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Profitable PC group pushes Compaq forward

CEO Michael Capellas ends his first year on the job with earnings that beat expectations and a return to profitability for the company's PC division.

Compaq Computer CEO Michael Capellas ended his first year on the job with earnings that beat expectations and a return to profitability for the company's PC division.

The company earned $387 million, or 22 cents per share, for the second quarter. A year ago, Compaq lost $184 million, or 11 cents a share.

Excluding investment gains, Compaq earned 21 cents per share, in line with analysts' expectations as polled by FirstCall/Thomson Financial.

Revenue rose to $10.1 billion from $9.4 billion a year ago. Analysts earlier forecast sales figures close to $10 billion, with growth in the single digits.

"These results demonstrate how far we have come in the past year," Capellas told financial analysts in a conference call today. "Revenue was up solidly, gross margins increased three percentage points, operating expenses declined 17 percent, and operating income increased to $830 million."

Compaq's enterprise division posted revenue of $3.4 billion, up 9 percent year-over-year, and income of $467 million. The company's commercial PC group returned to profitability with an operating profit of $62 million on revenue of $3.3 billion. But the consumer division saw signs of weakness with operating income down $15 million year-over-year.

Compaq's turnaround has been long in the making, with Capellas promising a profitable commercial PC division by the third quarter.

First-quarter results showed promise, with Compaq pulling in $9.51 billion in revenue and net income of $281 million, or 16 cents a share. But the commercial PC division dragged on profitability then, with Compaq losing $19 million in the first quarter. The division lost $78 million and $169 million, respectively, in the third and fourth quarters of the previous fiscal year.

The centerpiece of today's earnings report is Compaq's commercial PC division, which had lost money for more than a year. Since taking over the division last year, senior vice president Mike Winkler has worked methodically to improve manufacturing and distribution.

"The turning point was Michael Capellas turning manufacturing over to the respective organizations" (enterprise computing and services, commercial PCs and consumer), Technology Business Research analyst Lindy Lesperance said. "Mike Winkler clearly wanted that control for commercial PCs and had a clear idea how to fix things."

Winkler worked to squeeze costs out of manufacturing and distributing commercial PCs, which at one time cost Compaq more than twice as much to produce as it did rival Dell Computer, Lesperance said.

To help accomplish that task, Compaq last year acquired distribution assets from Inacom and increased direct sales.

Capellas said the commercial PC group's returning to profitability was "a top priority, and we achieved it a quarter ahead of schedule. Mike Winkler and his team have done an outstanding job during the year transforming our traditional PC business into one redefining Internet access."

During the quarter, Compaq shipped its 100,000th iPaq PC, "making it our fastest new product ramp ever," with "over 50 percent of these machines shipping with Windows 2000," Capellas said. Compaq started shipping the low-cost commercial PC in January.

Compaq's consumer division also performed well, despite seasonal sluggishness and a sales assault by rival Hewlett-Packard, but not as well as a year earlier.

While revenue rose 32 percent to $1.6 billion, operating income declined $15 million year-over-year to $31 million.

"This decline is primarily due to actions taken in North America in response to our competitors, who took aggressive actions to clear their channel inventories," chief financial officer Jesse Greene told financial analysts today.

The dip is not surprising, analysts said.

In June, for example, Compaq's retail revenue dropped 4 percent from a year earlier, said PC Data analyst Stephen Baker. Compaq's average retail selling price dropped to $804 in June from $891 in May, at a time when other manufacturers are trying to sell higher-priced, more profitable systems to counterbalance an industry-wide slowdown in sales.

Compaq's enterprise computing group saw revenue increase $347 million from a year earlier to $467 million. Operating income was 14 percent of revenue. PC revenue grew 40 percent to $1.5 billion from a year earlier.

One success: Compaq in early June introduced the ProLiant DL360, a dual-processor server aimed at service providers, "and shipped more than 24,000 servers by the end of the quarter. In other words, just over three weeks," Capellas said.

Capellas said that with Microsoft releasing the first collection of upgrades and bug fixes for Windows 2000, "we expect a significant increase in ProLiant (server) Windows 2000 deployments in the second half."

Revenue for larger servers decreased 13 percent to $750 million because of the transition to the AlphaServer GS, or Wildfire, line. Compaq shipped more than 50 of the servers during the quarter.

Storage revenue was $1.2 billion, flat year-over-year. "The results are below expectations, and we're focusing on accelerating growth in the second half," Capellas said.

Services declined 4 percent to $1.7 billion, with net income of $228 million, down $36 million. Services, as expected, suffered because of a post-Y2K slowdown that similarly affected EDS, IBM, Unisys and other large services providers.

In larger results, gross margins grew 3 points to 23.6 percent. Geographically, Compaq saw significant gains, with revenue up 10 percent in North America and 29 percent in Latin America. Revenue in Japan and China grew 40 percent and 16 percent, respectively, while Europe, Middle East and Africa revenue declined 4 percent.

For the first half of the year, Compaq reported net income of $712 million, or 41 cents a share, compared with $97 million, or 7 cents a share, a year earlier. Revenue for the first six months was $19.6 million, compared with $18.8 billion for the same period a year ago.

Looking to the third quarter, Compaq also is working to better promote its products, earlier this month adding two high-power marketing executives to its management staff.

"You should see Compaq getting stronger as the year goes on," said Piper Jaffray analyst Amir Ahari.

Compaq will introduce new storage products next Monday and plans to expand the iPaq line in mid-August.

"Compaq is in better position than ever for growth," Capellas said in the conference call. "Just as important, we're staying focused on execution and effective management of our business."

For the third quarter Compaq is forecasting $10.8 billion in revenue, which would be 17 percent growth year-over-year.