Listening to the rebroadcast of the earnings call without visuals, one could sense CEO Satya Nadella verbally punching the air expressing his pleasure about Q1 2015's results demonstrating real changes at Microsoft in terms of execution, innovation, and putting the customer at the heart of what Microsoft does. The customer is now regarded as a partner, not just as an ATM.
Look at what is happening to the competition. HP has chosen to split itself apart, which is probably the right action at the right time, but it will distract their customer-facing activities as the go-to-market operations change in size and charters. IBM finally needs to go CEO Rometty's woodshed and reinvent its market proposition beyond the Smarter Planet commercials. Cisco sits on its balance sheet and continues to blather on about the "Internet of Things."
Things don't buy hardware and software: people do. Corporate buyers clearly want more from their go-to providers.
MSFT reported Q1 2015 revenue of $23,201 million, up 25% over the prior-year period, or up 11% excluding the $2.6 billion in Nokia Phone revenue (9.3 million Lumia smart phone units) included in the fiscal 2015 number. Gross margin dollars increased 11% despite the inclusion of lower margin phone revenue and an unfavorable mix to low end equipment in that business.
Research and Development expenditures of $3,065 million increased 11% over the prior-year period. In addition to returning cash to shareholders, the company sends a message that it will continue to invest in innovation on behalf of the customer's future needs.
$1,140 million of integration and restructuring expense was recorded in the quarter, amounting to $0.11 per diluted share. GAAP diluted EPS of $0.54 in Q1 2015 compared to $0.62 in the prior-year period. DPS of $0.31 increased by 11% year-over-year.
Apart from OEM Windows licensing revenue declining by 2% and Consumer revenue decreasing by 5% as the transition to Office 365 continues, all the businesses performed well, certainly compared to the competition.
Computing and Gaming Hardware revenue of $2,453 million grew by 74% year-over-year, and the gross margin rate increased by over five percentage points. $908 million of Surface 3 revenue in the quarter continued to demonstrate the potential for a device that can do real work, while having the look and feel of a tablet.
Devices and Consumer Other revenue of $1,809 million increased 16% year-over-year. Search advertising revenue increased by 23% and Bing's share of U.S. search increased 140 basis points to 19.4%. 7 million Office 365 subscribers increased 25% sequentially over the prior quarter.
Finally, the Commercial Business revenue of $12,280 million increased a solid 10% over the prior-year period. Server product revenue grew 11%, and revenue increased across the range of servers from SQL to the newer, data center-oriented specialty servers.
Other Commercial Revenue of $2,407 million increased 50% over the prior-year period, driven by Commercial Cloud revenue growing 128%. The CEO noted in his remarks that 80% of the Fortune 500 use Microsoft's cloud infrastructure and services, while at the same time it was noted that the Azure pay-by-usage computing model is enjoying significant penetration into start-ups. With Amazon's recent record losses, one would suspect that its commodity cloud services might be looked at askance as that company comes under pressure for its suspect business model.
Free cash flow in the three months ended September 30, 2014 was $7.1 billion, and $2,307 million in dividends were paid and $2,888 million in common shares were repurchased.
Finally, two new board members were joined the Microsoft board, both of whom add professional profiles and board experience that should serve the new CEO and the management team well. Charles Scharf is the CEO of Visa, and he held senior executive positions at Bank One Corp., JP Morgan Chase, and Salomon Smith Barney. Financial services companies with their massive volumes of transactions and their growing need for robust data security should be prime customers for Microsoft's commercial data center and cloud offerings. Teri List-Stoll is the CEO of Kraft, Inc., and her twenty year career at Procter and Gamble should give her insight into the management and development of brand equity for consumer products; her service on the Danaher board is also useful because Danaher's culture (http://www.danaher.com/our-culture/danaher-business-system) which centers on the customer, measures efficiency and performance, and looks to optimize the portfolio is consonant with CEO Nadella's aspirations for the future Microsoft.
Overall, this quarter, especially in the current tech environment, demonstrates exceptional focus and performance across Microsoft, both in its business execution and its governance.
Showing posts with label Earnings. Show all posts
Showing posts with label Earnings. Show all posts
Thursday, October 23, 2014
Monday, August 25, 2014
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.
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.
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.
Thursday, May 22, 2014
HP's FY14 Q2 Call: Financial Engineering and Confusing Messages
We're more than two years into HP's long journey, which I recall CEO Meg Whitman characterizing as a five year turnaround. Listening to the analyst questions on the webcast, I can confidently say that I wasn't alone in being confused and a bit concerned about the messaging, particularly from CEO Whitman.
Let's fly over some of the numbers, without going into the minutiae. Consolidated net revenue in the quarter was $27.3 billion, down 1% year-over-year and 3% sequentially. On a constant currency basis, revenues were flat year-over-year. In the Personal Systems business, revenue of $8.2 billion, increased by 7% as HP regained the leading industry share in corporate desktops and laptops, benefiting from a corporate spend rebound driven by the XP support expiration. Operating margins continue to be tough in this business, and the OM increased by 30 basis points to a paltry 3.5%. Printing revenue declined by 4% to $5.8 billion, but the operating margin increased by 360 basis points to 19.5% of revenue.
The discussion of this business was all over the place. Reference was made to the historical lack of innovation to a tired line of multifunction laser printers, which has opened the door to Japanese competition. With a large installed base, toner business was down, but it was unclear why. An analyst question on this point drew a confusing response. The consumer ink business was said to be "good," whatever that meant.
A 360 basis point increase in margin deserved a simple, clear explanation, but it wasn't forthcoming.
The printing business' segment operating income in the quarter was $1,430 million. The operating profits of the Enterprise Group and of the Enterprise Services combined were $1,105 million. This is not a healthy balance for the future. Unlike Microsoft's consistent demonstration of the power of its Enterprise businesses, HP seems to be treading water by issuing lots of press releases and launching web pages. The Enterprise Services business continues to go nowhere, with operating margins below that of the Personal Systems business.
For example, it wasn't long ago that a conference call heralded the launch of the Moonshot server line, which presumably was going to rescue the company from the commoditization of ISS. On this call, Moonshot was again mentioned, but with a very cautionary tone. My takeaway? It is a New Thing, but not the Next Big Thing.
On the current call, the CEO lauded the creation of HP Helion, a sort of "Joy of Cooking" for the IT customer looking to create any kind of cloud: the recipe is in Helion. Have a look at the HP Chief Marketing and Communications Officer explaining what HP Helion means.
Total non-GAAP operating income of $2,341 million was flattish with a year ago, and the operating margin declined by ten basis points to 8.6%. Net earnings of $1,691 million were flat to a year-ago, and diluted, non-GAAP EPS of $0.88 per share was at the high end of the guidance and of analyst expectations. The EPS compared to $0.87 per share in the prior-year period, on the same basis.
For the six months fiscal year 2014 to-date, the company spent $1,396 million on share repurchases, about 42% of FCF over the same period, and the average price per share received was $29.70. $596 million was paid to shareholders in the form of dividends over the six months.
The CFO made reference to buying shares only with a "return based" focus: the stock was a bargain, her comments implied. With the current revenue outlook, more significant cost cutting, and a P/E which seems to fairly reflect the uncertainty, what kind of internal model would suggest that shares are a bargain at $30?
Let's fly over some of the numbers, without going into the minutiae. Consolidated net revenue in the quarter was $27.3 billion, down 1% year-over-year and 3% sequentially. On a constant currency basis, revenues were flat year-over-year. In the Personal Systems business, revenue of $8.2 billion, increased by 7% as HP regained the leading industry share in corporate desktops and laptops, benefiting from a corporate spend rebound driven by the XP support expiration. Operating margins continue to be tough in this business, and the OM increased by 30 basis points to a paltry 3.5%. Printing revenue declined by 4% to $5.8 billion, but the operating margin increased by 360 basis points to 19.5% of revenue.
The discussion of this business was all over the place. Reference was made to the historical lack of innovation to a tired line of multifunction laser printers, which has opened the door to Japanese competition. With a large installed base, toner business was down, but it was unclear why. An analyst question on this point drew a confusing response. The consumer ink business was said to be "good," whatever that meant.
A 360 basis point increase in margin deserved a simple, clear explanation, but it wasn't forthcoming.
The printing business' segment operating income in the quarter was $1,430 million. The operating profits of the Enterprise Group and of the Enterprise Services combined were $1,105 million. This is not a healthy balance for the future. Unlike Microsoft's consistent demonstration of the power of its Enterprise businesses, HP seems to be treading water by issuing lots of press releases and launching web pages. The Enterprise Services business continues to go nowhere, with operating margins below that of the Personal Systems business.
For example, it wasn't long ago that a conference call heralded the launch of the Moonshot server line, which presumably was going to rescue the company from the commoditization of ISS. On this call, Moonshot was again mentioned, but with a very cautionary tone. My takeaway? It is a New Thing, but not the Next Big Thing.
On the current call, the CEO lauded the creation of HP Helion, a sort of "Joy of Cooking" for the IT customer looking to create any kind of cloud: the recipe is in Helion. Have a look at the HP Chief Marketing and Communications Officer explaining what HP Helion means.
Total non-GAAP operating income of $2,341 million was flattish with a year ago, and the operating margin declined by ten basis points to 8.6%. Net earnings of $1,691 million were flat to a year-ago, and diluted, non-GAAP EPS of $0.88 per share was at the high end of the guidance and of analyst expectations. The EPS compared to $0.87 per share in the prior-year period, on the same basis.
For the six months fiscal year 2014 to-date, the company spent $1,396 million on share repurchases, about 42% of FCF over the same period, and the average price per share received was $29.70. $596 million was paid to shareholders in the form of dividends over the six months.
The CFO made reference to buying shares only with a "return based" focus: the stock was a bargain, her comments implied. With the current revenue outlook, more significant cost cutting, and a P/E which seems to fairly reflect the uncertainty, what kind of internal model would suggest that shares are a bargain at $30?
Confusing Messages
After looking at the company and its businesses for two years, "more opportunity" was found to improve the cost structure and speed up internal customer response and innovation by having an additional 16,000 staff leave the corporate work force! This raised a pretty high degree of angst among the cadre of analysts who are the leading voices on the stock, no matter what their opinions. What were their concerns?
- Much of the success in righting the ship and stopping the hemorrhaging has been accomplished through the 2012 planned reduction in force. If anything, the benefits expressed in future, lower run rates of expenses have been above-plan.
