HP Inc. (HPQ) Earnings Call Transcript & Summary

Great. We'll go ahead and get started. 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 IR website at investor.hp.com. With that said, welcome to the HP fireside chat at the Goldman Sachs Communacopia and Technology Conference. I have the privilege of introducing Enrique Lores, Chief Executive Officer at HP. Enrique has been at HP for nearly 35 years. And prior to taking over as CEO in 2019, he served as President of the Printing business, helped to architect the separation of HP in 2015 and held multiple roles in sales and customer support. My name is Michael Ng, and I cover HP and IT hardware here at Goldman Sachs. We have about 35 minutes for today's presentation, inclusive of Q&A. So if you have any questions at any point during the session, please feel free to raise your hand, and we'll get a mic runner over to you. So first, Enrique, thank you so much for participating and being at our conference. It's a pleasure.

Thank you for calling me here.

So HP is a leader in PCs and printing. Would you talk about the 3- to 5-year vision for HP, discuss the areas that you're investing in, the growth opportunities that you see, and also some of the challenges that you might be managing right now?

Sure. So as you said, today, we lead both in Personal Systems and Print. Both of them are large markets where we expect will continue to grow in the coming years despite of the challenges that we are seeing in the short term. We have articulated a strategy where our goal is to maintain our leadership in the core businesses, while at the same time, we are growing into 5 key adjacencies where we see a lot of opportunity to grow. These adjacencies are really supported by trends and changes that we see in the market. For example, we believe that hybrid work is here to stay, and this is opening us a big opportunity, what we call hybrid systems, enabling people to work from home and from the office. We think gaming is going to continue to be a big trend. So we have one of our growth businesses is gaming. We also see a lot of opportunities to grow on the industrial space. And one of the growth opportunities we have is both industrial printing and 3D. So really what we have is areas where we see opportunities to grow because the market will grow, or our share will grow, that are really supported by big trends in the industry.

Great. That's a really good overview. And I did want to have you just describe what happened in the last quarter? And if you could give us a little bit of a postmortem? What are you seeing in the demand and pricing environment now that may have been different several months ago? How have the industry recovery trends been in PCs and printing, respectively?

Yes. So we just have had our earnings announcement last week. And for the previous quarter, our Q3, we delivered sequential growth in revenue, operating profit, EPS and free cash flow, and our results in terms of EPS, we're in the midpoint of our guide. So we did what we had said we were going to do. At the same time, given the trends that we see in the market, especially in terms of pricing, especially in terms of pricing for PC, we decided that it was important to be more conservative in our guide for Q4, and we lower the guide -- the guide that we had before. Despite this change, we think that the market is going to continue to recover. Our Q4 in the midpoint is still stronger than what our Q3 has been, and Q3 was stronger than Q2, and Q2 was stronger than Q1. So we see an improved trajectory over the year, but we also need to acknowledge that the environment continues to be fluid. Specifically, we have seen, as I said, more pressure on PC prices that we were expecting. We also have seen slower demand in enterprise in China versus what we were expecting and the combination of all these things drove the change of guide.

Great. I'd like to dive in a little bit deeper on what you're seeing and what you're expecting in the industry PC environment and the PC TAM. Obviously, the industry enjoyed a tremendous uplift in PC demand in 2021, and we saw a subsequent normalization from that very elevated level in 2022 and 2023. So what are your current expectations around PC shipments this year into next? Will the installed base be larger than it was pre-pandemic?

We -- our estimation today is very similar to kind of what other industry analysts are saying is that the PC market in units in 2023 will be similar to what it was in 2019. It will be, though significantly bigger in pricing -- in revenue or in dollars because average selling prices have significantly increased, driven by usage and the type of products that are being bought today. We think that when we look at the future, and we will be sharing much more detail in a few weeks when we have our Investor Day, the market will grow in units in 2024. So we will start seeing a recovery from where we are today. And this will be driven both by the need of upgrading technology, be driven by AI. They need to upgrade, continue to upgrade systems, the age of the installed base. All this is going to help to drive growth on the category going forward. You were asking also about the situation today and the situation in channel inventory. We have done very well reducing our channel inventory, except for Chromebooks, we are now back to the level where we should be, and Chromebooks is really driven by a pull over of demand that happened at the end of the quarter. So it's something that will be sold or is being sold as we speak. But our channel inventory has been normalized. We still see high channel inventory in the market, and this is why we expect pricing to continue to be very aggressive.

