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HP plans more cost cuts amid EDS buyout

Posted: 22 Aug 2008 ?? ?Print Version ?Bookmark and Share

Keywords:EDS buyout? HP cost cut? services market?

While real estate market is under water, financial companies are reeling and equity market is swooning, Hewlett-Packard Co., under chairman and CEO Mark Hurd, is breezing past financial forecasts and raking up huge profits in all corners of the globe.

Hurd doesn't want HP to rest on its laurels, however. He wants to further reduce HP's overall costs to boost margins even as it completes the integration of Electronic Data Systems Inc. (EDS), which the company is buying to boosts its competitive stance against IBM Corp. in the high-tech services and consulting business.

"Make no mistake about it," Hurd said. "We are going to execute on the EDS acquisition and we are going to bring the strength of HP's operating discipline, the strength of HP's innovation, the strength of HP's position in the marketplace to make a combined business that we think will be quite competitive."

Even now, however, HP did much better than many expected. As if beating analysts' fiscal Q3 revenue estimate by more than half a billion dollars wasn't astonishing enough, the company notes sales for the current quarter would improve approximately 7 percent on both a sequential and y-on-y basis.

And as for that pesky dollar, which continues to gyrate wildly against other major currencies, HP sees some revenue impact but nothing that would derail its net profit expectation.

"As we've seen in the last few weeks, currency rates can be at times volatile," said Catherine Lesjak, VP and chief financial officer of HP, during a conference call with analysts. "If the dollar remains where it is today there will be downward pressure on our revenue but we will be able to come in on our earnings per share range."

Notwithstanding the strength in its operations currently, HP is not immune to problems in the global economy and rivals are targeting its lucrative printer and ink cartridge business, which recorded the slowest growth of the company's business divisions in the latest quarter.

"HP continued its string of earnings per share beats on the back of lower operating expenses," said Kathryn Huberty, an analyst at Morgan Stanley & Co. Inc. "The imaging & printing group was the only segment that missed our revenue and operating income targets, a sign of lengthening lifecycles in the slower macro environment."

Additionally, HP could be headed for its biggest challenge in years as completes the $13.9 billion acquisition of rival EDS within the next few weeks.

The huge transaction, which HP and EDS have assigned about 500 people to work on, could by some estimates drain between $1.5 billion and $2 billion of HP's cash in integration costs over the next couple of quarters.

"We expect to close the EDS acquisition by the end of [August] and this will result in a substantial cash usage for fiscal Q4," said Lesjak who declined to provide an actual estimate.

HP wants to use the EDS acquisition to bolster its high-tech consulting and services business in an effort to improve its competitive position against IBM Corp. The acquisition and successful integration is therefore critical to HP's future revenue and profit growth, according to analysts.

"We believe the acquisition and integration of EDS should help HP manage the macroeconomic storm better than others," said Shaw Wu, an analyst at American Technology Research in a report. "We see room for significant operating leverage, particularly in fiscal 2010, regardless of economic conditions."

Key to future growth
To secure the expected benefits from the EDS acquisition, HP would have to continue successfully managing its current businesses, including the growth-challenged imaging and printing division, further reduce operating costs and seamlessly integrate the new unit.

Many analysts believe HP should be able to orchestrate the successful integration of EDS into its operation. The company declined to provide further details or assessment of the integration during the latest conference call, deferring all questions until its annual financial conference in September.

"The plan is going well and we are confident in the benefits this business combination will bring to customers, partners and shareholders," said chairman and CEO Hurd. "The feedback from the vast majority of the customers that I talk to continues to be extremely positive as they contemplate the power of HP's innovation coupled with EDS' scaled services business."

In the meantime, HP is focusing on continuing to squeeze costs out of its operations. With projected fiscal 2008 revenue of approximately $115 billion, HP believes it still has ample opportunity to further slash costs and boosts margins.

In the latest quarter ended July 31, the company's net income jumped 14 percent to $2 billion, or 80 cents per share, up from $1.8 billion, or 66 cents per share, in the comparable year-ago quarter. Revenue climbed 10 percent during the same period to $28 billion from $25.4 billion.

Gross margin in the fiscal Q3 slid slightly to 24.2 percent from 24.5 percent, reinforcing the company's position it must further tighten up total costs and find ways to protect itself against both currency risks and falling average selling prices.

Hurd said during the conference call that he believes HP's costs, which he defined as revenue minus profits, are more than $100 billion.

The addition of EDS would boost that number strongly, giving the company considerable leveraging power with suppliers and outsourcing contractors in addition to cost reduction opportunities at the corporate, sales and marketing levels.

"We think about that $100 billion worth of costs every single day and how we can make it as efficient as we can to give us the best opportunity to go in the marketplace," Hurd said. "There will never be a day at HP at our scale when we are not trying to work hard to make our processes more efficient and get our cost structure right."

- Bolaji Ojo
EE Times

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