HP Inc.
Q2 2016 Earnings Call Transcript

Published: 26 May 2016

[Operator:]

Good afternoon and welcome to the Second Quarter 2016 HP Inc. Earnings Conference Call. My name is Amy and I’ll be your conference moderator for today’s call. At this time all participants will be in the listen-only mode. We will be facilitating the 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, Diana Sroka, Head of Investor Relations. Please proceed.

[Diana Sroka:]

Good afternoon. I’m Diana Sroka, Head of Investor Relations for HP, Inc., and I’d like to welcome you to the fiscal 2016 second 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 and 10-Q. HP assumes no obligation and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on information available at this time and could differ materially from the amounts ultimately reported in HP’s Form 10-Q for the fiscal quarter ended April 30, 2016. 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, Diana and good afternoon, everyone and thank you for joining us today. I’m pleased with our second quarter results. We did what we set out to do. Non-GAAP diluted net earnings per share was $0.41 above our previously provided outlook range. Free cash flow was strong at $1.5 billion. We took action to improve our cash conversion cycle and are on track to deliver our full year outlook. And we returned more than $0.5 billion of capital to shareholders through dividends and share buybacks. In the difficult market conditions, net revenue was in line with our expectations down 11% year-over-year as reported or down 5% in constant currency. And in APJ for the second quarter in a row, we delivered constant currency revenue growth with strength in personal assistance across much of the region. I will not be completely satisfied with the company performance until we return to sustain growth. Delivering our financial commitments is evidence of the solid progress we’re making against our strategy to protect our core, deliver on growth and invest in our future. Let me take a moment to remind you of our objectives when we started the year. First, we said the markets were going to be tough for at least several quarters. We are on track to reduce our cost structure by more than $1 billion in FY16 through productivity initiatives and an acceleration of our three year restructuring plan into this year. We executed a number of cost sections including a reduction of approximately 1,200 headcount year-to-date and are on track to achieve our savings objective by year end. I continue to believe we have even more opportunities. Second, we said we will be rational in how we price in our core competitive markets. In Q2 we achieved another quarter of sequential ISP improvement in print hardware. While these actions did pressure hardware unit placement we are starting to see more rational pricing in the market. Third, we said we will continue to shift our portfolio towards strategic and future growth areas. Year-over-year in Q2 we had constant currency growth in commercial notebooks, commercial mobility, commercial services, managed print services and graphics printing solutions and we just launched our first 3D systems, which I’ll cover shortly. A key to success in competitive markets is product differentiation and innovation. It’s thrilling to see the innovation coming out of HP supporting our core growth and future initiatives. We are reinventing our business and our technologies so that industries and individuals can reinvent what matters most. Let me share some examples of incredible innovation this quarter. We launched a robust business printing line up with more than 15 new page wide Officejet Pro and jet intelligence laser jet printers. This launch included incredible innovation in productivity and supported our objective to reshape the install base towards units with higher supplies usage. As the industry continues to shift from transactional to contractual sales HP and our partners are differentiated with a secure managed print services offering. At a time when security is essential to customers HP has the strongest security protection available in the industry. In our Graphics business Drupa, the Olympics of graphics is just one week away and we are planning several exciting announcements. Among others we are expanding our packaging portfolio to address customer needs as they shift to digital and we are enhancing our commercial graphics printers with image quality and productivity simply unmatched in the industry. And just last week we delivered the world’s first production ready commercial 3D printing system, marking a major step forward towards igniting what could be the next industrial revolution. I’m really proud of this announcement which we made with some significant ecosystem partners including Nike, BMW, Johnson & Johnson and Siemens among others. The new HP Jet Fusion 3D printing solutions produced superior physical parts up to 10 times faster and at half the cost of current 3D printing systems. Our products deliver the speed, cost and quality and economics that will democratize manufacturing and help deliver mass customization. These systems leverage decades of HP’s R&D