HP Inc. (HPQ) Earnings Call Transcript & Summary

Okay. Let me start with the trends, and then I will talk about the plans. In terms of trends, what we have seen is growth in our consumer business driven by people working from home, kids learning from home is driving demand both of home printers and supplies for those printers, which is a very positive trend for us. At the same time, we have seen with people not working from the office and companies reducing their investment in capital equipment, this has had a negative impact on our commercial business. The number of pages has -- the growth of pages in the office has been down, and this has been impacting our results. But as the crisis evolves and as companies go back to a higher level of activity, we also have seen the recovery in the office happening. As we shared during the call, when we started the quarter, pages were declining -- pages printed in the office were declining by 40%. By the end of the quarter, they were declining around 25%. So it's a 15 point improvement during the quarter. And we think this trend is going to continue. In terms of where this goes forward, we think that during the next quarter, we are going to continue to see this positive impact on the home side and a negative pressure on the office side until the situation totally recovers. And we even think that in almost any scenario we look at, the office business will be negatively impacted versus the previous plan and the home business will be positively impacted versus the previous plan. And this is a trend that is not -- that is actually positive for us because as we shared during the call, the share of pages that we have in the home is higher and the margin per page at home is also higher. So from a profit perspective, it could be a positive impact even if from a revenue perspective, it may have a negative impact. In terms of changes, what we announced a year ago and we have been executing. And in many cases, the crisis has helped us to accelerate the change. We said we were going to be driving change in the business model of print, where we want to reduce from a profitability perspective the dependency that we have in hardware to -- sorry, in supplies to grow -- by growing the profitability on the hardware side. What we shared is that today we have -- when we look at our installed base, we have a large number of customers that are not profitable. They buy a printer. But either because their usage is low or because they don't use HP original supplies, over the life of that customer, we don't make money. And this happens with about 25% of our customers. With this change of model, we can reduce the number of customers that are not profitable. And therefore, it will have, over time, a positive impact in the profitability, in the absolute profit that we will be getting from the business. And we are driving this change around 3 key actions: First, we are shifting our model from a transactional model into a contractual or subscription model, where customers, when they buy the printer, they get a subscription program for us. And this has accelerated significantly because of COVID. Customers more and more want to buy subscriptions, want to buy products as a service. Last October, we shared that we have -- within our subscription program, we have 5 million consumers. We expect to have 8 million consumers at the end of this quarter. So it's a 3 million increase in slightly more than 3 quarters, which is very significant growth. We also shared that we are also driving this change by creating a new category of products where consumers, when they buy them, they get printer -- the printer, the hardware and supplies built into the device. And we have also seen very significant growth of this category during the last month. And this is mostly focused on emerging countries. And then at the end of the year, we're going to be starting to shift our whole portfolio to additional model, where for every unit, we will be selling an end-to-end system where consumers will have to use HP supplies and they will get a unit at a lower price and a unit that will be able to work with other supplies that will be priced higher. And the combination of these 3 things will really help us in the evolution of the business going forward.

Well there's no doubt that you're making great progress on the subscription model. In fact, this morning, for a variety of reasons, I was looking at subscribing myself. I'm sure I will end up doing so by the end of the day. But the -- there's a lot of things there that you're doing. And with -- it's difficult to predict exactly the outcome, but I assume that you are testing out markets as we speak. This isn't just a big bet. This is a lot of kind of carefully thought-through processes. So perhaps you can just elaborate a little bit.

