Even after it managed to beat the diminished expectations of analysts with its second-quarter results, shares of Cisco Systems fell by more than four percent in after-hours trading.
On a conference call with shareholders, CEO John Chambers was upfront about the problems Cisco is facing. Rather than stick with usual practice and let CFO Frank Calderoni issue the guidance at about the halfway mark, Chambers himself delivered the bad news at the top of the call: Cisco expects sales to continue to fall and is expecting revenue in its fiscal third quarter ending in April to decline in a range between six percent and eight percent versus the same period last year.
This came on top of difficult results in the second quarter. While sales fell by about eight percent overall, they fell by much sharper rates in several key business segments compared to the year-ago quarter. Switching, Cisco’s biggest segment, fell by 12 percent. Routing fell by 11 percent. Service provider video fell by 22 percent. Collaboration sales fell by seven percent. In fact, of the nine segments Cisco reported in a presentation for shareholders, only three showed increases, and two of those were from Cisco’s four smallest segments.
Sales around the world also continued to be a problem: Revenue in the Americas fell by nearly 10 percent; in Europe, more than six percent; and in Asia, nearly four percent. Cisco’s gross margin, a closely watched metric of profitability, fell year on year by one percentage point to 61.3 percent.
It’s not as though there wasn’t good news, but it came in places that were too small to make much impact. Cisco’s data center business, where it sells its Unified Computing System, which combines servers, storage and networking and competes with traditional computing vendors like Hewlett-Packard and Dell, grew 10 percent and continued to take share away from other companies. But at $605 million, it accounts for about five percent of overall sales.
Revenue from security products and services grew by 17 percent. Again, the size of the business, at $305 million, or about four percent of revenue, made it too small to have an impact.
But as Chambers is fond of pointing out in these cases, Cisco is often an early indicator of trends that other tech companies and indeed the world economy will see two or more quarters in the future. I had a chance to talk to him shortly after the conference call with shareholders ended. A summary of our conversation is below:
Re/code: John, Cisco saw declines pretty much across the board. Can you walk me through what’s going on and why you’re seeing what you’re seeing?
Chambers: Sure. The most important thing is that we did this quarter exactly what we said we were going to do. And we outlined where the three areas we needed to focus on were and which were exposed. The weakness in the emerging markets, I think everyone now understands, and once again unfortunately we were right in our predictions when we said we thought the BRIC countries and Asia were about to turn down. If your readers had shorted the emerging markets back then, they would have made a lot of money. We just tend to be an early indicator. Back in the summer and fall of 2012, when our enterprise and U.S. commercial business started to turn up, we also turned out to be right as well. If you’d have bought into the Dow back then, you’d have made a ton of money.
So is there an indicator of when things begin to turn?
We’ve built up a backlog to the highest level we’ve ever seen coming out of a second quarter, and we’re going into Q3 and in almost every area, the bookings were better than revenue numbers. And if you watch the areas that are most in transition right now, U.S. enterprise and commercial customers, they grew in almost all those areas. If you look at one of our partners, Worldwide Technologies, it’s a $2.8 billion partner of ours that sells almost all Cisco for us — they grew almost 29 to 30 percent last year. And they take all these products into their labs and show customers how they work, and they’re already showing them the Internet of Everything. So what you’re seeing is that our strategy is working, and as we deploy that we’ll be successful. But the emerging markets will be challenging for a little bit longer, and we’re not betting on an economic recovery there in the guidance that we gave. … Also look at security, that’s a business that’s on fire. Meraki [acquired in 2012] grew its number of new customers from 4,300 to 9,600 so you know what that means. With Sourcefire [acquired last year] we increased quarter over quarter in deferred revenue from what we had before. You add that up over a year, and you realize you’re rolling a billion dollars of new revenue from this year into next year. That’s a big number for us. So the hand is playing out exactly like we said it would.
So this is the point where I pick a song to illustrate Cisco’s quarter. It’s funny little tradition I started once on a lark back at the old site. Since Chambers always asks about it, and occasionally likes to bust my chops about my selections, I thought I’d continue it here at Re/code.
Sticking with the notion that Cisco is indeed an early indicator of trends that other tech companies will be seeing later on, does that make it something of a canary in a coal mine? That can of course be a good and bad thing. So here’s a song with that exact title from The Police’s breakthrough 1980 album, Zenyatta Mondatta. Enjoy.