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Compaq decline multifaceted

Theories that computer buying has slowed are bolstered with Compaq's report that first-quarter earnings would be essentially nonexistent.

The first-quarter ice age is emerging.

Theories that computer buying has slowed were bolstered this afternoon when Compaq Computer (CPQ) announced that first-quarter revenues would be roughly equal to sales from the same quarter a year ago, while earnings would be essentially nonexistent.

Compaq's sales will likely come to $4.8 billion, a healthy number in its own right, but one that represents a 34 percent drop from the quarter before. The PC giant blamed the loss primarily on slow sales to commercial markets. Price cuts will follow as a result, the company said.

The news could create difficulties for Compaq's proposed acquisition of Digital Equipment. While the deal's mechanics are unchanged, a decline in Compaq's stock price will make the deal more expensive.

Earlier this week, several analysts said it appeared that the pace of PC sales had declined, although the verdict is not unanimous. Two days ago, Intel said its sales would be lower than expected. (See related story)

While there are several theories that explain the slowdown, most point to the aggressive price-cutting PC makers undertook in 1997. Lower prices led to lower revenues and profit margins per machine; the reductions couldn't be made up by increased sales volume. On the demand side, customers began to understand that waiting is better. In addition, the recent lack of real technological PC innovation also made higher prices tougher to justify.

In corporate America, the slowdown can be explained by the market's frustration with the generally higher prices for business systems. While several consumer PCs retail for less than $1,000, sub-$1,000 units are tougher to come by for commercial customers. Compaq, among others, is scheduled to come out with sub-$800 business machines soon.

"People aren't paying as much as they used to. [But] nobody is offering low-cost products to corporate America yet," said Kim Brown, an analyst at Dataquest.

Others state the problem isn't demand so much as it is Compaq. "Their forecasts for the fourth and first quarter were way too aggressive," said Kurt King, an analyst with NationsBanc Montgomery Securities. "Looking at the channel, which is the real indication of end-user demand, sell-through is fine," he added, meaning retail purchases are about average.

Pricing pressures won't subside anytime soon. To relieve pent-up inventories, Compaq will cut prices through the first half of the year.

"We looked closely at our market and business plan once it became clear that sales out of our North American commercial channels were not meeting our expectations," said chairman Eckhard Pfeiffer in a prepared statement. "We are putting in place price reductions and aggressive promotions in the first and second quarter to reduce these channel inventories and accelerate the implementation of our Optimized Distribution Model."

The Optimized Distribution Model is Compaq's initiative to streamline manufacturing through "build-to-order" techniques. The program was implemented last year.

Although the exact magnitude of the decline has not yet been pinpointed, it looks pretty severe, especially when put into context with Compaq's superb 1997, commented Brown.

Compaq expanded market share last year in both commercial and consumer markets. Last quarter, the company reported record revenues of $7.3 billion and earnings of $667 million. While revenues and earnings typically drop off between the fourth and first quarter, Compaq's will likely decrease more precipitously this year. The revenue drop between the fourth quarter in 1996 and the first quarter of 1997 came to 16 percent; this time, it appears it will be double that figure.

The numbers also illuminate the effects cheap computers and rampant price-cutting are having on vendors. In the first quarter a year ago, the company reported revenues of $4.8 billion, resulting in earnings of $387 million. This year, the same amount of revenues will produce a break-even situation for the company.

Bruce Stephen, an analyst at International Data Corporation, said that growth in U.S. demand would drop from 19 percent in 1997 to 15 percent this year, while worldwide demand would drop from 15.2 percent last year to 13 percent this year.