Hewlett-Packard's Management Presents at Credit Suisse Technology Conference (Transcript)

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Hewlett-Packard Co. (HPQ) Credit Suisse Technology Conference December 3, 2013 7:00 PM ET

Executives

Cathie Lesjak - EVP and CFO

Analyst

Kulbinder Garcha - Credit Suisse

Kulbinder Garcha - Credit Suisse

Okay. We'll get started. My name is Kulbinder Garcha. I am the IT hardware analyst at Credit Suisse. We are very pleased to have from HP, for the last keynote of the day, Cathie Lesjak, who is the CFO. Before we start, please pay attention to the forward-looking statement that should be up on the screen shortly.

And Cathie, if I kick you up with some broad questions first of all, maybe one just in terms of how you would describe the environment and visibility, especially in the context of we see very mixed messages come out many of your peers, as we go into the back half of this year.

And then you can speak about either from a product perspective or from a geographic perspective about how would you describe the conversations you are having with your customers with respect to IT budget heading into next year and the visibility that you have.

Cathie Lesjak

Sure. So at our Security Analyst Meeting in October, we basically gave an outlook for the year and our expectations built into that outlook were that the macro environment would stay largely the same as what we've seen in Q4 and so specifically with respect to Q4, what do we see?

So from a U.S. perspective, we did see some improvement. And in HP, we weren’t largely impacted from a federal perspective. We have a fairly significant state and local business and we do think that maybe there is some opportunity there, especially with kind of healthcare reforms.

And in EMEA, EMEA continue to be soft, weak and although not weakening, it was more stable. So it's kind of bouncing along the bottom here at this lower level. And then in APJ, broadly APJ was soft, China was soft. Although for us, China is really a tale of two cities, because in our networking business we had very strong performance in China. I'm very pleased with the growth that we saw there and then basically the rest of HP, if I could kind of generalize, saw a tougher China environment.

And then, really as you look at consumer, very tough environment in consumer and we don't expect that this improves much, especially unless and until kind of macro GDP, global GDP or unemployment improves, we don't think there's going to be a lot of change on the consumer side and commercial is continuing to be soft across all of our major groups. So generally stabilizing a bit, but continued more of the same in '14.

Kulbinder Garcha - Credit Suisse

And as we look into next year and beyond, I think you've always made it clear for the last couple of years that the first two years of this turnaround or five-year turnaround would be challenging. I guess we are going to see another third year in which HP's revenues aren't growing next year.

If we're looking beyond the near term, which are the product segments that you would say we should pay attention to now that will drive as such that maybe in fiscal year '15 or beyond you actually start seeing positive revenue growth. Which are the two of three segments you think can do that?

Cathie Lesjak

Well, to start, I think it's a little bit early for us to be kind of [pronounced to be heading] on what revenue is going to do in '15. There's just so many moving parts and a lot of uncertainties. Certainly macro is part of that. And then also, frankly, the shift to the new style of IT is got some deflationary pressures on parts of our business and while at the same time are creating opportunities for growth in other parts of our business.

And what we were calling for fiscal '14 is the growth at the revenue line or the decline in revenue to moderate in '14. So to be a lower decline year-over-year than what we saw in '13 with pockets of growth and some of the pockets of growth that we kind of call those are kind of areas like storage.

Our 3PAR business is continuing to grow very nicely in Q4 and it grew, I think it's like 64%. Converged storage broadly grew 47%. And even within storage one of the things I think the really important metric is to look at 3PAR combined with XP, which is the high end that 3PAR is cannibalizing and EVA which is the mid range that 3PAR also addresses. If you add those up, I think we said on the call we grew better than market, we grew 6%.

Kulbinder Garcha - Credit Suisse

Right.

Cathie Lesjak

And so we really believe that we're continuing to take share in the mid and high end and that business is going to continue to accelerate. Networking is also an area where we think we'll see growth.

