Marie Myers
Chief Financial Officer at HP
Thank you and good afternoon, everyone. We delivered solid financial results in Q2 against the backdrop of a tough macroeconomic environment. We generated sequential growth in non-GAAP operating profit and margin, non-GAAP EPS, and free cash flow. Non-GAAP EPS was at the high end of our guidance range, while free cash flow was better than we expected. We delivered these results by remaining focused on prudently managing costs and optimizing our cost structure further under our Future Ready plan. At the same time, we prioritize strategic investments that will help drive future growth when the macroeconomy recovers. We remain focused on what we can control in the current environment, which enabled us to deliver on our commitments for Q2.
Now let's take a closer look at the details of the quarter. Net revenue was $12.9 billion in the quarter, down 22% nominally and 18% in constant currency, driven by the declines across each of our regions. In constant currency, Americas declined 21%, EMEA declined 22%, and APJ declined 7%. Gross margin was 22.7% in the quarter, up 2.5 points year-on-year, primarily due to mix shift to print and lower commodity costs in Personal Systems, partially offset by currency and competitive pricing, particularly in Consumer Print. Non-GAAP operating expenses were $1.8 billion, or 14% of revenue. The decrease in operating expenses was driven primarily by rigorous cost management, including Future Ready structural cost savings and lower variable comp, partially offset by the Poly acquisition. In addition, recall last year, we provided aid related to the war in Ukraine. Non-GAAP operating profit was $1.1 billion, down 22.4%. Non-GAAP net OI&E expense was $172 million, relatively flat sequentially and up year-over-year primarily due to higher interest expense, driven by an increase in both debt outstanding and interest rates, as well as higher factoring expenses. Non-GAAP diluted net earnings per share decreased $0.28, or 26%, to $0.80, with a diluted share count of approximately 1 billion shares. Non-GAAP diluted net earnings per share excludes a net benefit totaling $269 million, primarily related to restructuring and other charges, amortization of intangibles, and acquisition and divestiture-related charges, more than offset by other tax adjustments and nonoperating retirement-related credits. As a result, Q2 GAAP diluted net earnings per share was $1.07, mostly due to one-time noncash tax benefits related to tax planning.
Now let's turn to segment performance. In Q2, Personal Systems revenue was $8.2 billion, down 29% or 25% in constant currency. Total units were down 28% with declines in both consumer and commercial driven by weaker economic activity as customers in both market segments were more cautious with spending. Despite this, we improved our overall market share in calendar Q1 by 1.3 points year-over-year driven by gains in the commercial market where we improved our share by 2.5 points. Improved market share contributed to commercial representing greater than 70% of our revenue mix for the quarter, while constituting about 53% of our PC unit mix. We continue to make solid progress on reducing our channel inventory level sequentially, but levels remain slightly elevated for us and across the industry. As a result, we continued to see aggressive pricing in the quarter. We estimate sellout declined less than sell-in during Q2, which means that end-user demand was stronger than sell-in shipments.
Drilling into the details. Consumer revenue was down 39% and Commercial was down 24%. Lower volumes, FX, and increased promotional pricing remained headwinds, partially offset by contributions from hybrid systems revenue. We increased our market share in high-value more profitable segments, including commercial and premium notebooks. Our strategy remains focused on driving profitable share growth. Personal Systems delivered almost $450 million of operating profit with operating margins of 5.4%. Our margin declined 1.5 points year-over-year primarily due to currency, increased pricing competition, and the higher opex due to the Poly acquisition. This was partially offset by lower costs, including commodity costs and structural cost savings and services mix.
In Print, our results reflect our focus on key initiatives and improving execution within the context of a softer print market. In Q2, total Print revenue was $4.7 billion, down 5% nominally or 2% in constant currency. The decline was driven mostly by lower consumer hardware and lower supplies revenue and currency. Hardware revenue was down about $100 million driven by lower volumes and competitive pricing actions in Consumer, partially offset by an increase in Commercial hardware revenue. Industrial graphics revenue declined, reflecting continued demand weakness in the enterprise space. Total hardware units decreased 4%, driven by market share loss and soft home printer demand. By customer segment, commercial revenue increased 5% or 8% in constant currency with units roughly flat. Consumer revenue decreased 19%, or down 15% in constant currency, with units geographies down 5%. ASPs were mixed. Favorable mix shift towards commercial helped to offset promotional pricing and incremental price reductions in Consumer across multiple geographies to remain competitive. Supplies revenue was $3 billion, declining 4% nominally and 3% in constant currency; better than expected. The decline was driven primarily by lower usage as expected as home printing normalizes further, a lower installed base, and a gradual recovery in commercial. This was partially offset by favorable pricing actions last year, and Lunar New Year timing, as well as continued market share gains. Print operating profit was approximately $900 million, down 5% year-on-year and operating margin was 19%. Operating margin decreased 0.1 points driven by promotional pricing, higher commodity costs, and unfavorable currency, partially offset by cost improvements and pricing actions. The cost improvements were largely due to lower variable comp and transformation plan related savings. Our Future Ready transformation continues to build on our strong start through the first half of FY '23, and we remain on track to deliver at least 40% of structural run rate savings of at least $1.4 billion in FY '23. We continue to see significant opportunities to drive further structural cost reductions across our business.
