HP Inc. (HPQ) Earnings Call Transcript & Summary

All right. Good morning, and good afternoon, Everyone. I'm Sidney Ho. I cover semiconductor, semi-cap equipment and IT hardware at Deutsche Bank. The next company we have here is HP. And HP is a leader in the personal systems and printing markets. And today, we're joined by Alex Cho, President of Personal Systems at HP. Welcome, Alex.

Thank you very much. Hello.

Yes. So before we start, for those investors who are listening to the webcast through our portal. If you want to ask a question, there is a box on your screen where you can type in your questions. I will try to ask the questions as we go through our discussion. And I also want to make an announcement on behalf of HP. Today's discussion includes forward-looking statements that involve risks, uncertainties and assumptions, which are further described in HP's SEC filings, including HP's Form 10-K and 10-Q. HP assumes no obligation and does not intend to update any such forward-looking statements. For more information, please visit HP's Investor Relations web page at investor.hp.com. I think that's it. I always want to do that. So thank you for giving me that opportunity.

You did well. You did well, Sidney.

Thank you. Thank you. I need to keep practicing.

All right. And so maybe I will start out with a few industry questions in the near term related to -- specifically to your business, Alex. So the demand environment appears to be still quite robust. Can you give us an overview of what you are seeing in the market on both the consumer and the enterprise side of things?

Sure. I think just to set the context, you're right. We are in an environment where we are not really constrained by demand, as you know, we're in a bigger environment where supply is constraining this. Demand is very strong. And the driver for that demand is really around what we've been talking about and experiencing. It's hybrid working and hybrid learning and more entertainment and gaming happening on PCs, people connecting virtually largely because it can't travel, but also recognizing, wow, there's very unique ways of pulling many people together. And because of that, we've found that demand remains very strong. It is driven in multiple segments. We see that for work, people are recognizing that the importance of the PC for working is only more now understood. We call it, the PC is essential. Same thing for learning, for augmenting learning, enabling learning, it's becoming a very important in education and then some of the other segments. We see that in our traditional commercial space, which people, I think, understand when I talk about the commercial segment. We also see that in our consumer segment. And for us, in particular, not only is that a market reality and dynamic, demand for HP products has never been stronger. And so our backlog remains elevated. It actually is larger now. We shared that in our last earnings meeting that it is very strong across notebooks and desktops. And we see that this backlog is standing up very robust and waiting for fulfillment as we work with the ecosystem to do so.

So that's definitely a high-class problem. So maybe drill down a little bit more on the consumer side, we've been seeing growth rates coming down, maybe just off tougher comps from last year. But curious if you think that's driven by maybe there's some mitigating factors of mitigated growth in terms of supply shortages or more because consumers may have pulled some purchases in the past 1.5 years. I think a lot of investors want to hear your thoughts on that.

Yes. So for clarity, we actually see our Consumer segment continuing to be strong. I think in terms of classification, we've talked about the Education segment. The Education segment in Chrome is really captured in the Commercial segment. But in terms of pure consumer, we see strength in consumer, particularly because of some of the trends that I mentioned before, meaning people are spending more time connecting to other people. They're spending more time gaming. We see, particularly, again, on our backlog, our quarter-on-quarter backlog in consumer is growing. And we see, again, the driver is not just the fact that people need a PC, but they actually need experiences and what they want are these modern experiences, digital experiences and they see the PC and the refresh of the PC is a strong driver for that.

Okay. Maybe -- you talked about Chromebooks. Obviously, HP is very big on Chromebooks. And I know you talked about -- just talked about in the enterprise segment. On the last earnings call, Chromebook demand appears to have softened in the quarter, but you expect this demand to return later this year. Can you give us an overview of how you think about the Chromebook market in terms of revenue growth and margin profile compared to the rest of the PC business?

Yes. So Chrome today, I mean, has been a key player in the education space. And just by the way, for us, I think we've communicated that education is an important segment for us. We've been able to capitalize on the growth, the huge growth in that segment in the past few quarters. We have made progress, as I mentioned, in reducing our backlog in the Chrome segment. We see that buying patterns are really reverting back to more normal purchasing cycles because for several quarters, education was continuing to just grow in demand, but we see that returning back to more normal seasonal purchasing patterns, at least for education. That being the case, we are the leaders in this space. We think that we're positioned very well. And for us, we made a lot of progress on the profitability on our Chrome and education portfolio, so that is operating within our Personal Systems averages. So for us, as you can see, we can make progress in segments like Chrome, education and still continue to deliver strong profit growth. We do think the secular trends around education becoming more hybrid, enhanced by enabling remote connections is a secular positive shift that will continue to drive growth in the segment. Again, I said that about the working space. Same thing applies in the learning space. And because of that, we're very enthusiastic about how hybrid trends will really be a continued tailwind in this space to make education far more meaningful for students, but also teachers. And so because of that, we're very proud of the progress we made in the education space to date. Now just remember as well that you mentioned Chrome. Chrome itself, is less than 10% of our revenue. So while Chrome is a dynamic in the overall portfolio, it is still a smaller part. We do expect, again, that in the education space, it will be an ongoing growth area. And we expect that it will come back again with normal purchasing cycles even starting at the end of this year and heading into next year.

