Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Hewlett-Packard Company (NYSE:HPQ)

F1Q2014 Results Earnings Conference Call

February 20, 2014, 5:00 pm ET

Executives

Rob Binns - Vice President of Investor Relations

Meg Whitman - President, Chief Executive Officer, Director

Cathie Lesjak - Chief Financial Officer, Executive Vice President

Analysts

Katy Huberty - Morgan Stanley

Toni Sacconaghi - Sanford Bernstein

Jim Suva - Citi

Keith Bachman - Bank of Montreal

Mark Moskowitz - JPMorgan

Benjamin Reitzes - Barclays

Aaron Rakers - Stifel

Brian Alexander - Raymond James

Steve Milunovich - UBS

Shannon Cross - Cross Research

Bill Shope - Goldman Sachs

Maynard Um - Wells Fargo

Operator

Good day, ladies and gentlemen. Welcome to the First Quarter 2014 Hewlett-Packard Earnings Conference Call. My name is Ellen, and I will be your conference moderator for today's call.

At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Rob Binns, Vice President of Investor Relations. Please proceed.

Rob Binns

Good afternoon. Welcome to our first quarter 2014 earnings conference call, with Meg Whitman, HP's Chief Executive Officer, and Cathie Lesjak, HP's Chief Financial Officer.

Before handing the call over to Meg, let me remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately one year.

Some information provided during this call may include forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, the results of HP may differ materially from those expressed or implied by such forward-looking statements.

All statements other than statements of historical facts are statements that could be deemed forward-looking statements, including but not limited to any projections of revenue, margins, expenses, earnings, earnings per share, HP's effective tax rate, cash flows, share repurchases, currency exchange rates or other financial items, any statements of the plans, strategies and objectives of management for future operations, and any statements concerning the expected development, performance, market share, or competitive performance relating to products or services.

A discussion of some of these risks, uncertainties and assumptions is set forth in more detail in HP's SEC reports, including its most recent Form 10-K. HP assumes no obligation and does not intent to update any such forward-looking statements.

The financial information discussed in connection with this call, including any tax-related items, reflect estimates based on information available at this time and could differ materially from the amounts ultimately reported in HP's first quarter Form 10-Q.

Revenue, earnings, operating margin and similar items at the company level are sometimes expressed on a non-GAAP basis and have been adjusted to exclude certain items, including amongst other things, amortization of purchased intangibles, restructuring charges and acquisition-related charges.

The comparable GAAP financial information and a reconciliation of non-GAAP amounts to GAAP are included in the tables and in the slide presentation accompanying today's earning release, both of which were available on the HP Investor Relations webpage at www.hp.com.

I will now turn the call over to Meg.

Meg Whitman

Thank you, Rob, and thanks all of you for joining us today. With the first quarter of fiscal 2014 close, HP is in a stronger position than we have been in quite some time.

Since laying out our five-year strategic roadmap for turning the company around, we have made significant progress. We have reignited innovation of HP, and the first quarter was no exception as we introduced industry-leading technologies across our portfolio.

Our focus on rebuilding our balance sheet has resulted in an improvement of our operating company net cash position by more than $6 billion in the first quarter of 2013. We have strengthened our relationship with customers and channel partners, something I see every day in my interactions with them, and our global workforce is fully aligned behind the common vision of the company, delivering solutions for the new style of IT. And we are seeing acceleration in the industry's movement towards that new style of IT.

These changes create tremendous pressure in the marketplace as technologies and business models evolve, customer needs change and incumbents look to respond. Many of our competitors are now confronting these new realities by making major strategic shifts and exiting significant parts of their business. At the same time HP is more than two years into its work to reposition the company to meet these challenges. We believe this is a competitive advantage. With the steps we have taken, I think we are well positioned to seize on opportunities that will arise in the marketplace. We still have a long way to go but I am more convinced than ever that we are making the right moves to set HP up for the long-term.

Rest assured, we are not taking our foot off the pedal. Over the next few quarters, we will introduce significant new innovations that will build upon our offerings in cloud, security, big data and converged infrastructure, as well as some remarkable new technologies in printing and personal systems. In addition, at our Global Partner Conference next month, we will roll out updates to our partner programs that we expect will further strengthen our channel relationships. We are doing all of this while we continue to optimize our cost base and invest in our infrastructure to help create a more agile and more aggressive HP.

In the first quarter, HP delivered $0.90 in diluted non-GAAP net earnings per share compared to our financial outlook of $0.82 to $0.86 per share. Total revenue for the company was down 1% for the quarter, but up slightly in constant currency. And we once again delivered very strong cash flow, generating $3 billion in cash flow from operations. As a result of our focus on driving cash flow, the company exited the quarter with operating company net cash position of $1.7 billion after returning $843 million to shareholders in the quarter in the form of dividends and share repurchases.

We saw further encouraging signs in the quarter that our efforts to turn the company around are taking hold. There was revenue growth in our personal systems and enterprise group segments and at the total company level, on a constant currency basis, we achieved revenue growth for the first time since the second quarter of 2011. As I said in past, turnarounds are not linear and we have a lot of work ahead of us. While I would certainly not declare victory based on these results, they represent real progress. Make no mistake, we are focused on consistently and profitably growing revenue over the long-term.

You have heard me say that revenue growth will ultimately be driven by great products and in the first quarter, we held our Annual Innovation Showcase for our European customers at HP Discover in Barcelona. We used the event to introduce some significant new technologies in key areas for the company. WE introduced our new converged system portfolio, a family of integrated IT systems using HP server, storage and networking technology that is purpose built for key workloads such as virtualizations, big data and hosted desktops. These new products deliver a total systems experience that dramatically simplifies IT, enabling clients to go from order to operations in as little as 20 days.

We also introduced new solutions in our converged storage portfolio, including StoreOnce Backup, StoreAll Archive and StoreServ Storage. Collectively these innovations deliver industry-leading performance and efficiency making it possible for enterprises to manage their data in the new style of IT. We announced the next generation of our flagship private cloud solution, CloudSystem 8. This solution integrates with our OpenStack architecture and enables enterprises to build a private cloud and deploy cloud services in a matter of hours rather than days or weeks.

