Looking forward into fiscal 2005, which HP is in the middle of right now, the company seems to be facing as much uncertainty as ever, although it might be in different areas than it worried about this fiscal year.
For the quarter ended October 31, HP booked $21.4 billion in sales, up 8% from the $19.9 billion in sales it had in the fourth quarter of fiscal 2003. Operating margins for the quarter were 6%, up a smidgen, and HP brought $1.1 billion to the bottom line after taxes, or $0.37 a share, compared to $862 million of profit this time last year, or $0.28 per share. The 32% growth in earnings per share will please Wall Street, but comments that Fiorina and Bob Wayman, HP’s CFO, made in discussing the results will probably cause the street to pause.
HP is a consumer and an enterprise company, and as is often the case with large companies that span many products and many markets, there always seems to be something going wrong somewhere.
At the end of fiscal year 2003, we saw a stronger consumer market and a weakening enterprise market, explained Fiorina. Now, we are seeing an improving enterprise market and a so-so consumer market. When pressed on how she thought the holiday buying season would turn out, Fiorina said that we had not yet passed through the critical Thanksgiving holiday season in the US, which is usually a barometer for the whole holiday season, so she warned that anything she said was based on very preliminary information. Our current read of the consumer situation is that it is not bad, but that it is not great, either, she said.
Perhaps equally perplexing for HP is that the shift to powerful yet low cost x86 servers and entry storage devices with huge capacities and low price tags is making it challenging to wring profits from its server and storage businesses. To that end, Fiorina announced that the cost cuts (which she did not specify) that were planned for fiscal 2006 would be pulled forward into fiscal 2005 to help HP meet its profit targets.
These actions will result in a hit of about 4 cents a share in the first half of fiscal 2005, which will be mitigated in part by share buybacks and beneficial currency fluctuations that will together help HP to the tune of 2 to 3 cents a share during the first half, according to Wayman. In other words, any growth in profits for the first half will have to be real growth, not financial engineering through accelerated stock buybacks or other such things.
HP has approximately $14.5 billion in profits parked in subsidiaries around the world that, thanks to a stunning tax break passed by the US Congress, will allow US companies to move that money back home at a tax rate of only 5.25%. The company also has $12.7 billion in real cash in the bank. So it has plenty of maneuvering room financially to take the ups and downs of the enterprise and consumer markets it chooses to participate in. HP’s competitors hate that. Too bad.
That said, HP investors want to see its stock rise and the company make real money in a sustainable manner. HP rakes in big bucks in its Imaging and Printing unit, which had sales of $6.5 billion in the quarter and an operating profit of $1.1 billion. This market is where HP clearly makes most of its money. But growth slowed to only 5% in the fourth quarter, even though HP shipped 14 million printers, its highest unit sales in any quarter to date.
IPG hardware sales to businesses was up 6%, but consumer sales were down 2%. The printer supplies business was up 8%, pushed by sales of color printing supplies that are in turn being driven by the use of digital cameras. In the Personal Systems Group, HP says it is seeing a revitalization of desktop sales thanks to PC upgrade cycles among businesses, with commercial PC sales up 12% in the quarter, but consumer PC sales grew at only 4%. The entire PSG unit, which had $6.5 billion in sales as well, only booked a $78 million operating profit, which unfortunately is its best performance in terms of income since 2000.
HP may talk about its Technology Services Group as a single entity, but it is really thee very different businesses – servers and storage, software, and services. Collectively, these three units did pretty well in fiscal Q4, with sales up 10% to $8 billion. However, this unit only posted operating profits of $469 million, which is less than half of what its imaging business does.
The Enterprise Storage and Server unit posted sales of $4.1 billion in the quarter, up 7%, with shipments of x86-based ProLiant servers up 18% and revenue up 16%. HP is fighting to keep that average server selling price higher, but it is very tough to do that in this aggressive server market, and all that HP can hope to do is drive up the attachment rates on storage, software, services, and other features on the ProLiant machines that it does sell.
Within the Business Critical Systems part of the ESS business, which pushes Unix and proprietary servers, sales for HP-UX systems were up 8%, but sales of AlphaServers (which support Tru64 Unix and OpenVMS) were down 27%. Perhaps unexpectedly, sales of NonStop fault-tolerant Unix servers were up 13% in the quarter. Fiorina said that HP’s Integrity line of Itanium-based servers (which run HP-UX, Windows, Linux, and very soon OpenVMS) now account for 16% of total sales in the BCS unit, up from 5% a year ago.
While that sounds great, what it means is that Itanium-based servers accounted for about $161 million of the $1.03 billion in BCS sales. This is a very small amount compared to the amount of revenue HP must be getting from the PA-RISC systems that the Integrities are intended to replace.
Storage sales were weak in the third quarter, forcing the ESS unit to post a $208 million operating loss. Storage and server sales both improved in the fourth quarter, but storage sales were still down 9%. ESS posted an operating profit of $107 million. On the services front, HP’s managed services business grew 35% in the quarter, and customer support sales were up 10%, but consulting and integration sales were only up 4%. Overall, HP’s services biz booked $3.7 billion in sales and posted an operating profit of $367 million. Finally, HP’s software business posted sales of $277 million, up 25%, but the unit had a small operating loss of $5 million.
Looking forward, Wayman said that HP reckons that sales in the first half of fiscal 2005 will be in the range of $41.8 billion to $42.3 billion, and that non-GAAP earnings per share will be between $0.72 and $0.74 a share. Those non-GAAP estimates include around five cents a share to cover charges relating to acquisitions.
