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Cisco still confident after networking shock

The networking giant reports third-quarter earnings that beat lowered expectations, yet said it "underestimated" how fast the economic climate could change.

Networking giant Cisco Systems reported third-quarter earnings Tuesday that beat lowered expectations, yet said it "underestimated" how fast the economic climate could change for the once high-flying industry.

Net earnings for the period were $230 million, or 3 cents per share, on revenue of $4.73 billion, excluding charges. That compares with earnings of $1 billion, or 13 cents per share, on revenue of $4.93 billion in the same period last year.

Analysts expected the networking giant to earn 2 cents per share on revenue of $4.69 billion, according to a survey of analysts polled by First Call.

Cisco reduced the size of its write-off of excess component inventory by $300 million to $2.2 billion.

Cisco Chief Executive John Chambers attributed the company's revised earnings to the current troubles in the telecommunications and high-technology industries.

"The peaks in the new economy will be much higher and the valleys much lower and the movement between to the two much faster," Chambers said during a conference call with financial analysts.

The economic downturn has left few telecommunications companies, let alone general technology companies, standing tall in its wake. Cisco competitors Nortel Networks, Lucent Technologies and Extreme Networks, among several others, have all had their share of earnings warnings and layoffs.

Chambers said the company should emerge from the current conditions with a clearer vision of what's expected to survive.

"We underestimated how quickly the valley could occur and the depths of that valley," Chambers said. "So you will see us respond to the troughs more effectively."

Excluding charges, Cisco lost $2.69 billion, or 37 cents per share, compared with a net income of $641 million, or 8 cents, a year ago. Those figures include the $109 million in charges related to the acquisitions of Active Voice, Radiata and ExiO Communications as well as charges totaling $3.37 billion for restructuring, inventory write-offs, and other items.

Cisco reduced its inventory charge to about $2.25 billion from the $2.5 billion that was announced previously. Chief Financial Officer Larry Carter said the company does not expect to use the inventory in the next 12 months unless demand significantly improves, upon which the company would exclude the benefit from its pro forma margin results.

The company said 20 percent of the inventory, about $450 million, was made up of finished goods and the remaining 80 percent raw materials. Semiconductor memory like flash and DRAM chips made up $300 million of the inventory, while non-memory components like ASIC (application specific integrated circuit) and DSP (digital signal processor) chips added up to $900 million.

Optical components and electro-mechanical parts comprised $450 million and $150 million, respectively, of the remainder.

The leading networking equipment maker warned of slow sales and layoffs in April. It now finds itself in the midst of the worst decline in its fortunes as a public company.

Chambers discussed the layoffs during the conference call, saying that the reductions were the most painful part of the company's restructuring process. He said that wild stock price fluctuations and strong criticism are part the rapidly changing high-tech world, but that "letting go of people for doing their job is the worst thing a leader can do."

During the quarter, the company cut 3,401 employees to reach a total head count of 39,660. About 6,000 of the planned cuts are temporary or contract workers.

But Cisco executives said the company would remain vigilant about possible acquisitions, given the lower valuations for companies as a result of the high-tech slump. In the past, inflated stock markets forced the company to buy fledgling start-ups at huge valuations even though it would be months before they could get a product to market. The depressed environment has cooled things to the point that Cisco can afford to wait.

"With valuations coming back to more modest levels, we will have the opportunity to acquire more mature companies" with the prospect of better returns, said Chambers.

At 1 p.m. PDT, the close of regular market trading, Cisco shares were up $1.11 to $20.36. The earnings report was issued after the close of regular trading. In after-hours trading, Cisco shares fell about 64 cents.

Cisco stuck by its forecast of flat to a 10 percent drop in revenue for its fourth fiscal quarter and declined to extend its outlook further because of the shifting nature of the telecommunications climate. Chief Strategy Officer Mike Volpi said in an interview after the earnings announcement that "visibility is still very cloudy".

Chambers told investors on the conference call that he expects the downturn will continue to pinch customers in the high-tech, manufacturing, and financial service sectors, in particular. He also said that the climate for alternative service providers, or small phone companies, "is close to bottoming out."

Chambers expects to see slow improvement in this business over the next few months, but he acknowledged that market factors have decimated the sector. Cisco now sees only 150 telecommunications providers as potential customers, down from 3,000.

But Chambers remained "optimistic" that Cisco's long-term growth could return to the 30 percent to 50 percent range, even as the industry Cisco serves consolidates.

Separately on Tuesday, Morgan Stanley upgraded Cisco stock ahead of the earnings announcement.