HP issues bullish profit forecast

"I do believe we can deliver EPS (earnings per share) growth of greater than 20 percent this year and for the next couple," Fiorina said Tuesday at the company's financial analyst meeting here Tuesday.

HP, based in Palo Alto, Calif., faces plenty of rivals who are willing to aggressively cut prices on competing products. In PCs, printers and servers, HP is up against the distribution power of Dell. For more complex offerings, such as services designed to help customers adapt their companies with new technology, it faces IBM and, to a lesser degree, Sun Microsystems.

In its last quarter, HP reported profit growth and raised its sales forecast. But analysts are still wary.

"HP had a strong quarter across the board," Technology Business Research analyst Humberto Andrade said in an earlier interview, but "I never saw them post two or three strong quarters in a row."

Merrill Lynch analyst Steve Milunovich on Monday urged HP to split into two companies--dividing printers from computers or consumer technology from higher-end enterprise products.

Fiorina said analysts should look at what HP is accomplishing. By the end of fiscal 2004, HP will have $7 billion in new revenue, she said. "We created in organic growth a company the size of (storage company and Dell ally) EMC." Regarding HP's ambitious merger with Compaq Computer in 2002, she said, "We cannot say every step has been perfect, but we can say with confidence today we are where we intended to be."

And HP has finished laying a new foundation, she added. "We have done a lot of heavy lifting--whether managing our way through the technology bust, consolidating 87 different product lines, executing through a highly complex merger. All of that heavy lifting is behind us, though we still have work to do to improve our business," she said.

That work positions HP to expand in new directions. The company's current products and services are for markets with annual sales of $710 billion, but new work with security, management, digital media and other areas will mean more turf: "The addressable market we have the opportunity to go after is at least $1 trillion," Fiorina said.

Fiorina didn't directly address Milunovich's prescription, but she did indicate that she believes that his ideas are misdirected. In her view, technology companies must offer products that span "horizontally" across different segments, not focus on specific "vertical" niches.

For example, HP argues that it can help companies create digital content such as movies or music, help others package or distribute it, and then help consumers watch it or listen to it on PCs or other devices.

Fiorina showed a new three-year, three-pronged strategic plan for HP's profit growth:

• First, HP would improve profitability by measures such as increasing direct sales rather than those in which profits are shared with sales partners, delivering products globally, wringing lower prices from suppliers and making HP itself more efficient.

• Second, it would "grow its share of wallet": HP customers currently spend 10 percent of their budgets on HP products and services, a percentage HP will increase.

• Third, it would build on existing offerings and expand into new areas, such as digital entertainment, simplified technology for small businesses and the sweeping "Adaptive Enterprise" push to help customers become more flexible.

Since HP launched Adaptive Enterprise in 2003, it's taken $7.8 billion in orders for the initiative, said Peter Blackmore, executive vice president of HP's Customer Solutions Group.

Dinging the competition
Fiorina, who injected a measure of feistiness into staid HP when she was hired in 1999, didn't shy away from attacks her competitors.

"IBM is in categories that are slow-growing," she said, including database software, the higher-level middleware software and high-end mainframe servers.

In addition, she said, Big Blue hasn't reached critical mass in some arenas. "IBM is today in a number of subscale businesses that are losing money," including PCs and processor manufacturing. "The PC business is a business that demands scope and scale," she said, and building chips "is an intensely competitive environment with lots of players that are already at scale with no intention of ceding any existing business."

Dell came under a different attack. "Dell has a terrific business model, no question," she said of the company's expertise distributing products from Intel, Microsoft, Lexmark, EMC and others, but added, "There is limited opportunity for profitability leverage in that model." Over time, Dell could have to adapt to the razor-thin profit margins of the retail industry, she said.

And Sun barely warranted mention--the server market is a two-horse race between IBM and HP, she said.

But HP's enterprise technology hasn't fared spectacularly, though it has reached profitability. Ann Livermore, executive vice president of HP's Technology Solutions Group, said the company will improve this through "attach rates"--selling extras such as more storage, services or processors along with an initial product.

Analysts are paying close attention to HP's server, storage and software group, part of Livermore's organization. "Despite assertions that (the group's) profitability should improve, due to volume, the second quarter's results showed further erosion in profitability, even though (its) revenues increased," Sanford C. Bernstein analyst Toni Sacconaghi said in a report Monday. Profit margin pressures will increase, now that HP has finished cutting jobs and is moving to lower-margin Intel-based servers, he said.

HP's software group was unprofitable in its most recent quarter and will remain so for several quarters, in part because of future possible acquisitions to beef up the Adaptive Enterprise plan, Livermore said.

"The goal is to approach breakeven by the end of 2005. We may choose to add a couple other point acquisitions to fill out the portfolio," Livermore said.

Printing money
A large fraction of HP's profits comes from its imaging and printing division, which sells printers, digital cameras, ink and paper. Dell's entry into this market has raised the prospect of tougher competition.

"We reiterate our belief that Dell will inevitably gnaw away at HP's (and other incumbents' shares) in the printer market, but given HP's huge size, investors are not likely to see a visible impact until 2006," Sacconaghi said.

HP took the offensive. It's shipped 312 million printers to Dell's 2.8 million; it has 9,000 patents in printing and imaging and 2,000 more expected per year, where Dell relies on others' research; and HP sells printers spanning a comprehensive price range of $39 to $1 million.

Dell made gains in the U.S. printer market, but "Most of the market share gains Dell got was at the cost of their partner, Lexmark," said Vyomesh Joshi, executive vice president of HP's Imaging and Printing Group (IPG).

And Fiorina argued that HP no longer is so dependent on printing revenue; in recent years, the Imaging and Printing Group subsidized other parts of the company. "If you looked a couple years ago, you would have seen that IPG contributed well over 150 percent of the profit of the business, but today that is less than 70 percent," she said.

HP relishes the arrival of digital photography, which has shifted printing from photo labs to the home and spurred growth of high-profit inkjet cartridges and photo paper. The company estimates that 56 billion digital photos were taken in 2003, 18 billion of them printed. By 2008, that should increase to 312 billion photos and 82 billion prints, Joshi said.

New PC directions
HP is changing its PC business, said Duane Zitzner, executive vice president of the company's Personal Systems Group.

For one thing, last quarter saw HP's first blade PC sale, a model in which processors and storage stay in central areas where administrators have tight control and users get only a keyboard, mouse and monitor.

HP has also begun selling its own "thin clients," minimal systems that rely on central servers for processing power. Previously, HP had resold others' products, which means lower profit margins, Zitzner said.

He also showed off two new gadgets. The first was a handheld iPaq with built-in 802.11b wireless networking, a Bluetooth short-range wireless link and mobile phone abilities. The second was a "ruggedized" notebook geared for tough environments from arctic tundra to scorching deserts. Standing on the system, he added, "For those of us who aren't tall enough, you can use it as a stepstool."

HP has consolidated North American PC manufacturing from five sites to two and will do the same elsewhere around the globe, Zitzner said. The company will also expand its China-based configure-to-order custom PC operations from the consumer market to the business market, he said.