Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Hewlett-Packard Earnings Conference Call. My name is John, and I'll be your operator for today's call. [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. Rob Binns, Vice President of Investor Relations. Please proceed.

Good afternoon. Welcome to our second quarter 2013 earnings conference call with Meg Whitman, HP's Chief Executive Officer; and Cathie Lesjak, HP's Chief Financial Officer. Before handing the call over to Meg, let me remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately 1 year. Some information provided during this call may include forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, results of HP may differ materially from those expressed or implied by such forward-looking statements. All statements, other than statements of historical facts, are statements that could be deemed forward-looking statements, including but not limited, to any projections of revenue, margin, expenses, earnings, earnings per share, tax provisions, cash flow, share repurchases, currency exchange rates or other financial items. Any statements of the plans, strategies and objectives of management for future operations and any statements concerning the expected development, performance, market share or competitive performance relating to products or services. A discussion of some of these risks, uncertainties and assumptions is set forth in more detail in HP's SEC reports including its most recent Form 10-Q. HP assumes no obligation and does not intend to update any such forward-looking statements. The financial information discussed in connection with this call, including any tax-related items, reflect estimates based on information available at this time and could differ materially from the amounts ultimately reported in HP second quarter Form 10-Q. Revenue, 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 amongst other things, amortization of purchased intangible assets, 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 web page at www.hp.com. I'll now turn the call over to Meg.

Thank you, Rob, and thanks to all of you for joining us today. With the first half of our "fix and rebuild year" now behind us, I must say that I'm encourage with where we are. Since sharing our turnaround plan with you on October, we've made significant progress. We've evolved our strategy for the business, we're bringing our costs in line with revenue while investing in key innovations and we're optimizing our cash flow and lowering our operating company net debt. And most of all, we once again exceeded the financial performance we said we would deliver in the second quarter. You can feel the turnaround taking hold at HP. I see it in my daily interactions with our employees and in our product portfolio and roadmap, and I hear it every day from our customers and partners. But, as I've said so many times before, this is a multiyear journey and we have a long way to go. We need to do a better job growing the top line and defending our margins. That means continuing to implement critical programs that speed innovation to commercialization, optimize our supply chain, improve our go-to-market and demonstrate our product leadership across our markets. In the second quarter, HP delivered $0.87 in non-GAAP diluted earnings per share, exceeding by $0.05 the top end of our financial outlook of $0.80 to $0.82 per share. Our results in the quarter were driven by better-than-expected performance in Enterprise Services and Printing, coupled with the accelerated savings from our restructuring program and improvements in our operations. For example, we're in the process of aggressively reigniting our channel partner programs, and we're seeing some progress. Since our Global Partner Conference in February, we've already developed more than 700 joint business plans, which will ensure greater alignment and…

Thanks, Meg. Q2 was another solid quarter where we demonstrated that we are effectively executing against the plan we laid out and we are improving the business performance in some key areas. The resiliency of our business model is evident again this quarter in our earnings and particularly, our cash flow performance. In the quarter, revenue was $27.6 billion, down 10% year-over-year as reported and down 9% in constant currency. Some of our year-over-year revenue declines we foreshadowed in our last earnings call, but there were incremental market pressures during the quarter as IT spending softened and the macro environment clearly did not improve. We also need to execute better in certain areas. In the Americas, revenue was $12.4 billion, down 10% year-over-year as reported and 9% in constant currency. Revenue in EMEA was $9.9 billion, down 9% as reported and 8% in constant currency. Revenue in Asia-Pacific was $5.3 billion, down 12% as reported and 11% in constant currency. Europe continued to be pressured, but we also saw weakness across Americas and APJ. In Q2, fiscal '12, we benefited in Personal Systems from the hard disk drive recovery, which means quarterly revenue and market share declines over prior year are magnified. Non-GAAP gross margin of 23.7% was up 50 basis points year-over-year, driven by margin improvements in printing, unfavorable supplies mix and higher average prices for consumer hardware, units. This impact was somewhat offset by margin declines across Personal Systems, Enterprise Services and the Enterprise Group. Sequential non-GAAP gross margin was up 140 basis points. We benefited from a favorable mix, given the steep decline in Personal Systems revenue, plus margin improvements across all segments led by improvements in underperforming contracts within Enterprise Services. Non-GAAP operating expenses were $4.2 billion, down 5.3% year-over-year and up 1.5% sequentially. Our restructuring…

[Operator Instructions] Our first question comes from Katy Huberty from Morgan Stanley.

