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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Okay. I think we're going to get started momentarily. So if folks want to get settled in their seats and Dion can join us that would be great. Kind of can't get started until Dion is here.
Good morning, everyone, I'm Toni Sacconaghi, I’m the IT Hardware Analyst here at Bernstein, I also follow electric vehicles. We're really pleased to have Dion Weisler joining us today, CEO of HP Inc.
Dion has spearheaded the company largely since its separation from HP and the company has performed very well with strong execution. I think the stock has appreciated about 56%, the SS&C during that timeframe, is up about 25%, so kudos to Dion for job well done so far.
To the team, thank you.
So thanks very much for joining us and for supporting the Strategic Decisions Conference, always a pleasure to see you.
Thanks, Toni, you too.
You reported results last week, maybe we can just, excuse me, this week, it’s been a long week as I say it slow and it was a pretty good quarter. So maybe you can talk a little bit about just the IT spending environment, what you're seeing out there and some of the things that you were most proud of?
Yes, so look I would tell you what I'm most proud of is that we continue to do what we said we would do and that's been the hallmark of how I want the company to operate and how the company is operating that we set out and we make commitments to our customers, we make commitments to our partners, we make commitments to shareholders and we execute to those commitments and we - I'm not too surprised that we’re on the down side and wherever we can take advantage of market opportunity, we see, we like to outperform.
And we're off the back of another quarter of double-digit growth in industry that is - I would say in Print relatively flat, and in PC is relatively flat, and we're outperforming the market, we're outperforming our competitors.
And it’s - when I think about the IT environment, in Personal Systems, we've had almost a couple of year now of cost headwinds on key components, primarily memory, but there's been other key components along the way, and we've executed our way through that.
We've focused a lot on the overall strategy of mix shifting, and I'm sure we'll get into areas of that. But as I look around the world, I would say, the business conditions are relatively favorable, despite sort of geopolitical uncertainty. The markets are relatively strong, almost in every single region, and in every single country that I visit. And that's true for both Print and Personal Systems.
I think consolidation is continuing to happen in both market segments, which is natural, when they mature categories. And I think our strategy is very much tied to understanding of those markets, operating well in our core, identifying a few areas of growth that we're investing in, and also defining longer term future potential for access the company and our shareholders.
So I think I'm proud of the way we're executing, doing what we said, we would do, double digit growth of strong compares a year ago, expanding profit margins, expanding market share is an outcome of good execution, not as an objective.
And one of the things that you also announced concurrent with the call was that, longtime CFO, Cathy Lesjak would be retiring, and in the interim, she would be assuming the COO role, until the beginning of the New Year. How are you thinking about whether you will have an ongoing COO, my observation is that of all the companies that I cover none have a COO, even though many are bigger than HP Inc. and so how are you thinking about the need for that role and is Cathy’s placement an indication we should expect that role to persist or the fact that it’s interim means are you trying to figure that out or work on something specifically during the next six months?
I think there is an element of still figuring it out, when Jon Flaxman, tragically passed during the course of last quarter was an incredibly big blow to our organization. He was a long time multi-decade veteran of the company. And COO roles not very well understood, because they differ from company-to-company. In some companies the COO is the heir apparent to the CEO and they really take on a sort of right hand to the CEO.
And in other companies it’s often a collection of - a collected very important functions that you want a very experienced leader to run and that’s what it was in our case, when we established the company I'm a very hands on CEO in the business. I want to be with our customers, I want to be with our partners. I want to spend time in the business units working on the product roadmap and understanding the strategy and where we're going as an organization.
As a result of that, I don't have as much time to focus on very important functions like customer service and support and IT and real estate management when you’re operating in 170 countries around the world.
Sales operations, there was a number of functions that sat inside that COO role and only someone of John and Cathy’s caliber that have decades of experience of being all around the company have the capability to truly understand all of those areas. And so over this next period, we'll figure out exactly what is the best way to operate and then we'll make decisions on that after Cathy retires in early 2019.
Dion, in each of the first two fiscal quarters this year, you've raised your EPS guidance and most recently saying it'll be a $1.97 to $2.02 for the year. So with $0.15 the first quarter and $0.05 this past quarter, when you think about the raise this quarter, how much of it was sort of fundamental operational and how much of it was buyback and currency and/or tax? How do you think about that?
