The following information is summarized from the 1999 annual report of
Compaq Computer Corporation:

Product cost of sales for the year ended December 31:
1999 $25,263,000,000
1998 $21,383,000,000

Inventories, December 31:
1999 $2,008,000,000
1998 $2,005,000,000

Product revenue for the year ended December 31:
1999 $31,902,000,000
1998 $27,372,000,000


The following information was summarized from the 1999 annual report of Gateway:

Cost of goods sold for the year ended December 31:
1999 $6,745,744,000
1998 $5,921,651,000

Inventory, December 31:
1999 $191,870,000
1998 $167,924,000

Net sales for the year ended December 31:
1999 $8,645,561,000
1998 $7,467,925,000


1. Calculate the gross margin (gross profit) ratios for Compaq
Computer and Gateway for 1999 and 1998.
2. Calculate the inventory turnover ratios for both companies for 1999.
3. Which company appears to be performing better? What other
information should be determined to see how these companies are
performing in this regard?

BONUS
$15 if you explain your working and all the terms
$15 if you reply with an acceptable answer within 72 hours of this posting

Thank you.

Thanksmate --

An interesting question, particular as the consolidation of the
personal computer (PC) industry continues.  As you're probably aware,
subsequent to these financial reports, Compaq Computer Corp. was
purchased by Hewlett-Packard in 2001:
Gartner Group
"H/P-Compaq -- What You Need to Know" (Burton, Sept. 12, 2001)
http://www4.gartner.com/1_researchanalysis/focus/hp_sl.html


GROSS MARGIN
--------------

Gross margins = gross profit/sales

Where, 
Gross profit = sales - COGS

An excellent site, which has a number of articles on key business
topics from textbooks, is QuickMBA:
QuickMBA
"Financial Ratios" (undated)
http://www.quickmba.com/finance/financial-ratios/

So here are the gross profits for the two companies:

CPQ 1999: $6,639,000,000
CPQ 1998: $5,989,000,000

GTW 1999: $1,899,817,000
GTW 1998: $1,546,274,000

And the gross margin percentages are:

CPQ 1999: 26.3%
CPQ 1998: 28.0%

GTW 1999: 22.0%
GTW 1998:  20.7%


INVENTORY TURNS
------------------

Inventory turns = COGS/average value of inventory

In this example, we really have the end-of-year inventory.  Though
it's the commonly-used number for inventory analysis, it can be open
to some manipulation as companies push inventory out the door at
year-end:
American Express OPEN
"Inventory Turnover Ratio"
http://www10.americanexpress.com/sif/cda/page/0,1641,15657,00.asp#section3

But here are the turns for each of the companies:

CPQ 1999: 12.6
CPQ 1998: 10.7

GTW 1999: 35.2
GTW 1998: 35.3


PERFORMANCE
------------

Seemingly Compaq is much more profitable -- but we don't have all of
the data.  Logical questions to ask are:
?	Why are their inventory turns so dramatically different?  Well, when
you look at operating data you find that Gateway does far less
manufacturing, often sourcing components from others.  This means less
work-in-process -- though it should be expected that gross profits are
lower because other companies are building major sub-assemblies?
?	What are the two companies spending on engineering?
?	Are their sales costs comparable?  After all, Compaq is known for
developing the reseller channel with firms like CompUSA, Businessland,
Fry's and other companies -- and Gateway sells direct.
?	What do we know about differences in cash generation?  Are there
differences in financing that put one company at a relative
disadvantage?
?	What are the long-term obligations of the companies for contract
purchases or licenses?
?	Are these two years masking a trend?  Note that Gateway's margins
rose during the period, while Compaq's were declining.
?	Are the inventories properly valued?  Personal computer models
change every 6-9 months; is one of the firms carrying inventory that
is actually below market value?  (Note that Gateway's 1999 Form 10-K
cites the rapid changes in technology and in inventory value as a key
risk of the PC business.)
?	What are market shares in various segments of the business, such as
retail, education, government, direct sales to the Fortune 1000?  This
will give us an idea of long-term competitiveness.
?	And finally, what about other competitors in the business?

As for long-term viability of the firm -- there's yet another factor
that has nothing to do with financial ratios.  I'll treat that last.


