Server biz saves Cisco profits

China's Huawei is now the big threat


Networking giant and server upstart Cisco Systems' financial results for its most recent quarter show that it's moving in the right direction – even though it has some ways to go and a rabble of competitors that want to take a piece out of its hide.

And what direction might that be? It's coming back to its senses and competing aggressively in its core switching and routing businesses, and its trimming employees to get its bottom line in order.

In its first quarter of fiscal 2012, ended October 29, Cisco's revenues across its catalog of hardware, software, and services rose by 4.7 per cent to $11.26bn. Product sales were up by only 2.9 per cent to $8.95bn, while services sales were up 12.4 per cent, to $2.3bn.

Even after trimming research and development costs a bit, sales, marketing, and administrative costs rose and the company also booked $202m in charges relating to its workforce reduction and other restructuring back in July of this year. Cisco aims to cut 6,500 workers and shed another 5,000 through the sale of a factory to Chinese manufacturer Foxconn, and as of the end of the first fiscal quarter, it has shed about 8,400 employees.

The charges whacked Cisco's profits, which fell by 7.9 per cent to $1.78bn. If it were not for the restructuring charges, Cisco's net income would have been flat. This is a little better than expected, but it's still a decline in profits – and Cisco CEO John Chambers said in a conference call with Wall Street analysts that the company is "focused like a laser" on margins.

Despite Cisco's server aspirations, the company is still a switch and router vendor – and it's under pressure in both of these markets.

During the call, Chambers said that switching orders were up 10 per cent, but revenues were flat at $3.67bn. Gross margins on the high-end Nexus 7000 converged end-of-row switches were up two points, but continue to have lower margins than the Catalyst products they replace.

These Catalyst products, by the way, are in the same place proprietary minis were in more than two decades ago when Unix minis came along. That market doesn't recover so much as transition from plain switching to converged server-storage switching – at least that's the theory.

Margins for the top-of-rack Nexus 5000 switches and various offshoots (fabric extenders and blade switches) improved by four points. Chambers said that the combined Nexus 7000 and 2000 products had order growth of 120 per cent in the quarter, and are now at a $1bn annualized sales run rate.

Cisco's various routing products had an order bump of 7 per cent, but revenues fell 3 per cent. High-end router sales were up 4 per cent, but other products fell by 16 per cent.

Cisco's hodgepodge of collaboration tools had $1.09bn in sales. Video products aimed at service providers accounted for $879m (up 13 per cent), while wireless products hit $362m (up 8 per cent).

The Unified Computing System blade and rack servers and their converged switching and management tools are tossed into a category Cisco calls Data Center, which had order growth of 122 per cent in the quarter and revenues up 116 per cent to $259m.

The UCS annualized run rate of the UCS products is now at a $1bn, said Chambers, and the company added 1,572 new customers in the quarter, bringing the total UCS customer base to 8,983.

To give you a sense of scale, Sparc machines have 60,000 customers, according to Oracle, and there are tens of millions of x86 server customers. Customer count is not everything, though: assuming the growth rates cool, Cisco could end up with a multi-billion UCS server and switching biz over the next couple of years – which is nothing to shake a stick at.

On a geographic basis, the big surprise was the recovery of Cisco's Japanese business, which jumped 43 per cent. Japan is now reported as part of the Asia/Pacific-Japan-China region, which accounted for 16 per cent of revenues for Cisco in the quarter.

Sales in the United States were up 9 per cent, but dropped by 24 per cent in India. Revenues in Russia rose by 7 per cent in the quarter, and Brazil spiked by 28 per cent, only slightly ahead of China's 27 per cent growth.

Chambers said that while Cisco was concerned with the competition it faces in the switching and routing market, the trick was never to lead on price but to lead with technology and the customer relationship. That is, once again, a very IBM-style approach to marketing and customer-relationship management, but Chambers does not have his head in the sand regarding what he sees as Cisco's biggest worry: China's Huawei Technologies.

"We have to take on Huawei in China," Chambers said. "Huawei will always compete with us on price, and they will be our toughest competitor going out four to five years." Huawei just launched a reseller channel program in the US, and Chambers promised that Cisco was "going to make it hard on them" on its home turf.

Of course, Huawei has the inside track – bigtime – in China.

Looking ahead to the second fiscal quarter ending in January, Cisco expects year-to-year revenue growth of between 7 and 8 per cent, or between $11.13bn and $11.24bn. That's a pretty tight range, which shows Cisco's confidence despite some of the macroeconomic issues in Europe and government spending cuts back home in the ol' US of A. ®

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