The Daily Magic Formula Stock for 08/15/2008 is Hewlett-Packard Co. According to the Magic Formula Investing Web Site, the ebit yield is 9% and the EBIT ROIC is >100 %.
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HP is a leading global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses ("SMBs") and large enterprises, including in the public and education sectors. Our offerings span:
personal computing and other access devices,
imaging and printing-related products and services,
enterprise information technology infrastructure, including enterprise storage and server technology and software that optimizes business technology investments, and
multi-vendor customer services, including technology support and maintenance, consulting and integration and outsourcing services.
HP was incorporated in 1947 under the laws of the State of California as the successor to a partnership founded in 1939 by William R. Hewlett and David Packard. Effective in May 1998, we changed our state of incorporation from California to Delaware.
HP Products and Services; Segment Information
During fiscal 2007, our operations were organized into seven business segments: Enterprise Storage and Servers ("ESS"), HP Services ("HPS"), HP Software, the Personal Systems Group ("PSG"), the Imaging and Printing Group ("IPG"), HP Financial Services ("HPFS") and Corporate Investments. Given the solution sale approach across our enterprise offerings, and in order to capitalize on up-selling and cross-selling opportunities, ESS, HPS and HP Software are structured beneath a broader Technology Solutions Group ("TSG"). While TSG is not a business segment, this aggregation provides a supplementary view of our business. In each of the past three fiscal years, industry standard servers, desktops, notebooks and printing supplies each accounted for more than 10% of our consolidated net revenue.
A summary of our net revenue, earnings from operations and assets for our segments and business units is found in Note 18 to the Consolidated Financial Statements in Item 8, which is incorporated herein by reference. A discussion of factors potentially affecting our operations is set forth in "Risk Factors" in Item 1A, which is incorporated herein by reference.
Technology Solutions Group
TSG provides servers, storage, software and information technology ("IT") services that enable enterprise and midmarket business customers to better manage their current IT environments and transform IT into a business enabler. TSG products help accelerate growth, minimize risk and reduce costs to optimize the business outcomes of customers' IT investments. Companies around the globe leverage HP's infrastructure solutions to deploy next generation data centers and address business challenges ranging from compliance to business continuity. TSG's modular IT systems and services are primarily standards-based and feature differentiated technologies in areas including power and cooling, unified management, security, virtualization and automation. Each of the three business segments within TSG is described in detail below.
Enterprise Storage and Servers
The server market continues to shift towards standards-based architectures as proprietary hardware and operating systems are replaced by industry standard server platforms that typically offer compelling price and performance advantages by leveraging standards-based operating systems and microprocessor designs. At the same time, critical business functions continue to demand scalability and reliability. By providing a broad portfolio of storage and server solutions, ESS aims to optimize the combined product solutions required by different customers and provide solutions for a wide range of operating environments, spanning both the enterprise and the SMB markets. ESS provides storage and server products in a number of categories.
Industry Standard Servers. Industry standard servers include primarily entry-level and mid-range ProLiant servers, which run primarily WindowsÂ®, (1) Linux and Novell operating systems and leverage Intel Corporation ("Intel") and Advanced Micro Devices ("AMD") processors. The business spans a range of product lines that include pedestal-tower servers, density-optimized rack servers and HP's BladeSystem family of server blades. In fiscal 2007, HP's industry standard server business continued to lead the industry in terms of units shipped and factory revenue. HP also has a leadership position in server blades, the fastest-growing segment of the market.
Storage. HP's StorageWorks offerings include entry-level, mid-range and high-end arrays, storage area networks, network attached storage, storage management software and virtualization technologies, as well as tape drives, tape libraries and optical archival storage.
HPS provides a portfolio of multi-vendor IT services, including technology services, consulting and integration and outsourcing services. HPS also offers a variety of services tailored to particular industries such as communications, media and entertainment, manufacturing and distribution, financial services, health and life sciences and the public sector, including government services. HPS collaborates with the Enterprise Storage and Servers and HP Software groups, as well as with third-party system integrators and software and networking companies to bring solutions to HP customers. HPS also works with HP's Imaging and Printing Group and Personal Systems Group to provide managed print services, end user workplace services, and mobile workforce productivity solutions to enterprise customers.
