Networking giant Cisco Systems Inc. announced a solid third quarter Wednesday, posting a beat and raise.
Here are my top five thoughts from this quarter.
- Artificial intelligence revenue is gaining momentum. On the call Cisco noted $600 million in AI product orders, blowing by the $1 billion target set for fiscal year 2025. Notable was that about two-thirds of this was for Cisco networking gear, with the other third being optics. This is a stark shift from historical numbers that were closer to 50/50, highlighting the acceptance of Cisco networking gear with web-scale customers. On the call, Chief Executive Chuck Robbins talked the three legs of the AI opportunity for Cisco being AI training infrastructure for web-scale customers, AI inferencing and enterprise clouds and AI network connectivity. We are at the very beginnings of the AI revolution, and it should create a “rising tide” for networking vendors, like the internet, and given the reach Cisco has with large companies and governments, I expect it to benefit disproportionately. A good example of Cisco’s uniqueness is the partnership with Humain in Saudi Arabia, where the company worked with government leaders on the initiative.
- Tariffs and macro creating caution but not delaying business. One of the big questions on investor minds is the impact of tariffs. Is this causing customers to push orders out or to pull orders in? In fact, the first question during the analyst Q&A was from Meta Marshall from Morgan Stanley and she asked whether there was a pull forward, which could push numbers up and cause an air pocket in future quarters. Robbins answered the question, “We looked at a ton of data points to see if we saw any signs of broad-based pull ahead business, and we did not.” Chief Financial Officer Scott Herren added, “We didn’t motivate a lot of pull-ahead by talking about price increases.” This morning on CNBC, Robbins mentioned that though the macro is on customers minds, the pressure to keep up with AI and modernize far outweighs any concerns and that’s keeping customers spending.
- The business is firing on most cylinders. Taking a granular look at the numbers, product revenue was up 15% and services up 3%. Networking was up 8% with growth coming in routing and switching, offset by a decline in servers. Security jumped 54% primarily driven by Splunk and secure access service edge. Collaboration grew 4% and observability rose 24%. I’ve often described Cisco as an eight-cylinder car that typically fires on six as we have seen great performance in one area offset by a sharp decline in another. Other than servers, which is a small part of Cisco’s business, all product areas saw growth. To me, this indicates Cisco is finally capitalizing on its platform strategy as it’s better able to create a “1+1 = 3” value proposition. Another proof point of platform execution is that both gross and operation margins were up slightly indicating they aren’t getting squeezed on price as they did when specific products drove sales.
- Nvidia partnership in the early innings. During the call, Robbins talked about the systems Nvidia and Cisco are partnering on. During the quarter, Cisco announced its intent to create a cross portfolio unified architecture where Silicon One will be the only third-party chip to be part of Spectrum-X and Cisco will build systems that include Spectrum silicon. Partnerships work best when there is an equal amount of value exchanged and this one seems like a slam dunk. Nvidia has more AI domain knowledge at a system level than any other company in the world and Cisco has an equal amount in networking. Add in Cisco’s massive channel, which is licking its chops to jump onto the Nvidia train, and it’s easy to see how Nvidia can pull Cisco into AI and how Cisco can help Nvidia complete the infrastructure stack and go to market. The two companies are highly complementary, and I expect to see a significant amount of co-creation between the two.
- Cisco is looking to lead in quantum networking. Cisco has certainly been bitten by the “Innovators Dilemma” in the past where emerging trends that look negative to the current business are ignored until it was too late, letting new vendors jump into the market. Software-defined wide-area network, software-as-a-service-based collaboration and the cloud come to mind. Cisco is not going to be late with quantum. Last week Cisco introduced its Quantum Network Entanglement Chip and opened its Quantum Lab. The company mentioned this on the earnings call, and I was a little surprised analysts did not ask about the timing of this. We are certainly early in the cycle, but at IBM Think just last week, IBM CEO Arvind Krisha was fairly bullish and expected to see broader adoption in the three- to five-year time frame. This and AI are two market transitions Cisco will not miss.
The other news from the quarter was the retirement of CFO Scott Herren, who has been in the position for five years. Herren has had an incredibly busy tenure at Cisco having gone through the COVID phase, supply chain issues, the biggest acquisition in Cisco’s history (Splunk) and more. Current Chief Strategy Officer Mark Patterson,will assume the role of CFO, a title he held before joining Cisco. Patterson is one of the sharpest minds at Cisco; if Chuck is the James T. Kirk of the Starship Cisco, Mark Patterson would be Spock. He hasn’t had as much public-facing time as many of the Cisco executive leadership team, but he’s the person in the background calculating how to execute on the plans in place.
Also, Chief Product Officer Jeetu Patel was named president, assuming the position Gary Steele had held. When looking at all the hires Robbins has made in the last decade, it’s fair to say that Patel has been the most important one. Prior to Patel, Cisco had a lot of great technology, but few great products and Jeetu is an interesting combination of technologist, businessperson and product evangelist and has shaken things up at Cisco. In the conversations I have had with Patel, he is obsessed with building great products that people love and that obsession has been pushed down through the product teams.
I wasn’t surprised Robbins promoted from within. After Steele left, I talked to him about who he might put in the global sales role, and he mentioned he was hesitant to go external as he feels the executive team is finally at the point where everyone has a great deal of trust in each other, and he didn’t want to disrupt this. Hence the appointment of Oliver Tuszik into that role. Patterson and Patel certainly fit that strategy.
Overall, given the AI momentum combined with the platform focus for products, Cisco should be able to continue to see steady growth in its core business complemented by accelerated growth in security and other emerging areas.
