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Hewlett-Packard Company (NYSE:HPQ)

F4Q09 Earnings Call

November 23, 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

William Shope - Credit Suisse

Katie Huberty - Morgan Stanley

Benjamin Reitzes - Barclays Capital

Richard Gardner - Citigroup

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Keith Bachman - BMO Capital Markets

David Bailey - Goldman Sachs

Shannon Cross - Cross Research

Scott Craig - Banc of America Merrill Lynch

William Fearnley - FTN Equity Capital

Brian Alexander - Raymond James

Operator

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

Jim Burns

Thank you. Good afternoon. Welcome to our fourth quarter earnings conference call with Chairman and CEO Mark Hurd and CFO Cathie Lesjak. This call is being webcast and 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 most recent Form 10-Q.

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 2009 10-K. 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.

With that, I will now turn the call over to Mark.

Mark V. Hurd

Thanks, Jim. Good afternoon and thank you for joining us. In the fourth quarter, Hewlett-Packard continued to execute, delivering solid performance while building for the future. Revenue of $30.8 billion was roughly $1 billion above our guidance. Sequential, we grew revenue 12%, while growing non-GAAP earnings per share to $1.14, demonstrating the leverage of layering growth on a reduced cost structure.

Year over year, we expanded non-GAAP operating margins by 170 basis points due to efficiency gains in services and IPG. We generated $3.4 billion of cash flow and deployed $2.1 billion in share buy-backs.

Services had another solid quarter, marked by strong signings and record profits. The EDS integration has gone well. We have removed roughly 19,000 of the identified workforce reductions and that work will soon be completed. Customer retention and satisfaction remain high. With a new competitive cost structure and the leverage of HP's global reach, services ended the fiscal year with strong momentum in signings and a significant number of new logo wins.

For the full year, signings were substantially above revenue and the book-to-bill ratio was both solid and improving. This bodes well for services growth in 2010.

Tech services also had another good quarter. The services delivery transformation is contributing nicely to profits and we still have more work to do to fully optimize that model. We've done a lot of work in services this year, integrating EDS and it is paying. This is now a business that can compete and win. We are well-positioned to grow.

IPG is poised for recovery and is getting on the attack. As we enter fiscal year 2010, the headwinds in channel inventory are behind us. We expect supplies growth to improve with economic trends and employment levels and project a flattish result in Q1.

Demand is also improving for our printers. We gained share sequentially and we expect to drive further share in installed base gains with double-digit printer unit growth in Q1. Due to improvements in our cost structure, we can do this while remaining within the 15% to 17% operating margins that we laid out at our analyst meeting in September.

IPG is also gaining significant traction with its growth initiatives. We deployed hundreds of photo kiosks this quarter at Walmart and look forward to further expansion in 2010. Recent studies released by market analysts highlight HP's leadership in management services, with more signings than any of our competitors. We are encouraged by our management services funnel, which is at record levels and these deals are generally from multiple years and have a high attach rate of supplies.

In commercial print, the analog to digital page shift is occurring and we are leveraging our technology to accelerate the transition. Partnerships with industry leaders like Pitney Bowes, R.R. Donnelly, and web press purchases from communication leaders Omnicom demonstrate the power of our portfolio and capabilities. We expect you will hear more partnerships from us shortly. With our significant market leadership and broad patent portfolio, we are well-positioned to capture this significant page opportunity.

ISS continued to build momentum. Revenues grew 15% sequentially on the back of 16% sequential growth in Q3. Customers are embracing our G6 servers, which provide roughly 12-month pay-back on upgrading from a G5 server and roughly a three-month pay-back when upgrading from a G4.

In my experience, any deal with a pay-back of a year or less is easy to close given the value to the customer.

The personal systems group also delivered in Q4, extending its market leadership by more than a full point yet again. We saw good consumer acceptance of Windows 7, particularly in the U.S. Given that we gained double-digit points of market share in U.S. enterprise and have claimed the top market position, we are well-positioned to win when corporations upgrade to Windows 7. PSG delivered healthy operating margins despite increasing commodity costs.

I mentioned to you numerous examples this quarter of how HP continues to effectively execute its strategy. Of course, a component of HP's strategy revolves around mergers and acquisitions. M&A enables us to enter market adjacencies and accelerate our time to market for key technologies. We use our strong cash position to enhance our portfolio of hardware, software, and services with acquisitions that advance our leadership position in a given market. Of course, all deals need to make strategic financial and operational sense when compared to alternative uses of capital.

