Hewlett-Packard F1Q08 (Qtr End 1/31/08) Earnings Call Transcript

Feb.19.08 | About: HP Inc. (HPQ)

Hewlett-Packard Co. (NYSE:HPQ)

F1Q08 (Qtr End 1/31/08) Earnings Call

February 19, 2008 5.00 pm ET

Executives

Jim Burns - VP of IR

Mark Hurd - CEO

Cathie Lesjak - CFO

Analysts

Ben Reitzes - UBS

Richard Gardner - Citigroup

David Bailey - Goldman Sachs

Tony Sakanagi - Sanford Bernstein

Bill Shope - JP. Morgan

Andrew Neff - Bear Stearns

Shannon Cross - Cross Research

Brian Alexander - Raymond James

Katie Huberty - Morgan Stanley

Louis Miscioscia - Cowen and Company

Scott Craig - Banc of America

Jason Nolan - Robert Baird

David Wong - Wachovia

Operator

Good day, ladies and gentlemen and welcome to the first quarter 2008 Hewlett Packard Earnings Call. My name is Melanie and I'll be your coordinator today. (Operator Instructions).

I would now like to turn the call over to Mr. Jim Burns Vice President of Investor Relations. Please proceed sir.

Jim Burns

Thank you, Melanie. Good afternoon, and welcome to our first quarter earnings conference call with Chairman and CEO, Mark Hurd and CFO, Cathie Lesjak. This call is being webcast live 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 Form 10-K for the fiscal year ended October 31st, 2007. 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 amount ultimately reported in HP's 2007 Form 10-Q for the fiscal quarter ended January 31, 2008.

Earnings, operating margins and similar items at the company level are sometimes expressed on non-GAAP basis and have been adjusted to exclude certain items including amortization of purchase intangibles and restructuring charges. The comparable GAAP financial information and a reconciliation of non-GAAP amounts to GAAP are included in the tables and in the first quarter earnings slide presentation accompanying today's earnings release, both of which are available on the HP Investor Relations webpage under company information at hp.com.

Finally, please refrain from asking multi-part questions or clarifications during the Q&A. And I'll now turn the call over to Mark.

Mark Hurd

Thanks Jim, we in the room are always motivated with Jim's opening, so got to pass that to you, good afternoon and thanks for joining us.

HP delivered a strong first quarter. We had balanced growth and profitability across all regions and gained share in key market segments. Our performance continues to be driven by three important factors, significant cost savings to both fund our growth and expand our earnings. Two, our deployment of additional sales resources to capture incremental opportunities in the enterprise and mid-markets, and three diverse global customer base and a broad portfolio that's aligned with the growth areas of the market. Let me be clear, our cost savings are significant and ongoing.

Now let me walk you through some highlights for the quarter. Revenue was up 13% to $28.5 billion. Non-GAAP EPS was $0.86 and that's up 32% versus the prior year period. HP generated $3.2 billion of cash from operations, which includes the payment of considerable annual employee bonus commensurate with our strong 2007 performance and we returned $3.3 billion to shareholders through share repurchases. In addition, we announced our intent to acquire Extreme Software, a leader in variable data publishing solutions.

Next, I will give you a few of my thoughts on the state of the business and then Cathie will review the numbers. PSG continued to generate strong results by expense discipline and our investment in blade solutions, management software and data center services. PSG grew revenue 10% and expanded operating margin 2.5 points versus the prior year period. I am pleased with our improved performance in this business and content that we can execute against the significant opportunities that remain.

The Imaging and Printing Group delivered revenue of 4% and operating margins of 15.7% in the quarter. IPG results show strong execution in our core ink and laser business and solid growth in both the Graphic Cards and the Enterprise.

PSG produced another excellent quarter, growing revenue by 24% and expanding operating profit 52%. Our commercial business delivered strong revenue and margin performance, augmenting our strength in consumer, notebooks and emerging geographies.

According to the fourth quarter industry data, emerging geographies accounted for nearly half of the PC units shipped in the market and over 60% of the growth. Our results reflect this trend and we are expanding our presence in these developing economies.

Now I'll turn it over for a little more depth on the numbers.

Cathie Lesjak

Thanks, Mark, and good afternoon everyone. Before I get into the numbers, I just want to briefly touch upon our financial reporting item. Each year as part of our first quarter annual financial review, we review our reported segments and make changes between these segments to reflect any organizational shifts between the businesses.

As indicated in our Q4 call, beginning in FY '08 the Business Intelligence and Information Management businesses have moved into HP Software from ESS and Services. As a result of this change, the revenue and operating profit and loss associated with these businesses have been moved from ESS and Services into HP Software.

I'll discuss the impact to HP software P&L more fully in a few minutes when I talk about the segment results. Additionally, there are changes in PSG and IPG, but with no net change at the segment level.

Our detailed bridge of these changes, including historical data, is available on our investor relations website, as well as furnished on our Form 8-K filed with the SEC. I want to be very clear that the changes do not impact HP's previously reported consolidated net revenue, earnings from operations, net earnings or EPS. This should just be viewed as an annual fine tuning of our financial reporting structure to better align it with how we manage the business.

