Chief Financial Officer at HP
Thank you, and good afternoon, everyone. As Enrique mentioned, our Q3 results were impacted by macroeconomic challenges, including a significant slowdown in consumer demand in our categories: inflation, currency and geopolitical challenges. We took swift actions across the levers within our control to help address these headwinds, focusing on rigorous financial management in both our costs and our investments across our businesses.
In addition, we are executing on our strategy and returning significant amounts of capital to shareholders. Disciplined financial management, particularly opex and cost management, is core to our DNA at HP, and we are confident in our ability to navigate adeptly in up and down market conditions.
Furthermore, we continue to realize structural cost savings from our transformation program and see additional opportunities to drive significant cost reductions ahead of us. Despite these recent challenges, we remain confident in both our end markets and strategy to drive the long-term value creation. With that, let's take a closer look at the details of the quarter.
Net revenue was $14.7 billion in the quarter, down 4% nominally and 2% in constant currency. Approximately 2 points or half of the decline was due to the change in estimated sales and marketing incentives benefit in our prior year results. Gross margin was 19.8% in the quarter, down 2.4 points year-on-year, driven by the change in estimated incentives benefit in the prior year and currency.
Non-GAAP operating expenses were $1.5 billion or 10.3% of revenue, down 20% year-on-year. In Q3, we installed further rigor in our cost management. We reduced our opex spend by over $370 million year-on-year and quarter-on-quarter by prioritizing our variable spend in R&D and marketing aligned with our growth categories.
Lower variable compensation given the more challenging business environment was also a key driver. At the same time, we are making prudent and targeted investments where we anticipate significant opportunity to drive growth, including our key growth areas which I will touch upon in a few moments.
Non-GAAP operating profit was $1.4 billion, down 8%, and non-GAAP net OI&E expense was $104 million for the quarter. Non-GAAP diluted net earnings per share increased 4% to $1.04 with a diluted share count of approximately 1 billion shares.
Non-GAAP diluted net earnings per share excludes a net benefit totaling $40 million, primarily related to non-operating retirement-related credits and other tax adjustments, partially offset by restructuring and other charges, amortization of intangibles, acquisition-related charges and Russia exit charges. As a result, Q3 GAAP diluted net earnings per share was $1.08.
Now let's turn to segment performance. In Q3, Personal Systems revenue was $10.1 billion, down 3% and flat in constant currency. Total units were down 25% as a result of a decline in chrome demand as well as the rapid deterioration of demand late in the quarter, particularly in our consumer business.
In addition, we continue to see ongoing supply chain constraints as expected in some pockets of PS. In spite of those challenges, there were several bright solid demand in our higher-value categories across commercial and consumer, consistent with our strategy. Commercial revenue constituted over two-thirds of our Personal Systems revenue in Q3, and our commercials Windows-based revenue grew approximately 18%, with units up 6%.
Mobile workstation revenue was up approximately 60%. Consumer premium revenue was up 10%. The long-term secular tailwinds we continue to see in Personal Systems, including hybrid work, give us confidence in our long-term outlook. And regarding hybrid work, an area of focus, I want to give a warm welcome to our Poly team.
We anticipate significant opportunity ahead from both a strategic and financial perspective, with clear opportunities to capitalize on both secular tailwinds and synergies to help drive long-term revenue and non-GAAP operating profit and EPS growth. I will cover the financial impact of Poly shortly.
Let's drill into the details. Commercial revenue was up 7% year-on-year and up 11% in constant currency. Consumer revenue was down 20% year-on-year and down 18% in constant currency. FX was clearly a key factor in our results this quarter. As an example, currency was an approximate 5-point headwind to our Personal Systems business in EMEA this quarter.
By product category, revenue was down 10% for notebooks, up 13% for desktops and up 38% for workstations. We also continued to perform well in many of our key growth areas, including peripherals and DAS, which was up strong double digits.
Personal Systems delivered $695 million of operating profit with operating margins of 6.9%, flat sequentially as we continue to execute despite the headwinds I mentioned earlier. Operating margin declined 1.5 points year-on-year primarily due to currency and higher costs particularly in consumer, partially offset by lower opex, including lower R&D and variable compensation and improved commercial product mix.