Technology Services. HPS provides a range of technology services from standalone product support to high availability services for complex, global, networked, multi-vendor environments. This business also manages the delivery of product warranty support through its own service organization, as well as through authorized partners.
Consulting and Integration. HPS provides consulting and integration services to architect, design and implement technology and industry-specific solutions for customers. Consulting and integration also provides cross-industry solutions in the areas of architecture and governance, infrastructure, applications and packaged applications, security, IT service management, information management and enterprise Microsoft solutions.
Outsourcing Services. HPS offers a variety of IT management and outsourcing services that support customers' infrastructure, applications, business processes, end user workplace, print environment and business continuity and recovery requirements.
HP Software provides a suite of Business Technology Optimization ("BTO") software solutions, including support, that allow customers to manage and automate their IT infrastructure, operations, applications, IT services and business processes under the OpenView brand. In addition, this segment delivers a suite of comprehensive, carrier-grade software platforms for developing and deploying next-generation voice, data and converged services to network and service providers under the HP OpenCall brand.
We are focused on extending our enterprise systems management leadership position into application, service management and business process management market segments. During fiscal 2007, we completed the acquisitions of Mercury Interactive Corporation, Bristol Technologies, Inc., SPI Dynamics, Inc. and Opsware Inc., which added transaction monitoring, applications security testing and data center automation capabilities to the BTO portfolio. We expect to continue to make strategic acquisitions as well as undertake internal realignments as we deem appropriate. The portfolio of BTO solutions is designed to enable our customers to reduce their IT costs, and gain better insight to their business and IT operations. This helps our customers align IT resources with their business goals and automate data center operations and IT processes, enabling IT to deliver more value to the business.
Personal Systems Group
PSG is the leading provider of personal computers ("PCs") in the world based on unit volume shipped and annual revenue. PSG provides commercial PCs, consumer PCs, workstations, handheld computing devices, digital entertainment systems, calculators and other related accessories, software and services for the commercial and consumer markets. We group commercial desktops, commercial notebooks and workstations into commercial clients and consumer desktop and consumer notebooks into consumer clients when describing our performance in these markets. Like the broader PC market, PSG continues to experience a shift toward mobile products such as notebooks. Both commercial and consumer PCs are based predominately on the WindowsÂ® operating system and use Intel and AMD processors.
Commercial PCs. PSG offers a variety of personal computers optimized for commercial uses, including enterprise and SMB customers, and for connectivity and manageability in networked environments. These commercial PCs include primarily the HP Compaq business desktops, business notebooks, and Tablet PCs.
Consumer PCs. Consumer PCs include the HP Pavilion and Compaq Presario series of multi-media consumer desktops and notebooks, as well as HP Media Center and Voodoo Gaming PCs, which are targeted at the home user.
Workstations. Workstations are individual computing products designed for users demanding enhanced performance, such as computer animation, engineering design and other programs requiring high-resolution graphics. HP provides workstations that run on UNIXÂ®, WindowsÂ® and Linux-based operating systems.
Handheld Computing. HP provides a series of HP iPAQ Pocket PC handheld computing devices that run on WindowsÂ® Mobile software. These products range from value devices such as music or Global Positioning System receivers to advanced devices with voice and data capability.
Digital Entertainment. PSG's digital entertainment products are targeted at the intersection of the personal computing and consumer electronics markets and span a range of products and product categories that allow customers to enjoy a broad range of digital entertainment experiences. PSG's digital entertainment products include HD DVD and RW drives and DVD writers; plasma and LCD flat-panel televisions; and the HP Digital Entertainment Center, which allows consumers to access their music, movies, home videos and photos from a single device via remote control.
Imaging and Printing Group
IPG is the leading imaging and printing systems provider in the world for consumer and commercial printer hardware, printing supplies, printing media and scanning devices. IPG is also focused on imaging solutions in the commercial markets, from managed print services solutions to addressing new growth opportunities in commercial printing in areas such as industrial applications, outdoor signage, and the graphic arts business. When describing our performance in this segment, we group inkjet printer units and digital photography and entertainment products and services into consumer hardware, LaserJet printers and graphics and imaging products into commercial hardware and break out printer supplies separately.