SOME ADDITIONAL DATA
---------------------

The annual reports for those two years are available at the U.S.
Securities and Exchange website, even if Compaq is no longer a public
company:
SEC
Edgar Company Search
http://www.sec.gov/edgar/searchedgar/companysearch.html

Note that the SEC Form 10-K, which is the annual report that is filed
each year by public companies, often includes many details
(engineering expenses, factory locations, long-term commitments) that
are omitted from the flashier, color annual reports.  Here's the
Compaq 1999 10-K, which includes 1998 operating data as well:
SEC
Compaq Form 10-K for FY1999
http://www.sec.gov/Archives/edgar/data/714154/0000912057-00-008116-d1.html

And the Gateway 1999 10-K:
SEC
Gateway Form 10-K for FY1999
http://www.sec.gov/Archives/edgar/data/895812/0001072993-00-000232-index.html

Note that it may be easier to find the Gateway 1999 annual report:
Gateway Computers
1999 Annual Report
http://www.gateway.com/about/investors/docs/1999_gateway_report.pdf


REAL COMPARISONS OF FINANCIALS
-------------------------------

We've already seen that Compaq is running at gross margins about 4-8%
higher than Gateway, making their gross margins about 25% higher.  But
what is it costing CPQ to get the higher gross margins?  Unfortunately
Gateway doesn't break out R&D separately, but still the numbers are
astounding.  I'll use 1999 alone for simplicity and look at overhead
costs as a percent of revenue:

CPQ 1999
Gross margin: 26.3%
SG&A: 19.9%
R&D: 5.2%

In other words, Compaq is spending enough on sales and
general/administrative expenses to match Gateway's GROSS MARGINS. 
Combined with R&D expense, overhead spending comes close to wiping out
any profits in 1999 for Compaq.

Here are Gateway's comparable 1999 numbers -- and again note that SG&A
includes R&D for Gateway:

GTW 1999
Gross margin: 22.0%
SG&A: 15.1%

So Gateway is generating almost $0.07 cents of profit on every dollar
sold by holding down the overhead expenses.

In fact, the comparable measures are worse than that.  Compaq in 1999
had such large accounts receivable that their days sales outstanding
(DSO) were over 93 days -- starving the company for cash.  By
contrast, with its direct-to-customers model, Gateway's DSO were 24
days and consistent with the low numbers for accounts receivable that
it ran through the 1990s.


AND ONE OTHER FACTOR
---------------------

The annual reports of the two companies tell some interesting tales. 
In 1999, Gateway was expanding its retail store presence by opening
Gateway Country stores.  Later, the pattern would be reversed and
Gateway would close the stores.

Of course there is a third competitor in this market, one even more
adept at holding down sales & marketing costs than Gateway.-- that's
Dell (NYSE: DELL).  But that's outside the scope of this question.

But the most important factor in why Dell and Gateway continue to be
independent and Compaq is now owned by H-P is an even more interesting
story.  All three companies had a principal shareholder behind them:
at Gateway it's Ted Waitt; at Compaq it was Ben Rosen; and at Dell
it's Michael Dell.

Ben Rosen, 70, retired as chairman of Compaq about a year before the
acquisition.  Ted Waitt, 40, is still actively involved in running
Gateway, just as Michael Dell, 38, is still actively involved in the
management of the company that sports his name.


Google search strategy:
"gross margin" + analysis
"inventory turns" + "financial ratios"


Best regards,

Omnivorous-GA

Thank you very much! You did a good job and I appreciate the extra information.

Not sure what the goal of this exercise is, but it should be noted
that Compaq merged with HP in 2003.

A few comments on ratios and margins.

It appears you are trying to gauge the stretch/weakness of each
company in terms of its profitability in selling product.

Gross margin equals Net Sales minus Cost of Sales.

However, it should be noted that these companies may have revenue
unrelated to the selling product.

For example, Gateway has the following non-product operations:

Internet Access Services. 
Financing Programs. 
Training. 
Services and Support. 

These operations are obviously counted in Net Sales and have a
corresponding effect on Gross Margin, but the reality is that they
have nothing to do with product.  Unfortunately, the SEC regulations
do not require a separate revenue disclosure for business units.  I
guess what I am trying to say is to take caution when relying on these
ratios.  Because of the many revenue streams (and varying degrees of
their contribution to Net Sales) that a large corporation may have,
its hard to say which company is doing better in terms of the gross
margin, and their effectiveness to produce and sell product.  The main
reason is the incomparability described above.

Your other question related to inventory turns.  Here is another GA
question discussing turns and information you should know about the
effective management of inventory.
  http://answers.google.com/answers/threadview?id=244516

Don't mean to confuse you, but its important to understand what the
numbers mean and how they are calculated.

Hope this helps a little.

Your comment and the other thread helped a lot respree-ga, thank you!