Good day, everyone, and welcome to the First Quarter 2023 HP Inc. Earnings Conference Call. My name is Lisa, and I will 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 Orit Keinan-Nahon, Head of Investor Relations. Please go ahead.

Good afternoon, everyone, and welcome to HP's First Quarter 2023 Earnings Conference Call. With me today are Enrique Lores, HP's President and Chief Executive Officer; and Marie Myers, HP's Chief Financial Officer. Before handing the call over to Enrique, let me remind you that this call is a webcast and a replay will be 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 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. 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, 2023, 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. In addition, unless otherwise noted, references to HP channel inventory refer to Tier 1 channel inventory. 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 accompanies today's earnings release for those reconciliations. With that, I'd now like to turn the call over to Enrique.

Thank you, Orit, and thank you to everyone for joining today. Since our Q4 call last November, the macro volatility we described has continued. Our approach remains consistent. We are taking decisive actions to improve our performance while continuing to invest in long-term growth. By doing what we said we would do, we delivered on our Q1 EPS guidance. And we are reaffirming our full year outlook. Today, I'm going to focus my comments on 3 areas: I will begin by summarizing our results and progress against our future ready plan. I will then cover our business unit performance. And I will conclude with our outlook before handing the call to Marie. Starting with our results. Net revenue was $13.8 billion in the quarter. That's down 19% nominally and 15% in constant currency. This reflects industry-wide headwinds including corporate budget tightening that has started to impact large enterprise demand. Despite this top line pressure, we delivered non-GAAP EPS of $0.75. This is in line with our previously provided outlook, and it reflects the actions we are taking on cost as well as disciplined execution on pricing and mix. The future ready plan we shared with you last quarter is already having an impact. As a reminder, the plan has 2 primary objectives. One is to further reduce our cost structure. The second is to continue to assess and optimize our overall portfolio and to develop a required operational capabilities to deliver long-term sustainable growth. We are making clear progress in both areas. In terms of costs, our teams have done an excellent job reducing spend and driving efficiencies. We delivered on our Q1 cost target, and we are on track to deliver at least 40% of our 3-year savings by the end of fiscal year '23. This is allowing us…

Thank you, and good afternoon, everyone. As Enrique said, we continue to focus on what we can control and deliver on the commitments we have made. In Q1, we remain disciplined in rigorously managing our costs and investing strategically while delivering on our outlook. However, our results were impacted by ongoing soft demand. Macroeconomic challenges persisted and corporate budget tightening began to affect large enterprise demand this quarter. We are adapting quickly to the current environment but see continued opportunity to drive further improvement in our cost structure and operational execution. Let me give you a closer look at the details. Net revenue was $13.8 billion in the quarter, down 19% nominally and 15% in constant currency, driven by the declines across each of our regions. In constant currency, Americas declined 16%, EMEA declined 15%, and APJ declined 13%. Gross margin was 20.3% in the quarter, up 0.4 points year-on-year, primarily due to improved commodities and favorable print mix, partially offset by competitive pricing, including currency. Non-GAAP operating expenses were $1.7 billion or 12.5% of revenue. The decrease in operating expenses was driven primarily by lower variable compensation, rigorous cost management and favorable currency impacts, partially offset by the Poly acquisition. Non-GAAP operating profit was $1.1 billion, down 28.3%. Non-GAAP net OI&E expense was $183 million, up primarily due to higher interest expense driven by an increase in both debt outstanding and interest rates. Non-GAAP diluted net earnings per share decreased $0.35 or 32% to $0.75, with a diluted share count of approximately 1 billion shares. Non-GAAP diluted net earnings per share excludes a net expense totaling $262 million, primarily related to restructuring and other charges, amortization of intangibles, acquisition and divestiture-related charges, debt extinguishment costs and other tax adjustments, partially offset by nonoperating retirement-related credits. As a result, Q1…

[Operator Instructions] Our first question comes from Shannon Cross with Credit Suisse.