Meg, you mentioned that the services runoff will be pushed more in fiscal '14, which will obviously hurt top line growth. But just curious, if we exclude that impact, do you still think that HP can get to neutral or positive revenue growth next year, excluding net services?

So Katy, we do continue to believe that revenue growth is possible. I think you have to remember that we are rebuilding ourselves in the midst of some of the most profound changes that I've seen in the technology industry, almost in our generation. And the progress on this turnaround isn't going to be linear. And I would also say that the macroeconomic environment, I don't think is going to be a tailwind for us. So this lower ES revenue runoff will create pressure in 2014, but if 3PAR performs as we expect it will, if HP Networking does, if Security, Big Data and our Industry Standard Server business performs as we expected, too, I think we have a good shot at growth in 2014, but there's no question there's headwind.

Okay. And then just as a quick follow-up, with line of sight to a neutral net debt position, do you feel comfortable stepping up the share buybacks even versus the second quarter run rate?

I think the good news is we will be in the happy position now of being able to do capital allocation across a number of different options. And really, the past 18 months has been solely focused on rebuilding the balance sheet while increasing our dividend and in fact, purchasing shares to offset dilution. So we're going to look at this on a returns-based way. There's the opportunity to invest, the opportunity to return cash to shareholders, the opportunity to potentially do small tuck-in acquisitions that further our cloud initiatives or our Converged Infrastructure initiatives or our software initiatives. So you can be sure that we're going to be disciplined about this and it's going to be returns-based.

Our next question comes from Ben Reitzes from Barclays.

Just a little bit more on the free cash flow, considering the difference in the guidance. You had about a $5 run rate in free cash flow or with the $5 billion you did and your outlook, though, for the second half is much closer to a $3 run rate with the $2.5 billion to $3 billion -- or $2.5 billion so it's actually a little lower. But what is the real HP run rate in cash flow? Is it more like the second half, more like the first half or somewhere in the middle? And how should we look at that from a long-term basis when things settle down?

So Ben, I think way to think about it that it's not really the first half or the second half. It's the full year. We expect that for the full year, we'll get to approximately $7.5 billion. We are very focused on cash flow in this company. We have really changed the whole sensitivity and awareness of cash flow through a lot of education programs and what have you, and you're seeing it pay off. You're seeing it pay off in free cash flow because of the tight management about CapEx. You see it in cash flow from ops because of the cash conversion cycle. I mean, we improved the cash conversion cycle basically 7 days year-over-year. So we're going to stay focused on that and I think that you should then look at the full year free cash flow as a launching point for fiscal '14 and beyond.

So the goal is to grow it from 2013, that there's not like a onetime aspect to the first half?

No, I don't think there's a onetime aspect here. The seasonality in the year is a little bit different. First half had some lower CapEx, lower restructuring payouts than what we had originally expected, as well as some lower cash tax payments that are going to show up in the second half. So the seasonality in the year is a little bit different, but over the long term, our focus is absolutely to grow cash flow.

Our next question comes from Mark Moskowitz from JPMorgan.

Meg, I just wanted to touch a little more on the services piece. What is your confidence in this planned services leakage events actually happening in 2014? If it doesn't, is it really because of HP becoming more focused from a productivity and execution perspective? Are you able to maybe unwind some of these planned attrition events?

