Good day, everyone, and welcome to the First Quarter 2019 HP Inc. Earnings Conference Call. My name is William, and I will be your conference moderator for today's call. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes. And I would now like to turn the call over to Beth Howe, Head of Investor Relations. Please go ahead.

Good afternoon. I'm Beth Howe, Head of Investor Relations for HP Inc., and I'd like to welcome you to the Fiscal 2019 First Quarter Earnings Conference Call with Dion Weisler, HP's President and Chief Executive Officer; and Steve Fieler, HP's Chief Financial Officer. Before handing the call over to Dion, let me remind you that this call is being webcast. A replay of the webcast will be made available on our website shortly after the call for approximately 1 year. We posted the earnings release and accompanying slide presentation on our Investor Relations web page at www.hp.com. As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. For more detailed information, please see disclaimers in the earnings materials relating to forward-looking statements that involve risks, uncertainties and assumptions. For a discussion of some of these risks, uncertainties and assumptions, please refer to HP's SEC reports, including our most recent Form 10-K. HP assumes no obligation and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on information available now and could differ materially from the amounts ultimately reported in HP's Form 10-Q for the fiscal quarter ended January 31, 2019 and HP's other SEC filings. During this webcast, unless otherwise specifically noted, all comparisons are year-over-year comparisons with the corresponding year ago period. For financial information that has been expressed on a non-GAAP basis, we've included reconciliations to the comparable GAAP information. Please refer to the tables and slide presentation accompanying today's earnings release for those reconciliations. And now I'll turn it over to Dion.

Thanks, Beth. Good afternoon, and thank you for joining us. In Q1, we once again delivered top and bottom line growth. We continued to demonstrate our ability to deliver on our EPS, generate free cash flow, and we remained focused on positioning the company for long-term sustainable growth. While this quarter had many areas of strength and progress against our plan, there was an unexpected challenge in supplies, and we have more work to do there. First, let me cover the highlights for the quarter and then talk about the business more broadly. In quarter 1, we delivered revenue of $14.7 billion, up 1% or up 2% in constant currency; non-GAAP earnings per share of $0.52, an increase of 8% and in line with our outlook. And we generated strong free cash flow of approximately $700 million, returning almost $1 billion to shareholders in the form of stock repurchases and dividends. Our results demonstrate the continued vitality of our innovation across the portfolio as well as our ability to execute and adapt in a tough environment. Our strategy remains consistent, and a key part of that strategy is our focus on continuing to refine our business model to match changing customer needs and market conditions. This is one of the core strengths of our organization. We have a proven track record of leveraging change to create opportunity. Let's go through the performance of each of our businesses, starting with Personal Systems. Our Personal Systems team continues to perform at a high level, driven by a relentless focus on execution and profitable growth. In quarter 1, Personal Systems revenue grew 2% and delivered strong 4.2% operating margins. We are improving our product mix and managing our costs. As expected, the first half headwinds we previously shared with you are playing out,…

Thanks, Dion. Looking at the company's Q1 financial results, we delivered revenue growth, with non-GAAP EPS growing even faster. And while our respective business results were mixed, we are making good progress across our core, growth and future strategy in important areas. In others, we have more work to do. As always, we will continue to balance where to invest and capture opportunities on one hand and where to drive efficiency or fix challenges on the other, all with a focus on creating long-term shareholder value. Looking at the details of the first quarter, starting with the top line. Net revenue was $14.7 billion, up 1% or up 2% in constant currency. Regionally, in constant currency, Americas declined 2%, EMEA was up 2% and APJ grew 11%. Gross margin was 17.8%, flat year-over-year. Sequentially, gross margins were up 20 basis points, driven by improved rate in both Personal Systems and Print. Non-GAAP operating expenses were $1.6 billion, up 1% driven by an increase in SG&A. Non-GAAP net OI&E expense was $57 million for the quarter. We delivered non-GAAP diluted net earnings per share of $0.52, up $0.04 or 8%, with a diluted share count of approximately 1.6 billion shares. Non-GAAP diluted net earnings per share excludes amortization of intangible assets of $29 million, acquisition-related charges of $10 million, restructuring and other charges of $55 million, nonoperating retirement-related credits of $12 million, tax adjustments of $55 million and a tax-related impact on all of these items. As a result, Q1 GAAP diluted net earnings per share was $0.51. At the segment level, in Personal Systems, we are pleased with our results and ability to navigate the current environment. We have demonstrated a strong track record of execution and financial performance, and demand for our products remains strong. Revenue in the first…