HP was also recently recognized by Forrester Research as the clear leader in private cloud solutions. We also launched our new hybrid cloud management platform, a self-service portal with key management and security tools that allow IT managers to more efficiently deliver applications and services to their users.

Also in the first quarter, our personal systems group introduced two new mobile devices to the market in India, the HP Slate 6 and Slate 7 VoiceTab. These tablets demonstrate how we are clearly segmenting markets to target opportunities with cost-effective products that play to our strength.

Now let me turn to our business group performance in the quarter. Overall results in Q1 were driven by the revenue growth I noted earlier plus solid performance in printing and disciplined cost management. In personal systems, we delivered strong revenue performance. Overall the PC market contraction is slowing and we see signs of stabilization particularly in the commercial segment.

Revenue grew 4% over the prior year, our first quarter of growth in seven quarters. Growth was driven by strong performance in commercial, particularly commercial notebooks.

Operating margins for quarter were 3.3%, up over both, the prior year and sequentially. The competitive pricing environment remains aggressive, which put pressure on our gross margins. We are being selective in where we play, and as a result we lost 0.7 points of market share over the prior year in a declining market in the calendar fourth quarter, and 0.9 points, sequentially.

We believe our approach of being selective about where we play, coupled with good cost discipline will ensure we remain focused on profitable growth. Our Printing business delivered solid results with sustained profitability.

Operating margin for the first quarter were 16.8% up, 0.5 points over the prior year. Printing revenue was down 2% or 1% in constant currency, and while total supplies revenue declined, we did see growth in ink supplies over the prior year.

We also saw our third successive quarter of hardware unit placement growth, driven by very strong growth in laser units and ink in the office remains strong. The focus on unit placement is an investment that we believe will pay future dividends for supplies.

The overall printing market saw hardware unit growth for the second successive quarter, driven by strength in laser. For the third successive quarter, HP outperformed the market gaining two points of share over the prior year in total and in both, ink and laser, respectively.

In Enterprise Services, a soft revenue quarter pressured margins. As we laid out on our last call, delayed revenue runoff from FY'13 is impacting year-over-year compares for ES. In the first quarter, run-off occurred largely as we expected and resulted in a 1% operating margin, down 30 basis points over prior year.

We are in the early innings of the transition we outlined in October, to drive a more proactive sales approach. In the first quarter, we did see encouraging bookings growth in Strategic Enterprise Services, but there remains for an opportunity for us to improve our success in winning new large customers and securing add-on revenue from existing accounts.

I am confident that we have the right plan in services and the team has made good progress in executing against their strategy, but this is a big shift to turn and we need to move faster, particularly on aligning our sales engine and improving our service delivery for higher quality and lower costs.

In the Enterprise Group, we saw revenue growth of 1% and expect calendar fourth quarter share gains across all our hardware segments. Results in the first quarter were led by revenue growth in ISS and Networking, partially offset by revenue decline in TS. We saw stable performance in storage, where we continue to manage the transition from traditional to converged storage.

Finally, we continue to see revenue declines in Business Critical Systems. Overall, we are still seeing a very competitive pricing environment in EG. Over time, we do expect to improve margins in this business. There is more we can do, and as we look forward, we remain focused on better matching our product mix to market segments, cost savings opportunities and improving attach rates to drive increased operating margins.

In Industry Standard Servers, we continue to make progress in stabilizing this business in the first quarter. We had another strong hyper scale quarter although this contributes to pressure margins. In addition, we continue to make progress with Moonshot, as we roll that new workloads in the first quarter and introduced the first converged system for hosted desktop based on Moonshot technology.

Customer interest remains high and we are working with a number of customers on proof-of-concepts, addressing a variety of different workloads. In Storage, overall revenue was flat. In converged storage, we saw 42% revenue growth over the prior year and 3PAR continues to perform very well, particularly in the midrange segment.

Networking, we grew revenue 4% over the prior year. We saw good performance in switching, which grew revenue 5% over the prior year comparing very favorably against Cisco's results in the same period.

In Technology Services, revenue declined 4% over the prior year, but only down 2% in constant currency. We continue to see good adoption of our new portfolio, including Proactive Care, where ordered grew triple digits year-over-year and flexible capacity services where we are seeing strong customer demand.

In Software, I feel good about the progress we are making. We have simplified the product line while rejuvenating our core portfolio. We are investing in key growth areas and the team is making great strides on area of operational improvement.

Revenue was down 4% over the prior year, but we grew in key areas of the portfolio, including security, cloud and Big Data. Weakness in our traditional IT Management business, particularly in the U.S. and Asia was partially offset by strength in security offerings like ArcSight and Fortify, as well as in our Vertica business.

In Autonomy, the technology continues to resonate very well with customers as we launched Idol 10 and Data Protector 8.1, the industry's first adaptive and self-aware backup and recovery solution. In addition, Autonomy announced a major win with China Mobile, selected IDOL to power the search capability of its strategic wireless city platform. This platform allows users to access information on thousands of public services directly from their mobile phones. So overall I am very pleased with the progress we have made but we still have a lot of work to do to drive consistent execution and navigate a rapidly shifting marketplace.

Now let me turn to our future outlook. The approach we outlined at our Security Analyst Meeting last fall remains our compass to guide us in FY '14. We will continue to focus on innovation, cash flow, our restructuring plans and executing on the areas of improvement in the turnaround while taking advantage of the realities of the new style of IT. We are not expecting any significant change in the macro environment. There are definitely some encouraging signs with improved performance in Western Europe but headwinds remain in many emerging markets. Against the backdrop, our Q2 outlook for non-GAAP diluted net earnings per share will be $0.85 to $0.89 and for the full year the outlook will be $3.50 to $3.75.

But now let me turn it over to Cathie for a closer look at our performance in the quarter. Cathie?