Within PC it's really going to be in tablets, it's going to be in hybrids, it's going to be in all-in-one. In IPG seeing really strong performance both on the operating profit, the channel position, but also in the unit placement. This is the second quarter in a row that we are able to grow units and we're going to continue to focus on that -- on those strategies into fiscal '14 and then sets up kind of '15.

Kulbinder Garcha - Credit Suisse

Right.

Cathie Lesjak

And we're making changes obviously in the enterprise services area as well that helps to stabilize the revenue line going into '15. So there are lots of pockets of areas where we can see some growth in '14 that will then help us grow into '15.

Kulbinder Garcha - Credit Suisse

And if we go through some of those areas in a bit more detail, if we go with storage, what's the revenue mix of the next generation storage today? Has it crossed over half of the business now and therefore…

Cathie Lesjak

It hasn't yet. So our view of kind of the new style of IT for storage is our converged storage solution and in Q4 that was about 43% of the revenue. And so, kind of looking out there, I would expect these lines will cross in the first half of the year. And once that happens, when you see converged storage growth of 47%, you can see how we're going to go from overall storage of growing 1% to a much deeper incline in terms of revenue growth.

Kulbinder Garcha - Credit Suisse

Okay. And then on the networking side, if I remember, a couple of years ago you had a good boon year, very strong performance in terms of revenues, and then it just seems to have tapered off. So what's -- you mentioned there is a potential for a reacceleration? Is product driven? Is that -- are you going after specific customers? Is it the FDN play -- will you talk about -- could you speak about what's going to [lead] revenue growth there?

Cathie Lesjak

So I think it's a combination of a lot of those moves, plus the market seems to be growing a bit faster?

Kulbinder Garcha - Credit Suisse

Right.

Cathie Lesjak

And at least some of the estimates that we’ve seen is that the market is starting to grow and more in the mid single-digit. So growing networking 3% year-over-year in Q4, but China driving a lot of that, but also seeing positive growth in APJ excluding China and EMEA. Americas is still a challenge for us and we are changing our strategy a bit there to really figure out how to basically go after the campus edge and then kind of work towards the data center. I think we’ll hopefully focus and kind of turn the trajectory in Americas for networking over time.

Kulbinder Garcha - Credit Suisse

And on the PC side, are you abreast for the secular decline in the PC market? And do you think you can gain share and then hopefully add value with the tablet offering, or is it that you actually see the market as ultimately stabilize after hopefully you have this contraction?

Cathie Lesjak

So, when we laid out our kind of expectation for what the total addressable market will do over '14, '15 and '16 in our Security Analyst Meeting it's basically a decline of about 4% CAGR. There are pockets of growth. The growth that we see in PCs is again tablets, hybrids all-in-one. From a geographic perspective, we really see it in emerging markets. And if you look at BRIC, the PC penetration in BRIC is about 30% versus the developed world, which is more of 80% and so there is upside opportunity from that perspective in BRIC.

And then the other areas of growth are really are going to be around services and accessories. And in fact, when you look at the PC market, if you focus just on devices, growth is challenged, profitability is even more challenged. And so, what’s really important is to basically build out a differentiated total kind of customer experience. And that means, services attached, whether its 24x7 smart front tech help, its different types of accessories that are important to enhance the experience around tablets and hybrids.

For SMB, it's SMB in a box. We basically have in partnership with Google, we have a complete solution across printers, PCs, servers, networking, storage delivered in a box to a small business, so they can basically get started right away.

Kulbinder Garcha - Credit Suisse

On the PC side, I guess two follow-ups to the outlook we are talking about. On the tablet side, how important is it to be present in tablets? The reason why I ask is a lot can be seen till Friday and found it's very unprofitable, very difficult is relatively let to enter that market or to focus on let’s say, the android vendor. So, what’s the -- given that could be natural profitable profit that HP or is it just you have tablet complete offering and the entire PSG business is profitable or is that how you see holistically?