Sure. I think the key thing is that as we evolve the models, we need to be focused on improving the customer experience, not the evolution of the model itself. The evolution of the model is the consequence of us offering a better value proposition to our customers. For example, in the case of the subscription model that you were mentioning, this model from a consumer perspective has 2 key advantages that because it addresses the 2 key issues that our customers have about printing. First of all, the key concern that we hear from them is that supplies are too expensive. With this model, the cost per page is reduced by up to 70%, 7-0, depending on your volume. So it's significant advantage for you as a consumer. Second key problem we hear is that you are -- your kid needs to print some homework. It's 9 p.m. You go to the printer. The printer is not working because you run out of supplies a week before. You didn't go and buy the supplies. And now here you are at 9 p.m. scrambling to find supplies. You will not face that problem because the way this program works, we monitor proactively the amount of ink in your printer. And before you run out of ink, we ship to your home an additional -- a new cartridge which is -- so we make sure that the printer is also -- is always working. And on top of that, given how important the circular economy is becoming and how important sustainability is, we also offer you the opportunity of sending us back the cartridge, the old cartridge when you get a new one. So we get it back and we recycle it, which is also a very important message to our customers. So again, it's not that we are changing the business model. It's that we're using a new model to deliver a better value proposition to our customers, which will help us to grow our share by improving it and, on top of that, has better financials for us because it ensures that you will be using HP supplies as you will be printing.

Right. So the commercial side of the business, though, there's -- many of us are a little skeptical of this business. It seems to be in terminal decline, I mean as a function of digitization really. Perhaps you can talk to us about how -- what the -- what is your strategy there? It's only a modest part of your overall revenue. So it seems to be important to you, though.

In the commercial side, we have 2 different opportunities. One is the opportunity in the office. One is the opportunity in the graphic space. And the strategies and what we think will happen in the future is different. In the commercial side, in the office side, we think that almost in any scenario we look at, the opportunity will be smaller than what it was before COVID. But as you were saying there, compared to -- the size of our business is relatively smaller. And our goal was to grow share by accelerating the shift into contractual. So the strategy will not change. It's still a growth opportunity for us because our share is relatively lower than the share that we have in other categories. So the impact on us will be smaller because especially on the growth side, not so much that we will be losing that business. And a key part of our strategy going forward is going to be to enable the professionals to print securely from home. As companies are allowing their employees and enabling their employees to work from home, what they are telling us is that they want to allow them to print. But to do that, they need 2 things. It needs to be secured because in many cases, they will be sending content that is confidential. And second, they want to make sure the cost of printing -- the companies take care of the cost of printing. And this is the infrastructure that we are building. We are connecting the subscription model that I just explained to our managed print service offering. So we can -- companies can do that in a seamless way. And we are building a cloud system where if you are an employee and working from home, you can upload the content to a private secure cloud. You can print from there directly in your device when you authenticate yourself. And this will address the second problem that we see. And again, it's about -- it's an opportunity in office printing, but printing will actually happen at home. The second opportunity in commercial is really driven by graphics. And we think that even if in the short term the graphics business has been negatively impacted by COVID, in the long run, when economy will recover, that business will go back to growth to similar levels to what we are experiencing before. So our strategy has not changed with the exception that we are more focused on what we call industrial opportunities, labels, packaging, where we have seen very strong demand even during the last months.

Is there any difference in the margins for the commercial business versus the consumer printing business?

What we have said before is given that in the Consumer business, we are fully vertically integrated, our margins are higher.

So just turning back to print. You exited the print with what seems to be some positive momentum [indiscernible] so you're facing challenges as everyone does. 4Q, though, point to continued improvements sequentially. And I assume by now, you're starting to get a little bit of a sense of how beginning of fiscal year -- the next fiscal year is looking. Are we in a more stable, more predictable environment now? Do you see a sort of steady recovery ahead globally? Or are you still very concerned that we're at risk of a sort of a second dip here?

I have to start by saying that we are still seeing a very fluid environment. It's very hard for us to predict exactly what will happen just given how we are seeing the evolution of the pandemic in many different countries. There were countries that 3 months ago, the situation was totally under control, and we have seen that it has radically changed in the last days. So I don't want to dare to say that the environment is more predictable because we are seeing things constantly changing. What we have shared, and I will repeat what we said in our call, is that we expect in the case of printing, the business to improve the next quarter almost across all dimensions: revenue, unit, profitability. And there is nothing new to say on that direction. And on the PC side, we continue to see very strong demand. As I just mentioned before, we see pressure on price points driven by where demand is and also pressure from a supply chain perspective because the demand is so strong in certain categories that we are having availability programs of some critical components, which means that the demand will continue for a few quarters because this is not an HP issue. It's really a market issue driven by the fact that demand is very high and concentrated in a few categories. In terms of '21, we will provide more visibility on what we think and how we see the world evolving and our business evolving in our next earnings call.

