Ovum on: HP Earnings: All Good Things…

by John Madden, principal analyst at Ovum

After a strong year-end finish, HP's recent first-quarter earnings showed how the turbulent economy finally caught up with one of the most fiscally-disciplined IT companies in the market. With year-on-year drops in all lines of business but Services (with EDS), HP is continuing its ongoing cost-savings plan while implementing newer efforts such as company-wide salary reductions. The vendor is counting on these moves, along with customers' increased appetite for cost-efficient outsourcing through EDS, to maintain its balance.

Earnings take a hit, but it could have been worse

Last quarter, HP delivered impressive 4Q08 and FY08 earnings, with guidance for 8–10% growth in its next year. But that was before a brutal period from November through January, when IT spending slowed dramatically – or dried up altogether in some industries. Even with tighter financial controls, streamlined global processes, and a continuing cost-reduction plan that includes cutting 24,700 positions as a result of the EDS acquisition (of which some 9,000 have been eliminated), HP reported a slim 1% revenue increase (4% in constant currency) and a double-digit drop in earnings year-on-year, while estimating a 2–3% revenue decline in the second quarter and a 2–5% full-year decline compared to last year.

While it was clearly HP's toughest financial quarter in years, the reality is it could have been much worse. CEO Mark Hurd and his leadership team had been cracking the whip of fiscal discipline long before the recession forced many other companies to take up such behavior. Even prior to the EDS purchase, when HP reported record revenues, Hurd demanded greater cost justification and controls throughout the company; it just made good business sense.

Unfortunately, factors that helped power HP's impressive growth in the past few years – namely its diversified portfolio and global presence – are proving just as taxing on the bottom line now that the recession has spread to virtually all regions and industries. The numbers tell the story: revenues grew in the Americas 11% (13% in constant currency), but declined 3% (growing 1% when adjusted for currency) in EMEA, and declined 11% (9% adjusted) in Asia-Pacific. HP's Personal Systems, Imaging and Printing, and Enterprise Storage and Servers groups all reported double-digit revenue declines, while HP Software declined 7% year-on-year. Services, meanwhile, was a bright spot (as we detail below). We still see portfolio diversification and global reach as some of HP's strongest assets, and we anticipate HP has developed into a nimble enough company, at least financially, to effectively leverage these characteristics when needed. In fact, Hurd reiterated his commitment to make HP's cost structure even more variable and flexible.

Looking for real synergies with EDS

In recessionary times, the IT companies that best absorb the financial body blows will inevitably be the stronger ones left standing once the global economy rebounds. HP will continue implementing rigorous cost controls and new initiatives such as across-the-board salary reductions to make itself as sturdy as possible (for example, Hurd will take a 20% cut). In addition, HP's success with a full integration of EDS may prove the linchpin to its post-recession track.

HP's Services revenues, primarily due to EDS, increased 116% compared to last year, generating about one-third of the company's total quarterly profit. IT Outsourcing was by far the greatest revenue generator, with $3.9 billion, followed by Application Services with $1.6 billion and BPO with $743 million.

Even with the recession, Hurd said customer response from a HP-EDS combination continues to be positive, although he declined to provide additional details on progress with the EDS integration plan other than to say it remains ahead of schedule. He said HP with EDS is in a position to deliver additional services as customers continue "leaning on cost takeout" in their IT investment plans. We acknowledge that some customers may turn to EDS and its outsourcing capabilities in the name of efficiency, but questions remain around how HP's ongoing EDS integration will deliver the kind of leveraged, full suite of HP hardware, software and services that many expect. Executives from HP's Technology Solutions Group (TSG) – the group that includes EDS – are scheduled to address industry analysts at the end of March, and expectations not surprisingly are running high.

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