Cathie Lesjak

So, I think when you look at tablets, you really have to look at consumer tablets separate from commercial tablets. And our focus is more heavily on commercial tablets and it's about tablets -- it’s about jackets that you add to the tablets, so that you can customize applications. You can add additional devices to the tablet experience in the commercial space.

And in that space, it's about -- it’s about inoperability with kind of existing applications like the windows platform. It’s about security. It’s about giving a tablet experience in more of a windows environment, one that CIOs feel secure with. On the consumer side, there are parts of the consumer market that we will play it. And we will look very carefully at the segmentation country by country as to where we’ll play and at what price point we’ll play.

And looking at consumer tablets in 49, 59, 79 range that you’re seeing really from Black Friday and this holiday season is really not much interest to us, because that's just a recipe for losing a lot of money. It’s not sticky business. It’s not going to help us further kind of our long-term value of proposition for PCs or tablets.

Kulbinder Garcha - Credit Suisse

And can you maybe update us on how you see the competitive environment in the more traditional PC market. Obviously, we had the whole way that Dell kind of behaved in the way into going private and then the other aspect that I’d like kind of your view on whereby it used to be the case you had an inborn market share by a fair margin just in volume terms, it's not quite the same margin, it tends to be more neck and neck or slightly ahead of where we are now today. Could you speak about -- did that change the economics? Have you seen any impact of that over the last couple of years and how does that impact the profitability outlook for that business?

Cathie Lesjak

So absolutely for a very competitive pricing environment. We've seen this -- actually if you think about -- and our personal assistance group in that business, it's been a very competitive and pricing environment for a very long time. I think it got a bit more aggressive in '13 as this is a large mature kind of industry that's shrinking and so that's put some incremental pressure in there, but at some level, we know how to compete.

We've got to figure out exactly where a few market segmentation -- where the market opportunities are for growth and for profitable growth because our focus is on profitable growth. At some point, we actually believe that if you can gain share and do it profitably, but you got to pick your spots and that's really what we are focused on.

Kulbinder Garcha - Credit Suisse

And then on the segment side and the printing side, the performance has been actually bad and I think most that was expected, has gone through the back half of the fiscal year and even for next year, as to the outlook assumed a fair amount of incremental profit in the printing business, can you speak about the drivers for that from a big hardware supply and the mix and how sustainable some of those endeavours are?

Cathie Lesjak

Sure, when you go back to the Security Analyst Meeting in which we laid out a waterfall around kind of what was going to drive EPS accretion over the course of the year and for IPG we said basically $0.07 to $0.11 before incremental investments that we've kind of kept off for the side of $0.12 that part of which will go into the IPG segment and really that is driven by the initiatives around driving print relevant, placing high value units, by high value units these are units that typically would use a lot of supply that you get a lot of HP connect to it, so it's Ink Advantage in emerging markets and this is basically a bias to basically capturing those that print more in emerging markets, by selling the hardware a little bit higher priced, the supply at a little bit lower price, so that strategy is working well.

We've got Ink Subscription that we are just starting to roll out in the U.S., which is for developed markets. Ink in the Office has been hugely beneficial to us. Our Officejet Pro X product is basically selling out very well. We've also got a complete new line-up of multifunction printers.

We were really strong in Q4 and indigo with a big web presence. So those are all initiatives to place the types of units that are going to drag a lot of your traffic supply and that is key to the strategy that we are driving for that business.

Over the course of '14, we continue to expect that we are going to be able to place additional units. We grew units in Q4, 6%. Year-over-year, we also grew units year-over-year in Q3. We expect to continue to do that in '14, and then over time what that does is that is going to pull though supply and that's been a -- that combined with a disciplined approach to cost is going to help us drive the incremental $0.07 to $0.11.

Kulbinder Garcha - Credit Suisse

So thinking beyond just the next year, this change of how you are placing units, should that mean that you can drive margin to the overall IPG segment beyond what we are seeing before because it seemed to have normally peaked out $0.17 plus or minus I think. Should there be -- just given this change in the business, why wouldn’t you have to be able to exceed that over time, will that offset from the negative time, which you think about?

