惠普 (HPQ) 2002 Q2 法說會逐字稿

I f you would like to withdraw your question press the '#' key. Before we begin let me introduce Mr.

the Director of Investor Relations, who has a brief message for you.

Thanks David.

Good Afternoon everyone. I would like to welcome all of you to our Second Quarter Conference Call. Joining me today is our Chairman and CEO Carleton S. Fiorina and Robert P. Wayman our Chief Financial Officer. Before we get started I would like to remind you that the call is being web cast on hp.com. Click on 'Listen to Q2 Earnings Conference Call' and follow the direction. A replay will also be available shortly after the conclusion of the call and will remain available for approximately one week. Before we get started I want to inform you that the primary purpose of this call is to provide you with information regarding the quarter just ended. It is possible, however, that some of our comments and responses to your questions may include forwarding looking statements. These statements are subjective to a number of risks and uncertainties and actual future results may vary materially. I encourage you to read the risks described in the company's annual report on Form 10K for the year ended October 31, 2001 and subsequent reports filed with the SEC for an understanding of the factors that may effect the company's businesses and results. Finally I want to point out that because our merger with Compaq closed after the need of HP's fiscal second quarter, the results we release today are for stand alone HP. That is they contain no Compaq results. So, with that I will turn it over to Carleton S. Fiorina for her remarks.

Thank

and Good afternoon everyone.

We stayed focused and executed well during a difficult quarter. The IT spending environment remained tough around the world, on top of this in the final weeks of the quarter 400 senior managers were named to their assignments in the new HP and we were involved in a highly visible

. So while there was real potential for distraction HP delivered. This afternoon as you know we reported second quarter revenues of $10.6 billion, down 7 percent from $11.4 billion last quarter and slightly lower than our original, modestly down, guidance. Gross margins improved significantly during the quarter. Pro forma gross margins increased sequentially to 28.7 percent from 26.9 percent last quarter, and 25.1 percent last year. We also reported pro forma earnings per share of $0.25, which is in line with the analyst consensus estimates for stand alone HWP. This results compares with $0.29 in the preceding quarter and $0.17 in the year ago quarter. Cost structure improvements and expense control continued to yield good results, with expenses essentially flat on a pro forma basis sequentially, and down 7 percent year over year. On the balance sheet side, we reduced inventory by nearly $500 million during the quarter. Cash flow from operations was $2.1 billion, and we exited the quarter with nearly $9 billion in cash and short-term investments. This represents the third consecutive quarter of cash flow improvement. On a stand alone basis over the past three quarters HP has generated $6 billion in cash. With the merger the new HP starts with $13 billion in cash. Today we also announced HP employees will receive a Company Performance Bonus for the first time in 18 months. I should point out the targets for this program are set for each six months period, well in advance by the compensation committee of the board. Payouts against these pre set targets are formulaic.

Turning to market conditions, they remained tough globally throughout the quarter. US revenue for the second quarter was down 11 percent sequentially and 16 percent. Revenue from outside the U.S. was down 4 percent both sequentially and year over year.

In Europe revenue was down 6 percent sequentially, but up 2 percent year over year. Europe is the only region of the world to show year-over year improvement. Asia Pacific was down 2 percent sequentially, 13 percent year over year. Latin America was up 3 percent sequentially, but down 12 percent year over year. For this quarter IT spending and tough deal pricing once again characterized the enterprise market. The Telecom and manufacturing sectors continued to be the weakest. Revenue in our enterprise business declined 5 percent sequentially. Meanwhile consumer demand continues to hold up better than the enterprise demand. Consumer revenues were down 8 percent sequentially, while this consistent with normal seasonal patterns, we did some softness in consumer demand as the quarter progressed. While revenues were down sequentially, operating profit for the business was strong, with all regions posting profitable results.

Now we will take a look at performance by each business segment. We will start with Imaging and Printing Systems segment. Second quarter was another very solid quarter. Revenues were down 4 percent sequentially, but down only 1percent on a year over year basis. Demand continued to be strong in the second quarter for All-in-one devices, Photosmart printers and low-end LaserJet printers resulting in supply constraints in these product categories. Perhaps the biggest news in this segment was that for the first time supplies totaled more than half of sales coming in at 53 percent of revenues. Supplies revenue grew 5 percent sequentially and 10 percent from 2001, as ink-intensive photo printers and All-in-one products continue to become a larger percentage of the mix. On the printer hardware front, Business printer revenue was down 9 percent sequentially, and while revenue was down, unit shipments were actually up as growth in the low-end continues to push down ASPs. In the Home printer segment revenue was down 7 percent sequentially. HP maintained its leading market share position in low-end inkjet printers during the quarter. The story continues to be growth in All-in-one products, where demand is similarly outpacing supply and to deal with this issue we are adding manufacturing capacity through partners as fast as we can. Digital imaging revenue was down 37 percent sequentially following a big holiday selling season, but was up 3 percent from last year. Ink-intensive photo printers again posted triple-digit unit growth during the quarter to the lead the category. Scanner revenue decreased 27 percent sequentially, but increased 3 percent year over year.

Moving to our Embedded and Personal Systems segment. In this segment overall revenue was down 13 percent sequentially. Commercial PCs, that is desktop and notebooks, had a relatively solid revenue quarter with growth of 4 percent sequentially, driven primarily by commercial notebooks which were up 17 percent versus the prior quarter and continued to gain market share world-wide out pacing the market growth rate year over year. Consumer PCs revenue which includes desktop and notebooks decreased 24 percent sequentially, down 8 percent year over year. Consumer notebooks up 10 percent sequentially, 74 percent year over year, while desktops were down 30 percent sequentially, down 19 percent year over year, signaling that the shift to mobile computing is clearly well underway. In fact our consumer notebook revenue reached an all-time high during the quarter. Although, as I had mentioned earlier we did see some fall off in overall consumer demand late in the quarter. It is also worth noting that our consumer PC business posted another profitable quarter. Our exit from the CD writer business was the primary reason for the decline in personal appliance sales, where revenue was down 33 percent from first quarter. I should mention that our new our new DVD-RW format looks to be emerging as the industry standard with 70 percent share after just 7 months in the market.

