Hewlett-Packard F3Q09 (Qtr End 7/31/09) Earnings Call Transcript

Aug.18.09 | About: HP Inc. (HPQ)

Hewlett-Packard Company (NYSE:HPQ)

F3Q09 Earnings Call

August 18, 2009 5:00 pm ET

Executives

Jim Burns - Vice President, Investor Relations

Mark V. Hurd - Chairman of the Board, Chief Executive Officer and President

Catherine A. Lesjak - HP Executive Vice President and Chief Financial Officer

Analysts

Benjamin Reitzes - Barclays Capital

Richard Gardner - Citigroup

William Fearnley - FTN Equity Capital

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Keith Bachman - BMO Capital Markets

Katie Huberty - Morgan Stanley

Shannon Cross - Cross Research

David Bailey - Goldman Sachs

William Shope - Credit Suisse

Brian Alexander - Raymond James

Shaw Wu - Kaufman Brothers

Jeff Fidacaro - Susquehanna

Mark Moskowitz - J.P. Morgan

Douglas Reid - Thomas Weisel Partners

Operator

Good day, ladies and gentlemen and welcome to the third quarter 2009 Hewlett-Packard earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Mr. Jim Burns, Vice President of Investor Relations. Please proceed.

Jim Burns

Good afternoon and welcome to our third quarter earnings conference call with Chairman and CEO Mark Hurd and CFO Cathie Lesjak. This call is being webcast. A replay of the webcast will be available shortly after the call for approximately one year.

Some information provided during this call may include forward-looking statements that are based on certain assumptions and are subject to a number of risks and uncertainties and actual future results may vary materially. Please refer to the risks described in HP's SEC reports, including our Form 10-Q for the fiscal quarter ended April 30, 2009.

The financial information discussed in connection with this call, including tax related items, reflects estimates based on information available at this time and could differ materially from the amounts ultimately reported in HP's Form 10-Q for the fiscal quarter ended July 31, 2009.

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 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 earnings release, both of which are available on the HP investor relations webpage at hp.com.

Finally, please refrain from asking multi-part questions during the Q&A. And with that, I will now turn the call over to Mark.

Mark V. Hurd

Well, good afternoon and thank you for joining us. In the third quarter, business continued to stabilize and Hewlett-Packard continued to execute. We delivered revenue of $27.5 billion, and non-GAAP EPS of $0.91, both of which exceeded the higher end of our prior guidance. We expanded non-GAAP operating margins by a full point due to efficiency gains in services and IPG. We generated $3.9 billion of cash flow, bolstering our strong balance sheet.

I am pleased with our execution in a tough market climate. Our business in China accelerated this quarter above historical seasonality, growing double-digits over the prior year and leading the Asia-Pacific region. The U.S. remained stable for the second quarter in a row but we’ve yet to see the same trend in Europe.

The technology solutions group had the industry’s best arsenal of hardware, software, and services to manage and transform our customers’ IT environments. We realizing the benefits of our own IT transformation, saving over $1 billion while doubling our IT innovation budget.

Many customers I talk to have enormous opportunities to realize significant benefits and are turning to HP for help.

This quarter, share gains in key markets provided yet another proof point that HP is winning in the data center. We also realized sequential improvement in operating margins and services, ESS, and software.

The services business, our largest segment --

[Technical Difficulties]

-- capture this opportunity and to grow our printing business as economic conditions improve. This quarter IPG further demonstrated the strength and resiliency of its business model. While reported supplies revenue was down 13%, sell-out in constant currency was flat to slightly down as customers are spending roughly the same amount on our supplies as last year. An aggressive focus on the entire supply chain has driven channel inventory levels down from the prior year. With this improvement, we would expect revenue growth for supplies in local currency to begin to improve starting next quarter.

Our inkjet portfolio is strong. We see increased opportunities for printer placements in Q4 and we made tangible progress in our retail photo and enterprise printing businesses.

Now before I turn the call over to Cathie to review the financials, let me reiterate the three reasons why I am confident that HP will emerge from the current market environment as a stronger force in the industry.

First, our broad market leading portfolio -- HP has scaled services, software, and hardware built upon open industry standards that differentiate us in the marketplace. We understand customer needs and we can deliver integrated solutions today.

Second, our ability to leverage scale -- our scale provides us a sustainable competitive advantage and our efficiency programs are significant and ongoing.

Third, our track record of successful execution -- as this quarter demonstrates, we are executing in the marketplace, executing on the EDS integration, and executing on our cost initiatives.

Our goal is to maintain our strategy through this economic cycle and emerge even stronger in the marketplace. By continuing to drive innovation, market coverage, and customer support and invest for growth, we have the opportunity to create a meaningful competitive advantage for years to come.

With that, I will turn it over to Cathie.

Catherine A. Lesjak

Thanks, Mark and good afternoon, everyone. HP posted another solid quarter in Q3 fiscal 2009 and continues to demonstrate its ability to execute in both good and challenging markets. Our portfolio diversification, focus on innovation and operational excellence have enabled us to effectively deliver results to both customers and shareholders.