Can you talk a bit about what's going on in terms of PCs with regard to end demand? And I think you're not alone in saying that second half of '23 should be better because inventory levels will normalize. But I'm wondering where you're seeing pockets of strength, what you're hearing, how you're thinking about discounting or what features are kind of going to drive an improvement as we get to the second half? And then I have a follow-up.

Sure. Thank you, Shannon. Let me take the question. So first of all, something that has not changed this quarter is the weakness that we have seen in the consumer space that we started to talk a couple of quarters ago. Something new, though, has been as we shared in the script, that we have seen weakening demand on the corporate enterprise space as we have seen especially large companies becoming more conscious about how they use their budget being slowly hiring people, and this has had an impact in the PC side. On the positive side, we have seen reductions of inventory especially that one that addresses consumer and SMB business, the more transactional side of the business, which reflects that end-user demand has been stronger than shipments. Our current view is that we will be getting to a normalized channel inventory situation by the end of Q2, early Q3, which means that in the second half, we will not have this headwind, and this is one of the reasons why we are optimistic about the evolution of the PC business during the year. We think that demand will evolve similar to previous seasonality before COVID, and this is one of the reasons why we expect our second half to be stronger than the first half.

Okay. And then, Marie, can you talk about working capital and how we should think about it as we go through the year? I understand factoring helped receivables this quarter. I don't know if that's sort of an immediate bounce back or a reversal. And then just in general, maybe where you think we can end the year in terms of inventory in that given some of the prebuys versus ability to work through what you have?

Shannon, so maybe it's a good time for me just to start out first with how I think about inventory and DOI sort of going forward. I mean look, candidly, we need to be good at doing both operationally and excellent actually and driving value where we see opportunities. So as you've seen, we've been very focused on driving up our inventory turns. And when we see economic value, we will pursue strategic buys, right, and look for lower-cost modes of transport. But let me sort of hit up specifically your question around Q1. And what we saw is that inventory turns declined but not necessarily in line with all our business volumes, and that was really largely a result, Shannon, of the strategic buys that we did in the quarter. So we want to remain open to evaluate those economic opportunities, both for strategic buys and frankly, for lower-cost modes of transport throughout the year.

We'll take our next question from Erik Woodring with Morgan Stanley.

Marie, maybe this one is for you. You obviously just guided the PC market a little weaker than you communicated 3 months ago. I think of that as a headwind to cash just given the strong negative cash conversion cycle. At the same time, as you just alluded to, your inventory is still at relatively elevated levels and 1Q free cash flow was negative with a tailwind from factoring. And so I guess my question is really just what gives you confidence in maintaining the full year free cash flow guide? What is it you see in the data? What are some of the specific factors that you think ultimately get you back or get you into that range for the full year? And then I have a follow-up.

So in terms of how we look at cash for the year, I'd say, first out, our free cash flow for Q1 was absolutely in line with what we expected. And plus, if you look at the earnings outlook that I gave in the guide for the rest of the year. It's absolutely in line with what we guided last quarter. So really, it is the combination of both that give me confidence in our guide of 3% to 3.5% for the year. A couple of other points of note to pivot off what Enrique said early about seasonality. Now we do expect cash flow to sort of line up with the seasonality comments that Enrique made earlier. So we expect it to be better and materially stronger in the second half of the year. With that said we do expect cash flow in Q2, therefore, to be roughly in line with Q1. And just remember, in the second half of the year, PS revenue will grow on the top line. And as you know, that PS contributes cash when it grows sequentially because of its negative cash conversion cycle. Another source of cash just to hit on it. I know Shannon brought up that point a moment ago, another sort is obviously continued inventory reductions. And actually this quarter, we did reduce inventory. So both of those, I think, are just really good examples of how we think about cash flow for the year.

Okay. That's really helpful. And then maybe my second question is just on print operating margins. Another really strong quarter. That's 5 consecutive quarters above your 16% to 18% target range. Do you expect to be above that range for the full year? So are we entering a new paradigm maybe where print operating margins are going to be above that long-term range? Or are there other factors that you expected to become offset such that longer term, we should think about print operating margins more within that 16% range?