Inkjet Printers. Inkjet systems include desktop single function and inkjet all-in-one printers, including photo, productivity and business inkjet printers and scanners.
Digital Photography and Entertainment. Digital imaging products and services include photo specialty printers, photo kiosks, digital cameras, accessories and online photo services through Snapfish. An important part of IPG's strategy is to provide digital imaging solutions that rival traditional imaging for quality, cost and ease of use so that consumers can manage their digital imaging throughout the home and outside the home. On November 7, 2007, we announced that we were seeking an alternative business model for our HP-branded cameras.
LaserJet Printers. LaserJet systems include monochrome and color laser printers, printer-based multi-function devices and Total Print Management Solutions for enterprise customers. A key initiative in this area of IPG's business has been and continues to be driving color printing penetration in the office.
Graphics and Imaging. Graphics and Imaging products include large format (DesignJet) printers, Indigo and Scitex digital presses, digital publishing solutions and graphics printing solutions. A key initiative for IPG is to capture high-value pages by developing compelling solutions for the industrial, commercial printing and graphics segments.
Printer Supplies. Printer supplies include LaserJet toner and inkjet cartridges and other printing-related media. These supplies include HP-branded Vivera and ColorSphere ink and HP Premium and Premium Plus photo papers, which are designed to work together as a system to produce faster prints with improved resistance to fading, increased print quality and better affordability.
HP Financial Services
HPFS supports and enhances HP's global product and service solutions, providing a broad range of value-added financial life-cycle management services. HPFS enables our worldwide customers to acquire complete IT solutions, including hardware, software and services. The group offers leasing, financing, utility programs and asset recovery services, as well as financial asset management services for large global and enterprise customers. HPFS also provides an array of specialized financial services to SMBs and educational and governmental entities. HPFS offers innovative, customized and flexible alternatives to balance unique customer cash flow, technology obsolescence and capacity needs.
Corporate Investments is managed by the Office of Strategy and Technology and includes Hewlett-Packard Laboratories, also known as HP Labs, and certain business incubation projects. Revenue in this segment is attributable to the sale of certain network infrastructure products, including Ethernet switch products that enhance computing and enterprise solutions under the brand ProCurve Networking. Corporate Investments also derives revenue from licensing specific HP technology to third parties.
Sales, Marketing and Distribution
We manage our business and report our financial results based on the principal business segments described above. Our customers are organized by consumer and commercial customer groups, and distribution is organized by direct and channel. Within the channel, we have various types of partners that we utilize for various customer groups. The partners include:
retailers that sell our products to the public through their own physical or Internet stores;
resellers that sell our products and services, frequently with their own value-added products or services, to targeted customer groups;
distribution partners that supply our solutions to smaller resellers with which we do not have direct relationships;
independent distributors that sell our products into geographies or customer segments in which we have little or no presence;
original equipment manufacturers ("OEMs") that integrate our products with their own hardware or software and sell the integrated products;
independent software vendors ("ISVs") that provide their clients with specialized software products, frequently driving sales of additional non-HP products and services, and often assist us in selling our products and services to clients purchasing their products; and
systems integrators that provide various levels and kinds of expertise in designing and implementing custom IT solutions and often partner with HPS to extend their expertise or influence the sale of our products and services.
The mix of HP's business by channel or direct sales differs substantially by business and region. We believe that customer buying patterns and different regional market conditions necessitate sales, marketing and distribution to be tailored accordingly. HP is focused on driving efficiencies and productivity gains in both the direct and indirect business.
TSG manages enterprise and public sector customer relationships and also is charged with simplifying sales processes across our segments to improve speed and effectiveness of customer delivery. In this capacity, TSG manages our direct sales for both volume and value products including industry standard servers products, UNIXÂ®, enterprise storage and software and pre-sales technical consultants, as well as our direct distribution activities for commercial products and go-to-market activities with systems integrators and ISVs. TSG also drives HP's vertical sales and marketing approach in the communication, media and entertainment, financial services, manufacturing and distribution and public sector industries.
