Annex Newsflash 2005-28                             August  16, 2005



Updated 8/17/05, 12:20 PM PDT (adds stock market update)

Analysis of HP's Third Quarter FY05 Business Results

Sweet Turnaround

Hurd Hurtles Easily Over Hurdles in First Full Quarter on His Watch

PHOENIX, Aug 16 Mark Hurd, HP's new CEO, hurtled easily over the hurdles in the first full quarter on his watch.  After dropping 1.5% in regular trading today (Aug 16), Hewlett Packard (HP) shares rallied by over 6.5% in after-hours market this evening, surging to a new 52-week record on the strength of a solid third quarter report card.  

HP reported third quarter net income of $73 million, or 3 cents a share, compared to $586 million, or 19 cents a share in the year ago period. The results were reduced by $960 million in taxes on $14.5 billion of repatriated earnings.  Excluding one-time items, HP earned $1.1 billion, or 36 cents a share.  Both revenue and earnings figures were above Wall Street estimates.

It was a sweet turnaround, especially compared to the disastrous third quarter of 2004 that sent HP shares tumbling to $16.51, a 52-week low set exactly one year ago today (Aug 16, 2004 - see "HP Savaged by Wall Street,").  Ultimately, that quarter signaled the beginning of the end for HP's former CEO, Carly Fiorina.

Enterprise Systems.  Back then, the company's Enterprise Storage and Servers (ESS) division reported a $211 million operating loss, causing three senior executive heads to roll.  This time around, however, the same unit led all others in terms of turnaround rates.  The ESS revenue surged by 20%, the fastest growth of any HP unit, while its operating earnings jumped from that big loss to a $150 million profit.  Ann Livermore, who has steered ESS since the year-ago debacle, has now earned the credit as HP's best turnaround artist to-date.

Within ESS, the "industry-standard" server revenue increased 28%, blade server revenue was up 53%, business-critical systems grew 7%, while network storage revenue grew 15%.  The HP Integrity servers jumped 113% year-over-year, while Unix server revenue rose 8%.  Midrange server revenues were up 44%.

Overall, the HP server revenue growth mirrors that IBM also reported in its latest quarter (see "IBM Bounces Back," July 2005 and "IBM: Polaris Eclipses T-Rex," July 2005).

Annex clients click here for a detailed HP Enterprise Servers & Storage forecast and valuation

Services.  HP's Services (HPS) is another unit under Livermore's jurisdiction.  After the first sequential quarterly revenue drop since the first quarter of 2004, accompanied by a 91% decline in operating margins, HPS seems to be the next "turnaround opportunity" for Livermore.  During the teleconference with analysts that followed the earnings release, the HP CEO made it clear that he was not happy with the HPS profit margins.

On the plus side, however, Hurd also said that were it not for accrued bonuses, the operating margins would have increased in the latest period.  Also on the upside, HPS third quarter revenues actually increased by 10% over the corresponding period a year ago.

Within HPS' business, the Managed Services revenue grew 21% year-over-year, Technology Services rose 7%, and Consulting and Integration increased 12%.

Annex clients click here for a detailed HP Services forecast and valuation

Personal Systems.  HP PC business reported an 8% revenue growth in the quarter, with unit shipments rising 14%.  Both figures represent improvements over the previous three-month period when the business grew by 6% and 12% respectively.

But an even better news for the HP shareholders was the improved profitability of this unit.  The PC operating profit jumped from $23 million a year ago, to $163 million in the latest quarter.

On a year-over-year basis, desktop revenue decreased 3% and notebook revenue grew 21%. Revenue for commercial clients, which includes workstations, grew 6% over the prior-year period, while revenue in consumer clients grew 8%.  

Annex clients click here for a detailed HP PC business forecast and valuation

Printing & Imaging.  Imaging and Printing Group (IPG) was a relative disappointment in the latest period.  Long regarded as the cash cow whose excellent profitability subsidized other HP operations, the IPG unit experienced a third consecutive drop in quarterly profits.  Its operating profit was $771 million, or 13% of revenue, down from a profit of $836 million in the prior-year period. 

This HP unit posted a quarterly revenue of $5.9 billion, up 5% year-over-year, but down sequentially from $6.4 billion in the second quarter, and $6.1 billion in the first.  Consumer hardware revenue increased 1%, with unit shipments up 8%, while the supplies revenue grew 6%.  Business hardware revenue grew 5%, with unit shipments up 12%.  Color laser unit shipments increased 31% year-over-year and multi-function printer shipments increased 67%.  Total hardware unit shipments were up 10% since a year ago.

Annex clients click here for a detailed HP Printing & Imaging forecast and valuation

Annex clients click here for a detailed HP Software forecast and valuation

Annex clients click here for a detailed HP Finance & Investments forecast and valuation

HP Accelerates Buybacks

HP executives did not dwell much on the topic of stock buybacks.  They let the numbers speak for themselves. 

And the tale that the numbers told was that the company has accelerated once again its share repurchase program.  The company spent $860 million on stock buybacks in the third quarter, up from $618 million in the previous three-month period.  When in doubt let buybacks sprout?  Hm... some investment strategy.