The way I think about the midpoint being a $0.05 increase is roughly half share repurchase and half operational some of that operational improvement in the quarter that we just announced about $0.015, and then about another deal thereabout in the second half of the year in terms of operational improvement and obviously with the increase in free cash flow which we don’t usually guide free cash flow regarded through the course of the year, we took that up to $3.7 billion and we still expect that capital allocation be in the $50 million to $75 million at the higher end of that range. That obviously creates capacity for more share repurchase, return to shareholders. And so, that’s going to drive about half-half of operational and share repurchase.
I’m going to turn to the businesses now, but I just wanted to folks if there are question cards that should be on chairs near you if you have questions please feel free to write them down and pass them to the center if someone is collecting them or heaven forbid you may even have to bring them up yourselves. But I would welcome any questions from the group. If you’re not I have plenty of questions in the absence of them.
So maybe we can talk a little bit about the printing market first and then we can spend some time on PCs. And so you talked about a flattish market for printing. How do we think about market growth and I posed this question to you before Dion but I think HP has kind of conceded that for the last few years have definitely seen less consumer printing and that's been reflected in your financial results but the corporate has been a bit more stable.
But I can't help thinking that people are printing less in corporate environments and I think I've mentioned this to you before but it's sort of the small example of what's happening. So, at AllianceBernstein, we're paying people not to print. So we actually have a program called AB Paperless where the firm will give an employee $400 to buy an iPad if they turn in their personal printer and we've had a thousand people to do that and two of them are sitting in the front row they're both on my team hold up your iPads…
They are much better devices I think they have.
So we're - one relatively smaller company AllianceBernstein but you know in the - what's interesting to me is what drove that. So there were two inputs into why that program came about, one was sort of a employee resource groups who are saying look it's environmentally friendly to save paper and then there were - there was an economic cost we completed, we spent $2 million a year in toner, and a lot of it with HP.
And we do have management service as well. So we actually want to drive people more towards our management services offerings, which have lowest cost per page but take the more expensive desktop printers off of their desks.
So I can't help thinking that just sort of intuitively it feels like people would print less monitors or bigger, younger generation is very comfortable reading things off a five inch screen. So I'm going on probably far longer than I should. But just how do we reconcile this notion of in the corporate setting that we can actually believe that printing might not decline over time.
So I think one of the biggest things to wrap your head around is that when you just sum up everything into averages, you get lost in the averages and segmentation and hyper segmentation is really important, it's important in the PC businesses, even more important in the print business.
If I ask you all to look in your bags and see how many printed pages you are carrying with you today indeed you're not using an iPad, you are using paper that is sitting in a folder on your lap and if I were to ask you to look inside your bag I'm sure there is even more paper in there whether it would be in a booklet which is also printed page or whether it's a free standing for a three page there’s still a lot of print happening. There's a lot of print happening in the graphics world as well.
So I think we try to fool ourselves like, you know, there is going to be this major growth spurt. I think, indeed and we've said for many years, home-based print market is under pressure. Our job is to make print relevant, and I think we're doing that with new categories, we're understanding how people are using print. It's very easy from one of those devices to print, it couldn't be easier, you just hit print, you just drive this to load as the thing come.
But it's become tougher because we got to go to the printer now and put our ID on it, which is another sort of gating factor to get people printing. So we can’t print wirelessly, but more and more companies have this partially for security reasons, but partially it's a duty - disincentive to print. It's more painful, they have to walk to a printer and put your ID on it, right.
That’s a fair way. We can get you one on your desk.
I have one on my desk. But I'm an older demographic, I'm sort of thinking of the future and younger…
So I think if you look like, if you look at products like the Sprocket, which was designed to enable people to free photos from that they've taken on their phone, on their mobile devices, and print them out, even in tiny little form and stick on their walls, it's been an incredible success, seeing a generation of print that is in many cases never printed before.
And what we’re finding with that, and there's been tremendous reaction to Sprocket is that people click what they look, print what they love, because it is very different, when you hold a printed page. And it's important that we introduced people to print, to a generation to print that haven't been printing, and they’re finding new use cases, making it easier to print from mobile, making that interaction smoother is important.
