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Compaq returns to profitability

The company manages to turn a profit despite the hubbub surrounding its proposed sale to HP. Execs say the company will thrive even if the deal collapses.

Servers and services helped Compaq Computer turn a profit in the fourth quarter.

After market close Wednesday, the computer maker reported fourth-quarter net income of $92 million, or 5 cents per share, on revenue of $8.5 billion. In the same quarter last year the company posted a net loss of $672 million. Compaq last week said it would report a fourth-quarter profit on revenue of $7.6 billion to $7.8 billion; until that announcement, analysts were expecting a quarterly loss.

For the year, Compaq lost $785 million on sales of $33.6 billion in 2001, as compared with earning $569 million on revenue of $42.2 billion in 2000.

The company managed a profit in the fourth quarter despite the hubbub surrounding its proposed sale to Hewlett-Packard. Compaq executives have said their company can thrive even if the HP deal collapses. Excluding merger-related charges of $36 million, Compaq earned 6 cents per share. Analysts expected a loss of 3 cents per share.

Compaq showed improvements across the board, particularly in services, storage and servers, such as the fault-tolerant Himalaya line, covered by its Critical Solutions Group. The group grew 31 percent from the third quarter. But Compaq's PC business, known as the Access Business Group, also did better, posting a smaller loss than in the third quarter.

Despite saying he is happy with the work of his troops, Compaq Chairman and CEO Michael Capellas, speaking during his company's conference call, said Compaq still has "more work to do."

"We're not going to be satisfied, of course, until we return the Access Business to profitability," he said. Capellas also plans to grow the company's services business, particularly in customer support, and to increase revenue from its Enterprise Computing, which includes all servers, storage and supercomputer products.

Although Compaq has emphasized that it's confident as a standalone company, Capellas said, "We continue to believe that the merger with HP is the best way to accelerate our strategy and extend our leadership in a dynamic industry.

"The merger clearly has been controversial, but we remain firm in our conviction that it is in the best interests of shareholders, customers, partners and employees," he said.

Looking forward, Capellas predicted a profit of a penny per share on revenue of $7.6 billion in the first quarter--normally a weaker period than the fourth quarter for most computer companies. First Call consensus was calling for a break-even first quarter on revenue of $7.3 billion.

During 2002, companies will likely focus on infrastructure, which includes computer networks and security, Capellas said.

"In this environment, we believe the fastest-growing market segments will be industry standard servers and storage area networks," he said. However, he added, "We did see some strengthening in the IT (information-technology) market in Q4, and pent-up demand should drive a stronger recovery in the second half of the year."

Boost from PC market?
Most analysts believe Compaq benefited from relative strength in the overall PC market. The two largest makers of PC processors, Intel and Advanced Micro Devices, sold more chips in the fourth quarter than industry observers predicted.

Compaq's Access Business Group, which oversees PCs and handheld devices, reported a fourth-quarter operating loss of $69 million on $3.8 billion in sales. The division lost $248 million in the third quarter.

Compaq will continue working to get its PC business--which, Capellas emphasized, is an "extremely important" business to the company--profitable in 2002.

"We're not happy with any loss," he said.

Capellas predicted that return to profitability would happen during the second half of the year.

Some of Compaq's surprise profit was fueled by the company's corporate business. Distributors reported that demand for Compaq's enterprise hardware increased in the second half of the fourth quarter, Morgan Stanley analyst Gillian Munson wrote in a research note. Compaq servers powered by Microsoft's Windows NT operating systems did particularly well, she said.

"Our channel and industry checks indicate that Compaq's results were led by NT servers relative to expectations," Munson wrote. "We think Compaq is benefiting from the restructuring of its NT server business. This has allowed the company to get into a better price position in this product category."

The company's enterprise computing unit reported net income of $56 million in the fourth quarter, compared with a loss of $104 million in the third quarter.

Services revenue increased to $2 billion, up 8 percent from the third quarter and up 4 percent year over year. Compaq's Global Services unit reported operating income of $253 million.

Sustainable surge?
Coming into the fourth quarter, Capellas said he feared a drop-off toward the end of the quarter, considering the tough year. But, he said, "We were very linear...all through the quarter. We didn't see people fold their tents up and go home. It was just sort of steady across the quarter across all categories."

Compaq's fourth-quarter results represent an improvement from the third quarter, when the company saw disappointing sales that it subsequently blamed on customer uncertainty related to the HP announcement, logistics problems caused by September's terrorist attacks, and a Taiwanese typhoon.

But the company seemed to shake that off in the fourth quarter, landing a number of large corporate contracts, including deals with Raytheon, General Motors, American Express and the U.S. Postal Service. The deals are valued at more than $2 billion combined over a period of several years.

Is the company's business surge in the fourth quarter sustainable? It all comes down to the merger.

"I think it's clear that uncertainty is facing the company's future, based on the merger," said Roger Kay, a PC industry analyst for IDC.

Indeed, Compaq's future "depends entirely on whether or not it gets picked up by HP," Kay said. "Having thrown its lot in with HP, I'm not sure where it would go" should the merger not go through. Some shareholders, including Walter Hewlett, who is attempting to thwart the merger, have vehemently opposed it. His latest salvo, a letter to fellow shareholders, called the merger a "backward-looking strategy."

Despite such uncertainties, Compaq has been emphasizing its server hardware and services offerings--a step in the right direction, according to Kay.

"If Compaq downsizes in terms of unit volumes, it could cherry-pick its customers and take the more profitable ones," he said. "If Compaq continues to execute on its model, it will retreat to more profitable opportunities."

And at Compaq, a return to profitability seems to be where it's at these days.