Cisco's Security, Services On Fire, But Switching, Routing Still Cooling

Cisco beat Wall Street estimates during its third fiscal quarter through double-digit growth in its security, collaboration and services business, which offset revenue declines in its bread-and-butter switching and routing, the company reported.

"We had security revenue growth of 17 percent, while deferred revenue grew 31 percent driven by our ongoing shift from hardware to more software and subscription services," said Cisco CEO Chuck Robbins during the company's earnings call Wednesday. "Security is and will remain one of our absolute highest priorities. … A lot of what you've seen is operational discipline and execution, to be honest."

The San Jose, Calf.-based networking giant saw its second straight quarter of double-digit growth in security, which climbed 17 percent in Cisco's third quarter, to $482 million, year over year.

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"It's a validation for Cisco, but also a validation for the channel [that] is making those same security bets," said Kent MacDonald, vice president of converged infrastructure and network services at Long View Systems, a Calgary, Alberta-based solution provider and Cisco Gold partner. "The market is recognizing Cisco's innovative technology to address security."

Overall sales for the third quarter, which ended April 30, reached $12 billion (excluding the service provider video CPE business it has sold), growing 3 percent year over year and beating Wall Street estimates of $11.97 billion.

Cisco's stock rose 6 percent in after-hours trading, jumping from $26.72 per share to $28.36.

The company reported an 11 percent uptick in overall service revenue, to $3.13 billion, year over year, as well as a 36 percent spike in deferred software subscription revenue.

"[We've] been trying to strengthen our capability around the entire software and subscription business model, which requires a lot of focus on adoption and renewals, and we've also taken that same approach to just sharpen our focus on our services renewal business and we did see improvement," said Robbins.

Chris Bottger, chief technology officer at IVCi, a Hauppauge, N.Y.-based solution provider and Cisco Gold partner, said IVCi is seeing similar services growth with higher margins compared with those of products.

"I'm now getting pull-through from the hardware maintenance services," said Bottger. "I'm getting pull-through from the standard Cisco cloud services. Then we are getting pull-through from our integration services and have professional services around it all. We see an increase in our services business overall [and Cisco] is allowing us to keep expanding it."

One negative trend identified in the earnings report was a 3 percent year-over-year decline in switching -- Cisco's largest revenue stream -- to $3.45 billion. The company reported a 4 percent decline in switching during its second fiscal quarter.

Robbins blamed the switching decline mainly on macro-related weaknesses in Cisco's campus business.

"Our campus switching business is largely driven by refresh, which, in an uncertain time -- enterprises that have infrastructure that's functioning for them -- they're not going to make the move to upgrade. So we see a pause in that refresh cycle, which we talked about last quarter, and nothing's really changed there," said Robbins.

Cisco also reported a 5 percent decline year over year in its routing business, its second-largest revenue segment, which generated $1.89 billion for the quarter.

"On our routing business, clearly there's ... macro issues we're dealing with. … We saw some increased caution in service provider space," said Robbins. "We saw slow movement in the core of those networks -- kind of flat-ish activity at the edge."

Cisco partners said they weren't concerned with the drop in the company's bread-and-butter switching and routing revenues.

"Look, they're driving those new product lines and holding, by in large, the route-switch number, and Cisco remains the dominant market leader," said Long View Systems' Macdonald. "That [switching and routing revenue] number is commendable while you're growing security and collaboration."

In collaboration, Cisco reported a jump of 10 percent, to $1.07 billion, compared with the same quarter the year before, while its service provider video segment increased 18 percent in the period, to $468 million.

Both data center and wireless increased 1 percent, to $811 million and $615 million, respectively.

Robbins reported that Cisco's Unified Computing System (UCS) now has an install base of 52,000 customers. The company's software-defined networking solution, Cisco Application Centric Infrastructure (ACI), grew revenue 100 percent year over year and now has a $2.2 billion run rate, he reported.

"We're far outpacing our next closest competitor in both size of business and growth rate," said Robbins.

In regard to acquisitions, Robbins said, "Over the next 12 months, I wouldn't expect it to be quite as fast-paced as it has been, but we'll continue to be opportunistic around the areas of growth that are important to our future."

For its fourth fiscal quarter, Cisco expects to see growth of zero percent to 3 percent year over year on non-GAAP earnings of 59 cents to 61 cents per share.

The company's fourth-quarter financial results are scheduled to be reported Aug. 17.