Where To From Here for HP?

HP reported results for Q3 FY14, and there were some things to like, and some weaknesses, but questions about the future still remain.  No one doubts that the company is on stable footing, and that CEO Meg Whitman has done a great job of convincing customers that their need for a reliable stable  of 'full service' IT providers will include an HP committed to providing the products and services their CTOs need in a world of complex and rapidly changing corporate demands.  This is no small achievement, and the stock price appreciation from the lows recognizes this.

However, what about the future beyond the next quarter?  What does HP want to be, and what is the future business model going forward?  Based on this quarter, it is more incrementalism, balance sheet management, and repeated references to acquisitions.  But the same issues have been on the table, in our mind, since 2012.

 "The new CEO says that the number one question she faced when going out and talking to customers, partners and investors was "What is HP?"   She characterized the company as being No. 1 or No. 2 in all of its operating business segments.  Based on the performance of the segments and on their outlook, this statement seems inaccurate.  There was talk about how smoothly the Autonomy acquisition was going, with the companies "exchanging hundreds of sales leads," and yet the acquisition seemingly has no impact on EPS in 2012, but without any detailed guidance, this isn't easy to tease out.  Autonomy's website claims the company has 25,000 customers worldwide, many of which must be small and scattered across a variety of product offerings from social media analytics to eDiscovery."

Before returning to these ideas, let's quickly review Q3 FY14.  Revenues of $27.6 billion were up 1% on a constant currency basis.  64% of revenues come from outside the U.S. which is encouraging because it speaks to the global reach of the company's offerings and to HP's not being tied to U.S. business trends (36% of consolidated revenue came from the U.S. in the quarter) for future growth.

20% of revenues, or $5.6 billion came from the Printing business, which declined 4% y/y.  Printing accounted for 38% of the company's adjusted, non-GAAP operating income of $1,026 million and an operating margin of 18.4%.  Supplies contributed 66% of the business operating income, but sales of supplies increased 4% y/y in constant currency.

Personal Systems sales of $8.6 billion, were 30% of consolidated revenue, and $346 million in non-GAAP operating income amounted to a 4.0% margin rate and 13% of consolidated non-GAAP operating profit--a contribution as opposed to a drag..  Revenue was up 12% y/y!  Commercial sales were up 14% y/y, and unit sales of notebooks were up 18% y/y in units.  There's no doubt that this is encouraging news, along with printing's solid performance, despite its lackluster y/y comparisons.

Enterprise Services continues to look like a boat rowing in circles.  $5.6 billion in revenues were 20% of consolidated revenues, but only 8% of consolidated, non-GAAP operating profit with a paltry 4.1% operating profit margin.  Overall revenues for the segment were down 6% y/y.  The information technology outsourcing business was down 6%, and the systems consulting business was down 5%.  This has been like a broken record for quite a while, and it is a fundamentally flawed business model.

Software contributed was a paltry 3% of consolidated revenue, and something is also amiss in this business, which contributed 7% of consolidated non-GAAP operating profit, at an operating profit margin rate of 21.2%.

Cash flow from operations was $3.7 billion compared to $2.7 billion, increasing 36% compared to the prior year period.  Free cash flow of $2.7 billion compared to $2.0 billion in the prior year period.

YTD FY 14 share repurchases amounted to $1,978 million versus $1,053 million for the comparable period in FY13.

The strength in U.S. sales was encouraging, helped by the rebound in the PC business, especially to corporate customers. Along with the performance of the Enterprise Group, it underlines HP's importance to large corporate buyers.  Foreign sales were also encouraging.  However, there was nothing new on the road ahead.  The easy work has been done, although that might not be the right word.

CEO Meg Whitman needs to freshen her message away from the that of the days when HP had a loaded gun to its head.  She has taken that away, moved the patient off the respirator, and instilled some confidence and discipline into the business. However, a turnaround like this can still go awry when the ship really has to go off in search of a New, New World.  Does the ship have the right crew?  Are they all on board?

The Autonomy fiasco still lingers.  Documents filed in the action by former Autonomy CFO Sushovan Hussain have some interesting passages.  They reveal that HP was preparing to buy Autonomy for $11 billion in 2011, HP CFO Cathy Lesjak said the price was too high and that HP was not prepared to integrate the organization.  Her adamant opposition was steam rollered by former CEP Apotheker, and by board member Lane and others.

The UK Serious Fraud Office has not moved forward at all in investigating HP's charges made after the $8.3 billion write off, and now HP has made a 'settlement" that really calls into question why it is looking to save face for its directors and previous management instead of 'fessing up to the incompetence and value-destroying behavior.

This company is clearly incapable of valuing, making and integrating large acquisitions to add value.  Witness EDS and Autonomy.  Therefore, why make the argument now that acquisitions are essential?  There's no reason to think anything has changed.  We've said before, the board should  be flushed out in one way or another before shareholders can have faith in an acquisition-driven strategy going forward.