HP : Second Quarter 2024 Transcript

29-May-2024

HP, Inc. (HPQ)

Q2 2024 Earnings Call

Total Pages: 19

HP, Inc. (HPQ)	29-May-2024
Q2 2024 Earnings Call

CORPORATE PARTICIPANTS

Orit Keinan Nahon	Timothy J. Brown
Senior Vice President-Finance & Head-Investor Relations, HP, Inc.	Interim Chief Financial Officer, HP, Inc.
Enrique Lores
President, Chief Executive Officer & Director, HP, Inc.

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OTHER PARTICIPANTS

Erik W. Woodring	Samik Chatterjee
Analyst, Morgan Stanley & Co. LLC	Analyst, JPMorgan Securities LLC
Michael Ng	A. M. Sacconaghi
Analyst, Goldman Sachs & Co. LLC	Analyst, Sanford C. Bernstein & Co.LLC
Wamsi Mohan	Michael Anthony Cadiz
Analyst, BofA Securities, Inc.	Analyst, Citigroup Global Markets, Inc.
Ananda Baruah	Steven Kinney Chin
Analyst, Loop Capital Markets LLC	Analyst, TD Cowen

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MANAGEMENT DISCUSSION SECTION

Operator: Good day, everyone, and welcome to the Second Quarter 2024 HP, Incorporated Earnings Conference Call. My name is Eric, and I'll be your conference moderator for today's call. At this time, all participants will be in listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.

I would now turn the call over to Orit Keinan Nahon, Head of Investor Relations. Please go ahead.

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Orit Keinan Nahon

Senior Vice President-Finance & Head-Investor Relations, HP, Inc.

Good afternoon, everyone, and welcome to HP's second quarter 2024 earnings conference call. With me today are Enrique Lores, HP's President and Chief Executive Officer; and Tim Brown, HP's Interim Chief Financial Officer.

Before handing the call over to Enrique, let me remind you that this call is a webcast and a replay will be available on our website shortly after the call for approximately one year. We posted the earnings release and accompanying slide presentation on our Investor Relations webpage at investor.hp.com.

As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. For more detailed information, please see disclaimers in the earnings materials relating to forward-looking statements that involve risks, uncertainties and assumptions.

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Q2 2024 Earnings Call

For a discussion of some of these risks, uncertainties and assumptions, please refer to HP's SEC reports, including our most recent Form 10-K. HP assumes no obligation and does not intend to update any such forward- looking statements. We also note that the financial information discussed on this call reflects estimates based on information available now and could differ materially from the amounts ultimately reported in HP's SEC filings.

During this webcast, unless otherwise specifically noted, all comparisons are year-over-year comparisons with the corresponding year-ago period. In addition, unless otherwise noted, references to HP channel inventory refer to Tier 1 channel inventory.

For financial information that has been expressed on a non-GAAP basis, we've included reconciliations to the comparable GAAP information. Please refer to the tables and slide presentation accompanying today's earnings release for those reconciliations.

With that, I'd now like to turn the call over to Enrique.

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Enrique Lores

President, Chief Executive Officer & Director, HP, Inc.

Thank you, Orit, and thank you all for joining today's call.

When we started the fiscal year, we committed to very specific goals, drive profitable growth in our core, accelerate in key growth areas and deliver operational efficiencies.

I am pleased to say we accomplished this and delivered a solid quarter and first half. The focus of our teams and actions we have taken, continue to drive results and build momentum. We delivered non-GAAP operating profit and non-GAAP EPS growth on a sequential and year-over-year basis. We made good progress against our Future Ready plan, and we continue to invest in innovative technologies with a strong emphasis on AI and hybrid.

Today, I will cover our second quarter results, including the recovery we are starting to see in commercial PCs, progress against our strategic priorities, key innovations we are bringing to market, and our expectations for the remainder of fiscal year 2024. Then, I will turn the call over to Tim for a deeper dive into our financials and outlook.

