Good day, everyone, and welcome to the Second Quarter 2023 HP Inc. Earnings Conference Call. My name is Sarah and I'll be your conference moderator for today's call. At this time, all participants will be in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. 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 Second 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 one 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 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 accompanying 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, everyone, for joining the call today. When we began our fiscal year six months ago, we were clear about two things. We said we would focus on the things we can control to navigate a demand-constrained market in fiscal year '23. And we said we would continue driving progress against our long-term growth priorities. Halfway through the year, this is exactly what we have done. And I am pleased to say the actions we are taking as part of our future-ready plan have started to take hold. Because of this, we delivered non-GAAP EPS towards the high end of our guidance and we have built strong momentum for the second half of the year. Today, I'm going to discuss our Q2 results and the progress against our future ready plan. I will then provide color on our business unit performance and I will close with some insight into how we see the balance of the year before turning the call over to Marie. Starting with our results. Net revenue was $12.9 billion, that's down 22% or 18% in constant currency. As expected, the industry-wide headwinds we described last quarter continued to impact our business. Against this backdrop, our teams did an excellent job controlling our costs, managing our pricing and shifting our mix. This allowed us to deliver non-GAAP EPS of $0.80. We also grew non-GAAP EPS and operating profit quarter-over-quarter. And we delivered on our year-to-date cost target, keeping us on track to deliver at least 40% of our three-year savings by the end of fiscal year '23. A key part of our strategy is to reinvest savings into innovation. We are doing this in our core business and our key growth areas. We believe this is very important because even though both…

Thank you, and good afternoon, everyone. We delivered solid financial results in Q2 against the backdrop of a tough macroeconomic environment. We generated sequential growth in non-GAAP operating profit and margin, non-GAAP EPS and free cash flow. Non-GAAP EPS was at the high end of our guidance range, while free cash flow was better than we expected. We delivered these results by remaining focused on prudently managing costs and optimizing our cost structure further under our future-ready plan. At the same time, we prioritize strategic investments that will help drive future growth when the macro economy recovers. We remain focused on what we can control in the current environment, which enabled us to deliver on our commitments for Q2. Now let's take a closer look at the details of the quarter. Net revenue was $12.9 billion in the quarter, down 22% nominally and 18% in constant currency driven by the declines across each of our regions. In constant currency, Americas declined 21%, EMEA declined 22% and APJ declined 7%. Gross margin was 22.7% in the quarter, up 2.5 points year-on-year, primarily due to mix shift to Print and lower commodity costs in Personal Systems, partially offset by currency and competitive pricing, particularly in consumer print. Non-GAAP operating expenses were $1.8 billion or 14% of revenue. The decrease in operating expenses was driven primarily by rigorous cost management, including future-ready structural cost savings and lower variable comp partially offset by the Poly acquisition. In addition, recall last year, we provided aid related to the war in Ukraine. Non-GAAP operating profit was $1.1 billion, down 22.4%. Non-GAAP net OI&E expense was $172 million, relatively flat sequentially and up year-over-year primarily due to higher interest expense, driven by an increase in both debt outstanding and interest rates as well as higher factoring expenses.…

Thank you. And we will now begin the question-and-answer session. And our first questioner today will be Erik Woodring with Morgan Stanley. Please go ahead

Hey, good afternoon guys. Thank you for taking my questions. Maybe Enrique, if I start with you. Just on some of the PC and Personal Systems commentary you made. Can you help us think how you guys are viewing the PC TAM in 2023. Why you have confidence in the back half recovery if you're seeing any signs of end market demand and specifically why you think the second half of the year could be above seasonal? And then I have a follow-up. Thanks.

