Quarterly revenue and non-GAAP EPS were $56 million and $0.03 ahead of street expectations respectively. The $12.7 billion in revenue represents 6.4% year-over-year growth, which is impressive for a $50 billion annual-run-rate company. While the financials give the industry a sense that demand for Cisco is strong, it’s worth looking behind the numbers to get a better picture of where Cisco’s business is and where it’s going.
Demand for company’s products never stronger
The numbers show 6.5% year-over-year growth, but that was tempered by the macro supply chain issues. Total product order growth for the quarter was up 33% YoY, making it the third consecutive quarter this metric has topped 30%. Looking at segments, enterprise orders grew 37%, its strongest number in a dozen years. Service providers and webscale grew 42% and 70%, respectively. These are notable because Cisco has struggled in these segments historically, but that ship seems to have turned on the strength of a refreshed ASR 9K and Catalyst 8K portfolios. These include the acquisition of Acacia. Commercial business (SMB) jumped 34% and public sector 22%. This order growth has resulted in an RPO growing (remaining performance obligation) 8.5% to $30.5 billion, with 53% to be recognized in the next 12 months. Also, Cisco reported its backlog is now over $14 billion, which oddly enough includes $2 billion in software backlog, which is unusual but occurs due to the tie to hardware. CEO Chuck Robbins addressed the backlog on the earnings call and noted that supply issues have not gotten worse but also have not improved. The shift to subscription and inventory backlog has put Cisco in a comfortable, predictable position with demand not seen in more than a decade. AA
A massive software company
Under Robbins, Cisco has been aggressive in its transition to subscription software. This wasn’t an easy thing to do for a company whose value is mostly tied up in hardware. Total software revenue is now $3.8 billion, 80% of which comes via subscription. That number annualizes to more than $15 billion in software, making it a top-5 software company. While many Cisco products are still delivered as hardware, much of the value is now through software. This is an important pivot because it enables the company to innovate new features its customers can use, faster than with a hardware-only model. Consider how Teslas, iPhones, and other consumer devices are hardware devices that deliver value through software updates. All of Cisco’s newer hardware products work this way. Customers buy the hardware but also purchase a software subscription. This ensures they can run the latest and greatest features without going through a costly hardware upgrade.
The network is not a commodity
Many industry watchers have been calling for the network to be commoditized for the better part of two decades. The bearish outlook on Cisco was that network features were largely becoming standardized, leaving no room for differentiation and causing the bottom to fall out of the industry. Huawei was going to do this to Cisco, the same way software-defined networking was going to do it to white boxes. These trends have come and gone, yet Cisco’s gross margins remain in the mid-60% range, where it has historically been. In technology, it’s always been my belief that no market is a commodity if the vendor can create differentiation. People pay thousands for a MacBook even though Chromebooks are just a few hundred dollars. VMware maintains healthy margins for virtualization despite a strong push from Microsoft. Cisco’s differentiation in networking has been and continues to be driven via its custom silicon. Most network vendors use merchant silicon from vendors such as Broadcom, but Cisco has largely eschewed that model. It has built its hardware, allowing it to often get a first-mover advantage with new features and performance numbers. From an enterprise perspective, the shift to hybrid work has shone a new light on the network, which rarely earned any C-level attention previously. In a recent ZK Research study, a little over 60% of business leaders stated that the network has grown in business value since the pandemic began. Most enabling technologies for digital initiatives, such as cloud, mobile, and IoT are network-centric, making the choice of network vendor a critical one for businesses. With that being said, the competitive landscape in this area is much tougher for Cisco. Arista, HPE, VMware, Juniper, and Extreme Networks are all strong companies. Also, AWS, GCP, and Azure eyeing network services and 5G could shift things to telcos, so it will be interesting to see if Cisco can continue to stay at the front of the innovation train.
Security, collaboration in transition
While the network business remains robust at Cisco, its security and collaboration businesses are currently in the midst of transitions. Security showed growth of 7%, which is well behind the growth of companies like Palo Alto, Fortinet, and Zscaler. However, Cisco’s security growth number is a mix of declining on-premises hardware and cloud-delivered security centered in its Duo product. Over time, the hardware business will level out and security growth should jump back up to the teens, but right now the legacy products are acting as a drag on the business. Similarly, Cisco’s collaboration products experienced a decline of 9%. I know the core Webex business is growing, but Cisco has a huge base of customers still using on-premises VoIP, Jabber, and Telepresence. Also, many of Cisco’s newer collaboration endpoints were bitten by supply chain issues, limiting availability. Again, over time I expect to see Cisco migrate customers over to Webex and, as this happens, collaboration should return to growth.
