HP Inc. (NYSE:HPQ) 2022 Citigroup Global Technology Conference Call September 8, 2022 8:15 AM ET

Company Participants

Enrique Lores - President & Chief Executive Officer

Conference Call Participants

Jim Suva - Citigroup

Jim Suva

Citigroup Global Technology Conference Day Number 2 here live in New York City. It's great to see you all in person and for all the people who are attending. Attendance is off the charts and we're so glad to be back in person. This session fireside chat is with HP Inc. stock ticker, HPQ. A few housekeeping items, no media and no press are allowed. Disclosures are available at the check-in desk and on the Citi Velocity website.

Also, I have a disclosure to read for HP Inc. and please see the slide here. Today's discussion includes forward-looking statements that involve risks, uncertainties and assumptions which are further described in HP's SEC filings, including HP's 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. Also, if you happen to be an investor who's subject to MiFID II, please ensure you have the applicable research agreement in place.

With that, I'd like to officially welcome the Chief Executive Officer, CEO, Enrique of HP. Those of you who may have followed HP for a long time, you know he used to also be in charge of their print division. And Enrique, you have been at HP for how many years?

Enrique Lores

34.

Jim Suva

34 years. And I have known him for 20 years, so a lot of history that he and I go back a long time. So I have a handful of questions that I prepared that we're going to share with him but then we're going to open it up to the audience of investors for Q&A. [Operator Instructions]

I'll ask my first question, then I'll join Enrique here on the stage. So first of all, Enrique, to start things off, can you talk about maybe the broader macro environment say, compared to prior macro environment? Specifically, investors, we've been having dinners and talking with them, they're all concerned about downturns, downturns, downturns. So if you can talk about macro, that would be great.

Enrique Lores

Sure. Thank you and Jim, great to see you and thank you for inviting us to be here. So as we shared in our investor call last week, we clearly saw a change in the macro during Q3. We have seen weakness on the consumer side. It started in Europe but it also got into North America during the quarter. And we clearly saw the impact of the combination of inflation, an increase of energy prices and in general, uncertainty about what is going to be the economic situation going forward. So clearly saw that changing in the quarter.

And on the other side, on the commercial side, we continue to see strength during the quarter, both for print and Personal Systems. But also, we think that companies are starting to be more measured in terms of the investments. So we are projecting that there will be a slowdown in that space also in the coming quarters.

Jim Suva

You just closed out what's called your fiscal Q3. How would you characterize, as CEO, the performance of that quarter? And then kind of as the quarter progressed, I assumed it was not linear.

Enrique Lores

It was a different quarter from what we were expecting. But I would say that the company performed well. And despite the macro changes that I was explaining before, we were able to deliver on our EPS goals which is important because we really -- for us, it's very important to deliver on our commitments and this is what we did during the quarter.

So I would say the quarter had two sides: one side where we saw the impact of the macro changes and this impacted our revenue overall; on the other side, both from a financial perspective, delivering on our EPS goals but also because we were able to continue to grow our growth businesses which is a very important part of our strategy. Clearly, the company performed well while we were able to deliver on our EPS goals because of both very disciplined pricing, very disciplined cost management and we were able to control costs as we saw the performance evolving during the quarter and also because the growth businesses continue to perform well.

Jim Suva

As CEO, you get pulled a lot of directions and I'm sure you have strategies and things like that. What are your most precedented priorities right now at the moment?

Enrique Lores

I think it's a combination of from one side, how do we protect the businesses that are feeling the impact from the economic slowdown? How do we continue to focus on those areas where there is opportunity? Because in every business, there are still opportunities today. How do we manage cost for that to really minimize the impact, while at the same time, we maximize the upside in the businesses where we continue to see growth both short term and long term? And managing that balance is easily critical for us.

We know and it is not the first time we go through an economic slowdown. We know what we need to do in this situation. But at the same time, we need to maintain our focus on the growth side. As we have shared during the last calls, we have identified 5 growth businesses where we really see the future of the company. Those businesses by the end of this year will represent more than $10 billion in revenue, growing double digit. And despite the economic slowdown, we expect this to happen at the end of the quarter.

