Cisco continues software transition, but slow service provider spending, switching impacts Q4 results

Cisco remains confident that its ongoing transition to a subscription and software-based model will continue to pay off, but in the near term, the vendor continues to face challenges with slower service provider and switching spending.

The company’s refocus on software is designed to stabilize revenue as its core routers and switching lines of revenue continue to decline.

Chuck Robbins speaks at a Cisco event in this screencap.
Chuck Robbins

“We're delivering the right consumption models to enable continuous value and innovation for our customers,” CEO Chuck Robbins said during the earnings call, according to a Seeking Alpha earnings transcript. “Our strong momentum continued in Q4 with 50% growth to $5 billion in deferred product revenue related to software and subscriptions which has doubled from two years ago.

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During the fourth quarter, Cisco generated 31% of its total revenue from recurring offers, an increase of almost four points from a year ago. Revenue from subscriptions increased 18% and now represents over 50% of the vendor’s software revenue. However, total product orders for the fourth quarter were flat.

"As we've discussed many times in the past, we're working on a multiyear transition," Robbins said on the call. "And while I'm confident with our progress, it's clear that there's more for us to do."

Specifically, service revenue rose 1% due to growth in software and solutions services partially offset by a decline in hardware maintenance. Revenue from subscriptions now represents 51%, or $5 billion, of the company's software revenue and 31% of Cisco's total revenue.

“We continue to transform our business to delivering more software offerings and driving more subscriptions and recurring revenue,” Robbins said.

Service provider weakness

While Cisco has clearly set a growth path based on software, likely due to its customer requests, the vendor continues to see weak spending in the service provider industry segment.  

Robbins noted that in the service provider segment it saw “weakness” in all of the regions it serves.

“I think we have characterized it as, it's less about different portions of the network and it's really about the disparity across large customers,” Robbins said. “As I said in the last couple of calls, we literally had some very big customers that were growing double-digits and others that were on the opposite side of that.”

Weak service provider spending is being caused by a number of issues, including regulatory and economic issues.

“It is really is more of a customer variability issue then it is a single place in the network infrastructure that is causing a problem,” Robbins said. “And that's what we've seen for several quarters and again some of it is based on regulatory issues and geopolitical dynamics others are based on consolidation going on in a certain part of the industry.”

Despite the near-term pressures, Cisco says it can play a major role as a supplier for wireless operators transitioning to 5G. Cisco is not in the radio access market, but the service provider can play a supporting role by providing necessary routing and software infrastructure to support the eventual ramp-up in customer data.

“We're beginning to have discussions with customers, who are thinking about 5G,” Robbins said. “While we're not in the macro radio space, one of the key things that they are working on is as I add a significant number of new devices at higher speeds and lower latency out at the edge of the network, what is that going to mean for the performance they need in the core of the network.”

Switching in transition

Besides lower service provider results, the vendor’s switching results continued to see struggles in the fourth quarter, with revenues declining 9%. Cisco is hoping that its new line of Catalyst 9000 switches and the intent-based networking concept—one that it is currently vetting with its largest enterprise customers—could boost switching revenues.

While it is taking time for customers to evaluate the concept and the new switches, Cisco is already seeing acceptance for the new solutions.

“Now anytime we do a major platform announcement particularly in switching there is a period of time where our customers pause because they want to understand what this means,” Robbins said. “We saw great traction with the new platform. Just in the four weeks where we closed the quarter we had 200 customers that embraced this new architecture and purchased a new Catalyst 9000 platform.”

Robbins added that a number of the customers are also purchasing a software subscription.

“The great majority of these customers also opted for the advanced software subscription that goes on top of it,” Robbins said. “We've had a lot of conversations over the last two years as to whether we could really drive a subscription business on our core switching platforms and what we see is that at least early indications are that we can do that.”

Here’s a breakdown of Cisco’s key metrics:

NGN Routing: Driven by weakness in enterprise access, NGN routing revenues were $1.89 billion, down 9%. The vendor noted that it saw a spending pause related to its acquisition of Viptela, which it will integrate into its SD-WAN portfolio.

Switching: Due to weakness in Campus, Switching revenues were $3.43 billion, down 9%. However, the results were partially offset by growth in the ATI portfolio, which was up 38%. The vendor reported initial traction of its intent-based networking portfolio of the Catalyst 9000 family of switches.

Data Center: Data Center revenue was $837 million, up 4%, topping analysts' estimates and helping overall revenue meet expectations.

Security: In Cisco's security business, which offers firewall protection and breach-detection systems, revenue rose 3% to $558 million but fell short of analysts' expectations of $580.5 million.

Financials: Total revenue was $12.1 billion, down 4%, with product revenue down 5% and service revenue up 1%. Thirty-one percent of total revenue was from recurring offers, up 4 percentage points from the fourth quarter of fiscal 2016.

For the fiscal first quarter, Cisco forecast a 1%-3% decline in revenue and an adjusted gross margin of 63%-64% versus 64.6% in the fourth quarter. EPS is estimated at 48 to 53 cents.