The PC maker reported a net loss of $184 million, or 10 cents a share, for the second quarter. Analysts had expected a loss of 11 cents a share, according to a consensus by First Call.
In a conference call, newly appointed chief executive Michael Capellas told financial analysts that the third quarter will be marked by turmoil as the company absorbs as much as a $1 billion charge for restructuring and deals with changes in its distribution model.
Compaq's top priorities are improving "product marketing around the high end of the business" and adjusting its operating model in the competitive commercial PC market, Capellas said. After a period of fence-sitting, the company intends to embrace direct sales.
Despite leading the PC industry in volume, Compaq has struggled over the last few quarters, finding itself confronted by problems ranging from excess inventory to strained relations with Wall Street, not to mention the complexities of integrating Digital Equipment. In April, Compaq ousted then-chief executive Eckhard Pfeiffer, but named Capellas as successor only last week.
First up, Compaq will lay off between 6,000 and 8,000 employees more than than the 2,000 it had planned to let go as a result of acquiring Digital Equipment. To date, the PC manufacturer has completed 15,250 of an expected 17,000 Digital-related layoffs, which were announced more than a year ago.
Compaq expects to take a charge of between $700 million and $900 million as a result of the streamlining. The company also will close additional facilities, beyond the previously announced consolidation of its Salem, New Hampshire, operation with a plant in Fremont, California.
Another factor that could hurt third-quarter earnings will be the company's new distribution model, slated to start Sunday. Compaq previously said it will reduce the number of distributors from 39 to 4 and the number of distribution centers by 70 percent. Distributors take product from Compaq and ship it to dealers.
If successful, the program will mean about 75 percent of all sales in North America will take place over the Web. Compaq has previously made a number of attempts to improve the efficiency of its distribution system, however, to little effect.
"The goal of that program is to reduce North America 'channel' inventory, which will have a short-term impact on margins," Capellas told financial analysts. The action is expected to reduce revenue by $100 million in both the third and fourth quarters and trim margins by $60 million, or about two cents a share, during the second half.
In the second quarter, Compaq reported 3.5 weeks of inventory. That compares to an average of 7 days for Dell Computer and between 1 and 2 days of inventory for Apple Computer. Generally speaking, having lower inventory levels is good because if products don't sell fast enough, Compaq has to write down the value inventory on hand, which hurts financial results.
The margins hit comes at a bad time for Compaq, which reported operating expenses increased to $2.2 billion during the second quarter (up from $1.9 billion in the first) and gross margins dropped to 20.5 percent from 24.7 percent.
The PC maker earned two cents a share on net income of $32 million in the same quarter a year ago, which at the time was seen as dismal. Factoring for the June 11, 1998, purchase of Digital Equipment, Compaq lost $3.6 billion, or $2.33 per share.
Not all the news was bad. Compaq reported sales grew by 17 percent on a pro forma basis to $9.4 billion worldwide. Enterprise revenue grew 11 percent over the second quarter of last year, with storage gaining 30 percent and the ProLiant server business increasing by 40 percent.
Commercial PC revenue increased by 19 percent, and the consumer business grew by 35 percent in terms of revenue and 63 percent in terms of units shipped. Compaq's North America revenue increased by 32 percent, but revenue grew a "disappointing" 6 percent in the Europe, Africa and Asia regions, Capellas said.
He attributed part of the problem to restructuring efforts in Germany and France and to "increased competition in the U.K., particularly the small and medium business markets as well as softness in financial services, which has been a traditional area of strength for Compaq."
Latin America grew by 17 percent and Asia-Pacific was up 14 percent. China was flat year-to-year, while Japan declined slightly.
One analyst predicted the worst is over. "It depends on where you're coming from. If you're from Wall Street, we've had the pain and now it's time for things to get marginally better. If you're part of the rank and file at Compaq looking at 6,000 to 8,000 layoffs, it might not look the same," said Kurt King, analyst with Bank of America securities.
Capellas also talked about the future, such as Compaq's new Internet appliance servers. "It's a great example of our commitment to drive Internet leadership," he said.
In response to an analyst question, the 44-year-old head man explained Compaq's Internet strategy as: "One, lead with virtually every product that you have positioned on the Web, and two, make sure those product categories can not only have full disclosure and really have intelligent selling and be able to hit 'buy now' for each one."
Capellas told analysts that their forecasts for the fourth quarter are in line, but he warned that uncertainty about the Year 2000 technology glitch could affect the traditionally strong quarter.
Compaq has also dedicated a team to e-commerce, and "we will be announcing a great new addition to the team in a couple of weeks," the CEO explained.
Capellas's own performance was stellar, said King, "night and day from what we've seen the last three years."
His giving facts and figures was unlike his predecessor. "I can't state how important it is that he got on the phone with frankness and candor. That buys Compaq a lot of leeway with investors," King said.
Compaq closed at 26 today on the New York Stock Exchange, up .41. The company's current market capitalization is nearly $43 billion.