Last week, we announced our intent to acquire 3Com. We looked at numerous networking companies and felt that 3Com had the best technology in the industry, in addition to having a very broad and complementary set of products. It's networking and security assets will be a tremendous addition to HP's products and solutions as we deliver the next generation data center to customers. 3Com will provide HP with the opportunity to grow in China and deepen penetration with an expand set of solutions into one of the world's fastest growing markets and we expect to accelerate the deployment of these products beyond China.

Before I turn the call over to Cathy to review the financials, let me make just a few comments as we head into 2010. First, we have worked hard on our cost structure to emerge from this economic downturn more competitively positioned. We have made significant progress in structurally reducing our cost structure in services, IPG, supply chain, warranty, real estate, and IT.

At the same time, we plan to increase investments in the business, in areas such as sales coverage. Going forward, we expect solid operating leverage just like we have demonstrated from Q3 to Q4.

Second, or portfolio is substantially stronger than when we entered the economic downturn. We are selling the best technology which we have continued to enhance with organically developed products such as G6 servers, touch smart PCs, and web-connected printers. Additionally, we have acquired companies like Left Hand and iBricks. EDS is an enormous assets which we are just beginning to leverage to sell not only services but also to pull through hardware and software. Upon acquiring 3Com, we expect to take our networking and security game to the next level. Additionally, this further extends our industry leadership in scaled hardware developed on industry standards, management software to optimize this infrastructure, all deliverable via global services.

As technology converges and is ultimately delivered as a service, nobody is better positioned than HP to capitalize on this trend, given our breadth and scale.

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. The economy remains challenging but we do see encouraging signs of recovery in certain markets. We will remain focused on executing our strategy and expect to outperform the market as growth returns.

With that, I'll turn it over to Cathie.

Catherine A. Lesjak

Thanks, Mark and good afternoon, everyone. HP's fourth quarter results again highlight the strength of our model. Our broad innovative portfolio continues to deliver significant value to our customers. At the same time, we are improving our competitive position and have prepared the company for growth in 2010.

Let's start with some details on the fourth quarter. Total revenue for the quarter was up 12% sequential and down 8% year over year, or down 5% year over year in constant currency. On a regional basis, excluding the effects of currencies, revenues in the Americas and Asia were each down 1% and EMEA was down 10%. In particular, the U.S. and China, which together represent more than 40% of total company revenues, are continuing to show signs of improvement. While Europe does appear to be stabilizing, we have yet to see consistent signs of improvement.

Gross margins for the quarter were 23.7%, up 60 basis points year over year due to efficiency gains in services and increased supplies mix in IPG. We continue to improve our cost structure, lowering operating expenses by 16% compared with one year ago and are doing so while continuing to fund innovation, sales coverage, and customer service. These lower costs are driven by structural changes that drive sustainable improvements. Non-GAAP operating profit increased to a record $3.6 billion with operating margin expansion of 170 basis points and net income hit a record $2.8 billion, or $1.14 per share.

For the full year 2009, we delivered revenue of $114.6 billion, non-GAAP operating income of $12.6 billion, or 11% of revenue and non-GAAP earnings per share of $3.85.

Now moving on to the details of our performance by business -- services closed the year with a strong finish in Q4 delivering revenue of $8.9 billion, up 5% sequentially and up 8% from the prior year. Within services, we saw sequential growth in each of our businesses with the strongest growth coming from application services.

On a year-over-year basis, operating profit in the quarter increased $500 million dollars to $1.4 billion, or 16.2% of revenue, driven by improvements in EDS as well as in technology services.

The integration continues to go well as a result of the focus and hard work of our employees. We have made good progress toward our goals for increasing or productivity and have improved our cost structure by an annualized run-rate of roughly $1 billion. And going forward, we expect to achieve an additional improvement of approximately $2 billion annually as I outlined at our September analyst meeting.

At the same time, we have expanded our book of business exiting Q4 with strong signings, including a healthy mix of new logos. Valet, one of the world's largest mining companies, is just one example of the power of the HP portfolio. Not only is this a big services deal but they are implementing HP's full portfolio from networking, blades, and storage, to HP management software to HP printers and PCs, all as a part of their new technology transformation process.

For the full year, bookings exceeded revenue by solid margins as customers recognize the value that HP's broad portfolio brings to their business. With a strengthened foundation and strong customer momentum, we feel well positioned to grow the business in 2010.