In Computing Systems, weakness persisted in the quarter. Revenue was down 6 percent sequentially. Enterprise IT spending is currently showing no signs of recovery and price competition, particularly in storage, continues to impact revenue and margins. In the UNIX space, overall revenues declined 4 percent sequentially, although we gained market share during first calendar quarter of 2002 according to research released by Gartner today. Revenues for our high-end Superdome UNIX servers were up 5 percent, and the order ramp was impressive with bookings up 33 percent sequentially in dollars. Meanwhile in our industry standard servers business, where enterprise accounts figured out our post merger product road map and delayed purchases, revenue declined 13 percent sequentially, and we lost share. This is clearly a category in the server market where Compaq's expertise and market position will have an immediate, positive impact on our business.

Moving to Storage, revenue was down 6 percent sequentially and fierce price competition continues to pressure margins. Despite the tough environment we think we held our own relative to our competitors. Last week, we announced the XP128 and XP1024 additions to our high-end lineup; and we think the HP-Compaq storage combination will make us formidable competitor in this category going forward. Finally declining systems sales pushed software revenue lower by 10 percent from first quarter.

Consolidating our Enterprise business with Compaq significant improves our market position across every category of the Enterprise business and improves our prospects for growth and profitability going forward.

Now let us look at IT Services. Overall IT services revenue was down 6 percent sequentially, 4 percent year over year, 2 percent in local currency primarily as a result of continued revenue decline in our consulting business. Consulting posted a 15 percent decline in revenues sequentially, down 21 percent year over year, consistent with the industry wide slowdown in IT project spending. Support revenue was down 3 percent sequentially and flat year over year, up 2 percent in local currency. Support continues to generate strong historic levels of operating profit for the IT services segment. Our outsourcing business continues to gain momentum. While sequential revenue was flat, we finished the quarter up 19 percent in dollars over last year, 22 percent in local currency and our order

looks promising. Finally within our financing segment second quarter revenue closed down 7 percent sequentially. Lower cumulative hardware sales over the past several quarters along with conservative financing policies are contributing to lower growth rates here.

Now let me turn the call over to Bob for additional detail.

Thank you Carleton, and Hello everyone. Well, after our long proxy contest it is nice to get back into the more routine business of reporting earnings for our most recent quarter. Our results are particularly gratifying, given the continue tough market conditions and the obvious distraction in the last several months. As you just heard Second quarter revenues was $10.6 billion and pro forma EPS was $0.25. Our revenue was below our original guidance. Our improved gross margin and continued solid expense management allowed us to post an EPS result consistent with our expectations at the beginning of the quarter. Performa EPS was down only $0.04 from the $0.29 level we earned in the first quarter, but was up substantially from last year's $0.17. A good result when evaluated in the context of a 9 percent lower revenue

. Our pro forma EPs number excluded approximately $260 million of charges. A particular in note was a $140 million charge related to our merger with Compaq, of which approximately $75 million was directly associated with our advertising and proxy

. In addition we incurred $59 million of in-process R&D expense related to acquisition of Indigo and $53 million in amortization of goodwill and purchased intangibles more than half of which was associated with Bluestone acquisition. Including these items, reported GAAP EPS was $0.12.

Let me offer some additional geographic details. At the macro level the economic slowdown continues to worldwide phenomenon. In the U.S. revenue was down 16 percent year over year, while Asia Pacific revenue was down 13 percent in dollars, but only 5 percent in local currency. A weak Yen continues to hurt performance in Japan where year over year revenue was down 17 percent, 1 percent in local currency. In addition for the first time in a number of quarters we saw weakening in China, where revenue was down 23 percent from last year. In Europe currency was not an issue as dollar-based revenue climbed to 2 percent for the quarter. In Latin America revenue fell by 12 percent.

Now let us look at gross margin. We exited second quarter with a Performa gross margin of 28.7 percent. This was a really solid performance in the context of lower revenues. Up from last quarters up from 26.9 percent and last year's 25.1 percent. This improvement was a result of good cost management, better overall business mix and high margins in our imaging and printing business driven by high growth in All-in-one and photoprinters, low-end laserjet printers and supply.

Next Operating expenses. Performa operating expenses were essentially flat sequentially, and down 7 percent year over year. As I indicated last quarter expenses are typically up 5 percent first quarter to second quarter. So, our expense guidance of roughly flat incorporated the expectation that we would aggressively manage these costs. In that context our expenses are in good order and I am pleased with our result. Putting all these factors together our Performa second quarter operating margin was 6.4 percent versus last quarter's 6.3 percent. That was off set somewhat by an unexpected drop in the net other income line, which ended the quarter as $45 million expense on a Performa basis. The drop was due almost entirely to $401 million in balance sheet re-measurement associated with Argentina. That $40 million translates into roughly $0.02 per share loss to the bottom line. So it was obviously pretty significant. Our Performa tax rate remained unchanged at 22 percent. The net of a higher operating margin and an unexpected fall off in other income resulted in a net earnings percentage of 4.7 percent and $0.25 of Performa EPS.

this quarter.

