Analysis: HP hit by loss, drop in sales

Hewlett-Packard Co.'s US$2 billion loss in its first postmerger quarter, amid weakened sales in several crucial areas of its business, underscores the serious challenges the company faces going forward, analysts said last week.

HP reported revenue of $16.5 billion for its fiscal third quarter ended July 31, compared with the $18.6 billion it would have reported as a combined company a year ago.

During the third quarter, HP ran up more than $2.4 billion in restructuring and other merger-related expenses. Excluding those charges, HP would have earned a profit of around $420 million for that period.

"Throughout our first 100 days, we've kept our eye on the ball," said HP Chairman and CEO Carly Fiorina. "We're hitting our integration milestones and are on track to meet our second-half targets."

Even so, the results, which come one year after HP announced its plan to acquire Compaq Computer Corp., reveal a disconcerting slowdown in several critical areas, said Paul McGuckin, an analyst at Gartner Inc. in Stamford, Conn.

"The performance of the enterprise systems group especially was very disappointing," McGuckin said.

Combined company revenue in that unit, which is responsible for HP's server and storage equipment, declined 22 percent compared with the same period last year, to $3.8 billion. HP blamed the decline on sluggish IT spending worldwide and aggressive competitive discounting.

But McGuckin said HP's problem is also related to a specific weakening of demand for the company's server and storage products.

"HP lost worldwide server market share to rivals in the second quarter of 2002," he said. "I think even they may have been a little surprised at how fast Alpha server purchases, for instance, declined.

HP also saw a slowdown in its personal systems business, which was expected to be the area that would benefit most from the Compaq merger. Instead, revenue declined 19 percent to $4.8 billion, with commercial PC sales dropping 15 percent.

Benefiting from this slowdown have been rivals IBM Corp. and Sun Microsystems Inc. on the Unix server side and Dell Computer Corp. in the Intel server market, analysts said.

One example is a recent order for 20 Dell PC servers by Virchow, Krause & Co. The 815-employee Madison, Wis.-based auditing firm previously used Compaq servers.

"Dell was extremely aggressive in trying to lure us away from Compaq," said Allen Smith, the firm's technology director. Dell offered not only better prices, but also a faster delivery schedule for the servers, he said.

Even IT services, which HP had predicted would remain largely unaffected by the merger, saw a decline of 7 percent in revenue compared with levels in the same quarter a year ago.

In fact, the only real bright spot for HP continues to be its print and imaging systems business, said Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray Inc. in Minneapolis. Revenue in this segment rose by about 10 percent to $4.7 billion. But that alone isn't going to be sufficient to sustain long-term growth, Kumar warned.

"They clearly need to accelerate their cost-cutting, given their lack of top-line growth for the foreseeable future," he said.

HP's heavy emphasis on hardware sales is also going to make things particularly difficult for the company at a time when IBM and Sun are looking to software and services to pull in profits, said Laurie McCabe, an analyst at Summit Strategies Inc. in Boston.

HP has said that it hopes to use its OpenView software to drive new sales. But the company's recent decision to pull out of the middleware market leaves it out of a booming and potentially lucrative business, McCabe said.

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