Now moving on to the results of the quarter, HP began fiscal 2008 with solid performance and balanced operating profit growth. Revenue for the first quarter totaled $28.5 billion up 13% year-over-year or up 8% in constant currency. Non-GAAP operating profit grew 31% to $2.8 billion or 9.9% of revenue.

Looking at revenue by geography, Asia-Pacific grew 22%, EMEA was up 15% and Americas increased 8%. We generated 69% of total revenue outside of the US, with emerging markets driving significant growth. First quarter gross margins were 24.5% compared to a year ago gross margin was up 80 basis points, driven by a generally favorable commodity environment, disciplined pricing and improvements in warranty and attach.

Non-GAAP operating expenses for the quarter were $4.1 billion or 14.6% of revenues, down from 15.1% a year ago. Adjusting for currency, expenses were up 6%, as we added sales and go-to-market resources and absorbed acquisitions. We will continue to align our cost structure for greater efficiency and growth.

Non-GAAP OI&E yielded income of $72 million or roughly $0.02 per share. Our non-GAAP tax rate was 21% in Q1. First quarter non-GAAP EPS was $0.86 up 32% from the $0.65 that we reported one year ago. GAAP EPS was $0.80, which included $158 million or $0.06 per share in after-tax adjustments, primarily related to the amortization of purchased intangibles that were excluded from our non-GAAP results.

Now drilling in on the performance by business segments, during the first quarter, Imaging and Printing had revenue of $7.3 billion, up 4% year-over-year. Excluding cameras, revenue was up 5%. Supplies revenue grew 6% and Commercial hardware revenue grew 7%, while Consumer hardware revenue declined 5% year-over-year.

Segment operating profit was $1.2 billion or 15.7% of revenue, reflecting gross margin expansion and favorable product mix. We continue to see solid momentum in our growth initiatives. Our Graphic Arts business grew in double-digits and color laser and multi-function printer units grew 14% and 23% respectively. Commercial hardware units increased 13% and consumer hardware units declined 2%.

We continue to focus on targeting unit growth in areas of high supplies consumption. But do believe that we had more unit opportunities than we realized in Q1. Going forward, we expect to at least maintain shares in the mature inkjet markets and see additional opportunities for growth in targeted areas, such as Graphic Arts and Enterprise Printing.

Within IPG we are also focused on reducing the cost structure and have a number of ongoing initiatives to improve supply chain efficiency and lower product cost. At the same time, we will continue to invest for growth and profitability through our commitment to research and development, targeted share gains, growth in Graphic Arts and expansion of our Enterprise Printing sales force.

Personal Systems had another outstanding quarter with market share gains and strong margin performance revenue grew 24% year-over-year, or $2 billion with unit shipments up 27%.

We had a strong holiday season with consumer client revenue up 29%, consumer notebook sold particularly well, demonstrating our strength, our strong product lineup, targeted marketing and the strength of our retail channels.

Commercial client revenue grew 22%, reflecting solid demand in enterprise and mid-market segments. Overall, notebook shipments grew 49%, with strong performance in both Consumer and Commercial. Desktop and workstation units were each up 15%.

Segment operating profit for the quarter was $628 million, or 5.8% of revenue. Compared with the prior year period, PSG operating profit increased 52%, or $214 million reflecting solid execution, increased attached and the benefit of a favorable commodity environment.

You should expect us to continue to balance revenue growth and profitability by managing our costs, investing in market opportunities and leveraging our strength in notebooks, retail and emerging markets.

Moving onto Technology Solutions Group, Enterprise Storage and Servers revenue grew 9% year-over-year to $4.8 billion. Within ESS, Industry Standards Server revenue grew 11% and ESS blades grew 81%.

Revenue in storage grew 10%, with the midrange EVA business growing 14% and the [Nearline] business posting 4% growth after many quarters of declining revenue. Business critical systems revenue grew 1% year-over-year, Integrity server revenue grew 37% and now represents 75% of BCS mix.

ESS operating margins for the quarter were 3.8 points to 14% of revenue, filled by favorable component pricing, improved execution and expense discipline. While we are pleased with the progress we've made, we can still do a better job penetrating our addressable market. You'll see us take actions to drive go-to-market initiatives and add sales resources to expand account coverage and strengthen our customer relationship.

We had a solid quarter in HP services, with revenue up $4.4 billion, up 11% over the prior year period. Outsourcing and consulting and integration revenue increased 15% and 13% respectively, while technology services revenue was up 9%. Operating profit for the quarter was $489 million or 11.2% of revenue.

We remained focused on balancing margin expansion with revenue growth. Our services results reflect improved focus on services attach, combined with operational improvements from our ongoing efficiency initiative. We've made progress reducing our cost to service delivery, but we still have considerable work to do.

As I discussed earlier, beginning in Q1 we are reporting Business Intelligence and Information Management businesses as part of HP Software. On this basis HP Software revenue was $666 million, up 11% from the prior year.