Total revenue for the third quarter, including the EDS acquisition, was down 2% year over year and up 4% in constant currency. Looking at revenue by region, including the addition of the EDS, Americas revenue increased 8% year-on-year, EMEA was down 12%, and Asia-Pacific decreased 4%. Excluding the effects of currency, revenue was up 11% in Americas, down 2% in EMEA, and flat in Asia-Pacific. Europe continues to be the most challenging region, while Asia showed the largest sequential improvement, led by growth, in China.

Within Americas, the U.S. continued to stabilize. While we would like to see further stabilization in Europe, we are encouraged by the signs we are seeing in U.S. and China, which together represent more than 40% of total company revenue.

Gross margins for the quarter were 23.7%, down 70 basis points due to lower volumes in ESF and the mix impact of EDF.

Non-GAAP operating expenses for the quarter were $3.5 billion, down $547 million, or 13% from a year ago. In addition to benefiting from the stronger dollar, this decline highlights both the work we’ve been doing to make our cost structure leaner and more flexible and the actions we have taken to improve our competitiveness in the current environment. Despite these reductions, we continue to fund innovation, sales, and customer service at appropriate levels.

Non-GAAP operating margin increased to 10.8%, up from 9.8% in the prior year, driven by margin expansion in services and IPG. OI&E expense of $177 million was primarily due to interest on our EDS related debt obligations, as well as currency hedging losses. All in all, we delivered solid non-GAAP earnings per share of $0.91 in the quarter.

Now moving on to the details of our performance by business -- services, including the addition of EDS, delivered revenue of $8.5 billion. On a year-over-year basis, operating profit in the quarter increased over $700 million to $1.3 billion, or 15.2% of revenue, driven by improvements in both technology services and EDS.

Drilling into the services business, Q3 revenue was $3.9 billion in IT outsourcing, $2.4 billion in technology services, $1.4 billion in application services, and $711 million in BPO. We continue to win significant deals in both the public and private sectors, most notably in the telecommunications and manufacturing sectors.

As we approach the anniversary of the EDS acquisition, the integration continues to go well as we work to standardize EDS’ processes with HP.

Enterprise storage and server revenue was $3.7 billion, down 23% compared with the prior year. Operating margin was 9.7%, down year-on-year but up sequentially due to increasing volumes in ISS and supply chain optimization initiatives.

While each of the businesses within ESS was down compared with the prior year, sequentially ISS grew 14% as a result of strong customer demands for our newly launched G6 platform. G6 is the latest generation of [Proliant] server and incorporates innovations in software and power and cooling technology, as well as the latest processors and chipsets.

Business critical systems declined 11% sequentially, reflecting a continued elongation of customer decision cycles. Storage was flat sequentially, driven by stabilization in the Americas. Within storage, the entry level SAN product continued to do well and our left-hand portfolio is benefiting from HP scale and global distribution networks.

HP software revenue declined 22% from the prior year to $847 million. BTO and other software revenues were down 22% and 23% respectively.

Support performance remains solid, reflecting strong maintenance renewals and sustained business value of our solutions.

For the quarter, software operating profit increased to $153 million, or 18.1% of revenue. Personal systems delivered revenue of $8.4 billion, down 18% year-on-year and operating profit of $386 million, or 4.6% of revenue. Total shipments increased 2% year-on-year with notebook unit growth of 19%, offset by desktop systems declines of 13%. Average selling prices declined due to product mix, currency, and a competitive environment. TSG continues to deliver solid performance in share gains driven by our innovative product portfolio and global reach, including the expansion of our distribution in the telco channels.

Imaging and printing revenue for Q3 was $5.7 billion, down 20% year-on-year due to the tough economic environment. IPG delivered operating margin of 17%.

Compared to the third quarter last year, total printer units declined 23% and consumer and commercial printer hardware units declined 16% and 42% respectively.

Supplies revenue declined 13%. Channel inventory corrections and currency accounted for most of this decline, with sales out continuing to be flat to slightly down.

Within printing, we are seeing growth in key segments. Our indigo press digital page volume grew 16% last quarter and wireless printers grew over 50%.

In the enterprise, our managed print services business had a number of competitive wins this quarter. Rounding out the segments, HP Financial Services had revenue of $670 million, down 1% year over year, due to unfavorable currency, and generated operating margin of 7.9%, up 40 basis points from the prior year.

Now on to the balance sheet and cash management -- we closed the quarter with a strong balance sheet, increasing the total gross cash to $13.7 billion, and improving our net cash position by $2.1 billion. We continue to manage our working capital very effectively with a cash conversion cycle of 18 days.

Third quarter days sales outstanding was 48, up for days from one year ago. Days payable was 55 days, down 7 days year-on-year. Owned inventory days were 25, down 10 days year over year.

With regard to channel inventory, each of our segments is within its target range. Compared with one year ago, ESS and IPG channel inventory were each down a half a week, and PSG was up half a week.

