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OEM earnings roundup: Unpacking a quarter of ‘record growth’

OEMs boasted revenue and profit gains in the first calendar quarter of 2021

“Record growth” was a frequently repeated phrase over the last week as Dell Technologies, Lenovo, Hewlett Packard Enterprise (HPE) and HP Inc. reported their earnings for the first calendar quarter of 2021. For these major OEMs in the PC and data center hardware space, record gains in revenue and profitability have been hard to come by in recent years due to several factors including slowed PC refresh cycles, stiff competition from cloud offerings, component shortages, and uncertainty about the  pandemic’s impact on businesses and consumers.

For all these reasons, it was a pleasant surprise to witness a series of positive earnings announcements. But as one company after the next reported breaking multiple growth records in revenue and/or profit, it led me to wonder the degree to which business growth was based on increased economic stability rather than major changes in the OEM’s go-to-market approach.

Comparing first quarter revenue figures from the last two years provides a good snapshot of how the hardware market has changed since the world was immersed in the COVID-19 pandemic. For Dell Technologies, HP Inc. and HPE, the earnings reported in the first quarter represent revenue from February to April. Looking back to 2020, this represents the time frame when many countries imposed lockdowns. Lenovo’s earnings time frame is slightly different — reporting on revenue from January through March — but remains a good comparison, particularly as Lenovo may have felt the pandemic impacts earlier than peers as a China-based company, especially given that Lenovo has a manufacturing facility in Wuhan.

All vendors but Dell Technologies saw a first quarter corporate revenue decline of at least $1 billion in 1Q20 compared to 1Q19. In 1Q21 all vendors exceeded their revenue levels from the start of the pandemic, and three of the four grew revenue by $1.9 billion to $3.9 billion compared to 1Q19. This is impressive revenue growth for these vendors operating in mature and, in some cases, declining market segments. But are all business units growing equally? The fact that HPE was the only vendor of the four to not grow revenue in 1Q21 compared to 1Q19 and is also the only vendor in the compare lacking a PC business suggests growth is not consistent across hardware segments.

PCs are the driving force in the revenue rebound

Demand for both consumer and commercial PCs has been strong throughout the pandemic as many people spent an increasing amount of screen time at home for work, school and socialization. Dell Technologies, Lenovo and HP Inc. have not only reported 1Q21 revenue gains of billions of dollars compared to 1Q20, but the OEMs’ revenue is also up significantly compared to 1Q19. In addition to pandemic-related demand for PCs, silicon supply shortages have also helped to stem the race to the bottom for PC prices. With limited chip supply available, Intel and peers have focused on producing higher-end chips for premium devices. OEMs are also less competitive on pricing while demand outweighs supply. Improving selling prices and shifting toward premium PCs benefit not only revenue but also profitability.

Data center is still not immune to the impact of cloud migration

OEMs’ data center business units tell a different story. While the three vendors all reported increased year-to-year revenue in 1Q21, both Dell Technologies’ and HPE’s data center revenues are down compared to 1Q19. This suggests that year-to-year revenue gains represent customers showing less pandemic-related spending hesitancy and resuming delayed data center projects, while declines compared to 1Q19 align to the overall trend of enterprise data center consolidation in favor of public cloud. Although with the smallest data center revenue base, Lenovo was the only vendor in the comparison that increased revenue from 1Q19 to 1Q21, possibly buoyed by its Cloud Service Provider customer segment, which has higher demand for data center infrastructure compared to the enterprise segment. Overall, the revenue trends suggest that a favorable year-to-year compare may be masking impacts of public cloud adoption, which have accelerated through the pandemic.

Looking ahead to the remainder of 2021, TBR expects the trend of favorable year-to-year compares to continue for hardware vendors as businesses gain confidence in resuming IT spend. Profitability will likely also remain strong as supply constraints on chips will lead to price premiums and a focus on selling high-end devices. The data center space will likely continue to benefit from pent-up demand, but will be offset to some degree by the ongoing trend of public cloud and SaaS adoption, leaving PCs to drive the largest OEM revenue increases in 2021.