One of the things I was quite impressed is that if I look at the technology specs of Chromebook, it's actually -- it's no longer just a skinny down version of notebooks. It actually has like -- DRAM was like 4 gigabytes or whatnot, so that's definitely going to help. Now if I switch over to enterprise side, with many people not in the office over the past 1.5 years, I would imagine that corporate PC refresh cycles have slowed down dramatically. How do you think this overdue enterprise refresh cycle is going to play out over the next 6 to 12 months?

I would -- we are actually seeing something a little bit different, meaning we see that the commercial space increasingly growing. And that is across -- when we say enterprise, yes, the classic large enterprise, but also in the mid-market SMB. We are seeing that refresh cycles, the amount of time before you update your PC is actually reducing and it's reducing for 2 drivers. Number one is there's a bigger shift from desktops to notebooks, and notebooks have a faster refresh cycle. But as well, just within notebooks and within desktops, refresh cycles are accelerating. And one of the main reasons why is, yes, you need a PC to work but you need more than a PC, you need these experiences that allow you to feel like you're connected, you're being heard, you're being seen. You can do a Zoom or a Team's call and still have browser tabs open and not have your PC slow down. And that is actually driving a lot of need for refresh. We actually think this is where some of the pending Windows 11 refresh will be nice additional accelerants. We see that the need for people working remotely also means security is top of mind. The amount of concern around security and endpoints in general has been growing come a dramatic increase in people working at home and in hybrid environments, that need will only increase. We're very bullish on just the value that we bring in the security space through technology and engineering as well as enabling all these modern experiences as a driver to capitalize on enterprise growth. Being a leader in that space actually is very favorable because as that market comes back is a very attractive space to be participating in, we think it will be a very strong tailwind for us.

Great. Well, speaking of Windows 11, how -- can you -- I know there is the launch date is announced and whatnot. When I think about the hardware upgrade, how should I think about -- how should I compare Windows 11 upgrade versus Windows 10 upgrade? And just maybe I'll let you speak to some of that, what you're seeing in the Consumer and the Enterprise segment?

We think that Windows 11 will be just another element to prompt refresh. When we step back, there's 2 main elements of the market that we see. Number one, structurally, as PCs are becoming essential, the real need is to get 1 PC for every person. It used to be the goal was 1 PC for every house. Well, if you're working or if you're schooling, you're not going to be sharing a PC. Penetration rates are still low and growing. And so the opportunity to get more PCs per person will drive the TAM. The other one that I mentioned is the need even if you have a PC to have more modern experience. I'll give you a perfect example. We're starting to get data that shows that 3 out of 4 people, they actually will judge you based on the quality of your audio and video. So think if you're a salesperson, like on top of the quality of whatever it is you have to sell, how well you show up becomes a part of your ability to be successful. So does that mean that you will be very interested in upgrading to make sure you have the latest in terms of audio and video experiences? Absolutely. That's why we're starting to see refresh cycles also reducing. Windows 11 is just a strong catalyst that helps that as well as the new technologies and innovations that we're bringing from an HP side. And we think that, again, together with security, will be strong drivers of continued growth. The installed base of PCs that are greater than 4 years old, just so that you get some magnitude of this, like dynamic is over 400 million PCs. So you have 400 million PCs that are ripe and ready because people, they really want the best in how a computing device allows them to show up, be productive, connect with their people and also in the consumer space, stay entertained.

Excellent. Now maybe we'll come back to the longer-term trend -- demand trends for PC in a second. But I want to talk about supply chain update. So obviously, we just talked about demand has been very strong. But you do have -- you did have some meaningful supply chain challenges in the PC business. Can you give us an update on what you are seeing in that supply chain now and what HP is doing to mitigate some of these challenges. Perhaps you can talk about where you see the biggest supply constraint coming from?

