HP Inc. (HPQ) Earnings Call Transcript & Summary

Thank you, everybody. Welcome to the HP fireside chat at the Goldman Sachs Communacopia and Technology Conference. I have the privilege of introducing and hosting Karen Parkhill, who's the CFO of HP. Karen joined HP in 2024 from Medtronic where she had served as CFO since 2016. My name is Mike Ng, and I cover HP and IT hardware here at Goldman. We have about 35 minutes for today's presentation. So first, Karen, thank you so much for making yourself available to us. It's such a privilege to have you here on stage with us.

Thank you, Mike. Great to be here with you.

Well, to start things off, maybe we can just do a brief recap. HP reported earnings 2 weeks ago. We saw strong PC refresh demand, a little bit of softness in print -- maybe before we dig into some big picture strategic questions, you could talk about some key takeaways that you'd like to highlight from the quarter.

Sure. Thanks for that opening questions. We had a really good third quarter. We delivered our fifth consecutive quarter of growth across the company and our sixth consecutive quarter of growth in our PC segment. The PC momentum has really been driven by the Win 11 refresh and the increase of AI PC shipments across our space. And we expect that momentum to continue through the end of this fiscal year and into next fiscal year. We did see in Print it performed as we expected. We did see a little bit of softness in the office space, but we expect that to be temporary. And within both businesses, we performed with our margins within the ranges that we've given despite the impact of increased tariffs that we've been rapidly working to offset.

Great. Maybe just following up on that. You talked about continuing to expect growth in PCs. The company said that they expect mid-single-digit year-over-year growth in industry PC unit shipments for the rest of the year. Maybe you can talk a little bit about what's driving that industry outlook? And how does the macro environment take into consideration when you give that type of forecast?

Yes. So when we look at the overall PC market. We do expect that mid-single-digit growth in line with the industry experts. And I'd say it's driven by 3 important parameters. One, we've got an aging installed base that is being refreshed. And with that installed base, we've got more and more laptops out there, and those have a shorter lifespan. So that's helping as well. Two, we've got the Win 11 refresh. And I'd say we've still got plenty of opportunity left. We'd say about 50% of the installed base out there has been refreshed, and so we still have plenty of room to go. And then third, we've seen an increasing mix of AI PCs across the shipments. And we had said originally that we expected to have 25% of our shipments be AI PCs by the end of this fiscal year and we actually saw it a little bit earlier in the third quarter, 25% of our shipments are slightly more than that in the third quarter were AI PCs. And we still expect 50% of our shipments to be AI PCs within the next couple of years. And with AI PC, that brings a higher price and higher margin as well. It's a premium product.

Right. So the AI PC penetration hitting that 25% target earlier than expected, which has been great to see I was wondering if you could talk about whether or not the prospects and the implementation of tariffs have affected that. Did we see much in terms of demand pull forward because of the threat of tariffs, not only for the AI PC penetration, but just for the environment overall. And are there any specific customer verticals where tariffs may have had an outsized impact just in terms of demand pull forward [indiscernible] in that?

Yes, we look at all of our data and trends to be honest, Mike, and we see very little impact of demand pull forward right now. And we said that in our second quarter, and we said it the same in our third quarter. So while I know that there's been talk about demand pull forward, really, our data doesn't show it.

Okay. HP recently took some price actions in both the PC and the Print portfolio, to offset higher commodity costs, some of which are related to tariffs. Could you talk a little bit about how those pricing actions have been received by the market? And any areas, whether product or customer types that are more price sensitive and how HP is exposed to some of those segments?

Yes. So obviously, with the increased cost of tariffs, we've been taking very decisive action. And that includes optimizing and moving around our supply chain first and foremost, and it includes cost reduction everywhere that we can. And then it does include increasing price. So we've been taking decisive action across both of our segments, both Print and PCs to increase price. And I would say our competitors are facing the same cost pressures and dynamics. So while it remains a competitive pricing environment, I do think that our customers do understand the need to increase prices. And so we're seeing our discipline across those price increases and us maintaining it.

Okay. Great. And going back to 1 of the key drivers of PC refresh, which is the Windows 10 end of life, that's supposed to occur, I guess, next month in October. I think the company has shared that slightly over 50% of the installed base has converted to Windows 11 to date. Maybe you could talk a little bit about the pace you see for the remaining roughly 50% to convert to Win 11 how many of those customers may potentially pay for some sort of license extension so that they don't refresh imminently, but how do you see that all playing out?