Gross CapEx was $1.1 billion, up 30% sequentially. On a net basis, CapEx was $940 million, up 26% sequentially. Increased capital expenditures were primarily related to new IT outsourcing deal transitions, such as Aviva, and growth in our leasing business. Cash flow from operations increased 15% year over year to $3.9 billion, and free cash flow was $2.9 billion.

Share repurchases in the third quarter totaled $1 billion, or approximately 28 million shares. At the end of the quarter, we had roughly $6.1 billion remaining in the current share repurchase authorization.

Finally, we paid our normal quarterly dividend, totaling $191 million.

And now a few comments on our outlook -- we are reaffirming the midpoint of the full year outlook we gave you in May. Regarding the fourth quarter, we expect a sequential revenue growth to be slightly below historical trends. We have gained significant share in PCs and X86 servers in recent quarters and while we are confident in the competitiveness of our products, we do not believe it is prudent to set investor expectations that we will continue to outpace the market at these rates and thus are modeling more modest share gains.

In addition, we could face top line pressure due to the continuing weakness in Europe and the competitive pricing dynamics in that region.

With regard to earnings, we expect OI&E expense of approximately $0.05, a tax rate of approximately 21%, and weighted average shares outstanding to be roughly flat.

With that in mind, we expect fourth quarter revenue to increase approximately 8% sequentially and non-GAAP EPS to be approximately $1.12.

We will be hosting our analyst day on September 24th, where we look forward to sharing with you our plans for 2010.

We will now open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Benjamin Reitzes with Barclays Capital.

Benjamin Reitzes - Barclays Capital

Thanks a lot, I appreciate that. I wanted to talk about printing supplies -- you mentioned that printing supplies would have -- could you clarify your revenue outlook next quarter for printing supplies? It sounds like with currency, it should only be down low single digits rather than down 13, and could you also talk about what the margin hit in the quarter was from the reduction of inventory that maybe we don’t see in upcoming quarters in IPG?

Catherine A. Lesjak

Thanks, Ben. In terms of supplies and our forecast for supplies, we expect it to be down less than its been in the last couple of quarters, so what we are calling for, as long as currency kind of stays in this range, is that it will up-tick a bit. There is still some channel inventory adjustments which I would categorize as fine-tuning that still need to be done in that number.

Mark V. Hurd

I think maybe your point that the customer, if you will, the end customer is buying roughly the same amount of supplies as a year ago when you look at end demand. So what we are getting now is less currency that is going to hit that number, so that’s going to go down and we have corrected -- you know, for the most part at a macro level we feel good about where the channel inventory is. We still have some tweaking to do in some SKUs in some geographies, so I won’t take you through all that detail, so we still have some tweaking but the bulk of what we needed to do from the channel inventory is behind us. So I think we have another quarter of some correction in some currency but your point is right -- you are going to see another quarter of improvement on the supplies line.

Benjamin Reitzes - Barclays Capital

Got it -- you said next quarter it will be down at a less rate? Okay.

Catherine A. Lesjak

That’s right and I just want to remind you that we do have tough compares in Q4 because if you think about last year’s Q4, we had price increases that folks were stocking up in advance of, and so if you look at Q4 growth last year, it was about 11%, up 11% so we do have some tough compares in Q4.

Mark V. Hurd

But it will be a better number.

Catherine A. Lesjak

It will absolutely be a better number.

Mark V. Hurd

Be a better number as we start working off the inventory and the currency starts to normalize, and really the key thing for us is that end user demand, the fact that people are really just simply printing as much as they -- buying as much as they were last year, so we just have to get through the currency and the inventory correction and we’ll be going from there.

Benjamin Reitzes - Barclays Capital

But isn’t the margin artificially depressed at 17 if you were just cutting inventory? Wouldn’t there be a margin benefit?

Mark V. Hurd

Yes, the answer is yes, Ben, there is some of that. The flip of it is is that as the demand is getting better for units, you’ve got a reinvestment back into the units in the market, so I won't take you through the balancing of that math because it’s going to depend on what SKU but at the same time, we are seeing improved demand for printers and so for us, getting more units out there is part of the model as well.

So I wouldn’t, Ben, say just look at it singularly like we are going to see an improvement in the dollars that are coming through the supply side and we are going to get all that margin that is going to improve. Some of that is going to get balanced back as we put more unit placements out there that we think are coming. And to be very direct on it, we could have put more units out there in Q3 and we are going to be looking to put more units out in Q4.

Benjamin Reitzes - Barclays Capital

Finally, if I may, is the enterprise picking up, Mark? It seemed like ISS really picked up at the end of the quarter. And that’s my final question.

Mark V. Hurd

That’s a good job, Ben. I think -- you know, picking up -- I’ll say it one more time. I think what we have seen so far this year is what we will see for the rest of the year. The only cautionary note I say is until I see the share numbers, I can’t tell you how much it’s picking up versus our numbers are just picking up. So that’s the only caveat I would give you. I think we saw a little bit of improvement -- clearly the G6 launch was extremely successful for us. We feel very good about the PCO that we are offering customers. It’s shown up as you’ve described. I just have to see the rest of the numbers come in to see where the share numbers are to really feel like we’ve seen a change here.