Jim Suva

Enrique, if we can maybe break it down now into your different reporting segments and probably start with PCs first since we had Dell yesterday. Maybe talk about PCs. It seems like there's been a big change. I believe we started off the year expecting PCs to be kind of flattish. And now I think the industry is expecting down ballpark 9%, 10%, 11% or so. Can you talk to us a little bit about PC expectations? And is there a difference between enterprise, consumer or geographic regions or verticals?

Enrique Lores

Sure. So there has been clearly a change in the expectation of the size of the PC market and is really driven by the change in the economic environment. And we see the majority of the change happening in the consumer space, as I was saying before. Our current expectation is that the market size will be around 300 million units which is significantly lower than what we were expecting at the beginning of the year.

As you are saying, there are differences across segments and also slight differences across regions. As of today, we clearly see the majority of the impact of the economic slowdown in Europe and in North America, while Asia continues -- in general continues to perform well. From a segment perspective, we see clearly a bigger impact in consumer than what we see in commercial. And in general, we see more impact on the low-priced categories than on the premium categories. And again, all this is driven by where the impact on the economic side. We think that inflation and the increase of price of energy, especially in Europe is having an impact, is clearly impacting families with lower income than with higher income. And this drives the change in mix or a big part of the change in mix that we are seeing.

And then on the commercial side, I would say the situation is more complex to understand. From one side, we'll continue to see, especially enterprises, be very active opening deals, investing to improve the experience of their employees. We need to have in mind that in majority of the cases, enterprises have not spent a lot of money in office equipment. And now all of us have an objective to bring employees back to the office at least a few days per week. And therefore, we need to invest in equipment in the office. So this is clearly driving that the number of deals that we continue to see is very healthy.

On the other side, companies are also becoming more cautious in terms of how fast they invest money, how fast they spend money and we are seeing also a slowdown in orders once we win these deals. So that's kind of the dynamic that we see in the enterprise. Great thing is that the opportunity to refresh is there. Citi is a great example of a company that is going to be going through a big refresh soon. And this shows that the demand in the market is clearly there.

Jim Suva

Well, it's great to be back in person for sure. And you can see that the room has quite a few people as well as a lot of people are holding printed agendas and printed schedules. You can look down the hallway, there are actually HP printers there. Switching actually to print since we're talking about that now. There was some pressure on top line revenues on print but your profitability went the other direction of improvement. Can you talk about the dynamics of what's going on in print?

Enrique Lores

Yes. I think we are seeing the impact of some of the strategy changes that we did 3 years ago. We announced 3 years ago that we were going to be rebalancing profitability between hardware and supplies because at that point, we shared that we -- 25% of our customers were unprofitable customers, meaning that we were selling a printer and they were not consuming enough ink or enough toner for us to get a return on that investment. And we -- since then, we have been driving a lot of changes in that space.

Specifically, we announced that we were going to be introducing a model of printers that were only going to be working with HP supplies. And if consumers were not willing to accept that trade-off, the price of the printer was going to be higher. We execute that change, is now we call it HP+ and it has been growing significantly since we launched it. Also for emerging countries, where in general, the market share of supplies is lower, we have introduced a new concept of printer where when you buy the printer, ink or toner come inside the printers so you don't need to go out buy supplies. You have supplies for 2 or 3 years inside that printer. And all those units are profitable that the consumers buy it. So we address that problem significantly.

And we shared last week that the combination of HP+ and these new models that we call big ink on big toner, they represent now more than 50% of the portfolio. More than 50% of the units that we shipped are within this category, it's a big change from -- on 2019. And additionally, since also we continue to be -- to see the impact on some of the component shortages in print, also from a pricing perspective, on the print side, we are in a strong position. So the combination of strategic changes we have driven plus the pricing environment has really helped on the profitability of print.

Jim Suva

Well, a shameless plug for the HP Instant Ink program is the Suva family, our subscribers to it. And during COVID, I greatly appreciated not having to drive to the store to buy the cartridges. And just before I got on the plane here, it was running low and my wife goes, "Oh, no, the box just came the other day." And that was.

