Whitman: HP’s Turnaround Is a Multi-Year Journey That’s Just Getting Started
HP’s quarterly results are out, and the early judgment of investors is that it was a mixed bag. While per-share earnings at 92 cents beat the consensus of 87 cents, sales were light by about $700 million.
It was a tough quarter, which is something HP executives will likely remind us all about during the conference call that’s set to get under way any minute. There were challenges on every front, from the shortage of hard drives to the decline in demand for printers.
So what’s the plan now? Perhaps CEO Meg Whitman will give us a look at the year ahead. I’ll be listening in and reporting what I hear.
2:03 pm: Opening comments from Steve Feiler, head of investor relations. Meg and Cathie Lesjak will also be speaking.
The audio is a little off. Maybe Steve should sit a bit closer to the phone?
2:06 pm: And here’s Meg. We’ve been working hard to set the right tone and calm the waters. She’s been traveling the world, talking to HP employee and customers. Eighty customer visits. So what have I found? I have found some skepticism and some incredible support.
The more time I spend listening and learning, the more passionate and determined I become.
I want you to understand where we’re going and why. In Q1, our performance tracks pretty close to the expectations we set in November. That said, we met our guidance. It was a tough quarter, with troubles in every segment. With the supply challenges, we focused on profitability rather than volume.
Now on to the printer unit. All of you know IPG has been the lifeblood of our company for a long time. But we also have to recognize that the business is being pressured on multiple fronts. We have work to do here, and are working to rebuild IPG’s leadership.
Software is a critical part of our portfolio, and key to strategy. Autonomy acquisition is going well. We see synergies across all our businesses.
2:12 pm: Now on to the macroeconomic environment. The U.S. has some positive signs. Guarded about Europe.
In the six months I’ve been CEO, my perceptions of the business have changed. Her issues are in three buckets: One, simplicity. She’s talking about SKU reduction, which means reducing the number of models of different products. With that, Meg is taking a key page from the Steve Jobs playbook at Apple, circa 1997.
2:14 pm: The second bucket is investment. There’s another stab at prior management for not investing in key lines of business.
Our current cost base just isn’t supportable. We’ve been running our business in silos. It’s made us too costly and too slow. We need to standardize, optimize and automate many business processes.
We have got to save to invest. We have got to save to grow.
I have no doubt that we’ll turn HP around.
2:17 pm: And here’s CFO Cathie Lesjak running through the numbers. Half of the revenue decline came from hard drive shortages. We made the decision to prioritize profitability over volume. We expect the supply will remain constrained in Q2.
PSG reported $8.9 billion in sales, down 15 percent year on year. Shipments down 8 percent.
Wow, consumer PC sales down 25 percent. That’s gotta hurt. That’s part hard drive shortage, but also some damage taken by Apple and the iPad.
Lesjak is talking about the legal spat with Oracle. The uncertainty around the Itanium-based servers has hurt sales considerably and, as legal papers show, HP makes a lot of money servicing those servers.
Software is looking good generally, but it’s too small to make a dent in the weak results elsewhere.
2:26 pm: Lesjak: We remain cautious about consumer and business spending. Hard drives will remain a problem. We still have hard work to do to align inventory levels with demand.
The expected decline in revenue will impact margins.
Back to Meg: I’d really like you all to take away these three messages: We’re committed to clarity. Two, we’re getting back to basics. Three, we are building HP to last, focusing not on short-term expectations.
Time for Q&A with analysts: First question from Barclays. It seems like a tone change for the printer group. Last time, it sounded economic and not secular, this time it sounds like it’s secular. He’s also worried about reaching the $4 EPS guidance for the year.
Meg: In IPG, we face a number of challenges. It’s a more mature market. I’m convinced it relates to macroeconomic problem. The sell-through of ink is at low levels, and it’s not just our ink, but industrywide. We do see pockets in decline. Consumers are printing fewer photos. We’re steady as she goes. Going to think hard about accelerating new business to compensate for the loss in ink sales. Also, the headwinds from the Japanese yen will remain. It’s a terrific business, but we’ve got some work to do.
Lesjak is talking now about the guidance question. The usual seasonal pattern shows that the second half of the year is stronger than the first. We think the hard drive shortage will be largely over by the third quarter.
Lesjak: There’s also an inventory correction to work through that will be largely done in the second half. Also, Autonomy will start showing results in the second half.
Question from Goldman Sachs: When do you expect to return to a “steady state” in IPG? How should we think about steady state?
Lesjak: There are three impacts to IPG: We continue to see weak consumer demand. That’s a headwind for ink sales and what we expected. And then currency, and then there’s a channel inventory correction. We expect challenging demand, but without the same headwinds as in first half of the year.
Sanford Bernstein question: There’s evidence of significant share loss across all businesses. It doesn’t appear you’re ceding share to improve profitability, because the numbers don’t support it. The data points to a widespread lack of competitiveness. I know you’ve talked about stabilizing the business. What does that mean, and how do you get there?