Catherine A. Lesjak

And right now one of the things that we are seeing is that we gained more share than we thought we were going to gain and that suggests that we are just executing better and that the G6 platform is being very well-received.

Benjamin Reitzes - Barclays Capital

Thanks a lot, guys.

Operator

Your next question comes from the line of Richard Gardner with Citigroup.

Richard Gardner - Citigroup

Thank you. Mark and Cathie, I wanted to follow-on on Ben’s question regarding printer supplies -- you mentioned that sell-through is flat year over year but you’ve done a couple of price increases, which I think amounted to a total of roughly 10% price increase year over year. So we’re down about roughly 10% in page volume. I was wondering if you could give us a sense of whether you are starting to see the page volume pick up at all within the core printer business and then maybe some thoughts in the early stages of a recovery about whether supplies or hardware will pick up first within the printer business?

Mark V. Hurd

Rich, listen, I’d be careful the way we model it and we think we have a pretty sophisticated modeling process on this -- when you look at the sell-out, the price increase gets merged into the aggregate sell-out environment, so I think you can’t take the 5% away twice, if you will. The sell-out neutralizes all of the price increases or promotions or sell -- anything like that gets neutralized in that sell-out number, so we feel good.

I think the way to say it would be we feel good -- I’ll add to it, about the installed base. We feel good about the installed base and we feel good about the page volume coming out of the installed base.

I think to try to put more color on it, we’ve been cautious if you go back into Q1 to make sure we had the right alignment of supply and demand from a unit perspective but all through this, the actual printing volume itself has looked quite stable to us.

Richard Gardner - Citigroup

Mark, would you be willing to give us any sort of rough estimate on what page volumes -- what you think page volumes are doing in inkjet and laser on a year-over-year basis?

Mark V. Hurd

I don’t -- I got those numbers, I don’t have them with me so I -- I will try to get our team to be able to give you something back afterwards but I don’t have it in front of me, Rich.

Richard Gardner - Citigroup

Okay, and the Mark, just quickly thoughts on whether supplies or hardware will pick up first within that business in the early stages of an upturn?

Mark V. Hurd

Well, I mean supplies -- if you start looking at the data that we look at, and I’ll let Cathie comment on it as well, supplies has really been pretty consistent through this entire environment and you have to look at it again ex currency and you have to look at it ex inventory correction and I think when you look at the data we get back from consumers, printing is one of the least things they want to stop.

And when we look at our enterprise business, we actually have the benefit of having major contracts with very big companies where we actually manage all of their printing and they give us annual estimates for how much they will print in a year and most of our customers are exceeding those estimates even in this economy of how many pages they are printing.

So from a supplies perspective, it’s been pretty consistent. Clearly what people have chosen to do is not buy that incremental unit that they would ordinarily buy in a good economy, so the way you asked the question, Rich, I think you are going to see units recover certainly quicker at a faster rate because of where they have been but again, I think the supply -- that’s only because the supplies market has been pretty steady through all this.

Catherine A. Lesjak

And when we think about the supplies market being steady, we really look at what sell-out has done on a constant currency basis and it’s been roughly flat to slightly down the last few quarters.

Mark V. Hurd

So as we start moving back towards a single digit growth, low mid-single digit growth in supplies, that just really comes we think with better GDP numbers, a little bit better employment numbers, and you’ll see that growth again on a local currency basis come back to where we described.

Richard Gardner - Citigroup

Okay, thank you.

Operator

Your next question comes from the line of William Fearnley with FTN Equity Capital.

William Fearnley - FTN Equity Capital

Yes, good afternoon, Mark. If I could, on -- how should investors be thinking about the laser business here? Very weak unit growth this quarter, worse than last quarter and last year was an easier compare. Our survey work shows shortages on multiple SKUs in the VAR channel -- was this intentional on your part or how should we be thinking about the balance between hardware unit growth here and IPG margins overall?

Mark V. Hurd

Okay, thanks, Bill. Listen, I think that we’ve had a case where as we align supply and demand, we were looking at the demand in Q1 and we have just really gotten through all of the inkjet issues. We now have inkjet supply and pretty good -- I know you asked a laser question but I want to make sure I get all the data out. Inkjet is in pretty good supply now and we have inkjet units available. We’d certainly recommend them for you, Bill, personally as well.

Laser side, we have been -- we’re short on availability on some SKUs, so we have worked hard now to try to get some of these laser holes filled. The good news, Bill, to your point is demand is stronger than it has been, so we have seen incremental improvement in demand. We’ve got to get the supply back up and to be -- to tell you where I think we are, I think we are going to be going through most of the fourth quarter with a couple of SKUs trying to fill that demand. So I don’t think we’ll be out of all of it until the end of Q4.

