Cisco: Order Inflows Insufficient to Arrest Steep Revenue Declines

Cisco's (CSCO) most recent quarter results were generally greeted with cheer as the company beat both sales and profit expectations. However, a closer look at the sales break-up and some sales trends doesn't seem comforting.

While sales met expectations coming in at $8.1B, they declined 16% on a yoy basis. In the context of the difficult environment in 1Q09, the results seem pretty decent.

Source: Gridstone Research

But a closer look at the revenue breakouts is not comforting. As the chart below (Source: Gridstone Research) shows, product revenue (referred as revenue-goods and in red) has declined steeply while service revenue has held steady thanks to the deferred revenue flowing in from the balance sheet. (Please note that service and goods revenue are in different scales. goods (product) revenue-LHS, service revenue-RHS.) Service revenue is also helped by the fact that it comes over a higher installed base on a yoy basis.

But the comfort from higher service revenue cannot last for long. Ultimately service revenue depends on more products being sold and increasing the installed base. Other services such as installations, training etc also depend on product sales.

The chart below (Source:Gridstone Research) shows the yoy change in product and service revenue. The growth rates for the service revenue has declined from ~20% to <10% as a consequence of the decline in product sales. In effect, the service revenue growth would further decline as long as product revenue keeps declining. Unlike a Microsoft (MSFT) or Oracle (ORCL), Cisco cannot enjoy the comfort of recurring license revenue from its installed base and therefore needs to continually sell new products to keep the service revenue going at the same clip. Product revenue has experienced yoy decline in the last two quarters only (Jan09 and Apr09), but the order volume declines that Cisco experienced in Apr09 quarter does not augur well for the next 2-3 quarters as well.

In the Apr09 quarter conference call (Source: Seeking Alpha), Cisco management talked of order declines across both the major product lines - routers and switches and across all geographies (US - down 20% yoy, Europe - down 28% yoy and Asia/Emerging markets - down 27-30%) indicating that product revenues look set to fall further in the quarters ahead.

The chart below shows the yoy trend for deferred product (blue line) and deferred service revenue. With the balance sheet contribution to both revenue streams set to decline (for products, balance sheet contribution has already declined yoy), the next few quarters might not see a quick turnaround in terms of revenue growth.

Deferred service revenue (~$6B as of Apr09) is more than twice that of deferred product revenue ($2.7B as of Apr09) and so the slowdown in deferred service revenue will have a more pronounced impact in the next few quarters. Ultimately the new orders need to offset the decline in revenue contribution from existing orders and that doesn't look likely for the next few quarters. The order declines have been in every geography and the major product segments and so positive up tick on the orders front look some distance away.

In conclusion, the Cisco results do not indicate that things will be better in the next 2-3 quarters, barring a dramatic turnaround. Till then, the Cisco sales team has one hell of a task to do!

Disclosures: No positions

Comments

[Mick Weinstein:]

Great work, Naveen.

May 12 10:04 AM

[BeachRider:]

It looks like CSCO had good reason to strike for new opportunities with its blade-server, etc. initiative. I wonder if CSCO is interested in buying someone like EMC, especially in this situation. EMC may now be ripe for an acquisition.

May 12 12:13 PM

[Andreas:]

We replaced Cisco and now we only use Huaweii, ZTE, and Synergon synergon.hu/en/ . Cisco is too expensive has tricky unfavorable contracts/legal terms and very bad service.

May 12 12:32 PM

[Fighting Yoda:]

Cisco suffers from large company size issues - not so nimble, higher costs, etc. Juniper, Huaweii seem better bets.

May 12 05:27 PM

[Moon Kil Woong:]

Thanks for your assesment. This reflects Cisco's much maligned idea to compete with its own customer base including IBM. Although it is understandable for Cisco to try to find other areas to expand since further growth in gobbling up other competitors in its own space is shrinking, I feel management should move more towards an appropriate model for a maturing industry rather than remain stuck in a consolidation, hyper growth model.

Sales can't make up for the failures in management. If you are buying Cisco as a growth stock stop. It's not the same Cisco anymore. The market has changed.

May 12 09:38 PM