- The expected turnaround in revenue from an improving IT cycle and the cloud hype has not materialized. It seems to be pushed out into the indefinite future.
- $11 billion was spent on Autonomy, and most of that was written off. Litigation was promised through the British SFO. Nothing has happened. Now, in fact, positive references are made about an Autonomy's win for its IDOL system in the current quarter, and its product revenue grew in the quarter. Will this acquisition be the building block to drive the Software segment forward, or will other acquisitions be necessary?
- George Kadifa, the former operating Partner from Silver Lake, is giving up his position as head of the Software business, after he was brought on with much ballyhoo reporting directly to Meg Whitman. Robert Youngjohns is taking over this portfolio. What does this mean? Is it a real move forward, and if so, "Why?"
- References were made to being halfway into the turnaround, and in other places, the company was in the "early innings" of improving execution. Where are we, and exactly when will the right players be in the right place with the right attitude?
- Put it all together, and the analysts, each in their different way, expressed their angst. Does the announcement of another staff reduction of 16,000 mean that this is the only way in which the management can meet its stated guidance? Is there diminished confidence in the revenue-producing capability of the businesses?
- Does this mean that analysts should be raising their estimates for the impact of this new staff reduction? Should they raise for this AND a revenue turnaround? Their customers will ask them tonight after the conference call, or by the latest tomorrow morning on their morning calls. They were told to wait until October's Analysts Day for additional guidance. Wrong Answer!!
- The CFO made a point that she sees the benefits from cost cutting as allowing higher reinvestment in the business, all of which is done on a "returns basis." When and where would be reinvestment be done? Research and development takes time and is expensive. This spend has been flat anyway. What does the CFO mean by this, and how would it compare, return-wise, to share buybacks above $30 per share?
- A legitimate question was asked about the effects on an organization's morale from continued, substantial downsizing. It is a very real issue,and the answers were, frankly, inept and insensitive. For the survivors, there will be a period of mourning and diminished productivity.
- There was a lot of sharp-penciled financial engineering in the quarter, as in getting the DSOs down to very low levels, apparently helped by increasing reliance on factoring of the corporate receivables, if I heard this right. This is all good, but it won't get this company where it says it wants to go.
- All in all, the tone of this call rang hollow. It is very hard for the Buy/Outperform analysts to make a case going forward for multiple expansion when there is nothing to hang their hats on for a revenue turnaround and predictable business outperformance.
Thursday, April 24, 2014
Microsoft's Third Quarter Shows a Strong Platform and Challenges Ahead
Microsoft reported FY14 Q3 revenues of $20,403 million versus an adjusted $18,831 million for the prior-year period, an increase of 8.3%, or about 7% on a constant currency basis. Gross margin increased 3% year-over-year on an adjusted basis, and diluted EPS of $0.68 per share increased by 5% over the adjusted $0.65 per share in FY13 Q3.
$1,895 million was returned to shareholders through share repurchases in the quarter, and $2,322 million through dividends. $4,167 million out of $10,099 million in cash flow from operations is a healthy amount of cash to return, and it fits with the now well established activist shareholder creed.
The strength of the company shows, I believe, when you consider that 81% of the quarter's revenues came from Devices and Consumer Licensing ($4,382 million), Commercial Licensing ($10,203 million), and Commercial, Other ($1,902 million).
Even more telling, 95% of the corporate gross margin came from these same three business segments: Devices and Consumer Licensing ($3,906 million), Commercial Licensing ($9,430 million), and Commercial, Other ($475 million).
Despite all the hype around tablets, and "Bring Your Own Device" into the enterprise, Windows and the Office suite are still what most people comfortably use to do their real work in the enterprise. So, Windows Pro OEM revenue grew 19%, as business PC growth in developed markets led the way in the quarter. Non-Pro Windows revenue declined by 15% (9% excluding China), so Windows OEM revenue increased 4% in total. 90% of enterprise desktops run Windows 7 or Windows 8.
The Office 365 nascent franchise now has 4.4 million users, and the company added a million users in the quarter. Making the Outlook.com free version of Office 365 available for iPAD, and engineering it specifically for that platform, was a long overdue step, and the new CEO made it with aplomb. Making Office for iOS 7.1 count for the five device licenses included in Office 365 enhances the value proposition for the product.
Bing's ad revenue was up 38% , and its share of search grew by 170 basis points.
Microsoft's server business, hardware and database, give it a lot of credibility with corporate IT officers. SQL server revenue increased by more than 15% in the quarter.Cloud revenue doubled from a relatively small level, as it has for HP.
The acquisition of Nokia Devices and Services is about to close, and hence the financial comparisons in the coming quarters will be even fuzzier than they are now.
The question and challenge will be "What can Microsoft make of Nokia Devices and Services?" Microsoft continues to really lack a champion for its consumers, whether of Office, XBox, games, tablets and phones. What credibility it has on the corporate enterprise hardware and software sides comes from a different mindset. CEO Satya Nadella came from this business, and he brings lots of easy credibility because he speaks the language of customers and developers in those businesses.
Check out his video presentation at Build 2014. The way he handled questions was relaxed, sincere, and credible to his developer audience. There was none of the ear shattering volume, bluster and rote litany of buzzwords from the Ballmer reign.
I wonder if anyone in the organization can speak for the consumer experience with those same virtues? Apple can charge outrageous prices for their devices for a few reasons: they all work relatively intuitively, the design and functionality of the phones and tablets are clean and present a consistent philosophy, the attention to detail even in the packaging is obsessive, and if there is anything wrong with the consumer's experience with the device or using it, the company stores make it right.
If Nokia is going to be the hardware platform that carries the Windows environment forward into a "Mobile-first, Cloud-first" world then can this be done without suffering the kind of 23% gross margin rates Microsoft is experiencing in its consumer devices now? Can someone, perhaps from Nokia or wherever, inculcate that care of the retail customer to the levels to which the IT and developer customers have been accustomed?
Microsoft has never treated its retail customers well, and it has never provided them with the kind of experience they deserve. A monopolist never acts that way, because it doesn't have to amaze or delight: it merely has to satisfy.
Here was a very simple, but penetrating question for Satya Nadella from an Android third-party developer, "Why should I spend my time and resources developing for Windows?" (paraphrase) Here's the CEO's response:
$1,895 million was returned to shareholders through share repurchases in the quarter, and $2,322 million through dividends. $4,167 million out of $10,099 million in cash flow from operations is a healthy amount of cash to return, and it fits with the now well established activist shareholder creed.
The strength of the company shows, I believe, when you consider that 81% of the quarter's revenues came from Devices and Consumer Licensing ($4,382 million), Commercial Licensing ($10,203 million), and Commercial, Other ($1,902 million).
Even more telling, 95% of the corporate gross margin came from these same three business segments: Devices and Consumer Licensing ($3,906 million), Commercial Licensing ($9,430 million), and Commercial, Other ($475 million).
Despite all the hype around tablets, and "Bring Your Own Device" into the enterprise, Windows and the Office suite are still what most people comfortably use to do their real work in the enterprise. So, Windows Pro OEM revenue grew 19%, as business PC growth in developed markets led the way in the quarter. Non-Pro Windows revenue declined by 15% (9% excluding China), so Windows OEM revenue increased 4% in total. 90% of enterprise desktops run Windows 7 or Windows 8.
The Office 365 nascent franchise now has 4.4 million users, and the company added a million users in the quarter. Making the Outlook.com free version of Office 365 available for iPAD, and engineering it specifically for that platform, was a long overdue step, and the new CEO made it with aplomb. Making Office for iOS 7.1 count for the five device licenses included in Office 365 enhances the value proposition for the product.
Bing's ad revenue was up 38% , and its share of search grew by 170 basis points.
Microsoft's server business, hardware and database, give it a lot of credibility with corporate IT officers. SQL server revenue increased by more than 15% in the quarter.Cloud revenue doubled from a relatively small level, as it has for HP.
The acquisition of Nokia Devices and Services is about to close, and hence the financial comparisons in the coming quarters will be even fuzzier than they are now.
The question and challenge will be "What can Microsoft make of Nokia Devices and Services?" Microsoft continues to really lack a champion for its consumers, whether of Office, XBox, games, tablets and phones. What credibility it has on the corporate enterprise hardware and software sides comes from a different mindset. CEO Satya Nadella came from this business, and he brings lots of easy credibility because he speaks the language of customers and developers in those businesses.
Check out his video presentation at Build 2014. The way he handled questions was relaxed, sincere, and credible to his developer audience. There was none of the ear shattering volume, bluster and rote litany of buzzwords from the Ballmer reign.
I wonder if anyone in the organization can speak for the consumer experience with those same virtues? Apple can charge outrageous prices for their devices for a few reasons: they all work relatively intuitively, the design and functionality of the phones and tablets are clean and present a consistent philosophy, the attention to detail even in the packaging is obsessive, and if there is anything wrong with the consumer's experience with the device or using it, the company stores make it right.
If Nokia is going to be the hardware platform that carries the Windows environment forward into a "Mobile-first, Cloud-first" world then can this be done without suffering the kind of 23% gross margin rates Microsoft is experiencing in its consumer devices now? Can someone, perhaps from Nokia or wherever, inculcate that care of the retail customer to the levels to which the IT and developer customers have been accustomed?
Microsoft has never treated its retail customers well, and it has never provided them with the kind of experience they deserve. A monopolist never acts that way, because it doesn't have to amaze or delight: it merely has to satisfy.
Here was a very simple, but penetrating question for Satya Nadella from an Android third-party developer, "Why should I spend my time and resources developing for Windows?" (paraphrase) Here's the CEO's response:
?You want to build for Windows because we are going to innovate with a challenger mindset. We're not coming at this as some incumbent trying to do the next version of Windows. We're going to come at this by innovating in every dimension, the dimension of hardware, the software experiences across the Windows family, and go after this in such a way that you see us make progress with rapid pace.
In fact, today was a massive milestone. If you look at what we've done on the phone, the update to the PC and tablet, the new devices Stephen showed, this is all what you can come to expect from us, and we'll keep pushing at it.
