HP Inc.
Q3 2017 Earnings Call Transcript

Published: 24 Aug 2017

[Operator:]

Good afternoon. And welcome to the third quarter 2017 HP, Inc. earnings conference call. My name is Denise and I'll be your conference moderator for today's call. We will be facilitating a question-and-answer session towards the end of the conference. [Operator Instructions]. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Steve Fieler, Head of Treasury. Please proceed.

[Steve Fieler:]

Good afternoon. I’m Steve Fieler, Head of Treasury for HP, Inc., and I’d like to welcome you to the fiscal 2017 third quarter earnings conference call with Dion Weisler, HP's President and Chief Executive Officer, and Cathie Lesjak, HP's Chief Financial Officer. Before handing the call over to Dion, let me remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately one year. We posted the earnings release and the accompanying slide presentation on our Investor Relations webpage at www.hp.com. As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. For more detailed information, please see disclaimers in the earnings materials relating to forward-looking statements that involve risks, uncertainties and assumptions. For a discussion of some of these risks, uncertainties and assumptions, please refer to HP's SEC reports, including our most recent Form 10-K. HP assumes no obligation and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on information available at this time and could differ materially from the amounts ultimately reported in HP's Form 10-Q for the fiscal quarter ended July 31, 2017 and HP's other SEC filings. 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. And now, I'll hand it over to Dion.

[Dion Weisler:]

Thank you, Steve, and good afternoon everyone and thank you for joining us today. It was another outstanding quarter, showcasing strong execution of our strategy. I'm very pleased with our sustained performance and continued momentum. We are striking the right balance in how we plan, innovate, and consistently deliver. We're competing and winning in our core print and PC markets. We're entering new growth markets and natural adjacencies with the right products, supply chain, and go-to-market with world class sustainability. We're investing in future categories where we can disrupt with innovation and we are relentlessly focused on increasing productivity and taking cost out of the business. With that context, let me highlight a few outstanding results for the quarter. We delivered non-GAAP diluted net earnings per share of $0.43 at the high-end of our outlook range. We grew net revenue 10% year-over-year to $13.1 billion. And for the second consecutive quarter, achieved growth in both Personal Systems and Print segments. And we continue to see broad-based growth across all regions with double-digit, year-over-year increases in both EMEA and APJ. We surpassed our expectations entering the year, delivering free cash flow of approximately $1.7 billion for the quarter and $2.8 billion year-to-date. And through quarter three, we returned approximately $1.6 billion to shareholders through share repurchases and dividends. In the past several quarters, since HP became a standalone company, you’ve heard us talk about reinvention. We reinvented ourselves, our company, and our solutions to amaze our customers, partners, employees, and shareholders. Reinvention is a long journey, but we're driving consistent results and seeing our hard work and dedication bear fruit. Make no mistake, there is much more work to do based on the volatility of our markets, but the past several quarters reflect our ability to consistently execute with a healthy balance across our portfolio and across all our regions. We continue to leverage our innovation, differentiation, and scale to create unique advantage and drive further growth. Now, let me turn to business segment performance. Personal Systems had another stellar quarter. We achieved double-digit revenue growth for the third quarter in a row, despite a tougher year-over-year compare. The results were balanced across the business, with double-digit revenue growth across all three geographic regions in consumer and commercial and across notebook and workstations. I’m also encouraged that desktops returned to growth in the quarter, reflecting the ongoing reinvention of products. In calendar quarter two, we outgrew the PC market unit growth by 9.5 points year-over-year, remaining the number one global PC market share leader with 22.8% share. We saw year-over-year share gains in each region with Americas increasing share by nearly 3 points in both consumer and commercial. While we are proud of these results and the team's efforts, share gain continues to be an outcome, not the objective. Profitable growth will continue to be our priority. To this end, Personal Systems operating profit dollars, margins, and revenue each grew sequentially despite the remaining industrywide component cost headwinds. We've been proactive with our ongoing productivity efforts, re-pricing actions, and focus on product mix. During the quarter, we continued to reinvent our Personal Systems business and shipped the most secure and manageable PCs to our customers. We have raised the bar in the premium segment with the new Spectre x2 and we expanded our Omen gaming portfolio with a new virtual-reality backpack. And we offered even greater value to our customers buying Pavilion devices, with extended battery life and new features such as biometric logon and inking support. As a category, PC market revenue grew year-over-year in calendar quarter two, although units were down. The market remains highly competitive. But with that said, we have a strategy that is delivering. We’re playing our own game, pursuing the heat in the market, and it's paying off. We are now consistently achieving industry-leading results and setting the standard for the type of balanced performance the category has not seen in quite some time. The team's execution is truly superb. Shifting to Printing, the business delivered across multiple dimensions, reflecting operational progress and sustained momentum as we continue to ignite a renaissance in printing. Total revenue was up 6% year-over-year and once again included growth in both hardware and supplies. Units also grew year-over-year for the fourth consecutive quarter and we remain well-positioned to place positive NPV units. Total print unit market share was 38.5% in calendar quarter two. We saw a slight unit share increase year-over-year in our office business and a slight decline in our home business. Turning to supplies, we are pleased to report that supplies stabilization occurred in quarter three, one quarter earlier than originally expected. Supplies revenue grew 10% year-over-year on a reported basis or up 2% after adjusting for constant currency and last year's supplies sales model changes. As you know, this is an important milestone and has taken a concerted effort across the print team to achieve. Going forward, we expect the same execution in the full box model in order to consistently win in the market. Additionally, we are making progress in our strategic growth areas and have the opportunity to do more. Our graphics business grew revenue year-over-year in constant currency for the 16th consecutive quarter. While I like this trend, with our leading portfolio, this is an area where we can be growing even faster. Quarter three was the first full quarter of shipping our portfolio of disruptive A3 multifunction printers, and we are encouraged by the early progress. These are the most secure printers in the world. The customer reception has been positive and we are adding new channel partners ahead of plan. Further supporting our A3 momentum, we expect the acquisition of Samsung's printing business to close in the fourth quarter of this calendar year subject to regulatory approval and other customary closing conditions. Managed print services continued to grow revenue year-over-year. We have the opportunity to further accelerate this business, especially with our growing A3 portfolio. In summary, for printing, I'm very encouraged by the strong and balanced performance across hardware, supplies, and our key growth initiatives. Turning to 3D printing, this quarter, we launched our business in Asia-Pacific, the world's largest manufacturing market, expanding into Greater China, Japan, South Korea, Singapore, and Australia. We now have more than 45 resellers globally and more than 20 Reference and Experience Centers. We're also expanding our open materials ecosystem adding Sinopec, one of the largest integrated energy and chemical companies in China, to our growing list of material partners. Shipments are accelerating and we continue to have new and repeat customer wins with some of the largest companies in their industries, such as Jaguar Land Rover, Flex, and others in automotive, pharmaceutical, government, and education. We're also driving continued growth with manufacturing service bureaus, a key part of our market expansion strategy. This includes leaders such as Forecast 3D in the United States, which has deployed a dozen systems to anchor a full-scale 3D production facility; Materialise in Europe and Shining 3D ePrint in China, among others. We are pleased with the progress of this strategically important part of our future and continue to execute on our long-term plan for disrupting the $12 trillion manufacturing market. Overall, I'm proud of our Q3 performance and confident in our future. We're executing across multiple strategic dimensions and positioning HP to capture the big opportunities today and well into the future. We're delivering short-term, while investing for the long-term, gaining share with a focus on profitability and driving both operational efficiencies and innovation across our business. In closing, I said a couple things last quarter that are worth repeating. First, every day, we must amaze our customers and partners. This focus underpins our results and guides our future performance. And second, change is a constant in this business. And to us, change equals opportunity. We must continue to embrace and drive change, with an eye on delivering long-term growth and returns. I’ll now turn the call over to Cathie to provide more details and our financial outlook.