William Fearnley - FTN Equity Capital

And just quickly, the shift to office jet from laser, how is that going? How is the office jet doing?

Mark V. Hurd

You know, Bill, one of the reasons we’ve had issues in inkjet has been the success of office jet. It’s just been a very successful product for us. I think the team has done a really nice job with it and again, the good news on inkjet is we have now caught up, so the good news is there’s more demand -- the bad news is we weren’t perfect in filling it. We got ink behind us -- we’ve still got some work to do on laser.

Operator

Your next question comes from the line of Toni Sacconaghi with Sanford C. Bernstein.

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Thank you. I was wondering if you could provide anymore color on leading indicators for the services business on a top line basis. Obviously the profitability story there is very, very strong. You mentioned that the funnel has improved but can you comment at all on signings? I think from a revenue perspective, you are down about 15% year over year pro forma this year versus EDS plus HP last year. It’s not too far off from IBM, which I think was down about 11 or 12, but can you help us understand what year-over-year pro forma signings might look like, or any other indicators about revenue growth in that business?

Catherine A. Lesjak

Toni, what I would say is that we feel good about the signings. We are making progress but the as we said at the security analyst meeting in September, our primary focus has been over the last year is really focused on getting the integration done and getting the cost synergies because at the end of the day, the leaner cost structure will enable the growth and we are getting to the point right now when we are starting to really focus on more growth. And I think it’s at that point in time that we will have more color that we can provide on signings, either on a kind of trailing basis or on a quarter to quarter basis.

Mark V. Hurd

I think you should think of this, Toni, as right at the pivot point, you know, where we’ve been doing a lot of work to get EDS integrated and it’s got -- you know, to your point, it’s done well for us in terms of being able to get done what needed to get done and get the companies lined up. We’ve not got most of the legal entities, or many of the legal entities now integrated with HP. We’ve got job architectures integrated with HP. We stayed on track with the integration. The good news is we’ve been winning deals, so the encouraging thing I would tell you on a competitive basis, we feel pretty damn good about our position in terms of winning deals. Our funnel is up and the acceptance is good.

I think to your point, we are going to think hard about then because we have had a number of milestones, to your point, we’ve been trying to nail over the course of the last 12 months as we integrate EDS and we’ll start thinking about now as we go into SAM what those next set of milestones are so that we can give you that kind of tracking you are talking about.

Toni Sacconaghi, Jr. - Sanford C. Bernstein

But when you talk about moving on a pivot point, should we be thinking about -- obviously if you are a bit more aggressive in your share aspirations on a signings front, all else being equal doesn’t that typically -- especially on longer term deals, impact short-term profitability? Now I know there’s a lot more savings coming forward that you guys have talked about but should we expect your capture rate on savings going forward to the degree that you tilt more towards an offensive stance to lower?

Mark V. Hurd

Yeah, I mean obviously it’s a longer conversation, Toni, right and to your point, when you are talking about deals with five-year horizons, there’s a portfolio of deals within it and first-year deals are typically not as attractive as fifth-year deals and you have to measure what your growth appetite is within the context of that portfolio.

I think it’s a better subject for us to lay out at SAM than probably on the call but to your point, that’s exactly how we think about it -- how much capital we want to deploy to drive what growth.

I would tell you though, as I mentioned earlier, there is -- we have not captured all of the savings out of the EDS integration. We’ve done a lot of work but we have a lot of work left to do that we will benefit from as we go out into future quarters, so I think we’ve got more work to do on that front. We are pivoting to try to focus on more growth. I wouldn’t think you should be thinking about it in terms of extremely dilutive to what you have seen so far, because we’ve got more work to do on the profit line to begin with.

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Okay, and then finally, could you --

Jim Burns

Toni, we need to actually move on here and I would like to ask everybody to refrain from asking multi-part questions, please? So let’s take the next question.

Operator

Your next question comes from the line of Keith Bachman with Banc of Montreal. Please proceed.

Mark V. Hurd

You’re on mute, I think, if you’re there.

Operator

Sir, your line is open.

Jim Burns

Still can't hear you, Keith. Okay, let’s move to the next question, please.

Keith Bachman - BMO Capital Markets

Jim?

Jim Burns

Oh, Keith, you’re there.

Keith Bachman - BMO Capital Markets

Yeah, sorry -- I think my line was muted out but let me jump in -- just on services and I’ll stick to one question, Mark, you mentioned that there was costs savings away from EDS and I think it was in the technology service area. I just want to try to get some more color on what was the benefit of those margins? What drove those margins and is there more room to go away from EDS specifically?

Catherine A. Lesjak

Let me take that one, Keith -- so in terms of technology services, we’ve been running our cost initiatives now for about a year-and-a-half or two. We basically think about them in three phases -- you get the job done in the right location, in the lowest cost location where you can be efficient. Then you next focus on getting your processes to be standardized and optimized, and then the obviously nirvana is getting them automated to whatever extent you can. And when we in the technology services plans, we’re kind of in that middle area where we are getting the processes standardized and optimized and so we think of that as being kind of middle innings for technology services and therefore we still have more opportunity on the cost of service delivery in our -- that traditional maintenance business.

