Top Stories of 2001, #7: PC Industry Stumbles Through Recession

Most economists agreed by the end of 2001 that the United States had slipped into its first recession in a decade. The ugly financial climate took a lot of PC companies down with it as falling profits, outright losses, and even mega-mergers became the norm. Interestingly, the first signs that something was amiss came in late 2000 with a weaker-than-expected holiday season that caught many in the industry off guard.

As 2001 began, certain signs indicated we hadn't yet hit rock bottom. Microsoft announced its quarterly financial results in late January, with record quarterly earnings of $6.59 billion, an 8 percent increase over the same quarter the previous year. But the company barely met its financial expectations (although Microsoft, like many companies in 2001, earlier reduced this figure because of the economic conditions) for the quarter and warned of future sales decreases. "While we are enthusiastic about the break-through products and services the company will be delivering in 2001, we remain guarded about the near-term economic outlook and its impact on PC demand and technology spending," said John Connors, Microsoft's chief financial officer (CFO).

Office revenues declined for the second quarter in a row, and, for the first time ever, the company's Office sales were down compared to sales in the previous year. Microsoft announced that growth would slow dramatically in 2001, from its typical average of about 20 percent to about 7 to 10 percent. Microsoft's stock was hit hard as well. After peaking at about $120 a year earlier, the stock fell into the $50 range in early 2001 and never really recovered.

A week after that announcement, Dell CEO Michael Dell predicted that two of the top PC makers would go out of business during 2001. "I think that there will certainly be some consolidation and competitive shakeout," Dell said in a conference call with the press. At the time, Dell was closing in on Compaq for the number-one spot in the PC market and, not coincidentally, Compaq later announced that it would attempt a mega-merger with Hewlett-Packard (HP), partially fulfilling Dell's prophecy (even though the deal dragged into 2002 and is still unresolved). Dell eventually surpassed Compaq because of a price war that also drove down profits.

In April, Microsoft announced another round of quarterly results, and the company beat financial forecasts with a 14 percent increase in profits. The company made $2.45 billion on revenues of $6.46 billion. "Despite this quarter's solid performance, we continue to be mindful of the current economic climate and the impact it may have on business and consumer demand," Connors said. For the quarter, Windows 2000 accounted for more than 35 percent of all 32-bit OSs the company sold, up from 31 percent in the previous quarter. Again, the company expressed concern about the economy and its effects on future profits. Microsoft stock traded in the $68 range soon after the company announced its results.

Compaq was one of many companies already feeling the heat in April. The company announced that its net income had fallen a whopping 74 percent, with earnings of $78 million compared to $296 million in the same quarter a year earlier. Overall revenues fell to $9.2 billion from the previous year's $9.5 billion. The company said that revenues from its PC business fell 7 percent to $4.4 billion; that unit lost $82 million for the quarter. Server sales were down 9 percent. As a result, Compaq announced that it would lay off about 10 percent of its workforce, or 7000 jobs--2000 more than the company had planned.

The financial problems weren't restricted to the PC world. Server-maker Sun Microsystems announced in May that its quarterly earnings would be significantly lower than previously expected, sending the company's stock nose-diving. Chief Information Officer (CIO) Michael Lehman said that the company expected revenues in the range of $3.8 to $4 billion, a figure that was one-third less than previous estimates. "Demand in Europe has really trailed off more than we thought [it would]," Lehman said in a conference call with the technical press. "The surprise is Europe."

In late July, Microsoft announced record revenues of $25.3 billion for fiscal year 2001 and revenues of $6.58 billion for the quarter ending June 30, a 13 percent gain from the same quarter a year earlier. The company posted operating income of $2.75 billion, an incredible feat given the state of the industry at the time. But investment losses sapped most of Microsoft's profits, bringing the company's effective earnings down to just $66 million. Despite its strong revenues, Microsoft also announced that the company expected further deterioration of the PC market to mar the next quarter. The company reiterated that it expected only single-digit growth for its desktop products.

That same week, analysts revealed that PC shipments would fall year-over-year for the first time since 1986. The one bright spot in the PC industry was Dell, whose sales jumped 20 percent in a year when the overall PC market fell 2 or 3 percent.