Sure. Thank you, Erik. So let me start by talking about what we saw during the first half, which really helps to understand our projections for the second half. During the first half, our performance was impacted by the channel reduction that we have been driving. And as I said in my prepared remarks, channel inventory continues to be slightly elevated, but we are almost there. What we saw also was that end-user demand was stronger than shipment, which is what really enabled us to drive these channel inventory reduction. When we think about the second half, usually, second half end-user demand is stronger than in the first half, mostly in the consumer side and driven by things like back-to-school or the holiday season sales. Now when we combine both, the fact that channel inventory will be normalized, which will help from a shipment perspective and also from a pricing perspective and we expect to see more normal demand following seasonality pre-COVID. This makes us believe that the second half will be stronger than the first half as we said during our prepared remarks.

Okay. That's helpful. Thank you. And then maybe, Marie, I think you just posted your strongest gross margin and quarterly gross margin ever, I believe. But at the same time, we're seeing declines in PC units, Print units, supplies are declining. They're all declining year-over-year. So maybe one, were there any onetime benefits that you saw in the quarter? But if not, can you maybe help us understand the most important margin factors this quarter by maybe rank ordering. What was the most significant tailwind to margin strength? And maybe help us understand what was the most significant headwind, if you could quantify that, that would be very helpful for us. Thank you.

Yes. Sure, Erik, and good afternoon. So let me sort of give you a perspective first on PS and then I'll sort of flip to Print. So I mean on the PS side of the house, I'd say, first of all, definitely, we saw the strength in terms of the cost reductions, and we started our future-ready transformation program now a couple of quarters ago. And some of that was offset by demand, et cetera, and increased competitive pricing. But in addition, we actually saw very strong commercial rates as well. So all of that together helped to really contribute to the strong margin performance in PS. And frankly we expect to see that continue into the back half as well. Now as we get to the Print side of the house, I would say, you've seen very robust margins in print, and this is really driven by a few factors, everything from the portfolio, strong pricing discipline. We actually saw a really favorable pricing in the commercial side. And then once again, just like the PS side of the house, we've had the benefits of cost management coming from the future-ready transformation program that's are very much on track, Erik.

And let me add a comment because there are always things that we could do better, but we are very pleased with the execution of the teams this quarter, both across Personal Systems and Print and this had a big impact in the results that we have posted.

Thank you.

Thanks, Erik.

Your next question comes from the line of Samik Chatterjee with JPMorgan. Please go ahead.

Hi. Thanks for taking my questions. I guess if I can start on the Print side. You talked about the margin improvement we're seeing there. But I'm just wondering, as you're reporting margins that are above your long-term range, it's hard to imagine that you're still seeing any benefit from supply chain constraints. You've done a lot of sort of -- you've taken a lot of actions around improving the upfront profit recognition subscriptions there. So as we think about these margins, should we think of them as more sustainable going forward relative to sort of how you probably imagine them 12 months ago? Just more curious about you can sustain these margins? And I have a follow-up.

Samik, I'd say we're still very much committed to long-term range of 16% to 18%. Obviously, we've seen some of the benefits as you mentioned from supply chain constraints, et cetera. And then as I mentioned earlier, with Erik, we've had the benefits of the portfolio, the pricing discipline, the cost management. I'd just add that as we sort of think around the back half and going forward, we do expect to see some continued pricing normalization. And ultimately, we supplies revenue will continue to decline, as we've said, low to mid-single digits over time. And so for those reasons, we expect that we will stay in that 16% to 18% operating range for the long-term, and it's the right range for the long-term, frankly.

And maybe add one comment from my side. We manage the businesses to drive operating profit dollar growth. This is really what we are focused, and this is where our strategies are designed for. We provide margins because we think it will help all of you modeling the business and understanding where the business is going to go, but growth in operating profit dollars is a key priority that we have as we manage the businesses.

Okay. Got it. And for my follow-up, it's more of a clarification and maybe a follow-up to Erik's question partly. When I go back and look at pre-pandemic trends in PS, you've talked about, you've generally done a high single-digit quarter-over-quarter revenue growth in PS in the back half in both the quarters. Are you basically implying that maybe 3Q is a bit below seasonal and then you are above seasonal in 4Q just as you sort of get to all the inventory digestion in 3Q itself? Is that how should we be reading into your guidance? Thank you.

