Tech and Healthcare Giants Share Insights at Major Conferences

Cardinal Health, Inc. (CAH) Baird's 2024 Global Healthcare Conference (Transcript)

Good morning, everyone. My name is Eric Coldwell. I cover pharma services, healthcare and distribution, a broad list of related healthcare business service type entities, and it's a great pleasure to have Cardinal Health with us here today. Before we get going, I'm going to let Matt Sims do some quick - Matt Sims, of course, do some quick intro and then Aaron Alt, CFO; and Jason Hollar, CEO and I will be doing, doing a lot of Q&A, so. And feel free to send in questions as you have them. Well, great. Thanks for hosting us today, Eric. It's great to be here. So just some quick housekeeping before we get started. We will be making forward-looking statements today which are subject to risks and uncertainties that could cause our actual results to differ materially from those projected or implied. For a description of these factors, please review our SEC filings, which can be found on our Investor Relations website at ir.cardinalhealth.com. Well, I had a laundry list of set questions, but you had a little bit of news this week, small amount. Your Elliott Board member and their related party have decided not to stand for reelection. So maybe we should just jump in there with a quick update on everything that's transpired here over the last couple of years and where you go from here. Jason Hollar Yes, let's step back. Right? It's been two years since I was placed as CEO and Aaron came in a little bit after that as soon as I could find the right partner for this. And like you said, Eric, we brought on four new independent directors almost simultaneously with my appointment. So we have been hard at work the last couple of years. And when you step back and think about the performance, let's just start the highest level. The financial performance has certainly been strong. When you look at the last two year, the cumulative earnings per share growth has been nearly 50%, and the cumulative adjusted free cash flow has been nearly $7 billion. So very strong financial returns and it's driven by a couple of key components. Yes, the industry has been much more resilient and predictable than it was over the pandemic, but that was only the foundation and the basis from which our performance then began. We had a broad based set of strategies across each of our businesses to simplify, focus on our core, and really lean in on investments on some of our most important growth areas. We did bring on these four new independent directors, one of which was Steven Barg with Elliott and worked with that team, as well as other legacy Board Members, to establish the business review committee where we evaluated our entire portfolio over that period of time. A little over a year ago, at the Investor day, June of last year, we had the first kind of report out that was less than a year in this role in going through this work. And we made some big conclusions at that point. We prioritized on our largest, most significant business that first year, which was our pharma segment, and made some conclusions. We took the outcomes business, where we were less well positioned than other pieces of our businesses, and contributed that to ADS to form a stronger company. We decided to retain and invest in our nuclear and precision health business. Just fantastic opportunities there. And then we took our - the remaining part of our pharma business and we prioritized specialty organic investments. We announced the Navista creation at that point in time, which is a little over a year ago, and also reemphasized and doubled down on M&A activity for the first time in quite a few years, and really for the first time in even more years as it relates to the pharma business. And that culminated with the first transaction, the first major transaction that we did over that period of time that was announced last January with specialty networks closed in March and is a key component of driving our specialty business going forward. And then at the same time in January of this last year is when we announced the further conclusion of some of that BRC, business review committee work where we highlighted the retention and the further investments in pieces of the medical segment, our at-home solutions business and our OptiFreight Logistics business, really identifying these areas as key growth areas, secular growth trends, rights to win. And that left us then the GMPD business, which we recently made some comments around there, around that business as well, highlighting that while we made fantastic improvements, very consistent with our plan, we think that there's still a lot of opportunity in front of us. And so we are continuing to execute upon that plan on track for the $175 million of profit, for fiscal '25 and $300 million by '26. So that's the work that we've done. That's the high level summary of all the work that we've done. And you know, I certainly won't speak for any of the Board Members, but we have accomplished a lot and it's been two years. The BRC has sunset here this last, just January. So we are now in kind of normal course type of mode where we will continue to always look at our portfolio, continue to look at right now more M&A than other restructuring, but it will be a constant process where we'll work closely with our Board, and evaluate where we go from here. And obviously, Elliot left on great terms in that regard. We believe they're still shareholders. We hope that they are, because we love all of our shareholders. We think it's a great story, and that everyone can continue to be successful, but we've accomplished a lot with them and with all the other Directors. Eric Coldwell Would you say that you've transitioned from fully from defense to offense? Are you - maybe the baseball analogy, what inning are you in? And how happy are you with where the company is today? Jason Hollar Yes, I think we made that transition after the first year. The first year, there was a lot of restructuring that we had to do, a lot of simplification. The second year, this last year, fiscal '24, we saw acceleration of the earnings, a lot of momentum. Each of our businesses, our service levels were fantastic, which drove great customer retention, which drove - great revenue and earnings growth. So the business model was working. The simplification was benefiting not only us, but our customers and ultimately patients. So this last year, and then we did M&A, right. I think M&A is a sign that we felt confidence, the Board felt confident that we could do more than, just the organic type of growth of the business, which, you know, in and of itself is significant opportunities. But now going forward, I think we can be even more aggressive with that. But we're not going to lose focus on what really made, the biggest improvement over the last couple