And so, we're not going to stop and just concede and give up on a market that is in some parts of the market, in secular decline. We're finding new categories that we can create and we've got an incredible roadmap, I can’t tell you about the entire roadmap, but I think it is very thoughtful, it understands and contemplates big megatrends that are happening and it incorporates style in a way that hasn't been done before.
It's amazing in the home-based world, people spend often in many cases, they spend more money on buying furniture to hide the printer than they spend on the printer itself, that's kind of tucking it away in a cupboard or something. And so why is that the case? How do we change that kind of behavior?
And in the commercial market, if you think about Park Graphics for a second, these are two big markets roughly $55 billion each, the A4 market and the A3 Copier market. We have very strong market share in A4 and we're still relatively nice in A3 and that was one of the reasons why we invested in the Samsung technology as well as our own organic solution because it’s $50 billion market where we believe is an actual adjacency and we ought to be stronger participants and we've said that we expect to have 12% market share by 2020 and I'm pleased with the progress we're making there.
So when there are 14 players in a market that is relatively flat, consolidation actually happens. We want to leverage our enormous supply chain, understanding of this business and incredible brand and we think, there is still headroom, the Print business grew 11% this quarter.
Dion, when we think about addressable market and obviously, you put a share gain over that – share gain or loss. But, when we think about addressable market, should we think about consumer market? Again, markets at HP as being kind of slightly down. I think, you guys have said that.
Do we think about the correlative market as being slightly down and A3 brings it has been slightly down and A3 brings it to full flat. This was again as a market for any share gains. And 3D printing is on top of that new opportunity obviously it's not traditional toner-based printing. Is that the right way to think about it or do you actually think that XA3, the laser market as a whole can grow? But again market right we didn’t talk about share in the second year or this year…
I’d say market on A4, we don't totally disagree with the analysts. And you know sometimes it's down 1%, sometimes it's up 1%. Let’s call that flat close enough for government work. The i3 is a big market where we have lower shares, so that represents an opportunity.
And if you look at that when you couple it together with services, and we're increasingly moving towards a service-based economy. There is growth opportunity is particularly we just start to think about how workflows managed inside an organization.
So 3D printing I think is an entirely different category. All it does is save benign printing. And yes we do use print technology to enable our 3D printing but that is an incredible growth opportunity, this is going to take many, many years to play out, and I’m sure those will. Another question tucked away around 3D printing we just spend more time on it.
So I think overall consumer down, i4 flat, i3 little bit of growth. And within all of that, we see pockets of growth as we do segmentation.
You talked about industry consolidation Dion, and obviously Lexmark was purchased a couple of years ago now, Xerox and – and Gucci had you know are advanced. Are there a fewer players, I mean the inkjet market is relatively consolidated but the laser market clearly is not. And there are 10 plus players in that. Do we see a consolidation in that market? And how does that happen?
I think we do. It's just that it appears natural to me, if we look back through history whenever markets become relatively flat. There is no longer room for a dozen players in any given market, if we think about PCs that's already happened. There was a time when there was a dozen players and there’s not anymore. How did that happen? I think some of it will - happens organically, some of it happens inorganically.
I mean Samsung was acquired by us so that's a good example inorganic. There that was all about the technology acquisition that acquisition is incredible R&D folks as opposed to market share. I’ve typically done market share, it’s a kind of a pyrrhic victory of customers based on the long-term rental agreement at least you have earn the right to be your customer every single day.
But I think others may think about acquisitions. Some of the balance sheets of their competitors aren’t particularly strong. And so just like in the PC business, some just choose to exit. And so I think it can happen in a variety of ways.
So do you not envision yourselves playing a role in inorganic consolidation going forward?
Well, M&A, I think as I've always consistently said is a big part of our strategy. I said we wouldn't surprise the market with any M&A that we did that would leave somewhere on a strategy page. We will take full investment opportunities, we weigh them against each other, we have a returns based framework.
I think we've been very disciplined and you can expect us to continue to be very disciplined about M&A, and it should always be towards accelerating our strategy. I’ve always fairly consistently said also is that you know I like technology, but I don't necessarily like buying market share for the sake of market share.
And so you know, we obviously don't talk about targets that we might be contemplating, but I think that's the message that you should take away. I also say any acquisitions we would do would be modest in nature so slice all together.
