HP Inc

NYSE:HPQ

Earnings Call Transcript 2018-Q2

[Operator]

Good day, everyone and welcome to the Q2 2018 HP, Inc. Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] And please note that today’s event is being recorded. I would now like to turn the conference 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 2018 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 1 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 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 on HP’s Form 10-Q for the fiscal quarter ended April 30, 2018 and HP’s other SEC filings. During this webcast, unless otherwise specifically noted, all quarterly comparisons are year-over-year comparisons with the corresponding year ago quarter. 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 will hand it over to Dion.

[Dion Weisler, President and Chief Executive Officer]

Thanks, Beth. Let me start by saying it’s great to have you back on the Investor Relations team. I am quite pleased with our Q2 performance. It’s yet another quarter of strength, growth and consistent execution of our reinvention. We are creating opportunities and taking advantage of favorable market dynamics to deliver strong revenue and profitability across our segments and our regions. This was our 10th quarter since separation and you are seeing a sharp focus on innovation and execution, continued improvement on our business fundamentals, and an intense focus on long-term and sustainable growth.

Our winning formula is straightforward. We are focusing on delivering operational excellence, predictable shareholder returns and prioritizing profitable growth, all aligned to our core growth and future strategy. Looking at our Q2 fiscal year ‘18 results, we added $1.6 billion to the top line growing revenue 13% to $14 billion. We grew top line and bottom line in both Personal Systems and Print. We delivered nearly $1 billion of free cash flow in the quarter and repurchased $800 million of stock and we delivered non-GAAP EPS of $0.48, an increase of 20% and at the higher end of our range. The market remains dynamic and competitive, but I am confident in our strategy and ability to continue to grow faster than the market and out-execute the competition. We are playing our own game pursuing the heat in the market and our strategy is paying off.

Let me review some of the highlights. Personal Systems delivered another exceptional quarter. Net revenue was up 14% and that comes on top of 10% growth a year ago on quarter two. This is now six consecutive quarters of double-digit growth. This performance and the innovation coming out of this team is nothing short of incredible. HP continued to outperform the PC market with broad-based growth across all segments and product categories, not only are we seeing strong growth in notebooks, this is also the third consecutive quarter of double-digit desktop growth.

In the first calendar quarter, we outgrew the PC market by 4.6 points, achieving 22.7% share. While we are proud of these results, share gain continues to be an outcome not an objective. Profitable growth continues to be our focus. In quarter two, operating profit dollars grew double-digits and operating margins expanded 60 basis points to 3.8%. Our team continues to drive improved productivity and product mix. One of the ways we drive value and profitable growth is through careful segmentation and aggressively pursuing targeted opportunities. One example is healthcare where safety, security and regulatory compliance are critical.

We recently introduced a portfolio of products purpose built for healthcare providers by optimizing clinical workflows with RFID readers and improving collaboration capability for telemedicine. And this is connected to our innovation story and the sprinkles of magic we deliver that continued to be recognized in the market as first and best.

This past quarter, we introduced the world’s first Chromebook detachable, the world’s widest curved all-in-one and the world’s first detachable in tablet with an integrated privacy screen. This is how we win with partners and customers. Much of our success is driven by the strength of our commercial channel and retail relationships.

For us, the channel is a great competitive advantage. We are deeply committed to listening to our partners, understanding their customers’ needs, and delivering innovation that drives growth. We are coming off three of our largest partner events of the year where we met with thousands of partners from all regions. Their response was tremendous and we are consistently hearing that our innovation engine and go-to-market programs are setting a new standard in helping them to grow their businesses. In addition to the core, we remain focused on our strategic growth areas. In Personal Systems this quarter, we made progress in areas such as retail point-of-sale and device-as-a-service, where we saw strong double-digit growth. In fact, we closed the deal with a major global fast food chain to implement both retail point-of-sale and device-as-a-service solutions.

Just like Personal Systems, the Print business delivered the trifecta of revenue, profit and share growth in quarter two. Total Print revenue was up 11%, with growth across commercial hardware, consumer hardware and supplies. We are seeing growth across all regions and broadly across the business. Print units were up 13% and supplies revenue grew 8% further supporting our confidence in the health of the Print business for the long-term. The overall Print hardware market grew 1.7% in the first calendar quarter and we grew faster than the market adding 1 point of share. With our continued productivity initiatives to improve supply chain efficiency and lower product costs, we remain strongly positioned to place NPV positive units. We are on a journey to reinvent print and our focus on this enabled us to achieve several important and innovative milestones. We launched the HP NVISS Printer to the International Space Station in April, where it is currently in use alongside HP Z-Book workstations. We are investing in next-generation printing with a focus on modern lifestyle innovations like the new mobile-optimized HP LaserJet Pros and our expanded offering of HP voice-enabled printing.

