Good day, ladies and gentlemen, and welcome to the first quarter 2007 Hewlett-Packard earnings conference call. My name is Melanie and I will be your coordinator for today. (Operator Instructions) I would now like to turn the call over to Mr. Brian Humphries, Vice President of Investor Relations. Please go ahead, sir.

Thank you, and good afternoon, everyone. I would like to welcome you to our first quarter earnings conference call. Joining me today is our Chairman and CEO, Mark Hurd; our CFO, Cathy Lesjak; and Jim Burns, who has recently been appointed Vice President of HP Investor Relations. Before we get started, I would like to remind you that this call is being webcast live. The webcast and the first quarter earnings slide presentation, including non-GAAP reconciliation tables, can be accessed on the HP investor relations webpage under company information at hp.com. A replay will also be available shortly after the conclusion of the call for approximately one year. Next, it is my duty to inform you that the primary purpose of this call is to provide you with information regarding the first quarter. However, some of our comments and responses to your questions may include forward-looking statements. These forward-looking statements are based on certain assumptions and are subject to a number of risks and uncertainties, and actual future results may vary materially. I encourage you to read the risks described in HP’s SEC reports, including but not limited to its annual report on Form 10-K for the fiscal year ended October 31, 2006. As in prior quarters, the financial information presented and discussed in connection with this call, including tax related items, reflects estimates based on information available at this time. As such, these amounts could differ materially from the amounts ultimately reported in HP’s Form 10-Q for the fiscal quarter ended January 31, 2007. I would also like to point out that earnings, gross margins, operating expenses and similar items discussed at the company level are sometimes expressed on a non-GAAP basis and therefore have been adjusted to exclude certain items, including in-process R&D, amortization of good will and…

Thanks, Brian. First, let me start by thanking Brian for his great work as our head of Investor Relations. He has done a fabulous job during my tenure at Hewlett-Packard and we are going to miss him. I additionally want to make the comment that we have asked Jim Burns to take on this assignment which is I hope you will see a strong commitment on our part to placing senior leadership in the IR function. Our relationship with investors is very important to us and therefore the commitment we have made of a senior member of HP to that function to build on the momentum we have built under Brian’s leadership. With that, let me start and say I am pleased with the first quarter results that we had. We delivered solid revenue growth across all of our businesses and geographies. We gained share in our key businesses. We showed expense discipline and we expanded margins. In addition, we returned significant cash to our shareholders through share repurchases. While we continued to invest in the long-term health of our various businesses, we drove further operating margin improvements in our reportable segments, with a year-over-year operating profit increase of 41% in the personal systems group, 40% in the technology solutions group, and 10% in the imaging and printing group. As I have said before, cost discipline and revenue growth go hand-in-hand, and our share gains, solid top line growth and margin expansion reflect our ability to drive operating leverage and invest in growth by freeing up costs. Financial highlights of the quarter include revenue growth of 11% year over year, or $2.4 billion of growth, to $25.1 billion. Non-GAAP gross margin of 23.7%, up from 23.2% in the prior year period. Continued year-over-year operating margin expansion in key businesses, with…

Thank you, Mark, and good afternoon, everyone. I will begin with a review of the total company income statement. Revenue of $25.1 billion for the quarter was up 11% year over year or up 7% when adjusted for the effects of currency. On a revenue growth contribution basis, growth was led by personal systems, imaging and printing, and HP Software, while industry standard servers posted strong growth within enterprise storage and servers, and outsourcing in consulting and integration grew strongly within HP Services. On a regional basis, revenue was up 6% in the Americas, up 14% in EMEA, and up 15% in Asia-Pacific. When adjusted for the effects of currency, revenue was up 6% in the Americas, 7% in EMEA, and 12% in Asia-Pacific. First quarter gross profit was $5.9 billion, or 23.7% of revenue, up from 23.2% a year ago, reflecting gross margin rate improvements in HP Software, imaging and printing, and services, and the mix improvement of HP Software. These rate and mix benefits were offset somewhat by a mix impact from the revenue strength in personal systems. Sequentially, gross margin declined from 24.3%, reflecting mix and rate impacts in personal systems and enterprise storage and servers, and rate impact in HP Services, offset by improvements in HP Software mix and gross margin rate improvements in imaging and printing. Non-GAAP operating expense totaled $3.8 billion for the quarter, or 15.1% of revenue, down from 15.7% a year ago and 15.3% sequentially. In dollars, operating expenses were up 6% year on year and up 1% sequentially. Adjusting for currency, expenses were up 4% year over year and flat sequentially. The year-over-year increase primarily reflects volume growth, the effects of the Mercury acquisition, and investments in growth initiatives, such as the continued hiring of sales resources. These increases were offset…

