Global Sales Save HP's Financial Cookies in the Second Quarter

Published: May 27, 2008

by Timothy Prickett Morgan

Hot on the heels of its proposed $13.9 billion acquisition of services pioneer and giant Electronic Data Systems two weeks ago, Hewlett-Packard last week duly reported its financials to Wall Street for the second quarter of fiscal 2008 ended April 30. And as it hinted two weeks ago, the numbers were a bit better than expected, with overall sales up 9.7 percent to $25.7 billion and net earnings rising by 15.9 percent to $2.06 billion. Thanks to share buybacks, HP was able to boost earnings per share by 23.1 percent to 80 cents a pop.

HP's Enterprise Storage and Servers unit, which contains its flagship data center products, posted sales of $4.78 billion, an increase of 4 percent, which is not all that great in terms of growth. But when you consider that HP has dominant market share in the commodity X64 market, where competition is fierce, you can't expect a lot of revenue growth.

More significantly for HP's managers and investors, the ESS unit reported an operating profit of $655 million in the second fiscal quarter, an increase of 44.9 percent from the year-ago quarter. HP said that blade server sales rose by 68 percent overall (but only 64 percent for X64-based ProLiant blades) Significantly, sales in the Industry Standard Server line (mostly X64-based tower, rack, and blade servers) were flat in the quarter at $2.82 billion, while Business Critical Systems (which peddles Integrity, NonStop, and various legacy platforms) rose by 7 percent to $919 million. HP said that Integrity server sales rose by 35 percent and made up 78 percent of BCS sales, or about $708 million in the quarter. Only two years ago, Integrity sales were a much smaller portion of BCS sales, but were growing in the high double-digits; growth has slowed as the Integrity line has gradually replaced HP 9000, HP 3000, and AlphaServer products, and it probably will not be too many years before HP's Integrity line grows at the same pace as the rest of the enterprise server space. (Meaning not much when averaged out over four quarters.)

Mark Hurd, the company's chairman and chief executive officer, said that the ISS unit was facing a tough compare in the quarter, after booking 17 percent revenue growth in the year-ago quarter, and said on a call with Wall Street analysts that HP "picked its spots" on where to chase business and where to not descend into bidding wars that hurt profits. He also said that HP missed a couple of big deals in the quarter. Cathie Lesjak, HP's chief financial officer, said that BCS had revenue growth in all of its regions, including in the United States, and had some big deals in the States, too. BCS sales in China and India were also strong, she said.

Storage sales (including disk and tape products) rose by 14 percent to $1.04 billion. High-end XP disk array sales were up 21 percent and midrange EVA array sales increased by 17 percent, so it was a better quarter for storage than HP has seen in a while.

HP's soon-to-be-radically-expanded Services unit posted sales of $4.63 billion in the quarter, up 12.2 percent, with technology services revenues of $2.33 billion (that's mostly break-fix money for HP gear), outsourcing services revenues of $1.37 billion, and consulting and integration sales of $926 million. The HP Software unit, which has grown from a number of acquisitions in the past two years, had sales of $727 million in the quarter, giving the overall Technology Solutions Group sales of $10.13 billion in the quarter and an operating profit of $1.26 billion. (HP Financial Services, which does leasing and renting of gear, is not part of TSG, but a free-standing unit and it had $685 million in sales.)

That is roughly the same revenue stream that HP's Personal Systems Group, which sells PCs, laptops, and similar end user devices, racked up in the second fiscal quarter, with $10.07 billion in sales and $544 million in operating profits. While PSG is the least profitable of the company's three major units, the HP and Compaq brands are on an awful lot of machinery out there on desks and laps, and this seems to be the main reason HP stays in the game. (The company makes three times as much profit for the dollar in its server biz than it does in PCs.) Total PC unit sales were up 21 percent in the quarter and sales were up 16 percent. The desktop business was essentially flat in terms of sales and profit growth, but notebook shipments shot up 46 percent and sales rose by 31 percent in the quarter as end users switch from desktops to laptops around the world. Notebook sales accounted for 53 percent of PSG's sales in the quarter, or $5.33 billion.

The real profit engine at HP continues to be the Imaging and Printing Group, and so long as HP can make buckets of money from cartridges of ink selling increasingly flimsy but nonetheless very useful printers, then the company can afford to be in the PC business. IPG had sales of $7.59 billion in the quarter, up only 6 percent, but IPG brought $1.26 billion of that to the middle line as operating profit--as much as its Technology Solutions Group hauled in with more than a third larger sales. Despite the intense competition from Lexmark (and partner Dell), Canon, Epson, Xerox, Ricoh, and a handful of other printer makers, HP shipped more than 14 million printers in the quarter, up 16 percent.

On a geographical basis, sales in the United States for HP during the quarter was flat and the company pulled in 70 percent of its revenues from outside of the United States. "The U.S. is a tale of many stories, and I would describe it as spotty," Hurd said, adding that he did not want to give the wrong impression that business in the U.S. was bad, but that certain areas and industries have softness. Sales in Brazil, Russia, India, and China rose by an aggregate of 26 percent in the quarter, by contrast. HP had $11.1 billion in sales in the broader Americas region, but sales in Europe rose by 16 percent, pushing up to $11.9 billion, and sales in the Asia/Pacific also rose by 16 percent to $5.2 billion. If you take out the currency effects of moving HP's sales back to its Palo Alto headquarters and the U.S. dollars, the Americas region only grew by 2 percent, EMEA by only 6 percent, and AP by 7 percent.

HP exited the quarter with $11.8 billion in cash and equivalents and $3.5 billion in cash net of debts after generating $4.8 billion in cash from operations in the second quarter and spending $2.8 billion on buying back 66 million of its shares from the open market. The current authorization for share buybacks has $4.5 billion still on the books, but with HP needing $13.9 billion in cash to buy EDS, it is not clear how aggressively HP can take shares off the market. Looking ahead, Lesjak says that HP will have $27.3 billion to $27.4 billion in sales in the third fiscal quarter of 2008, and expects $114.2 billion to $114.4 billion in sales for the full fiscal year. These numbers, she said, do not include any effects from the EDS acquisition.

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