[Operator Instructions] And today's first questioner will be Shannon Cross with Cross Research.

I wanted to understand -- and you gave a lot of disclosure during the call on Supplies. But I guess, Dion, when you look at it, I mean, is this something that can be fixed to get back to flat? Is it -- I know it's secular. But one, I guess, would have thought with the copier initiative and what's going on in 3D Printing and some of the other growthier areas that you'd be able to offset some of the core pressures. So I guess, maybe from a bigger picture standpoint, how are you thinking about this business over time? And should we think about it long term as something that's stable? Or will it just be sort of a constant decline? And then I have a follow-up.

Great. Thanks, Shannon, for the question. I'll try to summarize it in terms of if we accept that, really it was a loss of share and, to a lesser extent, pricing, the question is, why we're losing share? And what are we going to do about it? It's true that these challenges versus third-party alternatives are not new. We're essentially fighting the same war, but we're now engaging on a new battlefield, and it's called online. Historically, we've been very strong in our traditional channels, including both retail and the commercial channel. You see, online offers a growing route to market for alternatives. And we're seeing more of our commercial customers moving to online, where our overall share, while still leading, is not as large. The growth of online and the access it enables for reman and aftermarket alternative is also creating incentives for aftermarket alternative manufacturers to invest in breaking in on better technology faster. And this has resulted in a faster deceleration in our aftermarket share on some newer platforms than we expected through this route to market. So while we've been expanding our presence in the omnichannel, we need to do it faster, and we need to do it more effectively. We need new weapons to fight on the new battlefield. We just can't bring a musket to a drone fight. So most importantly, what are we going to do about it? First, we need to continue to evolve our go-to-market and expand our online initiatives as well as our targeted marketing, and we'll certainly be doing that. The second thing we have to do is we've got to expand our order processes to protect our brand and discourage counterfeit and other IP infringements. We've got to support the value proposition of original supplies in terms of quality, sustainability as well as environmental impact. Thirdly, we have to shift our business models in order to diversify our product pool for services and securing a high share of the supplies for those units. Both Instant Ink and Managed Print Services are great examples of these models. And then finally, we've got to also evolve our business to include products that generate a larger portion of the lifetime profitability at the time of purchase. So we know the situation that we're in. We've named it, and we also know what we need to do about it.

Okay. And then can you just talk maybe, Steve, a bit about cash flow? You maintained the cash flow. I know it's still early in the year. But given the pressure on Supplies, where are your other levers that you're going to be pulling? And how susceptible is it if we do see more of a PC slowdown? Just, I guess, your comfort level with the cash flow guidance.

Yes. I guess, for starters, I am comfortable with the at least $3.7 billion. Similar to what we've done in prior quarters, when we look at our free cash flow outlook, we do take into account our forecast on earnings, our volume, especially in Personal Systems and cash conversion cycle. And then from an earnings perspective, while we do have the challenge in Supplies, we are taking actions, including cost actions, to address some of that. So net-net, on our earnings, volume and CCC perspective, I feel confident in the guide. And as I mentioned last quarter, worth repeating, we finished Q2 with a negative cash conversion cycle of minus 35 days compared to minus 32 days at the end of Q4. I'd acknowledge that we would likely have some upside to that minus 32 days at the end of last quarter. I still see that as potential upside, which helps further confirm and give confidence in the at least $3.7 billion number.

