y 2.7% 4.4% 5.9% 7.7% 6.4% 1 Americas 7,004 7,161 7,555 7,752 7,732 20 0.3% % of Total Sales 58.9% 57.5% 58.8% 59.3% 59.9% % growth Q/Q -4.7% 2.2% 5.5% 2.6% 2.3% 0 % growth Y/Y 5.2% 1.6% 4.9% 5.5% 5.2% 0 EMEA 3,062 3,281 3,174 3,224 3,187 38 1.2% % of Total Sales 25.8% 26.3% 24.7% 24.7% 24.7% % growth Q/Q 5.3% 7.2% -3.3% 1.6% 0.4% 1 % growth Y/Y -0.1% 9.4% 8.4% 10.8% 9.5% 1 Asia/Pacific (incl. Japan) 1,821 2,021 2,116 2,096 1,990 106 5.3% % of Total Sales 15.3% 16.2% 16.5% 16.0% 15.4% % growth Q/Q -3.0% 11.0% 4.7% -0.9% -6.0% 5 % growth Y/Y -1.8% 6.6% 5.6% 11.7% 6.0% 6 9
Figure 8 Cisco Geographic Gross Margins Geographic Gross Margin Fiscal Year 2Q18A 3Q18A 4Q18A 1Q19A non-gaap Total Gross Margin 64.7% 63.9% 62.9% 63.8% Q/Q Bps chg 99 (70) (102) 88 Gross Profit 7,685 7,970 8,082 8,341 Americas 65.9% 64.4% 64.1% 65.4% Q/Q Bps chg 163 (144) (36) 133 Gross Profit 4,614 4,614 4,841 5,070 EMEA 64.6% 64.3% 63.6% 64.2% Q/Q Bps chg 135 (29) (64) 56 Gross Profit 1,977 2,109 2,020 2,070 APAJC 60.1% 61.7% 57.7% 57.3% Q/Q Bps chg (199) 163 (405) (40) Gross Profit 1,094 1,247 1,220 1,200 Figure 9 Cisco Customer Order Growth Product Order Growth--Customers 2Q18A 3Q18A 4Q18A 1Q19A Y/Y Growth Rate Product Order Growth (total) 5% 4% 7% 8% Enterprise (incl Public Sector) 5.2% 7.2% 6.4% 11.4% Enterprise (excl. Public Sector) 3.0% 11.0% 11.0% 15.0% Public Sector 8.0% 2.0% 1.0% 8.0% Commercial/SMB 14.0% 7.0% 9.0% 8.0% Service Provider -5.0% -4.0% 6.0% 2.0% 10
Figure 10 Cisco Balance Sheet Analysis Cisco Fiscal Year 2Q18A 3Q18A 4Q18A 1Q19A In millions Operating Cash Flow $ 4,070 $ 2,416 $ 4,100 $ 3,763 Net Cash $ 34,317 $ 26,359 $ 20,979 $ 17,029 Q/Q $ Chg $ (1,348) $ (7,958) $ (5,380) $ (3,950) Net Cash / Share $ 6.91 $ 5.44 $ 4.44 $ 3.69 DSO 30 31 39 32 Inventory Turns 8.9x 9.5x 10.3x 12.0x Deferred Revenue $ 18,788 $ 18,953 $ 19,685 $ 16,814 Q/Q Growth 1.2% 0.9% 3.9% -14.6% Y/Y Growth 10.0% 9.4% 6.4% -9.4% Short-term Deferred $ 11,102 $ 11,301 $ 11,490 $ 9,637 Q/Q Growth 1.7% 1.8% 1.7% -16.1% Y/Y Growth 8.4% 9.3% 6.2% -11.7% Long-term Deferred $ 7,686 $ 7,652 $ 8,195 $ 7,177 Q/Q Growth 0.5% -0.4% 7.1% -12.4% Y/Y Growth 12.3% 9.7% 6.8% -6.1% Product Deferred $ 7,825 $ 7,993 $ 8,254 $ 5,752 Q/Q Growth 3.3% 2.1% 3.3% -30.3% Y/Y Growth 19.3% 17.7% 14.8% -24.1% Service Deferred $ 10,963 $ 10,960 $ 11,431 $ 11,062 Q/Q Growth -0.3% 0.0% 4.3% -3.2% Y/Y Growth 4.2% 4.1% 1.1% 0.6% % of Total Revenue 158.1% 152.1% 153.3% 128.6% 11