Cathie Lesjak

Thanks, Meg. Overall Q1 was a good start fiscal 14 as some of the fundamental improvements we have been driving are beginning to take hold. As Meg noted, we still are not satisfied with the consistency of our performance or the profitability across some of our businesses. So we remain very focused on improving our go-to-market and cost structure.

Total revenue for the quarter was $28.2 billion, down 0.7% year-over-year and up 0.3% in constant currency. By region, the Americas revenue was $12.5 billion, down 2% year-over-year or down 1% in constant currency. The decline was primarily due to key account runoff in enterprise services in the U.S. partially offset by our previously announced sale of IP. EMEA revenue was $10.4 billion, up 1% year-over-year but down 1% in constant currency. While our EMEA outlook remains cautious, we are seeing some signs of stabilization in more mature markets such as Germany and France. APJ revenue was $5.2 billion, down 1% year-over-year but up 5% in constant currency. We saw particular strength in India again this quarter and China was flat. Relative to the overall market challenges in the region, we are pleased with this performance.

Gross margin for the quarter was 22.8%, up 0.5 points year-over-year and down 0.2 points sequentially. The year-over-year improvement included some benefit from the IP sale. We continue to experience an aggressive pricing environment across our hardware businesses which we are offsetting through productivity improvements and greater service delivery efficiencies.

Total non-GAAP operating expenses for the quarter were $4 billion, down 1.8% year-over-year and down 1.4% sequentially. R&D expense was up over the prior year period as we continue to invest in innovation in our strategic focus areas such as cloud and across many of our business segments. SG&A was down over the prior year period primarily due to gain from a real estate sale and expense benefits from our restructuring actions. These benefits were partially offset by higher litigation reserves and investments in systems and tools. As a result of non-GAAP operating profit was $2.4 billion or 8.5% of revenue up 0.6 points year-over-year. We recorded $163 million of expense in the other income and expense line, a decrease from the prior year period driven primarily by lower expense on reduced debt balances, partially offset by the unfavorable effects of currency exchange rates.

With a 22% tax rate and a weighted average diluted share count of 1.935 billion shares, we delivered first quarter non-GAAP diluted net earnings per share of $0.90. First quarter non-GAAP earnings primarily excludes pretax charges of $283 million for amortization of intangible assets and $114 million for restructuring charges.

Turning to the business units. Printing continued to perform well with solid hardware unit growth for the third consecutive quarter and good profitability as we continue to push our print strategy forward. Revenue was $5.8 billion, down 2.2% year-over-year and unit shipments grew 5%. Commercial Hardware revenue was $1.3 billion, down 2% year-over-year while Consumer Hardware revenue was $673 million down, just 1% year-over-year. We are seeing contraction in average selling prices across ink and laser hardware, driven by the tough pricing environment and the expected currency exchange rates but the underlying unit demand is improving. For example, demand for our Ink in the Office products remains strong. The Officejet Pro X saw double-digit sequential growth across all regions and we continue to see double-digit year-over-year revenue and unit growth in Ink Advantage.

In Laser, we gained share and are continuing to grow in multifunction printers and managed services and Graphics remains a bright spot with another solid performance in Indigo.

Supplies revenue was down 3% over the prior year period, or down just 1% in constant currency and made up 65% of printing revenue. Supply softness was attributable to weakness in toner. Software toner drove channel inventory levels marginally up above our target range. We are actively managing this and the net impact to Q1 results was immaterial.

Overall printing profitability remains solid, with operating profit of $1 billion or 16.8% of revenue, up 0.5 points year-over-year. The performance in Personal Systems was better than expected with revenue of $8.5 billion, up 3.6% year-over-year driven by commercial strength. There were signs of improved market conditions, especially in commercial PCs and we are confident about our portfolio and focus.

Although consumer sales declined 3% year-over-year, commercial sales grew 8%. Commercial notebooks grew double digits over the prior year period and commercial desktops were up as well.

Total unit shipments grew 6% year-over-year with growth in both, the Commercial and Consumer segments. Channel inventory levels are down and well within acceptable ranges across all categories and regions.

Personal Systems operating profit was $279 million or 3.3% of revenue, up 0.5 points year-over-year. The results of our continued focus on cost management and the IT sales were partially offset by increased DRAM cost as we indicated to you last quarter. We remain focused on driving profitable growth in this business.

Enterprise grew its revenue with $7 billion up 0.6% year-over-year and up 1.5% in constant currency. Operating profit in the quarter was $1 billion or 14.4% of revenue, down one point year-over-year.

We believe these results show the progress we are making on sales execution and the competitiveness of our portfolio as the market shift towards the new style of IT, however we still have more work to do to improve profitability in the business.

As Bill Veghte, discussed at our Security Analyst Meeting, we are focused on specific actions that optimizing our cost structure more closely aligning the business units in the region and better segmenting the market.

By business, industry standard server revenue was $3.2 billion, up 6% year-over-year as we saw strong growth in hyperscale again this quarter. Technology Services revenue declined have moderated somewhat with total revenue of $2.1 billion, down 4% year-over-year and down 2% in constant currency. Our profitability expanded and customer satisfaction improved

When you consider the significant headwind of the decline BCS business, the Technology Services operating profit performance was strong in storage and networking were driving execution improvements to capture more market opportunity and we are starting to see the results.

Networking revenue growth started to accelerate in the first quarter. Revenue was $630 million in the quarter, up 4% year-over-year. Storage revenue was flat versus the prior year. At $834 million as strong growth in converged storage offset declines in traditional storage converged storage grew 42% year-over-year and 3PAR for EDA plus XP grew 13% faster than the market again this quarter.

This metric indicates how well 3PAR is performing in disrupting the marketplace, taking in account the plan transition of our traditional offerings business critical systems continues to be impacted by declining UNIX market. BCS revenue declined 25% year-over-year to $228 million. We expect to gain two points of share in this market.

Enterprise Services revenue of $5.6 billion down 7.3% year-over-year to revenue decline was driven by the delayed key account run-off as we indicated previously. The revenue decline, along with the investments we are making our sales force and increased litigation reserves on legacy accounts, pressured our margins in the quarter.