I will start with our results. We continue to navigate well a dynamic and competitive environment. While our net revenue was down 1 percent, the rate of decline slowed for the fourth straight quarter. Personal Systems also returned to growth for the first time in eight quarters. This is a good indicator of overall market stabilization and solid execution.

Non-GAAP operating profit grew 2% and non-GAAP EPS was up 4% year-over- year, which was slightly above the midpoint of our last quarter's guidance.

In terms of new innovations, Q2 was one of our most significant quarters. At our Amplify Partner Conference in March, we showcased over 100 AI-enabled solutions redefining productivity and collaboration. This event is our largest annual channel conference, attracting over 1,500 of our top partners from 95 countries. It inspired our partners and will help us to drive long-term sustained growth.

Let me share some of the key innovations we announced.

For the more than half-a-million data scientists who are using our workstation solutions to create AI models that improve company workflows, we had a lot to share. We announced the HP AI creation center, the world's most comprehensive workstation solutions for AI development. And we unveiled a strategic collaboration with NVIDIA

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Q2 2024 Earnings Call

to integrate their pre-trained models and software into our AI studio set of tools. They will allow customers to access share and edit their data science workflows more easily from anywhere.

At the same time, we launched the industry's largest portfolio of AI PCs, the first to deliver the benefits of running AI locally on the device, for improved performance, efficiency, and privacy.

In Print, we shared how AI will unlock opportunities to make printing smarter, more efficient, and more personalized. And we unveiled our new Color LaserJet series, optimized for small and medium businesses.

We also stepped up in our key growth areas. In Hybrid Systems, we expanded our portfolio of room solutions with a Poly Studio 360-degree camera, enabling more immersive meeting experiences. In Workforce Solutions, we introduced an enhanced Workforce Experience Platform providing CIOs with an AI-enabled digital experience to unlock the full potential of their teams.

In addition, we are enabling our partners and sales teams to capitalize on the AI opportunity. We have introduced the industry's first ever role-based AI MasterClass training and certification program.

Doubling down on our momentum, last week at the Microsoft Copilot+ PC event, we introduced the world's most powerful ultra-mobile,next-gen AI PCs.

Designed from the ground up, they enable on-the-go leaders and freelancers to harness the most powerful AI technologies available. We also showcased our new AI Helix logo, that helps you easily identify and select this new category of devices. Initial reaction has been overwhelmingly positive, with our next-gen devices being recognized as "some of the most premium" announced and having "beyond cutting-edge hardware".

We are already helping customers unlock tangible value from their AI PCs. For example, collaborating with Deloitte Consulting, together we have created an on-device assistant to drive efficiency around common IT support challenges. The solution has the potential to return close to 100,000 hours of productivity to their practitioners. This is a powerful example of the positive impact of AI PCs.

One of HP's most important assets is the strength of our brand, and we continue to invest in it to build even greater value.

This quarter, we announced a historic title partnership with Scuderia Ferrari. This is an opportunity to elevate our brand and reach new audiences and geographies, particularly younger and premium customers. It also improves the effectiveness and efficiency of our marketing spend. And we are excited to work with Scuderia Ferrari, leveraging the latest HP innovations to help them drive their competitive advantage.

HP is a trusted brand. We are a company that stands for more than just the products we make. For the fifth year in a row, HP has earned a Triple "A" rating from CDP. Next month, we will release our annual Sustainable Impact Report outlining the progress we are making towards our climate action, human rights and digital equity goals.

Let me now share in more detail what we saw in each of our businesses in Q2. In Personal Systems, we executed our strategy, driving both revenue growth and increasing profitability year-over-year. The PS revenue was $8.4 billion. That's up 3% year-over-year, driven mainly by market growth and signs of commercial recovery.

Our PS operating profit was 6%, in line with our expectations and solidly within our long-term target range. Our teams continue to show their focus by driving profitable PC share in calendar Q1 in high-value categories like commercial premium and mobile workstation.

