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Stocks Of Cisco Are Falling As The Company Sends A Worrisome Signal Regarding Tech Demand

May 18, 2023
minute read

Cisco Systems Inc. achieved a notable milestone with its first double-digit quarterly revenue growth in years. However, a signal concerning future tech demand has raised concerns among investors.

In the fiscal third quarter, Cisco reported profits and revenue that surpassed expectations. The networking giant recorded revenue of $14.6 billion, marking a 14% increase compared to the same period last year. The company also saw a slight sequential improvement in overall GAAP gross margins, reaching 63.4%. Additionally, Cisco's executives raised their annual profit forecast.

Despite these positive figures, shares experienced a 4% drop in after-hours trading due to a crucial detail shared during the conference call in the remarks of the chief financial officer. It was revealed that Cisco's orders declined by 23% year-over-year in the quarter, following a 22% decline in the previous quarter, which raised doubts about future growth. While executives predicted sales growth of at least 10% for the current year with only three months remaining until the fiscal close, they only forecasted "modest" sales growth for the following year.

Chief Financial Officer Scott Herren, who made these disclosures, explained in an interview that the order decline was a result of customers absorbing prior shipments before placing new orders, combined with a reduction in fulfillment time due to shrinking lead times. He emphasized that customers are exercising prudence, a sentiment echoed by other CFOs in various companies. However, Herren highlighted that Cisco's order cancellation rates are significantly lower than during the pandemic.

Furthermore, Herren stated that Cisco expects earnings to increase as the company focuses on managing costs. He emphasized their commitment to prudent spend management in 2023, pointing out that Cisco did not engage in significant hiring during the pandemic, which has allowed them to minimize staff reductions compared to other large tech companies.

In the recently completed quarter, Cisco experienced strong growth in its secure agile networks business, which grew by 29%, and switching revenue also achieved robust double-digit growth. This was partially attributed to the success of offerings like the Catalyst 9000. The transition to software-based networks and expense controls have positively impacted the company's margins. Last November, Cisco announced a restructuring plan and significant real-estate consolidation that involved the closure of approximately 140 offices worldwide.

However, investors had higher expectations. JP Morgan analysts expressed their anticipation before Cisco's earnings, stating that if orders declined again in the fiscal third quarter following the 22% decline in the previous quarter, it would serve as definitive proof of a weaker demand environment. The concern now is that if Cisco encounters demand issues, it may indicate broader challenges within the sector.

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