Great. If we could just dive a little bit deeper into the discussion around PCs and being nuanced around Commercial versus Consumer. Last year in fiscal '22, I think commercial customers made up about 67% of Personal Systems Group revenue. The Commercial mix continues to increase, though, some of that is due to contributions from Poly. So just on Commercial, could you just talk about some of the outlook and trends in Commercial, PCs and highlight some of the areas that are differentiated relative to Consumer?

Sure. I would start by saying that our goal in the PC space, and the overall company is to grow profitable share. So we really don't get about share of -- the share that we have in the different segments. We grow -- we care about share that delivers operating profit. And as a consequence of that, Commercial is a very attractive segment for us because has, in general, higher margins than Consumer. And this is why in terms of share, sometimes we comment that we have the #1 position in Commercial because it reflects our focus on operating profit and in really driving the attention and the focus of the company in this direction. In terms of the dynamics that we see in Commercial, it's clearly a very large installed base. Clearly, an installed base that has been aging. We have seen a slowdown of the refresh process during the last 2 or 3 quarters because companies are being more conservative in managing these investments. But that's an installed base that will have to be refreshed sometime in the coming quarters. At the same time, we see a lot of opportunities to accelerate that, not only we the refresh of windows that happens periodically, but also because of the innovation and the opportunity that AI is going to be bringing in this space. We are working, as we have said before, to integrate AI capabilities into PC to make sure that customers -- to enable customers to run AI applications locally at the edge. This brings significant advantage for our customers, from a speed perspective, from a cost perspective, from a security perspective. And this will be -- this also will help to drive demand in this category in the coming quarters.

Great. Yes. And as you mentioned, there are some delayed refreshes for the time being. But what are you seeing in overall enterprise IT spending trends? How does that affect your outlook for what's happening in commercial PCs over the next 12 to 24 months? When does it get better?

We -- what we have seen in the short term is a slowdown of demand. The way we see that is deals continue to be open. We continue to win them, but then the time it takes to get orders of those deals has been extended. We also think that our demand is being impacted by the slowdown of hiring that has happened in many companies, because when people join the company, they need to give them new PCs, new equipment. And clearly, this is also one of the drivers of the impact. But again, as the year will go, we expect that all these will start growing again, and this is why -- at the overall PC space, we expect growth in '24 versus where '23 is going to finish.

Great. That's very helpful. And to round out the discussion around Commercial, I wanted to ask about Poly. HP acquired Poly in August 2022 for $3.3 billion of cash and the assumption of debt, and Poly helps with video conferencing solutions, cameras, headsets, voice and software to improve workplace productivity. Could you talk a little bit about how the environment may have changed in the last 1.5 years, how Poly is performing relative to your expectations? And really, what's the long-term opportunity and the potential synergies of the Poly acquisition?

Sure. I will start from the last question. The reason why we did the acquisition is because we think that hybrid work is an important trend, and it's a very big opportunity for us as a company. And therefore, it's important to have the complete portfolio that customers and consumers will be requiring to work efficiently from both home and the office. With the acquisition of Poly, we got a very strong portfolio of video conferencing solutions, a strong portfolio of camera, a strong portfolio of headsets and mic, which really complements very nicely the rest of the solutions that we already have. So from a strategy perspective and opportunity perspective, we continue to see the need and the opportunity that this is going to bring to HP. At the same time, there is also a big opportunity to innovate. I'm sure all of you have been in meetings where some people are in the room, some people are connected, and we know how painful that experience is today, and our innovation is going to be making that much easier, integrating the video conferencing systems with PCs, with mics, and really managing that as one system. So the opportunity there, clearly growth in the future. At the same time, as you said, things have changed a lot in the last 18 months. We did the acquisition right before the Russia war started. So this was right before that. And clearly, the overall market size in the short term has been impacted. You can just see -- you look at the results from some of our competitors. Of course, the results of Poly are also being put under pressure. But as I said, the opportunity continues to be there. And from a growth -- long-term growth perspective, we really think is still a good asset we have that is going to help us to accelerate our growth in these categories.