There is little doubt, however, that HP is in a turnaround mode.  Most of its units are improving at varying rates.  And the stock market has awarded the company with a hefty (+25%) increase in the last four months since Mark Hurd took its helm.

The increase in HP's market cap puts the company's P/E and other ratios roughly on a par with industry average for most of its units except one - Printing & Imaging.  As a result, breaking up HP now could yield only about $19 billion of additional market cap (as opposed to $25 billion back in April - see "Hurd's First RBI," May 2005).  Spinning off its IPG unit, on the other hand, might produce a $25 billion benefit to the HP shareholders.  But that would be tantamount to selling one's crown jewels.  And we're yet to see a king or a queen willing to do that.

So stand by for about $22.6 billion revenue in HP's final fiscal 2005 quarter, and for an EPS of 44 to 37 cents per share, excluding write-offs and other one-time items.  Which would out the company on track for full year revenues of over $86 billion, and net earnings of over $4.16 billion (again, without special one-time charges).

Not bad for a first year of a turnaround.

Annex clients click here for a detailed HP Consolidated FY2005 forecast and valuation

Happy bargain hunting!

Bob Djurdjevic

HP Stock Sets New 4-Year High

PHOENIX, Aug 17 - Propelled by solid third quarter results, the HP shares continued their climb in today's trading.  By late afternoon, they surpassed the four-year high, reaching $26.95 before easing slightly to $26.74.  The last time HP shares traded in this price range was in July 2001 - i.e., prior to the 9/11 and the Compaq merger (see the chart).

For additional Annex Research reports, check out... 

2005 IT: HP: Sweet Turnaround (Aug 2005); Dell Spooks Street (Aug 2005);  EDS Ups Its Forecast (Aug 2005);  Capgemini Beats Forecast (July 2005);  Fujitsu: Losses Reversed; Forecast Upgraded (July 2005);  IBM: Polaris Eclipses T-Rex (July 2005);   IBM Bounces Back (July 2005); Accenture: Smashing Records (July 2005); Merrill's New Bull (EDS) (May 2005);  IBM Trumps Trump (May 2005);  Tweaking Big Blue (May 2005); Hurd's First RBI (May 2005); Dell Rings the Bell (May 2005); Stock Buybacks: The Phantom Is Back (May 2005); EDS Misfiring on All Cylinders (May 2005);  HP Surges, Dell Slumps; Lenovo Completes IBM Deal (May 2005);  Fujitsu Revenues Flat, Lower Net (Apr 2005); Capgemini Jettisons Healthcare in N.A. (Apr 2005); HP: From India to Poland (Apr 2005); IBM: Slammed and Dunked (Apr 2005); Hurd Advice: Up Mount Market Cap (Apr 2005); Accenture: Roaring Ahead (Apr 2005);  Fujitsu Unveils New Servers (Mar 2005);  EDS Executive Suite; HP's New CEO (Mar 2005);  An iSeries Revival (Mar 2005); EDS Booster Club Fees Rise (Mar 2005);  An Upside-Down View (Mar 2005);   The Worst of Both Worlds (Mar 2005);  Octathlon 2005: Accenture Wins (Mar 2005);  IBM Global Services: Smaller, Shorter - Better? (Mar 2005);  IBM 5-yr Forecast: Quality over Quantity (Mar 2005); Rumor Lifts EDS', Fujitsu's Shares (Mar 2005); Capgemini: Turning the Corner (Feb 2005);  IBM Servers to Grow Again (Feb 2005);  Carly's Fickle Fans (Feb 2005);  CSC: Gearing Down on Purpose (Feb 2005);  EDS: Grossly Overpriced Stock (Feb 2005);  IBM Historical Update: 2004 Shot in the Arm (Feb 2005); New HeadTurners Series #1 (Feb 2005); IBM: A Crescendo Finale! (Jan 2005); Accenture: Strong Finish, Better Start (Jan 2005); Annex Coverage 2004: IT Services Dominate (Jan 2005)

2004 IT: EDS: The Titanium Stock (and other Wall Street tales) (Dec 2004); IBM PC: Good Riddance (Dec 2004); Fujitsu: Recovery Continues (Nov 2004);  IBM Server Renaissance (Nov 2004);  HP Hits Home Run (Nov 2004); Capgemini: Revenue, Stock Soars (Nov 2004); EDS: Jordan's Swan Song? (Nov 2004);  To Russia with Love and $ (Oct 2004); IBM: Slow Quarter No Longer (Oct 2004); Accenture: Revenues, Profits Up, Stock Down (Oct 2004); Capgemini: A Takeover Target? (Oct 2004); Sellout of America (Oct 2004); Spy Wars (Sep 2004); Outsourcing Boomerang (Sep 2004); EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004); HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004)IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004);  EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004);  IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)

Or just click on and use "financial engineering" or similar  keywords.

Volume XXI, Annex Newsflash 2005-28
August 16, 2005

Bob Djurdjevic, Editor
(c) Copyright 2005 by Annex Research, Inc. All rights reserved.

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