In A3, we continue to onboard new partners and gain year-over-year share. This business is strategic to us given the higher attach rates of supplies and services. Our A3 solutions provide our partners and customers with cost savings, increase manageability, and peace of mind with best-in-class security. As an example, ImageNet Consulting lowered its service cost are more than 15% using HP Smart Device Services remote management. And I am pleased with the progress in S-Print since the acquisition closed this past November. We continue to rationalize SKUs and streamline processes while we are working on new innovations and adding features and options that our customers and partners truly value.

Finally, in our graphics solutions business, we closed our largest packaging deal ever with ePac Flexible Packaging, a leader in web-based digital printing that quadrupled its capacity with HP Indigo presses. We also unveiled the industry first hybrid latex printer capable of printing on both rigid and flexible materials for the print service provider community. As you know, the 3D printing business is a huge opportunity for us and one where we aim to disrupt the $12 trillion global manufacturing market. The growth trajectory and momentum behind this business continues. We are seeing an increase in customers placing repeat orders, upgrading their systems for higher volume manufacturing and scaling with double-digit unit installations.

Forecast 3D, one of the oldest and largest 3D manufacturers in the U.S. is expanding and upgrading its entire fleet to our 4210 solutions as they respond to growing demand and full-scale production. They are expecting to produce millions of parts on Multi Jet Fusion in the coming year. And Jabil, one of the world’s largest contract manufacturers is now deploying Multi Jet Fusion in the U.S. and Asia as part of their distributed manufacturing strategy. We continue to make incredible progress across key industry verticals and expand into new geographies, including our market entry into Mexico. Overall, I am very pleased with our Q2 results and the efforts of our team. But as always, we have more work to do. We are never satisfied and we see plenty of room for us to grow, innovate, improve our cost structure and adapt to an ever-changing marketplace.

Now, before I turn the call over to Cathie, let me address the other news we announced today. After 32 incredible years and the last 11 years as Chief Financial Officer, Cathie and I have decided it’s the right time to transition CFOs before she retires in early calendar 2019. Today, I am thrilled to announce the appointment of Steve Fieler, our Head of Treasury as HP’s new CFO. Cathie will become our Interim Chief Operating Officer lending her experience and leadership to help define our future of operations. Both appointments will begin on July 1. On behalf of all HP employees and shareholders, I want to thank Cathie for her remarkable contributions and commitment to shareholder value. We have been on an amazing journey together since separation and Cathie deserves tremendous credit for helping drive our performance and reinvention as a company. She is being my partner for the last 3 years and I could not ask for a better confidant and leader. Cathie has also cultivated incredible shareholder respect through their integrity, transparency and world-class financial discipline. She has built a deep and talented finance organization capable of leading us into the future. Steve is a great example of that bench. Having worked with him for many years, I am excited to have him join my executive leadership team and I am looking forward to our partnership. Steve has an impressive background as a leader in finance and operations and has the reputation for operational excellence and accountability. He is a great addition to the team as we continue to drive long-term profitable growth.

With that, I am now going to turn the call over to Cathie to provide more details on our performance and financial outlook. And Cathie after 46 earnings calls, make this a good one.

[Cathie Lesjak, Chief Financial Officer]

Thanks, Dion. I have been privileged to serve as CFO for the past 11 years or as you noted 46 quarters, but who is counting. It has been an honor to work as part of the team with so many outstanding dedicated employees during a time of tremendous change and reinvention. With Steve taking over as CFO, I am convinced HP is in excellent hands. As many of you already know, Steve is an experienced finance and Investor Relations executive with a deep understanding of HP. He will be an outstanding CFO and a great successor.

Now, looking at the results for Q2, we continue to deliver consistent results, with strong revenue growth and increases in operating profit dollars, free cash flow and earnings per share. Net revenue was $14 billion, up 13% or up 10% in constant currency. Our performance remains strong across businesses and geographies. Regionally, Americas grew 7%, EMEA was up 21% and APJ grew 13%. Gross margin was 19.3%, up 10 basis points year-over-year. Sequentially, gross margin was up 150 basis points higher than normal seasonality primarily driven by favorable rate in Personal Systems and improved mix. Non-GAAP operating expenses of $1.7 billion were up 16% driven by the addition of S-Print, along with incremental R&D and go-to-market investments to support growth.