[Cathie Lesjak:]

Thanks, Dion. We've continued the momentum from our strong first half and I'm very pleased with our third quarter results. We delivered net revenue of $13.1 billion, up 10% year-over-year as reported or 11% in constant currency. We continue to see broad-based and consistent performance across businesses and geographies. Regionally, year-over-year, Americas grew 8%, EMEA was up 14%, and APJ grew 15%, all in constant currency. Gross margin at 18.6% was up 30 basis points year-over-year. The increase was driven primarily by print margins, resulting from productivity improvements and higher supplies mix, partially offset by higher commodity costs in Personal Systems. Sequentially, gross margin was down 60 basis points, driven by an unfavorable Print mix and a higher sequential growth in Personal Systems. Non-GAAP operating expenses of $1.4 billion were up 35% as reported, but this year-over-year variance is largely driven by gains recorded last year, resulting from the divestiture of certain marketing optimization software assets. Sequentially, operating expenses were down 1%. Net OI&E expense was $66 million for the quarter. With a non-GAAP tax rate of 22% and a diluted share count of approximately 1.7 billion shares, we delivered non-GAAP diluted net earnings per share of $0.43. Non-GAAP diluted net earnings per share primarily excludes restructuring and other charges of $46 million and acquisition-related charges of $40 million, partially offset by non-operating retirement-related credits of $34 million, tax indemnification credits of $10 million and the related tax impact on these charges. In Q3, GAAP diluted net earnings per share from continuing operations was $0.41. Turning to the segments, Personal Systems net revenue was an impressive $8.4 billion, up 12% year-over-year as reported or 13% in constant currency. This was our fifth consecutive quarter of year-over-year growth and third consecutive quarter of double-digit constant currency growth. We continue to segment the market and offer some of our most innovative products ever. These efforts have helped us sustain revenue momentum, deliver consistently across each region, and drive strong market share as an end result. By customer segment, consumer revenue was up 14% year-over-year and we gained unit share across each of the three regions in calendar Q2. Commercial revenue was up 11% year-over-year and, similarly, we gained unit share across each region. We also achieved strong results by product category, with notebooks up 16%, desktops up 5% and workstations up 11% year-over-year. We delivered 3.7% operating margin in the quarter, which is up 0.5 points quarter to quarter, above historical seasonality, and down 0.7 points year-over-year. Consistent with what we said last quarter, margins have been pressured by industrywide increases in component costs and currency headwinds. We have increased pricing globally and have continued to see positive mix shifts in the business, both of which have helped improve operating margin sequentially. However, we remain cautious about the potential negative impact on demand, which could result from higher prices. Turning to Printing, the momentum gained in Q2 carried into Q3. Revenue was $4.7 billion in the quarter, up 6% year-over-year or 7% in constant currency. Hardware units were up 1% year-over-year, with consumer units up 1% and commercial units flat. As noted previously, our total unit growth includes HP Sprocket, our handheld photo printer. In calendar Q2, overall print unit share was roughly flat sequentially and year-over-year. We remain optimistic about our print growth businesses. Our A3 business is off to a strong start since launching its new product lineup in Q2 and we're excited about the opportunity to be a disruptive new entrant in this $55 billion market. As Dion highlighted, both graphics and managed print services continued to grow revenue year-over-year and we have the opportunity to increase our growth rates. Now, moving to Q3 supplies performance. Revenue of $3.1 billion was up 10% year-over-year and represented 66% of print revenue. The supplies growth was better than anticipated, driven by improving four-box model drivers. As we described in the past, the way we look at supplies revenue growth operationally is to take our as-reported number and adjust for two things. First, we look at constant currency growth. In Q3, currency represented less than a point of delta, so supplies grew 10% year-over-year in constant currency. Second, we adjust for changes made in the second half of last year to our supply sales model. In Q3 2016, reported supplies revenue was negatively impacted by approximately $225 million or eight points of growth. Therefore, when you deduct the eight points against the 10% constant currency growth, net adjusted