HP Earnings: Cost Restructuring Takes Center Stage As Revenues Remain Tepid

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Hewlett-Packard (NYSE:HPQ) posted its second quarter earnings for fiscal year 2014 on May 22nd. In line with our expectation, HP’s revenues declined by 1% year over year to $27.3 billion, albeit at a slower pace. [1] Furthermore, the company delivered $0.88 in non-GAAP diluted earnings per share, up 1% from the year-ago quarter. However, revenues continued to reflect the challenging economic environment across some of its business verticals. While services revenues declined by 7% year over year to $5.70 billion, the enterprise group revenues declined by 2% to $6.65 billion. However, personal systems and printing revenues, buoyed by share gains across the hardware segments, grew by 7% and 2%, respectively.

See our full analysis on HP

Outlook for Q3 and 2014

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For Q3 FY14, HP estimates non-GAAP diluted net EPS in the range of $0.86 to $0.90, and GAAP diluted net EPS in the range of $0.59 to $0.63. For fiscal 2014, HP estimates non-GAAP diluted net EPS between $3.63 and $3.75 and GAAP diluted net EPS between $2.68 and $2.80. Fiscal 2014 non-GAAP diluted net EPS estimates exclude after-tax costs of approximately $0.95 per share, related primarily to the amortization of intangible assets and restructuring charges. [2]

Restructuring In Focus

The company announced significant restructuring plans in May 2012 as it planned to simplify business processes and lower its sales and marketing expenses. According to its plans, the company is slated to reduce its workforce by 34,000 by the end of 2014, resulting in projected savings to the tune of $3.0-$3.5 billion annually. However, according to this  earnings announcement, the company now expects the reduction in force will reach 41,000 employees by the end of 2014 andwill likely total 45,000 to 50,000 by 2015 (i.e. and exodus of another 4,000 to 9,000 employees). The company expected this to create additional run-rate savings in fiscal ‘16 of approximately $1 billion per year on top of what it previously laid out ($3.0-$3.5 billion).

HP Service Revenues Suffer Due To Tepid Business Environment

The services division makes up 32% of HP’s estimated value. HP’s enterprise services division reported a 7% year-over-year decline in revenue to $5.70 billion, primarily due to softness in new signings for the quarter. Within this segment, the infrastructure technology outsourcing division reported a 7% year-over-year decline in revenues to $3.59 billion, due to a contractual revenue run-off and pricing pressures. Furthermore, its application and business services revenues declined by 8% year over year to $2.1 billion, primarily due to softness in the applications business.

ISS Buoys Server and Storage Division

The server and storage division is HP’s second largest business division and makes up 20% of its value. HP’s Industry Standard Server (ISS) division reported 1% year-over-year growth in revenues to $2.82 billion. The primary driver for this growth was demand in servers from EMEA (Europe Middle-East and Africa) and APJ (Asia Pacific- Japan) regions for servers. However, the company continued to experience decline in its business critical systems division as revenues declined by 14% year over year to $230 million.

The storage division revenues declined 6% to $808 million as the demand for traditional systems and converged system declined during the quarter. However, its mid-tier 3PAR storage unit continued to gain traction. As more companies adopt Cloud storage, we expect 3PAR and converged storage solution will drive revenue growth at its storage division.

Pricing Pressure Drags Printing and Ink Cartridge Division

The printer and ink cartridge division is HP’s third largest division and makes up ~17% of its value. The printer division reported 4% year-over-year decline in revenues to $5.8 billion in the quarter as supplies revenues declined by 6% to $3.866 billion. However, a 5% year-over-year growth in the number of hardware units shipped helped offset the decline to some extent. While consumer hardware unit sales were flat, commercial hardware unit sales increased by 3% against the same metric.

Commercial Sales Spur PC Division

HP’s PC and Workstation division is the fourth largest division, contributing nearly 30% to its revenue and 9% of its estimated value. Weak PC demand globally continued to plague computer manufacturers during the quarter as the shipments declined. [3]  However, HP bucked the downtrend and outperformed the market with particular strength in its commercial PC business. While consumer PC sales declined 2% year-over-year, commercial sales grew 12%.

The company reported 10% growth in total units shipped during the quarter, buoyed by a 7% increase in notebook and 6% growth in desktop shipments. As a result, the company reported 7% year-over-year growth in revenues to $8.17 billion against the backdrop of a 1.7% decline in PC units in the first calendar quarter. Additionally, operating profit improved by 0.5% year over year to $290 million or 3.5% of revenue.

Software Division Revenues Flat lines

The software division makes up 10% of HP’s estimated value. While the company reported 8% growth in license revenues and 3% growth in service revenues, support revenues declined by 4% year over year. As a result, its software division revenues were flat at $971 million. Furthermore, HP reported double-digit revenue growth in its cloud, security and big data services. We believe that cloud services are potentially the biggest new revenue source for HP in FY2014. [4]

We are in the process of updating our model. We presently have a $25.04 price estimate for HP, which is 20% below the current market price.

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Notes:
  1. See HP’s Pre-earnings article []
  2. 8-K []
  3. Gartner Says Worldwide PC Shipments in the First Quarter of 2014 Declined 1.7 Percent, April 9 2014, www.gartner.com []
  4. Earning transcript call, May 22 2014, www.seekingalpha.com []