HP's (HPQ) Management Presents at Credit Suisse 20th Annual TMT Conference (Transcript)

| About: HP Inc. (HPQ)

HP Inc. (NYSE:HPQ)

Credit Suisse 20th Annual TMT Conference Call

November 29, 2016 11:00 AM ET

Executives

Cathie Lesjak - Chief Financial Officer

Analysts

Unidentified Company Representative

Okay. I think we will get started. I'm very happy to have Cathie Lesjak, the CFO of HPQ. And Cathie maybe a good press to start would be, in effect the things announcements of the Company recently, you had your Analyst Day recently a few weeks ago and you had your results.

Maybe one thing I think is topic off our investors, the business hasn’t grown in the last couple of years and you have kind of laid out a vision of stabilizing to growing. Could you speak about maybe in the printing and the PC side, what the key things i.e. you need to deliver on just stabilizing and growing this business over the next couple of two to three years?

Cathie Lesjak

Sure, I think the best way to start is to talk a little bit about our strategy. So we have got a strategy around kind of core, the core markets that we are in today. The areas where we think there are growth opportunities, significant growth opportunities and then the longer term growth opportunities in the future.

So in the core there are pockets of growth areas, which we are very excited about and in that category I would put some of the pockets of growth that we see in personal assistance, around gaming, around premium, on commercial services is also an items.

On the print side of the house, it’s really focusing primarily on basically the commercial print space and having the most secure commercial printer out there, which is absolutely very important to our customers.

But then it’s in the growth segment, when you think about growth, you think about imprint graphics, I mean we saw graphics grow both nominally and in constant currency in Q4, got a great product line up in graphics.

You also think about basically the A3 copier space, we are going to have a very extensive portfolio in the A3 copier space coming out in Q2 with both the commercial agreement and the announcement around the Samsung print business. And so that is a market, that is $55 billion in TAM, where we are very under represent and we think there is a real opportunity for us to take significant share, because we have a very disruptive play in that space.

And then from a personal systems perspective, it’s really around commercial mobility and we saw really strong growth and double-digit growth in commercial mobility in Q4 really powered by our Elite X2, and our Elite X3 is also in that category. So those are kind of the - we think that as being kind of two to four, two to five year timeframe. That helps to offset some of the declines that we are seeing in the core and then longer term it’s really about [immersive] (Ph) computing and 3D.

3D is today expected to be a $20 billion, $30 billion, $40 billion TAM, but we are investing in that part of the market in plastics for 3D for disrupting the manufacturing market, which is close to the $12 trillion. And we know exactly what we need to do in order to unlock that potential and that’s the longer term growth. So that’s probably five plus years. Significant opportunity again another disruptive play that we bring to the market.

Unidentified Company Representative

Maybe to touch on those growth opportunities on graphics. So if you have the technology and the sort of portfolio in place. Will you say that over the course of this year, you would have that? And what is anything from distribution and how you approach that market is different from your other segment in printing?

Cathie Lesjak

So we have the portfolio today and it’s actually well one of the players that has a really broad portfolio. So we have DesignJet, kind of large format, all the way up to corrugated packaging, really big web presses. Using again on the web press side of the house are PageWide technology our inkjet 30 years of inkjet technology that is serving us very well in that space.

So today, that represents something 15% of the print revenue. As I said, it’s growing, if you actually look at the TAM over the next three years, the total analog and digital part of graphic is expected to grow about 2%. But within that and we only play in digital, the market is moving digital and that’s expected to go two or three times in the analog.

So we think there is a great opportunity there, while it’s only about 15% of printing revenue today, we are a leader, in fact we are the leader in most of the categories and graphics that we playing. And so we think that that continues to be a really big opportunity.

In graphics, we sell to largely print service providers. So they buy the machines, so that they can then provide services, print services to a whole host of different businesses.

Unidentified Company Representative

And on 3D printing as you mentioned, what is the time scale for that to become an actual business that we might notice in HP?

Cathie Lesjak

It’s actually funny that you say that, I noticed it is today, because we are making big investments in that space. We are leveraging 30 years of inkjet technology and all the patents that we have in space. But there are certain things obviously that you needed to do for 3D printing specifically around plastics.