(Operator Instructions) Our first question comes from the line of Ben Reitzes with UBS. Please go ahead.

Cathy, could you give a little more detail on inventory? Was there any particular component or what not that happened to raise the inventory number and/or any impact from Vista? Then, just a little more detail on what you are going to do to lower inventory and have the cash flow snap back. Thanks a lot.

Thank you. In terms of inventory, the increase in inventory was pretty much across the board. There was not any one single business that was impacted by it, nor was there one specific reason for it. Some of the increases were due to what we discussed last quarter related to putting more inventory on boats from China in order to get cost of sales reductions, and so we definitely saw some increase in PSG as a result of that. We also had some increase in PSG for Chinese New Year, and while some of you might smile at that, the reality is we source a lot of product from China and when they go on vacation for Chinese New Year, we did not want to be without product, so we do have some inventory build as a result of that. We also had some inventory build in supplies and hardware in preparation for the tax season in IPG. Plus, we saw an up-tick in SAB 101 inventory. So in terms of what we are going to do, what I would like to do and will be doing is basically scrubbing these inventory numbers going forward to make sure that we have absolutely the minimum amount of inventory that we need so that we are utilizing the capital to our best advantage. That is not to say that everything will come down. There are still good reasons to make trade-offs, like I mentioned, around the PSG boat inventory, and so we will continue to do those types of things as well.

Ben, let me make sure you are clear before you get off the phone: we are all over this thing. At the same time, we are trying to look at an aggregate P&L view so that we get an optimal answer in terms of the performance of the business, and we are looking at return on invested capital on everything we do. I think when you look at the rate of inventory relative to the margin drop, we feel pretty good about that dimension. Secondly, we feel pretty good about the freshness of the inventory that we have relative to Cathy’s points. You get the Chinese New Year effect, which I understand the smile point that Cathy made, but at the same time, we wanted to make sure we had inventory as we went into the coming quarter. From a cash flow perspective, our big issues were we had an incremental bonus that we paid that we think was appropriate relative to the performance of the business in 2006, and the issue that you are describing. But I want to make sure you do not have any confusion: we’re all over this thing.

And you expect a big snap back in cash flow?

Sure do. We sure do.

Thanks a lot, Mark.

Next question, please.

Our next question comes from the line of Laura Conigliaro with Goldman Sachs. Go ahead.

Yes, thank you. Last quarter you indicated that you really didn’t know what the impact of Vista was likely to be. What would you say to that now? Your enormous number of PCs driven by notebooks obviously coincides with the holidays and a Vista launch. How should we be thinking about your PC potential in a seasonally slower quarter?

Laura, I will do my best but very bluntly, Vista will have an impact in Q2, and we are talking mainly about Q1 and I do not want to give you much about how the quarter started, other than to say, as we have said before, we were not forecasting any Vista moment, so to speak, in the context of how we were seeing this thing roll out. I think at this point, while we have a couple of weeks of data, I do not have anything enough to give you any color, and I would be afraid to do that in the context of such a short period of time. Like we said before, we are optimistic. We think it drives a more robust configuration in terms of what gets sold but we have not forecasted any big change in terms of trajectory as part of the next couple of quarters.

Laura, we would just reiterate that our FY08 financial model called for 4% to 6% revenue growth per PSG and we are still very comfortable with that.

Thank you, Laura. Next question, please.

Our next question comes from the line of Rich Gardner with Citigroup. Go ahead.

