Tuesday, August 25, 2009
Including the Good Stuff while Excluding the Bad Stuff: Come to Think of It, We Will Get Fooled Again!
One of the first books we bought on our new Kindle was “Bill and Dave,” Michael Malone’s 2007 account of “How Hewlett and Packard Built the World’s Greatest Company.”
Having written a book, and knowing how hard it is to actually do that, we’re not going to say anything remotely disparaging about “Bill and Dave”—it’s a good, readable account of what the title says it’s about.
In fact, whether you agree that HP is, or was, “The World’s Greatest Company,” anybody with an interest in HP—now run by Mark Hurd, the genius who built a sleepy technological has-been known as NCR into a make-the-numbers machine favored by Wall Street’s Finest—ought to read it.
You’ll be reminded how hard it is to not only build and run a business, but how to maintain that business when it depends almost entirely on technological innovations to stay relevant.
Just ask the boys at Eastman Kodak.
Also, it’s an interesting journey back to the beginnings of the electronics era—the very, very beginning—when the two men met in the fertile climate of Stanford University and the San Francisco Bay area, where entrepreneurs were putting up radio antenna and trying to figure out how to make money on this strange idea of broadcasting, while headstrong individuals were quitting one pioneering company to start their own company seemingly every ten minutes.
It’ll remind you of the dot-com boom, in a good way.
But that’s all gone—as are Bill and Dave. Their legacy, however, continues to exist. In fact, just last week “The World’s Greatest Company” reported quarterly earnings.
And, as you might expect, under the earnings-obsessed Mr. Hurd, “The Number” the company reported was exactly 1 penny above the Wall Street consensus: 91 cents per share compared to Wall Street’s Finest’s expectation of 90 cents per share.
“Gosh, how’d they do it?” a reasonable person might ask.
And it’s a great question.
HP is, after all, a $100 billion-a-year company with more than 300,000 employees manning far-flung operations across the globe. Two-thirds of its revenues are derived in foreign currencies that fluctuate every day.
Not only that, but four of the company’s five major businesses experienced sales declines of 20% or more in the quarter.
Of the five businesses, one looks doomed to eventual irrelevance (personal computers), a second looks doomed to brutal competition as far as the eye can see (servers and storage) and a third is exposed to the kind of technology shift that brought about the collapse of the aforementioned Eastman Kodak (printers.)
Oh, and the one business that showed growth in the quarter did so entirely thanks to the fact that the company spent $13 billion buying EDS, in a deal that closed one year ago tomorrow.
With all that going on, one might reasonably wonder how in the world it is possible for anybody, even the heroically numbers-obsessed Mr. Hurd, to beat “The Number” by the requisite penny?
The answer—aside from brutal cost-cutting—is that HP waves “Non-GAAP” earnings of 91 cents a share, up nicely from last year’s 86c a share, in front of Wall Street’s Finest, thus distracting the thundering herd from actual GAAP earnings, which are more of a downer.
Like, 25% more of a downer.
That’s right: HP’s July quarter GAAP earnings were only 67 cents a share—25% below the 91 cent so-called “Number” used by HP management and Wall Street’s Finest—and down, not up, from last year’s 80 cents a share GAAP earnings.
Defenders of “The Number” will note that the 25% difference in HP’s GAAP versus non-GAAP earnings calculation lies mainly in expenses related to EDS. Those expenses include:
1. $379 million worth of amortization relating to purchased intangible assets.
2. $362 million worth of “restructuring charges.”
3. $59 million worth of “acquisition-related charges.”
4. Netted against these are $232 million of book income taxes.
Voila! Thus does $0.67 a share in standard GAAP earnings become $0.91 a share in non-standard, non-GAAP “earnings.”
And a poor-looking GAAP operating margin of 8% becomes a healthier looking, non-GAAP operating margin of 11%.
Now, defenders of the faith, and Wall Street’s Finest, will no doubt defend the non-GAAP number-jiggering by noting that HP’s acquisition of EDS resulted in many “non-recurring” expenses, in addition to the non-cash amortization charges that don’t have a bit of impact on the economics of the underlying business.
And they would be absolutely correct.
But if HP is going to exclude those EDS-related expenses, shouldn't they also exclude EDS-related revenues and profits?
How is it that companies get to include the good stuff, and exclude the bad stuff?
After all, EDS is the whole key to HP’s recent mirage of growth: without EDS, revenues would have been down 20% or so, and the company is not shy about bragging about EDS.
Paragraph four in the press release begins by trumpeting “Record profit in Services”—the EDS portion of the business. A bit later the company begins the individual segment reporting by noting with pride the benefit from EDS:
“Services revenue increased 93% to $8.5 billion due primarily to the EDS acquisition.”
So how is it that HP gets to brag about newly acquired revenues from EDS, yet at the same time delete from “The Number” newly acquired expenses from EDS?
Like “Bill and Dave,” all this reminds us of the Dot-Com boom, only in a bad way. This is, after all, precisely the kind of thing Dot-Com companies used to do.
And it is precisely the kind of nonsense Wall Street’s Finest swore off after all that came to grief—vowing never to be fooled again.
Meet the new boss…same as the old boss!
I Am Not Making This Up
© 2009 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.
Posted by Jeff Matthews at 9:04 AM