Keith Bachman - BMO Capital Markets

And Cathie, I assume EDS was the larger driver of the services’ sequential change in profitability?

Catherine A. Lesjak

On a sequential basis, EDS was more of the driver. On a year-on-year basis, they both contributed significantly.

Keith Bachman - BMO Capital Markets

Okay. Thanks very much.

Mark V. Hurd

Keith, I think it’s really a good question that we want to make sure you have clarity on -- think of those technology services opportunities as when a customer has got a problem, the real benefit that we can bring as a technology company is to resolve that problem with no human intervention. And cost structure is one dimension of it but I can tell you the cost to run a call physically versus running and dealing with a call remotely and dealing with a call even electronically has a tremendous cost delta and even customer satisfaction delta to the good when you can get that done.

So the real beauty of technology services for us over the past several years has been yes, we’ve gotten the cost structure better but secondly, we’ve gotten the technology platform better so that we can resolve a bigger percentage of our customers’ problems with minimal human intervention and at the same time, improve the customer satisfaction with HP.

So it’s really all of those things that to Cathie’s point you’ve got to get lined up together, which is driving the improvement we’ve seen and to Cathie’s point, we’ve just got a lot more work to do and it’s a good opportunity for us.

Jim Burns

Thanks, Keith. Let’s move on to the next question.

Operator

Your next question comes from the line of Katie Huberty with Morgan Stanley.

Katie Huberty - Morgan Stanley

Thanks. Good afternoon. Even with the PC share gain slowing, revenue guidance appears conservative if we take your comments on demand stabilizing more -- less volatile currency, and even the server share gains were in the context of a very weak market that is starting to rebound and you’ve got the easy comp in printer supplies, so can you just drill into what is making you cautious on the revenue view for October? Is there something you are seeing in Europe or in the early days of back to school that is holding back the revenue performance next quarter?

Catherine A. Lesjak

Katie, I think the way to start is to think about what our revenue does typically sequentially and then take into consideration the fact that that sequential growth for HP without EDS, you know typically 10% or 11%. With EDS, EDS comes in at kind of low-single-digits seasonality and so that dampens obviously the quarter-to-quarter up-tick in revenue. Then you take into consideration the fact that Europe has been a very tough market just generally and therefore we usually see a very significant up-tick from Q3 to Q4 in EMEA that we just -- we just don’t think it’s going to be as large. It’s going to be muted and therefore you’ve got to take that away and the fact of the matter is from a currency perspective, a lot of the currency tailwind sequentially comes from EMEA -- again, tough market, tough competitive pricing dynamics that say that is probably not going to result in a lot of top line benefit for us.

And then finally to the point that I made in my prepared remarks is that we have gained a lot of share in PC and servers, and that is more share than what we had expected, which suggests to us that the market is not as good as we thought it was.

Katie Huberty - Morgan Stanley

But if we back out EDS, the core business would grow sequentially closer to that 10% range.

Catherine A. Lesjak

Closer -- with these adjustments for EMEA, you get pretty close. I think the other thing to remember is that if demand is better than we are calling for, we’re thinking it’s going to be, we’re very well-positioned to take advantage of it.

Mark V. Hurd

I think, Katie, first of all I think you are exactly right with what you are saying and it’s -- the non-EDS sequentials are pretty close to historical seasonalities but a little short of that based on the points that Cathie raised and I think for us, we’d really like to see more strength in the overall market in Europe and the currency up-tick you see -- you know, it’s a good thing. It’s a good thing -- we just -- it’s in a market that’s already got its other issues, so I think we just think it’s prudent to see how this plays out and again the share gains, we feel good about them. It’s just that when we think the market is strengthening, sometimes we get a bit muted when we see the share gains that are just bigger than we had projected.

Katie Huberty - Morgan Stanley

Got it. Thanks for the clarity.

Operator

Your next question comes from the line of Shannon Cross with Cross Research.

Shannon Cross - Cross Research

Thank you very much. Mark, could you talk a bit about how you are thinking about just an aggregate share gains versus margin within the product categories? You know, how you are thinking about ASPs -- printers, PC storage, servers, et cetera? Just maybe an idea of how you kind of look at it as you get a bit more this quarter what you are thinking about going forward and that, just so we know how you are sort of balancing things.

Mark V. Hurd

Again, I think we’ve not built models, Shannon, to try to have large share gains. These are not -- and we typically don’t go into a quarter saying let’s try to gain this much share, let’s try to do this. We try to build our models, to your point, to optimize multiple issues and that’s why I think like you hear Cathie and I keep talking about the share gains because I would say they surprise us a little, based on the way we have been pricing. We have not been doing intentionally anything from an aggressive pricing perspective in this economy because to a large effect, there isn’t as much elasticity as you would see in a good economy.