of years, which is focusing on that core business, ensuring our customers have a fantastic experience, and that we keep that marching along, too. Eric Coldwell When we met at your Investor Day, what I think it was two years ago now, if I remember? Gosh, everything feels like, yes, it's been one of those markets, but you did emphasize that you were hoping to get back on that path, but it was going to be very selective. And basically, you knew you had to get the first one right. So to that regard, specialty networks, can you, I think you're six months in now since the close. Can you tell us what you did and why you did it? How is it going? Jason Hollar Yes, so let's just step back from the process. Why specialty networks in the first place? Maybe it's obvious, but what I was very clear about, especially at that point in time, Eric, was that it needed to be in specialty. We weren't even looking at anything outside the specialty business, because it needed to be the right area. We needed to put all of our attention on, first and foremost through organic growth, treating our customers really well. But we were ready for some inorganic expansion. But we needed it to be in the most important part of the growth of the company. At that time, we were $32 billion specialty business that's grown to $36 billion in fiscal '24, and we have confidence it's going to continue to grow. So that's a 14% CAGR that we've had now, the last four years on this business. And so, we felt it was the right area to further invest. Why specialty networks is, they brought to us really two key things. First of all, breadth of different therapeutic areas, so very strong in neurology, fast growing area, but also a good presence in GI and rheumatology. But they also brought and was probably even more important to us, a leadership team and a technology stack that could be applicable across the rest of our business. PPS analytics is their technology. Think of it as AI that takes electronic medical records and other data, medical data feeds, and creates actionable insights both upstream with manufacturers and downstream with healthcare providers, helping the healthcare providers not just run their business better, but probably more importantly, provide even better service and solutions to their patients. So that has given us everything we thought it would, from an earnings perspective, but also from a capability perspective, using this to now look across the rest of our portfolio. And specifically, I referenced briefly in Navista earlier, which is our organic initiatives to build our MSO for oncology, and we are partnering and building different pieces of it. This is now bringing some technology and leadership capabilities as well, to that team that allows us to grow that space even further. So, we're very pleased with that and couldn't be happier with really the business, the people, the culture, as well as the technology. Eric Coldwell I want to step back and jump into - jump in the pharma growth rate. So ex-Optum, you came out with fiscal year guidance of 15% to 18% growth. Pretty amazing, right? So breaking that down, $10 billion of net customer wins and expansions, you'd still be in that - very high-single-digit to low-double-digit growth. Even if I strip out the good guys, the wins - take out what's left to annualize on, specialty, maybe knock off another point or so, but you'd still be a high-single-digit to low-double-digit target growth rate. And even if I ripped out the GLP-1s, which I'm going to throw out there, let's say 30% to 50% growth, let's go haywire, you'd still be talking very solid mid-single-digit growth. How are you doing that again, ex-Optum? How are you doing that kind of growth in this environment? Jason Hollar Yes, your math, I think is pretty close to spot on. I'd say maybe, you may overestimate a little bit the GLP-1 contribution. We do agree in the percentages, but just given the relative size.... Eric Coldwell Are you're talking, I was actually trying to bring the number down a little, because it was so good? Jason Hollar Yes, but when you look at that mid to high growth rates, ex GLP-1s, ex new customers wins and losses, that's fairly consistent with what we've seen the last couple, several years. And how I break that down, is actually quite straightforward. We continue to believe utilization will be in the low-single-digits. And while revenue is an interesting and relevant number, as we've talked. It's not the best measure of our financial success. Because a lot of inflation does still permeate through our revenue. And so, I think the key difference is that low-single-digit utilization. You do need to add several hundred basis points for normal branded inflation, because that still remains by far the largest part of our revenue. Not the units and not the profitability, but in the revenue. And when you add those two together, you get into well beyond the mid-single-digits, into the mid to high-single-digits. So it's just that inflation. And I know at times I get some questions around, well, is that inflation changing meaningfully? Well, you know, not so much, maybe plus or minus 50 basis points for that core branded inflation. There are things like insulin repricing. There's some biosimilar type of conversion. But that's still relatively small to our overall revenue. And I know one of the further questions then is just Humira and the impacts there. A lot of our Humira business was through Optum. And so, that's not going to be so much of an impact for us going forward. So fiscal '25, certainly we don't anticipate IRA you know, that's a calendar '26 item. So all those items we don't anticipate being very significant for our business, outside the customer wins and losses for this year. Eric Coldwell So ironically, one of the larger shareholder holdbacks in the past, before this team joined the company and had the roles that you had, was that the company was underexposed in specialty relative to your peers. And that would have included products like Humira, although that's a Part D drug. So not as important, but from a revenue standpoint? And now, ironically, with your customer, that didn't stick with you. That takes away some of the revenue downside risk that otherwise might have come in over fiscal '25. As we see more and more of these Part D conversions, which are going to accelerate. I think there's clear signs from a number of the PBMs that are going this route? Jason Hollar Yes. And again, it's hard to tell exactly where things will go longer term, but in the near term, when we think about that $32 billion in fiscal '23, for specialty growing to $36 billion, what we've guided towards is we anticipate still growing that $36 billion this year, even though 10% of the Optum revenue is specialty. So pretty small percent, but $4 billion coming off. So basically restarting at $32 billion, which means that we have another 12%, or