Beyond Cisco’s downward guidance and layoff carnage lies a glimmer of software

By Fritz Nelson , written on August 19, 2013

From The News Desk

Cisco set several records of substance for its 2013 Q4 earnings last week. The company’s revenues ($12.4 billion), non-GAAP operating income, net income and earnings per share led the way, along with $4 billion of cash flow, of which $2.1 billion was returned to shareholders. The company exceeded the midpoint of its guidance, grew its wireless business and its data center business, saw topline growth in the enterprise in the U.S., and acquired SourceFire, an information security provider, and the seventh acquisition this calendar year.

In other words, as one of the world’s largest, most strategic technology vendors marches toward the $50 billion annual revenue mark, everything seemed to be going just swimmingly.

But then the drowning began. Cisco provided a more unpleasant Q1 guidance (only 3 - 5% year-over-year growth for the foreseeable future), announced that it would lay off 4,000 employees, and saw its stock tumble from highs of more than $26 to slightly above $24.

Cisco CEO John Chambers attributed the Ciscophrenia to an inconsistent recovery, a depressed global GDP, and the lack of predictability in Asia and in emerging markets, particularly in Japan (usually a strength for Cisco), and China, which only accounts for 5% of Cisco’s revenues, Chambers said, but was down 6% in the quarter.

Chambers described Cisco’s projected growth as “painful.” He indicated that the layoffs, which follow a headcount increase of about 900 since Cisco’s last substantial cut in July 2012 when approximately 1,300 jobs were cut, will happen quickly. The impetus is, in part, Cisco’s quest for continued profit growth. Specifically the company is targeting middle management, Chambers said, adding that he’s “after speed of decisions and speed of execution.”

But Chambers also said the cuts will include the realignment of resources with Cisco’s brightest long-term business opportunities. Chambers left several breadcrumbs that indicate where Cisco might flex its considerable muscles more.

First, the company’s data center business grew by 43% year-over-year, and Chambers made a big deal about how well Cisco is doing here. For example he said that Cisco’s converged architecture grew into a $2 billion business in five years. Here he’s referring at least in part to Unified Computing System (UCS), an architecture that combines networking, storage, servers, virtualization and unified management, and pits Cisco more squarely against HP, IBM and Dell. Cisco claims that UCS customers total more than a whopping 23,000 now, after only four years.

Cisco’s server business is a pittance when compared to others in the broadest sense, but the company’s market share in blade servers has climbed to number two, according to IDC -- a number Chambers gladly squawked about; but IDC also reports that blade servers account for only 17.7% of total server revenue. Still these growth numbers are impressive, especially after most analysts dismissed Cisco’s chances in this market. Cisco even has a certified reference SAP Hana platform on UCS.

The Cisco Nexus product line, a series of enterprise data center switches Cisco introduced almost six years ago, saw 20% growth in Q4, according to Chambers.

Chambers also said that enterprise deals in the U.S. were up 9% year over year, and he seemed to attribute much of that to ability of the Cisco sales organization to sell what he refers to as “architectures,” a favorite Chambers euphemism for multi-component systems. These architecture deals, he said, are typically sold not just to CIOs, but also to business leaders, where Cisco is clearly advantaged.

Most of Cisco’s competitors would rather sell that way, too, but Chambers claimed that the number of $1 million+ deals in Cisco’s pipeline is up 50%. He also said that UCS deals average about $10 million per sales reps (it’s unclear whether he meant this over time, as more components are added, or for an initial purchase). He said that Cisco will add 400 more sales reps and systems engineers to go after this market.

Chambers also pointed to data showing that Cisco had garnered the number one spot in cloud infrastructure market share, overtaking HP and IBM in calendar Q1 2013 with more than 15% share, representing over $1 billion for the quarter.

Cisco saw a 32% uptick in its wireless business, marking a record quarter according to Chambers. Cisco recently began shipping the Catalyst 3850, a converged wired/wireless switch and the product is starting to achieve significant revenue milestones--a $150 million order rate so far, according to Chambers (it’s always a little difficult to parse meaning from his phraseology).

Although Cisco’s wireless business is already an amalgamation of past acquisitions, one of them (Linksys) the company later sold off, Cisco acquired wireless manufacturer Meraki late last year for $1.2 billion. Chambers said that 35% of Meraki’s business (on a $250 million annual run rate now, according to Chambers) is a recurring revenue stream.

This recurring revenue point is an important one that could presage how Cisco will realigns its workforce, namely deeper into software where those long-term revenue projections are steadier and more predictable. And presumably less painful.

Cisco has started emphasizing location-based services on WiFi, said Mike Fratto, senior analyst at Current Analysis. At a recent industry event John Bollen, VP of Technology at MGM Resorts talked about how he has begun to look at the network as a data source, and an opportunity to learn about his customers, all in hopes of understanding revenue opportunites. Meraki, Fratto said, has been building sample applications that use location data.

In the data center, everything Cisco has been building is software-defined and more easily programmable, Fratto said. An overarching theme to nearly all data center technology, Fratto noted, is Cisco ONE, or Open Network Environment, an architecture for programming the network. Cisco has tossed its weight behind everything from OpenFlow (a software-defined network standard), to OpenStack (standards for creating private and public clouds), to Open Daylight (another software-defined network standards effort).

Fratto said there’s plenty of growth ahead for software-defined networks, and while Cisco is notably late to the party technologically, it is also fashionably just in time from a customer point of view. Cisco saw fit last year to invest in Insieme, a software-defined network “spin-in” startup headed by Mario Mazzola, formerly chief development officer at Cisco. Cisco and Inseimi haven’t said very much about what it will provide, except that it’s likely not going to be the typical SDN fare.

It seems Cisco doesn’t desire so much to be writing network controllers, but creating network applications, Fratto said, adding that Cisco has recently snapped up some Microsoft employees, hoping, he suspects, to further beef up some of the company’s more software-oriented aspirations.

Even the SourceFire acquisition strikes a slightly different tone: it’s a company that makes an open source intrusion detection and prevention system. Chambers said that Cisco’s own security revenue was flat, and that the culprit was a recurring revenue trend in the security market. Hence, Sourcefire.

And as anyone who talks to Chambers will tell you, for the past couple of years, the man can’t shut up about the Internet of Things. But once again, Chambers put his money where his mouth was, carving out a $200 million Internet of Things division, with 500 employees.

Maybe if next quarter’s numbers continue to look “lumpy,” as Chambers would put it, he can enlist a friendly phone call from Carl Icahn.

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