COVID-19 dealt only a glancing blow to federal IT, but market dynamics are still shifting

COVID-19 will accelerate a range of secular trends in federal IT

Despite the inevitable short-term impact of COVID-19 on federal technology outlays, IT infrastructure modernization will eventually return to the top of the list of federal IT spending priorities, as will investments in cybersecurity, analytics, AI, big data, cloud and machine learning. The epidemic will disrupt contract delivery, create resource deployment challenges at federal IT vendors and their agency clients, and may cause nonhealth-related discretionary spending to be redirected to healthcare areas, benefiting vendors such as Leidos, Accenture Federal Services, Maximus and ManTech (Nasdaq: MANT).

As federal agencies transition large portions of their workforces to remote environments IT infrastructure improvements and migrations to cloud and everything “as a Service” will follow, along with projects to improve private networks and broadband connections and engagements to enhance security requirements as the “threat surface” exposed to new security breaches expands. Federal IT decision makers are increasingly seeking methods of combating COVID-19 that have been proved in the commercial sector.

Federal spending levels are expected to increase on preparedness and response activities and other disaster recovery or mitigation work in the fiscal 2021 budget, with a growing volume of IT modernization opportunities around disease surveillance improvement, including the implementation of new IT systems and advanced analytics. Still, the overall landscape for products and services to counter biothreats remains unclear and federal IT vendors will be tapped to provide the vision and road map for the adoption of biothreat surveillance solutions. Spending on electronic warfare, countering drones and unmanned systems and other areas of the National Defense Strategy will remain strong for the next two years and in fact may expand to include bio-monitoring and bio-surveillance technologies.

Most of the results from the 1Q20 earnings season are in, and federal technology contractors have provided initial reactions to the impact of the coronavirus pandemic on their fiscal performance and their outlook for federal fiscal 2020 and beyond. By and large, the fiscal effects of COVID-19 were limited to the final few weeks of the quarter, according to a plurality of federal IT vendors, minimizing the top- and bottom-line impacts for most federal technology contractors. Negative impacts were most concentrated in the global aerospace sector, and as such, companies with a footprint in commercial or government aeronautics encountered severe growth and margin headwinds. However, all federal contractors had to scramble to acclimate resource management, operations, service delivery, business development and supply chain management strategies to the new COVID-19 environment.

COVID-19 earnings impact review: Early warnings

Early earnings indicators reveal ICT vendor ‘new normal’

The reality of COVID-19’s impact potential is clear. You do not have to be an analyst by trade to understand the pandemic will create new normals in our personal and professional lives, disrupting entire business sectors, including ICT, in the process. What remains unclear in many respects, however, is the quantification of that impact.

As of the publication of this report, approximately half of the vendors that TBR authors dedicated quarterly or semiannual reports on have released their 1Q20 earnings results. While earnings announcements and presentations are still rife with uncertainty, these releases, plus TBR’s ongoing vendor-centric financial modeling, provide some indicators of how to quantify the impacts yet to come.

Beginning with this report and continuing through this quarter’s earnings and benchmarking cycle, we will be aggregating some of our financial modeling data across our upcoming reports to assess the current state impact of COVID-19 on vendor performance and to predict next quarter and full-year outcomes.

TBR’s advice to vendors: Get predictive about benchmarking

These early results suggest the industry will be split on how to best set business performance expectations in the current environment but will increasingly err on the side of caution in terms of predicting the future. Stalwarts yet to release, such as Dell Technologies and Hewlett Packard Enterprise (NYSE: HPE), have already announced that they, too, will suspend financial guidance. Now more than ever, understanding the trajectory of the ICT vendor peer ecosystem and aligning on industry best practices to navigate the effects of COVID-19 is critical for ICT players. Building, maintaining and updating line-of-business financial models on competitors enables vendors to better benchmark performance, predict quarterly and annual outcomes, and deploy tactics to optimize performance. Vendors should look at the context of peers’ earnings announcements for clues — while many are “going dark” in terms of providing revenue guidance, rich discussions are occurring in earnings calls regarding resource utilization, portfolio management, sales and go-to-market alignment that can be tapped for vendor insight to infuse into practices

In addition to this report, we are writing and reporting in depth on the COVID-19 impact in a dedicated special report series, webinars and our regular published analysis as vendors release earnings. Our published content is regularly updated on TBR’s website and can also be accessed through our client portals.

