Good day, everyone, and welcome to the Second Quarter 2020 HP Inc. Earnings Conference Call. My name is Ailee, and I'll be your conference moderator for today's call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. 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 2020 second quarter earnings conference call. With me today are Enrique Lores, HP's President and Chief Executive Officer; and Steve Fieler, HP's Chief Financial Officer. Before handing the call over to Enrique, 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 the accompanying slide presentation on our Investor Relations web page at investor.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, including the potential impact of the COVID-19 pandemic. 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 and Form 10-Q. 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-K for the year ended October 31, 2020, and HP's other SEC filings. During the 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 Enrique.

Thank you, Beth, and thank you, everyone, for joining. Let me first say that I hope you and your families are healthy and safe. Our thoughts are with all of those affected by this global pandemic. I especially want to thank all the frontline workers who are showing incredible courage. I speak for all of HP when I say we are grateful for all they are doing. The world has dramatically changed since our call in February, and we have a lot to cover today. I will start with a brief update on how HP is responding to COVID-19. I will then discuss the near-term impact from the pandemic and our Q2 performance. And I will provide updates on our strategy and our previously announced value plan. Steve will then take you through the details of the quarter and provide updates on our balance sheet, liquidity and outlook before we open the lines for Q&A. So let me start with our response to the pandemic. We like to say that tough times are when HP's culture shines brightest, and that's exactly what we have seen in recent months. I am proud of the way our teams have stepped up to support our partners, customers and communities. Our top priority has been and will remain the health and safety of our employees. From the start, we quickly pivoted the vast majority of our people to work from home. For those in manufacturing, another critical function that cannot work remotely, we implemented social distancing along with additional safety and cleaning protocols. And as significantly, we have taken meaningful actions to remain close to our customers and partners. Specifically, we have implemented a variety of relief initiatives to help them navigate their operational and financial challenges. We believe this investment will further strengthen…

Thanks, Enrique. As Enrique described, we've experienced significant changes since our last earnings call. This is creating both challenges and opportunities across our businesses and geographies. Importantly, as we have seen over history, we believe the strong can become stronger in the years ahead, and therefore, we are not standing still. This requires leadership and agility coupled with strong execution and leveraging HP's foundational strengths, including our geographic breadth and scale, portfolio and customer segment diversity from the office through the home as well as our balance sheet and strong liquidity position. We have multiple levers of value creation in the company both in the short term and long term to adapt and manage the ups and downs in our business. Now let's look at the details of the second quarter. Net revenue was $12.5 billion, down 11% year-on-year or down 10% in constant currency. Regionally, in constant currency, EMEA declined 7%, Americas declined 10% and APJ declined 16%. Gross margin was 20%, up 60 basis points year-on-year driven primarily by disciplined execution and improved rate in Personal Systems. Non-GAAP operating expenses were $1.6 billion, down $136 million sequentially and $138 million year-over-year. We are seeing tangible structural cost savings achieved through our transformation program as well as the benefits of additional temporary discretionary cost actions taken in response to current economic headwinds. Non-GAAP net OI&E expense was $57 million for the quarter. We delivered non-GAAP diluted net earnings per share of $0.51 with a diluted share count of approximately 1.4 billion shares. Non-GAAP diluted net earnings per share excludes a net benefit totaling $23 million related to nonoperating retirement-related credits and other tax adjustments, partially offset by amortization of intangible assets and restructuring and other charges. As a result, Q2 GAAP diluted net earnings per share was $0.53. Before…

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

Enrique, when you rolled out the shift in printer strategy back in October, you said that you would take in market feedback, which may cause you to either slow or accelerate the rollout of that strategy and the geographic expansion. How has COVID impacted the pace at which you look to shift the Printing strategy particularly given there is some discussion around more of a structural shift away from the office and towards working in the home? And then I have a follow-up.

Sure. Thank you, Katy. So actually, what we have learned in the last week has been very encouraging in terms of the changes or the evolution of the business model that we were driving in print. As we mentioned during the prepared remarks, we have seen a significant increase in adoption of subscriptions, which is a key part of the evolution. And this means that really supports the rest of the changes that we are going to be driving. As we announced almost a year now or 9 months ago, we will be launching the first products with a new model this fall and we are on track to make that happen. And as we said in February, the feedback we are getting from customers has been very positive, and we have been sharing that now with a significant number of retailers all over the world.