And the next questioner today will be Wamsi Mohan with Bank of America Merrill Lynch.

Dion, can you talk about why you're seeing this particularly in EMEA in Supplies and the risk that this spreads to other regions as well? And how confident are you about this prediction of 3% decline you -- and that you have actually captured an appropriate amount of data and telemetry that's guiding that given that this is not the first time that we'll see the Supplies reset? And I have one more question.

Yes, no problems, Wamsi. I'll start, and I'm sure Steve may want to chime in as well. I guess, the underlying cause as we outlined during the call, was the surprise around our assumptions about share were wrong, and it was most specifically in EMEA. There are 2 main drivers that I'll comment on. The first is the omnichannel impact, and the second is our operational visibility. Let me start with the omnichannel. The omnichannel and the consumer preferences to buy online are definitely not new. What we've seen is more commercial customers purchasing online. And while our online business has been growing significantly and we have leading share online, it's at a lower percentage than our share with traditional commercial resellers and install retailers. Where we went wrong is that we had incorrect Supplies share assumptions in our 4-box model regarding the plans for Supplies selling in quarter 1 '19 and in prior quarters. This made it very difficult to spot the buying behavior change as a trend. It didn't necessarily all happen in Q1, but now that we understand the trend better, it has driven a change in our expectations for share going forward. In addition to that, the macro uncertainty has also increased, and we've seen further price sensitivity among customers pressuring both our share and our Supplies pricing. If I turn to operational issues, since we don't have much visibility into the downstream channel ecosystem and we were maintaining CI levels below our Tier 1 ceiling, we did not see clearly enough that we had an issue. However, we saw lower sell-through during the course of quarter 1 and adjusted our operational plans to reduce shipments, consistent with our Supplies sales model. We also received new share analytics. It's a really important point, and we were able to triangulate that our revised share assumptions were below our previous ones. And so in retrospect, when the new share insights are applied, we believe that our inventories in the ecosystem -- in the whole ecosystem began growing in prior quarters. However, the prior share assumptions made it hard to call this out as a trend as it was masking the underlying problem. And as a result of that, we've adjusted our go-forward 4-box assumptions and sizing inventory impact, as Steve talked about, to be approximately $100 million.

So then I'll just add to that and address more specifically on the extent beyond EMEA and then even the sizing of that $100 million. So in Q1, certainly, the revenue weakness and the incorrect share assumptions were primarily in EMEA. And while the multi-tier channel dynamics that have been described are not unique to EMEA, they are more prevalent there. That said, the competitive trends are global, and both the changes in the customer buying with more commercial customers purchasing supplies online and the pricing that Dion just referred to are more macro in nature. And therefore, when we revisited our 4-box assumptions, we did look at all regions and revised our share and pricing accordingly, and that's all embedded in our guidance. And then specifically, I think you indicated this is what happened before. In terms of the channel itself, just to put context, we're talking roughly 1% of our total Supplies stream of over $13 billion. And while there are some things that are clear with data, there are others that we need to triangulate on. And we can't be precise on all fronts, especially because we don't have visibility into the entire downstream unmonitored ecosystem. So our approach here was to triangulate on a channel inventory number across the ecosystem by analyzing different data points. We compared our old share assumptions with the revised one that have been informed by big data, and we also looked at prior selling statistics and CI trends. We then estimated how much additional downstream channel inventory may exist, and we believe $100 million is the right estimate.

Okay. Appreciate that. And then if I could just quickly follow up. Can you talk about the longer-term print margin assumptions for the segment now, given that we're talking about some structural headwinds here on Supplies?

Yes. So we obviously delivered 16.2% in the quarter. And when we entered FY '19, Dion and I had a good conversation. We actually took proactive steps to address some of the growing global uncertainty we saw at the time and began some targeted expense reductions. We didn't anticipate this Supplies challenge, but we saw, we reacted quickly and further tightened OpEx. It's important that we continue investing in the areas where we expect good returns, like our growth initiatives, placing the right units and evolving our business model to be more contractual. So that's important for us to continue. It is why, though, that we must continue to drive more productivity and more efficiency in the model. I do acknowledge that maintaining the 16% going forward is tougher, given the Supplies challenge, but it does remain our target.

