HP Inc. (HPQ) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Krish Sankar from Cowen. I'm the analyst who covers HP, and we are very fortunate enough to have Enrique Lores, the CEO of HP here. Thank you, Enrique, for your time. And I just wanted to read a quick disclosure 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 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. And thank you with that.

Enrique, really appreciate your time. And let me just start out by saying congrats on the really strong results. You had your earnings call a couple of days ago, a tough environment. You guys are executing really well. So just can you just give us a brief overview on the state of the business today? And then I have like a bunch of follow-up questions.

Sure. I think I'll highlight 3 things about the quarter and about where the company is today. First, as you said, in a fairly complicated environment, we did well, and we have showed that we can do this consistently because it was not only this quarter, but our performance during the last quarter has been very consistent, which is something we emphasized in the call. Second, last October, we shared that there are some key growth businesses where we are investing, where within the growth of the company is going to come from. And this business has also performed very well this quarter and have been performing very well. Our goal was for them to be more than $10 billion by the end of the year. In the first half, we have done $5.6 billion. So they are growing and really delivering or overdelivering versus our own plan. And third, we continue our plan to reward investors. We have a fairly aggressive capital return plan, both in terms of dividend and share buybacks. We bought $1 billion of shares last quarter. We gave close to $300 million of dividends. So we continue to execute on our plan, and we will continue to do that in the near future.

Got it. Got it. And let me probably go sequentially. I'll start with PS, system and print and then probably get to capital returns. So on the Personal Systems side, you kind of spoke about supply constraints being an issue, maybe some moderation in PC demand from a unit perspective, not necessarily from an ASP perspective. So it's kind of interesting because historically, people viewed HP as more consumer driven, but it looks like you're gaining some traction in commercial. So can you just talk a little bit about it like kind of how the shift happened from consumer to commercial? And what is kind of driving that momentum that HP is seeing today?

Sure. First of all, our commercial business in PCs is around 65%. So it's the dominant part of the business. And 65% is revenue from a margin perspective, it's even more relevant because margins in commercial are better than in consumer. But what I would say is we have the value of being in both sides. So when one of the segment grows, we can grow in there. This is what happened a year ago. When commercial grows, we have proven also that we know how to grow. And when we have and we can grow with the market or faster than the market. As you said, our view of the PC market is that from a unit perspective, it's going to slightly decline this year versus a very high number last year. So it's really declined from a much bigger market than what it was before the pandemic. But in revenue, we expect the market to grow. What we see is a shift towards more premium categories, towards highly -- more highly configurable products, higher mix to commercial, and this is driving prices to go up and therefore, the business overall to grow in -- the market overall to grow in revenue.

Got it. And I remember like even last year, there was this talk about like 1 PC per person because the PC density is increasing. Arguably, supply constraints is definitely a headwind this year. So to the extent you can articulate a long-term view on PCs, do you think that trend is still intact of rising PC density per household. And we've just taken a detour because of supply constraints? Or do you think the last 2 years of COVID-infused surge in PC demand is going to moderate over the next few years.

It's a combination of both. The way we look at it is -- if we think about the market size before the pandemic, it was in the $260 million, $280 million per year. Last year, it was in the $340 million range. And we think in terms of units, there is going to be a slight decline, but it's going to stay significantly above where it was before. And this is mostly driven by density. And we think this is going to continue. We don't think the market is going to collapse in terms of units. It's not going to continue the growth we have seen. So it's going to stay stable, slightly declining. But again, revenue will -- or prices will help on the other direction. So from a revenue perspective, we expect it to grow between 1%, 2%, 3%. But as part of this business, we also see opportunities in what we call peripherals and services, which are 2 of our growth areas. Markets that we think are going to continue to grow because of the use model that PCs have and a big part of the growth strategy of the company is about leading those categories, expanding into these categories which also has another benefit because we have better margins at the core PC business. So from a margin perspective, there are also better opportunities than just the core PC space.

Got it. That's very helpful. And then obviously, on the peripheral side, I think you're in the process of acquiring Poly, then you did the HyperX acquisition like a while ago. So can you just talk a little bit about how Poly fits into the big picture for HP. And clearly, that seems to be like high growth, high margin helps like the PS business like get even bigger.