Yes. Erik, maybe I'll take a shot at that one. So as we've guided, we do expect print margins to be above the high end of the range going forward, at least for '23. And really, it's a tale of what you saw in Q1. The Print margins are really driven by, I think, our strategy working. And you see that, I think, in a couple of dimensions, both in terms of rebalancing the profitability between hardware and supplies, also just shifting the business into HP+, big tanks. In fact, if you look at the last quarter, more than 50% -- 56% of the units shipped were in that HP+ and big tank. The other point to note is just execution. I think if you look at what we did in this last quarter, it's a really good example of where you're seeing the actions both around future-ready cost cutting, expense management are all showing up, combined with resilient pricing. All those factors are contributing to the robust margins. So what we saw in Q1, Erik, is really what we expect to see for the rest of the year in Print.

Let me add that we are pleased both with the strategic progress we have made at executing the strategies that we defined 3 years ago but also taking advantage and getting the benefit from all the work on cost that we did during the last 3 years and that we are continuing to do now.

We'll take our next question from Ananda Baruah with Loop Capital.

Really appreciate it. I may have missed it Enrique and Marie, but did you mention of the growth business category what percentage of revenue those are now? And what's the growth profile was for the quarter? And then I have a follow-up as well.

Sure. Let me -- thank you for the question because this is something that we wanted to clarify. We mentioned briefly on the script, but we wanted to provide more details. So during this quarter, we have made some changes in the definition of the growth categories because we wanted to align better how we talk about them externally to some of the internal changes we have made. By growth categories, we really are referring to the 6 businesses that we think are going to be growing faster than the core business and that we're going to have accretive margins compared to core. Something common, they have a common strategic intent, which is really to create more value for our customers by focusing on the long-term relationship with those customers. And this is behind the expansion into services, subscriptions and many of these businesses. During the last quarter, we made 2 internal changes: one is we created a focused organization to [indiscernible] after Workforce Solutions and Services. And we defined the goal of that team to drive and to grow service-driven opportunities. We also have just created a consumers subscriptions team that will be driving that opportunity across the company starting from the work that we have done on Instant Ink and expanding now and during the next quarter to the rest of HP portfolio. And we also decided to align the HyperX business with our gaming PC team. So we have one group that is really responsible for the full experience for gamers. As we went through all these changes, we realign also how we externally will be reporting those especially in the Workforce Solutions & Services, since we are really focused now on service-enabled businesses.

And Enrique -- I'll keep it here Enrique. Is that to say that you'll no longer be providing us a sense of kind of the old grouping, what the percentage of revenue is and what the growth rates of that old grouping was? And then I have just a quick clarification after that, too.

No, we will continue to do that. I was just highlighting the changes because, for example, as we have done that, the overall size of Workforce Solutions is going to be smaller than what it was because we have redesigned, redefined the business. This is what I was highlighting. Every quarter, we will provide visibility as we have done over the last quarter of the growth of the different businesses, you see that on the deck. And every year, we will be reporting the total size as we have done in the past, Ananda.

And they did grow double digit collectively in the quarter as well and other just to answer part of your question.

And then my quick follow-up is, Enrique, you mentioned in the prepared remarks and you just mentioned a moment ago, shifting the HP portfolio towards subscription. Is that to say the entirety of the HP portfolio, you guys have an eye on moving towards the subscription model? I just want to make sure I understand the context of those remarks.

So this is something that we shared already in our Investor Day a couple of years ago, so it's not new. But we see an opportunity to better serve our customers by expanding our subscription business from supplies to eventually other parts of the portfolio, our long-term direction is to enable a large part of the HP portfolio, but this is a journey that is going to take multiple quarters. You will see us making progress in the next quarters. We are now included paper. We will be including some of our PCs and printers in the coming quarters. And over time, we will continue to expand the offering.

We'll take our next question from David Vogt with UBS.

Maybe just a question for both Enrique and Marie. When I think about your comments about how the TAM develops in fiscal '23, if I extrapolate what you've done in the past pre-COVID it would suggest that by, let's say, by fiscal Q4, your PC segment could be basically flat on a year-over-year basis. Is that the right way to think about the business as it sort of plays out over the next couple of quarters? And then I have a follow-up.