supplies growth for Q3 2017 was 2% year-over-year. We are very pleased to have achieved supply stabilization a quarter earlier than expected. We also expect to consistently operate with supplies channel inventory levels, remaining at or below our ceiling. And in Q3, channel inventory levels were below the ceiling. As a reminder, as part of making the supply sales model changes last year, we lowered our channel inventory ceiling to better reflect the more demand-driven sales model. Looking forward to Q4 2017, we expect that our year-over-year supplies revenue growth will remain flat to slightly up when making similar operational adjustments for currency and then backing out approximately $225 million for the supply sales model channel inventory adjustment taken in Q4 of 2016. Print operating profit was 17.3% in the quarter, down 3.1 points year-over-year and down 10 basis points sequentially. The year-over-year decline was primarily due to the one-time adjustments I mentioned earlier. The positive margin impact of deducting certain marketing optimization software asset, offset by the negative impact of changing the supply sales model, plus productivity improvements year-over-year. Excluding the one-time adjustments, we saw good operating profit dollar expansion year-over-year. Sequentially, the 10-basis point decline is consistent with normal seasonality. Now, turning to cash flow and capital allocation. Cash flow from operations was $1.8 billion in Q3 and approximately $3 billion year-to-date. Free cash flow was $1.7 billion in the quarter and approximately $2.8 billion year-to-date. Cash conversion cycle was minus 35 days, a five-day sequential improvement, driven by an eight-day increase in days payable outstanding, offset by a one-day increase in days of inventory and two-day increase in days sales outstanding. The strong Q3 results were driven by Personal Systems revenue performance, which grew sequentially by over $700 million or 10%, well above historical norms. This incremental volume materially helped near-term working capital including days payable. As you know, since Personal Systems has a negative cash conversion cycle, the timing of cash flow is impacted either positively or negatively depending on its sequential revenue performance. Also, we saw positive business linearity in purchasing and other receivables, which supported improved timing of cash flows by couple of hundred million dollars. Year-to-date cash flow is now ahead of our full-year range provided during last year's security analyst meeting. We are now targeting a higher revised full-year free cash flow outlook of at least $3 billion. This assumes a cash conversion cycle down sequentially, more-than-normal seasonality, and more in line with the first half performance. Finally, we expect higher fourth-quarter capital expenditures, but will not exceed our full-year CapEx guidance of $500 million. During the quarter, we had a total capital return of $524 million through share repurchases and cash dividends. Year-to-date, we have returned 56% of free cash flow as compared to our full-year target of 50% to 75%. For the full year, we still expect to deliver returns towards the higher end of the range. Looking ahead, keep the following in mind related to our financial outlook. For the full year, we are on track to deliver our productivity initiatives as announced at SAM. In Personal System, we expect to see continued increases in cost of components in Q4. We expect to offset these headwinds with increased pricing, which could have a more significant impact on demand and operating margins than we've assumed. With this demand uncertainty, combined with our very strong Q3 revenue performance, we expect Personal Systems Q4 revenue to grow less than normal sequential seasonality. For Printing, we expect supplies revenue to be flat to slightly up in Q4 in constant currency and adjusted for last year's supply sales model change. We also expect to continue placing units with a positive NPV. Given our hedging strategy, we have rolling currency hedges, which extend into future quarters and, therefore, we do not expect a material tailwind from currency in Q4 2017. We will also continue to leverage our balance sheet if we see attractive economic opportunities to do so. With all that in mind, Q4 2017 non-GAAP diluted net earnings per share in the range of $0.42 to $0.45. Q4 2017 GAAP diluted net earnings per share from continuing operations is in the range of $0.37 to $0.41. We are raising the midpoint of our full-year fiscal 2017 non-GAAP and GAAP EPS. Full-year fiscal 2017 non-GAAP diluted net earnings per share to be in the range of $1.63 to $1.66 and full-year fiscal 17 GAAP diluted net earnings per share from continuing operations to be in the range of $1.46 to $1.50. With that, let's open it up for questions.