Yes. Maybe I'll take that one. So what we expect is that PS Q3 revenue is expected to be in the high single digits sequentially. So we're getting back to what you typically see from a seasonality perspective. And then Q4, obviously, we'll see greater volumes as Enrique pointed out, because that's our typical holiday season as well. So I think the way to think about it is we're starting to see more the normalized seasonality trends return back.

Got it. Thank you.

Your next question comes from the line of Toni Sacconaghi with Bernstein. Please go ahead.

Yes, thank you for taking my question. I'm just wondering if you can comment on OpEx and SG&A sequentially from Q1 to Q2. What the forces that work were there and how we think about the trajectory of operating expense over the course of the year, do you expect most of the savings from your restructuring actions to actually help OpEx? Or will we see that more on the gross margin line? And then I have a follow-up, please.

Hey, Toni. Good afternoon. Good to hear from you. So maybe I'll start out with the back half of the year first. So we do expect OpEx to be up in the back half. And that's because it's going to be driving both our contribution to some of the growth and investments that we're doing in our growth areas and also in our people. But in terms of where the savings are going, they're going to both cost of sales and OpEx. And as you look at the sequential OpEx, you asked me both sequential and year-on-year. Sequentially, we did see an increase, and that was primarily due to some external funding that we had in R&D that we received in the quarter plus we had some incremental investments and we had some unfavorable currency and bad debt. And obviously that was offset by future-ready savings and expenses. But on year-on-year, you did see a decline, and that was due to expense management, the work we've done around future-ready. And last year, we did have some onetime contributions for aid relief in the Ukraine. So that's how to think about OpEx. And obviously, future-ready, we're pleased with our performance so far and we're looking at new programs as the program continues to mature. But essentially, it's both cost of sales and OpEx and we are on track to achieve the numbers that we talked about earlier.

Thank you. If you could just clarify when you say that OpEx will be up in the second half, is that from Q2 levels or in absolute dollars? Is that how you're thinking about? And then just my follow-up is maybe you can provide a bridge from EPS to free cash flow or from net income to free cash flow. So I think your net income is going to be about $3.3 billion at the midpoint of your guide. You have restructuring charges of $400 million. I would imagine if your PC business is continuing to decline, that working capital will actually be a headwind on free cash flow. So how do we get to your free cash flow range if we start from net income? What are the puts and takes, please? Thank you.

Yes. Maybe I'll start on free cash flow and then I'll go back and answer your question on OpEx. So in terms of free cash flow, Toni, let me start out by saying that, obviously, you saw results in the quarter and certainly they're better than expected. But as you know, Enrique commented here a moment ago, the sequential growth in Personal Systems is really driven by that negative cash conversion cycle. And that's a very important factor as we think about the second half. And obviously, this is going to drive a material improvement in CCC in terms of the actual business mix. And as Enrique said, just with the second half, PS will have a substantially stronger Q3 and then ensuing Q4, and that will obviously drive the cash flow as well. And I'll just might add, as I said in the last quarter and I think in the prepared remarks, we're also looking at capacity for strategic buys and shipments. So we're going to make sure that if we may not see a material improvement in inventory just due to that. Now in terms of OpEx itself, we do expect to see an increase in the second half. As I mentioned earlier, Toni, some of that's because we're investing in some of the growth initiatives from our future-ready savings and some of it is the investment we're making in people. But just a reminder that year-on-year, we still expect OpEx to be down. But if you think about the back half of last year, we did take some fairly significant actions. So just keep that in mind when you think about the back half compares as well.

Thank you.

Your next question comes from the line of Shannon Cross with Credit Suisse. Please go ahead.

Shannon you might be on mute.

I was on mute. I am so sorry. Thank you. Thank you so much for taking my questions. I'm curious the AITC commentary. Can you flesh that out a bit in terms of where you see the opportunity, timing? I guess I'm a little concerned that people right now have x amount of IT dollars to spend. And obviously, there's a big sucking sound coming out of all of the AI initiatives. So how do you see your PC offerings fit in? And when do should we expect to see some benefit? And then I have a follow-up.

