Hewlett-Packard F2Q08 (Qtr End 4/30/08) Earnings Call Transcript

May.20.08 | About: HP Inc. (HPQ)

Hewlett-Packard Company (NYSE:HPQ)

F2Q08 Earnings Call

May 20, 2008 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

Richard Gardner - Citigroup

Benjamin Reitzes - Lehman Brothers

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Shannon Cross - Cross Research

Keith Bachman - BMO Capital Markets

Brian Alexander - Raymond James

David Bailey - Goldman Sachs

Jeff Fidacaro - Merrill Lynch

William Fearnley - FTN Midwest Securities

Louis Miscioscia - Cowen & Company

Katie Huberty - Morgan Stanley

Clay Sumner - Friedman, Billings, Ramsey & Co.

Scott Craig - Banc of America

Operator

Good day, ladies and gentlemen and welcome to the second quarter 2008 Hewlett-Packard earnings call. (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

Thanks, Melinda. Good afternoon and welcome to our second 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-Q for the fiscal quarter ended January 31, 2008.

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 Form 10-Q for the fiscal quarter ended April 30, 2008.

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 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 second quarter earnings slide presentation accompanying today’s earnings release, both of which are available on the HP investor relations website at hp.com.

Finally, please refrain from asking multi-part questions or clarifications. I will now turn the call over to Mark.

Mark V. Hurd

Good afternoon. Thanks, Jim. Thanks for joining us. Hewlett-Packard delivered a strong second quarter. It was strong in most every dimension we measure. We grew revenues 11% and earnings per share 24%. We generated $4.8 billion in cash from operations and returned $3 billion to shareholders through share repurchases and dividends.

As I said last quarter, our performance continues to be driven by three important factors -- cost savings from initiatives across the company, our deployment of additional sales resources, and a diverse customer base and a broad portfolio that’s aligned with the growth areas of the market.

While we’ve become more efficient I am pleased -- and I am pleased with that performance, don’t be confused -- our cost initiatives are ongoing and they are significant, and we expect them to create additional leverage in our operating model. And while we primarily want to focus this call on our quarterly results and outlook, before I pass things to Cathy let me summarize what we discussed last week regarding our definitive agreement with EDS.

First, we expect the acquisition of EDS to accelerate our reach into key enterprise accounts, and as I said before, we are a great engineering and great customer support company but we have a market coverage problem, and I’ve spoken to you many times about our efforts to improve our enterprise account presence, especially in the U.S. We expect this deal to significantly improve our enterprise share of wallet and create a platform that gives us opportunities for new business growth.

Second, we believe that the cost synergies from this business combination are significant and make this transaction very financially attractive, even without the expected revenue benefits.

The cost opportunities take many forms, from overhead costs to scale efficiencies to service delivery automation -- we have opportunities to materially improve the margin performance of our combined outsourcing businesses.

Make no mistake -- we will get the cost out and we will create value for shareholders.

With that, I will turn it over to Cathy who will review the numbers for the quarter.

Catherine A. Lesjak

Thanks, Mark and good afternoon, everyone. For the second quarter, revenue totaled $28.3 billion, up 11% year over year, or up 5% in constant currency. Non-GAAP operating profit was 10% of revenue, or $2.8 billion, up 22% year over year.

Looking at revenue by geography, EMEA and Asia-Pacific were each up 16% and the Americas increased 4%. We generated 70% of our total revenue and all of our growth outside the United States.

Second quarter gross margin was 24.8%, up 30 basis points compared to a year ago. This gross margin increase was driven by a generally favorable commodity environment and disciplined pricing.

Non-GAAP operating expenses for the quarter were $4.2 billion, or 14.8% of revenue, down from 15.5% a year ago. Adjusting for currency, expenses were up just 1% as we maintained expense discipline while investing in sales and go-to-market resources and absorbing acquisitions.

Non-GAAP OI&E yielded income of $3 million in the second quarter, down from the prior year primarily as a result of lower net interest income and net losses from our currency hedging programs.

Our non-GAAP tax rate was 21% in Q2. Second quarter non-GAAP EPS was $0.87, up 24% from $0.70 one year ago. GAAP EPS was $0.80, which included $172 million, or $0.07 per share in after-tax adjustments, primarily related to the amortization of purchased intangibles that were excluded from our non-GAAP results.

Looking at the performance by business segment, during the second quarter imaging and printing revenue was up 6% to $7.6 billion, led by supplies growth of 8%. Commercial hardware revenue grew 6%, while consumer hardware revenue declined 3% year over year. Excluding cameras, consumer hardware revenue increased 2%. Segment operating profit was $1.2 billion, or 16.2% of revenue.

In terms of our core printing business, we shipped more than 14 million units in the second quarter, an increase of 6% year over year. We continued to see solid momentum in our growth initiatives in the second quarter. Our graphic arts business, which is now roughly 10% of IPG revenue, grew in double-digits again this quarter. Color laser unit shipments increased 22% year over year and printer based MSP shipments grew 41%, buoyed by the introduction of new products this quarter.

