Hewlett-Packard Company (HPQ) F4Q 2013 Results Earnings Call November 26, 2013 5:00 PM ET
Rob Binns - Vice President, Investor Relations
Meg Whitman - Chief Executive Officer
Cathie Lesjak - Chief Financial Officer
Katie Huberty - Morgan Stanley
Ben Reitzes - Barclays
Mark Moskowitz – JPMorgan
Toni Sacconaghi - Sanford Bernstein
Jim Suva - Citi
Steven Milunovich - UBS
Bill Shope - Goldman Sachs
Kulbinder Garcha - Credit Suisse
Amit Daryanani - RBC Capital Markets
Shannon Cross - Cross Research
Maynard Um - Wells Fargo
Brian Alexander - Raymond James
Good day, ladies and gentlemen. And welcome to the Fourth Quarter 2013 Hewlett-Packard Earnings Conference Call. My name is John, and I’ll 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.
Good afternoon. Welcome to our fourth quarter 2013 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, margin, 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 report including its most recent Form 10-Q. HP assumes no obligation and does not intend 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 FY’13 Form 10-K.
Revenue, earnings, operating margins, 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 intangible assets, 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 earnings release both of which are available on the HP Investor Relations webpage at www.hp.com.
I’ll now turn the call over to Meg.
Thank you, Rob, and thanks to all of you for joining us today. With the final quarter of our fix and rebuild year now behind us, I am pleased with our progress in fiscal 2013. As we said, when we laid out our five-year plan, we expected that our turnaround would not be linear and we saw that during the year.
However, as I reflect on the key priorities we outlined at the beginning of 2013, driving innovation across HP, improving operations, aligning our cost structure and rebuilding our balance sheet, we made great progress. We also saw some positive momentum in our execution leading to pockets of revenue growth in key areas in Q4.
The fourth quarter caped the year of significant innovation at HP. We launched OneView, a revolutionary consumer inspired infrastructure management platform that allows customers to dramatically improve data center operations while reducing costs. We introduced the new store virtual storage appliance, bundled with our industry leading ProLiant servers, underscoring our leadership in the software defined storage market. We also launched Version 7 of the HP Vertica Analytics Platform, which dramatically simplifies analysis of semi-structured data. And just last week, we announced the partnership with Salesforce.com to create the HP Salesforce Superpod, a dedicated instance of Salesforce running exclusively on HP’s converged infrastructure.
In addition to the product innovation happening across HP, we are driving significant business model innovation as well. In printing, we are seeing success with our Ink Advantage program and our newly launched Instant Ink offering. In software defined networking, we launched the new app store that coupled with our network developer will create the industry's first enterprise class open ecosystem.
As you all know, in fiscal 2013 we focused on improving our operations, driving better cash flow and rebuilding our balance sheet. These foundational improvements were critical early steps in our turnaround and I am extremely proud of the results we delivered in this area.
In Q4, we brought our cash conversion cycle down to 17 days and delivered free cash flow of $2 billion. For the full year, we delivered more than $9 billion of free cash flow, well above our most recent outlook of about $8 billion. We reduced operating company net debt by more than $1 billion for the seventh consecutive quarter and as a result, we achieved our operating company net debt goal ahead of plan.
We also ramped back up our share repurchase activity in the fourth quarter and returned a combined $763 million to shareholders in the form of share repurchases and dividends. More importantly, we once again achieved the non-GAAP diluted earnings per share we said we would, delivering $1.01 in the fourth quarter and $3.56 for fiscal 2013 at the high-end of our most recently provided outlook. Looking forward, we will stay committed to smart capital allocation and profitable growth.
As we said at our Securities Analyst Meeting last month, we believe we can grow both margin and share over the longer term. We will continue to be aggressive and targeted cases but we have more opportunity to improve our profitability.
Now let me turn to our business group performance in the quarter. Overall, results in Q4 were driven by strong performance in printing, revenue growth in the enterprise group, improved revenue performance in personal systems, plus continued execution in software and enterprise services.
