August 12, 2004 11:41 AM PDT

Storage, servers bruise HP earnings

update Hewlett-Packard said Thursday that its third-quarter results improved from a year ago but fell short of analysts' expectations.

The company reported fiscal third-quarter earnings of $586 million, or 19 cents a share, compared with earnings of $297 million, or 10 cents a share, in the year-ago quarter. Excluding the write-off of assets and other acquisition-related charges, the company reported earnings per share of 24 cents, compared with 23 cents a year ago. A consensus of analysts had been expecting 31 cents per share, excluding charges, according to Thomson First Call.

Problems in various business segments have hurt overall results, CEO Carly Fiorina said of the quarter that ended July 31.

"Although we are satisfied with our performance in personal systems, imaging and printing, software and services, these solid results were overshadowed by unacceptable execution in enterprise servers and storage," she said in a statement. "We therefore are making immediate management changes. We are also accelerating our margin improvement plans in this business."

The company wasn't expected to release results until next week.

In May, HP merged its server, storage, software and services businesses into the Technology Solutions Group, which is run by longtime HP executive Ann Livermore. That makes Livermore ultimately responsible for HP's server and storage problems. However, HP replaced three other executives on Thursday afternoon. For instance, Peter Blackmore, head of enterprise sales, is being replaced with Mike Winkler, who is the company's chief marketing officer.

Fiorina pointed to problems with a new order-processing and supply-chain system in the United States, and to issues with channel management in Europe, speaking during a conference call with analysts. Specifically, compensation, overly aggressive discounting and a centralized claims process had been problems overseas.

The order problems in the United States caused HP to miss some sales completely and, in other cases, forced it to expedite orders via air shipment. The problems mainly affected less-expensive servers that are most often based on Intel chips and Windows or Linux. But the issues in both the United States and Europe cut into server revenue and profit. In addition, server inventories rose to higher-than-expected levels.

Fiorina added that the acceleration in server sales the company normally sees toward the end of the quarter was "muted"--a comment that analysts aren't likely to take well. That's because server sales typically reflect on the mood of HP's business customers, and thus shed some light on the state of the economy.

"I think it's fair to say that in the last month or so of the quarter, we did see a slowing. The economy did a bit of a stutter step, I would say," Fiorina said in the conference call. "That is why we did not see the normal acceleration in demand toward the end of the quarter."

The company's enterprise server and storage segment reported total revenue of $3.4 billion, down 5 percent from a year ago. The segment posted a quarterly operating loss of $208 million, compared with a loss of $20 million a year ago.

Products that declined the most in the server business were Alpha servers, where revenue fell 32 percent compared with a year ago, and NonStop servers, where revenue declined 25 percent. Unix server revenue rose 8 percent.

Total storage revenue was $709 million, off 15 percent from a year ago and "significantly below plan," HP said. Online storage fell 23 percent, while "nearline" storage, which includes the tape library business, fell 16 percent year-over-year.

The server problems weighed on HP's Technology Solutions Group, which posted revenue of $7 billion, up 4 percent from the same period a year ago. When combined, HP's server and storage problems accounted for about $400 million in missed revenue and $275 million in missed profit during the quarter, Fiorina said.

The Technology Solutions Group's operating profit fell dramatically, from $209 million in the year-ago quarter to $56 million.

HP had a very poor showing indeed in storage systems, said Jonathan Eunice, an analyst at Illuminata in Nashua, N.H. However, the quarter's results showed more of an internal company problem with execution than a problem with the business market for technology as a whole, he said.

"Storage looked terrible," Eunice said. "That was dismal, especially if you look at who in the market is resurging, including EMC and IBM."

But Eunice was willing to give HP some leeway in servers, noting that it is a "tough business."

"It's like catching the greased pig," he said. "There's an element of luck to it, just as much as there is skill. In this business, one of the dangers is if meeting a quarterly number becomes an all-consuming task and requirement, sometimes that can force you into counterproductive activities like discounts or (air shipment) deliveries that are expensive."

Companies such as Sun, IBM and Dell are likely to have taken up those sales that HP left on the table, he added.

Still, Fiorina said that HP, on the whole, believes that it's headed in the right direction. The company said it has resolved or will soon resolve many of the server issues it had during the quarter. Further, HP said it expects its server and storage businesses to return to profit during the fourth quarter. Overall inventory levels at the company, including PCs and imaging products, were acceptable during the quarter, HP Chief Financial Officer Bob Wayman added during the call.

HP expects revenue for its fourth quarter to be between $21 billion and $21.5 billion, and earnings per share to be 35 cents to 39 cents. Those earnings figures include a charge of around 5 cents per share to write off various assets. Analysts were expecting the company to report earnings of 43 cents per share for its fourth quarter, including the charge.

HP's other businesses, including the Technology Solutions Group's services arm, fared relatively well in the quarter. The unit reported revenue of $3.5 billion, up 12 percent from a year ago, due largely to the company's managed services business.

The personal systems group, which includes PC sales, saw revenue rise 19 percent to $5.9 billion, with desktop sales up 26 percent and notebook sales up 12 percent.

The imaging and printing division reported revenue of $5.6 billion, up 8 percent from a year ago, and operating profit of $837 million, a third-quarter record. HP shipped almost 10 million printers during the quarter. Digital-imaging revenue rose 11 percent, with digital camera shipments offsetting a decline in the scanner market.

HP also expects to deliver a number of new imaging and printing products later this month to prepare for fall and holiday sales.

HP's earnings statement hit its stock price hard on Thursday. By midmorning PDT, the price had slipped considerably to just over $16 from its Wednesday close of $19.52.

 

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