Right. So on the - and this is surprised the market in light of those statements. So you know we would be you know if I heard that we would be really surprised that if you bought someone like Xerox, because that would feel like market share, and that would feel like a big acquisition. Is that an example of - so if I translate that, - if you buy bought something smaller the core technology and metals, 3D printing we probably wouldn't be surprised.
That would sound consistent with what you just said. If we did a larger deal like you bought Xerox because it gave you the market share and cost takeout opportunities that would be inconsistent or thus - or you know I don't want to put words in your mouth, but you say well you wouldn't be surprised, so tell me something that you know you think we wouldn't - you know you wouldn't do because there will be a turn…
I think it would be surprised if I turn around and bought Fitbit, right.
That doesn't kind of leave on our strategy page. It doesn't make - it's not consistent with what we're doing, and it doesn't enhance our strategy. So that would be a surprise. It would not be a surprise, if we went out and acquired some cool kind of 3D print related technology that’s going to enhance and it wouldn’t Print 3D spandex, you know that would be collected, right.
I don’t think that it exists. I don’t know. We print latex. So that’s cool in our graphics business. So anything that leaves on our strategy page is fair game, but apply those other filters and the other one that I mentioned is in order to be modest in nature.
And modest meaning like Samsung service modest or do you think about under $3 billion is this modest or…
I think 3D is starting to trend towards sort of way we think modest fleets, but if you think we're going to go out and make a $10 million, $11 million, $12 million acquisition as we have in our previous history at least in the old corporation. I would not say…
You went behind that one, all right.
I was not here.
Maybe we can talk a little bit about just supplies and we've talked a lot in the past about this, but it’s obviously where the money is. So we'll revisit that topic.
So you said supplies would be 5% to 7% for the remainder of the year. You came in at 6% last quarter exactly on plan and you've talked about supplies next year being kind of flat to slightly up. Now one question that I've gotten is look last quarter Q1 4% supplies growth at constant currency and the quarter before that, a couple of quarters I think you were at 2% and 3% and now it feels like you're more like flat to down.
And so but since you're you know placements are pretty good and starting to get some traction in A3. Is that - how do we reconcile that, was there something unusual about the three previous quarters and because otherwise it sort of feels like it’s a deceleration. So how do we reconcile those?
I don't think there is any surprises. We sat here a year ago got time flies. And we said that…
And you came back this year too…
So much fun, I’ll come next year. We said that we would stabilize supplies, we stabilize supplies a quarter earlier than we said we would. We mentioned on our Q1 earnings call, but for the remainder of this year we would be in the 5% to 7% range. And we came in at 6% certainly within that range.
And then you could expect that for the rest of the year and then next year we’ll be flat to slightly up. We’ve talked a lot about the four-box drivers and the four-box driver model has been a good predictive tool for us.
And you know it’s - when we retrospectively go back and look at what actually happens this is what the model told us would happen, it is pretty consistent. So we feel good about the guidance that we’re giving.
We know that obviously in the first year of Samsung coming in so that was going to drive supplies up in the first year, but a lot of that installed base was a A4 and low-end A4 that doesn’t yield a lot of supplies, and so that rolls off after you lap it, and then we are back into the stabilization.
And Dion, in terms of the levers within the four-box, I don't want to mechanically go through each one, but are there – are there one or two that are sort of positive pluses and minuses meaning you know I know aftermarket capture rate is obviously a very big factor, you move that needle a little bit either way you know that can really have a big impact obviously, installed base is a big factor, so are there one or two levers that structurally are getting a little bit better or becoming more of a challenging headwind within that model that you could highlight for people without again untangling the whole thing.
It’s pretty complicated. You'd even be impressed with - with the spreadsheet.
I go to sleep at night thinking if I could just someday get into that Four Box Model.
You'll have to join HP. A.M.
That would be good. So I would say the installed base is, is just such a complicated box all by itself because no units are created equally. Some units return more supplies than other units, home versus office, different countries, different zip codes and that’s the kind of big data that we have that informs us about where we're going to make those investments because every print unit we place by and large is an investment that return supplies over time.
So figuring out exactly where you want to place those units and ensuring that they're NPV positive, these entirely big data exercises into of itself. And as you noted being aggressively putting units into the market this quarter has just gone now 15% growth on units.