BTO, formally reported as OpenView increased revenue 19% to $548 million and other software, which includes OpenCall, Business Intelligence and Information Management had revenue of $118 million. Q1 operating profit for the segment was $51 million or 7.7% of revenue. For comparative purposes HP software would have reported revenue of $611 million and operating margin of 12.7% of revenue, if we had excluded the impact of business reclassifications, but included the impact of acquisitions. We have included a slide in the presentation that provides historical bridges for the business reclassification.

The software business includes the combination nascent and scaled businesses. We are pleased with the progress the BTO organization is making in integrating Opsware and expect to grow this business, as we help customers manage their IT infrastructure. At the same time, we're expanding our Information Management and Business Intelligence businesses by investing in our solution portfolio and go to market presence.

Similar to last year, we expect to expand profit margins as the year progresses and are comfortable with the 20% to 22% operating margins for FY '09 that we outlined at our analyst meeting in December.

Finally, HP Financial Services had revenue of $642 million, up 17 % year-over-year and generated operating margin of 6.7%. We are encouraged with the growth in our core financing volume and portfolio assets over the last several quarters, as well as the strong performance in end of lease renewals and equipment sales.

Moving now to the balance sheet, HP-owned inventory ended Q1 at 33 days of supply, this is down six days compared with a year ago reflecting our focus on improving execution and working capital management. With regards to channel inventory, we ended the quarter with PSG and ESS down roughly half a week year-over-year and IPG flat year-over-year.

Days sales outstanding increased to 39 days in Q1 from 37 days one year ago, days payable was 47 days, down from 53 days last year. As we've discussed in prior quarters, we will continue to leverage our balance sheet to drive shareholder value.

Next, property, plant and equipment was up $759 million year-over-year and down 20 basis points, as a percentage of revenue.

Gross CapEx was $611 million, down 15% year-over-year. On a net basis, CapEx was $523 million, down 10% from the prior year period. Capital expenditures were primarily related to assets used in our leasing business and our investments in IT.

Moving on to cash balance and cash flow. Strong operational performance combined with ongoing focus on working capital metrics resulted in Q1 cash flow from operations of $3.2 billion and free cash flow of $2.7 billion. Included in these results was the significant FY '07 annual bonus, which was paid out in the first quarter.

In addition, we spent $3.3 billion on share repurchases during the quarter. Relative to prior quarters, the linearity of repurchases in Q1 was backend weighted. At the end of the quarter, we had roughly $7.4 billion remaining in the current share repurchase authorization.

Finally, we paid our normal quarterly dividend totaling $206 million. We closed the year with a strong balance sheet including total growth cash of $10.1 billion and net cash of $2.9 billion.

Now a few comments on our outlook for both the second quarter and the full fiscal year. We expect Q2 fiscal 2008 revenues to be approximately $27.7 billion to $27.9 billion. Similar to last quarter and in light of the increasingly tough compares in PSG, we do not believe it is prudent to set investor expectations that our personal systems business can continue to grow at this pace, nor do we think it appropriate to build the cost structure on that basis.

Given our significant international exposure, our results may be favorably or unfavorably impacted by currency. Assuming exchange rates stay roughly where they are and given our assumptions about hedging and pricing we expect full year revenue will be approximately $113.5 billion to $114 billion. Regarding earnings there are few variables to keep in mind. First we expect the component pricing environment to be less favorable in Q2 than it was in Q1.

Second we estimate non-GAAP OI&E to be about $0.01 per share in Q2 and approximately $0.07 for the full year 2008.

Finally we expect to continue to repurchase shares in the coming quarters, however likely at a lower rate than in Q1. Share count will be impacted by the share price trends, option exercise patterns, common stock equivalents and repurchase activity. Currently, we expect the somewhat steeper decline in Q2 and a more modest decline in weighted average shares outstanding in the second half of the year. With that in mind we expect Q2 '08 non-GAAP EPS in the range of $0.83 to $0.84.

For the full year we expect non-GAAP EPS to be in the range of $3.50 to $3.54, representing growth of 19% to 21% on revenue growth of about 9%.

So, all in all we delivered solid results in Q1 and increased our outlook for the year, reflecting the strength of our business model and our progress today.

Before we go to Q&A I'll now turn it back over to Mark for a few additional comments.

Mark Hurd

Thanks Cathie. Well I realized that macro economic uncertainties exist, its important to note that we control many of the levers that drive our performance. We are therefore confident in our ability to neatly expand our earnings per share. We expect to remove significantly more cost this year than we did last year. We will take this savings and realign our cost structure to fund investments that both improved the efficiency of HP and create growth opportunities. Combined with our strong balance sheet, broad geographic reach and considerable recurring revenues, these factors allow us to constantly raise our EPS guidance.

With that Cathie and I will now take your questions.

Jim Burns

Okay. Let's take the first question, operator.

Question-and-Answer Session

Operator

Our first question comes from the line of Ben Reitzes with UBS. Go ahead.

