Hewlett-Packard Propped By EDS

Hewlett-Packard (HPQ) third quarter revenue and adjusted EPS were slightly above the Zacks Consensus Estimate of $27.3 billion and 90 cents, respectively.

Revenue came in at $27.5 billion, a decrease of 2.1% over the $28.0 billion reported in the year-ago period but up 4.0% when adjusted for currency fluctuations. Pro forma EPS was 91 cents versus 86 cents in the year-ago quarter. EPS exceeded the high end of the company’s guided range of 88 to 90 cents.

Revenue fell across all businesses, including servers and data storage systems, software, PCs, printers and ink supplies due to weakening demand for computers and printers, particularly in Europe, partially offset by strong results in the Technology Solutions Group. This group represents more than half of total profits, highlighting the strength in services. The company continued to win significant deals in both the telecommunications and manufacturing sectors.

Operating expenses (both R&D and SG&A) were down 13.4% from the year-ago quarter. Driven by strong expense management and a solid contribution from services, non-GAAP operating margin for the quarter increased to 10.8% from 9.8% in the year-ago quarter.

The quarter benefited from double-digit revenue growth in China. While revenue from the U.S. remained stable, there was some softness in Europe. Geographically, revenue grew 8.0% in the Americas, fell 12.0% in Europe, the Middle East and Africa (EMEA), and fell 4.0% in the Asia-Pacific.

Results and Analysis by Segment

By segment, the Technology Solutions Group (TSG) group was up 27.1% year over year. Under TSG, Enterprise Storage and Servers (ESS) revenue was down 22.8% year-over-year with declines across each of its three business units - Industry Standard Servers, Business Critical Systems and Storage.

Services revenue increased 93.1% year over year. This outstanding growth was the result of the addition of EDS’ revenue. EDS’ integration was ahead of the company’s plan.

HP Software revenue fell 22.0% year-over-year with decline in both the Business Technology Optimization (BTO) portfolio and other software. The company experienced strong demand for its ProLiant servers and continued to gain share the x86 servers.

Personal Systems Group (PSG) revenue fell 17.8% year over year despite improvement in consumer spending, strength in China and a 2% year-over-year increase in unit shipments. The company maintained the leading market position in PCs in every region, although it continues to face pricing pressure on all fronts. Notebook unit growth of 19.0% was offset by desktop systems decline of 13.0%. Average selling prices declined more steeply this quarter due to product mix, competitive pressures and currency impact.

Imaging and Printing Group (IPG) continued to struggle as revenue fell 19.6% year over year. Both ink supplies and hardware posted double-digit declines. We believe the segment has come under pressure due to high competition from cheaper brands. Printer unit shipments decreased 23.0%, with Consumer printer hardware units down 16.0% and Commercial printer hardware units down 16.0%.

Outlook Better than Expected

Hewlett-Packard’s EPS guidance was well above the Zacks Consensus Estimate of $1.07 for the fourth quarter and $3.76 for the full year.

For the fourth quarter, the company expects revenue to be up approximately 8% sequentially. Non-GAAP diluted EPS is expected to be approximately $1.12. For the full year 2009, the company reaffirmed its guidance, estimating a revenue decline of approximately 4.0% to 5.0% from 2008, including an unfavorable impact from currency exchange rates of approximately 6 to 7 percentage points.

Non-GAAP EPS is expected to be approximately $3.76 to $3.88, representing a growth of 4% to 7%. In addition, management expects to face top line pressure due to the continuing weakness in Europe and the competitive pricing.

Remain Neutral

Hewlett-Packard’s closest rival International Business Machines (IBM) reported better-than-expected earnings and raised its full year guidance. Cisco Systems (CSCO) and Apple (AAPL) also reported positive results. We are confident about Hewlett-Packard’s performance going forward as demand is stabilizing and its cyclical businesses (particularly consumer PC) are rebounding.

However, we remain concerned about the long-term growth prospects for the company’s printing unit and continued pricing pressure which may lead to erosion of profits. Thus, we maintain our Neutral rating on the stock.

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