Enterprise storage and server revenue was $4.2 billion, up 13% sequential and down 17% compared with the prior year. Operating margin was 11.4%, down year-on-year but up sequential due to increasing volumes in ISS. While revenue in each of the business within ESS was down year-on-year, each grew sequential. Business critical systems and storage improved 6% and 11% respectively. ISS grew 15% as a result of strong customer demand for our newly launched G6 platform. G6 is the latest generation of proliant servers and incorporates innovations in software as well as the latest processors and chipsets.

With its compelling value proposition, we are seeing rapid adoption of this platform with approximately 60% of ISS sales now coming from G6.

HP software delivered revenue of $967 million, up 14% sequentially and down 15% from the prior year period. Compare with Q3, BTO and other software revenues were up 17% and 8% respectively. Sequential improvements were driven by increasing license revenue. For the quarter, software operating profit increased to a record $234 million or 24.2% of revenue.

Personal systems delivered revenue of $9.9 billion, up 17% sequentially and down 12% compared with the prior year. On a year-over-year basis, China delivered the strongest performance, with over 40% revenue growth.

Total unit shipments increased 8% year-on-year with notebook unit growth of 17% and desktop systems declines of 3%.

Average selling prices stabilized in Q4.

Segment operating profit totalled $460 million, or 4.7% of revenue as PSG continues to deliver solid performance and share gains, driven by our innovative product portfolio, scale, and global reach.

Turning to imaging and printing, IPG continues to deliver over $4 billion in operating profit annually with Q4 operating profit totalling $1.2 billion or 18.1% of revenue. In Q4, revenue improved 14% sequentially to $6.5 billion as printer demand begins to pick up. We are reinvigorating the core business by driving adoption in high page output areas such as wireless printing, office jet pro, and multi-function printers.

In addition, we are driving growth in long-term, high value annuity businesses such as managed print services and retail publishing. We have been expanding our retail publishing pilot with Walmart. We have begun to deploy our self-service photo kiosks at Walmart and this win, coupled with other major retail publishing wins such as Kesko, Duane Reid and K-Mart Australia represents a significant proof point in IPG's scaling of its contractual businesses.

Operationally, IPG is in much shape as it enters 2010. It has made significant progress in its cost structure, inventory management, and overall operational rigor. These improvements give us capacity to invest in unit placements while maintaining industry leading profitability. Going forward into Q1, we expect to have double-digit unit growth while at the same time delivering operating profit in the range of 15% to 17% as we outlined at our analyst meeting in September.

Rounding out the segments, HP Financial Services grew 5% year-on-year to $726 million and generated operating margin of 9.1%, up 170 basis points from the prior year. For the full year, financial services increased its return on equity roughly 100 basis points to over 12%.

Now on to the balance sheet and cash flow, our balance sheet remained strong and we made solid improvements in working capital management. We closed the quarter with total gross cash of $13.4 billion.

With regard to channel inventory, each of our segments is in good shape. Compared with a year ago, ESS channel inventory was down a week, IPG was down roughly a half a week, and PSG was flat.

Beginning in fiscal 2010, we will only report whether channel inventory is within the target range of roughly four to six weeks and we will provide further details in the event that we are outside of this range.

We generated $3.4 billion in cash flow from operations this quarter and $2.6 billion in free cash flow. During the quarter, we paid down $1.5 billion in debt and returned $2.3 billion to shareholders through continued share repurchases and our quarterly dividend.

For the full year, HP generated $13.4 billion in operating cash flow, $10.2 billion in free cash flow, and returned $5.9 billion to shareholders through share repurchases and dividends.

Looking ahead to our cash flow in Q1, the pay-out of the fiscal 2009 bonus will have an effect on our seasonally lower operating cash flow.

And now a few comments on our outlook -- for the first fiscal quarter, we expect revenue to be approximately $29.6 billion to $29.9 billion, and non-GAAP earnings per share in the range of $1.03 to $1.05. Included in these estimates for Q1 is approximately $0.04 of OI&E expense and an expectation that weighted average shares outstanding will be roughly flat.

In addition, as we outlined in our analyst meeting, we expect our tax rate to increase 1 point to approximately 22%.

Looking at the full year, as we reported on November 11th, we are increasing our fiscal 2010 outlook to revenue of approximately $118 billion to $119 billion and earnings per share in the range of $4.25 to $4.35.

We will now open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of William Shope of Credit Suisse.

