HP Inc. (NYSE:HPQ) Evercore ISI 2nd Annual Technology Conference September 8, 2022 1:30 PM ET
CorporateParticipants
Enrique Lores – Chief Executive Officer
ConferenceCall Participants
Unidentified Analyst
Fireside chat we have HP Inc., and I’m really delighted to have Enrique Lores, the CEO of HP over here with us. We’ll spend about 30 minutes on the fireside chat. I’ll kick it off with about 20 minutes of questions from my side, and then open it up to the folks in the group for any questions they have. But before I do that, I’m going to read some safe disclosure statements. Today’s discussions include forward-looking statements that involve risks, uncertainties and assumptions which are further described in HPs 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 HPs Investor Relations website if you need it. So do I get the IR job now? I’m pretty good.
Enrique Lores
Very well done. And thank you for inviting us.
Unidentified Analyst
Thank you for being here. I appreciate it. Enrique, I have a whole bunch of questions for you. You’ve been on the road. And you’ll be — before I get into the questions, you reported recently, maybe it’s worthwhile spending a couple of minutes just recapping what you folks are seeing, what you talked about, especially as it relates to the print and the PC markets going forward? We are going to spent a couple of minutes on recap, and then we’ll do some questions.
Enrique Lores
Okay. So let me start with, what do we see from a market perspective, and then maybe touch on the results. So from a market perspective, what we saw last quarter is a decrease of demand in the consumer space, mostly driven by the macroeconomic situation we are seeing. The combination of inflation, increase in energy prices, uncertainty, because of the war, China lock downs clearly had an impact on consumer demand. And we saw that both in our PC business and in parts of our print business.
On the other side, commercial remains strong. We had a good quarter on the commercial side. But we added demand on commercial continues to remain strong. So we also have some signals slowed down mostly because we think companies as we are becoming more conservative in terms of how we manage our budgets. That’s the market.
From the HP perspective, our revenue was impacted by the slowdown. But on the other side, we were able to deliver on the EPS goals that we had, through very rigorous management on pricing, of course. And also we maintained the momentum of our growth businesses, which is really for the future of the company, something really important.
Unidentified Analyst
Absolutely. And maybe we’ll start on PCs to get that out of the way a little bit. Maybe just touch on, what do you expect the PC time to look like in ’22 and maybe even beyond? In the panel want to really love your perspective on this, I think pre-pandemic indicators will be a $250 million — 250 million unit industry. What’s the risk, we kind of end up over there in the next few years versus now?
Enrique Lores
So our view for this year is that the market is going to be somewhere in the 300 million unit range plus minus, this is what we’re using for our internal plans, which is lower than we were expecting a few months ago, really driven by the dynamics that we have explained. When we look forward within that, structurally, the market is going to continue to be bigger than what it was before the pandemic. I think many of the changes that the pandemic has brought from hybrid work to telemedicine, the growth of gaming case, remote schooling, or combination of remote schooling, has clearly showed that PCs are much more important for our lives than before. The four factor helps us to be more productive. And therefore, we think that the market is actually going to be bigger than what it was before the pandemic. How much and when I think we need to see now what is — how long these current slowdown lasts but I think structurally, we continue to see that it will be bigger.
Unidentified Analyst
Got it. Another aspect it’s been a nice benefit in a lot through the pandemic. I think it’s been ASPs on PCs have gone up double digits right 20, 30%. Historically, it used to be business actually declined, I think part of that was competition you have from Asia a lot. What do you think the right way to think about ASP trajectory for the PC businesses. And then, for HP specifically how that would deviate.
Enrique Lores
There are two — there have been two drivers for the increase of average selling price. One is mix and the other one is just pure in price increases because of the difference between supply and demand. We have seen the second part is clearly temporary. And we expect that prices will normalize to what it were before the pandemic.
On the other side, mix has really been driven by the new use models at PC fares. If you are using your PC as a communication tool, you want a better camera, you want more memory to work with the speakers, you want a better display, which has driven the mix towards more premium products. And we think this is going to be more permanent.
Unidentified Analyst
Got it.
Enrique Lores
By the way, we expect that from where we are today to what will be the future that is going to be a reduction of prices.
Unidentified Analyst
Right. If you reflect back on the tailwinds you’ve had on ASPs over the last four quarters call it. How much of that do you think is mix versus actual price increases you’ve implemented because you’ve also seen at the same time this big shift I think from consumer to enterprise it’s been a bit of benefit on the pricing side?
Enrique Lores
It will more than consumer to enterprise easily has been the reduction of the mix of Chromebooks in the portfolio, this has had an impact. And also the change of mix from more into categories to more premium categories in both sides. So, clearly, this has had an impact. I would say this is more than 50% of the impact the rest will be price increases.
