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H-P Hits One Out

Alexei Oreskovic

Strong sales of notebook PCs and printers pushed Hewlett-Packard's(HPQ) fiscal first-quarter profit up 26% and lifted its top line above Wall Street expectations.

The better-than-expected financial results, which H-P reported after Tuesday's market close, also were achieved by continuing cost-cutting. And H-P signaled that cost controls remained front and center, announcing that it would terminate its pension plan for U.S. workers.

The Palo Alto, Calif., company grew first-quarter sales 11% to $25.1 billion, ahead of its own guided range of $24.1 billion and $24.3 billion, as well as Wall Street's expectation of $24.3 billion.

"This was a solid start to the year: revenue grew, margins expanded and we continued to take market share," said CEO Mark Hurd in a conference call with the press following the release of the results.

H-P earned $1.5 billion, or 55 cents a share, vs. $1.2 billion, or 42 cents a share, a year earlier.

Excluding $279 million, or 10 cents a share, in amortization charges for purchased intangibles and in-process research and development costs, H-P said it earned 65 cents a share.

On that basis, analysts were expecting 62 cents EPS.

Shares of H-P were recently off 47 cents to $42.66 in after-hours trading.

H-P said it sold $8.7 billion worth of PCs in its first quarter, with unit shipments up 19% year over year. While desktop PC revenue declined 1%, sales of notebook PCs surged 40%. And H-P grew its operating margin to 4.7%, which Hurd described as the highest level in years.

H-P's success in the PC business owed to strong consumer sales during the holidays and the continuing struggles of rival Dell(DELL), which recently brought founder Michael Dell back as CEO in hopes of reviving the company's fortunes.

In the October-December period, H-P beat out Dell for the title of the world's No. 1 PC maker for the second quarter in a row.

H-P also got a lift from its printer business in the first quarter, with sales up 7% year over year and a 15.3% operating profit.

In the post-earnings conference call, Hurd brushed off fears that its profit margins could suffer if it opts to match rival Eastman Kodak's(EK) forthcoming low-cost inkjet printer cartridges. Hurd said H-P's focus on cost structure gives it the flexibility to participate in the market however it feels is appropriate.

"To be very blunt, I like our chances to be very competitive," said Hurd.

Since taking over as CEO in March 2005, Hurd has made restructuring the company's costs a key priority, slashing 10% of the workforce and consolidating its real estate assets, among other things.

In the first quarter, H-P said operating margin was 7.3% vs. 6.6% at the same time a year ago. Hurd recently set a target of 9% to 9.5% operating margins for fiscal 2008.

Not all of H-P's businesses are performing flawlessly. Hurd acknowledged that there remains work to be done in H-P's enterprise storage and servers group, where the company experienced declines in its tape business and high-end Unix servers, despite strong sales of industry standard servers.

Similarly, H-P said it needed to do a better job of inventory management, after inventory levels ballooned by $1.6 billion year over year to $8.4 billion.

The inventory situation, along with end-of-year bonus payments, resulted in H-P posting negative $22 million in cash flow from operations for the quarter.

H-P also announced that it would modify its retirement plan by stopping payments to its remaining traditional defined-benefits pension plan. The move will give H-P a one-time gain of $500 million, although H-P said it would reinvest the savings into offering an early retirement program for eligible employees.

Employees who turn down the early retirement option will be placed in H-P's 401(k) plan, where H-P will now match 6% of employee contributions, vs. its previous 4% level.

Looking ahead, H-P projected $24.5 billion in sales for its fiscal second quarter, with adjusted EPS of 63 cents to 64 cents. Analysts polled by Thomson Financial had expected $24.1 billion with EPS of 63 cents.