Our printing business delivered an excellent quarter with continued strong profitability. We outperformed the market for the second successive quarter, getting 4 points of total unit market share over the prior year. Revenue for the quarter was down 1% but we saw a growth of 1% in constant currency. For the second consecutive quarter, we grew unit placement, which was up 6% over the prior year, driven by strength in laser volume and our SMB home business.
Our managed print services business also had a good quarter with double-digit PCT growth driven by our partner program. In personal systems, we outperformed the market with particular strength in our commercial PC business. Revenue for the quarter was down 2% over the prior year but flat in constant currency against the backdrop of a market declining 9.5% in units in the third calendar quarter. Overall, we gained 1.8 points share over the prior year and 1.2 points sequentially. As a result, we improved our share position in all three regions. In the fourth fiscal quarter, HP saw its first unit growth since the first calendar quarter of 2012 even as the market saw a continued decline in units.
Our commercial PC business grew revenue 4% over the prior year, driven by commercial notebooks with our EliteBook Folio doing particularly well. The personal systems team did a good job managing the DRAM challenges in the quarter, but we expect upward cost pressure will create a headwind in the first quarter of fiscal 2014. We continue to manage the end-to-end cost structure of our personal systems business with profitability very much in mind.
In enterprise services, the business is now more predictable and we continue to execute well against our recovery plan. ES revenue was down 9% for the quarter and down 8% for the full year, well within our previously provided outlook range. Operating margin in the fourth quarter was 4.4%, resulting in operating margin of 2.9% for fiscal 2013 at the high-end of the target range for the year.
In Q4, bookings were up over 30% over the prior year, driven by strong renewals. At the end of fiscal 2013, trailing 12-month book-to-bill was approximately one in line with our guidance at last year’s Securities Analyst Meeting.
Looking for fiscal 2014, we are focused on the sales force retooling program that we outlined at our Securities Analyst Meeting. We will continue our relentless attention to cost and productivity as of the delayed revenue runoff puts further pressure on our fiscal 2014 services revenue.
In the Enterprise Group, we saw revenue growth of 2%, the first time we have grown revenue in eight quarters. We saw improved sales execution, a strong Hyperscale quarter and stabilization in blades, complemented by revenue growth in networking and storage.
Overall margins were pressured by competitive price environment and an unfavorable mix. Looking forward we are focused on improving our channel performance, driving cost savings to improve operating margins and bringing new innovations to market in converged infrastructure.
As we discussed last quarter, we made significant leadership changes in the enterprise group. Bill Veghte and his leadership team have hit the ground running and the early signs are encouraging. In addition, last week we announced that Martin Fink will assume responsibility for leading the HP Cloud business as its General Manager. This is in addition to his role as HP CTO and Director of HP Labs.
Martin is a true technology visionary who brings tremendous understanding of the enterprise hardware and software phase, extensive experience in platform development and he literally wrote the book on open source. We believe Martin will help significantly accelerate our cloud business.
In servers, we saw very strong growth in Hyperscale over the prior year driven by several key wins although this did put pressure on our margins in the quarter. Our blade business were covered as the benefits of our targeted segmentation, an efforts to improve operational excellence paid off.
We expect to again over a point of share here and extend the market leadership position we have already held for 27 quarters. We saw improved sales in our mainstream server business but we need to improve our pricing discipline and profitability.
Although revenue continued to decline in Business Critical Systems, we expect to hold or gain share in calendar Q3. And we have announced the plans to bring 100% fault-tolerant HP NonStop platform to the x86 architecture.
In storage, I'm very pleased with our progress. Total storage product revenue grew 1% year-over-year with good sequential growth. We saw another record [three par] quarter and are very encouraged by the strong customer acceptance we’re seeing.
