HP Inc. (HPQ) Earnings Call Transcript & Summary

Thank you, everybody, for joining. Good morning. My name is Erik Woodring. I am an IT hardware analyst here at Morgan Stanley. We have the pleasure of hosting HP's CEO, Enrique Lores today. And let me just quickly read through some disclaimers for important disclosures. Please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. And then from the HPQ side, today's discussion includes forward-looking statements that involve risks, uncertainties and assumptions, which are further described in HP's SEC filings, including HP Form 10-K and Form 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 investors.hp.com. I got that right. Perfect. So Enrique, thank you for joining us. Obviously, you're a veteran of the company, 30 years at HP. You've held a number of positions at HP, and you became CEO in November 2019 after leading the $20 billion Printing business. So again, thank you very much for joining us today.

Congratulations.

Thank you very much. So let's start high level. Obviously, the world has gone -- undergone a significant amount of change over the last 2 years, right? The way that people interact with PCs and printers has meaningfully changed. Last October, at SAM, you discussed your evolving strategy, how you plan to lean into some of these emerging value creation opportunities to offset slower growth in some of your core markets to drive, let's call it, 2% to 4% annual revenue growth, greater than 8% EPS growth over the next 3 years. So maybe just help us unpackage that. What are the various market factors or catalysts that are kind of helping to enable that -- this new growth outlook for HP?

Sure. So first of all, again, thank you for having me here, and congratulations, again.

Thank you.

I think what we try to explain in our Investor Day is the shift that we are doing in the company. We are leading 2 large market, Personal Systems and Print, but we also see in both markets, significant opportunities to grow. And I think the narrative of the company is to focus on the size of the market and how much good we can get in the overall market. And we thought it was important to highlight that, in the company, we have already several businesses that have relevance that are growing in growing markets and that we think is important for investors to understand the dynamics in these areas. We highlighted that by the end of the year, by the end of this year, we expect the collection of these businesses to represent more than $10 billion, growing double digit. These businesses are gaming, what we call peripherals, which are all the accessories or devices that you buy around your PCs, consumer digital services, starting from subscriptions that we have in print, workplace solutions and then industrial printing and 3D. And we really -- we think it's important that investors understand the size of these businesses, the fact that they are growing in growing markets, the fact that we think we can capture significant value in all of those to really understand what the narrative of the company is going to be going forward. For the first time since separation, we provided long-term guidance to show the confidence that we have in our ability to execute. And I think this is -- this was really probably the most important message that we deliver in our Investor Day.

So let's begin to -- let's start with PCs, we'll work to print some of the growth markets and so on. So I think we can all agree as we sit here today, PCs have become a more important part of our lives, leading to a structurally larger TAM versus pre-COVID. Investors still express some concerns about the sustainability of PC demand. So with data points, what anecdotes can you share that kind of give -- that can give us, as an audience, greater confidence in the sustainability of PC shipments just as we think about the next 12 months? Let's just start there first.

I mean there are about many different factors, those driven by how we see consumers or professionals having changed their habit to also what is investment that we expect to see in many corporations to also what was the difference between demand and supply last year. But let me go one by one. If you think about PC penetration, as we look at how we work now, how we entertain, how we communicate, as you were saying Erik, PCs have become much more relevant than they were 2 years ago. Think about where do you use PCs today, how frequently you use them to communicate with your world to participate in meetings or to communicate with their families, the penetration of gaming and how much more growth we have seen in areas like gaming. All this is driving higher penetration of PCs than what we had before. We also monitor the amount of time consumers or professionals spent in front of their PCs. And this time has grown significantly. It was growing before the pandemic, has grown even more. We measure the time that people spend in front of PCs that are middle aged. And we are seeing younger generations spending more time in front of their PCs than previous generations, also talks about how the relevance of PCs and the relevance of the use factor. Also, that's one set of factors. Another set of factors is the difference between demand and supply. PCs grew significantly in 2021, but you have heard from us and from all the other key vendors that we see in this year with significant backlog, backlog meaning demand that we couldn't fulfill through the year. So this shows the demand in 2021 was even higher than the demand -- I'm sorry, the demand was even higher than the shipments that we were able to make. That's another important factor. And third, it was driven by the demand we see today. As companies and offices are reopening, we are seeing a lot of investment in new PCs, new form factors. We are seeing a significant change in the configuration of PCs. More high-end devices both for consumers and commercial customers being demanded. And also, this gives us confidence in the business. So it's not one factor, it's a series of different things, all of them telling us that. We don't think the market is going to continue to grow at the 20%, 30% growth, it was, but we think it's going to stay at close level to where it is today.