Within IPG, we are also focused on reducing our costs and have a number of ongoing initiatives to improve supply chain efficiency and lower product costs. 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 continued to post solid results, maintaining the number one worldwide market share position in calendar Q1, with revenue growing 16% to $10.1 billion and unit shipments increasing 21%. PSG maintained balanced growth across the businesses with consumer client revenue up 16% and commercial client revenue up 17%. Notebooks continued to be strong with unit shipments increased 46% year over year.

Segment operating profit for the quarter was $544 million, or 5.4% of revenue. PSG operating profit increased 30%, reflecting solid execution and, to a lesser extent, benefit from a favorable commodity environment. You should expect us to continue to balance revenue growth and profitability by managing our costs and investing in growth.

Moving to the technology solutions group, enterprise storage and servers revenue was $4.8 billion, up 4% year over year. Industry standard server revenue was flat versus a tough 17% year-over-year compare.

ISS blade growth continues to be strong with revenue increasing 64%. ESS growth was driven by the strength in storage and business critical systems, which each grew faster in Q2 than they have in the last 10 quarters.

Revenue in storage grew 14% to just over $1 billion, with the mid-range EVA business growing 17% and the high-end XP business posting 21% growth. The robust storage results reflects the continuing improvements in our coverage and go-to-market model, and positive reception of the new EVA and MSA storage products.

Business critical systems revenue posted 7% year over year growth, with integrity server revenue increasing 35%. BCS grew in every region with significant wins in the United States. Business in markets such as India and China also posted strong growth as these markets build out their infrastructure.

Enterprise storage and service posted solid second quarter operating profit of $655 million, or 13.7% of revenue, up 390 basis points from the prior year period, led by stronger performance in storage and BCS, favorable component pricing, and expense discipline.

We had a solid quarter in HP Services, with revenue of $4.6 billion, up 12% over the prior year period. Technology services delivered strong revenue growth of 10%, outsourcing and consulting and integration revenue increased 14% and 15% respectively.

Operating profit for the quarter was $508 million, or 11% of revenue, up 10 basis points year over year. The contribution of strong revenue performance from technology services was partially offset by workforce rebalancing in Q2, as we initiated a plan to simplify the organizational structure within services. We are pleased with the progress we have made in reducing costs and accelerating growth.

HP Software revenue was $727 million, up 28% from the prior year. We continue to take share in the management software layer, both organically and through acquisitions. BTO maintained its momentum with 36% year-over-year growth. Other software, which includes Open Call, Business Intelligence, and Information Management, grew 2% to $134 million. Solid growth in information management was largely offset by year-over-year declines in our open call business.

Software reported operating profit of $93 million, or 12.8% of revenue, up from $7 million in the prior year. Strong operating performance within BTO was partially offset by integration costs and investments in business intelligence.

HP Financial Services had revenue of $685 million, up 25% year over year and generated operating margin of 6.9%. We are encouraged with the growth in our core financing volume and portfolio asset 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 Q2 at 32 days of supply, down two days compared with a year ago. With regard to channel inventory, we ended the quarter with ESS down roughly a half-a-week, PSG up roughly half-a-week, and IPG approximately flat year over year.

Days sales outstanding increased to 43 days in Q2 from 41 days one year ago.

Days payable was 53 days, down from 54 days last year. Next, property, plant and equipment was up $567 million year over year, and down 40 basis points as a percentage of revenue. Gross CapEx was $704 million, down 7% from the prior year period.

On a net basis, CapEx was $599 million, roughly flat year over year. Capital expenditures were primarily related to assets used in our leasing business and our investments in IT.

On to our cash balance and cash flow, cash flow from operations accelerated to $4.8 billion for the quarter and free cash flow was $4.2 billion. Year-to-date, cash flow from operations was a very strong $8 billion, up 92% year over year and free cash flow was $6.8 billion, up 131%. During the quarter, we also had a net cash outlay of about $1 billion for acquisitions.

In addition, we spent $2.8 billion on share repurchases during the quarter, representing approximately 66 million shares. At the end of the quarter, we had roughly $4.5 billion remaining in the current share repurchase authorization.

Finally, we paid our normal quarterly dividend, totaling $197 million.

We ended the quarter with a strong balance sheet, including total gross cash of $11.8 billion and net cash of $3.5 billion.

Now a few comments on our outlook for both the third quarter and the full fiscal year, neither of which includes any impact from the acquisition of EDS we announced last week.

We expect Q3 fiscal 2008 revenue to be approximately $27.3 billion to $27.4 billion, in line with typical seasonality. 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 $114.2 billion to $114.4 billion.

Regarding earnings, there are a few variables to keep in mind. First, we expect that the component pricing environment to be less favorable in Q3 than it has been in the last several quarters. Second, we estimate non-GAAP OI&E to be approximately zero for the remainder of the year due to lower interest income and higher cost of currency hedging. Finally, we expect to continue to repurchase shares in the coming quarters with a modest decline in weighted average shares outstanding in the second half of the year.

