November 30, 2000 2:00 PM PST

Inventory glut foreshadows sales woes for Compaq, Apple

Gateway shares were pounded Thursday after the company said consumer PC sales came in lower than expected, but analysts warn things could get just as bad, or worse, for Apple Computer and Compaq Computer.

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Inventory glut hammers PC makers
Roger Kay, analyst, IDC
Both Apple and Compaq face a potential consumer PC sales crisis because of slowing sales, growing inventories and a looming first-quarter price war. While no PC company will remain unscathed by the triple whammy, these two appear to be particularly exposed.

Market researcher ARS reports Apple is sitting on 11 weeks of inventory and Compaq on 10.5 weeks, well above the industry average. Hewlett-Packard sells to the same market but apparently has done better at keeping its inventory under control. Generally, companies seek to keep inventory at four weeks or below.

PC companies selling through dealers typically "build up some extra inventory in anticipation of holiday sales," ARS analyst Matt Sargent said. "But levels are unusually high."

Mike Winkler, Compaq's executive vice president of global business units, balked at the reported inventory levels. Because about 95 percent of consumer product goes direct to retailers such as Best Buy and Circuit City, Winkler said he couldn't imagine where these inventory reports were coming from.

"This is the big Christmas season?and you've got to have enough inventory out there," Winker said. "There is nothing abnormal whatsoever about the inventory levels that are out there."

Apple would not comment on sales or the inventory situation.

An inventory buildup often has the same lingering effect on the industry as a three-car pileup does on commute traffic. Typically, companies slash prices to clear computers out of stores and warehouses, which saps profit margins for a quarter or two. But after the excess computers vanish, the next problem comes up: Sales dip in subsequent quarters because many consumers bought PCs at fire sale prices.

The last time Compaq saw a buildup close to this size--about 12 weeks of inventory in early 1998--it took nearly three quarters of price cuts to clear out the backlog. In the meantime, Compaq's aggressive clearance techniques reverberated to other major PC companies, some of which quickly found themselves stuck with eight weeks of inventory.

The same sort of ripple effect is looming now, but it could be even worse. During its last glut of PCs, the company basked in a sunny economic light while many consumers were just discovering the Internet. Now, well over half the homes in the United States already have a PC, and everyone is worried about the economy.

Consumer PC sales plummeted nearly 25 percent the week before Thanksgiving, according to PC Data, making for a hostile sales climate just when computer makers were counting on the holidays. Gateway on Wednesday reported that sales during the Thanksgiving weekend--usually the biggest shopping period of the year--were down 30 percent compared with the same period last year.

Between the two, Compaq's situation appears to be better than Apple's. The inventory crisis of 1998 hit Compaq hard, but the company has since broadened its product portfolio, with about 55 percent of revenue now coming from high-margin servers and related products.

Apple, by contrast, started the quarter with excess inventory on dealers' shelves--nearly eight weeks--and relies heavily on the consumer market, particularly during the holidays.

"Apple is certainly more exposed," Technology Business Research analyst Tim Deal said. "Apple came into this quarter with a lot of excess inventory to clear, product lines not really priced for the consumer market, and weakened sales across the board in the consumer space."

PC backlog
In June, the industry average at retail, which includes catalog sales, was 4.7 weeks of inventory, rising slightly in July before reaching a September low of 3.9 weeks during one of the three strongest sales months of the year, according to ARS. But in October--when NPD Intelect reported retail sales plunging 18 percent year over year--inventory levels swelled to 7.4 weeks, according to ARS.

Apple and Compaq saw huge jumps from September to October: 5.7 weeks to 11 weeks for Apple and 4.5 weeks to 10.5 weeks for Compaq. By comparison, HP rose a more modest 3.5 weeks to 5.6 weeks during the same period, according to ARS.

Analysts see Compaq and Apple's levels as abnormally high, particularly with retail sales dropping 25 percent or more as compared with 1999.

"You don't want a lot of inventory when sales are slowing," IDC analyst Roger Kay said. "Being well above the inventory average when there's week after week of year-on-year sales shortfalls is heading for the cliff."

Sargent agreed. "That's very, very bad for Apple and for Compaq with that much inventory going into a month that everyone sees as really weak," he said.

Apple's blight
Again, Apple's situation is more desperate, analysts say. NPD Intelect has Apple's sales down 37.8 percent between September and October year over year, following an increase of 35.5 percent between August and September.

Sources close to dealers and distributors report little change in Apple's inventory levels, which dipped slightly to 68,500 units in October from 67,800 units in September. Both months were up from about 41,000 units in August.

Like Compaq, Gateway and other companies selling consumer PCs, Apple saw deep declines right before the holidays, when sales traditionally begin to pick up. For the week starting Nov. 5, Apple sales plummeted 31.2 percent in units and dropped 26.7 percent in dollars compared with the same period a year earlier, according to PC Data. For the week of Nov. 12, Apple's retail sales declined 29.3 percent in units and 28.1 percent in dollars.

Unless holiday sales pick up dramatically, Apple could be forced to delay releasing new products, analysts say.

"Apple has a tendency to release products with some major event," such as the Macworld trade show in January, Deal said.

But with inventory building, Apple could get caught in a "vicious downward spiral," he added. "Apple may instead of releasing new products, preview new products with a later release date."

Price war
Much depends on whether holidays sales pick up.

Winkler would not offer details of Compaq's post-Thanksgiving week sales, but he said there is "certainly no cause for alarm."

But John Todd, Gateway's chief financial officer, said Wednesday that the first quarter of 2001 "will be an aggressive price war."

NPD analyst George Meier also noted a traditional steep sales decline between September and October. Retail sales dropped 20 percent between the two months in 1998, 29 percent in 1999 and 35 percent this year.

"October's always has done poorly next to September, but it's getting...worse," Meier said.

It's November and slow sales over the Thanksgiving holiday that are giving retailers and analysts the jitters. They warn of a brutal price war as PC makers cut costs to clear out clogged inventories.

"Inventory is the issue, but also because of the severe irrational price-cutting that's going on," said Robertson Stephens analyst Eric Rothdeutsch. "Gateway called it irrational price cutting, and I expect more irrational behavior through this quarter."

Compaq and Sony fired the first volley on Sept. 19, when they dramatically cut consumer notebook prices.

For now, PC makers and retailers must grapple with potentially slow holiday sales, which could stretch out into the first or second quarter because of a slowing economy.

Emachines chief executive Stephen Dukker sees an economic slowdown that will effect all consumer buying, not just PCs.

"The main driver of the slump is that we are in the midst of the 'soft landing' that the Federal Reserve board was looking for when they raised interest rates and tightened the economy six consecutive times," he said.

News.com's Ian Fried contributed to this report.

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