Cathie Lesjak

What you are going to think about the fact that we are going to continue to place units.

Kulbinder Garcha - Credit Suisse

Right.

Cathie Lesjak

Now, not all units are placed in an investment mode...

Kulbinder Garcha - Credit Suisse

Right.

Cathie Lesjak

...but some are done at fairly low margins and so in '14 as you see us continue to price units, that kind of keeps the cap of the operating profit and I would say the best way to think about operating profit in '14 is kind of at the levels that we've been seeing.

Kulbinder Garcha - Credit Suisse

Right. Okay. And if we move on to restructuring, obviously for the last couple of years has been a major restructuring program and you targeted I think initially $3 billion to $3.5 billion of savings and then you constantly going to be in the upper end of that range, can you just remind us where you are in that process and specifically how much of those initial savings have let's say impacted your P&L? How much are we yet to come through.

Cathie Lesjak

Sure, so we announced a restructuring program in 2012 and at that time, we basically said that we get through it by the end of '14 and that we would have roughly 29,000 folks leave under the program. We had then opted to give a range of 29,000 plus or minus 15, because it was a little bit difficult to manage it in such a tight range and now at the Security Analyst Meeting, we announced that we would go to the upper end of that, so more in that 33,000 to 34,000.

At the end of fiscal '13, roughly 24,600 folks had left underneath the program, so just under 13,000 in fiscal '13. We expect to complete the program by the end of '14 and so we have roughly 11,000 -- 10,000 to 11,000 more folks. And at the same time we're continuing to look for new opportunities.

But before we kind of identify new opportunities and put a quantification, which will take us some time, probably another quarter or so, the incremental savings in 2014 over 2013 is $1.1 billion. In 2013 we did just over $2 billion. On a full run rate basis, now after we get through the program about $3.5 billion to $4 billion worth of savings.

From a kind of GAAP charge, we're not completely through it, but largely we've accrued a lot of that already and now the cash flow. So in fiscal '13, we had about $900 million in cash outflows under this program. In fiscal '14, we expect about $1.4 billion.

Kulbinder Garcha - Credit Suisse

That's very helpful on the cash flow side. Is the -- what's been the experience or the strategy, or the thoughts with respect to reinvestment? I think initially when it was outlined you made it very clear how to reinvest the significant majority and now you moved the program and you found that there is more efficiency even beyond than you could target. What rule of thumb should investors think about if by the end of '14 you've -- this number is being $4 billion what would have been retained by HP versus what needs to be reinvested just for long-term revenues and product innovation?

Cathie Lesjak

So I would hope the incremental savings in fiscal '14 is $1.1 billion. We're setting aside basically $0.12 of EPS for incremental investment and that incremental investment shows up in R&D. It shows up a little bit in field selling cost as particularly within EG and then it also shows up more broadly across SG&A in the form of investments that we're making with business -- in business process reengineering, systems and tools that ultimately drive a more efficient Hewlett-Packard.

And in the R&D space you'll see an increase year-over-year at the total company level of R&D as we said what we expect and then at many of the major segments. They are in things like accelerating the commercialization of Moonshot, really driving our converged cloud; it's about Ink in the Office. It's kind of gotten a broad platform of R&D investments that we want to make in order to set HP up for the long term.

Kulbinder Garcha - Credit Suisse

And so, with respect to -- with respect to when this program is completed the hope is that you get to end of '14 the major restructuring, may be around the edges cost cutting you want to do year-to-year, but this isn’t going to become a story whereby there'll be charges at the gut level or restructuring cash cost in the business you don't think or how should we think about the longer term impact of the need to pursue efficiency in the company.

Cathie Lesjak

So, I get this question a lot and basically people say are you going to be a serial restructurer, is that the story? And it's not the story. We want to continue to execute on the programs in '14. Frankly, I would like us to do as much as we possibly can in '14, but as we come to the end of '14, we as a organization and a business have to get much more focused on operational excellence and that operational excellence is not restructuring charges.

