Thursday, December 27, 2012

HP 2012 10-K: First Impressions

HP's 10-K for the fiscal year ended October 31, 2012 just came through their Investor Relations site. Weighing in at 223 pages, it isn't a svelte document by any means, so my first reading took me to certain sections where I was looking to get impressions about specific issues.  My pencil and green eye shade were put away for another day.

The document's prose, tone and organization show the hands of new authors, whether internal or external, including additional outside counsel.  It also looks like important parts were written fresh to reflect what the management saw before 2012, the developments in 2012, and some realistic risk assessment about the future.

So, in order of reading the document, here are some things I found noteworthy:

  1. "We also began working to optimize our supply chain... During fiscal 2013, we will be focused on working through the anticipated disruptions expected to accompany the changes made in fiscal 2012 and continuing to implement our cost reduction and operational initiatives."  I presume that the anticipated disruptions, a rather strong phrase, apply to the supply chain optimization.  I'm curious what this means and how it might affect results, given that these risks were called out.
  2. I was encouraged to see a specific reference to the need to "rebuild relationships with channel partners."  The discussion about channel partners, their business models, and the impacts on HP's working capital is a good reminder of how HP's products come to market.  
  3. 29,000 employees will exit the company by the end of 2014.  Much of this will take place in national jurisdictions that make labor reductions difficult, and there was a comment I appreciated about the need to maintain morale within the remaining work force.  These are not issues to be glossed over if the company is going to succeed. 
  4. The Oracle issue continues to be problematic.  There is a clear reference to Oracle as an alliance partner that competes in the server market, and which also in the second quarter of 2011 stopped developing new software for the HP Itanium server product line.  Although HP won a court judgment against Oracle's tactics, the effect on HP customers has led to their delaying and canceling orders.  Although this was discussed during 2012 quarters, it is clearly still a risk going forward the way the disclosure is written.  It is even a risk of spilling over to other alliance partnerships. where the partners may be lured to competitors.  
  5. Margins in the printer cartridge business will come under pressure in Asia, where intellectual property rights are not held in the same judicial esteem as they are in the West. The CEO in one of the 2012 quarters talked about the IP surrounding the printer ink business.  She vowed that HP would defend this IP aggressively.  This must have been the markets to which she was alluding, but if this threat is to be staunched, then courts will not have a great bang for the buck.  
  6. There is a risk factor identified as copyright levies issued against the company in Europe.  I didn't understand what this referred to, but it doesn't remind me of historical boilerplate language. 
  7. Given what happened with Autonomy and the almost inevitable need to take stakes in, or acquire companies, this disclosure language was troubling, "Our ability to conduct due diligence with respect to business combinations and investment transactions, and our ability to evaluate the results of such due diligence is dependent upon the veracity and completeness of statements and disclosures made and actions taken third parties or their representatives.  
  8. "Our due diligence process may fail to identify significant issues with the acquired company's product quality, financial disclosures,accounting practices or internal control deficiencies."
  9. The underlined part of bullet point 7 is written partly to be consistent with the allegations made against Deloitte and KPMG with respect to actions against them and Autonomy in Britain and in the United States.  If one reads this statement literally, it makes HP executives and management seem incompetent.  Astute buy side analysts and their advisers independently and aggressively peel away financial statements prepared by others in order to take long and short positions.  Surely, HP doesn't need to depend on others to the extent they claim.  
  10. Looking at bullet point 8, if the due diligence process is that weak, it probably was weaker in the past two years when big acquisitions were made and written down.  Surely this would manifest itself somewhere as significant deficiencies in the system of internal controls over financial assets. No such weaknesses are identified in the certifications.  This is very disappointing to see.  
  11. I had to laugh when I read that a $1.2 billion charge was taken in the third quarter of 2012 to adjust the balance sheet value of the "Compaq" trade name.  No kidding--it was carried at $1.2 billion?  I'd like to see that valuation model.  
  12. In the fourth quarter of 2012, a two stage test was applied to remaining intangible assets and it is strongly suggested that further write downs will not be necessary.
  13. The implied control premia for each major business segment are the "fudge factors" that make the assertions in bullet point 12 work.
  14. What remains of Autonomy is now in the Software segment, under the executive management of Abdo George Kadifa, which seems like it is in good hands to me. If I recall, Kadifa reports directly to the CEO. 
Enough staring at screens for now.  Good reading!  

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