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On May 21, Hewlett-Packard (HPQ) reported its 2015 second-quarter earnings, which included an update on its turnaround plan and upcoming separation. As you may be aware, HP has had a difficult time combatting secular demand declines and macroeconomic headwinds in recent years, and its near-term outlook remains weak. Though it scores exceptionally well on our Valuentum dividend metrics, the firm’s turnaround plan will likely affect its dividend negatively. Overall revenue is expected to continue to decline in coming periods, but management has high hopes for the effectiveness of the separation of HP into two Fortune 50 companies.
Reported revenue for the quarter was a slight miss at ~$25.5 billion, a decline of 7% on a reported basis compared to the year ago period, or 2% at constant currency, reflecting the macroeconomic headwinds previously mentioned. The reported figure was only $180 million lower than expected, not exactly substantial when considering revenue was $25.5 billion for the quarter. Non-GAAP EPS declined 1% to $0.87 on a reported basis, largely tied to operating expenses being down 8%. Currency was a factor in the falling expenses, and SG&A and R&D were both reported as declining. On a constant currency basis, however, R&D spending was up from the year-ago period, a positive sign for the long-term outlook of the company. The decline in SG&A is primarily a result of job cuts that have been taking place at HP, which aims to reduce its workforce by 55,000 by the end of fiscal 2015. Nearly 4,000 people were laid off in the most recent quarter.
Perhaps unsurprisingly to those that have been following the company for some time, each segment reported a decline in revenue for the period. The biggest loser was the firm’s Enterprise Services segment–~20% of 2014 revenue—where sales fell 16% in the quarter. Speaking on the goal of improving execution despite top-line struggles, operating profit for the segment showed an increase for the quarter. Personal Systems, HP’s largest segment by percentage of revenue at ~30%, performed well compared to expectations in a softening market. The division’s revenue was flat on a constant currency basis, and down 5% on a reported basis.
Revenue in the company’s second-largest segment, its Enterprise Group segment, fell only 1% on a reported basis and was buoyed by positive momentum from industry standard servers, strength which is expected to continue in the second half of the fiscal year. HP’s printing segment, an expected source of growth for the separating company in coming years, reported a decline of 7%. Management pointed to a highly-competitive market, aggressive pricing from overseas competitors, and currency headwinds as explanations for poor top-line performance of the segment that delivered ~20% of 2014 revenue.
HP also provided an update on the separation plan it announced last October in its recent report. As a quick recap, the reasons for the separation are to 1) provide a sharper focus on markets served, 2) increase ability to adapt and shift more rapidly, and 3) provide an increased connection between results and rewards for shareholders. HP’s management feels the separation will satisfy the need to act with greater speed and agility in order to compete effectively in a world where technologies, markets and consumer expectations are changing more rapidly than ever. We tend to agree.
The two new publically traded companies will be Hewlett-Packard Enterprise, which will include HP’s Enterprise Group, Enterprise Services, Software, and Financial Services segments, and HP Inc., which will include HP’s Personal Systems and Printing segments. Management expects the separation to accelerate its turnaround plan and offer the ability to increase focus on long-term growth and profitability. The targeted completion date is October 2015.
It doesn’t take much to realize the near-term for HP is less than exciting, and the current turnaround plan is focused on the long-term health of the company, so investors shouldn’t expect great improvements to come quickly. The firm’s most recent earnings report, which was generally in line with management’s expectations, supports such a view. We like the separation of the company into two smaller entities in theory. HP has simply gotten too big to maintain the laser-focus needed to compete as effectively as it once did across all of its rapidly-developing end markets.
Whether or not the two companies that eventually emerge from the separation will be able to effectively execute the goals of the turnaround plan remains to be seen. We aren’t ready to dive in just yet, and we point to Apple (AAPL) and Microsoft (MSFT) as two of our ongoing favorites in large cap technology. Both are trading below fair value and have fantastic long-term growth prospects.