Right, right. And so that almost gets into my next question, which is, if we look longer term, you go back to a little over a decade ago, annually PC shipments peaked right around 360 million. We then went through 7 consecutive years of declines. There were things that were different around them, right? The launch of the tablet, the emergence of the smartphone. We're in a different period today. We all have our smartphones. But -- what's different about the market today and the opportunity ahead that gives you confidence that Personal Systems can grow 3% to 4% annually over the next 3 years?

First, customer needs is what changed. When the decline happened 2 years ago, it was driven by the growth of other form factors in the personal computer space. Smartphones grew, tablets grew and they cannibalized some of the PC sales. We don't think this is going to happen now going forward. And that's one of the major factors and a big difference from the past. If we think about the form factor, we think about the innovation that we are seeing in the category, well this case is complementing the projection of the PC business going forward. But also, I think what is important to understand is when we look at the total PC market, and we see where is growth going to be coming from, we expect the core PC business to be kind of flattish during the next year. So we are not expecting significant growth there. We expect to see growth in the categories that we call peripherals, which is, again, headsets, cameras, all the other devices that you need to be able to use your PCs effectively. So if we think about gamers, for example, which is a growing category, an average gamer spends 5x more money in headsets, in the speakers, in the camera, if the game require cameras than they spend on their complete equipment, whether it is a PC or whether it is a console. This gives you an idea of the magnitude of the opportunity. And for us it's especially relevant because, today, our share there is significantly lower than the share that we have in PCs. So that's a growth opportunity. And the other growth area in the market is services. We expect it to also grow faster than the traditional business space, and it's also margin accretive and a great opportunity for us to grow.

And so let's dig into that because we've talked about the market here, but I want to talk about what you guys are doing, especially when you lean into innovation to drive differentiation. What is HP doing, whether that's in the core PC market, whether that's peripherals, whether that's video conferencing, can you just kind of share some more color on what you guys have been focused on in terms of innovating and driving differentiation?

Sure. We continue to think that, in the PC category, as it has been in the past, innovation is a critical element to allow us to grow and to grow our share. And we have chosen different vectors to continue to do that. First of all is industrial design. If you think about PCs, HP PCs, we really have made a significant change during the last years in investor design, making PCs attractive both to professional and to consumers. Second very important driver of differentiation is security. Security has become -- has been a problem for many years, has become even a bigger headache with people working remotely and people working from home. And that's another big driver of differentiation and growth. And connecting to that, everything that has to do with the hybrid way of working, to enable consumers and professionals to work and to communicate effectively from home is another significant area for us for investment. During the last months, we have introduced a set of technologies that we call HP Presence that we are building into the majority of our portfolio to make video content more effective, to improve audio, to improve video. That's a big differentiation in this hybrid world. And the final differentiator we have chosen is sustainability. We, both as a company, but especially in the PC space, designing and building sustainability in our products. We think it's an important differentiator going forward. We have now more than -- I think it's 40 products now in the PC space that are using Asian-bound plastic, which means plastic that would have ended in the ocean that we are taking and we are building into our PCs. And this is just an example of many, many other things that we are doing to improve the sustainability of our business especially in the case of PCs.

Right, right. Great. So let's shift to Print. At SAM 2021, you guided to long-term print market growth of around flat to 1%, supplies down low- to mid-single digits, implying that there's printer hardware growth on the other side of that, but obviously, it's more than just core printing, right? You sell printers across a number of different end markets. So maybe just help us unpackage walking through your different printing end markets, home office, graphics, industrial, et cetera, how do you think about it is contributing to growth of your printing business going forward?

