HP's Q4 Sales Grow, Profits Hit by Restructuring

by Timothy Prickett Morgan

Hewlett-Packard reported its fourth quarter and year-end fiscal 2005 financial results after we went to press in the last issue, and the numbers were more or less in line with the expectation that the company would see decent revenue growth, but would see its bottom line in the quarter impacted by restructurings announced earlier in the year. HP pushed $22.9 billion in various wares and services in the quarter, up 7 percent year-over-year, but net earnings were down 62 percent to $416 million due to nearly $1.6 billion in restructuring charges.

Mark Hurd, HP's relatively new president and CEO, said that the company's revenue growth was driven by some refreshed product lines and momentum in key segments, and added that margins were impacted by price competition, employee bonuses, and the accounting of stock-related compensation. "The employees at HP have been working hard and their efforts are paying off," explained Hurd in a conference call with Wall Street analysts. Both Hurd and Bob Wayman, HP's chief financial officer, reminded everyone that this is HP's fourth quarter, which is usually its strongest one, and that extrapolating some of the profitability levels HP attained in its fiscal fourth quarter will not necessarily follow through to the first quarter of fiscal 2006. He also justified the fact that HP is paying bonuses even as it is laying off employees. "There hasn't been a bonus here for quite a while, and the fact that there is a bonus at all it is good for morale," said Hurd. "We will continue indexing bonuses based on performance," he said, saying that it was his hope that in the coming quarters he would be saying the same thing again. HP would not quantify the hit profits took because of bonuses.

While HP's Imaging and Printing Group was once again the main engine for HP's sales and profits, this time around the Enterprise Storage and Servers group was a big contributor too. And HP's Personal Systems Group--which has been hammered by Dell in the past few years--also saw a balance of revenue growth and a return to more solid profitability.

The printer unit posted higher sales than this time last year, with $6.8 billion in products sold, up 5 percent, but operating profits fell 18 percent to $896 million. The printer business is not an easy one, and more aggressive moves by Dell in this area as well as more aggressive pricing by HP to protect is market share against incursions from others such as Lexmark, definitely has an effect on HP's margins in this area. HP said that total printer unit shipments were up 8 percent, with consumer printer shipments up 6 percent and commercial printer shipments up 16 percent. Color LaserJet sales were up 41 percent and enterprise multifunction printers rose by 83 percent. Printer supply sales, undoubtedly bolstered by color InkJet and LaserJet supplies, were up a more modest 7 percent. Supplies accounted for 56 percent, or $3.8 billion, during the quarter. This is HP's profit engine, just as much as IBM's mainframe software is Big Blue's profit salvation quarter after quarter. The trouble is, corporations are a lot more addicted to mainframe software, which has no practical substitute, than they are to HP's printers, which can be more easily replaced with alternatives.

The Enterprise Storage and Server group, which was supposed to be a profit engine following the Compaq acquisition, has been problematic for years, but not so much in this quarter. Sales were up 10 percent to $4.5 billion, and the unit showed an operating profit of $405 million, over four times the level HP had this time last year when it had but $4.1 billion in server and storage sales. Sales in the Industry Standard Server unit within ESS were up 12 percent, and blade server sales were up 65 percent. The ISS unit creates and sales servers based on Pentium, Xeon, and Opteron processors, and this unit accounted for 56 percent of sales in the quarter, or just over $2.5 billion. The Business Critical Servers unit, which accounted for 23 percent of ESS sales, or just over $1 billion, saw its revenues drop 1 percent in the quarter. HP did not provide a lot of detail on what is going on here, but the BCS unit is where the sunsetted HP 3000 and AlphaServer hardware and Tru64 Unix software platform all reside, as well as the new Integrity Itanium-based machines, PA-RISC boxes, and NonStop fault tolerant servers. The AlphaServer's OpenVMS operating system and the NonStop platform have been ported to the Integrity line, as HP-UX was long ago, but HP is still not growing Integrity business as fast as it is losing legacy platform business, and that is why BCS is falling. HP said that Integrity server sales were up 70 percent in the quarter, and now account for 25 percent of the BCS unit's sales. That's about $260 million in sales. When HP is selling four times this amount, the transition will be over. On the storage front, the Network Storage Systems unit posted revenues of about $950 million, up 17 percent, with midrange EVA storage arrays showing growth of 44 percent and high-end XP arrays having growth of 32 percent. HP has recently refreshed its midrange and high-end disk arrays as well as bolstered its storage sales force (after foolishly weakening it a few years ago), and is now seeing the fruits of its labor.

While IBM has ditched its PC business and Dell is having some difficulties, HP is getting its PC house in relative order, at least compared to past quarters. Sales in the Personal Systems Group climbed 9 percent to $7.1 billion in the fourth quarter, with an operating profit of $200 million. Total PC shipments were up 13 percent in the quarter, with consumer notebooks up 48 percent. Desktop sales were up only 1 percent as shipments rose 9 percent, which shows just how intense the price pressure is. Desktop sales still accounted for 51 percent of all sales in PSG, compared to 39 percent for notebooks and 5 percent for workstations. Notebook revenues were up 23 percent, with unit shipments up 42 percent in the quarter. Sales to consumers rose 14 percent, but sales to companies rose by only 8 percent. It is pretty safe to say that consumer notebook demand is one of the key factors in the rebound at PSG.

In other units, HP's services business also grew 6 percent to $3.9 billion in sales, with an operating profit of $322 million. A little less than two-thirds of HP's services business is for so-called technology services, while the remainder was split between managed services and consulting and integration services. Growth is higher in the two latter units. HP's relatively tiny software business posted $311 million in sales, due mostly to its OpenView system management product, which accounted for 64 percent of software sales. OpenView sales were up 16 percent in the quarter, in fact, helping to offset lower growth with the company's OpenCall call center software and helping to give the software group an operating profit of $27 million--it's first quarterly profit ever, in fact. HP Financial Services had sales of $514 million, up a mere 3 percent, and had an operating profit of $52 million. HP said that its financing volumes were down 1 percent and its asset portfolio dropped 3 percent to $6.9 billion.

Wayman said that it left the quarter with $13.9 billion in cash, which is a tidy sum, and he said further that some 4,700 employees had been laid off and left the company during the quarter. At the end of July, HP said that it would be cutting 14,500 employees from its personnel ranks, dropping it down to around 136,500 when this is finished. Looking ahead to the next quarter and the next fiscal year, Wayman said that HP was expecting sales of between $22.3 billion and $22.6 billion in the first quarter of fiscal 2006, with non-GAAP earnings per share in the range of 46 cents to 48 cents a share (not including 3 cents to 4 cents of stock-based compensation expenses). Based on the euro being worth between $1.25 and $1.35 in fiscal 2006, Wayman said that HP expected sales for the full fiscal 2006 year would be in the range of $89.5 billion to $91 billion, and non-GAAP earnings per share would be in the range of $1.88 and $1.95 per share.