print expertise and thousands of patents from our core. We are building a whole new partner channel for 3D printing and will continue to grow our ecosystem of co-development and technology partners in powerful industries like automotive, aerospace, medical and consumer goods. In Personal Systems, we continue to deliver design and engineering in the consumer premium segment including our most recent announcements of the HP Specter the world’s thinnest laptop. We introduced this beautiful product at the New York Times Luxury Show in Paris to write reviews. We grew double-digits year-over-year in this profitable segment while the broader consumer premium market declined. Among other highlights in Personal Systems we reinvented the Chromebook to be ultra-thin for home and office and announced it with Google earlier in April, commanding a higher selling price this modern thin and light device offers quick boot time, simple navigation and thinking, multilayered security and the ability to share and access information anywhere. It’s also the first to use a 6th generation Intel Core M processor. With our superior product line up we continue to grow our reputation and competitive position. Some of our major logo wins include Ella Louis [ph], GM and PricewaterhouseCoopers. I’ll shift now to provide color on the segment results. In Personal Systems we executed well against a challenging market backdrop. We continue to make progress on our strategy delivered profitable share gains, while gaining momentum in key growth markets. In the core we outperformed the PC market once again. We extended our worldwide commercial leadership to a new all-time high share position of 24.6% with meaningful year-over-year share guidance in all three regions. We maintained our number one share position in worldwide desktop work stations 45.6% and grew our number one share in mobile work stations to 38.9%. And beyond the core we delivered constant currency year-over-year growth in strategic areas such as detachables, commercial services and consumer displays all very profitable businesses. Personal Systems operating profit improved to 3.5% with year-over-year growth in operating profit dollars. A key commercial customer win came with Deutsche Post DHL Group the world’s leading logistic service group. The deal included a broad range of commercial products including EliteBooks, x2 tablets, Chromebooks and Displays. Now turning to printing, in line with our expectations the year-over-year revenue decline continued, but was approximately flat sequentially. In addition to demand weakness we faced currency headwinds of about 6 points year-over-year. We simply needed to focus on operational improvements in the core business to support stability in supplies revenue, and in Q2 all elements of the supplies Four Box Model performed largely as expected. Specifically on hardware units we pulled back on discounts. This resulted in an increase in constant currency ASPs both quarter-over-quarter and year-over-year and as I mentioned earlier these actions did pressure total unit sales. However our cost actions enabled us to place additional positive MPV units as a result we grew 2 points of share sequentially in calendar first quarter in both ink and laser hardware. As I always say not only hardware is created equally, the quality of the install base is important. Overtime we are working to shift the install base to units with higher supplies usage. We saw double-digit unit growth in PageWide print hardware, while gaining share in value multi-function laser printers. Also we continue to execute on our initiatives to win back after market supplies share. We started to see progress and expect continued momentum in the coming quarters. Instant Ink, our subscription based delivery service had another quarter of sequential enrolling growth and high retention rates. Let me also highlight that we made this progress while reducing hardware and supplies channel inventory globally. We are now within our targeted ranges and given our progress we still expect our supplies revenue trajectory in constant currency to stabilize by the end of 2017. Beyond the core we had solid momentum in our growth categories, in Graphics we delivered the 11th consecutive quarter of year-over-year constant currency growth supported by strength and large format design, production and services. A terrific win was with Staples where we supported their entire graphic solutions business with technologies ranging from design check graphics to Latex to Scitex flat bed systems. This is another major expansion of the graphics wide format relationship and symbolic of our leadership in service delivery. Before I turn it over to Cathie, I want to reinforce that this was a strong quarter for HP where we delivered solid progress towards our strategy in the core growth in future markets. Despite a tough market we delivered on our objectives, unleash truly amazing innovations and grew in strategic areas of our business. I am confident in our ability to execute and remain committed to long-term growth. I’ll now hand it over to Cathie who will share additional details including our financial outlook.