[Operator:]

Thank you. [Operator Instructions]. And your first question will be from Sherri Scribner of Deutsche Bank. Please go ahead.

[Sherri Scribner:]

Hi, thank you. You guys have done a good job of returning supplies to some modest growth. When you make the adjustments from last year, we saw 2% growth this quarter, which was the same growth we saw last year. What type of long-term growth would you expect based on the four-box model? Should we assume that supplies are generally flat long-term or do you think that grows modestly single-digit [indiscernible]? That would be helpful to know your long-term perspective. Thank you.

[Dion Weisler:]

Thanks for the questions, Sherri. I think it's important to remind everybody how we define stabilization. We've done that on previous calls and we've said that supplies revenue in constant currency not declining further is our definition. We also walked you over the last couple of years through the four-box model drivers and our consistent focus on driving improvement across each of those four boxes. Now, in quarter three, our focus and execution over the last two years on all four of those drivers saw the supplies revenue mature and stabilize one quarter ahead of plan. And we are very, very encouraged by that. As it relates to quarter four, we're on track for supplies revenue to be flat to slightly up in constant currency, as well as being adjusted for last year's supply sales model change. Beyond quarter four, we believe we can drive further improvements across all the four-box model drivers to impact supplies revenue as we go forward.

[Cathie Lesjak:]

And, Sherri, we'll talk more about FY 2018 specifically at our security analyst meeting in October. So, everyone should join us then.

[Operator:]

The next question will be from Wamsi Mohan of Bank of America Merrill Lynch. Please go ahead.

[Wamsi Mohan:]

As part of shaping this installed base that you talked about sort of placing high-value printers, you’ve seen some deceleration in the growth rates on printer placements. How much of that is an opt out of lower NPV printers versus competitive dynamics or versus the market slowdown? And do you feel that the install base is shaping up to a profile that can keep this positive supplies growth over the next year or so on an organic basis as you're defining on this adjusted basis? And I have a follow-up for Cathie.

[Cathie Lesjak:]

Sure. So, from a growth perspective – first off, it's a little bit tougher compare, right? So, if you actually look at what's happened to unit growth, kind of each of the quarters this year, each quarter, the previous year is a bit tougher. So, I think that's part of what's going on. And then the other part is that we are very much focused on high-value units. As we've talked about before, all units are not created equal in the market. And where we want to focus all of our energy is really on positive NPV and those typically are really the high usage categories. That's where we want to grow and where we want to gain share.

[Dion Weisler:]

So, double-clicking a little bit on that one, I’ll say that the team continues to execute on both the core and the growth initiatives and they're maintaining sort of steady momentum in print hardware as we have over the last several quarters. In quarter three, print hardware units grew 1% year-over-year. But, notably, this was driven by better-than-normal sequential growth of 4%, and we achieved slight increases year-over-year in both commercial and consumer hardware, which was driven by a very disciplined focus on the four-box model drivers, particularly high-quality units that you are referring to there in you question, such as growth in the office A4 laser market. Of course, this comes with high usage. Double-digit growth in multifunction value. That’s the 21st consecutive quarter in a row of growth in that segment. We are ramping our A3 business for the first full quarter. We only have 6% market share, as you'll recall, of this $55 billion market. Encouraging thing is that it's up 1%. We were 5% last quarter. And home ink also, which is a more profitable part of the market for us due to the full verticalization of our technology. We're pleased with the results, but obviously always more work that we can do.

[Wamsi Mohan:]

Thanks for the color, Dion. If I could follow-up, on your free cash flow, you're now achieving $3 billion here, and that's including some restructuring payments as well. How close is this to what you would call normalized free cash flow for the company?

[Cathie Lesjak:]

I don't think there is necessarily a normalized free cash flow. One of the things that you saw in the strength of our free cash flow this quarter was the business mix impact. So, Personal Systems grows $700 million in revenue sequentially or 10%, well above normal sequential, you're going to see a big increase in accounts payable, as you saw and a lot of free cash flow. So, the concept of normalized free cash flow is really not one that I can really comment on directly.

[Operator:]

The next question will be from Katy Huberty of Morgan Stanley. Please go ahead.