Enrique Lores

This has been one of the big successes of print, especially on the consumer side. We launched a subscription program a few years ago. And through the pandemic, the business has more than doubled. And really, it is -- it continues to grow because it's a great value proposition for consumers. It is very convenient. So you don't need to buy cartridges which is one -- always of the key issues that consumers have with print.

It is also significantly cheaper for consumers to print with -- if they are subscribed and if not, so this is more effective from a savings perspective which these days is also very important. And third and more important every day is more sustainable because every cartridge, we send cartridges, we receive cartridges back and we recycle every cartridge. So it's also very important from that perspective. And over time, we are going to continue to drive a change in this direction. Today, we have more than 11 million subscribers. So it's starting to be relevant and we expect that to continue to grow. We grew double digits this quarter and we expect to continue to grow going forward.

Jim Suva

I have one last question. So why don't we get ready to start asking questions from the investors in the audience. And again, please raise your hand and we'll get the microphone to you. And that is HP is blessed with a lot of cash flow. You talk about 5 areas of growth. Of course, your CFO, she would like to make sure that you don't spend it all on growth, that you actually make it all for -- or spend it on dividends, stock buyback, debt paydown, things like that. You're also integrating an acquisition. And so maybe you can talk a little bit about your capital allocations that you see, Enrique.

Enrique Lores

Yes. I wouldn't say we are blessed. I would say we work very hard every quarter to get that cash flow. But, in any case, our capital allocation strategy has not changed. We explained that almost 3 years ago and we are going to continue to apply the same strategy going forward. First of all, we think it's important for us to continue to be investment grade. And to be in that range, we think our leverage ratio needs to be between 1.5 and 2 which is where we are today. And once we are within that range, our commitment is to continue to return 100% of free cash flow to investors as we have been doing, except if we identify opportunities for M&A that really will provide and will bring better return than buying our own shares. This is what we have been doing during the last 3 years and this is what we are going to continue to do going forward.

Specifically, one of the commitments we made when we launched our value plan in 2020 was to return, by the end of '22, $16 billion. When we will close the quarter -- this quarter, we will have returned more than that. We said we expect to exceed that. Again, it's a combination of dividends and share buybacks but investors should expect us to continue to have this investor-friendly approach going forward.

Jim Suva

I'd like to now open it up to investors in the audience. [Operator Instructions] Any questions? Okay. We have one right here up front.

Unidentified Analyst

I guess a lot of investors ask about pricing, right? I mean what you're seeing on the -- at least on the PC side, given we're going through this kind of correction due to inflation and other macro-induced pressures. How are competitors reacting in this pricing? We still have shortages on some components. So how are just your competitors responding to the pricing? And that kind of flows into your profitability targets for the PC segment.

Enrique Lores

Yes. So as you said, the situation is not homogeneous in the whole PC market. There are some pockets where we continue to see shortages of a few components much less than a year ago and the evolution -- the situation is evolving as we were expecting. So in those areas, we -- clearly, the price impression is much smaller. But in other parts of the market, especially in consumer PCs and in the low end of commercial which is closer to consumer, we see the pressure, the price pressure has clearly increased.

Inventories also in the channel are high and this is not an HP statement. It's a market statement. And this usually drives to more aggressive pricing as well. And this is why we shared that especially in Q4, we expect pricing to be more aggressive and this was included in the guide that we provided, that that's the situation.

Jim Suva

There's a question here in the middle of the room.

Unidentified Analyst

Could you perhaps talk a little bit about the pace of improvement in the supply chain? You talked about the component storages but we're also starting to hear that things are getting better. How are things going for you in both PC and printing?

Enrique Lores

Yes. So the situation has clearly improved and I think it's growing as we were expecting a quarter ago. So no major surprises, no major deviations from where we were. In the case of PCs, the shortages are very focused in a few areas and it's impacting some of the commercial shipments and some of the consumer PC shipments. We should be out of the current shortages in Q4 or early Q1, unless something that is not expected happens which we don't think is the case. In the case of print, also again, the situation is evolving as we were expecting. As I shared in the past, the biggest impact on print is in what we call ASIC, so our chips that are designed by us and therefore, they are single source. Again, the situation is getting better. We should be out of the current situation by end of Q4 or very early next year.

