Overseas and Notebook Sales Offset Printer Declines for HP in Q3

Published: August 26, 2008

by Timothy Prickett Morgan

While the U.S. dollar may be strengthening a bit in recent weeks, overseas currencies where IT sales are growing very rapidly were and continue to be a lot stronger and business is a lot more brisk, which means that Hewlett-Packard's third quarter of fiscal 2008 ended July 31 was helped considerably by the ongoing lopsidedness in the global economy. HP posted sales of $28.2 billion in the quarter, up 10.2 percent, and net earnings of just over $2 billion, up 14 percent.

Currency effects accounted from translating overseas sales back into U.S. dollars accounted for half of that revenue growth. The good news for companies like HP, IBM, Sun Microsystems, Microsoft, Cisco Systems, and other big IT suppliers is that they spend a lot of their money back here in the States, so a weak dollar helps them three times. First, it makes sales look stronger than they are, which makes Wall Street happy. Second, it allows overseas customers help pick up the tab for research, development, marketing, and other costs back here in the States. And third, the weak dollar makes it possible for IT vendors to sell their gear into foreign markets more aggressively without cutting prices. The weakened U.S. dollar is, in effect, a price cut relative to homegrown IT alternatives, which bear their costs in local currencies.

"Hewlett-Packard delivered another strong quarter," bragged Mark Hurd, HP's chairman and chief executive officer in opening his call with Wall Street analysts. But a few moments later, after talking about the acquisition of Electronic Data Systems closing by the end of this month, Hurd said that not every product line was firing on all cylinders. "As is the case with any quarter, some areas were strong and others show where we have some work to do," he explained.

One of the relatively strong areas was the Enterprise Storage and Servers group, which sells IT gear into the data centers and data closets of the world and which had sales of $4.7 billion in fiscal Q3, up 5 percent as reported (and presumably more or less flat at constant currency). Cathie Lesjak, HP's chief financial officer, said in the conference call that sales within Industry Standard Servers unit did better than in Q2, when sales were flat, with revenues up 2 percent against a 13 percent increase in shipments; significantly, HP shipped its 1 millionth Blade System blade server in the quarter. (ProLiant rack and tower servers still account for the bulk of ISS sales, however.) If you do the math, ISS had sales of just under $2.9 billion in the quarter.

The big revenue grower in the quarter was the Blade System machines, which had a 66 percent revenue growth and 58 percent shipment growth. (ProLiant-branded blades had sales growth of only 58 percent in the quarter.) Sales in the Business Critical Systems unit of ESS, which makes and sells Itanium-based Integrity servers as well as legacy HP 9000, AlphaServer, and NonStop systems, rose by 2 percent as well, to just under $829 million. Integrity servers accounted for 78 percent of this, or about $647 million, up 18 percent compared to the third quarter of fiscal 2007. The StorageWorks disk and tape storage unit had growth of 16 percent in the quarter, to just over $1 billion. Lesjak said that midrange EVA disk arrays and low-end MSA arrays both had 19 percent revenue growth in the quarter. The overall ESS group had an operating profit of $544 million in the quarter, up 7.3 percent. This is as solid a result for ESS as HP can expect, especially considering there is no dot-com boom underway, no matter how many time vendors chant "Web 2.0, Web 2.0, Web 2.0."

The Personal Systems Group, which seemed to be a boat anchor around HP's neck a few years back, had a great quarter as companies and consumers alike make the switch to laptops. Revenue was up 15 percent to $10.3 billion, with 20 percent unit shipment growth. Notebook shipments rose by 37 percent in the quarter, and drove 26 percent revenue growth to $5.35 billion for this segment in Q3. Even desktop sales rose by 6 percent to $4.16 billion. Commercial PC sales (including desktops, laptops, and workstations) rose by 15 percent and consumer PC sales rose by 17 percent. Significantly, PSG had an operating profit of $587 million, up 13.1 percent. And it is important to note that HP has been keeping sales and profits more or less in line with PCs--a difficult task--and also to see that it takes roughly twice as much PC dollars to bring the same operating profit as ESS can do with servers and storage. This is an inherently low-profit business, as most volume electronics eventually become.

The somewhat related Imaging and Printing Group, which is the big profit engine for HP, had a weaker 3 percent revenue bump to $7 billion in the quarter, with supply sales up 11 percent to $4.55 billion and commercial hardware sales down 5 percent to $1.57 billion and consumer hardware sales down 14 percent to $861 million. HP said that it shipped 13 million printers in the quarter, a 2 percent decline. That said, operating profits for IPG came to $1 billion, up 1.9 percent. Hurd said in the call that HP consciously walked away from some deals in printers to preserve its profits.

HP Services, which is about to double in size once the EDS deal is done, had sales of $4.8 billion, up 14 percent, and an operating profit of $574 million, up 37.6 percent. Unfortunately for HP shareholders, EDS is nowhere near this profitable, and until HP wrestles EDS into its organization and makes it hum, profits for HP Services are going to take some hits. But, then again, the same thing happened with the server business when HP ate Compaq, so Wall Street will probably be a little more patient this time around. The HP Software unit, which has grown through acquisitions, had growth of 29 percent to $781 million and an operating profit of $122 million, up by a factor of 2.4 compared to the year ago quarter. The Financial Services arm of HP had revenues of $680 million, up 17 percent, with an operating profit of $51 million; this part of HP has $8.7 billion of assets under lease at the moment, up 13 percent.

On a geographical basis, sales in the Americas region for HP rose by 4 percent in fiscal Q3 to $11.6 billion. Sales in EMEA rose by 16 percent (as reported back in Palo Alto in U.S. dollars) to $11.2 billion, with Asia/Pacific sales up 14 percent (again, as reported) to $5.2 billion. Taking out currency effects, sales in the Americas rose by 3 percent, in EMEA rose by 5 percent, and in AP rose by 8 percent. Interestingly, sales in Brazil, Russia, India, and China collectively grew sales by 24 percent (as reported) and accounted for 10 percent of HP's total sales in the quarter. Some 68 percent of HP's sales came from outside the United States in the quarter, which obviously has helped a lot, financially speaking.

Looking ahead into the final quarter of fiscal 2008, Lesjak said that revenue was expected to come into a very tight range of $30.2 billion to $30.3 billion, with earnings per share in the range of 95 cents to 97 cents.

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