[Cathie Lesjak:]

Thanks, Dion. Q2 results were solid and in line operationally with our expectations. Net revenue was $11.6 billion, down 11% year-over-year as reported or down 5% in constant currency. Gross margin of 19.4% was down 0.3 points year-over-year driven by unfavorable currency and competitive pricing, partially offset by cost improvements and favorable mix. Gross margin was up 0.7 points quarter-over-quarter largely in line with normal seasonality. Non-GAAP operating expenses of $1.3 billion were down 16% year-over-year, primarily in SG&A. As a reminder due to the use of discontinued operations basis of accounting some historical expenses primarily in admin were fully allocated to the parent company, which was HP Inc. in the U.S. Also in Q216 we recorded a gain in SG&A from the sale of certain marketing optimization software assets. Further, we had year-over-year savings from reductions in our overall cost structure. Non-GAAP OI&E was a net expense of $13 million lower than normal run-rate due to a one-time benefit from a legal settlement benefitting net EPS by about $0.03. Although timing was unknown when we set our FY16 annual financial plan the settlement was modeled in our full year earnings outlook and was fully booked in Q2. With a non-GAAP tax rate of 21.5% and a diluted share count of approximately 1.7 billion shares, we delivered non-GAAP diluted net earnings per share of $0.41. GAAP diluted net earnings per share from continuing operations of $0.38 primarily excluded restructuring charges of $100 million only partially offset by non-operating retirement related credits of $40 million. Non-GAAP results also excluded an $8 million net tax indemnification credit related to the tax matters agreement with Hewlett-Packard Enterprise Company. We expect that certain tax matters and the related indemnification effect will continue to change each quarter and will be recorded as adjustments in GAAP only results. Now turning to the segments, Personal Systems net revenue was $7 billion down 10% year-over-year or down 5% in constant currency. Consumer revenue was down 16% while commercial revenue was down 7% year-over-year as reported. While we outperform the market overall, we did especially well in the commercial segment with improvement in the year-over-year revenue decline. Innovations across the portfolio have been well received by customers. We are very excited about the great momentum of the Elite x2 commercial mobility product, which had solid initial sales and has a very strong sales pipeline. As a result of our focus on growth opportunities beyond the core, we increased constant currency year-over-year revenue in commercial notebooks, commercial mobility, consumer premium and gaming. Personal systems’ ASPs were down slightly year-over-year, but improved sequentially due to favorable mix partially offset by highly competitive pricing. Personal Systems’ operating profit was 3.5%, up 0.6 points year-over-year driven by improved gross margin rate. Also we reduced operating expenses as compared to last year, but not in line with revenue declines. Turning to printing, net revenue was $4.6 billion down 16% year-over-year or down 10% in constant currency. Hardware units were down slightly sequentially, but better than normal seasonality as our cost actions increased the number of units that were now at a positive NPV. Approximately 11 points of the 16% year-over-year unit decline were related to the market. The remainder was largely associated with our pricing disciplines and focused on only positive NPV unit placement. We are very pleased with our refreshed product portfolio, which will support our hardware strategy to price on differentiated value and to ensure strong HP Original supplies attached. Supplies revenue was down 16% year-over-year as reported or down 10% in constant currency. Considering currency and the channel inventory position, the supplies revenue trajectory has improved. We reduced channel inventory in the quarter, which was a 7 point headwind as compared to the prior year period. In Q2, supplies revenue mix was 67% flat sequentially and channel inventory was within our targeted range. Operating profit for printing was 17.3% down 0.5 points year-over-year driven by currency and competitive pricing; partially offset by operational improvements, favorable hardware mix and divestiture gains. The gain from the sale of certain marketing optimization software assets helped to offset the incremental placement of hardware unit and the reduction of supplies inventory in the quarter. Now to an update on the restructuring activities we announced at our Security Analyst Meeting last fall. Over 800 people exited the company in Q2 and approximately 1,200 year-to-date. The acceleration of the restructuring activities is on track and we still expect approximately 3,000 people to exit by the end of the year. As Dion said, we are continuously seeking efficiencies and we believe there are incremental actions to take beyond this fiscal year. Turning to cash flow and capital allocation, cash flow from operations was approximately $1.6 billion and free cash flow was approximately $1.5 billion. The cash conversion cycle was negative 24 days, a nine day sequential improvement driven by six day increase in days payable outstanding and the a three day decrease in days of inventory. I’m extremely pleased with the operational rigor of the entire organization and all the working capital metrics. We still expect full year fiscal 2016 free cash flow to be in the range of $2.3 billion to $2.6 billion. Our expected seasonality would suggest Q4 to be a stronger cash flow quarter than Q3. During the second quarter, we repurchased 28.7 million shares and paid $213 million in dividends for a total capital return to shareholders of $518 million. Given where we are year-to-date, we will clearly achieve and may exceed the high end of our original 50% to 75% target range of returning free cash flow to shareholders for the full year. Looking ahead, there are a few assumptions we made in our financial outlook for the remainder of the year. We expect year-over-year revenue declines to moderate for Personal Systems and Printing. Also in printing, the progress we are making on our cost structure as well as some price disciplines gives us the opportunity to place more units. Hardware unit declines will moderate, although we still expect low double-digit declines year-over-year. Supplies revenue in constant currency will continue to decline, but is still expected to stabilize by the end of 2017. Productivity initiatives and accelerated restructuring actions across the company are expected to improve overall profitability as compared to the first half of the year. With all that in mind, Q316 non-GAAP diluted net earnings per share is in the range of $0.37 to $0.40. Q316 GAAP diluted net earnings per share from continuing operations is in the range of $0.34 to $0.37. Our full year fiscal 2016 non-GAAP diluted net earnings per share is in the range of $1.59 to $1.65. Our full year fiscal 2016 GAAP diluted net earnings per share from continuing operations is in the range of $1.52 to $1.58. With that let’s open it up for questions.

[Operator:]

We’ll now begin the question-and-answer session. [Operator Instructions]. The first question is from Kathy Huberty with Morgan Stanley.

[Kathryn Lynn Huberty:]

Yes, thanks. Shannon, how should we think about the yen influence on printing margin through the remainder of the year?

[Cathie Lesjak:]

Thanks, Kathryn. From the yen benefit perspective, we do expect a little bit of a benefit, we saw a little bit in Q2 as well. But that benefit is significantly coming down as the yen has appreciated a bit.

[Kathryn Lynn Huberty:]

And then as you think about PCs in the back half, maybe Dion, we are hearing from distributors that inventories have come down, you seem to sight that as well. Would you expect a meaningful improvement in unit growth as we go into the back half of the year?