In early August, Metricom announced that it would shut down its Ricochet wireless Internet service within a week. The company auctioned off Ricochet's assets on August 16 and immediately terminated all 282 employees. Ricochet offered 128Kbps wireless Internet access in several US cities, but high prices, balky connections, and sparse access areas doomed the service. The service was briefly revived in the wake of the World Trade Center terrorist attacks, however, so that rescue workers could more effectively communicate on-site.

Later that month, software-retailer-turned-online-merchant Egghead announced that it was filing for Chapter 11 bankruptcy protection, and electronics superstore Fry's Electronics moved in to buy the company's assets. Egghead said that it had recently suffered a dramatic and sudden decline in sales, making its profitability plans impossible. After trading as high as $108, Egghead's stock hit a low of 30 cents in August.

PC-maker Gateway also had some bad news in August; the company announced that it would cut 25 percent of its global staff as it exited the Asian market and significantly trimmed its European presence. The move resulted in 5000 lost jobs and a $475 million third-quarter charge. Toshiba followed Gateway with its own announcement: It would cut a whopping 18,800 jobs--most of them in Japan--in response to an expected quarterly net loss of almost $1 billion. By late November, Toshiba had exited the US market for desktop PCs altogether after sales fell from 250,000 units in 1999 to just 52,000 units in 2001.

In early September, Microsoft surprised financial analysts by refusing to lower expectations despite the rapidly deteriorating economic climate. "In the second [fiscal] quarter we anticipate that PC shipments will pick up a bit with the launch of Windows XP on October 25," Connors said, "and that the second half of the year [will see] a modest improvement over the previous year." Connors noted that Microsoft's entry into the video-game market with its Xbox device--due that November--would also have a positive impact. Connors also said that the economic slowdown was affecting Microsoft less than other companies because of its diverse portfolio and lack of reliance on the dying dot-com market. And the company's broad geographic footprint let it weather regional problems more adeptly than some of its competitors. Although Microsoft was concerned about the downturn in PC sales, Connors said that the slump wouldn't affect the company's profits or expansion plans.

Then came the devastating September 11 terrorist attacks, which gripped an already shaky economy and dragged it down for the count. Despite the fact that 2001 was already a wash for many companies, September 11 became the excuse du jour for layoffs, losses, and consolidations late in the year. Using September 11 as a financial excuse was common, but also a bit disingenuous in many cases.

By November, the country had finally acknowledged the "R" word, but that didn't stop shoppers from crowding brick-and-mortar and virtual shopping centers during the 2001 holiday season. Retailers reported that shoppers spent more money by mid-November 2001 than they had by the same point in 2000, and Internet-based shopping was up 22 percent. Sales of big-ticket electronics, such as new gaming systems from Nintendo and Microsoft, went through the roof: Both companies reported that their new systems sold out everywhere.
 
By the time the holiday season ended, the outlook was bright. E-commerce sites such as Amazon.com and eBay saw huge sales increases, thanks to resurgent PC sales and strong sales of video games, digital cameras, portable music players, and other electronic items. Microsoft said that sales at its MSN sites rose 56 percent compared to the previous holiday season; Yahoo! saw growth of 86 percent. MSN traffic increased 39 percent year-over-year to 75 million users; Yahoo! traffic rose 31 percent to 72 million users, and AOL remained in the top spot overall with 84 million users. Online shopping, overall, was up 73 percent, or $345 million, compared to the previous year. The big loser during the holidays, however, was Apple, whose new retail stores posted a loss, according to a filing with the Securities and Exchange Commission (SEC). Predictably, the company blamed the "continued deterioration of the US economy and the after-effects of the events of September 11" for its problems and said its retail operations would continue to post losses throughout 2002. Worst of all, Apple's sales slipped 33 percent in 2001 as the company continued to lose market share.

If you want me to make a financial prediction for 2002, sorry; I'm not an economist. Recessions, like any financial trends, are cyclical, and we might already be past this one: We won't actually know for sure for several months. But many of the problems we saw in 2001 will continue in 2002. The Compaq/HP merger is still up in the air. Apple, Gateway, Toshiba, and other companies will continue to struggle in many ways, although PC sales will probably grow, albeit at a slower rate, as consumers move to new XP systems. And analysts will continue to watch Microsoft's quarterly balance sheet to see how the software giant is weathering--or bucking--the storm. Whatever happens, the coming year will be interesting. Nothing brings out the best--and worst--in companies like public financial disclosures.