Yes. As we -- as I mentioned upfront, while demand is strong, what you see as a dynamic in this industry is that we are supply constrained didn't just provide more color, as you asked. 18 months ago, a lot of the discussion was on CPU constraints. And then there was a discussion around -- and we see that around panel constraints. Really, the nature of the constraints that the industry is experiencing is more around ICs. And by the way, it's not even a computing industry -- as you know, there are adjacent industries who are just screaming for and needing ICs as well, again, in other industries. And that's driven by the, again, very strong demand in our industries and the need for more modern compute experiences or electronic experiences that are pulling the need for these. So in that environment, yes, the industry is seeing IC-driven constraints. We're seeing more IC-driven constraints. We share that, that is what was constraining our ability to deliver to our full backlog into the demand that we're getting. We see that, that is something that is being addressed across multiple different areas for us. We have areas that we know that we can actually do better on to take advantage of that environment or at least navigate within that environment. It includes multiple things around how we use our balance sheet for inventory, how we build long-term relationships with our partners and continuing to actually simplify our overall portfolio to navigate in that environment. So demand is very strong. Supply has limited us. We actually think we could do even better. So quite frankly, while I'm very proud of the progress we're making around just general profitability and growth and managing through it, we're not satisfied. We think we can do a lot better and plan to see that materialize over the next few quarters.

Are there areas that are more impacted than others in notebook versus desktop, enterprise versus consumer? Or are they just across the board?

I wouldn't call out one area. I would say ICs that drive things like different controllers, et cetera, are equal opportunity constraints across the portfolio.

All right. One more question on the supply chain. This may be a stupid question. Now I know supply continues to outpace demand. Can you talk about how your customers actually adapt to that? Do they just go out and buy another brand? Or do they kind of wait? Or it depends on which segment they are in? Or there's a bigger impact for -- everyone is supply constraint, so it doesn't matter.

Yes. The quick answer is the latter. I mean this is an industry-wide constraint. And in fact, as you know, it's cross industry, but this is an industry-wide constraint. Lead times on parts and supplies are continuing to get along. And that applies across -- since we're in the computing segment, let's talk about that. It's a computing wide challenge. We find that customers are number one, they're waiting, backlog in orders that are not fulfilled remain. They are looking to see if there's any other alternatives like form factors or devices. But to your earlier question, because the constraints are driving the fundamental nature of how a PC BOM is created, there are fewer alternatives. And we find that customers are continuing to wait in order to get the device that they need to be able to stay connected, work better and again, in a more modern way.

Is it an opportunity to raise prices, maybe upsell to a different configuration, maybe a better desktop or notebook? Have you seen any of those behaviors?

I think, in general, consumers are open to any kind of alternatives that would be available for them. I would also say that we are, in general, operating in a more inflationary environment overall. And so one of the things that for us that we've shown and we talked about it last quarter, is that our ability in an inflationary environment to make sure that we are -- with the discipline of repricing across all of our segments is an important part of how we manage through this time. And we've demonstrated that we're able to do that, which is important, particularly as commodities have puts and takes, right now, obviously more inflationary in nature.

Got it. One more near-term question. I would imagine your peripheral business remains pretty strong as people continue to invest in a good setup at home. Can you talk about the demand in your peripheral business through the pandemic? And how you think about this business post pandemic? Just to level set, is peripheral a meaningful revenue contributor to your business? And how are margins compared to the rest of it?

Yes. Let me just first start with our mission and our ambition in this space is really around delivering experiences. And it's such an important fundamental orientation for us and what we believe we need to deliver for our customers. That's why when I talked about the PC market, which is now much bigger because of the TAM, a lot of what you see our innovation has been focused on is on experiences for a more modern hybrid environment. And in order to deliver an experience, let's say, for gamers, guess what, you have to understand the contribution of a great gaming headset or keyboard or mic or mouse in order to do so. And so from us, in the ambition of really delivering experiences, peripherals is a very natural area that we have been investing in, you see us growing in. We've recently announced the close of HyperX, the leader in gaming headsets. We like it because, again, it helps us deliver on our mission around experiences. Second, it allows us to really be -- provide leaders in key segments that are very attractive, gaming is one. Retail point-of-sale is one where a whole peripheral ecosystem is so critical. Third is -- we love the fact that margins are higher, right, on them, and that's very favorable for us as the mix continues to grow. I mean we did share in our last earnings that consumer accessories, including HyperX for us, grew 72%. So it's also a growth area in large. And we've been relatively under indexed. So you take the footprint of a very large PC business that's accelerating. You add in great peripherals to enhanced experience. It gives the customer a better overall immersive experience, it's very strong in margins and large upside, and we think together bodes very well for -- as we look forward for Personal Systems as a whole.