So for us, we’ve been trying to balance the answer. Now we’ve got some other things going on in ASPs too and we have new entrants in the markets, so when you add the fact that earlier we introduced an office jet, we introduced a mini notebook, we’ve moved into several adjacencies that have some impacts on the ASPs as well but at the same time, they’ve given us incremental market opportunity as well.

So we’re trying to balance all of those things and I would say think of us as being in a -- from a pricing perspective, Shannon, we’re trying to be steady as it relates to our impact on the pricing side. That steady approach has led to more share than we thought we’d have.

Shannon Cross - Cross Research

Okay, great. Thanks.

Operator

Your next question comes from the line of David Bailey with Goldman Sachs. Please proceed.

David Bailey - Goldman Sachs

Great. Thanks a lot. With a lot of the EDS integration behind you and demand beginning to stabilize in most of the geographies, are you looking to increase your buy-backs or get more aggressive on the acquisition front, given the cash flow that you are generating?

Catherine A. Lesjak

You know, we feel great about our cash flow this year -- $5 billion last quarter, $3.9 billion this quarter, and expect to have healthy cash flow in Q4. One of the things that we really -- we talked about at the security analyst meeting last September is that we wanted to get back to a positive net cash position. Within 12 to 18 months of the acquisition of EDS, and we’ve made good progress, improving our net cash position by $2.1 billion this quarter gets us closer. We’ve now got a negative net cash position of $3.2 billion, so we still have a little bit of work still to be done.

In terms of buy-backs, because of that we have moderated our buy-backs with the focus continuing on making sure that we cover dilution from employee benefit plans and then buying a little opportunistically, kind of when we get through this I think we’ll re-look at what we are doing from a share buy-back perspective.

David Bailey - Goldman Sachs

Thank you.

Operator

Your next question comes from the line of William Shope with Credit Suisse.

William Shope - Credit Suisse

Okay, great, thanks. There have been some concerns that recovery for PC and server OEMs would be at least partially muted in the near term by rising component prices and essential shortages. Can you give us your view on where you think the key [inaudible] points are in this respect, how they may evolve into the peak season in the second half and how you are managing this with strategic inventory management or other methods?

Mark V. Hurd

We saw pricing and supply pressures on memory and LCDs a bit in Q3, so that was contained in the results that we’ve given you. We think some of that will continue on certain commodities into Q4, so we know how to navigate these situations pretty well, to your point. We view our procurement team as a real competitive advantage. We think we do a good job in these types of situations and actually typically tend to do a little better when these situations occur. But that’s what we saw.

William Shope - Credit Suisse

Okay. Thank you.

Operator

Your next question comes from the line of Brian Alexander with Raymond James.

Brian Alexander - Raymond James

Thanks. In ESS, Mark, you highlighted leverage in the model and if I look sequentially, your contribution margin in ESS was north of 30% after backing out the Cornell charge from last quarter, and that was with ISS driving all of the growth, which is presumably lower margin than BCS and storage, so how should we be thinking about leverage going forward in ESS? Can you keep contribution margins well above 20% for a while, or was there anything unique in the quarter that we should know about? Thanks.

Mark V. Hurd

Well, I would really like to no comment that. I think that your math is sort of roughly right. I’ll leave it at that and I think we’ll just have to see again -- we’ll have to see first how demand goes and if demand goes, I think it is fair to say that we think we have leverage in this business, yes.

Catherine A. Lesjak

And I would say there was nothing particularly unique about this quarter once you take out the adjustment that you took out for Cornell in the compare.

Brian Alexander - Raymond James

Thanks.

Operator

Your next question comes from the line of Shaw Wu with Kaufman Brothers.

Shaw Wu - Kaufman Brothers

Thanks. Mark, just a quick question on your networking business -- any color you can provide there? And also on the competitive environment? And then last, just on your virtual connect technology that you are doing there? Thanks.

Mark V. Hurd

Sure. I think [inaudible] came from a competitive market position. We think they did well. Virtual Connect, of course, is an important product for us because it’s actually in our server business, our opportunity to virtualize the number of network connections, so think of us playing to -- I think to your point, Shaw, both ends of this, both trying to virtualize the number of network connections that a customer needs and secondly being with our edge products and our wireless products today, very active in the networking market and we feel very good about the acceptance of Pro Curve and the relative position of Pro Curve in the market.

Catherine A. Lesjak

And I would add on that that from a preliminary perspective, it does look like we gained share again this quarter, roughly a point.

Shaw Wu - Kaufman Brothers

Okay, thanks.

Operator

Your next question comes from the line of Jeff Fidacaro with Susquehanna.

Jeff Fidacaro - Susquehanna

Great. Thanks for taking my question. Mark, just wondering if you take a look, particularly in the PCs and in ISS and the share gains, and can you discern for us the difference between the share gains and the actual market demand turning around as you look into 2010? In other words, is IT spending when you talk to your customers looking to pick back up? And where would you look to see that first?