There will be a couple of things that will be pretty unique to what we do. One is what I call the sensibility we have of bringing end users, developers and IT professionals together. That's one thing that we've always felt is what birthed the magic of platforms, from sort of the first version of Windows to what we think is Windows in this era of mobile first, cloud first. (I don't think the real end users were ever in anyone's mind at Redmond)
And then the second real attribute for us is to be able to create a developer opportunity which is broad. So one of the things that we are doing is making sure that the opportunity for you as developers across the Windows family is expanding. Some of the changes that both Joe described and Terry alluded to where we are going, which is to be able to make your new applications built for WinRT and the Windows Store, in fact, the fact that you can use them in the desktop mode, that completely opens up a huge base of users for your applications that you're targeting Windows with.
So this notion of creating the broadest Windows opportunity for your sockets for you is a huge priority for us, and we have huge volume still. We have hundreds of millions of PCs, tablets and phones still on a run-rate basis, and a billion-plus PCs that will all be upgrading. So therefore we have a significant opportunity for any application you target Windows. (This is the "ching ching" answer that is music to their ears.)
And then the last thing is, we are betting on this platform ourselves. You saw from Kirk Koenigsbauer how we're building the next generation of Office applications for this platform. So we are going to basically use the same platform that we want you to target to build our own set of applications.
So those would be the three reasons, because we're going to innovate with a challenger mindset, we're going to create the broadest platform opportunity in terms of sockets for you, and we are going to bet on that platform ourselves, and that's the reason why you should target Windows. (Applause.)"
So, the stock is fairly valued on its near-term prospects, with good support from the dividend, and the new CEO is bringing a fresh look to his long-time employer. (he has a nice quote from T.S. Eliot that covers his experience well) A new independent board member who comes from the analyst perspective has joined the board. A critical acquisition, its integration and the opportunity to really become a premier consumer technology brand await.
Thursday, March 13, 2014
Is Met Life a SIFI? Still Undecided.
Since the middle of 2013, a decision about Met Life being a "Systemically Important Financial Institution" was imminent. Now with the publication of their 2013 10-K, the company is still waiting.
In all our of American regulatory fog about SIFIs, it is funny to note that most documents and studies acknowledge that key concepts like "systemically important" or "contingent capital" do not have widely accepted definitions.
Recent research from the New York Fed, found in its Liberty Street Blog, has assiduously tried to show that the effects of the current "unconventional" monetary policy has been equivalent to conventional policies relating to monetary aggregates and Fed funds. Their conclusion, not surprisingly, is that rates are not in a very different position than they would have been under a conventional policy. Forget about the conceptual difficulties of this exercise, but the critical effects of a persistent, artificial low rate environment are on the behavior of market participants, which fall outside of any of these studies.
Insurance companies fall under the SIFI umbrella because it has been suggested that the pressures put on their net interest margins would inevitably force them to take inordinate risks so as to maintain their earnings.
In the case of Met Life specifically, this seems to be incomprehensibly far off the mark.
Researchers from the Society of Actuaries--not exactly cowboy risk takers--have long written about the risks of a low rate environment for insurers. Their advice, beyond the creation of deeper risk management processes within companies, really talked about product redesign, changes to the nature of policy guarantees and crediting rates, and hedging or re-insuring older products. These are the kinds of things that are evident in Met Life's financial disclosures.
MET reported fourth quarter 2013 operating earnings of $1.6 billion, up 14% yr/yr, and full year operating earnings of $6.3 billion, up 12%. Diluted EPS on an operating basis was $1.37 in the fourth quarter (+10%) and $5.63 for 2013. All of these were better than expected by the Street.
Adjusted return on equity for the fourth quarter was 11.5%, and 12% for the full year 2013. Equity market performance in the fourth quarter and the steepening of the yield curve at the front end helped the return on equity and variable investment income by 50 bp and by 40 bp respectively in the fourth quarter.
Equity/Assets ratio was 8.1% in 2010 and rose to 8.9% in 2012 and finished 2013 at 9.9%, so the company has deleveraged through the risky period of low rates.
Sales of variable annuity products, per management guidance, have been reduced to $10-$11 billion, with the kind of product changes suggested by the SoA implemented in new product sold.
Although the absolute size is still small, international revenue, which is more oriented towards protection products, has been a strong point in Europe, Japan, and in Latin America, where the company acquired a profitable Chilean operation. A shift in mix towards international should, all things equal, be better for the corporate risk profile.
The argument made by Met Life management is that imposing a bank-centric set of capital rules on an insurance operation with a fundamentally different business model will generate unintended consequences like raising the cost of guarantees and policy pricing for health and life products.
In all our of American regulatory fog about SIFIs, it is funny to note that most documents and studies acknowledge that key concepts like "systemically important" or "contingent capital" do not have widely accepted definitions.
Recent research from the New York Fed, found in its Liberty Street Blog, has assiduously tried to show that the effects of the current "unconventional" monetary policy has been equivalent to conventional policies relating to monetary aggregates and Fed funds. Their conclusion, not surprisingly, is that rates are not in a very different position than they would have been under a conventional policy. Forget about the conceptual difficulties of this exercise, but the critical effects of a persistent, artificial low rate environment are on the behavior of market participants, which fall outside of any of these studies.
Insurance companies fall under the SIFI umbrella because it has been suggested that the pressures put on their net interest margins would inevitably force them to take inordinate risks so as to maintain their earnings.
In the case of Met Life specifically, this seems to be incomprehensibly far off the mark.
Researchers from the Society of Actuaries--not exactly cowboy risk takers--have long written about the risks of a low rate environment for insurers. Their advice, beyond the creation of deeper risk management processes within companies, really talked about product redesign, changes to the nature of policy guarantees and crediting rates, and hedging or re-insuring older products. These are the kinds of things that are evident in Met Life's financial disclosures.
MET reported fourth quarter 2013 operating earnings of $1.6 billion, up 14% yr/yr, and full year operating earnings of $6.3 billion, up 12%. Diluted EPS on an operating basis was $1.37 in the fourth quarter (+10%) and $5.63 for 2013. All of these were better than expected by the Street.
Adjusted return on equity for the fourth quarter was 11.5%, and 12% for the full year 2013. Equity market performance in the fourth quarter and the steepening of the yield curve at the front end helped the return on equity and variable investment income by 50 bp and by 40 bp respectively in the fourth quarter.
Equity/Assets ratio was 8.1% in 2010 and rose to 8.9% in 2012 and finished 2013 at 9.9%, so the company has deleveraged through the risky period of low rates.
Sales of variable annuity products, per management guidance, have been reduced to $10-$11 billion, with the kind of product changes suggested by the SoA implemented in new product sold.
Although the absolute size is still small, international revenue, which is more oriented towards protection products, has been a strong point in Europe, Japan, and in Latin America, where the company acquired a profitable Chilean operation. A shift in mix towards international should, all things equal, be better for the corporate risk profile.
The argument made by Met Life management is that imposing a bank-centric set of capital rules on an insurance operation with a fundamentally different business model will generate unintended consequences like raising the cost of guarantees and policy pricing for health and life products.
Wednesday, March 12, 2014
Mamma Mia! UniCredit's Fourth Quarter Loss at €15 billion.
We started watching UniCredit in 2012 when its rights offering was greeted less than enthusiastically by equity investors. Their slide presentation on Q4 FY13 is fairly confusing, as it tries to weave in extraordinarily bad news with the good news to come from the strategic plan out to 2018. A reeling shareholder probably needs to get his feet on the ground first as to where the bank is today, and that is not clear.
For Q4, UniCredit reported a net loss of €15 billion ($20.8 bn), and a full year FY13 loss of €14 billion, which is the fifth biggest loss reported by a European bank since 2005, according to the Wall Street Journal.
The fourth quarter LLP was €9,337 million compared to a provision of €4,516 million in Q4 FY12, an increase of 107%. For the full year, the LLP was €13,658 million, a 47% increase over the prior year. €6.8 billion in the fourth quarter provision was attributable to Western Europe, of which €5.4 billion came from Commercial Bank of Italy and €1 billion from Corporate assets.
The company also wrote off €9,368 million in goodwill, covering €8 billion from acquired assets and €1.3 billion from the impaired value of customer relationships. Operations in Poland, Austria and Germany seem to be good businesses, and deposit gathering in Poland was strong in the quarter, but there is little goodwill left in these operations.
There was a €1.4 billion pre-tax gain from a revaluation of a 22% stake in the Bank of Italy, among the non-recurring items.
Non-performing loan coverage increased from 54.9% in the third quarter to 63.1% in the fourth quarter. Overall, the gross impaired loan portfolio stands at €2.1 billion, and the charge off rate was steady between the first and second halves of 2013. It's not easy to glean confidence about the asset quality going forward or about the new management's ability to get out ahead of any problems.
On the cost reduction side, 8,455 full time equivalent employees will leave by 2018, with 5,700 of them in Italy and most of these losses coming from the Commercial Bank of Italy operation.
Group revenue increased 6%, as UniCredit's trading operations and presence in syndicated loan markets is still strong. Most of the one-time items were non-cash impacts, and the company's massive additions to provisions were neutral for Basel III capital tests. The stock price went up after the announcement.
Some U.S. value fund managers who got into UniCredit early have been burned and left. Some others, like Oakmark, have continued to hold positions in Intesa Sanpaolo, an Italian retail and commercial bank, which had strong fourth quarter 2013 share price performance.
With UniCredit, the value of the equity is a bit opaque. In some ways, it is analagous to Bank of America's position a few years ago. On the credit side, however, KKR has become engaged with the new management, and this may be the better play in the short-term.
For Q4, UniCredit reported a net loss of €15 billion ($20.8 bn), and a full year FY13 loss of €14 billion, which is the fifth biggest loss reported by a European bank since 2005, according to the Wall Street Journal.
The fourth quarter LLP was €9,337 million compared to a provision of €4,516 million in Q4 FY12, an increase of 107%. For the full year, the LLP was €13,658 million, a 47% increase over the prior year. €6.8 billion in the fourth quarter provision was attributable to Western Europe, of which €5.4 billion came from Commercial Bank of Italy and €1 billion from Corporate assets.
The company also wrote off €9,368 million in goodwill, covering €8 billion from acquired assets and €1.3 billion from the impaired value of customer relationships. Operations in Poland, Austria and Germany seem to be good businesses, and deposit gathering in Poland was strong in the quarter, but there is little goodwill left in these operations.
There was a €1.4 billion pre-tax gain from a revaluation of a 22% stake in the Bank of Italy, among the non-recurring items.