So we do have as I mentioned in the - with the Samsung business, with A4 lowing of the A4 coming up of that is we're not aggressively putting those low end units in that becomes a bit of a headwind to the installed base but you got to think about this huge installed base into sub-segments and so I think we’re making progress there in the layers as the more valuable units that we place.
I would tell we’re making improvements in the aftermarket share and that is goodness, usage is running pretty much according to plan and pricing is just a function of market elasticity and deeply understand again through Big Data what the competitive environment is looking like, region-by-region, country-by-country.
On the aftermarket share is I’d heard that…
Again it varies by country…
Of course, you know I'd heard but, I’d heard that there were some Chinese clones which HP and Canon have been taking more legal action towards which has helped, I don't know if that’s at all a contributing factor whether that's isolated, but …
Well, I think it's really important that we protect our intellectual property. We spend a lot of money on R&D, and Canon spend a lot of money on R&D, and we have very unique propositions within the formulas of the toner and the inks that we create, and what is most disturbing for us is when people try to counterfeit our product and so customer thinks they’re getting an original high HP branded supplies and they’re not, we're very aggressively pursuing that and we aggressively pursue anyone who breaches our intellectual property for market competition where it might - where it’s done legally. That's fine, but where it's not, we will be aggressive.
To that end you talked about Canon, what is the future of the Canon JV? Is it still equally beneficial to both parties?
Yes it really is, I’ve just comes back from Japan, and I meet twice a year we have a presidential meeting between Mitarai-san and myself, and I would say the relationships never been stronger. So, it's going on almost 35 years now, this American-Japanese relationship, I think is one of the longest in history, and it's incredibly mutually beneficial and we’ve figured out the value that each of us these bring to the relationship, they have some really terrific technology, it makes sense. We’re not duplicating R&D efforts.
We add a lot to on top of the engine that they create in terms of workflows and security and management of the devices in paper and handling and the topping of those scanning and all that kind of stuff is all HP developed. But, when you put those two together, one plus one is certainly greater than two and much closer to three and that business is going to grow.
And the acquisition of Samsung, are they're very clear in deliberate arrangements around because Samsung, obviously had a big A4 business which always was Canon's business. And that to me – or at least on the surface seems like a sort of treading on their toes to a certain degree and the A3 was - we’d have differenced OEMs, provide you with technologies in the past, but never really something that you've done over Canon. So that I get that, but they all have pretty sizable Samsung A4 business. Does that suggest that if you wanted to over time develop your own A4s and Canon will be totally cool with that?
I think, from a technology perspective, we quote the question is would it make sense to? And the way we look at the relationship at the moment, it would not make sense to give you at that current agreement that we have. So whilst we have that now, the technical capability and looking into intellectual property to be able to do that, commercially it makes sense for us to continue this very strong relationship.
It's a very transparent relationship that we have with Canon. They know exactly what we're doing. We know - they know what we're doing in this relationship. And we've had decades of market leadership together and we expect that will continue.
Just switching maybe to 3D printing. So the $12 trillion manufacturing market is sort of out there as this the mother of all opportunities which is like 60% of the U.S. GDP. So it's like kind of a scary big number. So, it still feels like a newspaper headline rather than a real addressable market but realistically when I think about 3D printing and the size of the print chamber is 40 centimeters by 40 centimeters today. The cost of materials is 5x what injection molding is. The speed is and throughput is maybe one/50th of what injection mold is today.
So, I mean holistically I think last year Tim had said this is a three-year opportunity. On the call, you've said a 5-year to 10-year opportunity. Is that really how we should be thinking about it? When I think about those three constraints, size of the printing chamber and the cost of materials and the throughput and the throughput in particular being at least by our work like 150 that’s right now, can this really - can this even be like are you even going to mention on our earnings call in the next three years in terms of financial contribution? Are we really looking 5-year to 10-year?
I've consistently said it’s a 5-year to 10-year opportunity and this is an incredible opportunity. The $12 trillion number is just effective. We are going to take all $12 trillion into 3D printing in the next 10 years of course, we’re not.
But that’s the size of the manufacturing end market not necessarily the cost of the goods in each one.
Sure. But any way you look at it, its potential is enormous. There's a lot in that question. First of all let's talk about the build size that’s the current build size. The way that we 3D print is very different to how everybody else 3D print. We've taken decades of thermal inkjet technology and we’re into a fourth generation of thermal inkjet and given that we've had three prior generations it doesn't blow your imagination I think we might have another generation of thermal inkjet.