Ben Reitzes - UBS

Yeah. Good afternoon, and good quarter. I wanted to just talk a little bit about the macro economic environment. I mean, going into the quarter, there was a lot of speculation about things having slowed in January, et cetera, and your guidance is obviously indicating that. And I am just wondering if you can confirm any linearity in the quarter? And also just talk, perhaps, a little bit more about how you control your own destiny? Maybe acknowledge share gains, or something that gives you confidence, or a little more that gives you confidence on the raising guidance, given the economic backdrop?

Mark Hurd

I will start, Ben. Thanks for the question, and thanks for your comments. I think we saw a pretty good linearity at the HP level during the quarter, and there was no story in terms of one month being better than the others, so it was pretty smooth. I'll try to give you a little bit more color. Obviously, we have a good position from a geographic deployment perspective. So, when you look across our segments and our businesses, we really had solid growth across all businesses and regions. Again, 69% of our revenue was outside the United States, so again I think that's probably an asset.

And again, in the U.S., Ben, I am giving you a little more color than your question, but I'll try to give you a little bit more insight. We've got multiple stories to go on, remembering it's only 31% of our revenue. I say only, but relative to what you see in some tech peers, we have an enterprise business, but frankly we're putting more go-to-market resources in, and there is an effect to a degree of that investment in growth. And frankly, we are putting more effort into the US than we have in the past. So, I'm not sure we're the best person to compare specifically year-over-year comps, because of the effort we are putting in to improve our position.

So, I would tell you in the US, at the end of the quarter, we saw a little bit more caution in the consumer segment than what we've seen in the past. But again, I tell you that in the context of the big picture on a global basis, we saw pretty steady growth across all of our businesses and segments.

And Ben, clearly there are stories within the story. On the EPS raise of guidance for us, part of it, frankly, the fact is the good news is we have lot of work to go do. The bad news is we have a lot work to go do, and we just got to get after getting it done. I think as we outlined in the Security Analyst meeting, we've done a lot of work on corporate overhead. We have a lot of work to do on some of our business unit owned processes, where a lot of our cost is, and as you've heard us say before, we're dead serious about getting this right, and we think getting this right puts us in a very strong position to go after the market and compete. And I can't comment on share gains, because I just don't know all of data yet, I only know frankly ours.

Ben Reitzes - UBS

Okay. Thanks a lot, Mark.

Cathie Lesjak

The only thing I would add to that, Ben, is just that, we have built capacity in our plans for fiscal '08, so that we can adjust if the demand isn't there that we are expecting. And we really have a good line to follow-up on some of Mark's comments, a good line of sight on our cost cuts. That combined with the investments that we have made to, frankly, improve our position in accounts, in terms of the share of wallet, and our recurring revenue, it gives us a lot of confidence in our EPS guidance.

Ben Reitzes - UBS

Thank you very much guys.

Jim Burns

Thanks, Ben. Let's take the next question please.

Operator

Our next question comes from the line Richard Gardner with Citigroup, go ahead.

Richard Gardner - Citigroup

Okay. Thank you very much. Mark and Cathie, the thing that struck me from a product perspective this quarter was that supplies revenue growth actually accelerated, despite the fact you had a tougher year-over-year compare, and it looked like you were actually a little bit better than seasonal norms for the quarter. And I was wondering if you could give us a little bit of color around what's driving the strength in supplies revenue growth, and whether it was toner or ink, et cetera?

Mark Hurd

I know no meaningful difference between toner and ink trends Richard in the quarter. Again, we have the benefit of a large install base. I mean, during the quarter we shipped our 500 millionth printer. And so, when you look at this, the pure scale of the business and the size of the install base it's a big one and as you know we've invested from a unit perspective into that base for a while. Now, let me give you some further color, when you look at camera and you look at the appliances and we were very cautious, as we mentioned in our previous call, about appliance placements. I am giving you a full year characterization here, Richard, roughly two to three points, I would say, growth headwind. And I want to say one more time growth headwind for IPG in rationalizing those two categories through the portfolio.

So, again, I would ask you, Richard, to take IPG in the context. There are pretty radical transformation we're doing inside IPG. We're working on a lot of cost that we're trying to take out of the business. We're investing in growth markets that are giving us subsequent growth that, Cathie's point, that she mentioned Graphics and the Enterprise, performed very nicely from a growth perspective for us in the quarter. So, we're taking money and investing in those categories and it is showing up. At the same time, as we have a core business, we're sort of picking our spots, as to where we feel makes sense to work on.

Now, as Cathie also mentioned, and I'll follow-up on that, that we had some inkjet placements in the quarter that we could have [made then] from a unit perspective. So, we had some tailwind, some headwind because of the appliances, but we could have done better than we did, and just to be very blunt, I am not real happy about it. So, there is more work for us to yet go do.

Richard Gardner - Citigroup

Great, thanks Rich. So let's take a next question please.

Operator

Our next question comes from the line David Bailey with Goldman Sachs. Go ahead.