Yes. So maybe a couple of comments on peripherals. What we see is both consumers and professionals spend significant amount of money, not only in their PC but in all the peripherals or the accessories that they need under the use around it, whether as headsets, cameras, speakers, keyboards, mice, the opportunity that is big and grow significantly. For example, in gaming, when we did the HyperX acquisition a year ago, consumers or gamers spend 3x more money on the peripherals than on the PC. So these -- and the margins are better in peripheral. So this talks about the opportunity in that space. In the case of Poly, we're really going to be focused on hybrid work. With Poly what we can do is enable 2 key use cases. One is to create for people professional studio when they work from home, great camera, great audio really so when they are connected, they are seen and they hear in an almost professional way. Second big opportunity is in video conference in rooms. I talked to a lot of companies all over the world. Every company in the world is investing now in improving their video conferencing systems, every company. Our estimation is that in the world there are around 90 million meeting rooms. And just do some calculations, I assume that half of them will have a video conferencing system. I assume that they will be replaced every 3, 5 years, assume that the pricing of them is in the $3,000 range. I assume that we will get 20%, 30% and you get a multibillion opportunity in video conferencing rooms.

Well very interesting. And it's fair to assume the margin...

This is the monkey math, but it's fairly real.

Fair disclosure, I'm not a gamer, but I actually do have a HyperX gaming chair. It's super comfortable.

Perfect. You should test the headsets, speakers.

I should go the whole shebang. That's right.

Absolutely.

So -- and then just like talking about like the peripheral business. With HyperX and Poly, it seems like you kind of captured. Do you think that there is more room to grow on the peripheral side? Or like kind of like the question I get from investors is like, what about things like what Logitech does and they kind of go around that path? Or is it something like let's take one step at a time.

We are really focused on use cases. We started with a gaming use case when we had a strong portfolio of products, and now we have a strong portfolio of peripherals. And now with Poly, we are going to really be focused on these 2 use cases: Remote work, professional studios, video conferencing systems. There is a lot of opportunity there. There might be other use cases in the future, but this is where we are at this point.

Got it. Got it. And then just to wrap up on the PS side. On the commercial side, it looks like the consumer spending has shifted to more commercial, obviously, like work from home, hybrid is kind of benefiting it. Where do you think we are in that IT spending cycle for commercial? Do you think this is like continues into next year? Or do you think it starts moderating?

The indications we have today is that the market is going to continue. The demand for the market is going to continue. And this is very consistent on the commercial side, almost in everywhere in every country. Now we also know that there are a lot of uncertainties that could happen next year from war, to inflation, and it's hard to predict that. But all the indicators that we have today in terms of demand is that the demand continues to be strong. We measure sell-out weekly, and we continue to see on the commercial side significantly stronger sellout than what we had 3 years ago.

Got it. And I think you also mentioned on the call about Russia was like $1 billion last year in revenue, and you stopped shipments there. Have you seen any like contagion effect on demand in Eastern Europe because of the war? Or do you think it's more contained to like Ukraine and Russia at this point?

So 2 things. So first is Russia, yes, was $1 billion of business for us in '21, margins below the market -- the company average because it's mostly PCs and it's mostly low-end consumer PCs, but it was from a revenue perspective, a significant business. In terms of the impact of the war, what we have seen so far is some impact in the consumer business in Europe. This we've seen a slowdown that we think is related to the war and to the concern that the war is creating there. And until now, we haven't seen any other impact.

And I think you also spoke about the impact of supply chain and doing some price increases because to offset some of the costs. Is that purely a function of because of the supply? Or are you also doing some inflation-related adjustment on pricing?

So 2 things. First of all, if we look at pricing and average selling price of our units, we have seen increases for 2 reasons. First is pricing rates have increased and second, mix has shift over more premium units. So when you look at the overall pricing of the -- in our category, you see the impact of both. And it's 40-60, 40 pricing, 60 mix. Something that as you build your models, it's important to know because mix is having a very strong impact. In the case of pricing, what we do is from one side reflect the increase of cost and whether it has been -- year-on-year, we have seen increase of cost in many of the components. We have seen an increase of cost in transportation. So this is reflected in pricing. But also given the strength of the demand, we haven't had to discount or to do promotions to sell the same amount of product. So this also has an impact of pricing, not so much that we are increasing prices themselves but we are not promoting products as aggressively as we were in the past.