Non-performing loan coverage increased from 54.9% in the third quarter to 63.1% in the fourth quarter. Overall, the gross impaired loan portfolio stands at €2.1 billion, and the charge off rate was steady between the first and second halves of 2013. It's not easy to glean confidence about the asset quality going forward or about the new management's ability to get out ahead of any problems.
On the cost reduction side, 8,455 full time equivalent employees will leave by 2018, with 5,700 of them in Italy and most of these losses coming from the Commercial Bank of Italy operation.
Group revenue increased 6%, as UniCredit's trading operations and presence in syndicated loan markets is still strong. Most of the one-time items were non-cash impacts, and the company's massive additions to provisions were neutral for Basel III capital tests. The stock price went up after the announcement.
Some U.S. value fund managers who got into UniCredit early have been burned and left. Some others, like Oakmark, have continued to hold positions in Intesa Sanpaolo, an Italian retail and commercial bank, which had strong fourth quarter 2013 share price performance.
With UniCredit, the value of the equity is a bit opaque. In some ways, it is analagous to Bank of America's position a few years ago. On the credit side, however, KKR has become engaged with the new management, and this may be the better play in the short-term.
Thursday, February 27, 2014
Best Buy's Q4 FY14: Many Points of Light
We go back a long way with Best Buy, recommending the stock when they were on the ropes, with Circuit City knocking at the door. Best Buy did exceptionally well, the stockholders were well rewarded, and the grim reaper eventually came for Circuit City and for many other smaller, specialty electronics retailers.
Renew Blue was a great start to digging out from under a long period of mismanagement that created the opening for Amazon and others to walk through, as electronics became like the grocery store's loss leaders.
Like a patient with heart disease, things looked fine on the surface--snappy new corporate HQ, consultants all over the place, expansion in China--while the patient was heading for the critical, life threatening event.
Like a cardiac patient, putting a stent in isn't the magic bullet by itself. Renew Blue's first phase was like that stent. So, in the Q4 FY14 earnings call, the CEO and CFO's commentary struck a good balance among the holiday season, the fourth quarter, and the next phases of Renew Blue. If this program continues to be executed well, the Best Buy three or four years from now will have been almost totally transformed. Let's hope the stock doesn't get ahead of itself in the meantime, as it's always had a habit of doing in the past.
Quarterly revenue of $14,470 million declined 3% from the prior year period. On the face of it, the same store sales decline of 1.2% was a bit better than last year's decline of 1.4% but disappointing. The non-GAAP operating margin declined 120 bp to 4.5%, off the long-term goal of 5-6%. However, against the backdrop of industry product cycles, competitive dynamics, and Best Buy's own internal changes, this performance seems encouraging.
CEO Hubert Joly said that the management team's focus in the quarter was on the corporation's own controllable levers, maintaining price competitiveness and on keeping the promises made to customers. There were a number of factors that put downward pressure on margins, e.g. 100 bp compression came from changes to a mobile warranty program, while another 125 basis point margin compression came as a result of investment in price competitiveness and promotions. The press release and financial tables spell out the year-over-year non-comparable factors in detail
On an adjusted basis, the CEO characterized the domestic same store sales decline as being 0.6%, or relatively flat; the non-GAAP operating margin decline of 120 bp, abstracting from some of the tactical investments and other factors declined about 70 bp.
The CFO also noted that the company's guidance for the fiscal fourth quarter had been for a year-over-year decline in the operating margin between 175-180 bp, versus the non-GAAP reported 120 basis point decline. The CFO noted that a less promotional environment than a year ago, vendor support, and cost disciplines were better than expected going into the quarter.
Domestic online sales grew by 25.8% over the prior-year period. Although the company's website has improved dramatically over the pre-Joly version, it still could use a lot more work, and it sounds like things are going to change.
Project Athena was mentioned, which sounds like an internal database project to build customer-by-customer records including website visits and clickthroughs which, in turn, will generate customized texts and email offers based on the visitor's expressed preferences or inquiries. This won't happen overnight, but it is the way the company has to go.
The profitability of online sales today is lower than that of comparable in-store visits. Certainly looking at Amazon's financials, that would seem to be the case, but Best Buy is really changing its customer-facing presence and it will take some time.
Non-GAAP SGaA of $2.3 billion was 15.7% of sales, compared to $2.5 billion or 16.6% in the prior-year period. Domestic SGaA expense was $1.96 billion of 16% of revenue compared to $2.06 billion or 16.5% of revenue in the prior-year period. Renew Blue's annualized run rate of expense reduction had been targeted at $725 million, and the fiscal year ended, the CEO said., at a rate of $765 million.
In the coming 24 months, the company's Renew Blue will focus on the real guts of the retailing function, namely Merchandising, Marketing, Operations, Stores, Supply Chain,General Systems and Employee Engagement. The absolutely amazing thing is how much room for improvement there still is, with the stock already having more than doubled.
The company's local advertising circulars are vendor-paid 1970s vintage to pick on one irritant I see every Sunday. They bear no relation to what is trending in the marketplace. The CEO has now raised the ante on Renew Blue to run annualized savings of $1 billion! Merchandising will be tasked with coming up with tailored assortments that matter, not what the vendors want or what the stores want to drive margin through mix. The company loses about $400 million a year from damaged merchandise: very hard to believe in a company this big with this history.
The Employee Engagement task will not be easy, because the new model revolves around an empowered General Manager, who has variable compensation targets for individual store performance. This model, especially given the nature of most centralized structures, is not easy to implement. I have heard this story dozens of times, but I've only seen it done a handful of times.. The corporate functions like to think that they are the brains of the operation. Mr. Joly's task will be to make them the servants of the stores who are the ones who can see and feel what the customers want or don't like.
The systems and ordering tasks are onerous and detailed, but they've been done many, many times.
The overall message is that the Best Buy ship has stopped taking on water, has been righted and is once again at sea. Cash flow from operations of $1.1 billion looks down from last year's $1.4 billion, but much of it seems like timing, apart from what looks like the closing of lots of square footage with the inventory still on hand, not being returned or sold. This number should get significantly better.
Samsung stores, which we wrote about positively at the outset, could do much better next year, as that company slowly seems to be unleashing its innovation engine in phone, phablets, and other consumer health and electronic items. Microsoft's stores too should do better.
Management's challenge will be to manage expectations and to change around the internal teams and culture, with restructurings and new hires, to transform the company's way of dealing with vendors and customers in the new retailing structure of the future.
Renew Blue was a great start to digging out from under a long period of mismanagement that created the opening for Amazon and others to walk through, as electronics became like the grocery store's loss leaders.
Like a patient with heart disease, things looked fine on the surface--snappy new corporate HQ, consultants all over the place, expansion in China--while the patient was heading for the critical, life threatening event.
Like a cardiac patient, putting a stent in isn't the magic bullet by itself. Renew Blue's first phase was like that stent. So, in the Q4 FY14 earnings call, the CEO and CFO's commentary struck a good balance among the holiday season, the fourth quarter, and the next phases of Renew Blue. If this program continues to be executed well, the Best Buy three or four years from now will have been almost totally transformed. Let's hope the stock doesn't get ahead of itself in the meantime, as it's always had a habit of doing in the past.
Quarterly revenue of $14,470 million declined 3% from the prior year period. On the face of it, the same store sales decline of 1.2% was a bit better than last year's decline of 1.4% but disappointing. The non-GAAP operating margin declined 120 bp to 4.5%, off the long-term goal of 5-6%. However, against the backdrop of industry product cycles, competitive dynamics, and Best Buy's own internal changes, this performance seems encouraging.
CEO Hubert Joly said that the management team's focus in the quarter was on the corporation's own controllable levers, maintaining price competitiveness and on keeping the promises made to customers. There were a number of factors that put downward pressure on margins, e.g. 100 bp compression came from changes to a mobile warranty program, while another 125 basis point margin compression came as a result of investment in price competitiveness and promotions. The press release and financial tables spell out the year-over-year non-comparable factors in detail
On an adjusted basis, the CEO characterized the domestic same store sales decline as being 0.6%, or relatively flat; the non-GAAP operating margin decline of 120 bp, abstracting from some of the tactical investments and other factors declined about 70 bp.
The CFO also noted that the company's guidance for the fiscal fourth quarter had been for a year-over-year decline in the operating margin between 175-180 bp, versus the non-GAAP reported 120 basis point decline. The CFO noted that a less promotional environment than a year ago, vendor support, and cost disciplines were better than expected going into the quarter.
Domestic online sales grew by 25.8% over the prior-year period. Although the company's website has improved dramatically over the pre-Joly version, it still could use a lot more work, and it sounds like things are going to change.
Project Athena was mentioned, which sounds like an internal database project to build customer-by-customer records including website visits and clickthroughs which, in turn, will generate customized texts and email offers based on the visitor's expressed preferences or inquiries. This won't happen overnight, but it is the way the company has to go.
The profitability of online sales today is lower than that of comparable in-store visits. Certainly looking at Amazon's financials, that would seem to be the case, but Best Buy is really changing its customer-facing presence and it will take some time.
Non-GAAP SGaA of $2.3 billion was 15.7% of sales, compared to $2.5 billion or 16.6% in the prior-year period. Domestic SGaA expense was $1.96 billion of 16% of revenue compared to $2.06 billion or 16.5% of revenue in the prior-year period. Renew Blue's annualized run rate of expense reduction had been targeted at $725 million, and the fiscal year ended, the CEO said., at a rate of $765 million.
In the coming 24 months, the company's Renew Blue will focus on the real guts of the retailing function, namely Merchandising, Marketing, Operations, Stores, Supply Chain,General Systems and Employee Engagement. The absolutely amazing thing is how much room for improvement there still is, with the stock already having more than doubled.
The company's local advertising circulars are vendor-paid 1970s vintage to pick on one irritant I see every Sunday. They bear no relation to what is trending in the marketplace. The CEO has now raised the ante on Renew Blue to run annualized savings of $1 billion! Merchandising will be tasked with coming up with tailored assortments that matter, not what the vendors want or what the stores want to drive margin through mix. The company loses about $400 million a year from damaged merchandise: very hard to believe in a company this big with this history.
The Employee Engagement task will not be easy, because the new model revolves around an empowered General Manager, who has variable compensation targets for individual store performance. This model, especially given the nature of most centralized structures, is not easy to implement. I have heard this story dozens of times, but I've only seen it done a handful of times.. The corporate functions like to think that they are the brains of the operation. Mr. Joly's task will be to make them the servants of the stores who are the ones who can see and feel what the customers want or don't like.
