HP Inc

NYSE:HPQ

Earnings Call Transcript 2019-Q1

[Operator]

Good day, everyone, and welcome to the First Quarter 2019 HP, Inc. Earnings Conference Call. My name is William and I will be your conference moderator for today’s call. At this time, all participants will be in listen-only mode. We will be facilitating a question and answer session towards the end of the conference. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes.

And I would now like to turn the call over to Beth Howe, Head of Investor Relations. Please go ahead.

[Beth Howe, Head, Investor Relations]

Good afternoon. I am Beth Howe, Head of Investor Relations for HP, Inc., and I would like to welcome you to the fiscal 2019 first quarter earnings conference call with Dion Weisler, HP’s President and Chief Executive Officer; and Steve Fieler, 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 on our website shortly after the call for approximately one year. We posted the earnings release and 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 the forward-looking statements that involve risks, uncertainties and assumptions.

For a discussion of some of these risks, uncertainties and assumptions, please refer to HP’s SEC reports, including our most recent Form 10-K. HP assumes no obligation and does not intend to update any such forward-looking statements.

We also note that the financial information discussed on this call reflects estimates based on information available now and could differ materially from the amounts ultimately reported in HP’s Form 10-Q for the fiscal quarter ended January 31, 2019 and HP’s other SEC filings.

During this webcast, unless otherwise specifically noted, all comparisons are year-over-year comparisons with the corresponding year-ago period. For financial information that has been expressed on a non-GAAP basis, we have included reconciliations to the comparable GAAP information. Please refer to the tables and slide presentation accompanying today’s earnings release for those reconciliations.

And now I’ll turn it over to Dion.

[Dion Weisler, President and Chief Executive Officer]

Thanks, Beth. Good afternoon and thank you for joining us. In Q1, we once again delivered top and bottom-line growth. We continued to demonstrate our ability to deliver on our EPS, generate free cash flow and we remained focused on positioning the company to long-term sustainable growth.

While this quarter had many areas of strength and progress against our plan, it was an unexpected challenge in supplies and we had more work to do there. First, let me cover the highlights for the quarter and then talk about business more broadly.

In quarter one, we delivered revenue of $14.7 billion, up 1% or up 2% in constant currency. Non-GAAP earnings per share of $0.52, an increase of 8% and in line with our outlook and we generated strong free cash flow of approximately $700 million returning almost $1 billion to shareholders in the form of stock repurchases, and dividends.

Our results demonstrate the continued vitality of our innovation across the portfolio as well as our ability to execute and adapt in a tough environment. Our strategy remains consistent and a key part of that strategy is our focus on continuing to refine our business model to match changing customer needs and market conditions.

This is one of the core strengths of our organization. We have a proven track record of leveraging change to create opportunities.

Let’s go through the performance of each of our businesses, starting with Personal Systems. Our Personal Systems team continues to perform at a high level driven by relentless focus on execution and profitable growth. In quarter one Personal Systems revenue grew 2% and delivered strong 4.2% operating margins. We are improving our product mix and managing our costs.

As expected, the first half headwinds we previously shared with you are playing out. But we are navigating them well. We are also strengthening our position in strategic segments where we see pockets of growth and delivering differentiated and premium hardware services and solutions.

In January, we kicked off CES with a bold line-up of innovative first and modern lifestyles, changing workplaces and immersive gaming. For consumers, we introduced the new Spectre x360, the world’s first 15-inch laptop with an AMOLED display for exceptional clarity and color.

We announced the world’s first quantum dot on glass display providing movie theater quality visuals at home and we showcased the world’s first AMD-based Chromebook bringing the power of cloud applications to a broader range of customers.

We also introduced solutions designed to power the workforce workplace and work styles of the future. We launched the third generation of HP Sure View Technology, further protecting users against visual hacking and with more than 70% of U.S. workplaces using open concept designs, we unveiled the world’s first display and first all-in-one with an integrated privacy screen, giving workers confidence in their security, and privacy.

We also expanded our gaming portfolio with innovation that creates even more immersive experiences to take gaming to new heights.

We debut the world’s first 65-inch gaming display with integrated sound box and launched the new OMEN 15 featuring HP’s fastest display refresh rate 240 hertz to help gamers stay ahead of the competition.

We also remain focused on driving innovation and growth in key vertical segments. This quarter, we introduced a variety of education-centric Chromebooks, simple, secure and shareable devices that enable schools to empower the next generation of innovators and leaders.

And in Retail, we launched a new point-of-sale solution including the strategic collaboration with PayPal specifically designed to small and medium-sized retailers and hospitality owners.

In print, while we have made progress against our strategy growing hardware revenue, share and operating profit dollars, our supplies performance did not meet our expectations this quarter. So this is what I want to cover first.