With that in mind, we expect Q308 non-GAAP EPS in the range of $0.82 to $0.83. For the full year, we expect non-GAAP EPS to be in the range of $3.54 to $3.58, representing growth of 21% to 22% on revenue growth of roughly 9.5.

Overall, we delivered solid results in Q2 and increased our outlook for the year, reflecting the strength of our business model and our progress to date.

We will now open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Richard Gardner with Citigroup.

Richard Gardner - Citigroup

Thank you very much. Mark, I just wanted to ask a quick question about the ISS performance in the quarter. I know that Cathy mentioned that you were up against a difficult 17% or 18% year-over-year compare but it still looked like you were down a little bit more than normal seasonal in the quarter, despite the solid growth in blades and I was hoping that you could provide some color there.

Mark V. Hurd

Sure. Thanks, Richard. I think down a little but seasonal, you’re on it. I mean, it was against a tough compare, 17% the year before. Good blades growth within it but very frankly, we’ve picked our spots. We saw some spots where we thought we could take advantage of things and we did. There were also in there, Richard, blades being one of those, there were a couple of deals we missed that we would like to have had, and that’s sort of an execution issue that we’ll be looking through. But I would say it’s really the tough compare. We picked our spots, some good numbers in there, for the example of the blades that we described, and a couple of deals that we would like to have had that we didn’t get.

Richard Gardner - Citigroup

Mark, would you say that there’s been any significant change in the competitive environment in terms of pricing, or how your competitors are approaching the marketplace that is factored into the performance?

Mark V. Hurd

Spotty. I would say it’s not -- I would not say globally. I’d say we saw some spotty stuff in different markets but as I always tell you, Richard, I have a hard time with the -- I can’t remember when it wasn’t competitive as opposed to when it is, but yeah, a couple of spots where it was a little bit more competitive than perhaps what we’ve seen in the last couple of quarters.

Catherine A. Lesjak

I think I would also add the fact that we ended channel inventory in really good shape for ISS and ESS, and so we are going into the quarter in good shape.

Mark V. Hurd

I think, Richard, that’s another point that Cathy hit on, which I think is great. We were pretty prudent with the way we looked at inventory and while you see the ESS number in total, within the ISS channel inventory was pretty strong -- pretty strong being defined we have less inventory in the channel at the same time as we are going up against that compare, so that’s really the ISS story.

Richard Gardner - Citigroup

Okay. I know Jim’s going to kill me for asking a three-part question, but do you feel like virtualization is having any impact on your X86 business at this point with customers virtualizing with [EMware] on existing hardware as opposed to buying new hardware?

Mark V. Hurd

Certainly not materially in the quarter and Richard, as you look at the $60 billion server market and the opportunity to re-platform from sort of non-industry standard platforms to industry standard platforms, the industry standard server platform is really the beneficiary of that transformation. So depending on which way you look at the virtualization question, virtualization actually can be in many ways a driver for industry standard server growth. So I think my answer would be certainly intra-quarter within that, no.

Richard Gardner - Citigroup

Okay. Thank you.

Operator

Our next question comes from the line of Benjamin Reitzes with Lehman Brothers.

Benjamin Reitzes - Lehman Brothers

Thank you very much. Good afternoon. Mark, could you talk a little bit about Europe? There’s some worries in the marketplace about Europe and what that is going in -- what the momentum of business has gone in to your July quarter. And then if I could also just sneak in similar questions around PCs. It actually seems maybe that units picked up in April. I was just wondering if you could characterize the PC market in competition, given what’s going on there. Thank you very much.

Mark V. Hurd

Well, I’ll tell you, we’re having a tough time with discipline on the multi-part questions but Ben, I’ll go take them. Europe was strong for us, obviously, 16% growth year-on-year. It’s up to 43% of the company. The performance across Europe was strong, it was broad across all of our divisions -- very strong. I will tell you that within linearity, and I won’t answer it specifically into PCs, but within the quarter, we had a pretty normal quarter in terms of linearity. If anything, and I say this cautiously, but we were probably a little stronger in April than traditional linearity. And I only say that cautiously because I don’t want somebody to run too far with it, but the quarter behaved roughly as we would have expected, perhaps as you saw we obviously beat our guidance from a revenue perspective and April was a healthy month for us.

Benjamin Reitzes - Lehman Brothers

Okay, and competitively in PCs? You know, you were able to have that, even with a competitor filling the channel. I was just wondering --

Mark V. Hurd

Yeah, I mean, we felt very good about the -- you know, the PSG quarter. Obviously we are going up against a -- you know, talk about tough compares. I mean, this was a huge quarter for us last year from a growth rate perspective in PCs and dialing in to 16% growth number here was again probably, to be very blunt, a little stronger than we had expected and that we had modeled, so PSG had a very strong quarter.

Benjamin Reitzes - Lehman Brothers

Thanks a lot.