The systems and ordering tasks are onerous and detailed, but they've been done many, many times.
The overall message is that the Best Buy ship has stopped taking on water, has been righted and is once again at sea. Cash flow from operations of $1.1 billion looks down from last year's $1.4 billion, but much of it seems like timing, apart from what looks like the closing of lots of square footage with the inventory still on hand, not being returned or sold. This number should get significantly better.
Samsung stores, which we wrote about positively at the outset, could do much better next year, as that company slowly seems to be unleashing its innovation engine in phone, phablets, and other consumer health and electronic items. Microsoft's stores too should do better.
Management's challenge will be to manage expectations and to change around the internal teams and culture, with restructurings and new hires, to transform the company's way of dealing with vendors and customers in the new retailing structure of the future.
Thursday, February 20, 2014
H-P Upside Surprise for 1Q FY14: Execution Issues Still Remain.
H-P surprised analysts expectations in terms of revenue and EPS, and the businesses about which analysts were concerned also did better. Revenue of $28.2 billion was down 0.7% y/y and up 0.3% on a constant currency basis; this compared with expectations of a revenue decline of around 4%.
GAAP diluted EPS of $0.74 per share increased 17% over the prior year period level of $0.63. The company had bracketed its expectation between $0.60-$0.64, a flat to down quarter year-over-year.
Non-GAAP diluted EPS came in at $0.90, representing a 10% increase over the prior year quarter's level of $0.82 per share. The company's guidance had been in the range of $0.82-$0.86.
CFO was $2,990 million, compared to $2, 562 million in 1Q FY13, an increase of 17%, well ahead of all expectations. Free cash flow cited by the CFO was $2.4 billion. The company did a large, well received institutional debt offering of $2 billion in the quarter. Return on equity was 18%.
$843 million in cash was returned to shareholders in 1Q FY14, comprising $278 million in dividends and $565 million in share repurchases at an average price of about $28.25. The percent of free cash flow returned in the quarter was about 35% compared to the target of 50%, which I still believe should not be a focus for management's energy or shareholder capital at these levels.
Revenue, Earnings and Cash Flow
Consolidated GAAP operating margin of 7.1% was up 90 basis points over the prior year period; on a non-GAAP adjusted basis operating margin of 8.5% increased 60 basis points year-over-year.GAAP diluted EPS of $0.74 per share increased 17% over the prior year period level of $0.63. The company had bracketed its expectation between $0.60-$0.64, a flat to down quarter year-over-year.
Non-GAAP diluted EPS came in at $0.90, representing a 10% increase over the prior year quarter's level of $0.82 per share. The company's guidance had been in the range of $0.82-$0.86.
CFO was $2,990 million, compared to $2, 562 million in 1Q FY13, an increase of 17%, well ahead of all expectations. Free cash flow cited by the CFO was $2.4 billion. The company did a large, well received institutional debt offering of $2 billion in the quarter. Return on equity was 18%.
$843 million in cash was returned to shareholders in 1Q FY14, comprising $278 million in dividends and $565 million in share repurchases at an average price of about $28.25. The percent of free cash flow returned in the quarter was about 35% compared to the target of 50%, which I still believe should not be a focus for management's energy or shareholder capital at these levels.
Surprises in Business Segments
The Personal Systems Group revenue grew 4% to $8.5 billion, which CEO Whitman said was its best performance in the past four quarters, possibly signaling an inflection point in the PC cycle. Analysts had forecast doom and gloom for this business, as the world would be working on tablets, according to them.
Total unit sales were up 6%, with commercial units sold increasing 8% while consumer units declined by 3%. Desktop units in total decreased 3%, while notebook units sold increased 5%. The Windows XP changeover to Windows 8.1 was not a major factor in the segment's unit sales, according to the CEO.
Operating margin in the Personal Systems Group was 3.3%, almost 50 basis points ahead of the prior year period.
PSG revenue accounted for 30% of 1Q FY14 consolidated revenue and about 10% of non-GAAP operating profit.
The Printing business of $5.8 billion declined 2% year-over-year, and about 1% in constant currency. Printing's operating margin of 16.8% was 50 basis points ahead of last year. Total hardware units sold were up 5%, with laser units sold increasing by 2%, leading to a 2% increase in market share, according to the CEO. Supplies sold decreased by 3%, while ink sales increased. This business, which for a time was milking consumers for ink sales to maintain its profits, seems to have returned its business model to some normalcy, focusing on units in its key commercial segment. The CEO gave a "shout out" to her new leadership group in this business.
Printing accounted for 20% of consolidated quarterly revenue and a hardy 37% of non-GAAP consolidated operating profit.
The Enterprise Group revenue of $7.0 billion increased 1% over the prior year period. Operating profit of $1 billion represented an operating margin rate of 14.4%, down about 100 basis points compared to the prior year period. Now that the revenue base has stabilized, the CEO noted that the profit margins really have to increase in this business. A lot of the margin has to do with mix of sales, she noted. If H-P can mix in more storage and networking products and services into sales, this would be accretive to margins, whereas higher sales of Industry Standard Servers ("ISS") are dilutive to margins ISS sales are still 46% of EG sales, and ISS sales grew 6% while storage sales were flat and networking sales were up 4%.
Highlighting the issue of product line transitions, storage sales were flat overall, but sales of the Converge line of storage solutions increased 43% and the former 3PAR products form the backbone of the new solutions. Traditional, stand-alone storage solutions will have to be transitioned out of the portfolio.
Two Challenging Areas
Since 2010, we have expressed our view that the Enterprise Services business doesn't really fit as a value contributor. Representing 19% of quarterly revenue, it contributed only 2% of non-GAAP consolidated operating income.
This business can't compete with the high end IT consulting groups, and so it cannot aspire to that industry-leading profitability. 63% of its revenue still comes from Information Technology Outsourcing ("ITO") a commodity business in its sunset years, especially for profitability. The ITO business was down 9% year-over-year. Enterprise Services revenue of $5.6 billion declined 7% year-over-year, while producing a meager $57 million in operating profit, or a paltry 1% of revenue.
Here's what we wrote about this business after reviewing the 2013 Analyst Day presentations:
"The CEO reviewed the major businesses. Enterprise Services, a $17.5 billion business (based on nine months, YTD), accounts for 21% of the YTD revenues but only 5% of the non-GAAP operating income. Whitman cited the inconsistent leadership, strategy, lack of EDS integration, and inadequate internal systems as the biggest reasons for its historically poor performance. This business needs some portfolio pruning, in my opinion, but the CEO said that there would be no major restructurings in fiscal 2014. The segment's non-GAAP operating margin was said to be at the high end of the outlook given at last year's meeting, but that doesn't change the fact that this is an albatross that needs to take flight. It clearly has the CEO's attention.Listening to the CEO on this quarter's conference call, it sounds like the group has its sales tools, new leadership and new processes, but the kind of change from putting a bucket out and waiting for renewals to going out and proactively marketing new ideas takes time and nine months of fiscal 2014 seems like a short time. Let's see.
Whitman cited a pretty extensive list of new leadership within Enterprise Services, including executive promoted from within and new hires from Bain, Accenture, Microsoft, and Elastic Intelligence/BMC. The leadership group has pretty easy comps to have a strong 2014, let's hope that they get there."
Software was the second challenging area, in our opinion, in an otherwise strong quarter that caught analysts off guard on the upside. Something appears wrong in this segment, and the measured evaluation of prospects by George Khadifa at Analysts Day may have been too optimistic. If I recall, Mr. Khadifa was to report directly to the CEO. Software is only 3% of the first quarter's revenue and 5% of its non-GAAP operating profit.
Quarterly revenue of $916 million was down 4% year-over-year, while operating profit of $145 million was a sub-standard 15.8% of revenue, a 50 basis point decline over the prior year period. Support revenue which is 53% of the business and an add-on to a project sale was down 2%. Professional Services, the equivalent of a higher-end offering, declined by 12%. This business needs more critical mass.
Closing Comments
The CEO, in response to a question, said that acquisitions were back on the radar, and certainly looking at the software business, it's not hard to see why. Areas that would be considered are in security, big data, mobility and cloud. Of course, some of these areas are precisely what Autonomy was supposed to provide. The target size was described as "small to medium" sized companies. The $2 billion in debt, along with continued strong cash flows from operations, and some portfolio pruning could set the stage.
CEO Whitman talked about increased innovation from inside H-P, and she drew attention to the wide range of new product introductions at the European client meeting in Barcelona. This is all to the good.
The company guided to 2014 EPS in the range of $3.50-$3.79, on a non-GAAP basis. This seems like this would support a price from $30-35 a share, absent any collapse in corporate technology implementations for which there seems to be a growing appetite.
Nelson Peltz: No Fritos with My Pepsi.
Trian Fund Management, LP wrote a letter to Pepsi's board saying that as an owner of $1.2 billion in PEP shares and with experience in the food business, Pepsi should spin off its snack business to shareholders and leave the beverage business as a stand-alone company.
Trian spins its arguments specifically for the seven year period of current CEO Indra Nooyi's tenure, and this seems to coincide with the data points about Pepsi's under performance. Here are the really salient points in their argument:
All of these points are on the money. Pepsi has become the Microsoft of its snack foods and beverages business: a duopolist in colas and dominant in snack foods, but unable to innovate and really leverage its assets into earnings growth. Agility, culture and costs should be the bread and butter charters of the board and management and clearly these have to be addressed.
But, to go from here to a spinoff seems to hang on some pretty weak arguments, such as "We've seen Kraft and others do this, so ipso facto, it must be the best thing to do right away." The board should address how costs are going to be cut visibly and faster, and the right people should be put into the right slots to make the businesses perform better with the assets they have. Innovation is not as easy, but it's not rocket science either, because this isn't drug discovery, after all.
In recent quarters, Pepsi appears to have actually pulled a few earnings surprises. It has also given its longer-term projections as being a low single digit revenue growth business with mid to high single-digit revenue growth, with cash flows for dividend growth. This is about all this business can be in the medium term.