Okay, thank you. Cathy, I wanted to go back to your guidance for the second quarter. As you said, and gave several reasons for, you are guiding below normal seasonality for the quarter but it does sound like the channel inventories are pretty lean and we certainly have seen a big pickup in sell-through per the NPD data after the launch of Vista in early February. I am also a little bit unclear why EPS would be down sequentially, given that if revenue is down, that means you will see a mix shift toward supplies, which would tend to push up the margins and the EPS sequentially.

Let’s tackle the revenue first. Our robust holiday season in PSG makes us think that in fact we will come off of that high in Q2, which is per my comments, unusual but so is the tremendous pick-up that we got around the holiday season for PSG. That is why we are guiding down a bit, relative to seasonality. On the guidance in terms of EPS, it is true that IPG margins pick up Q1 to Q2, but we also have to deal with the effect of lower revenue than what we typically see when we go from Q1 to Q2.

Rich, to your point, we feel pretty good about channel inventory levels. We feel good about how we are positioned. We have raised our guidance and we feel good about our position. We hope we do better but to be very blunt, that is where we see things falling at the current time. Just to be clear, we will not get any impact of this pension curtailment in the quarter either. That is going to play out over the quarter, so I think it really is the revenue mix story that comes into play. We will see how it turns out.

Thank you, Rich. Next question, please.

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

Great, thanks. Can you comment on component pricing and availability during the quarter, and potentially your outlook for some of the key components? Also, in line with that question, do you see any risk, given your inventory levels, that you may get hit with some of these, or the strategic inventory purchases may actually hit your margins in the second quarter, given the component price declines we have seen in the past few weeks?

We feel pretty good about the freshness of the inventory, Bill, again. We feel pretty good about it so I think the answer to that question would be no, not really. We are seeing memory loosen up a little bit. We went through a horrible time with memory for almost all of ’06. It was a difficult thing for us at back to school and even through the Christmas season, so memory has freed up. We are concerned though that memory is going to go up and down in terms of availability during that timeframe. Processors were stable during the quarter, so nothing significant there. Hard drives were stable. There could be some tightness with hard drives as we go up in the first calendar year quarter of ’07, because there are some technology transitions in there. We expect some modest price erosion in panels but again, there is some supply tightness in panels too, so -- memory has been a little bit of a change in that we are able to get a little more than we were. In the other spots, I would say roughly stable and a bit of concern.

Thank you, Bill. Next question, please.

Our next question comes from the line of Richard Farmer with Merrill Lynch. Go ahead.

Cathy and Mark, I just want to make sure I understand the curtailment and more broadly, the financial effect of the headcount reductions, both from the curtailment but also the anniversary benefit from your prior restructuring. On the pension curtailment, I understand you expect roughly the $500 million gain to be offset by the expense of the employees leaving, but wouldn’t that put the run-rate of the savings significantly higher than the $0.01 to $0.02 benefit I think I heard you describe? And then, on the restructuring anniversary, I understand you are done with the actions but you are still going to be comping on much higher cost quarters from last year, so shouldn’t we think of that as being roughly $700 million of gross savings from that original plan in 2007 over 2006 in terms of operating income? Combined, what I am asking is: what is the total effect year over year of the headcount changes?

First, we are going to send the investor relations discipline police after you for breaking the multiple questions in a conference call rule, but given that, let me try to first tackle the new announcement that we have. First, do not assume that these jobs are eliminated. In many cases, when you establish one of these, Richard, you cannot pick and choose where you offer the program. You have to offer it in a broad way. So we will have people in multiple functions across all of HP that may take advantage of this program. Many of those jobs will be replaced, so there will be a replacement factor. Will those jobs be replaced with a potential cost savings? Potentially. What we have tried to do is model the timing of the replacement and the different cost structure of the replacement relative to the current situation that we have, and that is what you see modeled out. So I think to your point, this is a one-time in and out from a gain perspective and then payment from the EER. The cash flow from this, of course, as Cathy mentioned, comes directly from the pension plan itself, so it has no cash flow implication. The ongoing savings relates to the fact of if you think of the majority of those jobs being replaced, what exits versus what comes in. That is what we have tried to model and that is what we have given you. As it relates to the cost structure in ’07 versus ’06, yes, we think we have a better cost structure in ’07 versus ’06. What you see happening in our financials though, even though you see good cost discipline -- I hope you think that, because that is what we are trying to do -- we are shifting our spending out of G&A categories and to some degree, you are seeing that investment going into more outbound categories to create more demand, and it is beginning to have an impact for us. It is not all just netting. There is some better situation from a cost structure perspective than we had in ‘06. I concur with your points there, but there is also some offset as it relates to reinvestment back into demand creation.