Got it. Got it. All right. Let me just pause to see if anyone had any questions for Enrique. If not, I will continue along. So then moving on to the printing business, the print supplies, et cetera. One of the questions that investors always ask is like you guys have this target model like 16% to 18% margin. But it seems like you're always exceeding that number, right? I understand...

We will check out the like...

So the question is like do you have to move it higher? Or is this more like conservatism on your part that these are like onetime things that might not be sustainable, so 16% to 18% is probably a more realistic target?

We think 16% to 18% is a more realistic target because similar to what I was explaining about PC's also on the print side, there is a difference between demand and supply, demand is higher than supply. And therefore, today, we can command especially on hardware, significantly higher prices than what we were able to do in the past. But as supplies will normalize, we think that some of this effect will disappear and therefore, we will go back to the 16% to 18%. Now we are going to stay above 18% for as long as we can. No interest in going back to 16% to 18%, but I think the logical projection is that it will go back to 2020.

And then I think one thing you mentioned, Enrique, on the call was how the supply constraint is definitely impacting print more than PS seems like. Out of curiosity, is it like -- I'm sure there's some components that are common between the two. So is it more preferential allocation towards PS versus print? Or is it just purely a function of the supply chain there is more challenged.

It's a factor of the supply chain in the case. One of the key advantages we have in the print side is that we design our own chips, and we design our own chips for a specific foundry. So -- and therefore, we cannot use a different foundry because when you build a chip, you design it based on the libraries that foundry has. Some of our providers are experiencing capacity problems. And therefore, we don't have enough of these unique chips that we only use. We are doing a lot of work to redesign our boards, to design the next generation of chips. So in a couple of quarters, we will have seen an improvement. But today, we are limited by these chips that have been designed by us and someone else is building.

Got it. And would you say the hybrid work environment is actually slight negative for commercial print versus everyone being in the office full time?

Yes. Our estimation is that hybrid work whenever the pandemic will finish, which is hard to project, the amount of printing in the office will be around 80% of what we were projecting it to be before the pandemic started. This is kind of the estimation that we have, we made it a year ago. And based on the data we have today, we still think it's the right number. So there is going to be an impact because with fewer people being in the offices, there will be fewer printing, fewer pages printed in the office.

Got it. And then just on the shortage side, like is there a way to segment saying, I think you mentioned ASIC was one of the components that is short for like...

These are the ones we design.

Right. Is that more tied to like general commercial print? Or is it more like laser jets? Is there any specific application that's more impacted? Or...

Today, in our case, where we have more of these components is in the high end of the consumer space, in some of the color laser space. These are the ones that where we see the biggest impact because it's where we are using this component. We shouldn't read anything related to demand or anything, is purely supply-driven, and purely availability of these chips.

And just any update on the print supply side. I think you spoke about it actually being in a much better position, but kind of curious how the inventory levels there are on the supplies.

I mean inventories in print in general are very low because of the difference between demand and supply across all segments. And this is true also for supplies, not so much because of capacity or manufacturing issues, but because we are going to be managing very tightly inventory for supplies in the channel, and therefore, we are going to keep it there for the foreseeable future.

And can you give us some update on the Instant Ink side? And where -- I remember like a few years ago when you started doing this with a lot of vigor, there was like the goal to move more to a subscription model, kind of like where are we in that story? And do you think like subscription being like maybe 30%, 50% of revenue is a reality anytime soon? Or is it a much longer process?

I mean I continue to see it as one of the most exciting and more rewarding things from an investor perspective because when we shift customers to the Instant Ink model to the subscription model, first, it's more accretive for us. We make more money per customer. It's also a better value proposition for the customer. So it's a win-win for both. And we make sure that this customer is always using HP supplies. So really, our goal is to shift as many consumers as we can to the subscription model. Today, we are in the 20%, 30% adoption in new printers, and our goal is to reach much higher than that 50%, 60%, we think is doable. And we are starting to see it in a few countries where the program was launched before on specific categories. But definitely, our plan is to continue to grow it. It's not something that happens overnight because it's mostly driven by new printer placements. So then it takes time until we drive that. But clearly, this is our intent. And from a strategic perspective, it's very critical, not only because of the impact it has in the print business but also because of, as I said before, of making more money per customer also because it's now a platform to sell additional services, which is something that we shared in the last Investor Day, today, we have more than 11 million subscribers to the program, 11 million people that pay us every month to be able to print with whom we have a direct connection. In the last quarter, we have been testing now the service of delivering paper to these customers, which is another key value proposition because if you print at home, having to go buy paper, heavy, very painful, and we are going to be delivering that. And this is just an example of additional services that we are going to be building on top of the platform. And for every service, we will increase the amount of money that we make per customer. And when you have 11 million, is starting to be scaled. So it's something that we will notice from an OP perspective.

