Good day ladies and gentleman, and welcome to the First Quarter 2010 Hewlett-Packard Earnings conference call. My name is Michael and I will be your conference moderator for today’s call. At this time, all participates are in an listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Steve Fieler, Vice President of Investor Relations. Please proceed.

Good afternoon. Welcome to our first quarter earnings conference call with Leo Apotheker, HP’s CEO and Cathie Lesjak, HP’s CFO. This call is being webcast. 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 most recent Form 10-K. 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 amounts ultimately reported in HP's Q1 Form 10-Q. 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 and intangibles, restructuring charges and acquisition-related charges. The comparable GAAP financial information and a reconciliation of non-GAAP amounts to GAAP are included in the tables and in the slide presentation accompanying today's earnings release, both of which are available on the HP Investor Relations webpage at www.hp.com. I'll now turn the call over to Leo.

Thank you, Steve. When I come to see you, one of the most commonly asked questions has been what does HP do well, and where does HP need to improve. With one full quarter under my belt, I now have an insider’s perspective on the answer. For starters, I’m convinced that we have the core strength to deliver for our customers, partners, employees, and shareholders. When you look where the market is heading with cloud and connectivity converging, HP is well positioned to win. I’m confident in our future and our ability to execute effectively. I’m also confident that our business model can sustain our earnings power. Our Q1 results demonstrate the powerful operating leverage and diversity of our portfolio. We grew revenue 4%, gross profit 10%, operating profit 14%, and cash flow from operations and EPS were both up over 20%. We have a business model that benefits from scale and leadership in our core businesses. And we have an evolving portfolio mix with higher-margin businesses such as networking, helping to extend company gross margins. As we discussed during our last earnings call, gross margin expansion allows us to invest for future growth. If you want operating profitability, it was in dollars and percentage, what’s strong and demonstrated sound financial discipline. But, our Q1 results also show that there are opportunities to improve our growth in a few isolated areas. Despite strong profitability and cash flow in the quarter, we did not meet our top-line growth expectations, and I’ll provide some specific color on PSG and services. Let me start with PSG which declined 1% year over year. Going into the year, we made a few assumptions about the PC market in our business. First, we assumed that we would enhance our number-one share position. Indeed, in the most…

Thanks, Leo. HP continued to demonstrate disciplined execution in Q1. We added over $1 billion of revenue growth, expanded gross margins and operating margins, grew earnings per share by 27% year on year, and generated $3.1 billion in cash flow from operations. Before I get into the details of the quarter, I want to review our annual reclassification process. Each year, as part of our first quarter annual financial review, we make changes across and within the reported segments to reflect organizational shifts between the businesses. This year, we’ve made several changes that I will now highlight for you. As I told you in the fall, networking has moved into the renamed, enterprise service, storage, and networking segment from corporate investment. In addition, the communications and media solutions business transferred from HP Software to Services, and the Business Iintelligence business moved from HPs Software to Corporate Investment. A detail bridge of these changes, including historical data, is available on our Investor Relations website, as well as furnished on a Form 8-K filed with the SEC. I want to be very clear that this an annual process designed to align our financial reporting structure with business changes and that the changes do not impact HP’s previously reported consolidated net revenue, earnings from operations, net earnings, or EPS. However, in the interest of complete disclosure, we felt it was appropriate to mention them at the start of this call. With that, let’s review the details of the quarter. Revenue for the first quarter totaled $32.3 billion up 4% from the prior year. We continue to see good performance in our commercial hardware businesses led by strength in converged infrastructure and commercial printers and PC’s. We posted solid double-digit revenue growth across these businesses with Enterprise Servers, Storage and Networking growing 22% and…

(Operator Instructions). And your first question comes from the line of Ben Reitzes of Barclays Capital. You may proceed.

Yeah, I’d like to understand the services shortfall a lot more. The restatement kind of makes it a little murky, but versus my prior estimates, it looks like 6 or $700 revenue lighter in service than expected. And you mentioned application services but it looks like it’s more on the outsourcing side. So if you can discuss in more detail what the shortfall is in services and what exactly are you doing about it to get that growth rate up, I’d appreciate it. Thanks.