[DionWeisler:]

And Kathryn was that for Printing or Personal Systems?

[Kathryn Lynn Huberty:]

For PCs.

[DionWeisler:]

For PCs, I would say that we have consistently remain very vigilant in our control over inventory. I think it’s a mix bag in terms of the inventory out in the channel. There are some vendors that still have higher levels of inventory and somewhere inventory has come down. I think all of it points to sort of broadly speaking, we don’t largely disagree with what the major analysts are predicting for the second half of the year that whist the market will continue to be pressured it will abate somewhat in the second half of the year. Our inventories are well in control and so is our aged inventory too very important metrics that we watch very closely.

[Cathie Lesjak:]

And Cathy sorry about that I’m so used to Shannon asking the questions so I run immediately to Shannon I apologize.

[Kathryn Lynn Huberty:]

It’s okay.

[Diana Sroka:]

And then operator next question please?

[Operator:]

Thank you. The next question is from Rodd Hall with JP Morgan.

[Rodd Hall:]

Thanks for taking the question. So my question I guess is along similar lines the broader that you guys have such a broad impact and kind of an outsize impact from currency especially from the strong dollar. And it looks like the interest rates most people are expecting [indiscernible]. How stress tested is your earnings guidance for the full year against a stronger dollar what sort of assumptions are you making? Could you just give us some idea on that?

[Cathie Lesjak:]

Rodd, if you actually look at where currencies are today. They are not that different than where we start at the beginning of the year when we provided our first outlook. On top of that we obviously put hedges in overtime. And so we feel pretty confident in our outlook given where the dollar is now even if it were to get a little bit stronger.

[Rodd Hall:]

Okay. So you assume a little bit of interest rate rise, but not much more than that, Cathie, is that correct?

[Cathie Lesjak:]

So I look at it more from a currency perspective. I understand it’s the interest rate rise drives the currency. So we look at it more and we’ve modeled the different levels of the dollar.

[Rodd Hall:]

Can I ask you one follow-up which is your interest expense was quite a bit lower than last quarter, I just wonder if you could give us any color on what drove that?

[Cathie Lesjak:]

Sure. The biggest difference wasn’t interest rate, it was this legal settlements that we had that benefited EPS by about $0.03 that was showed primarily up in OI&E.

[Rodd Hall:]

Great, thank you very much.

[Diana Sroka:]

Thank you. Next question?

[Operator:]

Your next is from James Kisner at Jefferies LLC.

[James Kisner:]

Yes, thank you. I just want to clarify your comments on supplies I believe you said that while the decline was worst year-over-year had a pretty significant headwind from inventory adjustments and just kind of wondering if you could talk about how that impact from inventory affected last quarter’s constant currency growth. And just in general what kind of market decline you’re modeling for supplies or assuming for the supplies market to stabilize the revenue by the end of 2017?

[Cathie Lesjak:]

So I think the way to think about this is probably to go back to the Four Box Model and how we think about supplies. In terms of us being on the trajectory that leads to stabilization in constant currency supplies revenue by the end of 2017. And I believe Dion said in his prepared remarks that when we started the quarter we have an expectation of what the Four Box -- the different elements of the Four Box model are going to do and then -- based on the models that we have. And then we look at the end of the quarter to see how they responded in actuality and they were largely in line with what we were expecting and that says that our model predicting within the quarter is doing a good job of predicting what’s going to happen to supplies. So we are on track with that. In terms of the channel inventory corrections off the top of my head I don’t remember what the impact was last quarter. We did have some -- we definitely had some channel inventory corrections last quarter as well. But this quarter was larger and it was 7 points of the headwind. So if you look at this you look at supplies growth or a decline of about 16% you take off about 6 points of currency, 7 points of channel inventory, if you look at kind of the real demand it’s basically down about 3% again in line with what we were expecting.

[Dion Weisler:]

And just to give you my perspective on this, what I’m most happy about is we did exactly what we said we would do and what has happened in the market and what we thought would happen in the market has actually transpired. We said we needed to adjust to what I call the new normal and that was a sort of combination of further market contraction that was driving an increased competitive price market. We said that we saw weakness in emerging markets and we did indeed see that continue currency continued as a headwind and that we were expecting tough macroeconomic conditions worldwide. We actually adapted to this new normal and you remember on our fourth quarter earning call and our first quarter earning call we talked about having to not only deliver on the $1 billion of productivity improvements, but actually that wasn’t going to be enough and that we were going to need to do more and we are on track to doing more than our $1 billion. We also said that we needed to accelerate our restructuring and in Cathie’s prepared remarks she said that we are also on track to doing that and but we needed to persist with our efforts to drive price stability in the market. So all of that is actually working, our supplies trajectory improved, but it was somewhat masked by the channel inventory reductions that we had, supplies inventory is now back within the ranges globally and that’s obviously where we wanted to be. So with all of those productivity improvements continue to reshape the install base. We’re focusing on high value units that’s evidenced through the continued growth in value multi-function laser we said we needed to continue to refresh the product line up we did that 15 new devices launched last quarter JetIntelligence, PageWide Array and OfficeJet Pro and we said we needed to continue to grow in our graphics business and we did for the 11th consecutive quarter in a row as we did with Instant Ink. So as Cathie mentioned all of that translates to what we’re seeing transpire as we planned it out to be and therefore with all of that we expect to stabilize our supplies revenue trajectory by the end of 2017.

