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Cisco revenues fall, likely to go lower

Top-line Cisco revenues fell in the July quarter, as the company's legacy switching business continued to weaken. Cisco could soon reach two straight years of revenue declines.

Cisco's latest earnings report reflects the pains of a legacy vendor struggling to overhaul an outdated business model while rivals chip away at its market share.

Overall Cisco revenues dropped 4% year over year for the quarter ended July 29, to $12.1 billion, the company reported this week. Cisco expected the decline to continue in the current quarter, forecasting a reduction of between 1% and 3%. The drop in the October quarter would mark nearly two straight years of declines.

Cisco's troubles are mostly due to the steady weakening of its switching business -- the company's largest. Sales of switches in the July quarter fell 9%. The company reported the same decline in its router business, another important hardware line.

Falling Cisco revenues show rivals cutting into market share

While Cisco stumbled, switching rivals Arista Networks and Juniper Networks reported double-digit growth in their June quarters.

"Rivals are chipping away at Cisco, for sure," said Glenn O'Donnell, an analyst at Forrester Research. "In many ways, they [rivals] are reacting more effectively at what the market really needs."

Cisco's competitors have been more successful at selling to cloud and communication service providers that favor products less likely to tie them to a single vendor. At the same time, enterprises -- Cisco's core customers -- are buying fewer switches, as they migrate more software to cloud providers.

"Cisco's decline in their core market is another signal that the general networking vendor is an old business model," said Andre Kindness, an analyst at Forrester.

Cisco's solution to revenue drop

Cisco understands its dilemma and is gradually moving away from its legacy hardware approach to networking. The company has introduced software that centralizes network control, so operators no longer have to make changes box by box.

In June, Cisco introduced a central software console, called the Digital Network Architecture Center, for managing a campus network. The hardware underpinning is a new line of Catalyst switches, called the 9000 Series.

Cisco's decline in their core market is another signal that the general networking vendor is an old business model.
Andre Kindnessanalyst at Forrester Research

Cisco attributed its latest drop in switch revenue to the product launch. "Anytime we do a major platform announcement, particularly in switching, there is a period of time where our customers pause because they want to understand what this means," Cisco CEO Chuck Robbins told financial analysts following the latest earnings report.

Within the enterprise data center -- Cisco's historic sweet spot -- the company has been pushing customers to switch to its software-defined networking platform, called Application Centric Infrastructure. ACI is also dependent on Cisco hardware, namely the Nexus 9000 Series of switches.

Enterprise adoption of ACI, which Cisco started shipping in 2014, has been slow, according to analysts. In February, Gartner reported that only 30% of companies buying Nexus 9000 switches were also using ACI.

Forrester has found that many businesses are choosing VMware's competing NSX because it requires fewer architectural changes within the data center. "Cisco ACI is an all-or-nothing proposition," Kindness said.

Also, ACI is less flexible when working with third-party appliance vendors. Companies using ACI are often limited to products from Cisco partners for load balancing and firewalls.

"My clients don't want to have one vendor dictate the other vendors," Kindness said.

Cisco revenues from security slow

To mitigate its troubles in networking, Cisco has been focusing on high-growth areas in the tech industry, such as the internet of things, technology for connecting data centers to the cloud and security. In security, Cisco's revenues failed to meet analysts' expectations for the July quarter, reporting 3% growth, which was significantly less than the 16% increase a year ago and the 9% growth in the previous quarter.

Despite the slowdown, Robbins said he had "zero concerns about the business," because the company has recently recorded "some of the strongest order growth as we've seen in the last two years."

Cisco's approach to security is to sell it as part of an overall purchase of networking infrastructure, and not as a solo product. As a result, security sales will tend to move up or down depending on sales of switches and other products.

"I think we should wait a few quarters to see where this goes," said Patrick Moorhead, an analyst with Moor Insights & Strategy, based in Austin, Texas. "The security products are so linked to their networking products that we didn't see the numbers that the street [Wall Street] had expected."

If Moorhead has it right, then security sales will improve as sales of switches head north. But indicators are Cisco has yet to reach the bottom.

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