Compaq earnings mask deeper woes
Some Digital revenues are included in the numbers, even as demand slows and consumers remain interested in lower-priced machines.
Demand for PCs appears to be slowing down; at the same time, consumers and business customers are demanding lower-priced machines. While Compaq maintains that its sub-$1,000 machines are just as profitable as higher-end machines in terms of gross margin percentage, the aggregate margin dollars generated by each machine is less, according to analysts and even Compaq executives.
Some of the price reductions come as a result of component cost reductions, but some come straight out of margins, according to most observers. As a result, PC makers have to make up the difference by selling more units, again, in a market that appears to be slowing down.
"We should get a seasonal uptick. All the indications are that there is really no reason to think that it won't happen," said Gene Glazer, vice president of Fortis Advisers, an international financial services company. "But there has been a slowing of demand generally in the world."
Vendors are going to have to emerge from this cycle either by taking market share from each other, cutting costs, or moving into new areas such as service.
Compaq's problems are compounded by the fact that it has only just begun to integrate recently acquired Digital Equipment.
The company's experience this quarter typifies the struggle between unit and revenue growth. In the past three months, Compaq cut inventories and boosted unit sales in all markets, including an 86 percent jump in the consumer arena.
Sales, however, stayed relatively flat at $5.8 billion when compared with the same period for the year before, and generated approximately one-fifth of the operating profit.
In fact, when revenues and earnings from the acquisition are removed, Compaq posted lower revenues than the same period the year before, showed relatively flat unit growth, and could have suffered a loss. Nineteen days of Digital revenue were added to Compaq's numbers for the quarter.
Without Digital, Compaq's revenues declined to $4.9 billion for the quarter and resulted in a ten cents a share loss, said Ashok Kumar, an analyst with Piper Jaffray. "If you look at it without Digital, Compaq has a 14 percent sequential decline and an 11 percent decline year by year. "
Kumar added that the average selling price of the company's PCs dropped to $1,750, down 30 percent compared with year-ago numbers. By contrast, Dell currently has an average selling price of $2,500, while Hewlett-Packard is at $2,200.
"I suspect that it [the Digital acquisition] actually helped them because this is seasonally Digital's strongest quarter," added Glazer.
"The underlying revenue appears to be off more than is apparent in the financial statement," agreed Roger Kay, an analyst with International Data Communications. "There is an apparent revenue drop that can be accounted for by average selling price decrease."
The decrease, he added, can be attributed to both component drops and Compaq's reaction from customers for even lower prices.
Glazer and others have pointed out that Compaq will partially skirt the revenue-unit conflict by cutting costs and reducing revenues. Compaq is in the midst of its job-cutting program and continues to move forward on its build-to-order initiative.
Beyond PC pricing, Compaq still has the lion's share of work ahead of it in digesting Digital, pointed out Daniel Kunstler, computing analyst at J.P. Morgan Securities.
"In the near term, there is the nuts and bolts of restructuring. You have to look at the number of employees that will be reduced, the expense ratio," he said. "In the long term you have to see some tangible evidence that the marketing of DEC's products has some teeth."
To successfully sell DEC products, Compaq will have to bridge a credibility gap with Digital's customer base. Compaq has been an active proponent of Windows NT; however, a substantial portion of Digital's product and service revenue comes from its Unix base. "Digital's legacy business has the highest margins," he said.
To his credit, CEO Eckhard Pfeiffer seems to recognize the need to develop this revenue stream, Kunstler said.