Distribution channels in the food business are everything. Frito Lay was the best in breed, and I presume that it still is, abstracting from any overhead allocation issues. Pepsi owns 11 out of the top 15 snack food brands direct delivered to retail, and Fritos are at the top. Buying its bottlers has been criticized, with Trian quoting the CEO as admitting it was a "mistake." The argument for doing so was, in addition to competing better with Coke, to give the company flexibility in pushing new and niche volume products through the distribution chain as sugared colas are clearly a declining unit volume business. Independent bottlers wouldn't want to take on a line of new organic juices instead of the larger volume carbonated drinks, the argument would go,
The answers to these questions are nowhere near as clear as Trian's letter makes out. In the emerging markets, much is made of losing share in India: that has more to do with the dynamics of Indian distribution than it does with Pepsi's execution. Pepsi, unlike Coke, is said to be gaining share in China.
Should Pepsi become leaner, more agile and more efficient? Absolutely, no doubt, and in a hurry. Is the holding company structure the best for Pepsi? It should be, but it isn't because of the above failures of management. Is a structure of two independent companies the best? Unclear.
I'll take that Diet Pepsi now, please.
Trian spins its arguments specifically for the seven year period of current CEO Indra Nooyi's tenure, and this seems to coincide with the data points about Pepsi's under performance. Here are the really salient points in their argument:
"As a distant number two competitor in beverages, PepsiCo never had the luxury of following the same strategies as those deployed by industry leader Coke. But PepsiCo nevertheless competed extremely effectively The company did so, from its earliest days through the 1990s, and was known for being faster on its feet, quicker to introduce new products, more willing to take risks and more willing to occasionally fail by doing so. Pepsi not only survived in this role of “industry disruptor,” it thrived.
Meanwhile, Frito-Lay was known historically for having one of the best corporate cultures in America. Its culture was separate and distinct from Pepsi, which made sense given different category and competitive dynamics – snacks versus beverages, push versus pull marketing, Frito-Lay as #1 in an industry with regional competitors versus Pepsi as #2 in an industry with one large competitor. Frito-Lay’s strong culture, combined with a dominant market share in an attractive category, created a force to be reckoned with in the food industry.On the corporate front, PepsiCo was known for running with low overheads, even after the company moved to Purchase in 1970."
All of these points are on the money. Pepsi has become the Microsoft of its snack foods and beverages business: a duopolist in colas and dominant in snack foods, but unable to innovate and really leverage its assets into earnings growth. Agility, culture and costs should be the bread and butter charters of the board and management and clearly these have to be addressed.
But, to go from here to a spinoff seems to hang on some pretty weak arguments, such as "We've seen Kraft and others do this, so ipso facto, it must be the best thing to do right away." The board should address how costs are going to be cut visibly and faster, and the right people should be put into the right slots to make the businesses perform better with the assets they have. Innovation is not as easy, but it's not rocket science either, because this isn't drug discovery, after all.
In recent quarters, Pepsi appears to have actually pulled a few earnings surprises. It has also given its longer-term projections as being a low single digit revenue growth business with mid to high single-digit revenue growth, with cash flows for dividend growth. This is about all this business can be in the medium term.
Distribution channels in the food business are everything. Frito Lay was the best in breed, and I presume that it still is, abstracting from any overhead allocation issues. Pepsi owns 11 out of the top 15 snack food brands direct delivered to retail, and Fritos are at the top. Buying its bottlers has been criticized, with Trian quoting the CEO as admitting it was a "mistake." The argument for doing so was, in addition to competing better with Coke, to give the company flexibility in pushing new and niche volume products through the distribution chain as sugared colas are clearly a declining unit volume business. Independent bottlers wouldn't want to take on a line of new organic juices instead of the larger volume carbonated drinks, the argument would go,
The answers to these questions are nowhere near as clear as Trian's letter makes out. In the emerging markets, much is made of losing share in India: that has more to do with the dynamics of Indian distribution than it does with Pepsi's execution. Pepsi, unlike Coke, is said to be gaining share in China.
Should Pepsi become leaner, more agile and more efficient? Absolutely, no doubt, and in a hurry. Is the holding company structure the best for Pepsi? It should be, but it isn't because of the above failures of management. Is a structure of two independent companies the best? Unclear.
I'll take that Diet Pepsi now, please.
Thursday, February 13, 2014
Cisco's Fiscal Second Quarter 2014: Nothing New From the First
After looking back at our lengthy post on 1Q FY14, Cisco's recent announcement of 2Q FY14 results didn't seem surprising. The bottom line is that analysts rate a fair value of $20 for the stock based on about $2.00 in EPS and a P/E about 70% lower than that of a competitor like Juniper Networks. Again, I get concerned when stocks are priced for perfection, but when they're priced like a "going out of business" sale that's the time to look closely at the risk/reward ratio.
Quarter two's revenues of $11.2 billion were 8% below the prior year, which is at the low end of the projected range of an 8-11% decline. Non-GAAP net of $2.5 billion was down 7%, and adjusted EPS of $0.47 compared to $0.51, including a substantial charge for defective component chips from a trusted vendor.
The gross margin pressure which everyone is looking for continues apace. The product gross margin of 59% is, as one analyst pointed out, the lowest rate in ten years. The consolidated GAAP gross margin rate was 53%, but 61% on a non-GAAP basis. Again, not nice to look at, but this is a common phenomena among all the tech giants, save for Apple and Google, whose models are quite different.
For example, Cisco has decided to get out of the low margin set top business, while today's papers have stories about Apple reportedly getting ready to launch a set top business. Inconsistent? Different business models. For Apple, it has yet to launch a product for which its customers aren't willing to pay a premium price, and so given their proprietary, closed iOS and their approach to content, this could be a nice niche for them. Or, it could be their first stumble: I surely don't know. For Cisco, with its goal to be the leading provider of infrastructure and management across the Internet and its plumbing, it makes perfect sense to get out of the box business.
Free cash flow of $2.3 billion was 6% ahead of the prior-year period. $4.9 billion was returned to shareholders, comprised of $4 billion in share buybacks and $900 million in dividends. This was a record. The quarterly dividend was raised from $0.17 per share to $0.19. Shareholders are getting paid for waiting.
Meanwhile their list of acquisitions and continuing integration of prior acquisitions continues. If they are overpaying, it isn't hurting the balance sheet. Emerging markets are a weakness. They are in total chaos for all vendors in many product lines. Is this a big deal now?
Cisco still has one of the strongest sales forces in the industry. If they didn't, how did they get to this point? To grow and retain this force, they have to execute a strong new product portfolio refresh, and this is where they should be putting money and management time. Share buybacks above $20? Back off the accelerator unless the stock craters, which doesn't look like it's in the cards.
Cisco, IBM, HP and Microsoft. There's value in there somewhere.
Quarter two's revenues of $11.2 billion were 8% below the prior year, which is at the low end of the projected range of an 8-11% decline. Non-GAAP net of $2.5 billion was down 7%, and adjusted EPS of $0.47 compared to $0.51, including a substantial charge for defective component chips from a trusted vendor.
The gross margin pressure which everyone is looking for continues apace. The product gross margin of 59% is, as one analyst pointed out, the lowest rate in ten years. The consolidated GAAP gross margin rate was 53%, but 61% on a non-GAAP basis. Again, not nice to look at, but this is a common phenomena among all the tech giants, save for Apple and Google, whose models are quite different.
For example, Cisco has decided to get out of the low margin set top business, while today's papers have stories about Apple reportedly getting ready to launch a set top business. Inconsistent? Different business models. For Apple, it has yet to launch a product for which its customers aren't willing to pay a premium price, and so given their proprietary, closed iOS and their approach to content, this could be a nice niche for them. Or, it could be their first stumble: I surely don't know. For Cisco, with its goal to be the leading provider of infrastructure and management across the Internet and its plumbing, it makes perfect sense to get out of the box business.
Free cash flow of $2.3 billion was 6% ahead of the prior-year period. $4.9 billion was returned to shareholders, comprised of $4 billion in share buybacks and $900 million in dividends. This was a record. The quarterly dividend was raised from $0.17 per share to $0.19. Shareholders are getting paid for waiting.
Meanwhile their list of acquisitions and continuing integration of prior acquisitions continues. If they are overpaying, it isn't hurting the balance sheet. Emerging markets are a weakness. They are in total chaos for all vendors in many product lines. Is this a big deal now?
Cisco still has one of the strongest sales forces in the industry. If they didn't, how did they get to this point? To grow and retain this force, they have to execute a strong new product portfolio refresh, and this is where they should be putting money and management time. Share buybacks above $20? Back off the accelerator unless the stock craters, which doesn't look like it's in the cards.
Cisco, IBM, HP and Microsoft. There's value in there somewhere.
Monday, January 13, 2014
Revenue Growth: A Challenge for Banks
This is a big earnings reporting week for the Big Banks, starting tomorrow. The folks at Credit Suisse are relatively positive on the big banks, although their overriding comment for the sector is that revenue growth will be very challenging.
Even more ironically, their favorite idea based on earnings exposure to emerging markets and relative valuation is Citigroup. Now remember that former CEO Vikram Pandit was drummed out of his position because his strategy was not engendering a turnaround fast enough. Never mind that possibly apart from Bank of America, no other global mega-bank had been as badly managed for decades. It appears from reading the CS analysts their bullish case on Citi is based on developments that really had been the core of Mr. Pandit's presentation from the beginning.
It should be an interesting week for financial stocks.
Even more ironically, their favorite idea based on earnings exposure to emerging markets and relative valuation is Citigroup. Now remember that former CEO Vikram Pandit was drummed out of his position because his strategy was not engendering a turnaround fast enough. Never mind that possibly apart from Bank of America, no other global mega-bank had been as badly managed for decades. It appears from reading the CS analysts their bullish case on Citi is based on developments that really had been the core of Mr. Pandit's presentation from the beginning.
It should be an interesting week for financial stocks.
Saturday, December 14, 2013
Cisco's 2013 Financial Analyst Conference
Looking at the three key executive presentations at Cisco's Financial Analyst Conference, management made a case for why Cisco should emerge as the preferred IT provider for large global enterprises, even as their corporate customers face exponentially growing volumes of data, greater demands for analytics and decision making agility, and a rapidly evolving cloud-based computing environment. They make a pretty good case.
At the end of the CFO's presentation, however, it becomes clear that to get to this promised land, Cisco has to navigate a period of low or no growth in their core switching and router businesses, while they begin the most significant product line refresh in corporate history. The 'core' Cisco business is projected to show revenue growth of 0-1% per annum over the next 3-5 years. This brought the projected revenue growth rate for the consolidated business over the next 3-5 years to 3-6%, which is down 1% from the top end of the prior projected range. This is the point that wasn't taken well by analysts, who then felt that Cisco might not emerge as the preferred IT provider they aspire to be.