so that's implied in our fiscal '25 guidance for our specialty business, ex-Optum. Eric Coldwell Let's shift to, got to get your other businesses in here. So let's shift to medical for a second. Probably the hardest question to ask, because it's so diverse. But overall, I'm looking for a lay of the land on what's going on in the market. And my setup would be, we've seen some of the med-surg distributors in primary care, have more challenged results recently. Speaking about some general weakness in the marketplace. What I'm seeing in more acute care, and other sectors of med-surg distribution has been maybe stronger than recent growth rates. You have the largest competitor, is purported to be seeking an IPO. The street often fears increased competitive behavior in front of that, as companies get ready to come out. If that's in fact the case, Medicaid disenrollment. Just a lot going on. What's the overall lay of the land in med-surg today? Jason Hollar Yes, let's step back and remind ourselves where we have the greatest share in this space. We are clearly over-weighted towards acute, larger healthcare systems and ASCs. So ASCs often will be aligned with those healthcare systems. And so, we have the natural ability, to benefit from that ASC growth through those health systems. But we also have very strong relationships with the largest IDNs. And so, we have that particular, those spaces of this part of the industry, as by far our greatest exposure. The physician office has much lower exposure to that. And so, can't really speak for those that, we don't have as our customers. But what I see within utilization of our healthcare systems, is they've been through a lot, right. When you think about, COVID and the substantial reduction in elective procedures that impacted that customer base significantly. And then after they, they all got through that, then of course we had the healthcare professional shortage, that further kind of delayed normalization. But when you go back to about two years ago, things started to feel a lot more normal. And then that continued to improve for us - over that same period of time about two years ago, we were investing heavily in our service, so that we would make sure that we could retain and grow with our customers, better than we had in the past. And so that improvement we saw, over that first year and then over this last year, and we saw that actually result in the retention of customers, and growing with the market. And that's why we had the low-single-digit revenue growth that, we had this last year and low-single-digit type of growth that we saw in Cardinal Health brand products. So in our space, we see it being much more predictable, much more resilient, much more normal over the last two years. But today, we're not seeing any change in that. And that, you know, there - you can see that they're continuing to have a better environment to hiring, and having the right staff on place. So they can continue to - to operate their businesses more effectively. And so, we think we're in a much more normalized environment. Eric Coldwell Aaron, I'm going to try to sneak you in on one. I'll throw a numbers question at you on the profit side. So, we came into this year with Cardinal as our best idea. And then, of course, international freight went from about 1,300 a container, to about 6,000 a container in eight months. And that took away a little bit of the thunder early in the year, of course, before we also got the Optum news. You've come back through a lot of that. Stocks up about 12% right now, so that's good. But when I think about this international freight, I think I and a number of investors struggle with the concept of, how do freight costs quadruple with no change to your AOI targets, either this year or, as you said earlier in your prepared remarks, the goal, the march towards $300 million. So how do you manage through that? Have you found additional upside elsewhere? Have you changed - how you contract? How often you ship? What's the real driver here? Aaron Alt So, I think it's important to reflect on the fact that our last two years of journey with our, what we now call our GMPD global medical products and distribution business, has been about building a resilient supply chain. And put us in a place, where we can actually manage the business versus react to what happens, just have to react to what happens to us. And whether it's on the freight costs or other elements of inflation that touch the portfolio. Steve Mason, his team have done an excellent job of taking a giant step back and assessing. Okay, what does our overall supply chain need to look like, where are we manufacturing? Where are we sourcing from? What lanes are we using, as we're moving the goods around the world? Because of course we manufacture and source from around the world, building the right supplier contracts, making sure we're not - where we can avoid it, exposed to spot rates, so that we can manage the business smartly. Now, it's also important to keep in mind that while the outside world was reacting to this in the moment, we saw a lot of this coming, right. And so indeed, when we provided our updated guidance, we were able to take into account, the cost trends we were seeing in providing the confirmed guidance, the $175 million for fiscal '25 and indeed confirming the $300 million for fiscal '26 as well. And so, while there will always be puts and takes as we manage the business right, we walked into the year with the guide, seeing what was happening with the freight rates. And oh, by the way, when we, by the time we gave the guide, it was starting to come down, right. And our commitment is we'll continue to manage the business smartly, we continue to look ahead, and we'll also ensure that we have the right customer relationships. So that we don't get holding the bag, the way it has happened - in years in the past. Anything you'd add Jason to that? So perhaps the takeaway is that, we should be cautious not to get overly worked up on one data point like that. Assume that you're in the right spot to manage through it most of the time. On the flip side, as those rates have started to come back down, and last I looked, we were closer to $5,000 instead of $6,000. We'll see where it goes? Jason Hollar Yes. Maybe one thing I can add just to put it all into perspective...? Exactly. No, that's it. You nailed it. So at 5,000-ish. And by the way, that's an average over a lot of different lanes. And we source, as Aaron highlighted, all over the world that was enough. So to put it all in the perspective, that was closer to, at the peak, perhaps close to $20,000. So from $1,000 to $2,000 to $5,000, $6,000. Yes, we don't love it, but it's much more manageable than at $20,000. But here's the biggest difference in my mind. During the middle of the pandemic, if we were lucky to actually be able to get service by paying $20,000, so