Wall Street will be closely watching Houston-based Compaq Computer's fourth-quarter results, which will be announced after the market closes.
Compaq is the first of the top-three computer makers to reveal how badly the sudden slowdown in commercial and consumer PC sales has cut into profits. In fact, analysts say, how Compaq handled the end-of-year sales crisis is likely to foreshadow what can be expected from Dell Computer and Hewlett-Packard. Both companies will report their fourth-quarter results in February; Dell issued a profit warning Monday.
For Compaq, the fourth-quarter crisis will be the real first test of CEO Michael Capellas' mettle and the company's efforts to shift sales from PCs to higher-margin products, such as servers, storage and services. The company is expected to report a sales slowdown in commercial and consumer PCs, as well as in PC servers.
Like other high-tech companies, Compaq in mid-December issued a profit warning that set off a rash of analyst downgrades. The company warned that revenue would be 8 percent to 10 percent below expectations, in the range of $11.2 billion to $11.4 billion. The company forecast earnings in the range of 28 cents to 30 cents per share.
A consensus of analysts polled by First Call projects $11.5 billion in sales, with earnings coming in at the lower end of the range, 28 cents per share. For the full year, analysts predict earnings of 96 cents a share.
In a report two weeks ago, Merrill Lynch analyst Steven Fortuna said he expects Compaq to meet the lowered consensus estimates. Fortuna projects earnings of 28 cents per share and $11.43 billion in revenue for the quarter. He also expects 95 cents a share for the year and sales of $42.3 billion.
Technology Business Research analyst Lindy Lesperance shares Fortuna's optimism.
"I would expect them to come on the higher end of the revised estimates," she said Monday. "They've done a good job managing expectations."
But Robertson Stephens analyst Eric Rothdeutsch said he expects that slow commercial and consumer PC sales will likely force Compaq to reset 2001 expectations.
"Compaq did preannounce, and they guided to 10 percent revenue growth. But I wouldn't be surprised to see them revise it down again," he said.
Gartner analyst Kevin Knox is expecting mixed results.
"I think that in the PC space, Compaq's results will be as bad as everybody else's and maybe a bit worse," Knox said. "But overall, I think Compaq has done a great job spreading all the wealth across the enterprise."
The fourth-quarter computer sales slowdown is expected to hit hard both Compaq's consumer and commercial PC divisions, which together account for about 35 percent of the company's revenue. Market researcher IDC on Friday put fourth-quarter PC shipments at a scant 0.3 percent year-over-year growth, more than 10 points off the most conservative estimates previously.
Despite sales weakness, the commercial division is expected to remain profitable, in part because of better inventory management, lower cost structure and higher direct sales than the consumer group.
Compaq's consumer division, which accounted for about 19 percent of revenue during the third quarter, is expected to drag heavily on the company's income.
In fact, many analysts expect the division to post a loss or, at best, make negligible profit for the fourth quarter.
"I think there's a very good chance the consumer group will lose money," Lesperance said.
Although the collapse of holiday consumer sales contributed to Compaq's problems, it only accentuated existing weakness, Lesperance added.
"The margins in their consumer business have been grower slimmer and slimmer," she said. "There wasn't a lot of room there to maneuver for a downturn in the market."
While Dell and HP focused more on managing their supply chains and cutting costs in manufacturing and distribution, Compaq instead pushed volume. The company relied on selling more PCs at a low cost with razor-thin margins.
"You can do this, but only as long as you're selling PCs," Lesperance said.
PC Data reported Monday that Compaq's sales in retail stores plummeted 25 percent in December compared with the same period a year ago.
According to Dataquest and IDC, Compaq, Dell and HP are the worldwide and U.S. leaders in PC sales.
Worldwide, Compaq ranked No. 1 during the fourth quarter and all of 2000, followed by Dell and HP. In the United States, Dell beat second-ranked Compaq and also HP.
"What happens to Compaq will have a bigger indication of what happens to Dell than it does HP," Knox said. Much has to do with Compaq's December profit warning, which indicated sales sluggishness potentially spanning most of Dell's product line.
If Compaq reports, as expected, slow sales of consumer PCs, commercial PCs and PC servers, Dell likely will too. "That's much of the bulk of what Dell offers," IDC analyst Roger Kay said.
Although Dell's cost structure is better than Compaq's, the company potentially faces greater exposure to the PC sales slowdown than does Compaq.
"Compaq will be a predictor of what Dell will report, because they operate in the same markets," Lesperance said. "The only thing that may cushion Dell a little bit is that they're not big in the consumer market."
And Dell doesn't face the same inventory problems as Compaq, which started December with about 8.4 weeks of inventory on dealers shelves, according to ARS. Sources close to dealers and distributors still report levels of about five weeks, which Compaq could be forced to discount to clear out. That is an advantage Dell could exploit through aggressive price cuts.
Much more could depend on the hit to PC server sales, Lesperance said. Dell more desperately needs these sales than Compaq.
Knox agreed. "Compaq is somewhat safeguarded because their wealth is spread so much across the enterprise, such as high-end servers and services," he said. "Dell has less room to play at the high end."
Because Compaq and HP compete head-to-head at retail, Compaq's consumer sales results are also expected to foreshadow HP's in this area. There, inventory could be the big issue--that is if HP doesn't use its extra month to unload the overhang. Compaq's quarter closed Dec. 31; HP's quarter ends Jan. 31.
"Because of the timing of the quarters, HP might be able to fix the inventory problem before the end of the quarter," Lesperance said. "Compaq would have to carry the inventory into the next quarter."
No matter what happens, Rothdeutsch believes Compaq will be very cautious about setting expectations that deal appropriately with weak PC demand.
"That being said, the stock prices are at or near the bottom," he said. "Investors are looking for any snippet of good news, and that's going to take these stocks even higher. Compaq may deliver that reason."