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During 1991, Cray™s revenues increased by seven percent, while pro¬ts increased
only slightly. While such performance might normally be viewed as disappointing,
Cray™s letter to shareholders placed it in context: “These results came during what many
observers are describing as the worst year overall in the computer industry™s history.”
Based on Cray™s performance relative to the industry, management indicated that “these
results mean that we will not have to divert our attention in 1992 to ˜rebuilding™ or ˜re-
structuring™ efforts that have become almost commonplace in the industry.”
During the ¬rst quarter of 1992, Cray installed 11 new and 2 used systems, generating
sales of $165 million, up 15 percent over the ¬rst quarter of 1991. Nevertheless, net in-
come fell 26 percent, to $3.9 million, re¬‚ecting lower volume in high-end systems. In
mid-1992, Cray is just beginning to ship its top-of-the-line C90 systems at the rate of
894 Case: The Computer Industry in 1992




164 Part 4 Additional Cases




about one per month. Analysts expect that Cray, which tends to make a big push to install
systems before years™ end, will see a pickup in earnings in the latter half of the year. An-
alysts forecast sales increases of 10 percent and 11 percent for 1992 and 1993, respec-
tively, and return on equity of 13 to 14 percent in each year.
A summary of Cray™s ¬nancial statements for recent years appears in Exhibit 2.
The Computer Industry in 1992




TANDEM COMPUTERS
Tandem operates within the niche of fault-tolerant mainframe and mid-range computer
systems. Its products (labeled NonStop systems) are used in on-line transaction process-
ing (OLTP) in banking, manufacturing, communications, distribution, brokerage and se-
curities, and other industries. NonStop systems feature multiple independent processors,
and are designed to continue operating through any single processor failure. (This is re-
ferred to as “continuous availability.”) Beginning in 1990, Tandem produced a new
fault-tolerant, high performance UNIX-based system, based on the high-speed Reduced
Instruction Set Computing (RISC) technology. Through its subsidiary, Ungermann-Bass,
Tandem also produces general-purpose local area networks. Almost half of Tandem™s
sales are within the U.S.; the remainder are primarily in Europe, with some in the Paci¬c
Rim and elsewhere.
Tandem pioneered the fault-tolerant market and remains the acknowledged world-
wide leader in fault-tolerant systems, with a 70 percent market share. However, it faces
competition from Digital Equipment, Hewlett-Packard, Fujitsu, and Hitachi”all of
which have entered the market in recent years”and from Stratus, a much smaller man-
ufacturer. Moreover, some standard mid-range systems (produced by IBM and others)
now have fault-tolerant capabilities, and so lines are blurring between the fault-tolerant
market and mainstream systems market.
Tandem™s revenues increased only slightly in 1991, and earnings declined. In the Tan-
dem Annual Report for 1991, President and CEO James Treybig stated that “we are not
satis¬ed with our ¬nancial results,” and attributed the ¬rm™s dif¬culties to “the length
and severity of a widespread recession.” He indicated that the ¬rm would “change the
basic cost structure of [its] business” by reducing the size of its workforce, eliminating
redundancies, increasing the leverage of sales and marketing efforts, and realigning the
organization. Treybig indicated that Tandem would capitalize on opportunities in an
OLTP marketplace that would continue to grow by “extending leadership in price/perfor-
mance, open networking, and continuous availability.” However, with the product cycle
just beginning for some new RISC-based systems, substantial growth in Tandem sales
could be a few quarters away.
In the ¬rst quarter of 1992, Tandem recorded an after-tax restructuring charge of
$80 million, while sales rose only slightly. Thanks to that change, analysts expect the
ROE to be only 4.3 percent in 1992, but to rise to 8.1 percent in 1993. Sales growth is
projected at 4 to 5 percent for the next two years.
A summary of Tandem™s recent ¬nancial statement data appears in Exhibit 3.
895
Case: The Computer Industry in 1992




165
Part 4 Additional Cases




STRATUS COMPUTER
Like Tandem, Stratus produces fault-tolerant computer systems for use in OLTP, and is
introducing a new generation of RISC-based fault-tolerant computers. Stratus systems
consists of up to 32 processing modules connected via a high-speed communications
link. The systems are used in the securities industry, banking, distribution, plant man-




