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Apotheker prescribes transformation elixir for HP

Down the hatch, dinosaur

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As everyone knows by now, Hewlett-Packard is trying to buy the British software company Autonomy as it shuts down its webOS hardware business and hopes to spin off its Personal Systems Group.

But here's a question for you: In HP's third fiscal quarter, which of its units actually showed year-on-year as well as sequential quarterly growth for operating margins?

Nope, it wasn't HP Software. It wasn't Enterprise Servers, Storage, and Networking, either. And it sure wasn't HP Services. Yup, it was Personal Systems Group (PSG) as well as the tiny HP Financial Services unit that gives leases on the company's gear.

The third quarter was not a great one for HP, but the outlook is even tougher, partly because HP is so tied to consumers that are skittish about the uncertainty in the global economies. HP booked sales of $31.2bn, up a point compared to the year-ago period, and net income hit $1.93bn, rising 8.6 per cent.

The PC business is cut-throat, and no IT giant wants to be shackled to the whims of consumers who cannot be goaded into buying new hard and soft wares even when they don't have the money. Corporate customers can always be lured by the promises of efficiency gains and lower costs in the long run. But PSG posted operating income gains on lower revenues thanks to a slowdown in consumer and public sector spending, and that is about as good as it gets on planet Earth right now.

In the third quarter, the PSG unit had sales of $9.59bn, off 3.3 per cent, but earnings from operations rose by 20.9 per cent, to $567m. That's not a great level of profitability compared to lucrative software margins, of course, which is why HP is considering all of its options in the PC racket. HP CEO Leo Apotheker saying on a conference call with Wall Street analysts that it would take the company between 12 and 18 months to sort out what it would do with the PC business, which includes everything from selling it to breaking it up to spinning it off to doing nothing at all.

HP's notebook PC sales were off 4 per cent, to $5.08bn, and desktop PC sales slumped the same amount down to $3.78bn. Workstation sales rocketed up 19 per cent to $547m, so HP will probably want to keep that bit – presuming that it is making money on workstation sales. For all we know, HP isn't.

Here's the real rub: Revenues of commercial PCs were up 9 per cent, but consumer PC sales were off 17 per cent. Maybe what HP really needs to do is sell off the consumer PC business to Lenovo or Acer.

It's the app and the cloud, stupid

The good news for HP is that after it shelled out $1.2bn for Palm last year, it did not merge this into the PSG unit, but kept it in the bookkeeping DMZ of Corporate Investments, where 3Com sat for a while until it was integrated with HP's ProCurve switching business and then melded with servers and storage to Create the ESSN Group. In the third quarter, Corporate Investments accounted for just $266m in revenues and booked $332m in losses from operations – which HP CFO Cathie Lesjak said on the call was entirely due to webOS software and devices.

Lesjak said that HP made a bet on webOS a year ago, and basically conceded that this bet did not pay off. HP believes that it would take one to two years of intense investments going forward to make a dent in the market peddling webOS devices and characterized it as a "risk without clear returns" that HP was no longer willing to take.

HP's TouchPad went on sale in July and was dead on arrival, and not because people don't want tablet PCs, but perhaps because they want tablet PCs that run iOS applications and have a familiar infrastructure that supports them and caters to their whims. Instead of buying Palm, maybe HP should have built a cloud. Or both. Five years ago.

HP expects to eventually take a $1bn charge relating to the shutdown of webOS devices and says that there is $1.2bn in goodwill on its books relating to the webOS business that may need to be impaired at some point – and yet still insists that there might be some strategic way to license webOS and extract value from it.

Perhaps by selling it as a patent portfolio.

Printing money in the data center?

Apotheker might be a software guy, but he is going to have to make his numbers on enterprise IT gear and printer ink.

Margins took a hit in the third quarter in HP's ESSN group thanks to lower than expected sales of its Itanium-based Integrity server line, which is part of its Business Critical Systems unit. ESSN had $5.4bn in revenues, up 7 per cent compared to the year ago period, and earnings from operations fell by a point to $699m.

The Industry Standard Servers unit (Xeon and Opteron boxes) raking in $3.3bn, up 9 per cent. The BCS unit posted a 9 per cent decline, to $459m, and Lesjak said that HP's ability to close deals was impacted by Oracle's decision back in March to cease development of its database, middleware, and application software on future Itanium processors, including next year's eight-core "Poulson" Itanium chip.

Lesjak said some customers delayed Integrity server purchases and others canceled them because of Oracle's actions, and said that there was a "knock-on" effect in its Technology Services unit (now part of ESSN organizationally but still with its revenue reports in HP Services for the moment) because new server sales and upgrades drive services deals.

HP Networking posted a 15 per cent revenue gain in the quarter, to $659m. This is one of the few really bright spots in terms of growth for HP but it is still a tiny business compared to PCs and servers. HP's storage unit had $976m in sales, up 8 per cent. External storage array sales rose by 17 per cent in the quarter, with tape and EVA products showing softness and 3Par arrays showing triple-digit growth.

HP Services had $9.09bn in sales in fiscal Q3, with Infrastructure Technology Outsourcing up 5 per cent to $3.88bn, Technology Services up a similar 5 per cent to $2.75bn, Application Services up 2 per cent to $1.7bn, and Business Process Outsourcing off 9 per cent to $658m.

Earnings from operations for HP Services fell 11.3 per cent, to $1.23bn, and it will now be the job of John Visentin, who has been running the Enterprise Services behemoth in the Americas region since the departure of Tom Iannotti earlier this year, to knock this services biz into shape since he is now in charge of it. Visentin previously ran North American operations for IBM's Integrated Technology Services business.

The software is the hard bit

There's not enough money in the world – or in the HP coffers – to build the kind of software business that will make Apotheker comfortable, but the massive expense in buying Autonomy is a start. The British company has over 25,000 customers using its tools, which manage and archive unstructured data, and currently has on the order of 30PB of data under management, according to Apotheker. It remains to be seen if this company, which is on track to break $1bn in annual sales, is worth the hefty premium that HP is paying to acquire the company.

In Q3, HP Software had $780m in sales, up 20 per cent, but operating profit fell 17 per cent to $151m. Whoops.

Thank heavens for printers and ink, then, although profits are a little harder to come by because of shortages in LaserJet and InkJet ink components in the wake of the Japanese earthquake and tsunami in March and because of a slump in consumer spending. The Imaging and Printing Group raked in $6.1bn in sales (down 1.3 per cent) but more shockingly for HP operating earnings of only $892m (down 14.2 per cent).

Maybe HP has figured out that it needs Autonomy to be the corporate digital equivalent of printer ink because this is how we are going to keep data in the cloud age. Or maybe it is just guessing, like it was with the Palm acquisition.

Because of the uncertainty in the US and European economies and the disruptions and transitions in many of its product lines, HP is dropping its revenue and profit guidance for the fourth fiscal quarter and full year. HP now expects for Q4 sales to be in the range of 32.1bn to $32.5bn, with earnings per share between 44 cents and 55 cents. For the full year, the bar is lowered to $127.2bn to $127.6bn on the revenue front, with EPS expected to be between $3.59 and $3.70. ®

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