HP Earnings Begin Long Journey Back

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 |  About: HP Inc. (HPQ)
by: David Dyer

The self-styled "world's largest technology company" HP (NYSE:HPQ) financial results brought a sigh of relief and hope with GAAP earnings per share ($0.63) and continued Non-GAAP earnings per share ($0.82) for the quarter ending January 2013. The Non-GAAP EPS beat both the management outlook ($0.68 to $0.71) and the analysts' estimate ($0.71). This was after 2 disastrous quarters of GAAP net losses totaling a demoralizing $15.7 billion.

HP continues to redefine and restructure to catch up with the leading edge of technology. CEO Meg Whitman still has a long journey ahead before the "onwards and upwards" phase is achieved. Both revenues and earnings per share in the first half of 2013 are projected to lag the 2012 performance.

The year over year growth rate for total revenues was a contraction of -5.6%, which nonetheless beat the estimate of -7.5% for the quarter ending January 2013. This was the 6th consecutive quarter of revenue contraction attributable to the corporate restructuring process and being left behind in the technology sector. The initial estimates for the future quarters of April 2013 and June 2013 are for more pullback to -8.9% and -6.4%, respectively.

Non-GAAP earnings per share dropped -10.9% year over year, but did beat estimates of -22.8% for the quarter ending January 2013. As with revenues, this was the 6th consecutive quarter of EPS contraction. The contraction is projected to continue for April 2013 (-17.4%) as estimated by the management outlook midpoint. Analysts project July 2013 at -16.0%, which may be revised upwards slightly.

The Non-GAAP earnings per share, core operations, has been respectable though lower in the past year. This results in the ongoing year over year contractions. It is the GAAP earnings per share that plunged. In October 2012 via the non-cash charge-off of the Autonomy acquisition. In July 2012 it was the non-cash charge-off of the Compaq goodwill plus restructuring charges. Accordingly, GAAP EPS has rebounded and somewhat normalized.

Gross margin was disappointing and dipped to a 5-quarter low of 22.3%. The prior quarter was a then encouraging 24.2%, which was a 6-quarter peak. The 14-quarter average is 23.4%. A higher and consistent gross margin had been the bright spot for HP. Operating and net margins have suffered with the restructuring and charge-offs but rebounded this quarter.

The newly realigned segment revenues and performance are not encouraging to-date. From the prior year, the 4 largest segments reported contraction in January 2013: Personal Systems -8%, Enterprise Services -7%, Printing -5%, and Enterprise Group -4%. The remaining segments are immaterial. HP has entered open cloud services via CloudSystem, which may someday provide a significant leading edge revenue stream.

A hopeful sign in regional revenues was an Asia Pacific gain of +1% year over year at January 2013. Both Europe, Middle East, Africa -11% and Americas -3% contracted yet again.

HP generates cash and is remarkably liquid. Capital is adequate. Debt is high and is mostly attributable to an embedded financing operation. Stock repurchases and dividends continue.

Since summer 2011, restructurings have been announced, amended, and then reorganized. HP continues attempting to redefine itself. Yet another multi-year restructuring plan is in effect under the direction of CEO Whitman. The plan is thus: long-term good with incoming short-term and intermediate-term pain for GAAP earnings. Non-GAAP operating earnings has fared much better.

Is the bottom finally in for HP? Most likely, yet there are more costs coming with the restructuring and redefining. In the next 2 fiscal years, through FYE October 2014, another $1.8 billion in restructuring charges are projected. $130 million was expensed in the current quarter. The overall annualized savings of the restructuring, including a workforce reduction of 15,000+ in the FYE October 2013, is ultimately projected to be $3.0 to $3.5 billion.

There is still almost $36 billion of goodwill and intangible assets on the books even after the charge-offs, down from a peak of $55 billion at the quarter ending October 2011. I say this partly in jest, but management did mention in the past an impairment review was underway. Management noted that HP was on a "multi-year journey" beginning in 2012.

Management earnings per share outlook for the next quarter April 2013 is operating Non-GAAP $0.80 to $0.82 or a -18% to -16% year over year contraction. Management projects GAAP earnings per share of $0.38 to $0.40, which implies no further material charge-offs or huge restructuring costs.

Management earnings per share outlook for the FYE October 2013 for Non-GAAP is $3.40 to $3.60 or a -16% to -11% year over year drop. This is a sign on the aforementioned multi-year journey on the long and winding road. Management estimates GAAP EPS at $2.30 to $2.50 or a +136% to +139% year over year increase. The large GAAP increase is due to the charge-offs of Compaq, Autonomy, and restructuring in the prior fiscal year.

I continue neutral long-term on HPQ stock. Innovation and creativity, the lack of which got HP into this mess in the first place along with some poorly thought out and executed acquisitions, will need to be demonstrated. Then some year over year growth in revenues and ultimately earnings per share will appear on the horizon. Cost cutting on declining revenues only plays out for so long.

Obviously the short-term upside from the earnings beat has already occurred. Yes, these latest financial results were encouraging, no massive charge-offs or costs are imminent, and the buyers are lining up for HPQ stock. No, I do not see a significant downside in 2013 as the restructuring continues. Long-term optimism is another story waiting to unfold through segment innovation and the product pipeline.

Management expects their reorganization efforts to begin paying off in 2013. The stock hit a closing low of $11.71 on November 20, 2012 before the disastrous earnings of the prior quarter were announced after market close. That was billions of dollars in losses ago and appears to be the bottom.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.