In Print, our results reflected our focus on execution and the breadth of our portfolio as we navigate the current environment. In Q3, total Print revenue was $4.6 billion, down 6% nominally and down 5% in constant currency, driven by lower supplies revenue and lower print hardware units. This was partially offset by higher home and office hardware ASPs and growth in industrial graphics and Instant Ink services.
Total hardware units declined 3%, driven largely by lower-than-expected IC component availability and logistics constraints. While we have qualified additional suppliers and our Board redesigns are on track for product inclusion later this year, we still expect Print hardware constraints to extend into FY '23.
By customer segment, commercial revenue declined 3% and down 1% in constant currency on unit declines of 15%. Consumer revenue was up 1% and 3% in constant currency with units down 1%. However, we saw some softening in home hardware demand sequentially, particularly on low-end units, impacting ASPs driven by the headwinds I described earlier.
In Q3, commercial recovery continued to be impacted by the slow return to the office. In contrast, we did see solid growth in industrial graphics and 3D. In graphics, our flexible packaging business had another solid quarter and impressions have more than doubled versus pre-pandemic levels. Overall, we continue to expect a gradual and uneven recovery in commercial, with the overall office market returning to approximately 80% of its pre-pandemic TAM over time based on our current outlook.
Supplies revenue of $2.8 billion declined 9% in constant currency. The decline was driven primarily by a significant reduction in consumer demand, driven by the challenging environment and continued normalization in home printing, partially offset by the gradual recovery in industrial print. The estimated impact of our decision to stop and permanently wind down our Russia business was approximately 1 point headwind to our supplies revenue year-on-year.
Instant Ink services delivered another quarter of double-digit increases in both cumulative subscriber growth and revenue, continuing to highlight the success of this business model even in a tougher macro. Print operating profit was $911 million, up 6%, yielding an operating margin of 19.9%. Operating margin increased 2.3 points, driven by rate improvement in hardware and opex management particularly lower variable compensation, partially offset by unfavorable mix.
Now let's move to our transformation efforts, where we had another strong quarter of progress and are on track to exceed our $1.2 billion in gross run rate structural cost reductions by fiscal year end. During Q3, we delivered on numerous fronts, driving cost reductions to help drive long-term value creation.
In Q3, we took several actions to drive structural cost reductions across both our manufacturing and real estate footprint. We executed two significant actions intended to optimize our factory footprint, driving both efficiency and increased global resiliency across our ink and laser hardware and supplies manufacturing.
In addition, we continue to optimize our real estate footprint with site exits or reductions. Year-to-date, we have now executed 23 site optimizations, including eight site exits, and our overall plan has now reached 90 site optimizations since the start of our transformation. Our efforts have established a strong foundation that we fully intend to build upon going forward. As Enrique mentioned, we are currently finalizing our next phase of digital transformation focused on further cost and efficiency opportunities and plan to provide an update during our Q4 earnings call.
Now let's move to cash flow and capital allocation. Q3 cash flow from operations and free cash flow was $0.4 billion and $0.3 billion, respectively. The cash conversion cycle was minus 29 days in the quarter, a sequential improvement of three days.
Free cash flow and the sequential improvement in the cash conversion days came in below our expectations, driven primarily by the larger-than-expected sequential decrease in Personal Systems volume, delays in supply availability and unfavorable manufacturing linearity. And while we saw a meaningful improvement in our days of inventory in Personal Systems driven primarily by a decrease in commodities, these benefits were more than offset by higher days of Print inventory largely from assurance of supply and increased lead times.
Looking ahead to Q4, we expect to see further improvement to our cash conversion cycle. Driving our outlook are our expectations for additional operational improvements, including further reductions to inventory levels, and we also expect some improvement in Personal Systems volume sequentially in Q4. Strong capital returns continue to be a key part of our capital allocation strategy.
In Q3, we returned approximately $1.3 billion to shareholders. This included approximately $1 billion in share repurchases and $255 million in cash dividends. Since the start of our value plan, we have returned over $15.6 billion to shareholders and remain on track to exceed our $16 billion return of capital target by fiscal year end while also maintaining a strong balance sheet and investment-grade rating. In Q4, we expect to continue to be active in our shares.