Thank you, Richard. Next question, please.

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

Thanks. Mark, how are you thinking about printer margins, given you are above your target range for the past two quarters and can clearly afford to invest even more into new products and pricing going forward?

Katie, you are right. We think about this a lot. We are trying to make sure we are appropriately looking at this unit growth. For us, unit growth is really key in the consumer segment and so we are trying to make sure we are going after the high usage segments in the appropriate markets. One thing to be cautious of that our emerging markets supplies connect is a little different than our mature markets supplies connect with counterfeiting and fraud and some of the things that go into some of those markets, so we need to factor that in. Secondly, we have some very important adjacencies, like the enterprise market, that we are trying to invest in and we are trying to do all of that at the same time that we deal with the short-term and optimize those margins. I really think the team in IPG has done a pretty nice job of focusing on its cost structure, focusing on the short-term unit growth and then the supplies connect in relationship to that, and then at the same time, investing in some of these adjacent markets that we think makes sense. I think right now, we think of our range being roughly right and continue to stay in that range, but to your point, if we have opportunities, we will accelerate our ability to get after some of these incremental opportunities.

Thanks, Katie. Next question, please.

Our next question comes from the line of Tony Sacconaghi from Bernstein. Go ahead.

Yes, thank you. I have a question about gross margin percentage. Over the last two quarters, it has gone down about 100 basis points sequentially on a GAAP basis. I think you had commented that Mercury would add about 50 basis points to gross margins, so it has actually gone down 150 basis points over the last two quarters. Mix alone certainly does not explain it. PCs are only 3% higher as a percentage of total during that time period so I do not think that is the answer. The question is what is really driving the I think you called them rate changes, in gross margin? Are these conscious steps for you to drive revenue, or is the competitive environment getting tougher?

Tony, we feel pretty good about our gross margin rate. We are up 50 basis points year over year in our performance. We have a strong PSG component, to your point, which is a big driver. I know the numbers pretty well and that is the majority of the driver. Now, you have some compares you have to be careful on the supplies connect, which get back to a different mix issue as it relates to the Q4 sequential compare. But overall, when you look at it differently than at the company level, segment by segment and break it down into those various pieces, the continuity of gross margin rate I would say roughly right, no material change in gross margin rate on a segment-by-segment basis.

One of the rates benefits also, Tony, that we are getting is that we really got an up-tick in supplies in the mix. So in Q4, we had a relatively weak supplies position and in Q1, it is much --

Thanks, Tony. Next question, please.

Our next question comes from the line of Harry Blount with Lehman Brothers. Go ahead.

Thanks. Questions coming back to the cash flow. As I look at the cash flow statement, I think a lot of the things are pretty apparent based on both the outline of what you guys provided but one of the categories I am a little unclear of was the use of cash in the amount of $1.5 billion of other assets and liabilities. I just would love to get a better sense of that and incorporate that within the sense of what kind of snap back we should expect in cash flow over the next several quarters.

That $1.488 billion was made up of a number of items. Certainly it includes our bonus payments but it also includes that payables and receivables that frankly went against us this quarter, as well as some vendor rebates that were [inaudible] that were up quarter over quarter.

So as we take a look at that number then, what you are saying is a lot of those are one-time items that we should not be recurring in future quarters, other than the bonus payment periodically?

Again, those other items, the VAT receivables and payables as well as the vendor rebates receivables, they go up and down with the business so it is very hard to predict those. It really depends on the cut-off on a particular quarter, and then the bonus payment is once a year.

Thank you, Harry. Next question, please.

Our next question comes from the line of Keith Bachman with Banc of America. Go ahead.