[James Kisner:]

Quick follow-up on that I mean it sounded you’re on track from your restructuring and supplies growth long-term so I guess wondering why you’re lowering the higher end of guidance here? Thanks.

[Cathie Lesjak:]

Yes, so what happened in Q2 and what we are expecting will be true in Q3 and Q4 as well is that with the cost reductions we’ve made we actually have in effect opened up more positive NPV TAM in printer units. So we took advantage of that in Q2 and we gained two points of share sequentially, while maintaining our price rationality and we expect that in the back half of the year we will also be able to take advantage of placing additional units, which is from my perspective and Dion’s perspective the right thing to do for the business to maximize the area under the curve. And so that took the top end of our previous guidance down a bit, but for the long-term value for the company.

[Diana Sroka:]

Thank you, James. Operator can we have the next question please.

[Operator:]

The next question is from Sherri Scribner with Deutsche Bank.

[Unidentified Analyst:]

Hi it’s Elaine Colby [ph] for Sherri. Thanks for taking my question. I was hoping you could update us on your expectations for the cash conversion cycle you obviously saw some impressive improvement, but how should we think about working capital over the balance of the year?

[Dion Weisler:]

Well, let me just say that I was very pleased with the improvements in each of the cash conversion metrics that we closely track and monitor. Our goal was as you remember to reduce our cash conversion cycle by several days from our quarter one exit. We got there plus a little bit more and this was actually an enormous enterprise wide effort and we’ve made some permanent changes to our processes and to our business management system. I think the team rallied exceptionally well together to focus on all the levers that we have available to us. So we expect to exit FY16 with the cash conversion cycle several days improved over FY15 and that will enable us to achieve our full year free cash flow outlook of $2.3 billion to $2.6 billion for the full year.

[Diana Sroka:]

Thank you. Operator next question?

[Operator:]

The next question is from Toni Sacconaghi of Bernstein.

[Toni Sacconaghi:]

Yes, thank you. Cathie you talked about the legal gain helping $0.03 you also mentioned that there was a gain on sales of marketing optimization software how big was that and was that completely captured in the printing and imaging group? And I have a follow-up.

[Cathie Lesjak:]

Yes Toni it was completely captured within the printing op and while we’re not specifically sizing it I think what we did was we used that opportunity to fund the incremental unit placements that we had as a result of cost reductions that we’ve done we placed more units we were able to gain that share I mentioned. And then we also -- we took our channel -- our supplies channel inventory levels down even a bit further than what we had originally intended because we believe that managing having a tight handle on the channel inventory levels is good for our business.

[Toni Sacconaghi:]

Okay. And just a follow-up I mean it sounds like you’re saying you’re going to invest and trying to take more share yet you also said to expect double-digit declines in units for the remainder of the year, and I know I probably asked some form of this question every call, but 100% of your profits are driven by supplies and your assertion that supply should stabilize next year still not transparent to make. And so if we look at last five quarters hardware revenue has been down double-digits, hardware revenue has been down 19 out of the last 20 quarters. So if I’m looking at that box in the Four Box Model that says what’s happening to my install base it’s down and it’s probably down mid-single digits. So to stabilize what’s the key thing that changes? Are you expecting much better capture rate on remand? Are you expecting people to start printing more given their printers, but the only thing that we really see is what’s happening to your installed base and that’s declining. So I appreciate that your model tells you and it’s been accurate. But it would be really helpful if we to understand what you think happens in the model that go from what’s been closer to mid-single digit declines in supplies to zero given the backdrop that we see, which is hardware units continues to be negative.

[Cathie Lesjak:]

So Tony really what I said was that the printer unit declines would be low double-digits in Q3. Q3 is a relatively tough compare. Because if you remember last year, we did some incremental what we called insurance policy because of the split that we were going through. So it is a tough compare. But we went from minus 20% declines in Q1 to minus 16 and then it’s going to come down further as well in Q3 of 2016. And I think what’s important is it we’ve captured, it’s not like this is a surprise to us, we’ve captured it within the modeling that we have done. Our models are holding up and our models basically show that supplies revenue in constant currency will stabilize by the end of 2017.