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Q2 2024 Earnings Call

Importantly, we continue to invest and grow in high-value and key growth areas. In Gaming we grew revenue year-over-year again this quarter. PS Services was up, with strong growth in managed services. And in Hybrid Systems we saw signs of recovery. Here we drove sequential growth and strong performance in video collaboration. We remain confident that this evolving market will be a long-term growth opportunity.

In the second half, we expect to see the introduction of AI PCs accelerate demand, over-and-above the anticipated PC refresh cycle and Windows 11 roll out. We believe the AI opportunity in front of us, will help drive higher ASPs and premium mix.

We have a comprehensive portfolio of AI-enabled devices, from consumer, commercial, gaming, accessories, room solutions, to advanced workstations solutions. We are innovating beyond hardware, with software and security solutions like HP AI companion and HP Wolf Security that uses deep learning, behavior analysis and AI- based protection against malware and deepfakes. With a rich history and proven track record of integrating meaningful AI technologies, such as noise removal and gesture controls, together with our strong innovation pipeline - we are well positioned to capture the opportunity and lead the industry.

Turning to Print, results were in line with what we expected. Revenue was $4.4 billion, down 8% year-over-year and flat quarter-over-quarter. We continue to see soft demand, particularly in China and some parts of Europe. The pricing environment remains competitive in consumer, with intensifying pressure in commercial. We continued to make progress on pricing and share gains in Supplies, with revenue results as expected.

We delivered Print operating profit of 19%, in line with our guidance. Once again, we demonstrated disciplined cost management, improved mix, and the benefits of the strong innovations we have brought to market.

Our focus in Print remains on regaining profitable share, and we are making progress. We grew share quarter- over-quarter in home and in office. Importantly, we gained share year-over-year and sequentially in big tanks and business ink. We also grew in key growth areas like Consumer Services. We saw growth in revenue and in subscriber numbers across Instant Ink and our new All-In plans.

In Industrial Graphics, we continue to accelerate the adoption of digital technologies. In Q2, we grew year-over- year and for the third straight quarter. We also expanded our portfolio adding new end-to-end automation processes leveraging AI and robotics. These are on full display right now at Drupa 2024 - the largest trade fair for the printing and graphics industry worldwide.

3D continue to be impacted by elongated purchasing cycles in Q2, reflecting constraints on capital spending. The decline in hardware was partially offset by growth in services and supplies.

Overall, in Q2, we made good progress against our Future Ready strategy. We continue to execute according to plan, and we are on track to deliver on our three-year annual gross run rate structural cost savings target of $1.6 billion by the end of fiscal year 2025.

We remain committed to our capital allocation strategy and expect to return approximately 100% of our free cash flow to shareholders in fiscal year 2024 and over time, as long as our gross leverage ratio remains below 2 times and unless higher ROI opportunities arise.

Looking forward to Q3 and the second half of fiscal year 2024, we expect the demand environment will remain dynamic and that our markets will continue to be very competitive. That said, we're encouraged by the progress we have made delivering a solid first half. And we expect a stronger second half.

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HP, Inc. (HPQ)

Q2 2024 Earnings Call

The anticipated commercial PC refresh as well as early gains from the AI PC, together with our plans to gain share in Print, gives us confidence we are well-positioned to drive growth in our core businesses. At the same time, we see significant opportunities to accelerate in our key growth areas.

As you have seen repeatedly, we are delivering to expectations and will continue to maintain our focus as we enter the second half. We remain confident in our strategy and we'll continue to execute on our plan.

Let me now turn it over to Tim.

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Timothy J. Brown

Interim Chief Financial Officer, HP, Inc.

Thank you, and good afternoon, everyone.

We delivered solid financial results in Q2, driven by disciplined financial management and focused execution, while navigating a dynamic and competitive environment.

