HP Earnings: Strong Dollar And Tepid Demand Impact Revenues

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Hewlett-Packard (NYSE:HPQ) posted its first quarter earnings for fiscal year 2015 on February 24th. (Fiscal years end with October.) In line with our expectations, HP’s revenues declined by 5% year over year (2% in constant currency) to $26.8 billion. [1] The company delivered $0.73 in GAAP diluted earnings per share, marginally down from the year-ago quarter. The company attributed the decline in revenues to appreciation of the U.S. dollar and challenging economic environment across IT services business in EMEA, which contributes nearly 50% to HP’s revenues. The HP enterprise services, software and HP Finance failed to deliver growth yet again. Furthermore, despite the improvement in PC shipments, its computer hardware group failed to post any growth in the top line. However, the enterprise group posted encouraging results as Industry Standard Servers and Business Critical Systems witnessed growth. Enterprise group revenues were flat at $6.98 billion, while the enterprise service revenues declined by 11% to $4.93 billion.

See our full analysis on HP

Outlook for Q2 and 2015

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For Q2 FY15, HP estimates non-GAAP diluted net EPS in the range of $0.84 to $0.88, reflecting an estimated currency impact of $0.09. It expects GAAP diluted net EPS in the range of $0.57 to $0.61. For fiscal 2015, HP has revised its guidance downwards due to currency headwinds.  It estimates non-GAAP diluted net EPS between $3.53 and $3.73 and GAAP diluted net EPS between $2.03 and $2.23. [2] The stock is down nearly 10% in the wake of the conference call and reduced guidance.

PC Shipments Improve

HP’s PC and Workstation division is the fourth largest division, contributing nearly 30% to its revenue and 10.6% of its estimated value. According to Gartner, worldwide PC shipments experienced marginal improvement in the fourth quarter of 2014. [3] HP’s personal systems division outperformed the industry as both the number of shipments and revenue grew during the quarter. The company reported 9% growth in total units shipped during the quarter, buoyed by a 21% increase in notebook shipments. While consumer revenues were up 2%, commercial revenues declined by 1%. As a result, the company reported 3% year-over-year growth (in constant currency) in revenues to $8.5 billion. Operating profit also improved to $313 million or 3.7% of revenue. Recently, news has surfaced that Lenovo, which is the leader in PC sales, was pre-installing software that made PCs susceptible to hacking. While Lenovo has stopped pre-installing the software, we believe that the damage has already been done and this should help HP to boost its sales in the coming quarters. Additionally, the surge in PC sales suggests that HP’s  recently launched thin notebooks have gained traction with users as Notebook revenue were up by 9% against  21% improvement in shipments, indicating increased sales of cheaper notebooks.

Server Demand Spurs Enterprise Group

The Enterprise Group is HP’s third largest business division and makes up 20% of its value. This division includes HP’s Industry Standard Servers (ISS), Business Critical Systems (BCS), and storage solutions. The division was able to buck the headwinds of currency appreciation, and reported revenues at $7 billion. While there was a 7% year-over-year improvement in ISS, the company continued to experience decline in its Business Critical Systems division as revenues declined by 11% year over year, albeit at a lower rate. The company reported double-digit increases in ISS’s ASPs as the Gen9 ProLiant server drove margins. Going forward, the combination of Gen9 and the refresh cycle of server should drive growth in the remainder of 2015.

The storage division revenues declined 8% to $878 million as revenues for traditional systems declined by 14%. However, storage revenues grew 3% year over year in constant currency as converged storage grew by 21% and now makes up 50% of storage revenues. The mid-tier 3PAR storage unit continued to gain traction as revenues grew by 12% during the quarter. In sum, sequential comparisons suggest momentum is increasing, even as the year-to-year counterparts remain negative.

HP Service Revenues Continue To Suffer

The services division makes up 25% of HP’s estimated value. HP’s enterprise services division reported a 11% year-over-year decline (8% decline in constant currency) in revenue to $5 billion, primarily due to key account revenue run off, softness in new signings from EMEA, and currency headwinds. Within this segment, the infrastructure technology outsourcing division reported an 11% year-over-year decline in revenues to $3.15 billion, due to a revenue run-off of lapsed contracts and pricing pressures. Furthermore, its application and business services revenues declined by 11% year over year to $1.85 billion, primarily due to softness in demand from EMEA and key account runoff. Going forward, we expect that the company will continue to report a decline in service revenues as the weak business conditions in EMEA remain, and the company has not been able to bag substantial new contracts.

Pricing Pressure Drags Printing and Ink Cartridge Division

The printer and ink cartridge division is HP’s second largest division and makes up 22% of its value. The printer division reported 5% year-over-year decline (4% in constant currency) in revenues to $5.5 billion in the quarter as supplies revenues declined by 5%. The primary reason for the decline in supplies revenue was reduction in channel inventory from the consolidation of U.S. retailers, which also suggest some softness in demand in the future. Furthermore, declines in low-end home and single function minor laser hardware units drove overall units down 4% year over year. Additionally, aggressive pricing from Japanese competitors in the printing business, primarily due to the weakness of the yen, continued to challenge HP’s market share.

Software Division Revenues Flat lines

The software division makes up 7.7% of HP’s estimated value. Software division revenues were impacted by the shift in its portfolio and operating model to SaaS and subscription-based offerings.The company reported 16% decline in license revenues, and 4% decline in service revenues. As a result, HP’s software division revenues witnessed 5% year over year decline in revenues to $871 million. However, 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 FY2015. [4]

We are in the process of updating our model. We presently have a $31.33 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 Grew 1 Percent  in the Fourth Quarter of 2014, January 12 2015, www.gartner.com []
  4. Earning transcript call, February 25 2015, www.seekingalpha.com []