Operator

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

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Thank you. Mark, I was wondering if you could talk at all about the economic environment. The thing that struck me most was the U.S. growth rate actually looked like it was slightly negative in the quarter, and that’s down from 6%, 7%, and 12% growth in the last three quarters. Additionally, if I look at your guidance and run my little currency model, it looks like you are guiding for about 2.5% growth at constant currency year over year in Q3, and 2.7% in Q4. Now again, very tough comparisons, completely understand that. But is there something here, particularly in the U.S. that caused that pretty notable deceleration in the second quarter in your business, and then something around the overall economy, maybe U.S.-centric, that has you forecasting a revenue growth rate that was ultimately below your target model and I think would certainly be the lowest reported growth rates at constant-currency that you’ve had since you’ve joined HP.

Mark V. Hurd

Well, thanks, Toni. By the way, if you’ll send me that little currency model, I’ll review it for you and give you some thoughts. But listen, I think the -- back to the overall situation, right? I mean, the fact that we could have a flattish performance in the U.S. and grow the company 11% I think is indicative of the position of the company. And to be very blunt, Toni, we pick our spots, right? We look around where we see the opportunity and we try to be nimble enough to take advantage of those opportunities as we see it, and that’s -- for us, obviously, as you know we have to position inventory, we have to position to align our demand to where we see the opportunity. And I think to be very blunt with our businesses, we did a pretty darn good job in the quarter trying to line up to fulfill the opportunities that we saw.

U.S., to be specific, was just spotty. We had some very good numbers in the U.S. Cathy talked about storage. She talked about business critical systems. IPG had positions of strength, so there’s some very -- I could go on. I mean, there were some positions that were very positive and to your point, we are going up against tough compares.

So I hate to give you so much data. I usually try to make it a little bit more concise but the U.S. is a tale of many stories and spotty would be the best way I’d describe it. I wouldn’t describe it all bad, but I wouldn’t describe it all good, either.

And then within that, we frankly spun the dials to the opportunities that we saw to take advantage of what we saw in the market and we really -- while we look at countries, we look at optimizing the entire business as we go and that’s what we did, Toni.

Toni Sacconaghi, Jr. - Sanford C. Bernstein

But is the choice around where you chose to play, Mark, I mean, are you effectively saying there are parts of the U.S. market because of the growth or because of the pricing that’s required that you chose not to play in, you know --

Mark V. Hurd

I wouldn’t go to elasticity so much, Toni. I mean, I think it really is the alignment of demand and I don’t think in the U.S. that the -- I would go drive right down to pricing, although it’s an element of what we looked at. We try to line up where the demand is and again, I think the best thing I can tell you about the U.S., and it’s probably where I’ll leave it, it’s just right now a very spotty market and one that we try to maintain caution around.

Toni Sacconaghi, Jr. - Sanford C. Bernstein

Okay. Thank you.

Operator

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

Shannon Cross - Cross Research

Good afternoon. Just a question on cash flow, because obviously at $4.8 billion, it was quite strong in the quarter. Can you, Cathy, provide us with any sort of puts and takes, things to keep in mind as we look for the full year, since obviously you did as much cash in the first two quarters as you did in I think it’s all of 2005. Thanks.

Catherine A. Lesjak

We laid out some guidance around cash flow from operations at the security analyst meeting in December and we said we thought we’d be about $11 billion. Basically having done $8 billion so far this year, with only half completed, we clearly expect to do a bit better than that. We are ahead of plan. Part of that is due to earnings and frankly part of that is due to some improvement in the working capital space. We’ve made -- we really focused on getting inventory in better order and making good progress there, and we are focusing on accounts payable as well. So definitely some upside to cash flows from ops this year.

Mark V. Hurd

I think there’s clearly some inter-quarter movement across the cash flow. I wouldn’t make it all additive and I wouldn’t double $8 billion to 16, but we’ll clearly do better than our forecast. We’ll have to see how it eventually lands in but clearly this has been a very strong performance for us and it’s no one thing. It’s a multitude of things that have occurred and so to Cathy’s point, we’ll clearly beat this forecast.

Shannon Cross - Cross Research

And can you talk -- just can you talk anything about your share repurchase strategy with the acquisition of EDS? And that’s my last question, thanks.

Catherine A. Lesjak

With the kind of cash flow that we are generating, we fully expect to be active in our shares, even post the EDS acquisition, probably not too dissimilar from the programs that we run today.

Shannon Cross - Cross Research

Great, thanks.

Mark V. Hurd

We like our shares pretty well, Shannon.

Shannon Cross - Cross Research

Good. Thanks.

Operator

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

Keith Bachman - BMO Capital Markets

Thank you. I had a couple of questions, or a question, rather, on the ICG group. Cathy, just a clarification though -- consumer printer hardware units in the slide deck says up 4%. I thought you said it was up plus 2 net of some consumer units. I just wanted you to clarify.