And on the consumer side, obviously, the HP+ program, how is that rollout working in the U.S.? And is there a way to segment how much percentage of them are actually like maybe high end or people are using HP -- like genuine HP Ink or..

I mean the rollout is going very well. Something we shared -- let me start differently. Two years ago, we shared that one of our key goals was to rebalance profitability between hardware and supplies. In print, we were making all the profit on supplies because every time we were selling a printer, we were losing money and was kind of an investment. And we said at that point that we were losing money with close to 25% of our customers. And therefore, it was really important to rebalance that and start making money in -- with some bigger percentage of our customers. And we launched 2 initiatives to do that. One initiative was about selling printers with supplies built in. So when customers buy the printer, they pay more because they have ink or toner for the life of the printer, and we launched this in emerging countries. In developed countries, we launched what we call the HP+ model which means we offer customers the choice of paying less for the printer or getting less value from the printer and only using HP supplies or paying more for the printer and they're being able to use also other suppliers that may be violating our IP. We have launched -- we launched a program almost a year ago now and the adoption of HP+ is very high. When we present customers the choice, majority of them picks the HP+ solution. And we will be completing the rollout in all the portfolio within the next 2, 3 quarters. So middle next year, you will be able to make this choice in the full transactional portfolio, and we will be in a much stronger position, both because we make more money on the printers and because customers -- the market share on aftermarket will be also higher.

Got it. Got it. And on the print side, this is a question I've gotten from investors in the past, which is a lot of your competition is actually in Japan. Do you feel like the profitability will be much higher if this was a more consolidated industry? Or do you think that this is how it's going to be because any kind of U.S. Japan merger is basically not going to happen, so you just have to deal with the way things are.

I mean I have said this publicly many times. I think over time, consolidation is going to happen. We were the first ones that started that with the acquisition of the Samsung Printing business 3, 4 years ago, and it worked well. And if I think about the business 5, 10 years from now, I think we will see consolidation. We were in a similar situation in the PC space 5 years ago. There were many Japanese PC vendors, many of them have left the category, have left the business. I think something similar will happen in print. I think it will take more time because the print business if you have an installed base, resupplies, you can be profitable for a longer period of time. Japanese companies are slow in making these decisions. They have a lot of loyalty to the categories where they are, but over time, it will happen.

Got it. Got it. And then on the supply chain, I think you mentioned, I think, last quarter, it was a little more -- the cost -- commodity cost is a little inflationary, now it's going to be a little more deflationary. Especially if you look at it, it seems like memory and storage is probably a big chunk of that commodity cost. And given the fluctuation in those prices, how do you prepare for that? And is there a way to think about it saying let's say, memory pricing is going up now, you see that impact a quarter later? Or is it a lag effect, how to think about commodity costs in this environment?

Two things. One is it is different if you compare year-on-year or quarter-over-quarter. Year-on-year, we continue to be in an inflationary environment and cost of almost every component is higher than what it was a year ago. Quarter-on-quarter, we start seeing some declines, for example, in memories, in panels because more products is starting to be available. What we have in the company is a team that projects the cost of component going forward. And then they sign contracts or they change contracts based on the projections that they make. So we never pay the cost that you see in the market. There is always an agreement, and we always have an advantage in terms of the cost that we get both because of volumes, but also because of the projections that we make.

Got it. Got it. Let me just pause for a second to see, yes, go ahead...

I have a question or a couple of questions. I guess a couple of things. First is can you quantify [indiscernible].

Well, this is why we -- because I get many times questions from the other side, how do you -- why are you sure you're going to be able to stay within the 16%, 18%. And there are many other factors that are negative on the print side like volumes are declining. And we see this transition to HP plants as a way to create more margin to be able to stay in the 16% to 18% range. So it really helps to compensate many of the headwinds that we are going to face in other parts of the business.

[indiscernible].