Meg: We prioritized profitability. We made a decision to priortize profitable products and customers and regions. Reiterating, we hope to get through the hard drive shortage by the second half. We didn’t have the perfect match for the disk drives we needed. Those two business, I’m not worred about endemic share loss. If you look at some of our other business — printers and ink — takes me to three big challenges. I don’t know if it’s a widespread lack of competitives. Our own execution, turning orders into products faster than our competitors. We’re world-class in how we buy our components. Our systems and processes were underinvested. We have an enormous number of SKUs, which leads to complexity in support and in selling. Some of our competitors do some of those things better than we do.
Then the Business Unit leaders are working hard to lower their costs, bring new products to market. PSG has some great products coming up, and in ESSN, too. Each BU leader has to work on strategic challenges. We have got to make sure we own the tectonic plate shift. Cloud, information management and one other I didn’t catch (sorry).
2:40 pm: Lesjak: We shipped servers that were less richly configured as a result of the hard drive shortage.
Follow-up question: When you both mentioned this concept of stabilizing the business, what does that mean? Is that holding share, growing in absolute terms? How will investors know, and what is the time frame?
Meg: The first thing we have to do is stop the revenue decline. The second is, then we have to start growing revenue, you have to gain share in every single market. The unit cost is going down, and you have to sell more. I would hope that as we get through 2012, you’ll see revenue decline flatten out, and as we get into 2013, we’ll start to grow. It depends on how fast we can get after some of these challenges in the business. A lot of this is in our own hands.
Lesjak: We let you know what our outlook is, and we deliver to it.
Meg: If you look at companies who go through these turnarounds, these things are not done in less than two years, and often they take three to five years. You’ll see forward progress. We’ve got a journey ahead of us.
Morgan Stanley: How are you assuming Windows 8, Intel’s Romley chip and other things will help you stabilize the business?
Meg: We feel good about Windows 8. We have x86 products. We have good reviews on our first ultrathin product. The better Windows 8 is, the better off we are. We’re rooting for a great Windows 8 product. You have to remember that PSG is only a part of the entire portfolio.
Question from Raymond James: Why did HP have such a significant impact from hard drive shortage relative to competitors? What is it about the supply chain that is the biggest in the world that put HP at a disadvantage?
Meg: We focused on profitability versus share. It was a remarkably fluid situation. Matching drives you ordered with the models. We were not as effective as we needed to be. It showed us that we have some challenges in our supply chain. We’ve got to get better in taking an order and delivering a product.
2:47 pm: Meg: We were not as advantaged as I would have anticipated. I think we’re world-class at buying, but if you look at the whole thing, there’s some advantages we can get.
Cross Research: How are you interacting with your direct reports, and how are they breaking down the silos?
Meg: We actually are a team. We have a cadence and a rhythm in how we meet. I couldn’t be more pleased with how the team is working together. If you were to ask the senior team, it would be a pretty positive feedback versus previous management. One thing I’m working on is bringing the entire product portfolio to customers as one HP. Our biggest customers want to buy from one HP, and not from different segments. I think the executive council members say the relationship with the CEO is as good as its been.
Lesjak: We’ve moved out of offices and into cubes. We’ve spoken more frequently with Meg than we have in the entire year. More over-the-cube-wall quick discussions. (Wow, all the senior execs at HP work out of cubicles instead of offices?)
Missed an entire question there. I’ll catch the next one.
Meg: Talking about printer business. The yen is a real problem.
Cathie: If you look at the yen increase year over year, it’s like 7 percent. It has been increasing over the last couple of years. We’ve been able to absorb it when it just became too difficult to take the cost out fast enough to offset appreciation in the yen.
2:54 pm: Question about services investment. Where is the bottom in services margins?
Cathie: The performance we delivered was in line with the expectations we gave last quarter. Revenue was up 1 percent, or flat in constant currency. The services we put in that category are services around cloud and security. We are on this long-term turnaround, and we are making progress, but we did see some margin compression from contract renewal. Almost all contracts get renewed at lower prices. We’re making investments in processes and IT to increase our ability to take costs out of services quickly. If you look at the outlook for 2012, we expect margins will continue to be down.
Meg: The way you have to think about services, we are going through a multiyear turnaround. In services, we know what the problem is, we have a plan, but it’s not a quick fix. It goes back to the assets we acquired in 2008 (EDS), then ran right into 2009 and the global recession. This has to be our solution selling arm, but we have a multiyear journey ahead of us.
2:58 pm: Incidentally, as I’m typing, HP shares are down more than 1 percent after hours, and that’s after falling 1.4 percent during the regular session. The view of the market appears to be more negative than it was early on, when the mixed bag of numbers first hit the wires.
I missed Maynard Um’s question, however.
3:04 pm: One more question: One about streamlining processes and what it means for operating expenses. And a follow-up for Cathie about cash conversion levels.
Meg: We have a strategy that I’ve seen work many times before. We have to save so we can invest. We have to streamline processes, optimize the supply chain, reduce SKUs and rationalize the go-to-market. What never works is to keep your cost structure the same and layer investment over it. Stabilize declining revenues and gain share in the categories we can keep. This is what great leaders do.
Cathie: We pay our annual bonuses in Q1, we accrue the expense in the previous year. It’s typical that Q1 is a low cash-flow quarter.
Meg is wrapping up. She’s incredibly optimistic, but she and her team have a lot of work to do. And that’s it.