William Shope - Credit Suisse

I wanted to dig a bit more into your share gains in the corporate PC segment. As you know, there have a lot of discussions surrounding the corporate refresh cycle for PCs in 2010 and as you look at this opportunity right now, do you think corporations are showing an increased willingness to swap out their incumbent provider as part of these refreshes and as we look forward, is pricing going to be your primary weapon for winning these engagements?

Mark V. Hurd

Yeah, I mean, the share increases are important -- again, I think it is important to note we don’t usually start with an objective of gaining share. It's more the result of us just trying to do the right work for the customer and I think as we mentioned a couple of times, we have increased our sales coverage, which we think is part of the reason that you have seen this performance occur as it has. Second, we've worked really hard to work on our service experience and the service experience is a really big deal, Bill, as you know. So it's a combination of trying to get more at bats and frankly in the U.S., this is the place that we haven’t had as many at bats as we'd like to have and we have increased sales coverage there. Secondly, trying to continue to focus on service, so yeah, we feel pretty well-positioned that as long as we can maintain the at-bat level and with the service experience that we are delivering now, that we think we will be in pretty good shape. I think you couple that with the product line-up that we have just announced and Windows 7, we think we've got a pretty compelling offer so yeah, we're optimistic about it.

William Shope - Credit Suisse

Just as a clarification, is EDS a contributor there as well?

Mark V. Hurd

Not really -- I mean, I think again, EDS is certainly an asset for us and EDS is managing a large number of desktops, several million desktops are underneath management of EDS services but I wouldn’t want to take away from the just simple execution I think in PSG -- more sales coverage, solid product line-up, great service, really is a good formula with or without EDS. I think EDS you should think of as really not an enhancement to it more than anything else, Bill.

Catherine A. Lesjak

Let me just add a quick point to what Mark said because it's not -- it's the end result, it is not the goal. But we did take on number one in U.S. enterprise and grew our share in calendar Q3 double-digits, so we are making good progress in that area and very well positioned for when there is a refresh cycle in the U.S.

Mark V. Hurd

I think if you looked back four quarters or so, Bill and you started looking at the service levels, what we call TCE or total customer experience, you could start predicting some of these numbers based on the improvement in TCE and as you start looking at the product line-up, it again -- it's the result. You have to work on these several quarters before he actual market share type of performance shows up but to Cathie's point, it's encouraging.

Operator

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

Katie Huberty - Morgan Stanley

In light of better visibility in the printer demand, the mix that you are driving in that business and the cost cutting you have in place, do you think you can grow both revenues and operating profit dollars in fiscal '10 or does the hardware growth come at the expense of op inc dollars?

Catherine A. Lesjak

The hardware growth does come at the expense of operating profit dollars but with the cost structure that we have developed and worked hard on, we are able to keep IPG within the range on the operating profit between the 15% and 17% that we outlined at the security analyst meeting in September.

Katie Huberty - Morgan Stanley

So in other words, if the printer growth comes in as you expect, you would model operating income dollars in sum for that division down in fiscal '10 versus fiscal '09?

Catherine A. Lesjak

Yes.

Katie Huberty - Morgan Stanley

Okay. Thanks.

Mark V. Hurd

Let me go up a level for you -- I think in many ways, the tough market has been a blessing for IPG. I think the business is now run with stronger operational rigor than we have ever had before. I think as Cathie mentioned, the inventories' been leaned out. Sales in and sales out are continuing to converge. We have made progress on the cost structure. Clearly we have more work to do. To the point of the question, printer demand is picking up and we plan to grow printers materially double-digits in printer units in Q1 while staying within the operating margins. So a little bit will depend on what the demand looks like and how we go for the printer unit growth. We will probably trade off, to Cathie's point, some operating profit dollars, no question about it but what we are talking about doing, we could not have done a year-and-a-half ago. We simply could not have done it at the magnitude that we are going to do it and frankly that in a strange way, the 2009 situation was a positive for us in that we knew this was coming. As we said through 2009, we saw strong page performance and strong supply usage through 2009. Now we have a printer refresh that is coming and we are putting ourselves in a position now to operate with strong operating margins while doing the refresh, so we feel pretty good about it and I know many of you have heard in the market, we've had some situations where we've got more demand than we have printers and we are now getting in a position where we can fulfill that demand.

Katie, I want to make sure it's clear - we feel we've got IPG on the attack and we feel better about it and if we have to trade off some operating profit dollars as we refresh that base, we will.

Katie Huberty - Morgan Stanley

And presumably the investment in 2010 set up for operating income growth in '11?