12 Figure 11 Cisco Income Statement (in millions, except EPS) Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21 Jul-21 FY18A FY19E FY20E FY21E NON-GAAP Total Sales 12,136 11,887 12,463 12,844 13,072 12,494 13,124 13,531 13,844 13,224 13,895 14,331 14,595 13,937 14,576 15,035 49,330 52,220 55,294 58,144 Q/Q % Growth 0.0% -2.1% 4.8% 3.1% 1.8% -4.4% 5.0% 3.1% 2.3% -4.5% 5.1% 3.1% 1.8% -4.5% 4.6% 3.2% Y/Y % Growth -1.7% 2.7% 4.4% 5.9% 7.7% 5.1% 5.3% 5.3% 5.9% 5.8% 5.9% 5.9% 5.4% 5.4% 4.9% 4.9% 2.8% 5.9% 5.9% 5.2% Cost of goods sold 4,410 4,202 4,493 4,762 4,731 4,452 4,596 4,715 4,805 4,577 4,811 4,958 5,046 4,806 5,027 5,181 17,867 18,494 19,150 20,060 Gross profit 7,726 7,685 7,970 8,082 8,341 8,042 8,528 8,816 9,039 8,647 9,085 9,373 9,549 9,132 9,550 9,854 31,463 33,726 36,144 38,084 % Gross Margin 63.7% 64.7% 63.9% 62.9% 63.8% 64.4% 65.0% 65.2% 65.3% 65.4% 65.4% 65.4% 65.4% 65.5% 65.5% 65.5% 63.8% 64.6% 65.4% 65.5% Total Sales (ex-sp Video) 11,888 11,657 12,244 12,638 12,904 12,494 13,124 13,531 13,844 13,224 13,895 14,331 14,595 13,937 14,576 15,035 48,427 52,052 55,294 58,144 Q/Q % Growth -1.9% 5.0% 3.2% 2.1% -3.2% 5.0% 3.1% 2.3% -4.5% 5.1% 3.1% 1.8% -4.5% 4.6% 3.2% Y/Y % Growth 8.5% 7.2% 7.2% 7.1% 7.3% 5.8% 5.9% 5.9% 5.4% 5.4% 4.9% 4.9% 7.5% 6.2% 5.2% Cost of goods sold (ex-sp Video) 4,230 4,064 4,340 4,645 4,624 4,452 4,596 4,715 4,805 4,577 4,811 4,958 5,046 4,806 5,027 5,181 17,279 18,387 19,150 20,060 Gross profit (ex-sp Video) 7,658 7,593 7,904 7,993 8,280 8,042 8,528 8,816 9,039 8,647 9,085 9,373 9,549 9,132 9,550 9,854 31,148 33,665 36,144 38,084 % Gross Margin (ex-sp Video) 64.4% 65.1% 64.6% 63.2% 64.2% 64.4% 65.0% 65.2% 65.3% 65.4% 65.4% 65.4% 65.4% 65.5% 65.5% 65.5% 64.3% 64.7% 65.4% 65.5% Operating Expenses Research & Development 1,393 1,373 1,412 1,448 1,437 1,424 1,470 1,502 1,537 1,521 1,556 1,576 1,576 1,575 1,603 1,609 5,626 5,833 6,190 6,363 % of sales 11.5% 11.6% 11.3% 11.3% 11.0% 11.4% 11.2% 11.1% 11.1% 11.5% 11.2% 11.0% 10.8% 11.3% 11.0% 10.7% 11.4% 11.2% 11.2% 10.9% Sales & Marketing 2,196 2,098 2,176 2,199 2,267 2,174 2,270 2,327 2,395 2,288 2,404 2,465 2,525 2,397 2,522 2,571 8,669 9,039 9,552 10,015 % of sales 18.1% 17.6% 17.5% 17.1% 17.3% 17.4% 17.3% 17.2% 17.3% 17.3% 17.3% 17.2% 17.3% 17.2% 17.3% 17.1% 17.6% 17.3% 17.3% 17.2% General & Administrative 451 440 457 462 470 462 486 501 512 489 514 516 540 502 525 541 1,810 1,918 2,032 2,108 % of sales 3.7% 3.7% 3.7% 3.6% 3.6% 3.7% 3.7% 3.7% 3.7% 3.7% 3.7% 3.6% 3.7% 3.6% 3.6% 3.6% 3.7% 3.7% 3.7% 3.6% Total Operating Expenses 4,040 3,911 4,045 4,109 4,174 4,060 4,226 4,330 4,444 4,298 4,474 4,557 4,641 4,474 4,650 4,721 16,105 16,790 17,773 18,486 % sales 33.3% 32.9% 32.5% 32.0% 31.9% 32.5% 32.2% 32.0% 32.1% 32.5% 32.2% 31.8% 31.8% 32.1% 31.9% 31.4% 32.6% 32.2% 32.1% 31.8% Total Operating Expenses (ex-sp Video) 3,973 3,847 3,984 4,050 4,115 4,060 4,226 4,330 4,444 4,298 4,474 4,557 4,641 4,474 4,650 4,721 15,854 16,731 17,773 18,486 % sales 33% 33.0% 32.5% 32.0% 31.9% 32.5% 32.2% 32.0% 32.1% 32.5% 32.2% 31.8% 31.8% 32.1% 31.9% 31.4% 32.7% 32.1% 32.1% 31.8% 2018A 5.7% 5.2% - Operating Income 3,686 3,774 3,925 3,973 4,167 3,981 4,302 4,486 4,595 4,350 4,610 4,816 4,907 4,658 4,900 5,133 15,358 16,936 18,371 19,598 Operating margin 