The day after Cisco Systems Inc. announced its third-quarter 2024 earnings, investors are wavering on the results, as the stock was falling 2% this morning, reversing a 5% jump after-hours Monday.
The company reported revenue of $12.7 billion, down 13% year-over-year — 16% without Splunk — and $70 million ahead of consensus estimates. Gross margins remain best-in-class for an infrastructure vendor at 68.3%.
Cisco continues to transform into a recurring-revenue company as subscriptions now represent 54% of total revenue. The Splunk deal closed during the quarter, accounting for $413 million in additional revenue. Looking ahead to the fourth quarter, Cisco expects revenue from $13.4 billion to $13.6 billion, the high end of which is slightly ahead of Wall Street’s estimate of $13.54 billion.
Even if the stock movement today indicates investors are uncertain about the results, several facts about the quarter indicate what the future holds for the networking giant. Here are my top five takeaways from Cisco’s most recent quarter:
Splunk provides near-term revenue and profits with significant long-term upside
Cisco’s acquisition of Splunk does two things. In the short term, it adds both revenue and profitability. When the deal closed, Cisco Chief Executive Chuck Robbins (pictured) and Splunk CEO Gary Steele discussed this on CNBC.
“Splunk brings $4.2 billion of ARR to Cisco,” Steele said. “We just wrapped up a good year where ARR grew 15% and generated over a billion dollars in cash flow.” That alone will propel Cisco’s growth, but there’s a bigger prize to be won here as the data from Splunk can transform many of Cisco’s business units.
During the recent RSA Conference, Cisco talked extensively about how Splunk data can advance Cisco’s security products. Splunk can add to Cisco’s observability business. In the CNBC interview, Steele explained, “Bringing AppD capabilities with the Observability Cloud will enable customers to monitor their footprint and understand the uptime of their digital footprint.”
However, Cisco can also add to Splunk. On the earnings call, Robbins stated, “We identified 5,000 existing Cisco customers who have the potential to become meaningful Splunk customers. We also see significant opportunities for revenue synergies by leveraging Cisco’s robust partner and customer ecosystem where Splunk has limited or no presence.”
Security is set to go in FY25
For years, I have viewed security as Cisco’s most significant needle-moving opportunity. The massive, highly fragmented market has no de facto standard. Over the past few years, Executive Vice President Jeetu Patel has wholly retooled the security business unit, starting with a strong security leadership team led by Tom Gillis. The company has shifted away from a collection of products to a platform built on the Cisco Security Cloud. This has given rise to products such as XDR and the recently announced Hypershield product.
The product work is done, and now it’s time for Cisco to execute and accelerate growth. This quarter, excluding Splunk, Cisco Security grew 3% year-over-year at a billion-dollar pace. This is well behind the growth curve of the security pure plays.
The one significant factor that bodes well for Cisco is that security is moving away from a reactive model to one driven by artificial intelligence-enabled data analytics. Given the combination of Cisco’s networking, observability, security and Splunk data, the company should be able to “see” things a pure play can’t. The product is in place and now it’s time to step on the gas pedal.
AI is on the horizon, but the timing is still unclear
There’s no question AI is the “next big theme” and has created massive tailwinds for Nvidia Corp. and a handful of other companies. One fact that has flown under the radar is that one can’t build an AI platform without the network playing a pivotal role. On the earnings call, the company talked about the AI opportunity.
“In Webscale, we continue to see momentum with three of the top-four hyperscalers deploying our Ethernet AI fabric,” Robbins noted. “In the past two quarters, Cisco has been granted additional design awards based on our 51.2 TB G200 Silicon One ASIC.” He added, “We expect these awards to yield orders in FY25, reinforcing our confidence in our line of sight to $1 billion of AI product orders.”
Cisco has a strong partnership with GPU leader Nvidia, and the two can work together to deliver Ethernet-based engineered systems for AI. AI is coming, and so too should network sales.
Core networking looks to be stabilizing
Although Cisco plays in many markets, networking is still the biggest. This quarter, networking declined 27% year-over-year, albeit off tough comparisons. Coming out of the pandemic, businesses were buying well ahead of their needs because of unavailable products when there were supply chain shortages. On previous calls, Cisco management talked about customers needing to deploy products purchased previously, creating the air gap we see today.
Robbins noted that the environment improved as the quarter moved along. “We believe our customers are on track with the inventory digestion we discussed last quarter, so that’s a positive,” he said. “We saw the Americas, excluding Splunk, was up 2%, so that’s a positive. Also, campus switching and data center were both positive,” indicating the networking business should return to normalcy soon.
Collaboration transition continues
Much of the external attention given to Cisco over the past year has been Splunk and security. However, collaboration contributes about a billion dollars a quarter, and that group has been going through its own transition. The business was flat this past quarter, but what’s notable is that cloud calling and contact center were up, though declines in devices and meetings offset that growth.
In the past, Collaboration was led by meetings, and Microsoft Teams was viewed as the mortal enemy. Today, Cisco endpoints interoperate with Teams, delivering a high-quality experience together. Also, Cisco has invested heavily in its contact-center-as-a-service offering and is often leading in this area compared to internal collaboration.
Although I believe the strategy is correct, the collaboration industry is filled with tough incumbents and hot start-ups, making this area of Cisco’s business with the stiffest competition. In this case, slow and steady is the only approach, and the Webex brand needs to establish itself in the contact center, which will happen one customer at a time. There’s no silver bullet here other than steady execution.
Since the pandemic, mixed quarters have become the norm for Cisco, but security, Splunk, AI and network stabilization point to a return to growth in fiscal year 2025. This isn’t a given, as many global macro issues, new competitors and Cisco’s extensive portfolio make it hard to fire on all cylinders. I’m looking forward to checking out the mood of Cisco customers are partners at next month’s Cisco Live event as that will be a litmus test as to what next fiscal year will look like.