we were paying $20,000 per container, we were not able to get the service that we needed. And then we had a whole bunch of detainment fees on top of it because the supply chain was so screwed up. So it's not just the container cost, it's all the other fees, all the excess ground freight. Then by having product not where it needed to be, it compounded in a way that as frustrating as even $5,000 to $6,000 is for me today, because I don't think that that's actually what the rate should be. It's what the market currently is. At least, we are getting markedly, substantially better service for that. So we can operate efficiently and effectively throughout our supply chain, which gives us opportunities with other productivity, other efficiency that is as important as this penalty is in and of itself. Eric Coldwell So one or two quick hits on medical, and I'm going to shift to your other businesses. Number one, you've announced some investments in new domestic near - I think it's all onshore, maybe some nearshore domestic manufacturing help clarify that if I've got that wrong, what specifically are you investing in? When do they come online? What's the benefit to you? Jason Hollar Right, so look broadly, we often get asked about tariffs and the impact to our profitability profile as well. And it goes back to what I was saying earlier about us creating a resilient supply chain that we're able to source or manufacture the most effectively. And in this particular case, there's been some action around the world, whether it's tariffs or FDA actions, which have created an opportunity for us where we actually produce syringes domestically in the U.S. And so what we called out as part of our guidance in particular as it relates to the first half of our year, is the fact that we are investing in existing - in existing facilities we have for domestic production of syringes, which present us with an opportunity to drive revenue and profitability on that basis. It's important to think about that, because whereas in previous years we were somewhat defensively working on how do we optimize, now we're leaning in and looking where do we have opportunities leveraging the more resilient network that we have? It's having an impact on us in the first half of the year. And so that tells you it's an inner year benefit to us, but the first half is impacted by some of the manufacturing.... It's all part of our guidance. Right. Just keep in mind, the 175 is the 175. We're not changing that, but it's a contributing piece to that. Eric Coldwell Yes, sounds good. Okay. Other businesses. Hard to tackle three very different businesses in one question, but, lay out maybe a one liner on OptiFreight, nuclear and precision health, and at-home. And then I think, most intriguing, they're growing great, right? Higher margin, growing well. It doesn't get ironically, the things that are working often don't get as much attention as the things that don't. I'm hoping these start to get more attention. But what is the single biggest catalyst for each of those businesses? Maybe a one liner on what you do for people less familiar. And then the single biggest catalyst as we go into the next 12-24 months. Jason Hollar Okay, so let me just walk through each of them. So overall, they all benefit from favorable secular trends in the industry. So we love the healthcare industry, but we also love that these are each three businesses that are, in faster growing areas of the market. And we have a right to win and continue to lead in each of these three areas. Yes, they're in the same segment, but they are very individual in terms of their management of that business and the investments that go into them. So let's start with nuclear and precision health solutions. In the name, precision health solutions kind of tells you what you need to know there. It's riding the wave of precision health targeting with these therapeutics to benefit the patient in a variety of different needs. It's got cardiology, it has neurology, some of the Alzheimer's drugs. But what's really, I think, underappreciated is how much overweighted this whole business is more and more, especially in the Theranostics side to oncology. And that's through the Theranostics business that we've been investing heavily into. This is about $100 million, over $100 million. From '24 to '26 we're investing in Theranostics and the PET sites that go along with it. So this is a business that we continue to invest in heavily. We see growing quite nicely, and we have a lot of opportunities to grow with. Last year, we grew 20%, a variety of Theranostics business, a variety of products. But one of the ones that really stands out is [EluSiX]. This year, we're expecting further 20% growth. On top of that, Pluvicto is one of the key products that will be driving our revenue this year in terms of incremental growth. And then we have a pipeline of 60 plus additional programs that we think will continue to be that pipeline for us well into the future. On at-home solutions business, this is the secular trend of care more and more moving into the home. So we have a fantastic patient direct business, but also distribution business that services other HMEs, other providers, and we see that business growing very consistently over many years. A lot of investment in this business as well, but here a little bit more on the capacity side, the distribution side. We have a nationwide network of 11 different distribution centers, three of which are new in the last 12 months. And with that new distribution centers, why that's important is that we're putting in the best, latest state-of-the-art technology on automation to improve certainly productivity, but also to drive worker safety, but also throughput. We can get a lot more capacity out of each square foot through this technology. And then finally it's our OptiFreight Logistics business. This secular trend is just really all about freight management. When you think about the costs continue to get more and more expensive for the type of courier services that this industry uses for near real time type of delivery of product, and that becomes more difficult, more costly. And we have some of the best health systems in the world. 