No, we haven't seen it. And 2 things. First of all, in the last 2 years have been -- the situation has been so different because of the supply constraints that I think everybody has not been trying to maximize prices based on the lack of availability. So I think we will see more in the future. And I think if there is a competitive response, it's something we will welcome because it will mean that others are also raising prices. And either they move with us and it will be good for the whole industry. And if they don't move and they get some of the customers that we were losing money with it's also something that we will welcome. So it's kind of a win-win no matter what we do because either we lose customers we don't want because we lose money with or if they raise prices, the whole industry will be more profitable.

And Enrique, I just wanted to touch on this one. I remember, I think it was like maybe last July quarter, if I remember right, there was like little bit of inventory mismanagement issue. Some share shift happened in 1 quarter, but what amused me the most was, you folks recovered really quickly and corrected that issue. So I'm kind of from the -- like what is like the lesson learned from that? Because it seems like after that, the inventory management has actually dramatically improved except for that 1 quarter of this one. So I'm kind of curious what is the lesson learned in that, that's kind of like made you guys like react so positively so quickly.

Yes, it was not so much inventory management. It was like -- we didn't have visibility of the components that we needed across the full value chain. And therefore, our shipments in Q3 last year were below what we were planning and what the rest of the industry did. And we did a lot of changes that we explained a year ago in terms of having better visibility of the components, we build tools to be able to prioritize orders but also to have visibility of the components that the ODMs were going to use, which are in contracts with some of the component providers that we have never had a relationship with, but we realized that in this situation, we needed a contract with them. We also did a lot of effort to simplify the portfolio, so we could use the same component more in more product. I mean we have been working nonstop since then, and this helps us to have better results, and this is what has been happening in the last 3 quarters.

Got it. Then the other thing that's always interesting about the HP story has been your extremely strong free cash flow generation and the capital return, right? And I think you're still saying you're going to do about $4 billion in buybacks this year, and you've done about $2.8 billion so far. And is that $1.8 billion in the prior quarter and then $1 billion the last one, is the buyback curtailed because you had to close the Poly deal? And if so, the longer it takes, does it mean the longer it's going to take to restart the buyback back to the $1.8 billion level on a quarterly basis.

No. So 2 things. So it is not impacted by the Poly deal. So Poly deal we'll have cash to pay for it. Remember that we also got a payment from Oracle of close to $2 billion. So this helps significantly to pay the Poly deal. What we are doing is our commitment with investors was by the end of 2022 return at least $16 billion is what we committed in 2020, and we are going to make that commitment. And therefore, is around $4 billion that we need to do this year to be able to be there. This is, let's say, Wave 1 that we'll be closing in at the end of the year. Beyond that, we have also said that we are going to be continuing to buy aggressively. We're going to continue to return aggressively capital to shareholders. And what we have said is, we will be returning 100% of free cash flow unless opportunities with a better return on investment show up. And this is -- this was our commitment a year ago and continues to be our commitment.

And then maybe the final question I just want to touch upon is I think it was like late 2019 or early 2020 when you guys came out with this transformational effort with cost savings. And it looks like you're definitely running well ahead of schedule. So how would you gauge yourself on that transformation road map? And given the fact that you're adding peripherals, which to me is a higher-margin business, maybe at the next Analyst Day, should we expect revision to the 5% to 7% PS and 16% to 18% print op margin targets.

So starting from the last part, we will see what we say in October. I think the margins that we created last year really included all the benefit from peripherals and services. So really, the 5% to 7% and 16% to 18% was already including this significant shift toward the new businesses and the new opportunities. And compared to where we were, for example, in Personal Systems, we increased 150 basis points. So it was already a significant improvement. And the first part of your question was?

The progress on the transformation.

In terms of transformation, I think we have executed the plan that we said. Our original plan was to save $1 billion, we raised it to $1.2 billion, and we will be delivering our plan. Now I have been in this business for long enough to know that there are always opportunities to remove cost always. And in our case now, when we look at the opportunities that we get by adopting better digital tools, better digital processes becoming more efficient there, is we are investing. We have been investing in better IT systems, and this will help us to continue to get savings down the road, but there are more opportunities that we are going to go after is like cost. It's like a mine, you can always keep digging and keep finding gold. We are going to continue to do that.

Great. Excellent. Thank you very much, Enrique. I really appreciate your time and insights. It was very helpful.

Thank you.

Thank you.