Thursday, May 23, 2013

My Biggest Takeaway from the HP Call

Instead of jumping to pushing the pencil through the HP Second Quarter 2013 earnings release, I listened to the conference call, while flipping through the release.  The most notable things I heard had nothing to do with the actual numbers.

In the aftershock of the Apotheker departure and Meg Whitman's coming on board, I wondered on this blog about the strength of the CFO and her ability to turn the CEO and the board away from some of their profligate ways.  On the early calls, which featured the "I'm Meg Whitman.  I've run this playbook before at eBay.  No worries."   I felt the CFO was passive and speculated about her possibly not having a lot of support from a board with a poor performance record.

What I heard on this call was qualitatively different, and that's encouraging. 

To set up the context, revenues in the second quarter were $27.6 billion, down 10%, y/y.  The biggest decline was in Personal Systems, whose revenues declined 20%; non-GAAP operating profits of $239 million dropped by $277 million from the prior-year period, and the non-GAAP operating margin fell 220 basis points to 3.2%. Notebook revenue and units both declined by 24%.  Because of the early release of industry shipment numbers, all of this was discounted, although it is still disconcerting. 

Printing revenue of $6.1 billion declined only 1%.  Non-GAAP operating profit of $958 million increased by $150 million y/y, and the margin rate increased by 260 basis points to 15.8%.  Thus, the Personal Systems Group with $13.7 billion in revenue managed to keeps its non-GAAP operating margin above the prior year by 30 basis points, despite a 12% decline in revenue.  Not bad. 

For those commentators who said that HP should get out of hardware entirely and become a software company, the quarter gave some pause.  Software revenue of $941 million declined by 3% y/y, on a double digit decline in new license revenue, but non-GAAP operating margin was a healthy 19.8%, 140 basis points better than the prior year.  The CEO's comments were a bit tepid when talking about this segment, and the word "execution" was used. 

Operating cash flow in the quarter was $3.6 billion, and free cash flow was $2.9 billion with the full year's free cash flow projection being upgraded to $7.5 billion. The cash cycle improved to 21 days, an improvement of 7 days. Net debt declined, and there is ample capacity to deal with debt maturities coming due.  $797 million was applied to share repurchases to offset dilution, in the words of the CEO, and $283 million was returned to shareholders as dividends.  Quite an impressive performance.

In response to a question from the Barclay's analyst, the CFO said that there had been increased educational efforts within the company about the importance of cash flow from operations.  This effort was not solely directed to upper management.  Rather, she noted that the message, "every individual can make a difference" had been promulgated throughout the organization.  This is a very big deal for me, having gone through the same process myself.  It can really engender changes in behavior from sales executives to administrative staff. 

In response to a question about walking away from unprofitable RFPs, the CEO was rambling on, getting herself into a cul-de-sac when the CFO interrupted and added a financial number which shed light on the analyst's question.  I never heard her interject herself that confidently before.  Again, this was a big deal for me.  If I were in that analyst's shoes, I would note, "It's the Meg and Cathy team now."

The question was asked about the improvement in cash flow from operations having a timing aspect to it; here the discussion became too arcane.  Some of the W/C improvements had to be timing, but these flips happen in any business.  The point is the full-year projection of CFO, which is quite healthy.

The CEO made a good point in response to the knee-jerk analyst question about accelerating the pace of share buybacks.  The stock here is clearly ahead of itself: it isn't a no brain buy from here up.  CEO Whitman said that capital allocation would be on a return basis, including reinvesting in the businesses and perhaps some tuck-in acquisitions.  Bravo.  That makes sense.  Her focus has to be on long-term, sustainable value creation. 

Especially since the CEO suggested that revenue growth in 2014 would be a "challenge," it is critical for the CFO to maintain a grip on the cash flows, with the goal of priming the balance sheet and reducing net debt in order to upgrade the credit rating.  HP is off to a good start.

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