Great. Switching gears to talk more about Consumer, which made up about 1/3 of Personal Systems Group revenue last year in fiscal '22. Maybe you could just expand a little bit more about the end demand for consumers, some of the key factors that may be impacting demand, whether that's macro, hybrid work, the refresh cycle, notebooks versus desktops, that sort of thing?

So overall, I would say, similar to commercial, the overall demand in Consumer is also impacted by macro. But as we said a quarter ago, we are seeing the demand strengthening in the second half of the year, and it started to follow normal seasonality, which we expected it to follow. In fact, in Q3, if anything, consumer demand was slightly stronger than we were expecting. So that recovery in Consumer has started to happen. And some of the dynamics are similar to what I was covering for Commercial. We see opportunities to -- for the need for consumers to use PCs more to communicate and to work, and something that we monitor closely is the time people spend in front of PCs, and that amount of time is growing, which indicates the higher need to use PCs, and therefore, the opportunity for demand. And also this quarter, we have seen a recovery of the gaming business, which is one of the important segments within consumer. And that also from a margin perspective, it's relevant because configurations tend to be richer in gaming than in other parts of the market.

Great. And maybe you can just comment on demand from other verticals beyond gaming. Like what are you seeing in education and healthcare? Are there any nuances in terms of verticals that have seen more stability and strength?

I mean 2 segments or 2 verticals where clearly we are seeing strong demand coming back is education. We saw growth of education or recovery of the education opportunity in the last quarter. And another vertical where we see in many countries of the world growth is in the defense space. More governments are investing in those categories, and therefore, there is an opportunity for us.

You mentioned that AI was an opportunity to pull demand through as channel inventory normalizes. I was just wondering if you could talk a little bit more about the growth in AI and generative AI applications and how that could be a driver of PC demand? Do you see that more in the commercial space or consumer space or both?

Yes. If we think about where we see the AI demand today is clearly happening in the cloud. And you're seeing many companies really growing very aggressively in that space. We see an opportunity to grow because of AI will also be run at edge. And what we are doing is integrating into our computer's AI processing capabilities, whether or CPUs, GPUs, neural processors. Next-generation of PCs will be integrating those technologies. And this brings 3 important advantages for our consumers. This brings an important advantage in terms of latency. If you are running an application and you need a fast response time, running that application in the cloud will slow you down. And for example, in gaming, and most of the key gaming companies are going to be introducing games with built-in AI capabilities. Those applications will run much more efficiently in the edge in PCs. Second big opportunity is driven by security. Today, if you are an SMB and you want to run an application that will combine your private data with AI, you need to upload that to the cloud. And many SMBs are not going to have the fund to create their own instance in the cloud to be able to run it there. If you run the application locally, you will be able to do -- to take advantage of your private data. And finally, is cost. Running applications on the cloud is significantly more expensive than doing it locally, and both for big service providers, but also for companies, the opportunity of reducing that cost is going to be very relevant. So what we are doing is developing the technology, and at the same time, working with all the key ISVs and the key applications that are building those to make sure that our systems will really deliver great performance in these new solutions.

That makes a lot of sense. Changing gears to Print. Clearly, there are some secular headwinds that make the category kind of challenging, but there's also a lot of HP-specific initiatives that have gained a lot of traction, HP+, Instant Ink, Big Tank. Could you just expand on those a little bit more, talk about some of those initiatives that you put in place to help drive strengthen Print? And then if you could just categorize the printing industry as a whole, that would be helpful as well.

Sure. So I think the Printing business overall is going to be a stable market for the foreseeable future. Within the overall market, though, there are different trends, different segments. There is one segment which is home printing where that has been declining during the last year and that we expect to continue to decline. Another big segment is office printing. It declined through the pandemic, but now is stable or slightly growing. And then we have what we call industrial printing that we expect will continue to grow in the coming years. So a lot of our work has been to make sure that we can grow in the segments where there is growth. And industrial printing is a good example. And then that we look for opportunities to optimize our profitability in the segments where we see growth happening. And this is what we have been doing in the home space. This is why 4 years ago now, we launched what we call the HP+ category or the HP+ business model, where we're trying to change the model in -- the business model and make more money on hardware, which have not reduced our dependency on supplies, and we have seen very fast growth of this category during the last 4 years. We have also focused in capturing -- offering more value per -- to customers and they're capturing more value over the life of our customers. And we have been driving a significant shift of our business model to subscriptions. And this is what we call Instant Ink that has had very strong growth during the last years. And building on Instant Ink, now we are starting to add additional services. A few quarters ago, we launched also a paper program. So if you are Instant Ink customer, now you can also get paper delivered at home. And we have -- and that's another way to offer more value to customers, and for us to capture more value from them. And this clearly showing how we are going to be managing this category going forward.