Okay. Maybe looking even longer term, you acknowledged at the beginning that you have 2 major markets that you're pursuing. They're both fairly mature in many respects. What should investors be sort of expecting in terms of the long-term growth outlook for your core business?

What really -- what investors can expect is that our focus is going to continue to be in profit dollars and in growing the profit dollars that the business generates. We are in mature categories, as you are saying, but within those mature categories, we see opportunities to continue to grow value. In both print and Personal Systems. There are areas where there is going to be growth, subsegments where we will see growth and we are going to be gaining share in those areas. So this will help us to compensate other areas that will be declining. In PCs, for example, we have an opportunity of -- to continue to grow in the premium categories, where our share is lower. We have opportunities to grow our business in the accessories space, as I was mentioning before, because considering the opportunity -- every time that a customer buys PC, a lifetime opportunity for us. We see opportunities to grow in the education space. All these, we will be focused and will help us to continue to grow value in this category. And on the print side, there are opportunities both to grow. Graphics is clearly an opportunity. 3D Printing is another opportunity to grow. Contractual is an opportunity to grow, but we also can capture more value by rebalancing our business between hardware and supplies and growing our share in the supplies area, which is a big profitable segment and that where we have been implementing strategies to grow our share that are starting to pay off. Then in the long run, they will continue to help us to grow value in this business. So in the long term, what we expect is even if we assume revenue -- flattish revenue for the coming years, that the profitability on the Personal Systems side will be in the 3.5 to 5.5 range and on the print side will be in the 16% to 18% ranges. And driven by that, we expect that we'll continue to grow OP and also EPS over time.

So I mean basically, what you're saying -- it sounds like you're not committing to growth, but you are committing to growth where it's available, whether it's through market share gain or through value proposition in certain segments.

What I'm saying is we are -- our focus is going to be on growing operating profit dollars, and we don't need revenue growth to make that happen. If we see opportunities to grow revenue, we will and will be on top of what I explained. But our priority as a company for the coming years is going to be on growing -- in growing operating profit dollars.

Well it sounds reasonable. And the other reasonable thing that you're doing under such circumstances, of course, is -- given the fact that your balance sheet is in very good shape is that you're returning capital to shareholders. And I think you've now -- it's kind of -- we'll come back to this. But in the course of the Xerox situation, you committed to a very aggressive capital return strategy. You sort of backed away from it momentarily is my sort of sense as the pandemic kicked in. But actually, from actual behavior perspective, you're sort of getting back on track, right, because you're now in $1 billion a quarter buyback mode. You've just taken on some debt that will allow you to -- give you a bit more flexibility in terms of capital allocation. It sort of feels like, without being too brash about it, you've actually kind of returned to some of the commitments you made at the time of the -- rebuffing the Xerox deal.

What we have said and what we are doing is that the principles that we shared in February when we presented our value plan have not changed. And these principles are simple. First is we think we can operate the company with a leverage ratio between 1.5 and 2. We think that we have committed to return 100% of free cash flow and excess cash unless opportunities with a higher ROI present. And we are executing on this plan. In Q2, given the uncertainty of what was going to be happening, we decided to slow down our share repurchase and our capital programs to see to -- until we had more certainty on what was happening. And in Q3, as we gain more confidence on the evolution of the economy, on the evolution of the business, we decided to actually increase our share repurchase plan. We bought back $1 billion as a sign of confidence in our business and in our business going forward. And also, we have committed that in the coming quarter, we will maintain this elevated amount of share buybacks because we have confidence in our business and how the business is going to evolve. As the situation will become more stable because we still think that at this point it's prudent to maintain a higher level of cash and to stay on the low side of the leverage ratio. As the situation will be more stable, we will look at ways of increasing even further our return capital programs always, unless an opportunity with higher ROI presents.