And our next questioner today will be Katy Huberty with Morgan Stanley.

Just following up on the Printer Supplies discussion. It sounds like some of the visibility into market share came on the back of the telemetry data, which is something that you've talked about for a couple of years. Why this quarter did that show you a picture that actual market share was different than you thought? Why weren't the systems flagging that ahead of time? And do you have to invest in technology so that you can get better insights out of that data? And then I have a follow up.

Thanks, Katy. To help you understand it better, let me explain a little bit about our methodology that drives the share assumptions we use on office supplies, which is primarily toner-based, and how it's changed. It's worth noting that it's different than ink-based products, where we've historically had more telemetry data. Previously, we had used periodic third-party survey data and market research aggregators to estimate toner supply shares. We did not have a statistically significant sample from the system telemetry and the instrumentation nor the capabilities to calculate share for toner-based products in the installed base. We've had this data for ink-based products, but due to the limited number of machines that were phoning home in commercial due to enterprise firewall constraints and otherwise unconnected devices, we've had to build the connected installed base over time. And so with the increasing mix of newer products and the growth of the connected installed base, combined with improvements in big data, we've been able to move to a better source of share data based on system telemetry. It's worth noting that the share we calculate through big data reflects the share at the time the customer hits the print button, which may be months after they actually purchase the supplies. So when the new share insights are applied, we believe that the inventory in the ecosystem had been growing during quarter 1 and previous quarters. And the combined effect of the change in market dynamics impacting share and the lack of visibility to the change resulted in excess HP supplies in the market and lower Tier 1 channel sell-through. Having said all that, we will obviously need to continue to refine the telemetry data and our instrumentation and business management system as we move forward.

And then just shifting the discussion to PCs, how is the industry reacting to lower memory prices? Is that at all getting passed through in prices to customers? Or was holding onto the lower cost a contributor to the margin expansion for both you and some of your peers this quarter?

Yes. When we looked at our margin in Q1 and certainly, the ASP portion of that, the large sort of greater than 50% increase in the ASPs was actually driven by mix, with the remainder being overall pricing dynamics. And we did see some favorability from Q4 to Q1. We'd expect continued favorability from Q1 to Q2 on the overall commodities. Exactly how this will play out in our margins going forward is going to depend, though, on overall market and pricing dynamics. Obviously, we've got currency volatility we continue to see, and likely headwinds from currency will partially offset some of the tailwinds we are seeing on commodity costs.

And our next questioner today will be Toni Sacconaghi with Bernstein.

Your guidance for EPS for Q2 is a little bit -- the midpoint of it is a little bit below Street consensus. Should we interpret that as you're feeling now more confident in the low end of your EPS guidance, particularly in light of the Supplies news? Or do you believe that consensus has mismodeled seasonality for the year? And I have a follow-up, please.

Yes. I think in general, our Q2 EPS guide is in line with normal seasonality. And I think the comment was on the full year, so maybe I'll comment on the full year and get back to Q2. Full year, we are maintaining our guide at $2.12 to $2.22 non-GAAP EPS. Confident we can deliver across the various puts and takes. We have factored in now the lower Supplies revenue; the CPU constraints, which we had already taken into account; and FX headwinds. We have multiple levers to offset. As I mentioned earlier, we expect to continue driving cost management whether they be in-flight initiatives that we can accelerate or continued push around digital transformation. I mentioned the components on the prior call -- or excuse me, prior question. And so how much of that sticks, again, is to be seen. So we do have levers. But if I reflect back at SAM when I laid out the FY '19 guidance and broke it up between the segments, which was about $0.05 to $0.12 of the year-over-year increase, and shares and other about $0.05 to $0.08 of the year-over-year increase, I think we're generally in line with that. On the segments, more strength in Personal Systems, and now we have some challenge on the Print overall. And on the corporate and other, have a year-over-year favorability on shares, to a lesser extent, OI&E. But we are investing more in corporate investments and other. So net-net, I feel confident holding the midpoint of our guide.