Non-GAAP net OI&E expense was $84 million for the quarter, with a non-GAAP tax rate of 16% and a diluted share count of approximately 1.6 billion shares. We delivered non-GAAP diluted net earnings per share of $0.48. Non-GAAP diluted net earnings per share primarily excludes restructuring and other charges of $57 million, acquisition-related charges of $45 million, amortization of intangible assets of $20 million, debt extinguishment cost of $126 million as well as non-operating retirement related credits of $53 million and the related tax impact on all of these items. It also excludes a net gain of $424 million for tax adjustments. The gain was a result of several tax settlements across various jurisdictions covering a multiyear period. The gain was partially offset by an additional provisional revaluation of the deferred tax assets due to U.S. tax reform and a $671 million tax indemnification. The tax indemnification amount is associated with our Tax Matters Agreement with Hewlett-Packard Enterprise Company since these tax settlements were based on pre-separation tax years. As a result, Q2 GAAP diluted net earnings per share, was $0.64.

Turning to the segment, Personal Systems net revenue remained very strong, delivering $8.8 billion, up 14%. We are encouraged as the results continued to be broad-based reflecting execution against our strategy and an innovative product portfolio. By customer segment, consumer revenue was up 10% and commercial revenue was up 16%. By product category, revenue was up 15% for notebooks, up 16% for desktops and up 9% for workstation. Our disciplined focus on market segmentation enabled profitable share gain. Personal Systems operating profit dollars grew year-over-year and operating margin was 3.8%, up 60 basis points as we lack some of the largest commodity cost increases we saw last year. We will continue to balance pricing to adjust for the impacts of currency and commodity and logistics costs and other market dynamics.

Turning to printing, revenue was $5.2 billion in the quarter, up 11%. We are pleased with this growth and are encouraged by the progress we are making integrating S-Print. Total hardware units were up 13% with consumer units up 4% and commercial units up 88%. Sequentially, commercial units were up 10%. In calendar Q1, overall print unit share was 42%, up 1 point year-over-year and up 4 points sequentially. Q2 supplies revenue of $3.4 billion was up 8% year-over-year or 6% in constant currency. The supplies mix of total print revenue was 65% and we continue to operate the lower ceiling for supplies channel inventory. We also had good momentum in our contractual offerings. We are pleased with the strong growth in Instant Ink, where we are growing our global subscriber base and in MPS, we continue to grow revenue. Print operating profit grew $19 million and operating margin was 16% in the quarter, down 1.3 points year-over-year, but up 20 basis points sequentially. The primary drivers of the year-over-year margin decline were strong unit placements and go-to-market investments largely as a result of adding S-Print. Additionally, we saw increased raw material cost in the quarter, which we expect to continue throughout the year.

Now, turning to cash flow and capital allocation, Q2 cash flow from operations was $1.1 billion and free cash flow was $937 million. For the full year, we now expect free cash flow to be at least $3.7 billion. Cash conversion cycle was minus 30 days, improved 3 days sequentially driven by a 7-day increase in days payable outstanding offset by a 3 day increase in days sales outstanding and a 1 day increase in days of inventory. Increases in days of inventory and days payable outstanding are largely a result of negotiated payment terms and leveraging our balance sheet. Consistent with the cash priorities described in Q1 in connection with U.S. tax reform, we successfully completed a $1.85 billion debt tender during Q2. Additionally, we had capital returns of $801 million in share repurchases and $227 million in cash dividends. For the full year, we still expect to deliver returns toward the higher end of our long-term range of 50% to 75% of free cash flow.

Before turning to guidance, I want to reiterate the importance of focusing on our cost structure. Because of the synergies we see in Print, including the result of the acquisition, combined with other cost efficiency opportunities, we will be expanding our current restructuring program. Compared to the high-end of our prior restructuring outlook, we expect the restructuring costs to increase by $150 million to $200 million. This includes both labor and non-labor related actions. We still expect to complete the plan by the end of fiscal 2019, including these incremental actions. We expect that the total gross annual run-rate savings before reinvestments to increase by at least $75 million over the higher end of the previously communicated range beginning in fiscal ‘20.

Looking forward, keep the following in mind related to our financial outlook. In Personal Systems, we expect that logistic and overall component cost will continue to increase throughout FY ‘18. This headwind and any net impact on re-pricing will ultimately depend upon actual market demand, competitive dynamics and any impact from currency. In printing, we have began to see increases in raw material costs in Q2 and expect that pressure to continue during the second half. In addition, we expect to continue to have strong positive NPV unit placements, which should continue to push the hardware revenue mix higher. We will also continue to leverage our balance sheet if we see attractive economic opportunities to do so.