Thank you. I wanted to follow up on the gross margin comment and Mark, just get your perspective, or Cathy, as we look out over the next few quarters in the context of the guidance you have given, how would you anticipate the gross margin trends on a year over year basis? Are they going to remain roughly flattish? You have some tougher comps coming up with April and July of last year, where you had pretty good supplies numbers. How should we be thinking about the gross margin trend as we look out in say the next three quarters? Cathy, you kind of faded out on the last answer. I am not sure what happened there, vis-à-vis the mic.

Sorry about that.

Let me make sure on the last answer, I think it was pretty important. The bonus payment is a non-recurring payment from Q1, Q2, Q3, so it is a true-up, so to speak. At the end of Q4 it is netted out of our income statement but the cash hits all at one time. Just back on that too, we had modeled this pretty close to what had transpired from a cash flow perspective going into Q1. We were a little light because of the inventory positions we took but we felt pretty good about that as well. On gross margin, Keith, I think your point is right. This is all about mix. There is no segment change of consequence in absolute gross margin. Now, to be very clear with you though, Keith, it depends on what happens in the market. I do not want to predict for you how the market will behave as we go into the next future quarters. We certainly improved our position to the point that we have more flexibility to do various things in the market, as you can see by the numbers we are producing so I cannot predict for you how that pricing behavior and that market behavior will occur. But given current course and speed, no extraordinary changes, we are not seeing any change in gross margin behavior by segment, so it will come down to a mix issue and to what those mix numbers look like in the quarters ahead.

I would just add that Q2 of course with the supplies percentage improving, which is normal seasonality for us, you would see some increase in gross margin in Q2.

Thanks. Next question, please.

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

My question is just on the acquisition strategy. You had the acquisition obviously of Mercury. Could you give us a sense about your thoughts, Mark, as you look forward? Are you interested in doing more acquisitions of this size? Can you talk about what area it would be in and what criteria? Just your general thoughts; how should we think about that?

I think we have done some acquisitions, Andy, as you know, but we are pretty aligned around this strategy that says we are not going to do anything that is not strategically sensible, that financially makes sense, and that we can operate the acquired property effectively. While I know there are rumors that go on in the marketplace which occur, we take a pretty disciplined view towards this stuff. We do look at most of the properties that are out there like anybody does, but we are going to be very disciplined about what we do and it is going to have to make sense across those three criteria. Again, I think we will never say never to anything, but you should expect us to do pretty much more of the same, and the acquisition of the Mercury class to be more a rarity as opposed to commonplace kind of activity.

Thanks, Andy. We’ll take the next question, please.

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

Good afternoon. Just a quick question on what is going on with Kodak and its inkjet strategy. Mark, I am just curious as to your thoughts on their idea of taking up hardware prices and down the ink prices in order to be more competitive and gain share.

It is an interesting concept. We hope hardware prices go up. That would be great. We would sign up for that and be glad to participate in that. Again, I think we like our position, Shannon. We have a very strong position. You have seen it strengthen over the past quarters. We think we are in a great position from an innovation and technology perspective, from a channel of distribution perspective, and we are going to continue to be very focused on our cost structure, so again, back to the earlier questions that we have had, we have flexibility to participate in any way that makes sense and is appropriate in the marketplace. That said, competition is great. I hope it will make us even sharper.

But no plans to follow them down in pricing in the near-term though?

No, and I think in the end, we will see what happens, but we really like our value proposition. We like our position and we want to expand on that. Of course, there are other competitors out there other than the guys you mentioned, so we are also focused on them because there are some strong competitors in that market. We want to make sure we are doing our job.

Okay, thanks, Shannon. Next question, please.

Our next question comes from the line of Bill Fearnley with FTN Midwest. Go ahead.

Yes, thanks, just one other follow-up, if I could, on the inventory question. Will this require additional promo spending, MDF investments or price cuts to move the inventory through? When should we be looking for the improvement? Do you see dramatic improvement in the second quarter or is this a second quarter to third quarter phenomenon? Thanks.

