HP's Revenues Up 5 Percent in Q2, Profits Jump 51 Percent

Published: May 23, 2006

by Timothy Prickett Morgan

While Hewlett-Packard has improved its sales and boosted profits in the past year, the second fiscal quarter shows that HP still has a lot of work to. As he has done in the past two quarters in announcing HP's financial results, chief executive officer Mark Hurd once again started and ended his call with Wall Street analysts reminding everyone last week that he knows HP has issues and is trying to address them. Having said all that, HP's fiscal second quarter was not all that bad.

When Hurd came on board in March 2005, after getting his hands wrapped around the business a few months later, he said that his goal was to grow the company at around 4 to 6 percent a year and to get HP's various business segments delivering the same profits as its largest competitors in those areas. In the second fiscal quarter of 2006, ended April 30, HP hit right in the middle of that range revenue growth target, with sales of $22.6 billion, up 5 percent from the year ago quarter. Thanks to cost cutting initiatives that HP announced last July, including 14,500 layoffs and a change in the company's pension benefits plan, and a revamped printing, server, and PC product line, the company has been able to ramp up sales just a little bit and make some more of that dough hit the bottom line. In the quarter, HP had net income of $1.5 billion, up 51 percent, and thanks to $1.6 billion in share buybacks, it was able to push earnings to 51 cents per share, up 55 percent.

In the call with Wall Street analysts, Hurd said that the performance of the Enterprise Servers and Storage group and its commercial printing segment within the Imaging and Printing Group were not performing up to his expectations, and that HP would be hiring hundreds of new salespeople to get more feet on the street to drive revenue in these areas--even as it continues the layoffs it announced last July. Bob Wayman, HP's chief financial officer, said that HP laid off 1,600 workers during the quarter and has let go of 8,100 employees since the layoffs were announced last July. And, as he has said for many quarters now, Hurd said that it would take time to execute the remaining layoffs because of labor laws in Europe and other regions, which do not make it easy to remove employees from the payrolls.

Hurd did not elaborate much on the hiring that HP would do in its server, storage, and commercial printing businesses, except to say that the company had just completed a review of its go-to-market strategy and had come to the conclusion that it needed more people. While he did not give out numbers, he wanted to make it clear that HP was not going to start stealing business from its channel. "We're an engineering company, and we are good at that," Hurd explained, adding that the sales force was not as strong as the engineering team and that the company needed to fix that. This was a complaint years ago, in the wake of the Compaq acquisition, when HP cut too many good salespeople and saw its revenues in servers and storage take a big hit. As for the channel, he wanted to make it clear that HP had no intention of changing the mix of how it gets sales. "I think the channel is a big asset for us, and resellers can get to places that we can't," Hurd said. "We're going to create more demand for Hewlett-Packard products, and that's going to benefit the channel as much as it benefits HP."

While HP's Personal Systems Group and Imaging and Printing Group are the main revenue drivers for the company, the Enterprise Servers and Storage unit is supposed to contribute to revenues and profits more than it has in the past couple of years. Ditto for software, and even with several acquisitions (including Peregrine Systems last year), the HP Software is not making HP's managers happy, either.

In the second quarter, PSG sales came in at $7 billion, up 10 percent despite a 5 percent decline in average selling prices. Desktop sales were up 1 percent, while notebook sales grew 27 percent. PC sales to businesses grew only 3 percent, while sales to consumers were up 24 percent. Notebook unit shipments were up 48 percent in the quarter, while desktop units were up 8 percent. HP, like other PC makers, is benefiting somewhat from the trend from desktop to laptop machines. But desktop PC prices persist and prices are so low that revenue growth is very difficult. The operating profit for the PC unit was $248 million, up 69 percent. On the printer front, Hurd said that HP pushed 12 million units during the quarter, and expected unit sales to accelerate in the second half of the fiscal year. IPG had overall sales of $6.7 billion, up 5 percent, and brought $1 billion in as operating profit, up 23 percent.

Over in the ESS group, ProLiant sales kept humming along, but pricing is aggressive in the X64 server business and the sales of Itanium-based Integrity machines is not offsetting--at least in terms of revenue--declines in sales of AlphaServer and PA-RISC machines. HP said that the ESS group posted $4.3 billion in sales in the second fiscal quarter, up 2 percent, and its core Industry Standard Server unit had sales of $2.45 billion, up 4 percent. HP didn't give precise figures for its BladeSystem blade servers, but said that revenues for this product were up 60 percent. Sales in the Business Critical Systems unit, which comprises AlphaServer, PA-RISC, and Integrity machines, were down 7 percent to $946 million, even though Integrity sales were up 93 percent to $341 million. The reason is that sales of AlphaServer and PA-RISC machines fell by 28 percent to $605 million. HP said that sales of servers running its HP-UX operating system fell by 8 percent in the quarter, which includes PA-RISC machines and the portions of Integrity machines running HP's Unix variant. Sales of storage products--including disk and tape arrays--increased 8 percent to $903 million. Midrange EVA storage arrays saw sales explode by 46 percent, while high-end XP arrays increased by 8 percent. Even with all of the troubles in the ESS group, the tiny increase in sales and cost cutting allowed HP to wring $322 million of operating profits out of servers and storage, an increase of 79 percent from a year ago.

By the numbers, HP's services, financial, and software businesses were not performing up to par in the second fiscal quarter in terms of revenue, but HP is watching the bottom line and apparently walking away from deals to protect it. HP Services booked $3.9 billion in sales, a decline of 2 percent, but operating profit increased 18 percent to $345 million. HP's Technology Services unit revenues declined 4 percent, the Consulting and Integration unit's revenue declined 2 percent, but Managed Services' grew by 2 percent. HP Financial Services had revenue of $518 million, down 5 percent, with financing volumes down 14 percent. Operating profit fell 33 percent to $39 million. HP Software had sales of $330 million, up 20 percent, with OpenView systems management tool sales up 25 percent and OpenCall call center software sales rising by 11 percent. Operating profits for HP Software were $3 million, compared to a $2 million operating loss a year ago.

Looking ahead, Wayman said that HP had factored in layoffs, the cost of hiring and training for ESS and commercial printing sales people, currency effects and hedging, and other factors into its models and come to the conclusion that it would book about $21.75 billion in sales in the fiscal third quarter, and about $91 billion in sales for the fiscal year. He and Hurd declined to talk about fiscal 2007 in the call. HP expects to bring between 41 cents and 44 cents a share to the bottom line in the third quarter, and about $1.87 to $1.91 a share to the bottom line for the year.