Okay. And then just back to Supplies. So if Europe is a third of your business and was down 9%, that suggests that Supplies outside of Europe was down 0. And I guess, the question would be, why does the rest of the world not start to migrate towards sort of negative sell-through growth on a go-forward basis? And accordingly, why do you have confidence in minus 3% growth?

Yes. So as I mentioned earlier, clearly the issue in Q1 was and pertained to EMEA. And even the share delta from the assumptions that we previously had to what we now view as our share was, primarily, the delta was in EMEA. That being said, we looked and reanalyzed the entire business across all regions. And the minus 3%, we believe, is a prudent guide. It does take into account both, number one, the channel inventory in the entire ecosystem. Again, it's about a point of it, the $100 million takedown. And the second is we did revise our shares and pricing assumptions worldwide. So net-net, we think that it's the right way to look at the business even though the issue in Q1 was primarily EMEA-based.

And our next questioner today will be Steve Milunovich with Wolfe Research.

Just one question. In the past, at some of the SAM meetings, you've talked about $1 billion negative hit from commodity costs. I'm just curious, how much of a positive are you expecting this year in the swing? One would expect it could be quite substantial. You've also, in the past, talked about the ability to offset that by taking out $1 billion of costs annually in the business. And just said that's the normal course thing we have to do. Are you still on track to take out about $1 billion from the cost base?

So let me respond to that. So on the first piece, actually, on a year-over-year basis, costs and commodity costs are still a headwind. Sequentially, they're a tailwind. But we're still, from a year-over-year basis, going through the period where costs had risen for some time. I think whether it be headwind or tailwind, I think the reality is that the market adjusts pretty rapidly to different changes in component costs and other short-term factors such as currency. So how much actually falls to the bottom line or how much we need to mitigate through additional productivity is very dependent upon the circumstances. In terms of the actual dollars that we're driving, we do remain on track to our productivity initiatives. It's an area where we'll continue to look to accelerate, candidly, given some of the Supplies challenges. But this is really in the DNA of HP, and I'm very confident in our ability to drive expense actions where we need to.

And the only thing I would add to that is that we won't lead the market down on price. We obviously need to remain competitive in the marketplace, and we've been investing heavily in innovation and we believe our customers are valuing that innovation. And the demand signal for our products remains really strong.

The next questioner today will be Rod Hall with Goldman Sachs.

I just want to come back to the telemetry question and ask you if you could give us some idea where you are in the process of improving telemetry. So have you -- what kind of sample you have? So should we expect for you to continue to look at this and improve telemetry over time, and therefore, maybe come back to us and continue to adjust this inventory in the channel? Or is everything pretty much done now, and you wouldn't expect any changes? And then I have a follow-up.

I guess, for starters, the 4-box model historically has been a relatively good predictor. And I think we need to acknowledge that it is not perfect. There is data and science. There is also judgment and art to it. And to your question, we do need to get better with the telemetry data. And also, we've -- bundled it up to more analytics and business management system in general. And so what it really depends upon, I would sort of call it, a few dimensions, it's really the quantity, quality and speed of the telemetry. And from a quantity perspective, it's installing and shipping more of our installed base with the kind of newer, toner-based telemetrics such as the JetIntelligence. But it's also ensuring that we have access to that. And so increasingly, the penetration of our installed base and quantity is important, but also then the quality and speed in which we can analyze this information, apply more predictive BI analysis around it. So we are investing in this, and I would expect it to get better over time. But I'd -- to my opening comments, we have been pretty good at predicting with the 4-box model, and this is fine-tuning.

