Cisco Systems Ekes Out an Earnings Win, Disappoints On Forecast

Cisco Systems has successfully managed to meet investors’ expectations while simultaneously beating Wall Street’s estimates for fiscal Q1 2015. Analysts had expected Cisco Systems’ non-GAAP EPS to be flat at $0.53 and revenue to be $12.2 billion, while Cisco Systems reported a non-GAAP earnings of $0.54 and revenue of $12.2 billion. While this is technically an earnings beat, it is still a quarter over quarter decrease from $12.3 billion during the same quarter last quarter.

For GAAP earnings, Cisco Systems reported $1.8 billion in profit on $12.2 billion in revenue, which represents an increase of 1.3% for revenue and a decrease of 8.4% in terms of profit when compared to the same quarter a year ago. When compared to non-GAAP earnings, however, Cisco Systems appears to be much more flat with non-GAAP earnings coming in at $2.8 billion for Q1 2015 compared to $2.9 billion in Q1 2014. EPS is also a different story with non-GAAP EPS increasing to $0.54 from $0.53, which is where analysts had expected Cisco Systems’s earnings to remain flat.

Developed Markets and Products Battle to Offset Slowdowns in High Growth

As expected, Cisco Systems’ regional revenues (yoy) were a mirror of last quarter with the Americas reporting a 2% increase in revenue thanks to extremely strong public sector growth (22%) and EMEA reporting an increase of 6% driven mostly by 20% growth in the UK and Southern Europe. This counteracted the revenue losses in APJC of nearly 12%, translating to an overall year over year revenue increase of only 1% globally across all regions and a 1% decrease quarter over quarter. This is the same outcome that Cisco Systems’s earnings saw last quarter and considering the existing political and economic climates within the BRIC countries and the US and Europe, there appears to be no end in sight to such a trend. Although, recent trade agreements between the US and China may help Cisco Systems improve in APJC in future quarters.

Cisco Systems’ business units also saw some changes, but for the most part remained within the same portions of the company’s revenues. Switching moved up to 31% of revenue from 30% quarter over quarter, while growing 3% year over year. Routing stayed mostly flat quarter over quarter in terms of revenue, but shrunk by 4% year over year. Collaboration also stayed essentially flat quarter over quarter, but was down 10% year over year. Service Provider Video revenue took the biggest hit of all the business units, dropping nearly $200 million quarter over quarter, as suspected could happen in the earnings preview. Service provider video was down 12% year over year and 19% quarter over quarter. Data center was slightly down to flat quarter over quarter, but up 15% year over year, indicating continued strength in the data center. Wireless was also slightly down to flat quarter over quarter, but still up 11% year over year. Security also saw growth, up slightly quarter over quarter and 25% year over year, continuing the compound growth of Cisco Systems’s security business.

Small Bright Spots Need to Get Bigger

For Cisco Systems, it saw switching revenue grow 3% year over year and the company believes that their Nexus routers are starting to see more customer adoption. Cisco Systems claims over 900 customers of the Nexus 9K and claims more than doubled paying customer adoption of APIC, meaning that there is some weight to rumors that Cisco Systems is giving away some of their switches just to fend off SDN competition. The company also claimed a record 600 new customers for the Nexus 3K, but did not give details of exactly how many are paying customers.

Cisco Systems has shown strength in wireless, especially with the growing adoption of 802.11ac and Cisco Systems finally closed their acquisition of Metacloud, which will enable Cisco Systems to have a more powerful hybrid cloud platform. It remains to be seen how Metacloud will help Cisco Systems grow their hardware sales, but it could definitely help them expand their already enormous services business.

More Bumps in the Road

Cisco Systems is still a profitable company, but it has a lot of things that are working against it. It is battling a squeeze from Asia and major revenue losses in their Service Provider Video business unit which the company paid $5 billion for. Last quarter, Cisco Systems was barely able to make up for the revenue losses in Europe and Asia with growth from the US, and even then if you look at it from quarter to quarter it was still down.

In addition to the regional economic and political problems in Asia and Europe, Amazon faces strong challenges from changing infrastructure trends at home. Some of their biggest potential customers are building data centers that are custom-built SDNs like Amazon’s own implementation of single-root I/O in order to virtualize each user and network connection to have their own virtual network card.

Cisco Systems also faces challenges from some of their biggest customers, the carriers and ISPs potentially holding off on network upgrades in 100 cities due to changing political climate. In fact, AT&T recently said that it would halt their nationwide fiber rollout until Net Neutrality issues were resolved and the FCC decides how they will regulate ISPs. The same will very likely apply to carriers like Verizon who don’t want to spend the money if they don’t believe they will get the ROI. All of that is potentially a lot of lost business for Cisco Systems, when the US market is their strongest market and what has been helping keep them profitable.

Cisco Systems’s own John Chambers, very likely realizing this has even spoken out against Obama’s plan saying that it is a bad idea and will hurt innovation. In fact, Chambers has already warned that some of Cisco Systems’s service provider business is likely suffering, part, due to uncertainty regarding Net Neutrality. Even though, the reality is that Cisco Systems also needs to seriously find ways to keep their service provider customers, even if there are Net Neutrality issues muddling the waters.

Investors seem satisfied with Cisco Systems’ most recent quarterly performance, but the truth is that Cisco Systems has a very challenging longer term future with so much uncertainty in the networking business. The company needs to step up their SDN rollouts, reconsider a more open SDN approach and really show that it is making major strides forward in the SDN space by talking about big customer rollouts and showing how their SDN-based systems interoperate with other vendor’s SDN systems. As for the open networking threat in the public cloud, Cisco simply doesn’t have an answer. Google, Amazon, Microsoft Azure and Facebook are actively rolling out bare metal routers sourced from ODMs and running their own flavor of Linux-based networking OS or branded open networking switches like Dell with Cumulus or Big Switch on it. I’d like to hear Cisco weigh in on this some time.