Arik Hesseldahl

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HP’s “Everything Including the Kitchen Sink” Conference Call

What was supposed to be a relatively routine Hewlett-Packard quarterly earnings call turned into something else entirely. Rather than simply reporting results that just barely beat the consensus expectations of Wall Street analysts, the company announced the kind of radical surgery that the more aggressive analysts have been urging for some time.

Gone is the webOS hardware business acquired with Palm last year, though the WebOS software business remains alive and well for now. The business of selling phones and tablets was unceremoniously killed in a move reminiscent of Cisco Systems’s decision to kill its Flip video camera business. At least we know why: As AllThingsD reported exclusively Tuesday night, sales of HP’s TouchPad have been embarrassingly bad, particularly at Best Buy.

Soon to be going — either spun off or sold — is HP’s consumer PC business. Exactly what will happen there is anyone’s guess. Will HP create an independent company or sell it? If it’s to be a sale, the smart money says that Samsung would be a possible buyer, and sources have told AllThingsD that HP was shopping the PC business around Asia earlier this year. But there are several reasons that HP would choose to follow the model of Motorola and spin the unit off into an independent company. As CEO Léo Apotheker said on the conference call, all options are on the table, including a spinoff sale to another company, sale to private equity, or even no transaction at all. The reason for making today’s “strategic options” announcement is that it frees up management and the board of directors to take a deep dive and look at what’s best. My guess: Bet on a spinoff.

My notes from the conference call are below.

2:01 pm: And so we’re waiting for the conference call to start. Lots of soothing music to keep our minds off all the questions reeling in our heads.

Among those questions: What kind of transaction can we expect for Hewlett-Packard’s PC unit? A spinoff or a sale? Will it include the enterprise PC business as well as the consumer PC business?

Was there ever any attempt to sell the webOS assets? What about the webOS and Palm-related portfolio of patents? I bet those are pretty valuable right now. Will HP sell them or keep them?

The call is underway.

Léo will be speaking shortly.

2:05 pm: And here’s Léo.

Today is all about driving shareholder value and addressing the challenges in our business. I’ve been CEO for nine months and made some tough decisions. There are four elements to the path forward.

Consumers are changing the use of the PC, and sales of the TouchPad are not meeting expectations. (Where have I heard that before?)

The plan to separate PSG is to sharpen HP’s focus on cloud and other services. There are tactical issues to consider. We are still facing headwinds, stemming from the Japan earthquake, in the printing business.

There is a clear secular movement in the consumer PC space. The tablet effect is real, and the TouchPad is not gaining momentum in the marketplace.

For our PC business to function properly, it needs to be able to make decisions that are best for itself. We anticipate we will take 12 to 18 months to complete this process.

Additionally, we have been tracking the progress of webOS. We were successful at launching software that was praised. We are exploring options of how best to optimize the webOS assets in the future. The devices aren’t getting traction. Continuing to execute in this market space is no longer in HP’s interest. The webOS hardware business will be shut down by Q4.

Now on to services. The transformation will be a multiquarter journey. We are focused on addressing sales delivery and other challenges.

He’s now announcing John Visentin as the head of Enterprise Services. He’s an IBM veteran and has previously run Enterprise Services. He’s Ann Livermore’s replacement, and thus has big shoes to fill.

Now on to tactical challenges. In business critical services, we think the Itanium platform is the best in the industry. We are fully committed. We are doing everythying we can, including pursuing legal action against Oracle’s “anticompetitive behavior.” (Long story, but you can read several posts I’ve written about this.)

Fourth: Adding more value-added intellectual property. More software. More big data. More cloud.

2:14 pm: A good example is the acquisition of Vertica.

And now he’s talking about the acquisition of Autonomy. Here are the financials: This is a milestone, because there is a very real need to address the explosion of structured and unstructured data.

HP will pay $42.11 per share, though Léo is giving the amounts in British pounds.

2:17 pm: In 2010, Autonomy had gross margins in the high 80 percent range, and operating margins in the 40-plus percent range. Autonomy will continue to operate separately.

As an executive who has spent most of my career in software, it is a world I know well. We believe this transaction will unlock synergies across multiple industry verticals. We are building a strong HP software business.

We are focusing on what needs to be fixed, shut down and considered for separation.

A comment on guidance. I am lowering the Q4 guidance in order to be realistic about where we are. I don’t take this action lightly. I know our investors don’t like being in that position, and neither do I.