As a result, converged storage product revenue grew 47% over the prior year. Revenue declines moderated in traditional storage driven by higher storage networking attach and sales of our recently refreshed entry products. With these results, we expect once again gain share in the combined high-end and mid-range markets.
In HP networking, we saw 3% growth driven by strong performance in China as well as growth in EMEA. We are also encouraged by our growth momentum in wireless LAN and we will continue to focus on driving innovation in software defined networking.
In technology services, revenue was down driven by lower hardware sales in prior quarters, particularly in DCF. However I'm encouraged by the positive traction in new portfolio offerings like flexible capacity services and proactive care. New services that give customers cost effective flexibility in their data center while ensuring they can manage spikes in demand.
In software, disciplined cost management resulted in operating profit of 30.8% for the quarter. Revenue decreased 9% over the prior year although we had a tough compare due to a large General Motors deal last year. However, the software, team did grow in a number of areas, including good growth in cloud and automation and SaaS bookings, double-digit growth in security after normalizing for the impact of the General Motors deal. And in autonomy, we continue to make progress and saw the second successive quarter of sequential license revenue growth.
Now let me turn to our future outlook. Overall I'm 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. As we enter the third year of our turnaround, we will continue to execute against the improvement areas we outlined at our Securities Analyst Meeting last month, including increasing our commitment to research and development.
This is what broadly falls into three buckets. The first is a shipping market forces. As an example in personal systems, we are making progress on our mobility strategy but we still have not broken through. Similarly, we are still in the early stages of building an ecosystem to capture a greater share of personal device accessories and services.
Second is the change in competitive landscape. We need to keep the customer at the center of what we do and deliver comprehensive and innovative solutions as our competitors look to expand across the IT stack.
And finally, the third bucket is our own ability to execute. At our security analyst meeting, we highlighted a number of areas where we need to execute better. For example, we need to do more work to fix our go-to-market strategy in enterprise group, particularly in channel engagement and pricing.
On cost management, we are optimizing our service delivery and enterprise services and as we reinvigorate our core software business, we must ensure we have the right back-office systems and operational excellence to support this effort. As a result of both the challenges and the progress we’re making, we expect first-quarter non-GAAP earnings-per-share will be $0.82 to $0.86 and our full-year outlook is $3.55 to $3.75.
Now let me turn it over to Cathie for a closer look at our performance in the quarter. Cathie?
Thanks, Meg. Good afternoon. In the fourth quarter fiscal 2013, we generated revenue of $29.1 billion, down 3% year-over-year and down only 1% in constant currency. Total FY’13 revenue was $112.3 billion, down 7% year-over-year or down 5% in constant currency.
We saw a year-over-year revenue growth this quarter in industry standard servers, networking, storage and constant currency revenue growth in printing. Personal systems performance was better than expected and sales outpaced the market. Enterprise services were broadly in line and software had a tough year-over-year compare but continued to drive growth in key areas while expanding operating profit.
On a regional basis, Americas fourth quarter revenue was $13.3 billion, down 2% year-over-year or down 1% in constant currency. U.S. revenue was down slightly with declines also in Brazil and Canada and Americas full year revenue declined 6%.
EMEA fourth-quarter revenue of $10.3 billion was down 4% year-over-year, or down 5% in constant currency. The Q4 EMEA environment remained tough, although sales declined less year over year than in Q3 and we saw growth in Germany and other pockets of Western Europe. Full year EMEA revenue declined 9%.
APJ fourth quarter revenue was $5.6 billion, down 1% year-over-year but up 4% in constant currency. In Q4, we saw strong growth in India, mostly due to our recent educational PC win in the state of Uttar Pradesh. This offset weaker China performance across many of our businesses, although networking continued to perform well in China. APJ full year revenue declined 5%.
Overall, we’re pleased with our fourth quarter results. Revenue declines moderated, demonstrating the quality and the competitiveness of our portfolio. At the same time, we recognize we have more work to do on continuing to align our cost structure to support profitable long-term growth.