PSG manages SMB customer relationships and commercial reseller channels, due largely to the significant volume of commercial PCs that HP sells through these channels. In addition to commercial channel relationships, the volume direct organization, which is charged with the management of direct sales for volume products, is hosted within PSG.
IPG manages HP's overall consumer-related sales and marketing activities, including our annual consumer product launch for the back-to-school and holiday seasons. IPG also manages consumer channel relationships with third-party retail locations for imaging and printing products, as well as other consumer products, including consumer PCs, which provides for a bundled sale opportunity between PCs and IPG products. In addition, IPG manages direct consumer sales online through HP Home & Home Office.
Manufacturing and Materials
We utilize a number of contract manufacturers ("CMs") and original design manufacturers ("ODMs") around the world to manufacture HP-designed products. The use of CMs and ODMs is intended to generate cost efficiencies and reduce time to market for certain HP-designed products. Third-party OEMs manufacture some products that we purchase and resell under the HP brand. In addition to our use of CMs and ODMs, we currently manufacture finished products from components and sub-assemblies that we acquire from a wide range of vendors.
We utilize two primary methods of fulfilling demand for products: building products to order and configuring products to order. We employ building products to order capabilities to maximize manufacturing efficiencies by producing high volumes of basic product configurations. Configuring products to order permits configuration of units to the particular hardware and software customization requirements of certain customers. Our inventory management and distribution practices in both building products to order and configuring products to order seek to minimize inventory holding periods by taking delivery of the inventory and manufacturing immediately prior to the sale or distribution of products to our customers.
We purchase materials, supplies and product subassemblies from a substantial number of vendors. For many of our products, we have existing alternate sources of supply, or such sources are readily available. However, we do rely on sole sources for laser printer engines, LaserJet supplies and parts for products with short life cycles (although some of these sources have operations in multiple locations). We are dependent upon Intel as a supplier of processors and Microsoft for various software products. However, we believe that disruptions with these suppliers would result in industry-wide dislocations and therefore would not disproportionately disadvantage us relative to our competitors. We also have a valued relationship with AMD, and we have continued to see solid acceptance of AMD processors in the market during fiscal 2007.
Like other participants in the high technology industry, we ordinarily acquire materials and components through a combination of blanket and scheduled purchase orders to support our requirements for periods averaging 90 to 120 days. From time to time, we experience significant price volatility and supply constraints of certain components that are not available from multiple sources. Frequently, we are able to obtain scarce components for somewhat higher prices on the open market, which may have an impact on gross margin but does not disrupt production. On occasion, we acquire component inventory in anticipation of supply constraints or enter into longer-term pricing commitments with vendors to improve the priority, price and availability of supply. See "Risk Factorsâ€”We depend on third-party suppliers, and our revenue and gross margin could suffer if we fail to manage supplier issues properly," in Item 1A, which is incorporated herein by reference.
Our products and services are available worldwide. We believe this geographic diversity allows us to meet demand on a worldwide basis for both consumer and enterprise customers, draws on business and technical expertise from a worldwide workforce, provides stability to our operations, allows us to drive economies of scale, provides revenue streams to offset geographic economic trends and offers us an opportunity to access new markets for maturing products. In addition, we believe that future growth is dependent in part on our ability to develop products and sales models that target developing countries. In this regard, we believe that our broad geographic presence gives us a solid base upon which to build such future growth.
A summary of our domestic and international net revenue and net property, plant and equipment is set forth in Note 18 to the Consolidated Financial Statements in Item 8, which is incorporated herein by reference. Approximately 67% of our overall net revenue in fiscal 2007 came from outside the United States. The substantial majority of our net revenue originating outside the United States was from customers other than foreign governments.
For a discussion of risks attendant to HP's foreign operations, see "Risk Factorsâ€”Due to the international nature of our business, political or economic changes or other factors could harm our future revenue, costs and expenses and financial condition," in Item 1A, "Quantitative and Qualitative Disclosure about Market Risk" in Item 7A and Note 9 to the Consolidated Financial Statements in Item 8, which are incorporated herein by reference.