Mark V. Hurd

You know how the model works -- that's exactly how it works and the good thing as an entire company, we've got the room to increase our guidance to improve the operating leverage while doing this and we also are I think doing a better job of where the units are in high value areas with very strong connect rate and let's remember as Cathie went through when she talked about things, we've also got growth in retail photo, we've got growth in managed print services, we've got growth in graphics share, and these are areas with 100% -- let me say it this way, very, very high connect rates in addition to the fact that we can put the printer and unit growth out that we have described.

So when you look at the total picture, it's a nice picture than we had a year ago for sure.

Catherine A. Lesjak

And the investment is an easy decision. It has got such a high pay-off because of the high value units that we are putting out there and the connect rate that we are getting.

Katie Huberty - Morgan Stanley

Great. Thank you.

Operator

Your next question comes from the line of Benjamin Reitzes with Barclays Capital.

Benjamin Reitzes - Barclays Capital

You were able to have a pretty solid PC margin, at least within your guidance, in the wake of really tough component costs. Can you talk about how you are dealing with that right now and also just in general with that kind of component environment, what does that mean for gross margins that we are modeling for FY10 and is it impacting any other segment outside of PCs?

Catherine A. Lesjak

We saw commodity prices basically up-tick throughout Q4. We do expect that commodities are going to continue to be a challenge in Q1 and frankly this shouldn’t be too surprising -- it's a pretty normal cycle. In a recessionary environment, suppliers basically take capacity out of the market. Then when demand starts to pick up, obviously supply gets tight.

For HP with our scale and our position with suppliers, we believe we have a competitive advantage. We obviously also, as we have talked about from time to time, we do use strategic buys, either to generate assurance of supply or better pricing, so again we believe we've got a competitive advantage.

In fact, one of the factoids that I like to throw out there is that in tight supply situations, HP actually has been historically good at gaining more share and therefore we actually see this as an opportunity and you see that we have been able to manage margins very well. I think that's also because we have done a great job of focusing on getting our cost structure right.

Benjamin Reitzes - Barclays Capital

Is it just in PCs?

Catherine A. Lesjak

Pardon me?

Benjamin Reitzes - Barclays Capital

Is it just in PCs, the pressure, or is it impacting any other segments? And can you get -- and how does that play out throughout the year, you think?

Catherine A. Lesjak

We also obviously see it in industry standard servers, especially in the memory space. And again, you can see that we are managing through that pretty successfully as well when you see that the margins in ESS are actually up basically sequential even though commodity prices have continued to up-tick. So again, I think we have developed our cost structure very effectively so that we can compete -- be very competitive in the market and manage any kinds of commodity moves?

Benjamin Reitzes - Barclays Capital

Thanks a lot.

Operator

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

Richard Gardner - Citigroup

Thank you. Cathie, you talked about channel inventory to clients on a year-over-year basis but I was hoping that you could provide some sequential color on inventories this year as well, specifically how are you approaching the normal seasonal inventory build this year, given the uncertain economic environment? And are you doing anything differently? Are you erring perhaps a little bit more on the side of conservatism, recognizing that you are always trying to balance inventories with sales opportunities?

Catherine A. Lesjak

I wouldn’t call out any specific changes in how we are managing our inventory, whether that is channel inventory or owned inventory. I really don’t see a real different swing. Obviously we've got a forecast of what we think Q1 revenue is going to look like. You have seen the guidance that we have provided and so the area where I would say we are being prudent is around a recovery in the EMEA region, where we have seen basically Q2, Q3, and Q4 stabilization but we really haven’t seen kind of a consistent up-tick through Q4. So we are being a bit prudent there but in general, the swing around what we are doing with channel inventory or owned inventory is not a whole lot of different than it's been in the past.

Mark V. Hurd

I think to add to it, we exited Q4 pretty lean from an inventory perspective and so right now we are doing exactly what you described. I think we are a little more -- I guess prudent would be the right word in Europe. We have seen stories within the story in Europe, so I wouldn’t call it everything is the same but there are some opportunities in the U.S. and Asia, and so I think we are trying to take a balanced view of managing our assets properly at the same time as we look for opportunities to grow as you described. So I think no real change in the way we have looked at it but we did exit with a fairly attractive position as it relates to overall inventory.

Richard Gardner - Citigroup

Okay, great. Thank you.

Operator

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

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Perhaps related to that last question, I wanted to get a sense of how we should interpret your guidance for Q1. Typically you are flattish to slightly up sequentially from Q4 to Q1 if you take out 2009. You were up three of the four previous years in Q1 versus Q4. You are guiding down about 3% and currency is probably going to help a couple percent so arguably you are five to seven percentage points below normal seasonality. Is that a reflection of being prudent around Europe or is there something else we should think about?

