HP Firing on All Cylinders in the Fiscal First Quarter

Published: February 26, 2008

by Timothy Prickett Morgan

Somewhere, in the wintry confines of Westchester County, New York, there are a whole lot of executives at IBM who must be asking perplexing questions. Why did we get out of the printer business that is dominated by Hewlett-Packard and that gives the company so much profit? Why did we sell the PC business? Why didn't we buy Compaq to become the market leader in X86 and now X64 servers? How did HP get to be bigger than Big Blue in the IT space?

Such are the kinds of questions that it would be reasonable to ask as HP reported a fine opening to its fiscal 2008 financial year last week, with sales up 13 percent to $28.5 billion in the first quarter ended January 31. Even more significantly for HP, which has been challenged in years gone by to turn a profit from its Compaq acquisition, this no longer seems to be as much of a problem, with HP bringing $2.1 billion to the bottom line, up 38 percent from the year-ago quarter.

Mark Hurd, HP's chairman and chief executive officer, said that three factors attributed to the growth in sales and profits that the company attained in the first fiscal quarter. "Our performance continues to be driven by three important factors. One, significant cost savings that both fund our growth and expand our earnings; two, our deployment of additional sales resources to capture incremental opportunities in the enterprise and mid-markets; and, three, a diverse, global customer base and a broad portfolio that is aligned with the growth areas of the market." Hurd said that HP grew in all product lines and all geographies, and said that unlike some U.S.-centric IT suppliers, HP generated 69 percent of its sales outside of the United States in the quarter. That said, growth was more of a challenge in the U.S. market, as has been the case with other IT suppliers. HP's sales as reported were up 22 percent in the Asia/Pacific region, up 15 percent in EMEA, and up 8 percent in the Americas.

The nature of our corporate IT newsletters means we are most interested in HP's Enterprise Storage and Servers group, which grew sales by 9 percent in the quarter to $4.8 billion. The Industry Standard Servers unit, which sells ProLiant and BladeSystem machines, accounted for just under $3 billion in sales, up 11 percent; blade server sales rose by a stunning 81 percent in the quarter, and HP is buying back a lot of market share it lost a few years ago to IBM. The Business Critical Systems unit, which sells Integrity Itanium-based servers that run HP-UX, OpenVMS, Windows, Linux, and NonStop as well as old HP 9000 and AlphaServer boxes, had sales of $864 million in the quarter, up 1 percent. Integrity server sales grew by 37 percent in fiscal Q1, and Itanium-based gear now accounts for 75 percent of BCS sales, or about $648 million. HP's storage business grew 10 percent to $960 million, with midrange EVA disk arrays growing 14 percent and nearline products getting 4 percent growth after many quarters of decline.

"While we are pleased with the progress we have made, we can still do a better job penetrating our addressable market," said Cathie Lesjack, HP's chief financial officer, in the call she hosted with Hurd for Wall Street analysts. "You'll see us take actions to drive go-to-market initiatives and add sales resources to expand account coverage and strengthen our customer relationships." HP added 2,000 sales reps in fiscal 2007, by the way, and they contributed mightily to the $673 million operating profit ESS booked in the quarter.

HP Services, which is the other big piece of the Technology Solutions Group, had sales of $4.4 billion, up 11 percent, with outsourcing up 15 percent, consulting and integration up 13 percent, and technology services up 9 percent. HP software sales went up 11 percent to $666 million, with the Business Technology Optimization unit (that's OpenView plus Opsware and a bunch of other things) up 19 percent to $548 million. HP has reclassified some business intelligence and information management software that used to be part of the ESS unit into HP Software, and now the "other software" category at HP accounted for $118 million, which declined a bit in the quarter. The Technology Solutions Group, which includes all data center products, software, consulting, and support, had sales of $9.9 billion, up 10 percent, and an operating profit of $1.2 million, up 38 percent. These old Compaq businesses have come a long way--but then again, it took a long time, too.

Lesjak said that HP's Personal Systems Group had another great quarter, and once again Lesjak warned Wall Street that while sales were indeed still hot for laptops and desktops, it would be foolish to think that HP can continue to outgrow the market as it has been doing for several quarters--and that HP would not be so foolish as to build a cost structure on the assumption that PC demand will continue to be so brisk. In any event, HP is happy to take the money while it can get it, and booked $10.8 billion in sales for PSG in fiscal Q1, up 24 percent, and attained an operating profit of $628 million, up 51 percent. Notebook sales rose by 37 percent, and desktop sales rose by 15 percent.

The Imaging and Printing Group is still, despite all of the changes HP has made, the profit engine for the company. During the quarter, HP shipped its 500 millionth printer, a stunning number, and its strength in the many-faceted printer market is one reason why it could boost sales by 4 percent to $7.3 billion and boost operating profit by 9 percent to $1.2 billion in the quarter.

Looking ahead into the second fiscal quarter and the remainder of fiscal 2008, HP once again raised the guidance that it gives to Wall Street from time to time. HP now expects fiscal 2008 sales to be in the range of $113.5 billion to $114 billion with earnings per share in the range of $3.26 and $3.30, and says that second quarter sales will be between $27.7 billion and $27.9 billion, with earnings per share in the range of 83 cents to 84 cents.

That's pretty tight guidance, and Hurd and Lesjak know it.

"While I realize that macro-economic uncertainties exist," explained Hurd on the call, "it is important to note that we control many of the levers that drive our performance. We are, therefore, confident in our ability to meaningfully expand our earnings per share. We expect to remove significantly more cost this year than we did last year. We will take these savings and realign our cost structure to fund investments that both improve the efficiency of HP and create growth opportunities. Combined with our strong balance sheet, broad geographic reach, and considerable recurring revenues, these factors allow us to confidently raise our EPS guidance."

We'll see if the economies of the world, and their millions of corporations and consumers, cooperate with that assessment. So far in the past five quarters, they have as far as HP is concerned.

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