Operating profit was $57 million, or 1% of revenue down 0.3 points year-over-year. By business IT Outsourcing revenue of $3.5 billion down 9% year-over-year and applications and business services revenue was $2.1 billion, down 4% year-over-year, both businesses were impacted by the key account run-off.

Overall, signings were soft in Q1, but smaller and medium deals grew. Overall, our trailing 12 month book-to-bill within acceptable ranges we make some progress in improving productivity but we have to move faster to drive service delivery efficiencies, grow add-on business within existing accounts and capture new logos.

Software revenue declined 3.7% over the prior year period to $916 million although we saw continued growth in key areas such as SaaS, Vertica and security and gained traction in our innovative big data platform, HAVEn. License revenue declined 6% year-over-year due to continued market transition to SaaS as well some pressure in our IP management business.

However we saw double-digit growth in cloud, Vertica and Autonomy's IDOL license revenue. Support sales declined 2% year-over-year as a result of historical license revenue declines. Professional services sales declined 12% year-over-year but the gross margin improved as we continued to prune our portfolio and focus on profitability. SaaS revenue grew 6% over prior year period as we see continued momentum. Operating profit was $145 million or 15.8% of revenue, down 0.5 points year-over-year. We continue to invest in strategic growth areas of software and make progress on simplifying and enhancing our systems and processes to increase productivity.

HP Financial Services revenue was $870 million, down 9.1% year-over-year. Operating profit was the $101 million or 11.6% of revenue, up 1 point from Q1 fiscal '13. Pressure from volume declines in previous quarters impacted HP Financial Services revenue however new financing volume was up double-digits driven by strength in the direct customer financing business. The health of our portfolio of assets was strong and return on equity was 18% in the quarter.

Turning to cash flow and capital allocation. We had another strong quarter generating $3 billion in operating cash flow, up 17% year-over-year which resulted in $2.4 billion in free cash flow. We continued our focus on working capital and got our cash conversion cycle down to 16 days in the first quarter, down seven days from the prior year period. We improved across all metrics but the largest improvement was in days payable outstanding. We returned $565 million to shareholders by repurchasing 20.4 million shares in the quarter and paid $278 million in the form of dividends. For the year, we are still committed to capital distributions and our plan to return at least 50% of free cash flow to shareholders in the form of share repurchases and dividends as we outlined at our Security Analyst Meeting.

During the quarter, we also completed a very successful $2 billion debt offering, our first term debt issuance in almost two years. We ended the quarter with gross cash of $16.4 billion and operating company net cash of $1.7 billion, a $6.4 billion improvement over this period last year.

Looking forward to Q2, the market and competitive environment continues to be challenging. While there are signs of recovery in some geographic regions, many areas across the globe are soft. Currency impacts are also affecting the global business environment and we expect currency to be about one point headwind year-over-year to revenue in Q2.

By business, in printing you will continue to invest in hardware unit placements where the lifetime return on the unit makes economic sense and we expect to drive continued momentum in key strategies across ink, laser and graphics. For personal systems, while we expect the commercial segment to continue outpace the consumer segment, we believe the overall market is likely to remain highly competitive. In enterprise group, we remain focused on more successfully managing the margin profile and we expect continued traction in networking, converged infrastructure and converged storage. In enterprise services we expect the delayed key account runoff to continue to pressure growth and profitability as we drive forward the transition from reactive to proactive sales. Finally in software, we expect to see continued traction in key growth areas like big data while we invest in disruptive technologies like cadence HAVEn and security and manage our portfolio transition to SaaS.

As you go through your models pleas keep in mind, there was a net benefit to Q1 results from the few items I have mentioned earlier including the IP and real estate sales as well as litigation and other expenses. Adjusting for these items, our Q1 non-GAAP diluted net earnings per share would have been around the midpoint of our previously provided Q1 outlook of $0.82 to $0.86.

Also in order to drive greater operational improvements, we plan to increase our reinvestment in the business for the full year by around $0.02 per share up from the $0.12 we discussed at our Security Analyst Meeting. With that context, we expect full year fiscal 2014 non-GAAP diluted net earnings per share to be in the range of $3.50 to $3.75. For fiscal 2014 Q2, we expect non-GAAP diluted net earnings per share in the range of $0.85 $0.89. From a GAAP perspective, we expect a full-year diluted net earnings per share to be in the range of $2.85 to $3 and GAAP diluted net earnings per share for fiscal Q2 is expected to be in the range of $0.62 to $0.66.

For cash flow, based on the actions we are taking to drive working capital efficiencies, we now expect moderate improvement in our cash conversion cycle from the low 20-day range we estimated previously. We expect this to provide some upside to our original cash flow Outlook for the year.

With that, I will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Katy Huberty with Morgan Stanley. Please go ahead.

Katy Huberty - Morgan Stanley

Thanks. Good afternoon. Cathy, as you noted you continued to beat the cash cycle target of 20 to 21 day, so can you just give us a little more detailed view as to what the right realistic near-term cash cycle target is?

Then assuming you still think that the company will trip back to the 20 to 21 day range are there offset that longer-term opportunities in CapEx or cash tax payments or other items such that you can offset an increasing cash cycle longer-term. Thanks.

Cathie Lesjak

Thanks, Katie. As I mentioned in my prepared remarks, we do expect a moderate improvement in the cash conversion cycle off the guidance that we previously provided around the low 20s and we are very pleased with the progress that we made in Q1 to drive 16 days cash conversion cycle, which is just so everyone thinks through this is actually down a day, sequentially, and normal sequential performance is up anywhere from a couple of days to three days.

Now, we did have some help in that, in the sense that we had some nice favorable revenue linearity and we also benefited from IP sale as well as the mix of PCs, because if you recall, the PC cash conversion cycle is negative, so as the PSG business increases its relative mix. It puts a nice downward pressure on cash conversion cycle.