30.4% 31.7% 31.5% 30.9% 31.9% 31.9% 32.8% 33.2% 33.2% 32.9% 33.2% 33.6% 33.6% 33.4% 33.6% 34.1% 31.1% 32.4% 33.2% 33.7% Operating Income (ex-sp Video) 3,685 3,746 3,920 3,943 4,165 3,981 4,302 4,486 4,595 4,350 4,610 4,816 4,907 4,658 4,900 5,133 15,294 16,934 18,371 19,598 Operating margin (ex-sp Video) 31.0% 32.1% 32.0% 31.2% 32.3% 31.9% 32.8% 33.2% 33.2% 32.9% 33.2% 33.6% 33.6% 33.4% 33.6% 34.1% 31.6% 32.5% 33.2% 33.7% Interest and Other Inc/(Exp.), net 206 159 119 246 104 121 129 177 184 200 235 243 383 390 398 406 730 531 862 1,577 % of sales 1.7% 1.3% 1.0% 1.9% 0.8% 1.0% 1.0% 1.3% 1.3% 1.5% 1.7% 1.7% 2.6% 2.8% 2.7% 2.7% 1.5% 1.0% 1.6% 2.7% (9) 2019E Net Income Before Tax 3,892 3,933 4,044 4,219 4,262 4,102 4,431 4,663 4,779 4,549 4,846 5,059 5,290 5,048 5,298 5,539 16,088 17,467 19,233 21,175 % of sales 32.1% 33.1% 32.4% 32.8% 32.6% 32.8% 33.8% 34.5% 34.5% 34.4% 34.9% 35.3% 36.2% 36.2% 36.3% 36.8% 32.6% 33.4% 34.8% 36.4% Income Taxes 856 787 849 893 810 780 842 886 908 865 921 961 1,005 959 1,007 1,053 3,385 3,318 3,655 4,024 % tax rate 22.0% 20.0% 21.0% 21.2% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 21.0% 19.0% 19.0% 19.0% Net Income 3,036 3,146 3,195 3,326 3,452 3,323 3,589 3,777 3,871 3,685 3,925 4,097 4,285 4,089 4,291 4,486 12,703 14,149 15,577 17,151 % Net margin 25.0% 26.5% 25.6% 25.9% 26.4% 26.6% 27.3% 27.9% 28.0% 27.9% 28.2% 28.6% 29.4% 29.3% 29.4% 29.8% 25.8% 27.1% 28.2% 29.5% Non-GAAP diluted EPS $ 0.61 $ 0.63 $ 0.66 $ 0.70 $ 0.75 $ 0.74 $ 0.81 $ 0.88 $ 0.92 $ 0.88 $ 0.94 $ 0.99 $ 1.06 $ 1.01 $ 1.07 $ 1.12 $ 2.60 $ 3.17 $ 3.72 $ 4.26 Shares (fully diluted) 4,994 4,966 4,844 4,722 4,614 4,514 4,414 4,314 4,214 4,194 4,174 4,154 4,054 4,034 4,014 3,994 4,882 4,464 4,184 4,024 2020E 2021E This report is intended for world-cowen-morningnotesdistribution@cowen.com. 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VALUATION METHODOLOGY AND RISKS Valuation Methodology Data Networking & Wireline Equipment: Our valuation methodology is based on Price to Earnings per Share (P/E) and in cases where the company lacks consistent positive earnings, Enterprise Value to Revenue (EV/Rev). In certain cases, our valuation is also informed by a discounted cash flow (DCF) analysis. Investment Risks Data Networking & Wireline Equipment: (1) rapidly changing/disruptive technology, particularly software defined networking, network functions virtualization, and virtualization could have an adverse impact on demand and/or pricing; (2) deterioration in the macro environment both domestically and internationally could lead to a reduction in enterprise IT spending and service provider capital expenditures with a consequent adverse impact on Data Networking and Communication Equipment companies revenue and valuation multiples; and (3) further consolidation among service providers or adverse regulatory