David Bailey - Goldman Sachs

Great, thank you, just sort of follow-up on that. Your overall printer unit growth has come down four quarters in a row, and given the weakness that we see in inkjet demand across the industry, should we think this is a trend that should continue? Or are there some reasons that you should start to see some stabilization or rebounding growth, as we go through the year?

Mark Hurd

I will make couple of comments and Cathie can follow-up. I sort of tried to give you that, even actually in Richard's question; I mean we reported 1% unit growth. There is couple of points in unit growth tied up in the appliance piece. Remember, that the laser growth in the quarter was 13%, so very significant double-digit laser growth. So, when you think a couple of points on the inkjet side, our total units would have come back through the appliance side, plus we left a couple of points on the table that we thought we could have.

So, you really got two different tails here David. You’ve got laser business that's 13% growth, that's going pretty quick. You’ve got the inkjet business that has some of the characteristics you described. I would, at the risk of giving you one more twist, tell you that in the long run we are very focused on pages. So when we talk about inkjet units we sort of lose the context that what happens in SITEX growth and Indigo growth in the high-end commercial printing, frankly, has as much to do with our future.

And to Richard's earlier point, we may wind up with a slight disconnect in trying to model unit growth in inkjet to supplies growth, because what happens is, and I won't do this again, but an Indigo printer when it goes out, is worth thousands and thousands of inkjet consumer printers going out. And as those businesses grow, you can start to get a disconnect from what the supplies growth looks like, and what the actual inkjet unit growth looks like. And you are going to hear us talking a lot more about trying to get you some transparency to what that page growth looks like, and the implications it has, long-term, on our supplies business.

David Bailey - Goldman Sachs

Great, thanks David. Let's take the next question please?

Operator

Our next question comes from the line of Tony Sakanagi with Sanford Bernstein. Go ahead.

Tony Sakanagi - Sanford Bernstein

Yes, good afternoon and thank you. Mark and Cathie, you are providing guidance for revenues to be down just over 2% sequentially in the second quarter, and for the last five Q2s, your revenues have actually gone up sequentially in Q2. Given the context for your comments, which seemed very positive, is this good old fashion conservatism? Given the environment, is this something you see coming in the PC marketplace that will cause your PC growth rate to accelerate, which you alluded to, or is there something else that we should think about relative to recent seasonality?

Cathie Lesjak

So Tony, as I mentioned in my script, and we've been saying this now for a number of quarters, we don't think it's a good idea to actually put out a cost structure in place for our PC business and expect it to grow at the same rate it's been growing at. So each of the last few quarters, we have in fact taken our guidance down for the PC side of the house. We also think it's smart from a cost perspective to do that, but other than this, our guidance is frankly very well aligned with the typical seasonality that we see in each of our businesses.

Now, the only other thing I would add to this is, as our businesses are growing at different rates, the mix in our seasonality is changing a bit. So, when you look at it at total company level, you do need to adjust for that as well. And we actually see the seasonality from Q1 to Q2 probably closer to flat to maybe up just a snitch.

Tony Sakanagi - Sanford Bernstein

So, Cathie, are you suggesting then, if PCs are third of your business and you're about three points off your seasonal guidance, that implicit in your outlook is about a 10 point deceleration in the PC revenue growth rate?

Cathie Lesjak

I don't think it's quite that large, but it's certainly directionally correct. The other thing I would add is that if you look at the seasonal pattern Q1 to Q2, you've also got to adjust for currency, right? And on a currency adjusted basis it's more like 0%.

Mark Hurd

And Tony, I just can't help myself with the word deceleration, because we're now comparing it against big, big growth rates in last year. So, when you combine the growth rate in 2007 with what's going on in 2008, I saw somebody writing some sort of note about PSG just a few minutes ago that it decelerated to 24% growth for the year, being this Q1 number that we just reported. So boy, if that's a definition of deceleration, it’s an interesting comments, so.

Tony Sakanagi - Sanford Bernstein

You'll take it any day. Okay.

Mark Hurd

Yeah. And Tony I think, to your point, and we've talked about this before at Security Analysts meeting, its really important for us to not get a business model build on those kind of numbers. And again what we try to do is build capacity, to Cathie's earlier point, into our model. That, if that opportunity is available then, and it make sense for us, we go get it. But the fundamental business model is built on a more conservative platform and we're not trying to go out and necessarily gain share and that's the objective. We are trying to build the great business and if we build the great business, we believe the gain of share and those growth rates are really the result. And so, I don't know if that helps. But again, and I know you've heard this before, but that really is our core focus.

Tony Sakanagi - Sanford Bernstein

Thank you, Mark. Thank you, Cathie.

Jim Burns

Okay. Let's take the next question please, operator.

Operator

Our next question comes from the line of Bill Shope with JP. Morgan. Go ahead.

