HP Falls Behind?

Steve Johnson, sjohnson@mercurynews.com, got a front page story in the San Jose Mercury-News  this morning, his headline breathlessly reporting that "HP falls behind on R and D spending: Share of company revenue devoted to research dwindles".

The story is actually lengthy, some sixty column inches, including a great graph of HP versus 19 other local companies.  another of HP's R and D decline from 11% in 1987 to 2.8% today, along with a table of the top R and D spenders in total dollars.  For those who haven't paid attention, this is a new and BIG story; for long-term blog followers, shareholders, and generally aware folk in the Valley, this is hardly new news.

See, for example, "HP R and D and Palmisano"  on 9/15/10 where I noted that:for the last three CEO's, here is the track record:
Platt reduced R and D percentage by 34% in seven years
Fiorina reduced it by 27% in five and a half years
Hurd reduced it by 47% in five and a half years

Johnson couched his story with Meg's promise to re-instore higher R and D levels, which has ever so slightly happened.  Actually, she has raised the percentage by a new trick -- cutting the revenue line a lot changes the denominator.

Still, the article is a good reprise of a fairly clear set of decisions at HP to de-emphasize innovation in favor of today's profits.  Every HP CEO since John Young -- yes, and three of them, Lew Platt, Carly, and Hurd - cut R and D big-time percentage-wise, EACH.  The cross-product of the three was a staggering 74.5%.  And the rub, as those cuts took place, in general, was that the 'further out' stuff gets cut rather than the 'close-in' stuff.  Most estimates, supported by the actual employment numbers at HP Labs, indicate that 80 to 90% of longer-range (i.e. more break-through ideas) were axed or allowed to lapse.

Even Phil McKinney defended the low numbers when he was the Innovation Champion, arguing that Apple only spent 2.2% on RandD, so why should HP need to spend more.  Well, one reason is that HP is not "big hit driven" in the way that Apple is.  Another just could be that Apple's model isn't all that effective for the long term either, as the Android crowd and others are putting much more pressure on the creative leader.  But Phil didn't have the team to finish the HP TouchPad, or to recast it when Apple's iPad clearly out-invented them.  He was dealing almost exclusively with outsourced R and D.

It was refreshing to see Johnson ferret out (with HP help) some 'recent' R and D contributions.  Sure, the scientific calculator, the first commercial LEDs, ultrasound medical detectors, and Hewlett's oscillator got billing, but so did the energy saving algorithms for IT centers, and some virus-thwarting software of recent years.  And notably, the low-cost laser and ink-jet printers weren't trotted out.  Nor were those ubiquitous logic analyzers,   But then again, of the ones Johnson mentioned, all but the last two software things were really Agilent, not HP, contributions.  And Agilent still spends 9.7% on their R and D investment, similar to Cisco at 11.3%.  Both are dwarfed by Intel's $10.1 billion, and 19% rate

Johnson accurately notes that such luminary organizations, with their 27 year old analysts, as Booz and Company, KPMG and Battelle, question R and D spending as a gauge to innovation prowess.  I much prefer Ron Enderle's succinct statement, "strategically, it's suicide"

Sign of the times?

Today's announcement that HP Pavilion will soon be renamed SAP Center had to have some head scratching.  Todd Bradley has long been HP's leading sports supporter at the Execom level -- is he losing favor?  Another signal was the HP sponsorship of the Byron Nelson Classic Golf tourney, when Keegan Bradley finished second, not first, and in the final twenty minutes of TV time, HP was not mentioned once on the tube, nor given the traditional option to hand over the trophy or anything.

Keegan is Pat Bradley's nephew, and no relation to Todd of which I'm aware.  But stranger things have happened.  HP used to design the sailboats for the America's Cup, back when HP had the leading workstations (and before King Larry started competing).  Wonder if the Thug is sailing this year?

And SAP?  What now?  Well, the initial news of course is that Hasso Plattner, the German founder of the German company, is part owner of the San Jose Sharks, and since the HP Pavilion is known fondly as THE SHARK TANK by all of the ice hockey fans, what a natural.  Plattner, you may recall, is actually a dedicated contributor to the Bay area, having funded the D'School at Stanford for David Kelley and team, much to Stanford's chagrin for awhile, but now they're pleased because Stanford B'school kids pick Stanford over Harvard thanks to the D'School reputation.