Excellent. I know we just talked about a number of longer-term growth drivers. So I want to talk about longer term here. When we talk about a hybrid work environment, people are doing more setup at home. We talked about eventually, we'll get to maybe 1 PC per person in each household, and you just talked about gaming. Among all these factors, when I think about the PC market, at least how do you guys think about the PC market, I know it hasn't been growing for a number of years until the last 2, but how do you think about the longer-term prospects of PC when you combine all these things together? Let's start with that.

I'm very optimistic. I just got to say, I've been in this business for several years, in technology. It is like the amount of innovation and energy around it in many ways, it's really reflective of the broader structural opportunity of the category. As I mentioned before, it's a structural shift. And the one thing about hybrid means that people are more distributed for the base unit business, that just means a lot more. We talked about that. If the industry this year shifts between 350 million and 360 million PCs, to get to 1 PC per person, you can understand the upside. But as well, as I mentioned, it's not just getting 1 PC a person. It's all these new digital experiences, which people want all the innovation that comes with it. So the innovation energy is just invigorating and tremendous. Then you add in the fact that if you want a real gaming experience, you want a world-class peripheral, like a gaming mouse and keyboard that allows you to really play effectively that expands the TAM. And the other element for us, even more than the PC unit TAM growing and peripherals being there, the time spent digitally is increasing, minutes of use, digital experiences. So as digital experiences are growing, the third vector of what has been important for us, and that is all around services and digital services as a catalyst for growth is really tremendous. We made a lot of progress in our services business. We just communicated last quarter that we were up contractually 32%. The opportunity to make sure we're enabling services around compute is one that we believe will continue to be a growth driver. So again, we're very excited about the category, the innovation, the size, the margin contribution and just the ability of it being such a core category to how people are going to work, learn, play and just stay connected. And it becomes something that's somewhat of a side utility to really the centerpiece of how a lot of these activities will get done in the future.

Great. You talk about innovation, you talk about experience. Clearly, if we look at notebooks, it's quite amazing how thin they are and how long they can last. Are there some of the innovations in your business that help you differentiate yourself from some of your -- other top vendors? What would you highlight some of those?

Sure. I mean, number one is we always focus on customer insight-driven innovation. We're just not into like creating innovation for innovation's sake. We spend a lot of time and really built the muscle on building our insights muscle. Secondly, underlying multiple years of investment as well as inorganic, and we leverage the technology of HP Labs, it's all around security. Endpoint security is only more important, particularly in a more hybrid world, clearly differentiated. We are the world's most manageable and secure PCs. Our footprint actually on -- equally in the consumer the commercial, strong workstation space, we think is a real differentiating asset because we can get the manageability strengths of our commercial heritage, also all the design strengths of our Consumer business with things becoming much more hybrid, actually having both of those strengths and those channels allow us to really accelerate, we believe, in a far more holistic way than our competitors. The other areas that we have is we've got unique technology that's enabling some key experiences, audio is one. And in fact, with the closure of HyperX, we've got some very unique audio capabilities that we're able to deploy more broadly around the organization. And then maybe the last thing I would add on top of the differentiation we provide at the security, at the consumer and commercial design level as well as some key, I would say, experiences like audio and video. It's also sustainability. Like we think it's meaningful for our customers that we're making a lot of progress as the world's most sustainable PC portfolio, actually also across our accessories as well because we really look at the entire portfolio. That has taken a lot of work to get there. We still have a lot more that we have to go do. We think that's a very meaningful differentiated value proposition that we offer across our entire Personal Systems on portfolio stack.

Great. Maybe another question on the PC business is that I understand subscription-as-a-service as a meaningful revenue stream for HP's printing business. You've got the Razor/Razorblade kind of model. Do you think such a revenue stream that's feasible in the PC business -- they're obviously very different things, right? Or will it mainly stay as a transactional business? I know you just mentioned digital services, but if you can double-click on that, what is kind of the attach rate potential? That will be awesome.

Yes. And let me just bridge your last question. I mean it's one of the other differentiating things that we have is we have a massive printing business that now we are actually working even more together on leveraging collective assets. And it applies in multiple segments. Let me just start, even in the enterprise space, so we have a leadership position in Managed Print Services, as you know. And as I mentioned to you on the Personal Systems side, our devices, service and contractual business is ramping very quickly. We're now able to take the learnings from the print side, offer it together or across print, PS assets with a common security stack, manageable and going to the IT managers who are trying to figure out, how do I keep my employees productive with everything that they need. One clear area of leverage and where we see that there's mutual growth. The same thing will apply in the segments below it when you talk about the assets we have around our consumer ink subscription, we call that Instant Ink. The head start we have in that from an industry perspective, the relationship we have, those customers, we absolutely believe that PCs can also leverage from that, and you're going to see more coming from us in the future. Another example why this business model shift in having the breadth of a PC and a printing business and now getting a lot more leverage across them is something that we believe bodes very well for how we can be structured to win in the future.

