Cisco Beats Q3 Expectations While Security Growth Masks Core Business Challenges

Cisco's Transformation Strategy Shows Promise Amid Mixed Q3 Results

Cisco has delivered a quarter that reveals both the promise and perils of its ambitious transformation strategy. The networking giant reported third-quarter fiscal 2025 results that exceeded expectations, with revenue reaching $14.1 billion—an 11% year-over-year increase that surpassed the high end of its guidance range. However, beneath these impressive headline numbers lies a more nuanced reality of uneven growth across segments and increasing dependence on acquisitions.

Splunk-Powered Security Surge Masks Core Business Challenges

The standout performer in Cisco's portfolio was its security business, which saw a remarkable 54% surge in revenue to $2.01 billion. This dramatic growth, however, comes with an important caveat: much of it stems from orders related to Cisco's $28 billion Splunk acquisition rather than organic expansion.

"When you strip away the Splunk effect, Cisco's product order growth drops from 20% to just 9%, revealing a company increasingly reliant on inorganic growth to maintain momentum," noted a veteran technology analyst who tracks the company closely. "It's a strategic pivot that could pay dividends long-term, but also carries significant execution risk."

Meanwhile, Cisco's core networking segment—long the backbone of its business—grew at a much more modest 8% to $7.07 billion. Even more concerning for long-term investors, networking revenue for the first nine months of fiscal 2025 has actually declined by 8% year-over-year, from $22.5 billion to $20.7 billion, suggesting persistent competitive pressures in the company's traditional stronghold.

The AI Gambit: Early Success in New Growth Frontier

Cisco's aggressive push into AI infrastructure appears to be paying dividends sooner than expected. The company reported that orders from webscale customers exceeded $600 million in Q3 alone, bringing the year-to-date total to over $1 billion—surpassing their fiscal 2025 target a full quarter early.

These AI-related orders primarily involve white-box GPU networking racks using Cisco's Silicon One technology and liquid-cooling intellectual property. The company has positioned itself as a key supplier in the AI infrastructure buildout, though these products carry lower gross margins compared to Cisco's software offerings , creating a potential margin compression challenge as this business scales.

"The AI infrastructure play represents both opportunity and risk," explained a portfolio manager at a large investment firm who holds Cisco shares. "While it's driving significant revenue growth now, the lower margins could eventually pressure overall profitability unless Cisco can effectively cross-sell higher-margin software and services."

Services Slowdown Signals Potential Saturation Point

Perhaps most concerning for Cisco's long-term growth trajectory is the anemic 3% year-over-year growth in its services business, compared to 15% growth in product revenue. This imbalance suggests potential saturation in Cisco's traditionally high-margin services segment, which has been a reliable profit center for years.

Deferred revenue grew just 2% year-over-year, trailing overall revenue growth and potentially signaling future deceleration. Additionally, Remaining Performance Obligations increased by only 7% to $41.7 billion, compared to 21% growth in the previous year, with only 51% expected to be recognized in the next 12 months.

Financial Engineering and Balance Sheet Evolution

Cisco continues to reward shareholders through aggressive capital return programs, distributing $3.1 billion in Q3 via dividends ($1.6 billion) and share repurchases ($1.5 billion). The company generated $4.1 billion in operating cash flow, a modest 2% year-over-year increase.

However, Cisco's balance sheet is evolving, with cash and investments declining to $15.6 billion from $17.9 billion at the end of fiscal 2024. The company has issued $17.4 billion in new debt while repaying $18.5 billion, resulting in modestly higher net debt levels.

This shift in capital structure has already impacted Cisco's financial results, with net interest swinging from $44 million in income to a $255 million loss as interest expenses rise and yields on cash fall. This trend suggests higher net finance costs ahead, potentially pressuring future earnings.

Accounting Nuances Worth Noting

Investors focused solely on headline numbers may miss several accounting details that provide important context for Cisco's performance. The company's GAAP earnings per share of $0.62 (up 35% year-over-year) benefited significantly from a $720 million one-time tax benefit stemming from an August 2024 Tax Court decision. This windfall drove Cisco's nine-month GAAP tax rate down to just 5.8%, far below its normal rate of approximately 17%.

Non-GAAP adjustments also played a substantial role in Cisco's reported performance. The company added back $1.697 billion in pre-tax items, including $930 million in share-based compensation and $507 million in intangible amortization, effectively inflating non-GAAP EPS by approximately $0.34.

Additionally, acquisition-related intangible amortization for the first nine months jumped to $774 million, compared to $430 million in the same period last year, which could pressure future margins as these costs continue to rise.

Leadership Transition and Forward Guidance

Amid these mixed results, Cisco also announced a significant leadership change: CFO Scott Herren will retire on July 26, 2025, with current Chief Strategy Officer Mark Patterson stepping into the role. This transition comes at a critical juncture as Cisco navigates its complex transformation.

Looking ahead, the company provided Q4 FY25 guidance projecting revenue between $14.5 billion and $14.7 billion, with non-GAAP EPS ranging from $0.96 to $0.98. For the full fiscal year 2025, Cisco expects revenue of $56.5-56.7 billion and non-GAAP EPS of $3.77-3.79.

The Road Ahead: Integration Challenges and Strategic Crossroads

As Cisco continues its transformation from a traditional networking hardware company to a more diversified technology provider with stronger footholds in security, observability, and AI infrastructure, several critical challenges loom.

The successful integration of Splunk remains paramount, as any significant execution hiccups could undermine the strategic rationale for the acquisition. Industry observers anticipate that Cisco will likely push a unified security-observability offering by fiscal 2026, aiming to upsell its 300,000 networking customers and lock them into multi-year "Cisco+ Splunk" bundles.

Meanwhile, the company must continue to defend its core networking business against specialized competitors like Arista in high-speed data center switching and Juniper in service-provider edge applications, while simultaneously accelerating its pivot toward subscription-heavy software offerings to offset the apparent erosion of its traditional SmartNet maintenance business.

"What we're witnessing is a high-stakes transformation effort," concluded a senior technology equity analyst. "Cisco is essentially trying to change the engines on an airplane while in flight. The Q3 results suggest they've made meaningful progress, but significant turbulence still lies ahead."

For investors, the key question remains whether Cisco can successfully navigate this complex transition without sacrificing margins or losing further ground in its core businesses. The answer will likely determine whether the company can secure its position as a central player in the next generation of technology infrastructure, or gradually cede relevance to more agile competitors.