We are pleased with our continued progress we made in Q2 toward delivering on our financial commitments. Total revenue decline slowed further. Our gross profit dollars and margin, our non-GAAP operating profit dollars and margin and our non-GAAP EPS, all improved both year-over-year and quarter-over-quarter. In addition, we generated solid free cash flow. We achieved these results while simultaneously reinvesting in our key growth areas and in AI, and managing through a mixed market environment, characterized by slightly stronger PS commercial performance, balanced against continuing Print market demand challenges.

Now, let's take a closer look at the details of the quarter:

Net revenue was $12.8 billion in the quarter, down 1% both nominally and in constant currency; in constant currency, Americas increased 2%, EMEA declined 3%, and APJ declined 5%. APJ was impacted as soft demand in China continued.

Gross margin was 23.6% in the quarter, up 1 point year-over-year, primarily due to lower commodity and logistics costs and cost savings, partially offset by unfavorable mix and competitive pricing.

Non-GAAP operating expenses were $1.9 billion or 14.8% of revenue. The year-over-year increase in operating expenses was driven primarily by continued investments in higher variable compensation, partially offset by cost reductions. Non-GAAP operating profit was $1.1 billion, up 2%. Non-GAAP net OI&E was $158 million, down primarily due to lower interest expense driven by a decrease in debt outstanding.

Non-GAAP diluted net earnings per share increased 3 cents or 4% to 82 cents, with a diluted share count of approximately 1 billion shares.

Non-GAAP diluted net earnings per share excludes a net expense totaling $205 million primarily related to:

• Amortization of intangibles,
• Restructuring and other charges,
• Acquisition and divestiture- related charges, nonoperating retirement-related credits, and other tax adjustments.

As a result, Q2 GAAP diluted net earnings per share was $0.61.

Now let's turn to segment performance.

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HP, Inc. (HPQ)

Q2 2024 Earnings Call

In Q2, Personal Systems revenue was $8.4 billion, up 3%, or 2% in constant currency, driven by higher volumes led by Commercial, partially offset by a decline in ASPs and continued weakness in China. Total units were up 7% with Consumer down 1% and Commercial up 12%. Personal Systems revenue returned to growth, exceeding our expectations. We are encouraged by the positive momentum exiting Q2 as we head into the seasonally stronger second half of the year.

Drilling into the details, Consumer revenue was down 3%, and Commercial revenue was up 6%, representing greater than 70% of Personal Systems revenue. ASPs were flat quarter-over-quarter driven by a favorable mix shift toward commercial and increased consumer pricing, offset largely by an increased mix of lower end devices. While our market share declined in calendar Q1 as competition intensified, we drove share improvements in high value categories including mobile workstations, and commercial premium. We remain focused on driving profitable revenue and share growth in both our consumer and commercial markets. Last week we announced the launch of our next gen AI PC which is part of a series of launches planned for this year that will expand our portfolio of AI PCs, as we enable our customers to deploy advanced AI technology at the edge.

Personal Systems delivered $508 million of operating profit, with operating margins of 6.0%. Our margin increased 0.7 points year-over-year, driven by lower commodity and logistics costs and cost savings, including Future Ready savings, offset partially by competitive pricing and investments.

In Print, our results reflected our focus on improving execution and diligently managing cost as we continue to navigate a very competitive Print market.

In Q2, total Print revenue was $4.4 billion dollars, down 8% on a reported basis and down 7% in constant currency. The decline was driven by declines in both hardware and Supplies. Hardware revenue was down 18% year-over-year, driven by lower volumes attributable primarily to continued weak demand, especially in China and EMEA, as well as share loss in both home and office due to aggressive pricing partially driven by further depreciation of the Yen. Total hardware units decreased 17% year-over-year. Industrial Graphics grew revenue for the third consecutive quarter driven by supplies and services, offsetting softer hardware demand as we believe customers delayed purchasing decisions in anticipation of Drupa which started yesterday.