And we have these nozzles that are lined up on a print bar, on a print array, and on an A4 with page, this 40,000 nozzles that are spraying billions drops of agent per second with 21 microns of accuracy, and they piece together just as they are in our graphics business into arrays.
So we can make the array bigger and bigger. And if you look at our graphics business we've got 100-inch arrays. And so our technology lends itself to being able to make a bigger bed size if we so choose to. The second thing you talked about was material cost. And I'll give you a couple of facts…
And Dion, just to give me a sense, I mean is there a Moore's Law curve for bed size, I mean do we think about it doubling every...
I would think about it as a Moore's Law curve for that technology that goes into - not just a bit.
Right, but it’s a heuristic, maybe I shouldn’t think a Moore’s Law like doubling every - a 10 years, 5 years?
I think it's in the range of about 2.5.
It could double every 2.5 years. It’s that kind of rule of thumb and I would say the industry is still learning and we are still learning. And so that might change when you're in the infancy of an industry. That might change over time as we create new inventions.
The second thing if you think about material costs, a fuel injection mold something today, you'll buy let’s call it PC12 plastic in beads, and the beads cost $10 a kilo. You can’t put beads into a 3D printer, you put powder into a 3D printer, and if it's those - basically if those same beads ground up into a fine powder.
That process to grind the beads into a power is a - we estimate about $3 a process. So it should cost $13 a kilo. When we started this business a year ago it was $80 a kilo. So to give you an idea of how much margin stacking material companies has been putting in the box, but with competitive pressure, what we've done by creating an open platform that anyone - we're not doing our own materials, we are doing our materials, but it’s an open platform and our own agents. We've invited the whole industry and it’s creating competitive pressure, and that cost has already come down.
So if you consider those two variables alone the material costs and the size of bead with plus the speed of that which you can print. So, if you could double the speed, or you could increase the size of the bead by 2X multiplier, I’ll share with you when we launch the printer, if you had a print gear cogs, gear cogs are in everything, they’re in windows, winders, they’re in dishwashers, they’re in washing machines.
If you need to print less than 50,000 gear cogs, it would be cheaper to 3D print. This was a year ago, when we launched, then it will be to injection molding, and probably is he doing much larger than 50,000. So that isn’t captured in the TAM.
If you get that material cost down to $20 a kilo, not inconceivable and you would double the capacity of the machine either by speed or by size that inflection point would go from 50,000 to 1 million. Now that's how you increase the size of the TAM.
So as it follows this Moore's law kind of curve, you’re going to get orders of magnitude of greater parts that can be produced for production runs. Add to that the benefits of complexity is free, the time to market are being able to produce a part.
You’ve got many other benefits, the cost of holding inventory, and printing what you need, all sorts of benefits. There is no doubt in my mind that in time as this technology and the industry and the ecosystem continues to develop, this will significantly change the way manufacturing is done all over the world.
And your strategy is more of a, like strategies in 3D Systems appeared to be almost focused on sort of niche market applications now. I don’t know if that’s sort of the necessity of being a public company and you got to sort of make money now, and see how to pick your stocks and whatnot, but it feels like your aspirations are actually sort of broader, which is we want to - we want to be the equipment that replaces traditional manufacturing equipment, is that fair to say and is that a - differences and strategies?
I can’t talk to my competitors, while I can talk to as what we’re doing. We’re certainly tapping into production. We’re not trying to get any issue, we’re not trying to do recovery base. One of the German large auto manufacturers came to us. This is - everyone is in a race to create as many AVs as quickly as possible.
They came to us and they said we created an area of a car that needed to exchange heat from the batteries in AVs that they need to run at the optimal temperature and not too hot, not too cold. They said we try to do it with an injection molded pot and it's not fitting in. Can you help us? So we took a brief and it had to have very specific coolant flow so this is connected effectively to the radiator and this goes out to three chambers of the battery. There are sensors in heat to monitor the temperature.
We went from brief to a final production part in nine days. It's incredible, nine days. If you do that injection molding, that's four months, it’s five months, six months. And this is iterative in terms of its ability to be redesigned. So in the very next car, if you find a better way to optimize the temperature, it's almost like the app on your phone, you change the file the next pot is produced is optimized.