Yes. I would say the good news is that we're at 50%, and there's more to go -- and I'd say the pace of the refresh started up lower than I think we anticipated, but we've seen some pickup in the last couple of quarters. And now it's on pace, I'd say, with prior refreshes that we've had and seen. I'd say it's starting more strongly with the large enterprise, but moving down, obviously, to the small and medium businesses and into the consumer. And so I'd say there's more to go. And that, I think, is one of the -- but not only drivers of growth momentum, not just for the end of this fiscal year but into next.

Right. The aging installed base probably being the most important one of the 3 that you mentioned.

Yes, yes, and AI PC pickup.

Yes, yes. Okay. Maybe if we could double-click on Personal Systems margin, which is the segment that houses PCs. Last quarter, PS EBIT margins of 5.4% return to what you guys have talked about as the long-term range of 5% to 7%. How do you think about the drivers of margin improvement in the quarter, but also the key drivers of sequential improvement next?

Yes. So with the impact of tariffs that hit mostly in the second quarter, we took some really decisive action to offset that impact. And so as expected, we drove that sequential increase in our PS margins back into our target range of 5% to 7%. We expect those actions that we've taken to gain further traction in this coming quarter. And so we expect continued sequential improvement in those margins. And as we look ahead, we're focused on maintaining those margins within the 5% to 7% range.

That's great. And on the AI PC piece, as you mentioned, these are PCs with more content, comes with higher ASP, presumably more margins. They made up 25% of shipments last quarter. Could you maybe just talk about the magnitude of ASP or price increases you expect from AI PCs and what are really the key drivers of that?

Yes. So AI PCs are premium products. And so they do carry higher price and higher margin with them. We've said that we expect an ASP uplift to the overall PC category of 5% to 10% with AI PCs by the time we reach the 50% shipments within a couple of years, and we're on track for that and just expect that to continue.

Okay. Great. And maybe you could talk a little bit about like the demand driver for an AI PC. I think some people just wonder like why anybody would need that at this point -- how much in terms of software workloads happen on device relative to in the cloud? Or is this really more about future proofing, right? And if you're an enterprise, right, like you want to get the thing that will last you over the test of time, so to speak.

So AI PCs are a little bit about future proofing right now with enterprises because we see CIOs making that decision to refresh their installed base with AI PCs because they don't want to be outdated in a year or 2. But I'd say more and more, we're seeing more applications being developed that are going to be able to run at the edge, it's faster, it's more secure, it's cheaper because it doesn't require the increased cost for network and cloud. And so we're seeing it today. We've got software from Adobe and Zoom that are running at the edge on the AI PCs. We've got CrowdStrike today that is using the higher NPU of AI PC to scan the memory and be able to operate more effectively and faster for its customers. So there's examples today, and there's more and more examples that are being developed as we speak, that are rapidly coming to market. And so AI PCs are the wave of the future, and that's the key reason why we expect 50% of our shipments to be AI PCs in the next couple of years.

Somebody has to pay for the cost of compute. So if you can put it into the device, all the better. Shifting gears, maybe we can talk a little bit about Print. HP has done a very good job of increasing the value-added services and home printing, right? And I think about some of the subscription services like HP+ and Instant Ink and Instant Paper -- maybe you can elaborate a little bit on the HP home print strategy and where you see this business evolving to in the long run?

Yes. Yes. So obviously, the home print business has been declining a bit. And we've been focused on operating at the most effectively and most profitably that we can. We've been focused on increasing the amount of big tank printers that we sell as part of our mix, and we expect that to continue. We've been focused on increasing our subscription base. We've got Instant Ink. Instant Paper all-in subscription, and we have 13 million subscribers globally right now, and it's ramping at a rapid pace. And we've also been focused on increasing pricing to offset the costs that we've seen, particularly in tariffs and of course, reducing costs everywhere that we can across our Print business.

Great. Maybe going back to some of our earlier discussion points around office print, some of the softness -- you may have seen in the quarter, if I recall correctly, it was some of the enterprise customers that may have deprioritized some of the print investments because of things like PC refresh, investing in AI when does HP expect commercial demand and print to stabilize and improve? And do you see the risk of potentially investments in enterprise print being crowded out by some of these things for some foreseeable time.

Yes. Thanks, Mike. I would say while we did see a slight decrease in office demand this past quarter, we do believe that's temporary. We did see companies, particularly larger enterprises choosing to prioritize other investments over print right now. But we don't expect that to be something that's long lived. In fact, when we look at our usage data across Print, it's very stable. People are using the Print services. We expect that to continue. And eventually, you're going to need to refresh your installed base of printers -- and then as we look at the back-to-office momentum that is continuing around the world, we're expecting more and more enterprises to upgrade their print fleet as they welcome more employees back to the office period.

Could you comment a little bit about the competitive environment in Print there's been some pressure for some time, particularly from foreign competitors. How does HP balance market share and margins given the competitive intensity in Print?