Looking forward to Q4 and our fiscal year end, we continue to navigate the challenging macro and demand environment, including inflation, logistics constraints and pricing dynamics. In particular, keep the following in mind related to our Q4 and overall financial outlook. Given the changing demand environment driven by the headwinds I've described, we are modeling several scenarios based on a range of assumptions. For FY '22, we now see a wider range of outcomes. And as a result, we are lowering our overall outlook for FY '22.
We expect to rigorously manage our overall cost structure and opex spend while continuing to prioritize investments where we see opportunities for growth. We expect currency to be approximately 3 percentage points, year-over-year headwind in Q4 and about 1.5 percentage points for FY '22, reflecting the continued strengthening of the U.S. dollar.
For Personal Systems, we expect many of the trends we saw in Q3 to continue, including softer demand in both consumer and commercial. We anticipate these factors will put some sequential pressure on overall pricing. We expect Personal Systems unit mix to continue to shift towards higher-value categories, including commercial premium and peripherals.
With regard to our Personal Systems supply chain, we expect availability and most of our key components to improve with pockets of semiconductors to remain constrained into FY '23. We expect Personal Systems margins to be in the lower end of our 5% to 7% target range in Q4. And regarding Q4 Personal Systems revenue, we expect to be up slightly sequentially. Regarding Poly and our results, they will only reflect the last two months of the quarter, and we expect Poly to be accretive to non-GAAP EPS in FY '23.
In Print, we expect further softening in demand in consumer similar to what we saw in the latter part of Q3, favorable pricing in higher-end consumer and commercial units and further normalization and mix as we expect commercial to gradually improve over time. With regard to Print supply chain, we expect, similar to Q3, component shortages and logistics delays to constrain hardware revenue in some areas.
We expect these conditions to continue into FY '23, but with some incremental improvement in Q4. We now expect Print margins for Q4 specifically to once again be above the high end of our range, given continued hardware constraints and disciplined cost management.
And finally, regarding supplies revenue, we are holding to our long-term outlook of a low- to mid-single-digit annual decline in constant currency. In the near term, over the next few quarters, we expect to see a decline of roughly low double digits, given the challenging environment. And as a result, we expect to be above our long-term range for FY '22.
With regard to the impact of Poly on our financials in the fourth quarter and for FY '22, we expect a non-GAAP diluted net earnings per share and approximately $0.05 headwind from Poly, including debt-related expenses and other deal-related costs. And for our GAAP diluted net earnings per share, we expect an incremental approximately $0.27 GAAP-only charge related to the Poly acquisition charges.
And regarding free cash flow, we expected approximately $300 million cash flow headwind related to Poly acquisition and integration costs. Taking these considerations into account, we are providing the following outlook.
We expect fourth quarter non-GAAP diluted net earnings per share for HP without Poly to be in the range of $0.84 to $0.94. For HP with Poly, we expect fourth quarter non-GAAP diluted net earnings per share to be in the range of $0.79 to $0.89. Fourth quarter GAAP diluted net earnings per share for HP without Poly to be in the range of $0.76 to $0.86.
For HP with Poly, we expect fourth quarter GAAP diluted net earnings per share to be in the range of $0.44 to $0.54. We expect FY '22 non-GAAP diluted net earnings per share for HP without Poly to be in the range of $4.07 to $4.17.
For HP with Poly, we expect FY '22 non-GAAP diluted net earnings per share to be in the range of $4.02 to $4.12. And FY '22 GAAP diluted net earnings per share for HP without Poly to be in the range of $3.78 to $3.88.
For HP with Poly, we expect FY '22 GAAP diluted net earnings per share to be in the range of $3.46 to $3.56. For FY '22, we now expect free cash flow for HP without Poly to be in the range of $3.5 billion to $4 billion. For HP with Poly, we now expect free cash flow to be in the range of $3.2 billion to $3.7 billion.
We continue to make progress against our priorities as we navigate through a very volatile fiscal 2022. And we are taking decisive actions with the levers within our control. Looking forward, we plan to provide guidance for FY '23 as part of our Q4 earnings call. Typically, we would provide guidance as part of our Annual Analyst Day or Security Analyst Meeting event.
Moving forward, we plan to have these Analyst Day events biannually or as we have key updates to our strategy. We continue to be confident in our ability to deliver long-term value creation and we look forward to sharing our progress with you.
I'll stop here so we can take your questions.