Our Q4 gross margin was 23%, down 1.2 points year-over-year and down 0.4 point sequentially. The year-over-year decline was mostly driven by competitive pricing environment and an unfavorable mix across the enterprise group, particularly in ISS. Sequentially, the competitive dynamics in the enterprise group and personal systems were mostly offset by the seasonal uptick in the enterprise services and an improvement in printing. Our full-year gross margin was 23.1%, down 0.2 point year-over-year as the competitive pricing pressures in EG and personal systems were partially offset by margin improvement in printing.
Savings from our restructuring program in enterprise services and technology services were offset by revenue declines in those businesses. In the fourth quarter, we had non-GAAP operating expenses of $4.1 billion, down 1.4% year-over-year and up 0.2% sequentially. R&D is down due to streamlined operations across the enterprise group and lower R&D expenses specifically within DCS. Long term we remain focused on investing in innovation across the organization and in fact, we’ve added headcount in engineering in FY’13.
SG&A is up around 3.8% year-over-year, although that largely reflects the impact of our real estate gain in the prior year quarter. We also made investments to improve operational efficiency, which are already driving significantly shorter quote turnaround time and improved win rates.
Total non-GAAP operating expenses in fiscal 2013 were $16.1 billion, down 2.9% year-over-year. This reduction was mostly due to savings from our labor restructuring initiative and our ongoing efforts to better align costs with revenue. For the year, across cost of sales and OpEx we saw a labor savings of approximately $2 billion, slightly below the range we estimated for you at the beginning of the year. But total savings, including non-labor, were in line with expectations. We are continuing to look for further cost savings and while we are still in the early stages, we believe there maybe incremental opportunity.
Our fourth quarter non-GAAP operating profit was $2.6 billion, down 16% year-over-year but up sequentially 14%. We recorded a $103 million of expense on the other income and expense line, a decline from the prior year due in part to currency gains in the quarter.
With the 22% tax rate and a share count of 1.94 billion shares outstanding, we delivered fourth quarter non-GAAP diluted earnings per share of $1. Fourth quarter non-GAAP earnings excludes pre-tax charges of $371 million for restructuring and $317 million for amortization of intangible assets.
For the full year, non-GAAP diluted earnings per share was, $3.56, which is at the high end of the $3.40 to $3.50 outlook we provided at our Security Analyst Meeting in 2012. Full year non-GAAP earnings excludes pre-tax charges of $1.4 billion for amortization of intangible assets, a $1 billion for restructuring and $22 million of acquisition-related charges.
Turning to the business units, we are very pleased with the fourth quarter performance in Printing. The initiative we began executing to increase Printing relevance, drive high usage units and improved unit shares are paying off. Q4 revenue of $6 billion was down 1% year-over-year, but up 1% in constant currency, as hardware unit growth offset declines in supplies.
Total unit shipments grew 6% over last year and this was the second quarter in a row of year-over-year unit growth and as Meg said, we continue to gain share. We are seeing great results with Ink in the Office, which helped drive Q4 SMB hardware sales up double digits, and Ink Advantage had strong performance across all regions.
In the laser market in calendar Q3, HP grew at over twice the rate of the rest of the market and graphics revenue grew to a record level in Q4. Within graphics, Digital Press, which includes Indigo, saw double-digit growth.
Printing operating profit was $1.1 billion or 17.7% of revenue, up 0.2 points from the prior year period. Our favorable yen impact and operational improvements were mostly offset by lower supplies mix. Commercial hardware revenue grew 5% year-over-year, while units grew 9%, driven by strength in transactional laser, management services and graphics.
Consumer Hardware revenue grew 7%, while units grew 4% year-over-year in Q4. Officejet Pro X, a great example of our recent innovation is seeing strong customer traction.
Supplies revenue declined 4% from the prior year period and made up 63.9% of Printing revenue. Supplies declined only 0.5% on a constant currency basis. The team executed well in the quarter and supplies channel inventory levels are back down within our targeted range.