Some points that struck me in CEO John Chambers' slides:
At the end of the CFO's presentation, however, it becomes clear that to get to this promised land, Cisco has to navigate a period of low or no growth in their core switching and router businesses, while they begin the most significant product line refresh in corporate history. The 'core' Cisco business is projected to show revenue growth of 0-1% per annum over the next 3-5 years. This brought the projected revenue growth rate for the consolidated business over the next 3-5 years to 3-6%, which is down 1% from the top end of the prior projected range. This is the point that wasn't taken well by analysts, who then felt that Cisco might not emerge as the preferred IT provider they aspire to be.
Some points that struck me in CEO John Chambers' slides:
- CIOs are taking longer to make big commitments to new computing architectures from Cisco and other providers. This is similar to comments made by HP CEO Meg Whitman, and it jibes with IBM CEO Virginia Rommety's frustration with her sales force's inability to 'execute' or close sales on the usual schedules;
- Despite this nervousness and macroeconomic headwinds, Cisco has had 5 consecutive quarters of 8-10% growth in revenue from U.S. Enterprise customers. For the recent 2013 fiscal year, U.S. revenues of $24.6 billion increased by 8.9% over the prior year. U.S. Commercial customer revenues over the same trailing five quarters increased 5-11%.
- Current growth areas are cloud computing, mobile, and video, as everyone agrees.
- Cisco's research and development budget and acquisitions will be directed to future growth areas in IT services, security, and collaboration.
- The key takeaway for me is the CEO's assertion that core routing and switching capabilities will be the foundation for the IT and business processes transformations that will create large, new addressable markets. Most analysts disagree with this assertion.
Rob Lloyd, President of Development and Sales, made these points, among others:
- For me these slides make a very important distinction about the different kinds of 'clouds' that will exist in the emerging computing environment, viz. public, or commodity, clouds like those provided by Amazon and others; private clouds, and virtual private clouds, both of which will feature highly developed security environments to protect corporate data. Lloyd says that CIO decisions will be based on business agility (from the cloud provider and from the responsiveness of the environment), total cost of ownership, data sovereignty and trust and control. The latter two points are, in my opinion, going to be critical for a CIO and a board which will have to look at the risks associated with a move to the cloud.
- He has some interesting industry statistics on the components of data center spending:
- Hardware accounts for more than thirty percent of data center infrastructure spending, despite its increasing commoditization;
- People expenses account for 29 percent of the spend;
- Software comprises 22 percent of data center costs;
- Energy and facilities absorb 12 percent;
- Disaster recovery (7 percent), Networking (10 percent), Storage (7 percent), Servers (11 percent), and Overhead (2 percent) make up the balance.
- Cisco's largest total addressable growth opportunities in 2017 will be in Saas (collaboration, security, and network operations), enabling cloud providers, and building private corporate clouds.
The financial press suggested that Cisco might become the target of activist investors because of the stock's relative under performance relative to the 88% increase in HP, for example. I'd find this company to be an unusual target for a few reasons.
- As we've said before, despite all the challenges in macro environment, pressures on pricing and reluctance of CIOs to make big commitments, and Cisco's continuing appetite for acquisitions, the company has a fortress balance sheet;
- Cash from operations of $12.9 billion in fiscal year 2014 increased by 12% over the prior year, and free cash flow was $11.7 billion.
- The company returned $6.1 billion to shareholders in fiscal year 2013 or 52 percent of its free cash flow, and it wisely changed the mix down to make the share buybacks a lower proportion than in the prior year.
- The proposal to divest the set top business picked up during the acquisition of Scientific-Atlanta has been floated, and it might improve profitability, if critics are right, but it's small potatoes in the scheme of things. In addition, the CEOs slides provides a justification for keeping the product line.
- If the stock gets below $18, it will be selling at about 9x adjusted fiscal 2014 EPS, which is about the level that HP hit before investor interest started to rise. What new value enhancing ideas would an 'activist' shareholder propose?
- The stock has a dividend yield in excess of 3%. Assuming that the bottom doesn't fall out from under this company, an investor would get paid to wait for some revenue growth.
On the gross margin side, the product gross margin rate did dip below sixty percent in the last fiscal year, declining 1 percentage point to 59.1 percent. Services margins held in at 65.7 percent, bringing the consolidated gross margin rate to 60.6 percent, a sixty basis point decline from the prior year.
While pricing and an unfavorable product mix due to the product line changeovers took 360 basis points off the gross margin rate year-over-year, this was entirely offset by productivity gains of 3.7 percent. In fact, the net erosion in the gross margin rate came from higher amortization of intangibles and an inventory adjustment from the acquisition of NDS. Fundamentally, the company seems to be managing its manufacturing and procurement operations very well, and it is investing some of its cost-saving from staff reductions into getting design and production efficiencies.
Analysts said that it wasn't an 'exciting' FAC from Cisco. Maybe not, but this stock could have some legs in 2014: let's see. I know that I have some tech head readers from the industry. Send me your thoughts.
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.
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.
Friday, December 28, 2012
HP 2012 10-K: Share Buybacks and Potential Divestitures
HP's share buyback program to-date has been badly managed, as we discussed in a previous post. Now, although the shares may be undervalued, the company is financially much less flexible than in the past. In the 10-K, there are several risk factors discussed that militate against further large share buybacks:
- The paramount need to raise the corporate credit rating;
- "We may have to continue lowering the prices of many of our products and services to stay competitive.."
- "We renewed our focus on developing new products, services and solutions..."
- "W must make long-term investments, develop or obtain, and protect intellectual property and commit significant resources before knowing whether our predictions will accurately reflect customer demand for our products, services, and solutions.."
- "...we must continue to successfully develop and deploy cloud based solutions for our customers."
- The company has repeatedly suggested that it has underinvested in research and development in the past.
All of this taken together, along with many other similar statements, suggests that the higher return investments are within the business itself as opposed to in the stock market. In fact, the company itself may be at risk as a stand-along entity if it doesn't reclaim a place at the table of technology leaders. The cash needs to be invested in the business, and rationally within the portfolio.
In talking about their services business, particularly the lower value services business like business process outsourcing and staff augmentation, the company talks about not being able to manage the four key drivers of this business: rate, margin, utilization and leverage. If this is what HP is talking about at this stage of their corporate development, these business segments might be candidates for divestiture to partners, particularly to foreign partners. Valuations won't be stellar, and HP has no particular comparative advantage in these businesses. Foreign firms may be very interested in them in order to broaden their international scope. Sixty-five percent of HP revenues are outside of the U.S. These commodity businesses probably don't belong in a high performance portfolio.
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:
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:
- "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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- "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."
- 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.
- 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.
- 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.
- 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.
- The implied control premia for each major business segment are the "fudge factors" that make the assertions in bullet point 12 work.
- 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!
Friday, November 2, 2012
U.S. Equities: An Expensive, Clean Dirty Shirt?
I'm paraphrasing Bill Gross' comment about U.S. Treasuries and expanding it to the U.S. equity markets.
Cliff Asness of AQR Capital Management put out a third quarter bulletin to investors in which he talked about the Cyclically Adjusted Price-Earnings ratio ("CAPE") of Robert Shiller. Depending on how you look at the long-term picture of CAPE, the equity markets are relatively cheap, or not.
The bullish case would say that the CAPE at 9/30/2012 was 22.5 times the average of ten year trailing real earnings. This is one-half the level of 1999-2000, at the peak of the market bubble. So, we should feel 'the pump' as the weightlifters would say.
When I first looked at his chart, it's clear to see the bullish conclusion, but then the other side is also evident. Asness notes that the CAPE time series has spent 80% of its time below the current level of 22.5. So, he concludes, based on some additional partitioning of the long period, that someone expecting a 10% nominal equity return (about 8% real) is betting on exceptional returns compared to history.
This gets us back to Bill Gross' metaphor. Emerging markets, for all the bullish broker comments, aren't attracting the big money, such as Norges Bank Investment Management. There has been a flight to liquidity, size and decent dividend yields, which largely spells U.S. equity markets.
However, we've seen in repeated corporate reports a blizzard of financially engineered quarters, with simultaneous challenges expressed about future revenue prospects. Next year, comparing to these strong quarters might be problematical. Shouldn't the market move downward?
The typical buy and hold investor, who isn't foolish enough to think that he can trade against the market with their broker's option software, should find his prospective returns being truly circumscribed. Thanks, Uncle Ben, for nothing!
Cliff Asness of AQR Capital Management put out a third quarter bulletin to investors in which he talked about the Cyclically Adjusted Price-Earnings ratio ("CAPE") of Robert Shiller. Depending on how you look at the long-term picture of CAPE, the equity markets are relatively cheap, or not.
The bullish case would say that the CAPE at 9/30/2012 was 22.5 times the average of ten year trailing real earnings. This is one-half the level of 1999-2000, at the peak of the market bubble. So, we should feel 'the pump' as the weightlifters would say.
When I first looked at his chart, it's clear to see the bullish conclusion, but then the other side is also evident. Asness notes that the CAPE time series has spent 80% of its time below the current level of 22.5. So, he concludes, based on some additional partitioning of the long period, that someone expecting a 10% nominal equity return (about 8% real) is betting on exceptional returns compared to history.
This gets us back to Bill Gross' metaphor. Emerging markets, for all the bullish broker comments, aren't attracting the big money, such as Norges Bank Investment Management. There has been a flight to liquidity, size and decent dividend yields, which largely spells U.S. equity markets.
However, we've seen in repeated corporate reports a blizzard of financially engineered quarters, with simultaneous challenges expressed about future revenue prospects. Next year, comparing to these strong quarters might be problematical. Shouldn't the market move downward?
The typical buy and hold investor, who isn't foolish enough to think that he can trade against the market with their broker's option software, should find his prospective returns being truly circumscribed. Thanks, Uncle Ben, for nothing!
Sunday, October 21, 2012
Google Blows a Quarter: No Worries
I'm in the process of reading "What Would Google Do?" by Ben Jarvis. I'm very skeptical of books that are written by acolytes or high priests of corporate worship, which is what this book's title suggests. This book does flirt with idolatry at points. However, it is a very interesting and provocative book, ostensibly about Google but it is also about first principles of business models in the digital age.
