SlowCompany.com: H-P Warns Again

For Hewlett-Packard (HWP Quote) investors, the idea that things won't get any worse is trumping the reality of how very bad they've already become.

Serial warner H-P said Wednesday morning that earnings in its second quarter ending this month would come in between 13 cents and 17 cents a share, a range that sits more than 50% below analysts' already lowered expectations. But the stock took off on the news, rising 5% even before the Federal Reserve's surprise decision to cut interest rates whisked it off to the same altitude that every other tech stock was testing Wednesday afternoon. H-P was lately trading up $4.02, or 14%, to $33.27.

Why? You had to listen closely to catch it, but investors fixed their minds on the one thing CEO Carly Fiorina had to say that gelled with Intel's (INTC Quote) claim that it feels the microprocessor business may have bottomed: Although Europe has fallen into the same swoon that the U.S. has already experienced, although the Unix market is starting to slip away into negative-growth territory, and although it really doesn't seem like anything will be improving anytime soon, it looks like business may have bottomed.

"We're talking about the second quarter being a bottom," Fiorina said. "I say that with great caution, because visibility remains low and we're all having difficulty predicting this. That is what we're saying today."

What Else We're Saying Today

H-P had other, similarly tepid assurances for investors. Though PC pricing certainly isn't good, it's not as bad as the company had anticipated -- though it doesn't seem to be improving any. The company vowed to pursue only profitable PC market share, much as Compaq (CPQ Quote) did earlier this year before it confessed that it was unable to hide from Dell (DELL Quote). It said it was adjusting to the general shift away from the high-end inkjet printer business by fighting vigilantly for to maintain market share against Lexmark (LXK Quote) in low-end inkjets. Never mind any implications of gross profit margin pressure or a possible price war.

H-P also said it saw "a slight improvement in the enterprise business versus the first quarter," and that revenue would be flat or up slightly on a sequential basis. That's much better than the consumer segment, which the company said was tracking about 15 percentage points below plan. But it's not saying much in the context of the disaster the enterprise business suffered in the first quarter, when H-P's salespeople were competing against the company's own channel resellers, trying to sell single accounts the same Unix offerings.

"In H-P's case, it's not just the economy," said A.G. Edwards analyst Shebly Seyrafi. "Its core markets are commoditized, and getting more commoditized. The PC market is saturated in the U.S., as is the market for the printers attached to those PCs." (A.G. Edwards hasn't done recent underwriting for H-P.)

And then there's the writedowns. H-P became the latest company to writedown the cost of inventory, setting plans to take a charge of $100 million to cover the inkjet printers, handheld computers and consumer imaging products it has sitting around gathering dust. H-P said it would take another charge of $50 million as it writes down the cost of shutting down extra capacity it built in its consumer products division.

CFO Robert Wayman blamed the economy for the $150 charge -- the second one-time charge against earnings H-P has taken in the last two quarters. "All of these items are affected by the economic environment," said Wayman. "We developed capacity plans based on unit volumes that we're now not coming close to."

An Incremental Education

The company reiterated its devotion to controlling costs. New measures include not paying any executive bonuses in the first half of 2001 (the company pays bonuses on a bi-annual basis) and forcing employees to take six "incremental" -- a euphemism for unpaid, apparently -- days off. In an attempt to save on travel and hotel bills, H-P has already relocated its spring analyst meeting from Manhattan to Palo Alto, Calif., where the company is headquartered.

H-P's prospects have taken quite a tumble since the days when it insisted it could grow sales by 15% annually, something it was insisting as recently as last November.

With few observers convinced that H-P can ever get back to that sort of growth on a consistent basis, valuation questions lost amid Wednesday's Fed-induced rally will likely resurface. Based on what he knows now, Seyrafi at A.G. Edwards said he plans to lower his fiscal 2001 earnings estimate to $1.05 a share. Using that figure as a benchmark, H-P is currently trading at more than 30 times its forward earnings -- earnings that could fall by 40% from 2000, and would represent the worst EPS figure since 1994, when the company earned a split-adjusted 77 cents a share.

"It's troubling that their growth rate will normalize in the 10% to 12% range at best," said Seyrafi. "You don't want to pay a whole lot more than 20 times [earnings]."