I think, Mark, it's both. I think there is runoff that is lower from some of these big identified customers. We've done a good job of selling into those customers. So we've managed it effectively. I will say we're also executing a lot better in this business. We are managing our cost much better. There is a predictability to this business that there was a not in 2012. And we have built out a management team that I think is very well suited to really taking this business to a whole new level. We have a sales -- a new sales leader in place, a real sort of Lean Six Sigma manager in place, JJ Charhon is doing a terrific job as COO; Christine Reischl, as CFO; and then of course, Mike Nefkens. And the control of this business just feels very different to me than it did a year ago. So I think it's partly the runoff is happening is slower by the customers, but we're also managing it much better than I think we would have a year ago.

And then as a follow-up, just in terms of the learning points. Clearly, you're having some good success around productivity and execution. Are there any learning points that can be shared with other businesses or have they already been shared, maybe improve execution elsewhere?

So we're working to improve execution across the company, and I think we are, overall, getting better at execution. There are pockets that I hope -- hopefully, we'll do better in. We certainly learned every quarter from our mistakes and we get better. But if you think about fundamentally, we are fixing a lot of the impediments to HP being great and whether that's our IT systems, we're making big investments there and that's paying off. We're making investments in our go-to-market in terms of streamlining and getting the right people in the right job. So we're fixing a lot of the HP impediments that I described at the Security Analyst Meeting. I will say this takes time. This is an enormous organization, global in nature with 180,000 partners that need to be brought along. And you'll recall that in many of our businesses, 60% to 70% of our business go through partners. So as we make changes to the partner program, which we're well over due and I think right on target, it takes a while for that behavior to change. Our big changes in our partner programs went in May 1. So that's going to unfold over the next 2 quarters and probably, actually into 2014 as we change our go-to-market. That will have some impact this year but again, in 2014. So listen, we are a learning organization. There's a lot of best demonstrated practice sharing going on. And then there are still things we find out every quarter in terms of what we could do better. So a little bit of a long-winded answer, but I think we're on the right track here.

Our next question comes from Toni Sacconaghi from Sanford Bernstein.

I was hoping you could clarify really what your strategy for balancing profitability versus share in key competitive segments like ISS and PCs? Meg, I think I heard you say we're committed to win. Cathie, you said we're going to pursue profitable growth. I'm not quite sure what either of those really means. But what is the near-to-medium-term focus in terms of either share or a threshold level of profitability for each of those businesses? And part of the reason that I ask that is that they're both key drivers, particularly ISS support very high margin, support revenues, which have now been negative for the last 4 quarters, your deferred revenue balance fell much more dramatically than any other quarter, at least that I have, in 10 years of history. So it's not just the near term. There's a downstream consequence as well and maybe you can tell me if and how you think about that as you think about the broader growth and share and margin trade-offs in the near term.

Yes, good question, Toni. So it's a balance, right? You want to gain share, every place you can or are minimize the share loss, but you have to balance this with profitability. And it's a balance we focus on every day and every week. And this quarter, you saw one of our big competitors, Dell, completely cratered their earnings. And that is not sustainable for a company like Hewlett-Packard. Maybe it's what you do when you're going private, but it is not what you do if you're running a big publicly held company that is trying to create the financial capacity to invest in innovation, to invest in our future. And I've said, we're here to set this company up for the long term, not just get through this year, so it's a balance. And I would say in ISS this quarter, we did walk away from deals that were really problematic from an operating margin perspective. Now what the team understands is that can't be an excuse. That means we've got to figure out how to compete. Either our gear has to be much better, we have to make sure we've got the right product design for the right market segment, appropriately featured, not over-featured and we have to make decisions about what deals we must win. And we're going to be focused on the deals that are sticky as opposed to the deals that are strictly transactional in nature that you do one and there's no long-term relationship and the next time they go to market, they don't care whether it's us or someone else. So that's the balance that we are putting in place. In terms of TS revenue, we're actually really happy with the management of Technology Services under Antonio Neri. He's doing a good job, but he's got a couple of the headwinds because as we see BCS decline, of course, the attach rate of TS was very high to BCS. So that's a headwind that he's fighting. At the same time, he's working to increase the attach to servers, to storage, to networking and he is also developing products like Datacenter Care that can be sold to customers that haven't necessarily bought an HP product in that quarter. So it's all a balance, and every quarter, every month, we adjust that balance, but I also think we've got to make sure that we have the low end of the market priced right and featured right. Cathie, do you want to add to that?