[Dion Weisler:]

And I think Tony what you’re really highlighting here is the complexity of the business and there is no single magic pill that changes the supplies trajectory. So what we need to do is to continue to focus on all areas of the Four Box Model the install base being one metric. But remember, that the install base is a function of every kind of category and segment of business that we do. From those printers that produce less supplies to those that produce a lot of supplies. And we are placing more APP positive units enabled by the cost that we’re taking out of the business. And we are innovating and we are introducing new products, a new series of printers that are really very much focused on the business side of the ledger. And these new platforms generally come with higher supplies attach, because the aftermarket alternatives have not yet made their way into the market. Usage is another part of a Four Box Model, not all printers are created equally. And even the same printer placed in the different location or different a zip code produce a different amount of supply. So reshaping that installed base to high usage printers is kind of job number one. The other major shift that’s happening is the move from transactional to contractual. And as that shift happens we move to 100% supplies attached. And the final area in terms of usage is the work we’re doing around marketing to stimulate printing demand. We’re shifting our marketing efforts from marketing printers to marketing printing. And that sort of takes care of box number two. On the third box, the aftermarket share you had these newer platforms that come with higher attach, you’ve work we’re doing around the omni-channel it’s very comprehensive covering online coverage and marketing as well as the innovation that we’re driving our ink formulas and new toner technology resulting in the much better printed page when they’re using original HP supplies. And the fourth lever of course is pricing which remains flat and consistent with our expectations. So all these factors drive supplies consumption not just the installed base and the model would suggest that we are on track to that stabilization by the end of 2017 in constant currency.

[Cathie Lesjak:]

And we have initiative in every one of those boxes.

[Diana Sroka:]

Thank you, Tony. Next question please?

[Operator:]

The next question from Wamsi Mohan at Bank of America Merrill Lynch.

[Wamsi Mohan:]

Yes, thanks. Dion you mentioned more rational pricing, how much do you attribute that to the recent moves in the yen? Are you seeing any difference in the competitive behavior? And I have a follow-up.

[Dion Weisler:]

Well I think it’s a little hard to speculate because I don’t necessarily understand the hedging strategies of each of our Japanese competitors. I would say in the long-term if the yen remains where it is that ultimately is good news for us. But I think we’ve been very disciplined in the market in the terms of not dragging the market down in price selling the value of our product shifting away from spending counter dollars on discounting to marketing and sales and that’s resulted in higher ASPs. So we are very focused on our activities and I think we’re starting to see some signs of market stabilization.

[Wamsi Mohan:]

Okay, great. And as my follow up, sounds like you regain some share in the aftermarket supplies can you talk about where that was how much it was whether it was commercial or consumer and was it like related primarily to the new printer introductions in the quarter? Thanks.

[Cathie Lesjak:]

So I don’t believe that we’ve made any statements specifically about aftermarket share for supplies improving. Now we are as part of going after the Four Box Model we are working on increasing our aftermarket supply share and we are starting to make some progress specifically in the omni-channel space, which is what Dion mentioned I believe in his prepared remarks.

[Dion Weisler:]

So I think I would expect that aftermarket share would come up as we release these newer platforms, those newer platforms come with almost 100% supplies attached. I would expect that aftermarket share as we move from transactional to contractual where that comes with 100% supplies attached to drive up our aftermarket share. I would expect the work we are doing around omni-channel as Cathie mentioned which is some very comprehensive work around online coverage of marketing to also improve our aftermarket share and the innovation that we are driving in ink formulas and toner would also do that.

[Wamsi Mohan:]

Okay, great. Thank you.

[Diana Sroka:]

Thank you, Wamsi. Next question please?

[Operator:]

Your next question is from Maynard Um at Wells Fargo.

[Maynard Um:]

Hi, I think I have a question that looks out a little bit further. You have a number of drivers in 2017 including 3D printing the A3 market, number of other new products. But can you help us identify what the mile markers are to jet success? I mean what should we be looking for as we enter 2017 that points us to these materializing as growth drivers for you? And how long does it take for these products to ramp to a level that’s material enough that it can actually have an impact on revenue and profits. Is it two or three quarter? Thanks.

