Analyst Corner: HP Q3 – Printers Largely Holding Their Own

by John McIntyre

Printer and PC giant HP Inc. reported its Q3 financials August 23 and there was mostly good news to announce. Our reading of the tea leaves indicates that PCs are gaining ground and printers are largely holding their own, although it is a little more complex than that.      

• Total revenues exceeded $13B for the quarter – an 11 percent year-over-year increase in constant currency (cc)
• $8.4B in revenues were brought in by the PC (Personal Systems) group – up a healthy 13 percent year-over-year (cc) in a category that has seen revenues eroding for a while – though IDC did report a relative uptick in PC activity in both Q1 and Q2 this year.
• Printing delivered revenues of $6.98B, up 7 percent year-over-year (cc) – also in a category that has seen eroding revenues from many major makers for several years.
• Non-GAAP operating income was just over $1B, 7.7 percent of revenues, down $109M and 1.7 percent from Q3 last year – 72 percent of which came from Printing
• All three HP regional operations delivered revenue growth:
  • Americas up 8 percent year-over-year (cc)
  • EMEA up 10 percent year-over-year (cc)
  • APJ up an impressive 15 percent year-over-year (cc)
  • Non-U.S. net revenue = 61 percent of total net revenue
• GAAP diluted net earnings per share from continuing operations and net earnings per share met or beat previous guidance.
• The firm generated $1.7 billion in free cash flow and returned $524 million to shareholders in the form of share repurchases and dividends.

In a conference call announcing the results, HP President and CEO Dion Weisler commented, “It was another outstanding quarter, showcasing strong execution of our strategy. I am very pleased with our sustained performance and continued momentum. We are striking the right balance in how we plan, innovate and consistently deliver. We are competing and winning in our core print and PC markets.”

Within the Printing group, HP segments its sales into Commercial, Consumer and Supplies operations. Weisler talked confidently about achievements in the Printing group in Q3, saying “[Printing] Units also grew year-over-year for the fourth consecutive quarter and we remain well positioned to place positive NPV [Net Positive Value] units. Total Print unit market share was 38.5 percent in calendar quarter two. We saw a slight unit share increase year-over-year in our office business and a slight decline in our home business.” Weisler added “… for Printing, I am very encouraged by the strong and balanced performance across hardware, supplies and our key growth initiatives … .”

Highlights were:

• Total printing hardware units were up 1 percent with Commercial hardware units flat and Consumer hardware units up 1 percent.
• Supplies net revenue was up 10 percent, though this figure includes the $450M-plus buyback of supplies from distribution channels last year ($225 million in FY Q3); year-over-year net revenue was up 2 percent factoring in that element – it was later explained that figure represented 8 percent of the growth from the buyback and therefore a net 2 percent increase in constant currency year-over-year.
• Supplies represented 66 percent of revenues, Commercial Hardware 21 percent, and Consumer Hardware 13 percent.

The firm promoted a number of highlights in its Printing operations in the quarter, including:

• Supplies revenues stabilized a quarter earlier than the company had projected after last year’s major channel inventory adjustment, and increased year-over-year with the adjustment (“sales model changes  and currency”) considered. Weisler commented, “… this is an important milestone and has taken a concerted effort across the Print team to achieve.”
• Revenue growth in “strategic areas”: Graphics, MPS and Instant Ink – note that HP doesn’t include Consumer hardware and most Commercial hardware as a strategic area. Weisler said, “Our Graphics business grew revenue year-over-year in constant currency for the 16th consecutive quarter … Managed Print Services continue to grow revenue year-over-year.”
• This was the first quarter of shipping the full portfolio of differentiated A3 multifunction printers – the units sourced from Samsung and aimed at the “contractual” market sector – and Weisler  characterized that activity as follows: “the customer reception has been positive and we are adding new channel partners ahead of plan.”
• HP experienced continued 3D momentum with strong unit placement and materials ecosystem development, and it extended its 3D reseller program into the Asia Pacific region.
• The company again reiterated that its acquisition of Samsung’s printer business is expected to close in calendar Q417.