Supplies revenue was weaker than anticipated, particularly in EMEA, with supplies declined 9%. As you know, we look at our Supplies business in terms of our four box model, install base, usage, share and price. The two factors that varied from our plan were a decline in share and to a lesser extent pricing. We saw this more significantly in our commercial channels which is having the largest impact on office supplies.

There are several factors contributing to the change in customer purchasing behaviors. More commercial customers are purchasing supplies online and while we have leading share online, it’s at a lower percentage than our share with traditional commercial resellers and in-store retailers. In addition, as macro uncertainty has increased, we have seen further price sensitivity among customers pressuring both our share and our Supplies pricing.

The combination of these two factors negatively impacted HP’s Supplies share. It also changes our assumptions in the full box model for the remainder of the year. As a result, we no longer expect supplies to be flat to slightly up in fiscal 2019.

On a related note, we continue to maintain the levels of channel inventory under our Tier-1 ceiling and monitor Tier-2 inventory where we had some visibility. However, we continue to fulfill orders likely over the multiple quarters based on our original share assumptions which we now believe were overestimated. This resulted in additional HP Supplies in the ecosystem including the unmonitored downstream portion.

In summary, this is what led to the challenges in Supplies. Now let me tell you what we are going to do about it and Steve will provide additional details. We are taking actions to lower the level of supplies inventory in the markets to be consistent with our new share assumptions.

And we are implementing additional share improvement plans including online programs, targeted marketing and brand protection to promote the value of HP original supplies in terms of quality, sustainability, and environmental impacts.

The team’s agility and ability to respond to challenges gives me confidence in how we will manage through this environment. We are taking actions and importantly, we are maintaining our non-GAAP EPS and free cash flow outlook for the full year.

As Enrique talked about at our Security Analyst Meeting, our markets are changing and we must keep evolving our business and business models. This is why we are focused on accelerating our strategy to more contractual sales which we expect will have two benefits diversifying our profit pool through services and securing a higher share of the supplies of these units.

Both Instant Ink and Management Services are examples of these models. The Instant Ink subscriber base continues to have impressive growth. We have now rolled out the program in 18 countries and continue to see strong adoption rates.

In Management Services, our machines in field number is growing double-digits and we are scaling our NPS coverage for the expanded opportunities for our premier channel partners in both the A3 and A4 categories. We are also evolving our business to include products to generate a larger portion of their lifetime profitability at the time of purchase.

This includes, not only products like Sprocket, but also our HP Smart Tank and HP Ink Tank printers that can print up to 8,000 color pages before more ink is required. These printers not only deliver strong total cost of ownership, they deliver the quality and durability that customers expect from HP Original Inks. Our print innovation continues to help define this business.

In Home, printing products like HP Tango X, the world’s first smart APP-based home printer helping us to make printing relevant again in modern homes and to a new generation of uses. This quarter, Tango launched in APJ and expanded into new countries in EMEA. This printer has been called the smartest and most elegant printer on the market.

In Office Printing, our push into the contractual A3 market continues with the introduction of finishing capabilities on a range of systems that helped to drive affordable color printing best-in-class performance and energy efficiency. We now have 9% A3 market share, which up 1.1 points since last year.

In Graphics, we introduced the Design To Print portfolio of Autodesk University to help users experience the speed and simplicity of HP PageWide XL and large format printing solutions. This kind of innovation paired with our transition to services is how we will reinvent the print category and deliver on our long-term opportunities.

Looking at the 3D printing business, we are expanding both our production and prototyping install base across the automotive, industrial, consumer and healthcare markets. Millions of final production parts are now being produced each quarter on the Multi Jet Fusion platform and the range of applications in printers is incredible.

As part of our Multi Jet Fusion portfolio expansion, this quarter we began ramping shipments of our 300, 500 solutions targeted at the prototyping market. We also continue to execute on our 3D printing metals technologies with partners including Volkswagen, and GKN.

As I speak with CEOs across multiple industries, the fourth industrial revolution is here and it’s shaping up to be one of the most significant opportunities of our lifetime. The future of manufacturing and production is digital and is becoming a mainstream topic as businesses look to change the way they design, manufacture, and deliver new products to their customers.

Leaders from the corporate world, government and academia recognize there is incredible potential to not only unlock new economic growth, but to also drive a more sustainable industrial revolution with new re-skilled workers. HP is leading the industry forward to democratize manufacturing with their 3D printing technology. This continues to be an enormously exciting part of our business.

To sum up, HP delivered results consistent with our financial outlook, and we are generating strong cash flow and investing in the future to create long-term value. We know we have work to do to manage through the current Supplies dynamics and that’s exactly what we are going to do.

We will continue to play our own game, execute our strategy with rigor, and focus on driving sustainable long-term growth. Our markets will continue to change and evolve and we will focus on adapting and reinventing.

