This week, Cisco Live! kicks off in San Francisco. Live! is Cisco’s annual global user conference and it’s the place to be for anyone who wants to learn more about Cisco, or just networking trends in general. Formerly known as Networkers, the show has steadily increased in size as Cisco has grown from a small network pure-play to a massive vendor that now deals in many adjacent markets, such as servers, collaboration, cloud, security and mobility.
Recently though, Cisco’s business model and CEO have come under attack as the threat of SDNs loom large on the horizon. It seems not a week goes by that I don’t hear the chatter of how SDNs will commoditize the traditional network since the perception is that the world is embracing pure software solutions on commodity infrastructure.
My opinion is that this fear is highly over-rated. In fact, the commoditization of the network is something that’s been rumored and discussed for the past 20 years, but it’s never happened. My thesis is that most of the struggles that Cisco has faced over the past few years have been more product transition and global macro-oriented than anything, and this past quarter seems to have supported that.
Two quarters ago, the sky was falling on Cisco. Product margins fell below 60% for the first time in a decade and corporate margins were dangerously close to falling below that number. I had talked with a large Cisco investor that told me that 59.9% margins would be viewed as much worse than 60.1% based purely on perception. However, that could also be interpreted as Cisco’s business finally being commoditized.
This past quarter, though, product margins returned to 61.4% and overall non-GAAP margins rose 140 basis points to 62.7%. This increase came despite service margins taking a bit of a dip and returning to more normal levels from an anomalous previous quarter. Book to bill was also well above 1, indicating a strong backlog of orders to come.
What’s causing the new strength? I believe Cisco is starting to see some of the fruit of many of its new products. The most notable product was the new ACI-enabled Nexus 9000. At the end of the quarter, Cisco had 175 customers using the 9K, up from 25 the prior quarter. Cisco should hit 1,000 customers over the next quarter or two, which bodes well for the release of the ACI controller. Cisco announced the 9000 well ahead of its release and, in doing so, it created its own “air pocket” in switching, as customers awaited the release of the product instead of buying a 7000. Overall switching revenue was down year-over-year though, primarily due to pressure in campus switching. While the 3850 continues to grow, that area has become more price-competitive, although far from being a commodity. Cisco transition in switching is still early, but the business unit is headed in the right direction.
Also, high-end routing bucked a three-quarter trend of declining revenue to show growth this year, led by the ASR 9000 almost 60% growth in this quarter. Again, the routing business was down 10% year-over-year, but up 11% sequentially, indicating new product transitions are just starting to kick in. Routing and switching are the foundational technologies at Cisco and having these business units rebound bodes well for foreseeable future and certainly counters the claim that the network is being commoditized.
Wireless also had a rebound quarter. This past quarter, Cisco introduced a new mid-range access point to the family. Prior to this quarter, Cisco had high-end Aironet products and lower-end Meraki-managed APs, causing the company to push a lower-cost Meraki product or heavily discounting the Aironet APs based on customer demand, neither of which is ideal.
Despite the strength Cisco showed this quarter, there are still some chinks in the armor, the most notable of which is the collaboration business unit. Collaboration declined again this quarter, but the company is unveiling a number of new collaboration products at this week’s Cisco Live! conference to complement the products released at Enterprise Connect in March. Also, we’re all waiting with baited breath to see how ACI fares as it goes into general availability very soon.
It seems the story for Cisco over the past couple of years has been “new products are on the way,” and that caused some of the mediocre performance we saw over that time period. It’s not that the business was bad, but that it wasn’t great. It just seemed like Cisco was treading water. The company has launched a number of new products this year and we should expect the remainder of the calendar year to be much of the same. So before we call for the fall of Cisco, let’s see how these new products fare over the next few quarters.