But then Mark, on a broader scale, I was just hoping you could speak about how we should think about the inkjet side of the business in terms of unit potential, as well as on, if you can, disseminate a little bit on the supply side of inkjets and how we should be thinking about that market evolving. Thanks.

Catherine A. Lesjak

Let me just orient you on the first question, because I was -- one of the units, so we are up in units 4%. In revenue, if you adjust for cameras, we are up 2%.

Keith Bachman - BMO Capital Markets

Okay, but Cathy, can you adjust for cameras on units, please?

Mark V. Hurd

We could try, Keith. We’ll try to get somebody to get back to you on it.

Jim Burns

We don’t count cameras as printer units.

Mark V. Hurd

Yeah, that’s really not in the unit count anyway, Keith, so it really hits the revenue number but not the unit number as we calculate it. But let’s go back to the inkjet thing -- inkjet actually looked pretty strong. You know, within the roundings of the inventory too, we’ve done a good job on our channel inventory. Demand looked better, so overall good, sort of ecosystem result would be the way I would describe it, Keith, in the context of both unit placements and a supply attach associated with it.

Keith Bachman - BMO Capital Markets

And so Mark, just a broader question is when we talk about slowdown in the U.S. or the economy, are you seeing or have differences in terms of the -- what’s happening in the inkjet? Because this quarter was frankly a little bit easier compare than the last couple of quarters. Are you seeing some reaction due to the consumer slowdown here in the U.S. or otherwise on that particular business unit? Thanks.

Mark V. Hurd

I would say that we saw no material change in inkjet in the U.S. If anything -- if anything, and again I say this on the margin, if anything perhaps a little bit better and it’s back to my earlier answer to Toni. It’s just the U.S., I would not want you to walk away from the call with HP said the U.S. is all bad. That’s certainly not what we are seeing. We are seeing spotty results in the U.S. It’s a little different by industry. It’s even a little different by geography and it’s a little different by business unit, and within that I can tell you a storage story, I could tell you a business critical systems story, an inkjet story, and it’s just a mixed bag.

And so what I’ve tried to do today was not go into all of that detail, because I think it would take a long time to go through. But there’s good numbers in there, Keith and there’s some numbers that we wished were better, but we think it’s a factor in the market. We also feel very good about our share position within the context of all that. So long answer but that’s what we are seeing, Keith.

Catherine A. Lesjak

I think the other overlay to that is the fact that we had said last quarter that we didn’t execute as well as we would have liked. We would say that we executed better this quarter.

Mark V. Hurd

This is an IPG comment that Cathy’s making. I think last quarter, you know, we left some units on the table and we didn’t feel as good about the execution and this was a better execution from IPG’s perspective this quarter.

Keith Bachman - BMO Capital Markets

Okay. Thanks, guys.

Operator

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

Brian Alexander - Raymond James

Thanks. Mark, this is -- on the PSG side, this is the first quarter where I think commercial revenue grew faster than consumer since January of ’05, albeit the delta was small. It also represents a slight deceleration in the contribution margin for PSG, but still a strong 9%. I’m not sure if I should be connecting those two factors but the questions would be do you expect the mix shift to continue toward commercial? And two, there’s still a sizable gap in operating margins between consumer and commercial, such that this creates an additional headwind going forward.

Mark V. Hurd

Listen, I think you’re -- I appreciate your analytics, Brian. I think you’ve done a nice job with that. You are connecting dots I wouldn’t connect. Don’t connect commercial and consumer, don’t connect the mix. There’s also loads that go in, which are not unique to each business in terms of costing loads, so I would not connect those dots. I would not connect the dots of a shift in mix. I would not connect the dots of different contribution margins based on those shifts as anything material to the business.

I would say that PSG saw opportunities in the commercial segment, took advantage of them, had some very, very strong wins in the quarter that we were pretty pleased with. Their operating margins are on the margin, if that makes any sense. But I mean the difference is on the margin and again, I’d say PSG, as we went into the quarter, because we are trying to pick our spots prudently. As we look at the market, PSG performed in line with our expectations, Brian, if not a little bit stronger than what we thought, so we felt very good about the PSG quarter and their position.

Brian Alexander - Raymond James

Great, thanks.

Operator

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

David Bailey - Goldman Sachs

Thank you very much. The slowing growth in the U.S. I guess is not a big surprise, given what’s going on in the economy, but your year-over-year growth in APAC at a constant currency dropped a fair amount this quarter. Can you comment on how much of that is macro driven, and more broadly, what you are seeing from a demand perspective in Asia?

Mark V. Hurd

We feel pretty good about Asia, David. I mean, we grew obviously 16% and you’ve got to look at currency on a year-over-year and sequential basis. One thing about currency that just to be a little bit cautious about is when you look at the cycle times of our business, not all that currency -- I don’t want to get into a big currency dialog because this could take up longer than we have left for the call but when you look at the cycle times of some of these businesses, the currency doesn’t all stick to your fingers, so to speak, because of the speed by which these move across. It’s a little different in each business, so I wouldn’t read as much into as I think many people do, into those things. I still think this is the right way for us to report it but we felt good about Asia. We felt good about the demand and the position in Asia, our share position in Asia, so we came out of the quarter in Asia pretty encouraged, David.