Part of the value creation plan, of course, also required you to bear down on your operating expenses. And I think they were down like 10% year-on-year in the most recent quarter. Have I got that right? Or am I -- I mean perhaps you can just update us on the cost containment program?

This was -- when we announced our plan almost a year ago before the Xerox conversation started, this was already a key part of our strategy was what we call part of our transformation initiative. We committed at a point to $1 billion of structural savings. We also said that we were going to continue to look for opportunities to increase that number. In February, we raised it to $1.2 billion over the next 3 years, and we are making very good progress executing our plan. We said that during the first year, we expected to achieve 40% of that plan. We're actually slightly ahead of that. And we continue to look for opportunities to exceed that number from a structural perspective. What you have seen also that we did in Q3 and we will continue in the coming quarters is we also took some additional operating expense actions to respond to the short-term problems driven by the crisis. They are not structural. They were more savings driven by things like travel or in other initiatives across the company to really help us manage cost as we saw that in some segments, the demand was being impacted. But these are more short-term actions that will not continue per se over the long period of time.

You are sitting virtually in front of perhaps some of the most valuable real estate in the world, both in terms of its dollar value but also its sort of cultural value in some ways, a place of great innovation. I'm wondering perhaps you can talk a little bit about the innovation. I mean one of the frustrations I have here is with the 3D Printing business. It sounds quite exciting, but it doesn't seem to be moving the needle at all. I'm sure you've got other innovations as well in imaging and so on that are worth talking about. But should investors expect this to be material anytime soon?

Yes. So I think innovation is one of the key pillars of the company, was a key pillar when the company was created and it continues to be really what drives the company forward. And even during the last months where employees were working from home, where offices were shut down, we were able to maintain our momentum on innovation. And we continue to introduce new products, new categories, new businesses. And I think we are driving innovation across the board. We just introduced a new family of commercial notebooks, again, partially designed from employees working from home. The whole transition that we were talking before to subscription models is not technology innovation apparently, but there is a lot of technology innovation behind it. How do we manage -- how do we monitor the amount of ink that you have in your home, how do we manage that remotely and how do we create a new business model around that show significant innovation from our side. And these are innovations in our core businesses. At the same time, we continue to believe that innovation will help us to create new businesses in the future. And 3D Printing is a good example of that. I think you are right when you say that 3D Printing is more a medium- to long-term opportunity. And I have been saying this for -- during the full last year, but still in the long term, it will be a fantastic opportunity for us because of the value it brings to customers. And what has happened during COVID shows the value that this technology has. When hospitals needed medical parts that were not able to get because of all the supply chain systems were shut down, we worked with our partners, companies that have bought 3D printers for other type of equipment. We design part, we produce the part, and we got these parts to hospitals and to doctors where they were most needed. And in these few months, we have produced more than 4 million parts that both have had an impact in our communities but also show the value that this technology is going to have. And if you think about where is the world going, where more and more companies looking for ways to make their supply chains more resilient to bring more production locally, these are all long-term opportunities for 3D Printing. At the same time, as we shared last year in time, we are going to be complementing our traditional business in 3D Printing with areas where we will take a more active role in the end-to-end side. And at that point, I use an insole example. It is not only for us an opportunity to create a printer that will produce the insoles, but in some cases, we are going to be also building the end-to-end businesses directly so we can capture that value also for our shareholders. And this is something that over the next quarters, you will see us taking a more active presence.

Enrique, thank you so much for joining us on the U.S. All Stars Conference today. We really appreciate it. It's a pleasure having you participate. Thank you, sir.

Thank you, Paul. And again, thank you for having me here but especially for listening about the confidence that we have about the company and where we think we are going to be creating value for our shareholders.