Thanks, Ben. So services that we mentioned did have a mixed overall performance this quarter. It had solid long-term findings. It obviously had good margin expansion and we drove pull through, product pull through in the double digits. The long-term signings have been primarily in the ITO space. And frankly, over the last few quarters it’s been a nice mix of both new logos but also renewals. In Q1 as an example, we find a record number of mega deals. Those are deals that are greater than $100 million in TCV and more than half of them were new logos, so we’re making progress there. These solid long-term signings are helping us to build what I would consider a foundation of solid annuity-based revenue. But the softness came in our short-term signings. And the short-term signings really are in the space of both ITO as well as application services because there are short-term deals in ITO. We call that add-on work. Also in services, I think you need to take a look at technology services because as reported, technology services declined 1%. We made a decision about a year ago to stop selling some low-margin third-party hardware and that is generating good business – it’s a good business decision for us, but it’s generating a headwind of about 3 points of growth in the technology services space. So that means that technology services, instead of really declining 1% on what I would call a go-forward basis, is actually up 2 points. In constant currency, our services business was basically flat year over year when you adjust for the third-party revenue headwind and the divestiture of ExcellerateHRO. That doesn’t mean that we don’t think that there is an opportunity to improve in the short-term space.

So then let me maybe address the question of what are we going to do about it. As Cathie has already outlined, we need to do a much better job in our higher value-added services, services that we deliver to our customers. And what is apparent in Q1 is that we have some work to do. We need to do a better job in selling short-term value-addrf projects into our installed base. And actually offer add new customer orders. And we have taken some very specific actions. We are doubling our senior management focus on this business. And we have added new leadership to the team. We have continued to invest in our capabilities to sell and deliver long-term and short-term deals. We will continue to improve our internal processes so that we can drive our service delivery transformations. We’ll continue to emphasize new types of higher value services like some of the cloud services that you recently announced. For example, we announced our development works in Q1 and those have already generated more than $250 million of pipeline.

And maybe one of those pieces of information that everybody would be interested in is basically that with the actions that Leo’s outlined, we do expect to have an improving position in services. For the year, we now expect services to grow low-single digits. And we expect the growth to ramp over the course of the year.

The next question, Operator.

Next question comes from the line of Mark Moskowitz of JP Morgan. You may proceed.

Yes, thank you, good afternoon. I wanted to follow up here first, should we think about the need to redouble senior management in services as an isolated event? I think a lot of investors are going to be wondering if there’s a spillover elsewhere in the business. And then my question is more for you, Cathie. As far as the outlook, can we understand more about the puts and takes to the operating margin profile for the second quarter, please?

Let me maybe answer the first part of your question, Mark. What we intend to do is to continue to drive our portfolio services of short-term value-added services into the market. That is part of the transformation that we are undertaking in the Enterprise Services business that HP had already taken before. We need to continue to drive this. And therefore, you’ll see us paying a lot of attention to this asset.

Mark, let me take your question in kind of two pieces, in gross margins and in OpEx. So from a gross margin’s perspective, we did benefit this quarter from a benign commodity-pricing environment. We also benefited from an improving business mix as well largely due to network. Less largely due to PSG as well, but we don’t expect the component prices to continue to be a benefit for us, or as big a benefit in Q2. And so what we’re calling for basically from a gross margin sequential perspective is that it will be a little less uptick from Q1 to Q2 than what we have seen historically. So that’s gross margins. In terms of OpEx, you absolutely have to adjust the OpEx trend for the net real estate gains that are in OpEx. So our OpEx or Admin is actually understated by roughly $250 million of net real estate gains in Q1. If you take that out of the equation, we expect OpEx will increase sequentially from Q1 to Q2 due to normal seasonality and the salary increases that we talked about in the last quarter. Obviously, all of this, both the gross margins as well as the OpEx increase from Q1 to Q2 is completely factored into our guidance for Q2.

Next question please.

Next question comes from the line of Richard Gardner of Citigroup. You may proceed.

Thank you. Cathie, I was just hoping you could give us a sense of what the real estate gain was versus your expectations in the quarter. You had guided non-GAAP EPS to $1.28 to $1.30. Was the $250 million what you expected there? And do you expect any of that to recur going into Q2?

