HP Inc. (HPQ) Earnings Call Transcript & Summary

Okay, great. Okay. Everyone. Thank you for joining us. My name is Shannon Cross, and I'm the IT, Hardware Analyst here at Credit Suisse. And I'm now joined by the CFO of HP, Marie Myers. Prior to getting started, in preparation for my future IR career, HP has asked me to read the following. 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. So with that, maybe, Marie, would you like to talk a little bit about yourself, introduce yourself and let us know what you've done at HP over the last several years, became acting CFO in 2020 and actual CFO in 2021.

Yes. No, thanks, and great to be here this morning. And thank you, Shannon, for the opportunity. And yes, so I've had a long history at HP, been with the company, and actually before that, with Compaq for about almost 25 years in a variety of finance roles. And I actually left, did a start-up and came back to do the transformation program and became the CFO as well. So delighted to be here this morning and really looking forward to this session.

Well, the -- your background with transformation is appropriate given what you just recently announced with the Future Ready Transformation. I'm going to have to memorize that. We'll hear about that, I'm sure, a lot over the next few years. What were the key drivers behind that decision? And what are your key points that you're trying to actually get to, markers that we can watch along the way?

Sure. No, thanks for that. And yes, we just call it FRT to make it easy, Shannon. So Future Ready Transformation -- I actually came back about 3 years ago to lead the prior transformation. It was really successful. We just closed it out last quarter. Actually, exceeded our goals. We had planned to deliver about $1 billion. We delivered about $1.2 billion. And given we're coming to the end of that transformation, we looked at what we had accomplished, and really saw the opportunity to continue to grow even more beyond that. So that was really the impetus for launching what we call Future Ready. Future Ready really has a couple of goals. It's building off the original program. So we laid a lot of digital infrastructure, the first time around. And so now we see that opportunity to really grow and help our growth businesses, frankly, really drive that digital investment. And then the second thing is a company as large as HP, there's just always an opportunity to take out costs and drive efficiency. So really, the program is anchored around both those different dimensions. And I would say, we kind of broke it up into 3 key pillars. And the first one was really around optimizing our portfolio. If you think about the last couple of years, it's interesting. We added a lot of SKUs to the portfolio because just because of the sort of constraints that we've had out there, we found our portfolio got a lot more complicated. So we see an opportunity to actually streamline, a lot of SKUs. We laid the groundwork for a very large ERP implementation during the first phase of the program. We completed our S/4HANA. Now we have the digital infrastructure in place for one ERP. So there's a lot of opportunity to continue to really enable our contractual business because it's a very different delivery model than our sort of product business. So we're building out those capabilities. And finally, we actually -- and I'm really glad we did this, we started optimizing our real estate footprint before the pandemic, and there's just more opportunity to continue to do that. So as you can see, lots of different pillars. And we are actually anticipating we'll deliver about $1.4 billion in savings. So it's a rich program. I think it will drive the company to its next stage.

How much of the $1.4 billion will we actually see fall through to the bottom line? Because there's an argument in some of the more, we'll use the word, mature tech companies that you become serial restructurers, just sort of shrinking and shrinking and shrinking as the business shrinks. So how can you position the company to at least stabilize and maybe grow, and then also see some of the benefits fall through?

Yes. So in terms of just the benefits, so if you look at the guide for the year, we've actually got those benefits in the guide. But I think what's really -- the way we're thinking about it is really we'll see the flow through in the outer years. And that will be driven very much by the growth businesses because these growth businesses, Shannon, really need a different type of operating infrastructure. The product business has a whole different operating model, say to services and subscription. And if you look at our growth businesses, those models are really services and subscriptions. So we've got to make those investments and really repivot the company towards delivering success in those areas. So -- and then on the small side, actually, the company is growing, just to kind of get it out there for everybody. We've actually grown, and if you look at sort of prepandemic HP and post-pandemic, we've added $4 billion on the top line and over $1 billion on the bottom line. So I think our trajectory is around being a more efficient company, a more agile company and continuing to really drive OP, grow OP dollars in the segment over time. And so the expectation is we'll see the flow through in the outer years.