Yes. Yes. print does remain a competitive environment. I would say competitors always make us better, too. So that's good. But despite the competitive environment, we're very focused on maintaining our discipline and running the business for the right profitability. And that's why you see us operate at the higher end of the margins across the Print space. So in some cases, we may choose to seed some share in certain geographies to maintain our discipline around the competitive environment. And that's just how we're choosing to operate, I think, very smartly.

Okay. Great. Kind of relatedly on Print supplies, the company talked about higher supplies volume next quarter after a 4% year-over-year revenue decline this past one. How would you characterize the short- and long-term dynamics across printing supplies? And any color you can provide around just supplies mix and some of the nuances in toner versus ink that might be helpful for people to think about.

Yes. So on the supplies front, just in the recent quarter and this quarter, there's seasonality to it. And so we typically see lower supply sales in the summer months. And then we see it ramping as we move out of the summer and into the holiday season. And so that's just very typical, and it's what we saw last year and what we expect this year. I would say longer term with the supplies business, we do expect a low single-digit decline because we do have a declining installed base. But again, we're focused on operating that business very effectively and focusing on optimizing the profitability with the hardware placements that we're doing and the supply is on top of it. And when we see headwinds like tariffs, we are going to increase prices. And we've done that, and we're maintaining our discipline.

Okay. Great. One of the key growth areas of HP is the managed services business, which continues to show very strong growth. Maybe you can expand about -- expand on some of these key growth areas for what traction have you found most meaningful from these categories? And do they drive margin improvement? When should analysts and investors see more of these growth areas contribute to top and bottom line results.

Yes, yes. So our key growth areas are designed to grow faster than the core, and they are higher margin. And so we like our key growth areas, and we've seen good growth come out of them for a while now. And this past quarter, we saw strong double-digit growth both quarter-over-quarter and sequentially in those areas. And in the PS side, it's our AI PCs, it's our workstation business. It's our hybrid business. In our Print business, it's our subscriptions and our services and our industrial print and 3D printing, and we're seeing good growth from all of those areas actually and expect that to continue.

Great. Maybe just 1 last 1 on Print. One thing that's been remarkable is HP's ability to continue to grow Print margins certainly over time. And there's just been an incredible focus on managing costs within the segment. Could you just elaborate on some of the margin and cost opportunities within print and how much more runway there is to keep managing costs tightly into the segment to stay in those long-term margin ranges? .

Yes. I would say we are really good at execution and at discipline. And that's one of the key reasons that you see us operating so effectively at the higher end of the margins across the Print space. And I would expect that to continue. As we look ahead, we see further improvement to our cost base. With the advent of embedding AI in almost everything that we do to make us more effective and more efficient, we've got more runway there. So think about it in our call centers and how we service our customers and how we credit -- look at credit and collections for our customers lots of areas that we have opportunity to both redefine our process and embed AI tools into those processes to enable us to be better and more cost effective.

I mean I think that's a natural segue to talk about the company-wide cost program, the future-ready savings plan, where HP has talked about exceeding the original $2 billion of gross annual savings by the end of this year. Once the program is done, do you see further opportunities across the organization? And where do you see those savings sitting in terms of the pockets of the P&L?

Yes. Thanks, Mike. First of all, I'm really pleased with that program and with the progress that we've made and the momentum that we had. The original cost savings target was $1.6 billion, and we've increased it twice to $1.8 billion and the $2 billion and we're well on track to deliver over $2 billion in cost savings by the end of this fiscal year. So pleased with how we've delivered that. And those cost savings have enabled us to withstand and offset a lot of the headwinds that have come our way as well as invest in the future growth opportunities for the company. So it's been a really important program. I'd say as we look ahead, there are more opportunities. And it relates to this notion of embedding AI into practically everything that we do, and again, changing our end-to-end processes. So we do see more opportunity. Expect to hear more from us on this both on our fourth quarter earnings call and at our upcoming Investor Day this spring.

Great. Looking forward to getting the update there. Just on the other component of cost that's been very top of mind, tariffs. HP has done, I think, a very good job of mitigating the impact of tariffs on the P&L. I believe all products sold in North America were assembled outside of China last quarter. So could you talk a little bit about the company's efforts in mitigating the impact of tariffs, production ramps elsewhere oftentimes, leveraging existing partners and suppliers that you're using already? And also how you think about pricing as well in that context.