And just to add to that from a contractual perspective, what we've started to hear from customers is because HP plays so prevalently in both the home and office -- and that's not just from a product perspective but that's from a services perspective, it's from a delivery perspective of how we can uniquely leverage our Managed Print Services offering with our Instant Ink offering to provide that sort of seamless transition from the home to the office with customers' employee base.

Yes. That's a very important comment. We have been having lots of conversations lately with customers on what do they need to do to enable their employees to work from home. They ask for PC, they ask for accessories, and they ask for the ability to be able to -- for their employees to print, and this is a unique advantage that we have.

Interesting. Steve, just as a follow-up, can you talk about what the makeup of inventory looked like at the end of the quarter, sort of PCs versus printers and component inventory versus finished goods? Which of those categories drove the increase? And then when should we expect to see inventory fall materially?

Yes. I mean our inventory both in terms of dollars as well as days obviously peaked here in Q2, coming from a lower base in Q1. It was driven heavily by the build in the Personal Systems space. That was really 2 factors. The largest factor was, as expected, the back-end-loaded linearity of the quarter. With the China factory shutdown early in the quarter as we headed to the back half, it just, by math, sort of creates a higher inventory in the back half of the quarter as well as all the in-transit. We did pursue some level of strategic buying on the Personal Systems side also in the quarter to set ourselves up for the second half. Looking forward, I would say that we are anticipating some level of higher inventory than what we traditionally held not to the levels that we are at today. And that's really more of a function of, in the short term, pursuing some resiliency particularly around ink or other products that we want to hold a higher balance with. We also did a pretty effective job around channel inventory and I said that broadly across hardware and supplies. While there's pockets clearly where we had to slow sell-in in the quarter as we reflect in our channel inventory levels, broadly speaking, we remain with a lot of discipline throughout the quarter on CI.

Our next question comes from Amit Daryanani with Evercore.

I guess first off, Enrique or Steve, I just want to go back to the capital allocation discussion. If I got this correctly, the commitment is to return over 100% of free cash flow for this year and then 100% for fiscal '21, but you're going to pause on the outsized buyback program that was part of that $16 billion capital return program. I want to make sure I got that right. And what makes you un-pause this? What are the guideposts? What are you going to look for to go back to that outsized buyback program you talked about 90 days ago?

Why don't I take that and I'll repeat a little bit and maybe add maybe a bit more context or color to the prepared remarks. But I think at the macro level, the principles of the value plan remain in place, and that includes how we manage the balance sheet, our target leverage, the 1.5 to 2x, the importance of investment-grade credit rating. Also, over time, we do see the opportunity to lower the cash on hand. That being said, in the short term, we think having a higher cash balance is prudent to ensure we can work through any economic cycle. We also see from a principal perspective the opportunity to drive free cash flow into the future, and we believe we're undervalued. So I take all of those in consideration. And then specifically in this current COVID-19 situation, there is just a high level of uncertainty. And we believe being prudent with our approach is the most important thing and therefore expect to be operating at the lower end of our leverage ratio and then get higher cash on hand. And navigating the business is our top priority. And then as it relates to the actual return of capital, once we get through the different economic impacts from the pandemic, we're going to update you on the specifics. In the meantime, we do plan to be active, returning at least 100% in this fiscal '20 year. For '21 and beyond, we remain committed to the 100% of free cash flow unless there's a better returns-based opportunity. But I think the fundamental point is when we outlined those principles of how we want to manage a balance sheet, how that would ultimately free up excess cash and how we see the use of that excess cash to return it to shareholders all remains, but we really need to manage through this current situation. And clearly, as we look at the months and quarters ahead, we'll be looking at our business in the market in general. There's things that are in our control, but more importantly, we're probably looking at things outside of our control at the pace of folks moving back into the office and other social and health indicators of making sure we're getting through the situation.

Perfect. That's really helpful. And if I could just follow up. You guys talked about, I think, elevated backlog on Personal Systems very specifically, but is there a way to think about how big was this backlog and how long does it take to clear up? And I assume this is all about Personal Systems and not supplies, but just any dimensions and time line to clear the backlog that you just talked about?

