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HP overshoots on Q1

But will it boost merger prospects?

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ComputerWire: IT Industry Intelligence

Does the fact that Hewlett Packard Co did a little better than expected in its first fiscal quarter mean that the $25bn merger with rival Compaq Computer Corp is a good idea, as chairman and CEO Carly Fiorina clearly believes,

Tim Prickett Morgan writes

Or does it mean that, as founder's son Walter Hewlett believes, the HP-Compaq merger is unnecessary?

That's a good question, and one that Wall Street analysts, institutional investors, and HP and Compaq shareholders will be mulling over as they contemplate HP's first fiscal quarter financial results, which were announced yesterday after the market close.

Fiorina was pretty emphatic in her interpretation of what the somewhat unexpectedly good numbers meant. "Walter Hewlett and I agree on one thing," she said during a conference call with analysts yesterday. "This is a strong company that is not afraid to take a bold step. I think it is clear that we are not distracted by the merger, and that our customers are not defecting."

Fiorina eluded to the fact that many of HP's and Compaq's competitors had been rubbing their hands together, thinking that their respective installed bases would be easy prey in a tough economic climate. She says that rivals have not been able to use the merger as a lever to steal HP's customers. She went further to explain why this merger is not like other mega-mergers, and why it will work. "This is a merger of consolidation, not diversification. HP and Compaq are in the same businesses. We speak the same language. This industry is beginning to consolidate, and such mergers are not only necessary, they are inevitable."

For the three months ended January 31, the company's first fiscal 2002 quarter, HP's overall sales were down 8% to $11.4bn. Even though earnings from operations declined by 19% to $625m, during last year's fiscal first quarter HP booked a $272m charge relating to a change in accounting required by the Securities and Exchange Commission that knocked net earnings down to $141m or 7 cents a share. This time around, net earnings came in at $484m or 25 cents a share. This seems like a big improvement, but without that charge, HP would have earned 20 cents a share this time last year. That said, any improvement in earnings considering this sluggish economy and HP's difficulties with the Compaq merger have to be seen as a victory.

Revenue was off in every HP category except IT services, which saw sales climb by 2% to $1.6bn. HP's crown jewel, the imaging and printing business, saw revenue drop by 2% to $5.1bn. Sales of embedded and personal systems were off 13% to $2.5bn. HP's computing systems business, which includes all of its server and storage lines, fell by 21% in the quarter to just under $2bn.

Financing operations declined by 6% to $342m. While HP booked a loss on operations in the HP server and storage businesses to the tune of $160m in the fiscal 2002 first quarter, compared to earnings of $58m this time last year, losses from the PC and embedded systems unit were drastically reduced and earnings from operations in the company's printing and imaging and services units improved considerably and allowed HP to bring some extra dough to the bottom line.

What was exciting to Fiorina and HP CFO Bob Wayman was that first quarter revenues were up compared to HP's fiscal 2001 fourth quarter, which came in at $10.9bn in sales. Wayman said yesterday that HP usually has a seasonal downtick moving from fiscal Q4 to Q1, which contrasts with and roughly compares to the calendar Q3 to Q4 transition among HP's main rivals.

Drilling down into the printing and imaging business, HP said that sales of digital cameras were up 30% in the quarter, and sales of photo printers was up 34%. Scanner sales were up 21% compared to fiscal Q4, but down 17% compared to last year's first quarter. Commercial printer sales were up 2% sequentially and declined 4% year-on-year. Home printer sales plummeted by 2% sequentially and by 23% year-on-year, and HP said that consumers are shifting to lower-cost, multi-function printers.

Sales in the Computing Systems unit were off 4% sequentially and off 21% compared to last year. HP said that margins were adversely impacted by weak demand and severe pricing pressure. HP continued to see Unix server sales slip, with revenue down 7% sequentially from fiscal 2001 Q4 and down 21% from last year. Sales of Intel-based servers were down 21% compared to last year, too. Storage revenue was off 4% sequentially and off 13% compared to Q4 2001, and HP again attributed this to extreme pricing pressure, which Fiorina said was much worse for rivals EMC Corp and Compaq than for HP.

As for the future, HP cautioned Wall Street and investors against too much optimism. In its earnings statement, HP said that conditions in the commercial and consumer IT markets continue to be unpredictable and that the company is uncertain as to when a real uptick in demand will occur. HP said that it continues to be conservative in its estimates, and warned that it was expecting sales in the second fiscal quarter to be down sequentially and gross margins and expenses to remain more or less flat.

"Enterprise spending is showing no signs of an uptick," said Wayman. "We look at Q1 as something of a pleasant surprise, and we are not counting on anything."

Fiorina echoed his caution, saying that spending in the telecom, airline, and high-tech manufacturing businesses remains very weak. "We do not expect a recovery in enterprise spending until the second half of the year," she said. "People are holding their budgets tight, and they are waiting for a clear sign to let go of their purse strings."

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