Let me now take a moment to run through operating performance by business segment. Starting with the Imaging and Printing systems segment. Second quarter was another very solid quarter. Revenue was down 4 percent sequentially, but down only 1 percent on a year over year basis. On a operating profit level the Imaging and Printing segment showed sequential improvement to 15.7 percent from last quarter's 14.6 percent. The price pressure that we discussed last quarter simply did not materialize which directly benefited bottom line performance. As noted earlier demand has been so strong that we remained supply constrained on several of our All-in-one and photo printer products. In addition better utilization of ink supply manufacturing facilities, continued improvement in mix to higher margin products and another quarter of favorable

all contributed to the rise. In short everything went right this quarter. Much as I wish these profit levels were sustainable they simply aren't. With our continued investment in commercial printing and increased R&D, ink supply capacity expansion plan, and the introduction of new products, I expect profit levels to be lower in the coming quarters returning to more historic levels. Another important event for Imaging and Printing Systems was the acquisition of Indigo during the quarter. As most of you already know Indigo is a key part of our longer term growth strategy and while the acquisition had little impact on revenues or earnings this quarter it did result in the addition of approximately 1200 employees and the issuance of about 32 million shares of common stock.

Turning now to Computing Systems. Second quarter was another challenging quarter for this business. While revenue 6 percent sequentially, operating profit finished the quarter with an operating loss of 12.7 percent, down from last quarter's operating loss 8.0 percent. Enterprise IT spending is simply showing no signs of recovery. We have made good progress in reducing expenses, which are down 12 percent versus the year ago quarter. But revenue is down 20 percent, with NT revenue down almost 30 percent. Lower revenue combined with continued aggressive price competition, particularly in storage, continues to impact gross margins. While gross margins are still healthy the impact of the revenue decline continues to pressure the bottom line. It is for this reason that we have persuaded our merger with Compaq so aggressively. The synergy opportunities within the

will allow us to improve margins and make the necessary R&D investments required to retain our leadership in these important markets. We are confident that new HP is positioned to win in this segment once the economy turns around and IT spending picks up. Until then competition in this market will continue to make this is a challenging business.

On to Embedded and Personal Systems. Overall revenue was down 13 percent sequentially, and 15 percent year over year in our Embedded Personal Systems group. Operating margins eroded during the quarter as costs rose and prices fell. Operating profit at the end of the quarter is -4.9 percent, down from last quarter's near break-even levels. Home PCs remained profitable despite a seasonal decline in revenue of 24 percent and despite additional provisioning for price

protection. Within commercial PCs revenues increased 4 percent sequentially, but gross margins and operating profits were squeezed by tough competition and rising component costs. Memory costs alone rose by approximately $35 per unit versus first quarter levels. Costs increases that we simply could not fully pass on to customers. Personal appliance margins also deteriorated primarily due to

. Looking ahead, margins in this segment will continue to be pressured. However, here again our merger with Compaq creates significant opportunity. Specifically volume economies combined with expense synergies and preparant savings will benefit our cost structure. And growth of our direct selling

model will reduce supply chain cost. Together with improvement in laptop and desktop mix and lower component cost, we continue to believe that the PC business is a good business.

Looking now at IT Services. Lower revenue hurt operating margins in all major business areas. Despite the challenges the overall IT Services margin remained at historic levels and ended the quarter at 11.1 percent. While this is down from last quarter's six quarter high of 13 percent it is nearly unchanged from last year's second quarter of 11.3 percent. In consulting, the economic slowdown has created excess capacity and under utilization of resources and that has hurt margins. Although we continue to be encouraged by our outsourcing business the fact remains that the contracts are much less profitable early in their life segment. The excellent growth in recent quarters has created a business portfolio that is heavily weighted with these early life cycle deals. Margins in that business will improve as our portfolio mix matures. Finally looking at our financing unit. Operating margins declined from a negative 2 percent last quarter to negative 2.5 percent this quarter. Revenue continues to feel the squeeze of lower

hardware sales over the past several quarters and also the more conservative financing policies I discussed with you last quarter. In addition we took a charge of $20 million related to business in Mexico during the quarter, which obviously hurt performance. Nevertheless financing remains an important asset as an enabler for our other businesses and an important source of profit and growth going forward.

That wraps up my discussion of the business units. So, now let us take a few minutes to look at the balance sheet, asset management and cash position.

HP owned inventory continues to be a good story, ending the quarter sequentially down $500 million, not including the inventory added with the Indigo acquisition. This is essentially in line with our revenue decline of 7 percent for the quarter and leaves our inventory position nearly $1.2 billion below where we started the year. As was the case last quarter, virtually all businesses showed declines in inventory level with the greatest decline coming in our imaging and printing business. We simply can't meet demand for several Inkjet, LaserJet and All-in-products, and so inventory levels are extremely low for these products. Looking forward third quarter inventory typically turns higher as we prepare for the busy back to school selling season. Combined with our desire to add inventory for supply and same products, I expect notably higher owned inventory levels next quarter. Channel inventory was a mixed story for the quarter. As Carleton mentioned, demand for consumer PCs fell off somewhat as the quarter progressed. As a result we ended the quarter with home desktop PC inventories at 8 weeks, 9 weeks versus

. I should note that while these numbers seem high, home desktop PC mix in the channel fell by approximately 57,000 during the quarter. So we are bringing the absolute numbers down. It is just that the demand has fallen more quickly then we can reduce inventory. In addition we have also taken steps to further deal with this issue by taking a charge of approximately $37 million for price protection, roughly double the level of first quarter. We are also scaling back production plans. Commercial PCs inventory in the channel looks much better with levels at a more normal three to four weeks. Overall printer channel inventory looks good and is currently at about four weeks of supply. Finally Ink and toner supply levels may actually be lower then where we want them at about four weeks. Moving to trade receivables, we had another good quarter with receivables down $200 million. At present levels trade receivables stand at 9.1 percent of revenue, down 1.3 points from last years second quarter and down 0.3 points from last quarter. All in all I am pleased with the job we have done in managing this important business fundamental.