Operational excellence is frankly fine-tuning every day, every week, every quarter on what you need to do from a headcount perspective. So it's not saying that there won't be people let go, it's saying that they need to be done in smaller quantities on an ongoing basis and what we call workforce rebalancing. And that has to be part of the P&L of the segment. So it's converts from being a GAAP-only charge to being embedded in the day-to-day operations of our non-GAAP segment.

Kulbinder Garcha - Credit Suisse

Okay. So also beyond the end of next year this is going to be just -- whatever operational efficiency you find will be just within your ongoing vision...

Cathie Lesjak

And it needs to be funded by the P&L of the segment.

Kulbinder Garcha - Credit Suisse

Okay.

Cathie Lesjak

And then I think that in certain businesses, especially in the services space, you have to manage your headcount very carefully and there is probably going to be opportunities. There's going to be times when you are going to have to make adjustments, but that has to be in this part of the business model, and therefore it has to be covered within your business model.

What we're doing right now is we're catching up. We're not fine-tuning, we're catching up and once we get caught up, then we have to stay on top of it. It has to be part of our DNA. We have to make that pivot to operational excellence.

Kulbinder Garcha - Credit Suisse

Okay. That makes sense. And with respect to free cash flow, I think it was a very good year for free cash flow especially versus initial expectations. In '13, '14 guidance were declined, part of that dealt between [environment]. I guess Op income or net income is clearly just the restructuring charge picking up year-over-year. Can you speak about the working capital movements and is there chance that on the working capital headwind that you’re going to face this year? Is it conservatively built into that? If there is excess cash that's generated, how will HP deploy, how should we think about as we go through '14?

Cathie Lesjak

Sure. There are lot of questions there. So let’s start with the cash conversion cycle.

Kulbinder Garcha - Credit Suisse

Yes.

Cathie Lesjak

So, one of the very positive results that we got in fiscal ’13, which we drove very hard on the cash conversion cycle, and we’re able to actually end at a much better spot than what we had anticipated, even as much as at the beginning of the fourth quarter. So our cash conversion cycle ended Q4 at about 17 days. And that was better than what we view as the long-term sustainable level. So long-term sustainable is in the low 20s and I think I’d say, 20 to 21 days.

And analytically if you kind of peel back all of the one timers and the different things that went on in the cash conversion cycle in Q4, you naturally get to that range, okay. Now, I think that that is long term sustainable, that’s not aspirational and I don’t think that we’re paid to just deliver what analytically would pop out of an equation, but we’re paid to basically drive a better result.

So, we are focused on trying to improve that. It will take us some time. If there is real opportunity in the short term, it’s probably in the payable space, but we’ll see as we go through. In terms of the other part of your question, what are we going to do with the cash.

Kulbinder Garcha - Credit Suisse

Right.

Cathie Lesjak

What we laid out at the Security Analyst Meeting is that we thought free cash flow would be $6 billion to $6.5 billion. And that at least half of that would be return to shareholders in the forms of share repurchases and dividends. And we’re still committed to doing that. And then the remainder would go to kind of paying down debt, M&A kind of whatever.

We’ve actually got a few degrees of freedom there and our flexibility from my perspective because we ended with an operating company net cash position that was better than what we’d expected. We expect it to still be in the net debt position. And so that gives us a little bit more room to -- at the margin to around whether we do a little bit more share repurchase, a little bit more M&A or some combination.

But the key though for any decision around share repurchase or M&A is that it’s going to be based on return. And we stack up the different alternatives relative to one another to determine what is kind of in the best interest of driving shareholder value in the short term and in the long term.

Kulbinder Garcha - Credit Suisse

On the topic of M&A Cathie I guess there’s been some not so good M&A in the past. There was some disappointing M&A. On the other hand, you need to innovate. You can’t do all it all organically. And what’s the strategy for just the size of deals that HP would consider now. Because it seems that you want to retain cash to shareholders. You put that almost constrained around what you’re going to do in the next year at least.