Unidentified Analyst
And then, on the print side, right, I think that especially the supplies business had a very predictable trajectory, somewhat predictable pre-pandemic, things got high a little bit over here. And I think last quarter supplies were down 9%, you talked about it being low double digits in the next few quarters. What does a normalized print supply trajectory look like as you go forward?
Enrique Lores
Our normalized number continues to be low to mid-single digits, this is what we shared in our last analyst event, and this is what our models continue to project. What we have seen this quarter it varies in ink supplies, it is very similar to what we have seen in consumer PCs, where there is a clear slowdown of customer demand. And therefore this is what has been impacting the demand and the sales of supplies. It is not driven by our channel inventory correction is not that we are losing share, is a pure reduction of demand driven by what consumers are experiencing.
We were talking before, I was in Europe last week and it is more an anecdote, but I think helps to explain the impact of some of the themes we are seeing. And we were having all our key resellers of Europe, and we were meeting and discussing the status of the business. And one of them from Germany share that they have decided to pay the fuel for their employees so they can drive to work. Because they have seen that as they look at the impact of energy cost increases, per family, they are spending more than 700 euros more than they did before this. And 700 million in a family with an income of 3000 euros per month for 24 months is a very significant number.
And again, it’s an anecdote. I don’t think this represents what is happening. But I think, this is really what they are facing in many countries.
Unidentified Analyst
The reason is it gets worse that 700 number could go higher through the winter. So –
Enrique Lores
To be seen.
Unidentified Analyst
Also have thought about which companies have transitioned their business attractively through the pandemic versus not. And I think one of the underappreciated threats to HP has been this, more move towards a subscription model, right. And you have, I think devices service, you have management services, you have instant ink, which I think resonates really, really well. Maybe talk a little bit about what does the totality of this subscription offerings means for the company. And I’m sure it’s not a big part of the personal revenue, I could be wrong. But maybe it’s a bigger part of the percent of gross profit dollars. And please talk about the scale, the size of this business.
Enrique Lores
So numbers we have here, these, we will look at, we have like two set of offerings. One is for businesses, one is for consumers. Businesses we call it Workforce Solutions. For businesses, we call Consumer subscriptions, or Instant Ink, the business side represents more than $4 billion of revenue already. So it’s a significant part of the revenue of the company. The consumer side, when the year started, is represented $0.5 billion is also a fairly relevant part. And the consumer side has more than doubled since the pandemic started. So this talks about the growth we have seen during the last three years.
And directionally, this is a big part of our growth strategy. When we think about where is the company going to go? And how do we grow the company, we have a strategy to modernize our core businesses, which is shifting them to our subscription or services models. And this is what we just talked. We have also done a lot of work to expand into adjacencies both in gaming, but also in peripherals both organically and in organically we have — and we are creating a much bigger part of our business. And then, we continue working to create totally new categories like with 3D printing, like with industrial print. So we have really used a pandemic time to continue to evolve our portfolio and make it more growth oriented, which we think for the long-term of the company is really important.
Unidentified Analyst
Absolutely. And I imagine the volatility that you’re seeing on the PC side or the print side is less when a customer or enterprise is on a subscription model versus transactional, I guess for lack of a better word.
Enrique Lores
[Indiscernible] another reason why shifting the business to subscription in the case of supply is so important, because it’s a much more resilient model. We have barely seen any increase in the number of subscribers and subscribing. And it’s really a better model for our long-term.
Unidentified Analyst
On the print side, one of the things that surprises me the most in there, having a model that goes back a lot longer than it should have is, I would not have envisioned print margins to be at 19.5%, 20% range if supplies were declining, nine 10%. So there’s something really different I think, from a profit mix that you have been able to accomplish over here. So maybe just talk about what’s enabling the high margins when supplies are down? And then what is the longer term trend line look like on print margins?
Enrique Lores
Sure. So three years ago, we shared that we were going to be rebalancing profitability between hardware and supplies, that the business had too much reliance on supplies, and that we thought there was an opportunity to increase the margins on hardware. And we also share that at that point, we had 25% of our customers of our install base was not profitable for us, meaning those customers bought our printer, when a customer buy a printer, we lose money because we tend to lose the money — used to have negative gross margin per printer, and will recover that in supplies. And we will lose money with 25% of the customers. So we initiated three different initiatives. One was to create a model where consumers were only going to be able to use HP supplies, which is what we call HP Plus now. At that point, we didn’t have the model in the market. We launched it a year later and has been growing since then.