Additionally, just [in another context], you did raise your guidance for the full year $1 billion in terms of the range. It feels like currency has actually probably moved more than that since then so has your outlook or your perception of what HP can do competitively in the marketplace changed at all?

Catherine A. Lesjak

There seemed to be a lot of questions in that one so let me take some of them -- let me take the last one first, so that there is a complete understanding of what we have done for our outlook for the year. So the currency environment is absolutely more favourable today than what was implied in our security analyst meeting guidance for the year. But currency is always hard to predict, so what we have done is we have updated Q4 -- I'm sorry, Q1 for the current currency environment but we have left Q2, Q3, and Q4 basically at the FX rates implied at the time we gave the forecast at the security analyst meeting. So to the extent that currency stays where it is today, net of any pricing actions that we need to take, we would expect there to be upside in revenue and the respective drop that you would expect from that for the year.

In terms of your question around Q4 to Q1 seasonality, when you factor in EDF, we actually -- the normal sequential seasonality is probably closer to down 2 and therefore we are down -- in our guidance, we are down 3% to 4%. And that really comes right back to the comments we made around the EMEA and the macro demand in EMEA and feeling that we should be prudent about calling a recovery there when we have yet to really see that through Q4. Again, Q2, Q3, and Q4 were roughly the same. It stabilized but we'd like to see an up-tick before we start calling for that, so that is really what is driving the Q4 to Q1 guidance.

Mark V. Hurd

I cannot really add much color to that -- that is what it is. I mean, we are basically in a situation where we feel as good about our portfolio and our market position as we ever have, so make no mistake about that -- if you talked about our view of our competitive position, it just has never been stronger. But for us, we've got to factor EES into the sequentials and for us, I think you'd see us be more bullish if we had seen signs in Europe that were consistent over a period of at least a quarter or two where we would see the sequential improvement. It doesn’t mean we haven’t seen a few things -- it's just not there long enough for us to start to call it, so I think it's what we described and hopefully it's a little bit better than that but right now, we think this is prudent guidance for us to give. And to your points, exactly right -- Q2 and Q3, Q4, we are not putting the currency in until we see it for a longer period of time.

Operator

Your next question comes from the line of Keith Bachman with BMO Capital Markets.

Keith Bachman - BMO Capital Markets

I wanted to ask a follow-up question on the printers, if I could -- Mark or Cathie, could you just talk on what the impact was on printer inventory or availability and the impact of the supply in the October quarter, rather -- specifically supplies, what was the push or help from inventory? And then also on the laser jets, we detected many stock-outs through the October quarter -- how much did it impact you in related markets? Will you be all caught up do you think in the January quarter when you talk, in laser jets specifically, when you talk about double-digit unit growth?

Mark V. Hurd

Keith, you are exactly right -- we had -- we were short of availability in what was our fiscal Q4. We are catching up. I think that is the way I would word it. We are catching up. I would not describe us as caught up. So we are getting there. We are making improvements by region and it's getting better.

I would say now that one of the issues we have had has been that order rates have continued to be strong even though shipment rates are catching up, so if you will, we still have a backlog that we are trying to clear to get within normal backlog corridors. Do I think we will be all caught up in Q1? And I think the way I would describe it is -- I think so. The only thing it will depend on is what the order rates are. If the order rates continue to be as strong as we have seen, it will still have some backlog issues at the end of Q1. I actually in some ways hope the order rate continues to be strong but we are trying as best we can to catch up.

Did it affect us in Q4? It did not affect our performance relative to guidance because we knew what we had in Q4 at the time that we guided. But to your point, if we had had more availability, we would have performed better in Q4 because the demand certainly was there.

Keith Bachman - BMO Capital Markets

Thank you.

Operator

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

David Bailey - Goldman Sachs

Could you give us a little more detail on the linearity you saw throughout the quarter and maybe into this month as well? And then some detail around the industry verticals, strength or weakness?

Mark V. Hurd

Well, we only talk about the quarter we are reporting, so imagine whatever I tell you will end at the end of October and so David, I think the way you would describe it is linearity was good. We had a very sort of consistent start to the quarter but as you can tell by our performance relative to guidance, we obviously had a strong October. So October was strong and stronger than what we had forecasted and that showed up. It also impacted our inventory because we forecasted a certain outcome and that is one of the reasons why we have the lean inventory position we have going into Q1 as we do.