Great. Could you talk a little bit about the competitive environment within Print. What are you seeing from a pricing perspective? And anything that HP can do from a company-specific initiative to address some of the competitive concerns?

Sure. I think the major dynamic we see in Print from a pricing perspective is actually driven by currency. Many of our key competitors are Japanese. And if you look at the exchange rate between dollar and yen, yen is probably the -- one of the lowest positions it have been in a very, very long time. And therefore, this gives them a strong short-term cost advantage. So what we are doing is, first of all, as I said before, our goal is not to grow share. Our goal is to grow profitable share and especially in the case of Printing is to reduce the number of unprofitable customers. Because when we sell a printer, we are making an investment, and if this customer is not using that printer in the future, we are losing money with that customer. So we are really focused on reducing that. And as a consequence of that, we have really been very careful of how aggressively we price our units and how aggressively we go after some of the very low-end products, which many of our competitors are focused. We also announced last week that we see an opportunity to accelerate some of the cost reductions that we had been working on for some time to be able to respond more aggressively to the situation and is part of what we are doing to see how can we reduce our cost structure so we can compete and make money in more opportunities.

How do you think about some of these company-specific initiatives like Instant Ink and Big Tank and paper when you consider the margin profile of the Printing segment. It's obviously a segment that has done really well in margins. Are margins potentially structurally a little bit higher because of all these initiatives? Just how are you thinking about that?

We see both tailwinds and headwinds. If I think about pricing, we think it's going to be a headwind for some time. Also, the fact that we expect the Supplies business to the client is going to be another headwind. On the other side, the work we are doing with business model, changing the business model, it's going to be a tailwind for us. The more we shift our business to subscriptions and contracts is going to be another significant tailwind for us because we -- when we look at profitability per customer, we make more money per customer when -- if a customer in the subscription program, especially we start adding additional services. And then some of the growth businesses like industrial are also accretive from a profit perspective. So we see this balance of headwinds and tailwinds. Overall, our plan or our estimate is at the range -- the operating range for Print will be in the 16%, 18% lower than what it is today, but aligned to the guide that we have been providing for a long time.

Great. That's very clear. Just while on the topic of things like cost savings, HP has demonstrated a tremendous amount of discipline in managing cost structure and you're embarking upon the future-ready restructuring plan. Could you just talk about the momentum of these initiatives? How much more opportunity is there for HP to manage costs through potentially a down cycle? Do you see more incremental savings beyond what you've laid out for future ready?

Yes. First of all, we are making very good progress executing the plan that we announced last year. Our goal is -- it's a 3-year program. The goal was to deliver 40% of the savings this year, and we are on track to deliver that. At the same time, having been in business for a long time, I know there are always opportunities to reduce cost, and to reduce cost in the right way. It's not about cutting investment. It's not about really damaging the future. There are always opportunities to do things better. And during the last months or quarters, we have seen all the opportunities that, for example, AI is going to bring. Some of them we had in the plan because we had an aggressive part of the plan coming from digitizing the company in a more efficient way, but there are also areas that we are now working on that we think will bring more value, more savings in the future.

Great. If I could just talk about the consolidated business for a moment. I was wondering if you could just describe whether you're seeing diverging performance across different regions. And this is both PCs and Print. Are some regions doing better than others? What are you seeing from a geographic...

I would say, overall, the demand that we see is soft across the board. If I want to go 1 level below and see or discuss some of the nuances, in the case of PCs, we have seen some recovery in Europe and North America during the last quarter. At the same time, we have seen clearly a weaker market in China than we were expecting. And that's probably the biggest difference that we see. In the case of Print, the dynamics I was explaining before about aggressive -- aggressiveness from our competitors are happening worldwide, but we are seeing some recovery, especially on the office business compared to where it was a few a year ago, driven by more people coming to the office.