Research and Development
We remain committed to innovation as a key element of HP's culture. Our development efforts are focused on designing and developing products, services and solutions that anticipate customers' changing needs and desires and emerging technological trends. Our efforts also are focused on identifying the areas where we believe we can make a unique contribution and the areas where partnering with other leading technology companies will leverage our cost structure and maximize our customers' experiences.
HP Labs, together with the various research and development groups within the five principal business segments, are responsible for our research and development efforts. HP Labs is part of our Corporate Investments segment.
Expenditures for research and development were $3.6 billion in each of fiscal years 2007 and 2006 and $3.5 billion in fiscal 2005. We anticipate that we will continue to have significant research and development expenditures in the future to provide a continuing flow of innovative, high-quality products and services to maintain and enhance our competitive position.
For a discussion of risks attendant to our research and development activities, see "Risk Factorsâ€”If we cannot continue to develop, manufacture and market products and services that meet customer requirements for innovation and quality, our revenue and gross margin may suffer," in Item 1A, which is incorporated herein by reference.
Our general policy has been to seek patent protection for those inventions and improvements likely to be incorporated into our products and services or where proprietary rights will improve our competitive position. At October 31, 2007, our worldwide patent portfolio included over 31,000 patents, which was slightly above the number of patents in our patent portfolio at the end of both fiscal 2006 and fiscal 2005.
Patents generally have a term of twenty years from the time they are filed. As our patent portfolio has been built over time, the remaining terms on the individual patents vary. While we believe that our patents and applications are important for maintaining the competitive differentiation of our products and maximizing our return on research and development investments, no single patent is in itself essential to us as a whole or any of our principal business segments.
In addition to developing our patents, we license intellectual property from third parties as we deem appropriate. We have also granted and continue to grant to others licenses under patents owned by us when we consider these arrangements to be in our interests. These license arrangements include a number of cross-licenses with third parties.
For a discussion of risks attendant to intellectual property rights, see "Risk Factorsâ€”Our revenue, cost of sales, and expenses may suffer if we cannot continue to license or enforce the intellectual property rights on which our business depends or if third parties assert that we violate their intellectual property rights," in Item 1A, which is incorporated herein by reference.
We believe that backlog is not a meaningful indicator of future business prospects due to the large volume of products delivered from shelf or channel partner inventories, the shortening of product life cycles and the relative portion of net revenue related to our service and support businesses. Therefore, we believe that backlog information is not material to an understanding of our overall business.
General economic conditions have an impact on our business and financial results. From time to time, the markets in which we sell our products experience weak economic conditions that may negatively affect sales. We experience some seasonal trends in the sale of our products and services. For example, European sales often are weaker in the summer months and consumer sales often are stronger in the fourth calendar quarter. Demand during the spring and early summer months also may be adversely impacted by market anticipation of seasonal trends. See "Risk Factorsâ€”Our sales cycle makes planning and inventory management difficult and future financial results less predictable," in Item 1A, which is incorporated herein by reference.
Lawrence T. Babbio, Jr.
Director since 2002
Mr. Babbio has served as a Senior Advisor to Warburg Pincus, a private equity firm, since June 2007. Previously, Mr. Babbio served as Vice Chairman and President of Verizon Communications, Inc. (formerly Bell Atlantic Corporation), a telecommunications company, from 2000 until his retirement in April 2007. He was a director of Compaq Computer Corporation from 1995 until HP's acquisition of Compaq in May 2002.
Sari M. Baldauf
Director since 2006
Ms. Baldauf served as Executive Vice President and General Manager of the Networks business group of Nokia Corporation, a communications company, from July 1998 until February 2005. She previously held various positions at Nokia since 1983. Ms. Baldauf also serves as a director of SanomaWSOY, F-Secure Corporation, YIT Corporation, and CapMan Plc and as the non-executive chairman of the Savonlinna Opera Festival and as a member of the Global Board of the International Youth Foundation.