The second strategy was to shift in emerging countries to a model where when consumers get the printer, they get supplies built in. And therefore — and with that unit, we make money and they have consumable for two or three years. And then, the third part of the strategy was to shift to subscription. And we have been making very good progress in all of them. We have more than 11 million subscribers. And the combination of HP plans and [begin] [ph] big donor last quarter represented more than 50% of our printer shipments. And these are units where we know we are going to be making money and that have better gross margins on average.
So this is clearly having an impact in the profitability of print overall and specially on hardware. But also there has been the benefit of the pandemic and the difference between supply and demand, which overtime we think will also disappear. But the structural advantages of the new models will stay.
Unidentified Analyst
So if I think about the outperformance in print margins from the long-term targets have talked about 16 to 18, I believe right? How much of that is due to the supply demand dynamic upon which could be more transitory versus a lot of things you’ve done that are structural like which one do you think is a big piece?
Enrique Lores
This is why, long-term, we continue to believe that the margins are going to be in the 16% to 18% range. Even if we are above today, we shared a few quarters ago that when we compare our price increases, the average had been around 27 points, the market increases have been around 20 points. So you could one way to look at this will be the delta between both is what we’re driving structurally, the rest will be — what has been driven by the market.
Unidentified Analyst
Fair enough. You’ve talked about so far, these five growth vectors for the company, right. And 3D printing is obviously one of the big ones and always thought a very logical extension for what HP does is to get into additive manufacturing, 3D printing. Can you just touch on how big this is business at any dimensions you can provide to us in terms of where’s this asset going to go over time?
Enrique Lores
Yes. I think we have been making a lot of progress in our 3D printing business. A few quarters ago now probably six quarters ago, we shared a slightly change in direction, in the sense that to capture more value, we don’t think it’s only about designing printers and consumables and support services. We think it’s also important to participate in more end-to-end businesses, where we not only build a printer, but we design the parts, we create the parts and we sell the parts to consumers or to businesses, because there is much more margin to be made there. So in the last quarter we have continued to make progress on the more traditional approach. And we share the business continues to be to grow double-digit. We are going to be launching a new metal solution now in the coming months which is kind of a big extension of the portfolio. And we have been making very good progress on some of these end-to-end businesses. For example, in the U.S., we launched a few quarters ago, an insole business, where we are helping doctors to scan the foot of their patients, and we designed and build for them, insoles that based on algorithms that we have to correct whatever pain customers have. And in the next month, we are going to be launching that business direct to consumer. That’s a good example of the progress we have made.
And another example is with 3D printing, we can create special molds for molded fiber. And we have seen an opportunity not only in designing those molds, and we have a business of designing molds. But also, with some of these molds with molded fiber, we can create almost any object. And we are now working with several multinationals to replace plastic bottles with molded fiber bottles, these are totally plastic free. We own the technology to create the mold. We also own the technology to — of the lining that goes inside the bottle to make it waterproof. And we think that there is a big opportunity in this area. And this is one of the verticals that we are starting to work. So it’s a very exciting opportunity for the future.
Unidentified Analyst
Yes. This looks fairly fascinating anyhow, since I see the poly equipment that Alaska Poly question now. Maybe just touch on, you had the give growth vectors obviously, can be video communications, was one of them. And Poly’s a great asset to get there. But just talk about, what made you decide to say, I need to buy Poly versus doing it organically because you had some initiatives organically. Maybe start there and then I have a couple of questions around the Poly integration.
Enrique Lores
Sure. Before maybe I go there, let me kind of frame the different opportunities. So when we think about growth, we think about modernizing our core businesses go into subscription, go into services, we think about expanding into adjacencies. One adjacency is video conferencing rooms or hybrid work, another adjacency is gaming, another adjacency is industrial printing. And we also talk about totally new categories like 3D. This is how we think about our future.
In the case of Poly, what we see is in the next two years, a huge opportunity in the video conferencing space. We think that in the world there are 90 million rooms, only 10% of them have video conferencing capabilities. And this is almost every company in the world is investing on this today. So we saw a big opportunity short-term, we saw that we needed to accelerate our plan, both from an R&D perspective, but also from a go-to-market perspective. Poly has a very strong position in video conferencing solutions. Their portfolio was fairly complementary with ours. And it was a great way to accelerate our plans in that space. And by combining the R&D teams and the sales teams, we can really accelerate the innovation, we can accelerate sales and maximize the business in the next two to three years. So it was a great combination and a great opportunity for us to really accelerate our plans.