Sure. Let me start by saying that we are really excited about the opportunity that this is going to bring because we really think it's an opportunity to redefine what PCs are redesigned, the value that PC brings and be a big, big driver of refresh, both in the commercial, but also in the consumer space. What we are working on is to build AI capabilities in the PC. So consumers or professionals will be able to run AI applications at the edge and will not have to run them on the cloud. The benefit this will bring is that if you're a small company and you want to use some of your private data, your confidential data to in an AI application, you will not have to upload it, you will be able to run it locally. And also there will be advantages in cost and advantages in latency. What this requires is a new architecture of PCs that combine program, processors with AI processors or GPUs. And this is the work that we are doing with the key silicon providers to make sure that their new designs are integrated into our PCs and into and really help to drive this new value. There's going to be a significant change. Customers will start seeing some of these solutions available in 2024 about 12 months, 20 months from now, and it's going to be a huge opportunity to really bring energy to the category.

Okay. That's helpful. And then -- in terms of the printing business, I know there's been talk about moving more to subscription. And you obviously are doing it for ink, but then just start adding in hardware. So I'm wondering, and maybe you can talk about PCs as a service, too. But I'm just curious how we should think about as you consolidate your SKUs. How you're thinking about new -- more recurring revenue business model.

Yes. So as we have said before, growing our subscription business is one of the priorities that we have. And over time, we want to offer the majority of our portfolio as a subscription. As you said, we started offering ink, we have extended into toner. We have also -- we are offering now also a paper subscription that really grew -- has been growing very fast during the last quarter. And during this year, we will start introducing the first printers as a subscription and we will start by offering that to customers that will be already in the program. We think this is really important because it enables us to capture more value per customer. We are all -- and we do that because we offer a stronger value proposition. NPS is higher in subscription models, and we really see this as an opportunity to grow and expand our businesses in the future.

Thank you.

Your next question comes from the line of Michael Ng with Goldman Sachs. Please go ahead.

Hey, good afternoon. Thank you very much for the question. It was encouraging to hear about the continued expectation for the normalization of PC channel inventory next quarter. I was just wondering if you could talk a little bit about whether you expect sell-in to also return to growth as we approach the latter part of the fiscal year? And what do you expect to happen from a pricing perspective, both from an industry perspective and then also for HP? Thank you.

Yes. So let me take that question and maybe Marie wants to complement. So from a channel inventory perspective, we expect it to be normalized in Q3 and exit Q3 we channel at normalized levels. What this will mean is especially in consumer where during the first half, including Q2, there have been significant promotional activity. This will have a positive impact on pricing since those promotions will not be necessary anymore. And as I said before, what we also expect is that end user demand toward customers will really be buying to be stronger in the second half than in the first half following normal seasonality. From a revenue perspective, what this will imply is that second half will grow versus the first half, which will have a significant impact on free cash flow, as Marie was saying before and is one of the key drivers of the free cash flow generation that we expect to see in the second half.

I think you said it all, Enrique.

Thank you.

Great. Excellent. Thank you very much for that, Enrique. And just as a quick follow-up. I was just wondering if you could update us on your industry PC selling expectations for this year. And any comments you can make about the new size of the installed base relative to pre-pandemic labels. Thank you.

Sure. We have not significantly changed the expectations that we have in terms of the selling size of PC market this year. We continue to believe that it will be in the $250 million to $260 million unit range, very similar to what it was in 2019, pre-COVID. We also think that the market is going to grow beyond that. We think that the fact that the installed base is bigger than it used to be, the new applications that we see especially driven by hybrid work that requires better cameras, better audio, better systems are going to be all positive drivers. And in '24 and beyond, we expect to see growth. Specifically, what we expect to see in '24 and '25 is something that we will be -- we are working on that, and we'll be sharing the details during the next quarter.

Excellent. Thank you for all the thoughts, Enrique. Really appreciate it.

Thank you.

Your next question comes from the line of Wamsi Mohan with Bank of America. Please go ahead.

