The economy's loss appears to be HP's gain

by Scott M. Fulton, III

Typically a "recession" is defined by two successive periods of negative growth. But wherever that recession may be taking place must be another planet, from HP's perspective, as it has yet to see even one such period in the Mark Hurd era.

It's the type of quarterly report that makes one ask the increasingly pertinent question, "Carly who?" In an unequivocal validation of its re-invention strategy under CEO Mark Hurd, Hewlett-Packard last night posted fabulous numbers, earning way more than it has before on seasonally weaker, though still very strong, revenue.

How strong? In a presentation graph unveiled yesterday -- whose timeline curiously extends back to the beginning of Hurd's tenure -- HP showed it's reaping nearly 35% greater revenue today than for its fiscal third quarter three years ago ($28 billion) and that its earnings per share ($0.86) during that same interval was catapulted by some 239%.

Executives' attitudes during yesterday's quarterly conference call -- as evidenced by Thomson Financial's transcript produced for HP (PDF available here), probably resembled more Shawn Johnson than Michael Phelps. They were certainly smiles all around and the requisite grace and humility, but nothing being rubbed in anyone else's face. The word "Dell" was only uttered by a questioner.

"Our cost savings programs allow us to invest in strategic areas such as sales force hiring, software and graphic arts, while expanding our margins at the same time," Hurd told analysts yesterday. "As I mentioned to you last quarter, while we become more efficient, our cost initiatives are significant and ongoing and we expect them to create additional leverage in our operating model."

HP's rate of revenue growth had been slowing down -- in fact, quite dramatically over the past four quarters. But that decline in the growth rate screeched to a halt last quarter, at 10.5% annually. Net earnings for the quarter just ended were at about $2.03 billion, down a tiny fraction over the previous quarter (a very minimal hit on account of seasonality) but a 14% gain over the third quarter of 2007. This while costs and expenses rose by only 9%.

Those expenses will definitely increase next quarter, CFO Cathie Lesjak warned, as the company will begin accounting for charges related to its buyout of EDS. "We expect to close the EDS acquisition by the end of the month and this will result in a substantial cash usage for Q4," Lesjak told analysts.

Executives declined to give hard estimates for the toll this would take on profits. At one point, Hurd deflected a question about whether Q4 earnings could dip below $2 billion.

What's frankly the most astounding element of HP's numbers is the fact that it has done so well despite some obvious weaknesses. Earnings for the Personal Systems Group were up 8% annually, but only to $587 million for the quarter. And the segment of the company to which former CEO Carly Fiorina's "hanging on" strategy was tied -- Imaging and Printing (IPG) -- dangerously nosedived by 15% over the prior year's Q3, to $1.05 billion.

As Lesjak explained, a big part of HP's problem there is the fact that printing has become a commodity market, where manufacturers have lesser freedom to choose prices and influence margins. But an apparent price freefall in that market in previous quarters may be bottoming out, she predicted.

Then as Hurd told analysts, another part of the performance story in that division has to do with how he chooses to fine-tune his company. When some markets are underperforming, he said, he's glad to have the freedom now to invest resources on the fly in other divisions to compensate.

"One of the blessings I think for us -- it could be a curse depending on how you view it -- is that everybody wants to look at every single segment every single quarter for their optimal performance," said HP's CEO. "And the reality is we do at times turn this up higher and turn this one down lower because of what we see in the market. The result gives us an opportunity to we think have a pretty strong integrated story overall."

Later, Hurd added, "When we see very low-end units that we believe have very low, long-term contract rates of supplies and we see an ultra aggressive pricing environment, we may choose for a period of time not to compete and reinvest those dollars in some other part of the market, either...in IPG or some other place in the company. So...we try to optimize our portfolio, and...the breadth of that portfolio and the number of markets that we can compete in gives us a lot of options."

Come next quarter, another of those options will be EDS, a tremendous expansion to HP's services business which has already been perceived as very strong. If the global economy's really in tumult right now, HP appears to have built a diversified formula for navigating these rough waters, and its performance thus far is, without a doubt, impressive.

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