Think about the benefits in almost any industry you can think of when you move to generative design, we were able to fit it. You could not miss the part in an analog form, the complexity is, it’s not possible. So you can do things in additive design, you simply can't do with traditional manufacturing and the future is so bright in this area.
Well, thank you for sharing that. I hope you didn't have to go through airport security with that thing. We have about a little under 10 minutes left. So I’m going try to implore us both to be in the Cramer lightning round mode, I get one sentence answers and as far many questions as possible.
So we'll switch to PCs. How far can consolidation go I think top five are about 70% of the market in units? They used to be 45%, 10 years, 12 years, 15 years ago, how far can that consolidation go, so top five can go to - go to more?
You wanted a quick answer. I would say here's what I think. I think that the complexity of the industry, the industry is becoming more complex, it used to be easy. There was a Wintel world and you made a desktop or you made a laptop they all roughly look the same. You had one operating system and one piece of silicon and you tried to make differences as best you could.
And therefore a lot of people could play, because it wasn't too complicated. Now you've got multiple operating systems, multiple silicons, you've got multiple form factors, you’ve got detectable, convertibles, two-in-ones, you've got Android, you've got Chrome, you've got Windows, you've got Microsoft in there, and you've got Intel and AMD, and Qualcomm and NVIDIA.
For you to survive sub-optimally is becoming increasingly difficult because the market has been so segmented, that is what is in my view driving the consolidation, I expect that consolidation continues.
On the - but is it like 85% or 90% realistic for five players?
I mean I think it's possible. It just gets increasingly harder. The bigger those bigger guys get - it just makes it incrementally harder for a smaller guy that to be able to compete from a cost perspective. You know increasingly complicated complex world.
On ASP changes you’ve had nice ASP increases this quarter I think on an average it was a 7% increase currency maybe it was three point to that, but 4% increase. How do we think about, is that really a function of just passing on our DRAM prices or is that reflective of some of the mix changes and how do we think about ASP changes going forward? Is it realistic to think that ASPs and PCs on a steady state basis can be flat or even better or is that ambitious given the dynamics of Moore's Law?
Well, I’ve certainly been doing PCs for 30 years and what I know is that, we’re always in the cost up cycles and cost down cycles. I mean, it always happens and I don't think this cycle will be any different. We’re in a cost up environment today. And at some point it turns the ASP increases today for us a function of pricing and currency and cost headwinds are some of that, roughly half and the other half is due to policies and exchanges that we're making through really strong segmentation, sub-segmentation, choosing where to play and equally choosing where not to play. And you can expect that kind of discipline from us in the future.
The other thing I would remind you is roughly a $333 billion market, half of that market is what we're talking about here, these devices. The other half of the market is services, displays, accessories. We've really got strong market share in the part that we've been talking about but we’re sub-optimized in the upper half and at our Security Analyst Meeting, you would have heard say that we’re going to move more into the upper half because it’s a margin rich environment and we've been solidly executing there.
So, in addition to the mix shift towards premium and gaming and better ends of the market in our core, we're also moving towards services. Our Device as a Service pipeline is incredibly healthy, it’s very sticky, it's a natural line of business conversion from a managed print service customer, we can go to the customer and say, we'll manage everything for you, you manage everything from your PCs to print fleet.
But Dion, are those collectively enough so that the positive mix shift that you had in gaming, some of the stuff you're doing around service and data, are those collectively enough that even in a down cycle ASPs could be flat? Or is that really…
We probably have the range. We sort of say it’s a three to five points of ink business.
And speaking up of ink, you talked about three to five points, but at the beginning of the year you also talked about three to four points, but you are very close to that four this past quarter. Why shouldn't we be thinking that particularly now where DRAM prices are stabilizing, and you're executing extremely well, we couldn't be in the top half of that range?
Well, I would say that - I wouldn't say DRAM is stabilizing yet, I would say it’s slowing down its rapid increase. And you know it's still increasing towards the back half of the year, but is certainly slowed from where it's been.
