HP profits fall, but beat estimates

As its pending merger with Compaq simmers, Hewlett-Packard logs a decline in fourth-quarter profits. Still, it edged ahead of analysts' lowered expectations.

Margaret Kane
Margaret Kane Former Staff writer, CNET News
Margaret is a former news editor for CNET News, based in the Boston bureau.
6 min read
Hewlett-Packard, battling to complete a proposed megamerger with Compaq Computer, reported Wednesday that fourth-quarter sales slipped 18 percent from the previous year, but earnings surpassed analysts' estimates for the quarter.

see special coverage: Big iron: HP to buy Compaq Analysts said similar strong results shouldn't be expected in the next quarterly report, as uncertainty about the merger is expected to hurt sales.

Sales for the quarter were $10.9 billion, down from $13.3 billion a year ago. But that was an improvement compared with the third fiscal quarter's $10.3 billion.

The company reported a net profit of $97 million, or 5 cents per share, including a $282 million restructuring charge and other items. That contrasts with a profit of $922 million, or 45 cents per share, in the year-ago quarter.

Excluding the charges, HP recorded a profit of 19 cents per share.

According to First Call's consensus estimates, analysts were expecting HP to report earnings of 8 cents a share on revenue of $9.87 billion. Estimates had been as high as 17 cents a share earlier in the quarter, but analysts have been trimming them since.

The news gave HP a lift on Wall Street. Shares were up 9 percent Wednesday, gaining $1.85 to close at $22.08.

But forecasts for next year's results weren't positive. Market conditions "continue to be difficult," HP said in a statement, adding that it is "not counting on an economic recovery in 2002."

In the first quarter, revenue is expected to drop slightly from the fourth quarter "due to normal seasonal effects," while gross margins are expected to be flat, "reflecting an intensely competitive environment," the company said. Expenses are expected to stay level.

The company's updated forecasts caused some analysts to lower their forecasts for the company. SoundView Technology analyst Mark Specker said after the conference call that he doesn't expect the company to make his estimates for the current quarter, and he advised investors to "stay away" from Hewlett-Packard's stock.

The analyst lowered estimates for the current quarter and 2002, owing mostly to evidence that merger uncertainty is putting off customers. "Inputs from our survey work at Gartner Symposium and inputs from the field concur that the confusion surrounding the proposed merger with (Compaq) is having a material affect on (HP's) close rates and sales momentum as customers worry about which product lines would survive the merger," Specker said in a research note.

Wall Street will be watching to see if competitor Dell Computer has picked up any new customers as a result of the uncertainty with Compaq and HP.

Dell will report its third-quarter results after the market closes Thursday--the same time HP had originally scheduled its report. HP changed its time to avoid conflicts for analysts that cover both companies. "We knew this would be a long call--given all the questions about the merger," Chief Financial Officer Robert Wayman said in an interview.

HP stock watch
HP and Compaq announced a stock-swap deal worth $25 billion. Because of fluctuations in the stock, the value of the deal may change. This is the approximate value (20-minute delay):
Merger uncertainty has been plaguing the company for some time now. A fight has erupted over the company's bid to merge with Compaq, and representatives from both the Hewlett and Packard families have come out against the deal. According to some analysts, the David and Lucile Packard Foundation, owner of almost 12 percent of HP shares, could make or break the merger.

"We're always happy when a company beats expectations," David and Lucile Packard Foundation CFO George Vera said in a phone call after HP reported earnings Wednesday. But Vera said the foundation hadn't analyzed the details of HP's results well enough yet to determine which way it would sway its vote.

CEO Carly Fiorina said in the earnings release: "We are convinced that the Compaq transition is a unique opportunity to move HP into the future and benefit our shareholders, customers and employees." Fiorina also said that the merger will result in an addition of $2.5 billion to the company's bottom line annually.

"This is different from other hi-tech mergers," said Wayman in a phone interview. "Most just have synergies in their corporate staffing," but HP and Compaq also have synergies on the operational level, he said.

Compaq offers "breadth and depth"
Fiorina took an even more direct line during a conference call with analysts, spelling out a list of HP's challenges and explaining how the merger would help solve each of them.

"Fundamentally, it's clear that we need to do more to ensure that our computing business is truly poised for leadership and growth. With Compaq we gain...the breadth and depth (to do that)," she said. "Change can be unsettling...but preserving the status quo and taking small steps to improve our competitive business will not serve anyone's interest."

Fiorina later said that the quarter was "characterized by a strong August and a strong October," but that September revenue was hurt by the Sept. 11 terrorist attacks, which "really caused a pause in purchasing activity across the board for a couple of weeks."

There had been concern that the brouhaha over the merger would put off customers. However, Fiorina said, "While overall computing systems results remain weak, we saw improvement in certain segments, including storage and PCs."

Computing systems revenue--which includes workstations, desktops, notebooks, servers and storage--dropped 1 percent from the third quarter and 31 percent from a year ago.

HP's consulting business saw revenue rise 2 percent from the third quarter, and 5 percent from the year-ago quarter.

Revenue at the printing and imaging segment was off year over year, but it was up 16 percent from the third quarter.

The performance of the company's printing business was of particular interest this quarter. Analysts had said that the stronger HP's printer business, the better off it would be as a standalone company. Critics of the merger had said Compaq would dilute HP's strong business in printers.

"I personally don't relate to that," said Wayman. He believes the merger would help the printing business along with the computer business because, he said, a larger-scale business creates cost efficiencies across the board.

Declining margins
HP has already made progress in trimming expenses through cost cutting and layoffs, but more work may still be needed to deal with the company's declining margins.

Operating margins for the computing division dropped to a negative 4.7 percent, compared to a negative 3.8 percent in the third quarter and a positive 4 percent a year ago. HP attributed the decline to a highly competitive market and weakening demand.

"Long term, the margin targets for the PC or access device space is 3 percent, with targets of 8 to 10 percent for the rest of enterprise computing segment," Fiorina said.

However, she cautioned that she doesn't expect to return to an 8 percent to 10 percent level "until the IT environment (becomes normal) and the economy gets back to normal levels."

HP did manage to trim the company's overall operating expenses 4 percent from the third quarter, and 11 percent from a year ago, but margins at 25.7 percent were essentially flat from a year ago.

Some of those savings came from job reductions; HP laid off approximately 4,000 people in the fourth quarter. The company's plans call for a total reduction of 6,000 jobs; Wayman said most of the remainder of the cuts will come during the first half of 2002.

Wayman also said in a phone interview that those cuts were "independent of the merger." Several more job cuts can be expected, as the companies have overlap in operations as well as corporate roles in their PC and services businesses.