With that, I’ll pass the call over to Steve to go through additional details.

[Steve Fieler, Chief Financial Officer]

Thanks, Dion. Looking at the company’s Q1 financial results, we delivered revenue growth with non-GAAP EPS growing even faster. And while our respective business results were mixed, we are making good progress across our core growth and future strategy in important areas. In others, we have more work to do.

As always, we will continue to balance where to invest and capture opportunities on one hand and where to drive efficiency or fix challenges on the other, all with a focus on creating long-term shareholder value. Looking at the details of the first quarter, starting with the top-line, net revenue was $14.7 billion, up 1% or up 2% in constant currency.

Regionally, in constant currency, Americas declined 2%, EMEA was up 2% and APJ 11%. Gross margin was 17.8%, flat year-over-year. Sequentially, gross margins were up 20 basis points driven by improved rate in both Personal Systems and Print.

Non-GAAP operating expenses were $1.6 billion, up 1% driven by an increase in SG&A. Non-GAAP net OI&E expense was $57 million for the quarter. We delivered non-GAAP diluted net earnings per share of $0.52, up $0.04 or 8%, with a diluted share count of approximately 1.6 billion shares.

Non-GAAP diluted net earnings per share excludes amortization of intangible assets of $29 million, acquisition-related charges of $10 million, restructuring and other charges of $55 million, non-operating retirement-related credits of $12 million tax adjustments of $55 million and a tax-related impact on all these items. As a result, Q1 GAAP diluted net earnings per share was $0.51.

At the segment level, in Personal Systems we are pleased with our results and ability to navigate the current environment. We have demonstrated a strong track record of execution and financial performance and demand for our products remains strong.

Revenue in the first quarter was $9.7 billion, up 2% against a tough year-over-year compare and industry-wide supply constraints. Operating profit was $410 million, up $75 million versus last year. Operating margins were 4.2%, up 70 basis points year-over-year driven by better pricing, and mix partially offset by higher costs and currencies.

Sequentially, operating margins were up 50 basis points driven by better pricing and mix, as well as cost favorability, partially offset by currencies. By customer segment, Consumer revenue was up 1% and Commercial revenue was up 3%. By product category, revenue was up 6% for notebooks, down 3% for desktops, and up 3% for workstations.

In calendar Quarter four, our market share was 23.6%. We continue to execute our strategy and focus on growth areas such as premium and gaming, and at the same time leverage the scale of our business including our supply chain and go to market.

In Print, our results were more challenged. We grew hardware revenue, increased our unit share, and continued to make progress in our contractual offering. However, this performance was offset by disappointing total Supplies revenue.

Let me start with some comments on Supplies and then I’ll summarize the rest of the Print results. First quarter Supplies revenue was $3.3 billion, down 3%, which is below our expectations driven primarily by EMEA.

During the quarter, we saw a slowdown in sell-through from Tier-1 to Tier-2 channels. Therefore, consistent with our Supplies sales model, we reduced our revenue sell-in so that we would maintain channel inventory levels below our tier-1 ceiling.

The size of this slowdown made it increasingly apparent that inventory head grown in the ecosystem including the downstream portions beyond our reporting visibility. This was supported by new share insights. Previously, we had relied primarily on lagging and incomplete market share surveys.

But as the install base of newer, connected toner-based products has increased, and become more statistically significant in key geographies we have gained incremental telemetry data. This new telemetry data indicated that each piece Supplies’ share and particularly in our office business, was significantly lower than what we had assumed in our four box model.

We have size with the potential incremental inventory impact used in the ecosystem, as well as changed our go forward supplies growth assumptions. As a result, as Dion described, we expect to lower the inventory in the entire ecosystem enabled by reducing our Tier-1 channel inventory.

The impact of this action will create an approximately $100 million headwind to Supplies revenue for the remainder of FY 2019 or roughly 1% of total Supplies revenue. We expect this impact combined with the lower go-forward Supplies share and pricing assumptions to result in Supplies revenue decline of approximately 3% for the year.

In addition, it is important that we tightened the levels of total inventory available in the ecosystem going forward. By doing this, pricing should improve. Therefore, we will be fine tuning our operations and further reducing our channel inventory ceilings. Also, we need to enhance our business management systems including more telemetry data to improve the quality of our inputs.

Our four box model is only as good as its assumption. With some of our recent enhancements in both big data and software, and an increasing installed base of newer, connected, toner-based products, we expect to have an increasingly clearer picture of Office Supplies share. The four box model remains our best predictor of Supplies demand. It does require a combination of data analytics and judgment to accurately forecast our Supplies results.

Finally, it’s important that we continue making the right returns-based investments, including the investments required to win back share. We have made good progress with previously implemented cost actions which help support these investments and we will continue to focus on a lean cost structure going forward.