Google's share price was buffeted last week by mistakes of carelessness and inattention by a vendor--someone pressing "Send" when they weren't authorized to do so and without reading what they were sending---and by disappointment in 3Q 2012 financial results. The basic comment was that Google's take from a mobile ad was lower than that from a desktop ad because of lower rates; the stock swooned. It was probably talked down so that buyers could find a better entry point.
From what I've read about Google, including from Jarvis' book, I would guess that none of Google's founders or senior executives would be the least bit concerned by Wall Street's quarterly hand wringing.
In fact, here is an excerpt from the recent Wall Street Journal online edition,
"About half of all U.S. mobile ad spending goes toward search ads, more than the roughly 47% of total digital spending in Web search, according to eMarketer Inc. And Google takes a 95% share of mobile-search revenue in the U.S., estimates eMarketer."
Google CEO Larry Page said that at this point last year Google generated about $2.5 billion from mobile advertising, apps and content. This year, they are on pace to generate more than $8 billion in revenue from these channels! "I am not worried about this at all in terms of our business at all," he said. That's the kind of confidence I like to see.
By contrast, Facebook and Zynga have either been late to the mobile advertising party or slow to generate revenue growth. So, even among its New Digital Age peers, Google is clearly at the head of the table.
In traditional newspaper or media businesses, with considerable overhead and inefficiencies, a corporate strategy would have been to dip the toe into the water of mobile advertising, including "setting" rates at some desired, higher level. Instead, Google's approach is to watch customers and partners create a mobile advertising platform on top of their search platform without any attempt to control or set the architecture or rates.
Instead, Google focused on grabbing a 95% market share of a market which analysts say is only going to grow as corporate marketers themselves get more comfortable with this new advertising medium and move dollars there.
Google, among other things, is all about speed and aggression. One of their senior execs wrote another one of their principles, "Done is better than perfect." Aggression, especially towards any of their competitors, used to be a chromosome in the Microsoft DNA. Microsoft certainly didn't worry about Windows releases being perfect: they went the other way and released really awful bloated, bug-infested software. Let's see how things go in the upcoming Windows 8 release and the uptake in Surface RT. It should be a new day for them.
I need to have a Google expert explain something to me. Their practice of releasing all kinds of versions of Android OS on mobile phones: Ice Cream Cone, Cookie Monster....and not allowing users to easily update to the latest and best version: what is that all about? This makes no sense at all: it borders on Microsoft arrogance, unless there's a nefarious upside I am missing.
Meanwhile, according to CS analyst Stephen Ju, GOOG is selling at 11 times P/E-ex cash, which doesn't seem expensive on any absolute basis. He rates the shares Outperform. (I don't own any shares).
Thursday, July 12, 2012
Barclays Downgrades HP
HP closed at $19.35, close to its 52 week low of $19.02. As we mentioned a while back, the chart looked awful. Every newspaper reader knows the tech sector is challenged for top line growth. The market also appears to be entering the summer malaise.
Given how poor HP's technobabble guidance has been, analysts are realizing that there's absolutely no reward for being heroic about the upcoming third quarter earnings due out August 22nd. So today, Barclay's analyst Ben Reitzes cut his rating on HPQ to "Equal Weight," whatever that means. It doesn't mean, "buy," or "accumulate."
Reitzes' 2012 EPS estimate is cut from $4.04 to $3.99, a reduction of 1.2%. So, since the market appears to want to price HP at 5 times forward earnings, it would suggest a $20 price, which is roughly where the stock is today. The analysts is derisking his position.
His main reason for the reduction in revenue and earnings is pressure on the printing business. That's all well and good, a reasonable conclusion which reflects the current realities with retailers, channel pricing, and promotions to fight off ink refills.The fear factor is a interesting tactic. Why is printing under pressure?
"Reitzes also notes that as younger workers join the workforce, they may be doing less printing (and more with mobile apps)."(Street Insider)
This is a demographic shift which is surely not taking place intra-quarter! What measure would the analyst have for this shift? I sympathize with him: he wants to cut his number to get closer to consensus and he needs a cover. It sounds good, forward looking, and it goes with all the ads for people staring at their smart phones.
This demonstrates again the limited value of Wall Street research and the lack of any real clarity from HP management in where their business is going and what will drive it. Hopefully, HP has set expectations so low, with so much slop in their guidance, that there won't be an earnings warning between now and August 22nd.
Given how poor HP's technobabble guidance has been, analysts are realizing that there's absolutely no reward for being heroic about the upcoming third quarter earnings due out August 22nd. So today, Barclay's analyst Ben Reitzes cut his rating on HPQ to "Equal Weight," whatever that means. It doesn't mean, "buy," or "accumulate."
Reitzes' 2012 EPS estimate is cut from $4.04 to $3.99, a reduction of 1.2%. So, since the market appears to want to price HP at 5 times forward earnings, it would suggest a $20 price, which is roughly where the stock is today. The analysts is derisking his position.
His main reason for the reduction in revenue and earnings is pressure on the printing business. That's all well and good, a reasonable conclusion which reflects the current realities with retailers, channel pricing, and promotions to fight off ink refills.The fear factor is a interesting tactic. Why is printing under pressure?
"Reitzes also notes that as younger workers join the workforce, they may be doing less printing (and more with mobile apps)."(Street Insider)
This is a demographic shift which is surely not taking place intra-quarter! What measure would the analyst have for this shift? I sympathize with him: he wants to cut his number to get closer to consensus and he needs a cover. It sounds good, forward looking, and it goes with all the ads for people staring at their smart phones.
This demonstrates again the limited value of Wall Street research and the lack of any real clarity from HP management in where their business is going and what will drive it. Hopefully, HP has set expectations so low, with so much slop in their guidance, that there won't be an earnings warning between now and August 22nd.
Tuesday, July 3, 2012
Don't Forget the IndyMac Debacle
While Countrywide Financial is back in the financial news, it's worth readers remembering IndyMac Bank and New Century Financial. The linked post above still makes good reading, but I want to expand on IndyMac from the role of the CEO and his enabling board. None of these folks are in jail either, as far as I know.
IndyMac CEO Michael Perry began his career as a KPMG auditor, and was an inactive CPA during his tenure at IndyMac. After working in the mortgage business at Commerce Security Bank, he joined IndyMac when it had four employees. By 2006, the bank had about 8.000 full time equivalent employees. Despite the complexity of subprime financial services Perry clearly understood subprime mortgage origination, and how the product affected the income statement and balance sheet.
The board of directors included Lyle Gramley, a retired member of the Board of Governors of the Federal Reserve System. Gramley's pronouncements about monetary policy, interest rates and banks had been very visible in the financial press for years. Hugh Grant was a director who served as the Managing Partner for the Western Region of KPMG, where he worked for 38 years. Retired California Senator John Seymour was a board member whose legislative career had centered on housing and finance issues.
According to the 2006 proxy, the CEO's incentive compensation rested on EPS and ROE targets, both of which were subject to the highest degree of accounting manipulation in this subprime mortgage business. IndyMac's reported earnings were of low quality, and its balance sheet reported inconsistently with its risk profile. We've noted a few of thise points in the previous posts, and won't repeat anything here.
In 2004, the CEO expressed to his risk managers via emails his concern that credit quality was deteriorating. Yet in the corporate culture of the firm, risk managers were routinely overridden by a network of roguish, non-employee mortgage originators whose only objective was to maximize their own commissions. By 2006, the Office of Thrift Supervision's Inspector General noted that 75% of IndyMac's option ARM holders were making only the minimum monthly payments on their mortgages. Yet, provisioning levels continued to be minimal, and reported earnings were high.
At the end of fiscal 2006, three sophisticated institutional investors held stakes that were reported in the proxy: Barclay's at 13%, NWQ (Nuveen) Investment Management at 10%, and Capital Guardian Trust at 7%. Investors got what they wanted with outsized earnings growth, the share price outpaced the Russell 1000 Financial Services Index by a wide margin, and management paid itself handsomely, despite the fact that they had to have known that the reported numbers were of dubious quality and the business unsustainable. These sophisticated investors apparently couldn't see through the numbers to the fundamentals either. The problem is not about process. It almost never is, yet our regualtion only addresses layering on more process. It is all about individuals being bad actors and not doing their jobs, for which there is no accountability.
IndyMac CEO Michael Perry began his career as a KPMG auditor, and was an inactive CPA during his tenure at IndyMac. After working in the mortgage business at Commerce Security Bank, he joined IndyMac when it had four employees. By 2006, the bank had about 8.000 full time equivalent employees. Despite the complexity of subprime financial services Perry clearly understood subprime mortgage origination, and how the product affected the income statement and balance sheet.
The board of directors included Lyle Gramley, a retired member of the Board of Governors of the Federal Reserve System. Gramley's pronouncements about monetary policy, interest rates and banks had been very visible in the financial press for years. Hugh Grant was a director who served as the Managing Partner for the Western Region of KPMG, where he worked for 38 years. Retired California Senator John Seymour was a board member whose legislative career had centered on housing and finance issues.
According to the 2006 proxy, the CEO's incentive compensation rested on EPS and ROE targets, both of which were subject to the highest degree of accounting manipulation in this subprime mortgage business. IndyMac's reported earnings were of low quality, and its balance sheet reported inconsistently with its risk profile. We've noted a few of thise points in the previous posts, and won't repeat anything here.
In 2004, the CEO expressed to his risk managers via emails his concern that credit quality was deteriorating. Yet in the corporate culture of the firm, risk managers were routinely overridden by a network of roguish, non-employee mortgage originators whose only objective was to maximize their own commissions. By 2006, the Office of Thrift Supervision's Inspector General noted that 75% of IndyMac's option ARM holders were making only the minimum monthly payments on their mortgages. Yet, provisioning levels continued to be minimal, and reported earnings were high.
At the end of fiscal 2006, three sophisticated institutional investors held stakes that were reported in the proxy: Barclay's at 13%, NWQ (Nuveen) Investment Management at 10%, and Capital Guardian Trust at 7%. Investors got what they wanted with outsized earnings growth, the share price outpaced the Russell 1000 Financial Services Index by a wide margin, and management paid itself handsomely, despite the fact that they had to have known that the reported numbers were of dubious quality and the business unsustainable. These sophisticated investors apparently couldn't see through the numbers to the fundamentals either. The problem is not about process. It almost never is, yet our regualtion only addresses layering on more process. It is all about individuals being bad actors and not doing their jobs, for which there is no accountability.
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