Cisco Sees a Sales Slump Ahead

Networking hardware company Cisco Systems (CSCO 0.44%) beat expectations for its fiscal first-quarter results, but the numbers were overshadowed by a poor outlook. Cisco expects to report a substantial revenue decline in the second quarter, along with lower-than-expected adjusted earnings.

Up to this point, Cisco's results have held up well despite growing global economic uncertainty. But a tough macroeconomic environment was bound to catch up with the company sooner or later.

A decent quarter

Cisco grew its first-quarter revenue slightly, and adjusted earnings per share surged thanks to a reduced share count from share buybacks.

Data source: Cisco. GAAP = generally accepted accounting principles.

Excluding the divestiture of the service provider video software solutions business, Cisco's revenue was up 2% year over year. On a reported basis, product revenue was down slightly, while service revenue was up 3.1%.

The infrastructure platforms segment, which contains Cisco's core switching and routing businesses, suffered a 1% sales drop to $7.54 billion. Applications revenue was up 6% to $1.50 billion, while security revenue soared 22% to $815 million.

Product orders were down across all geographies, and only the public sector customer segment produced product order growth. Enterprise orders were down 5%; commercial orders were down 5%; and service provider orders were down 13%. Product orders from public sector customers grew 6%.

Economic uncertainty is starting to lead Cisco's customers to pull back, as CEO Chuck Robbins explained during the earnings call: "It feels like there is a bit of a pause. We saw things like conversion rates on our pipeline were lower than normal, which says that things didn't close the way we would have historically seen it."

Image source: Getty Images.

A slowdown has arrived

Lower product orders will lead to lower revenue in the second quarter. Cisco expects revenue to fall by 3% to 5% on a year-over-year basis, ending its growth streak. Non-GAAP EPS is expected between $0.75 and $0.77, below analyst expectations of $0.79.

The current global economic environment, rife with uncertainty amid a U.S.-China trade war, was eventually going to cause problems for Cisco. Uncertainty can lead Cisco's customers to push back or downsize orders, which seems to be exactly what's happening.

This isn't a new phenomenon for Cisco. The company last reported a revenue decline in the first quarter of fiscal 2018, capping a two-year period of slumping sales. Cisco's push in the past few years to grow its subscription-based revenue may help make the current cycle less severe, but it won't stop it entirely. The situation could get much worse for Cisco if major economies are thrown into a recession or if the U.S.-China trade war escalates further.

Robbins is optimistic that this period of weak sales won't last all that long:

And I also believe that our customers they will pause for a while, but technology is so absolutely core to their fundamental strategies that it just seems to me that the time that they're going to be able to pause is going to be shorter than what you would have seen in the past. I mean they worry about their competitors' investments. They worry about falling behind.

Cisco's results will be rough for at least a few quarters, and possibly for longer. But cycles are nothing new for Cisco, so investors should stay focused on the big picture.