Investments in acquisitions and startups enrich Capgemini’s next-generation solutions portfolio and improve its competitive position

Capgemini has taken multiple steps to enhance its portfolio to drive transformations through next-generation technologies and create business value for clients. The acquisition of Altran to deliver digital transformation in the industrial sector, enhanced relationships with Microsoft around Microsoft Azure solutions and with SAP around certification of industry innovation accelerators in manufacturing and retail, and investment in startups and joint commercial activities exemplify Capgemini’s recent activities to advance its competitive position,” said Senior Analyst Elitsa Bakalova. “Offering deep industry expertise improves Capgemini’s ability to address clients’ business-specific challenges. The company will continue to experience momentum in cloud services, with cloud revenue driven by offerings in the Capgemini Cloud Platform portfolio that support clients when building, migrating and managing applications and infrastructures in cloud environments. Offering each client its entire portfolio of solutions enables Capgemini to provide holistic transformational solutions and effectively compete with peers. The expanded partnership with Microsoft around Microsoft Azure solutions will enable Capgemini to increase cloud professional services activities, especially around cloud application development and maintenance.”

Additional assessments publishing this week from our analyst teams

Apple continues to pursue both service and hardware initiatives to maintain growth. The company is leveraging services and its wide install base to grow continuous revenue streams as device refresh activity wanes amid lengthening device life cycles and slowing hardware advances. While services are growing as a cornerstone strategy for Apple, the company also remains focused on maintaining its market perception as the most advanced smartphone producer. TBR expects the iPhone 11, which is slated to be released later in 2019, to have steady sales, but Apple will likely not see breakout sales like that of the iPhone X until the release of the 2020 model, which will deliver larger hardware upgrades such as 5G enablement. — Dan Callahan, Analyst

Google doubled its revenue over the past six quarters, surpassing $2 billion in 2Q19 as the vendor migrates customers to Google Cloud Platform (GCP) and attains particularly strong revenue growth from selling analytics. Google’s PaaS business will continue to drive revenue growth as enterprises integrate their hybrid environment with Anthos and leverage Google’s analytics, AI and machine learning offerings. In addition, Google supplements growth with G Suite as the company’s growing sales base brings industry-specific versions of the collaboration suite to market and cross-sells G Suite into GCP-oriented customer engagements. — Jack McElwee, Research Analyst

Cognizant has reworked its corporate strategy to emphasize the criticality of digital technologies to its growth plans. Pursuing acquisitions, such as that of Meritsoft, enables Cognizant to diversify its revenue mix, fostering new sources of digital revenues within key verticals. We expect Cognizant will maintain steady revenue growth year-to-year, largely led by demand around its digital operations capabilities.    — Kelly Lesiczka, Analyst

An integrated sales structure, paired with investments in price-competitive AI solutions and on-site presence, will help Infosys transform its brand identity. At the same time as Infosys builds a healthy pipeline, the company may need to calibrate stakeholders’ expectations around margins to sustain trust. — Boz Hristov, Senior Analyst

Reinforcing Verizon’s reputation as a premium wireless service provider will be essential for the operator to sustain revenue growth in the 5G era, as competitive pressures from T-Mobile will intensify, especially given the pending Sprint merger. Though Verizon will continue to trail T-Mobile in postpaid phone net additions over the next several years, Verizon will be able to sustain revenue growth by attracting customers willing to pay a higher price for the operator’s network coverage and premium unlimited data plans. Steve Vachon, Analyst