Maybe can you talk a bit about the growth pillars and maybe business by business, starting with the one that you -- because it's always good, starting -- I guess, peripherals would be the biggest, right? So from peripherals, but then of the other 4, what are the key drivers? Because sometimes they get subsumed within the greater business.

Yeah. And I think that's the lesson we've learned, is that the company, when you've got a company that's a $60-plus billion revenue company, these growth businesses sort of can get not lost, but it's difficult to see those businesses flourish. So one of the intentional decisions we made at our last Security Analyst Meeting was to call out these growth businesses. And we've kind of called them the 5 key growth areas, really interesting name like you. Difficult one to wrap your head around, but these 5 key growth areas really have -- they delivered double-digit growth in terms of revenue. Just this last year, they delivered [ $11 billion ]. And we expect that collectively, they'll continue to drive double-digit growth going into '23. So they're not just attractive on the top line, but they're incredibly attractive on the bottom line because they have much richer margin profiles than our core. And to give you just a flavor of what they look like, I think you mentioned peripherals, Shannon, and we just did an acquisition of a company called Poly that I know we'll talk about. And Poly clearly sits right inside the sweet spot of our growth vectors. Peripherals is just a really large TAM. It's 100-plus, and it's growing single digits. So very attractive TAM. And it's one where we see just enormous opportunity to leverage the core with the peripherals. So that's just one example. A couple of other ones. I'll just call out. We see Instant Ink is one area in terms of consumer subscriptions. So we see these models, not just in terms of the product, but it's in the type of business, right? So we're getting into subscription. So that business now is a very substantive subscription business. We've got a platform that we can actually leverage of and drive other consumer services. For example, we launched Instant Paper. So it makes sense if you've got nonstop ink at home, you don't want to run out of paper either. So we see the opportunity there to really pivot and continue to add these services to the platforms. And then obviously, one big area that we're really interested in is workplace services and workforce services. And we recently reorganized even inside our company to get much more vigilant around the focus around services end-to-end. So there are a couple of examples of the growth categories, more to come. And certainly, we've been giving, I think, investors, and many of you more transparency. So we've talked -- in our earnings calls, we typically give an indication of how those businesses are performing, and a few more sort of deeper insights into what we expect that will deliver in the future years.

Do you think -- do you see from a consumer perspective, an opportunity maybe someday where I can pay $50 a month, then I'll get my printer, my PC, my supplies, my paper, my warranty, all of that?

Yes, absolutely, Shannon. I think in the near future is what I would say. We're definitely heading that way. I think what we've seen during the pandemic, I think we saw the rise of what we call the prosumer, where we're working from home and we wanted to have everything in a box come to the house. And I think a lot of CIOs really struggled with how to get it all to an employee. And certainly, I think that was one of the biggest drivers for us with the acquisition of Poly. We just saw that opportunity for really giving a CIO an end-to-end capability. Many -- and I actually ran IT at HP. When I came back, that was right at the early stage of the pandemic, and I had to enable 55,000 people around the world to basically work from home in less than 10 days. And one of the biggest struggles I remember being -- working -- running the IT department was how to get people enabled. So we have to literally deliver all the laptops, but what we did is we couldn't source peripherals and so the peripherals became a personal decision. Today, CIOs don't want that. They want it all pulled back. So to your point, I think being able to deliver it all in a box on a service subscription model is really a -- is where the future is going.

Great. Maybe we can pivot over to the Printing business -- particularly more on the [indiscernible] business from the standpoint of supplies. I think there's been a lot of questions about why supplies are down 10% plus. What's really going on there? Is this a recategorization, if that's the word, from maybe what was supplies to maybe a little bit more in the hardware because you have -- now have your all-in-one printers and that? Just -- or maybe it's because you've gone to Instant Ink? I just -- I'm trying to understand why there's been such a contraction, and it was so abrupt. And then maybe at the end of this, are we reset at a different level that will be more sustainable over time?

