Heads Will Roll At HP Over Declining Server and Storage Sales
by Timothy Prickett Morgan
It is a fair guess that Hewlett-Packard's chairman and CEO, Carly Fiorina, is not happy this morning, as the company felt compelled to pre-announce its fiscal third quarter financial results. HP, like other companies, pre-annnounces financials when things are going better or worse than Wall Street expects, allowing them to take their kudos or lumps in installments rather than all at once on the day the financial results actually come out. HP is going to get a lot of lumps today, because it missed its targets.
Before the market opened this morning, HP announced that overall sales in its fiscal third quarter ended July 31 were $18.9 billion, up 9 percent, and net earnings were $586 million, up 90 percent. In this IT market, those percent changes don't sound that bad. So what is Wall Street so upset about that it sent HP's shares down 17 percent in early morning trading on Thursday? For one thing, HP booked $20.1 billion in sales in the fiscal second quarter and had $884 million in net profits, which worked out to earnings of $.29 a share. For another thing, depending on who you ask, Wall Street was expecting something closer to $.31 a share in the fiscal third quarter, not the $.19 that the company expects to book when it posts its official results next Wednesday.
According to the statement HP released, the culprit was its Enterprise Servers and Storage unit, which had caused the company to miss its revenue and earnings targets in the fiscal third quarter of 2003 as well. Back then, HP was shy a few hundred million dollars in sales and a few pennies per share of profit, and Wall Street didn't react kindly then, either. HP's Technology Solutions Group, the umbrella organization that sells servers, storage, services, and software, will report sales of $7 billion in the fiscal third quarter, up 4 percent from this time last year. However, operating profit for this unit, which accounts for a third of HP's sales, was $56 million, down 79 percent from the $265 million in operating profits it posted in last year's also-poor showing in the third quarter of fiscal 2003. Within the Enterprise Servers and Storage division, sales were actually down 5 percent, to $3.4 billion. Sales of ProLiant X86 servers were up only 2 percent, and sales in the Business Critical Servers unit, which peddles AlphaServer, HP 9000, Integrity, and NonStop servers, were off 8 percent, to $828 million. Unix server sales (that's both PA-RISC HP 9000s and Itanium Integrity machines) were up 8 percent in the quarter, but sales of AlphaServer systems were down 32 percent and NonStop sales were off 25 percent. On the storage front, HP also had problems. HP said that total storage sales in the third fiscal quarter were down 15 percent, to $709 million. HP's disk array sales (what HP calls online storage) were off 23 percent, and nearline storage (including tape and optical technologies) saw sales drop by a less severe 16 percent. After boasting that the Enterprise Servers and Storage unit was profitable in the fiscal second quarter, the unit is back in the red, reporting an operating loss of $208 million, considerably worse than the $20 million operating loss in last year's third quarter.
So heads will roll inside HP. Fiorina said as much in her statement accompanying the preliminary results for the quarter. "Although we are satisfied with our performance in Personal Systems, Imaging and Printing, and Software and Services, these solid results were overshadowed by unacceptable execution in Enterprise Servers and Storage," she said. "We therefore are making immediate management changes. We are also accelerating our margin improvement plans in this business. With these changes, we expect our server and storage business to return to profitability in the fourth quarter." That sounds like a threat as well as a promise.
While the miss in the third quarter was bad, Wall Street seemed to be upset by the fact that the company lowered its earnings targets for the fiscal fourth quarter. HP estimates that sales in the fourth quarter will be in the range of $21 billion to $21.5 billion, and non-GAAP earnings per share will be in the range of $.35 to $.39. The way things work, the GAAP numbers will be smaller--perhaps a little, perhaps a lot. HP said that it knows there will be at least five cents in charges related to acquisitions and the amortization of intangible assets in the quarter.
HP said that the fiscal third quarter was adversely affected by the migration to a new order processing system in the United States and that this disrupted its supply chain system. The company also said that in Europe, the channel was giving it woes concerning compensation, "overly aggressive discounting," and the transition to a new channel claim processing system. HP also said point-blank that the storage business had sales that were "significantly below" the company's forecasts, and that finally the normal uptick in sales at the end of the quarter "was muted." It may have been muted, in fact, by issues with the channel.
HP said that other business units did decently in the quarter. Software sales were up 17 percent in the quarter, to $223 million, but the unit reported an operating loss of $45 million. HP Services posted sales of $3.5 billion, up 12 percent, with managed services up 42 percent, customer support services up 7 percent, and consulting and integration services up 6 percent. This unit's profits were under pressure as well, though, with an operating profit of $309 million, down 8 percent. HP's Personal Systems unit had sales of $5.9 billion, up 19 percent, with desktop sales up 26 percent and laptop sales up 12 percent. Sales to consumers and commercial customers were both strong, with 20 percent and 19 percent growth respectively. The PC unit had an operating profit of $25 million, much better than the $56 million operating loss it had this time last year. The Financial Services unit booked $488 million in sales, up 10 percent, with an operating profit of $42 million. Finally (and thankfully, for HP), the Imaging and Printing unit that anchors the company had sales of $5.6 billion, up 8 percent, and an operating profit of $837 million, up nearly 15 percent.