[Katy Huberty:]

Yes, thank you. I’m trying to decipher your comments on PC revenue for the fourth quarter. Do you see a scenario where PC revenue actually declined sequentially or your commentary is just that it grows slower than normal seasonality? And then maybe in that answer, comment on which market – consumer or commercial – you see more price sensitivity? And then I have a follow-up.

[Cathie Lesjak:]

Sure, Katy. So, it's that it'll grow less quickly than what is typical seasonality, not that it'll decline. We do expect it will grow sequentially. And then in terms of price sensitivity, we see the greatest impact in the commercial space. Consumer price increases have taken hold and we continue to perform very well in the consumer space. I think consumer revenue was up 14% year-over-year, even though we have done price increases. So, it’s much more in the commercial space. And our view is that, as we mentioned on the Q2 call that it would take a quarter for them to kind of catch up and we did see some of that in Q3. Hence, some of the sequential improvement in operating profit for Personal Systems.

[Katy Huberty:]

Okay. Can you share some metrics around the A3 success thus far? I know it's early, but any color on how many partners you’ve ramped, any customer numbers? And then, as you think about this going forward and we try to track the business, are you planning to break out any metrics more consistently, so we can monitor how the business scales?

[Dion Weisler:]

We don't release a lot of detail around the business for obvious competitive reasons. But what I would tell you and to give you a little bit of color is that I’m very encouraged by the initial progress. I'm excited by our future in this $55 billion market. We only have 6% share of this $55 billion market in the last quarter. It was our first full quarter of shipments. The customer reception is particularly positive, and particularly positive around our security message, having the most secure printers on the market as well as the choices that are available to our customers from a technology perspective. They're able to choose both ink-based solutions and laser-based solutions. We are – as it relates to go-to-market, we're ahead on our partner onboarding targets across all three regions, across transactional managed print service channels, as well as the traditional copier partners that we were looking to onboard. The pipeline is very strong. We have a very clear ambition to be a relevant A3 player and we're on track to doing that. If we can add just 10 points of revenue share in the next three to five years or so, that's $5.5 billion of topline and the associated OP drop. So, encouraged with our first full quarter start here.

[Cathie Lesjak:]

And let me just add. Dion mentioned that we had 6% share. That is up both year-over-year and sequentially, a point or a little over a point. So, that's one of the metrics you can absolutely see externally and track as we make progress here.

[Operator:]

The next question will be from Steve Milunovich of UBS. Please go ahead.

[Steven Milunovich:]

Thank you. Dion, you mentioned reinvention a few times, and that's your tagline that we've written about and have some interest in. Regarding that, first of all, what's changed? Parent HP tried to kind of get back to the invent idea without a lot of success. What's different about what you're doing, particularly in terms of the new product pipeline? And second, why should investors be excited about this? I remember when the split first happened, a number of HPQ investors were kind of saying, I don’t want to hear about growth, I just want the cash flow. What gives you confidence you'll get a substantial return on capital on your investment in the new product areas?

[Dion Weisler:]

That’s a great question. And the way we think about it is to anchor ourselves in our strategy, which straddles multiple time periods. The core is all about the here and now. It's our core businesses of Printing and Personal Systems. We have to be excellent in the core. I would say we're doing a lot of things differently, right across the company. We begin our journey through customer insights. And we've really bolstered our customer insights team, listening to our customers, working with our customers to help define and build our products. Then we go to work on the costs associated with those products, the full bill of materials, taking out the costs that we can in adding in the sprinkles of magic that delight our customers. And that's across the entire portfolio, both Printing and Personal Systems. The third thing we've done differently is really put a focus on design. Design really matters in a one life world, and whether it's the design of our award-winning x360 or our new Sprocket printer that is – Sprocket for your Pocket. We really do think about how customers use our products every single day. And then, we think about what really concerns customers, what's most on their mind? Things like security. It's a dangerous world out there. And for us to have the most secure printers and personal systems on the market, it is important to our customers. Therefore, it's important to us and we invest heavily in that area. And then, right across the company, we reinvent all of our processes. We take out on non-revenue generating costs in our business that allows us to continue to innovate across the core, but also invest in our future growth areas. And we only have three of those. We have our A3 business that we see as a $55 billion opportunity. We have our graphics business, which continues to grow, and commercial mobility. And that’s over the next two to three years. And the third time horizon is, obviously, that sort of three to ten years plus where we contemplate our future around immersive computing and 3D printing, where we've got some very strong indicators as we release our new 3D printers into the market globally.

[Operator:]

The next question will be from Jim Suva of Citigroup. Please go ahead.