17 of Gartner's top 25 health systems are our customers. And it's because we provide a lot of value, but also a lot of insight and expertise into freight management. So these are each three fantastic businesses that we think will be, small but mighty. There are 4 billion plus in revenue, 400 million plus in earnings. And so yes, higher margin for our type of business, higher growth, and we think will be a nice consistent tailwind long into the future. Eric Coldwell So when you said your first move in M&A needed to be specialty, where does this stack up in terms of your current strategic priorities in M&A? Jason Hollar Yes, great question. Because we have evolved our messaging. You're leading me to the answer I think you already know, which is we - that first year was clearly about specialty and that culminated with specialty networks. And while specialty remains our highest priority, we have indicated we will consider M&A for these three growth businesses. So I would call it a secondary priority. But there's such great organic opportunities, that's where we're most focused. But we think it's possible there could be a partnership in there somewhere that would allow us to accelerate that. I think the key about M&A that I would like to stress is that we see M&A as an acceleration of our strategy, but not the driver of it. We are not going to rely on M&A because you can't control it. You can't control what the seller is going to do when an asset is going to be available or not. So we need a strategy, which is why with oncology within specialty, why we created Navista, we were not going to be reliant upon, a particular acquisition for that strategy. And we'll continue to evaluate our options within a specialty or within these other businesses, but it will be prioritized that way. We, if you can't tell already, we believe strongly in prioritization across the enterprise to make sure our team knows exactly where we need to put our time and our attention. Aaron Alt And to that point, if I can just add, we have a very disciplined capital allocation philosophy where, setting aside M&A, the first thing we're going to do is invest in the business. Right. And so we're going to spend between $500 million and $550 million in organic capital investments in our existing portfolio of businesses. The good news from a balance sheet management perspective, which is our second priority, maintaining our strong investment grade rating. We don't have a lot to do there this year because the team has brought the debt down and we're now within our leverage ratios with Moody, which takes us to our third priority, which I just wanted to emphasize, which was a baseline return of capital to shareholders. And we actually increased our guide for '25. We now committed that our baseline or the commitment we've made for '25, will be 750 million of share repurchase versus the 500 million we had called previously. After that, we look at M&A and we go back to the top when we start again. And it's the plan we had last year. It's the plan we've got going forward as well. Eric Coldwell All right, 40 seconds. This was going to be a 10-parter, I'll make it a one part. You guided May 2 to $2.5 billion give-or-take free cash flow. By June 30, you did about $4 billion. What changed? Jason Hollar Blood, sweat and tears and the team working really hard. If you go all the way back to our Investor Day, what we commented was, is that cash flow was an opportunity for us and the team worked really hard to deliver on increasing that cash flow. We continue to work on that, notwithstanding the fact that for this year, the cash flow will be dramatically less as we work through the negative working capital from the Optum non-renewals, as we work through an additional payable your day-out, and importantly, as we invest in working capital in the back half of the year to support that $10 billion of new revenue that's coming on board with new customers and customer expansions in the back half. Eric Coldwell All right, we're at time, guys. Thank you. Fantastic. Really good to see the progress and performance this year. Everyone, please join me in thanking Cardinal.

International Business Machines Corporation (IBM) Goldman Sachs Communacopia + Technology Conference (Transcript)

International Business Machines Corporation (NYSE:IBM) Goldman Sachs Communacopia + Technology Conference September 9, 2024 8:30 PM ET Okay. Good morning, everybody. Welcome to the Goldman Sachs Communacopia and Technology Conference. I'm Jim Schneider, I'm the IT services here at Goldman. It's my pleasure to welcome IBM and CFO, Jim Kavanaugh with us today. Thanks Jim for being here. James Kavanaugh Thank you very much for having us. We're looking forward to a great discussion here. Likewise, Maybe start out strategic macro side of things. Global economy still has a lot of uncertainties to it. We assured from our chief economist this morning, we've got inflationary pressures, unevenness in key markets. How is IBM adapting to these kind of shifts? How are you changing your operating model to kind of deliver resilient financial results in this challenging environment? James Kavanaugh Yes, it's a great place to start overall, and [Hans] (ph) did a great job this morning talking about it from a Goldman perspective. I would tell you, today's macroeconomic environment can be defined by one word, dynamic. When you take a look at it, enterprises are focused around a slew of challenges with regards to interest rate volatility, inflation, demographic shifts, supply chain dislocations, geopolitical uncertainty overall. And clients are looking at technology as a source of competitive advantage. That's why technology always outgrows GDP as an enabler of global business and economic growth overall. But Jim, as you know me quite well, I spent a lot of time talking to many of my peers across the industry. And when you look at it, how do they view technology. They view technology as a source of competitive advantage. In areas around one, it allows them to scale their businesses. Two, it drives efficiency and productivity that enables financial investment capability for them to go compete. And three, more importantly, right now with GenAI, which I'm sure we'll talk about, is it's a way for them to evaluate new market opportunities, new businesses and new sources of revenue overall. And you talked about IBM. Within IBM as CFO, I have the honor of running all of the operations for the company, too. So in this macroeconomic uncertain environment, around disruption. As a CFO, you've always got to be prepared for multiple scenarios. And we've done a lot of work around IBM, to your point, repositioning our business to form better stability in revenue, profit and cash, what I mean by that? Geographic diversity. We operate in 175 countries around the world. I would say that's a pretty good natural hedge because not all markets operate the same. Industry diversification, 17 different industries we serve, client set. We're actually all enterprise focused. We serve 95% of the Fortune 1000. And our business mix profile, which is high-value recurring revenue that drives that stability in revenue, profit and cash. So when you take a look at it, that underpins how we've kind of guided 2024. We expected a very dynamic environment. We're seeing that play out. But we're very confident about the macroeconomic environment for technology. Albeit we acknowledge short-term dislocations and uncertainty. But our guidance this year, we see revenue accelerating mid-single digit. We see continued operating leverage