HP hits Q3 targets, shoots for same in Q4

Eye on ball

ComputerWire: IT Industry Intelligence

Carly Fiorina, chairman and CEO of Hewlett Packard Co, is probably not breathing a huge sigh of relief now that the merged HP and Compaq has hit the financial targets that the company set for its fiscal third quarter of 2002,

Timothy Prickett Morgan writes


After all, HP saw revenues decline by 11% to $16.5bn and posted a $2.5bn loss, thanks in large measure to a $1.6bn restructuring charge and $1.4bn in merger-related costs. This is not a lot of fun. But it sure beats not hitting the financial targets that the top brass sets, which is something that Fiorina experienced when she first took the helm of HP a few years ago. No matter what excuse HP might have had in this trying time in the IT market, Fiorina would be under fire today if HP had not hit its targets.

"Throughout our first 100 days, we've kept our eye on the ball," Fiorina said yesterday in a conference call with Wall Street analysts. "We're hitting all our integration milestones and are on track to meet our second-half targets. The top 50 contracts we won in the quarter totaled $2bn in new long-term revenue, and we exit the quarter with almost $12bn in cash and equivalents. While we have more work ahead, given the tough economy and a major integration, we did well." She also said that HP had only $8.1bn in debt, most of which is associated with its captive financing arm.

Like other vendors in tough times, HP talks to Wall Street in pro forma results that remove the effects of inventory write-downs, acquisition and restructuring charges, legal fees, and a whole slew of things that make financial results messy. Just for the record, HP posted pro forma earnings from operations of $533m in the quarter, up from $352m for the combined HP and Compaq in the third fiscal quarter of 2001, and had pro forma earnings of $420m or 14 cents a share, up 31% from the $320m or 11 cents a share a year ago.

While there is some credence to the idea that you have to look at how a company's core business is performing in isolation from the tumult caused by mergers, acquisitions, and charges, the fact remains that HP lost 67 cents a share in the quarter according to accepted accounting principles. Such losses are real, and they affect how companies behave and how their customers, competitors and credit rating agencies treat them.

Fiorina said that HP had made 4,740 cuts to the payroll in fiscal Q3, which ended July 31, and that another 1,760 employees had been given pink slips in August already, which means that the company is on track to remove 10,000 people from the payroll by October 31, the fiscal year end for HP. HP had 153,500 employees at the beginning of the third quarter.

HP's president and chief operating officer, Michael Capellas, gave a breakdown of HP's revenues by segment. The core Imaging and Printing group posted revenues in Q3 of $4.7bn, up 10% from $4.3bn in the same quarter last year. Thanks to the announcement of new imaging products with lots of features that are being snapped up by customers, this group saw earnings from operations rocket up to $813m, up from $343m in last year's fiscal third quarter.

HP is in the midst of a several month rollout of some 50 new printing and imaging products, part of a $1.2bn investment HP has made in this area to take on Lexmark, Canon, Kodak, and other competitors. Sales of the PhotoSmart photo printers more than doubled in the quarter, all-in-one printer sales were up 59%, and LaserJet revenues were up 14%. Sales of imaging and printing supplies were up 19%.

Sales in the Personal Systems unit were down 20% year over year to $4.8bn, and HP posted a loss from operations of $198m (which was better than the $372m loss from operations in the same quarter last year for the combined HP-Compaq). Capellas said that consumer PC spending was down 21% and that corporate PC buying was down by 15%, but because direct PC sales improve profits, he was encouraged by the fact that 18% of the company's PCs were sold directly to customers in the quarter; drilling down, he said that 26% of PCs sold in the Americas were done on a direct basis and that 53% of commercial PC sales in the U.S. were direct to customers.

HP's losses were quite a bit worse in the Enterprise Systems group, which saw its earnings from operations go from a slim $17m on sales of $4.8bn of servers, storage and related software in Q3 2001 to a loss of $422m in this year's third quarter on sales of $3.8bn. Capellas conceded that it is in this area that HP faces the most integration challenges, but as he correctly points out, has the greatest chances of attaining synergies and profits if it can convince customers that the combined roadmaps HP has created for its many server lines dovetail with their own long-term strategies.

He also said that part of the 22% decline in revenues in the Enterprise Systems unit was undoubtedly the result of customers evaluating its roadmaps. But it is also true that companies are shifting to low-cost servers and away from big ticket, high profit Unix machines that have been the flagships of the Compaq and HP server lines before the merger in these tough economic times.

In the Business Critical Server unit, which is comprised of PA-RISC, AlphaServer, and Tandem machinery, sales were off 31% in the quarter due to the weakness in the telecoms and financial services markets that are big buyers of Unix servers and in Japan, which is seeing its economy soften further. He also said that HP's Unix business was historically strong in Europe, and that the weakening European economy was impacting server sales and lengthening sales cycles. That said, unit shipments of the high-end Superdome PA-RISC servers were up 9% in the quarter.

Sales of Intel-based servers in the Industry Standard Server unit were off 18% in the quarter, and even with the retiring of the NetServer line, HP reckons that it only lost one point of market share in the quarter. Storage sales were off 15%, which HP said was significantly better than the 31% decline in sales that rival EMC Corp posted in the same period. "Clearly, these results are unacceptable," said Capellas, indicating that HP would be chopping costs in this organization to bring it in line. But later in the call he seemed to think HP had the problem under control. "I do think we will see a rebound in our Unix business in Q4 and we will gain share in industry standard servers. I am not going to predict profitability, but you will see improvement in the current quarter and in the next quarter."

Revenues in its services segment were off 7% to $3bn, driven down by declining demand for consulting and integration services and a modest decline in maintenance fees, which seems to be as much a result of the depressed sales levels in the past two years in the server market as it is caused by customers retiring old kit and consolidating onto fewer servers. Companies also appear to be cutting corners on IT spending by cutting back on services levels for the computers. Still, the services unit was able to pull in $275mn in earnings from operations, down from $384m for the combined companies a year ago. HP's financing arm made up the remaining $510m in revenues and a loss of $24m before taxes.

As always, Wall Street wants to use blue chip companies like HP as a barometer for the economy at large, and analysts pressed HP's top brass to be prognosticators. Chairman Fiorina, like other executives at IT companies, didn't take the bait. "We are not economists, and we have difficulty predicting the future. Many of us had been hoping for a rebound in IT spending in the second half of calendar 2002, and this is clearly not happening." HP's chief financial officer, Bob Wayman, said that the company is anticipating that revenues would be up somewhere between 4% and 6% in the fiscal fourth quarter and that gross margins would hold more or less steady in the 25% to 26% range even with intense price competition, a mix of less expensive printers, declining Enterprise Systems sales, and other factors because of the cost cutting and synergies that are the driving force and the result of the HP-Compaq merger.

"The bottom line is that there are a lot of variables impacting our results going forward, some which we can control and some which we cannot. That said, we are happy with consensus estimates." And that, presumably, is about as good as anyone can expect in the IT market these days.

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