So Amit, I'll go first. So I won't size the specific backlog. What I'll say -- I'll make a couple of points. So first being we've had, from a historical perspective, the several quarters of high backlog just given the CPU constraints. What I'd say in the current state, the backlog has been even higher than what we've seen in prior quarters. Moreover, just from a linearity perspective -- and I mentioned this in my prepared remarks but it's a really important statistic, and that is we had 50% of our revenue in Personal Systems achieved in month 3 in April. That's historically high levels. And so as we saw the quarter progress clearly in the first month and 2, we were constrained by supply even though the demand was there. And then month 3, with the supply started coming more robustly online, we have a demand to go fill, but it really created a very high backlog situation by the end of the quarter particularly in notebooks.

And what is even more important is not only what is the operational situation, it is what is our confidence about the business, what we have learned during the last weeks are that PCs have become even more essential than they were before for people working from home, for students learning from home, from kids playing from home. And our confidence in the medium and long-term for the business has yet increased. And whether it's for PCs, for accessories, we clearly see a very strong opportunity in this category.

Our next question comes from Toni Sacconaghi with Bernstein.

Yes. I just wanted to follow up on the PC commentary. So if you're seeing strong demand and you have backlog to fill, should we be expecting PC revenues to be up more than what they typically are in Q3 sequentially? So sequentially, you're typically up high single digits or double digits. I guess given all your commentary, that would suggest to me -- and given that you have a high level of inventory, that would suggest to me that you should be able to grow PCs on a sequential basis higher than that high single-digit seasonal pattern you typically see. Is that a fair interpretation? And if not, why? And I have a follow-up, please.

So when we look at our Q3 expectations around Personal Systems, I won't specifically guide revenue. I will say that we do see the opportunity to grow above normal sequential. I think there's a lot of different periods, but I think if you look back in -- over multiple periods that we see the opportunity to provide upside on a normal sequential growth. That being said, we continue to monitor to make sure we've got the supply to fulfill all that demand. And while all the factories in general are -- have been back up and running, given that much of this demand is coming from notebooks and given the reliance on various component suppliers in the geographies in which they operate, it's important that we continue to monitor the situation. But from a demand perspective, we're definitely seeing demand to perform above normal sequential.

Okay. And then I just wanted to follow up on the value creation plan. So I get the level of uncertainty. I think what you've been asked sort of 2 or 3 times in various forms this question. But let's say that this year is a tough year, obviously it's going to be a tough year, and you want to conserve cash. Let's say fiscal '21 goes back essentially to normal free cash flow generation levels, can we then assume that through fiscal '23, we should expect that you would buy back $13 billion worth of stock, which is what the announced plan, so the timing would get pushed out 1 year that you would buy back $13 billion worth of stock? And I guess the question would be why not. You announced this plan when the stock was at $23. It's now $16 and change, and so the proverbial expression of, if you liked it at $23, you must love it at $16 and change. So is that essentially what you're saying? Things are slowed down but you're committed to that magnitude over time. It's just going to be pushed out. So we should be thinking that order of magnitude, $13 billion through 2023, let's say, assuming the economy comes back to something close to normal in fiscal 2021.

So this is how we're thinking about it. Again, the principles remain. And from a framework perspective, there's really 3 drivers, first of which is the leverage we take on. And while, in the current state, we expect to be at the lower end, certainly in a more steady state, we have comfort moving up in the range and taking on greater leverage and therefore bringing up cash. The second is our cash on hand, we finished with $4.1 billion of cash on hand. Again, in a steady state where we don't need to necessarily manage through such severe economic changes in the short term, we can lower the cash on hand, and that would also free up capital. And then the third is the free cash flow generation. And again, I guess to your question, as we begin to stabilize and the market begins to stabilize, we do have confidence in the multiple levers we have to drive cash flow. And as we get more visibility into that free cash flow projection, that clearly provides even further opportunity. We'll take all those into account to then determine the actual size and deployment of what the enhanced return of capital program could look like, but that's kind of how we're thinking about it.

Our next question comes from Shannon Cross at Cross Research.

I was curious what you've seen and heard from your customers recently as some of the countries in Europe have started to open up and then obviously some of the states, both on the Printing and the PC side, and if you've seen some improvement in terms of demand and flow-through. And I have a follow-up.

