Arik Hesseldahl

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HP Says It May Not Grow Sales in 2014 After All

hp_logo_380On Hewlett-Packard’s third quarter conference call today, CEO Meg Whitman explained her rationale behind the recent management shake-ups and many other things. She also revealed that the company no longer expects to grow revenue in 2014 as has been expected. This is the first major step back from the five-year turnaround plan outlined at last year’s meeting with securities analysts.

The results were close to what Wall Street expected, but ultimately fell short. As I’m typing these words, HP shares are down about 1.5 percent in after-hours trading, mainly in response to the lighter-than-expected guidance for the remainder of the year.

2:03 pm: The hold music has just ended and the call is about to get under way in earnest.

Boilerplate on “forward-looking statements.”

Meg is now speaking.

Some sectors are showing progress. Overall our turnaround continues. I remain comfortable with where we’re heading.

2:07 pm: Meg is basically saying that the company is executing against the long-term turnaround plan. And also talking about some of the new product offerings.

From a macroeconomic standpoint, we continue to see a weak enterprise spending environment. Sentiment is better in the U.S. China and Europe continue to be weak.

Cash flow from operations was $2.7 billion. Operating company net debt is now approaching “pre-Autonomy levels.”

Here comes the talk about management changes. Dion Weisler is shifting the PC business to a multi-OS multi-form factor strategy.

And now on to the Donatelli-Veghte change. Donatelli is taking on a “special assignment,” she says. Bill Veghte will retain responsibility for the pan-HP cloud product.

Henry Gomez will assume marketing in addition to communications. Marty Homlish will be “chief customer service officer.”

Now it’s on to business unit performance. First what went well. Printing did well. We’re seeing strength in ink-in-the-office program. Hardware sales are up. Revenue is down, profitability is up.

In Enterprise Services, business is stabilizing. We saw add-on business offset the runoff from four accounts that chose to leave HP services. Improvements in signings, but they were mostly renewals.

This will be a multi-year journey. One big win was with the U.S. Navy worth $3.4 billion over five years.

Enterprise Group: We see near-term revenue pressure in ISS and storage. Interest in Project Moonshot has been strong. We are in testing and development with many key customers. Converged storage was up 37 percent, but was offset by weakness in traditional storage.

Networking revenue was flat, but “we must grow this business faster.”

2:15 pm: Software was up one percent. We saw continued improvement in operating leverage. Operating margin was 20.5 percent.

Let me turn to where performance needs to improve. Enterprise Group was pressured by lower revenue especially in ISS, which continues to suffer from business model problems. The net impact is five points of market share. (Now we see what’s up with the management change.)

Here’s future outlook: “We now expect that revenue growth in fiscal 2014 is unlikely.” That’s a big walk-back from the analyst meeting last year.

If I’m not mistaken, that’s the first admission that the overall turnaround strategy isn’t taking hold as expected.

Aaaand … HP shares are falling in after-hours trading again. They had recovered a bit after falling nearly four percent, but are now down by more than three percent again.

As of 2:19 pm PT, HP shares are trading at $24.57, down 81 cents.

And falling further.

Okay back to the call. CFO Cathie Lesjak is speaking.

Lesjak: Operating profit of $908 million in printing. Commercial hardware sales up 12 percent.

Lesjak: Personal systems continues to change a challenging environment. Consumer weakness led the problem. Broad-based regional softness led by Europe.

Personal systems contributed just nine percent of profitability. (So while it continues to account for a lot of sales, the exposure to profitability isn’t all that much.)

Lesjak: Storage revenue down 10 percent. We remain excited about converged storage, up 37 percent.

Business Critical Systems — the Itanium server line that was the subject of the lawsuit with Oracle last year — fell 26 percent, but that’s consistent with expectations.

Lesjak: Signings up double digits in Enterprise Services. Our ability to sign deals outside our traditional focus needs to improve.

Sales of security products grew double digits and Vertica was up triple digits.

2:28 pm: Lesjak: We saw better execution in software sales this quarter, but we still have work to do.

Lesjak: We continue to drive free cash flow and improve the balance sheet. Free cash flow was $2 billion.

Lesjak: We spent just $3 million on share repurchases. During the quarter we had material non-public information that prevented us from buying back shares. The average for share buybacks was way off the historical average. Gross cash was $13.7. Operating net debt was $1.2 billion.

Lesjak: I am pleased with reducing net debt. We paid off a $1.1 billion maturity on Aug. 1.

Lesjak: She’s restating the non-GAAP EPS expectation of $3.52 to $3.57 which is on the low end of the consensus. Full-year free-cash flow will be $8 billion. “We expect some pullback in Q4.” More details about FY14 to come at the analyst meeting in October.

2:33 pm: Now time for Q&A. First is J.P. Morgan, asking Meg about commentary on execution. How much was driven by tech deficiencies versus go-to-market problems, or both?