Yes, let me add a couple of points. The first one, Toni, I think part of your point is a really important point in that's that we may well be more aggressive on pricing on an industry-standard server if we're getting attached to TS. And so really, how aggressive and where we might go for more share and take a lower margin will be based on kind of the complete picture and the long-term view of the opportunity in that account. And so it's really, yes, it's very much like the IPG business where we know every time we place an Inkjet unit, we're placing it in at a loss, but we know that over the life of that unit, it's going to generate a positive NPV. So we definitely take that into consideration. And then the second thing, just tactically on the deferred revenue, potentially what you're not -- you don't realize is that there was re-class in our deferred revenue on the balance sheet from short term to long term, so the decline that you see or you're backing into is larger than what is really there. The re-class is roughly $750 million out of short term into long term.

Our next question comes from Shannon Cross from Cross Research.

Can you provide more color on currency? Remind us in short how your hedging strategies work. And then I'm also curious about your comments regarding the pricing environment and what you're seeing from the Japanese, and if you're going to actually be more price aggressive, say, with your laser printers, given you also benefit on the COGS side?

So why don't I start? So if you look at year-over-year Q3, currency is probably about 1 point of headwind to revenue. For the full year fiscal '13 over fiscal 2012, also about 1 point in headwind. Now that's improved versus our Security Analyst Meeting when it was 2 points of headwind. But you -- you kind of alluded to it, we really need to think about the fact that HP is exposed to a whole basket of currencies. And we have different hedging strategies depending on the competitive business that we're in. And so, for example, in the services space, we hedge longer term than we do on a purely transactional business -- piece of business in the Personal Systems Group. It also depends on how quickly we can pass on changes in currency and pricing. And so that basket of currency and then the different hedging strategies really mutes the kind of the currency impact quarter-to-quarter in our business. From a supplies perspective, the depreciation in the yen didn't give as much of a benefit in Q2. It's more skewed to the second half and mostly in Q4 when we see the big ramp and that's really because of the contract that we have with Canon and the hedges that we had in place at the point of time that the yen started to depreciate. We do expect that our cost savings in the second half are creating quite a war chest for Japanese competitors and we're starting to see a more aggressive pricing. They now have a lower cost structure than they did before.

So we're going to use some of that yen benefit to fight back and I think that's right thing to do, Shannon. So the currencies are pluses and minuses. In the laser business, it helps us in terms of our profitability, but hurts us biggest the competitors are now most cost-competitive because of what's happened to the yen.

And Shannon, we will also use the opportunity to place a more valuable unit in the market for printers.

Okay, great. And I guess, would you assume that you'll be more -- spending more in marketing and such to drive the new Inkjet in the Office initiative as well?

Not above what's planned in the forecast. I mean, we actually knew obviously Office Pro -- Officejet Pro X was coming online. We knew it was a big bet. We also wanted to take some of our contra revenue and put it back into marketing, so we're planning on that. So that's built in to our forecast.

Our next question comes from Keith Bachman from Bank of Montreal.

Cathie, for you, please. Could you -- I want to go back to cash flow. In '09 and 2010, the cash cycle actually was as low as 15 and was ranging between 15 and 18 days. Can you get down to those type of days or are there structural issues as you think about your cash flow that would prohibit you from reaching kind of mid-to-high-teens days? And/or when you're talking about ongoing cash flow generation capability in '14, is it more driven by improved profitability? If you could just talk a little bit about how you're thinking about the cash cycle versus profitability as drivers to your overall cash flow.

Sure. So, Keith, what makes it difficult to get back to teens in the cash conversion cycle is the Personal Systems business. Personal Systems, if you look at them as a standalone business, they actually have a negative cash conversion cycle. So that business is growing well and when it's a bigger percentage of HP, the opportunity on just on a mixed basis is to get to a cash conversion cycle that is much lower. So unless and until that changes, I don't think we'll get to the teens. I think 21 days is actually a very strong performance for us. In terms of growing cash over time, it's about growing earnings. It's about continuing to manage our CapEx in a very returns-based manner. And it's continuing this focus within the organization around cash and how every single individual in the company has an opportunity to impact, in a positive way or negative way, our cash.