And so today, it’s an investment, so it puts some pressure on the bottom-line. In terms of when is it going to be material to the top-line and then be a real profit contributor? Probably not material in FY 2017, but beyond that it become increasingly important. I will tell you that we shipped our first order last week and so we are on our way. This is a business that we are going to make money in hardware, we are going to make money on consumables and we are also going to make money on services.

So it’s a little different business models than kind of the traditional razorblade model. It also has a very long sales cycle. Especially given the newness and the opportunity to disrupt manufacturing, there is a lot of work that needs to be done with potential customers to help them understand how they use 3D and what it can do for them in terms of overall saving costs for them in their manufacturing processes, that’s very important. They also have to understand how to design for 3D manufacturing.

So there are certain things that manufacture with 3D printing that you cannot do otherwise, but that means you have had to design tools to really understand, how you can design. And so this market is really quite nascent and so it’s going to take a while for it to really get to the point meaning the curve, but we believe that we are well situated to take advantage of it.

Unidentified Company Representative

Can you maybe explain how the distribution and the sales approach in that business might work, and how it’s different to your additional print business? Because I think of it, it’s one thing serving commercial printers to the CI or the PC, the printing press in organization and other things saying, “Well we are going to help you redesign your portfolio.” So is there different sales effort motion, how you address that and how you go about it?

Cathie Lesjak

So there is a bit of different sales motion, but at kind of the highest level, we will be selling direct. We will be selling with what we consider kind of consulting partners, global service providers, who are developing their own practices within 3D manufacturing, 3D printing and then on to channel. So we will have all three different motions.

I think that at least early on, the motion with kind of global service providers is probably a pretty important one, because there is a fair amount of work that needs to be done with the customer to help them understand how to take full advantage of the opportunity that exist.

So it’s not just does it make economic sense, which is certainly something that a customer needs to go through, but it’s also how do you fine tune the machine, what are the materials that make sense for the parts that you are thinking about manufacturing with 3D printing.

So it is a complicated long sales cycle, but it is a little bit closer to our graphics than our traditional commercial printing, because the graphics motion is also a longer sales cycle and a more consulted sale.

Unidentified Company Representative

Okay. And maybe turn to some of the specifics for this year, one of the things I think from the results call that still wasn’t quite clear to me was, are you still committed to the stabilization of supplies by the end of the fiscal year. We also noted that it may slightly worsen the first half. Can you just talk through, why that’s happening, because I can see it in both ways bounce and the hike on the comps would have been quite easy for you in the first half and the end it might have been a analysts on a curve of smooth line to [Multiple Speakers].

Cathie Lesjak

We are like a smooth linear line, up until the right, but it doesn’t always work that way.

Unidentified Company Representative

So could you maybe talk through what the dynamics are and the confidence you have in the Four Box model, because I think that’s a key debate that I have with investors as well. Ultimately, supply is stabilizing and one day even growing moderately this can look very different I think.

Cathie Lesjak

So I think first off let’s talk little bit about the Four Box model. That is a model that looks across basically the four dimensions the installed base, kind of a quality of the installed base, our market share and after market supplies and then also pricing. And we basically have model for each of those boxes and we know that types of initiatives that we have got working on each of those boxes and we know then how that they interplay to drive supplies growth.

In the last three quarters, the decline in supplies really is the core of the decline has been roughly 3% to 4%. The model given how we have sold in units, so the first box around the installed base. We know that units were soft in Q1 and Q2 before we got our cost structure in a better spot, I guess with the right cost structure, we create a bigger universe of NPV positive units and we are NPV positive units.

And there is a dip, because those units that didn’t get placed in Q1 and Q2 are they are not supplies in the early part of that FY 2017 and that’s what is causing the dips. What important is that even with that dip the Four Box model, which is we have had for many years over a quarter, over a multi-year period of time, it has been very accurate, it has been able to predict what the supplies revenue growth look like.

It already has in the model a dip Q1 and its still expecting that supplies will stabilize by the end of 2017 in constant currency. So that’s what give new confidence, I have confidence in the predictability of the model.

Unidentified Company Representative

Under this model, I guess it depend upon the margin information that your installed based is sending back to. How rich is that information today, has it been improved over last few years, whereby I don’t know 50%, 60% of your printers are sending back information to HP. Is that how it works out of the Big Data kind of analysis? And are you improving the predictability overtime.