Yes, thank you. You mentioned strategic buys a couple of times. I was wondering if you could talk about the component pricing environment for you and where you're specifically thinking about strategic buys and I have a follow-up.

Yeah, hey, Wamsi, it's Marie. So look, I think as we said last quarter that basically, look, even though we're focused on driving inventory declines operationally, we said we'd take advantage of strategic buys and frankly, lower the ships where it made economic sense. And so we have continued to do so, and we will continue to do that in the back half of the year. And I think then your second part of your question was around commodities and what the outlook is on commodities. And so I just said for PS, we do expect to see declines sequentially into Q3. Q4, slightly different situation because we expect, as Enrique said earlier, there's going to be a bit of a demand recovery. And plus coupled with some of the comments you're seeing from commodity suppliers that's potentially scaling back on production, that's likely to result in some price increases in the basket of commodities. So that's how we're looking at commodities in terms of the back half of the year.

And let me reinforce the comment that Marie just made. Operationally, we are going to be driving HOI down because as we have said before, we increased HOIs during the pandemic. We think we can operate with lower levels of HOI. But at the same time, if we see opportunities to do strategic buys or to increase the amount of product that we send by both, which has lower cost, is something that we will do even if it has implications in terms of HOI because they have both have good financial return to the company and they are both good decisions. So this is something that we manage very carefully, but if we do it, it's because we really see the economic value behind those decisions.

And I'll just add to Enrique's comments that all of that is reflected in our guide as well too, Wamsi.

Okay. Thanks for that. And as a follow-up. Clearly, you mentioned this promotional pricing in PCs. How is the elasticity of demand response to that promotional activity? And as you think about the back half of the fiscal year, is that increase in PC growth largely coming from consumer or commercial? And what kind of impact do you expect on margins? Thank you.

Yes. The impact of pricing that I was mentioning before was mostly in consumer, where we saw the need to drive more promotional activities. As we look at the second half, we expect consumer pricing to slightly improve as the situation will normalize from an inventory perspective and we expect to see stability in prices on the commercial side.

Yes. And I'd say just from a guide perspective, if you look at PS, our Q3 op margin is in the range of 5% to 7%. So it would incorporate what Enrique said and plus just to reiterate that we see very strong commercial margin rates right now, too, as well.

Thank you so much.

Your next question comes from the line of Amit Daryanani with Evercore. Please go ahead

Thanks for taking my questions as well. I guess, Enrique, maybe to start with -- it's been a fair bit of talk on PCs, but as you think about the back half performance being better than the first half, can you just touch about -- how do you think about the Print segment stacking up in the back half across both consumer, commercial and supplies. It would be helpful to understand how you think Print ramps up in the back half, given the fact you're talking about a better -- stronger back half versus first half?

So let me talk briefly about print. I think for -- during the first -- during Q2, two things to highlight. Clearly, supplies performed better than we were expecting, and this was more driven by stronger demand on the office side. And also, actually, we saw a bigger market in the office space than we were expecting, which is really related to the previous comment. When we project and when we look at the second half, we expect Print to continue to perform at similar levels in terms of operating profit that we have seen in the first half. And some of it will be supported by stronger growth in the office side, really leveraging and being driven by the trend that I just explained.

And I'll just add with respect to the margin ranges that we also expect to see the continued impact of cost management from our transformation costs as well in terms of supporting the margin outlook.

Got it. And then I guess, Marie, when I think about the free cash flow cadence, and you sort of touched on this earlier, but you expect a bigger back half recovery about $3 billion of free cash flow I think in H2 roughly on better PCs, as you talked about and a few other things. I guess maybe just talk about do we start to think about as free cash flow improves in the back half and just logically, your net leverage comes down, buyback should resume as well in the back half. Is that the right thing to think about the buyback cadence or is there different things you're going to look at when in terms of deciding when to restart the buyback program?

No, great question, and thanks for asking. And you're absolutely spot on. We do expect that our leverage should trend down through the back half of the year. And to your point, based on the real strong cash flow that we're going to have, we expect that we will actually have room and actually repurchase shares in Q4. So you're absolutely spot on. Thank you.

