Cisco steadied the ship in its fiscal third quarter (to April) and said the growth in mobile data and the internet of things continued to fuel demand. However, much of that stimulus is being felt in the traditional router business rather than the wireless products themselves, which delivered only 3% growth.
The company reported a 5.5% year-on-year fall in revenues to $11.5bn, but this was a less sharp decline than Wall Street had expected. Net profit was down 12% to $2.2bn and earnings per share dropped 8.7% to $0.42.
Cisco ended the quarter with total cash of $50.5bn, and is likely to be on its well-trodden acquisition trail this year to bolster its platforms for mobile and M2M data and the cloud, which it sees as the main sources of new revenues for its core network infrastructure offerings, and for emerging businesses such as SDN (software defined networking) and managed services.
Across the portfolio, a key challenge will be to improve performance in the carrier sector, which has been dragging down revenues even as the heartland enterprise business has improved. Cisco says the service provider operation will take ‘multiple quarters’ to return to growth, though orders in Q314 were down 5% year-on-year, far better than the 12% decline seen in Q214 or 13% in Q114. A point of concern will be the 26% fall in revenue from service provider video systems, which Cisco has identified as a key growth area.
In contrast to many rivals, the weakest regions, in terms of the carrier segment and overall, were in emerging economies, while orders were up in the US and Europe, especially for enterprise products including high end routers, data center and security offerings. US orders were up 7% and northern Europe 4%, though austerity round the world continues to weigh on public sector sales. Orders in the BRIC economies and Mexico fell by 13%, partly because of China’s rising tendency to rely on its homegrown vendors.
Stabilization of the carrier business, recovery in enterprise, and the promise of new revenues from the IoT and the cloud, were all factors behind a better-than expected forecast for sales in the current fiscal fourth quarter. CEO John Chambers said Q4 revenue would be between $12bn and $12.3bn, which would represent a drop of 1% to 3% on the year-ago period, and a significant improvement on analyst predictions of $11.8bn.
Chambers remained cautious, however, pointing to slow progress among carriers ‘ both a ‘macro and Cisco-specific’ problem ‘ and admitting on the analyst call that ‘we’ve got some real heavy lifting to do and I’m sure there will be a couple of bumps along the way, especially in emerging markets’. Challenges include the shift to SDN, which will force Cisco to rethink not just its core products but its margins and channels, and which is seen by some customers as an opportunity to break the long reliance on Cisco’s network platforms. ‘The industry has been doing a lot of work to become less reliant on Cisco,’ Matt Robison, an analyst at Wunderlich Securities, told Bloomberg.
Although Chambers has masterminded a major reorganization over the past few years ‘ exiting the consumer sectors and starting the long transition to SDN ‘ growth still proves elusive. In December the company reduced its forecast for average sales growth to between 3% and 6% for the next 3-5 years, down from an earlier projection of 5% to 7%. Cisco has reduced its workforce by over 12,000 in the past two years.
The return to growth will rely heaviy on the cloud and IoT, as well as increased mobile operator business, says the firm. One of its challenges is that a company of this scale and position needs not just to enter new markets, but to shape and lead them. It has risen to this in characteristic fashion, with bold platforms that claim to unify the industry, while effectively establishing Cisco-driven technologies as de facto standards.
This has been seen in SDN, where Cisco is promoting an approach which some label ‘hardware defined networking’ for its close ties to the firm’s infrastructure. Chambers said Cisco would “not only embrace SDN and benefit from it, but we’re going to lead in SDN.” The heart of its offering its is Application Centric Infrastructure which will be embedded in the cloud, data center, LAN, and edge network, said the company.
The bid for cross-industry leadership is also seen in the cloud, where the vendor recently announced its Intercloud strategy, to provide a ‘cloud of clouds’, spanning its own and those of partners – not just targeting traditional enterprise customers, but providing a platform on which telecoms or vertical market operators can run services for their own customers.
Intercloud also provides an important building block for future IoT strategies. Cisco will invest about $1bn over the next two years in expanding its cloud platform, buying in ‘ perhaps grudgingly ‘ to the IT sector notion that in the next network architecture, only two things will matter – the infrastructure to support the mobility of users (some of that virtualized in data centers), and clouds where services are centralized. Cisco’s hopes for recovery in its operator business, and dominance in IoT, will rely on service providers needing a lot of help to make that transition, and being willing to entrust the leap to third parties.
That will see Cisco, almost inevitably, becoming a far bigger supplier of managed services than it currently is, going up against the giants from the IT and telecoms sectors ‘ IBM, Ericsson, HP ‘ and the cloud majors like Amazon, Google and Microsoft, which are also targeting enterprise and carrier business. The future pattern is illustrated in the breakdown of its Q3 revenues by category. Product revenue was down 8% year-on-year while services sales were up 2.6%. Data center revenue was up 29% and security up 10%, and growth in the latter business is accelerating. But the flatness in the core business remains a concern – router revenue was down 10%, and switches down 6%, though orders have picked up. Wireless revenues were disappointing, up by only 3%, though the current quarter should be better, as Cisco announced orders up 12%, with Meraki again a key driver. Set-top boxes are the major weakness, showing 26% decline, and Cisco is likely to accelerate the sidelining of that unit.
A small step in these directions was taken when Cisco acquired Meraki, which brought a cloud-based platform for managing enterprise WiFi, but which will be the basis of broader services. The 2012 purchase was justified by its performance during the quarter, with revenues up 150% year-on-year and a 30% increase in customer numbers since Q214.
Despite these bright spots and a fairly convincing medium term growth strategy, based around the industry’s hottest talking points, Cisco has a long struggle ahead. It has demanded patience from its investors, with its share price having been stagnant for a decade and its investments in new markets yet to show significant impact on the results. It has made some tough decisions, such as refusing to sacrifice its margins in the quest for revenue growth. In the quarter, gross margins were a respectable 62.7%, up on the previous period, indicating that Cisco is holding its nerve amid the commoditization of its core business, and that it still commands a price premium with many customers.