increases, and we just raised our full year free cash flow guidance to above $12 billion. So we feel pretty good about our ability to compete in this market. James Schneider And maybe one thing that's been a little bit touchy has been the discretionary IT spending environment from a macro standpoint, what do you think we're going to need to hear or see for your clients to be a little bit more confident about kind of raising that kind of discretionary portion of the budget? James Kavanaugh Yes. I think at the core, it's getting back to certainty. There's a lot of uncertain variables right now, whether it's geopolitical with the elections. By the way, it's not only the U.S. I think the last count I had was about 73 different countries this year going through elections overall. So it's about getting better certainty in the macroeconomic environment. But at the core of your question, the discretionary spending, what do you typically see? And by the way, this has played out historically for information technology over decades, right? In major technological shifts or macro uncertainty human capital-based businesses where discretionary spending comes out. Typically, the growth model always experiences shift in reprioritization. I think the consulting industry is seeing that today, we're definitely seeing, albeit I would match our consulting business with any around taking share in our capabilities. But I think what you're seeing right now is, one, we got to get better certainty back into the market, and that certainly then will lead to how clients then will take that cost and productivity initiative of what they're driving right now that is creating a buffer of investment capability that's going to go back into areas that we've been investing in IBM that differentiate for the long run, where we think there's long-term growth factors and that hybrid cloud, that's AI, that's automation, that's digital transformation. And we still see and very confident about that growth going forward. James Schneider And then I guess IBM obviously has a very long historic history or recently over the past several years, your CEO, Arvind Krishna, when he took over, made some pretty big strategic changes large M&A in software, some divestitures in the services part of the portfolio, you've been integral to all that. How do you plan to sort of differentiate yourself over the next several years in this changing landscape? And how would you position in terms of what inning we are in, in terms of the changes at a strategic level that could drive more transformations for IBM over the next three to five years? James Kavanaugh Yes. Well, thanks for the question overall. There's been a lot of hard work by 280,000 IBMers around the world. But under Arvind's leadership, we are a fundamentally different company today than where we were four, five years ago. When you think about it, Arvind has brought this company a strategic focus around what we believe arguably is the two most transformative technology shifts, that being hybrid cloud and AI, and we repositioned and built a platform-centric business model that's going to capitalize on those two technology transformational SIPs around 75% of our business, now growth vectors, software and services that have integrated capability around our infrastructure portfolio. And third, we built a very attractive economic multiplier effect on those platforms. the platforms being the Red Hat acquisition around Red Hat OpenShift as our leading industry hybrid cloud platform and now around our Gen AI platform with RHEL AI, OpenShift AI and our enterprise AI middleware, Watson X. But that platform economic model is very attractive in that every dollar we land on a platform, we get $3 to $5 of software and $6 to $8 of services. So really a lot of strategic focus, a lot of work on portfolio and now capitalizing on that attractive economic multiple. But I would tell you, Jim, I think the market is moving to what we have been calling as our strategic convictions for the last four or five years under Arvind's leadership. One, we believe technology is the only deflationary force and it's a source of competitive advantage as we talked about. Two, we think that hybrid cloud is the most dominant client architecture you're prevailing today. By the way, 90% plus of enterprises operate in a hybrid multi-cloud environment today. So it is a reality. Third, we're seeing right in front of us, AI is going to be the most powerful form of productivity that we will ever see across enterprise and around the world. And fourth, open source is the new source of innovation. So to your question, Arvind and the team and all of us have been focused on redesigning our operating model to capitalize on those strategic convictions for long-term sustainable value. We've done work around our integrated value thesis, bringing a powerful tech stack with a consulting business at scale, which is differentiated in the market today. Two, we've done work around portfolio optimization. Tremendous strategic capability and acquisitions that we've been able to garner since the Red Hat acquisition, that has really expanded the growth profile, both of our software book of business and our consulting businesses, but it wasn't only acquisitions. We also had to prune our portfolio around areas 15, 17 divestitures of assets that weren't either strategic fit or the financial equation that we wanted. But I'd tell you, one of the most underappreciated components of what Arvind has done is he's opened up IBM to ecosystem partnerships with AWS, with Microsoft, with SAP, I think Nikesh who was up earlier with Palo Alto, Adobe and go on and on and on. And we've been able to capture synergistic value of IBM with those partners overall. And fourth, I'd be remiss if didn't say a whole new cultural transformation within IBM around a growth minus around speed, velocity, risk taking. So all that's led to differentiated performance. I mean it's played out our investment thesis, IBM today, higher revenue growth, higher operating margin, strong free cash flow yield and a higher return on invested capital and put it in perspective to wrap up. Let's talk about three years ago before we came out with our mid-term model and we spun off Kyndryl. We had a business profile that was declining revenue growth. Over three years, we change that to a sustainable mid-single-digit revenue growth profile. We had a business that had dilutive margin operating leverage to a business over the last three years that has generated 700 basis points of improvement in margin. And finally, a business that was stagnating on free cash flow. And over the last three years, we're about double our free cash flow generation. So we feel pretty good about where our position is, and more importantly, always more work to do to drive continuous reinvention, and that's the mindset that we have in IBM. James Schneider It's