[Jim Suva:]

Thank you very much. I have a question and a follow-up and I’ll ask them both at the same time. So, the first question is, I think, Cathie, in her prepared remarks mentioned that the goal is to have printers that consume more ink and more NPV and that yields itself to more consumer – I’m sorry, more commercial growth over consumer growth. But, Cathie, if I look back, it looks like the past three quarters or so, consumer units have meaningfully outgrown commercial units. And maybe I don’t know if that’s due to Sprocket or something else there. Nut it looks like, while the goal is to grow the commercial, it looks like actually consumer has been growing much faster. And then, the follow-up question is on the seasonality for PCs. You mentioned that the market will still grow, but you'll under-grow normal seasonal. Do you expect to lose share this quarter or why do you think you'll be below seasonal? Is that because of pricing action and do you think maintain share or lose – or cede some share. Thank you.

[Cathie Lesjak:]

So, Jim, let me take the second one first. Just to make sure that we're all communicating well, what I said was that our business in Personal Systems would grow slower than normal seasonality for our business. We have been outgrowing the market by quite a bit. So, I don't expect that we will lose share even though our revenue will be a little bit behind normal seasonality.

[Dion Weisler:]

And as it relates to printer hardware, obviously, not all printer units are created equally. And I mentioned a couple of data points earlier. There are certain segments of the commercial market that we are very interested in, the growth in office A4 laser, which comes with that higher usage is very important to us; the double-digit growth in multifunction value is also very important to us; obviously, ramping the A3 market goes without saying. And it means not abandoning our traditional home ink markets. We have done very well there with the release of new desktop printers, as well as the Sprocket, which is, obviously, exciting a customer that, in many cases, had never had access to print in the past. The sub-segment of demographics that are buying sprockets are largely millennials; in many cases, their first print experience. And what they're finding is that they store what they like and they print what they love.

[Operator:]

The next question will be from Toni Sacconaghi of Bernstein. Please go ahead.

[Toni Sacconaghi:]

Yes, thank you. I have a question and a follow-up. First on the question, I know you talked about currency really not having an impact in Q4 because of the way hedges work for HP. But if we just step back from that, I think entering fiscal 2016, you talked about a currency headwind of $0.34 to EPS for HP when the dollar was a 3% to 4% headwind. I think spot rates would point to a dollar being a 2% tailwind for fiscal 2018, which if you just did sort of the blind linear math would suggest you should have a $0.15 to $0.20 benefit looking forward. So, I understand hedges need to roll off and that's why you don't really expect much impact in Q4. But as we just think about currency more broadly, looking forward, given we saw a really material hurt in 2016, why couldn't we see a really material benefit looking forward if spot rates stay where they are? And then I have a follow-up please.

[Cathie Lesjak:]

So, Toni, we'll talk a lot more about 2018, obviously, at the security analyst meeting in October. But I think one of the things that needs to be brought into that analysis is what's going to happen in the market from a pricing perspective. We've now seen in fiscal 2017 pretty significant price increases. And so, if there is a tailwind from currency in 2018, our expectation is that prices are going to have to come down pretty significantly to relieve some of the pressure that's building because we've been increasing prices this year. And so, then it's going to be, ultimately, what is the total impact, it's going to be how many price declines do you have to do and what impact does that have on both revenue and EPS.

[Dion Weisler:]

I've got to tell you, I've spent my life in sales, a large part of it in any case. And one of the hardest things that any salesperson ever has to do is to stand in front of a customer and convince them why their price has to go up, either through currency or cost headwinds or other issues that impact the business. I think Christoph, Nick and Richard, our three regional presidents, along with their sales team, have done an outstanding job in doing that repricing. But as you get in front of those customers, whilst they understand for the large part that they have to pay more for the products that they receive and they see the value in our products, they expect that, as currency goes the other way, that you equally reprice the products as well. And I think that’s very much worth keeping in mind as we head into the security analyst meeting, and we'll talk more about it.

[Toni Sacconaghi:]

And then, just to follow up, in your guidance for Q4, you’ve talked about PCs being up sequentially, although not as much. Typically, the Printing business is also up. And yet, the midpoint of your EPS guidance is up only fractionally. I'm wondering if you can comment about whether there are any assumptions for Samsung accretion or dilution that are embedded in your Q4 guidance or how specifically you might be thinking about component costs or other operating profit forces at work on Q4 because I think just at a high level, given that revenue should grow between Q3 and Q4, I probably would've expected a little more EPS upside?

[Cathie Lesjak:]

So, first, on the Samsung part of your question, Toni, we don't expect that Samsung is going to close until calendar Q4. So, we do not expect that in our fiscal Q4. And so, I think that's important. It will be – Q4 will be without Samsung. And then, in terms of kind of the puts and takes of the sequential view, probably, the two biggest things to call out. First is commodity costs. We do expect commodity costs to go up sequentially. And so, that'll be a bit of a headwind. But probably the bigger impact is just the opportunity that we see to place more positive NPV units. And so, that's really what is kind of the biggest impact sequentially on EPS – I’m sorry, relative to normal seasonality.

[Operator:]

The next question will be from Shannon Cross of Cross Research. Please go ahead.