For the full year, we expect to deliver our productivity initiatives as guided at SAM. We are also updating the way we estimate our quarterly non-GAAP tax rate in order to provide better visibility across quarterly reporting periods. Going forward, we’ll report our non-GAAP earnings incorporating a 16% tax rate calculated using long-term non-GAAP financial projections. The non-GAAP tax rate is based on our financial forecast and all currently available information and maybe subject to change for a variety of impacts, including the company’s ongoing analysis of the tax act over the measurement period, the rapidly changing global tax environment or other changes to the company’s strategy or business operations. Additionally, we would expect our cash tax rate to be 16% plus or minus 2% for the full year.

With all that in mind, we expect Q3 ‘18 non-GAAP diluted net earnings per share, is in the range of $0.49 to $0.52. Q3 ‘18 GAAP diluted net earnings per share is in the range of $0.47 to $0.51. We are raising our full year fiscal ‘18 non-GAAP diluted net earnings per share to be in the range of $1.97 to $2.02 and our full year fiscal ‘18 GAAP diluted net earnings per share to be in the range of $2.75 to $2.82.

With that, let’s open up the call for questions.

[Operator]

Thank you. And we will now begin the question-and-answer session. [Operator Instructions] And our first questioner today will be Steve Milunovich with UBS. Please go ahead.

[Steve Milunovich, UBS]

Thank you and congratulations to you Cathie and Steve. Cathie, do you expect the printer margin to rise sequentially through the next two quarters or whether that will be offset by the higher raw material costs and higher unit placements? And specifically what raw material costs are you referring to that are going up?

[Cathie Lesjak, Chief Financial Officer]

Sure. So, in terms of the raw material costs what we are really seeing is increases in resin, plastics as well as DRAM, because there is DRAM also in the printer. Resins and plastics are largely up as a result of oil prices increasing. So that’s where what we are seeing there. In terms of how to think about the OP rate over time, we don’t really have an explicit rate for operating profit for print in any particular period. We do long-term expect that the margins will be 16% to 18%, which we talked about at SAM, which was pretty consistent with what we have seen historically. When you think about the progress in the, I would say, near to mid-term the way to think about it is as we integrate S-Print, ramp the A3 business as well as the 3D business and execute on our productivity initiatives, we do expect that the margins will improve from the 16%, but that’s really a kind of a mid-term kind of comment.

[Steve Milunovich, UBS]

Okay. And could you update us in terms of the buyback, I am not sure last quarter you were at that point ready to talk about the use of repatriated cash and so forth?

[Cathie Lesjak, Chief Financial Officer]

So in the first half, we repurchased shares for a total price of about $1.3 billion. In the second quarter, we did about 800 million of share repurchases, which is higher than what we have typically done. When we look forward to the rest of the year, we will be active in the market, but the second half will really be consistent with our capital return priorities. So, we have talked about the fact that we are going to be towards the higher end of 50% to 75% of our free cash flow this year and our buying in the second half will be consistent with that. And keep in mind that, that towards the higher end of 50% to 75% applies to now the increased free cash flow of at least $3.7 billion for the year.

[Operator]

And our next questioner today will be Paul Coster with JPMorgan. Please go ahead.

[Paul Coster, JPMorgan]

Yes, thanks for taking my questions. So, I will move it to one if I may. Cathie, if you can just give us some sense of what the organic versus the acquired growth rate for the printer business was that would be helpful? And Dion, I guess we are seeing some potentially transformative consolidation taking place in the printer industry, arguably part of the end game, it must be trying for opportunities and risks. Can you just talk to us about what the near-term tactical opportunities might be given some of the strategic uncertainty amongst the two players? And also how it’s changing your view of what HP will do during this end game?

[Cathie Lesjak, Chief Financial Officer]

So, why don’t I start? Paul, as we talked about, I think it was last quarter or maybe even the quarter before, we are integrating the S-Print business into the core HP print business frankly as fast as we can. And the reason for that is that it’s going to drive shareholder value. So as a result of doing that, there isn’t really a way to meaningfully separate what is organic growth versus inorganic growth for the Print segment. I think the best way to think about it is that Print by all means has had a very strong first half in terms of performing. We are very pleased with the top line growth as well as the unit placements, the margin expansion and frankly the supplies revenue growth as well.

[Dion Weisler, President and Chief Executive Officer]

And thanks Paul for the question, the print industry is no different to the Personal Systems industry. I think we have seen the Personal Systems industry consolidating over many years and it’s still consolidating today and we are able to continue to grow in the Personal Systems businesses as you’ve seen us do double-digits for the past six quarters by playing our own game. And I think the Print business is no different. There is not room in an essentially flat market for 14 players. And so I think naturally over time that market will consolidate as well, but I don’t subscribe to the fact that it has to be done through acquisition. I think we made a very strategic execution of the Samsung print business that was a technology acquisition as well as an acquisition of some incredibly talented people, but it wasn’t a market share play. As we look at the market today, we feel that from a technology perspective we are very well positioned in both ink as well as laser in A4 as well as A3 and we continue to move towards a service-orientated business. And so by adding the sprinkles of magic that we do across the portfolio, I expect that we can outpace the market. Having said all of that, I have always said that M&A is an important part of our strategy that we wouldn’t surprise anybody, any of our investors or the industry with what we would do that. When we do think about M&A, it would leave somewhere on our strategy page and would need to bolster our strategic intent and accelerate our strategy that it will be returns based and it would be weighted against other organic options and alternative uses of cash that it would come at a reasonable cost and be modest in size and that we’ll remain thoughtful and disciplined and ensure that the opportunities are compelling and will maximize shareholder value.

[Operator]

And our next questioner today will be Sherri Scribner with Deutsche Bank. Please go ahead.

[Sherri Scribner, Deutsche Bank]

Hi, thank you. Cathie, you mentioned the operating expenses were up a little bit sequentially related to the S-Print acquisition. Can you maybe help us think about how operating margins will trend now that Samsung is in the business? Should we seem operating expenses at these levels or do you expect to be able to bring operating expenses down somewhat as we move through the year based on the cost-cutting initiatives?

[Cathie Lesjak, Chief Financial Officer]

Sure. So, Sherri, what I actually said was the OpEx is up largely as a result of S-Print, but not exclusively. We are also – we have made incremental investments in R&D and go-to-market as well and I believe that those will continue. Now, clearly when you look at either the total company or specifically the print business, our S-Print business has been in investment node in the first half. And as we talked about at the total company level that it would be accretive by about $0.01 in the full year. So, we do expect it to shift to making some money, which is always good. But keep in mind that even as it makes the money, it’s going to be dilutive to operating margin rates. I think that, that’s very important when you think about the trajectory of the print operating margin rate in fiscal ‘18.

[Sherri Scribner, Deutsche Bank]

Okay, great. Thank you. And then just looking at the supplies business, it’s trending very strongly and clearly you have turned that segment around, how should we think about growth in Supplies, I think we have talked about kind of flat maybe slight growth this year, I know there is some inorganic pieces in there, but it seems like you are trending well ahead of that supplies?

[Cathie Lesjak, Chief Financial Officer]

So, Sherri, what we expect that kind of the sum of Q2, Q3 and Q4 on a year-over-year basis that we would say see 5% to 7% growth in constant currency. That’s what we expect for FY ‘18. For FY ‘19 we expect that supplies will be flat to slightly up. Once we have an apples and apples comparison with S-Print in both years.

[Sherri Scribner, Deutsche Bank]

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

[Toni Sacconaghi, Bernstein]

Yes, thank you and congratulations Cathie on your tenure and all best wishes for the future.

[Cathie Lesjak, Chief Financial Officer]

Thank you.

[Toni Sacconaghi, Bernstein]

I have a question and a follow-up please. First on PCs, ASPs were up about 7% year-over-year and we have seen real strength in ASPs for the last several quarters. Perhaps you can help us understand how much of it you think is coming from DRAM versus changes in your mix like gaming and accordingly sort of how sustainable once DRAM starts declining, how sustainable are ASP increases in PCs going forward or what’s sort of the right way to think about ASP changes in a more normalized environment? And I have a follow-up please.

[Cathie Lesjak, Chief Financial Officer]

So Tony, we saw good progress as you mentioned in ASPs both year-over-year as well as sequentially. And in both cases, the positive mix shift that we are driving into premium is having a significant impact on the ASPs and we believe that those will continue to be the case. We also saw as you mentioned we definitely saw some help from DRAM pricing or pricing that we took as a result of commodity cost increases. And depending on what happens to commodity costs that piece will obviously go up or down. And then from a foreign exchange perspective also with the tougher dollar, we could see some ASP increases as a result of currency as well.

[Toni Sacconaghi, Bernstein]

But was the impact from mix greater than the impact from price from DRAM and I will ask my follow-up, just on supplies back to printer supplies, I think last quarter you had said that the contribution from S-Print was about 6 points and I know it’s become more monies now, but would it be fair to sort of assume that the contribution from S-Sprint was sort of in that vicinity this quarter and were there any changes to your channel inventory? I think you said you were under your ceiling, but it’s a little bit of a different commentary from prior quarters where I think you said you were within your range. So just the follow-up on the ASPs and then supplies please? Thank you.

[Cathie Lesjak, Chief Financial Officer]

Sure. The impact of mix on ASPs was material and greater than the pricing impact. In terms of supplies, I will go back to what I said earlier, we really have integrated the business here. So, it’s really not – we are really not able to meaningfully determine what was S-Print’s contribution to supplies versus the core, because we are rationalizing SKUs, we are now selling more HP SKUs than S-Print SKUs and therefore are those supplies S-Print supplies or are they HP supplies. So it’s just gotten. It’s not just gotten money, it’s just well-integrated, which is exactly what you want us to do, because that’s what’s going to drive the value. In terms of the channel inventory, I think we changed our commentary I want to say two or three quarters ago, when we really now are managing below a ceiling and we have been consistently below the ceiling for supplies frankly since we made the change to our supply sales model.

[Dion Weisler, President and Chief Executive Officer]

And Toni, I think we have consistently said and you and I have talked about it, we have this relentless focus on execution and we have a continued confidence in their predictive value of the full box model, where you can expect us to drive continued improvements across all full boxes to maintain supply stabilization in ‘19. We anticipate the headwinds that Cathie mentioned earlier. We have contemplated them. We have captured them in the expectations and we have guided that for the rest of ‘18 as well as ‘19.

[Operator]

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

[Katy Huberty, Morgan Stanley]

Thank you, Cathie. My congratulations as well. I have two questions, I will just ask them together. First of all, can you bridge the $0.05 guidance increase on EPS from roughly $1.95 to $2 at the midpoint? And then secondly from a free cash flow perspective, if you look at the last couple of years over half of free cash flow came in the back half of the year, which would suggest that you could do $4 billion plus this year, why is seasonality different this year versus the past couple of years?

[Cathie Lesjak, Chief Financial Officer]

So, Katy since it’s my last call, I think I am going to say if I give an inch you take a mile, I am just on the free cash flow. So, when we look at the first half free cash flow, we are very pleased with the performance. It’s really based on the strength primarily of Personal Systems to use Dion’s term a double-double and a double-double is pretty significant from a timing perspective to cash flow given the negative cash conversion cycle of Personal Systems. We expect Personal Systems to do well in the second half although compares are getting increasingly difficult. So I think that’s one piece. The other piece is that in the first half we did have some one-time positive cash flow items that won’t repeat themselves. And then when you think about the bridge for the $0.05 increase that you talked about, it’s largely as a result of the share repurchases that we did in Q2 that were in excess of what we had originally expected when we provided the guide. So, you have got the follow-on effect of that as well as obviously the share repurchases that we are going to do in the second half consistent with returning towards the high-end of the 50% to 75% of our free cash flow.

[Operator]

And our next questioner today will be Shannon Cross with Cross Research. Please go ahead.

[Shannon Cross, Cross Research]

Thank you very much. And I echo the congrats, Cathie. I hope you get to take a nice long vacation sometime in 2019.

[Dion Weisler, President and Chief Executive Officer]

Thanks for saying that, Shannon in 2019.

[Shannon Cross, Cross Research]

As I say but not before that.

[Dion Weisler, President and Chief Executive Officer]

Exactly.

[Cathie Lesjak, Chief Financial Officer]

I have got a lot to do, I am not going anywhere.

[Shannon Cross, Cross Research]

In terms of the 3D print business, Dion, maybe you can talk a bit about what you are hearing from customers, how you are seeing the ramp, I know you have a few new products that will be coming out this year, so just curious as to how it’s progressing in line or ahead of your expectations?

[Dion Weisler, President and Chief Executive Officer]

Yes. Look, I am really excited about the leadership position we have taken in 3D printing and the segment where we operate in a very short period of time, we are on the path towards disrupting this $12 trillion global manufacturing industry. But it’s a long path, I have always said this is a 5 to 10-year journey and we are making the investments today to really secure shareholder value both today and for the future we are seeing significant sales momentum, including repeat orders from customers as well as service bureaus. We are expanding our adoption across key verticals. We are seeing more than 50% of the customer benchmarks. So these are when a customer is contemplating buying 3D printing they will give us a file and they say can you make this path for us who want to see and test this path. And we are of course checking what that path is for and then 50% of the cases therefore production applications, which is really what differentiates us with this technology. And some of the recent highlights, Forecast 3D, one of the oldest and largest 3D manufacturers in the U.S. has expanded its Multi Jet Fusion footprint. It’s upgrading its entire fleet to our 4210 solutions and as they respond to the growing demand, they are expecting to produce millions of parts on Multi Jet Fusion in the coming year. Jabil, one of the largest contract manufacturers is now deploying Multi Jet Fusion in the U.S. and Asia as part of its distributor manufacturing strategy. And this quarter, we also continue to grow unit placement across all verticals and geographies, including new customers in the automotive and electronics industry. And we officially announced our market entry into Mexico as well. So stay tuned this is a great business for the long-term. We remain really confident.

[Shannon Cross, Cross Research]

Thank you. And then Cathie, I had a follow-up on cash flow, from like I know I think it’s going to probably kick you if I ask this, but from a 50,000 foot level, this year obviously cash flow has been up year-over-year or should be and so how do we think about it from sort of recurring going forward? Obviously, PCs play into it, but when we think about more sort of the recurring level of cash flow, it should come off the model maybe you could talk about puts and takes that happened this year that will or will not repeat?

[Cathie Lesjak, Chief Financial Officer]

Sure. Actually, thank you for the question. I probably should have mentioned this when we were talking about cash flow. Over time, free cash flow basically grows in line with earnings. And so we do get a timing benefit when Personal Systems has a particularly strong growth sequentially, because of course it has a negative cash conversion cycle, but over time, the cash flow that it generates is going to be largely, its profit. And so there is a pull-in for cash. And so over the long-term you should really think about free cash flow being in line with earnings.

[Operator]

Our 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. Congrats to you Cathie from me as well. Your margins have been pretty robust despite these commodity headwinds. Can you just talk about the commodity environment in terms of memory both DRAM and NAND I think you said that some commodities will be a headwind, but how have they changed relative to your expectation from last quarter or are you seeing any impact from extended lead times in some items like passive? And I have a follow-up for Dion.

[Cathie Lesjak, Chief Financial Officer]

Wamsi, we have seen an increase in commodity costs. If you think about going back to our security analyst meeting, we actually thought it was going to flatten out in Q4 of last year or towards the end of Q4 of last year. So, we have seen an increase that at that time we had not expected. But as important as commodity costs are as well as by the way the logistics costs are also going up a bit, it’s really about how you respond. What are the tools at your disposal to figure out how you mitigate those types of increases and this team has just done a tremendous job at mitigating and managing in that environment. In fact, I put my money on them in a tough commodity environment. So think about it we have used things like pricing, we have used our supply chain scale, we have leveraged our balance sheet and then to go back to Toni’s question we have done a great job of driving positive mix. And so those are the types of things that we will continue to use to kind of manage this tough environment. And I have every confidence that we will continue to be successful.

[Wamsi Mohan, Bank of America/Merrill Lynch]

Okay, thanks Cathie. And Dion, as a follow-up to the question on the strategic changes that are happening, can you talk about the opportunity if you are seeing any that has been created for HP, particularly in managed print services and in the copier space given some of the events at Xerox and can you give an update on your Ink in the Office initiative as well? Thank you.

[Dion Weisler, President and Chief Executive Officer]

Sure. Look, the way I think about change in the marketplace is that change equals opportunity and so whilst these competitors that are distracted with structure and that generally presents an opportunity in the marketplace. So what we are doing is doubling down and playing our own game. If we are out in front of a customer making a call and our competitors are gathered around the water fountain, then we are out in front of the customer and that’s really where we want to be spending our time. I think we have incredible assets inside the organization. We are very focused on managed print services. There is no doubt the business model is shifting even in the traditional A4 space. It’s moving from transactional to contractual that’s happening at a different price in every country, but it is a mega-trend that we certainly want to be out in front of managed print services, we have been doing now for many years. And I think we have really mastered the art of how to manage this for a customer and the pipeline not only for managed print services, but device-as-a-service is really strong, so PC-as-a-service and increasingly customers are looking to have everything both at Print and Personal Systems and workstations and even 3D printing in the future as a service. So we remain focused on that.

With regards to Ink in the Office, it’s an important part of our overall strategy. We have two incredible technology platforms. We have an ink-based platform and we have a laser-based platform. And as we talk to a customer, we don’t sell them a technology, we understand what their needs are and inside a customer, every department, every user has an individual need. So the marketing department is going to want laser-based quality. They are going to be wanting really vibrant color when they print proposals, as same with sales inside Cathie and now Steve’s organization. They are a little more frugal and so they want to be able to see red and black, but we would like to see green on headlights, that’s good too, but it doesn’t require the same high-quality, you get incredible quality with ink, but just not that glossy kind of quality. And so that represents a really unique solution. That means that when we go to a customer we can provide this mix of hybrid solutions down to a departmental and individual basis that makes our offerings very unique and compelling. So that’s what we are focused on playing our game.

[Operator]

And our next questioner today will be Amit Daryanani with RBC Capital Markets. Please go ahead.

[Amit Daryanani, RBC Capital Markets]

Yes, thank you. Congrats on mine as well to you, Cathie. I guess two questions. First one when I think about the commentary you guys have on supplies for next year being, I think flat to slightly up? I understand you don’t want to breakdown the delta or kind of breakdown the delta between HP and S-Print, but the supplies commentary would suggest that your installed base is perhaps declining at a faster rate today post S-Print versus what it was before? Is that a fair assumption to take away from your commentary for supplies in fiscal ‘19 and if so when do you see the installed base starting to normalize as you go forward?

[Cathie Lesjak, Chief Financial Officer]

Amit, the core HP installed base, I don’t think is declining at a faster rate, but clearly, the S-Print portfolio will decline at a faster rate and part of that’s because of that nature of the units that S-Print put into the markets, but also because we have rationalized SKUs and that’s why it’s not meaningful to talk about S-Print separately from HP, because they are one in the same, the better job we do at integrating, the better value for our investors and the fact to the matter is you can’t separate the two.

[Amit Daryanani, RBC Capital Markets]

Got it. I guess maybe I am trying to get a sense of when do you think the combined installed base starts to normalize and have the same trajectory that maybe HP did a year ago? And maybe just my follow-up by the way, how do you think about FX within your guidance for the full year given the fact you have had some fairly volatile consumables as of late?

[Cathie Lesjak, Chief Financial Officer]

So, I think I take you back to the security analyst meeting, where we talked about kind of what we thought was going to happen at the home, the office and the graphics level in terms of the four-box model. I think that’s probably the place to go. So, from a home perspective, we did expect that the installed base would continue to decline, that from an office prospective we thought the installed base with the addition of A3 would be flat, and that from a graphics prospective we thought the installed base would be up. And that gives you a sense of what’s happening from an installed base, our expectations from an installed base perspective.

[Dion Weisler, President and Chief Executive Officer]

I think we continue to successfully execute those growth initiatives, but it takes time and we had certainly expected it to take time as we enter into a new $55 billion business, the A3 business, where we have very low market share, we know that it is going to take time to develop that business, but we remain really confident that we will achieve the 12% market share that we set out to achieve by 2020.

[Cathie Lesjak, Chief Financial Officer]

And I think it’s important when we talk about S-Print that you separate the A3 business which was a very small part of the Samsung print business. It was really all about the future technology that future with their technology and it’s the A4 piece of the S-Print business that we talk about on the installed base coming down pretty significantly and to Dion’s point as expected.

[Amit Daryanani, RBC Capital Markets]

And you might want to answer the second question on FX?

[Cathie Lesjak, Chief Financial Officer]

I am sorry can you remind me the question on FX?

[Amit Daryanani, RBC Capital Markets]

Yes, Cathie. I was just trying to get a sense on how you think about FX and the impact of FX, which has been fairly volatile baked into your July guidance for the full year guide?

[Cathie Lesjak, Chief Financial Officer]

Sure. So FX has been very unpredictable and when we think about where the dollar is trading today, we think about revenue kind of the impact of revenue as a result of FX for the total year would be approximately 2 points and obviously most of that impact – the vast majority of that impact was happening in the first half.

[Operator]

And the last questioner for today will be Jim Suva with Citigroup. Please go ahead.

[Jim Suva, Citigroup]

Thank you very much and Cathie you will be missed and the great results and outlook. My question is Cathie, [Technical Difficulty] investment into the Print business. Can you specify was that equal amongst S-Print and your core typical prints or more on the graphics side or the 3D print side, the supply side and maybe allocate – maybe just talk about where these incremental investments are being allocated? Thank you.

[Cathie Lesjak, Chief Financial Officer]

So, Jim, the biggest impact to FX was the addition of S-Print in the portfolio from a year-over-year perspective. But as I mentioned, we did make incremental investments in R&D and go-to-market and those are along the initiatives that frankly we have been talking about now for several quarters in A3 figures prominently in that, especially along the go-to-market lines. In terms of the specifics of how much is in the core, in the A3 space, S-Print, graphics, we don’t typically go into that level of detail, but I would say that you think about the initiatives that we have for growth and that’s going to help drive you to where the OpEx investments are being made.

[Jim Suva, Citigroup]

Great. Thanks so much for the clarification and detail.

[Dion Weisler, President and Chief Executive Officer]

Great. Well, thank you. We are at the top of the hour. I’d like to reiterate that that I am very pleased with the results of the quarter, but as always, there is more work to do. We never stop. We remain confident in our strategy and our ability to grow. Our reinvention is paying off. And I believe our best is yet to come. And finally, I again want to thank Cathie for her incredible partnership and I look forward to having Steve here on the call next quarter and to speak to you all then. Thanks so much.

[Operator]

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