David Bailey - Goldman Sachs

Thank you.

Operator

Our next question comes from the line of Jeff Fidacaro with Merrill Lynch.

Jeff Fidacaro - Merrill Lynch

Thanks for taking my call. Mark, I was wondering if you could just give a quick update on some of the operational savings as far as the data centers and where they stand as far as percent completion of closings, as well as the applications. I know you’ve been working them down from 6,000, getting toward your target of 1,500. Just if you can give us a quick update on where that stands.

Mark V. Hurd

Sure. I’ll give you some rough numbers. We closed the quarter with 2,500 applications running Hewlett-Packard. We’ve got about 65% of our data centers now closed that we will close. We believe by the end of Q3 we’ll be about 90% to 95% of the way through and finish by the fiscal year.

So a couple of points on that, Jeff, that I think we are in position to get the full run-rate savings in ’09, as we’ve talked about. I think we will be at the -- somewhere a little higher than 1500, about 1700, 1800 applications by the end of the year. It’s I think 1780 is the destination point. This puts us in a position to do a couple of things.

One, obviously finish off our transformation but to do two things, one to integrate any other acquisitions that we’d do, or at least the one that we talked about last week, which is a big issue for us to be in a position to have that kind of capacity and capability to integrate, and that’s significant for us.

Secondly, we’ve got an opportunity now to start working on our applications and the productivity that comes from the applications now being integrated. We’ve given examples before that you know, we had 18 planning applications in the company, so I don’t know how many different ways you can plan but we found 18 different ways to do it. We now plan one way. I could go down this area by area -- consumer apps where we had 75 and now have one. So the fact that we now have global application sets allow us to now accelerate our productivity sort of process by process as we go across the company.

One last one I’ll give you free of charge is we used to deal with our channel partners where anytime a channel partner wanted to give us information, we accepted the format that the channel partner gave us, so we had however many channel partners, that’s how many different ways that we accepted data, which isn’t just an application, it’s different processes.

Getting those all collapsed into one global way to do it gives us an opportunity now to increase our productivity, so darn near completed, very good job I think by our IT, now capable of with capacity to be able to integrate an acquisition like we’ve talked about, in addition to the fact that we now have a productivity model that allows us to enhance our global applications because we now have a simpler environment.

So maybe more data than you wanted, Jeff, but that’s where we are.

Jeff Fidacaro - Merrill Lynch

Okay, and just one quick follow-up; as you look at your data centers and you get closer to completion, what sort of utilization levels do you have available for say like an EDS type integration? Is there a lot of room to move them to your data centers or -- and/or automate their processes?

Mark V. Hurd

Yes, we could completely house them in our existing capacity and yes, we have an idea about the application and yes, we have an idea about how to globalize those applications and those processes, so it’s a very -- to your point, I think very insightful. It’s a very important piece of what we do and Jeff, we think we’ve built a competency now in this capability. I can tell you if you look over three years and the total report card and you look holistically over where we started and where we’ve come to, that capability and that asset for Hewlett-Packard is now a big opportunity, big advantage for us.

Jeff Fidacaro - Merrill Lynch

Thank you.

Operator

Our next question comes from the line of William Fearnley with FTN Midwest.

William Fearnley - FTN Midwest Securities

Good afternoon. I’d like to switch gears if I could, sort of to storage -- Mark, how do you rate your performance in relation to competitors and especially in storage? Have you turned a corner here and are you gaining new customers or selling more to the existing base?

Mark V. Hurd

Bill, good question. I think it’s a lot better, so I’m happier. So I just gave you an incremental metric. On an absolute basis, listen, we can just do better than this and you know, we’ve got new product we’ve announced into the market during the quarter in the storage space that we are excited about. We’ve begun to bring together some of the acquisitions we’ve done and align some of our storage essential software with our platforms. We are doing more work in the channel and it turned into good growth. I mean, for us to get mid-double-digit growth or 14% growth in the quarter is better than we’ve seen.

Would I tell you that there -- if there’s anybody taking a lap around the building, I sure haven’t seen him because we’ve got a lot more work to do to be a participant in the way that HP ought to be a participant in the storage market, so I think it’s good and the good news is we are getting it done with good old fashioned blocking and tackling. There are net new customers in addition to us being able to up-sell and cross-sell into our base, and we have really got to do a better job integrating our channel partners go-to-market because we obviously as you know, we’ve got a tremendous server channel support and getting that same support on the storage side from many of the same partners is important for us.

William Fearnley - FTN Midwest Securities

Are you increasing incentives to get them to do that or do you think they are making the proper progress at this point?

