By Susan Kelly of Raine Consulting August 28, 2003 - Hewlett Packard (NYSE: HPQ) Palo Alto, CA announced third quarter revenues that totaled $17.35 billion, compared to $16.54 billion in the prior year period. Revenues increased 5% year-over-year, but declined 4% sequentially reflecting business seasonality. Non-GAAP operating profit totaled $858 million for the quarter, up 61% year-over-year, and down 25% sequentially. Non-GAAP operating profit was 4.9% of revenue, up from 3.2% of revenue in the prior year period, and down from 6.4% in the second quarter. GAAP operating profit for the quarter was $301 million, or 1.7% of revenue, up from a loss of 15% of revenue in the prior year period and down from 3.6% sequentially. GAAP diluted EPS was $0.10 per share. Topics of this summary: * Chairman Comments * Business Segment Results * Financial Overview * Outlook * Q & A Chairman Comments “The third quarter is always tough, but we still should have done better," said Ms. Carly Fiorina, HP Chairman and Chief Executive Officer. "Nevertheless, we are confident in our strategy and the actions we're taking. We expect to deliver a strong fourth quarter with every one of our businesses profitable. Imaging and Printing had a good quarter with revenue growth of 10% year-over-year, outpacing competitors. As planned, profit returned to more normal levels, with expenses up 20% year-over-year as we continued to invest in R&D, product rollovers and marketing to extend our leadership in this business. Our recent consumer launch of 158 digital imaging and entertainment products has been extremely well received.” IPG makes up 30% of HP’s total business worldwide. Business Segment Results * Imaging and Printing revenues totaled $5.24 billion in the quarter, an increase of 10% year-over-year, and down 5% sequentially, in line with normal seasonality. Supplies revenue growth continued to outpace competitors with revenues up 16% over the prior year period. Digital imaging revenue grew 16% year-over-year. Business printing hardware increased 6%, while home hardware declined 7%. Imaging and Printing revenue share continued to grow faster than market in all regions, strengthening HP's leadership position in key categories around the world. Operating profit was $739 million, or 14.1% of revenue, returning to more normal levels compared to 17.9% in the prior year and 16.6% last quarter. Operating profit declined as a result of top line seasonality, product transition costs, and increased marketing and sales investments to further extend HP's market leadership. * Enterprise Systems revenue was $3.71 billion, essentially flat year-over-year, and down 4% sequentially. Operating losses for the quarter grew to $70 million, up from a loss of $7 million in the prior quarter, but an improvement of $252 million over the prior year period. * Personal Systems revenue totaled $4.97 billion in the quarter, up 5% year-over-year, and down 3% sequentially. Personal Systems reported an operating loss of $56 million in the quarter, compared to a loss of $140 million in the prior year period and a profit of $21 million in the prior quarter. * HP Services revenue was $3.08 billion, up 5% year-over-year and 2% sequentially. Revenue in consulting and integration was down 15% year-over-year due to project deferrals and continued overcapacity in the consulting market. HP Services posted an operating profit of $337 million, or 10.9% of revenue Financial Overview * HP exited the quarter with $13.4 billion in gross cash, which includes cash and cash equivalents of $12.9 billion and short- and certain long-term investments of $500 million. * Cash generated from operations for the quarter was $468 million after approximately $400 million in restructuring charges, nearly $300 million in retention payments, $260 million in first-half performance and sales bonuses, and $265 million in retirement funding during the quarter. * Inventory ended the quarter at $6.1 billion, a sequential increase of $399 million, reflecting normal build-up in advance of the back-to-school selling season. * Trade receivables decreased $271 million from the prior quarter to $7.6 billion. * HP's dividend payment of $0.08 per share in the third quarter resulted in a cash use of $244 million. In addition, HP repurchased $203 million of stock. * Workforce restructuring charge of $376 million was taken in Q3 for 4,800 people; 1,300 more than forecasted last quarter. * In Q3, 3,100 employees were terminated. HP continues to utilize offshore resources for IT, transaction processing, call center, and support delivery costs. (Note: more than 8,000 people in India alone) Outlook For the fourth fiscal quarter 2003, HP estimates revenues will grow between 8% and 10% sequentially or $18.8 billion to $19.1 billion with non-GAAP EPS of $0.34 to $0.36, which assumes after-tax exclusion for charges in the fourth quarter totaling approximately $0.05 to $0.07 per share from amortization of purchased intangible assets, restructuring, and acquisition-related charges. Q & A 1. Analysts grilled HP executives repeatedly about the gross margins for the IPG group. Analysts believe that expenses were not a surprise and were anticipated. IPG expenses were up 20% because of R&D and IP Protection costs which will continue in Q4. Some of the product roll-out costs and marketing expenses will decline in Q4 however HP will be launching a $300 million consumer marketing campaign in October. One analyst cited recent HP executive comments about Big Bang 3 program as a process which makes marketing events a yearly event. Analysts wanted to know how IPG gross margins will look in the future. Carly Fiorina jumped in to confirm that Big Bang is an ongoing opportunity to introduce new products to the consumer market. The CFO, maintains that future investments will not be as large as the current program. 2. The EPS miss was approximately $200 million which was largely attributable to gross margins and aggressive desktop pricing. Pricing actions are being taken and in retail there is a lag of 3-4 weeks because of channel sales but impacts are more immediate in direct sales. 3. Analysts wanted more details about laser toner revenues as compared to ink sales. It was reported by analysts that Canon had a great quarter yet there was consternation about their Q4 guidance since they are 10 points lower than HP. HP doesn’t believe those forecasts and they are seeing a continued shift to color in laser toner and do not see a drop off coming soon. 4. The Chairman commented about the balance between margins versus market share. “We grew our consumer notebooks and took four pricing actions to get that growth. But we need to do it in a profitable way. Our objective is not to claim bragging rights quarter after quarter, we need to go after profitable growth and concentrate in the most profitable segments.” 5. Compaq restructuring charges continue and HP expects them to continue into Q4 but are not expecting any in 2004. All businesses will be profitable throughout each quarter in 2004. 6. The US market is stabilized with no rapid upturn in IT spend expected. The chairman speculates that IT spend will lag the overall economy but clearly it’s stabilizing. The same goes for the rest of the world except for Europe. 7. There was no channel fill for IPG big bang program in the last quarter. HP discounted older products earlier in the season to make room for big bang products in July. 8. HP’s acquisitions focus is on software, particularly managed services and applications development. HP is not interested in an EDS, such as backward cost structures, or internal integration issues, and consulting continues to be characterized as a space that is overcapacity with too much high priced talent. 9. HP is expecting another 2,200 workforce reduction in Q4 from Enterprise Services and Consulting…none from IPG.