Cathie Lesjak

So we get printers on home regularly. We have a bigger installed base of printers phoning home in the in space. Over the course of 2016, we now are having a commercial side of the house, those LaserJet printers are phoning home too. And so yes, we are constantly refining the model with the data that we get.

So a really good example of this, probably not one of more positive discussions that we had about the model, though it was about a year ago. You will recall at the end of Q4 last year on our Q4 earnings call, we talked about how the supply stabilization got pushed out specifically for Ink, because of the data that we were getting from the printers.

And what we saw was that some of the printers OfficeJet Pro X that were really designed to go into the commercial space, because we were pricing too competitively, they were going into the high-end consumer. The high-end consumer does not print as much as a commercial and small business to us.

And as a result of that, we were spending too much to put a unit out there and it wasn’t driving as positive in NPV and not the same usage and we had to - we used the Big Data that we were getting to refine the model. And we are now doing this on fairly regular basis.

Unidentified Company Representative

Okay. One of the things on the results I would like to clarify was, I think you mentioned in the Q&A, the print margins in the next year would be in the mid-teens. I think you said that and whereas like you consistently executed probably higher than that mark 17% probably for the last couple of years. Now step down, is that link that these supplies in the first half or is it something else happening in the cost structure side and putting that even aside for this year. Is there any inherent reason why historic print margins can’t be preserved?

Cathie Lesjak

So I think that our definitions of mid-teens are a just a little bit different. I think of mid-teens is 13 and 19, not 15, but 16, 17 range. So I think that we expect the margins to kind of be in that range. The range that we have seen historically and I do think that in a particular quarter where we see real significantly more opportunity and we have model today to place NPV positive units they will be as kind of lower end of the range, the mid-teens range.

So I think of mid-teens, as kind of 15, 16, and that’s kind of how I think about it. And I think that I want the business to do that, because of their NPV positive units, and what we will do is we call that out, it will show up in unit placement. So it will be very tangible as to what is happening. But I think of the business as being in that range of the margin that we have seen historically.

Unidentified Company Representative

Okay. Great. And maybe moving on to a couple of questions on the PC side and PSC side and it looks like PC trends have in the last few quarters started improving after several years of limited and declining units in revenues. And I also look at this as a massive installed base of very aged PCs out there. So it feels right now is the time to be more optimistic many of the industry forecasts aren’t really called in. So how do you guys see the PC industry and then also within the HP is executed quite well I think on the [Indiscernible] and especially much better than I thought in the margin side. So can you address what has been going on specifically in PC margins in that environment?

Cathie Lesjak

Sure. But let’s start first with the market. So the expectation if you include detachable. So a lot on the IDC data doesn’t include detachable, but since the detachable are actually are a substitute for other products within the space. We think about the detachable, so the market kind of low to mid-single digits declines is what we see, but it’s not just, what the market does, it’s what you do in the market.

And we believe that we are very well positioned, we think we continue to stay focused on a very lien cost structure. We are continuing to innovate in way differentiate ourselves from others in the market, whether that’s cutting back on visual hacking with our Sure View privacy that’s built into that PC or the incredible security that we had built into the BIOS of the PC. We feel good about that piece of that.

And then we also I think a really good job of segmenting the market, and segmenting at a detailed level that detail enough to understand that there are market opportunities that exist out there, and that’s actually how we determined that there would be opportunities for us in consumer premium as well as in gaming.

And then because we have that detailed segmentation that informs the innovation that we need to make sure that we have got the right combination of price, feature and value. And that has enabled us to actually grow and in personal system is both in units as well as revenue in the last quarter, and we think that we have got really good momentum in the personal systems space.

From a margin perspective, we have typically seen margins in the 3% to 4% range. Some quarters we are a little bit higher than that in the fourth quarter 4.3% we stay completely focused on making sure that we have got this lean cost structure and that we are going after the opportunities that can create interesting opportunities for us from a device perspective, but also beyond the box and so basically attaching services, it’s usually important.

On the commercial services side, we include double-digits in Q4 you have to think about commercial services as having many multiples of gross margins to the devices. So that attach will help a lot over time from a margin perspective. And then there are other categories things like two-in-one, retail point of sale, thin client that all help us from a margin perspective as well.