Personal Systems performed better than expected in the quarter, driven by commercial sales and supported by the India PC deal I mentioned earlier. Fourth quarter revenue was $8.6 billion, down just 2% over prior year and almost flat in constant currency, reflecting the good progress Dion is making.
Total unit shipments grew 2% year-over-year in Q4, with growth in both consumer and commercial. Consumer sales declined 10% year-over-year, but grew 19% sequentially, while commercial revenue grew 4% over prior year and 8% sequentially.
Personal Systems operating profit of $259 million or 3% of revenue was down 0.5 points over prior year. As we discuss in our recent Analyst Meeting, we remain focused on improving long-term profitability and returning those business to growth.
Our channel partners are key to helping us succeed and we continue to seek opportunities to make it easier to promote and sell HP products. For example, we are expanding our receivable program to support the demand of our resellers and distributors.
Our fourth quarter Enterprise Group results proved that we can be competitive across our portfolio but we still have work to do, so that we can continue to win deals at the right margins.
EG revenue grew 2% year-over-year to $7.6 billion in Q4, with growth in Industry Standard Servers, networking and storage. Operating profit was $1.1 billion, or 14.5% of revenue, down two points from last year.
We experienced competitive pricing, particularly in ISS and networking, higher costs of service delivery in TS and an unfavorable margin mix from strong hyperscale revenue. In general, the pricing environment remained similar to Q3, with continued aggressive pricing specifically in ISS and to a lesser extent in networking.
By business, industry standard server revenue grew 10% year-over-year to $3.5 billion, significantly outpacing the market. We had strong sales in hyper-scale, which grew high double-digit due in part to one large deal. Storage revenue grew 1% year-over-year to $952 million with a very strong growth in converged storage, which represented 43% of total storage revenue for the quarter, up 13.5 points year-over-year.
As Meg mentioned, we saw a great traction with 3PAR which grew 64% year-over-year. When you combine 3PAR, XP and EVA, you have a metric that adjusts for the planned product transition and based on this, we outgrew the market again this quarter.
Business Critical Systems revenue declined 17% year-over-year to $334 million due to a declining UNIX market. Networking sales grew 3% year-over-year in the quarter to $656 million led by strong growth in China and more moderate growth across the rest of APJ and EMEA. Revenue in the Americas was down year-over-year but we are taking actions to improve results by targeting areas where we can win and deliver disruptive solutions.
Technology services revenue declined 6% year-over-year to $2.2 billion in Q4, or 4% in constant currency. We are moving to reduce reliance on traditional hardware businesses and offer new services to address the new style of IT. The enterprise services business performed broadly as expected in the quarter. Revenue of $5.8 billion was down 9% year-over-year due to the account run-off we discussed. ES operating profit of $255 million or 4.4% of revenue was down 2.3 points year-over-year as the revenue run-off offset continued improvements in productivity and underperforming contracts.
By business, IT outsourcing revenue was $3.6 billion, down 9% year-over-year, primarily due to run-off pressure and we saw declines across all regions. Applications and business services revenue was $2.2 billion, down 10% year-over-year primarily due to softness in the applications business.
Overall we saw good momentum in signings and had renewal rates in our expiring contracts. Strategic enterprise services, which includes cloud, big data, application and modernization and security, grew double-digits. As discussed at our analyst meeting last month, we are pivoting to a more proactive sales approach and longer term we are focused on building out our portfolio to push more aggressively with strategic enterprise services.
And turning to software, overall software also performed in line with expectations with good margin performance in the quarter. Operating profit for the quarter was $328 million or 30.8% of revenue. This was up 3.6 points year-over-year and 10.3 points sequentially driven by great cost management and our efforts to exit low margin professional service contracts, while we continue to invest in innovation.
Revenue declined 9% year-over-year to $1.1 billion on a tough top year-over-year compare. You will recall that last year in the fourth quarter fiscal 2012, we signed the General Motors contract, that is the largest customer deployment at HP software on record. Excluding that deal, revenue declined low single digits.