changes on service providers could lead to a reduction in their capital expenditures. Risks To The Price Target Software Defined Networking and Networks Functions Virtualization result in the commoditization of hardware, causing Cisco s gross margins to significantly contract; Cisco is unable to extract additional productivity gains needed to offset the rate of pricing decline; Cisco is unable to fund its current dividend; Cisco's current growth products are unable to offset the flat to declining growth of its switching and routing businesses; and continued macroeconomic uncertainty. 13
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40 35 30 25 20 15 70 60 50 40 30 20 10 (1):$32.00 12/10/15 (1):$33.00 06/03/16 (1):$35.00 12/09/16 (1):$36.00 06/02/17 (1):$33.00 12/06/17 Ciena Rating History as of 11/14/2018 powered by: BlueMatrix (1):$37.00 06/01/18 (1):$39.00 08/31/18 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Jul 17 Oct 17 Jan 18 Apr 18 Jul 18 Oct 18 I:(1):$57.00 07/23/18 (1):$64.00 08/08/18 Closing Price Target Price II-VI Incorporated Rating History as of 11/14/2018 powered by: BlueMatrix Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Jul 17 Oct 17 Jan 18 Apr 18 Jul 18 Oct 18 Legend for Price Chart: Closing Price Target Price I = Initiation 1 = Outperform 2 = Market Perform 3 = Underperform UR = Price Target Under Review T = Terminated Coverage $xx = Price Target NA = Not Available S=Suspended 16
POINTS OF CONTACT Analyst Profiles Paul Silverstein New York 646 562 1340 paul.silverstein@cowen.com Paul Silverstein is a senior analyst covering networking and wireline equipment. He has covered the industry for almost 20 years. Reaching Cowen Main U.S. Locations New York 599 Lexington Avenue New York, NY 10022 646 562 1010 800 221 5616 Atlanta 3399 Peachtree Road NE Suite 417 Atlanta, GA 30326 866 544 7009 International Location Cowen International Limited London 1 Snowden Street - 11th Floor London EC2A 2DQ United Kingdom 44 20 7071 7500 Boston Two International Place Boston, MA 02110 617 946 3700 800 343 7068 Chicago 181 West Madison Street Suite 3135 Chicago, IL 60602 312 577 2240 Fahad Najam New York 646 562 1427 fahad.najam@cowen.com Fahad Najam is an associate covering networking. He spent 13 years in the networking industry in various roles and has an MBA from Wharton. Cleveland 20006 Detroit Road Suite 100 Rocky River, OH 44116 440 331 3531 Stamford 262 Harbor Drive Stamford, CT 06902 646 616 3000 Elizabeth Pate New York 646 562 1437 liz.pate@cowen.com Liz Pate is a research associate covering networking and wireline equipment. She has spent nearly 20 years in equity research. San Francisco One Maritime Plaza, 9th Floor San Francisco, CA 94111 415 646 7200 800 858 9316 Washington, D.C. 2900 K Street, NW Suite 520 Washington, DC 20007 202 868 5300 COWENRESEARCH COWEN INC. 17