And during Q4, for example, we are going to be introducing a lot of new boards, so we can use both the different families of ASICs for all of our printers to make sure that we maximize flexibility. So there has been a lot of work done during the last months to really compensate for that and we are starting to see the impact of those -- of that effort.

Jim Suva

There's a question here on the very front row.

Unidentified Analyst

In the consumer, the pricing has benefited quite a lot in the last couple of years, I think, from lack of supply. And that's starting to ease. And now I think you have the yen approaching JPY 145. Just wondering how you see the outlook for pricing in the consumer brand, particularly from your Japanese competitors?

Enrique Lores

Yes. So in general, we are seeing Japanese competitors being very cautious on pricing, different from what we saw in other situations where they were more aggressive using the advantage that the weak yen was providing. We are not seeing it this time. We are seeing them, in many cases, even increasing prices given the shortages. And we think it's also driven by the impact that the last 2 or 3 years have had from a financial perspective. They have been tough years for many of them since they have large businesses in the office.

And therefore, in general, we see the market being much more rational than what it has been. And I didn't say that before but I think it's important. This is going to be our approach. So we are going to be very rational from a price perspective. We have demonstrated that we know how to manage prices very -- without really going aggressively after share. This is not our approach and this is true for both print and Personal Systems. We have done in the past and we are going to continue to do that.

Jim Suva

So you're not chasing share, you care about profits?

Enrique Lores

We care about profits. We are not interested in gaining share for the sake of gaining share and losing money on those units. In both markets, share is a variable that goes up and down, depending on how aggressive you are in price. And this is not our strategy. We want to grow in the categories where there is value and this has been our strategy and this will continue to be.

Jim Suva

Are there additional questions from those in the audience? Please raise your hand and we'll get the microphone to you. There's a question first in the middle of the room. And then after that, we'll make our way to the front of the room.

Unidentified Analyst

HP+ and big toner accounts for more than 50% of your business. Could you perhaps talk about how we should think about the LTV, the lifetime value of a customer who would purchase big toner versus who would purchase hardware and the customers afterwards [ph]?

Enrique Lores

Yes. When we look at big toner or big ink, we are really prioritizing emerging countries, where our share has been lower. So for those areas, the profitability per customer, the long-term value per customer is higher in these models than what it used to be. And -- but this is where we are prioritizing it in those units. In other markets, the situation might be different. And this is why in other markets, we are prioritizing Instant Ink or the traditional model, so we can really optimize profit around the globe. And I think that's one of the key things that we have learned how to manage much better during the last years. It's the same model that's going apply in every country of the world. And you see us applying very different strategies country by country, market by market because we think this is the best way of maximizing profitability.

Jim Suva

There's a question here on the front.

Unidentified Analyst

Yes. Sorry, back on the PC market. Given that there were shortages up until a certain point in time, is there really a lot of inventory in the channel that needs to be worked down? Or do you think this is a 1- or 2-quarter phenomena?

Enrique Lores

Well, if all companies are rational, it will be a 1- or 2-quarter phenomena but there is a lot of inventory in the channel today. But again, this is not something that is the first time this happens. When there are economic slowdowns, usually the inventories go up. This is what we are facing this time. And if you look back at history, it has happened other times but it will take 2 quarters to quarter-on-quarter, depending on how demand also evolves but it's a temporary phenomenon.

I think in general, we see that the current economic environment is temporary. We don't think it's permanent. This is why what we're really doing is focusing on how do we mitigate the impact on those categories that are more impacted, managing pricing and costs to mitigate the impact. And at the same time, maintaining our focus on growth because that balance is what we think will help us to be a stronger company when this is over.

Unidentified Analyst

And so before we had this downtick in PCs, there was a lot of discussion on the structural changes that have happened in the PC market, more PCs per household. PCs are essential. We can no longer wait 7 years to update PCs, at least on the consumer side. Commercial, I know it's closer to 4. What's your thinking about all those structural factors? Have they just gone by the wayside due to this economic -- set an economic impact or those still hold? And at some point, as the inventories work out, we'll see kind of -- we're not going back to pre-pandemic levels.