Unidentified Company Representative

And linked to some of the cost initiatives that happen or happening at HP in the bridge this year, I think you are concerned as every year, you see this earnings contribution have to come from efficiency gains across the organization. I think Dion said hat we will get there, you haven’t quite identified all them, [Indiscernible] can you speak about what is that you are doing, I think what a lot of us do is product to redesign the costs, what did the HP have to do to ensure you drive efficiency home to the bottom-line?

Cathie Lesjak

So I think first to hopefully give you a little bit more confidence. We have the amount of line of site now that we have at this time of the year, all the time. So last year at this point in time, we have expected to do about $1 billion in productivity. At the end, with accelerating, restructuring and variety of things that we did, we did well in excess of $1 billion. Again, with about the same amount line of site at this time last year.

So it’s just something that you work through over the course of the year. I would say that internally, we have a lot of confidence that we can achieve those productivity savings of about a $1 billion in fiscal 2017. And it’s just something that in the business that we are in and the markets that we play in, you have to do this. You have to stay focused day-in and day-out on every cost.

The cost within the products, so product simplification on reengineering products so that they to use an example that run [indiscernible] we reduced the amount of metal we have to use, we reduced the amount of interconnections that we have to use and still deliver the quality product. We have to do the things in the print space. We also have to simplify the portfolio. We are constantly focused on logistics and making sure that our supply chain is efficient as it can be. An example of that in 2016 we changed how we do our logistics and supply chain around desktops.

While that caused us to carry a little bit more inventory, at the end of the day, it created such significant savings from a supply chain perspective, we implemented it. We are now doing that similarly both on the consumer side, we are not looking at doing that in the commercial space. We look at non-revenue generating expenses all the time. So it’s not one thing, it’s not even five things, it’s hundreds of things that we have to stay focused in order to drive these productivity initiatives.

Unidentified Company Representative

And maybe last couple of questions on cash flow and capital returns. Can you [indiscernible] finish the free cash flow last year getting to 2.8 billion and this year that is the range is 2.3, 2.6. Was there exceptional items or one-off benefits working capital otherwise don’t be occur to now by this more normal range or can you explain that bridge on free cash flow and then also with that level of cash generation just again remind us on the plan are for distribution [Indiscernible]?

Cathie Lesjak

Sure. So in terms of kind of the walk from FY 2016 free cash flow of about $2.8 billion to the range that we provided to FY 2017 is 2.3 to 2.6. The walk is actually no difference and what we provided at the Security Analyst Meeting. All the items are the same, except for the headwinds associated with the cash conversion cycle or working capital.

The over performance or the better performance I think is the better way to say it. In Q4 that deliver the 2.8 billion in free cash flow for the year was entirely as a result of finishing stronger on the cash conversion cycle. So originally, we had expected the cash conversion cycle to be negative 25 days and we came at negative 29 that’s about $400 million, $500 million.

So then, when you go looking into FY 2017 unless you now expect that you can improve your cash conversion cycle by the 10 days that we improved in FY 2016 is going to be a headwind. And that headwind is at least 10 days, because at this point, we think at best its flat year-on-year, so minus 29 to minus 29 at the end of 2017, but it’s likely that it’s not quite as good as that.

Because some of the better performance in Q4 really came from strong personal systems performance, as well as better vendor mix depending on the products that we are selling we work with vendors and those vendors have different payments. And so I would think the best way to think about the cash conversion cycle next year is kind of in the range of minus 27 to minus 29.

And if I can just remind everyone that in Q1 it is our seasonally weakest cash flow quarter, its weak for two reasons, the biggest reason is that the bonus that we have been accruing in FY 2016 we actually pay it in cash in the first quarter, okay. And secondly from Q4 to Q1 is typically a personal system declined and that’s puts pressure on that first quarter’s cash flow.

Unidentified Company Representative

Okay. And quickly on cash distribution.

Cathie Lesjak

Okay, cash distribution. As we have talked about our expectation is that we will continue to return 50% to 75% of our free cash flow to shareholders in the form dividend and share repurchases and in FY 2016, we delivered 72% back to shareholders and in FY 2017, we expect to be at the higher end.

Unidentified Company Representative

Okay. Great. Thank you Cathie for your time.

Cathie Lesjak

Thank you very much.

Question-and-Answer Session

End of Q&A

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