Mark V. Hurd

Well, when you say see it first, I’ll tell you, I think right now is again a very important time in the market because from an enterprise perspective, most of our customers are now doing the planning for 2010. And we expect that 2010 will be a better year than 2009. I think the important thing will be how customers choose to spend that money.

A couple of things, Jeff, that I think are important is that customers have user bases, if you will, that are ageing and they have deferred a lot of infrastructure spending because of the economy. At the same time, many of our customers have deferred innovation spending for the same reason, so they are going to have to deal with not only what is the scale of their IT budget in terms of year over year but secondly how to break that up in terms of the replacement of infrastructure. They are looking at some very attractive TCOs with things like the G6, et cetera, in addition to what they do from an innovation and project perspective, and that obviously relates back to our services business and some of the work we do in ad services.

So I think right now, customers are deciding where they are going to go and my guess is you are going to see a little bit of both -- you are going to have to see an improvement in the innovation budgets out there and you are going to have to see some necessary refresh of the infrastructure.

Now, I think one other point I would tell you is that the installed bases of infrastructure that will be replaced in 2010 is install base that was sold many years ago, not the installed base that was sold in 2007, 2008, and 2009. So one of the big issues for us is what share position do we have? Our share position now is stronger than it was in the past, so we’ll be competing against many incumbents on a non-HP installed base that will come up for bid in 2010, so we’ll have to see how we fair.

Jim Burns

Thank you. Let’s take the next question, please.

Operator

Your next question comes from Mark Moskowitz with J.P. Morgan.

Mark Moskowitz - J.P. Morgan

Good afternoon. Thank you. Real quickly here, Mark, in terms of all your models you have internally, what do you hear from your sales force? And if you are able to kind of qualify the impact on [inaudible] especially over in China. How much of that is really impacting the consumer versus the corporate customers [inaudible] over there?

Mark V. Hurd

We think it’s very positive. I think the stimulus package on the consumer I think is -- we mentioned this, Mark, even in Q2 that we saw an improvement in Q2 in China after the consumer stimulus was released and we saw that continue into Q3. We have additionally seen help into corporate projects that have been helped as well, so in China, the stimulus packages, both from a corporate perspective and a consumer perspective, we’ve seen directly get into the market and certainly help the business.

Mark Moskowitz - J.P. Morgan

As a follow-up, I was just kind of curious on the corporate side, I heard your comments about 2010 in terms of infrastructure versus innovation but I was just kind of curious in terms of the near-term when you talk about some client stabilization -- where does the RFP get layered in [inaudible] -- are you starting to see RFPs starting to pick up with some of the customers who had not been buying, or are they just doing more kind of maintenance upgrades?

Mark V. Hurd

You know, Mark, I think it again depends very much on the region that we are talking about and I again want to make sure I am clear in delineating -- in Q1, which was our of course November, December, January -- we saw a very consistent set of results across the world in terms of countries and segments. We saw that change a bit in Q2 and we saw it change yet more in Q3. And so for us, it depends where you are talking about. The U.S. is beginning to do some refresh work and you are seeing that show up in the numbers. Things are still not as robust in Europe.

Jim Burns

Great. Why don’t we take one more question please, Operator?

Operator

Your last question comes from the line of Douglas Reid with Thomas Weisel Partners.

Douglas Reid - Thomas Weisel Partners

Thanks for taking my question, and my question is on the handset opportunity -- I am wondering if you could share with us what you may have learned from your experience with netbooks that may make you more or less likely to make a bolder move into handsets?

Mark V. Hurd

Well, I won't talk about anything about handsets because we obviously have a handheld business today but the netbook opportunity, as we call it the mini-notebook opportunity, has been pretty positive for us. It’s opened up not only incremental market for us but it’s also opened up an incremental market through an incremental channel, so when you look at what’s gone through the telco channel, this is a channel that frankly has not been in this market before and our success with some of the early launches in that channel have been pretty favorable.

The other piece that I think is important is because of the resiliency of our business model in PSG, we can do it in roughly the same margins that we do the rest of the business and so it’s an attractive adjacency for us and we are getting -- we believe we are getting to a new set of buyers. I won't say they are all incremental buyers but certainly some percentage of them are incremental buyers. So we are generally favorable on it.

Douglas Reid - Thomas Weisel Partners

Great. Thank you.

Mark V. Hurd

Thank you. Listen, thanks everybody, for joining us. I think the way I would summarize for us is the quarter was solid for HP, relative to our expectations going in. Certainly we beat the top line, we beat the bottom line. I think the cash flow, the margins being up 100 basis points for us on the strength of the cash flow and I think to Cathie’s point, we’ve generated almost $9 billion in cash flow in the last two quarters, was very strong.

We are encouraged I think by the stability that we are beginning to see in the market but not yet at a point that we are ready to call it a turn. I think we have seen improved stability and we feel good about that. We are confident in the outlook that we have given you today and I think probably more importantly, confident that of the potential we’ve got when this economy does fully turn around that we are well-positioned to take advantage of it.

So with that, I appreciate all of you taking the time to spend with us this afternoon.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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