Demand for Cisco's networking equipment has fallen to the point that the company will write down a massive $2.5 billion of excess inventory and let 8,500 workers go as part of a broad -- and expensive -- restructuring. Visibility, once a hallmark of this former high-flier, is now worse then ever, according to CEO John Chambers.
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Networking equipment maker Cisco Systems (Nasdaq: CSCO) rocked investors after the market's close today, CEO John Chambers announcing in a politely titled "Business Update" that the company sees significant near-term turbulence ahead -- as well as big-ticket charges as the one-time growth gorilla restructures its business. "The business environment that our segment of the IT industry is facing has never been more challenging," said Chambers in a prepared statement. "In fact, this may be the fastest any industry our size has ever decelerated, which has required us to make difficult business decisions at an unprecedented speed." (For more on the networking sector, visit our InDepth page on the subject.) Cisco said it expects fiscal Q3 revenues to come in 30% below the previous quarter's $6.7 billion. The company is looking for pro forma operating earnings per share in the low single-digit range, compared with First Call's $0.08 consensus estimate and last year's $0.14. For Q4, Cisco warns of flat sequential revenues or worse, suggesting that a drop of another 10% could be possible. The second half of the fiscal year has traditionally been the slowest for Cisco, but this is something else entirely. Also of note were the company's restructuring moves and attendant charges, to be taken in fiscal Q3: "Business demand consistently exceeded our expectations throughout most of calendar year 2000," said CFO Larry Carter. "And in an effort to meet our customer expectations we continued to increase our inventory and capacities to keep up with rising demand. This charge reflects the recent significant and unexpected drop in customer demand." What happened to demand? Many of Cisco's customers, in short, were not cash flow positive in their own right, so they relied on equity, debt, or vendor financing -- the latter discussed in a recent Rule Maker column -- to fund equipment expenditures. When the market turned, those companies no longer had the wherewithal to buy products from Cisco and other companies such as Nortel (NYSE: NT). Now it's harder than ever to tell when the fog will lift. As economic woes trickle out from the U.S. to global economies, Cisco noted today, "visibility going forward is more difficult in the current business climate and is subject to more variability than normal." For more on what Carter was getting at above, consider a recent column from Mike Trigg, in which he warned: "According to Cisco management on its last earnings conference call, the company had committed itself to long-term purchases of raw materials based on the then-budgeted 65% revenue growth. When the economy turned down suddenly in December, growth of only 55% materialized, and Cisco was left holding the bag on a significant chunk of raw materials inventory." John Del Vecchio said it even more succinctly in a subsequent column that discussed several red flags at Cisco: "Slowed sales growth has built up inventories to dangerous levels, increasing the likelihood that the company may have to cut prices to move the products or take a charge for its excess inventory." Cisco's business still has many attractive characteristics, not the least of which are high gross margins in excess of 50% -- though the company does expect them to fall in fiscal Q3 because of continued costs on top of lower sales volumes. Dave Marino-Nachison thinks it's important when superheroes come together. His stock holdings can be viewed online, as can the Fool's disclosure policy.
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