But with all that said and done, I think it's also important to note something I mentioned earlier. We need to shift our business models in order to diversify our profit pools through services and securing a higher share of the supplies for these units. And so I am encouraged by the work that we're doing around Instant Ink and growing our installed base there as well as Managed Print Services. They're great examples of that model. And secondly, what I talked about is we've got to evolve our business to include products that generate a larger portion of the lifetime profitability at the time of purchase.

Okay. And then I wanted -- on the follow-up, I just wanted to come back to the cash flow guidance. And I guess, do you see if there's any way -- I guess, the issue -- it makes sense to us that you could take working capital out. But this is a year when Personal Systems, we're not expecting a lot of growth, whereas we've had double-digit growth the last couple of years. So it seems like a tougher year to take working capital out. So I just wonder if there's anything else you can do to help us bridge back to the cash flow guidance or is it just a case that the cash flow guidance is a little bit more aggressive, considering the underlying fundamentals?

I already highlighted the likely improvement in cash conversion cycle, and that obviously brings cash into the current year. When the Personal Systems business grows sequentially, even if it's small growth, it does pull cash into that period. And so while we are not anticipating the growth that we have seen in prior years, we do -- we are factoring in what we think the revenue and volume trajectory is of Personal Systems. And as long as that business has sequential growth, it is a cash generator.

And our last questioner today will be Ananda Baruah with Loop Capital.

Two if I could. Just going back to Supplies, Dion, is there any way for us to think about how you're thinking about what long-term, new normalized Supplies rates will be? And appreciate all the detail that you guys gave. But how should we be thinking about -- what's the best way for our models after '19 for us to be thinking about it, best you can tell right now? And then I have a follow-up.

Look. First, as Steve alluded to in our outlook, we've taken into account the approximately $100 million headwind from reducing inventory in the Supplies ecosystem. This is about a point of Supplies revenue, as Steve highlighted. And the remainder of the decline is the base is really based on factoring in the revised share and the pricing assumptions. And future outlook beyond '19 will depend upon a number of things including the progress we're making across each of our 4-box drivers and the pace of our business model evolution that I referred to at the last question. So at this time, just as we ordinarily do, we're not going to comment about future years.

And maybe to provide a little additional context, I'll just sort of give an update of where we are on the 4-box. Enrique shared at SAM what we thought the various 4-box arrows looked like. And if Enrique were doing that today, given the changes we've seen driven by the commercial channel and evolving marketplace Dion described, first, we wouldn't expect any changes to installed base or usage. Where we would expect some change is in office. Whereas we have previously had an arrow going up of gaining share, given the new data, we'd actually expect share to be down to a lesser extent on office. Pricing, which was a down arrow, driven by the mix more to A3, we offer additional commentary that there would be pricing pressures, again as we described on the call. On home, almost all the boxes will remain the same except for share, given that a smaller portion of home does have toner-based products. And so the share we have previously had going up, it would still be going up but not as, I guess, strong of an arrow going up, as we had said at SAM.

That's helpful. I appreciate that. And then just a quick follow-up. Reiterating the EPS guidance, should we think any differently now about the potential for the upper half of the range? My personal -- I mean, our assumptions were that you actually had a good chance to beat the EPS guidance previously. So maybe there's still a good degree of confidence to land the upper half as well. But how should we think about that where it stands today? That's it for me.

Well, as always, we view and take a very prudent view to our guidance, taking into account all of the puts and takes and risks and opportunities that we see, and we provide a range around it. I'm not going to comment specifically other than we have a range, and we've got confidence we can deliver within it.

And we'd held that range.

Yes.

So thank you, everyone, for taking the time to join us. We remain confident in our business. We're reaffirming our full year EPS and full year cash flow guidance. We're relentless in both managing our costs and reinvesting to create long-term value. We know we have work to do to manage through the current dynamics, and that's exactly what we're going to do and what you should expect from us. We'll continue to play a long game. We'll execute to our strategy with rigor and focus on driving sustainable, long-term earnings and cash flow growth. Thanks very much.

And the conference has now concluded. Thank you for attending today's presentation, and you may now disconnect your lines.