I am taking ownership for these actions and investments as we shape the new HP.

Cathie Lesjak, CFO, is now speaking and doing the numbers. “This is the toughest guidance in my career as CFO.”

Company gross margin of 23.3 percent was down 70 basis points year on year. Printing and webOS posted lower gross margins, which were offset by favorable commodity environments.

Generated $3 billion in earnings from operations, down 14 percent sequentially and down from $3.4 billion a year ago.

HP repurchased $4.6 billion of shares.

Segment info: Personal systems, revenue of $9.6 billion, down three percent from prior year.

Commercial client revenue grew nine percent, led by workstations. Consumer down 17 percent. Ouch. Desktops and notebooks equally affected by drop in consumer demand.

Lesjak says webOS ran a loss. Clearly, the sell-through wasn’t what was expected. It quickly became clear that pricing parity wouldn’t generate demand. The price cuts had added incremental cost to our model. We took a five-cent charge to EPS. We would expect a bigger loss in Q4.

To make this a financial success would create more risk without certain returns. We will explore options for strategic value of the software. (Hint hint, webOS software is for sale. Again.)

Now on to the printing business. Three million Web-connected printers sold. Sell-through is slowing in supplies. Supplies business tends to follow the economy. Expect a revenue and margin impact for the next few quarters.

Still more troubles from Japanese currency and the rise in the yen. Expect that to continue, too.

Our services transformation is a four- to six-quarter journey.

Industry standard servers: We expect to show share gains, though we expect growth to slow. HP remains number one in blade services.

Revenue decline in business critical servers is down nine percent because of the legal mess with Oracle.

3PAR sales continue to accelerate. Seems it was worth taking on that bidding war with Dell last year.

Balance sheet: Total gross cash of $13 billion. Looks like the Autonomy deal is going to consume $11 billion of that, if I read the presentation of that deal correctly.

Long-term EPS commitment is now gone. I think Lesjak said it was $7.14 in EPS by 2014. I may have mangled that. Whatever, they’re not going to make it now, anyway.

Q4 EPS expected at 44 to 55 cents a share.

Léo is back. This is about a transformation of HP for a new future. HP is at a critical point in its existence. These changes are fundamental. The changes will transform HP. The transformation starts today.

And here’s the Q&A. Should be interesting.

2:39 pm: Morgan Stanley. Can you talk about which customer segments and geos weakened in July, and which ones will weaken in October?

Léo: A summary of this — we saw our business in Asia grow, and if you look at the other two regions, they declined in constant currency. On a rough basis, consumer PCs declined while commercial increased. We had good performance in ESSN. But public sector, which is 10 percent of business, is being impacted by budget constraints on both sides of the Atlantic.

Lesjak: We had a back end loaded quarter, but it was softer that we expected in July.

Barclays asks about services: Did you cut enough when you bought EDS? Is 12.5 percent margins low enough?

Léo: We are making progress on services. One thing we are focused on is growing the top line. We didn’t do it. We now have a leader for this business. What we are trying to achieve is a much better mix, from the execution standpoint. We can increase our coverage and bench in application and services. We are engaged in a systematic account review, so we are optimizing value.

Lesjak: I said 12.5 percent. We are affected by the weakness in public sector, and also by business critical systems. (There’s the Itanium fight with Oracle rearing its head again. -Ed.)

Citigroup ask about the synergies between printers and enterprise business. How do you feel about keeping printers and enterprise together?

Léo: IPG, the printing unit, is important to HP. It has been leading the disruption of the analog printing market.

IPG has the opportunity to reinforce its strengths. We are driving our document- and content-management solutions. With the acquisition we announced today, we will be able to provide IPG with additional intellectual property.

Sanford Bernstein asks about Autonomy. You are paying a fantastic price. He’s worrying that HP is overpaying for Autonomy at a time when HP’s stock is at a historic low. It’s going to cost you 15 percent of your market cap. Also it’s going to eat into the cash position.

Léo: Let me start by making sure everyone understands what Autonomy represents. It will allow us to lead a large and growing space, enterprise information management. It will help customers manager the explosion of information. It will position HP in a large and growing space. It will provide differentiated IP for services. It will give IPG a base for content management.

Léo: Autonomy has grown its revenue at compound annual growth rate of 55 percent over three years. We think we can extract a lot more out of it by combining it with HP.

Lesjak is speaking about cash. We have repurchased $15.6 billion worth of shares. We would spend to rebuild our balance sheet, and will moderate share buybacks.

