HP, Compaq sales bookings spark debate
Some allege PC sales artificially boosted, expenses underreported
By Elise Ackerman
Mercury News
When Hewlett-Packard and Compaq Computer reported surprisingly strong quarterly sales and profits recently, Wall Street immediately began asking whether the numbers were too good to be true.
In particular, some analysts are concerned that the computer giants artificially boosted personal computer sales and underreported expenses related to those sales as part of their campaign to convince shareholders that the hotly contested HP-Compaq merger makes sense.
PCs and their low profitability are a central issue raised by dissident HP director Walter Hewlett, who is lobbying shareholders to veto the deal on March 19. The reliability of HP's and Compaq's numbers directly affect the credibility of company executives as they try to win votes.
Both HP and Compaq emphatically deny they massaged the numbers. ``We did nothing out of the ordinary,'' said Bob Wayman, HP's chief financial officer. ``The reality is, in the consumer PC space, we are doing extremely well.''
Like others in the PC industry, HP and Compaq book sales when products are delivered to middlemen, such as retailers or distributors, instead of when they are actually sold to end users, such as consumers or businesses.
This practice has led to allegations that HP, the world's No. 3 PC maker, engaged in ``channel stuffing'' -- or selling more products to middlemen than end users are likely to buy in a reasonable time period -- during its most recent quarter, which ended Jan. 31.
At the same time, UBS Warburg analyst Don Young says Compaq's new accounting method for promotional incentives related to PC sales artificially boosted profits for its most recent quarter, which ended Dec. 31.
While not illegal, channel stuffing is frowned upon because it provides a short-term boost to sales while reducing them in later periods. In the worst case, a channel stuffer is eventually forced to take a large write-off for products that are severely discounted or never purchased by end users -- a particular risk in the PC industry, where models quickly lose their value.
``We believe that HP is pulling revenue and demand from the April quarter,'' said Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray.
Kumar said recent, independent checks with companies who resell HP computers to consumers show a troubling buildup of PC inventory. In the U.S. retail market, where Compaq and HP enjoy a 70 percent market share, PC inventory doubled from December to January, he said.
Unsold inventory
Kumar believes some of that unsold inventory may account for the sharp spike in HP's unit shipments of PCs in the fourth quarter. According to preliminary figures from researcher IDC, HP shipped 40 percent more PCs in the United States in the quarter ended Dec. 31 than in the quarter ended Sept. 30.
HP's growth was more than triple that of Dell Computer, the industry leader, which saw only an 11 percent increase. Gateway, IBM and Apple all suffered shipment declines.
Wayman said HP always has a large spike in U.S. sales in the fourth quarter because of an annual Thanksgiving promotion with Wal-Mart Stores that offers hundreds of thousands of PCs in special bundles with other computer products. In addition, he said HP was restocking retailers after especially strong sales of PCs with Windows XP in the third quarter.
``HP is very good at the logistics of retail,'' agreed Roger Kay, an IDC analyst, who said he doesn't believe the company stuffed its sales channel.
But other observers cite specific cases of bloated inventory at HP resellers as a sign of trouble. In a recent issue of the ``The High-Tech Strategist'' newsletter, publisher Fred Hickey pointed to the sudden swelling of inventory at PC Connection, one of the country's biggest direct marketers of computer products, from the third to fourth quarter.
During the Merrimack, N.H., company's earnings call, executives explained that the 18 percent increase in inventory was the result of ``buy-ins'' -- or incentives -- to purchase additional desktop and notebook PCs.
PC Connection's ``primary suppliers of these computers are Compaq and Hewlett-Packard,'' Hickey wrote. ``Computer resellers and distributors participate in `buy-ins' from vendors when they are offered sweet deals by their vendors to take additional product they do not need at the time.''
In an interview, Mark Gavin, chief financial officer of PC Connection, acknowledged that the company often receives special incentives from manufacturers and distributors, but he disputed Hickey's characterization of the deals with HP and Compaq as channel stuffing.
Indeed, determining when traditional marketing incentives turn into channel stuffing can be tricky. Rebecca Runkle, an analyst at Morgan Stanley, said at a conference last week that one of her colleagues checked with HP's channel partners and did not find any evidence of stuffing.
Interpretations of inventory figures also vary. Don Young, an analyst at UBS Warburg, sees evidence of channel stuffing in figures from NPDTechworld, which show that the number of HP computers stockpiled at stores and distribution centers has grown from 4.5 weeks' worth of sales on Jan. 31, 2001, to six weeks' worth by Jan. 31, 2002.
Booking sales
Wayman said HP's inventory was a little higher than the company wanted, but it was the ``right amount'' given expected February promotions by retailers to sell specific HP models. ``The retailers want to have that inventory,'' he said.
Young said investors would get more clarity about the true level of sales if HP and other PC makers adopted a more conservative practice of only booking revenue after a product is sold to an end user -- a policy used by many tech titans, including Microsoft and Intel.
Compaq is getting scrutiny over promotional expenses related to PC sales. In a research note published Tuesday and in a follow-up Webcast, Young detailed how Compaq's recent adoption of a new accounting standard for promotions allowed the company to tack on an extra $85 million to its 2001 profits -- and possibly even more.
The new standard changed a previous Compaq policy of booking sales to middlemen immediately while delaying the booking of associated expenses, such as a free monitor thrown in as a sales incentive, until after a product was sold to an end user. The old policy ``clearly distorted the financial performance,'' Young wrote.
The new standard reports those promotional expenses at the same time as the products are shipped, reducing the reported revenue up front.
Young also questioned the timing of Compaq's implementation of the standard, which gave the company a one-time boost shortly before the merger vote. The change effectively pushed some expenses that would have hit the books in 2001 into earlier quarters.
In response, Compaq said the timing reflected ``Compaq's commitment to full and transparent financial disclosure.'' HP already uses a similar policy to immediately account for promotional expenses.
Richard Gardner, an analyst at Salomon Smith Barney, an investment banking firm that is advising Compaq on the HP merger, said Compaq acted conservatively by adopting the standard soon after it was issued in November.
But Gardner agreed with Young on one key point: Compaq and other PC makers would give investors ``a more accurate portrayal of economic reality'' by booking sales when products are sold to the end customers.
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Mercury News Staff Writer Vindu Goel contributed to this report. |