Bill Shope - JP. Morgan

Okay, great, thanks. I was wondering if you can give us some more color on ASP trends specifically in PCs, they were remarkably tamed for you guys, as well as the industry, all of last year? And I am wondering are you expecting that's a whole this year? Have you seen any material changes in pricing patterns, particularly over the holiday season? And if not, how much room do you think you have here to possibly get more aggressive on pricing to obviously gain share, but also to counter some potential macro pressures on units?

Mark Hurd

So, Bill to your point, it was tame in Q4. It was fairly tame again, I would say in Q1. I wouldn't say that we're seeing pricing pressure beyond the norm. I again go back to the comments, that when somebody says did you see a competitive environment, I just don't remember when it wasn't competitive. So, if somebody said the other way, did I see if there is some big change, we did not in the quarter. So, when we go back to your point, to go for more share gains, that's not where we start Bill. We don't start the discussion with let's drive prices as the number one driver in the market. So, it's probably not where we start. Again, we'll look to pick our spots based on market and segments that make sense, but probably not where we go, but to answer your question, probably more of what you heard in Q4 than some sort of change.

Bill Shope - J.P. Morgan

Okay. Thank you.

Mark Hurd

Thank you, Bill.

Jim Burns

Thanks, Bill. Let's take the next question please.

Operator

Our next question comes from the line of Andrew Neff with Bear Stearns. Go ahead.

Andrew Neff - Bear Stearns

Good, thanks very much. I just wanted to know Mark, you gave us an update on the data center consolidation, there was an article in the Wall Street Journal the other day that quoted you and others talked about how tough it was, just give me a sense of how that's coming together, where you think you are and what the implications are for HP and also with regards to your customers, with this sort of what you've done for your self.

Mark Hurd

All right. Andy, thanks for the question. Yeah, I saw that, and listen our team has done just a superb job. We still have more work to do, and you know as we talked about much of the savings that comes along with it sort of trails, certainly as opposed to lead. But we are a long way through, and it really starts with us with a process change, then an application consolidation and application modernization process, and then that allows us to consolidate infrastructure and therefore close data centers. So it really falls in that flow.

We run the company. We started running the company, and we were running the company in early 2005 on roughly 6,000 applications. And Cathie and I looked at this about week ago. We're running the company right now on a little more than 3,000 applications, so we're about halfway through the application consolidation.

We're a little further ahead in the infrastructure consolidation and data centers that trail us. So, that's roughly where we are. To your point, we've done a lot of hard work and I think the article, which I think was a representation of us telling customers that this is very important work to go do, and what we are trying to do is show all of the things that we encountered, as we went through the process, so it becomes a learning vehicle for them. So, as a result of trying to teach learnings and to show those, we actually focus on more of the problems that will do the benefit. If I step back for a second and sit from where we started, I think our team has really done well Andy and I think Cathie and I would both -- we are all proud of them.

Andrew Neff - Bear Stearns

You talked about getting most of it done during fiscal '08. Are you still comfortable with that?

Mark Hurd

Yeah, we're making a lot of progress. We had a very strong quarter, in terms of IT getting its work done. It's very important to us too, because it's not only the fact that we save money, but we also actually get a simpler infrastructure. So, just to give you an idea of the implication of this, when you consolidate applications, I will give one example, we use to have 75 separate consumer support applications at Hewlett Packard, so we had a separate consumer support application in each country for our consumer PC and consumer printer business. We now consolidated those to one application, one application that now supports our entire consumer support across the company, which means IT can now do one modification to our code base, drop it down one time, whereas before we had to do 75 different modifications to be able to get that done. That not only lowers our cost, but increases our speed. It makes us more nimble, and this gives us a better platform to run the company. So, yes, I think we're on track. We think we feel good about it, we still have work to do and we'll let you know as soon as we're comfortable with the goal line.

Andrew Neff - Bear Stearns

Thanks very much.

Mark Hurd

Thank you.

Cathie Lesjak

And we still fully expect to have a run rate savings for the full year FY'09 of a $1 billion related to IT. And the beauty, frankly, in this model is also that, with that reduced spend you are still getting a much more significant percentage of spend, focused on innovation, than you do on maintenance, because with the simpler application and infrastructure your maintenance costs go down pretty dramatically. And frankly, I can tell you all of our businesses are very excited about getting more innovations.

Mark Hurd

I can't help myself, Andy, rather than to say and the point that goes to customers, that's needed about this is, you're actually playing into the environment that's saying, listen, in a tough environment, here is an opportunity to get to save money at the same time as you get a better platform to go build upon in the future. So, the internal work we're doing is in many ways the basis of our enterprise go-to-market discussion with customers.

Andrew Neff - Bear Stearns

Thank you.

Jim Burns

Okay, thanks Andy, lets take the next question please, Melanie.

Operator

Our next question comes from the line of Shannon Cross with Cross Research. Go ahead.

Shannon Cross - Cross Research

Good afternoon. Just wanted to ask you a bit more on the printer side of the business, just Mark, when you think about the trade-offs between margins and market share and units placements in that. Can you give us your idea on where you are going after this year, because obviously with unit volumes slowing, you think you'd have a mix shift to supplies and I think you also mentioned some pretty aggressive cost moves within IPG? So at the end of the day, how aggressive do you think you will be on pricing? How much you can go for to return to the bottom-line for margin expansion etcetera? Thanks.

