Volume 3, Number 6 -- February 16, 2006

HP's Restructurings Start to Pay Off in Profits in Q1

Published: February 16, 2006

by Timothy Prickett Morgan

It is safe to say that Hewlett-Packard has had more than its share of drama in the IT market in the past five years, and if the first fiscal quarter ended January 31 is any measure, HP is going back to being a little more boring and steady--and making a little more money, too. This is a trade-off that HP was not only willing to make, but made on purpose when it ousted Carly Fiorina and replaced her with Mark Hurd last year.

While Hurd has been careful to say that a lot of the changes that are taking effect in stabilizing HP's revenues and profits in the many areas where the company makes its living were well under way before he got the job of running the company (but not the board of directors), the fact remains is that he is perceived of as being a balanced, analytical, IT-savvy executive and he has had a calming influence on HP, much as Louis Gerstner did when he came into an IBM that was in much worse shape over a decade ago as its top gun. Whatever the cause, the effect is undeniable: HP is more focused, balanced, and predictable, which is something that Wall Street likes and which customers probably do, too.

In the quarter, HP was able to bring in $22.7 billion in sales, up 6 percent as reported and up 8 percent in the local currencies where HP does business (so-called constant currency, a habit of speaking that HP is picking up from rival IBM so it can differentiate between currency effects and real growth). Net income for the quarter was $1.2 billion, up 30 percent compared to last year's first fiscal quarter. Earnings per share came to 42 cents, up 31 percent from the year-ago quarter.

HP's chief financial officer, Bob Wayman, who is reportedly fixing to retire soon after a 37-year career at HP--with 22 of those years as CFO--said in a conference call with Wall Street analysts after the market closed that the quarter came in more or less as HP expected, adding that some business units did a little bit better than HP anticipated.

But the news was not all good, as it can never be in an IT behemoth like HP. While HP's Personal Systems Group and Imaging and Print Group each had decent sales growth and showed improved operating profits, Enterprise Storage and Servers had softer growth (but increased operating profits) and its HP Services unit actually posted a revenue decline and relatively flat operating profits.

HP said that the Personal Systems Group had sales of $7.4 billion, up 8 percent, with overall PC unit shipments up 16 percent in the quarter. Desktop sales were up 1 percent with units up 9 percent and notebook sales were strong with 26 percent revenue growth and 47 percent unit growth. Sales to consumers grew 18 percent (yes, we are all apparently buying notebooks), while sales to companies grew only 6 percent. The operating profit of PSG nearly doubled to $293 million.

HP's anchor Imaging and Printing Group continues in that role, and Wayman said that both laser and inkjet supplies were up a little more than expected. IPG had sales of $6.5 billion, up 8 percent, with consumer hardware sales only up 1 percent. Sales of all-in-one devices, which combine printers, scanners, and fax machines into a single box, grew by 20 percent. On the commercial side of printing, Wayman said that color laser printer shipments rose by 36 percent and multi-function printers grew units by 40 percent. And even though supplies, which are almost entirely profit, rose by 11 percent, HP was nonetheless only able to bring in $973 million in operating profit in this unit, up 4 percent from the prior year's fiscal first quarter. Considering all of the pressure that Lexmark, Dell, and others are bringing to bear on the HP printing business and the number of product transitions underway, any operating profit growth at IPG is probably a cause for jubilation at HP.

In the Enterprise Storage and Servers group, HP booked $4.2 billion in sales, an increase of 5 percent as reported, lead as always by its Industry Standard Servers unit, which peddles ProLiant rack and tower servers and BladeSystem blade servers based on Intel Xeon and AMD Opteron processors. The ISS unit booked $2.48 billion in sales, giving it 6 percent revenue growth in the quarter, with blade server sales up 58 percent. In the Business Critical Server unit, sales were up only 1 percent to $882 million, with sales of HP-UX servers using PA-RISC or Itanium processors being up only 2 percent. HP said that sales of Itanium-based Integrity machines--which can run HP-UX, Windows, Linux, OpenVMS, or the NonStop Unix variants--were up 94 percent, and that Integrity machines accounting for 30 percent of the BCS unit's sales in the quarter, or about $265 million. On the storage front, HP pushed about $840 million in storage arrays and software, only a 4 percent growth from last year. And considering that midrange EVA array sales were up 28 percent and high-end XP arrays were up 14 percent, that means some small products (like those used with the ProLiants) must have not fared so well. The good news as far as HP is concerned is that even with less revenue growth than the two larger PSG and IPG parts of its business, the ESS part was able to bring in an operating profit of $326 million, nearly a factor of five better than it pulled this time last year.

HP's services unit had a 2 percent decline, but HO said that at constant currency sales were actually up 3 percent. The company's technology services business declined by 2 percent to $2.36 billion, managed services was down 1 percent to $760 million, and consulting and integration was down 1 percent to $684 million. Operating profits were $293 million, up a smidgen from the same quarter last year. HP Financial Services, which is still a separate unit, saw sales decline by 11 percent to $496 million, with HP's financing volume down 10 percent and its portfolio losing 2 percent of its asset value. Operating profits shrank by 16 percent to $38 million. Finally, HP's fledgling software unit, which has seen some significant (but not huge) acquisitions in the past several quarters, had sales of $304 million, up 29 percent. HP's OpenView system management software sales rose by 34 percent and its OpenCall call center software rose by 19 percent. The software unit had an operating profit of $9 million.

In describing the quarter, Hurd said much as he did the last time he hosted such a call 13 weeks ago. "There is a lot of opportunity, but we've got a lot of work to do," he said, specifically talking about wringing costs and therefore profits out of the HP machine. "We're roughly on track with out restructuring, and we've said before that it would be a six-quarter process." Last summer, HP said it would layoff approximately 14,500 workers around the world to get its costs in line with revenue expectations. Hurd told Wall Street that HP's model going forward was to get 4 to 6 percent revenue growth annually and increase operating margins by 6 to 8 percent.

Looking ahead, Wayman said that he expected HP to post sales of $22.4 billion to $22.6 billion in its fiscal second quarter and somewhere between $90 billion and $91 billion in sales for all of fiscal 2006, which ends in October. That's a pretty tight range, and considering that this is the second quarter that HP has raised estimates--and therefore Wall Street's consensus on its possible future sales and earnings--it would seem that HP has a pretty good handle on where it is and where it is going. Wayman warned everyone that the third quarter is always a tough one because of the summer holiday season, and Hurd told Wall Street not to count all of the layoff savings dropping right to the bottom line. HP has plans to reinvest some of those savings in hiring and training new people and better chasing markets. "You don't spend a lot of money to a develop a product to then underparticipate," explained Hurd.

When asked for how the IT market feels right now, Hurd got a laugh. "I get a kick out of it when people ask me if there is anything that stood out in the quarter," he said. "I can't remember a time when it wasn't aggressive. I think the pricing in the market is aggressive and I expect it to continue to be." That's just the modern IT business, and HP is reconciled to that.

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Editor: Timothy Prickett Morgan
Contributing Editors: Dan Burger, Joe Hertvik,
Shannon O'Donnell, Timothy Prickett Morgan
Publisher and Advertising Director: Jenny Thomas
Advertising Sales Representative: Kim Reed
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