HP Earnings: Soft Demand And Strong Dollar Impact Revenue Even As The Company Gears For Split

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Hewlett-Packard (NYSE:HPQ) posted its second quarter earnings for fiscal year 2015 on May 21st. (Fiscal year end with October.) In line with our expectations, HP’s revenues declined by 7% year over year (2% in constant currency) to $25.5 billion. [1] The company delivered $0.55 in GAAP diluted earnings per share, marginally down from the year-ago quarter. The company attributed the decline in revenues to the appreciation of the U.S. dollar and soft demand across the IT services business. The softness in demand was further accentuated by the challenging business environment in EMEA, which contributes nearly 50% to HP’s revenues, and China.

The HP enterprise services, software and HP Finance posted a steep decline in revenue. Furthermore, despite the improvement in PC shipments, its computer hardware group failed to post any growth in the top line due to pricing pressures. However, the enterprise group posted encouraging results as Industry Standard Servers witnessed growth. Enterprise group revenues declined 1% to $6.56 billion, while the enterprise service revenues declined by 16% to $4.81 billion. In this note, we will review results for its divisions and discuss the planned split of the company.

See our full analysis on HP

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Outlook for Q3 and 2015

For Q2 FY15, HP estimates non-GAAP diluted net EPS in the range of $0.83 to $0.87. It expects GAAP diluted net EPS in the range of $0.50 to $0.54. Fiscal 2015 third quarter non-GAAP diluted net EPS estimates exclude after-tax costs of approximately $0.33 per share, related to separation costs, the amortization of intangible assets, restructuring charges, defined benefit plans settlement charges and acquisition-related charges. For fiscal 2015, HP estimates non-GAAP diluted net EPS between $3.53 and $3.73 and GAAP diluted net EPS between $2.03 and $2.23. [2]

Separation Update Takes Center Stage

HP provided an update on its planned separation into two independent, Fortune 50 companies. The spinoff is fueled by the idea that companies with a narrower focus perform better. The separation remains on track and the company expects associated dis-synergies of approximately $400 to $450 million divided about equally between the two companies. The company also believes that it can offset more than half of these dis-synergy costs in FY2016, and more than fully offset these costs by FY2017. HP also announced new future leadership appointments for both companies. While   Cathie Lesjak will become Chief Financial Officer of HP Inc, Tim Stonesifer will become CFO of Hewlett Packard Enterprise. Mr Stonesifer currently serves as CFO of HP’s Enterprise Group.

PC Shipments Improve

HP’s PC and Workstation division is the fourth largest division, contributing nearly 30% to its revenue and 14.6% of its estimated value. According to Gartner, worldwide PC shipments experienced 5% decline in the first quarter of 2015. [3] HP’s personal systems division outperformed the industry as both the number of shipments and revenue during the quarter. The company reported 2% growth in total units shipped during the quarter, buoyed by a 19% increase in notebook shipments. While consumer revenues declined 2% (and grew 3% in constant currency), commercial revenues declined by 7% (down 2% in constant currency) as the buyers deferred PC purchases in advance  of the expected release of Windows 10 later this year. As a result, the company reported 5% year-over-year decline (flat in constant currency) in revenues to $7.7 billion. Operating profit declined to $235 million or 3% of revenue indicating the intense price competition in the industry. The company achieved 23.1% share indicating that HP’s recently launched thin notebooks have gained traction with users as Notebook revenue were up by 5% against 19% improvement in shipments.

Server Demand Spurs Enterprise Group

The Enterprise Group is HP’s third largest business division and makes up 17.8% 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 $6.6 billion. While there was an 11% year-over-year revenue increase (17% in constant currency) in ISS, the company continued to experience a decline in its Business Critical Systems division as revenues declined by 15% year over year. The company reported double-digit increases in ISS’s ASPs as the Gen9 ProLiant server and strength in density-optimized systems drove margins. Going forward, the combination of Gen9 and the refresh cycle of the server should drive growth in the remainder of 2015.

The storage division revenues declined 16% (2% in constant currency) to $740 million as revenues for traditional systems declined by 14%. The mid-tier 3PAR storage unit continued to gain traction as revenues grew during the quarter. In sum, sequential comparisons suggest momentum is increasing, even as the year-to-year comparisons remain negative.

HP Service Revenues Continue To Suffer

The services division makes up 20% 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 largest contributor and makes up 25% of its value. The printer division reported 7% year-over-year decline (2% in constant currency) in revenues to $5.5 billion in the quarter as supplies revenues declined by 5%. The channel inventory for supplies increased during the quarter indicating that slowdown in sales. This also suggests some softness in demand in the future. Furthermore, declines in low-end home and single function laser hardware units drove overall consumer units down 6% 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 6.8% 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 17% decline in license revenues, and 11% decline in service revenues. As a result, HP’s software division revenues witnessed 8% year over year decline in revenues to $892 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 $30.35 price estimate for HP, which is 10% 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 Declined 5.2 Percent in First Quarter of 2015, April 9 2015, www.gartner.com []
  4. Earning transcript call, May 21 2015, www.seekingalpha.com []