Let me update you on our progress in Q2. We further enhanced our digital capabilities, driving additional automation and process improvements. In our Workforce Solutions & Services business, we harvested more proactive data insights from more connected devices with our enhanced diagnostic tools that drove repair cost efficiencies. In our supply chain, we delivered significant improvements in reducing portfolio complexity, improving continuity of supply, and increasing our forecast accuracy to facilitate material cost and profit improvements. We saw further opportunities to drive structural cost reductions through headcount reductions and driving efficiencies in our core businesses. In Print, we focused on platform consolidations and roadmap reductions in our large format business. Looking ahead, we see potentially significant and incremental opportunities to leverage Al and generative Al to positively impact both our products and solutions and how we operate. We are actively exploring opportunities, such as expanding our product portfolio to include a new category of high-performance PCs, accelerating software development productivity, and enhancing the customer service experience to drive higher value offers while optimizing pricing.
Shifting to cash flow and capital allocation. Q2 cash flow from operations was solid at $0.6 billion and free cash flow of $0.5 billion was better than expected. Free cash flow results benefited from better purchasing linearity. The cash conversion cycle was minus 26 days in the quarter. This improved four days sequentially, primarily due to days payable increasing 10 days, more than offsetting an increase in DOI. While we decreased our inventory by $0.1 billion sequentially in Q2, the upward pressure on days inventory was driven and by strategic buys, increased ocean transit mix, and a change in business mix. We have more opportunity to improve our core inventory turns and are focused on doing that. But when it is economic to do so, we intend to continue to drive value via strategic buys or more sea transit, both of which would result in carrying more inventory.
In Q2, we returned approximately $260 million to shareholders via cash dividends. Given where we finished the quarter on our debt to EBITDA ratio, we did not repurchase any shares in the quarter consistent with our outlook. We remain committed to our capital allocation strategy longer term, but near-term we'll continue to manage our leverage profile prudently and maintain an investment-grade credit rating in the current challenging environment. Looking forward to Q3 and the rest of FY '23, we expect the macroenvironment will remain challenged, and we will remain focused. On rationalizing our cost structure further, while continuing to invest in our growth businesses.
In particular, keep the following in mind related to our overall financial outlook. We are narrowing our FY '23 non-GAAP EPS outlook range, reflecting greater visibility into the potential range of outcomes for H2 '23. We still expect operating expenses, excluding Poly, will be down year-over-year for FY '23. For Personal Systems, we expect our and the industry's channel inventory will normalize in Q3 and the back half of the year will be seasonally stronger from an end-user demand perspective. We expect Personal Systems margins in Q3 to be in the mid-range of our 5% to 7% long-term target, driven by increased volumes, the continued progress on normalizing Cl levels, as well as further cost reductions and efficiencies. For FY '23, we expect margins to be solidly in our target range driven by the gradual improvement in PC revenue in the back half of the year and increasing Future Ready transformation savings. In Print, we continue to expect supplies revenue at FY '23 to decline by a low to mid-single digit in constant currency, with easier year-on-year compares in the back half of the year. We expect Print margins to be above the high end of our 16% to 18% target range for H2 '23, driven by disciplined pricing and cost management and continued progress on rebalancing our system profitability.
Taking these considerations into account, we are providing the following outlook for Q3 and fiscal year 2023. We expect third quarter non-GAAP diluted net earnings per share to be in the range of $0.81 to $0.91, and third quarter GAAP diluted net earnings per share to be in the range of $0.61 to $0.71. We expect FY '23 non-GAAP diluted net earnings per share to be in the range of $3.30 to $3.50, and FY '23 GAAP diluted net earnings per share to be in the range of $2.91 and $3.11. We continue to expect free cash flow to be in the range of $3 billion to $3.5 billion for FY '23.
And now I would like to hand it back to the operator and open the call for your questions.