Mark V. Hurd

I wouldn’t say we’ve increased incentives as much as we’ve focused those incentives and that we’ve done some things to say listen, again back to our previous discussion in calls about -- sometimes for us it’s the way we spend our channel money and our incentives as opposed to how much. Do we incent on pure volume or pure units or do we incent on attach?

So if you just went down a metric of storage attached to our servers, you would get a big growth in storage volume. The question is why hasn’t that occurred? Well, some of that is the way we incent the channel. It is an amount of dollars but it’s the way we package those dollars, so it’s more about that than it is increasing the amount but getting focused and being very clear to our partners, this is what we value so therefore this is how we incent and some of that has occurred in 2008 and that’s at least a reason why you are seeing some of the improvement that you are seeing.

William Fearnley - FTN Midwest Securities

Thanks.

Catherine A. Lesjak

So it’s also how we’ve segmented our channel partners in some cases because we didn’t have as good a storage relationship in some of our ProLiant channel partners and so we’ve really expanded that. We’ve also added what we call road warriors to basically help sell the storage through the channel. That is also showing some early good returns.

Mark V. Hurd

Cathy’s point is exactly right. I mean, the ProLiant franchise and what it has driven and aligning that with the storage group is a very important thing that is going on here. So we want more -- we are expecting more good things, Bill, there. I don’t want you for one minute to think we are satisfied with it.

William Fearnley - FTN Midwest Securities

Thanks for the detail. Appreciate it.

Operator

Our next question comes from the line of Louis Miscioscia with Cowen & Company.

Louis Miscioscia - Cowen & Company

Thank you. Going back to EDS, I have a couple of quick questions here; I guess your comment that you could completely house EDS’ operation in your existing capacity, you know, they spent a ton of money throughout the years on their own IT infrastructure. What were they inherently doing that I guess was less efficient that you could bring to the table? Was it decentralization of their data centers?

And then the second question would be if you could give us a little bit more of a comment on just India in the sense of EDS obviously has best shore but they’ve sort of stumbled a little bit but do have a footprint in India, and can you actually do a lot with that in expanding it?

Mark V. Hurd

I think your comment, Lou, was about EDS and their utilization levels of IT and how they dealt with their IT expenses -- that was the question, right? The first one and the second one is India?

Louis Miscioscia - Cowen & Company

Yes.

Mark V. Hurd

Okay, great. Let me try to nail it -- first, the data center consolidation we talked about for EDS, I want to make sure it was clear, was internal IT, not trade. So just to make sure there is no confusion, we separate trade and internal IT and what I was talking about was internal IT and I think you are too.

I certainly can’t explain to you any historical issues other than what we see and the opportunity we see, which we think is significant to leverage that capability with our capability. So we feel good about it. We’ve done a lot of due diligence on it. We think it’s a pretty significant opportunity that puts us in a better position.

In terms of India, obviously both companies have a footprint there but we are less, sort of these days, and I’ve tried to mention this several times, we feel very good about India. We think India is an important country but at the same time, we look to optimize in many locations, and so India is important but it isn’t the only country where we have significant operations that we leverage. So we are still bullish on India. Obviously EDS has been bullish on India. They’ve got some 40,000 employees there.

Remembering too of their 130,000 employees, 30,000 of those employees are government employees that work right next to the government because of contracts, so their 100,000 remaining employees, they have a very significant presence in India. But we continue to optimize to best shore locations as we think it makes sense.

Louis Miscioscia - Cowen & Company

Okay, great and just a quick follow-up -- how about what both you and they are doing from an IT infrastructure outsourcing? Obviously it seems like you plan on merging those two and you think you can get some efficiencies there too?

Mark V. Hurd

We think about efficiencies all over the place, Lou, so we think it’s material in both process and in what we do, yes.

Louis Miscioscia - Cowen & Company

Okay. Thank you.

Operator

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

Katie Huberty - Morgan Stanley

Thanks. Good afternoon. Cathy, in light of the currency hedge losses that hit the P&L this quarter, what was the net impact of the weaker dollar on the bottom line and how should we think about that over the next couple of quarters?

Catherine A. Lesjak

Katie, I’m afraid I’m going to go down an accounting route here that I’m going to lose some of you on, but the currency losses that I was actually referencing are from hedging our balance sheets outside the United States. And that currency loss is -- a big chunk of that is really just the fact that interest rate differentials have switched, flipped around on us and we are now paying away points when we hedge our balance sheet, as opposed to earning points. And so it’s really not related to the revenue hedging that we do because the revenue hedging is all completely in from the revenue line all the way to operating profit. So we don’t actually -- it’s very difficult for us to completely capture the total currency impact on the P&L. I can tell you what is from a balance sheet perspective easily because it shows up in OI&E, but the rest of it is buried in basically every line.

Katie Huberty - Morgan Stanley

Okay, thanks.

Jim Burns

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

Operator

Yes, sir. Our next question comes from the line of Clay Sumner with FBR.

Clay Sumner - Friedman, Billings, Ramsey & Co.