Sprint continues to undercut its rivals as the operator remains reliant on competitive pricing to attract subscribers given its subpar network coverage, though the company is moving away from more aggressive promotions, such as its previous Cut Your Bill in Half offer, to improve average revenue per user (ARPU). Sprint will continue to struggle to balance ARPU and subscriber growth, however, as many customers are unwilling to pay higher prices for the company’s network quality and Sprint is experiencing high churn rates from customers rolling off promotional pricing offers. — Steve Vachon

Public sector IT services spotlight: The U.S. federal earnings season continues the week of July 29 with three services-led defense contractors — Booz Allen Hamilton (BAH), Leidos and ManTech — releasing their fiscal results for the second calendar quarter of 2019.

As reported on Monday, July 29, Booz Allen Hamilton delivered 10.8% year-to-year growth during 2Q19, the first quarter of its fiscal 2020, and 100% of BAH’s growth was organic as the company continues to eschew acquisitions. BAH’s strong performance in 2Q19 reflects how ideally positioned the company is to serve its federal clientele, as well as a growing number of commercial entities, with a high-value, differentiated solutions suite spanning the strategy, mission and critical IT needs of public and private sector clients alike. As a result of its strong 2Q19 year-to-year growth, BAH is also likely to be the top-performing organic growth vendor in TBR’s upcoming 2Q19 Public Sector IT Services Benchmark (publishing in early October). BAH’s growth and margin performance (operating margin of 9.8%) in 2Q19 mostly outstripped that of the trio of federal competitors that released 2Q19 earnings and fiscal performance last week: Raytheon (YTY growth of 5.3%; operating margin of 9.1%); General Dynamics Information Technology (YTY contraction of 11.6%; operating margin of 7.1%); and Northrop Grumman Technology Services (YTY contraction of 0.4%; operating margin of 10.8%). We believe BAH’s performance relates directly to its solution set, which sits at the juncture of federal agency IT and mission objectives with a differentiating blend of consulting, technology and emerging solutions.           John Caucis, Senior Analyst  

Leidos will release its earnings on Tuesday, July 30, and is expected to post top-line, year-to-year growth of between 5% and 7% to reach about $2.7 billion in 2Q19 revenue. Growth will derive from Leidos’ continued strong pace of new awards, net increases in volume across several high-profile programs, and improving win rates, which are accelerating the conversion of pipeline opportunities into bookings and revenue. Leidos should also be able to offset the wind-down of existing programs and some limited currency headwinds from unfavorable swings in the U.S. dollar. The company has guided for 2019 revenue of between $10.5 billion and $10.9 billion, implying a median 5% growth rate, and record backlog levels achieved in prior quarters positions Leidos well to achieve its projections. — John Caucis  

Finally, ManTech will release its 2Q19 fiscal performance and earnings after business hours on Wednesday, July 31. ManTech’s latest strategic acquisition (Kforce Government Solutions, or KGS) will add roughly $100 million in new revenue and expand ManTech’s opportunity set in the federal civilian segment, augmenting robust Department of Defense (DOD) and intelligence growth while inorganically boosting ManTech’s top-line growth (projected to be between 6% and 8% in 2Q19). ManTech’s top-line growth in 2Q19 should be significantly augmented by the KGS acquisition, as the purchase closed in April and immediately began to contribute inorganic revenue to ManTech’s top line. On an organic basis, classified customers continue to accelerate spend with ManTech, while spending on behalf of ManTech’s principal DOD and Intelligence Community clients continues trending upward. Prior to the KGS acquisition, ManTech tendered a 2019 outlook for full-year 2019 revenue of between $2.05 billion and $2.15 billion, implying growth of between 4.7% and 9.8% over FY18 revenue of $1.96 billion. KGS is expected to contribute between $60 million and $80 million in inorganic revenue during the latter nine months of FY19; this compelled ManTech to elevate its prior guidance for FY19 revenue to instead reach between $2.13 billion and $2.21 billion, implying growth of between 8.8% and 12.8% over FY18. — John Caucis