We're going to continue to execute our strategy and play the long game here, that half of the market is margin rich, we’ve got opportunity there, we're going to continue to mix shift a retail point of sale is really strong as an example, a strong market segmentation as this gaming and it’s probably taking 70 points in premium. You can continue to see that kind of execution from us, but we live in a competitive environment. And so, we need to remain competitive, we have lot of what we call price function value, and in fact competitors move, then we're not going to yield and so as long as we're making positive dollar, OP accretion that's the kind of business that we're looking for.
Okay. So we have about two minutes, super lightning round. What is normalized free cash flow beyond this year, so this year is $3.7 billion at least, next year my model says net income will be $3.5 billion. Do I think about net income being equal to free cash flow which means free cash flow goes down next year, and how do I think about more normalized free cash flow?
I think normalized is a hard word when it comes to free cash flow, is not how we think about it, we've been fairly consistent around this point. We say that free cash flow will grow over time in line with any, that’s how we think about.
But arguably so it’s $3.7 billion this year, earnings are growing next year in part because of buyback of 10% that would say $4 billion, but I only have $3.5 billion in net income, is that - is it reasonable to believe that free cash flow can be sustainably higher than net income?
So we haven't guided next year yet.
No, and I’m not - answer to the general question, is it reasonable to believe that free cash flow can be higher than net income?
It’s reasonable to believe that we'll do what we said we would do and we’ll grow free cash flow in line with earnings. Understand what's driving free cash flow at the moment. We don’t normally guide out free cash flow, we did something unusual this quarter, just because of the outperformance of the…
The negative cash conversion cycle of PCs and when PCs are performing so well sequentially means at the current time it's driving a lot of free cash flow. If those dynamics change, it has an impact obviously to free cash flow. So that's why we say over time, it will grow in line with earnings.
So, Dion, the last thing I want to just talk about is capital return. So you generate $3.7 billion in free cash flow this year. Let's just assume that's flat. So your dividend, I think cost about $800 million a year, it’s 2.4%, 2.5% yield. You could double that dividend. It would be - I mean, when you separate it, this was a yield curve that was the roadshow, it was yield curve.
Now, your yield is 2.5%, you can double the dividend. It would be $1.6 billion, it would still be well less or $1.8 billion. Would be less than half of your free cash flow and you'd still have opportunity to buy-back shares and have cash for acquisitions or alternatively, you could buy-back 5% plus of your shares per year.
I guess, the question is, why are you not making a bigger deal about sustained cash return? Why aren't you making a statement to the market that we feel really confident better free cash flows and we're going to pay out 50% through a dividend going forward and have one of the best yields in tech, one of the best yields in the marketplace like why wouldn't you do that?
Well, we've got and I talked to our investors and our team talks to investors regularly. We have very mixed views from our investors around the benefits of dividends versus share repurchases. There is not a common point of view around this. When we think about it as a company and the board together with the team constantly evaluating the capital returns and the dividends and we'll continue to do that.
We believe our capital being consistent with our capital allocation policy, 50% to 75%, we want to maintain the ability to continue to make investments in the market. We think we're executing well, we’re proving to the market that we do what we say we’re going to do. We evaluate all of our investment options, one against the other. We have very returns based framework. You should expect for us to continue to do that and make the right long-term decisions for our shareholders.
So just a follow-up. Could you not be more bold? I mean this is not a capital intensive business. You’ve steady cash flows that you can borrow against that. Why not be, I get the fact that some investors like buyback, some like business. Why not be more declarative and say, we're going to return at least 80% of our free cash flow on an ongoing basis?
Would that hamstring you in anyway because A, it's not capital intensive, B, you have a solid, relatively solid and predictable set of cash flows through your supplies business that you should be able to borrow against.
So the 50% to 75%, I know you've been at the high-end but you're not getting credit for, I know I'm getting 75% or 80% every year, why not be more declarative on that?
It's because we are so confident in our strategy. There are parts of our business that are more capital intensive than other parts, you're referring to largely PCs which is not a capital intensive business. We certainly leverage balance sheet but it's not capital intensive but printing is more capital intensive, as is 3D printing is a lot linkages between the two. We want to maintain that flexibility.
We've said this year that we're going to be towards the higher end. We have been towards the higher end of the range and we think for the long-term, it's better for our shareholders for us to maintain that flexibility as we're executing our strategy.
Great. Dion, thank you very much for joining us. Really I appreciate.
Thanks for your question.