H-P Warns Again, This Time of a Weak Third Quarter

Updated from 5:01 p.m. ET

We now return you to your regularly scheduled Hewlett-Packard (HWP Quote) warning.

Smooth Operator

Numerous profit warnings and skepticism about the company's ability to grow its business have kept H-P under steady pressure all year. And the Palo Alto, Calif.-based firm did its best Wednesday night to live up to its growing reputation as the blackest sheep in the enterprise hardware herd, serving up fiscal second-quarter earnings that plunged from their year-ago level and warning investors of weaker-than-expected third-quarter sales. The warning was the company's fourth this year, with the first coming Jan. 11, the second Feb. 15, and the third April 18.

H-P said that excluding certain charges it earned $356 million, or 18 cents a share, in the quarter that ended in April. The 18 cents a share figure was 58% lower than the 43 cents a share the company earned in the same period last year, though it was also 3 cents higher than the consensus estimate of analysts polled by Thomson Financial/First Call. But H-P made the project of meeting expectations considerably easier last month, when it warned that second-quarter earnings would come in between 13 cents and 17 cents a share. That range was more than 50% below what analysts had been looking for at the time.

Sales were somewhat disappointing, even considering lowered expectations, totaling $11.6 billion. That's about nearly $200 million below what analysts were expecting and represents a decline of 3.6% from H-P's revenue in 2000's second quarter. Meanwhile, H-P offered revenue guidance that suggested that management's prior claims that business had stopped getting worse were a bit premature: It now expects third-quarter revenue to come in somewhere between flat to down 5% from its second-quarter level. The guidance translates to sales of $11 billion to $11.2 billion. Analysts currently expect sales to total just over $12 billion in the third quarter, which ends in July.

Plan 9 From Palo Alto

H-P's performance was weak in nearly every segment in the second quarter. Imaging and printing systems sales, the company's breadbasket, fell 3%. Computing systems revenue fell 7%, including a 13% decline in Unix servers, a 4% drop in PC servers, a 4% drop in commercial PCs and a 15% fall in consumer PCs. The PC business managed to break even in the quarter, perhaps a marginal victory on an otherwise bleak battleground.

Much of H-P's problems boil down to the interplay of volume and costs. Falling demand across pretty much every product line has cut sharply into product volume, while leaving fixed costs intact. The company is already taking measures to reduce costs, having fired 3,000 workers in management positions and withheld executive bonuses for the first half of 2001. (H-P said it's planning to pay bonuses in the second half of what's shaping up to be a very lackluster 2001, a decision that won't make managing operating expenses any easier.)

The trick now is regaining sales momentum, and hoping higher production volume lowers the cost structure correspondingly. In some cases, growth is already happening. Sales in the company's outsourcing business grew 23%, while consulting revenue increased 33%. Meanwhile, H-P's mammoth Superdome Unix server is finally starting to ship in volume, with the company having only recognized revenue on 60% of the units it has shipped so far, producing a nice backlog in that segment. (H-P recognizes revenue once Superdome servers have been installed, rather than shipped.)

But it will take more than backlog in select business lines to get H-P's sales growing again. For one thing, H-P already has been drinking from that well for a while now. "We have, in the past quarter or so, been living off of backlog," said CFO Robert Wayman on the conference call following the company's earnings release. "This is just the case in some of these businesses."

Crawling Along

Execution issues still loom large at H-P. The first quarter had brought to light the much-publicized snafu among the company's salespeople, who were found to be competing against H-P's own channel resellers. CEO Carly Fiorina said that it has yet to fix that problem, despite her having issued H-P salespeople "new rules of engagement" involving who owns which accounts. As long as H-P customers keep getting calls from multiple salespeople trying to sell them the same H-P products, the business will surely lag that of its competitors.

In the meantime, H-P will have to negotiate the same paradox Compaq (CPQ Quote) faces. It is gains in market share that bring the sort of scale that keeps production costs low, and thus increases profitability. But chasing that share in a price war does just the opposite. Threading the needle will require strong execution by -- gulp -- the sales staff.

"We're asking our teams to go after profitable revenue growth, as opposed to share," Fiorina said. "That gives them clear ceilings and floors -- particularly floors -- in terms of prices below which they do not go."

H-P's second-quarter results included $155 million in costs of writing down inventory and shutting down excess capacity. Without those charges, the company said its earnings would have been 6 cents a share higher.

Including charges, but excluding a gain, H-P said it earned 15 cents a share. The company's earnings release left the exact nature of those charges unclear, though a spokesman said it covered the cost of goodwill and amortization.

So, then. Is this it?

"We're moving through a bottom," Fiorina ventured. "We don't see it getting substantially worse, but we don't see it getting better in the near term. I don't know whether you call it crawling along or bottoming or moving through a trough. We don't know how to predict the future, but that's how we see the environment."