Yes. So let me -- you've said a lot there, so let me unpack. First, unpack how to think about the business. I think first and foremost, we are intentionally shifting our business model, right? So we've launched HP+. And the objective there on HP+ is obviously to get a lot more of the profit upfront, but also it actually is an enabler of pulling through Instant Ink. So -- and today, we ship more than 50% of our units are HP+. What's been really interesting during the pandemic is just the growth of Instant Ink and the sort of take out rates that we saw. And clearly, customers really appreciate that opportunity to never run out of ink, and they like that model. And then how does this all sort of tie together with supplies. I think the key here, and the way to think about supplies is, we have really been able to change and shift, I think, the model to that Instant Ink. We see more of that going forward. But in terms of what we've seen in the last couple of quarters, I would say that supplies usage rates are in line with what we've seen from a model perspective. But during the pandemic, we did see a shift in terms of customer behavior patterns. And I think some of the economic issues that we've had in the macro most recently, certainly, that is what we saw in terms of the correction on supplies. This last quarter, though, we did see our supplies channel inventory really fall back into really acceptable ranges. So I think our thought process here is that we'll see supplies return back to single digit in the latter half of the year while we continue to sort of see the macro work its way through the system. So I think overall, given what we've done relative to pricing, we've been very successful in pricing. We've been very successful in share. We've been very successful in managing the reman. So overall, that's resulted in sort of a better ASP for us, relatively speaking. But I think the key here is what does it look like for the rest of the year. We do expect to return back to single digits, Shannon, in the back half.

And I guess the interesting thing, too, is if you look at the Printing margin, even though supplies have been -- I mean, it obviously, historically, was -- or the margin followed supplies. But here, we've had supplies under a lot of pressure and you're at all-time high margins. So that would lead one to believe that a big driver of that is ASP but is there some of the printers itself. Is there something else that's driving a better margin?

Well, we've been -- I think we have very durable pricing on the hardware. We've had supply constraints on Commercial. As a result of that, we've been able to really command better pricing. So that's played through. And then secondly, we've seen the benefits of some of the initiatives, the transformation, the OpEx cut. We've managed our OpEx, I think very prudently, and that's all flowed through to as well. So I would say that we do expect going into '23, we'll see a little bit more pressure, particularly on Consumer. The yen is at an all-time low, as you well and truly know. So we expect that some of our Japanese competitors will continue to get more active and more -- put more pricing pressure on Consumer in '23. But overall, I expect we'll stay in 16 -- in our long-term range of 16 to 18. The last couple of quarters, we've been well above the range because of those constraints. But I think in '23, given where Consumer is going, we'll be back in the range.

So is it fair to think that the -- during the downturn -- oh sorry, not the downturn, the pandemic, with the shift, you had higher ASPs on the printers? And you're basically saying that some of that is sustainable, I guess, on the Commercial side. So I guess what keeps that sustainable versus expecting to see some ASP reduction within Consumer? Because it would seem to me that when there's more supply, and the Japanese all have their yen to play with, that they might turn and be a bit more aggressive on the corporate side?

Yes. I would say we haven't seen it on the corporate side, to be honest with you, yet. But we're already thinking ahead of that and really addressing the underlying cost structure of the core through the Future Ready program. And the other piece is just the growth businesses, right? So part of the reason why we called out the growth categories in both Personal Systems and in the Print business to really give line of sight to the fact that these businesses are not only going to deliver on the top line, they've got a better margin profile, Shannon. And so over time, it's just natural that they're going to contribute and support -- back to supporting the ASPs. They just have a much better flow through.

And then one other -- you flexed your OpEx during -- which made sense because you had so much money coming through because everybody went out and bought a new PC during the pandemic. Was a large portion of that expense actually on the Printing side and not on the PC side? So...

