November 17, 2004
The Hewlett-Packard Numbers You May Have Missed
Or why the coverage on HP’s financial results today is no different than the myopic coverage on Enrons’ gone by.

For the quarter ended October, Hewlett-Packard reported a 7.73% increase in year-over-year quarterly revenues and a 26.5% increase in net income. HP’s earnings would have been $136 million stronger if the company didn’t have to deal with repetitive acquisition, restructuring, and amortization of purchased intangibles charges.  And while HP made no attempt to erroneously call these recurring charges ‘one time’, some news outlets did: “Excluding one-time charges, H-P would have earned $1.23 billion”. CBSM.

While HP’s impressive income statement results quickly became a topic of discussion, what received little or no attention was the performance of HP’s two other financial statements.  Rather, and while using the terms ‘pro forma’ and ‘non-GAAP’ (as if the 1990s never happened), articles from TheStreet, AP, and countless other ‘news’ outlets speculated at great lengths about HP’s income statement results, but made no mention whatsoever about HP’s balance sheet and cash flow results.  This oversight needs correcting.

HP’s Cash Flows

HP generated $1.9 billion in cash from operations for the quarter ended Oct (unadited).  This figure, while strong, is nothing special compared to previous quarters. 


As for the annualized figures, HP’s CFO for fiscal 2004 was the weakest since 2001 (keep M&A in mind). Moreover, free cash flow declined in 2004. Remembering that cash flows are the most factual of three financial statements - unless committing fraud a company can not fudge cash – these numbers are not at all suggestive a remarkable turnaround.

HP ~ in millions $ 2004 2003 2002 2001 Cash From Operations 5,088 6,057 5,444 2,573 Capital expenditures 2,126 1,995 1,710 1,527 Dividends paid to shareholders 972 977 801 621 Basic Free Cash Flow 1,990 3,085 2,933 425 Shares Outstanding - Diluted 3,055 3,063 2,499 1,974

HP’s Balance Sheet

HP’s working capital position declined by more than $1 billion in the quarter, and shareholders’ equity declined to $37.5 billion (tangible equity of $17.6 billion).  These numbers, like the cash flows, do not jive with the impressive numbers from the income statement.


The Truth About The Income Statement

The income statement is not only the most easily manipulated, but it is also the least important financial statement when analyzing corporate health. Quite frankly, the investor would be well served to remember how companies like Interstate Bakeries can get slowly crushed:

1) Financial concerns/troubles show up in a stressed balance sheet.

2) The rating agencies pay no attention to balance sheet distress until cash flows are negatively impacted.

3) The income statement can look rosy (i.e. profits being logged as the balance sheet crumbles) during the entire corporate downturn.

This trend has been repeated time and time again - Enron and Worldcom to name two - and yet it is still revenues and EPS that catch all of the headlines today.

Conclusions and Speculations

That the financial press and many Wall Street analysts largely ignore the balance sheet and statement of cash flows is troubling.  For that matter, that some analysts still state ‘one time charges’ without investigating the facts (quarter after quarter HP is calculating charges from amortization of purchased intangible assets), is bewildering. 

Getting back to HP, the company trades at more than 30 times free cash and has a dividend yield that is less than the lowly yield on the S&P 500.  Also, the company operates in an extremely competitive/cyclical industry and it has, for lack of a better made-up word, a clunkier business model than DELL. That HP generated more business in the latest quarter is newsworthy, but not necessarily the only reason to buy or sell. 

On a closing note, during the next major down cycle watch the clunkier HP struggle (again) while the more efficient DELL continues to rake it - meaning CASH! - in. And yes, be sure to keep an eye on HP’s balance sheet for early signals of distress.  There are none showing today.