I think it goes down to also keep the product planning, how many platforms are we going to build to, how many SKUs on top of those platforms? Because the more SKUs, the more platforms, maybe the more customer needs you can meet. But getting the right amount of inventory in the right place at the right time, the more complex it is, the harder it is. So that's why have a real eye on platform minimization. As -- to best -- as best we can, to still meet customer needs.

Our next question comes from Brian Alexander from Raymond James.

Meg, you talked about renewed channel momentum and you mentioned improvements in areas like deal registration and turnaround time. You gave some examples and you said it would take until 2014 to really see progress in the top line, but you also talked about aggressive pricing in pretty much all of the segments where you might see benefit and obviously, you're going to be focused on profitability. So I guess, the question is what segments of the business are you most confident that you'll actually see revenue stabilization and market share momentum improve as we head into next year? Where should we be looking for the signs of success that you're doing with the channel?

So I think 3PAR and StoreOnce is going to have a great year with the channel, the second half and next year. I would also say HP Networking. With the new Datacenter networking products that introduced at Interop last week or the week before, that's a perfect channel product, where actually George Kadifa is working hard to improve our software sales to the channel and there's a great deal of interest on the part of the channel. We just had our Channel Advisory Board and many questions were how can we get involved with security, how can we get involved with Vertica and Autonomy? Listen, we hope that it will help -- the change to the programs will help our mainstream Industry Standard Servers. The great thing about the channel is they are very commercial. They want to go where they're going to make the most amount of money and where the sale is going to be the easiest to their end customers. We've tried to be a whole lot easier to do business with, with varied competitive channel programs. For example, starting at paying at dollar one as opposed to a complicated set of gates and hurdles that they have to jump over. And then PCs. Listen, if we have the right product priced right, the channel still loves HP and they want to sell in our product, whether it's to small businesses, medium-sized businesses or the enterprise and frankly, having Android products here helps a lot. This $169 Slate helps cover a segment of the market that we didn't have before. So I'd say those are the things, the first ones were the ones I feel most certain about, and we'll have to see how Industry Standard Servers pans out and how our PC product is received by the channel.

Our next question comes from Steve Milunovich from UBS.

I wonder if you could give some color first on industry verticals? How much exposure, perhaps, generally you have to different verticals and what kind of strength and weakness you're seeing, particularly in the federal government? And then just an accounting question on the balance sheet, accumulated other comprehensive income has jumped quite a bit in the last couple of quarters. What's that about?

Okay. Let me take vertical area. So as you know, we have particularly in Enterprise Services, a significant presence, a good presence with the federal government in the United States, as well as the government in the U.K. and other countries. EDS had a very strong federal government practice, and we are excited about that business. There's no question that the tenor and tone has changed with sequestration in the United States and frankly, austerity in Britain. So we have to be very sharp and very competitive to win that business and we have to come to them with ideas about how they can fundamentally change their cost structure. Because the days are over in the federal government of ever-escalating IT budgets. And frankly, and it's over in some of the big industries like financial services and others. So it's about providing solutions that can fundamentally change their cost structure and get to them to, if you will, the new style of IT. So we are on this. I feel pretty confident about it but we are seeing a lot of pressure on the government side of things, as you might imagine. Cathie, you want to answer [ph] the...

Yes. On that, Steve, there's lots of puts and takes in accumulated other comprehensive income. And so what I think probably best is for Rob will follow up with you after the call.

Our next question comes from Aaron Rakers from Stifel Nicolaus.

On the operating expense savings, can you just give an update where you stand as it relates to your headcount reduction effort of 26,000 people for the year? And then I think obviously, you talked about accelerated savings on the OpEx line, but can you also talk about the rate of reinvestment relative to what you had said at the Analyst Day event, which I think you had outlined a $0.15 headwind from reinvestment. Where do we stand relative to that at this point halfway through the fiscal year?