That was on both actually. What we did do consciously, I might add, was we accelerated investments. And we took opportunity that came by our way. So we saw it and we did invest. If you look at our R&D investments, even on Personal Systems, we heavily invested during the pandemic because we knew it wouldn't last forever. So we took advantage of that. And that, I think, gave us -- it sort of accelerated a lot of what we did around the growth areas because we had time to not only invest, but to really strategically start to pivot the company and also reinvested in that digital infrastructure. That was something that we sort of ran through to complete during the pandemic. I must admit, very difficult to wrap up a ERP during middle of COVID remotely, but we did it.

The PC pricing, maybe we can talk about that a little bit. I think during the most recent call, the expectation is basically that once you clear the inventory out of the channel, PC's pricing will improve again. And I guess I struggle with how once you take prices down in the economy that we're in with sufficient supply, how you actually get it to go the other direction? Unless -- I mean, there's currency and there's other things that could play in but it seems like a hard one to do.

Well, I think I recognize -- I think it's definitely -- what we're seeing is it's in the Consumer space, where we're seeing heavily more promotional activity. I wouldn't characterize Commercial in the same regard. So I think you've got to differentiate between the 2 categories. And if you think about it, once we bleed through the inventory, which we expect will take approximately 6 months, about 2 quarters, there is some deflationary pressure on commodities. So you can imagine as you bleed through that inventory, you're able to push back into the channel, move back into the channel, inventory that's got a better pricing profile because you've got the opportunity to take advantage of deflationary. That's one way to think about it. The second thing is, you've seen us consciously continue to move our mix towards Commercial and Premium categories. These categories tend to be more price elastic. So we expect that, that will provide support for ASPs. And then third, you and I were both talking about Poly and Peripherals, clearly, that's going to have an impact as well. And that's going to be a much larger part of our portfolio going into '23. So -- and then finally, yes, we do expect to see the benefits of our Future Ready Transformation program show up probably more clearly in the back half, which is right when if you think that inventory bleeds off in the first half, all of that will contribute to really driving a better margin profile for Personal Systems in the back half.

What are you using right now? I know you're -- I think you said it was down 10% for PC units in '23. How do you stress test the model? Because I mean, there are -- there's -- I mean having discussions with, people are like, well, maybe it's 240 million because nobody really knows and people bought an awful lot of PCs during the pandemic. So I know we recently took our numbers down to 275 million. But again, I think 2023 is a big question mark. If PCs go down to, say, 240 million units, what type of steps can you make? Or is the Future Ready Transformation enough to get you to acceptable profitability?

Yes. No, I mean our guidance range, honestly, we had probably the largest range we've had in a while. And the intention of that range was at least to calibrate the events that we knew at the time, put it that way. So with respect to the units, I mean, I can't -- I don't have a crystal ball. I can't tell you if it's 240 million, or whatever, in '23. But I think we've built our guidance based on a 10% reduction. So that's the way we're thinking about the market. We believe that Future Ready will give us the, at least the platform to be able to pivot the business pretty quickly. And I think we've shown that here just in the last 6 months. If you look at what we've done on operating expenses, we've taken out almost, I think, more than $800 million in the last year. So we know that we've got the levers that we can pull to help adjust the model where we need to. But certainly, I think at this point in time, the guidance range we've built is really predicated around a 10% reduction in the business.

If you think about your cost base, maybe net of -- I mean COGS, you have engineering and things in there. But in general, how do you think about fixed versus variable costs within it? I mean I would assume during the pandemic, you flexed up your variable costs pretty significantly. But overall, where are you at this point? And where do you expect to be maybe when you get through the Future Ready, I am going to just call it FRT.