Perfect. Thank you.

Your next question comes from the line of Krish Sankar with TD Cowen. Please go ahead

This is Robert Mertens on for Krish. Thank you for taking my question. Just in terms of a quick question back in the channel inventory commentary. I know you've gone through quite a bit, but just in terms of when you would think normalization would happen, is that something during Q3 or something you think could happen exiting the year this year? And then I have a quick follow-up.

It will happen during Q3. So we expect to exit Q3 with normalized channel inventory levels.

Great. Got it. That's helpful. And then just in terms of looking at the print business, is there any sort of ramifications for the recent merger with Toshiba, how you think about strategically the Print market as a whole there?

No, no changes in our approach. I think what this shows is the need to look for opportunities to find efficiencies, especially given that the Print market, the office side is going to be smaller than what the projections were before COVID. And this is what we have been doing during the last multiple quarters. The significant part of the $1.4 billion of savings that are part of our future-ready plan will help on the Print space and really our focus is on driving growth organically when we announced last quarter that we were creating the Workforce Solutions and Services business, growing our office business, growing our office business contractually is one of the key priorities for the team and we are making good progress there.

Great. Thank you very much. I appreciate it.

Thank you

Your next question comes from the line of David Vogt with UBS. Please go ahead

Great. Thank you guys for taking my question and I apologize if this was asked. My line had a bit of a problem. So maybe Marie just a bit of clarification. I think you mentioned that PSG margins would be sort of in the middle of the 5% to 7% range in the third quarter. But Enrique also mentioned. You would see relatively stronger growth sequentially because of consumer, which I think has a lower segment margin. So can you kind of talk through how do we bridge the gap from five, four in the second quarter to something notably better in the third quarter? And then I'll just give you my follow-up while I have you. When I think about the second half of the year, I think about normal seasonality, typically, Q4 is up mid to high single digits versus 3Q as you build into your fiscal fourth quarter. Is that how we should be thinking about it because that would imply that the PC units would be down, I guess, again, year-over-year, high single-digits. Is that kind of how we're thinking about the second half of the year? Thanks.

Yes. So maybe I'll take the second half of the year and then flip to the op margin question. So look, the PS revenues expect to be high single-digits going into Q3. And then think about the back half as being seasonally stronger and lining up more with normal seasonality. So from an op margin perspective, let me quickly go there. So just to clarify, Q3, we expect to be in the mid of the 5% to 7% long-term range, the year in the range. And then as you go to Q3 to Q4, just bear in mind that we're going to have the benefit of commodity cost reductions, cost management, better volumes, impact of future ready and then we're going to have stronger Q4 volumes, much stronger than Q3 and all of that will help to drive the op margin in Q4. So hopefully then that gives you sort of some context that combined with what I mentioned earlier around the strong commercial margin rates as well. So all of that combined will contribute to the strength that we're expecting to see in Q4. And then in terms of just the PS rate being solidly in the long-term range in the year.

Got it. And maybe I can slip one in. So does the buyback -- the high end of the guidance contemplated by the buyback picking up later this year? Is that kind of how we think -- should think about the high end of the full year guide?

So the high end of the guide, basically, it reflects that -- you saw we took $0.10 off. Originally, we had the high end actually representing the macro. So the high end today just reflects the range of scenarios that we have. And look at as always, it's a prudent guide. If we can do better, we absolutely will. Like I said earlier, I think to, Amit, we do expect we'll have capacity in Q4 based on the strong free cash flow, and that's when we would expect to buy back shares.

Perfect. Thank you. Marie.

No worries.

Thank you. And let me now take an opportunity to close the call. I wanted to, first of all, thank everybody for joining today and also share that we are currently planning for our next Analyst Day event. We will provide more industry information as we close the details of the plan and we will do that as soon as we have that. So thank you, everybody, for joining. Looking forward to talk to all of you soon. Thank you.

This concludes today's conference call. You may now disconnect your lines.