Earnings Outcomes: Cisco inventory plunges greater than 15% as China lockdown, uncertainty weigh on outlook

Cisco Systems Inc. shares plunged in the extended session Wednesday after the tech bellwether’s revenue and forecast fell well short of Wall Street expectations as executives explained that supply problems caused by COVID lockdowns in China were the main culprit.

shares dropped more than 15% after hours, following a 4.4% decline in the regular session to close at $48.36.

The company reported third-quarter net income of $3.04 billion, or 73 cents a share, compared with $2.86 billion, or 68 cents a share , in the year-ago period. Adjusted earnings, which exclude stock-based compensation expenses and other items, were 87 cents a share, compared with 83 cents a share in the year-ago period. Revenue was virtually flat at $12.83 billion compared with $12.8 billion in the year-ago quarter.

Analysts surveyed by FactSet had forecast 86 cents a share in adjusted earnings on revenue of $13.37 billion, based on Cisco’s forecast of 85 cents to 87 cents a share on revenue of $13.19 billion to $13.44 billion.

“In terms of supply, we expect the challenges we experienced in Q3 to continue into Q4,” said Scott Herren, Cisco’s chief financial officer, on the conference call with analysts. Both Herren and Chuck Robbins, Cisco’s chief executive and chairman, said that the forecast is “100% supply.” Robbins told analysts the company is sitting on a record backlog and record inventory.

Cisco forecast fiscal fourth-quarter earnings of 76 cents to 84 cents a share on a 5.5% to 1% year-over-year decline in revenue, or a range between $12.1 billion and $12.67 billion. Analysts surveyed by FactSet estimate 92 cents a share on revenue of $13.87 billion.

That guidance forced Cisco to chop its annual forecast with just a couple of months to go in its fiscal year. After consistently predicting revenue would increase 4.5% or better in this fiscal year, Cisco executives reduced their view to sales growth of 2% to 3% for the year, while also reducing their annual forecast for adjusted profit.

“We did not have a plan for a country to shut down,” Robbins said on the call.

Robbins explained that since the company’s fiscal quarter ended in April, it is experiencing a whole quarter of lockdowns in China as opposed to companies with quarters that ended in March. When China locked down Shanghai starting on March 27, it threw a monkey wrench into Cisco’s ability to get components.

“We’re talking really about the Shanghai situation, so we had $200 million from Russia, and then we had $300 million that was completely attributed to our inability to get power supplies out of China,” Robbins said. “That’s the simplicity of what caused the problem.”

“When we look at Q4, and you think about the Shanghai lockdown, and what we’ve heard, because in Shanghai there are lots of components that go into our power supply, so we’re not able to get those components,” Robbins explained. “Shanghai now is saying they are going to open up June 1.”

“We don’t know exactly what that means, and what that means to when that implies that we would start getting any supply out, and correspondingly, we believe when they open up and when they do allow transportation logistics to start up, we believe there’s go being to be a high degree of congestion,” Robbins said.

While Robbins used power-supply components as an example, CFO Herren added that supply problems extended to many more components.

“It’s not just power supplies,” Herren said. “We’ve got issues in a number of different areas. I tried to give you a sense of scale because I know it’s 41,000 unique components, what we said is about 350 have potential supply concerns right now.”

Getting back to how sales broke down for the third quarter, the company reported that “secure, agile networks” sales rose 4% to $5.87 billion; hybrid work, or collaboration, sales declined 7% to $1.13 billion; “Internet-for-the-Future” sales rose 6% to $1.32 billion; and end-to-end security sales rose 7% to $938 million from the year-ago period. Analysts had forecast “secure, agile networks” sales of $6.1 billion, “hybrid work” sales of $1.13 billion, IftF sales of $1.44 billion, and end-to-end security sales of $930.8 million.

Total product sales rose 3% to $9.45 billion, compared with the Street’s estimate of $9.81 billion, and services revenue declined 8% to $3.39 billion, while analysts expected $3.54 billion.

Last week, focus fell on Cisco’s security business following reports that Shelly Blackburn, Cisco’s vice president of security sales and a 22-year company veteran, was leaving the company. Cisco has not confirmed such a move. As of Wednesday, Blackburn’s Twitter and LinkedIn pages still list her at Cisco.

Last quarter, Robbins admitted the company needs to improve its security business, and overall the company told MarketWatch that while supply-chain issues had not gotten any better they had also not gotten any worse. Supply-chain issues have dogged Cisco for more than a year as they have most manufacturers who rely upon semiconductors amid a global chip shortage.

“I will say that we have room to get better on security and the teams are working hard on that,” Robbins told analysts three months ago, when asked why Cisco’s security business wasn’t growing as fast as Palo Alto Networks Inc.
Fortinet Inc.
or Check Point Software Technologies Ltd.

Supply problems caused by the China lockdown is also affecting software sales at Cisco. On Wednesday, Robbins said the company had a software backlog of “well over $2 billion” that was “connected to a piece of hardware that we will not begin recognizing the revenue until the hardware ships.”

In the past 12 months, Cisco shares fell 9% as of Wednesday’s close, compared with a 7% decline by the Dow Jones Industrial Average 
of which Cisco is a component, a 10% drop for the S&P 500 index
and a 16% fall by the tech-heavy Nasdaq Composite Index 

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