great to hear. And maybe just kind of pivoting to a topic we've already heard about. We're going to hear a lot more about at the conference. You mentioned it Gen AI. We've heard from some of the biggest technology companies around the idea of taking a general purpose model with hundreds of billions of parameters in LLM and that consumes a lot of computing power and a lot of cost. The IBM started saying thinking a relatively differentiated approach. You've talked about kind of taking smaller LLM that are 85% to 90% lower cost to operate and implement. What is going on there? Maybe explain for us what difference between what those companies are doing, what you're doing, how you're applying this to more tractable specific business problems and where you see the advantage for you? James Kavanaugh Definitely. Great question overall. First, we're extremely excited about the secular growth opportunity with regards to Gen AI. I believe this is going to be a multitrillion dollar market opportunity TAM around value creation overall. Jim, you were at our Think Conference earlier this year, where we made significant announcements around how we were going to bring the open source community to Gen AI and since then, we've announced now last week just actually launched general availability of our open innovation AI platform overall. We bring a full stack capability around Gen AI for our clients that I think is differentiated. Starting with RHEL AI, which today is our enterprise open innovation Gen AI platform, that includes IBM Granite models, the most cost performance efficient in the marketplace and InstructLab, which is an open source way in a very cost-efficient way to do inferencing, training, fine-tuning modeling. RHEL AI, what are the benefits of it? Number one, it's neutral to hardware. It's the most cost-efficient way to distribute general AI from a platform because RHEL AI sits now on Dell. It sits on Lenovo eventually around HP and many others, too. It's agnostic to infrastructure, NVIDIA, AMD, Intel and others. And three, it's open source. But that's the foundation of our platform. On top of that, you have OpenShift AI that allows us to run our Gen AI platform in a hybrid cloud environment, so that's synergistic effective hybrid cloud and AI. Then we have our AI middleware, Watson X, which we announced at Think with a whole suite of .ai.data.gov. We then have all of our solution agents, our assistants that run on top of that, that capitalize on things like code modernization or things like customer service or digital labor. And then we have ecosystem partners that run on our platform. But to the core of your question about large versus small, when I talk to clients, especially CFOs were cost-minded by focus, right? We're looking for ROI. We're looking for value. If you look at large language models, they are very expensive. Why? Computational resources, memory requirements, latency, updating, fine-tuning, inferencing costs. CFOs today around Gen AI are focused on four things: cost efficiency, performance, scale, speed of innovation and governance. And when you think about it, small models today are at the essence of the most cost-efficient way to deploy Gen AI strategies, 85% to 90% more cost-efficient than a large language model today. That obviously would get my attention as a CFO. Second, from a performance and a scale perspective, our IBM Granite models range from $3 billion to $34 billion. They're trained on 116 different programming languages. They consistently from a cost performance perspective, rank well in excess of our competition. Third, speed and innovation. I think reality is open source innovation is unmatched. Our analogy is we're going to bring to Gen AI with RHEL AI and OpenShift AI, what Linux has done to become the most dominant operating system in the world. And then finally, governance. We were the first to market to indemnify all of our data, all of our models, all of our weights with transparency. So I think when you look at those four client value vectors, they've influenced our strategy around small open innovation. And by the way, it's playing out in the marketplace. We just finished second quarter, first full year of our Gen AI tech stack in consulting. We've got north of a $2 billion book of business, and I think we're capitalizing both on that technology architecture and inflection shift and also on consulting being the strategic provider of choice. James Schneider One more strategic question for you, and that's on M&A. I think, obviously, that's been a core part of the strategy, as we discussed before, Red Hat has obviously performed very well, a number of acquisitions through the years. And this year, some of the software AG assets you plan to close on Hashi by year-end. But maybe just kind of contextualize this in terms of your broader AI strategy, how do all these acquisitions fit together? What is the kind of common purpose or a common technology alignment? What are you trying to solve for customers and clients with this? And should we expect the pace of your software M&A to actually pick up or slowdown from here? James Kavanaugh Yes. Great question. I mean, one, I think we've built credibility over the last handful of years under Arvind's leadership about running a very disciplined capital allocation process around, obviously, starting with investing in our business organically and inorganically around where we see a differentiated way to win and to compete and get synergistic value. Two, our capital allocation centers around maintaining a very solid investment-grade balance sheet, focused on debt leverage. And then three, we enable a very attractive return to shareholder dividend policy. But that capital allocation is supported by a capital structure that gives us tremendous financial flexibility to go compete in the marketplace. And M&A has been an instrumental element of us extending our leadership in hybrid cloud and AI, and it's also been a growth vector model of us delivering about 1 point, 1.5 points of revenue growth to IBM's top line. Now we've talked many times, our criteria hasn't changed. Strategic fit, hybrid cloud and AI, synergistic value so we can get the multiplier effect of product, technology, consulting and go-to-market synergies. And three, it has to have an attractive financial profile, read that free cash flow accretive within two years or less. When you take a look at that strategic fit, what are the areas we're focused on. We're focused on where we believe those strategic convictions are where revenue profit pools are going to move. That is going to be around hybrid cloud. That's going to be around data. That's going to be around AI. It's going to be around automation, which we've capitalized on tremendously. It's also going to be around consulting and building out differentiated expertise and capabilities for not only IBM Tech, but also for our strategic