Richard A. Hackborn
Director since 1992
Mr. Hackborn has served as HP's Lead Independent Director since September 2006. Previously, Mr. Hackborn served as HP's Chairman from January 2000 to September 2000. He was HP's Executive Vice President, Computer Products Organization from 1990 until his retirement in 1993 after a 33-year career with HP.
John H. Hammergren
Director since 2005
Mr. Hammergren has served as Chairman of McKesson Corporation, a healthcare services and information technology company, since July 2002 and as President and Chief Executive Officer of McKesson since April 2001. Mr. Hammergren also is a director of Nadro, S.A. de C.V. (Mexico) and Verispan LLC.
Mark V. Hurd
Director since 2005
Mr. Hurd has served as Chairman of HP since September 2006 and as Chief Executive Officer, President and a member of the Board since April 2005. Prior to that, he served as Chief Executive Officer of NCR Corporation, a technology company, from March 2003 to March 2005 and as President from July 2001 to March 2005. From September 2002 to March 2003, Mr. Hurd was the Chief Operating Officer of NCR, and from July 2000 until March 2003 he was Chief Operating Officer of NCR's Teradata data-warehousing division.
Joel Z. Hyatt
Director since 2007
Mr. Hyatt has served as the Chief Executive Officer of Current Media, LLC, a cable and satellite television company, since September 2002. From September 1998 to June 2003, Mr. Hyatt was a Lecturer in Entrepreneurship at the Stanford University Graduate School of Business. Previously, Mr. Hyatt was the founder and Chief Executive Officer of Hyatt Legal Plans, Inc., a provider of employer-sponsored group legal plans.
John R. Joyce
Director since 2007
Mr. Joyce has served as a Managing Director at Silver Lake, a private equity firm, since July 2005. Prior to joining Silver Lake, Mr. Joyce spent 30 years with IBM, a global technology firm, serving most recently as Senior Vice President and Group Executive of the IBM Global Services division from May 2004 until July 2005 and Chief Financial Officer of IBM from 1999 until May 2004. Prior to that, Mr. Joyce served in a variety of roles, including President, IBM Asia Pacific, and Vice President and Controller for IBM's global operations. Mr. Joyce is a member of the Bertelsmann AG Supervisory Board and a director of Gartner, Inc., Avago Technologies Limited and Serena Software, Inc.
Robert L. Ryan
Director since 2004
Mr. Ryan served as Senior Vice President and Chief Financial Officer of Medtronic, Inc., a medical technology company, from 1993 until his retirement in May 2005. He also is a director of UnitedHealth Group Incorporated, General Mills, Inc., The Black and Decker Corporation and Citigroup, Inc.
Lucille S. Salhany
Director since 2002
Ms. Salhany has served as President and Chief Executive Officer of JHMedia, a consulting company, since 1997. Since 2003, she has been a partner and director of Echo Bridge Entertainment, an independent film distribution company. From 1999 to March 2002, she was President and Chief Executive Officer of LifeFX Networks, Inc., which filed for federal bankruptcy protection in May 2002. From 1994 to 1997, Ms. Salhany was the Chief Executive Officer and President of UPN (United Paramount Network), a broadcasting company. From 1993 to 1994, she was Chairman of Fox Broadcasting Company, a national television network, and from 1991 to 1993 she was Chairman of Twentieth Television, a division of Fox Broadcasting Company. Ms. Salhany was a director of Compaq from 1997 until HP's acquisition of Compaq in May 2002. She also is a director of Ion Media Networks, Inc.
G. Kennedy Thompson
Director since 2006
Mr. Thompson has served as Chairman of Wachovia Corporation, a financial services company, since February 2003 and as a director since 1999. He has also served as Chief Executive Officer of Wachovia since 2000 and as President since 1999. Mr. Thompson also is a director of Wachovia Preferred Funding Corp.
MANAGEMENT DISCUSSION FROM LATEST 10K
RESULTS OF OPERATIONS
In fiscal 2007, HP net revenue increased approximately 14% from the prior year period (10% on a constant currency basis). The favorable currency impact for fiscal 2007 was due primarily to the movement of the dollar against the euro. U.S. net revenue was $34.8 billion for fiscal 2007, an increase of 8% from the prior year, while international net revenue increased 17% to $69.5 billion.