By customer segment, Commercial revenue decreased 12% with units down 17%. Consumer revenue decreased 16% with units down 17%. In Big Tank we increased our volumes and market share sequentially, partially offsetting continued market softness and competitive pricing in the traditional home ink market. In Consumer Services, we drove revenue and subscriber growth in both our Instant Ink and All-in plans.

Supplies revenue was $2.9 billion, down 5% on a reported basis, and down 4% in constant currency. This was in line with our outlook.

Print operating profit was $829 million, down 8% year-over-year, and operating margin was 19%. Operating margin was flat year-over-year, driven by disciplined cost management, including Future Ready savings and favorable mix, offset by competitive hardware pricing.

Turning to our Future Ready transformation plan. We are on track to achieve our fiscal year-end 2024 goal of delivering a cumulative 70% of our year-end 2025 goal of gross annual run rate structural cost savings of $1.6 billion. We expect to achieve this by driving efficiencies in our core businesses.

We are pleased with our progress in reducing our cost across Print and PS. We continue to see the benefits of initiatives we launched in prior quarters. For example, we continue to optimize our location strategy with plans for additional site actions this year. In our digital transformation initiatives, we're accelerating our generative AI

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Q2 2024 Earnings Call

capabilities, including rolling out AI tools such as GitHub Copilot to approximately 60% of our developers, as well as implementing HP-specific large language models to improve efficiencies across our sales and service organizations. In Marketing, we continue to optimize and in-house our digital media capabilities and maximize programmatic investments. Specifically, we are delivering savings through AI-enhanced capabilities, scaling content production and working towards translation cost efficiencies, helping us improve our NPI marketing efficiency, with lower agency costs and next-gen market insights and measurement. In PS, we are simplifying our portfolio as we announced last week our brand simplification strategy across our consumer and commercial portfolios.

Now let me move to cash flow and capital allocation.

Q2 cash flow from operations was approximately $581 million and free cash flow was $481 million, driven by net earnings.

The cash conversion cycle was minus 31 days in the quarter. This decreased 2 days sequentially due to days inventory increasing 9 days, days payable increasing 16 days, and days receivables increasing 5 days. The increase in DOI was driven primarily by an increase in strategic buys and sea shipments, both of which drive economic value. The strategic buys continue to allow us to take advantage of attractive economic offerings from suppliers to reduce the near-term financial impact of rising commodity costs. The increase in DPO was driven by an increase in accounts payable due to purchase timing and higher strategic buy inventory.

In Q2, we returned approximately $369 million dollars to shareholders, including $100 million dollars in share repurchases and $269 million dollars in cash dividends. We finished the quarter within our target leverage range, and expect to return approximately 100% of our free cash flow to shareholders in FY24 and over time, as long as our gross leverage ratio remains below 2 times and unless higher ROI opportunities arise.

Looking forward to the second half of FY 2024, keep the following in mind related to our FY 2024 and Q3 financial outlook.

• As Enrique said, we expect performance in the second half of fiscal 2024 will be seasonally stronger than the first half.
• We continue to model multiple scenarios based on several assumptions. For FY 2024, we are narrowing our non-GAAP EPS outlook range to $0.30, but we continue to see a range of potential outcomes for H2 2024, which is reflected in our updated outlook.
• We remain focused on improving our cost structure and our performance, while continuing to invest in our growth businesses.
• Regarding OI&E expense, we now expect it will be approximately $0.6 billion in FY 2024.
• We continue to expect free cash flow to be in the range of $3.1 billion to $3.6 billion for FY 2024, improving sequentially in both fiscal Q3 and Q4. As a reminder, our free cash flow outlook includes approximately $300 million of restructuring cash outflows.

