In a word, Cisco Systems Inc.'s (Nasdaq: CSCO) third quarter for fiscal 2001 was brutal.

"You deal with the world the way it is, not the way you wish it was,” said Cisco CEO John Chambers in a conference call with analysts and investors this afternoon. And the world is now rather... well, brutal, as Cisco’s executives somberly telegraphed during the course of the call.

Cisco net sales for the quarter were $4.73 billion, down 4 percent from last year's $4.93 billion figure. But after considering the effects of the charges against earnings, the story becomes worse (see Cisco Reports Weak Q3).

During the quarter, Cisco recorded a $1.17 billion restructuring charge against earnings and took an excess inventory charge of $2.2 billion. Put another way, in just one quarter Cisco wrote off about half of all its 1996 revenues, due to excess (and largely unusable) inventory.

The company's pro forma earnings -- ignoring stuff like acquisition charges, payroll tax on stock option exercises, restructuring costs, and an excess inventory charge -- were $230 million or 3 cents a share. This is a 77 percent drop from its year-ago number of $1 billion or 13 cents a share.

In one year’s time, Cisco’s earnings per share have crashed. A year ago, Cisco’s Q3 net earnings were $641 million or 8 cents a share. Cisco’s actual net loss for this year's third quarter was $2.69 billion or 37 cents a share.

Cisco CFO Larry Carter attributed the significant drop in revenues to three things: an unfavorable product mix, slowed shipping volumes and increased overhead, and an increase in deferred revenue.

Last month, the networking giant said revenues for Q3 would be about $4.69 billion, down about 30 percent sequentially from its Q2 revenues of $6.7 billion. For its fourth fiscal quarter, Cisco executives timidly suggested that revenues would be in the range of $4.22 billion to $4.69 billion, or flat to down 10 percent when compared with Q3 (see Cisco's Inventory Woes Mount).

The slowing economy’s effect on service providers was illustrated in one rollicking anecdote Chambers relayed regarding Cisco’s sales to alternative carriers, such as CLECs. The company had previously been accustomed to book $500 million worth of orders each quarter from that one group of customers, he said. But this quarter, the number of orders from those carriers dropped by about 75 percent.

On the call, Cisco CFO Larry Carter detailed the firm’s excess inventory charge for analysts, pointing out that it was a bit less than the $2.5 billion the firm had previously expected. He attributed 80 percent of the excess inventory to raw materials, including about $300 million in semiconductor memory; $450 million in optical components such as lasers and transponders; $150 million in electo-mechanical parts; and $1.3 billion in other non-memory components, such as ASICs. The other 20 percent, or $400 million, of the excess inventory charged off was attributed to “work-in-progress,” or subsystems.

Carter also assured investors that Cisco would exclude from its pro forma results any benefit the company realizes from selling the inventory. Most of Cisco’s parts are custom made, and any income from sales of its excess inventory would be “nominal,” Carter said.

Apparently, Cisco investors had already been prepared for the worst. In regular trading today Cisco shares climbed $1.13 to $20.38. In after-hours trading on the Island ECN, Cisco’s stock had dropped slightly to 19.70.

— Phil Harvey, Senior Editor, Light Reading
http://www.lightreading.com