Yeah. FRT. So I'd say that Future Ready, the program itself is focused on both COGS and OpEx. So we've got levers in both those places that we can absolutely pull. As I said, we've taken about $800 million out. A lot of that, to your point, was probably variable expense. So we've seen -- we made some of those investments, as I mentioned, in R&D. We accelerated some of those spaces. We've also obviously looked at things like variable compensation. Those things go up and they sort of go up and down depending on business performance. And I would say that in a company as big as HP, there's just always an opportunity to continue to take out cost. And so the areas that we look at, as I mentioned, we kind of had 3 pillars in Future Ready. The portfolio simplification, it's not a small one. I mean, we do have this. If you think about the SKU complexity in itself and where does that show up, I mean, it probably shows up in a few different places. And there's a lot of pull-through cost that goes with simplifying your portfolio. And we know, as a company, that complexity is our friend sometimes. So we've got an opportunity, I think, to drive a lot more simplification there. And then in terms of just operational efficiency, I mentioned that we invested heavily when we had the opportunity in the pandemic to get that digital infrastructure in place. There's another layer of transformation around automation that we can drive, and that really will hit at efficiency. So -- and that can show up in really hitting at your fixed cost structure as well. So that's why I'm saying there's opportunity across the different spaces, and it will take time, Shannon. But I think we've laid a lot of the foundation to be able to pivot.

Is there an opportunity to take hp.com and drive incremental sales, almost more inside sales or direct so that you're not utilizing the channel as much, although any channel people, they still have the channel because that's -- I remember once [ P.J. ] was speaking at a conference and he made some comment about the channel and it caused a big uproar.

It erupted. Yeah, because we don't need to do that really.

Yes. No, exactly. But just in general, I've heard it from a number of companies actually that they're looking at how they can take their digital platform -- exactly.

Digital platforms. Well, look, there's no doubt the pandemic accelerated digital transformation and accelerated the way -- I'm assuming you probably buy everything online today. Buy a bit online myself, except for Black Friday, when we did go to do shopping. But...

You are brave.

Yes, I was brave. I decided to try it once. But I would say back to our own business and how we're thinking about the digital platforms. Clearly, there's a good reason why we invested so heavily in the pandemic in that digital infrastructure, we see an opportunity there. And if you think about the model shift we're doing in terms of subscription, subscription naturally plays with digital. So you can kind of see that intersection working, and that's where we're headed Shannon. I mean, it's clearly an opportunity. But let's not forget the channel. The channel is incredibly important. And we do believe there is a way to kind of make it all work together, that we can get the channel engaged in this model. And we've seen it in Instant Ink, to be frank. We've built a model where I think that there -- the channel is participating and seeing opportunities. So that's how we're thinking about it. And clearly, as we think about the growth categories, it's not just the categories themselves, but how you enable that value through your digital platforms and through e-commerce.

Are there incremental -- I mean you kind of made your bet with Poly at this point, I think, from a late -- and we'll get to balance sheet in a bit from that standpoint. Are there incremental areas maybe that are smaller? I mean you did HyperX that -- to really target and grow? Or are you pretty satisfied with the portfolio at this point and just kind of where we'll be for the next few years?

That's an interesting question, Shannon. Look, I'd say we're probably never satisfied. But certainly, we've got a lot to do in the next 12 months, is the way I would sort of look at it. I mean in terms of where we're at with Poly, we've just actually closed the deal. We were early. I think we got it done relatively quickly, but we expect that we'll be heavily involved in driving the hard integration here in '23. So that's going to consume a lot of our time. I think it's important also to think about just where we're at relative to leverage. I think that's another driver of how we think about it. But we're always looking for accretive -- value accretive opportunities. Clearly, peripherals is a big bet, and it's one that we're focused on here in '23.

And I guess getting to cash flow and balance sheet. You recently slowed your share repurchase program. I think you said you'll keep it at the level at least of offsetting dilution.

Correct.

But that's obviously a substantial change from $1 billion a quarter. What are the -- what should we watch for to determine when you might restart the program? I mean is this a short term, we don't know what the next couple of quarters are going to look like situation? Or is this more, we levered up to buy Poly, and given the state of everything and all the restructuring charges, we're going to have to undergo, it's a longer-term kind of shift?

