Thank you, and welcome to day two of Bank of America's global tech conference. I'm Wamsie Bohan. I cover IT hardware supply chain here for the bank. Delighted to welcome HP Inc here today. We have President and CEO Enrique Lores. Enrique has had a long tenure at the combined HP before and now at HP Inc. He has run many of the critical profit centers of the company. Enrique, welcome.
Thank you.
It's a pleasure to have you over here.
Thank you for having me here. It's always a pleasure.
Yeah, absolutely. Great to see you in person again. Enrique, maybe to kick it off, I think the macro environment has been challenging and volatile in some ways. Would love to get your take on sort of what your outlook is as you look at the business in sort of the near term.
Sure.
What you're hearing from customers.
Sure. I think I would say the macro environment has been mixed because from one side, we have seen strong demand, especially in the PC side, especially in the commercial side. We have seen strong demand. At the same time, clearly, we have faced some challenges on the cost side, mostly driven by the tariffs and the changes in the trade space. This is really what has been driving our performance, would drive our performance into solid growth. At the same time, very challenging results from a profit perspective because of the impact on tariffs. When we look at the second half, we expect the market to continue to grow, which is what we expected at the beginning of the year. We have moderated our growth expectations.
We think that we do that both because we think that the current environment and the uncertainty around what tariffs will be there and what will be the impact in the economy are going to have an impact in demand. Also, just the current environment, as many companies will be raising prices across multiple categories, whether we like it or not, is going to have an impact on demand. We know that we were ahead of some of the industry analysts in terms of projecting that. We think it's logical to expect a slowdown in demand, given that the prices, not only on PCs, but across many industries, are going to be increasing. If we are wrong, we will be super happy of being wrong. This will be reflected in our results.
We think it's logical to expect some impact on demand.
Right. Yeah. As you think through that, right, maybe just to start off with tariffs, clearly, you saw a higher impact than what you had anticipated in the prior quarter. Can you just break that down a little bit on what were some of the incremental costs that you experienced and what parts of the portfolio that were most impacted?
Yeah. Let me start by saying that we saw a bigger impact because the tariffs that were put in place were higher than we were expecting.
Correct.
It's not that we had forecasted from based on the tariffs we had. It's just that both in terms of the amount of tariffs, in terms of the countries that were impacted, was more than we had in the plan in February.
Absolutely.
I think this had an impact on cost. Cost came from four different places. First of all, of course, the incremental duties that we had to pay, given that tariffs were more than what we had in the plan. Second, in the quarter, we had to make investments to improve the situation for the future. But also that quarter also had an impact on cost. Third, to mitigate the impact in the quarter, we had to take additional actions, mostly from a distribution perspective, how products were shipped and when. That also had an impact on cost. Fourth, as we had to accelerate the plans that we had. For example, I had shared in February that our plan was to fully move our capacity from the US out from China by the end of the year. We accelerated that. Now we are in June.
In June, we are going to be totally out from China for products to the US. This also created some modern inefficiencies in our supply chain systems that also had an impact on cost. There were multiple areas. At the end, this is what we explained in our results, that it had an impact of about $0.10 of EPS. We have also said that from a cost perspective, we expect to have fully mitigate by Q4. We are on track to make it happen.
Can you talk about maybe two things, two follow-ups over there? One is on your comments about moving out of China. When did you start that process? How long was that process? What are the incremental inefficiencies that are created because of that process? Secondarily, the mitigating factors that you are undertaking, what are some of those? How much of that is pricing? How much of this is everything else in the supply chain that you have discussed?
Sure. Actually, we started this process right after COVID. We have talked about this before, not because of tariffs or not because of the changes in trade, but really because we learned through COVID that having a big concentration of factories in one location from a resiliency perspective was not the best model for the company. To improve resiliency, we decided to start this diversification process. We started probably more than three years ago. We started to move factories to Southeast Asia to increase the capacity in Mexico. What we have done during the last two quarters is to significantly accelerate this change. By now, for products for the US, we are totally out of China. China continues to be an important manufacturing site for us, for the rest of the world. We think it will continue to be.
For the US, we have changed that. The additional cost of this comes from two angles. There is some cost because producing out of China, especially because the lack of certain suppliers, is slightly higher. The impact is fairly small. In the long term, we can fully mitigate that. The second cost is more about the inefficiencies that happen in the short term. It is very different to run a big factory in one location, but multiple factories in multiple locations, and to drive this change so fast. These changes also will be mitigated. This is the plan. This is what we are working on.
Just in this process of moving away, where you have these large consolidated factories in China, does it change the way that you think about just-in-time and some of the cash cycles associated with the business? Does it have an impact on that?