Yes. Maybe I can sort of talk to just the PC outlook and how to think about the guide. So obviously, a big part of this is, I think what Enrique said earlier around the channel inventory. We do expect that, that channel inventory will get cleaned up through the course of Q2 and then into Q3. And I think Enrique mentioned that some of that pressure that we're seeing in the corporate enterprise space. And I think this is largely in line with what the industry is assuming. So at this point, if you look at the midpoint of our guide, we're not expecting any type of macro recovery. But if you sort of group all this together, what we're expecting is we're going to see better PS revenue in the back half as that channel sort of corrects and cleans up.

Okay. And then maybe just as a follow-up. If I think about the profitability of PC for the full year, and I kind of extrapolate your comments on revenue in the back half. that would suggest that in the second half of the year, just round numbers, quarterly profitability per quarter is going to have to be north of $0.90 per share. You're basically flattish with last year. Do you expect -- is that the kind of -- if I just kind of take the midpoint of your full year guide, is that the kind of leverage you would expect to get as the cost cuts start to flow in more in the July and October quarter from sort of where we are in the April quarter?

Yes. So that ties very much to the comments I made earlier around the channel but also just combined with the fact that we do expect, I think I said in my prepared remarks, to see ourselves in the lower half of the range in Q2 as we go through that channel correction. Then as we get into the back half, we're going to see the margin rates lift back up to be fully in the range. And so it's a combination of the channel plus we've got the impact of our future-ready efforts. We've already seen some of that impact play out here in Q1. We expect those actions to continue to take a stronger hold throughout the year. So expect to see some of that in the rates as well. And then I would add another factor which did help and contribute actually to the margin in Q1, and that was the mix inside the PS business. So remember, we have now a full quarter of Poly in our numbers and that overall mix shift is also a driver and contributing to the overall margin structure as well.

Yes. Maybe let me add a comment on TAM that I think will help to understand these numbers from Marie. As you were saying from a unit perspective, we expect the TAM of the year to be flattish compared to what it was in 2019, but we expect it to be higher from a revenue perspective because of the change of mix that Marie was explaining. So from a revenue perspective, this has an impact on total TAM, and it will also have an impact on our performance.

We'll take our next question from Toni Sacconaghi with Bernstein.

Yes. Thank you. I have 2 as well. Perhaps you can just give us an update on how much progress and savings were realized in Q1 and specifically, it looks like SG&A went up considerably sequentially, even though revenues were down. And I thought you had 2 months of Poly last quarter, so there's some incremental Poly, but maybe you can just reconcile what happened with SG&A on a sequential basis? And then how much of the progress towards 40% of the savings do you feel you captured in Q1? And I have a follow-up, please.

It's Marie. So maybe I will just hit up quickly SG&A, what drove that increase sequentially. So primarily, Toni, that was due to the increase in incentive comp and stock comp. So you might recall that Q1 is a normal quarter for our annual equity grants for employees. So that's what you've seen there relative to what drove that increase. And then with respect to the transformation savings, I would say that we're off to a very strong start. And in fact, these savings contributed to the overall results in the quarter. And you saw that obviously in the evidence and the strength of the margins in both PS and print. And I would say, look, we are absolutely confident we're on track for the plan for the year. And we're continuing to work that funnel put more into the funnel. So at this point in time, I'd say we're absolutely committed to delivering at least that $560 million of gross structural run rate savings by the end of this fiscal year.

And we -- and Toni, we have work going across all the areas that we described last quarter from portfolio simplification, removing some elements of the portfolio, simplifying them making our processes more efficient using some digital tools, looking for efficiencies across the board. So I think we have a full program across the company driving that, and we are making very good progress.