Richard, unfortunately it’s a bit more complication than that. So what we talked about last quarter was roughly a $0.04 gain from one-time items principally related to real estate. The way the accounting actually worked is that it had to be split across two different lines in the P&L. So there’s roughly a $250 million benefit in Admin obviously above operating profit. And then there’s roughly an $80 million headwind, or additional charge in OI&E for a net gain of roughly $0.05. As I mentioned, we thought originally that it would – it rounded to $0.05. It was going to be roughly $0.04 when we talked the end of last quarter.

Next question please.

Your next question comes from the line of Katy Huberty of Morgan Stanley. You may proceed.

Thanks, good afternoon. Cathie, of the 2 billion reduction in full year revenue, how much is PC related? And then as a follow-up, what inning do you think we’re in in the commercial PC refresh and if we were to see a deceleration in the commercial PC market like we have in consumer, what would be the company’s strategy as it relates to adjusting the cost models so that weren’t to derail the earnings story, or the multiple investors are willing to pay?

Katy, in terms of our revenue guidance, both for Q2 and the full year, we do remain cautious about the environment for consumer spending specifically around PCs. So we factored that cautiousness into our outlook as well as the fact that the HP services will grow in Q1 to Q2 below historical seasonality, and then start to improve there on. But there would still be an overall full year impact as a result of the short-term signings softness that we saw. And I think it’s important when you think about our guidance whether it’s the top line or the bottom line that we remind you that we plan conservatively, but we always execute aggressively.

Let me maybe address the issue of which innings we are in when it comes to commercial PCs. We actually see a rather dynamic market. I would well say that we are in the mid innings to use the American expression. And we see a good amount for our commercial PCs across all of the regions, all of the [inaudible]. In particular, it’s driven by what we do on the desktop on the work stations, but we also start to see some good recovery across the board for other products. So mid innings and these markets too have some legs to go.

Your next question comes from the line of Tony Sacconaghi of Sanford Bernstein. You may proceed.

Yes, thank you. I was wondering if you could first comment about China. It sounded like China was down pretty materially. You’re the only company that I know of whose Asia growth rate was slower than its overall company growth rate. Can you explain the dynamics and also specifically what was your year-over-year change in PC revenues in China in the quarter? And then I have a follow-up please.

Let me address the specific issues in China. By the way, we have already talked about this issues in China in previous calls as well. We have a particular PC issue in China, which was caused by some events that occurred about a year ago. Actually, we are progressing in China. Our desktop and work station business is solid in this country. And I believe that we are getting past the issues in China. And we actually saw some good progress in our plan to restore growth, which was up 25% sequentially. We exited the quarter with a healthy mix of new products in the channel. We are not yet where we want to be, but we are cautiously optimistic about the actions we have been taking in China. It’s a big market. It’s a very important market. And we are very much focused in getting it right. We have had a series of product refreshers particularly in G series. And that will help our effort for both our channel partners in China.

If I could ask a follow-up, and Cathie, maybe you could fill in the blanks on the numbers. Specifically, what was China’s overall year-over-year growth rate? And what was China’s PC revenue year over year in Q4? And my separate question is, you missed your own revenue guidance for Q1. You’re guiding sequentially for the lowest guidance in nine years other than in 2009, which was the downturn for Q2 in terms of sequential change. So it sounds like you’re expecting things to actually get worse in Q2. And then when I looked at the back half of the year, you’re actually guiding above normal seasonality for the mid-point of your range, so a pretty dramatic snapback. It feels like giving the majority of your services revenues is outsourcing and driven by long-term contracts, a turn in services of that magnitude doesn’t appear to explain all of it, so maybe you can help me with that.

So Tony, in terms of the guidance, there is no question that we are being prudent. And we’re remaining cautious about the environment for consumer PCs. I mentioned that earlier. In terms of the second half of the year, the reason why you see better-than-normal seasonality half-over-half is that we do expect to continue to recover in PSG especially in China. We also expect improvement in the short-term signings based on the actions that we’re taking in the services space. And finally, in the second half of the year, we’ll also benefit from the launch of our new webOS family of products. And so I think that kind of shows what happens in the second half. In terms of your services comment, one thing that I think is important to understand is that when you sign long-term ITO deals, there’s a period of time where there’s what’s called transition in transformation. And that period of time is usually the first 12 to 18 months of a contract. And during that time, you do not recognize all of the revenue. In fact, a large chunk of the revenue is in fact deferred until the project gets into operation. And then it is amortized over the remaining licensing deals. So again, long-term signings are great in terms of building the base. But when you’re in that period of time where you’re building the base, there isn’t significant growth.

