Earnings report a test for new Compaq CEO

Whether Wall Street toasts or roasts the newly appointed Capellas will have a lot to with his delivery, according to analysts. If Capellas keeps with the candor that dominated his acceptance speech last week, he could begin to turn around skeptics.

The performance will be especially difficult considering the news he will bear. Analysts have projected a loss of 11 cents a share for the quarter, according to a consensus by First Call. Last year at this time, Compaq emerged from a bruising quarter with a profit, excluding charges, of 2 cents a share.

Further, the new CEO will also have to convince observers Compaq is not losing steam in its core PC business and that the beleaguered company can play catch-up on the Internet. Compaq is perceived by many as being a e-commerce latecomer, despite picking up the AltaVista search engine with the Digital acquisition. Compaq last month unloaded the bulk of its AltaVista holdings to CMGI.

Expecting a heavy-hitting outsider to be called in, Wall Street forecasters including Merrill Lynch and Salomon Smith Barney have remained neutral on the Houston-based computer manufacturer's stock, even after Capellas's appointment. Part of the problem is fear of the unknown: Compaq's former acting chief operating officer has yet to prove himself as a chief executive.

But one analyst, Gillian Munson of Morgan Stanley Dean Witter, upgraded the stock to "outperform" on the strength of his presentation.

In a departure from tradition, Compaq will brief analysts after the market closes rather than before in opens. The company will also brief the media, another change.

Other hardware makers have reported surprisingly strong results for the second quarter because of higher-than-expected PC sales, strong demand for "big iron" servers, and increased revenue from new businesses like ISP services.

But Compaq's financial picture has been uneven since the first quarter of 1998, when the company had its earnings for the period decimated by the costs associated with excess inventory. The surplus of computers led to heavy discounts and flattened revenues for Compaq and other companies in the subsequent months. The company was also trying to absorb Digital into its operations, and cut approximately 17,000 jobs.

The company seemingly emerged from its inventory issues by the end of the year, but similar sales imbalances resurfaced in 1999. In February, then-CEO Eckhard Pfeiffer cut in half the company's second-quarter projections. Bungling by Pfeiffer and then chief financial officer Earl Mason following the bombshell announcement led to their ouster by an angered and frustrated board in April.

In the same quarter from a year ago, which at the time was seen as a dismal quarter, Compaq earned two cents a share on net income of $32 million. Factoring for the June 11, 1998, acquisition of Digital Equipment, Compaq lost $3.6 billion, or $2.33 per share.

First on Capellas's list of tasks in many minds is an honest appraisal of Compaq's integration with Digital and plans for a quick conclusion to the process. That could mean hard decisions Compaq should have made earlier.

"They made a few mistakes early on they should have avoided," said Jim Williamson, analyst with International Data Corporation. "If you1re going to cut 15,000 people from the payroll, you better do it quickly, within the first three months, and get it over with."

Compaq initially projected 17,000 layoffs resulting from the Digital acquisition, but instead dragged the process out for more than a year, putting a drag on morale and net income. Sources close to the company said even more are likely as Compaq continues streamlining operations.

Several analysts speculated that part of Compaq's second-quarter problems could reflect the company's biting the bullet, taking a hit now for the sake of future growth.

The numbers may include costs for fixing its distribution system. The company plans to launch a new distribution mechanism on August 1, designed to generate 75 percent of all sales in North America over the Web. This includes systems sold through Compaq's dealer network and direct from the manufacturer.

Inventory issues too will likely come up in the conference call tomorrow. Rumors circulated last week that Compaq might be sitting on four weeks' worth, its dealers another four weeks. Direct manufacturers, such as Dell typically have less than a week's inventory on hand.

"I wouldn't be surprised that Compaq has excess inventory and that they would sit on it rather than flooding the channel," said Lindy Lesperance, analyst with Technology Business Research. "Instead of shipping it this quarter, coming up with better earnings and coming short in the next quarters."

Compaq closed at 25.375 yesterday on the New York Stock Exchange, up .4375, less than two points better than before Capellas's appointment. The company currently has a market capitalization of nearly $43 billion.