Unidentified Analyst
You just closed the deals, I want to ask you about integration, how it’s going because it’s fairly new at this point. Maybe without asking how the integrations, what are the goals for the integration? And I think if I remember this right, the strategy was 600 basis points on margin expansion, what Poly was doing on surround basis, how do you get there? And what are the key levels of integration you are going to look at?
Enrique Lores
I think there are two. One is, that our margin improvements and cost savings that we want to drive cost savings because as we put two public companies together, there are many areas where there is redundancy and these are relevant. Second, we also can improve their margins by leveraging our scale with partners, suppliers, distribution, logistics. We have, in general better agreements with logistic companies with suppliers so we can really benefit them from that perspective. And the third part, which is probably the most exciting is growth and growth driven by the coverage that we have. We have many more enterprise accounts at AR. We have very good close connections with many large enterprise customers. We have very deep connections with channel partners in the commercial space, in the retail space that they have not been present. So there is a — let’s say sales in — growth driven by better sales coverage, one. And second is really innovation we can by putting together their R&D team and our R&D team, we can do things together faster than for the two companies, was going to take much longer. That’s a big part of the value proposition that we think the deal brings.
Unidentified Analyst
Right. Absolutely. And you’re in terms of how you integrate into your business, can you just talk a little bit of go-to-market dynamics and Dave Shull is going to remain at HP. So, what’s the continuity?
Enrique Lores
Where we are going to be fully integrating the business into our works? Operationally, it will be happening fast. And we have created under the personal assistance team, a hybrid work team that is really going to be driving this going forward, we have put a top executive leading that initiative for us. And we’re putting all day for all the work that we were doing, plus all the work they were doing. And that one totally integrated organization that’s on the R&D side. And on the sales side, we are integrating the sales teams in our country structures, in our teams to make sure that one, we maintain the focus, because there are special channels and special resellers that we want to keep. But at the same time, we leverage from the rest of HP and from the presence and all these needs to happen in the countries and we are working on both. We announced the organization to the Poly team this week. And we’re really working really fast to drive it and to make it happen.
Unidentified Analyst
Buybacks has been this big, positive narrative for HP for — I think pre-pandemic, it was like right before the pandemic started, you announced this sizable buyback program, you’ve executed really well on it. How does that alter as you go into fiscal ’23 and beyond, the cadence, the sizes, anything that help us think about?
Enrique Lores
Yes. So before, we will be completing our current wave for the value plan next quarter, our commitment was to return $16 billion of capital to shareholders. And we are going to be above that number. So I will say mission accomplished. And now we are going to be entering in the next phase. And investors should not expect a big change. So the same principles we have used to manage our capital during the last years, we’re going to continue to apply. We think is important to be investment grade. And we have seen that to be there, we need to be between one — we need to have a leverage ratio between 1.5 and 2. We are there. I think we are in 1.8, 1.9. So we are there now. And once we are there, we will continue to return 100% of free cash flow either in dividends or in share buybacks unless we see opportunities for M&A that provide better return. And this has been our approach in the last three years. And this will continue to be our approach going forward.
Unidentified Analyst
Fair enough. Maybe we will pause for a second, to see any questions in the room? All right. We shall keep going. You said M&A and it always kind of provokes everyone’s interests when you talk about M&A. But maybe just a) talk about how do you look at M&A as a vector for capital allocation? And then what are the holes you think you have in your portfolio today that you would like to go after?
Enrique Lores
Sure. I think the Poly example is a good way to see how we think about M&A. We have identified these five growth areas, gaming peripherals, workforce solutions, consumer subscriptions, and industrial print and 3D. And we have said that we are going to use M&A, mostly to accelerate these areas. And we are constantly evaluating opportunities in the five of them. And when we find something where we really — that we really think makes sense, we do it. Making sense means there needs to be strategic fit, means that it needs to have a very solid financial plan better than buying our shares, of course. And third, that we will need to be convinced that we operationally can execute on the plan. And these are kind of the three filters that we have. And last year we bought four companies, want to accelerate our play in 3D, want to accelerate our play in gaming, want to accelerate our play in workforce solutions, and hybrid that helps us both on peripherals, and also on workforce solutions. So that’s the approach that we are taking.
Unidentified Analyst
Got it. And the focus, it seems is always around these five growth vectors that you want to see how you scale up, rather than consolidating a given industry. Is that fair? That’s kind of –
Enrique Lores
I think that’s fair. I think we think we were going to be able to create more value in driving these five growth areas. We have been very consistent during the last few years. I also think and I have shared that before that, at some point consolidation may happen. And I will never say never. But at this point, our priorities clearly centered on these five areas and using M&A to accelerate growth.
