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Cisco services continue steady growth 12 August, 2007 Cisco Services, the services arm of parent company Cisco Systems, continued its steady revenue growth during 2Q07 (fiscal 4Q07) and, after lagging behind for the last five quarters, finally surpassed product year-to-year revenue growth. The organization reported revenue of $1.5 billion, a year-to-year increase of 19.3% and a sequential increase of 7.7%. The continued revenue expansion and a strong focus on keeping costs in line resulted in sequential improvements in gross and operating margins: gross margin expanded 200 basis points to 63.4% and operating margin grew 180 basis points to 37.4%. During the earnings call, Cisco Systems CFO Dennis Powell reported that "We saw improvements in both technical support and advanced services gross margins," which are the two major components of Cisco Services' revenue. However, on a year-to-year basis, gross margin showed a 120-basis-point reduction and operating margin showed a 230-basis-point reduction due to the hiring of new employees during the past three quarters to support services growth. In addition, services gross margin continued to lag, by 110 basis points, product gross margin which came in at 64.5% during 2Q07.
TBR believes the organization's past investments in services headcount growth to support increased demand continue to restrain margin growth. Cisco is relying on services to push product sales. At the same time, Cisco is focusing on creating the next generation of products. During the earnings call Cisco CEO John Chambers identified the three current/upcoming waves of product development and introduction to the marketplace: First wave includes security, wireless, storage, network home and Unified Communications. Second wave includes video systems, hosted small businesses, application, networking systems, etc. Third wave (also known as emerging technologies) includes digital media systems, TelePresence, IPeX, physical security, etc. To support these new products/technologies, additional investment in services and services personnel will be necessary. With a focus on Web 2.0 and Unified Communications, software will certainly play a significant part in bringing components together on the network. Subsequently TBR believes there will be a need for services personnel to be experienced in software applications and/or customization, and this will be a major focus for future services hiring. TBR also believes Cisco Systems will continue to use Cisco Services, and increasingly Advanced Services, to support more advanced customers and boost product growth, even if services gross margins lag behind product gross margins. www.tbri.com.
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