Another way to view the HP Pavilion name change, of course, is that HP needs the $3M or so per year that it costs to keep the name on the stadium, now that things have gotten so bad for this $120 Billion per year company.   Odds, though, are that HP's toilet paper bill is ten times the Shark Tank naming bill, so that doesn't ring too true.

TRUTH STRANGER THAN FICTION

Just when I thought we'd get May ended 'safely' this story gets posted:

May 31, 2013, 1:09pm PDT

In HP-Autonomy lawsuit, auditors Deloitte, KPMG out of gunsights

Enlarge

Reuters

Auditors KPMG and Deloitte have been quietly dropped from the legal fight over the acquisition of Autonomy, which puts more onus on the board and Meg Whitman to explain how they missed the alleged fraud that led to an $8.8 billion writedown.

Preeti Upadhyaya

Technology Reporter-Silicon Valley Business Journal

When Hewlett-Packard Co. shareholders in November sued the company and its directors over the disastrous acquisition of Autonomy Corp., the company’s auditors,Deloitte and KPMG, found themselves dragged into the mess as defendants.

What has largely escaped notice is that a May 3 consolidated complaint in the shareholders derivative case droppedKPMG LLP and Deloitte Touche Tohmatsu Limited as defendants, refocusing the case on the company’s management and board.

That’s interesting, given that CEO Meg Whitman in a Nov. 20 earnings call with analysts made a point of placing attention on the role of the auditors in the purchase of the British software firm, which led to an $8.8 billion writedown for HP. Whitman served on the board when it approved the purchase.

“What I will say is the board relied on audited financials, audited by Deloitte, not brand X accounting firm but Deloitte,” Whitman said in the call. “And by the way, during our very extensive due diligence process, we hired KPMG to audit Deloitte, and neither of them saw what we now see after someone came forward to point us in the right direction.”

She didn’t indicate the identity of that “someone” in analyst call.

With the auditors out of the case, Whitman and the board are left to explain their own actions in the Autonomy derivative suit. It also removes a cloud over the auditors. Auditing firms in past corporate disasters have taken the fall when they have been involved in massive mistakes or misdeeds, for example Arthur Andersen’s demise after Enron’s 2001 unraveling.

“To the extent that the light is no longer shining on KPMG, this puts greater pressure on HP’s board and management to take responsibility for this train wreck,” said Stephen Diamond, associate professor of law at Santa Clara University. “When you go to buy a company, you have an obligation as a director to make sure that the purchase is worth how much you pay for them.”

While Whitman has more than doubled HP’s stock price since the writedown, shareholder ire over the Autonomy messhas already shaken HP. Longtime HP Chairman Ray Lane stepped down in April, followed by the exit of John Hammergrenand G. Kennedy Thompson from the board.

Mark Molumphy, a lawyer representing shareholders in the suit, confirmed in a phone call that KPMG and Deloitte are no longer defendants. He didn’t respond to follow up calls seeking comment as to why the auditors are no longer in the crosshairs. HP declined to comment. A spokesperson from KPMG confirmed that the firm was no longer involved in the case. Deloitte didn’t return multiple calls seeking comment.

The shareholder suit claims that HP’s board failed to adequately review Autonomy’s finances before buying the British software maker. The purchase closed while Palo Alto-based HP, the world’s biggest maker of personal computers, was run by former CEO Leo Apotheker.

In a May 7 story that appeared in the U.K. publication The Guardian, HP commented on the case: "As we have continually said, HP relied on the audited financial statements and the representations of Autonomy's management and its auditors regarding Autonomy's business and revenue."

A solid PRODUCTS assessment

Unanswered question after earnings: Will HP's bets pay off?
  
Jon Xavier, w Silicon Valley Business Journal has done some very nice assessments of HP recently.  Here's his take after the 2Q report:   (my comments in red)

Hewlett-Packard Co.'s earnings yesterday weren't great, but the stock price closed up more than 17 percent at $24.86 today. (this is one of the biggest upward moves in a long time!)