It has had some impact on working capital because having multiple factories in multiple countries is going to drive an increase in the amount of inventory that we need to have to make sure that we can respond and have some good flexibility as we get orders from multiple areas. That is a major impact this will have. We shared in the call that this was having some impact in the free cash flow we will generate this year. Again, this is something that as we will learn and we will optimize our processes, we can reduce. Short term is going to have some impact.
Right. Maybe just to think through within the portfolio, a lot of the elements of manufacturing have been more concentrated in China, more so on the PC front. Can you just talk about the relative sort of impact on the print business and which parts of print are more or less impacted?
Sure. The impact on print was lower because we started from a more diversified situation from the beginning. That really helped. I mean, now most of the print manufacturing is happening in Southeast Asia. We have some production in Europe and some production in the US. Majority is in Southeast Asia. Honestly, we need to see now what are the impacts and what are the final tariffs there. The plan will continue to be to mitigate that through cost and eventually through price. This is very consistent across the industry. We announced some price increases on the print side. All of our competitors have made similar announcements. I think it is going to be an increase of pricing in the print space that is happening now.
What about on the PC front? Are you intending to change pricing on the PC front? Or how are you thinking about that?
PCs are mostly a cost-plus model. If cost increases, prices will increase. We were in the process already of increasing prices to respond to commodity cost increases. This is something that we have started. To the extent we cannot fully compensate some of the changes with cost, we will be increasing prices. We see this also as an industry trend. Many of our competitors are doing the same. We think most of the industry will be doing the same.
OK. Some of your competitors seem to express that maybe they will not actually be making price changes right now. Do you think that that's just a timing issue? Then we will see eventually it happen?
Yeah. I don't have information.
Sure.
Many have.
Yeah.
Knowing the margins in the industry and the magnitude of the tariffs, I see it difficult to see how to manage this situation without any price increases.
OK. OK, fair enough.
If we were in a different industry, it might be possible. Given the margins in PCs, I think it's hard to see how to absorb a 10%, 15%, 20% tariff increase.
Yes, absolutely. Yeah, when you've got 5%-7% sort of margins, it's very hard to offset a significant increase in your BOM cost. Maybe switching gears just to think about the outlook for the PC market. I think coming into this year, it felt it was going to be a solid year that had a lot of different tailwinds, including Win 11 adoption. We had AI PCs and, frankly, just COVID-era PCs coming up for replacement. Which of those do you think are still undergoing? Is it the rate and pace of that that has not kept up? Why do you think that is?
Two things. One is, if I look at the first half of the year, it really performed well. Demand performed as we were expecting or even better. The first half of the year, from a demand perspective, has been very solid. What we think now is the growth on the second half is going to be less than we were expecting. We continue to expect growth. We think that growth now is going to be in the low single digits for PCs. In units, more in pricing, mostly in revenue, because prices are going to increase. What we have done is moderated our growth expectations. We continue to think that there is going to be growth in the second half. The drivers are consistent to what you said. There is a very large install base that needs to be replaced.
There is a very strong deadline from Microsoft in October that will drive the Windows 11 upgrade. Also, AI PCs and the adoption of AI PCs is going to continue to have an impact and continue to drive sales. If we do not see all the upgrades happening now, this just means that demand will continue in 2026 and 2027. Especially the AI PC adoption, we see as a more continuous trend that will continue to positively impact the growth in PCs for the years to come.
Can you just talk about that a little bit in terms of where you have seen early adoption of AI PCs and sort of what kind of use cases those have been implementing and what kind of ASP uplift you got from the mix from that?
Sure. We are seeing adoption making progress as we were expecting. We said at the beginning of the year that our expectation was for 25% of our shipments, at least 25% of our shipments, to be AI PCs. And we are on track to meet that number. So adoption is as we are expecting. The value proposition of AI PC is, if you compare running an AI application in the PC versus the cloud, it's significantly less expensive. It's more secure because you can use your local data. And in many applications where latency is important, you can get a faster response if you do it locally. What we're seeing now is more and more software companies are developing their packages, their applications to support these capabilities. And this is going to be the key driver of adoption.
For software companies, this is very important, especially for those running SaaS models, because they are the ones that have the burden or the cost of running AI in the cloud. If you are picking whatever software company you want to think of, running applications to PCs significantly reduces your cost. There is a strong incentive for them to do that. We are going to see constant launches of software companies taking advantage of that.
Do you think that the software companies will also be offering differential pricing on their products in terms of what it costs to run it on cloud versus run it sort of locally on your PCs?
I think eventually they mean, because the differential cost is going to be very significant.
Right.
This is a big investment for corporations to drive it. Our message to them is, even if you do not see an application today, given that the life of a PC in a corporation is between three and four years, a year from now, for sure, there will be some. This is going to constantly increase. You do not want your employees and your workforce to be left out and not be able to take advantage of this productivity opportunity. Also, eventually, your cost is going to be higher. This message is resonating. This is driving the improvement in penetration that we see.
