The beleaguered computer maker spent the third quarter cutting costs everywhere, discharging nearly 3,000 workers, unloading unprofitable units, and consolidating facilities. The company also attempted to streamline PC distribution, which depends heavily on dealers.
The problem is that Compaq will still have to cut deeper and work harder to fend off fierce competitors, especially Dell Computer, as it loses momentum in its once sterling PC operation, analysts said.
The company lost money, for example, on its business PC line, which accounts for approximately 30 percent of Compaq's revenue and in many ways serves as the cornerstone of its brand. Regionally, growth in sales in the United States and Europe slowed considerably from the second to third quarters.
One person that appears to agree that the problems are bad is Compaq chief executive Michael Capellas. In an internal email message to employees sent today, Capellas wrote: "Compaq clearly has not kept pace with shifts in the PC sales and distribution model."
A turnaround will be based in part on a new strategy "that will enable us to lead the next generation of PC evolution and innovation," Capellas continued in the email. The company also plans to get into "e-tronics," the convergence of computing, consumer, and entertainment devices, he said in a conference call yesterday.
Still, Compaq faces daunting tasks.
"If you look at the commercial desktop line, which has historically been the cash cow for the company, it's completely lost traction, especially in Dell's win rate against Compaq," said Ashok Kumar, an analyst with U.S. Bancorp Piper Jaffray. "Once you let Dell into your account, it's almost like a parasite. You can't get rid of it."
"When a significant portion of your business is losing money, that's not a situation you want to be in," said Technology Business Research analyst Lindy Lesperance. "The thing that disturbs me is the 12 percent decline in revenue for the commercial group from a year ago."
On the surface, the third-quarter results are encouraging: Compaq had net income of $117 million, or 7 cents per share, excluding one-time charges and gains, on revenue of $9.2 billion.
While revenue rose 5 percent from a year earlier, it declined 2 percent from the previous quarter. Compaq also cut costs by $220 million compared to the second quarter.
The true analysis of Compaq's performance comes from examining operating margins, which are gross margins minus operating expenses, analysts said.
Lesperance estimates commercial PC operating margins of ?6.3 percent vs. ?5 percent in the second quarter.
"The more commercial PCs Compaq sells, the more money they lose," said Lesperance, who added that the decline "bothers me because of the measures in place to improve this."
Market share figures for the third quarter also showed that Compaq is not growing as nearly as fast as it once was. Compaq saw a 24 percent growth in units shipped in the third quarter compared to the same period a year ago, according to Dataquest, about the same growth rate as the market as a whole. In previous years, Compaq often grew faster than the market.
To his credit, Capellas is taking an aggressive role in solving the business PC crisis. He has been meeting with top execs as they work to simplify distribution and component management, said sources close to the company.
Compaq reduced inventory on dealer shelves to three weeks during the quarter, spending $200 million to do so. In contrast, rival Dell typically has less than a week's inventory on hand.
Despite Capellas's efforts, analysts estimate Compaq's PC operating expenses are nearly twice that of Dell?s.
"I think Dell is right: You can't compete unless you're the low-cost provider," said Roger Kay, an analyst with International Data Corporation. "If your costs are low, you can more aggressively bid for new business. You need that room to maneuver and that's an imperative for the industry."
Compaq's consumer division, which accounted for 16 percent of revenue, outperformed the commercial group, but still showed signs of weakness.
On the bright side, Compaq's enterprise solutions and services group, which accounted for about 55 percent of revenue, showed promise during the third quarter.
The PC server business grew a healthy 27 percent over the third quarter of 1998, but high-end servers and storage grew slower at 12 percent. Operating margins jumped to about 12 percent from a little over 7 percent a year earlier, mostly due to cost cutting, said analysts.
"I know the restructuring, the stock price, and some of the business issues we face take a toll on morale," Capellas wrote today in the email. "We all want that feeling of pride we get when we know we're at the top of our game. But I want to assure you that we are absolutely moving in the right direction."