No to your first question, Bill, in terms of all that. We feel good about our channel inventory, the freshness of it and feel good about what we did from a components acquisition perspective. We look to improve our cash flow in Q2, so we are looking for pretty immediate position here. We feel good about what we have done.

Okay, thanks, Bill. Next question.

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

Great, thank you. It definitely seems like you have gained significant share in certain areas, but maybe you could give us a couple of comments on how you are viewing tech demand, both in the first-half and the second-half. Maybe if I could sneak another one in there: do you see virtualization possibly affecting server business in the second-half? Thank you.

I guess I would say overall, we see demand steady. The issue always is there are stories within the story. We felt much better about the situation in Europe, to be very blunt with you. We saw some good strength across a number of different dimensions across a number of different markets in Europe in the quarter, which was encouraging. We continued to watch the U.S. consumer, and I think I said that for several quarters. The consumer has been strong and we continue to watch that. I cannot give you anything more specific than that. The U.S. enterprise is a place that we have always had some concerns. I do not think that is a virtualization issue so much as it just is that people are being prudent with their spending. Now, at the same time as you have seen that, we are clearly gaining share so we sometimes have to modulate what is the difference between our share gain and the macro demand environment. We feel very good about our position but we continue to monitor it. I gave you a lot of data there other than to say -- overall, I would say steady but there clearly are stories within the story.

Okay, we will take two more questions, please.

Our next question comes from the line of Dan Renouard with Robert Baird.

Just on the enterprise side, Mark, you alluded to putting more resources to work in the field, and of course that is an easier-said-than-done kind of proposition. Maybe you could just give us a couple of tangible examples of some things that you have done where you have seen some success that you expect will help pay off over the next several quarters or years.

We have done some hiring so clearly we have accomplished much of the hiring that we indicated that we would last year. To be very open with you on this thing, we just do not cover enough accounts. While we are covering more than we were, we do not cover enough. I am a strong believer that there is more demand for Hewlett-Packard in the marketplace than we are currently getting and we do not cover enough accounts. That is part of the reason that we have to get our cost structure right and we have to get it right as fast as we can so that we can get to the market and compete for more business. I believe there is an opportunity for us. Now, to your point, we cannot do this in 15 minutes. It takes time for us to source. We have to hire great people and then we have to train them and then we have to get them assimilated to HP and get them into territories where they can go out and compete. At the same time, we need help from our partners because they can help us close the gap by covering more accounts as well. So we are doing a lot of work here, Dan, on the total available market because we think there is an opportunity for us that plays out in later years with us being able to capture more share.

We will take one final question.

Our last question comes from the line of Chris Whitmore with Deutsche Bank. Go ahead.

Thanks. To follow up on that last question, I was hoping to get more color on the weakness in high-end servers and high-end storage, probably the one blemish from a market share standpoint. What is the underlying driver of that share loss? Related to that, can you speak to the sustainability of margin improvement in that segment, given the mix down market? Thanks.

I think storage is a more complicated story, so I will start with that. Our EVA line, which is our flagship mid-range line, grew 18%, so that was good performance for us and we felt good about EVA in the quarter. That was pretty well true across regions and segments, so a very strong performance there. We saw poor performance in tape and tape is the older part of the business. It is still a substantive part of our business and tape declined faster than we would like. It is kind of a mix story that you have to get into the piece parts and understand. We feel very good about EVA. We think we could do better even though in EVA and some other parts of the core storage business. In the business critical line, which is the higher end stuff, I actually think that is a different story than storage. There, we just had a weak quarter. I cannot be any clearer with you. I am just disappointed and we can do better than we are doing. Part of it is aligning our demand better and we had some deals that slipped -- I could tell you a whole set of long, sad stories but I do not think you would have time, nor care. We just need to do better. That is about as simple as I can make it. With that, we are going to close up and listen, first, thanks for your questions. I know we had a lot of data to put out today and I can imagine it is tough as we raise our guidance and do this pension curtailment, et cetera, et cetera. Let me try to summarize today’s call by saying that we had a solid quarter, characterized by solid revenue…

Ladies and gentlemen, thank you for your participation in today’s conference. That does conclude today’s presentation. You may now disconnect.