A deeper dive into the financials reveals the reason why: While revenue is slipping in basically every category besides printers, HP has slashed its expenditures, increased its cash flow, paid down debt, and has generally gotten its house in order. It's all part of CEO Meg Whitman's attempt to pull out of the nosedive HP has been in for the past few years.

It looks like Whitman and her team have done everything investors expect them to do, so if you believe in the turnaround narrative, yesterday's crappy-but-less-crappy-than-expected earnings report might give you hope that HP's salvation isn't a fiction.

But when will that salvation come? Even Whitman doesn't think the company will see a significant turnaround until 2014 at the earliest. Meanwhile, HP's revenue in traditional mainstays like PCs, servers and IT services continue to slide. Some analysts are saying that as much as 60 percent of HP's revenue might be in the middle of a secular decline.

If HP really wants to recover, it's going to need to at least stem the bleeding in down segments and create growth in new products and product categories. HP has several initiatives it's working on that could provide a way forward for the company. Here's what to watch if you want to know what will happen to HP:

Moonshot

HP talked a lot about Moonshot on its earnings call Wednesday, and with good reason. Moonshot represents the biggest innovation HP's server division has delivered in some time. It's a new server architecture which uses lots of small processors to deliver the same computing power with drastically reduced energy consumption. Given that electricity consumption is one of the biggest issues for most data centers, HP is hoping Moonshot will allow it to grab market share from its less energy efficient competitors.

Of course, Moonshot isn't quite as unprecedented as HP would have you think. If the idea behind it sounds familiar, that's because it's similar to the servers originally produced by a company called SeaMicro, which was subsequently purchased by AMD and which became AMD's server business. Facebook is also working on similar designs with its Open Compute Project. HP has a scale advantage, good channel partners, and it's moving into the space relatively early, but it's not going to be completely uncontested as it tries to take over the market for low-power servers.

The speed at which Moonshot is adopted could be a very important indicator for HP's future health and should be watched closely.  I concur fully

Software-defined networking

Software defined networking, the practice of using software and virtualization technologies to replace specialized networking hardware, is one of the fastest growing segments of the networking space these days. HP actually has some very strong offerings in this area, all of which are very complementary to Moonshot.  (it ts the combination of these two that is hardly the kind of thing AMD or Facebook would be expected to do; the question is IBM or Cisco or Oracle, not AMD, Intel, Facebook, or Sally's sodashop).

Android tablets

PC sales are dying. That's not even an HP problem, it's a PC market problem, as mobile devices like tablets eat significant market share. HP clearly needs to have some sort of product in this market if it wants its personal systems division to stay relevant, and until very recently, it didn't. But after messing about for far too long (famously cancelling its WebOS-based TouchPad after only a month). This may have been Leo's biggest mistake, far bigger than Autonomy, since HP squandered two years and precious mind-share time.  The product, priced wrongly and in the wrong channel, actually had the best user ratings of any tablet at the time and for months thereafter in the enterprise space, viz. user-tracking data from Argus Insights).  As these things happen though, it will never be reported that way unless we do another book.  HP has finally thrown in with a mobile OS — Android. It's Slate 7 looks to be very competitive with other Android tablets on the market, and at $169, it's priced to move. Watch sales figures on this very carefully.

Smart TVs

HP hasn't entirely jettisoned WebOS, either. It's sold many of the key assets to the electronics giant LG, which plans to use it to develop next-generation smart TVs. This is a coup for HP, as it's keeping the assets that would drive a WebOS app store, which could potentially be as profitable for the company as it is for Apple if those devices take off. There aren't any WebOS powered TVs on the market yet, but their success when they do get released might be an important indicator for HP.  Again, AH YES, what might have happened if Jon Rubinstein had been given full autonomy to run his Palm division with Phil McKinney and team?  HP'd have WebOS still running, linked to all the imaging products, as well as PCG, almost three years of building industrial-grade enterprise-wide communications networks, and some accumulated street knowledge.  After all, the cookie guy at IBM took several years to get the enterprise services group functioning.  What this Smart TV line item doesn't suggest is that HP will be the producer of next-gen smart TVs, just potentially a channel.  This is akin to owning the keys to the Apple stores, but not making the Apple products.  True, an App Store could have a run, but HP's experience base in this arena is modest indeed.  Again, recall it took Apple four tries and five years to get the iPod right with iTunes.

