Cisco Systems' recurring revenues are growing, but the networking giant faces big challenges in the service provider market -- where CapEx spending is weak.
Cisco CEO Chuck Robbins described the service provider market challenges during the company's Q4 2016 earnings call on Aug. 17. Overall revenue was $12.6 billion for the quarter, up 2 percent from Q4 2015. And net income grew 21 percent to $2.8 billion, which beat Wall Street's expectations.
The results would have been even better -- had the service provider market not weighed Cisco down. Amid that reality, Cisco confirmed plans to cut 5,500 employees amid the company's ongoing shift from hardware to software and services.
"Over this past fiscal year, we experienced a challenging environment with significant volatility," said Robbins. "Our fourth quarter was no exception. After three consecutive quarters of growth, both service provider and emerging markets turned negative. Service provider orders declined 5 percent -- reflecting the many challenges in that customer segment that you've heard from our peers."
During an extended Q&A session, Cisco CFO Kelly Kramer further described the service provider market challenges. Over 50 percent of the company's routing business comes from service providers, so there's a direct correlation between router sales weakness and the service provider market, Kramer indicated. Indeed, routing revenues dipped 6 percent, largely driven by the weakness in service provider spending, she said.
"And I think if you look at the discussions that have taken place with our peers, you look at some of the analyst reports on Service Provider CapEx, we actually saw exactly what the analysts have talked about," Kramer said. "I saw one report that discussed double-digit declines outside of the United States and maybe flat to slightly up inside the U.S., which is effectively what we saw from a demand perspective. So it was very much in line with that."
Still, video traffic workloads continue to grow -- which means service providers will eventually need to upgrade their network performance. But Cisco doesn't know "when" that potential upgrade cycle will kick in.
Some of the challenge involves shifting spending priorities within service providers. Many large telcos and broadband providers are marching toward network functions virtualization (NFV) and software defined network (SDN), which involves heavier software spending rather than traditional router purchases.
Meanwhile, Cisco is showing progress elsewhere in its business. Roughly 28 percent of Cisco's business now involves recurring revenue, up from 25 percent in Q4 of 2015, Kramer said. Also, Cisco's deferred revenue that's associated with software and subscriptions is up 33 percent, Robbins added.