Mark Hurd

Well, we'll try to be precise in our aggression, if that makes sense, as opposed to just running around, trying to do things that are aggressive in a broader sense. But again, I would like to tell you that IPG is a bit more complicated in the context of thinking them with at least four big things we're trying to do at the same time. One is we're trying to realign our cost structure. And the great thing about IPG is it's a great business that's made a lot of money. The bad thing is it's a great business; it's made a lot of money. And like with many businesses that have done that for a long time, we have certain ways of doing things that VJ and Cathie and I know we can do a lot better than we're doing today. And it forms the basis for a big cost opportunity for us and we are working it.

Secondly, we want to grow the Graphics business. Cathie, I thought, was very clear on our intent and our performance in that business. Third, we want to grow our enterprise business, and both of those have performed nicely for us over the past several quarters, again in Q1. Fourth, there is a core consumer business. And we look at that differently by geography, as we described. We look at the laser business a little different than we do the inkjet business. And so, when you look at that entire aggregation, we will pick our spots. And I would tell you here that we are not just trying to drive margin, we're looking at the optimization of long-term margin, which has a balance of units of placement, but making sure there are sensible unit placements that have long-term supplies connect at the same time as we try to get short-term operating profits.

So, it is very possible, Shannon, as you know, that we have a profit number and we wish to put more units in the market, and as I mentioned earlier, there were some units we could have put in the market, as we looked back on it afterwards, that we wish we had. And it is what it is. So we'll go back and make sure we try to get this right as we move forward here.

Shannon Cross - Cross Research

Okay. Thank you.

Mark Hurd

Thank you, Shannon.

Jim Burns

Okay. Thanks, Shannon. Let's take the next question please.

Operator

Our next question comes from the line of Brian Alexander with Raymond James. Go ahead.

Brian Alexander - Raymond James

Thank you. Mark, you were specific earlier in the call, saying you have reduced more cost this year than last year. Hence the question, are you accelerating any of the actions that you previously announced in light of the macro environment, or has that been the plan coming into the fiscal year? And any change in thinking on reinvestment versus flow through of those savings in light of the environment? Thanks.

Mark Hurd

No. We're really on the same trajectory Brian, I mean I commented earlier, when somebody tells me because of the macro environment are you doing something else, it implies there were some inefficiency we weren't going after anyway. And everything in the company is up for a debate. And so Cathie and I go through this excruciating detail to make sure we've got our cost structure headed in right direction. So, I would just tell you we're very focused on getting it right. And we have opportunities to do it. From a reinvestment back in the scale of our sales organization, we are on trajectory to do it and we're continuing to try to balance the cost take out relative to the investment.

Jim Burns

Okay. Thanks. Brian. And let's take the next question please.

Operator

Our next question comes from the line of Katie Huberty with Morgan Stanley. Go ahead.

Katie Huberty - Morgan Stanley

Yes, thanks. How purposeful was the reduction in inventory in late January ahead of the expectations of potentially slower PC growth? And where there any product segments that you feel inventory was constraint at the end of the quarter?

Cathie Lesjek

So, Katie it wasn't purposeful, other than to say that we've been working on our inventory management since Q1 last year, there has been a real intense focuses in the company on that, and this is just the result of many quarters of hard work. So, I wouldn't read anything more into it other than much better inventory management.

Operator

Our next question comes from the line of Louis Miscioscia with Cowen And Company. Go ahead.

Louis Miscioscia - Cowen and Company

Okay. Thank you. You had in your press release that you added 2000 more sales people. Could you give us the total number of sales people you have? And I know you have been talking about for quite a while of growing this, do you think you have finally hit the level that you're reasonably happy with. And maybe finally and [sorry] about most of our question, if you could talk about if a lot of this went into the emerging markets?

Mark Hurd

So we don't release headcount information at that level of detail, but we're obviously more than 2000 sales people, since we added to them, that many. But I would tell you that we are very under covered, and we're very under represented in the market, and it’s an issue for us. We think we have a just superb lineup of products and capabilities. It’s frustrating to us, because we obviously know we come to work everyday, and then under distribute them in the market. And we've got a very strong line up of partners out there. We have 144,000 resellers and partners that help us, but at the end of day, when you go through a detailed market, mapping by market segment, by geography, by product segment, even by industry, where it make sense certainly in the context of the mid-market and the enterprise, we are dramatically under covered. And when I say that, we're not off by 10% or 20%, we're off by more than that.

And so, we're trying hard to be fit up. And it’s not direct salespeople, so we give you that number as one fact point, but it really is a combination of partners, sort of badged and full time employed HP people, working in unison to try to get a broader distribution footprint across the entire market. Much of it is in emerging markets, but it's not all in emerging market and as you heard 31% of our revenue in the US and the US is one of the markets that we're not as well distributed as we'd like to be.