Maybe just talking about some of the other tariff dynamics, it feels like there's clearly been a little bit of pull forward associated with PCs. How have you noticed that? How significant will that change your first half, second half linearity for PC growth?
Yeah. I think we have done a lot of work to try to estimate what this impact has been. The best estimate we have is that in Q2, it represented around 1 point of growth for the total company. Of course, if you apply that number to the US sales, the percentage is higher. Still, at the total level, it's a relatively small number. We have reflected that in the projections for the second half. It's not that relevant or it's not that high as some of other information that we have seen.
OK. When you think about just sort of the pause, I mean, you obviously de-risked a little bit of your guide worrying about sort of an enterprise spending pause. Is that de-risked both across PC and print portfolios in your mind? Maybe you can address a little bit about what is happening on the print side, specifically with respect to the areas of the business which you have been turning more into a subscription area.
True. We think the impact is going to be more on the PC side. What we had seen before is, in terms of priorities for IT departments to invest, the print replacement was clearly below the PC replacement. This is why we think the impact on the print side is going to be smaller, because PCs were getting a larger amount of investment. Therefore, we think the impact there could be higher. That was kind of the logic that we applied. In the case of print, our forecast and our estimate is very similar to what you will get from the industry analyst. That is the projection that we have. It is that the market will be declining slightly in units in the second half. What was the second part of your question?
It was just sort of like, how's the shift to print subscription working in your favor? Because you've been working on that.
Yeah. Our strategy in the consumer side, which is a market that has been declining for some time now, our strategy there is to offer more value to customers and capture more value from customers. The transition to subscriptions is a big part of that. We have been growing the number of subscribers. Continues to be an area that is growing and is profitable. What we have done during the last quarters is to expand the amount of services that we offer. We launched a paper program. We started a program offering supplies as a service, mostly ink. We expanded to paper. The paper subscription has been growing steadily. I think we have now around 1 million subscribers. Recently, we also launched the full print as a service. You can buy the full printer as a service.
We have been offering that mostly online. The penetration and the growth has been very steady. We offer that both for traditional printers and for big ink tank printers. It has been really well accepted. We expect this to continue to grow. The main value for us is that it helps us to capture more value from every customer engagement, because the value proposition to customers is stronger. You should see us continue to grow that, continue to expand this geographically, because we think it is a better model for customers and a better model for HP.
Maybe, Enrique, you can talk a little bit about what has allowed this very strong margin performance in print, right? Like you've had several quarters now where you've been doing well above or the higher end of the range or even higher than the high end of your target ranges in print. What has allowed you to accomplish that?
I think it is the consequence of all the work we have been doing over many years. First of all, we have been reducing the cost structure on print, given that it's a business that has moderate growth. This has had a significant impact from a profit perspective. We also have been focused on, and this is something that you see the results over time. We have been focused on shipping printers that are more profitable from a consumption perspective. This overall also has an impact. We have been managing our supplies business very effectively. We have been responding to the reduction in the install base and to the reduction in office, growing share of original supplies, and managing price. We have done also fairly well there. We have some profitable categories growing, like the work that we are doing in the industrial space.
It is not one element. There has been a combination of things that has allowed us to deliver the margins that we have. In a business that overall is not going to be growing, we think this is the right way to manage a business, improving margins and responding to that to slower revenues.
It sounds like you're almost saying that the changes that you have made are more structural in nature. Should we be thinking like your print margin range of 16%-19% perhaps could move higher, just given where you've been delivering numbers? Clearly, it's been much higher.
At this point, I mean, we continue to see 16%-19% as the price range. Also, this gives us flexibility to place more units. If one quarter or two quarters, we see opportunity to place profitable units, because when we place a unit, as you know, from a margin perspective, you usually have negative margins. It is an investment we make to capture supplies down the road. Maintaining this margin gives us that flexibility that we think is important to manage the business in the right way for the future.
Right. Maybe you can also.
Our goal is going to be to maximize the profit from this business in the long term. No question.
You guys have executed really well in that regard. Maybe just in the same context of managing supplies, you could zoom out a little bit and talk about channel inventory at the company level, both on PCs and print, and in particular within supplies too. How is that trending? Did tariffs create some dislocation in that?
Let me start from the second part. Channel inventory across the board, based on all the analysis visibility that we have, is in good shape, both on supplies, hardware, print, PCs. We are in a good position. In some areas, we saw some increase in inventory also from a channel perspective to protect themselves from tariffs. We always stayed within the guidelines and the ranges that we have. There is not a significant change that we think may create a headwind going forward.
OK, great. I mean, I know this is going back some time, but I think you guys work to put systems in place to get increased visibility, not just at sort of like tier one level, but even tier two and down the road. Can you just update us on where that is and what sort of some of the hard work that you guys have done to accomplish that?
