More Cost Cutting Ahead From HP, Services Group A Key Focus

The question is whether it will be enough to satisfy some analysts frustrated with the company's performance. HP CFO and Interim CEO Bob Wayman and other executives faced tough questioning from analysts in a conference call after the computer giant posted better than expected results for its first fiscal quarter ended Jan. 31. (HP earnings details.)

The Palo Alto, Calif., vendor took a $60 million charge in the quarter related to layoffs of more than 600 employees, said Wayman. CRN previously reported that a number of HP direct sales account reps were laid off last week. One source close to HP said many as 2,000 employees were let go.

Wayman said the layoff charges will be a lot larger than $60 million in the current quarter with a heavy focus on cuts in HP's Technology Solutions and Services Group. HP has already said in a Security and Exchange Commission filing that it has budgeted about $200 million in expenses for workforce reductions for the first half of its fiscal 2005, which began Nov. 1.

The $60 million charge in the first quarter amounted to $33 million for reductions in the Enterprise Servers and Storage (ESS) business and $26 million in the Services business, said HP Technology Solutions Group Executive Vice President Ann Livermore.

For the current quarter, Livermore said the cuts will be more skewed to HP services. She said that 60 percent of the cuts in the current quarter will come from the services business. Livermore said she sees continued "very aggressive pricing in the services industry."

Livermore said she expects to make adjustments as necessary with workforce reductions and expense structure along with using technology to help the company deliver services. "We are going to continue to do whatever we have to on the cost reductions both in the delivery cost as well as the op-ex (operating expense) cost to hit the goals that we have," she said.

Livermore said that margin pressure is also coming in the Technology Solutions Group from a shift from proprietary HP Unix and high end non-stop systems toward industry standard servers and networking. Industry standard servers accounted for 58 percent of the HP's ESS portfolio, up from 53 percent in the year ago quarter.

Commenting on the ESS business, Sanford Bernstein analyst Toni Sacconaghi questioned if the cuts were deep enough. "Given what appears to be a pretty significant gross margin deterioration year over year (in enterprise servers and storage), how do you ever get ahead of this? " Sacconaghi asked Livermore. "How is it realistic to believe you are going to get ahead of this mix shift particularly with what appears to be quite frankly a relatively light workforce reductions."

Among the steps HP is taking to increase gross margin for servers and storage is to implement pricing and discount controls and increase attach rates along with a push to sell more profitable configurations and higher margin Unix system, blade servers and storage solutions.

Livermore noted that when HP sells direct in the ESS business it is a five point gross margin advantage. She sees an upside in the direct business particularly in Asia Pacific and Europe, Middle East and Africa.

Overall, HP's Enterprise Storage and Server group posted operating profit of $71 million for the first quarter (1.8 percent of revenue), down from $153 million in the year ago quarter. ESS sales for the first quarter were $4.0 billion, up nine percent from the year ago quarter. On a year-over-year basis, industry-standard server revenue increased 19 percent and business-critical systems (BCS) revenue declined 2 percent. Within BCS, HP-UX revenue growth of 3 percent year-over-year was more than offset by NonStop system declines of 19 percent and ongoing declines in AlphaServer sales.

Livermore said she anticipates continued intense pricing in the storage business. That said, she noted that the company is looking forward to a refresh of its EVA storage arrays in May.

What's more, she said, HP has seen continued improvement in the storage business performance. For example, she said, HP storage revenue was down one percent in the first quarter compared with the year ago period, an improvement from a 10 percent fall off in the fourth quarter and 15 percent in the third quarter. "We are on a trajectory there to build back revenue," she said.

For its first fiscal quarter ended Jan. 31, HP posted an operating profit of $1.3 billion, or 37 cents a share, for the quarter, on a 10 percent increase in sales to $21.5 billion. The Wall Street consensus was earnings per share of 34 cents on sales of $20.96 billion, according to a survey of analysts by Thomson Financial/First Call. The earnings announcement comes just one week after the HP board of directors dismissed the high-profile Carly Fiorina as chairman and CEO.