Here's some interesting reading.
OEMs slash inventories in fiscal spring cleaning
By Bolaji Ojo, Jack Robertson, and Claire Serant
EBN
(04/23/01, 08:46:10 PM EST)
At first glance, Cisco Systems Inc.'s announcement last week that it will take a $2.5 billion charge to reduce inventory on its books seemed like a healthy development for its supply chain.
The action was certainly welcome news for Cisco's harried suppliers and EMS providers, which were unwilling to share accountability for the huge inventory buildup the networking equipment supplier would have accumulated by the end of April.
“The responsibility for inventory lies with OEMs,” said Eugene Polistuk, chairman and chief executive of Toronto-based Celestica Inc. “I never expected EMS companies to carry the burden of inventory. ... We can't do it [and] we were never going to let it happen.”
But by writing off portions of their inventories, Cisco and other OEMs-including Hewlett-Packard, Juniper, Motorola, Redback Networks, and Sycamore-have handed suppliers and EMS providers what appears to be a Pyrrhic victory, according to analysts. Components will continue to clog the supply chain until used or declared obsolete, a process that may take months or perhaps several quarters, they said.
“Accounting write-downs may help equipment companies' balance sheets, but equipment and semiconductors still need to disappear from the channels,” said Dan Heyler, a Hong Kong-based analyst at Merrill Lynch & Co. Inc. “These chips need to be resold in an overcapacity environment, which still proves to be challenging.”
Cisco's write-off gives it an opportunity to present a leaner inventory burden to shareholders when it announces its results on May 8. Instead of the approximately $4.6 billion inventory load analysts estimate the San Jose company would have had, Cisco will announce a more modest figure-$1.6 billion.
Still, the company will slug shareholders with a fistful of negative news. Its fiscal 2001 third-quarter revenue will be roughly $4.7 billion, down 30% from $6.7 billion in the preceding quarter.
“The first three and a half months of calendar year 2001 have been extremely challenging for those of us in high-tech,” said John Chambers, Cisco's chairman and chief executive. “The changes that used to occur over quarters are occurring over months.”
Domino effect
Cisco and its rivals are not done cleaning house, however, and their actions will have a domino effect even on EMS companies that haven't gotten saddled with OEM or supplier inventories. Although major OEMs will start off with a cleaner balance sheet next quarter, they are still dealing with lingering problems from last year's unbridled growth.
Unable to ship enough equipment because of production delays and component shortages, Cisco early last year abandoned its tried and tested supply chain strategy of relying on its EMS partners to procure components. The company took the direct approach and began signing long-term supplier agreements. As a result, Cisco's inventory ballooned, rising from just $878 million in April 2000 to almost $2 billion by October and $2.5 billion in January 2001.
“To secure our large volume of orders, we had to commit to many of our suppliers an inventory requirement going out four to six months,” Chambers said. “When demand dropped off so dramatically in this calendar year, what might have normally been four months' supplies quickly evolved in many of our product areas to in excess of 12 months.”
Several other OEMs are stuck with excess inventory, though none has announced anything near the amount Cisco is lopping off. Last week, Hewlett-Packard Co. said it will take a one-time inventory and capacity write-down of approximately $150 million. Cisco's direct rivals, such as Juniper, Redback, and Sycamore, have also announced modest inventory reductions. When Nortel Networks Corp. reported its results Thursday, the Canadian communications equipment OEM announced what amounted to an inventory write-off but called it a provision against excess and obsolete components.
Chain inefficiencies
Analysts said the problem boils down again to inefficiencies in the electronics supply chain, particularly forecasting difficulties, which engender the boom and bust cycles.
“If you have difficulty forecasting, then you will have difficulty with inventory levels,” said J. Keith Dunne, an analyst at Robertson Stephens Inc., San Francisco. “The industry needs greater motivation to move where they were headed, which was a universe where supply chain A communicates with supply chain B.”
A write-off won't vaporize excess inventory. The action will definitely free space on the balance sheet, but a company, as in the case of Cisco today, will still be loaded with a huge pile of components.Even memory components that are traditionally easy to junk may present a major problem for Cisco because they are tailored to specific applications.
“These aren't modules you can simply dump on the spot market to bleed off excess stock,” said Bob Merritt, a Redwood City, Calif.-based analyst at Semico Research Corp. “Almost no other OEM can use these custom modules, so unless they are held for a long time until they find their way into products, they are essentially scrap.”
Cisco may even have trouble selling off standard DRAM modules if they are the kind of trailing-edge memory chips widely used by networking companies. Merritt said EDO and SDRAM modules have no market for PC OEMs and aren't likely to sell in the spot market to other networking and communication product buyers, which are coping with their own excess inventories.
EMS dilemma
EMS companies scored a major knock-down in their tussle with OEMs in the latest round. Razor-thin margins have prevented contract manufacturers from bearing some of the brunt of excess inventory, analysts said.
“Inventory is not part of the contracted services that EMS companies have offered to their customers,” Robertson Stephens' Dunne said. “If a company as significant as Cisco is taking these write-offs and not the EMS companies, how will a much less influential OEM be able to negotiate with an EMS company?”
Despite their victory, many EMS companies could be sitting around biting their nails for some time, industry sources said. Even though EMS providers aren't drowning in inventory, their customers have cut back orders.
Already analysts are lowering their forecasts for these companies by as much as 20% with the likelihood of further downward revisions. |
