HP Earnings Down, Optimism Inexplicably Up

Hewlett-Packard's first-quarter earnings fell 44% from the year-earlier quarter to $1.5 billion, on 7% lower revenue of $30 billion. HP's earnings call Wednesday was intended to be a sober but upbeat assessment of the company's fortunes, but after a series of down quarters, it's hard to imagine that the turnaround HP foretells is likely.

The bright side is that the numbers aren't quite as bad as HP had led the financial markets to believe they would be. Non-GAAP earnings were $0.92 per share, a bit better than the expected $0.86. Although HP may have been bracing everyone for bad news, however, that doesn't change the fact that it announced exactly that: Year over year, its profit margin was down 3.7 points, from 10.5% to 6.8%.

The earnings call did leave one head scratcher: HP said that it expects the second quarter to be similar to the first, but that it also expects to hit its full-year guidance of $4.00 per share. That's about a 45/55 split for earnings between the first and second halves of the year, implying a turnaround in the quarterly sequential earnings declines. That turnaround seems optimistic, particularly given HP's reasoning for the continued slide in earnings.

How Did THAT Happen?

Books could be written and MBAs awarded on an analysis of HP's financial woes. We'll take a look at them business unit by business unit--and point by point made during the earnings call.

Primarily for HP's Personal Systems Group but also for its enterprise systems, CFO Catherine Lesjak placed a good chunk of the blame for declining sales on the worldwide shortage of hard drives due to natural disasters in Thailand. HP says that in addressing the drive shortage, it emphasized profit margin over volume, and indeed PSG posted a 5.2% operating margin, which is at the high side for the hypercompetitive end user system business.

Meantime, however, commercial sales for the group declined 7% and consumer sales dropped 25%--thus the group's earnings were down significantly. On the consumer side, it seems likely that not all of that 25% drop is due to a lack of hard drive inventory. Buyers are still shaken by HP's top management musical chairs, and even more by its canceling and slowing down consumer product lines. But whatever caused the sales drop, HP is going to find a much tougher consumer market when supply channels fill again. Toshiba, Asus, Lenovo, Samsung, and others are eying the Ultrabook market, and so far they have more models and variations to offer than HP does.

On the earnings call, both Lesjak and CEO Meg Whitman talked about better supply chain management, but HP also needs a better product selection. Although Lesjak and Whitman were referring to data center systems (HP's enterprise servers, storage, and networking group), they also said enterprise customers want to "deal with one HP." If customers similarly want to deal with one vendor for smartphones, tablets, notebooks, and desktops, HP will look a lot less attractive than some of its competitors, as it can provide only half of those products.

When Cash Cows Stop Producing

HP's imaging and printing group saw its revenue and margins decline too. Here, explanations changed somewhat from previous earnings calls. The declines had been thought to be related to the weak economy and the strength of the yen (most all of HP's printing supplies are produced in Japan). Now HP says there's a fundamental change in buying behavior--Whitman says consumers and small businesses in particular are printing fewer pictures.

In the long run, HP hopes that it can create an imaging business to address the change in consumer behavior and therefore make up at least some of the declines. That sounds optimistic. It seems unlikely HP will turn imaging into a business that even approaches what the ink business has been for the company. Bottom line: The printing cash cow is about milked out.

In enterprise servers, storage, and networking, only networking wasn't down for HP--flat is the new "up" at HP. Again, the hard drive shortage was blamed. Whitman indicated that the situation was so dire that some customers were shipped configurations that were different from what they ordered because of product scarcity. The shortages, Whitman and Lesjak said, led to an 11% decline in HP's industry standard server revenue and a 6% decline in its storage revenue. HP's Itanium systems revenue was also down, 27%, with IBM continuing to reap the benefits of the dustup between HP and Oracle over the future of Itanium. IBM now has more than half of the Unix server business, as HP and Oracle continue to lose ground.

The one bright spot in HP's earnings report was its software group, whose revenue rose 30% year over year, thanks to the Autonomy business HP acquired last year, and whose profit margin was 17.1%. Whether forking out more than half of its cash stockpile for Autonomy was worth that uptick in business is hard to determine. But a closer examination of the HP software results shows that while margins are OK, and year over year revenue is up, revenue is down almost 7% from the prior quarter. If there are synergies like Whitman and Lesjak indicated, the company has yet to find them.

What Ya Do, See, Is…

While HP blamed a lot of external factors for its poor performance--strong yen, dearth of critical parts, changing buying habits, previous bad management--the list of remedies doesn't quite compare.

The company still has no coherent enterprise storage story. It knows it needs to innovate in the personal systems sector, and yet it released just a pair of Ultrabooks at the Consumer Electronics Show this year. Twice, while speaking broadly about remedies for the company's ills, Whitman indicated that HP needs to "own the cloud, security, and analytics," and yet she gave no guidance on how the company would do that. Instead, we got assurances of better supply chain management (we doubt anyone will manage out of worldwide shortages, but OK), a discussion of improved dynamics among senior executives, and hope for a new generation of industry standard servers. "If Windows 8 does well, we do well," Whitman said.

It's tough to see how those improvements would stop the downward spiral, let alone return the company to its former financial success. The company could differentiate itself more with software and services for the cloud market, but HP executives on the call said nothing more than the company intends to "own the cloud." HP has made some strong investments in best-of-breed security software, but we didn't hear about the next steps the company will take there either. (We'll likely hear more next week at the RSA conference in San Francsico.)

While earnings calls aren't the place to make product announcements, HP spent far too much time talking about how it would deal in the future with negative external forces and how it would shore up existing revenue streams, and far too little time indicating how it would leverage those streams to create new sources of income. Even meeting its target for improved second-half 2012 earnings seems like a bridge too far based on what the company said Wednesday. It's going to take a lot more than a couple of Ultrabooks and a new line of servers to pull off a turnaround.

HP hints at a strategy, but the time for hints is long past. Tell us what the strategy is--in detail--and start executing.