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Cisco warns, issues bleak forecast

The networking giant announces a profit warning for its third quarter and says conditions have "never been more challenging."

Cisco Systems announced a profit warning for its third quarter as sales of networking equipment to businesses and telecommunications carriers continue to slump.

In addition, the company announced a variety of charges that could total as much as $3.7 billion.

Cisco expects third-quarter earnings per share to be in the low single-digit range and for revenue to fall 30 percent from the second quarter, when the company earned $6.7 billion in sales. Cisco expects fourth-quarter revenue to range from flat to down 10 percent sequentially as the U.S. economic slowdown has begun to spread to parts of Asia and Europe, executives said.

Though Cisco executives have avoided admitting it in public comments, the company has succumbed to same steep decline in sales that has afflicted its primary rivals in the networking market, such as Nortel Networks, Lucent Technologies and Extreme Networks, among others.

"The business environment that our segment of the IT industry is facing has never been more challenging," Cisco Chief Executive John Chambers said in a statement. "In fact, this may be the fastest any industry our size has ever decelerated."

Wall Street analysts previously predicted earnings of 8 cents per share and revenue of $5.95 billion, according to a poll of analysts by First Call. Cisco's troubles were a foregone conclusion on Wall Street, where most analysts--though concerned about the severity of the company's write-offs--had already assumed there would be more bad news about one of the highest flying stocks of the 1990's.

"Everyone expected a miss; everyone expected a charge," said Paul Sagawa, an analyst at Sanford C. Bernstein.

In regular trading Monday, Cisco's shares closed at $17.20. In after-hours trading, the stock slipped to about $15.30. Cisco was the most active stock being traded after the regular market session closed.

Other network equipment manufacturers took a hit on Cisco's news. Juniper Networks, a Cisco competitor, dropped $1.78, or about 4 percent, to $46.60 in after-hours trading. Ciena fell $1.95, or about 4 percent, to $49.56 in after-market trading. Extreme Networks dipped 65 cents to $16.48; Nortel Networks edged down 35 cents to $14.90; Lucent Technologies shaved off 10 cents to $7.30; Foundry Networks lost 49 cents to $8.75; and Avici Systems fell 81 cents to $11.48 after the regular markets closed.

More charges
Cisco executives said the company expects to take a restructuring charge of $800 million to $1.2 billion as part of a companywide reorganization that includes previously announced layoffs of about 8,500 employees and the restructuring of certain businesses.

The company will take an additional $2.5 billion charge based on excess inventory, mostly raw materials and components that the company uses to build networking products.

"In an effort to meet our customer expectations, we continued to increase our inventory and capacities to keep up with rising demand. This (additional $2.5 billion) charge reflects the recent significant and unexpected drop in customer demand," Cisco Chief Financial Officer Larry Carter said in a statement.

The layoff of 8,500 employees, or about 18 percent, includes about 2,500 temporary and contract workers and is expected to save about $1 billion yearly. In a previous announcement, the company said it expected layoffs of 3,000 to 5,000 full-time workers and between 2,500 and 3,000 temporary and contract workers. This latest layoff announcement includes 500 new job cuts. To further cut costs, the company will consolidate facilities to save $300 million to $500 million.

As for the excess inventory, Chambers said in a conference call with analysts that the company last fiscal year lost 5 percent sequential revenue growth each quarter because of parts shortages. This fiscal year, the company loaded up on parts but will have more than needed because of the sales slowdown. After the $2.5 billion charge, the company will still have about $1.6 billion in inventory, he said.

The restructuring of businesses may include killing off some products that aren't selling well or that aren't profitable, such as portions of its digital subscriber line (DSL) equipment business, Chambers added. The company earlier this month discontinued an optical router that was selling well.

The magnitude of the warning may turn a few heads, Sagawa said. He roughly equated the charge to something along the lines of 60 cents a share, a huge amount for a single quarter.

Other analysts pointed out that the general negative mood might not stir up much reaction on the Street. "I think (Cisco's executives) have taken a pessimistic view for the past few weeks, which caused Wall Street to take the same view," said Richard Shannon, an associate analyst at Epoch Partners.

Taking the world by storm
Cisco executives said the economic slowdown that has hit the United States has spread globally. Sales in Asia and Europe were weak in the third quarter, Chambers said. In the United States, business sales were down 20 percent sequentially, while sales to service providers were down about 40 percent sequentially.

Long term, however, Cisco executives still believe the company will reach 30 percent to 50 percent revenue growth once the economy turns around. The company plans to report its final third-quarter results May 8.

"The 30 to 50 percent growth rate is something that might be called into question," said Steve Kamman, an analyst at CIBC World Markets.

"It's the price of success," he said. "Everything Cisco has done to become such a fantastically great company has led to the problems they face now."

Kamman noted that some parts of Cisco's businesses might grow that fast, but the company as a whole has become too large to sustain the astronomical growth it once displayed, especially because a depressed stock price has dampened its acquisition prowess.

"You've got to give them their due for what they've achieved, but the market is relentlessly forward-looking," Kamman said.

Another miss
Cisco's third quarter will be the second straight quarter in which the company will miss earnings estimates. Cisco in February missed second-quarter earnings expectations by one penny because of sluggish sales of networking equipment to telecommunications service providers. The company also saw sales to businesses slacken, particularly in manufacturing.

In a conference call with analysts in February, Chambers warned that sequential revenue growth for the next two quarters will be flat. He also predicted that Cisco's revenue for the current fiscal year would grow 40 percent from last year. But that prediction was based on the assumption that the U.S. economy would recover in the second half of this calendar year and that the economic slowdown wouldn't spread internationally.

In mid-March, Chambers warned sales were not picking up, and the company was seeing early signs of a sales slowdown internationally.

Like others in the technology sector, networking companies have been hit hard in recent months by the economic slowdown. Nortel, Lucent, 3Com, Sycamore Networks, Extreme and others have all announced earnings warnings.