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HP hammered in servers, storage, and PCs in fiscal Q3

Not much fun in services, either, but software showed life

Remember a long time ago, how Compaq put the squeeze on its supply chain, dropped the boom on PC prices, and essentially made it impossible for IBM, the former market leader, to stay in the PC business? Well, Dell and other competitors in the PC, server, and storage rackets are trying to do the same thing to HP now, and its financial results for its third quarter ended in July show just how artfully the competition is stealing Big Meg's lunch money.

The deterioration in HP's Enterprise Group, which makes and sells servers, storage, and networking gear and peddles support for these products, was deeper than expected, explained Meg Whitman, HP's CEO, on a conference call with Wall Street analysts after the market closed on Wednesday.

This was also just after HP announced that Dave Donatelli, a hardware guy from EMC who had been running Enterprise Group and its predecessors for the past several years, would be replaced by Bill Veghte, an ex-Microsoftie who came to HP three years ago to run its software business and was most recently its chief operating officer.

The mainstream x86 server business was experiencing "near-term business model challenges," as Whitman put it, impacting HP's hyperscale server sales, and mainstream ProLiant servers were adversely affected by "execution challenges, competitive pricing, and a misaligned go-to-market model."

Whitman said that the net impact of all of these challenges was that the Industry Standard Server business is expected to lose five points of revenue market share. "Fixing execution across Enterprise Group will be Bill Veghte's top priority in his new role," she said.

So many other parts of HP's business are also under pressure that you can't put it all on Veghte, and Whitman reminded Wall Street, once again, that this was a five-year turnaround plan, not something that can be pulled off in a year or two.

In the quarter ended on July 31, HP's overall revenues were down 8.3 per cent to $27.2bn. Thanks to a whopper of just under $11bn in goodwill writeoffs related to the Autonomy acquisition and restructuring charges related to the removal of 26,000 workers from the HP payrolls, the comparison on the profit front is relatively good.

Earnings before taxes came in at $1.71bn, which is a lot better than a $9.06bn loss in the year-ago period. Net earnings came to $1.39bn compared to a net loss of $8.86bn a year ago.

Cathie Lesjak, HP's CFO, said on the call that around 3,800 employees were let go as part of the restructuring during fiscal Q3, bringing the total to around 22,500 layoffs since the restructuring was announced last year. She added that HP was on track to meet its goal of laying off 26,000 people by the end of fiscal 2013, which comes to a close in October.

Walking through the HP groups, Personal Systems continues to be a drag, with revenues swooning 10.8 per cent to $7.7bn in the quarter and operating profits plummeting 43.7 per cent to $228m. Yes, boys and girls, Dell is trying to drive HP out of the PC business, and Lenovo is helping – along with Apple and a slew of other smartphone and tablet makers.

HP did better in the commercial PC racket, with sales down only 3 per cent, but consumer PC sales were off 22 per cent. By product type, notebook sales were $3.72bn (down 16 per cent), desktop sales were $3.15bn (down 10 per cent), and workstation sales were $537m (up 2 per cent).

Printing Group, which is ultimately lumped with PCs in HP's financial presentations, brought in $5.8bn in revenues, off 4 per cent; the bulk of that is ink and toner, and that is why HP was able to count $908m in operating profit from this group. However, that was also four points' fewer profits than in the year-ago period. Adding it all up, Printing and Personal Systems Group had $13.51bn in sales, down 7.8 per cent, and an operating profit of $1.13bn, down 16.1 per cent.

Circling back to Enterprise Group for a little drill down, revenues were $6.79bn, off 9.2 per cent, and operating profits were scrunched twice as hard to $1.03bn, down 19.6 per cent.

The Business Critical Systems group, which is where Itanium-based HP-UX, OpenVMS, and NonStop servers come from, continues to implode, with sales down 26 per cent to $284m. After several years of decline, this business is a shadow of its former self – and sadly so, because all three of those are great platforms that deserved a better chance.

HP has counted on Industry Standard Servers – what you and I call x86 iron, and in this case which bear the ProLiant brand – to more than make up for the gap in sales declines for Integrity and Superdome sales. But hyperscale data center operators are making their own boxes – or Dell is – and Dell is also pricing its mainstream PowerEdge machines very aggressively, while IBM is not sure what to do with its System x biz.

In any event, HP's x86 server revenues declined 11 per cent to $2.85bn in the fiscal third quarter, and no matter how much Whitman and others want to tout Moonshot microservers, no one is buying them in volume yet because none of the right processors are there for them yet. And even when the do arrive, who knows if service providers, cloud operators, companies, and governments are going to go for them?

HP does not provide operating profits for divisions in its groups, but it is hard to imagine that the company is making much money in servers. And to make matters worse, even with all the hullaballoo about in-memory databases like SAP's HANA, high-end x86 server sales are not growing fast enough to make up for declines in Itanium platform sales.

HP's storage revenues were off 10 per cent in sympathy to $833m in the third quarter. And while 3PAR, EVA, and StoreOnce products gained – with 3PAR up double digits, according to Lesjak – the hole from slumping tape product and XP storage array sales was larger. Lesjak said that HP was focusing on getting better attach rates between its slickest servers and storage.

Networking revenues were flat at $644m – which, as Whitman pointed out, was not good news in a market that is growing fast. And Technology Services, the break-fix business, hauled in $2.17bn, down 7 points but with higher margins compared to a year ago.

HP's Software Group actually showed 1 per cent revenue growth to $982m, and operating profits shot up by 14.9 per cent to $201m. You can see now why Veghte is running the enterprise hardware business at HP and Donatelli is not. Perhaps equally importantly, as Whitman pointed out, the combination of software and hardware is increasingly driving sales.

Anyway, software license sales were flat in fiscal Q3, while support sales were up 4 per cent. SaaS sales were up 4 per cent, which is lower than expected, but Lesjak said there was a good pipeline here. Security software sales were up in the double digits, and Vertica database sales were up in the triple digits, if you are looking for some bright spots.

On the services front, HP has two groups. HP Financial Services, which rents and leases equipment for customers and resellers, had $879m in revenues, down 6 per cent, and an operating profit of $99m, up 2 per cent.

The much larger Enterprise Services unit, which is largely the EDS business that HP acquired, had $5.84bn in sales (down 8.7 per cent) and an operating profit of $192m (down 20 per cent). IT outsourcing was $3.66bn of that services revenue stream and fell 7 per cent year-on-year. Application and business services made up the remaining $2.18bn and dropped 11 points.

Whitman's original five-year plan was to see some revenue growth in fiscal 2014, but on the call today, she said that this was probably not going to happen. She did add that she did expect to see "pockets of growth" in particular markets and product lines, but did not elaborate.

"We are not here for this quarter or for this year," Whitman explained. "We are trying to set HP up for another really great run here. You have got to decide where you are going to play, and how you are going to win because this isn't all about revenue growth. This is a margin-revenue trade-off business."

And, in a lot of cases, cutthroat pricing forces companies to trade margins for revenues until they figure out how to make something less expensively. And sometimes they don't figure that out – like IBM with PCs (and maybe with x86 servers before too long). The key for HP is to manage the supply chain and cost structure and map products to what customers will pay for – as obvious as that sounds.

"This is something that HP historically has done really well, but it is not being done as well as it could be in all parts of the business," Whitman said. "Especially as we are navigating these incredible shifts in the industry. It's not business as usual in our industry, and we have to be better at it than we have been in the last year or two." ®

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