Now looking at the Print business overall, total Q1 revenue was $5.1 billion, flat year-over-year Operating profit grew $22 million versus the prior year and operating margin was 16.2%, up 50 basis points. The primary drivers of the year-over-year margin improvement were expense management partially offset by unfavorable gross margins.

Total hardware units were up 3% with Commercial units up 4% and Consumer units up 2%. In calendar quarter four, each piece market share was 41.1%, while the overall markets declined. We continue to take advantage of opportunities to place NPV positive units.

Turning to cash flow and capital allocation. Q1 cash flow from operations was $862 million and free cash flow was $673 million. In Q1, the cash conversion cycle was minus 35 days. Sequentially, cash conversion cycle improved three days, with a three day increase in the payable outstandings, a one day increase in days sales outstanding and a one day decrease in days of inventories.

We returned $720 million to shareholders through share repurchases and $249 million via cash dividends in Q1.

Looking forward to the rest of FY 2019, keep the following in mind related to our overall financial outlook. We continue to expect a headwind from currency. In Personal Systems, we expect CPU supply constraints through the first half of calendar 2019 with improvements in the second half and we expect the cost from the overall basket of Components and Logistics to improve compared to Q1 levels.

In Print, we expect Supplies revenue to be approximately minus 3% for the remainder of the fiscal year. For Corporate Investments and Other, we expect the quarterly runrate expense to be approximately $175 million per quarter. Also, as I have said before, we remain committed to driving productivity and investing for growth at the same time.

Effective cost management remains a critical element of our success in very competitive markets and we’ll continue looking for ways to operate more efficiently and effectively.

In addition, for the full year, we expect our non-GAAP tax rate, which is based on our long-term non-GAAP financial projections to be 16% in FY 2019. Taking these considerations into account, we are providing the following outlook. Q2 2019 non-GAAP diluted net earnings per share to be in the range of $0.50 to $0.53, Q2 2019 GAAP diluted net earnings per share to be in the range of $0.45 to $0.48.

We are maintaining our full year fiscal 2019 non-GAAP diluted net earnings per share to be in the range of $2.12 to $2.22. We expect full year fiscal 2019 GAAP diluted net earnings per share to be in the range of $2 to $2.10 and full year free cash flow of at least $3.7 billion.

We continue to expect to return approximately 75% of free cash flow to shareholders through a combination of dividends and share repurchases over the course of the full year.

And now, let’s open up the call for questions.

[Operator]

[Operator Instructions] And today’s first questioner will be Shannon Cross with Cross Research. Please go ahead.

[Shannon Cross, Cross Research]

Thank you very much. I wanted to understand and you gave a lot of disclosure during the call on Supplies, but I guess, Dion, when you look at it, I mean is this something that could be fixed to get back to flat? I know it’s secular, but one – I guess, you would just start with the copier initiative and what’s going in 3D printing and some of the growth areas that you would be able to offset some of the core pressure.

So, I guess, maybe from a bigger picture standpoint, how are you thinking about this business over time? And should we think about it long-term as something that’s stable? Or will it just be sort of a constant decline? And then I have a follow-up.

[Dion Weisler, President and Chief Executive Officer]

Okay. Thanks, Shannon for the question. I kind of summarized it in terms of – if we accept that really as a loss of share to a lesser extent pricing, the question is why we are losing share and what are we going to do about it. It’s true that these challenges, this is third-party alternatives and not new. We are essentially fighting the same war but we are now engaging on a new battlefield and it’s called online.

Historically, we’ve been very strong in our traditional channels including both Retail and the Commercial channel. You see online office is a growing market for alternatives and we are seeing more of that commercial customers moving to online where our overall share while still leading is not as large. The growth of online and the access that enables to remain in aftermarket alternatives is also creating incentives for aftermarket alternative manufacturers to invest in breaking on better technology faster.

And this has resulted in a faster deceleration in our aftermarket share on some newer platforms and we expect it through this reactive market. So while we’ve been expanding our presence in the omni-channel, we need to do it faster and we need to do it more effectively. We need new weapons to fight on the new battlefield.

We just can’t bring a musket to a drone fight. So most importantly, what are we going to do about it? First, we need to continue to evolve that go to market and expand our online initiatives as well as our targeted marketing and we’ll certainly be doing that.

The second thing we have to do is, we’ve got to expand our order processes to protect our brand and discourage counterfeit and other IP infringements who got to support the value proposition of original supplies in terms of quality, sustainability as well as environmental impacts.

Thirdly, we have to shift our business models in order to diversify our product pools of services and securing a higher share of the Supplies for those units. Both Instant Ink and Managed Print Services are great examples of these models.