License revenue in the fourth quarter was down 24% year-over-year as the shift to SaaS continues to impact us and given the large GM license deal last year. Support revenue grew 4% over the prior year and professional services revenue declined 13%. SaaS revenue was up 15% over the prior year with higher bookings growth across all business units, particularly in Autonomy, IT Management and Fortify on Demand.
We have received great feedback from our customers and partners on HAVEn, our big data analytics platform, and going forward we are focused on delivering new innovative solutions. Additionally, as described at our analyst meeting, we are focused on rejuvenating the IT management business and expanding Autonomy.
HP Financial Services revenue in the quarter declined 6% year-over-year to $912 million. Financing volume was down 3% year-over-year with net portfolio assets up $12.2 billion. Operating profit for the business was $102 million or 11.2% of revenue. The return on equity in HP Financial Services continued to be strong at 18.9% for the fourth quarter and 17.8% for the full year.
Turning now to cash flow and capital allocation, we generated operating cash flow of $2.8 billion in the fourth quarter and $11.6 billion for the full year. This drove Q4 free cash flow of $2 billion and fiscal 2013 free cash flow of $9.1 billion, up 21% year-over-year.
A strong cash flow performance was driven by disciplined focus on working capital throughout the year. In the fourth quarter, we were able to get the cash conversions cycle to 17 days, down four days year-over-year to improvements in days payables and lower inventor days.
I’m pleased with the progress we have made this year and we will continue to focus on working capital going forward. For example, we are making improvements to our payment terms with key suppliers.
As we said at our Analyst Meetings, we believe our cash conversion cycle in the low 20 days is sustainable although we continue to look for ways to drive a better result. With this Q4 cash flow, we returned $479 million to shareholders in the form of share repurchases buying 21.5 million shares and paid $284 million in dividends.
We ended the year with gross cash of $12.5 billion and moved to an operating company net cash position of a $103 million. We reduced gross debt by over $5.5 billion in fiscal ‘13 and have improved our net debt position by over $12 billion since the beginning of fiscal ‘12. We are extremely pleased with the progress we’ve made on our goal of rebuilding our balance sheet. In fiscal ‘14, we remain committed to the capital allocation priorities that we outlined at our Analyst Meeting in October.
Looking forward to Q1 at a maximum level, the environment remains challenging and somewhat choppy. EMEA continues to be soft and China and other high growth markets continue to face pressure.
We expect currency to be about a point headwind year-over-year to revenue in Q1. Our business, in printing, we will continue to invest in unit placements with a 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, we expected greater revenue decline in Q1 than Q4 as we will not have the same big deal benefit and expect commodity costs to pressure margins. As we focus on profitability, this cost pressure may limit revenue upside.
In Enterprise Group, we expect revenue may decline from Q4 with a smaller impact from the large Hyperscale deal we mentioned. However, we expect continued traction in converged storage and networking and converged infrastructure. In ES, we expect delayed revenue run-off from fiscal 2013 to negatively impact Q1 growth and put pressure on first half results overall.
Finally, in software we will accelerate our shift to SaaS and our professional services rationalization while investing in a disruptive growth opportunities like HAVEn and Security. With that context, we continue to expect full year fiscal 2014 non-GAAP earnings per share to be in the range of $3.55 to $3.75.
For fiscal 2014 Q1, we expect non-GAAP earnings per share to be in the range of $0.82 to $0.86. From a GAAP perspective, we continue to expect a full year GAAP earnings per share to be in the range of $2.85 to $3.05 and GAAP earnings per share for fiscal Q1 is expected to be in the range of $0.60 to $0.64.
We don’t guide quarterly cash flow, but note that we have several factors that would significantly tamper cash flow generation in the first quarter including our annual bonus payments and accelerated restructuring payouts.
With that, I will open it up for questions.
Earnings Call Part 2: