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Investment loss deflates Compaq profit

The computing giant tops reduced analyst estimates with fourth-quarter earnings of 30 cents a share, but huge losses from the company's investment in CMGI overshadow the results.

Compaq Computer on Tuesday squeaked past diminished expectations for the fourth quarter and fiscal year 2000.

But a massive write-off on investments sideswiped what otherwise would have been a profitable quarter.

The Houston-based computer company earned $515 million, or 30 cents a share, excluding one-time charges. That topped the 28 cents per share average forecast by analysts polled by First Call. For comparison, Compaq's third-quarter income, including investment gains, topped $550 million, or 31 cents a share. In the fourth quarter of 1999, Compaq's net income was $332 million, or 19 cents a share.

Compaq posted $11.5 billion in sales, up 10 percent from a year earlier, when revenue reached $10.5 billion. Analysts had predicted about $11.5 billion in sales for the fourth quarter. Compaq's revenue rose slightly from $11.2 billion in the third quarter.

But Compaq also took a one-time charge of $1.8 billion primarily to write down losses associated with the decline in value of Compaq's holding of stock in Internet incubator CMGI. Compaq acquired approximately 17 percent of CMGI in its sale of AltaVista. Including the one-time charge, Compaq reported a net loss of $672 million, or 39 cents a share.

For the year, Compaq's income from operations grew threefold to $1.7 billion. But factoring the write-down, the company had net income of $569 million, or 33 cents a share, flat year over year. Analysts had expected earnings per share of 96 cents.

Compaq earned $569 million, or 34 cents a share. Revenue rose 10 percent to $42.2 billion, up from $38.5 billion in 1999.

Like many other computer companies, Compaq issued a fourth-quarter profit warning, cutting expectations by as much as 10 percent. Before the warning, analysts had expected revenue growth close to 18 percent and 36-cents earnings per share.

Compaq is the first of the top-three PC makers to announce earnings, which analysts said could foreshadow results from Dell Computer and Hewlett-Packard. Both companies disclose fourth-quarter results in mid February. Dell issued a profit warning on Monday, as did HP last month.

"Compaq continued to deliver improved year-over-year results in the fourth quarter of 2000," chief executive Michael Capellas told financial analysts during a conference call following the announcement. "I am particularly proud of our ability to drive profitable growth in a very difficult market environment."

Fourth-quarter results demonstrate the wherewithal of Compaq's enterprise and services businesses, which accounted for 90 percent of the operating profit but just just 51 percent of revenue, Capellas said.

This helped compensate for a consumer loss and lower commercial PC revenues.

"Server revenue grew 22 percent from the same quarter last year, and storage increased 17 percent, including more than 50 percent in enterprise storage," Capellas said.

Capellas said the $1.8 billion non-cash charge "largely reflects the write down of CMGI stock to market value, an issue we discussed with you in December."

Compaq grappled with sluggish commercial and consumer PC sales during the fourth quarter, with the company's consumer division reporting a loss of $6 million. A year earlier, the consumer group earned $69 million. Compaq's commercial PC group remained profitable, with $113 million net income, compared with a $79 million loss during the fourth quarter of 1999.

Consumer revenue was nearly flat year-over-year at $2 billion. Commercial revenue dropped to $3.47 billion, from $3.9 billion in the fourth quarter of 1999.

The enterprise group posted mixed results, with some segments showing signs of weakness. Overall, the division's revenue rose to $4.1 billion, from $3.4 billion a year earlier. The division earned $722 million, compared with $439 million a year earlier.

Services declined slightly to $1.8 billion, from $1.9 billion during the year-ago fourth quarter. Income dropped to $241 million, from $275 million a year earlier.

Geographically, Compaq sales rose 10 percent in the U.S. and 3 percent in Europe, the Middle East and Africa. Revenue rose 26 percent in Asia-Pacific, 16 percent in China, 36 percent in Japan and 24 percent in Latin America.

Gross margins rose 1.5 percent year-over-year to 23.7 percent. Operating expenses declined 1 percent to $2 billion, or 17.1 percent of revenue.

PC sales sag
Compaq, like other PC makers, took a beating during the typically high-sales holiday season. Market researcher PC Data reported overall December retail revenue plummeted 30 percent year-over-year. Preliminary fourth-quarter data from IDC shows U.S. PC shipments rose a scant 0.3 percent year-over-year.

The unexpected sales slowdown and a sudden buildup of inventory walloped Compaq's consumer division, which dragged down overall profits, analysts said. December retail sales tell part of the story.

For Compaq, overall December retail sales--including stores, catalog and online outlets--dropped 19.5 percent year-over-year, compared with HP's 1.1-percent decline, according to PC Data. At stores, Compaq's sales plummeted 25 percent, while HP was flat year-over-year.

This helped HP reclaim its retail sales lead in a stunning turnaround. In overall December retail sales, HP had 38.6 percent market share, compared with Compaq's 35.6 percent, according to PC Data. A month earlier, Compaq led 41.9-percent market share compared with HP's 31.2 percent. HP widened its lead in stores, with 44.1-percent share to Compaq's 35.5 percent. In November, Compaq whooped HP, 43.5 percent share to 34.5 percent.

But Compaq's problems were far worse in retail notebooks, a category where Compaq has long led with over 40-percent market share. In December, rival Sony closed the gap with 21.3-percent share, compared with Compaq's 22.5 percent, according to PC Data.

In overall retail, Compaq had 31.2-percent market share, compared with Sony's 26.6 percent. A month earlier, Compaq had 31.8-percent share, vs. 24.5 percent for Sony. Compaq's major retail rival started closing the distance during the summer, culminating in brutal November price war.

In the past, Compaq relied on sales of notebooks--with much higher margins than desktops--to help offset slim desktop margins.

"This spells more bad news for the consumer group, because these are the higher-margin products that make up a large part of the mix for them," said Technology Business Research analyst Lindy Lesperance.

Typically, Compaq has "relied on portable margins to compensate for razor-thin desktop" margins, she said.

"The loss of the commanding position in consumer notebooks is a big defeat, because basically they've had better revenue and margins per unit," said IDC analysts Roger Kay. "This is a value business that Compaq wants, along with the server business and workstation business."

The Bright spots
Throughout the conference call with analysts, Capellas emphasized the importance of the company's enterprise business, while saying little about PC sales hard hit by the industry wide slowdown.

Still, Compaq delivered some good PC news. Despite inventory problems early in the quarter, Compaq reduced commercial PC stock on dealers' shelves to 3.9 weeks and 4.3 weeks for consumer systems.

"The first week of December, we actually cut production back dramatically to ensure we didn't end the quarter" with excess inventory, Capellas said.

Direct sales accounted for about 40 percent of revenue, as the company continues to improve the efficiency of its manufacturing and distribution operations.

A sign of good times a head, the number of Windows 2000 Professional seats jumped 30 percent over the third quarter. It is now installed on 43 percent of desktops, and one in three servers ships with Windows 2000 Server.

Other high points: Sales of the AlphaServer GS server reached the reduced $800 million goal for the year; overall enterprise and storage business grew 20 percent year over year; and North America sales grew 16 percent, excluding consumer sales.

Compaq slightly reset expectations for the first quarter and 2001. The company said it expects revenue growth of 6 percent to 8 percent in 2001 and earnings-per-share growth in the 20 percent to 25 percent change.

For the first half, Compaq projected revenue growth of between 3 percent and 5 percent. For the first quarter, Compaq set revenue expectations at $9.6 billion and earnings per share around 21 cents.