Sure. We have 3 major segments in our printing business, what we call home, printers that you buy to print from home; office, printers that will be bought by a corporation and installed in an office environment; and then industrial printing, which are really large digital presence that are used to print books or to print logos, posters or almost anything else that you can think of and each market has very different dynamics. We think that, from today, and I am saying from today because depending on the reference point of time, the performance will be different. We expect that the home business is going to decline. We are going to perform better than we were expecting before the pandemic, but we think it's going to be a declining business over time. From today, we expect the office business is going to be growing. It is going to be smaller than what we were expecting before the pandemic. But as offices will be open and people will go back to the office, and companies will continue to invest in improving the employee experience, that market is going to be growing. And we expect to continue to see significant growth on the industrial side, which -- and the grower there has actually been accelerated in the pandemic, especially in categories like labels and packaging, but with the changes in supply chain, we are seeing higher adoption of digital printing. So that's kind of overall the expectation that we have across all the different segments. The way that we see printing playing in our portfolio is to grow operating profit dollars. This is a key goal that we have for the business. And this is the expectation that we have for the next years, but it's actually what has happened during the last 5 years. There is this mentality that printing is a declining business that is not growing. Since sometimes the past is a good predictor of the future, if you look at the last 5 years, printing has grown both revenue and also operating profit dollars. And what we are predicting going forward is that we will be able to continue to grow operating profit dollars going forward.

And so an important part of that is some of these strategic pillars that you have on the Printing side. So making the business less reliant on transactional supplies, increasing the penetration of HP+, moving into Instant Ink, all of these are examples. So you've achieved your goal of reducing the mix of unprofitable customers by 10 percentage points. What's next? What do you know, vision of this trend, transition in terms of shifting some of these -- some of your profit dollars? So why don't we set that?

Sure. I think let me highlight that because 2 years ago, we said we had about 25% of the customers that were buying printers from us were nonprofitable customers for us, meaning, we were losing money with them. And we put in place an aggressive plan to change that. And we have made really good progress executing that strategy. And there were 3 pillars of our strategy. First was to grow the percentage of printers that include supplies when we buy the printers. And that portfolio by -- in our Investor Day, we disclosed was already 20% of shipments. Second pillar of our strategy, we declared the introduction of a new model that we call HP+, which means that when customers buy that model, they will only be able to use HP supplies. And that's important because many of the customers that were not profitable is because they were not using HP supplies. We launched this model about 6, 8 months ago now, and the penetration of that model has grown significantly. And since in our Investor Day, we said it was around 20% of our Printers, since then, the penetration has continued to grow. And again, strategically it is very important because those customers will only use HP supplies going forward. They cannot use other supplies. And the third element of the strategy was the shift to service models, both to subscriptions and to managed services in the case of enterprise. And those have been growing very nicely. And in the case of consumers, we announced in our earnings call 2 weeks ago -- or last week that we now have more than 11 million subscribers in the program. And these are 11 million customers that have registered to the program that pay us every month to be able to print. And we think, strategically, this is really important because now we have a platform -- a subscription platform that we can use to sell additional services going forward. We announced in our Investor Day that we were going to be launching Paper-as-a-Service this year. We launched the program. We launched the program as a pilot. Today, we have more than 10,000 customers already buying paper from us in the program. We are fine-tuning how the program works. We will be scaling it up through the rest of the year. 10,000 is a small number in the big scheme of things, but shows how far it can really scale. And you are going to see us introducing additional services in the program that will help us to capture more value per customer, which is fundamental because when one customer is in the program, initial additional services is a great source of incremental value and you will see us playing that very aggressively going forward.

Great. Great. You obviously took the helm at HP after leading the Printing business, so you know a thing or 2 about printers and printing. If you look out, looks like 3 years from today, what do you see as the most significant challenges and opportunities that your printing business will face that will kind of help dictate growth and not just in revenues, but in OP dollars?