2:49 pm: Cross Research on Personal Systems Group: Why not spin it off now? And also on webOS. What about the plan (announced at D) for putting webOS in PCs?

Léo: What the board and management team have been working on is to look at our options, and what the board has decided to do is look at all the options. This will allow us to look at it much more closely. Over time, a decision will crystallize. All I can say now. We will refrain from commenting further. On webOS software business, we are looking at all our strategic options regarding the software. The software has been received very well. We will be looking at all of the options to third parties, to others who need this kind of option. Licensing or other possibilities, to extract value from webOS.


Goldman Sachs question: How should we think about strategic actions versus the need for further cost reductions, in light of the view that there’s been an underinvestment in prior years?

Léo: He’s not taking the bait to repeat the “Blame Hurd” message from last quarter.

BMO’s Keith Bachman, whose downgrade caused so much share-value loss yesterday, asks about the growth prospects at Autonomy.

Léo: When you analyze the numbers of Autonomy, they have been executing a shift to software as a service, or cloud services. They are one of the few traditional license-based companies who have executed such a successful transaction. Roughly one-third of revenues are cloud-based. Not going to talk about forward growth rates.

Raymond James: On PC, you’ve talked about strong return on capital in that business. Can you talk about what changed?

Léo: One of the reasons we announced today was so that we can study. We are going to look at all of our options, and also want to make sure everyone understands that all options are possible, including a nontransaction. Which means they may not ultimately sell the PC unit.

2:56 pm: Stifel Nicolaus asks: Operating profitability for two segments: Enterprise seems to be at 13 percent, which is below previous guidance. And the same question to imaging and printer, now 14.7 percent, though having supply-chain problems.

Lesjak: The macro picture has deteriorated since last quarter. We saw softness in Europe and Americas. Also there’s the lower mix of systems in Business Critical Systems. (Another reference to the Oracle fight.)

Another question, though I didn’t catch the firm that asked: Is there scope to cut more costs at HP at the group level?

Léo: How are we performing compared to peers? In fact, we are actually competing rather well. Our market share across the vast majority are stable, or in a few cases we have eked out gains. Are there any specific issues affecting our business in particular? We are facing macro trends. What HP is facing are essentially the following things: We are being challenged on business critical systems. We have an issue in printing, which was impacted by Japan. Overall, we have one issue that we want to tackle, and that’s our productivity in the salesforce. We are going to create a unified platform for the salesforce to go to market. We are now going to have a regular cadence and discipline around managing major accounts in this company.

3:01 pm: UBS question. How much of the $332 million in operating losses is related to webOS? How long is the leash to lower the losses or get to break-even?

Lesjak: We remain at the operating expenses of one to two cents a quarter.

A question from Jeffries about free cash flow. Can you give us an understanding of the cash balance? Also, do we have any bullet payments? Also around Autonomy: If it’s going to be independent, but if you see synergies, how will you integrate it?

Léo: Yes, we will run Autonomy as a separate entity. Of course we will be looking for synergies as quickly as possible. First off, we will give Autonomy access to our channels. We will be working across our softare teams and theirs. IPG is one case. There are other things we can do with ESSN, as you can imagine.

Lesjak: We ended with $13 billion in gross cash. With our lower top-line expectation, and the cash charges related to webOS shutdown, that is putting downward pressure on cash flow. We expect free cash flow for the year of $8 billion.

3:04 pm: Question from Gleacher about storage. What will drive that business to higher growth rates?

Léo: Our storage business is going through a mix shift. 3PAR is growing triple digits year over year. We are in the early days of the P6000(?) launch.

Lesjak: 3PAR revenue is up triple digits on a normalized basis.

ISI question: If PSG transition could take a year, do you expect disruptions in PSG revenue?

Léo: I just want to be sure that people understand that PSG will be managed in a normal manner. The team and employees and everyone will continue as if we are a normal day-to-day business. That is the expectation that we have. I’m sure we can manage whatever transition happens.

One more question, from RBC Capital: Can’t hear it well. Sorry, RBC.

And that’s a wrap.

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Another gadget you don’t really need. Will not work once you get it home. New model out in 4 weeks. Battery life is too short to be of any use.

— From the fact sheet for a fake product entitled Useless Plasticbox 1.2 (an actual empty plastic box) placed in L.A.-area Best Buy stores by an artist called Plastic Jesus