The Computer Industry in 1992
agement, hotel reservation systems, and communications. Stratus is the only computer
company in the world totally focused on continuous availability for OLTP; its 1991 an-
nual report claims that, of their 150 largest bids of the year, “not one situation was re-
ported where a competitor could show higher availability than Stratus.”
Stratus was but a minor player in the fault-tolerant market until the mid- to late 1980s,
but it now holds a 21 percent market share, second only to Tandem. More than half of
Stratus sales are within the U.S., with Europe accounting for most other sales. Sales to
IBM”which sells Stratus equipment on an OEM basis”accounted for 23 percent of
Stratus sales in 1991, down from 26 percent in 1990 and 35 percent in 1989. Stratus is
attempting to diversify its customer base, and expects increases in its sales to NEC (1.5
percent of 1991 sales) and others.
Stratus revenues for 1991 were up 11 percent, while earnings rose 34 percent. In its
upbeat annual report to shareholders, Stratus emphasized what it considers its systems™
unparalleled record of online applications availability, and indicated that “the growth of
critical online applications is outpacing the abilities of most vendors to provide the lev-
els of availability that customers actually need. This presents Stratus with the opportu-
nity to capitalize on the trend that more businesses are becoming increasingly reliant on
their online computer systems.”
In the ¬rst quarter of 1992, sales growth slowed to “only” 9 percent, largely because
of a dropoff of sales to IBM. However, earnings rose 40 percent. Analysts are projecting
ROE of about 17 percent for 1992 and 1993, on sales growth of 13 percent in 1992 and
17 percent in 1993.
A summary of Stratus™s recent ¬nancial statement data appears in Exhibit 4.


QUESTIONS
1. Profitability (as measured by return on equity) for the overall computer industry fell
steadily from 23 percent in 1988 to 11 percent in 1991, and sales had been flat for the
last two of those years. In early 1992, typical price-earnings ratios in the computer
industry were within the range of 9 to 12, while typical price-to-book ratios stood at
1.0 to 1.4.
Consider the factors that would determine the price-earnings ratios and price-to-
book ratios for the four firms in the case. Based solely on the information in the case,
would you expect price-earnings ratios and price-to-book ratios for each of the four
firms to be higher than, lower than, or within the ranges considered typical for the
industry at this time?
896 Case: The Computer Industry in 1992




166 Part 4 Additional Cases




EXHIBIT 1
Atari Corporation “ Common-Size Financial Statements and Selected Ratios

1991 1990 1989 1988 1987
..................................................................................................................................................
The Computer Industry in 1992




Cash 0.275 0.135 0.166 0.272 0.200
Receivables 0.318 0.352 0.324 0.297 0.196
Inventory 0.321 0.419 0.393 0.348 0.380
Other current assets 0.030 0.026 0.046 0.041 0.007
Total current assets 0.944 0.933 0.928 0.958 0.783
Plant, property, equip 0.038 0.050 0.042 0.025 0.128
Other long-term assets 0.018 0.017 0.030 0.017 0.089
Total assets 1.000 1.000 1.000 1.000 1.000

Notes payable 0.001 0.000 0.000 0.000 0.003
Other current liabilities 0.312 0.449 0.506 0.532 0.416
Total current liabilities 0.313 0.449 0.506 0.532 0.419
Long term debt 0.191 0.180 0.234 0.222 0.258
Other liabilities 0.000 0.000 0.000 0.000 0.000
Total liabilities 0.505 0.629 0.740 0.754 0.677
Shareholders™ equity 0.495 0.371 0.260 0.246 0.323
Total liabilities and equity 1.000 1.000 1.000 1.000 1.000

