August 17, 2000 3:00 PM PDT

Hewlett-Packard shares skid despite strong sales

Hewlett-Packard saw its shares slip today despite exceeding analysts' estimates with its report of a rosy quarter fueled by strong PC and software sales.

In conjunction with third-quarter earnings results, the computing giant also declared a 2-for-1 stock split after yesterday's market close.

HP reported earnings


Gartner analyst Paul McGuckin says a close look at Hewlett-Packard's numbers reveals a key weakness in its sales of high-end Unix servers.

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of 97 cents a share, or approximately $1 billion, from continuing operations, excluding extraordinary events and gains, for the third fiscal quarter. This was an increase of 37 percent over comparative earnings per share of 71 cents from the same period a year ago.

At the close of regular trading today, the company's shares were down $12.88, or 11 percent, to $108.

The uneasiness stems from the quality of HP's earnings surprise. At 97 cents a share, HP handily beat analysts' expectations of 85 cents a share. However, some of the surprise gains came from international currency conversions and cost-cutting.

HP also missed its overall revenue projections and revenue expectations for the Unix market, said Kurt King, an analyst with Banc of America Securities. At its analysts meeting on May 31, HP told analysts revenue would grow 15 percent, while Unix revenue would grow 26 percent. Instead, revenue grew 14.52 percent, while Unix sales only grew about half that.

"They were a little bit light on revenue and way light on Unix revenue," he said. "There were a lot of good things in the quarter, (but) that is a revenue miss."

Including investment gains, earnings per share came to 99 cents for the quarter, which ended July 31. Income from discontinued operations brought total earnings to $1.01 billion.

Revenue came to $11.8 billion for the third fiscal quarter, which ended July 31, a 15 percent rise over revenue of $10.3 billion for the same period a year ago. Analysts expected the company to report earnings of 85 cents per share, not including income from outside investments.

The numbers mark the eighth consecutive time HP has beat estimates. The results also put an upbeat note on CEO Carly Fiorina's first fiscal year at HP. Fiorina left Lucent to join HP last July at the end of the third fiscal quarter and has effectively run the company for four full quarters.

"What you are seeing is very focused expense management, improved margins and very targeted product marketing," Fiorina said in a conference call with analysts. "Any way you slice it, we beat estimates by a wide margin."

Carly Fiorina The financial figures released yesterday come from overall revenue growth combined with other factors. Among the highlights, software revenue grew 57 percent, while notebook sales went up 93 percent. Unix server sales grew by 15 percent. However, HP also saw the average selling price (ASP) of mid-range Unix servers rise 27 percent.

"Our (mid-range server) ASPs are the highest in the industry," Fiorina said.

At the same time, the company is phasing out low-margin businesses. HP sold its interest in a joint venture with Ericsson, for instance. "We will continue to divest non-strategic businesses," Fiorina said.

Last year, HP reported revenue of $12.2 billion and operating income of 85 cents a share. The figures, however, included sales from Agilent, the test and measurement unit that was spun off last summer.

Without the Agilent spinoff and some other extraordinary charges, earnings for the third quarter of fiscal 1999 came to 71 cents a share. Last quarter, HP reported earnings of $899 million, or 87 cents a share, on revenue of $12.03 billion.

HP has seen its fortunes grow in the computer industry in the past year. For the past few quarters, the company has been the fastest-growing major PC company. Last quarter, HP saw shipments grow 44 percent in the United States, nearly four times the market as a whole, and 34 percent worldwide, or nearly twice as fast as the overall market, according to Dataquest.

The company has also seen a revitalization in the past few quarters for its Unix server business, a profitable market fought over by Sun Microsystems, IBM, Compaq and HP, although HP missed its Unix numbers this quarter.

During the quarter, HP came out with a new version of HP-UX, its Unix operating system, and snagged a major contract to supply Amazon with equipment for its Web site. While corporate buying overall was seasonally slow, HP was able to sustain the momentum from its recent gains, said Amir Ahari, an analyst at US Bancorp Piper Jaffray.

"They've been really ramping up with Oracle and tightening the screws on Sun," Ahari said. "Carly has done what she can to align the company."

On the other hand, HP, like the rest of the industry, is seeing intense competition erode margins. A substantial portion of HP's growth in computer sales was in retail, which is often characterized by thin margins.

Analysts are divided about the future of the PC industry as well. Some, such as Charles Smulders, an analyst at Dataquest, have stated recently that the PC market is becoming saturated and that growth could begin to slow. Volume shipments are down from 1999. And a week ago, Dell Computer disappointed investors by posting lower-than-expected sales.

Other analysts, meanwhile, believe the industry is only going through one of its seasonal dips and will accelerate with the adoption of Windows 2000.

Bob Wayman, HP's chief financial officer, said PC prices could slide during the next three months because of bargain hunting during the back-to-school season. Nonetheless, the company is optimistic about the long term.

"(PC margins) are still below where we think they can be," he said. "We are experiencing over time improved profits in our computer business."

In all, HP is expected to report annual revenue growth for its fiscal year, which ends in October, of 15 percent, Wayman added.

 

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