And just to reiterate, Toni, they're in both cost of sales and OpEx. Just so [indiscernible]

Right. And if I could follow up just on cash flow. So if I think just really high level, midpoint of your guidance sort of points to about $3.3 billion in net income. You have $400 million in restructuring costs that would take you down to $2.9 million, adjusting just for that. And then you have a negative mix shift in terms of PCs growing slower than the overall company in all likelihood per your guidance. So that would also hurt free cash flow. So if I just look at those 3 structural things, you're actually looking below $3 billion. So are you -- what's the bridge to get to above $3 billion? Are you counting on meaningful working capital improvements? Because you did condition that you still might do strategic guides or there may be other reasons why perhaps you may not be able to bring down inventory. So perhaps starting with my bridge, you can tell me what's missing and how we can get comfortable with $3 billion to $3.5 billion?

Sure, Toni. So I think just to reiterate what I did say earlier that both the Q1 numbers and the earnings guide that we gave last quarter, we're absolutely committed to those yet again. I think that's just another point to note. But to build off your bridge, so one additional point that you pointed out just around working capital. So we did actually reduce our owned inventory in the quarter from -- by about $300 million. We do intend to continue to have reductions of owned inventory throughout the year. So obviously, we'll be managing those, pending any economic opportunities for strategic buys, as I said earlier. The other important point to think about is the -- we talked about -- a bit about this during the call, it's just that second half improvement that we're expecting in Personal Systems revenue. As you know, PS contributes cash when it grows sequentially, and that's because it has that negative cash conversion cycle. So there are just 2 incremental points to help you sort of model out the cash flow for the year.

And then just one clarification. The improvement in inventory that Marie mentioned is net of the strategic buys that we already did this quarter. So we already did some in Q1.

We'll take our next question from Sidney Ho with Deutsche Bank.

My first question is on the print side. It does look like the supply is a little better than you expected and you also slightly upticked the guidance for Q2. Just curious what the dynamics that you're seeing there? And do you think the overall business for Print has reached a bottom in Q1, considering supplies are starting to improve and commercial constraints are starting to ease as well. And then I have a follow-up.

Yes. So maybe I'll just answer your question on supply. So yes, you're right. We did actually see supplies perform better in Q1 and our guidance that -- I think the guidance we gave in our prepared remarks is that we expect it to decline by only high single digits in Q2. As we sort of think about the year, we do expect supplies revenue growth to be back to what we said at our Analyst Day so back in that sort of low to mid-single digit. Some of the sort of drivers of that, firstly, are really the strength that we're seeing around consumer usage and share trends. Plus I think I commented earlier, just around the pricing resiliency that we're seeing in print and specifically in supplies. And then finally, I'll just add because I know many of you asked this question, is just around the channel imagery. And if you look across our entire sort of multitiered ecosystem, supplies channel inventory is in very good shape.

And let me add one comment. And we have said that when results were below the expectations we had. And I will say now it also when we are above, looking at quarter-on-quarter comparison 1 year, is really not the best way to look at the health of the business. This is why Marie was saying, we continue to -- we maintain the guide that we had for the year for supplies. Year-on-year comparisons are much better. Small changes 1 quarter could have a big impact on the quarter-on-quarter compared so easily not the right way to look at the health of the business.

Great. That's helpful. A quick follow-up here is that if I look at the full year EPS guide being unchanged, obviously, but there is a lot of different moving parts. Partly, on the goods on the positive side, you've got foreign exchange being better, margins seems to be better. it sounds like on the negative side, there's some PC demand weaker than you expected. Just maybe if you can help us bridge the various components that get you back to the original guidance, that would be helpful.

Yes. Look, maybe I'll start out and say, look, the outlook, as you know, we've got a pretty broad range there. So it does contemplate multiple scenarios. And obviously, it's prudent. And as always, I think you see that from us. If we can do better, we absolutely will. So -- but a couple of drivers there. I'll just walk you through to kind of get you through the puts and takes on the guide. First and foremost, we've talked a bit about our cost actions today for future ready. We do expect that they're going to continue to yield quite positive results in the back half of the year. And as I said earlier with Toni, we're working that funnel to pull even more savings into FY '23. So that will be a contributor. We've talked about channel luminary contribution in terms of Personal Systems. Plus, we did get a chance to hit on today, just the continued improvement in supply chain. I think that's a very important point we didn't get much time to talk about. And then finally, just remember, at the midpoint, we don't expect a macro, but we're working multiple scenarios. So that's why we've got the range that we have on the guide this time.