Sure. We -- this is something that we are monitoring very, very closely, as you can imagine, Shannon. What we have seen, for example in China where the recovery started earlier, is a fairly steady recovery both of demand but especially of usage of printing from the office and also in graphics. 10 weeks after probably the worst week of the pandemic, we are still not at the levels where we used to be but we continue to see steady progress. We have also seen some improvement in some of the countries in Europe where the crisis started earlier. We have seen that in Italy, starting to see it in Spain, but are very, let's say, small moves. We think during the next weeks, we'll start seeing more activity. We will see a similar pattern to what we have seen happening in China.

Okay. And then I kind of hate to ask this just because of what you went through with Xerox but I'm curious. The printing industry is obviously under both COVID as well as secular pressures in various places. How are you thinking about consolidation? I mean is this something that makes sense for you to be involved in? Or does it make more sense for share repurchase and perhaps looking at adjacencies or other areas where there's growth, like 3D printing? And I'm not indicating you're going to buy a 3D printing company but just in terms of technology.

Sure. So at this point, Shannon, our focus is on executing our plan. This is where it was 8 weeks ago when -- before the crisis started, and it is even more important now given the overall environment. We had declared and we continue to believe that in the office space, consolidation is a value-creation activity. But really, we think that now, what we need to do is stay focused on our business and continue to drive it forward. We are also monitoring other M&A opportunity not only on the core businesses but also on the growth side that we think, because of the crisis, might be available to us. But again, our focus is on execution of our plan.

Our next question comes from Paul Coster with JPMorgan.

You're obviously tremendously successful in branding the value creation plan, and so we want to talk about it and we're all getting our naming conventions right as well. But if I understand this correctly, it's the leverage that is the compromise you've made in the context of what's going on here. It's not on the expense containment program and the severance and restructuring charges associated with that. Or am I wrong?

Yes. I mean if we sort of break down the various components of the value plan, there's the sort of return of capital, which I think we've discussed already on the call. And yes, that, to a large extent, is on managing through this situation with the right level of leveraging and cash on hand. As it relates to the other components of the value plan and specifically on our ability to drive operating profit dollars and free cash flow into the future, one of the primary mechanisms was the flow-through associated with our transformation program. And that transformation program called out for a $1.2 billion gross cost savings in FY '22 with $650 million of it dropping to the bottom line. As we sit here today, we have high confidence in the restructuring and cost takeout program and the structural reductions. In fact, we will continue to look for more opportunities, such as real estate and other activities. So we do remain committed to that. We also will continue to explore other discretionary cost takeouts. Certainly, in the current period, we have taken actions that Enrique highlighted across the company with certain salary reductions and such that we think is the right thing to do. And we're going to accelerate as much of that transformation earlier rather than later given we've got the opportunity to do so with the COVID-19 situation. So the short of it is, is we remain committed to the cost reductions that we have previously committed to.

Let me emphasize this point because I think it's important. In terms of the financial goals of the value plan, we are -- we stay fully committed to those, both the profit that the businesses will create and also the flow-through that the transformation activities are going to create. There might be some timing impact given the current situation and given that 2020 is going to be a challenging year, but we see both upside, downside. It is, for us, too early to restate what is the timing of the plan, but we are fully committed to the financial goals that we shared and that we published in February.

And maybe this is a technical question. I understand that you do not intend to do the accelerated buyback using debt. But did you get authorization from the Board to proceed with that expanded buyback program? And have you the discretion to execute should circumstances magically improve all of a sudden?

So as part of what we announced in February, we also announced that the Board did approve an authorization in total of $15 billion of share repurchase for the company. So there's plenty of authorization to pursue an enhanced repurchase program.

Our final question today comes from Jeriel Ong with Deutsche Bank.

Awesome. So I just have a question on the guidance. It seems like the guidance for the EPS at the midpoint is about 20% lower quarter-on-quarter. Now I kind of juxtaposed this against your revenue. July has -- at least in the last 4 or 5 years, has averaged about a 4% quarter-on-quarter growth. Kind of seasonally, July is better than April. So I'm just trying to understand, is the guidance for EPS conservative? Or do you expect revenue as well to be significantly below seasonal and perhaps even down significantly quarter-on-quarter?

Yes. So why don't I kind of walk through some of the assumptions. I think maybe stating the obvious but it does remain a highly dynamic situation across both supply and demand. That's why we have a little broader range than we typically would for a quarter. That being said, I think it's important for us to be as transparent around the dynamics that we're seeing. And specific to Q3, the dynamics are different by segment and even different by categories within segments. So the assumptions are important. In Personal Systems, I already commented on the expectation for strong demand entering the quarter with high backlog. Therefore, we would expect to see positive sequential -- sort of above normal sequential growth as well as good year-over-year growth, assuming that we are supply-enabled. The overall basket of supply chain and logistics cost, we do anticipate to go up quarter-over-quarter driven by logistics costs. And then we're closely monitoring the shift in our unit mix and, in particular, the demand around notebooks and the work from home and learn from home, including the demand on the Chromebook side. For print -- and this is really the substance, I think, of the Q3 guide to your question. We are anticipating that commercial print will remain challenged across both the office and industrial businesses. And this is a market-wide comment. We saw the negative impact beginning in March and more definitively in April as offices closed. Unlike Personal Systems where we saw a very back-end-loaded quarter for print, we saw just a bit over 1/4 of the business in month 3 given the slowdown in demand and our discipline on pulling back on revenue on the commercial side. As a result, we do expect a larger impact in Q3 across both hardware and supplies. And that's really the driver. And beyond the COVID-19 situation, we do expect to continue taking cost out of the business. But when you add it all up, what we see today is between $0.39 to $0.45. Clearly, we're going to be driving the business based upon the respective dynamics that we see, including where we can get supply. But the largest driver of the sequential decline is really that we've got more months in quarter 3 to deal with from COVID-19 than we did in quarter 2.

And the key thing is that we see this impact as temporary, yes. So you know we shared some of these data before. For example, in Managed Print Services, we saw a decline of pages printed of about 40% year-on-year. It's a significant decline as people were not in the office and there were not pages printed in the office. We saw a significant impact in graphics. We went from growing about 9% in Indigo pages in February to decline more than 20% in April. Again, these are temporary impacts. As economy will recover, we will go back to a more normal position. But when we look at the impact in Q3, as Steve just said, we expect 2.5 months, 3 months of bad performance in these categories versus about 1 month.

Got it. Appreciate that. And as a follow-up, just kind of the longer-term question, it seems like every quarter, my model, I just -- operating margins on Personal Systems side just keeps marching up. It's 6, 7 almost quarters, almost 2 years now that that's marched up and now above your range. And then conversely, print, I understand the latest quarter in particular is a little bit different but in general kind of a downward trend now that the mix is 50-50, right? And when, historically, Personal Systems is probably closer to maybe 1/3 if not 1/4 of the profit mix between the 2 segments, at what point do you think it's structural? Or do you think that at some point, you get back to that historical range, whereby Personal Systems is that 1/3 versus print, that 2/3 mix? Or do you think it takes a long time, it's going to happen in short order? Or do you think we're kind of seeing a new norm here?

Well, I guess we don't manage our business to try to solve for a respective mix. I think we're very pleased with the results from our Personal Systems business, and it's sort of by the end math that represents half of the company's profit. But to your question, we have been driving very good margins both from a rate, but more importantly, we've been driving very strong operating profit dollar growth in that business and certainly see the opportunities to continue executing in the higher end of that long-term range, which bodes well for a category where the PC has become even more essential. On print, I would say that Q2 in our -- embedded in our outlook in Q3 are really temporary challenges in the print margin structure. We're dealing with larger supplies revenue declines driven by commercial as well as commercial hardware declines. But once the market begins to recover and workers go back to the office, we would anticipate that those margins would normalize back into that 16% to 18%. And then longer term, as we drive our strategy to drive more profitable customers, to drive a higher mix of contractual, to further penetrate the developing markets with our big tank offerings, these should be margin-accretive opportunities for us in addition to the cost takeouts that we're driving.

Let me take now the opportunity to close the session. As always, thank you for joining and thank you for your questions. I wanted to end up by saying that we firmly believe that HP is very well positioned for the future. Most companies are facing challenges right now, but the best companies are those that have not simply weathered the storm, they are taking advantage of the opportunities that we see and transform their company. And this is exactly what HP is going to be doing. We have many strengths, a very strong balance sheet, a diverse portfolio, very disciplined cost management. And several of the trends that we have seen during the last week are going to help us to make our brand even more relevant, even more essential for our customers. Our focus stays in executing our plan and continue to drive value for our customers. Thank you, and stay safe.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.