Yes. Let me start from the challenges, and then I will talk about the opportunities. I think clearly from where we are today, there are 2 major challenges. One is, we don't think the supplies business is going to grow. We said in our Investor Day that it will be declining low, mid-single-digit. And nothing has changed from that point of time. We think this is what will continue to happen. And we are also because of all the supply chain shortages that we see today in a fairly favorable pricing environment, where we can -- we're ready to discount printers significantly because there is more demand than supply. So these are -- and over time, supplies will continue to decline and prices will rationalize. So these are 2 headwinds that we need to manage. We have -- but we also have significant tailwinds. First of all, is the growth that we expect to see in some categories. The office market is still very down. So this -- we expect to see a recovery in that business. We expect to see also continued growth on the industrial side that will help to compensate. All the growth in subscription and services also in the office space will help to more than -- to compensate the declines that we were seeing before. The change of business model that we are driving in print will also help to compensate. So we have significant areas where we can -- where we are investing, where we are going to be growing, that will compensate the tailwinds -- the headwinds that we see in some part of the portfolio.

Great. Let's go down to cost. So if I look back to the start of the pandemic, starting from the beginning of the pandemic, your Personal Systems operating margins have been at or above the midpoint of your new 5% to 7% operating profit range for, I think, it was 7 of the last 9 quarters. In print, you've been above the midpoint for the last 5 quarters. What factors have allowed you to maintain such strong margins? And then kind of what gives you the confidence that these segment margins can stay at the high end of these targets at least through the next 12 months, fiscal year 2022?

There are multiple factors. There is not one single thing, but definitely shall soon. Two years ago, we announced a significant cost reduction plan where we said we were going to be reducing $1.2 billion from our cost structure. It was not pricing. They were not cost improvements because we were not renegotiating with a supplier. This was permanent cost structure that we were reducing, and we are on track to deliver on that goal. We also have seen -- another big factor is pricing. We have been very effective managing pricing of our overall portfolio. Shortages have clearly helped. But if you look at how we have managed mix and the prices, this has significantly helped. We have been driving mix changes towards more premium categories. And this has had a very important impact on PC. And in the case of print, all the actions I explained before to change the business model, to grow share of supplies have really helped us to deliver the margins that we have now. What we have said long term is that for PCs, our expected gross margin -- our expected operating profit is between 5% and 7%, which is higher than what we were expecting before the pandemic. And for Print, we have kept it in the 16% to 18% range, consistent to the headwinds and tailwinds that I was explaining before.

Perfect. And you alluded to the $1.2 billion of gross cost cuts. Maybe talk about where you've been able to take some of these costs out. And then, more importantly, where have you been able to then reinvest those costs into driving future growth?

Sure. So firstly, in terms of -- we announced our transformation program 2.5 years ago, and the program had 2 intents: One, and probably more critical as a point was to reduce our cost structure. And we said what we're going to do is $1.2 billion, and we are on track to do that. And we have been reporting every year the progress we have been making. Also during the last 12 months, we have been shifting the focus of the program, not only on reducing cost but also accelerating the digital transformation of the company. And we have been investing significantly in new terms, new systems that now we can use as -- that have become now a new digital platform of the company. We announced a few months ago that we have completed in supply chain, in finance and support the transition to a new and integrated ERP system for the company. And this is really important for our company and for us because before that, we had more than 11 different ERP systems for different businesses, for different regions, which made the development of any new digital business extremely difficult. Now we have one platform that we can use to build from, and this has been a significant investment for us. And also as we have been really over-delivering versus the financial goals that we have, we have been investing in innovation across the different areas of the company, but especially in the 5 growth areas that I mentioned before. We have room for investment. We are making the investments to really accelerate the growth of the company in those areas.

If you were to call out one of those growth -- 1 of the 5 growth businesses today is maybe what gets you most excited? Could you point to one of them and why?

