Tuesday, February 26, 2013

HP's First Quarter: A Deposit on 2013 Projections

Hewlett-Packard's fiscal first quarter 2013 was a "beat," but only against the company's own Sad Sack  guidance for the quarter: non-GAAP EPS were $0.82 compared to the guidance range  of $0.68-$0.71.  Versus the prior-year period, non-GAAP EPS were $0.82 versus $0.92, a decline of 11 percent.
The non-GAAP pre-tax, operating margin was 7.9% compared to 8.6% in the prior-year period.

A change in the company's segment reporting seemed to chloroform the analysts on the conference call, who took turns asking immaterial and diffuse questions about industry issues like market share and the performance of new printer lines.  For us, the realignment of business units among new segments raises questions and points the way to potential divestitures.

Quarterly revenue of $28.4 billion was down 6% versus the prior-year period and down 4% in constant currency.  Revenue in the Americas was down 3% to $12,8 billion, which seems in line with the October 2012 Analyst Day picture of 2013.  EMEA revenue of $10.3 billion declined by 11 percent and by 9% in constant currency.  Asia-Pacific revenue of $5.2 billion declined by 1 percent both on a reported basis and in constant currency.

The big excitement in the financial press was about cash flow from operations which the company trumpeted as increasing 115% year-over-year, to $2,562 million in the current quarter, compared to $1,193 million in the prior-year period.  At the same time, CEO Whitman repeatedly refused to endorse raising projected full-year 2013 cash flows.  She reined in analysts by characterizing this apparent significant outperformance as a "deposit" on the company's guidance for 2013.

Looking at the statement of cash flows, most of the year-over-year delta comes from a swing in accounts payable and a movement in "Other assets and liabilities."  Unless there is something fundamental going on, this could be simple timing, but it's unclear what's going on in the "Other" category.  Bottom line is that the CFO was encouraging and probably speaks to timing and good cash management.

A bogeyman issue raised in the prior quarter was about a potential $400 million deposit for unpaid tax liabilities in HP's Indian subsidiary.  This wolf turned out to be a sheep.  A $34 million deposit was made in the fiscal first quarter and another $10 million deposit will be made in the second quarter to settle the matter. Perhaps this item was on the balance sheet and accounted for part of the delta in "Other assets and liabilities."

In the quarter, the company returned $511 million to shareholders, comprising $253 million in share repurchases and $258 million in dividends.  19.2 million common shares were repurchased in the quarter at an average price of $13.18.  Finally, some buying for a value-adding return!  We note the CEOs language now describing share repurchases as "offsetting dilution."

We like the balance in the way cash was returned to shareholders in the period.  It is also clear that much of the downsizing and restructuring savings to-date have been reinvested in the business, which is something that we have said is the highest and best use of free cash for shareholders at this juncture.

The new Enterprise Group segment reported revenue of $6,984 million compared to $7,282 million in the prior-year period, a decline of 4.1 percent.  From the recast historical numbers, we know that the $7.3 billion number in the first quarter 2012 contained $2,264 million of Technology Services, which carried a healthy 24.2 percent operating margin compared to an 11.6 percent operating margin for what was called the ESSN segment in 2012.  On the call the CEO mentioned that Technology services reported "strong profitability" in the fiscal first quarter 2013.

This suggests that margin pressures continue in the former ESSN businesses. Overall, the operating margin for the Enterprise Group declined from 18.3 percent in 2012 to 15.5 percent in 2013.  This business clearly is redefining itself as the markets and customers shift their purchasing habits and desired configurations. The CEO mentioned that revenue from converged storage products was up 18 percent year-over-year, including 3PAR products which increased sales 21 percent year-over-year.

Last year, revenue in storage, networking and business critical systems were some $17.2 billion.  The standard server business is under margin pressure, but here too the CEO was optimistic about market share gains in the future.  Sales of standard servers were $12.6 billion in 2012.

Personal Systems revenues declined 7.7 percent year-over-year to $8,204 million in the quarter.  Units sold were down 5 percent and price declined by about 3 percent.  Again, making corporate sales will continue to require personal computing devices, whether in the form of laptops, notebooks, or tablets.  Operating margins declined in this business from 5.2 percent in 2012 to 2.7 percent in 2013.

The CEO clearly rejected any conversation on the call about breaking the company into pieces or divesting large businesses like Personal Systems and Printing.

First quarter sales in Printing were $5,926 million, a decline of 5.3 percent over the prior-year period.  However, operating margins in the Printing business unit increased to 16.1 percent from 12.2 percent, due to a higher mix of supplies versus equipment, as well as higher realizations on ink due to new programs in emerging markets that drove higher volumes, market share and better pricing.  This is certainly encouraging news and speaks of good execution.

The Enterprise Services segment reported revenues of $5,919 million in the quarter, a year-over-decline of
7.1 percent.  The bad news is that the operating margin in this segment fell to a moribund 1.3 percent in 2013 compared to 2.3 percent in the prior-year period.  This segment included $3,701 million in Infrastructure technology outsourcing revenue in 2012's first quarter, which we believe is a commodity business, which is either in a secular low growth phase or at a cyclical low. The rest of this segment is made up of lower margin technology services that amounted to about $2.5 billion in first quarter 2012.  Now this segment is more visible on its own, and its future and fate are more visible for shareholders.

The most interesting comment, in my opinion, was the CEO's reference to resuscitating HP Labs to a primacy of place in the business for pursuit of  big ideas and enriching the patent portfolio.  This is a smart thing to do for a technology company which doesn't want to be left selling legacy products and me-too services.

Software revenue of $5,919 million in the quarter declined by 7.1 percent year-over-year.  One analyst put his finger on the fact that Autonomy revenue was probably down mid-double digits year-over-year, with the core software products growing at mid-single digit rates.  The CEO didn't disavow this estimate, which is logical given the write-downs and the limited scope of Autonomy products ready for production and sale. There were no follow-up questions about Autonomy.

Overall, understanding the CEO's desire to rein in expectations, it was a balanced presentation in the face of confusing comparisons given the short time frame to digest the new segment presentation.  The CEO said specifically, "We still face a long road ahead."  It would have been interesting to hear specifically about why she feels this way, as the road map laid out is becoming clearer.  It is definitely an execution story as 2013 unfolds.

Our proposed playbook looks like it is being run: easing off share buybacks, reinvesting in the business, keeping the portfolio together, pruning it at the margins and stepping up the invention.  An additional important item that would help the CEO would be to bring directors like Marissa Mayer and others on to the board.

No comments: