While most companies are busy telling us how they did in Q3 2006, one computer maker is ahead of the curve, ready to wrap up this year and move on to the next. On Thursday, Hewlett-Packard (NYSE:HPQ), the newly crowned biggest computer maker in the world by units shipped, reports its fiscal Q4 and full-year 2006 earnings.

What analysts say:

  • Buy, sell, or waffle? Of the 28 analysts following HP, 15 of them rate the stock a buy, 10 a hold, and three a sell.
  • Revenues. On average, they expect to see 5% sales improvement to $24.1 billion.
  • Earnings. Profits are predicted to rise 25% to $0.61 per share.

What management says:
Most of what HP has been saying this quarter has been variations on "you're fired" and "you can't fire me, I quit." In September, general counsel Ann Baskins and Board Chairman Patricia Dunn both lost their jobs over the scandal that erupted over HP's botched leak investigation. Presumably, there's been other news at HP this quarter, but it's hard to hear it over the roar of scandal.

Before this fiasco arrived, however, things had been going just swell. In the Q2 earnings release, management reported turning a 5% rise in sales (versus last year's Q2) into a 15-fold increase in profits per diluted share, and a whopping $2 billion in free cash flow. And over the noise of the scandal, the company's prediction of $24.1 billion in fourth-quarter revenues and $0.58 per share in net profits (the analysts' figure appears to be a pro forma number) still rings clear.

What management does:
How does a company turn a mid-single-digit rise in sales into a 15-fold increase in profits? By increasing the profitability of each of those sales. HP has been expanding its rolling gross and operating margins steadily over the past 18 months. Down on the net line, things look a bit wobblier, but that's mainly been caused by one-time charges, such as the $1.3 billion restructuring hit the company took in the quarter ended in October 2005. The important thing to note here is that operationally, HP is doing just fine.

Margins %




























All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

One Fool says:
So HP is expanding its margins -- that much is clear. But how, exactly, is it doing this? By growing its sales faster than the cost of goods sold and cutting costs of operation. Year to date, HP's sales climbed by the same 5% that analysts, and the company itself, predict we'll see in Thursday's news. Meanwhile, cost of goods sold rose only 3%, and selling, general, and administrative expenditures actually declined 3%. That explains why the 40-basis-point improvement in HP's gross not only passed down in full to the operating profitability line above, but actually expanded to a 60-basis-point improvement.

The story isn't quite as good over on the balance sheet, however. There, we see inventories and accounts receivable both growing faster than sales -- up 8% apiece year to date. In Thursday's news, we'll therefore be focusing on two things. First, we'll look at how badly the boardroom brouhaha has damaged margins. Presumably, all sorts of lawyers sent HP all sorts of bills this quarter, and that won't be good for operating profit. Then, over on the balance sheet, we'll look for evidence that HP is keeping its inventories in check and collecting more of its bills on time. Tune in next time for the details.


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Fool contributorRich Smithdoes not own shares of any company named above. The Fool has a disclosure policy.