2Q earnings reaction

Overnight, some of the stories filed had a more somber tone than the upbeat report of the last post.

The Associated Press headline reads:

"Hewlett-Packard's slump continues as revenue drops 10%

The company posts earnings of $1.1 billion in its fiscal second quarter, down 32% from a year earlier. But its stock rises on its guidance for the current quarter."

The story, using almost precisely the same words,was more tepid than the market reaction:

"Hewlett-Packard Co.'s slump continues. Its quarterly earnings marked the seventh consecutive decline in revenue compared with the same period the previous year.

And HP's 10% decrease in revenue during the three months that ended in April was the largest drop so far during the slump.

But HP predicted that its earnings for the current quarter ending in July would be slightly better than analysts have been anticipating. Excluding certain items, the Palo Alto company forecast earnings of 84 cents to 87 cents a share. Analysts on average had projected 83 cents a share, according to FactSet.

Investors seemed to interpret the guidance as a sign that HP's cost-cutting measures imposed by Chief Executive Meg Whitman are starting to pay off, even as the company's sales droop.

HP's stock surged $2.70, or nearly 13%, to $23.93 in extended trading after the release of the results Wednesday.

Most of the erosion in the company's sales occurred under the leadership of Whitman, a former CEO at EBay Inc. and defeated California gubernatorial candidate, who was hired to run HP in September 2011.

Whitman has repeatedly warned that HP's revenue might not start growing at an acceptable rate for another year or two as she cuts costs, overhauls the company's product line and pushes into more profitable niches in business software, data analysis and storage and technology consulting. In a Wednesday statement, she reiterated that the company remains on a "multi-year journey."

The San Francisco Chronicle posted a 3 inch 'column' reporting the bare facts with no particular bias, other than the typical "this didn't happen near here, so it doesn't matter" attitude.

By contrast, the San Jose Mercury-News headlined it on page 1 business section -- "HP PROFIT EXCEEDS FORECASTS", showing three graphs and Meg's picture, with 40 column inches of coverage in Steve Johnson's bylined story.  
Johnson quoted a number of analysts, including Brean Capital which said "our industry checks are starting to see pockets of change in culture at HP -- which we believe can serve the company well going forward."

Brian Marshall at Int'l Strategy Group was less sanguine, and Tony Socconaghi of Bernstein Research (he's been down on HP and on Meg for some time now) offered these pearls of wisdom: "either Meg Whitman improves company performance over the next 12-18 months or the board (or activists) will break up the company."

And Deutsche Bank analysts (lessee now, weren't they the ones who switched their vote -- probably illegally -- the morning of the ballot for the Compaq deal?) cautioned: "all of HP's major business lines continue to face structural decline", adding ominously (in Johnson's words) "we do not see a quick fix for any of these issues."

Otherwise, Johnson's story was plain vanilla, resurfacing the issues for the failed TouchPad, failed phone, dropping PC sales, slumping ink and printer sales, several bad acquisitions (naming again, with the $$$ of write-offs for Attensity, EDS, and Palm acquisitions -- $8.8B, 8.0B, and 1.0B in the past 3 years).  He also reminded readers of the board vote against Hammergren and Thompson and Ray Lane.  These stories, kinda like Sergio Garcia's, take on a life of their own, and they'll haunt for years.

HP 2Q EARNINGS REPORT

As I said in the last post, a topsy-turvy world in the stock market.  Here's how veteran Chris O'Brien (one of my favorite reporters, who has moved from the San Jose Merc-News to the LA Times) said it:

Hot off the wire : Hewlett-Packard Co. reported earnings for its fiscal first-quarter Thursday that sailed past analyst estimates despite shrinking revenue.

The results were some much-needed good news for a company that has drawn criticism on Wall Street because of its recent performance. During the previous two quarters, HP announced losses totaling $15.3 billion as the company suffered write-downs on a few ill-fated acquisitions.

Digging deeper, Meg said that:

"We did better than we expected on the bottom line.  We still see declining sales, which is something we want to fix. We're on it. We've got a plan."

