HP, Bolstered by Weak Dollar, Beats the Street in Q2

by Timothy Prickett Morgan

Hewlett-Packard, like other major U.S.-based IT players with a large international customer base, said this week that a slightly improving spending environment, a weak dollar, and relatively strong foreign currency helped it show decent growth for revenues and profits in its most recent quarter. And it didn't hurt that HP is again chasing market share against its competitors, now that its customers are no longer sorting out the merger with Compaq last year.

For the second fiscal quarter ended April 30, HP reported sales of $20.1 billion, up 12 percent compared with the prior year. HP's chairman and CEO, Carly Fiorina, said that the company had double-digit revenue growth in every product segment except servers and storage, which experienced only an 8 percent revenue bump. After HP reimbursed the Canadian government $105 million for a disputed contract for goods and services that the Canadians said were never delivered, HP booked a profit of $1.1 billion in the quarter, up 77 percent compared with this time last year. (Fiorina said in a conference call with Wall Street analysts yesterday that HP intends to pursue the partners that did fulfill the contracts and get that money back in the courts.) Earnings per share were shaved by 2 cents because of this matter, with the company bringing in 29 cents per share after the settlement. That is still a 32 percent growth in per share earnings, which has to be making HP pretty happy.

But, as always, HP is balancing its optimism about its prospects with the realities of this difficult IT market. "Customers are very focused on value and on fast return on investment," said Fiorina. "Pricing remains very competitive." She said that HP would continue to focus on its "high-tech, low-cost, best customer experience" strategy in competing with Dell in the PC market and the low end of the server and storage businesses and with IBM across the IT spectrum. "We're gaining ground, despite the competitive rhetoric," declared Fiorina. Both IBM and Dell have been saying for the better part of a year that HP would be crushed between Dell's direct model and IBM's vast customer base and services orientation. Fiorina said that HP has been using pricing as a way to drive market share gains, and Bob Wayman, HP's chief financial officer, said that, as customers are shifting toward standard, low-cost components, he expects HP will continue to see pressure on profits. Like other IT hardware makers, HP is counting on having higher attach rates on servers, storage, and PCs, for other items like peripherals and services, in order to drive sales and profits. This is how HP plans to grow in an enterprise IT market that it skeptically has said will only grow by 1 to 2 percent this year, despite the better numbers consultancies and analysts are predicting.

HP said that the Technology Solutions Group, which was formed on May 1 and includes servers, storage, software, and services, accounted for $7.7 billion in sales in the quarter, up 11 percent, and posted an operating profit of $400 million, up $108 million from the second quarter of last year (if TSG had existed). The Enterprise Storage and Servers unit within TSG accounted for $4 billion in sales during the quarter, up 8 percent as reported, driven by a 15 percent uptick in ProLiant server sales. ProLiant volumes were up 32 percent in the quarter, according to Fiorina, who said that March and April set new record shipment levels for the company, and that blade server sales were double that of the second quarter last year. However, the product mix across the server lines is toward lower-cost servers and storage across all architectures, and combined with the deterioration in AlphaServer sales, it has been difficult for HP to grow overall server sales. (Think of the position HP would be in right now if it had not acquired Compaq.) She said that Itanium-based Integrity servers comprised 16 percent of sales and 26 percent of shipments in the Business Critical Systems unit, which includes HP 9000 and Superdome PA-RISC systems, AlphaServers, and Tandem NonStop systems. Fiorina said that Superdome orders and shipments set another record level, but, as always, she declined to be specific.

HP's Personal Systems Group booked sales of $6 billion, up 17 percent, with notebook sales growing by 26 percent and desktop sales growing by 14 percent. Fiorina said this is the third quarter in a row that HP beat the growth rate of archrival Dell. This unit had an operating profit of a mere $45 million, although it was up from $23 million this time last year. The Imaging and Printing Group had $6.1 billion in sales, up 11 percent, driven by a shift to color printing and related expensive consumables, particularly because color laser printing is now taking off. As always, the Imaging and Printing Group accounted for the bulk of HP's profits, with an operating profit of $953 million in the quarter. HP Services grew 15 percent, to $3.5 billion, and reported an operating profit of $329 million. The managed services business inside HP Services grew by 50 percent, while revenues related to customer support grew by 9 percent, and revenues for consulting/integration services grew by 8 percent. HP Financial Services had a 6 percent boost, to $469 million, and, like other captive IT financing organizations, is having trouble growing its contributions to the top and bottom line as customers shift to cheaper IT gear. Operating profit for HP Financial Services was $35 million, nearly double that of last year's second quarter.

Wayman said that HP generated $2.6 billion in cash, after paying $164 million in restructuring costs, and that it finished the quarter with $15.1 billion in cash. He added that HP was looking at ways to invest that money to maximize its return on investment. Although conditions are not great, Wayman said that HP would raise its second-half target revenue range to between $39.7 billion and $40.7 billion. The current street consensus estimate for HP for the second half of 2004 is $39.7 billion.