David Bailey - Goldman Sachs

And then on the industry verticals -- any strength or weakness there?

Mark V. Hurd

No, I think that the industry verticals started to see -- you saw some improvement by vertical. I don’t think I will start calling each one out but we definitely saw some improvement across sort of each of the verticals. I think the bigger story rather than the verticals would have been what we saw by geography, which I think we have probably given enough color on today relative to the big geographic regions.

Operator

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

Shannon Cross - Cross Research

Mark, can you talk a little bit about the 3Com acquisition, provide some more color, what your thoughts are regarding the strategy? And then just any other thoughts you have with regard to future acquisitions?

Mark V. Hurd

We've had a strategy around converged infrastructure for some period of time and that for us is the inability to give customers the opportunity to see server, storage, and networking all sort of working together in a common capability that we can deliver to customers, either as a service or directly to them. So our strategy has been consistent and we think the right one. We want to continue to align software to that converged infrastructure and we want to align services to that converged infrastructure, so very important for us to get all that right.

Networking is certainly a key component of that strategy and as you know, we have been out in the market with [Procurve] for the past couple of years and had very strong growth with [Procurve] and strong share gains. We've had products on the edge of the network and a wireless product in the market that have both been quite successful.

I think the number one thing we get back from customers is to -- they would like us to do more. They would like us to have a broader portfolio with more capabilities, leveraging the strategy that I have described. And so for us, adding to that portfolio was a key strategic objective of ours to get done.

So to be simple about it, the best technology we saw on the planet to complement our portfolio was 3Com and so for us, we did a lot of work, Shannon -- I mean, we looked at a lot of different things. We tested technology both with our services business. You can imagine EDS has a ton of experience with this. Our own IT organization, which has a lot of experience, and our Procurve engineering organization and we just found exciting technology that we think can make a big difference in the market.

So for us, that is what we saw and remember too that we have a Procurve networking business, we hope to go through the appropriate processes to get this deal closed, which it is not yet. But you have to add to it the virtual connect software that comes typically to the market through our blade and converged infrastructure business and the server market, so we think with Procurve and with what we get through the 3Com acquisition added to our virtual connect software, we now bring an extremely robust networking solution to market both from trying to reduce the number of ports that customers have to buy but added to it the fact that we can bring great technology for the ports that the customers do have to deploy. So we are very optimistic, obviously very excited about it and we are just going to go through the process to try to get the acquisition closed and get the work done to get it to market.

Shannon Cross - Cross Research

Thanks.

Operator

Your next question comes from the line of Scott Craig with Banc of America Merrill Lynch.

Scott Craig - Banc of America Merrill Lynch

Mark, in the services business, it's been a couple of quarters now where you are 15% to 16% -- actually your goal for the fiscal year is 15% to 17%. But with all the cost savings there, does it seem like you are being a little bit conservative there?

Mark V. Hurd

It never seems to me that I am being conservative, so I actually think I am being awful balanced about it. But I think the way you should think of the services business is it is a portfolio business. So particularly in the services business where you think of the outsourcing services, there are a portfolio of five years of deals typically in what is in your P&L and the fifth year is usually a better economic result from a P&L perspective than year one when you are going through the transitions. So in order to get a proper view of what the business can do, you had to have a view of how much growth you are bringing, how many new signings you are bringing, how many deals you are transitioning at the same time as you are looking at that year five portfolio and then all of the steps in between. So when we give guidance, it is a combination of all those factors simultaneously.

Now, at the same time to your point, yes, we are going on an optimized cost structure. Now, Cathie and I gave you the positive of the amount of work we have done. We still have more to do, Scott, so there is still more cost savings to gain in EDS, the former EDS, through the business and we've got more work to do at technology services as well.

So do I think that the business can continue to improve? The answer is yes but that said, we are balancing it against the growth profile and we have done a lot of work in our services business this year to get the cost structure right to put it in a position to do what you began to see it do in Q4, which is grow and sign meaningful deals with very important customers who are betting on us over the next five years to help them transform and we hope for years to come and drive their IT.

So we feel awful good about it and we think we can deliver in the range we have describe and be able to grow very effectively while we do it.

Scott Craig - Banc of America Merrill Lynch

Mark, is there any thought to giving some metrics on the book-to-bill ratio or backlog or stuff like that, like some of the competitors do? And that's it for me, thanks.