Over the longer term though, we do expect that that mix from PSG will impact decrease on a relative basis and so that will put from put pressure on the cash conversion cycle, so we do as I say, overall expect moderate improvement off of the low 20s that we provided before. We are also very much focused on our capital expenditures and making sure that we are spending everything that we need to send, but nothing more and everything that we spend is driving the appropriate return and will continue to be focused on that.

Meg Whitman

Katie, I would just add one more thing. It's Meg. The next chapter in improving our cash generation capability is around SKUs and platform rationalization, because as you think about it, the more SKUs and the more platforms you have, the more inventory you have, the more parts you had and the chance is that you have the right inventory in the right place at the right time decrease others there's more leverage over the long-term, not necessarily in 2014, but there's more leverage in the long-term around making sure we have the right product for the my right market segment and don't over SKU.

Rob Binns

Great. Thanks for the question, Katie. Next question please?

Operator

We have Toni Sacconaghi with Sanford Bernstein. Please go ahead.

Toni Sacconaghi - Sanford Bernstein

Yes. Thank you. I have a question and a follow-up please. Cathy, I was hoping that you could just provide a little bit more detail on the sale of the mobile computing IT that you alluded to as well as the real estate sale.

I think you also mentioned in your in your summary remarks that there had been some litigation as well, which was a benefit, so perhaps you could just to mention the size of each of those and are they all captured in your corporate investments' reporting segment or are they somewhere else in your in your segment reporting. Then I have a follow-up please.

Cathie Lesjak

Sure. Toni, thanks for the question, so I think what's important to understand is that a number of these items are what I would consider normal operating transactions for the business.

Now, what's different in this quarter and the reason why we are calling them out is that they are larger than they typically are in the quarter, so we think it's important to provide that kind of color and what it is that we have got sales of IP that the vast majority of those sales do show up in the corporate investments segment but there is a small piece that shows up in ESG as well. And then we have got gains on sales of real estate, partially offset by increased litigation expenses as well as some other smaller items.

Meg Whitman

So Toni, the litigation expense was not a good thing. It was a negative.

Cathie Lesjak

That's right. It offset the gain from the sale of IP and real estate.

Toni Sacconaghi - Sanford Bernstein

And were those occurring? Are those also being captured in the corporate investments line or they are somewhere else in the reported segments?

Cathie Lesjak

Right. So the increase in litigation expenses shows up in the corporate other or corporate investments segment to a large extent but there is a small piece that is also showing up in the enterprise services group.

Toni Sacconaghi - Sanford Bernstein

And real estate gain?

Cathie Lesjak

Real estate gain shows up in the corporate investment or corporate other segment as well.

Toni Sacconaghi - Sanford Bernstein

Okay. Thank you. And then if I could just follow-up on the services side. You talked about some, it was largely in line with your expectations for Q1 but you expected the drive Are you still confident in your full year outlook of 3.5% to 4.5% operating margin for that business and 4% to 6% decline in revenues for that business for this year? Or were you recalibrating it in light of weak signings and other issues?

Cathie Lesjak

So we are not recalibrating. We still expect 3.5% to 4.5% from an operating margin perspective and the 45 to 6% decline in revenue.

Toni Sacconaghi - Sanford Bernstein

Thank you. Great.

Rob Binns

Thanks, Toni. Next question, please.

Operator

Jim Suva with Citi. Please go ahead.

Jim Suva - Citi

Great. Thank you and congratulations to the team of HP. You have done a lot of work and it's really showing which is fabulous. Of course, there's always areas for improvement and one area for improvement is, I think, the operating margins or profitability within the services segment. Can you talk a little bit about that? Year-over-year, you definitely have some trailing off of revenues which we understand, but given all the restructuring HP has been doing, it was kind of a bit surprising to see the year-over-year operating margins in that segment actually decline year-over-year. We understand the seasonal nature but the year-over-year decline and it sounds like you are sticking to your goals. Is it just truly you are investing a lot more and at some point you foresee turning the corner to positive sales growth in that area and would that be this year? Or help us understand how to bridge the gap of the restructuring with the year-over-year operating profit decline? Thank you.

Meg Whitman

So here at the beginning, as I said, a multiyear turnaround in our enterprise services business and this has unlike our PC business or even our industry standard service business, this has nothing to do with the transactional business. These are long-term contracts. So it takes a little bit longer to turn the ship around. We have got work to do on labor, not only the number of delivery centers or labor pyramid, and we have more work to do in terms of our labor force in Europe. And that is well underway.

We also are doing a lot of investments in our systems and technology. This business really didn't have the visibility and the instrumentation that we needed to run a very labor-intensive business. We have made those investments and they are starting to bear fruit and I think you will see those bear fruit through the rest of the year. And then ultimately we have to turn the revenue corner here. We had, as we said, a couple years now, key account runoff and we have got to turn the revenue trajectory and we restructured our sales organization. We have got seven new practice areas that are designed to meet the needs of, very specifically, customers what they want from our services business. So over the long-term, we are optimistic. This is playing out in 2014 almost exactly I think the way Cathie and I thought it would.

You want to add anything to that?

Cathie Lesjak

Maybe I can provide just a little bit more specifics on the decline year-over-year in the operating margins. What we saw was progress on productivity initiatives as well as improvement in some of our underperforming accounts on a year-over-year basis. Now this was offset by the fact that this key account runoff is higher-margin runoff. We continue to have by contractual price concessions that we have to make on certain contracts and then we did increase our investment in some of our OpEx items.

Jim Suva - Citi

Thank you and congratulations again, to the great team at HP.

Meg Whitman

Thanks.

Rob Binns

Thanks a lot, Jim. Can we have the next question please?

Operator

We have Keith Bachman with Bank of Montreal. Please go ahead.

Keith Bachman - Bank of Montreal

Hi, guys. I wanted to ask about enterprise group and PCs. On enterprise group, revenues were up 1% and ISS actually had another good quarter. And the question is, Meg or Cathie, as you look at 2014, is a positive revenue number sustainable for this division and the corollary question is on the PC side you mentioned you feel better about corporate and what's your confidence level on that in terms of sustainability, because it sounds like there is some pool in for XP, but just when you talk about your you feel like corporate buying is better, is that sustainable through the year or does that follow off as Microsoft goes through its transition? Thank you.