And then finally, we’ve got to also evolve our business to include products that generate a larger portion of the lifetime profitability at the time of purchase. So, we know the situation that we are in. We’ve named it and we also know what we need to do about it.

[Shannon Cross, Cross Research]

Okay. Thank you. And then, can you just talk maybe, Steve, a bit about cash flow? You’ve maintained the cash flow, I know it’s still early in the year, but given the pressure on Supplies, where are your other levers that you are going to be pulling? And how susceptible is it if we do see more of a PC slowdown, just, I guess, your comfort level with the cash flow guidance? Thank you.

[Steve Fieler, Chief Financial Officer]

I guess, I am comfortable with the at least $3.7 billion even similar to what we’ve done in prior quarters when we look at our free cash flow outlook. We do take into account our forecast on earnings, our volume, especially in Personal Systems and cash conversion cycle.

And then from an earnings perspective, while we do have the challenge in Supplies we are taking actions including cost actions to address some of that. So net-net, on earnings, volume and CCC perspective, I feel confident in the guide and as I mentioned last quarter worth repeating.

We finished Q2 with a negative cash conversion cycle of minus 35 days, compared to minus 32 days at the end of Q4. I’d acknowledge that we would likely have some upside to that minus 32 days at the end of last quarter. I still see that as potential upside which helps further confirm and give confidence to me - at least $3.7 billion number.

[Operator]

And the next questioner today will be Wamsi Mohan with Bank of America Merrill Lynch. Please go ahead.

[Wamsi Mohan, Bank of America Merrill Lynch]

Yes, thank you. Dion, can you talk about why you are seeing this particularly in EMEA in Supplies and the risk that this spreads to other regions as well and how confident are you about this prediction of 3% decline, you and that you have actually captured in the appropriate amount of data and telemetry that's guiding that given that this is not the first time that we will see the Supplies reset and I have one more question.

[Dion Weisler, President and Chief Executive Officer]

Yes, no problems, Wamsi. I’ll start then I am sure, Steve may want to chime in as well. I guess, the underlying causes we outlined during the call was the surprise around our assumptions about share were wrong, and it was most specifically in EMEA. There are two main drivers that I’ll comment on. The first is the omni-channel impact, and the second is our operational visibility.

Let me start with the omni-channel. The omni-channel and the consumer preferences to buy online are definitely not new. What we’ve seen is more Commercial customers purchasing online. And while our online business has been growing significantly, and we have leading share online, it’s at a lower percentage than our share with traditional commercial resellers and install retailers.

Where we went wrong is that we had incorrect supply share assumptions in our four box model regarding the plans to Supplies selling in quarter one 2019 and in prior quarters. This made it very difficult to spot the buying behavior change as a trend but didn’t necessarily all happen in Q1, but now that we understand the trend better that has driven the change in our expectations for share going forward.

In addition to that, the macro uncertainty is also increased and we’ve seen further price sensitivity among customers pressuring both our share and our Supplies pricing. If I turn to operational issues, since we don’t have much visibility into the downstream channel ecosystem, and we were maintaining CI levels below at tier-1 ceiling, we did not see clearly enough that we had an issue.

However, we saw lower sell-through during the course of quarter one and adjusted that operational plan to reduce shipments consistent with our Supplies sales model. We also received new share analytics, it’s a really important point and we are able to triangulate that our revised share assumptions were below our previous ones.

And so, in retrospect, when the new share insights are applied, we believe that our inventories in the whole ecosystem began growing in prior quarters. However, the prior share assumptions made it hard to call this out as a trend as this was masking the underlying problems.

And as a result of that, we’ve adjusted out go forward four box assumptions and sized the inventory impact as they've talked about, to be approximately $100 million.

[Steve Fieler, Chief Financial Officer]

And then, I’ll just add to that and address more specifically on the extent beyond EMEA and then even the sizing of that $100 million, so in Q1, certainly the revenue weakness and the incorrect share assumptions were primarily in EMEA. And while the multi-tiered channel dynamics that’s been described are not unique to EME, they are more prevalent there.

That said, the competitive trends are global and both the changes in the customer buying with more commercial customers purchasing Supplies online and pricing that Dion just referred to are more macro in nature. And therefore, when we revisited our four box assumptions, we did look at all regions and revised our share and pricing accordingly.

And that’s all embedded in our guidance. And then, specifically, I think you indicated just what happened before, in terms of the channel itself, just to put context, we are talking roughly 1% of our total Supplies stream of over $13 billion.

And while there are some things that are clear with data there are others that we need to triangulate on and we can’t be precise in all fronts especially because we don’t have visibility into the entire downstream unmonitored ecosystem. So, our approach here was to triangulate on a channel inventory number across the ecosystem by analyzing different data points.

We compared our old share assumptions with the revised ones that have been informed by big data and we also look at prior sell-in statistics and CI trends. We did estimate how much additional downstream channel inventory may exist and we believe $100 million as the right estimate.