The fact that the company reported Commercial unit shipments as flat but began shipping its new A3 Samsung-sourced multifunction printers tells us that other ongoing Commercial unit shipments must have declined because the new A3 units should have been an incremental volume contribution; so, as it was, even though they shipped, overall units were flat.

Also under the Printing umbrella at HP is the embryonic 3D business, which Weisler noted, “this quarter we launched our business in Asia Pacific, the world’s largest manufacturing market, expanding into Greater China, Japan, South Korea, Singapore and Australia. We now have more than 45 resellers globally and more than 20 reference and experience centers.” He also explained, “[3D] Shipments are accelerating and we continue to have new and repeat customer wins with some of the largest companies in their industries … We are also driving continued growth with manufacturing service bureaus, a key path of our market expansion strategy.” Of course, HP also includes 3D printers in the Commercial group numbers – and since 3D unit shipments were not called out or noted (if they were up, HP would presumably say so,) that may indicate that despite expanding distribution into Asia-Pacific, growing 3D printing remains a tough slog.

PCs – Outperforming the Market

On the Personal Systems side, the company’s results were impressive. Weisler told investors, “Personal Systems had another stellar quarter. We achieved double-digit revenue growth for the third quarter in a row, despite a tougher year-over-year compared … with double-digit revenue growth across all three geographic regions in consumer and commercial and across notebook and workstations.” He added, “I am also encouraged that desktops returned to growth in the quarter, reflecting the ongoing reinvention of products. In calendar quarter two (HP FY Q3), we outgrew the PC market unit growth by 9.5 points year-over-year, remaining the No. 1 global PC market share leader with 22.8 percent share … . While we are proud of these results and the team’s efforts, share gain continues to be an outcome, not the objective.”

Solid management execution was key as well, as Weisler explained, “Personal Systems’ operating profit dollars, margins and revenue each grew sequentially despite the remaining industry-wide component cost headwinds. We have been proactive with our ongoing productivity efforts, repricing actions and focus on product mix.” HP has been pushing aggressively into the higher-performance “premium” segments of the PC arena, especially gaming, and has been beefing up the feature/value equation in its general purpose Pavillion product line. HP’s strategy of selling higher-performance, higher priced and margin PCs was reflected in Weisler’s summary comment, “As a category, PC market revenue grew year-over-year in calendar quarter two, although units were down … . The market remains highly competitive, but with that said, we have a strategy that is delivering. We are playing our own game, pursuing the heat in the market and it is paying off.”

HP CFO Cathie Lesjak also spoke to analysts and highlighted the following:

• Gross margin of 18.6 percent was up 30 basis points year-over-year. The increase was driven primarily by Print margins resulting from productivity improvement and higher supplies mix.
• Personal Systems … fifth consecutive quarter of year-over-year growth and third consecutive quarter of double-digit constant currency growth.
  • By customer segment, consumer revenue was up 14 percent year-over-year and [HP] gained unit share across each of the three regions in calendar Q2. Commercial revenue was up 11 percent year-over-year and similarly [HP] gained unit share across each region. [HP] also achieved strong results by product category with notebooks up 16 percent, desktops up 5 percent, and workstations up 11 percent year-over-year.
  • She explained that PC “margins have been pressured by industry-wide increases in component costs and currency headwinds. [HP] increased pricing globally and have continued to see positive mix shifts in the business, both of which have helped to improve operating margins sequentially. However, we remain cautious about the potential negative impact on demand which could result from higher prices. … in terms of price sensitivity, we see the greatest impact in the commercial space. Consumer price increases have taken hold and we continue to perform very well in the consumer space.” It is not every day — or almost ever — that you read about a PC maker that has successfully raised prices and made them stick, but HP is doing it – so far anyway. Weisler added, “… I’ve got to tell you, I spent my life in sales, a large part of it in any case. And one of the hardest things that any salesperson ever has to do is to stand in front of a customer and convince them why their price has to go up.” He is absolutely right about that, folks.
• In Printing, Lesjack noted that “… our total unit growth includes HP Sprocket, our handheld photo printer. In calendar Q2 [FY Q3], overall Print unit share was roughly flat sequentially and year-over-year.” This makes me suspect that the 1 percent reported uptick in consumer unit shipments may have been driven by the $129 Sprocket, aimed at millennials. In response to an analyst question, Weisler explained “The sub-segment of demographics that are buying Sprockets are largely millennials … in many cases their first print experience, and what they are finding is that they store what they like and they print what they love.” Looking forward to Q417, she said the firm expected that its year-over-year supplies revenue growth will remain flat to slightly up factoring adjustments for currency and another approximately $225 million for the supplies sales model channel inventory adjustment taken in Q416.