Mark V. Hurd

Well, we think we give the most important metrics right now, which are revenue and operating margin. There are always metrics that we can drive to give color. Right now, we think we are giving the most important ones and the most meaningful to the marketplace. We are always hoping to input to add to it. We also try hard not to give so many metrics that we actually wind up confusing people. So -- but we will always it into consideration. Thanks.

Jim Burns

Why don’t we take two more questions, please?

Operator

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

William Fearnley - FTN Equity Capital

If I could ask another question on printers and IPG, Mark, how much more promotional will you be to drive better unit sales for laser and inkjet here, and will you be more promotional with the channel or end users on supplies to help fill the pantry or supply closet with more ink and toner, because it sounds like the pantry effect is still a headwind. And to stay on Jim's good side, I won't ask a follow-up.

Mark V. Hurd

Thanks, Bill. Yeah, listen, I think we are going to be out there. I hope you see us out there now. We are out there promoting. It's been important for us, Bill, to get our availability issues right. Demand for printers, the worst thing you can do is promote and then not be able to fulfill, so we've been trying to make sure we can fulfill and it's been a lot of work in IPG to get things lined up to be able to do what we just described to you a few minutes ago, we are going to do it in Q1. So right now, we think we have supply right. I do harken back to the earlier question about make sure we have got -- I think it was Keith's question about making sure that we've got enough laser inventory because order rates as we promote go up and we've got to make sure we can fulfill. But yeah, we are going to be out there promoting with the channel and with our partners. We think there's an important printer refresh coming and to Cathie's point, we think it is coming in the light usage areas that become very attractive to us from a long-term perspective. So we are going to be out going after it and we are pretty excited about it.

William Fearnley - FTN Equity Capital

Will you be more promotional on ink as well though?

Mark V. Hurd

Yes, we will be promotional on ink. I mean, we think at the end of the day, your point is correct, that there is a pantry effect but now let's -- I don’t want to get you confused on this. From an ink perspective, we saw reasonable ink sell-out even through all of this. Now remember, the external numbers have to converge now with what we have been seeing, so do we think there is more ink usage that is out there? We do. But at the end of the day, we'll be more promotional but I don’t want you think that we think that the growth rate's improvement in ink are directly the same as the improvement in units, so we had people not buying units all through last year. They still were buying ink. Do we think there will be an improvement in ink and supplies? We do as the economy improves, as employment improves, and as the pantry effect takes place. But again, we've got to go get that refresh at the same time and we think there's some important segments that we can grow in ink at the same time.

Operator

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

Brian Alexander - Raymond James

Another question on the networking market, Mark -- in your expanded presence in networking, how do you think about the financial model there longer term? Do you strive for 50% to 60% gross margins or do you think that is unsustainable? Just curious how you are thinking about just overall margins and returns in that segment relative to other hardware categories that you operate in today. Thanks.

Mark V. Hurd

Well, when you sit where we sit, Brian, any of that sounds attractive to us, so those gross margins are extremely high and we think we will be very competitive. We think we bring to it a supply chain that can give some advantage to networking businesses as well to our other businesses that will actually give it the opportunity to make yet more gross margin than it does today, at the same time as we will try to be competitive in the market. You've got one competitor that is very high market share but frankly you also have a lot of other competitors that have a lot of market share out there as well. It's not just the one company out there. So we think we've got an opportunity to bring some very, very attractive technology to the market, supported by our software business, supported by our services business, with an advantaged supply chain supporting it and so for us, we think it becomes a very attractive accretive gross margin opportunity for us, at the same time as it does something very important to customers that they want us to do for them. So for us, it makes a lot of sense and we will see how the gross margins work out as they do but again, it's very accretive and very attractive to us.

So why don’t we close on that and we appreciate all the questions. I think again obviously we had a strong quarter relative to as we talked at the end of Q3 but I would say going into 2010, we feel well-positioned. The economy is clearly more stable. We've gone through the EES integration and we feel integrated it well. We've got a sales force that we think is better and more prepared. We've already kicked off the year with our sales force to get them we think moving on the attack and we've talked about some of the improvements we've made in market position. We've made an acquisition with 3Com that we are very excited about. We feel like we've got IPG positioned to go on the attack and get in an advantaged position. Our inventories going into the year are lean and we see an opportunity to return the company to growth in 2010, leveraging on what we think is an improved operating model.

So we've got a lot of work to do. We know that but I would tell you we go into the year certainly feeling good about our position to deliver a strong 2010. Thanks again.

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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Source: Hewlett-Packard F4Q09 (Qtr End 10/31/09) Earnings Call Transcript
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