[Dion Weisler:]

Thanks, Maynard. So let me say that everything we have spoken about so far is really being focused on the core and we’re really incredibly focused on out traditional franchises of print and personal systems. But as part of our overall strategy for the company we do have certain growth areas that are incredibly important to us. You mentioned a couple of them. Our A3 product work remains on track and our portfolio will come out towards the middle of next year that is on time and on track and we are doing a lot of work around preparing not only for the products, but for the go to market that is required in order to be successful in this marketplace. Another part of our growth engine is graphics. Graphics grew for the eleventh consecutive quarter. We are just about to walk in to Drupa next week, which is the Olympics of the Graphics business it happens every four years and we are very excited about some of the products that we will be announcing at Drupa. And the third area is commercial mobility and our commercial mobility practice continues to grow we’re excited about the work we are doing there we made some really interesting category creating product announcements with the Elite x3 during the course of the quarter at Mobile World Congress to write reviews. So lots of positive signals in the market from a product perspective and the pipeline that we are building. Then of course only last week we announced our 3D printing products and we have really breakthrough innovation here solving the problems of speed, quality and cost. We said we would release them in the second half of this year and a proved point of that is the announcements that we made last week and the strategic announcements that we made with Nike, with BMW, with Johnson & Johnson and JBL a very important player in this space. So I think there is a lot of markers out there that point to the execution of this team. We do what we say we are going do whether it’s product whether it’s go to market or a business model readiness.

[Diana Sroka:]

Thank you. Next question please?

[Operator:]

Next question Jim Suva of Citigroup.

[Jim Suva:]

Thank you and congratulations to you and your team there at HP. I have one question for Dion and one Cathie. So I’ll just pass in both at the same time. First for Dion, your sister company HP Enterprise last night announced that they breakout part of their business to mainly their services, have you considered splitting out or would you and does it actually make any sense? And then for Cathie the operating profit margins in printing I believe was down year-over-year and I think you had mentioned the litigation help that so would have been down even more year-over-year. Is that the correct way to think about it is to stabilize it, is it top-line, is it mix, is it cost cutting? And how should we think about that stabilizing the operating margins of the Printing business that is so profitable for your company. Thank you and again congratulations.

[Dion Weisler:]

Well thank you Jim and thank you for the congratulations. And first let me extend my congratulations to Meg and the Hewlett-Packard Enterprise team on a spectacular earnings and on a very successful announcement of the spin merger they’re doing with CSC. I think what that demonstrates is that the separation and the focus of the organizations on the markets and moving in top speed is really working it produced better results for the Hewlett-Packard Enterprise it’s producing solid results for us as well as fueling the innovation engines of both companies. So I don’t want to comment much further on Hewlett-Packard Enterprise’s announcement, but I will say that we are really committed to the long-term success of HP I am very happy with the assets that we have in both printing and personal assistance they’re both an important and play very important role within our portfolio was the sort of broad things. We obviously always continue to look and reevaluate the markets as they change and measure all of our assets relative to the strategy and sometimes that results in a divestiture and we made a divestiture this quarter and some marketing optimization assets that’s an ongoing process. But as far as our major franchises go we are very committed to both portfolios.

[Cathie Lesjak:]

Down 50 basis points as you mentioned and that’s really driven by currency and the very competitive pricing environment we saw. It was partially offset by the productivity initiatives that we’ve got and the broader non-revenue generating cost reductions as well as the favorable hardware mix. And then we had some benefit from the divestiture gains it wasn’t litigation it was divestiture of the marketing optimization assets. But as I told you, we made the conscious decision to invest that gain back into placing incremental NPV positive units. And you can see the impact of that frankly in the share gains that we had quarter-on-quarter as well as basically bringing our channel inventory levels for supplies in a bit more. From quarter-on- quarter perspective, the increase was really driven by cost improvements as well as the divestiture gain. And that was partially offset by competitive pricing currency and some investments that we made in go-to-market and R&D.

[Jim Suva:]

Thank you and congratulations to you and your team.

[Cathie Lesjak:]

Thanks, Jim.

[Dion Weisler:]

Thanks, Jim.

[Diana Sroka:]

Thank you, Jim. Next question please?

[Operator:]

The next question is from Shannon Cross with Cross Research.

[Shannon S. Cross:]

Thank you very much. Dion I wanted to dig a little bit more into the 3D printing initiative from your standpoint. I’m curious what sort of feedback you’ve heard from beta customers, some of the partners? How are you thinking about this initiative over the next year or two? And then I have a follow-up.

[Dion Weisler:]

I’m super excited by it. I think the feedback from potential channel partners, from end customers and from analysts and those that follow the industry closely understand what a breathtaking breakthrough we’ve made towards really pulling through the printing into the mainstream. We released the first production short run productions 3D printing systems they’re 10 times faster than other products are out on the marketplace unbelievable quality and most importantly at half the cost. And when you get those 3 things right, you start to tap into specific applications that are better to be done by digital 3D printing than they are in an analog fashion. And the best example I can give you is our 3D printers themselves, 50% of the building materials of our 3D printers are printed by our 3D printers. So our printers are printing themselves. And it’s a perfect example in short run manufacturing of the great business case. We’re not doing this to make a point we’re doing this because it’s more economically advantageous to print these products in 3D than it is to use traditional manufacturing. So we’re very bullish, we have a long and complex and a like complexity here roadmap. This is not easy to duplicate we’re leveraging more than 5,000 patents from our core, leveraging 30 years of innovation that we’ve had in our printing business and we’re bringing it to bear into a market that really hasn’t had very large mainstream player with a brand that HP has a reputation that we have. So we’re really excited by the market, we’re happy with some ramp we’re doing on our partners and our certified channel partners we’re incredibly excited by the really impressive ecosystem co-innovators with us Nike, BMW, Johnson & Johnsons, Siemens, JBL the list goes on both in materials as well as in customer.