PSG had double-digit net revenue growth across all regions as a result of overall unit volume increases of 28%. The unit volume increases resulted from strong growth in notebooks with significant improvements in emerging markets. The impact of these increases was partially offset by declines in average selling prices ("ASPs") in commercial and consumer clients of 5% and 1%, respectively. IPG net revenue growth in fiscal 2007 was due mainly to increased unit volumes of printer supplies resulting from the continued expansion of printer hardware placements and the strong performance of supplies for color-related products. ESS net revenue growth during fiscal 2007 was the result primarily of strong blade revenue and unit growth in our industry standard servers business, increased option attach rates in our ProLiant server line, continued strong performance in mid-range EVA products, growth in commercial storage area networks and revenue increases from our Integrity servers. The ESS growth was partially moderated by the revenue declines in our tape business, high-end arrays and our PA-RISC and Alpha server product lines during fiscal 2007. The net revenue growth in HP Software during fiscal 2007 was due primarily to growth in our OpenView business as a result of the Mercury acquisition and increases in revenue from license and support contracts. HPS net revenue during fiscal 2007 increased due primarily to favorable currency impacts, revenue increases in outsourcing services driven by existing accounts growth and new business, and revenue increases in consulting and integration associated with acquisitions made in fiscal 2007. The HPFS net revenue increase during fiscal 2007 was due primarily to operating lease growth and higher end-of-lease activity.
In fiscal 2006, HP net revenue increased approximately 6% from the prior year period (7% on a constant currency basis). The unfavorable currency impact for fiscal 2006 was due primarily to the movement of the dollar against the euro and the yen. U.S. net revenue was $32.2 billion for fiscal 2006, an increase of 6% from the prior year, while international net revenue increased 6% to $59.4 billion.
PSG net revenue increased across all regions as a result of a 15% volume increase. The volume increase resulted from strong growth in consumer and commercial markets and significant improvement in emerging markets, which was partially offset by 6% and 7% declines in ASPs in consumer and commercial clients, respectively. IPG net revenue growth in fiscal 2006 was due mainly to increased shipment volumes of printer supplies resulting from the continued expansion of printer hardware placements and the strong performance of color-related products. ESS net revenue growth was the result primarily of strong unit growth in our industry standard servers business, blade revenue growth, increased option attach rates in our ProLiant server line, continued strong performance in mid-range EVA products within our Storage business and revenue increases from our Integrity servers. The ESS growth was moderated by revenue declines in our tape business and PA-RISC and Alpha Server product lines. The net revenue growth in HP Software for fiscal 2006 was due primarily to growth in our OpenView business as a result of the Peregrine acquisition and an increase in support and service contracts. HPS net revenue increased in fiscal 2006 due primarily to revenue increases in management services driven by new business and existing account growth, which were offset by declines in the technology services business resulting from competitive pricing pressures and changes in the mix of platforms being serviced. The HPFS net revenue decline in fiscal 2006 was due primarily to lower used equipment sales.
Stock-Based Compensation Expense
See Note 2 to the Consolidated Financial Statements in Item 8, which is incorporated herein by reference.
Total company gross margin increased slightly in fiscal 2007 from fiscal 2006. The improvement in HP Software gross margin in fiscal 2007 was due primarily to a favorable change in revenue mix driven by the inclusion of revenue from Mercury licenses and support, which typically have a higher gross margin than the other offerings within the segment. HPS gross margin increased during fiscal 2007 from fiscal 2006 due primarily to continued focus on cost structure improvements from delivery efficiencies and cost controls. This gross margin increase was partially offset by the impact from the continued competitive pricing environment. During fiscal 2007, ESS contributed unfavorably to our total company's weighted-average change in gross margin while the ESS gross margin remained stable. This stability was due primarily to improved cost management, which was offset by an ongoing mix shift to lower-margin Integrity products within business critical systems and a continued mix shift towards industry standard servers. HPFS gross margin decline during fiscal 2007 was caused primarily by increased bad debt expenses and lower bad debt recoveries, as well as lower margins on leases and
used equipment sales. During fiscal 2007, PSG contributed unfavorably to our total company's weighted-average change in gross margin as a result of higher growth than the other segments. However, PSG gross margin increased primarily as a result of component cost declines and improvements in supply chain costs per unit, which were partially offset by ASP declines. During fiscal 2007, IPG gross margin decreased due primarily to unfavorable hardware margins, increased costs associated with new product introductions and a change in product mix.