Unidentified Analyst
All right. I want to touch on free cash flow, but I didn’t get one of the surprises to some degree last fall was, the free cash flow expectations hitting template for the year for fiscal ’22. So just recap and tell us what were the big changes that led to the adjustment there. And then do you think ’23 could be a growth year for free cash flow basis.
Enrique Lores
I think if we look at our business from with a — from a long-term horizon perspective, free cash flow follows net earnings. We then do big capital investments is really net earnings and free cash flow will follow. Quarter-by-quarter, that could be fluctuations, because that will be driven by working capital. And this is what we saw this quarter. And this is a big thing of what we’re seeing this year, depending on what happens with working capital, there is a certain impact on free cash flow, but over time, a free cash flow follows net earnings.
In the case of fiscal year ’22, we are expecting a slowdown of demand that we have discussed before these will have an impact on net earnings and therefore it will be an impact on free cash flow.
Unidentified Analyst
Got it.
Enrique Lores
And on ’23, we will be providing guidance at the end of Q4. There are so many variables now happening around us that is hard to have a good projection of what the world is going to be the next four quarters, and therefore also what our business will be.
Unidentified Analyst
That is fair. So maybe something more or near-term step up. On the PC side you talked about 5% to 7% I think margin as the range, if typically be in at a higher end of it, if not better for the most part. What would take you towards the low end, because may actually say that you’re implying that you will be at the lower end this time. So what’s taking it there, then structurally, I would think a lot of the tailwinds that are there should enable you to be maybe at the mid to high end of it. It’s maybe just –
Enrique Lores
Again, this is Q4 comment. We are entering Q4 with significant inventory in the channel. And it’s not an HP comment, is an industry comment. So traditionally, when this happens, the market becomes more aggressive on pricing, because it is the goal of reducing inventories. And this is what we think is going to have an impact in the short-term, we expect to see more price competition given how high inventories are, especially how high inventories are for some of our competitors.
Long-term, we continue to believe that 5% to 7% is the range where PCs will go. We expect that over time there is going to be a rationalization of pricing, given how positive pricing has been during the — favorable pricing has been during the last few years. But at the same time, the expansion into adjacencies the expansion into services, more focused on premium categories will help to compensate for these price erosion.
Unidentified Analyst
If I think of the PC industry, right, it had a lot of benefits — you have challenges but also benefited from just logical consolidation of the years. And it’s a much more — your comments notwithstanding, it’s been a much more rational industry for the last few years now. And the top three companies have done really well. I would argue. What do you think as you step back and look at it, what precludes the printing business to go through that same degree of consolidation because there are in theory, six employees that are subscale of the business and you run this business for a long time on the print side. So it appears like, why print is not following the same playbook.
Enrique Lores
To a certain extent it has already followed it. If we look at consumer print. Today, there are basically three, four companies, five years ago, there were probably 10 companies, so on the consumer side has happened, on the office side has not happened yet. And this is why I think if you ask me 10 years from now, how many companies are going to stay probably shorter numbers, some of them may go bankrupt, others may be acquired or merged. So I think consolidation will happen on print over a longer period of time.
The probably the key difference between print and PCs is the fact that most of the small print PC companies were losing money because of the pre-model, even the smallest printing companies in a normal situation they continue to make money. So then the incentive for consolidation to happen faster ease is more.
Unidentified Analyst
Also think there are also a lot of Japanese entities which may be willing to run the businesses a lot longer versus –
Enrique Lores
Especially they make money.
Unidentified Analyst
If especially they make money. Fair enough. And we’re coming up on our time over here. So I had someone asked me this question yesterday about HP and it kind of stuck in my head. So I’ll ask you the question. 23, there’s a lot of challenges that are happening from — you’ve talked about PC, you’ve talked about print. But you also have good stuff like buybacks like Poly integration, I think, right. The question was very simple, which is, can HP grow EPS in ’23 versus ’22, given all the headwinds you have?
Enrique Lores
Again, we will be providing guidance at the end of Q4. I think what I would say is, it is not the first time we go through a slowdown. And we know that in this situation, we need to protect the businesses where the impact will be biggest. And we have talked about consumer and we will do that by being very careful on pricing, managing cost very rigorously, to really make sure we minimize the impacts while at the same time, we need to maximize the upside of the businesses that continue to grow. This is what we are doing. This is what we will continue to do. And no matter what environment we are, we will continue to be very investor friendly and maintain our capital allocation strategy. Details on Q3, on fiscal year ’23 in a few weeks.
Question-and-Answer Session
Q – Unidentified Analyst
Unidentified Analyst
Fair enough. I’ll wait for that. Thank you very much for your time.
Enrique Lores
Thank you.
Unidentified Analyst
Thank you
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