So as a result of excellent asset management of working capital during the quarter, cash from operations was 2.1 billion dollars. Property, plant, and equipment ended the quarter down 83 million dollar with capital expenditures net of dispositions at 245 million dollar that translated into an increase of 1.0 billion to our cash balance but together with our short-term cash equivalents, ended the quarter at about nine billion dollars. So this is another

this quarter

of cash generation in a run of really solid quarters. In addition of the 2.1 billion dollar of cash generated from operations this quarter, we added 1.7 billion dollar last quarter and 1.7 billion dollar in fourth quarter of last year. Over these three quarters, our cash and short-term equivalent balance increased by 5.6 billion dollars. Looking ahead, the addition of compact to our business model and the resulting synergies will only improve the cash generation capabilities of the merged company.

A quick update on capital spending.

At the beginning of the year, I told you that the capital spending would be 1.8 billion dollar for the year through the first half. We currently stand at roughly 700 million dollar. I will provide a second half outlook on capital spending at our June fourth meeting.

Let me also comment just briefly on head count for the quarter, which ended the quarter up roughly 1900 from last quarter. The vast majority of the increase came from our Indigo acquisition and from ads in our labor-intensive outsourcing business. Other business units were roughly flat or head of announced restructuring implementation.

As per outlook going forward for new HP, I will be providing a lot more detail about historical performance for the merged companies at our analyst meeting in June. As well as more detail guidance for you to model. In addition, I will update you on capital spending finance for new HP and offer some revised financial metrics. I will also try to answer your questions regarding financials for the merged companies.

In that context, I ask you to let me get questions today to our fiscal second quarter performance, which will get to after just a few brief comments from Carleton.

Thanks Bob.

One week ago, today, we launched the new HP and the response from employees, customers, and partners around the world has been overwhelmingly supportive and enthusiastic. It's been a long time coming. More than 100,000 employees participated in a live global broadcast event, one week ago today, outreach to our customers continues and we are laying out the detailed three-year product road map and migration plans we have put in place.

HP.com, our company website and online store was integrated on day one. A single employee portal was universally available on day one. Our two networks were integrated and secure on day one, our e-mail addresses are all converted to @hp.com. Employees of the new HP can plug into the company network at any site in any country. IT integration plans exist for every system in every business in every region. Our financial systems are integrated and we are ready for our financial close. We set up an integration escalation hotline for senior leaders around the world and nobody called, which is good news.

Last week, we began the next round of management announcement and they continued this week as of today, we 1000 managers now in their assigned positions in the new HP.

Yesterday, we also began rolling out our voluntary-enhanced early retirement plans for qualified US employees that we announced last week. Voluntary retirement packages were sent to 9000 qualified employees in the US yesterday. We also began notifying individuals who will be participating in the global workforce reduction programs. Details of these programs, their timing, and associated charges in countries around the world will be provided at our June fourth Security Analyst Meeting.

We have a lot to prove and we are realistic about the hard work ahead, but we are also proud and excited about our clean start out of the gate.

So with that, I would like to open the call out to questions.

Ladies and gentleman, we will now begin the question and answer portion of today's call. If you have a question, please press star then one on your telephone touch-tone pad, you will be announced prior to asking your question. If you would like to withdraw your question, depress the pound key.

One moment please for the first question.

Your first question comes from

of Goldman Sachs.

Yes, thank you, I have a couple of questions.

As you indicated, revenue was below your original target. To what extent can you actually factor that has that began to factor in to your thinking about revenue reductions and how that might come together? Also, several companies, notably IBM, indicated that the closure rate, in particular, at the end of the quarter has become, particularly, unpredictable and there is no urgency that customer seem to have as far as closing enterprise business. Can you give us some specifics as far as what you saw in the closure rate and then finally related to that, a number of customers and a number of industries seem to be indicating that while they haven't changed their budgets, they are spending less than what they have budgeted, again any comments on what you are seeing about that?

Okay, let

and Bob may want to add some additional commentary as well.

Off course, in terms of revenue lost due to the merger, as you know, we have modeled about 4.9 percent revenue loss due to the merger would begin virtually immediately with our announcement of the merger back in the Fall. I certainly think, in the case of, for example, NT servers, we do begin to see some merger-related revenue loss. The merger-related revenue loss we saw in this quarter is certainly consistent with our models. In some cases, a bit better, but reasonably consistent with those models. At the same time, it is also true that, I think, the level of overall IT spending continues to remain quite depressed and pricing pressures continue to be very real.

With regard to your comments from IBM, I guess the way I would put it is, I think in general what we are seeing is longer selling cycles. It takes longer to convince customers to make a purchase and the competitive bidding period tends to drag on. So I am not sure I would share their commentary about less sense of urgency in closing business for quarter, but, I think, in general, throughout the quarter, there is less urgency in making a fast decision and customers are certainly willing to take their time to make a purchase decision. I certainly would agree with the comments that in general with regard to budgets, IT budgets have not increased. Most CEOs and CIOs I talked to say they won't increase them until they see very clear signs of economic recovery over a couple of months and, therefore, most of them are trying to hold those budgets in check. In many cases, are spending below their budgets. Certainly that's the case in HP, just as an example.

Bob anything you want to add?

No, fine, that's right.

Next question please.

Your next question comes from Tony

of Sanford Bernstein.

Just a couple of questions.

Bob, may be you can just clarify, you gave some great detail on the Channel inventory, so we understand sequentially what happened beyond the commercial PC business, sequentially were your Channel inventory levels, on an estimated dollar basis, up or down in aggregate across the categories?

Are you asking about commercial or consumer?

Both, please.