HP posted a profit of $1.2 billion, or 63 cents a share, for the last three months of 2012. That was a 16% drop from the year-ago period when the company reported a profit of 73 cents a share.  Stripping out some accounting items, the company would have earned 82 cents a share -- easily surpassing Wall Street projections of 71 cents a share.

Sales declined 6% to $28.36 billion during the quarter, which was still slightly above analysts' expectations.

Highlighting the magnitude of the challenges, all but one segment of HP's business saw revenue decline in the first quarter from the same period a year ago: personal systems group revenue fell 8%; printing fell 5%; enterprise group fell 4%; enterprise servcies fell 7% and software fell 2%. Only financial services saw an increase, of 1%.  Left unstated in this release, but noted elsewhere -- PC sales were down an alarming 20% quarter-over-quarter, following the release of the underwhelming Windows 8 from Microsoft.

Still, the earnings report cheered investors, who drove the stock up $1.25, or 7.3%, to $18.35 in after-hours trading.

Whitman shared that optimism about the progress being made in her long-term turnaround plan. She has said in the past the the company probably wouldn't start to see revenue growth until 2014.

"I actually think part of what we've being doing is starting to pay dividends," she said. "I think we've got the best product lineup we've had across the business units in a decade."  (Now, you could be catty and say, "wow, she actually THINKS that PART of WHAT THEY're DOING is STARTING to help?"  What about all the rest?  Does she actually think the rest isn't helping?)

In the wake of rival Dell's buyout announcement and its recent weak earnings, Whitman remained confident that HP's Personal Systems Group, which includes PC sales, has a strong future.  Whitman said Dell appeared to be pursuing a strategy of commoditization, making the lowest cost machines possible. By contrast, she said HP is attempting to rethink features and design, to make distinctive gadgets that could deliver higher margins and revenues.

Whitman said the company continues to broaden its definition of PSG to include all computing platforms, including tablets and eventually smartphones. HP has recently announced plans to move beyond Microsoft's Windows to make devices based on Google's Chrome operating system. As of now, the company had no further updates regarding when it might return to making smartphones.  (Thank Gawd)

AN UPSIDE DOWN WORLD

I've always marveled at the stock market method of handling news.  Today was no exception.

"back in the day" we'd have terrific earnings, and within minutes the stock would get tossed.  Someone else, say DEC, would announce layoffs and the market was thrilled that they'd be reducing costs, never mind that their stuff didn't sell.

You've seen this time after time -- bad news gets stock to rise, and vice versa so often it doesn't surprise

So here's the story today

Shares of HP closed 0.7 percent higher at $21.25, and the stock was trading 10 percent higher in immediate after hours.  Why?  Because HP reported second quarter earnings today, showing earnings per share of $0.55 or $1.1 billion, a 31 percent decline in earnings from a year ago.

Here's the good news: Adjusted earnings came in at $0.87 a share or $1.7 billion, exceeding analyst expectations of $0.81 a share.  So the company did terrible, but the analysts thought it'd be worse.  Voila, stock goes up.

Net revenue fell 10 percent to $27.6 billion, but cash flow came in at $3.6 billion, a 44 percent jump from the year prior (makes you wonder about HP's use of those creative tax haven strategies).

"We beat the upper end of our non-GAAP diluted EPS outlook for the quarter by $0.05 a share, driven by better than expected performance in Enterprise Services and Printing, coupled with the accelerated capture of restructuring savings and improvement in our operations," said Meg Whitman, CEO and president in a prepared statement.

Meg was simultaneously listed as one of Forbes' TOP 100 women.  Sheryl Sandberg, chief operating officer of Facebook Inc., took the No. 6 spot on the annual list.  Sandberg, 43, was No. 10 on the list last year. 

Five other Bay Area business executives made the top 100 list this year.

• Meg Whitman, CEO, Hewlett-Packard Co. (NYSE: HPQ), No. 15
• Safra Catz, CFO, Oracle Corp. (NASDAQ: ORCL), No. 23
• Susan Wojcicki, SVP, Google Inc.(NASDAQ: GOOG), No. 30
• Marissa Mayer, CEO, Yahoo Inc. (NASDAQ: YHOO), No. 32