Total assets (millions) $253 $273 $331 $338 $518
Sales 1.000 1.000 1.000 1.000 1.000
Cost of sales 0.725 0.766 0.725 0.616 0.608
SGA expense 0.338 0.284 0.261 0.248 0.250
Operating income before depreciation “0.063 “0.050 0.015 0.136 0.142
Depreciation 0.010 0.012 0.006 0.005 0.009
Interest expense 0.017 0.016 0.015 0.011 0.011
Nonoperating gain/loss 0.024 0.030 0.012 0.008 0.029
Special gain/loss 0.156 0.000 0.000 0.000 0.000
Income before tax 0.091 “0.047 0.006 0.129 0.152
Income tax provision 0.000 0.004 “0.004 0.042 0.062
Income before extraordinary items 0.092 “0.051 0.009 0.087 0.090
Net income 0.099 0.036 0.009 “0.188 0.116

Sales (millions) $258 $411 $424 $452 $493

EBI/Sales 0.098 “0.044 0.015 0.091 0.094
Earnings/EBI 0.933 1.144 0.615 0.954 0.955
Sales turnover = sales/average assets 0.981 1.364 1.266 1.056
Leverage = assets/equity (average) 2.320 3.222 3.953 3.415
ROE = product of above 0.209 “0.223 0.047 0.314
..................................................................................................................................................
EBI = earnings before interest, net of tax. Tax effect of interest is assumed to be 40 percent.
897
Case: The Computer Industry in 1992




167
Part 4 Additional Cases




EXHIBIT 2
Cray Research “ Common-Size Financial Statements and Selected Ratios

1991 1990 1989 1988 1987
..................................................................................................................................................




The Computer Industry in 1992
Cash 0.034 0.071 0.072 0.182 0.194
Receivables 0.226 0.124 0.188 0.118 0.107
Inventory 0.227 0.191 0.212 0.238 0.214
Other current assets 0.030 0.024 0.007 0.005 0.006
Total current assets 0.517 0.409 0.479 0.543 0.520
Plant, property, equip 0.333 0.367 0.325 0.291 0.242
Other long-term assets 0.150 0.224 0.196 0.166 0.238
Total assets 1.000 1.000 1.000 1.000 1.000

Notes payable 0.006 0.039 0.053 0.009 0.010
Other current liabilities 0.186 0.177 0.175 0.192 0.176
Total current liabilities 0.192 0.216 0.227 0.201 0.186
Long term debt 0.100 0.112 0.151 0.111 0.120
Other liabilities 0.006 0.006 0.000 0.005 0.017
Total liabilities 0.297 0.334 0.378 0.317 0.323
Shareholders™ equity 0.703 0.666 0.622 0.683 0.677
Total liabilities and equity 1.000 1.000 1.000 1.000 1.000

Total assets (millions) $1,079 $944 $956 $991 $902

Sales 1.000 1.000 1.000 1.000 1.000
Cost of sales 0.333 0.306 0.289 0.272 0.252
SGA expense 0.348 0.356 0.370 0.330 0.321
Operating income before depreciation 0.320 0.338 0.341 0.398 0.426
Depreciation 0.131 0.137 0.130 0.110 0.105
Interest expense 0.009 0.010 0.011 0.010 0.013
Nonoperating gain/loss 0.009 0.022 0.023 0.031 0.029
Special gain/loss 0.005 “0.004 “0.061 0.000 0.000
Income before tax 0.193 0.209 0.162 0.309 0.338
Income tax provision 0.062 0.068 0.049 0.102 0.124
Income before extraordinary items 0.131 0.140 0.113 0.207 0.214
Net income 0.131 0.140 0.113 0.207 0.214

Sales (millions) $862 $804 $785 $756 $687

EBI/Sales 0.135 0.144 0.118 0.211 0.219
Earnings/EBI 0.973 0.972 0.964 0.980 0.976
Sales turnover = sales/average assets 0.852 0.847 0.806 0.799
Leverage = assets/equity (average) 1.458 1.553 1.532 1.471
ROE = product of above 0.163 0.185 0.140 0.243
..................................................................................................................................................
EBI = earnings before interest, net of tax. Tax effect of interest is assumed to be 40 percent.
898 Case: The Computer Industry in 1992




168 Part 4 Additional Cases




EXHIBIT 3
Tandem Computers “ Common-Size Financial Statements and Selected Ratios

1991 1990 1989 1988 1987
..................................................................................................................................................
The Computer Industry in 1992




Cash 0.059 0.049 0.122 0.095 0.328

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