So it's a broad based issue for us, just as our cost issue is a broad based issue for us. We try hard to work them in alignment. And this is the issue for us, to try to do two things at the same time, and that's where what we are working on. So we have improved the situation, based on the headcount that we described and also relationships investments we've made in the channel. That said, there is more work for us to go.

Mark Hurd

Okay. Thank you.

Mark Hurd

Thank you.

Jim Burns

Okay. Let's take the next question please.

Operator

Our next question comes from the line of Scott Craig with Banc of America. Go ahead.

Scott Craig - Banc of America

Hi, good afternoon. Hey Cathie, can you talk about the component cost environment a little bit? You mentioned that you don't see it as being as favorable going forward. So can it be a little bit more specific? It just seems like every quarter we keep hearing about that, and component pricing doesn't look that bad too us. Actually it looks like it’s gotten a little bit better over the past couple of months. So any flavor there would be appreciated? Thanks.

Cathie Lesjak

In Q1, it was clearly more favorable than we had expected, and you saw that in the margin expansion at the HP Co level, as well as the operating margin expansion at the PSG and Enterprise Server and Storage level. In terms of an outlook, we think that the supply generally looks good. We are starting to see a memory pricing environment that seems to be stabilizing a bit or getting more solid. There could be an uptick there, but we're certainly not seeing the same sort of declines that we've seen in the last couple of quarters. And so, we're basically pricing in, or thinking about the fact that memory will be a bit tougher than it was in last couple of quarters, and factoring that into our guidance.

Scott Craig - Banc of America

Okay. So it's predominantly memory then? The rest you still see as being somewhat favorable then?

Cathie Lesjak

No. I think LCD panels, as well, have started to tick off a bit. And memory is the biggest delta, if you think about it from kind of quarter-to-quarter in Q4 and Q1, but you definitely have seen some firming in prices in LCD panels as well.

Scott Craig - Banc of America

Okay. Thank you.

Operator

Our next question comes from the line of [Jason Nolan] with Robert Baird. Go ahead.

Jason Nolan - Robert Baird

Thank you. Question on follow-up earlier to the data center question, are you still seeing demand for tours of your new data centers in Texas, and specifically are Enterprises more likely to undertake a large data center consolidation in this environment?

Mark Hurd

So, first of all, what I think I can actually say is, we have (inaudible) demand for people that want to get into our IT organization and understand what they have done. We try very hard to not do just a one-off event with IT folks. We try to consolidate and make them more formal, and get people more exposure to what we've done in IT, because we have an IT organization that still has work to do for Hewlett Packard. So, yes, we have very strong demand for people to see it and for people to get into our data centers. But frankly, not just get into the data center, but understand strategically what we have done and then how the execution is done. And most of our work is done to create play books that actually talk about the way we approach things, and to be very blunt, I think Andy talked about earlier, the mistakes that we made, where we made them in terms of our approach.

In terms of companies, I think there are different companies in different forms of maturation, in terms of the states that they are in, and that has an implication on what they do. But there is no question right now. There is a lot of attention on IT and a lot of attention in terms of the relationship of IT to business benefit. So, we think it's a major opportunity in the market and there is a lot of strategic dialogue, I'll put it that way, about how people think about IT and the approaches they take to rationalizing.

Jason Nolan - Robert Baird

Thanks.

Jim Burns

Okay. Let's take one more question please operator.

Operator

Yes sir. Our next question comes from the line of David Wong with Wachovia, go ahead.

David Wong - Wachovia

Thank you very much. Can you give us the unit growth on your Industry Standard Servers and also the absolute levels of channel inventory, I think you gave us year-over-year, but not the absolute levels of channel inventory?

Mark Hurd

I think unit growth, I just want to make sure, I know the number. Do we give this out? It was very high double-digits, I'll just leave it at that. So high teens, sorry high teens, that's better. But high teens was unit growth, and I'll leave it at that one. We typically don't give the absolute channel inventory numbers. As we give them out, we give them in terms of weeks, and we give them in terms of compares. So, that's where we leave it. ESS inventory, which is what we report, was healthy and very well positioned coming out of Q1 and that was again purposeful on our part to just position ourselves well going into the rest of the year.

Okay. Thanks for your questions. I'd like to summarize today's call by saying that HP had a strong quarter. It was characterized by balance growth across all regions, share gains in key businesses, margin expansion, expense discipline, strong cash flow from operations and significant share repurchases.

Going forward, I am confident in our ability to deliver strong results, based on the three elements I mentioned to you earlier. Significant cost savings that both fund our growth and expand our earnings, our deployment of additional sales resources to capture incremental opportunities in the Enterprise and mid markets, and third, the diverse global customer base and a broad product portfolio that is inline with the growth areas of the market.

Given the solid fundamentals within our business, we are increasing our non-GAAP EPS guidance for the 10th consecutive quarter. I am pleased with our progress today. We have a lot of work to do. I am confident that we can continue to produce another year of strong financial returns. Thanks again for joining our call.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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