Excellent. We already answered some of the questions I have on the printing side. Well, I know we talked -- I spent a lot of time on the revenue growth side. But if I look below the revenue line, how do you think about R&D needed in the Personal Systems business? It seems like it's -- it has stepped up because all the innovations and all the experience that you guys are enhancing. And what areas of R&D are you most excited about?

So maybe I can first start by connecting this. Again, we're very bullish about the category. We think there's a lot of opportunity for more innovation. And as well, we stay focused on customer insight-driven innovation. That as a backdrop, we continue to make very prudent R&D investments as we see areas that we think that we can really drive meaningful benefits for our customers and for the long-term business. We've shared that we continue to make gains in security. We make gains in some of the key areas that are differentiating by segment. In the commercial segment, we're doing a lot around mobility and manageability and use cases around the hybrid workforce. In the consumer space, we show a lot of improvements and really leading on new creative applications and so much creativity that's happening there. We're investing in showing areas of even new forms of I/O like VR that's tied to bioanalytics. I mean we are making gains in all those areas. We've shared that we've increased R&D year-over-year for us because we actually have made a lot of gain structurally and the efficiency of how we run the business. And so we have more capacity to do so. We've also shown that -- where we have opportunities through inorganic capabilities to bring in strong talent and tech, we'll invest that way. We did so with Bromium on security a couple of years ago, and that's been a huge accelerant to really meaningful innovation for our customers around security. We've shown that we're going to go do that, and we just, as I mentioned, closed the acquisition of HyperX in world-class gaming peripherals, and it's really also in some of the audio and video capabilities that they have. We've announced the intent to acquire Teradici, really the world's leader in remote computing, particularly for graphics-intensive high-performance applications. So we really have a multiple multilayer approach to investing in meaningful innovation based on customer insights tied to where we think that there's long-term customer value as well as just real growth opportunity for us as HP.

Excellent. If I tie all that together, if I tie the revenue growth, the -- maybe the R&D, and obviously, we can talk about gross margin as well. Your Personal Systems operating margins has been quite impressive. I think it was over 8% in the last quarter, and that's well above the target range that you guys put out before. How much is -- and when you think about it, how much of that is supply -- is pricing a factor in a supply-constrained environment? How much is maybe it's just a strong margin business? Is it mix? Or is this something else? Longer term, do you think that target range is maybe too low, just given all the things that we talked about.

Yes. So let me answer your first part. First is, we do have multiple factors that have helped drive our operating margins. You're right. In Q3, we communicated 8.4% growth. And that is well above the high end of our range. It's driven by what I just talked about earlier, really favorable pricing and really managing that with a lot of discipline. We also see some benefits from currency. We have some mix elements that are also playing there. But as well, I would say that we believe that going forward that the confidence to be able to deliver profitably remains very high. We expect to be able to deliver at the top end of our range on an ongoing basis. It's because of the structural dynamics that I mentioned because we are driving more efficiencies in the system. We are driving more innovation to drive more value. We're also growing the higher-margin segments of our portfolio that I talked about. You're going to hear more about our expectations on an ongoing basis at our analyst meeting in a couple of months. But at least that kind of gives you the fact that we're very confident in our ability to deliver on the high end of our ranges. And we think that its structural capabilities operationally, portfolio and innovation that enables us to do that. And we'll speak in more complete form at Analyst Day. I think now the date is set in October.

Yes. Yes. I just got the invite.

Okay, good.

Okay so in terms of M&A, which you touched upon earlier, you talk about Bromium, you talked about HyperX, you talked about Teradici. What else -- if I -- what are these general things you're looking for in future acquisitions? And do you think that there needs to be additional consolidation in the PC market, whether it's PC OEMs or the peripherals or some sort of consolidation within the entire ecosystem?

So first is, we've been very consistent at our company that we will be very prudent in how we look for opportunities to do so. It will be a part of a broader returns-based assessment that we do, continuing to use our balance sheet both in buying back as well as acquisitions. We look at a set of criteria that is strategic, operational and financial. And as we assess that, we continually will look at opportunities to accelerate at least within Personal Systems, our Personal Systems strategy. I think what you can see is that there is very much room for a lot more growth in general and personal systems category. And as a part of our investment strategy, we will continue to entertain M&A as a part of that.

Okay. I think we are just about running out of time. So thank you very much for spending time with us, Alex, and hope you enjoy the rest of the conference.

Yes. Thank you very much. Nice to be here with you.

All right. Take care. Bye-bye.

Bye.