[Shannon Cross:]

Thank you very much. Can you talk a bit more about the underlying dynamics of the supplies revenue growth you saw and that you're expecting? And specifically, I’m thinking about between ink and toner, how the growth in commercial print, which is mainly ink, is maybe mixing it a little bit toward ink. I don't know if that doesn't work because of the offset of consumer, but, obviously, with the higher margin benefit from ink. I'm just wondering how we should sort of think about what's going on there below the 2% growth.

[Cathie Lesjak:]

So, Shannon, I think it's a bit difficult. We don't break out kind of that level of detail. What we have talked about is, obviously, our commercial business is bigger because of the usage than our consumer business. And, therefore, you'll see a difference in toner and ink as a result of that. Although, just to be clear, some of the consumer now has our low-end laser in it. So, when we talk about our home print system, it includes low-end laser. But, ultimately, what's going to drive the supplies is really the four-box model divers. It's not ink or toner, it's really about driving across the four boxes, focusing on placing the right units, the high-quality units, working on your installed base, working on, obviously, our market share – our aftermarket market share, as well as the pricing related to supplies.

[Shannon Cross:]

Okay. And then, I guess, I had a follow up on the commodity side. Cathie, you had mentioned that you expect commodity cost to actually go up in the fiscal fourth quarter. I know some people I've talked to are thinking more flat. So, I’m just trying to figure out, is that a reflection of contracts rolling off that are going to reset or are there specific areas where you think that you're going to need to buy more? And also, is any of that reflected in what's going on in your inventory in this quarter as well?

[Cathie Lesjak:]

Sure. So, I'm not aware of other views that say it's going to be flat. We actually think it's going to continue to go up, but at a slower rate. This is particularly true from a DRAM perspective. And then when you step back and you look at it kind of Q4 versus Q3, in the course of Q3, the commodity prices continue to go up. So, of course, that will represent a headwind for us in Q4, but we do expect some additional increases in commodities in Q4 as well.

[Dion Weisler:]

The other thing I would add to that, Shannon, is that starting out in front of these cost increases and being proactive has really worked for us. We called this particular issue well before our competitors and we took very early action here. And we did not get caught behind the curve. The other thing we did is we took some strategic decisions to leverage the balance sheet. We secured inventory as our highest priority – and you heard me talk about that on the last couple of earnings calls – because that then at least gives the opportunity for the sales team to go out and reprice our products if you don't have them, because you haven't gone and secured them in a tough buying environment, then, obviously, you have no opportunity there. So, we're very predictable for our suppliers. That helps them through a time when they have to put up their costs and they were in shortage. And then, of course, as I mentioned before, the team went out, the sales team, the category team did an excellent job of repricing the products and our customers still see a lot of value in incredible innovation that’s going into them.

[Operator:]

The next question will be from Abhey Lamba of Mizuho. Please go ahead.

[Abhey Lamba:]

Yeah, thank you. Cathie, you mentioned the price increases that are impacting commercial PC demand, and that's also the market where we have aging hardware install base. So, how do you think it plays out? Do you think it pushes out demand until prices become more reasonable in their mind or would there be pricing pressure, but we would see unit sales for that lower price? How do you expect the commercial demand to kind of play out from a year on out?

[Dion Weisler:]

I think you’ve got to take a several quarter view of the personal systems market. I think the first thing that’s important to remember is that it's still a $333 billion market. And about one in five machines have got an HP logo on it. It's very quickly becoming one in four. We're creeping up there. The top four players, including us, in aggregate, grew 1%. And we grew a five-point premium to that. So, the big are getting bigger and we're growing much faster than the big four in total. And that’s really off the back of innovation. That's what we're focused on, is delighting our customers and surprising them and amazing them with our products. And I think we have the best product line we've ever had, and that's picked up quite regularly now by third-party reviewers that look at our products relative to our competitors. For us, it's about driving a continuous transformation of the business to more profitable subcategories, where we can get value for that innovation. In quarter three, that paid off again. We do have incredible topline growth of 12%, sequential growth in operating profit, as well as share gains. But just recall, share gains are not the objective, but rather the outcome. There's no magic pill here. And I don’t think the markets, as they move from quarter to quarter, ever really are given a magic pill, except for sort of like the last month or two before an operating system changes over. This was broad based across all categories, all regions. Desktops back to growth as well. Channel inventory, aged inventory very well managed. A lot of kudos to our team in all regions, in the business unit, in the supply chain and the functions. And I think we're in a very good position to complete as we go forward as the various dynamics play out in the market.

[Cathie Lesjak:]

And then the other thing that I would add is that, I was asked to make a relative comment, and we saw consumer revenue this year – this quarter grow 14% year-over-year and commercial 11%. Last quarter, we said that the commercial price increases were going to take a while to work their way through and we saw some of that pickup in Q3. Some of that pickup on in Q3. So, I'm not suggesting that commercial customers are completely sitting on the sidelines at all. I think that with our great product lineup, we're certainly able to make the sales that we need to make in that space and get them off kind of the fence.

[Operator:]

The next question will be from Rod Hall of J.P. Morgan. Please go ahead.

