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Compaq lives up to warning

Price wars and economic weakness combine to hurt the computer maker's bottom line in the third quarter.

    Price wars and economic weakness combined to hurt Compaq's bottom line in the third quarter.

    After market close Tuesday, the computer maker reported a third-quarter loss of $499 million, or 29 cents per share. Excluding investment losses mostly related to an investment in CMGI, Compaq lost $120 million, or 7 cents per share.

    "There's no question that pricing got particularly heavy during the quarter," Compaq CEO Michael Capellas said during a conference call with analysts. "Despite our cost discipline, we were unable to offset pricing and volume trends."

    Compaq's report came as little surprise. The company previously warned of a third-quarter operating loss of 5 cents to 7 cents per share on revenue of $7.4 billion to $7.5 billion.

    Analysts surveyed by earnings tracking firm First Call produced a consensus forecast calling for a loss of 6 cents per share for Compaq's third quarter. Before Compaq's warning, First Call consensus had predicted a third-quarter profit of 5 cents per share.

    Company executives expect little improvement in the near term. Compaq predicts it will lose 3 cents per share on fourth-quarter revenue of $7.6 billion to $7.8 billion.

    "We do not anticipate dramatic changes in corporate IT spending, particularly through the first half of 2002," Capellas said.

    At the time of Compaq's warning at the end of September, Capellas blamed the loss on a confluence of events: a typhoon in Taiwan; last month's terrorist attacks in New York and Washington, D.C.; slower sales in the wake of the announcement of a Hewlett-Packard and Compaq merger; and a generally weak economy.

    The company continued to face a fierce price war from rivals such as Dell Computer. Compaq's gross margins fell to 19.9 percent, down 1.6 percent from the second quarter and 4.1 points from the same period a year ago.

    Third-quarter revenue increased 2 percent year over year to $1.9 billion for Compaq's Global Services division. Profit for the unit increased 15 percent to $284 million.

    After a couple of years of struggling after the acquisition of Digital Equipment, Compaq has finally turned its services unit into a strength as corporate clients shift from buying new hardware to making the best use of their existing machines, said Brett Miller, an analyst for A.G. Edwards.

    "We're seeing the company shift and migrate very, very quickly to being an enterprise play," Miller said.

    Enterprise computing--which includes servers and storage--lost $104 million on revenue of $2.4 billion. Compaq blamed the loss on weak markets in telecommunications and financial services, ongoing efforts to reduce a glut of products in the sales channel, and continued price wars, especially for low-end servers. Storage and high-end servers remain strong areas for Compaq, Capellas said.

    The Access Business Group--which oversees Compaq's PCs and handheld computers--lost $248 million on sales of $3.3 billion, which represents a 42 percent drop in revenue. The company has been trying to keep up with Dell, its primary competitor in PCs, which has been cutting prices this year in an aggressive bid to gain market share.

    "We clearly have more work to do to improve our Access business model," Capellas said.

    Miller wondered whether Compaq is consciously letting its PC business stagnate ahead of the HP merger. Although HP plans to keep Compaq's manufacturing facilities, the sales, marketing and distribution tactics would be spearheaded by HP personnel, so Compaq might be ceding retail shelf space to HP now, Miller said.

    "Compaq, I think, is intentionally getting killed out there," Miller said. "Of course, Compaq can't say that. But you kind of get that feel."

    Capellas said the holiday season could drive PC sales higher, largely on the backs of Microsoft's new Windows XP operating system and Intel's latest Pentium 4 processors. XP's built-in multimedia capabilities should motivate some consumers, Capellas said.

    "It's going to make things better for sure," Capellas said of a combination of XP and the Pentium 4. "How much better, we'll see."

    A.G. Edwards' Miller wasn't so sure. "Operating systems don't drive system upgrades anymore," he said, adding that average PC users have no reason to buy faster chips or new software just to read e-mail, surf the Web and do word processing. "I really don't think people have cared this year."

    Compaq is the third major Wintel computer seller to report results for the September quarter. Last week, Gateway reported a third-quarter loss in line with analyst expectations. IBM posted quarterly earnings that were a penny ahead of the consensus forecast.

    Shares of Compaq fell 25 cents to $9.40 in Tuesday's regular trading ahead of the earnings news.