Enrique Lores

I think the structural changes are there to stay. I think, for example, hybrid work is the way most companies are going to have. This is our model. I think this is a Citi model and many of your companies as well. And if employees are going to be in the office 2, 3 days a week, 2, 3 days at home, this -- the demand for additional equipment is there.

Additionally, most of this equipment is going to be portable that have faster replacement cycle. So the market will be bigger, it will have to be replaced faster. And in our case, we think this also opens a big opportunity for peripherals. And this is why when we look at long term, the opportunity in peripherals, whether it's gaming, or hybrid work, is very important for us and we see a big opportunity there. And I mentioned hybrid work but if you think about telehealth, education, we all have seen that the penetration of PCs has increased during this period of time. There are more applications for PCs than there were 3 years ago. The form factor is a much better form factor if you want to be productive and this is really what is driving demand.

So we expect the market to be bigger than it was before the pandemic. And again, we are going through a temporary slowdown but the key drivers of use are there and are going to continue to have an impact.

Jim Suva

I got an e-mail question asking about do you expect to -- what do you expect the PC replacement cycle or life to be kind of now that we've exited COVID?

Enrique Lores

I think our estimates are that if we look at per unit, it will not be drastically faster. So it will be a similar period of time but the mix is different. The mix of notebooks versus desktops has significantly changed. And therefore, the overall replacement rate will be faster but mostly driven by the change of mix.

Jim Suva

Of more mix towards notebooks which tend to break sooner because of traveling, spilling, dropping...

Enrique Lores

Yes. Because of how customers are using them, yes.

Jim Suva

We have a question in the far back corner, please.

Unidentified Analyst

I had two, if I could. The first, realizing you probably don't want to be too scientific about this but if you assume your 300 million unit TAM, we did about 70 million units roughly in calendar Q2, you believe third-party data. We're basically going to have to be around that same level for the next two quarters, perhaps low 70s. And so does that sort of conceptually make sense? Like on the one hand, I think you're arguing the market is like just now starting to get weak. On the other hand, the math would suggest we don't really get any weaker like in terms of nominal units. So how does one think about that conceptually?

Enrique Lores

So I think the numbers already make sense. You also need to consider inventory in your equation because one thing is shipments that happened during the first half, second is how many of them were really bought. And since inventories are high, kind of this skews the numbers one way or another. But again, this is what we expect in the short term. We will see this more temporarily driven by the current economic situation.

Unidentified Analyst

Helpful. Second one is, as we think about next year, I think there's a lot of variables this year. One of them is that China locked their economy down for like 6 months in a row like without telling anybody. And so that's a significant market. 25% of global PC is down double digits. What does that mean for 2023? Like if one assumes just that they keep the economy open, what does that do to the TAM? What did it do to the TAM this year, what would it do to the TAM next year?

Enrique Lores

Yes. It's hard to speculate what will happen in China during 2023. In general, what we will do is provide guidance and our view of '23 in our Q4 goal, given how many variables are -- how many things are changing that fast within a quarter will give us better perspective. So by the end of Q4, we will provide a view of what do we see happening in '23. But again, there are many ups and downs. China will probably be an up, what happens in Europe, could be a down. What happens in the U.S., depending on how fast we control inflation, could be an up or a down. So many multiple variables that we are monitoring carefully as we build the plan for '23.

Jim Suva

Additional questions from those in the audience, please raise your hand. We have a question in the middle of the room here on the side of the aisle.

Unidentified Analyst

I guess the question I have is you had 2 really strong years of pandemic-related shipments and now you're seeing some slowing. Do you think it's -- how do you differentiate that it's more macro driven than more possibly just some normalization of demand that you're finally seeing after we're seeing some normalization in the economy?

Enrique Lores

Yes. So first of all, we were expecting what you call normalization. And this is why our strategy to build what we call a more growth-oriented portfolio was so important. And this is why we were modernizing our core businesses, shifting towards services and subscriptions which is a better model for us from a value perspective. We also expanded into adjacencies aggressively and this is where we went into -- after peripherals, why we accelerate our play in gaming which are adjacent markets where we see a lot of opportunity and also why we continue to create new categories like industrial print on 3D. So we were expecting that normalization as was built into the plan that we had before.