Let me maybe add one comment to what Cathie has said. We have been looking very hard at our focus. And I can just confirm that we are very confident in our ability to deliver the updated 2011 outlook. It’s beyond the point that Cathie has already made. We see strength in our other businesses. And we have structured numbers going out, and we believe that these are the right numbers.

Operator, we’ll go to the next question. Just as a reminder, we’ll ask each of you to keep to one question please.

Your next question comes from the line of Shannon Cross of Cross Research. You may proceed.

Thank you very much. Leo, could you provide your thoughts on the potential for acquisitions during 2011? And your thoughts on sort of acquisitions vis-via HP strategy. And then, if you can just be specific as to whether or not there are acquisitions factored into the revenue growth that was given. Thank you.

Let me maybe give you a holistic picture on our imminent strategy. And in fact, I’m going to have to disappoint you because our approach to M&A hasn’t really changed. Across HP’s portfolio, we will continue to pursue growth. And we’re continue to pursue growth either through organic innovations, or we’ll continue to partner, or we’re continue to evaluate M&A opportunities to make strategic, operational and financial standing. Only those who actually fit this equation will enter into our imminent equation. So no real change when it comes to our imminent strategy, but we have some opportunities. And we’re looking at them.

And Shannon, there are – the only acquisitions that are included in our outlook are the ones that have already closed. There are no new acquisitions included in the outlook.

And is that a change from prior, or has that been always how you’ve guided on revenue?

That’s always how we’ve guided on revenue.

Okay, thank you.

Your next question comes from the line of Keith Bachman of Bank of Montreal. You may proceed.

Cathie, I wanted to ask you a question if I could. 70 days ago, you guys provided guidance. Now it’s down $2 billion over the course of when you provided guidance at the end of the quarter I should say. Is it all in those two areas that you mentioned of services and PCs where that $2 billion delta is coming up from? And then if you could just provide a little bit of color as part of that on what your visibility is on the services side because my understanding is, when you enter the quarter, you have a high degree of 90% plus of visibility at least for the one quarter out periods. So I’m surprised to hear some of the outlook difference comes from the services side. Thank you.

Let’s be very clear about this. What happened in the revenues in Q1 is exactly what we have just described. In fact, we executed well in many of our other businesses like ESSN and IPG. So it actually all came from these two isolated events we just talked about, which is services and the consumer PC business. In services, let’s make absolutely sure that we understand that there are at least two different drivers here. One is the outsourcing business, which is a long-term business. And Cathie has described already all of the mechanics of that business. And then there is the variable, which is the short-term value-added business, which can actually fluctuate significantly from quarter to quarter. In Q1, we had a number of significant issues that we had to address. We have addressed them. Our portfolio is much stronger going forward. And with the focus that we’re going to put on value-added services, I feel confident that quarter after quarter, we’ll be able to pick up the pace and actually meet the guidance again.

And let me just add one other thing. In the ITO space, even within ITO, there’s are long-term contracts and long-term signings, and there are short-term ones as well. And that’s really the project work that goes on within the ITO accounts. And the short-term signings both from an application services, value-added services, and this add-on business in ITO accounts, that was softer than what we had anticipated at the end of last quarter.

Your next question comes from the line of Brian Alexander of Raymond James. You may proceed.

Thank you. Back at the analyst meeting last September, you indicated you expected 3Com to contributed about three points of growth in 2011, which is just under $600 million. Based on the numbers you reported, it seems like you should do much better than that. So I was just wondering if you could update us on your progress and expectations for both of these acquisitions, and specifically where you’re finding success. And related to that, if I back into the networking margins, it looks like you’re in the mid 20%. That would be operating margins. And I was wondering if you could comment on the sustainability of those margins in the context of perhaps getting more aggressive on pricing. Thank you.