Thanks very much. I just wanted to revisit the IPG business. Revenue was up 6% or so, supplies were up 8%, yet operating income I think was flat in dollars year over year, and I just -- I assume that it essentially reflects a shift in the overall portfolio to laser. Might we expect that wide format makes an edge line to halt that shift to laser, and if so, when?

Mark V. Hurd

Listen, 16.2 is a pretty good number for us. We usually -- I remember the days when I got here; we never thought we could make more than 15 in the business, and so 16 is a good number for us overall.

We have invested in the sales people in enterprise. We have invested in sales people in the graphics. Graphics had another good strong quarter where we are investing some sales people into that mix. There is shift from laser, as you’ve described, that I would say sort of adds to that portfolio shift, but overall pretty healthy IPG performance all the way around and the fact that we could deliver 16.2, deliver 6% unit growth, turn in 8% supplies growth, and yet also invest in the demand creation for the future in the enterprise and in the graphics.

And I think as Cathy referenced a little bit earlier in her talk, graphics is now quickly becoming a material piece of the business that’s got a very attractive growth rate and delivers a very positive operating performance of the business, so we are investing into graphics as we invest into enterprise. And it’s really the mix of those factors that gets to the answer that we did, not just laser alone.

But what I would tell you as I said about Q1 and I’ll say this about Q2, IPG had a strong quarter in Q2.

Catherine A. Lesjak

I think you also need to take into consideration we’ve talked a lot about this, whether it’s in IPG or other segments, is that we are investing to grow, to Mark’s point, but we are also investing to save, to basically set ourselves up with the right cost structure in the longer term, and you certainly saw some of that in the IPG P&L this quarter as well.

Clay Sumner - Friedman, Billings, Ramsey & Co.

Okay. So just to clarify, you are suggesting maybe that gross margins were more positive than operating margins because of the investments?

Catherine A. Lesjak

There are investments in both the cost of sales line as well as in OpEx.

Mark V. Hurd

I’d say generally your question, your point is right, yes, and that there is some cost for investing to save, as Cathy described, and there is some investment to grow, as Cathy described. And it’s the combination of those two factors that we think it’s prudent to be able to invest to grow and also to invest to take structural costs out of IPG for the long run and both of those are in the Q2 numbers.

And again, I’ll say it one more time, and yet delivered 16.2 as we did it, so we feel good about that.

Clay Sumner - Friedman, Billings, Ramsey & Co.

Thank you.

Operator

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

Scott Craig - Banc of America

Good afternoon. Thanks. Mark, with regard to Europe specifically, I know you guys have a number of different channels that you are getting hardware product out to, but can you contrast what some of your larger distributors are saying, like the Ingram Micros and the Tech Datas of the world, where they are seeing weakness in Europe? And typically my understanding was that’s a larger channel for you in Europe than it is elsewhere, and then maybe what you are seeing in the direct business or the retail business over there, because there seems to be some sort of disconnect from the solid trends you guys are seeing in Europe versus some of your partners.

Mark V. Hurd

Scott, I very much don’t like talking for them, so I don’t want to have any affect on them or their commentary. We just saw a strong Europe and to your point, we are very diversified in Europe. There is also a very larger reseller base in Europe, so if you just looked at sheer number of partners, the way the channel works in Europe is a bit more dispersed than what you would see in the U.S. In addition, Europe is now a very diverse economy, between Russia, Central Europe, Eastern Europe, Middle East, and so when you talk about Europe, we combine it into this thing called EMEA, but inside EMEA, you’ve got a whole series of things that go on between more mature Euro markets and markets that are actually much more like an emerging market in the context of some of the markets I’ve already described.

So it’s really hard to generalize about a conclusion there and I would not -- I would not take a result from one of those distributors you described and then try to extrapolate Hewlett-Packard’s results across Europe for a quarter. I think it’s a very dangerous thing to do because of the disparate nature of Europe today and the different sets of types of partners that are out there.

So again, one more time, Scott, I think to your question, Europe was strong for us in the quarter across really everything that we touch. So it was strong across move every segment that we have.

Scott Craig - Banc of America

Okay, thanks.

Mark V. Hurd

Thank you. Okay, I think we’ll leave it there today and I guess just at the end of the day, to summarize the quarter for us, we had strong growth in the quarter at 11%. We felt it was balanced and we picked our spots where to participate and we felt like we got good results from that. We had margin expansion. The company executed from an expense perspective with discipline. Cathy gave you those numbers and we feel good about the fact that when you look at ex-currency, our spending was in line. This is the best cash flow performance we’ve had in the company’s history and we feel good about that and we were active in the market in terms of share buy-back.

So I think at the end of the day when you think about the second half for us, we go in with a diverse marketplace, diversity of customers, geography, and businesses, and at the same time as we see that from a revenue opportunity, we are going to continue to be very focused on driving efficiency and there is more leverage in our operating model to gain out of the cost actions that we are taking.

We’ll leave it at that today. Thanks for joining us and we’ll talk to you again soon.

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.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!