[Shannon S. Cross:]

Great, thank you. And then my second quarter is just on PCs, I’m curious what kind of trends you’re seeing or how you’re thinking about the market clearly it’s been pretty weak and how you’re also thinking about some of these future products like the x3 and leveraging continue on because it’s sort of a -- it’s not a phone, it’s not a computer how do you see this market developing both near-term and then in the next couple of years with some of these new technologies?

[Dion Weisler:]

Yeah look we’re not surprised with the PC market I think we were one of the earliest to predict that these markets will continue to be challenged for quite some time and as a result of that we needed to take immediate action to get our cost in line with where the markets were. But over the long-term we sort of generally broadly agree with the analyst and where they expect things to land. We see continued declines in calendar quarter two, the markets projecting that it will improve in calendar quarter three and four and we tend to disagree now whether it’s low single-digits or mid-single digits I guess that’s up for debate and no one is perfect making those predictions. But I think things are getting better. To your sort of second point on some of these new categories I think as the technology improves as we’re able to fit more power into smaller platforms we yet to have this continuous evolution of the continuum all the way from mobile up to work station and these lines are beginning to blur and that enables us to create new products in new categories like Elite x3. That technology is not going to slow down it’s only going to accelerate. So I think we’ve got to start looking as an industry at the entire spectrum all the way from phones to work stations. Think about that market think about how those hard lines were characterized in the past and how those hard lines will begin to break down in the future and Elite is incumbent enough to reinvent what the category is capable of and whether that be the success we’re having with our x2 or the new category trading products like x3 it’s all about changing that continuum. So we continue to have a very highly disciplined approach to this business. We segment, we segment again we navigate the heat in the market and we predict where we think the heat is going to be. We constantly challenging ourselves on price function value for our customers we’re always taking cost out of the system and we have to a massive innovator and I think we’re doing all of that as well.

[Diana Sroka:]

Thank you, Shannon. I think we have time for one more question please.

[Operator:]

Our next question is from Kulbinder Garcha of Credit Suisse.

[Kulbinder Garcha:]

Thanks. Just a couple of clarifications for me, in terms of the supplies I understand as you said many times today and before this going to stabilize by the end of 2017 but specifically on the year-on-year decline 10% constant currency this quarter, does that year-on-year decline start better from here given the lower channel inventories that you talked about the initiatives you put into place or could it be uneven for the next few quarters just I’m trying to understand whether just the decline gets a little bit easier? And then on free cash flow was there anything one-time in nature that drove that free cash flow number this quarter to help you? Thanks.

[Cathie Lesjak:]

Thanks, Kulbinder. On the supplies I think the right way to think about it is a 16% decline in supplies revenue the fact that there was 6 points of currency so you’re down 10% constant currency, but you’ve got 7 points of channel inventory correction that I believe is you don’t continue to correct channel inventory on a go forward basis. So really when you’re looking at I guess at least sometimes you refer to as real supplies growth or decline we’re at about minus 3. And we obviously as we go through 2017 we expect that that will continue to improve so that it stabilizes by the end of 2017. But again largely in line with what we expected. Then from a free cash flow perspective a couple of things, first off where we saw particularly strong performance within the cash conversion cycle. If you look back to Q1 our cash conversion cycle was minus 15 days and we now at minus 24. And we basically hit on every one of those metrics Dion mentioned it, it was a companywide initiative in which we educated and help people become even more conscious about cash flow. We enlisted the help our sales reps in getting collections done. It was an incredible team effort and something in many ways we’ve instituted now kind of permanent changes and permanent initiatives around that free cash flow and the cash conversion cycle. I also just really briefly want to mention the fact that it our free cash flow on a year-to-date basis also includes about $170 million of separation cash outflows, which obviously are more one-time in nature.

[Kulbinder Garcha:]

Thank you.

[Dion Weisler:]

Thank you all for joining us today. I hope you’d agree we delivered really solid results here and we did exactly what we said we would do and that’s important to us as a leadership team. We do know how to execute regardless of market conditions, where we don’t stick our head in the sands here. We understand what’s going on in the market and how to adjust our organization accordingly. We’re delivering on our financial commitments; we’ve made solid progress more work to do. We’re executing across core growth and the future and lots of proof points there we’re shifting to higher margin on growth product segments and we’re sitting this company up for long-term success. So thank you very much.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.