[Wamsi Mohan, Bank of America Merrill Lynch]

Okay. Thanks for all that color. I appreciate that. And then, if I could just quickly follow-up. Can you talk about the longer-term print margin assumptions for this segment, now given that we're talking about some structural headwinds here on Supplies? Thank you.

[Steve Fieler, Chief Financial Officer]

Yes. So, and we obviously delivered 16.2% in the quarter and when we entered FY 2019, Dion and I had a good conversation. We actually took proactive steps to address some of the growing global uncertainty we saw at the time we began some targeted expense reductions. We didn’t anticipate this Supplies challenge.

But we saw, reacted quickly and further tightened OpEx. It’s important that we continue investing in the areas where we expect good returns like our growth initiatives, placing the right units and evolving our business model to be more contractual.

That’s important for us to continue. It is why though that we must continue to drive more productivity and more efficiency in the model. I do acknowledge that maintaining the 16% going forward is tougher given the Supplies challenge. But it does remain our target.

[Operator]

And our next questioner today will be Katy Huberty with Morgan Stanley. Please go ahead.

[Katy Huberty, Morgan Stanley]

Thank you. Good afternoon. Just following up on the printer supplies discussion, it sounds like some of the visibility into market share it came on the back of the telemetry data which is something that you've talked about for a couple of years why, this quarter did that show you a picture that actual market share was different than you’ve thought? Why weren’t the systems flagging that ahead of time and do you have to invest in technology, so that you can get better insights out of that data? And then I have a follow-up

[Dion Weisler, President and Chief Executive Officer]

Thanks, Katy. To help you understand it better, let me explain little bit our methodologies that drives the share assumptions we use on office supplies which is primarily toner-based and how it’s changed. It’s worth noting that it’s different than ink-based products where we’ve historically had more telemetry data.

Previously, we had used periodic third-party survey data and market research aggregators to estimate toner supply shares. We did not have a statistically significant sample from the system telemetry and the instrumentation nor the capabilities that calculate share for toner-based products and the installed base.

We have had this data for ink-based products, but due to the limited number of machines that were phoning home in commercial due to enterprise firewall constraints and otherwise unconnected devices, we’ve had to build the connected installed base over time.

And so, with the increasing mix of newer products and the growth of the connected installed base combined with improvements in big data, we’ve been able to move to a better source of share database on system telemetry. It's worth noting that the share we calculate through big data reflects the share at the time the customer hits the print button, which maybe month after they actually purchased the Supplies.

So, when the new share insights are applied, we believe that the inventory in the ecosystem have been growing during quarter one and previous quarters and the combined effect of the change in market dynamics impacting share and the lack of visibility to the change resulted in excess HP Supplies in the market and lower Tier-1 channel sell-through.

So, having said all that, we will obviously need to continue to refine the telemetry data and our instrumentation and business management system as we move forward.

[Katy Huberty, Morgan Stanley]

Thank you for that. And then, just shifting the discussion to PCs. How is the industry reacting to lower memory prices? Is it not at all getting pass-through and prices to customers? Or it was holding on to the lower cost a contributor to the margin expansion for both you and some of your peers this quarter?

[Steve Fieler, Chief Financial Officer]

Yes. When we look at our margin in Q1, and certain of the ASP portion of that, the large sort of greater than 50% increase in ASPs was actually driven by mix with the remainder being overall pricing dynamics. And we did see some favorability from Q4 to Q1. We would expect continued favorability from Q1 to Q2 on the overall commodities.

Exactly, how this will play out in our margins going forward is going to depend though on overall market and pricing dynamics. Obviously, we’ve got currency volatility. We are continuing to see and likely headwinds from currency will partially offset some tailwinds we are seeing on commodity costs.

[Operator]

And our next questioner today will be Toni Sacconaghi with Bernstein. Please go ahead.

[Toni Sacconaghi, Sanford C. Bernstein]

Yes. Thank you. Your guidance for EPS for Q2 is a little bit – the midpoint of it is a little bit below Street consensus. Should we interpret that as you are feeling now more confident in the low-end of your EPS guidance, particularly in light of the Supplies news or do you believe that consensus has mis-modeled seasonality for the year? And I have a follow-up please.

[Steve Fieler, Chief Financial Officer]

Yes, I think in general, our Q2 EPS guidance is in line with normal seasonality and I think the comment has been on the full year. So maybe I’ll comment on full year and get back to Q2. Full year, we are maintaining our guide to $2.12 to $2.22 non-GAAP EPS. Confident we can deliver across the various puts and takes.

We have factored in now the lower Supplies revenue. The CPU constraints which we had already taken into account and FX headwinds, but we have multiple levers to offset as I mentioned earlier expect continue to drive in cost management, whether be the in-flight initiatives that we can accelerate or a continued push around digital transformation.

I mentioned components on the prior call, or excuse me, prior question and so how much of that sticks against to be seen. So, we do have levers but if I reflect back at SAM, when I laid out the FY 2019 guidance, and broke it up between the segments, which was about $0.05 to $0.12 on a year-over-year increase, and shares and other about $0.05 to $0.08 of the year-over-year increase.

I think we are generally in line with that on the segments more strength in Personal Systems and now we have some challenge on the Print overall and on the corporate and other year-over-year favorability on shares to a lesser extent OI&E. But we are investing more in corporate investments and other. So, net-net feel confident holding the midpoint of our guide.

[Toni Sacconaghi, Sanford C. Bernstein]

Okay. And then, just back to Supplies. So, if Europe is a 30 year business and was down 9%. That suggests that Supplies outside of Europe was down zero. And I guess, the question would be, why does the rest of the world not start to migrate towards sort of negative sell-through growth on a go -forward basis? And accordingly, why do you have confidence in minus 3% growth?

[Steve Fieler, Chief Financial Officer]

Yes, so, as I mentioned earlier, clearly the issue in Q1 was and pertain to EMEA and even the share delta from the assumptions that we previously had to what we now use our share was primarily the delta was in EMEA.

That being said, we looked and reanalyzed the entire business across all regions and with minus 3%, we believe it’s a prudent guide. It does take into account of both, number one, the channel inventory and the entire ecosystem. Again, it's about a point of it, the $100 million tick down. And the second is, we did revise our shares and pricing assumptions worldwide. So net-net, we think that it’s the right way to look at the business even though the issue in Q1 was primarily EMEA-based.

[Operator]

And our next questioner today will be Steve Milunovich with Wolfe Research. Please go ahead.

[Steve Milunovich, Wolfe Research]

Thank you very much. Just one question. In the past, at some of the SAM meetings, you've talked about $1 billion negative hit from commodity costs. I am just curious, how much of a positive are you expecting this year and the swing, one would expect it could be quite substantial.

You’ve also in the past, talked about the ability to offset that by taking out $1 billion of cost annually in the business and just that’s a normal course of thing we have to do. Are you still on track to take out about $1 billion from the cost base?

[Steve Fieler, Chief Financial Officer]

So, let me respond to that. On the first piece, actually on a year-over-year basis, cost – and commodity costs are still a headwind. Sequentially, they are tailwind, but we are still, from a year-over-year basis, going through the period where costs had risen for some time. I think whether it be headwind or tailwind, I think the reality is that the market adjusts pretty rapidly to different changes and component cost and other short-term factors such as currency.

So, how much actually falls to the bottom-line or how much we need to mitigate through additional productivity is very dependent on the circumstances.

In terms of the actual dollars that we’re driving, we do remain on track to our productivity initiatives.

It’s an area where we’ll continue to look to accelerate candidly, given some of the Supplies challenges. But this is really in the DNA of HP and I am very confident our ability to drive expense actions where we need to.

[Dion Weisler, President and Chief Executive Officer]

And then the only thing I would add to that is that, we won't lead the market down on price. We obviously need to remain competitive in the marketplace. So we’ve been investing heavily in innovation and we believe our customers are valuing that innovation and the demand signal for our products remains really strong.

[Operator]

The next questioner today will be Rod Hall with Goldman Sachs. Please go ahead.

[Rod Hall, Goldman Sachs]

Yes, I just want to come back to the telemetry question and ask you if you could give us some idea of where you are in the process of improving telemetry? So, have you – and what kind of sample you have?

So, should we expect that you to continue to look at this and improve telemetry over time and therefore maybe come back to it and continue to adjust this inventory in the channel? Or is everything pretty much done now and you wouldn’t expect any changes? And then, I have a follow-up.

[Steve Fieler, Chief Financial Officer]

I guess, for starters, the four box model historically has been a relatively good predictor and I think we need to acknowledge that it’s not perfect. There is data and science. There is also judgment and art to it. And to your question, we do need to get better with the telemetry data and I’ll sort of bow it up to more analytics and business management system in general.

And so, what it really depends upon, I would sort of call it a few dimensions, it’s really the quantity, quality and speed of the telemetry. And from a quantity perspective, it’s installing and shipping more of our installed base with – the kind of newer toner-based telemetrics such as the Jet Intelligence. But it’s also ensuring that we have access to that.

And so increasingly, the penetration of our installed base and quantity is important. But also then, the quality and speed in which we can analyze this information, apply more predictive BI analysis around it. So, we are investing in this and I would expect it to get better over time. But I – go to my opening comments, we have been pretty good at predicting it with the four box model and this is fine tuning.

[Dion Weisler, President and Chief Executive Officer]

And with all that said and done, I think, it’s also important to note something I mentioned earlier. We need to shift our business models in order to diversify our profit pools through services and securing a higher share of the Supplies for these units.

And sort of when I am encouraged by the work that we are doing around Instant Ink and growing our installed base there as well as manage print services, they are great examples of that model. And secondly, what I talked about is, we've got to evolve that business to include products that generate a larger portion of the lifetime profitability at the time of purchase.

[Rod Hall, Goldman Sachs]

Okay. And then, I wanted - on the follow-up, I just wanted to come back to the cash flow guidance and I guess, do you see that there is any way, I guess, the issue it makes no sense that you could take working capital out. But this is the year when Personal Systems we’re not expecting a lot of growth whereas we got double-digit growth the last couple of years.

So, it seems like a tougher year to take working capital out. So I just wonder if there is anything else you can do to help us bridge back to the cash flow guidance or is it just the case that the cash flow guidance is a little bit more aggressive considering the underlying fundamentals?

[Steve Fieler, Chief Financial Officer]

I already highlighted the likely improvement in cash conversion cycle and that obviously brings cash into the current year. When the Personal Systems business grows sequentially, even if it’s small growth, it does pull cash into that period.

And so, while we are not anticipating the growth that we have seen in prior years, we do – we are factoring in what we think the revenue and volume trajectory is for Personal Systems and as long as that business has sequential growth, it is a cash generator.

[Operator]

And our last questioner today will be Ananda Baruah with Loop Capital. Please go ahead.

[Ananda Baruah, Loop Capital]

Hi, great guys. Thanks for taking the question. Two if I could. Just going back to Supplies, Dion, is there any way for us to think about how you are thinking about what long-term, new normalized Supplies rates will be and I appreciate all the detail that you guys gave.

But how should we be thinking about – what's the best way for our models after 2019 for us to be thinking about it, best you can tell right now? And then I have a follow-up. Thanks.

[Dion Weisler, President and Chief Executive Officer]

Yes, look, first, as Steve alluded to in our outlook, we’ve taken into account the approximately $100 million headwind from reducing inventory in the Supplies ecosystem. This is about a point of Supplies revenue as Steve highlighted and the remainder of the decline is to base – is really based on factoring in the revised share and the pricing assumptions.

And the future outlook beyond 2019 will depend upon a number of things including the progress we are making across each of our four box drivers and the pace of our business model evolution that I referred to at the last question. So, at this time, just as we ordinarily do, we are not going to comment about future years.

[Steve Fieler, Chief Financial Officer]

And maybe to provide a little additional context, I’ll just sort of give an update of where we are on the four box. Enrique shared at SAM, what we thought the various four box arrows looked like and if Enrique were doing that today, given the changes we’ve seen, driven by the commercial channel and evolving marketplace, Dion described, first, we wouldn’t expect any changes to installed base or usage.

Where we would expect some changes in Office whereas we have previously had an arrow going up of gaining share. Given the new data, we’d actually expect share to be down to a lesser extent on Office, pricing which was a down arrow driven by the mix more to A3. We offer additional commentary that there would be pricing pressures again, as we described on the call.

On Home, almost all the boxes will remain the same except for share, given that a smaller portion of Home does have toner-based products and so the share, we have previously had going up, it would still be going up but not as, I guess, strong of an arrow going up, as we had said at SAM.

[Ananda Baruah, Loop Capital]

That’s helpful. I appreciate that. And then just a quick follow-up, reiterating the EPS guidance, should we think any differently now about the potential for the upper half of the range. My personal – I mean, our assumptions were that, you actually had a good chance to beat the EPS guidance previously.

And so, maybe there is still a good degree of confidence to land the upper half as well. But how should we think about that where it stands today? That’s it for me. Thanks.

[Steve Fieler, Chief Financial Officer]

Well, as always we view and take a very prudent view to our guidance taking into account all of the puts and takes and risk and opportunities that we see and we provide a range around it. I am not going to comment specifically other than we have a range and we got confidence we can deliver within it.

[Dion Weisler, President and Chief Executive Officer]

And we hold that range.

[Steve Fieler, Chief Financial Officer]

Yes.

[Dion Weisler, President and Chief Executive Officer]

So, thanks everyone for taking the time to join us. We remain confident in our business. We are reaffirming our full year EPS and full year cash flow guidance. We are relentless in both managing our costs and reinvesting to create long-term value.

We know we have work to do manage through the current dynamics and that’s exactly what we're going to do and what you should expect from us. And we will continue to play our own game. We will execute to our strategy with rigor and focus on driving sustainable long-term earnings and cash flow growth. Thanks very much.

[Operator]

And the conference has now concluded. Thank you for attending today's presentation and you may now disconnect your lines.