The way -- I'd say we very much haven't changed our strategy. We're still absolutely committed to return to shareholders 100% of our free cash flow. Just given where we're at relative to our current leverage, we have said, I think, multiple times, we wanted to stay in the range of 1.5 to 2x. As a result of that and where we're at and given the current macro we think it's prudent at this point in time to have just a modest program to your point, that offsets dilution. So that's the way we're thinking about share repurchasing at least here for the short term. But as -- we remain absolutely committed to returning 100% of our free cash flow to shareholders over time.

And in terms of drivers of free cash flow, working capital is certainly -- I mean, namely inventory, has been a big use of cash over the pandemic. How are you thinking about inventory? Because it used to be, we had just-in-time, and now they're talking about just in case and maybe go back to just-in-time. I don't know. I can't follow it. I'm just wondering how things have shifted, and if we can ever get back to maybe a leaner inventory outlook?

Yes. No, I think the pandemic taught us all a very valuable lesson around resilience, which I think where we went to was the just-in-case model that you described. And it was just so difficult. Most commodities were very scarce. I think we're starting to come out of that. The whole pressure on commodities has eased up. I would say that we've still got some challenges in our commercial print space. But overall, you've probably seen just in the last quarter, we took a big stair step reduction in our owned inventory, particularly on the Personal Systems side of the house. And it is our intention to continue to drive that. As we see the commodity pressure really ease up, and we don't see the component scarcity that we've seen over the last 24 months, we expect to continue to drive substantial reductions and to get back to what I kind of describe as prepandemic levels but noting that the business is much larger. So you probably can't do a line-by-line comparison. But we're a much bigger business today. As I mentioned $4 billion bigger on the top line. So you got to take that into account relative to our owned inventory. So -- but we're absolutely focused on managing that much more efficiently going forward, and particularly in light of the environment where commodities are just much more available today.

How much of the -- I think at one point, you had an awful lot of PCs probably...

On the oceans, yes.

Yes. How is that?

Well, if you think of one of the drivers was that, and I'm not sure folks appreciate was we had -- we were able to use the train that went up through China from Chongqing. And because of the Russian situation in Ukraine, we had to pause utilization of the train, which was a big deal. So that meant we had to put a lot more inventory on the ocean, and that was one of the drivers -- just one of the drivers. And I would also add that today, though, the ocean times have improved. We've started to see transit times improve. Shipping rates, logistics rates have somewhat improved. So we're seeing all of those benefits. I expect that will continue in '23. But certainly, at this point in time, we've definitely had to use -- we've used more ocean because it was also more economical, frankly, as well.

So I guess maybe to end up here, when you look forward in the next couple of years, how do you see HP -- I mean we've talked about the FRT. But how do you see HP sort of shifting and changing? And if you look back at yourself 2 years ago, or whenever in the future, where do you think the company will be? Because it's so different than it was prepandemic in terms of the -- what we learned about PCs and then maybe some of the secular challenges on Printing, and then you've got 3D printing, which I firmly believe will be something at some point. It's just like every time it gets to the inflection point, there's a war, there's -- I mean, it's kind of been kind of crazy as an industry. So maybe if you can look forward and give us in your crystal ball what we should expect?

Yes. No, as you've said, I think the company has changed an awful lot through the pandemic. We definitely continue to believe that the hybrid trends that we've seen, those secular trends have shifted and are going to continue to be a big impact for the future. So -- and if you think about our business, we're just so well positioned with our portfolio today, particularly now with peripherals as well. We believe hybrid is the way of the future and is going to be the way people will work. So I think we're incredibly well positioned as a company not only in terms of the trend, but in terms of driving growth in these areas that are going to be just far more important and drive the way people really work. I mean I don't think folks -- we're going to see the same style of working for -- that we saw prepandemic. Today, people are really comfortable working at home and working in the office. So I think that HP is incredibly well positioned to take advantage of a hybrid.

Great. Well, thank you so much for your time today. And thank you everyone, for joining us.

Thank you. Thanks, Shannon. It's great to be here.

Yes, absolutely.