This is like asking, which one of your kids you like? I can't choose one kid, I can't choose one, I like all of them. But also because they different roles in the portfolio of growth that we have, if I think, for example, about gaming, which is one of them, is a very attractive opportunity for us because it is really a very close adjacency, it's a growing market where our share today is between 4% and 5%, and our sharing business is around 20%, between 20% and 25%. So good market where our share is lower, where margins are better than in the average pricing than in average PCs. So it's good, good, good. I mean I love that kid. If I think about the growth in Consumer Services, I was explaining before, having now our platform of 11 million subscribers that keeps growing double digit is super attractive to be able to capture more value for each of our Printing customers. I love that. If I think about the work we are doing with 3D and the opportunity we have to these option industries and to really create long-term value, I have to say I love that too as myself. I could go on Frost & Sullivan, but again, we are in growing businesses in growing markets where we have a strong present, and they have different strategic profile, which is also important to continue to grow the company going forward.

Okay. Let's talk about capital allocation quickly with remaining time. You've obviously been returning a ton of cash to shareholders. Obviously, very beneficial from a dividend, but from a buyback perspective, you're on track to reach your $16 billion goal that you set out, the chiefs must have been...

2 years ago, yes.

So just curious, is this a sustainable level of capital returns. Is this kind of the new normal, so to speak, for HP? Or will there be a period of reevaluation as we go forward, whether you can accelerate or decelerate that rate?

Sure. So first of all, I would say that we are doing what we said we were going to do, which I think, for investors, is really important because we do what we say. And as you said, by the end of this year, we will be -- return at least $16 billion of capital to shareholders either in share repurchases or dividend. Going forward, what we have said is, our plan is to continue to return at least 100% of free cash flow. We have -- unless opportunities with a better return show up in terms of M&A. We have also said that we expect to operate with a leverage of around between 1.5 and 2. Today, we are lower than that. So this means we have opportunity also to create more capital or to return more capital just by executing on that. But we have also said that, again, in the 5 growth areas that I covered before, we see opportunities to accelerate the growth through M&A, and we will. And that we are going to be always very judicious in how and when we do it. It depends on the opportunity, but this is all part of the capital allocation plan that we have shared.

Right. Perfect. You mentioned M&A. Obviously, I feel like I need to touch just do you still see value in print industry consolidation? And outside of that, any opportunity to get more aggressive on the M&A front as we think about kind of what's happened over the market in the last few months, valuations have been getting cheaper.

Sure. So what we discussed in our Investor Day is that our -- when we think about M&A today, we -- and we look at opportunities to drive growth versus opportunities to drive consolidation, we think we can generate more value by investing in growth areas. And this is why we were so explicit in what those areas are, again, growing markets, where we have a strong presence, but with M&A, we can accelerate our growth. Consolidation continues to be a growth opportunity -- a value creation opportunity, but it's not a growth opportunity. And what we need to -- our goal is to create this sustainable, or to drive the sustainable growth for the company, which we feel that is a way of creating more value. I will never say never to a consolidation opportunity because, again, it creates value, but, today, we are prioritizing growth opportunities as we think about M&A.

Great. So we have 30 seconds here. I just wanted to give you the stage to be able to say, obviously, you're buying back shares. You're confident in the story, you're confident in the narrative. What do you think is most underappreciated about HP by investors today?

I think is the ability to drive sustainable growth, not only because it's what we have said we are going to do in the future is because we have done this already. So we have demonstrated that this is possible. With the 5 core areas, investing more there, it should be even easier. No, there is nothing easy in life, but it should be even more possible. And I think this is what needs to be understood. If I look at the value of the shares today, and you calculate this year's financial, there is an implication that free cash flow is going to continue to decline. And in reality, free cash flow has grown significantly since separation. So that difference in between reality and what investors believe is what we really need to fix and why driving this message around sustainable growth, being more transparent on the growth areas, articulating that more clearly is what we are doing to close the gap.

Perfect. Perfect, on timing.

Thank you.

Thank you, Enrique. Thank you, everyone, for your time. I appreciate it.