Making Their Own Troubles: Cisco Highlights the Inventory Woes at Tech Shops

Cisco (CSCO) on Monday showed the downside to having a lot of stuff.

The company, which said it would take a fat $2.5 billion charge in the third quarter ending this month to write down the value of its inventory, likely won't be alone in making such an announcement. So investors may want to begin looking now for other companies with bulging inventories, because inventory writedowns sap earnings and point to a deep weakness in demand at these businesses.

Companies are finding themselves in this fix because back when times were good, demand looked liked it never would cease. Customers were even ordering twice as much as they needed just to guarantee that they'd get something. So manufacturers like Cisco loaded up on parts and churned out products. Then the economy turned, the double-ordering ended and parts and products began to pile up.

"Business demand consistently exceeded our expectations throughout most of calendar year 2000," Larry Carter, Cisco's chief financial officer, said in a statement. "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."

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Others

Cisco isn't even the first networker to say it'll take a charge to write down inventory. Sycamore (SCMR) did so earlier this month. In acknowledging it needs to clear its books of gear it stockpiled in anticipation of unceasing demand but now can't sell, Sycamore said it would take a $140 million to $150 million charge in the third quarter ending April 28.

Other networkers with big inventories such as Lucent (LU) and Nortel (NT) also could face the prospect of writedowns.

Of course, the problems could spread beyond the networking sector. The recent information technology spending slowdown among corporations also has caused inventories to rise at enterprise hardware vendors. In their latest reported quarters, inventories grew faster on a sequential basis than did sales at both EMC (EMC) and Sun Microsystems (SUNW): 66% vs. 41% sales growth in EMC's first quarter, and 17% vs. 1.4% sales growth in Sun's fiscal second quarter. Both companies have warned that poor demand will hurt both sales and earnings since then.

And then there's Network Appliance (NTAP ), whose inventories rose an eye-catching 67% in its fiscal third quarter, which the company reported in February. That overhang in part foretold the dramatic breakdown the company confessed last week, when it preannounced a revenue miss of about 30% and a shortfall in profits of 70% to 90% for the fourth quarter ending this month. It's only natural to assume that inventories have continued to build up amid the chaos, though it should be noted that NetApp is working on a much smaller scale than Cisco; inventories stood at $37.1 million at the end of its third quarter.

Not Talking

A Sun spokesman declined to comment on both current inventory levels and the possibility of a writedown, noting that those questions likely would be addressed when the company reports results on Thursday. EMC, also scheduled to report on Thursday, didn't return a call seeking comment. NetApp declined to comment.

Meanwhile, some seemingly prime candidates for inventory writedowns could escape them, at least for now.

Inventory stockpiles have dogged semiconductor makers for months. Two companies with the biggest inventory levels are Altera (ALTR) and Xilinx (XLNX), competing makers of programmable logic devices, or PLDs. PLDs, chips that customers can program themselves, are largely used in the communications sector.

In March, Altera executives said that they expected to have eight months of inventory on hand by the end of March. Analysts believe Xilinx also has about eight months or so of inventory on hand. But an Altera executive in March ruled out a writedown. (Officials there and at Xilinx weren't available to comment Monday.) PLDs have relatively long shelf lives, which means Altera and Xilinx could simply hold on to them until the market turns.

Price Cuts

Some companies are trying to get around the inventory issue by cutting prices to move products. For instance, Palm (PALM) is creating pain in the handheld market by flooding the market with product to alleviate $300 million in inventory it accumulated. It hoarded components and now is putting that stockpile into devices selling for $20 to $50 less than previously priced.

But even that approach may not work out as planned. UBS Warburg analyst Don Young calls Palm's channel inventory, or the amount of products at retailers, "ominous." Young estimates that the handheld maker had 16 weeks of retail channel inventory at the end of February, while competitor Handspring (HAND) has nine to 12 weeks -- heightened levels that are more typical for the holiday selling season. (UBS hasn't done underwriting for either company.) All that inventory in the channel makes it awfully hard to push more products out the door, which in turn means more inventory could stack up at Palm after all.

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