Total company gross margin increased in fiscal 2006 as compared to fiscal 2005. The improvement in ESS gross margin in fiscal 2006 was due primarily to a favorable unit mix, improved discount management, and lower component costs. HPS gross margin increase was driven mainly by the continued focus on cost structure improvement from delivery efficiencies and cost controls, the impact of which was partially offset by the continued competitive environment in the solutions and services business and higher fiscal 2006 bonus accruals. For IPG, gross margin increased in fiscal 2006 due primarily to improved supplies margins and a favorable portfolio mix shift from hardware to supplies, which were partially offset by unfavorable consumer hardware margins. The improvement in HP Software gross margin in fiscal 2006 was due primarily to an increase in revenue and more effective management of the support and services costs for OpenView and OpenCall. The gross margin improvement in PSG resulted primarily from reduced warranty expense and supply chain costs as a percentage of revenue and component cost declines. HPFS gross margin was impacted unfavorably in fiscal 2006 due primarily to competitor pricing pressures, a higher mix of lower margin operating lease assets and lower recoveries for bad debts, which were partially offset by lower credit losses in fiscal 2006.
Research and Development
Total research and development ("R&D") expense increased in fiscal 2007 due primarily to additional R&D expense as a result of the Mercury acquisition in the first quarter of fiscal 2007. As a percentage of net revenue, each of our major segments experienced a year-over-year decrease in R&D expense in fiscal 2007.
Total R&D expense increased in fiscal 2006 due primarily to higher bonus accruals and stock-based compensation expense, the impact of which was partially offset by expense controls and cost savings from restructuring actions. As a percentage of net revenue, each of our major segments experienced a year-over-year decrease in R&D expense in fiscal 2006.
Selling, General and Administrative
Total SG&A expense increased during fiscal 2007 due primarily to additional expense as a result of the acquisition of Mercury in the first quarter of fiscal 2007, unfavorable currency impacts related to the movement of the dollar against the euro and additional investments in our sales forces. As a percentage of net revenue, the ESS, HPS, PSG and IPG segments experienced a year-over-year decrease in SG&A expense during fiscal 2007, while HP Software experienced a year-over-year increase in SG&A expense.
Total SG&A expense increased slightly during fiscal 2006 as higher bonus accruals and stock-based compensation expenses as well as increased marketing spending were offset in part by savings from expense controls and restructuring actions and favorable currency impacts due to movement of the dollar against the euro and the yen. As a percentage of net revenue, each of our segments experienced a year-over-year decrease or no change in fiscal 2006.
Amortization of Purchased Intangible Assets
The increase in amortization expense in fiscal 2007 as compared to fiscal 2006 was due primarily to amortization expense related to the acquisition of Mercury in the first quarter of fiscal 2007. This increase was partially offset by a decrease in amortization expense related to certain intangible assets associated with prior acquisitions, including the Compaq Computer Corporation ("Compaq") acquisition, that had reached the end of their amortization period.
The decrease in amortization expense in fiscal 2006 as compared to fiscal 2005 was due primarily to a decrease in amortization expense related to certain intangible assets associated with prior acquisitions including the Compaq acquisition that had reached the end of their amortization period, which decrease was partially offset by an increase in amortization expense related primarily to the acquisitions of Scitex Vision Ltd. ("Scitex"), Peregrine Systems, Inc. ("Peregrine"), and OuterBay Technologies, Inc. ("OuterBay") in fiscal year 2006.
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 todayâ€™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 thatâ€™s aligned with the growth areas of the market.
While weâ€™ve become more efficient I am pleased -- and I am pleased with that performance, donâ€™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 Iâ€™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.