So commercial Channel inventories are growing a little bit. The business has been growing a little bit. So we are fine there. In the consumer PC space, we have seen sequential increase in weeks of supply of Channel inventory. Even though we have brought the units down during the quarter. So the absolute level of consumer US PC Channel inventory is down. The demand has declined and we have too much inventory on a forward-looking basis.

Okay and then on the printer side on a sequential basis, you mentioned commercial, does that include commercial printers and then how about consumer printers?

Overall, both commercial and consumer printer Channel inventory is in line with our expectation.

Does that mean it was flat sequential or does that mean it was up or down sequentially?

I think, given the seasonality of consumer printers, there's probably some movement downward sequentially, but I don't have the absolute level here. I only have the month's supply, but it is a slower selling season right now for consumer products so I would expect that the dollars would be down.

In terms of your expectations for this quarter, Carly I think, you just alluded to the fact that you thought of have been thinking, you know, since the merger was announced there might be some revenue loss expected right from the

, as you announced on the call, you were a little lighter this quarter than you had anticipated at the beginning of the quarter. Was it solely due to economic factors or, do you think incrementally, the lawsuit and some of the management changes affected things on top of it?

Well, this isn't a science, but I would say that our belief based on the original modeling we did on the 4.9 percent and based on our market share position, is that we are still performing within or better than our original 4.9 percent revenue loss model, but we clearly have seen continued slowdown in IT spending and in some categories intensifying price pressure. Storage would be an example of the latter. So, we don't at this point think that our revenue loss assumptions are off base. We did anticipate some revenue loss changing, but our market share is, in fact, holding up across virtually all our enterprise categories and therefore we think the vast majority of this is market-condition related.

Okay, Thank you and then final clarification, Bob, you mentioned that the strength of the Yen, how should we think about that in terms of your impact on imaging margins? Is it coincidence

the Yen dramatically appreciates, do we feel that immediately on a modeling basis going forward or is there a lag effecting that's associated with that?

There was about a three-month lag, but of course the Yen had been strengthening through much of the early part of the year. It's actually gone a little sideways, little bit down in the last few weeks but, not much change at this point. I think at this point, I would not build any Yen change affect into any thinking going forward.

Thank you.

Next question please.

Your next question comes from Joel Wagenfell of Banc of America Securities.

Hai, I was wondering if you could comment a little on the linearity of the demand for low-end printers versus PCs. In other words is low-end printing demand slow over the quarter as the PC demand did in consumers and how should we think about that given the low-end as part of your strategy going forward?

Yeah, so this gets pretty tricky here. Low-end demand for both PCs and printers, in the United States, always weakens after April 15th. The same is even true for supplies. Supplies sell through is strong in the US

. So we absolutely do see some tail off of both low-end printers and PCs. We have seen more tail off of PCs than printers.

So essentially wasn't greater than seasonality I guess with what I was trying to clarify?

Okay, thanks.

Welcome.

Next please.

Your next question comes from Richard Gardner of Salomon Smith Barney.

Thanks. Two questions. First of all, Bob, when do you expect to catch up to the demand for Photosmart and All-in-One? Second question, I think that you had talked originally about something in the range of 15 percent revenue loss within the Intel- based server category. I know that the category is usually down seasonally and probably some of the business went to Compaq, but it feels like that category could be one of the ones that is suffering a little more than you had expected. Can you comment on that please?

May be I will comment on the Intel piece first and then let Bob comment on your first question. I am not sure where you are getting the 15 percent. If you look back at our original revenue loss model, what you will see is NT Servers in total for the two combined company is down six percent and within that we assumed a 30-plus percent decline in HP's NT Server revenues because of our direction with the product line roadmap, that is Compaq being the surviving NT product line and ours being the not surviving

. Whatever the right adjective would be NT product line. So I am not quite sure where the 15 percent comes from, but that is consistent with the comments I made earlier to Laura. What we are seeing in NT servers in the quarter is consistent with that modeling and I think there's an area where clearly customers figured out the product line roadmap ahead of our announcement of it, it was fairly easy to figure out.

Yeah, the numbers that we have put forth are for the merged companies, Rich. So you have to be careful. Yeah and keep in mind that size of the business is about four to one, Compaq is about four times as big. So every percentage loss on the HP side gets diluted proportionally.

Just based on the question, maybe it would be helpful for us at our June four meeting and the IR folks can answer your questions on the phone, but we can break down the model for you. What's behind six percent combined is 30-plus percent with HP. Another example you'll see UNIX server revenues in the model down 11 percent, but beneath that is an assumption of about a 40-plus percent loss of Compaq UNIX server revenue. Again based on the product line roadmap we had put together.

So to your first question on the hot-selling printers, the All-in-Ones, and Photo printers, we would expect to catch up on capacity there in this quarter in our third quarter. We have made some progress on it, but just not enough yet.

All right, thank you.

Next question.

Your next question comes from Daniel Kumslur of JP Morgan.

Thanks, good afternoon. A couple of things, on the printer margins, I understand you (Bob) pointed out some specific reasons why these margins were up and I take notice of the comment that these aren't sustainable. However, you said exactly the same thing last quarter. I am wondering whether there has not in some comment a systemic increase of the operating margin, you

percentage not the right number on a consistent basis, is it maybe, you know, as creeping up on the sustainable basis?

That's a reasonable hypothesis. It's really too soon to tell, but obviously when you see supplies growing as a share of the portfolio, if one doesn't give up further margin on the products, that is using lifecycle pricing theory, one could expect that there may be a systemic improvement in margin. We will just have to see and it's going to be hard to tell, Daniel, over the next few quarters because we are definitely going to be seeing some additional spending both in the classic R and D and Marketing areas when we rollout a very broad new family of printers. We are also going to see some negative impact of the transition to the new print head technology. Every time we've gone through a new print head technology investment period, we have seen some pressure on gross margins. So both of those will happen, but whether the steady state is 11 percent or 12 percent or something different from that, it's a little too soon to call.

Okay, thanks. My second question, I think, you made the comment that in the services business that you are weighted toward early lifecycle deals right now. Can you give us some idea what Compaq's weighting has been in that regard?

I am not prepared to comment on that today.

Okay

. Thank you.

Yeah.

Next question.

Your next question comes from Dan Niles from Lehman Brothers.

Thank you very much. First of all actually congratulations on surviving

and also on the results, which are surprisingly good given what you, have to go through.

Related to what you said, Carly, on the consumer side weakening on the PCs, how much of that do you think was potentially related at all to what's been going on out there related to the merger and how much do you think is this sort of related to the environment and then I don't you have any thoughts on what you're kind of seeing right now or how you're seeing that play out over the following quarter and then, you know, maybe tied into that I am not sure if you have prepared a comment on this today, but you had made the comment on you're not really counting on any on IT-spending pickup for the rest of this year. What are your thoughts in terms of as you look beyond this year forward? IBM made some comments that they don't necessarily see the IT environment coming back to normal even necessarily by 2003 in terms of getting that spending of ten percent plus. Do you have any thoughts on how this materializes just on a bigger picture side?

So let me take the first couple of questions and then turn it over to Carley. We are not going to comment at all on third quarter as it relates to any part of the business right now, but certainly not many consumers PC space. You asked if some of the consumer PC is due to the merger and I can't say for sure. All I can tell you is that I have asked our operating people whether they see any reason to believe it is related to that and the answer is a very clear `no` at this point in time. They do not believe they are being pushed off the shelves. They see no indication that this is a merger caused. So, we'll have to let it play out awhile.

In the earlier to this I would add to that, Dan, is we have, as you know, now announced a dual-branded strategy in the consumer PC space. Specifically to maintain try and shelf space to the maximum extent possible. Having said that in our revenue loss models, we have modeled quite a substantial loss in both consumer PC and commercial PC revenues and again we can break that out in detail for folks in June. I think, with regard to your overall question around market, when I use the term-muted recovery in second half, muted to me means up two percent something like that. Our current view of 2003 is the IT spending environment overall is probably eight to ten percent up, certainly not ten percent plus and that is not a change from where we've been over the last six months. Obviously, there are distinctions within that eight to ten percent. There are portions of IT services that we think will continue to grow faster than that. PCs, we think, will continue to grow more slowly. Printing and imaging will grow at ten plus, but all in we're thinking it's high single digits in enterprise IT specifically, not ten plus percent and we've consistently thought that for at least the last nine months.

Okay and may be I am trying up on your answer, Bob, with regards to the consumer PCs, do you see yourself having lost any significant market share or do you feel pretty good about how that was going and then maybe related to what you said on shelf space early. In terms of your dual-branded strategy and some of the things you are trying to do there, do you feel a little better about how much shelf space you actually can maintain relative to what you thought six months ago when the merger was announced, was there any significant changes there?

So let me start with consumer PCs. Obviously the softness that we have seen towards the end of the quarter, it is too soon to know what impact that has from a relative market share. We just don't know if this is broad or not. I would say that while we had a 24 percent sequential decline in home PCs from first quarter to second quarter this year, we had a 21 percent decline in home PCs from first quarter to second quarter last year. So, this is largely a seasonal affect. And we've got some noise level around that seasonal effect. So we will just have to see how it plays out.

Next question please.

Your next question comes from Andy Neff of Bear Sterns.

Andy, we can't hear you.

Your next question comes from John Jones of Trileigh.

Good afternoon.

Hello John.

How are you?

Good. A couple of questions and then I'd like to get back into the

discussion. Currency impact here we hear it sounded like it was 3% or 4%. Can you clarify? How much cash do you have in Puerto Rico or in other assets?

I'm sorry. I missed the first part of the question, John.

Currency in the year was a 3-4% impact.

You are breaking up on us.

Oh.

Yes try again.

Okay. I'll try again. Currency impact was 3% or 4%?

No. First from an overall basis sequentially, there was very little currency impact and on a YoverY basis probably more like 1-2%.

1-2%. Okay. Cash and other assets totaled how much?

Yes. Cash and other assets which was not included in any of the numbers (other long-term assets) that I mentioned, it is half a billion dollars. So it is only half a billion. So we didn't feel we had to break it out, but that says that our cash balance really is $9.4b. I think something like that. Yes.

Are you prepared to talk about the cash required to go through the downsizing?

No more so than I did back in February where we indicated that the cash requirements were probably in the $1-1.5b range.

The question I wanted to dig into is relating to the operating margins in the printer business. The Yen is obviously having a positive impact, but Carly you talked a number of times on various occasions about the fact that if the merger didn't go through, you wouldn't be able to invest at the level you'd like to. Yet, now that the merger has gone through, the assumption is that you will invest in that business. But on the other hand, 53% of the business revenue is now coming from your supply business. That is trending up at the rate of three to four points per year and that business is extremely profitable. So the question, given all those factors, is that as Bob talked about the operating margin expectations for that business trending down to historical levels, can you give us some parameters on what you think those historical levels are because this is not a historical business given the trend of supply

?

John, just one comment and then Bob can add here. In the context of the comments you ascribed to me and I certainly did make those comments, what we have been consistently trying to convey is that we want our imaging and printing business to continue to be a double-digit grower and a double-digit earner and that what we mean by the double-digit grower and earner is in the 10-12% category. That is important and it is above certainly the operating margin performance of our competitors at this juncture. You are right. Supplies revenue going to more than half of the business helps with that, but I think the comment that Bob were making is around 15 going down to double-digit operating margins that were slightly below that. We're not arguing with the hypothesis to say, we're just saying it's too soon to call.

There is couple of other things I would add. To keep this business growing, in the long term, we believe we will need to go through a period of investment here. Commercial printing is a clear example of that. That will cause some of that move down from the 14-15% range that we've had the last couple of quarters. The big unknown from my point of view is what will the competition do with regards to lifecycle pricing. One can argue that no one needs to earn 15% in this business for the long term and, therefore, people will price out some of what we are seeing right now with regards to the excess beyond what is needed in this business to feed it for the long-term health of the business. I don't know. We'll have to see how various competitors behave. Right now, we and some others are little short on some of these really hot product categories and so we're not having to lower the prices as we assumed we would have.

Next question please.

Your next question comes from Steve Malonovich of Merrill Lynch.

Thank you. Could you comment on the UNIX business a bit more? You indicated Superdome orders were up about a third sequentially. What do you attribute that strength to in what seems to be pre-weak environment? Can you talk a bit about the mid-range, which I believe where you do more business, as well as the low-end trends?

Okay. So in terms of the high end, we continue to believe that Superdome clearly is gaining share and we think that's based on its performance, I mean we continue to lead the world in terms of performance benchmarks. So we are to gain traction, I guess I would say, at the high end and those benchmark records continue to be set. In terms of midrange to your point where we have traditionally had leadership, we remained No. 1 in the mid range for the fifth straight year. We are sitting at a market share position that is now 3 points above IBM, in the No. 2 position and about 6 points above Sun, and in terms of entry-level or low end, we are sitting now in about the No. 2 position behind Sun who is still number one and the gap there is probably 15 points right now in terms of market share.

The mid-range also grew 3% sequentially, Steve.

Yeah. That's kind of what I was looking for. So that was up as well. Are you seeing any trends towards NT or Linux since you're in all the businesses?

Well, we do certainly believe that low-end in particular. But midrange, what is called the low end of midrange, overtime will be impacted very much by NT and Linux and that is why we have said over the past many months that frankly we think UNIX all in is probably a single digit grower going forward, say 5-7% as opposed to a double-digit grower with NT and Linux growing at 20-plus percent. It's really in the low end and the low end of the mid range where Linux and NT are going to continue to take share from UNIX systems. I mentioned publicly couple of weeks ago one of the places you can clearly see this is in Financials where you have a lot of financial institutions, some of which are represented on the phone today

moving a lot of their low-end systems to Linux.

Thanks.

Next question.

Your next question comes from Richard Chu of SG Cowen.

Thank you. I have a couple of questions. First of all don't want to beat the consumer issue to death but you mentioned April 15th. I wonder if you can go back and clarify whether the consumer weakness that you saw began to materialize in March or in April particularly since Compaq has been talking about mid March only? Then I would like to follow on with a couple of points.

We saw some weakening in March. Keep in mind that our first quarter, we had much stronger consumer revenues than we anticipated. The question is, how much extra demand was there in our base period in 1Q that might have set our expectations? But it was not just an April thing. March was a bit weaker. April a bit more.

Secondly, with respect to gross margins, which are unusually good, apart from the imaging and printing factors that we talked about, can you talk in general terms about how normalized these numbers are? How sustainable, generally, are the levels in the remaining businesses?

Richard, that all depends upon the growth of the various segments. As we indicated, one of the contributors was mixed here. If PCs recover, you're going to see pressure on the overall company gross margins just by the nature of that mix. If UNIX recovers even more, that would be favorable to gross margins etc., etc. So it really is a function of your view of the various growth rates of the various segments. At least at a macro level. Beyond that, we've laid out here in a number of ways why we believe that through the merger with Compaq we can improve gross margins in the enterprise space, the PC space, and to some degree, the services space as well. We see some definite leverage opportunities in services.

I couldn't help but notice your reference to new printer technology. Can you tell us about what the new technology is?

VJ has talked about this before. We have been designing a set of print heads and products to specifically be optimized around the low end of the market. So this will mean lower cost products, which will allow us to either compete more effectively or earn more profit in the low-end along with lower priced print heads.

Will that be a factor in 3Q or are you talking generally about the 2H02?

We're manufacturing and selling a few of them today. But the big impact will not show up until 4Q.

Terrific. Thank you very much.

Richard, The only comment I would add maybe for the benefit of others as well, just as a reminder, the model that we originally weighed out for the merged entity contemplates, lets call it in the 2003 timeframe, 25-27% gross margins with a 15-17 op ex structure and a nine point operating margin. So that's the model we're trying to build the expense structure to.

Next question please.

Your next question comes from Jay Stevens of Buckingham Research.

Yes thank you. Bob, I have a question for you on the balance sheet. You gave us a lot of detail about channel inventories. Yet when I look at the inventory on the balance sheet, it was down over $400m sequentially. Having trouble rationalizing the decline in the numbers vs. what you said about the channel inventories. So could you put some color that?

Sure. It's real simple. The large owned inventory decline occurred in printing where we have had no particular dynamic in channel inventory other than as I noted. We are a little light on channel inventory. We are also light on owned inventory on a few of the hot products. The channel inventory issues in the consumer space are PC. In fact they are US PC retail inventory. That is where we have too much channel inventory.

And that excess inventory in the number you reported for the April 30th balance sheet. Is that right Bob?

We don't report channel inventory on our balance sheet. We record the shipment at the time it goes to the channel partner. So now it is not in those numbers.

Okay. So it is not in those numbers.

And our PC inventory is very low. There's not much on the balance sheet at all. So you really do need to focus on what is in the channel.

One other balance sheet question as long as I have you Bob. The deferred revenue account, its remarkably flat quarter after quarter after quarter. This particular quarter sequentially it is up from the prior quarter. Is there any use we can make of this or is it just a statistic that appears?

