After Rocky Q1, HP CEO Whitman Makes Cost Cutting Top Priority

Last week at Hewlett-Packard's Global Partner Conference (GPC), CEO Meg Whitman rallied channel partners by vowing to return the company to its past glory, and in HP's first quarter earnings call Wednesday, she outlined the changes needed to make this happen.

In Whitman's first full fiscal quarter as CEO, HP reported revenue of $30.04 billion, down 7 percent year over year, and net income of $1.47 billion, or 73 cents a share, down 44 percent year over year. Non-GAAP earnings were 92 cents per share, compared to Wall Street analysts' consensus estimate of 87 cents per share.

For its fiscal second quarter, HP estimates non-GAAP earnings per share of 88 to 91 cents, and GAAP earnings per share of 68 to 71 cents. HP is sticking to its previous fiscal 2012 earnings forecast of $4 per share (non-GAAP) and $3.20 per share (GAAP).

After five months at the helm, Whitman said she now has a clear picture of HP's problems, and that the silos that exist within its organizational structure are one of the biggest. "For years, we’ve basically run our business in silos and under that model we’ve built some of the leading franchises in technology. But it has also made us too complex and too slow," she said during the call.

Another issue is HP's lack of R&D spending in recent years, which Whitman said has led to pressure on core businesses, including the Imaging and Printing Group, the Personal Systems Group, Enterprise Servers, Storage and Networking, and HP Services. HP spent $3.2 billion on R&D in fiscal 2011, a figure that represented 2.5 percent of annual revenue.

"We didn’t make the investments we should have during the past few years to stay ahead of customer expectations and market trends," she said. "As a result, we see eroding revenue and profits today. We need to invest now, as a market leader, from a position of strength."

PSG revenue fell 15 percent year over year with a 5.2 percent operating margin, as PC sales to businesses dipped 7 percent and sales to consumers dropped 25 percent. Last year's floods in Thailand, and "continuing difficulties in China," continue to pinch HP's supply chain, Whitman said.

Next: The Situation In ESSN & IPG

Enterprise Servers, Storage and Networking (ESSN) revenue fell 10 percent year over year with an 11.2 percent operating margin. Within ESSN, HP Networking revenue was flat, Industry Standard Servers revenue dropped 11 percent, Business Critical Systems revenue fell 27 percent and HP Storage revenue dipped 6 percent year over year.

Imaging and Printing Group (IPG) revenue fell 7 percent year over year with a 12.2 percent operating margin, and revenue fell in the commercial and consumer segments, for both printer hardware and supplies.

Whitman plans to boost HP's investments in cloud computing, security and information management, yet she characterized these as long-term initiatives. Given the looming threats to HP's traditionally profitable businesses, Whitman made it clear that restoring the company's financial health is her top priority right now.

"To seize this moment, we have to stabilize financial performance," Whitman said. "And it’s clear from both our revenue and margin profile that our current cost base just isn’t supportable. On the current trajectory, we just won’t have the capacity that we need to invest."

Whitman said HP can cut costs and complexity by reducing SKUs, upgrading customer facing sales systems, optimizing its supply chain and streamlining internal business processes. "It’s not easy work and it’s not a quick fix, but it holds the potential to improve the way we operate and execute and it simply has to be done. We have got to save to invest. We have got to save to grow."

It's unclear how this will impact Whitman's pledge, made last week at GPC, to "double down" on R&D in all of HP's business units.

In a Q&A during the call, Sanford Bernstein analyst Tony Sacconaghi asked Whitman to clarify her plans to bring stability to HP. "The first thing we have to do is stop the revenue decline, and the second is, we have to start growing revenue," she responded.

In order to achieve this HP will have to gain share in the markets in which it competes, and Whitman said this won't be easy given that unit costs are dropping in many of these markets. Acknowledging the vagaries of the macroeconomic environment, Whitman said she expects HP's revenue to "flatten out" by early 2013 and to start growing by the end of that year.

"If you look at business history, when companies go through turnarounds, these things are not quick," Whitman said. "It took us a while to get into this situation and it will take us a while to get out … we've got a long journey ahead of us."