Meg Whitman

Let me take a crack at that. It's Meg. Then I will get Cathy to weigh in. On Enterprise Group side, we do think revenue growth is possible through the remainder of the year. We saw good traction in ISS, and so we still have BCS drag on the portfolio and that's going to continue for the foreseeable future.

We are optimistic about storage, particularly 3PAR and networking got off to a good start, so we have got to continue to execute. We have got to get our sales motion exactly right and we have to get our innovation into the market and sold in a way that customers can understand and appreciate, so I think I feel good about Enterprise Group.

PSG, I think what most people will be surprised about in this earnings call is how well PSG did, and I do a shout out to Dion Weisler and his team as they continue to execute. Our multi-OS, multi-architecture multi-form factor strategy is working well. Market segmentation and leveraging our strength in commercial and go-to-market capabilities is working well and there was a bit of a tailwind on the migration from XP to Windows, but I wouldn't say that was an overwhelming factor. It was important, but not overwhelming.

I do think there's also some net momentum in the long overdue PC refresh, and what I think commercial customers are understanding from their employees is well employees may want a tablet. They actually also need more traditional compute devices to do their real work in the everyday environment in their company, so that is helpful.

Keith Bachman - Bank of Montreal

So, Meg, could this be a positive number for the year too as you think the PSG?

Meg Whitman

Hard to call it. This has been over the last year a pretty volatile market. My experience over many years in business is you always underestimate on the way down, or you underestimate on the way down about how bad it's going to be and then you on the way up, sometimes it's better than you think it's going to be, but I think it's too early to call. I think we should be relatively cautious here given the volatile nature of the business.

Keith Bachman - Bank of Montreal

Okay. Thank you.

Meg Whitman

What's really important with respect to the PC business is that we have got a focus on profitable growth and if that means that there is less top line growth, that's okay, because we are focused on profitable growth.

Keith Bachman - Bank of Montreal

Great. Okay. Thanks, guys.

Rob Binns

Thanks, Keith. Next question please?

Operator

We have Mark Moskowitz with JP Morgan. Please go ahead.

Mark Moskowitz - JP Morgan

Yes. Thanks. Good afternoon. Two questions if I could, but with the storage business continuing to improve are you starting to see some cross-pollination or cross-selling as a result of the pull through network in other parts your business. Then the second question is more philosophically, with the continued improvement in the balance sheet, business model small cash flow has really changed here in terms of organic versus inorganic investments. Could you start to maybe look outside and make some acquisitions, maybe bolt-on acquisitions first before you get a little more courageous?

Meg Whitman

Okay. Let me start with storage. Listen, we are making a big push towards converged infrastructure. We rolled out new converged infrastructure offerings, which we call Sharks at Discover in Barcelona. It's a perfect channel product, easy to sell, very specifically focused on certain workloads, so we are bullish on storage and we think that as we embed storage into converged infrastructure that there is some pull through. At least that's the bet we are making.

With regard to acquisitions, we stand by where we were at our Security Analyst Meeting last October that we will return at least 50% of our free cash flow to shareholders in terms of repurchase of shares and dividends, but I do think we will be now considering acquisitions.

As this market changes very dramatically, you can see that we may need acquisitions in security, Big Data, mobility and cloud. We will be very judicious. It will be returns based, and I would say it would be small to medium-sized acquisitions, so that's where we are headed, but the capital allocation strategy that we laid out at SAM, exactly the same.

Rob Binns

Great. Thanks for the question, Mark. Next one, please.

Operator

Benjamin Reitzes with Barclays. Please go ahead.

Benjamin Reitzes - Barclays

Thanks a lot. Can you talk about services just a little more, the 1% operating margin then you got to get that 3.5% to 4.5% for the year. So how do you get there? It sounds like you kept all your targets. So how do we improve this as we go throughout each quarter and what are you working on specifically to get there? Thanks.

Meg Whitman

So, Ben, one of the things, if you go back to some of the commentary in the first half of last year, you will recall that we talked about the delayed key account runoff but you might also recall that we talked about the fact that we were selling more project-based business into those accounts to help them make the transitions that they were focused on and that increased profitability and revenue but increased profitability in the first half of the year. So we are now working through that because now the account runoff is in fact coming through and the project upsell is now happening in those accounts. So we expected that the first half of the year would always be under more pressure and that we would see more of an uptick, we will see an uptick quarter-to-quarter but more mf an uptick in the second half versus the first half. We are also making this pivot or making investments into our sales force to move from less reactive renewal base to more proactive sales and that starts to have a bit more of a help in the second half of the year.

Benjamin Reitzes - Barclays

Okay, and obviously more leverage from the restructuring, I assume?

Meg Whitman

Absolutely. We are continuing to restructure as well and actually at the total company level, we had another roughly 3,700 employees that left under the program. So now we are at running program today that's at 28,300.

Benjamin Reitzes - Barclays

Okay. Thanks a lot.

Rob Binns

Thanks, Ben. Next question, please.

Operator

Aaron Rakers with Stifel. Please go ahead.

Aaron Rakers - Stifel

Thanks for taking the question. I want to go back and build on the Keith's questions with regard to the enterprise group, understanding the revenue growth and possibly the expectation that that can be sustained throughout this year. How are we thinking about particularly the hardware operating margin trend? It looks like, given your commentary with technology services operating margin improving, it looks like we still see a bit of a deceleration in the traditional hardware operating margin. So is that really product cycle driven? I think last quarter you also had implemented some go-to-market strategy. So any update there would be helpful? Thank you.

Meg Whitman

Well, let me weigh in and then I will let Cathie chime in as well. Listen, hat we are turning the enterprise group around and you can see it in the revenues and the success in ISS revenues as well as networking and storage. We still got more work to do on the margins, and the margin, Aaron, can't improve in two ways. One is within the product line because we decide what deals we are going to go after and with what product. We manage our cost structure aggressively. But there's also a mix thing going on here as well because every time we sell storage and networking that is margin accretive to HP versus our classic ISS business. So those are the two levers that we have to pull. And I think we have not demonstrated yet our best efforts in doing this. These things take a while to turn but we are on it. We have got the right people on it and I think you will see margin improvement over the course of the year if the market holds up and we can continue to execute.

Cathie Lesjak

I would add maybe a couple of points. First, its not just storage and networking, although that is a big piece of the mix. It is also our new products. Our new products have better margins as well. And then just as you think about kind of profitability of EG for the year and you go back to what we said at the Security Analyst Meeting where we said that EG's contribution to the year-over-year improvement in EPS at the company level would be anywhere from a $0.01 dilutive to a $0.02 accretive and this is before the basically $0.12 at that time that we are investing back into the business and now we are adding an additional $0.02. And so we still believe that that's what the result will be in EG.

Aaron Rakers - Stifel

Thank you.

Rob Binns

Great. Thanks, Aaron. Next up, please.

Operator

Brian Alexander with Raymond James. Please go ahead.

Brian Alexander - Raymond James

Hi, thanks. If I could go back to cash flow, Cathie, you mentioned that the cash conversion cycle should be moderately better than you expected. I think everyday improvement is a few hundred million dollars a quarter in cash flow. So is your operating cash flow target for the year rising by $1 billion to $2 billion or there are offsets to that? I think your specific number relative to your original goal was 9 to 9.5. So I was just hoping you could be a little more specific? Thanks.

Cathie Lesjak

So I didn't provide a very specific number because we don't typically update our cash flow guidance on a quarterly basis but you should read through that if the cash conversion cycle is moderately better than the low-20s, we are not seeing the same level of degradation in the cash conversion cycle in '14 as we originally expected that that would give us a bit of an uplifting the cash flow for the year.

Meg Whitman

I think if I heard you right, Brian, you said that the cash flow guidance have been 9 to 9.5. It's actually 6 to 6.5. That's free cash flow.

Brian Alexander - Raymond James

Exactly. Okay. Thanks for the clarification.

Cathie Lesjak

…but there should be a bit of upside to both of them.

Brian Alexander - Raymond James

Great.

Rob Binns

Thanks, Brian. Next question please.

Operator

Steve Milunovich with UBS. Please go ahead.

Steve Milunovich - UBS

Thank you. Obviously, your execution is much better, but Meg you talked about better repositioning of the company kind of relative to your competitors and I am just going to challenge a little bit on that IBM obviously getting out of server. You kind of alluded to that, out of that x86 servers, but that's because they see it is a very low margin business.

Your software exposure is still quite low relative to your competitors. You actually become somewhat more dependent on printing over the last 12 to 18 months, so I am not picking on the negatives, but could you talk about what you mean by improved repositioning from a competitive standpoint?

Meg Whitman

Yes. Sure. Two-and-a-half years ago, we embarked on some pretty significant changes to this company around the cost structure, around our pivot to the new style of IT around investments in innovation. We totally understood what was happening in this market two years ago and we began to take actions, and I think what you see is our competitors now having to take some of the same actions around cost reduction. You are starting to see some weakness in their results which we saw two-and-a-half years ago, so my point is that I think we have been hard at work on doing a lot of things that are going to position us as this industry continues to go through some very challenging changes.

I mean, that the pace of change and the magnitude change here is as great as I have seen them in my career and I think we are reasonably well positioned to take advantage of those changes.

We have businesses that are declining businesses, we understand where they are, we understand what we need to do with them. We have got businesses that are holding in terms of revenue and then we have got growth businesses and we have pivoted investment we pivoted people, we pivoted go-to-market to those growth areas of company. By the way, it started two years ago, so I guess would say we had a running start.

We never underestimate the competition, but I think because we were in such a tough situation going out years ago, we got a head start.

Steve Milunovich - UBS

That's fair. What are you hearing from your customers? Are they in fact making architectural decisions that are deferring some of their purchases right now or not?

Meg Whitman

I would say, I am hearing two things from our customers. One is, tremendous increase in confidence in HP. We look like the paragon of stability right now, which is very different than it was two years ago and they have a lot of confidence in where we are headed from a product roadmap perspective.

They are making decisions architectural decisions. We don't even holding off on that. There is movement around cloud. There is movement around which are they going to make a bet on HP's hybrid cloud or they are going to make a bet on someone else's cloud, so there is a battle going on for architectural control in the enterprise and we feel good about where we are in that.

It's early stages, there are still a lot of proof-of-concepts, there are still a lot of trying to decide what workloads people want to move to the cloud, what kind of cloud they want to move those workloads to, but I would say particularly within cloud and then Big Data, we have got a very compelling offerings. This hybrid cloud offering that we crafted well over a-year-and-half ago, it's the right answer.

I can tell you every single day customers say that is exactly what I want. Then in Big Data, the response to HAVEn is tremendous, because everyone's looking for a Big Data analytics platform that is based on the Hadoop, that can combine structured data plus unstructured data with enterprise grade security, with the ability for them to write apps, us to write apps and the ecosystem to write apps, and so the response to that is another really good thing in the marketplace, so it's a battle. It's a nice fight every single day out there, but we feel like we have got the right ammunition.

Steve Milunovich - UBS

Thank you.

Rob Binns

Thanks, Steve. Next question please.

Operator

Shannon Cross with Cross Research. Please go ahead.

Shannon Cross - Cross Research

Thank you very much. Can you talk a bit about what you are seeing in the Toner business, specifically you talked about, I guess, year-over-year declines in terms of revenue this quarter. How you think that plays out through the year and I think the channel inventory is up a little bit just any color you can give then I have a follow-up.

Meg Whitman

Sure. Thanks, Shannon, so what we are seeing on the toner side is definitely softness, and just to be clear on the ink side, we saw growth in ink supplies and it was really toner that took supplies down to 2.5% to that we saw as and also currency also contributed to that, but I would say toner softness was due to two big things. One is, we are seeing incrementally much more aggressive price competition from some of the Japanese competitors who of course have the benefit of the weaker Yen and then we are starting to see increasing competition from clones and remanufacturers as well.

Shannon Cross - Cross Research

Okay, great, and then --

Unidentified Company Representative

I am sorry. I was going to say, the other thing is, we have got to continue to place laser units with positive lifetime value and I think what we said the third consecutive quarter of incremental placements in laser. Our portfolio of multifunction color printers is actually now hitting its real stride. We just introduce many of them at the end of last year or even the beginning of this year. We are gaining share in a category that HP had been underrepresented but as we were underrepresented in that market share, it means we didn't have the toner trailing that market share. Now we have a product and so the units we are placing today pays dividends next year and the year after. So I think you should feel good about the share gains we are making.

And then lastly is the managed print services. This is where the benefit of management services is we get 100% of the aftermarket. So that's an important thing as well and what, four or five years ago, Cathie, we didn't really even have a business there and now that's a successful business for us and we are growing it.

Cathie Lesjak

Yes and the TCV in that business this quarter was up strong double-digit. So continuing to make good progress in management print services.

Shannon Cross - Cross Research

Okay great, and then if you can just talk a little bit about the server business? In specific, I am curious is what you are seeing in terms of the IBM sale? Any opportunity to gain share there and how you are looking at targeting some of that business?

Meg Whitman

Yes. So as everyone on the call knows, Lenovo announced they are buying IBM'S x86 server business from top to bottom and good news is that those create an opportunity for us because what I have learned about this business is instability and questions about the future make it very difficult because people want to bet on a roadmap and they are worried that as a change of ownership occurs, is the roadmap the same, is the investments the same, is the market to be the same, is the service going to be the same? So I think we had a near-term opportunity here to gain share in our enterprise services or in our server business. So we are all over it. We will over with our channel partners and I think there's a good near-term opportunity. In a long-term obviously, Lenovo is going to be a powerful competitor and we aim to be well set up by the time the deal is done to compete really aggressively.

Rob Binns

Great. Thanks a lot, Shannon. Next question please. We have time for one or two more.

Operator

Bill Shope from Goldman Sachs. Please go ahead.

Bill Shope - Goldman Sachs

Okay, great. Thanks. Can you give us a bit more color on the traction you are seeing with the new portfolio offerings for the technology services business? I guess over time as you think about when an increased detach rates here can fully counter some of the headwind (inaudible) you mentioned, given that's somewhat of a moving target.

Meg Whitman

Yes. I think there's a couple things going on here. First of all part of the decrease is that we have taken a grow only profitable revenue in technology services consulting. This was a business a couple years ago that was actually not very profitable or maybe even losing money. So part of the decline is a conscious decision to be in the consulting business only that makes money. But you are right. There was a very high attach rates to BCS and as BCS declines, you are going to see some natural degradation. I think the TS team deserves a huge amount of credit for product innovation that has mitigated that decline. Proactive data center care is the bookings, Cathie, correct me, triple digits. I mean, this is a very well received product in the marketplace. And then Flexible Capacity services which really capitalizes on the trend of Infrastructure as a Service. So what Flexible Capacity services is, is we can roll in a unit of compute into a customer's data center. They control it. It's on premise. And yet they can pay for it on a, if you will, as a service basis. There is a minimum that they have to consume. There's obviously a maximum of unit of compute can deliver but they have ability to flex up and down. And it turns out, that actually works for us economically because of Hp Financial Services. So we don't have a balance sheet problem that you might imagine on as a service infrastructure product. So we are excited about both of those. There's a big pipeline. This product, by the way, Flexible Capacity services was pioneered in Europe. We have got a big pipeline there. And proactive data center care is off to a really, really strong start. And so shout out to the team because they saw what was happening and they responded with product which is what HP has to do. We have to keep innovating because as some businesses start to fall away, we have to new businesses that can take their place with higher-margin.

Cathie Lesjak

I think it's also important in the TS business to understand that roughly half of the decline is as a result of currency. So then if you actually have modeled what decline in hardware over the last year would do to support, it would be materially more than what we are seeing and that's the result of all of these new product innovations that Meg was talking about.

Specifically, in terms of penetration rates, we are seeing growth in both, storage and networking penetration rates and that is going to help offset some of the pressure that we seeing from BCS declines.

Rob Binns

Great. Thanks for the question Bill. Time for one last one.

Operator

We have Maynard Um with Wells Fargo. Please go ahead.

Maynard Um - Wells Fargo

Thanks. Meg, so you have been in the CEO position now I think for three-and-a-half years. Presumably, you have a better feel for areas that are non-core, so I am wondering if we might see more divestitures coming this year. Then I was also hoping if you could just elaborate on the account runoffs, and in particular the navy contract, which was extended from June to September, so I am just wondering what the dynamics there are and if that helps this fiscal year in terms of the revenues and profits for the Services segment. Thanks.

Meg Whitman

Sure. Actually I have been here two-and-a-half years, still three-and-a-half. I have been here two-and-a-half, and obviously I have a much better feel of the product portfolio and capabilities of the organization. Now we are in a position of really looking at the portfolio within the portfolio, within the portfolio.

Right now, I don't see a major move of the big four businesses, but this is a vast portfolio and there are product lines and smaller businesses within these big operating divisions that could be candidates for divestiture. We haven't made a decisions, but we are now getting to the natural course of okay, do we have the optimize portfolio.

With regard to the navy contract, this was actually not really a key account runoff, because the navy contract was rebid and we won for 10 years, so we are excited about that contract. It was a lower margin contract as you might imagine, but we are in a very good position with the Navy, but there was profit pressure from a decreased profitability as we rebid that Navy contract, but it's not a runoff. It's another 10 years at slightly lower margins.

Rob Binns

Super. All right. Thanks very much and that that concludes the questions, and with that we will wrap up the call, so thank you everybody for participating and we will talk soon. Thanks very much.

Operator

Ladies and gentlemen, this concludes our call for today. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Hewlett-Packard's CEO Discusses F1Q 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts