惠普 (HPQ) 2016 Q3 法說會逐字稿

Welcome to the Q3 2016 HP Inc.

earnings conference call.

My name is Austin and I'll be your conference moderator for today's call.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Diana Sroka.

Please proceed.

Good afternoon.

I am Diana Sroka, Head of Investor Relations for HP Inc., and I'd like to welcome you to the FY16 third quarter earnings conference call with Dion Weisler, HP's President and Chief Executive Officer; and Cathie Lesjak, HP's Chief Financial Officer.

Before handing the call over to Dion, let me remind you that this call is being webcast.

A replay of the webcast will be made available shortly after the call for approximately one year.

We posted the earnings release and the accompanying slide presentation on our Investor Relations webpage, at www.hp.com.

As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today.

For more detailed information, please see disclaimers in the earnings materials relating to forward-looking statements that involve risks, uncertainties and assumptions.

For a discussion of some of these risks, uncertainties, and assumptions, please refer to HP's SEC reports, including our most recent Form 10-K and Form 10-Q.

HP assumes no obligation and does not intend to update any such forward-looking statements.

We also note that the financial information discussed on this call reflects estimates based on information available at this time and could differ materially from the amounts ultimately reported on HP's Form 10-Q for the fiscal quarter ended July 31, 2016.

For financial information that has been expressed on a non-GAAP basis, we've included reconciliations to the comparable GAAP information.

Please refer to the tables and slide presentation accompanying today's earnings release.

And now, I will hand it over to Dion.

Thank you, Diana.

Good afternoon, everyone, and thank you for joining us today.

I'm pleased with the progress we continue to make.

This quarter's results are all about focus and execution.

We continue to be disciplined to deliver in our core, gain momentum in our growth segments, and hit strategic milestones in our future initiatives.

Let me start with our overall performance in the third quarter.

We achieved all of our financial objectives.

We delivered non-GAAP net earnings per share of $0.48 above our previously provided outlook range.

We delivered solid free cash flow of $1 billion as a result of strength in Personal Systems and a continued focus on working capital metrics.

And we returned nearly $300 million of capital to shareholders through dividends and share repurchases.

As we move towards the end of our fiscal year, we are seeing the benefits of the significant productivity initiatives and restructuring actions we put in place at the start of this year.

We are on track to implement more than $1 billion of savings, providing us opportunity to invest back into our businesses to drive long-term success.

In Q3, our revenue trajectory improved, down less than 1% year over year in constant currency, driven by strength in Personal Systems, offset by expected declines in Printing.

As we've previously said, we believed overall revenue declines would moderate in the second half of the year and that is exactly what is happening.

The PC market improved slightly more than forecasted and we were well-positioned with an innovative product line-up and healthy channel inventory level.

We capitalized on market opportunities and gained share at the expense of our competitors, especially in the high-end premium category.

The innovation in our portfolio is serving us well.

We are building on a rich heritage and delivering experiences that amaze our customers and partners.

Our products and solutions contain the magic that differentiate HP from the competition.

This past quarter, our Printing and Personal Systems teams delivered awe-inspiring innovation.

The Spectre 13, that we announced in April rolled out in countries around the world, continues to elicit acclaim and praise, fueling our push into premium devices.

Likewise, the OMEN game platform is built for greatness, whereas those in the gaming world would like to say, domination, and new OMEN laptops and desktops all launched to rave reviews and strong consumer demand based on their performance and engineering power.

On the Commercial go-to-market side, customers are increasingly shifting from transactional to contractual buying, wanting everything as a service.

At the end of June, we unveiled our new PC-as-a-Service business model that is gaining interest from companies around the world.

Importantly, these premium gaming and service initiatives are all profit accretive.

Moving to Printing highlights, HP's presence at Drupa was unprecedented.

Our Graphics business sold a record 130 Indigo Presses; our large format & digital printers, including PageWide Technology, are accelerating the industry transformation from LO print to digital, opening new categories of packaging, print reduction, and specialized ink innovation.

During the quarter, we also unveiled the world's smallest all-in one inkjet printer, helping to reinvent the Printing experience for a mobile and socially connected consumer.

And earlier in May, we announced the world's first production ready 3D Printing System.

We continued to work with our ecosystem of manufacturers, co-development and strategic partners like Nike, BMW, Autodesk, Jabil, Johnson & Johnson, Safeway, Siemens and others and have now placed a number of demo units.

Our partners are pleased and enthusiastically engaged in putting our technology to work, Printing sample parts for automotive, consumer goods, medical, and other applications.

Most recently, BMW announced plans to use 3D Printing for the new Rolls-Royce Dawn and materials partners Evonik announced plans for a series of custom [pattern] materials on our open platform that will further 3D Printing as a viable form of manufacturing for many businesses.

Now turning to the segment-specific performance.

Personal Systems executed very well, with revenue growth, share gains, and improved profitability.

We outperformed both the market and all key competitors in our core business, while gaining momentum in our strategic growth segments, including Commercial mobility and services.

Sequentially, Personal Systems revenue grew by 7.5%, better than normal seasonality.

Our strong performance resulted in market share gains year over year and quarter over quarter in all three regions.

I've said many times, our focus is on profitable share gains.

We gained 1.8 points of PC unit share year over year in calendar Q2 2016, while delivering significant operating profit improvement.

Innovation, coupled with continued focus on cost management, was instrumental in driving these results.

I'm especially pleased with our consumer business, the strength of our high-end premium and gaming portfolios, supported improved gross margins both year over year and quarter over quarter.

In Commercial, we performed well but margins were pressured by an unfavorable mix shift to Chromebooks.

In the quarter, we had outstanding wins with customers like Volvo, where we signed a three-year device-as-a-service contract to deliver Elite PCs and workstations, together with Care Packs, factory services, and priority support to more than 25,000 users across all regions.

Shifting to Printing results.

In line with our expectations, revenue declined year over year in the third quarter, but with some improvement.

Starting with hardware, we've made steady progress, with unit sales down 10% year over year, as compared to 20% in Q1 and 16% in Q2.

On a quarter-over-quarter basis, hardware units grew 6%, well above normal seasonality.

This supported sequential market share gains of 2 points in laser and 1 point in ink hardware in calendar Q2.

The market remained very challenging and our progress was a direct result of disciplined and operational rigor.

We did what we said, by both reducing discounts, as evidenced by year-over-year improvements in constant currency ASPs and improving our cost structure to enable the more positive MPV unit growth sequentially.

Recall that not all printers are created equally.

Our key objective is to place hardware units with a higher usage of Supplies.

As a proof point for the 17th consecutive quarter, we gained share in the value multi-function laser printers, the strategic product segment given the associated higher Supplies usage.

We were more challenged in our business ink products, where we drove pricing discipline and lost some share.

While our Japanese competitors are talking about shifting their focus from share to profits, due to the strength of the Yen, it is not broadly evident yet that this is showing up in less aggressive pricing.

Turning to Supplies.

In Q3, we began to execute the sales model changes we discussed earlier in this quarter.

As we shared on our call on June 21, we made a strategic decision to evolve how we run and manage our Supplies business in recognition of the changing market dynamics, given global price transparency.

To [harmonize] pricing, we determined an increase in marketing combined with a reduction in channel inventory levels was necessary and we took the first step in the third quarter.

With continued support from our channel partners, the execution is on track.

We will continue to implement operational changes to our Supplies inventory management in the fourth quarter and will provide a further update on our Q4 earnings call.

In Q3, we also continued to make progress in our shift from transactional to contractual sales.

Managed print services revenue was up again year over year in constant currency and on the consumer side, we saw continued momentum in Instant Ink, our subscription-based supply service with cumulative enrollee growth and low churn.

Beyond Home and Office Printing, Graphics delivered another quarter of year-over-year constant currency growth.

Following our success at Drupa, we increased our HP Indigo manufacturing capabilities to fulfill orders, including 25 of the latest HP Indigo Presses for Shutterfly to support operations for the peak holiday season.

Our PageWide Web Press platform will deliver high quality and high speed on one press.

Installations are scheduled to begin this Fall and in corrugated packaging, the PageWide T Series deal signed at Drupa are in installation phases around the world.

Overall, we delivered on our financial commitments in the third quarter and I'm pleased with our progress; however, with the markets remaining challenging and somewhat volatile, we have more work to do.

We will keep our eye on cost controls while continuing to focus on executing our strategy, protecting our core business through solid execution, delivering our growth initiatives and investing in category creating opportunities for the future.

And now I'll turn the call over to Cathie.

Thanks, Dion.

Q3 results were largely in line with our expectations.

Net revenue was $11.9 billion, down 4% year over year as reported, or down just 1% in constant currency.

Our revenue trajectory improved significantly in the Americas and EMEA and APJ continued to perform well.

Gross margin of 18.3% was down 0.5 points year over year, driven by the unfavorable mix shift to Personal Systems and the reduction in Supplies, largely due to the impact of the changes in the Supplies sales model, partially offset by gross margin expansion across Personal Systems.

Not fully evident in the year-over-year compare is the steady progress the teams have made improving our cost structure.

Gross margin was down 1.1 points quarter over quarter, due primarily to unfavorable mix and competitive pricing in Printing, partially offset by favorable product premium mix in Personal Systems.

Non-GAAP operating expenses of $1.1 billion were down 25% year over year, primarily in SG&A, as we recorded gains from the divestiture of the Marketing Optimization software assets.

Recall that we leveraged these latest gains to offset the impact of the reduced Supplies into the channel related to the strategic sales model changes.

We also achieved year-over-year savings via the previously communicated productivity improvements and restructuring actions.

With the net expense of $65 million in OI&E, a non-GAAP tax rate of 21.5%, and diluted share count of approximately 1.7 billion shares, non-GAAP diluted net earnings per share was $0.48.

As compared to our previously provided outlook range, we recorded a higher gain from the divestiture as a result of closing more countries in Q3 than expected.

The impact of the reduction in Supplies revenue into the channel was in line with what we expected.

The net of these amounted to about a $0.02 shift into Q3 from what we had forecasted for Q4.

Non-GAAP net earnings per share primarily excludes restructuring and other charges of $36 million, more than offset by non-operating retirement related credits of $38 million and tax indemnification credits of $29 million.

As we noted on the Q2 earnings call, the tax indemnification changes relate to the tax matters agreement with Hewlett Packard Enterprise Company.

We expect that certain tax matters and the related indemnification effect will continue to change each quarter and will be recorded as adjustments in GAAP-only results.

On a GAAP basis, Q3 diluted net earnings per share from continuing operations was $0.49.

Turning to the segments.

Personal Systems net revenue was $7.5 billion, flat year over year and up 2% in constant currency.

Consumer revenue was up 8% while Commercial revenue was down 3% year over year, as reported.

We outperformed the market overall as well as in the Commercial and Consumer markets while staying focused on gaining profitable share.

We saw momentum in certain segments of the market, particularly in consumer and took advantage of the opportunities presented with innovative products including the X360, Spectre 13 and the new OMEN gaming portfolio.

As a result of our continued focus on growth opportunities beyond the core, we increased constant currency year-over-year revenue in Commercial and Mobility, especially detachables and in services.

Personal Systems ASPs were flat sequentially and down low single digits year over year.

We continued to see a decline in Commercial ASPs year over year given the increased mix of Chromebook; however, consumer ASPs improved both year over year and sequentially due to a strong premium mix.

Personal Systems operating profit rate was 4.4%, up 1.6 points year over year, driven by gross margin expansion and tight expense management.

Gross margin improvement was driven by cost reductions and premium mix, exceeding currency headwinds and competitive pricing.

Turning to Printing.

Net revenue was $4.4 billion, down 14% year over year, or down 10% in constant currency.

We made good progress, particularly in hardware placements.

Hardware units were down 10% year over year significantly better than 16% last quarter, as the cost actions we continue to implement increase the number of positive MPV units that could be placed.

We attribute approximately 5 to 6 points of the year-over-year decline to the market and the rest of the decline is split between less attractive units and channel inventory reductions in Q3 2016.

In Q3, Supplies revenue was down 18% year over year, as reported or down 13% in constant currency, in line with our expectations.

Approximately 7 points of the constant currency decline was associated with the planned reduction of the Supplies sales into the channel, with the remainder being a combination of the separation-related channel inventory build in Q3 2016 and declines in our Four Box Model drivers.

While Four Box Model drivers declined year over year, they performed in line with what we expected.

Q3 Supplies revenue mix was 64%, down approximately 3 points both year over year and sequentially, primarily due to the planned reduction of sales into the channel.

Supplies channel inventory was down year over year and within our targeted range.

Operating profit for Printing was 20.4%, up 3 points year over year, driven primarily by the gain from the Software Asset divestiture, in excess of the expected Supplies channel inventory reduction and marketing investments.

Related to the divestiture announcement on June 20, we recorded a gain of $280 million in SG&A.

This was greater than the estimate of $245 million, provided on the June 21 Supplies call, due to the acceleration of the close into Q3.

This will not have an EPS impact overall for the full fiscal year but will mean that Q4 will be lower by about $0.02 compared to what we guided in June.

R&D for Printing was up both year over year and sequentially, due to the ramp up of investments to support A3 Copiers and 3D Printing.

Moving to an update on restructuring.

Approximately 1,000 people exited the Company in Q3 and approximately 2,300 year to date.

The FY16 restructuring activities are on track and we still expect approximately 3,000 people to exit by the end of the fiscal year.

We continue to seek efficiencies in our processes and will likely have more savings opportunities beyond 2016.

The potential-related actions will be announced at a later date once we have a plan in place.

Turning to cash flow and capital allocation.

Cash flow from operations was approximately $1.1 billion and free cash flow was approximately $1 billion.

Cash conversion cycle was negative 29 days, a five-day sequential improvement, driven by an eight-day increase in days payable outstanding, offset by a three-day increase in days of inventory.

Days payable outstanding increased due primarily to Personal Systems, which had favorable linearity, volume, and supplier mix.

Days of inventory was up, largely in line with normal seasonality.

During our third fiscal quarter, we repurchased 4.5 million shares and paid $212 million in dividends for a total capital return to shareholders of $269 million.

Given where we are year to date, we will clearly be within and potentially above our original 50% to 75% target range for returning free cash flow to shareholders for the full fiscal year.

Looking ahead, there are a few assumptions we made in our financial outlook for Q4.

In Personal Systems, in line with the external analysts, we expect the market to be down mid to high single digits year over year, with incremental pressure in the Commercial segment.

In Printing, we expect to continue to make progress on our cost structure, giving us the opportunity to place more MPV-positive units.

As a result, we expect Print revenue and Hardware unit declines to continue to moderate year over year.

Our execution of the change in the Supplies sales model is expected to be in line with the $225 million reduction in revenue that we guided in June.

We believe declines in Supplies revenue, in constant currency, will continue but moderate.

Supplies revenue is still expected to stabilize by the end of 2017.

In Q4 and beyond, the uncertainty in the market caused by Brexit could create challenges, particularly in EMEA.

A negative impact in gross domestic product could introduce risk to our revenue, particularly Supplies, given the correlation we've seen in the past.

We will continue to provide updates as things progress and more definitive information is available.

As it relates to cash flow assumptions, in Q3, we started to note some issues with component supply availability in the Personal Systems market, given vendors shifting capacity to other product categories.

In Q4, we intend to opportunistically leverage the balance sheet for assurance of supply, which is expected to increase owned inventory and extend the cash conversion cycle by a few days.

We also expect our capital expenditures to be greater in Q4, as compared to Q3.

And lastly, we expect Printing revenue to be better sequentially as compared to lower quarter-on-quarter revenue growth in Personal Systems.

On a GAAP-only basis, we assumed a settlement expense of approximately $200 million for a lump sum offering we made during Q3 to certain terminated vested participants in the US pension plan.

With all that in mind, Q4 2016 non-GAAP diluted net earnings per share is in the range of $0.34 to $0.37.

Q4 2016 GAAP diluted net earnings per share from continuing operations is in the range of $0.22 to $0.25.

Our full-year FY16 non-GAAP diluted net earnings per share is in the range of $1.59 to $1.62.

Our full-year FY16 GAAP diluted net earnings per share from continuing operations is in the range of $1.46 to $1.49.

With that, let's open it up for questions.

We will now begin the question-and-answer session.

(Operator Instructions)

Our first question comes from Steve Milunovich with UBS.

Thank you very much.

Cathie, the 20.4% Printer operating margin, what would that have been without the gains?

So it would have been about 3 points lower, so in line with what we saw in Q1 and Q2, and in fact, the best way to think about the shift from Q4 into Q3, because the --most of the gain has shown up in Q3 is to think about the halves.

So in the first half, we were running in the 17% operating margin rate and we would expect normalized across both quarters to be roughly in that same zone.

Understood, thank you.

And you commented a bit on the Four Box Model being a little bit worse but still within your expectations.

Could you talk about each of those boxes and what's going on?

So we don't go through each of the boxes in detail.

I just want to make sure that you understood the comment.

So the comment was that on a year-over-year basis, the Four Box Model showed a decline in supply and that is roughly minus 3%, minus 4%, again, in line with what we saw last quarter as well.

What I did then -- what Dion then did say is that while the Four Box Model was down, it was in line with what we had expected, so again, giving a proof point to the fact that the model is a good predictor of what the results are going to be.

Our next question comes from Kulbinder Garcha with Credit Suisse.

Hi, can you hear me?

Yes, we can hear you.

Hi, thanks for the question.

Cathie, just going back to the previous one.

If the gain was $280 million and your Printing revenues are roughly $4.4 billion, the margin -- the underlying margin would have been like 14%; am I doing something wrong?

Well, you didn't take it the fact that we told you we were going to take that and divestiture gain and we were going to reinvest it.

We were going to reinvest it in bringing channel inventories down, Supplies channel inventories down over the course of the half, by $450 million and we were also going to increase our marketing investments.

So what the real impact is to Q3 on the upside is that we had the gain offset by half of the investment that we were going to make.

But then in Q4, we're going to have the second half of the investment and almost no gain to offset it.

Okay, and so basically if I understand it correctly, there's no reason after this quarter, why you believe going forward, once you pass the next one, why margins in Printing shouldn't be in the normal range you've seen over the last few years; is that a reasonable assumption?

That's exactly how you should think about it.

(multiple speakers) It's just a shift between quarters.

The half is in line with what we would expect.

We've taken these gains and we have, as we told you we would do on the June 21 call, we have reinvested it back into getting our channel inventories lower for the new model that we're executing on, as well as incremental investments we're making in marketing, in order to drive better awareness and preference for HP branded supplies.

Okay and then one final clarification.

The Supplies revenue basis basically is depressed because of this channel inventory clear up, that's why that normalizes at some point by the end of the year?

By the end of 2017, we do expect revenue in constant currency to stabilize, so if you look at the Supplies revenue decline, it's down 18% as reported, 13% in constant currency, so about 5 points of currency and then the Supplies actions that we took in Q3 contribute to another about 7 points of Supplies decline.

And then the remainder is, again, there was a build-up in channel inventory a year ago because we were separating the IT systems and we wanted to make sure we didn't stock out and so that impact was there, and then also this roughly 3% to 4% decline from the Four Boxes.

Does that make sense?

Our next question comes from Shannon Cross with Cross Research.

Thank you very much.

I had a question, as we sort of look forward with margins, and we think about Printing margins, I understand the give-and-takes of what's going on right now, but given what you've seen the opportunity for incremental restructuring, are you targeting around a 17% operating margin?

And similarly, Dion, if you can talk about your margin expectations on the PC side, because clearly, you've been able to find profitable sales in a relatively challenged market.

And then I have a follow-up.

Thanks.

Well, we don't -- Shannon, we don't have an explicit target for operating margin in Printing.

Each quarter, it's a combination of, obviously, the -- what's going to be ultimately the demand for Supplies given the new model that we're working on.

And then also, how many positive MPV units can we actually place?

And so one of the things I'll call out, even though I have said that in the second half I do think that margins are going to be kind of in that 17% range for Printing, we are significantly, from Q3 to Q4, we are significantly increasing the amount of MPV-positive units that we're placing.

So that growth in units is well in excess of normal seasonality and that does put pressure on kind of the bottom line.

Certainly, when you look at it sequentially; we're offsetting some of that with great cost improvements.

So, I would just kind of add to that, Shannon, that the team is incredibly focused on execution.

We're taking the cost out of the system so that we can effectively increase our total available market as we go after those MPV-positive units.

We're leveraging the strongest portfolio we've had in decades.

We have real tangible differentiation in security-embedded within the products.

We have new business models like Instant Ink and as those costs come out, you've seen over the course of the last three quarters, the investment that we're making in units in Q1.

If you will recall, we were down 20% in units; in Q2, we were down 16%; and in Q3, we were down 10%.

So a 6 point improvement quarter-over-quarter, as those costs come out that we would replace the units.

To answer your second question around PC margins, I would say that our strategy has always been the same here.

We're after profitable growth in this business.

I think we run a very highly disciplined approach to profitable share expansion.

It's about a number of things; it's taking costs out, costs always have to come out.

It's about segmenting the market and it's finally, targeting the market today and anticipating whether targeting is in the market in the future and scaling to the pack and innovating with sprinkles of magic that allow -- enable you to differentiate the product.

So therefore, we choose where we want to play and where we don't want to play.

And as a result of that, I think Ron and the team did just an outstanding job this quarter of executing to that strategy and we yielded a trifecta of growth in revenue, margin expansion, and profitable share gain.

And I think as a result of that, there's a range of somewhere between 3.5% to 5% that this business will deliver but what's really important is as revenue declines, about the negative cash conversion cycle of this business is very attractive.

Great, and just really quickly, Cathie, you mentioned Brexit.

I'm curious as to what you're thinking about if you've seen any impact from Brexit since the announcement?

Thank you.

Yes, so for Q3, we saw very, very limited impact from Brexit and this is largely as a result of the fact that we were largely hedged by the time the Brexit vote actually happened and so Q3 was really, it was really a non-event.

On a go-forward basis, it's unclear exactly what the impact is going to be.

We are definitely seeing and in some cases, following with our own pricing increases.

What's less clear is not so much what the currency impact is and how we adjust to the currency impact, whether it's through hedges or through price increases.

It's really what is going to be the impact on demand.

What is GDP going to actually do, both in the UK and then frankly, if it spreads broader to EMEA and it's just too early to tell, so we're going to keep obviously monitoring this very carefully and as we get more information, and we will share it with you.

Our next question comes from Jim Suva with Citi.

Thank you very much.

And congratulations to you and your team there.

On the earlier prepared remarks, you made, I believe, a comment about some shortages in Supplies.

Can you help us understand that a little bit?

Is that components like, I don't know, semiconductor chips or is it like assembly shortages?

Because it just seems like there's a bit of a lack of uncertainty in demand in the environment and I would think any supplier would be very pleased to supply a big company like HP and give them more than their share of components.

So can you help us understand that; and then the other part of the question is your inventory actually went up quarter-over-quarter, and it sounds like you're also saying you may have to build some more inventory due to these component shortages.

Was the inventory build this quarter because of that or are they two separate things?

Thank you.

Okay, let me tackle the first question and I'll get Cathie to tackle the second.

With regards to shortages in Supplies, I don't believe in Q3, we saw any material shortages that we had to deal with; however, as you know, these are long supply chains and we are seeing on the horizon, some shortages, particularly around LCDs, DRAM, and flash memory and it's not so much coming from the PC industry.

It's more coming from adjacent categories, going -- glass going into televisions, memory going into phones that are likely to double density, which is putting pressure on the overall industry.

We're going to leverage the balance sheet in quarter four to ensure that we get our own fair share of supply as we move forward but it is something that we're tracking closely.

So Jim, to your point, our suppliers are willing to supply HP.

And we're taking advantage of that and the strength of our balance sheet to do that in Q4.

The increase in days of inventory quarter on quarter, the three-day increase is normal seasonality so there is nothing particularly unusual about that, whereas we are calling out specifically the fact that days in inventory -- days of inventory will go up in Q4 more than is typical seasonality because of these incremental buys that we're going to make.

Thank you very much for the details.

Thanks, Jim.

Our next question comes from Simona Jankowski with Goldman Sachs.

Hi, thank you.

Another PC question which is can you comment on how sell-in and sell-through were in the quarter And then looking into the second half, how do you see demand shaping up for the Commercial vertical and Windows 10?

So sell-in and sell-through -- sell-in is a function of our revenue and that's obviously reported.

sell-through and sell-out is in line with our expectations, channel inventory levels as well as aged inventory levels are well under control as something, as you know, I'm particularly focused on as we operate the Personal Systems business.

Broadly speaking, I think the markets will continue to be pressured through the year.

We don't broadly disagree with the analysts that predict mid to high single digit declines, or which will be a little worse than calendar Q2; however, having said that, I think we have an incredibly strong portfolio of products.

Our costs are well under control and we took a 9 point premium to the market in this quarter, in Q3, so it's that kind of execution, innovation agenda that we have with the sprinkles of magic that are making a differentiation for our customers is what we're really focused on.

Just to clarify, did you mean that sell-through was above or below sell-in?

We did not channel inventory build last quarter.

Okay, thank you.

Our next question is from Katy Huberty with Morgan Stanley.

Thanks.

Good afternoon.

There's a little bit of a disconnect between the lowering of the full-year EPS guidance and the trifecta that you achieved in PCs and the in-line commentary about printers so wonder if -- just to start, if you can talk about what caused you to believe that the low end of the previous range was more likely?

And then I have a follow-up.

Katy, the largest contributor to that was the opportunity to place more incremental MPV-positive printer units.

That is what is driving us to the low end.

We think that's the exactly right investment to make and frankly, we could be at the very low end of that if, in fact, we see the Japanese broadly back off of aggressive pricing.

Because that will open up the opportunity for us to place even more MPV-positive units that, of course, will put pressure on the current quarter, or Q4, but will pay dividends with great Supplies revenue in the future.

So that is really the way we think about kind of managing our business is trying to take advantage of any opportunities that come up for us to place these MPV-positive units.

And I think Q3 is a great example of that.

We saw opportunity in the market in Personal Systems and in Print, that's where we saw the 6% improvement quarter over quarter on units and as we see that opportunity, as we continue to take costs out of the business, we want to invest in the future.

Understood, and then as a follow-up, you mentioned a couple of times, both in PCs and Printers device-as-a-service.

Is the revenue recognition and accounting impact of those type of deals different than your transactional business?

And should we expect, just broadly speaking, any impact to revenue and EPS growth as a result of that go-to-market shift?

Thanks.

So Katy, it's highly dependent on how the deal is structured and whether or not we partner with another company.

So if we actually do device-as-a-service deal with, let's say, Hewlett Packard Enterprise Financial Services, then we don't have real differences in revenue recognition.

If we, in fact, hold that same paper ourselves on our books, then yes, there is an impact to revenue recognition.

It has -- it's not material at this point in time but it certainly is directionally going to more contractual business.

It does -- it -- we'll call it out over time if it becomes material.

And don't forget that 80% of our business is conducted with -- through the channel and that's probably going to be closer to 87% through the end of the year so in many cases, those deals are structured together with the channel.

Our next question comes from Wamsi Mohan with Bank of America Merrill Lynch.

Yes, thank you.

Cathie, you mentioned larger TAM because of cost reduction ability on the printers because of the ability to place more MPV-positive units.

Can you size this increase in addressable market, in terms of how much incremental market share you can target?

Or maybe just some sense of how the curve looks where, say, the ability to drive the first $20 lower cost opens up like 2 points of share and the next $20 maybe opens up another 2 points.

What's a way for us to think about this more numerically?

So I think the best way to think about it is what we said in the last call.

We were going to improve our unit declines from Q1 from minus 20% to Q2 to minus 16% and we told you that in Q3, we were going to get it to low double digits improving over minus 16% in Q4.

You should think about it is another step function down, because the opportunity seems to be there.

We grew units 6% sequentially in Q3 and we expect to be able to do very well sequentially in Q4.

We also saw -- we've seen now market share improvements sequentially the last two quarters in Q2 and in Q3, and so those are the types of opportunities that are coming up.

Okay, thanks Cathie.

And a follow-up.

Just any early talks on how we should be thinking about cash conversion cycle heading to, into next year?

Not really prepared to talk about FY17 just yet.

We will have our Security Analyst Meeting and we'll talk a lot about FY17 but we are very pleased with the progress that we've made from a free cash flow perspective.

The cash conversion cycle and improvement that we've seen in Q3 was a result of kind of broad-based actions that we put in place coming out of Q1 that everybody in this Company is very much aware of what free cash flow is and how they can improve it.

But it's also, just to give credit where credit is due, we also saw very strong Personal Systems sequential performance, 7.5% growth and that also contributed pretty significantly to the incremental decline in the cash conversion cycle sequentially.

Thanks, Cathie.

Our next question comes from Toni Sacconaghi with Bernstein.

Yes, thank you.

I think in your prepared remarks, you had mentioned that you had taken down the supply channel inventory, as anticipated, by $225 million and that you were within your target range for Supplies?

And can you confirm that?

And given that you're going to draw down another $225 million next quarter, will you be below your target range or is that target range dynamic?

And when I think about Supplies trajectory, I do the same math as you and on the sell-through basis, it looks like Supplies were down about 6% or 6.5% and last quarter, they were down about 3%.

And I think there was inventory build in both Q2 and Q3 last year --

Toni, Toni, one thing at a time, please.

I cannot take all of the questions that you're putting out on the table.

So let's start with the very first one around the channel inventory levels.

We were within our target levels exiting Q3 and we did the roughly $225 million worth of channel reduction that we told you we would do with the new sales model for Supplies.

In terms of -- if we do another $225 million, will we be below our ranges?

We will still be within our ranges but obviously, at a much lower level within our ranges.

The ranges are not dynamic in the sense of we change them every quarter, kind of at the beginning of the quarter.

We set our ranges at the beginning of the year.

Now there's some different seasonality quarter to quarter and so the ranges can flux a little bit from quarter to quarter depending on seasonality and you see that in Q4 because you've got more holiday, back-to-school-type stuff going on.

But we should be -- we'll be in very good position when we take another $225 million out of the channel.

Okay, now what was your next question?

Just on the dynamic range, though.

I thought you had -- when you had your call in June, you had talked about the new omnichannel model and there being a different required inventory level.

So that was the reference -- is that within your range, that new target range that is driven by an omnichannel model or is that the range that you had talked about in Q2 where you were in line?

So as we are bringing down channel inventory, we have not made the formal change to our channel inventory levels or ranges.

We will do that at the beginning of FY17 once we get through the actions that we're taking.

Okay, clear.

Okay?

Yes.

On the follow-up.

It looks like, as I think you explained on the call, if you adjust for channel inventory and for currency, it looks like supply sell-through was down 6% to 6.5%.

Last quarter, it was down 3% and I appreciate there may have been some channel build in last Q3 but I think there was in Q2 as well.

The growth rates were very, very comparable.

So at least optically, it doesn't feel like the Supplies growth rate, on a sell-through basis, is getting better; that the margin actually looks like it's getting worse.

Was there anything anomalous about this quarter or last quarter that would explain that?

And again, I know you talked about channel inventory build but again, looking at the reported numbers, it doesn't look like it was really material difference between Q2 and Q3 last year.

Right, but last quarter, when we were at about negative 3%, it was adjusting for all of the channel inventory adjustments in the previous year as well as that current quarter.

So on a pure apples-to-apples basis, with making all of the same adjustments, currency, Supplies -- what we call the Supplies push/pull or the change in the Supplies model, and the build in Q3 of 2015, which was very significant because of the separation, the model in Q3 says we are down roughly 3% to 4%, which is roughly in line with what we saw last quarter.

I also think it is important that our view isn't that it's a linear path from whatever quarter you start out to stabilization, so it's not as if you're going to make progress every single quarter.

Because of the lumpiness with which we place units and didn't place some units at the beginning of the year because there just weren't as many positive MPV units, we are going to see some lumpiness.

What's really important is that our Four Box Model is predicting each quarter what we had -- what the results would be and doing it fairly accurately.

And so we believe that this model is a good predictor of the future and it's that model that is ultimately driving our view that there's stabilization in constant currency and Supplies revenue by the end of 2017.

And our next question comes from Sherri Scribner with Deutsche Bank.

Hi, thank you.

Dion, I wanted to clarify, in an earlier question, I think you suggested you view the PC market as a little bit worse in calendar Q3 versus Q2.

Did I understand that correctly because it seems like your PC business was pretty strong this quarter.

That was a market statement, not an HP statement, so the IDCs and the Gartners of the world predict that calendar Q3 will be weaker than calendar Q2 and what I then went on to say was even in calendar Q2, against a better market, we still took a 9 point premium to the market.

Okay, so you do agree with market expectations that 3Q will be slightly worse than 2Q?

Yes, we do.

Okay.

And then I just had two clarifications.

One, it seems like by my math, there was $5 million of gain left from the sale.

Cathie, can you tell me if that's correct?

And then also Cathie, based on your comments for the Printer operating margins, it suggests margins will be somewhere around the 14% range in the fourth quarter; is that correct?

Thank you.

Sherri, you got both of those data points exactly right.

Okay, thanks.

Our next question comes from Maynard Um with Wells Fargo.

Hi, thanks.

I was wondering if you can walk me through the reiteration of free cash flow.

You say you have a higher inventory by coming in the fourth quarter; if you look at your GAAP EPS, you've taken that down more than non-GAAP EPS for the year.

So are those non-cash charges?

Or should we expect there to be cash charges beyond the fourth quarter?

And I have a follow-up.

So the biggest change to the GAAP outlook is that settlement expense related to the lump sum offer that we've made to eligible US retirees.

So what we did was we've got some US retirees who are -- have chosen to take an annuity in the pension plan and we went out to them and we offered them a lump sum buyout.

And we got -- we did this about a year ago.

And we got a fairly good uptick on the ones that are newly eligible and that has a settlement expense impact of $200 million.

That is not a cash impact and that's the largest change that we made to GAAP versus the changes that we also made on the non-GAAP side.

And I'm sorry, I'm not sure I understand the rest of your question.

Well, I was just going through the different puts and takes, if you've got a higher inventory buy coming, are there other offsets to that, I guess, to keep that free cash flow number?

So we don't update our free cash flow outlook based on quarterly performance.

So we're still in the $2 billion to $2.3 billion but keep in mind that we've already done $2.2 billion on a year-to-date basis; but in Q4, again, one of the biggest dynamics in Q4 and I can go through all of the different puts and takes.

But probably, the biggest dynamic in Q4 is the fact that the Printing business that has a positive cash conversion cycle is growing sequentially, better than normal seasonality and they declined in -- sequentially in Q3 whereas the Personal Systems business is, in fact, not growing as quickly sequentially and below normal seasonality.

And they've got the negative cash conversion cycle and so it's a double whammy from a cash conversion cycle perspective and cash perspective in Q4.

The way we think about the cash conversion cycle is that at the end of Q4, we will have a cash conversion cycle that is several days better than last year's negative 19 days but it will back up from Q3.

We don't expect to have another quarter of minus 29 days, again, because of this business mix impact and the fact that one of our businesses has a positive cash conversion cycle and is growing and the one with the negative cash conversion cycle is growing, but not as rapidly as it did in Q3.

Okay, great.

And then just as a follow-up on the return of cash to shareholders, you talked about being at or above your target for the full year.

Are we to just take that comment literally in terms of you not then repurchasing more shares or being less aggressive in those?

Or do you feel like there's opportunity for you to be in the market opportunistically to go well above that 50% to 70% target?

Thanks.

So the comments that we make about the 50% to 75% of our free cash flow are annual comments and so at this point, given what we've already -- the performance year to date in terms of the return of share -- of cash to shareholders as well as the cash flow performance, we expect that we will be at the high end of the 50% to 75% and we may exceed it.

Our next question comes from Aaron Rakers with Stifel.

Yes, thanks for taking the question.

I just want to ask you back again on the component pricing environment.

As you look at the trends on a forward basis and you increase your inventory levels, are you factoring in any expectations to the negative from a gross margin perspective from component pricing?

And what do those trends look like, in particular, so far?

Aaron, with the leverage of the balance sheet that we are doing and the outlook for pricing, our view is that the component pricing environment doesn't get incrementally more difficult from Q3 to Q4.

We're expecting it to be relatively flat with Q3.

Okay, thank you.

Our last question comes from Rod Hall with JPMorgan.

Hi, guys.

Thanks for the question, for fitting me in.

I wanted to ask again on Supplies; this is an esoteric one but the Pound is very weak and I guess you guys called out that you're going to re-price at some point.

I guess it relates mainly to the UK.

But you can correct that if not; but does that cause people to hoard Supplies on Printing at all or affect your ability to adjust inventory there?

Could you just comment whether that's an issue or not?

Or do you have enough transparency into the channel and to avoid that?

And then I have a follow-up.

So at this point, we're not seeing that impact.

I will tell you that the change in the way we go to market on Supplies and the lower channel inventory levels, I think will certainly prevent some of the significant hoarding, or pantry effect, which is a nicer way of saying hoarding that we've seen in the past.

There's effectively no incentive for them to do that; this is exactly why we moved to this demand-driven model in this omnichannel world.

Okay, just if they anticipate price increases, wouldn't that then drive them to potentially engage the pantry effect, as you say, Cathie?

I like that term, by the way.

And obviously, we're monitoring that through very carefully, watching the channel inventory levels, so --

Okay.

So you just don't see that happening?

We won't allow it to happen.

Right.

Okay, okay.

And then the other thing I wanted to check is that you made a comment about the Chromebook mix a couple of times and I just wondered if you could give us a little bit more color on that.

Do you think that mix shift continues?

What's driving it?

Just help us understand a little bit more what you're seeing there on the Enterprise side?

I would say the Chromebook mix is a trend that we do see continuing.

It started first in education.

I think Chrome made significant headroom and headway in education and that is now expanding into some of the verticals, such as finance and banking.

We said a long time ago that we're going to be a multi-OS, multi-architecture organization so what we need to do is, obviously, establish where the heat is in the market and bring new devices to market.

What we've done with Chromebooks is something a little different to everybody else.

We not only have the lower-end cost of Chromebook but we also have high-end Chromebooks with really attractive [Z-hide] ruggedized for education that's helping stabilize some of the pricing but it is being offset by lower-priced Chromebooks that we're delivering as well.

So let me thank you all for taking the time to join us on our earnings call here.

I'm really confident in our future.

We've delivered solid progress on our financial commitments and whilst the markets remain challenged, we know we have more work to do but we're executing to our strategy of core growth and future.

We're investing in category, creating opportunities for long-term success.

We're almost coming up on the one-year anniversary, two months left in this year to go since the separation.

And we're really seeing value of independence with the ability to run at a rate of speed with more agility and more focus; it was absolutely the right thing to do.

We're looking forward to seeing all of you at our Security Analyst Meeting on October 13 and thank you again for your attendance.

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