I think the comment that I’d make around the acquisitions is that we are 3Com, 3Par, ArcSight, Fortify, the recent acquisitions are all ahead of plan and doing well. So I think that’s the answer I’d give you to the first one. In terms of the sustainability of the networking margins, we’re not calling for a significant change in those networking margins. Business has been very strong. We have increased the number of principle concepts that we’re doing under our proof of concept programs. Growth is accelerating. The networking business is strong.

Your next question comes from the line of Maynard Um of UBS. You may proceed.

Hi, can you just talk a little bit, I know in certain of your segments, you actually saw a good strength in your server and other businesses, but can you talk about the competitive environment obviously of new entrants like CISCO and Oracle in the space? What are you seeing? Are they having any impact to either pipelines or pricing? Any further clarity there would be great. Thank you.

Let me try to give you a little bit of a perspective broken down by each of these various product lines. On the service side, we’ve now had five quarters of formula growth. We have another 17% year over year in Q1 on the ISS, industries standard service side. We had a number one in all three regions in X86 servers. We gained market share year over year. So that’s performing really well. We have a very strong competitor position with our new product G6’s and G7’s. And we believe that we can maintain a very strong competitive position going forward. This is also by the way driven by some of IP that we put on top of these things, such as latest metrics that actually help us differentiate our product significantly. When it comes to [inaudible] and to the storage business, we are doing a great job. Cathie already indicated that that integration is going really well. We are focused on the next gen data center. Storage is a key part of that. And our future technology is a great compliment to our strategy and helps us differentiate from our competition there as well. And just to give you an additional color on the networking business, the 3Com integration has been a huge success. We are ahead of plan on our three quarters. And it’s a very quickly growing business for us, and we’ll continue to see very good traction.

And actually, let me just throw out the numbers. I guess I am the finance person. In terms of the Enterprise switching and routing business for us on an apple-to-apple basis, that was up more than 30% for HP this quarter. So it’s a good proof point that networking is in fact contributing to the growth, and to the gross margin profile of the company.

Next question please.

Your next question comes from the line of Kaushik Roy of Wedbush. You may proceed.

Thank you. In the past, you have mentioned that your R&D in sales and marketing will grow faster than revenues. Does that still hold for Fiscal 2011?

It does, and our guidance doesn’t call for any pull back in OpEx. So I think that we’re continuing to move forward with the sales expansion that we’re doing. The sales expansion in Q1 showed up mostly in Enterprise services storage networking and software. Those were the biggest areas where we expanded our sales footprint. And we are continuing to expand R&D through the course of the year as well.

Let me maybe add to that. We’ll be keeping a very watchful eye on these things. And we’re watching on the return we get from these OpEx investments. And we’ll keep on driving a very moderated approach to these expenses depending on our performance.

Operator, we have time for one more question.

Your next question comes from the line of Aaron Rakers Stifel Nicolaus. You may proceed.

Thanks guys, and apologize. I want to go back to actually Keith’s question earlier. So just to be clear, Cathie, you talked about low single digit growth now in the services business. I think at the analyst day, you talked about 2% to 4%. You know if I do the backwards math, that would be about $700, $750 million in revenue shortfall. That leaves you about a billion left kind of spread across the segments. I guess my question is, are you still confirming your 7% to 9% growth expectation in Enterprise service storage and networking as well as the 3% to 4% growth target for the imagining an printing segment for fiscal 2011? Thank you.

Well Aaron, on earnings calls, we don’t typically update our guidance relative to segments, to the segments. I’ve laid out for you, or we’ve laid out for you, the guidance for Q2 and the full fiscal year from a revenue perspective. And I don’ t have anything more to add to that.

Let me just wrap this call up by sharing with you some final thoughts. HP delivered strong margins, earnings, and cash flow performance in the quarter. And our operation discipline is intact. We continue to show strength in our core markets. We’re winning in the data center. We’re capturing the share of [inaudible] pages moving to analog to digital. And we’re well positioned as word of cloud and connectivity converge. As we discussed, we have some work to do in a couple of areas. And I’m confident in our ability to execute our plan. I look forward to sharing more of our strategy with you at our March 14th summit. Thank you.

Ladies and gentlemen, this concludes our call for today. Thank you.