Okay, so let me start with where we are with respect our labor restructuring. We are on track for 26,000 employees to exit the company under our restructuring plan by the end of this year. We had roughly 3,500 employees leave under the plan in the quarter and on a program-to-date basis, we're at about 18,800. And so we are actually probably a little bit ahead of plan, but kind of feel good about achieving the savings for the year.

In terms of -- Aaron, in terms of where we are versus the $0.15, listen, we have -- as we have created that financial capacity to invest. We are protecting that investment with everything we've got because that is the future of Hewlett-Packard. So you can see that investment in products like Moonshot, multifunction printers, Officejet Pro X, SDN, low-tier, mid-tier storage, I mean, the strategic Enterprise Services in Services business. And we're also driving investments into IT, whether it's quote-to-cash or other CRM tools, Salesforce, Workday, we are trying to fix a lot of what has been historic impediments to getting the work done here, and we are protecting that investment aggressively. Now what we believe will happen is that many of those investments in IT, you're going to start to see the benefit, for example, in services. The good news is they now have a labor demand-supply management system, they have a purchasing system that is going to allow them to get more productivity. So I'd say, we're -- I mean, I'll let Cathie comment. I think we're certainly protecting the $0.15 and as we see opportunities, we're making incremental investments to set us up for the longer term.

So I would agree with that. And one of the things when I was kind looking at the results and thinking about questions that you might ask, it was an interesting thing, I was looking at OpEx because OpEx is down just over 5% year-over-year and up about 1.5% sequentially. And I thought, someone might ask the question, "Wow, your revenue is down 10%, why isn't OpEx down at least 10%? Can't you cut cost faster?" And yet I thought a whole other group of people might say, "Why are you cutting expenses? Why aren't you making investments for the long term?" And so what I think is really important is a, we've got our arms around cost and we've got our around where we think it's appropriate to invest for the long term. So we're not making our EPS based on cost-cutting alone. This is really well thought out, well-placed OpEx dollars. And of course, we're cutting out the stuff that's not generating the returns that are going to help set us up for the future, but we're protecting the investment whether it's in R&D, whether it's in marketing or sales to set ourselves up for the future.

Time for one final question.

Our last question comes from Bill Shope from Goldman Sachs.

Okay, great. I have an extension of the last question. Prior to giving us the $0.15 reinvestment target at the Analyst Day, I believe when the restructuring program was first announced, you mentioned that the vast majority of the savings would be reinvested and I understand the end market dynamics have changed, so that shouldn't necessarily be the near-term goal. But can you help us to think about how much of the original reinvestment plans from a year ago are being delayed versus eliminated because they may simply not be necessary anymore? And maybe an example or two of where the latter may have occurred?

So let me start with -- let's level set. So what we said at the Security Analyst Meeting is that the labor savings would be roughly $2.2 billion in fiscal '13 and that's about $1.9 billion over fiscal '12. We are still committed to that plan. We are not -- none of those become unnecessary. Now they don't all drop to the bottom line either because we're reinvesting or we're using it to protect the weakening performance that we've seen. Then in November we talked about the fact that we have incremental nonlabor savings, incremental to the labor savings of roughly half of what the labor savings were and we talked about the fact that those were more weighted to the second half as it ramps. Now we did bring some of those into Q2 and we are pleased to that performance, but that again is all there to set up, protect kind of the commitments that we're making in the business environment that we see and reinvest,

Well, I think Cathie summarized it really well. I mean, this is -- we have an eye on the short term, but we have an eye on the long term. Because anyone can make this quarter or this year and it's all about setting ourselves up for the products and services and software that are going to power the new style of IT while we manage through the knothole of some declining businesses that, frankly, we're -- the way the industry used to be powered. And it is that transition that we've got to manage through. And it is not easy, but I think actually, we've got a handle on this and I think we're doing a reasonably good job of it. And so -- but it's absolutely critical to protect the investments. And then we can use some of the savings to cover weaker business performance, which we have. Thank you. Thank you very much for joining us and...

Yes, thank you, and that concludes the call. Thanks very much.

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