Okay. Great. And maybe just one more on Printing. You talked about the strength that you're seeing in industrial. You said it was margin accretive. Just wondering if you could talk about some of the secular drivers there. The strength in the 3D Printing business. How do you think about the magnitude of that industrial and 3D opportunity?

Sure. So I think -- first of all, they are long-term growth opportunities, but also in the short term, as the overall industrial segments have been impacted. These are segments that this quarter were impacted by macro. So I want to make sure that's clear. I think that the growth of these categories is driven by the opportunity of doing or building digitally, products, whether physical products or documents that until now we're then using analog technologies. And really is driven by the continuous development of technologies that we do. We continue to build printers that are able to print faster with lower cost, and therefore, we are able to capture more jobs that until now were than using analog technologies. And this is also driven by expanding into more segments. We are growing in the label market. We are growing in the flexible packaging market, which are areas where until 2, 3 years ago, the penetration of digital was very low. And this is why we -- this is -- there is still a large number of pages that are printed using analog technologies. So as from a long-term perspective, the opportunity is there.

Great. I do want to leave time for audience questions. So maybe I'll just sneak one more in. But if you do have a question, just raise your hand, and we'll get a mic runner over to you. On capital allocation, I was just wondering if you could talk a little bit about your appetite for M&A, what opportunities do you see to further strengthen your product portfolio and areas you can invest in inorganically going forward?

I would say that at this point, our focus from an M&A perspective continues to be the integration of Poly. It was a relatively big M&A, and we want to complete the integration, complete the work, and this is really where we are focused. At the same time, if we see opportunities to accelerate our growth in some of the growth areas, we will use our M&A dollars to do that. But we do that always in a very disciplined way. For us to buy a company needs to first be aligned to our strategy. Second, we need to be convinced that we can execute from an operational perspective. And third, it needs to be an attractive opportunity from a financial perspective. So we really look at every opportunity we with these 3 angles. In terms of capital allocation, our goal, as we have said many times, is to return to shareholders 100% of our free cash flow over time unless M&A opportunities arise and always that our leverage ratio is below 2, which is what we think we need to be to maintain our investment-grade rating. This is the strategy we have been executing for 4 years now of the year and the strategy that we will continue to execute in the future.

Great. Excellent. Any questions from the audience? There's one over there. If we can get a mic runner over to the...

Hi. Would you say that adding AI capability to your PCs will require a CPU, GPU, neural net, I think those are the 3 you mentioned. You're relying on an external semiconductor provider, I assume. When will those products be ready and actually going into production? And will they be capable of running the big AI models that are driving all the attention today?

So yes, we are not working only with one vendor. We are working with multiple vendors, and the configurations and the architectures are slightly different, but the concept is very similar. What we have said publicly is that the products will start to be available in the second half of next year. So by this time this year, we should have products already in the market. And they are going to help us to again drive refresh and create more demand, but also will be helping to increase the average selling price of PCs because the configurations will be, will be richer. So this is why we are so excited about the opportunity this is going to be bringing.

Any other questions from the audience?

Well, Enrique, I guess as we wrap up the session, maybe you can just talk about where you're most focused on and the key initiatives that you're trying to drive forward over the next couple of years? And what you're most excited about as you think about what HP could become and the vision over that same time period.

I think it's a combination of what we have discussed today is to continue to drive growth on our -- what we call our growth categories, our growth businesses, where we really think that we have very tangible opportunities to do that. At the same time, in some of our core businesses, we were just talking about AI and the impact it's going to have in our PC category. This is really going to help us going forward. And at the same time, continue to drive our efficiency programs both to be able to fund growth and at the same time, to deliver what our investors are expecting us to do in the bottom line. So doing both growth and cost is where my focus is. And I would say it's a very exciting plan. It will -- we will be able to deliver great solutions for our customers, and at the same time, deliver strong financials to our shareholders. We're excited about what we can do.

That's great. It's an excellent way to cap off the session. Enrique, thank you so much for being up here. It's been such a privilege to be able to host you.

Thank you.