Yes. We worked on this probably was six, seven years ago. This was about really getting better visibility of the channel inventory across the full ecosystem, especially in supplies. We have multiple layers of distribution. We have distributors, resellers. In some countries, we have also regional resellers that buy from resellers. We have put a lot of instrumentation to capture data from the different tiers to make sure we really have better visibility of supplies. Of course, it is hard to have 100% visibility, but the percentage is high enough to give us confidence to really understand what are the overall level of inventory across the layers, and actually also across countries, because we need to do that in all the countries in the world where supplies are relevant.
We also put in place additional controls in terms of pricing, because we saw that in a category as valuable as supplies, if there are small differences in price across countries, you start seeing gray marketing from country to country. So we also have put, and this is a long time ago now, very tight controls in terms of price differentials. If, because of currency, the local price in one place changes, we immediately, actually immediately, after a few months, we correct the price to make sure we do not allow this type of gray marketing things happening, which had a negative impact a few years ago, as you know.
One of the other points you mentioned was just better attach of HP Original Supplies. I think when we've looked at this in the past, you used to have maybe almost 80% of your install base used to be on HP Original Supplies. I think over time at Stroff, it was in the 60s and recovered from there. How do you look at this metric? I'm sure you pay a lot of attention to it. How has that metric progressed?
This is one of these metrics that I pay a lot of attention to. We have been steadily growing our supply share over the last five years. This is a consequence of a lot of small things we do across the board. Of course, we continue to innovate around supplies and make sure that the quality work with our supplies is much better than the quality of any other alternative. We have invested in brand and marketing to reinforce that. Also, the shift to subscription models is very important, because of course, when someone is buying ink as part of the Instant Ink program, we make sure that these customers only use HP Supplies. The same thing on the Print as a Service models that we have for businesses. It has been, again, it's not a consequence of one action. It's a consequence of multiple actions.
Also, we have programs in place to protect our IP. When we detect that someone is violating our IP, we have actions. We can take actions to protect that. Again, multiple things. At the end, every 0.1% of share of supplies is very relevant. We fight for each of them.
Yeah. That makes a lot of sense. Maybe if you could touch, I know it's like kind of 30 minutes just flies by very quickly, so can't really dig too deep into some of the topics. Maybe you could talk a little bit about what you're seeing in terms of traction with the Poly acquisition and also around gaming and PCs, if there's anything noteworthy within those two categories that you'd call out.
I think Poly is a very important part of our portfolio now. One of our key differentiators versus other companies is the fact that we can offer a full solution from a workplace perspective. We can offer printers. We can offer PCs. We can offer headsets. We can offer video conferencing systems. Having that portfolio in the conversation we have with customers is a very strong differentiator. Also, as we look in the future, the opportunity of offering what we call a better together experience is going to be even more relevant going forward. Our goal is to make sure that our headsets, our video conferencing rooms, PCs work better together. By doing that, how customers interact with technology is radically simpler when they use HP equipment. That is one of the major efforts that we have from an innovation perspective.
On top of that, financially, all these peripheral categories have better margins than our core category in PCs. Also, from a profitability perspective, the more we grow them relative to core, it's better from a margin perspective. This is why we are so keen to continue to drive growth in these categories.
OK, great. I know we're almost out of time. Maybe, Enrique, I'll give you the opportunity to just talk to the investors over here as to why you think people should be investing in HP at the moment. I know traditionally, your free cash flow has been very steady. Obviously, you have a strong record of returning all that free cash flow. As we look here, obviously, a year where you had to take down some of your cash flow for a variety of unforeseen situations. How should investors think about the normalized free cash flow, maybe of the portfolio, and any other parting comments you want to give the investors?
Let me address the free cash flow on them. I think you said it well. We look at this as temporary. Part of it is driven by the impact on cost that we are going to mitigate. Also, it is driven by the increase in working capital that also we are going to mitigate. This is a two-quarter effect. Even the changes in the environment, it was not something we see will have a permanent impact in the company, the opposite. I think from an investor perspective, first, we have, as you said, a friendly capital allocation process to investors where our goal is to return 100% of free cash flow unless there are other opportunities that we think will create more value. We have been very consistent applying this strategy over the years.
When we look at the opportunities that we see, especially driven by AI, the integration of AI across our portfolio, and the growth that is going to drive across our core categories, and the opportunity to expand into new spaces like video conferencing systems or more services, this is going to help us also to continue to drive revenue growth and to improve the profitability of the company. That is our goal and our strategy. We need to manage this interim process and respond to the changes in the environment. Nothing has changed in the projections we have for the company long term.
Excellent. Unfortunately, that's all the time we have, Enrique. Pleasure to have you as always. Thank you so much.
Good to see you.
Thank you.
Thank you.