Consumer products a boon to HP profits

The Palo Alto, Calif., computing giant, waging a battle to convince shareholders it's a good idea for HP to acquire rival Compaq Computer, had revenue of $11.4 billion for the quarter ended Jan. 31, an 8 percent decline from $12.4 billion in the same quarter a year earlier. Net earnings, however, increased 243 percent from $141 million the year earlier.

But much of the quarter's gains are unlikely to last. "While the holiday spending season was a pleasant surprise, we're not counting on it repeating in the post-holiday quarter," Chief Executive Carly Fiorina said. She also said the company doesn't expect an economic recovery until the second half of 2002.

April 1 has been set as a deadline for many aspects of unifying with Compaq, assuming the March 19 vote is in favor of the merger, Fiorina said.

"While I'm not predicting the exact day...we're assuming an operational date of April 1," she said. At that point, she said, the companies' Web sites and customer support operations would be integrated, customers would see detailed product plans, and employees would get HP paychecks.

The income amounted to 25 cents per share, or 29 cents per share on a pro forma basis that excludes $86 million related to acquisitions of Bluestone and Compaq, goodwill amortization and other charges. Analysts surveyed by First Call had expected pro forma earnings of 25 cents per share.

Analysts had raised estimates from an average of 16 cents per share after HP said earlier in the month that consumer product demand had increased.

Fiorina argued that the results show HP's operations aren't being hampered by distractions imposed by the Compaq merger, a criticism Walter Hewlett and other merger opponents have voiced.

"Our first-quarter results demonstrate HP's continued ability to stay focused on customers and effectively execute our business plan regardless of market conditions," Fiorina said in a statement.

Hewlett, the son of co-founder William Hewlett, praised the results Wednesday and said in a statement they "further confirm that Hewlett-Packard does not need to acquire Compaq."

In a conference call, Fiorina rebutted that position. "I agree with Walter Hewlett on one point: This is not a company in crisis," she said. "This is a company strong enough to take a decisive step and smart enough to know when to take it."

If customers are concerned about the merger distractions, salespeople are permitted to connect those customers with Fiorina and other top managers to discuss the issue, but "frankly, we're not getting called," Fiorina said.

Not in the clear
Still, the sales environment is difficult for large customers. "The enterprise market is even tougher, with sluggish corporate information-technology spending, aggressive competition and tough deal pricing," Fiorina said. Spending has been particularly tight among airlines, high-tech manufacturing and telecommunications companies.

"There are some improvements in spending habits and overall tone, but we continue to believe a recovery won't happen until the second half of this year," she said.

HP expects a second-half recovery based on macroeconomic indicators such as interest-rate cuts, employment, consumer confidence and business confidence, Chief Financial Officer Bob Wayman said in an interview.

The company expects its fiscal second-quarter revenue to be "modestly" lower. However, Wayman said, "around the merger, we think it's prudent to be conservative" and to provide estimates "that we have high confidence in."

Geographically, Latin America was bad, spurring HP to take a $25 million charge in its financing operation, Wayman said in the conference call. "Argentina has gone away from a business point of view, and the news in Venezuela worries us," he said, referring to a move Wednesday that led to a 19 percent currency valuation decrease.

The company's pro forma gross margins, a key measure of profitability, improved from 25.7 percent in the previous quarter to 26.9 percent, the company said. The operating cash flow was about $1.6 billion.

HP said improvements in PC, printing and imaging businesses were responsible for the improved results. Digital camera and photo printer revenue increased 30 percent from the most recent quarter, while PC sales increased 22 percent.

However, with the exception of outsourcing, many products for large corporations saw declines, the company said.

Server group needs work
HP's sales of servers--high-end networked computers--need work, Fiorina said.

Unix servers, a crucial product line facing keen competition from Sun Microsystems and IBM, declined 7 percent from the most recent quarter and 21 percent from the year-ago quarter. Storage revenue dropped 4 percent sequentially and 13 percent from the year-ago quarter. Software revenue dropped 3 percent sequentially and 18 percent from the year-ago quarter.

The Unix server group is profitable, though, an improvement over some previous quarters.

Revenue for lower-end servers built with Intel CPUs is bleak. "We still struggle in the low-end IA-32 (Intel) server arena," Fiorina said. "HP has been losing momentum and money in our (Intel server) business. Our efforts here need to be beefed up quickly."

Services grew 1 percent sequentially and 2 percent from the year-ago quarter. Boosting that segment was outsourcing, which increased 16 percent sequentially and 31 percent from the year-ago quarter.

HP is working on advancements in its printer business, including areas such as invisible document coding, identification cards and mailing addresses, Fiorina said. Wayman added that the company is "vigorously defending our intellectual property," meaning that HP is cracking down on sales of non-HP products such as ink cartridges.

In addition, HP has implemented part of its strategy for inexpensive inkjet printers costing less than $99 or even $49.

"We have only introduced a small part of that line at this time, and we will see a major impact in the fall," Wayman said in the interview. "HP acknowledges we did not make the decision to move into the low-end space soon enough. We have been competing there with products not designed for that space."

A key part of the new products is combining new ink cartridges with less ink capacity, lower manufacturing cost, and a smaller price tag than the $35 or so typical of higher-end inkjets. The new inkjets are "just as profitable for us," Wayman said.