Turning to Personal Systems,

• Specifically, for Q3, we expect Personal Systems revenue will increase sequentially by a high-single digit, though slightly less than typical seasonality.
• We expect Personal Systems margins to be towards the high-end of our long-term target range of 5% to 7% in Q3, augmented by disciplined cost management actions.
• For FY 2024, we expect Personal Systems margins to be solidly within our long-term target range, driven by improved PC revenue in the back half of the year, continued mix improvements and cost efficiencies.

In Print, we expect Print to stabilize in the second half of the year, consistent with the market outlook. For Q3, we

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expect Print revenue to decrease sequentially by low-single digit, in line with typical seasonality. We continue to expect supplies revenue in FY 2024 to decline by a low- to mid-single digit in constant currency. For Q3, we expect Print margins to be in the upper half of our 16% and 19% range and now expect FY 2024 margins to be at the high-end of the range, driven by rigorous cost management.

Taking these considerations into account, we are providing the following outlook for Q3 and fiscal year 2024:

• We expect third quarter non-GAAP diluted net earnings per share to be in the range of $0.78 to $0.92, and
• Third quarter GAAP diluted net earnings per share to be in the range of $0.63 to $0.77.
• We expect FY 2024 non-GAAP diluted net earnings per share to be in the range of $3 dollars and 30 cents to $3 dollars and 60 cents, and
• FY24 GAAP diluted net earnings per share to be in the range of $2 dollars and 60 cents to $2 dollars and 90 cents.

I'll stop here so we can open the lines for your questions.

HP, Inc. (HPQ)	29-May-2024
Q2 2024 Earnings Call

QUESTION AND ANSWER SECTION

Operator: Thank you. And we will now begin the question-and-answer session. [Operator Instructions] And our first questioner today will be Erik Woodring with Morgan Stanley. Please go ahead.

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Erik W. Woodring

Analyst, Morgan Stanley & Co. LLC

Q

Great. Thank you, guys, very much for taking my questions. Enrique, maybe if I, I think, turn to you first. At the start of the year, you had talked about the Print business kind of performing in line with the market at roughly flat this year. Year-to-date, it's declining, let's call it, mid-single digits. You're telling your supplies will continue to decline low- to mid-single digits, but you expect the market to stabilize in the second half of the year.

And so, maybe my first question is, why do you believe other than easier year-over-year compares, the Print market will stabilize in the second half of the year? Are there any of the underlying factors that have impacted the Print business? Are any of those changing as you look to the second half, like yen competition and broader market trends?

And then as we think about hardware seasonality in the second half of the year, should we still be thinking about an improving trend sequentially there? How does that translate to year-over-year growth? Kind of if you could unpack all of that just for print, that would be super helpful. And then I have a follow-up. Thank you.

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Enrique Lores

President, Chief Executive Officer & Director, HP, Inc.

A

Sure. Thank you, Erik. It's a long question. So I'll try to cover all your points. So first of all, in terms of what do we see from a competitive perspective, as you mentioned, we continue to see fairly strong competition in the Consumer side, similar to what we were seeing in Q1. Where we have seen an intensified competition is in the office space, driven by the similar reasons what has happened in Consumer. So this clearly has evolved.

When we think about the second half, we expect the market to stabilize and you mentioned one of the key reasons, which is an easier compare to what we had in the second half of 2023 are underlying drivers that give us some confidence in this number. First of all, is what we are seeing from a usage perspective that usage has been fairly stable, especially in the office space per printer, which is always a good indicator of what is going to be the overall performance from a printer perspective?

And then, in terms of our own projections for HP, as we shared last quarter, we have been working to reduce our cost structure to be able to be more competitive. So we expect to have some share gains in the second half, again, because of the cost actions that we have been driving during the previous two quarters. So in our performance, you should see that reflected. And again, this doesn't mean that we have changed our strategy. Our strategy continues to be profitable growth. It's just that we will be able to sell more units in a profitable way and capture share in this way.

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Erik W. Woodring

Analyst, Morgan Stanley & Co. LLC

Okay. That's helpful. Thank you.

Q

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