Whitman: We were disappointed in EG’s performance. This is less technology than it is a number of other areas. We have to have the right products in the right market segments in the right cost structure. We have some work to do around supply chain and manufacturing strategy. We also have to simplify the sales motion. There are some bright spots. My view is that we have some operational excellence work that has to be done. I’m confident in the technology but we have more work to do.

Lesjak: Commenting on service. We have been working with four big accounts. One is done, we’re working with three others on the transition.

Next question, from Toni Sacconaghi: He’s asking about the management changes. Perhaps you can comment about what are the specific marching orders to the new executives? Why not look to attract talent from the outside? You say you want fresh ideas, and all management changes have included promotions solely from within.

Whitman: This is a five-year turnaround. We’re entering the next phase. We need to accelerate into the next turn. We need the right job at the right time with the right experience and domain expertise. I have to match the right executive. I have a preference for promoting from within.

In the case of Dion Weisler, the results in Asia were good for PPG. In the case of Bill Veghte, his software and selling expertise from his days at Microsoft are helpful. Yes, I want to go with people who have fresh ideas and who don’t have to start at the beginning of the learning curve.

Katy Huberty of Morgan Stanley asks about the cash flow improvement: Printer hardware unit sales were the strongest in a while, so why are supplies sales down so much?

Lesjak: We’re happy with the cash conversion cycle. What’s showing up in the numbers is educating everyone in the company on how they can help improve cash flow, and that is embedded into their bonuses. We think the cash conversion cycle in the low 20 days is more realistic.

On printers, we used the “Yen tailwind” (currency stuff pitting U.S. dollar against Japanese Yen) to place more units. We expect supplies will be volatile quarter to quarter. Our strategy is to drive unit sales of printers that will consume more HP ink. Those are all really designed to drive more sales per unit. Early indications are those strategies are going to bear out.

Question from Citi for Meg: It used to be you had a lot of confidence in the five-year plan. It seems the confidence is down going into 2014. Is the five-year program changing?

Whitman: Our turnaround is working. Some businesses are performing as expecting, some not. Enterprise Group’s weak execution has amplified challenges we know exist. PC market has not yet stabilized. Enterprise Services has some growth challenges next year. I am confident that we can address the challenges. But I think it is unlikely given the changes that we will see revenue growth in 2014.

2:46 pm: A question about Technology Services. Also a question about industry standard services. Why didn’t we hear about the problems earlier?

Lesjak: One of the things we are seeing in TS is the need to improve attach rates on newer products. As older products like BCS services that have a long tail, they are coming down and impacting TS results. We are trying improve attach on new products.

Whitman: The server business has been under pressure for a long time. The revenue loss has been stronger than expected. We have to move faster. Moonshot will deliver, but it hasn’t yet.

I’m telling managers to set realistic targets and then deliver on them. This isn’t all about revenue growth.

This is something that HP has done well historically.

Question from Raymond James: Do you expect trends in the enterprise business to deteriorate further? What do you think about M&A activity?

Whitman: We are in the happy position of being able to reevaluate our capital allocations. We will be “back in the market” on acquisitions. Wow.

Whitman: We will be very focused and disciplined. Acquisitions are going to have to be a part of how we turn around.

There you have it. HP will be back in the M&A marketplace next year or even sooner.

2:53 pm: Incidentally, I just checked the latest price on HP shares in after-hours trading. As of 2:53 pm PT, it’s down more than five percent to $24 even.

Shannon Cross of Cross Research. She’s asking about strategy. Some competitors (Dell) are being very aggressive on pricing and winning share.

Lesjak: Whether on servers or PCs, we’re focused on long-term profitability. We believe the way we’re going to get there is investing in our own IP. The decision is what is the best thing for the business to drive long term profitability.

Cross is asking about demand in China.

Whitman: China is softer that we’d anticipated. We are seeing more growth in tier 4-6 cities. But it’s reasonably soft across the board.

Lesjak: Networking in China was very strong. We are the leading market share holder in China for networking. (ATD readers already knew that.)

2:56 pm: Keith Bachman of BMO: He’s asking for an update on restructuring. It’s not apparent that HP is getting the cost benefit from the restructuring. (He’s referring to the layoff of about 29,000 people.)

Lesjak: There’s labor and on-labor. We had 3,800 people leave in Q3. To date, that’s 22,500 who have left the company. We’re on track to hit 26,000 by the end of fiscal 2013 on the non-labor portion of the restructuring. This is enabling us to compete on price and other things. The savings that are getting generated is cushioning the bottom line. Without the savings, the results on the EPS line would be materially lower.

Bachman: Once the savings from cuts runs out, what happens to plans to grow revenue?

Lesjak: These savings are giving us cover to make the changes we need to grow revenue and fix our execution issues.

Whitman: We are making changes that we think will grow over time. The mix is currently weighted toward declining businesses. Our mix of business is not helping. Take storage. New products growing fast, older ones declining. “That is a metaphor for the whole company.”

Whitman is wrapping the call: “I feel very confident in our turnaround. I’m really excited about our new management team. We are on track and things are headed in the right direction.”

The call is now concluded. Thanks for tuning in.

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