If I think about the situation today or what we have seen during the last 2 quarters -- or last quarter, is really how fast the change has been is why we think this is really more temporary and driven by the current macro that we see and also how it has evolved. It clearly started in Europe, where the impact of inflation, war and energy prices was felt sooner and then it came to the U.S. Yes. So -- and this is more an anecdote but I think is very relevant.

Last week, we had our reseller event -- our event with all the key resellers in Europe. And I was having one-on-ones with some of the top ones. And one of them was sharing that, given the price increase that they had seen in energy, they were now paying the cost of fuel for their employees to be able to drive to the office. Because this was a reseller in Germany, they were saying that the cost per family, the increase of energy if per family was EUR 700 per month. So if you think about a family with a EUR 3,000 income per month, $700 now or EUR 700 are now going to pay for energy more than they were doing before the pandemic. This is having an impact on what is the available spend for those families.

And again, it's an anecdote but it was helpful for me to really understand at the level of a family, what is the impact that they are seeing in terms of energy increase -- energy price increase.

Jim Suva

We have time for one more question in the investor audience and that will be taken up here in our first row.

Unidentified Analyst

On your earnings call, it sounded to me like you're in the PC market that your pricing strategy was to be more reactive to your competitors. And just wondering if you could explain that a bit more and elaborate it. It seems like you've lost market share in the last few years, especially to Lenovo. So I'm just wondering if you can explain a bit more why that's the best strategy.

Enrique Lores

Sure. I think more than reactive is, first of all, our strategy is not to gain share for the sake of gaining share, it's really going after those segments where we see more opportunity. For example, if you look at the commercial space, if you remove Chromebooks which is probably the category that is less profitable, especially given the market dynamics in the last quarters, we have actually gained share this quarter. And our commercial business, excluding Chromebook, grew 18% this quarter. So it's really more about being very selective in those areas where we focus those areas where we want to win because there are many pockets, especially given the current environment where the profitability is very low or is negative. And we definitely are not interested in selling units where we lose money. That's more our approach.

And in general, we think that PCs have a lot of value and we are not giving -- willing to give that value away unless we really see the competitive environment driving that. That's more our approach. And it's what we have been doing the last 3 years. And this is why we really have been able to grow the value of the company and the profit of the company, because we really think there is an opportunity to manage it this way.

Jim Suva

Enrique, you've been at the company of HP for over 30 years. Obviously, you like it. But for the investors in the audience on the webcast, what's maybe the 2 or 3 things you want them to know about why they should be owning HP Inc. stock?

Enrique Lores

Sure. So first of all, we lead to large markets and we have proven that we know how to grow in those markets and also how to grow profit in those market. This is what we have been doing since separation, even more during the last 3 years but it is clearly a big part of our strategy. We are also building a plan or we have built a plan to be able to sustain -- to grow sustainably during the next years which is a combination of modernizing our core businesses, as I was saying before, shifting them or moving them into as a service business, both for consumers and for businesses.

In the case of consumers, we have made a lot of progress on our subscription business. In the case of businesses, we have made a lot of progress in managed print, in Device as a Service,, that are now really relevant when we look at the total size of the business. We have also expanded into adjacencies, both organically and inorganically. We have done several acquisitions to accelerate that and this will give us more growth going forward. And we have long-term growth opportunities with 3D, with industrial printing that also show the value that the company will have.

And third, we are investor-friendly. Our capital allocation has been and will continue to be investor-friendly. Our dividend is $1 per share which is fairly attractive, especially the prices where the shares are today. And as I said before, unless opportunities with better return from an M&A perspective show up, we are going to continue to return 100% of free cash flow.

Jim Suva

I'd like to thank everybody for joining us on the webcast as well as live here in New York and thank you for Enrique and the HP management team. Thank you.

Enrique Lores

Thank you, Jim.

Question-and-Answer Session

End of Q&A