Yes, yes, for sure. So I've been really impressed with the speed at which and decisiveness with which our team has been operating in this tariff environment, I'd say we've done a nice job and are continuing to offset the decent impact that we've had from tariffs. And it's impacting each of our businesses a bit differently. In the PC business, the tariffs that we've been dealing with are mainly the China tariffs that we've been moving quite rapidly to move our manufacturing and our supply chain outside of China. And by this past quarter, nearly all of the demand that we've been fulfilling in the United States has been manufactured outside of China. We've moved it to Thailand, Vietnam, Mexico, and the federal business that we have, we produced in the U.S. And so I'd say impressed with the speed at which we've moved around our supply chain. In the Print business, we've been optimizing our vast supply chain and manufacturing network to offset the reciprocal tariffs that we've been dealing with in Print. And we've also been focused on driving our cost down everywhere that we can and then increasing price where we need to. And so we've been focused on offsetting the impact across both of our businesses. And we've said that we've made continued sequential traction. Q2 into Q3, you've seen that improve in our margins. We expect further traction into Q4. And should we have more tariffs that come our way, we're going to handle it the exact same way we've handled it so far.

Could we talk a little bit about the working capital strategies that you've deployed either in anticipation of tariffs through strategic purchases or to support supply chain resiliency, which I think has been particularly top of mind for companies just given the disruptions in the supply chain and shortages that we've seen in the last several years, what's your philosophy around those types of strategic purchases? And how do you think about that in the context of your overall free cash flow?

Yes. So as we focus on offsetting tariffs, we use everything at our disposal. And increasing inventory in the short term has been something that we've done to help offset tariffs. And we've done it, yes, through strategic buys and through increasing our inventory to manage the moving supply chain and manufacturing network that we've been doing. And so you've seen increase in inventory, but we've offset that with improvement in working capital elsewhere and expect to do that for the full year. So while you've seen that increase in inventory we have a negative cash conversion cycle in our PC business. And as we ramp that growth, that clearly helps. We've also been focused on accounts payable, improvement there. And we're still expecting to deliver the free cash flow that we -- of $2.6 billion to $3 billion for the year.

Great. I do want to leave a minute or 2 for audience questions. But before I open it up, maybe I'll ask a little bit about M&A. The company recently acquired Humane including their AI-powered platform, CosmOS and intellectual property. Could you talk a little bit about just the M&A strategy that HP is pursuing? How do you think about acquisitions more broadly?

Yes. Thank you. Yes, we're really pleased with the acquisition of Humane that we made a few quarters ago. Not only did that enable us to have the platform of CosmOS, but it also gave us a very experienced software engineering team -- and we've been using that team to bolster our own team to really focus on developing the connectedness across our devices for the future of work. And so really pleased with that team and the traction we've been making there. As it relates to M&A in general, we're going to be focused on M&A that fits our strategy to drive the future of work -- and we're going to remain very disciplined about it. We want to -- we have a very firmly stated capital allocation framework that says that we're going to return 100% of our free cash flow to our investors as long as our gross leverage remains under 2x and unless there's higher ROI opportunities. So when we look at M&A, we're very focused on ensuring that it is a much higher ROI opportunity that drives the long-term value creation for our shareholders and you can just expect us to maintain that discipline. We're also focused on ensuring that whatever we acquire, we can execute really well against.

Right. Great. Why don't I see if there's any audience questions. I think we've got 1 back there. If you could just get a mic over to that gentleman, please.

Is there a sort of scenario or road map that can see the Print business return to growth over some sensible time horizon?

Yes. We've got pockets of growth in print right now and look at our industrial print business, which is roughly about 15% of our base, and it's been growing double digits, and it grew double digits this past quarter both year-over-year and sequentially. And that's the kind of business that prints labels for industries like the labels on our water bottles. And so that's a good growth. We're also seeing good growth in our subscription business. I mentioned already, we expect that to continue. And so overall Print, while we see pressure, particularly in the home print segment and a bit of a declining installed base. We're going to be focused on managing that incredibly well. as you've seen us do. And we do think we have continued runway there to maximize profitability across that business.

Excellent. Well, to close things out, maybe you can just tie it all together for us, talk about some of the key priorities and strategic goals that you and the rest of the management team are focusing on over the next 1 to 2 years and how that ties into the long-term vision for the business.

Yes. Thanks, Michael. We see really good continued momentum, as I mentioned, in the PC business. And again, it's driven by installed base by Win 11 refresh by AI PCs. We expect that growth to continue the rest of this year, in the next fiscal year. So we've got good momentum, and you can expect us to continue to operate with discipline, particularly on preserving and improving our margins despite headwinds that come our way like tariffs, we're going to be focused on offsetting any of those headwinds as quickly as possible while continuing to invest in our future. We are very focused on shareholder value on paying back to our shareholders and on creating long-term intrinsic value of the company. So expect that to continue.

Well, Karen, it's been such a pleasure and such a privilege to have you on stage with us. Thank you so much for your time here today.

Thank you. Appreciate it, Mike.