Cisco Slide Continues

Some investors wanted a stronger quarterly sales gain.
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Updated from Feb. 3

The slide in

Cisco

(CSCO) - Get Report

shares steepened Wednesday as investors wondered about the company's growth prospects.

Cisco posted the obligatory blowout quarter late Tuesday, easily besting fiscal second-quarter sales and earnings estimates. But its stock suffered a reversal as worries about sales growth cropped up again. It was recently off 6%, leading a sectorwide selloff.

The tech titan reported a strong second-quarter profit after the close Tuesday. On a subsequent conference call, CEO John Chambers guided toward the expected 1%-3% sequential sales rise in the seasonally weak third quarter. He also shrugged off questions about pricing pressure.

But investors, who have been remarkably bullish on the networking sector throughout 2004, chased Cisco and its highflying peers sharply lower. Cisco fell $1.69 to $24.72 around midday as some skeptics focused on the company's failure to beat sales-growth expectations.

"They have a 14-week quarter -- that's one extra week, so it seems like they don't have any sales juice," says one trader with no Cisco positions. Earlier, in Tuesday's call, Chambers had noted that the extra week "will have some positive influence."

The news comes as Wall Street weighs the strength of the economic recovery that has buoyed tech stocks in recent months. Chambers made remarks that could potentially undercut the spending-revival story that has boosted these stocks.

The "majority of our customers are cautiously optimistic but more conservative on capex and hiring than you would expect at this stage of the recovery," Chambers said Tuesday.

Otherwise, Chambers' comments on the call were mostly as expected. The executive didn't offer specific earnings-per-share guidance, though he did note a latest-quarter decline in gross margin.

The executive said second-quarter gross margin dipped to 68.5% from 69% in the fourth quarter, due to sales of lower-margin products, mostly gear to telcos. When asked on the conference call about price competition, Chambers said there was "nothing abnormal as far as pressure in the market."

Early on in the postclose call, Chambers noted that Cisco's book-to-bill ratio was below 1 in the latest quarter. That figure reflects the number of orders received vs. those shipped and can give investors a vague sense of sales trends.

Strong Position

For its fiscal second quarter ended Jan. 24, the San Jose, Calif.-based communications gear giant posted a profit of $1.29 billion, or 18 cents a share, before an accounting charge. That's up from $991 million, or 14 cents a share, a year earlier and a penny ahead of the Wall Street analyst consensus estimate. After the accounting charge, latest quarter earnings were $724 million, or a dime a share.

Revenue rose to $5.4 billion from $4.7 billion a year ago, again ahead of estimates.

"Our strong position in the core switching and routing business continues to be complemented by positive momentum in our advanced technologies, especially this quarter in storage, security, wireless and IP telephony," CEO John Chambers said. "The company is also gaining significant momentum in the consumer space, driven by innovative products delivered by the Linksys division."

For the quarter ending in April, analysts project an 18-cent profit on sales of $5.4 billion, though traders who have been bidding up the shares of networking companies would surely like to see more. Cisco shares are up 10% on the year amid talk of a network spending rebound.

Expectations always run high when Cisco talks about its sales outlook. The company was long one of Silicon Valley's great growth stories, racking up huge gains throughout the 1990s. Yet even as its expansion has cooled in recent years, Cisco has remained the top player in the communications-equipment market, and its numbers are seen as foretelling larger spending trends.

Investors' focus on the networking industry has only grown sharper in 2004, as Cisco's once-forgotten peers -- beaten-down telecom equipment giants such as

Nortel

(NT)

and

Lucent

(LU)

, to name two -- have enjoyed a remarkable resurgence. Shares across the networking sector jumped last month as Wall Street latched onto the notion that big telcos like

Verizon

(VZ) - Get Report

will soon resume sinking big bucks into network infrastructure.

Router Rivals

Further raising the bar for Cisco were comments last month from Scott Kriens, CEO of rival

Juniper

(JNPR) - Get Report

. Following his own company's

earnings blowout, Kriens volunteered that the large-router market the companies share is "robust" enough that "Cisco will have a strong quarter." Routers are high-speed junction boxes that help direct Internet traffic.

Cisco's news comes as analysts have begun to wonder if the networking industry's helium-filled bounceback is indeed supported by fundamentals. Some observers suspect that the real winners in this race will be companies such as Cisco and Juniper that offer gear that makes networks more efficient.

Meanwhile, Cisco's results can also be read as an indicator of the health of broader corporate information technology spending. Unlike most of the big telecom gear makers, Cisco makes most of its money selling things like routers to big companies for their internal networks.

But being the juggernaut that it is, Cisco finds even delivering on investors' high expectations doesn't always translate into a marketwide rally. Such was the case following Cisco's

last earnings blowout, a first-quarter upside sales surprise that failed to ignite a marketwide rally.