HP Scuttles TouchPad, Reveals PSG Spin-Off Plan In Wild Q3 Earnings

Hewlett-Packard reported fiscal third-quarter earnings Thursday, and it wouldn't be an exaggeration to call it one of the most seismic events in the Palo Alto, Calif.-based vendor's history.

One central theme from the conference call is that CEO Leo Apotheker is stepping up his efforts to remake HP into a leaner, meaner purveyor of IT services, software and hardware. As part of this transformation, HP is exploring a potential spin-off or sale of its Personal Systems Group, although Apotheker said such a move would likely take 12 to 18 months -- if it happens at all.

"HP's board and management team are looking at all strategic options," Apotheker said in a Q&A after the call. "Over time, our decision will crystallize over what do to with PSG going forward, and that's all I can say right now."

In a decision that shocked many HP channel partners, the company has decided to kill off the HP TouchPad just over six weeks after its launch. HP is also discontinuing its other WebOS hardware products, the Veer and Pre3 smartphones.

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There were plenty of other surprises in the Q3 call, including HP's $10.3 billion acquisition of Autonomy, a developer of information management and infrastructure software, and HP's appointment of John Visentin, who previously ran HP Enterprise Services for the Americas, as executive vice president of HP Enterprise Services.

"It is indeed a lot of news," HP CEO Leo Apotheker said.

For the quarter ended July 31, HP reported earnings of $1.93 billion, or 93 cents per share, up 9 percent, from $1.77 billion, or 75 cents per share, from the year-before period. The company posted revenue of $31.2 billion, compared to $30.7 billion during last year's third quarter. Wall Street analysts were expecting $1.09 a share and revenue of $34 billion.

PSG division revenue was $9.6 billion in the third quarter, down 3 percent year-over-year. Although HP's commercial PC sales grew 9 percent, consumer PC sales fell 17 percent, compared to a 23 percent drop in the second quarter.

Sales from WebOS hardware came in at $266 million, but the unit reported an operating loss of $332 million and HP took a 5 cents per share charge as a result. HP CFO Cathie Lesjak said the shortfall would have been even greater in the fourth quarter if HP hadn't made the decision to stop making hardware.

Although HP executives have spoken in bold terms about the possibilities of WebOS, HP evidently realized that Apple's sleeper hold on the tablet market would be difficult to overcome. "Our intention was to solidify WebOS as a clear number two in the market, but we were unable to achieve our target," said Lesjak.

HP plans to shutter its WebOS hardware business before the fourth calendar quarter begins in October. "The reality is that the TouchPad has not been gaining enough traction in the market," Apotheker said.

Next: The Situation In HP's ESSN Business

However, HP apparently still believes there could be opportunities for it to license WebOS to third parties.

"WebOS has been received very well -- developers like it and users like it," Apotheker said. "We are looking at all our strategic options regarding the software."

HP's Enterprise Servers, Storage and Networking (ESSN) business, which has boomed in the past few quarters, saw revenue grow 7 percent year-over year but drop nearly 3 percent from last quarter. ESSN's profit dropped one percent year-over-year and 8.75 percent from last quarter.

Within ESSN, Business Critical Systems sales grew 9 percent year-over-year and 16 percent sequentially, while switching and routing product sales jumped 18 percent. However, Apotheker said HP is still dealing with fallout from Oracle's decision in March to drop Itanium development.

"Our ability to close deals is being impacted by Oracle's decision, and orders are being canceled," Apotheker said in the call.

In the third quarter, HP's Services business revenue grew 3.6 percent, but profit dropped 11 percent. HP is in the process of transforming its services business with a view toward higher-margin deals, and Apotheker described this as "a four- to six-quarter journey".

HP's application services business revenue grew 2 percent year-over-year and Apotheker pointed to application modernization, security and private cloud services are specific areas of strength. "We continue to gain strong traction with our Cloud [Discovery] Workshops," he said.

HP's Imaging and Printing Group faces revenue and margin challenges as a result of the March earthquake in Japan, which is still contributing to laser toner shortages in HP's supply chain. IPG's third-quarter revenue was $6.1 billion, down one percent year-over-year, and operating margin was 14.7 percent.

HP lowered its guidance for the third straight quarter, a move Apotheker said was calculated to reflect the challenges HP is facing. "We don't take this action lightly, and we know investors don't like being put in this position," Apotheker said.

For HP's fourth quarter, the company is forecasting revenue of $32.1 billion to $32.5 billion and non-GAAP EPS of $1.12 to $1.16. For its 2011 fiscal year, HP expects revenue of $127.2 billion to $127.6 billion and non-GAAP diluted earnings per share of $4.82 to $4.86