[Roderick Hall:]

Yeah. Hi, guys. Thanks for taking the question. I guess I had one accounting question for Cathie and then a follow-up to that. So, I noticed that the other income expense last year in the fiscal fourth quarter was a pretty big negative number, Cathie, and I wonder if you could just kind of help us understand what that might look like this year and also maybe comment on interest income expense, how you would expect that to come out in the fiscal fourth quarter of this year? Thanks. And then I have a follow-up.

[Cathie Lesjak:]

So, Rod, let's just make sure we're level set. So, what I have is for OI&E last year was a negative $65 million in Q3 and for this year it's a negative $66 million. So, I don't see a real big difference there on a year-over-year – are you looking at a full year basis?

[Roderick Hall:]

Yeah. I was referring to the October quarter of last year. So, last year, the October quarter, other income and expense, I see it's minus $435 million. Do you have a different number?

[Cathie Lesjak:]

Sorry, I haven't been focused on Q4 last year. I don't remember off the top of my head what happened last – can we take that offline and I can look at that? And maybe even while we're talking here, I can look it up. But I haven’t focused on it.

[Roderick Hall:]

Yeah. Because there has been a big fluctuation last year, so I just wanted to make sure that – just understand if that was likely to do that again this year from a modeling point of view.

[Cathie Lesjak:]

And then, on OpEx, OpEx numbers were a little higher than we had modeled. Maybe we just mismodeled it in July. But just wanted to understand, in the October guidance, what you're thinking in terms of operating margins in OpEx?

[Cathie Lesjak:]

I’m sorry. Can you say that again?

[Roderick Hall:]

I was just wondering, on the October guidance, if you could talk a little bit about what you're thinking in terms of operating margins and OpEx and what some of the drivers of that might be?

[Cathie Lesjak:]

So, the big drivers off of normal sequential performance from Q3 to Q4 is basically the units that we expect to be able to place. We have made great progress in our Printing business on our cost structure, and that is enabling us to go into the market and find opportunities that used to be negative NPV opportunities that are now positive NPV opportunities and we expect to take advantage of those opportunities. That’s the biggest reason for not being in normal sequential. The other is that we do have commodity cost increases that we see in Personal Systems. We don't guide at an OpEx or an operating profit level.

[Roderick Hall:]

Okay. Since I missed the first one, Cathie, could I just ask you to comment a little bit on how far out you're hedged on commodities? Are you guys pretty well hedged looking forward or will you have to add to inventory over time to protect yourself from commodity prices in the future?

[Cathie Lesjak:]

We are fairly well hedged, in the sense that we have a fair amount of inventory, strategic buy inventory. But that's never for multiple quarters or has never been for multiple quarters, and so we will absolutely face increasing commodity costs, both in Q4 to some extent and into 2018.

[Operator:]

The next question will be from – and the last question, I apologize, will be from Ananda Baruah of Loop Capital. Please go ahead.

[Ananda Baruah:]

Hey. Thanks, guys, for taking the question. Hey, Cathie, just going back to the normalized – the free cash flow question from before and your comments around sort of normalized not being applicable today as it used to be? Do you feel that maybe, with what's going on in sort of higher-quality supplies and ongoing traction in PCs, that the cash conversion cycle could actually be in the process of redefining itself? And if you think that maybe it is, how would you like us to kind of think about that? Thanks.

[Cathie Lesjak:]

I don't really think of the cash conversion cycle as redefining itself. For this quarter, very pleased with the performance. We had a cash conversion cycle of minus 35 days, which was five days better sequentially. But as I mentioned, that was really driven by the incredible strength and sequential performance of the Personal Systems business. Because the Personal Systems business has such a negative cash conversion cycle that when it grows – its growth increases sequentially, you're going to see a fair amount of free cash flow. Similarly, if the growth is less in the following – in the next quarter sequentially, you're actually going to see a little bit of a reduction in free cash flow. What we expect for this year is that we would do at least $3 billion in free cash flow, so making great progress on free cash flow, and that our cash conversion cycle would likely end the year at a minus 29 days, kind of in line with FY 2016's exit. And I think of that more as kind of the range that I would be modeling over the longer-term.

[Dion Weisler:]

So, I’d like to thank everybody for taking the time to join us today. The key takeaways, I’d love you to leave the call with, is the following. We stabilized revenue a quarter earlier than we expected. We posted double-digit total revenue growth in the quarter. We delivered non-GAAP EPS at the high-end of our outlook range. And we generated $1.7 billion in free cash flow. We have growth across all segments and regions and sustained success across the three time horizons of our core growth and future pillars, and that's really important, in that we're delivering for today, but providing real opportunity for long-term growth into the future. Every day, we wake up knowing that we need to amaze our customers and partners with the most competitive, disruptive portfolios. Job number one for us. Very proud of the outstanding execution of the strategy from the team and I believe that our very best days still lie ahead of us. I look forward to seeing you all at SAM on Thursday, October 12 in Palo Alto. Thanks very much for your time.

[Cathie Lesjak:]

Thanks a lot.

[Operator:]

Thank you. Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.