I wouldn't pay a lot of attention to it because as you point out it is fairly stable. That is because the largest contributor to it is service contract sorts of accounting issues i.e. customers may enter into a contract and the revenue would be deferred on it. That is a fairly steady sort of action site. I don't think there is much to be read into it.

Thanks Bob.

Jay, just as a reminder because you are focused on this. The difference between the 500 inventory reduction that we've been talking about and the 440 whatever number you referenced is Indigo inventory.

Oh yes. Thanks Carly.

Okay.

That is helpful.

Next question.

Your next question comes from George Elling of Deutschebank.

Thank you. I have two questions. First for you Bob. Your computing systems loss was pretty steep. Can you give us any additionally color in light of the environment?

Not a whole lot. I will just emphasize two things. One is the industry standard server revenue. The decline is substantial. I noted down almost 30% over last year. I would also say that in that space our gross margins are not healthy. This is a business that is suffering. So if you look at the dynamics of operating loss, that is an area where we definitely saw an increase in operating loss. Another category where I think you will understand is software. Software revenue as we indicated is down. If you don't get the revenue in software, it falls almost straight to the bottom line. So that is another area where we have some work to do in terms of profitability.

Thank you. I guess the second question is sort of a variation on a theme of what other people have already asked, but with Hewlett now in transition, 2Q results were no doubt impacted by the merger fight. Where did you think you saw the most impact by the uncertainties in the quarter and is there any way it's quantifiable?

Well that's a hard one. I would say this. I think the merger related distractions that were most notable were the ones I mentioned up front both of which occurred in the last month of the quarter, which is obviously critical. So I mentioned that we had a very visible lawsuit in the last month of the quarter and that, you know

, took people's time and captured other's attention and at the same time in our last month, we named 400 senior managers and we were bringing those 400 managers into meetings on the weekends. People were beginning to transition into their new responsibilities and while I can't quantify it, I think it is real but people's heads in the last month of the quarter were focused in a couple of places at once.

Thank you.

Next question.

Your next question comes from Walter Winnitzche of First Albany.

Yes thanks. I have two questions, Carly, to just confirm. When you talked about the 8-10% growth, you were talking industry. So you are looking for a recovery back to sustainable levels next year. That is the first question and second Bob, can you just run through what you said about price protection and maybe give that to us from the framework of what price protection was last quarter. What is that for and is that something that you consider operational or a special charge?

So with regard to your first question, the 8-10% is, you are correct, industry growth rates for the businesses in which we compete. So it is a blended average comprising IT services, enterprise systems, PCs, and imaging and printing. So there's some variation by business around it, but all in we think it's 8-10% and while one can call that normal, it certainly is below the rates we saw industry-wide in the late '90s and even in 2000, but we think that lower growth high single-digit 10% is what will be the normalized pattern going forward.

With regard to price protection, what I said earlier is that in the home PC arena, which is where we have the excess channel inventory, we booked $37m of price protection this quarter which is about double the level of the prior quarter and this very definitely is operational. We do not adjust this out. What we do is basically back off the revenue assuming that we are going to have to give additional price consideration to move the goods and it falls straight to the bottom line.

Thank you.

We have time for one or two more questions.

Okay sir. Your next question comes from Don Young of UBS Warburg.

Thanks. This is actually Anthony for Don. Can you give us a little more detail on what you saw in consumer PC in terms of pricing and could you go into a little bit more on Europe as compared to the U.S.? Also, do you have any plans to change your dividend policy once the merger goes forward?

We have no plans at this point in time with regards to dividends. Let me start with that. We will be having our new combined company board meeting here soon and that is certainly on the agenda. I can't guarantee any decision will me made but certainly, it is on the agenda and we'll let you know as soon as something is known there. No, I don't really have much more detail on consumer PC pricing other than what you have all read generally that the shortage of some components earlier in the year did result in less price pressure than normal. In the case of memory, that is certainly now turned around. So after not lowering prices as much as normal a few months ago, we are now having to relook at where we appropriately stand on pricing and I really have no particular input on pricing in Europe.

Okay.

Europe, in general, as we indicated earlier I think Europe revenue was down 6% sequentially, but it was the only region to show YoverY improvement. So I think it remains the case that Europe relatively speaking has been a bit stronger than the rest of the world over the last couple of quarters.

Okay. One last question.

We will not take our final question from Andy Neff of Bear Sterns.

Thank you. If I could, just a question. There was a story on

quoting

saying that HP exec will fight DELL to retain top PC spot. I just want to get a sense about is there a change in thinking now that HP/Compaq combined are now number one? You want to hold No. 1 at all costs. Just what are the priorities in that business? Is there any change in that respect?

I do not think that Mike was conveying nor do we intend to sacrifice margins at all costs for marketshare. We have, as you know, laid out some clear operating margin targets for 2003 first full fiscal year of 3% operating margin for the PC business and we intend to hit those. On the other hand, we are also now a much stronger PC player. We think we have the right distribution model in the consumer PC space and a much improved distribution model in the combined entity in the commercial space and I think you should expect us to take advantage of that.

I would just add one more thing. We certainly are, for the next quarter or two, going to make sure that competitors don't easily take advantage of any of the changes that come about as a result of the merger. So we certainly will be taking on an attitude of in the short term making sure that we price as competitively as we can while we get these new capabilities in line and running smoothly and effectively.

Okay that's about all the time we have. Before we sign off, I just want to let you know that the June 4th Analyst meeting will be at the Swiss Hotel in Boston and we are finalizing the details and plan to send out invitations later this week. So that concludes our 2Q earnings conference call. Thanks for joining us and we will see you in Boston. Bye for now.

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.