On the other hand, there’s lot of innovation in this market. There’s a lot of things you could buy in the cloud side that would stick with your portfolio it feels like. So, how should we think about how you will use M&A, your approach to a big deal as completely off the table, anything like a [build of said] number of billion dollars or how should we think about the approach now?

Cathie Lesjak

The constraint that we’re putting on it is not -- if its X billion dollars, we’re not interested. But overall there is a constraint because we talked about what we’re going to do with our capital that we are -- or the free cash flow that we’re going to generate in fiscal ’14. And so, just doing the math, if you spend at least half of the $6 billion to $6.5 billion on returning cash to shareholders, the remainder, the maximum would be kind of the other half.

Kulbinder Garcha - Credit Suisse

Right.

Cathie Lesjak

So you’re kind of in the three, three and a quarter range. And that again on a returns basis it doesn’t say, we're going to actually spend that much in M&A. But it is the opportunity set against which we’ll look at other share repurchase and other investments.

In terms of kind of how we think about M&A, first of all, we think that we’ve got a great set of assets, the assets that we have either generated organically or accumulated inorganically over a time have really been targeted at the four-key focus areas for us; mobility, big data, cloud and security. So those are the key areas of the highest level of where we want to kind of invest and so, any acquisitions that you see would kind of fit into those sweet spots.

In terms of size, we haven't gone out with a specific number. I haven't -- we haven't put any constraints inside, but I think the way I think about it is that there will be kind of smallish to mid-size. So smallish is maybe some hundreds of millions of dollars; mid size is at some level everybody in this room probably has a different idea of what mid size is. The overall cap for the year given kind of how we're going to allocate capital gives you a sense for the max that we would do in the course of the year.

Kulbinder Garcha - Credit Suisse

Maybe one more question for me and then I'll open it to the audience if there are any. Can you speak about how HP is impacted by the transitions to the cloud? On the one hand as infrastructure moves of primary [starts in theory] should be a negative [move] and we've had some announcements at the recent deal with Salesforce.com. You're also trying to build out your own cloud offering it sounds like as well. Can you give us an update on how you feel HP is impacted by it and what the strategies are you have to counter?

Cathie Lesjak

Right. The cloud opportunity is an opportunity for us. It's an opportunity that creates new profit pools for HP to participate that we haven't had access to in the past. That doesn’t mean that there isn't also a deflationary impact on some of our more legacy hardware businesses. But overall, our view is cloud, the shift to conversion and the offerings that we've got in that space will over time kind of outgrow the flat to declining pressure that we see on some of the hardware businesses.

And we think that we're in a unique position compared to a lot of our competition that has a more narrow focus because we've got offerings that enable us to expand hardware, software and services, and frankly take customers on the journey to the cloud.

One of the questions or the comments that we get a lot from CIOs is; I know I need to get to the cloud. I just don't know how to start. Can you help tell me what the Blueprint is? Can you take me on that journey? And that is less about season, much more about selling business outcomes and solutions. And that's really, from our perspective, that's a lot about what cloud is and the opportunity that's created for us.

There's also kind of two vectors to cloud. There's build cloud and then there is consumed cloud. And both of those are disruptive opportunities for us. So for us Superpod is just an example of exactly kind of the opportunity that can get created. The sales force Superpod really addresses an issue that many enterprises have with Salesforce.com. They love the cloud, the apps in the cloud, but they don't want -- they don't want their data commingled in a datacenter.

So what they want? They would love to have a [debt]. The same Salesforce.com application in a dedicated datacenter with the security that they want, with the service level they want on HP's converged infrastructure with our security products. And that’s what this Superpod, the Salesforce Superpod really enables. And again, it's an opportunity that without a drive to cloud would not have been available to us.

Kulbinder Garcha - Credit Suisse

Are there any questions from the audience?

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