Since units are not increasing much, supplies won’t grow that much either – unless growth comes from captive supplies sales motions such as Instant Ink, MPS, production printing, and the new A3 MFP dealer line. Since HP continues to boast about its ongoing successes in these market areas, it seems to be a disappointment that supplies are not growing faster than units. If the company is truly gaining ground in these “strategic areas” then supplies growth should inevitably be seen, unless the growth in those areas is not offsetting supplies declines in mature office and consumer print sectors – declines driven by either eroding print volumes or supplies share losses to the aftermarket. In response to an analyst question about the outlook for supplies, Lesjack observed, “Beyond quarter four, we believe we can drive further improvements across all of the ‘four box model’ drivers to impact supplies revenue as we go forward … focusing on placing the right units, the high quality units working on your install base, working on obviously our market share or aftermarket share, as well as the pricing related to supplies.”

In response to a question details of the A3 launch and shipments, Weisler explained, “I am very encouraged by the initial progress … It was our first full quarter of shipments. The customer reception is particularly positive … around our security message, having more secure printers on the market, as well as the choices that are available to our customers from a technology perspective, they are able to choose both ink-based solutions and laser-based solutions. We are, as it relates to go-to-market … ahead on our partner onboarding targets across all three regions, across transactional managed print service channels, as well as the traditional copier partners that we were looking to onboard. The pipeline is very strong. We have a very clear ambition to be a relevant A3 player, and we are on track to doing that. If we can add just 10 points of revenue share in the next three to five years or so that’s $5.5 billion of top line and the associated OP drop. So, encouraged with our first full quarter start here.” Again, it sounds good – but commercial shipments were flat and supplies didn’t grow much at all – one might have expected some pipeline filling volume spikes for both of those segments in that situation.

Execution, Execution, Execution

HP’s Q3 results were strong, delivering in two overall market categories that are not exactly booming these days – PCs and printing. In PCs, the company is outperforming the market, and appears to be successfully doing a double somersault by increasing PC shipments around the world, while increasing prices — anybody want to sign up for that assignment?  Well done.

The Printing area is more clouded and complex; the company is not shy in boasting about its successes in commercial and production printing, in its MPS and graphics/wide-format sectors, in Sprocket, in A4 MFPs, in Instant ink, and now in its new Samsung-based A3 office dealer/BTA product line and acquisition – yet overall unit placements remain largely flat and the supplies business is still recovering from last year’s $450M reengineering of its channel inventory and sell-through strategies. If these focused “strategic areas” are the key to reigniting growth in the printing portfolio, then a reasonable observer would expect that the supplies revenue and margin line will improve even if the overall unit shipment volume does not. To that point, HP veteran Cathie Lesjack laid out the next major checkpoint – the company will talk more about FY18 and supplies specifically at its security analyst meeting in October. Stay tuned.

John McIntyre serves as a senior analyst for BPO Media. With more than 40 years of experience in the printing industry as an analyst, product developer, strategist, marketer, and researcher, he has covered the printing and supplies sectors for prominent market research firms such as Lyra Research, InfoTrends, and BIS Strategic Decisions, and served with major OEMs such as Samsung, NEC, and Diablo Systems/Xerox. McIntyre is the former managing editor of Lyra’s Hard Copy Supplies Journal and has conducted research and consulting engagements examining issues such as market and business strategies, product positioning, distribution channels, supplies marketing, and the impact of emerging technologies. Follow John on Twitter @John2001S.