We'll take our next question from Amit Daryanani with Evercore.

This is Lauren on for Amit. I just wanted to double-click into your views on the PC TAM beyond 2023. What kind of gives you the confidence in a structurally larger PC TAM versus some of the comments that IDC has made and some of the revisions they've made to their long-term forecast?

I think there are 2 big positive trends that I think is worth to highlight. Today, the installed base is significantly higher than what it was before. And therefore, at some point, these PCs need to be refreshed. So this gives us a positive tailwind for the business. Second, from a revenue perspective, as I said before, the way PCs are used today, the applications that are being used for drive better mix require -- require better configurations. And when we put both of them together, this gives us the opportunity of them to be bigger. Additional to that, we see the adjacencies around PCs like the hybrid opportunity in video conferencing systems, cameras that -- and we believe the hybrid work is here to stay. That's another incremental opportunity versus what we saw in 2019. And the shift to services, whether it's contractual services for businesses or subscriptions for consumers also gives us an opportunity of growing the business and growing the TAM.

We'll take our next question from Jim Suva with Citigroup.

Congratulations on the results and outlook. It's very impressive considered the macro outlook. Question, Enrique, I'm -- me and my family are a subscription on Instant Ink, and we love it. Your comments about shifting to subscriptions. Was that for all options of your various projects? Or was it you actually think the future sales actually strategically as you think everyone will probably be doing subscriptions only? The reason why I ask is I just think there might be kind of the view of potentially both of them helping out. But I just kind of wanted to see, I mean you said subscriptions for everything. How far down you're kind of thinking about for every single transaction sale? Or is it more of options based upon your clientele?

It will be more options depending on the clientele. We know that there are customers that will be willing to buy subscriptions and others that prefer not to. And of course, we will be offering both. But since you are a customer already of Instant Ink, let me do a small commercial, you should enroll now to the paper program because now you can get not only ink, but you can get only paper, which is an addition to the program. And over time, you will be able to buy the next printer and other type of services from us. So this is part of the road map that we have of expanding the portfolio of subscriptions that we shared in the past and that now is starting to become real.

Well, Enrique, you never know, you can keep an eye on my account. And then a question for Marie. Can you talk about your capital allocation plans? Because now Poly is integrated, it's a full year into your books. How should we be thinking about stock buyback, debt levels, investment, cash levels, where you feel comfortable in uses of capital?

Yes, no worries. I'd say nothing's changed. We continue to make the same capital allocation approach that we've used for the last sort of 3 years or so. But I would say one point, which I think you hit on there, would is that we are very focused on keeping our gross leverage under 2. And you would have seen in the quarter that we actually bought back only 100 million shares. So consistent with maintaining our leverage ratio, we don't anticipate buying back shares in Q2, but we do expect that we'll have room for share repurchases in the back half of the year. So I'd just like to kind of close and say, look, we're committed to staying within our target leverage range. For us, maintaining a strong balance sheet and an investment-grade credit rating is just critical to our business, Jim. I don't know, Enrique, if you have anything you want to add.

Yes. I would like to add like as our leverage ratio will allow us, we continue to believe that buying back shares is a great way to return value to our shareholders, and this is something that we plan to continue to do as we have done in the last years. And I think with that, this was the last question. So thank you, everybody, for joining. Thank you for spending time with us today. And maybe let me confirm some of the key messages that we have driven today. First of all, that even in a challenging environment, we have delivered on the commitments that we made a quarter ago based on the progress we have made in the areas that we can control whether it's costs, price, mix, growing share in profitable categories. We know that this is how we can manage where we need to focus and what we have been doing during the last quarter. And at the same time, we have maintained investment in the growth areas because we think that our goal continues to be to position HP in a strong way for whenever the economic recovery will happen. Thank you again for joining us today and looking forward to talk again in a quarter. Thank you.

And that does conclude today's presentation. Thank you for your participation, and you may now disconnect.