HP beats the street in EPS, has a shortfall in revenue due to weak IT spending, and vows to “stay on the offense while focusing on the things we can control.” By Pat Veverica of Raine Consulting March 3, 2003 -- Hewlett Packard (NYSE: HPQ) the leading global provider of products, technologies, solutions and services announced its First Quarter results after the bell on Tuesday February 25th, 2003. HP beat the street in Earnings per Share (29 cents vs. expected 27 cents per share) but had a shortfall in revenue down 1% sequentially. The company also reaffirmed consensus estimates of $.027 for the second quarter. The company reported first quarter revenue of $17.9 billion, compared to $18.0 billion in the prior quarter. Revenue reflected ongoing weakness in commercial IT spending in the United States and Japan, while Europe and Asia-Pacific posted solid revenue growth quarter over quarter. Topics: - Financial Summary - Chairman Comments - Q&A - Summary Comments Financial Summary: Non-GAAP (formerly reported as pro forma) operating profit totaled $1.1 billion, up 25% sequentially. Non-GAAP operating profit was 6.2% of revenue, up from 4.9% of revenue in the prior quarter. Non-GAAP diluted earnings per share (EPS) for the quarter was 29 cents, compared to 24 cents in the fourth quarter, up 21% sequentially. Non-GAAP diluted EPS and operating profit reflect a $156 million adjustment on an after-tax basis, or 5 cents on a diluted per share basis. The pre-tax adjustment includes $138 million of amortization of purchased intangible assets, and $86 million for other acquisition-related items. GAAP operating profit for the quarter was $879 million, up 107% sequentially. GAAP operating profit was 4.9% of revenue, up from 2.4% in the prior quarter. GAAP diluted EPS was 24 cents per share, versus 13 cents last quarter, representing an improvement of 85% sequentially. Gross margin increased from 25.9% to 26.5%, up 0.6 percentage points sequentially, reflecting continued improvement in HP's cost structures. Integration-related cost savings for the first quarter were $734 million, up from $482 million last quarter and 14% above first-quarter plan. Non-GAAP expenses as a percent of revenue were down sequentially from 21% to 20.3% of net revenue. Chairman Comments: Best Overall Profit Performance since the Merger: Citing good progress on cost structures and market share gains in each of its businesses, HP Chairman and CEO, Carly Fiorina, is confident about the company’s ability to continue to improve gross margins. Revenue Results: HP revenue shortfalls were largely confined to the U.S. market, as weak commercial spending continued. Outside the U.S., revenues improved 3% sequentially with strong performance in Europe and Asia-Pacific. Personal Systems posted a profit for the quarter, and Enterprise Systems improved operating results by 36% sequentially. Specifically, in the Americas, revenue declined 7 percent sequentially because of weakness in the U.S. and Latin America. Canada, on the other hand, reported solid sequential revenue growth. The strongest performance was in Europe, Middle East and Africa, where revenue was up more than 6 percent from the previous quarter. In Asia Pacific excluding Japan, revenue was up 3 percent. Economic weakness in Japan continued to negatively affect the business, with revenue down 6 percent sequentially. Q&A 1. IT Spending Remains Unpredictable: Said Ms. Fiorina: “It is difficult at this point to declare a trend in IT spending for 2003 - up or down. If you look at market surveys you will find they are widely divergent on this point, with estimates ranging from a decline of 5 percent to an increase of 6 percent.” In the Q&A session, HP executives were reluctant to forecast any up tick or analysis of the state of corporate IT spending in the U.S. Ms. Fiorina did observe that the U.S. market is neither deteriorating nor improving. “Today's world is full of uncertainty and predictions are difficult. We're staying focused on what we can control -- maximizing our operating model leverage, delivering the best possible products and services, accelerating market share gains, staying on the offense and investing in growth. Therefore, we're comfortable affirming analyst consensus estimates of $0.27 for the second quarter," says Ms. Fiorina. 2. Continued Sequential Share Gain Across the Businesses: Server shipments and server revenues grew sequentially. HP increased its share of the UNIX market, displacing Sun as the No. 1 UNIX vendor worldwide. Linux server, storage and services also grew. HP personal systems re-gained the No. 1 position in worldwide PC shipments. Imaging and printing were also up. And HP Financial Services was also able to achieve a profit. 3. Cost Savings: One of the big factors in improving profitability is the success HP is having in capturing savings from the integration of HP and Compaq. Of the approximately $250 million in incremental savings achieved during the first quarter, about half came from workforce reductions and the rest from direct and indirect procurement savings, reduced logistics costs, facilities closures and other savings. In the Q& A session, a question was posed as to when/where more workforce reductions would need to take place to achieve targets. The company stated, “We still have not made progress in some major countries in Europe. So, there is significant head count yet to come out (in France and Germany). Said Ms. Fiorina: “The delay in taking our restructuring and head count reductions in France and Germany are because of legal issues and workers council’s requirements. And, in essence, that head count in ESG has not yet come out.” 4. Digital Printing: The company demonstrated further progress in digital publishing despite tough market conditions. Two key business indicators - the active installed base and the total number of printed digital pages - continued to grow quarter on quarter. The total number of printed digital pages from HP Indigo presses was up 11 percent sequentially. 5. New Services Business: Recent managed services wins include a 5-year, $240 million contract with Telecom Italia for helpdesk, onsite services and management of the overall IT environment, and a 5-year agreement to manage DirecTV's 7x24 billing environment in North America. 6. Near-Term Outlook: The economic environment remains challenging. Expect second quarter revenues to be up and a mild improvement in gross revenues. The Company expects continued supply chain improvements to affect gross margins, but anticipates higher Quarter 2 expenses. The expectation of an increase in second-quarter expenses were due to several factors, including the normal seasonal increase tied to shipping computers for the back-to-school season. HP meanwhile is increasing spending on brand identification and on efforts to generate demand. The company in addition is incurring an expense for transferring Compaq employees to the HP retirement plan. Ms. Fiorina said: “From gross margin to expenses to operating margin, (our) performance reinforces my confidence in our ability to continue to improve earnings and shareowner value, even in a revenue-challenged IT environment. If you look at the key trends, you can see how much earnings leverage we have - and you can understand what that will mean as we begin to increase revenues.” Summary: In the Q & A session, Ms. Fiorina observed that, “HP has shown that we can produce earnings growth in good times and bad. We believe that pretty much sums it up.” Following the call, HP share price began to drop in after hours trading and opened lower as analysts and Wall Street weighed in, many citing HP’s reluctance to make positive predictions on the state of IT spending. At the time of this writing, HP shares had dropped 10%, and Goldman Sachs lowered its opinion of HP. This reporter notes that Wall Street is so starved for a positive outlook, that the clarity of a company’s crystal ball outweighs its numbers and performance.