THREAD--- VERY STRONG ONE LINER FROM EP IN THIS ARTICLE ---The Wall Street Journal -- April 16, 1998
Technology Journal:
Compaq Posts a Profit But Warns of Difficulties
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By Evan Ramstad
Staff Reporter of The Wall Street Journal
Compaq Computer Corp. earned a mere $16 million, or a penny a diluted share, in the first quarter and warned that it expects another quarter of flat sales and profit growth as it tries to change how it distributes its computers.
As it has for the past six weeks, Compaq, the world's largest maker of personal computers, said it will continue to manufacture machines at lower-than-normal levels to reduce dealers' supplies.
Despite the outlook for another bleak quarter, the Houston company said its unit sales growth in the first quarter was stronger than the overall industry, which lifted investor confidence that demand for PCs is solid. Even as financial analysts ratcheted down their forecasts for second-quarter profits, Compaq rose 68.75 cents a share, to $26.75 in heavy New York Stock Exchange composite trading.
Chief Financial Officer Earl Mason said he isn't certain where Compaq's profit margins and sales-growth targets will settle after the company gets through the current quarter and begins to integrate Digital Equipment Corp., which it agreed to buy in January.
Compaq warned in early March that it would report flat sales and only break even in the first quarter, reflecting a failure to meet its sales plans, sharp price declines for computers, its need to trim inventory already on dealers' shelves, and to take other steps to become more efficient. First-quarter sales increased 8% to $5.69 billion, from $5.27 billion a year ago.
Compaq earned $414 million, or 27 cents a diluted share, in the year-earlier quarter. Before its March warning, the company had been expected to earn about $510 million, or 33 cents a diluted share, in the latest quarter.
Compaq's troubles began when managers set aggressive sales goals for the end of 1997 and, to meet those goals, offered incentives to encourage dealers to take more Compaq machines. That left the company in a bad position when rivals cut prices early in the first quarter. Compaq systems languished on dealers' shelves until late February, when the company began giving away monitors and other accessories.
The inventory buildup also threatened Compaq's goal to complete a makeover of its manufacturing and distribution processes by mid-year. Trying to get closer to the low-cost structure and customer responsiveness of direct PC dealers such as Dell Computer Corp., the company last summer started building PCs when dealers order them, instead of to quarterly forecasts. Compaq also has wanted to cut dealers' inventories to two to four weeks, which would allow it to respond faster to new technology and price changes.
Compaq's Mr. Mason declined to specify the level of inventory dealers now have, although analysts' estimates range from six to eight weeks. But to illustrate the improvement, Mr. Mason said unit sales to commercial dealers in North America rose 37% in the first quarter while shipments by dealers to customers rose 53%. Compaq's world-wide unit growth for all products was 40%, compared with an expected 15% for the industry.
Robert Anastasi, analyst at Robinson-Humphrey Co. in Atlanta, said he is uncertain Compaq can make such a quick cut. "Maybe you can take a week out, but not two to three weeks," he said. "I think this could be with us for the rest of the year."
Compaq Chief Executive Officer Eckhard Pfeiffer, in a conference call with analysts, spoke with unusual firmness in saying that Compaq would manufacture to the inventory goal rather than any other target in the current quarter, several listeners said. "He rarely speaks with that conviction," said Charles Wolf, an analyst at Credit Suisse First Boston in New York. "It was a unique moment in Compaq conference calls."
Mr. Pfeiffer has pushed since 1994 to complete the change, but Compaq was bogged down by troublesome computer systems and resistance from employees and dealers. Until now, however, those problems didn't harm Compaq's financial performance.
Compaq made progress in the quarter with the management of its own inventory, which fell to $1.26 billion from $1.57 billion at the end of the fourth quarter and $1.37 billion a year ago.
In another challenge, Compaq said it won't be able to sustain the profit margins of its most lucrative product line, powerful machines called servers, which have been in the low 40% range. As more competitors have entered the market with lower pricing, Compaq has been forced to cut its prices and now expects server margins to be around 35%.
Because of the discounting in February and March, Compaq's overall gross profit margin fell to 18% from the mid-20% level where it has been since 1992. Mr. Mason said he expected a slight improvement in the current quarter but added that beyond then, "That's a wild card for us."
Analysts expect the incorporation of Digital's minicomputers and high-end workstations will lift Compaq's margins.
Compaq's consumer business, which surged to account for about 21% of revenue in the first quarter, continued to be profitable despite lower selling prices, Mr. Mason said.
The company factored, or sold off, about $500 million in receivables during the first quarter, down from about $700 million in the fourth quarter, Mr. Mason said. Such transactions allow a company to convert its bills into cash more quickly, albeit at a discount. The practice, which is more common in the retailing industry, raised eyebrows when Compaq disclosed it for the first time several weeks ago.
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