partnerships. In terms of synergies, we run a playbook, and we've been pretty consistent since the Red Hat acquisition, a playbook that drives synergies not only from a cost efficiency but I think you're asking more from a revenue client value perspective around product technology. Let me give you a couple of examples, right? Let's talk about the Red Hat since you started there. Red Hat, when we announced that acquisition in 2018, we saw a very strategic pivot of where the market was going to go around hybrid cloud and around AI. And that was our differentiated point of view of having a hybrid multi-cloud multi-environment strategy with the industry-leading Red Hat OpenShift. When we announced that acquisition, Red Hat OpenShift was basically a $100 million ARR book of business. Less than five years later, we just exited second quarter through IBM's global distribution, scale and incumbency. That book of business is now north of $1.3 billion, a 10 times scale improvement. That is a go-to-market leverage of how we run that playbook inside IBM. Second, what has it done with the software synergies and consulting synergies. It's enabled us to reinvigorate our software growth, which, by the way, we took up this year to high single digit. And it's also allowed us to build a consulting synergistic book of business in less than five years, roughly $13 billion of signings on hybrid cloud, Red Hat and a $3 billion book of business. So we know how to run this playbook overall. Where are we at? We've taken advantage in 2024 with probably M&A-wise. Our typical model is $4 billion to $5 billion a year. We're probably going to press north $9 billion this year. Very excited about the Hashi acquisition. We got a lot of work. We just closed the Software AG stream sets and web methods. So we've got a lot of work in front of us around integrating and ensuring we get those synergies. But I think you'll see us back in the market in 2025 and to be opportunistic, always aligned to that strategic fit and criteria I talked about. James Schneider Relative to Red Hat, you laid out that case fairly articulately. Maybe just talk about what are the other growth opportunities you see for Red Hat that maybe haven't been fully realized yet. What excites you most from both a product and go-to-market perspective? And related to that, we've actually seen changes in the technology landscape relative to Red Hat from a competitive perspective with some key industry acquisitions by your competitors. So maybe where does IBM see the future of that space and the implications for Red Hat? James Kavanaugh Yes. We're very pleased with our Red Hat performance over the first five years. It is really repositioned the IBM company is a fundamentally different company, as I talked about earlier. Red Hat sits at the foundation of our hybrid cloud AI platform-centric company. One aspect Red Hat OpenShift as the industry-leading hybrid cloud platform that we drive that platform economic model on. And now, as I said earlier, at the core of our Gen AI open innovation platform-based strategy with RHEL AI with OpenShift AI overall. If you take a look at it, where are we excited about the future growth opportunity because we've taken a book of business. Five years ago, we've been able to accelerate. We've been growing mid- to high teens over our compounded rate over the last five years. When you take a look at future opportunities, I would highlight kind of a handful. Number one, Gen AI. we're at the early innings of that long-term future growth factor overall. And I think the power of our open innovation strategy, coupled with the integrated value thesis of our Watson X, AI middleware of our solution agents of our consulting book of business to drive scale and adoption, there's a lot of room for growth and accelerating Red Hat there, one. Two, I think the Hashi Terraform acquisition, which we're extremely excited about, expect to close by the end of the year. When you think about the powerful combination of Hashi Terraform, Ansible, Red Hat OpenShift, our Watson X platform, our consulting services. There's a lot of synergistic value and accelerating growth overall. Three and it touches some of your competitive dynamics, VMware opportunity. We're extremely excited about and have generated a tremendous amount of pipeline and client interest right now. And four, we've been working on and excited about the future potential of new markets, new verticals, Red Hat Edge, Telco, Industrial segment, automotive, this hybrid cloud architecture and more importantly, the synergistic value of hybrid cloud and AI together. We're getting a lot of interest overall. So those are three or four growth areas. And just to conclude on your point about the competitive landscape and the market opportunity around VMware, we're extremely excited about the compelling value proposition that we can bring to market. What it's forcing right now with the Broadcom acquisition is it's forcing every enterprise client to make platform architecture decisions, and that's going to be between virtualization and containerization. And when you think about the power of IBM plus Red Hat with our Red Hat OpenShift virtualization, plus containerization plus our Gen AI platform with Watson X plus a consulting business at scale that can do the application modernization. That's why clients are coming to us with extreme interest around a growth factor that I think will play out for multiple years, and we're excited about that. James Schneider You mentioned consulting. I want to pivot to that one next. It's no secret that, that market has been a little bit weak for the whole industry, broadly speaking, because of the discretionary IT pullback that we've seen. What are you doing that's within your control to sort of reaccelerate growth from here? You talked about the partnerships, but what else is there to it? James Kavanaugh Yes. Well, to your point, right now, we're operating in that extreme dynamic based market environment. As CFOs like myself, are all looking at spending programs around how they drive cost efficiency to create reprioritization of financial flexibility so they can invest for their own sustainable advantage overall. But I would tell you that's not a surprise to us. In any human capital-based business. When you look at it, any major technological shift or macroeconomic volatility, discretionary-based spending consulting-based market, the growth model always experiences some shift in some reprioritization. But we're actually very confident in the medium- to long-term market potential of the consulting business overall to grow on their average 5% to 7% overall, and we're excited about the position of consulting inside IBM to be a key differentiator. Why is it important to IBM? One, it capitalizes on that multiplier effect of every dollar we land on Red Hat OpenShift hybrid cloud platform are now Gen AI, we can get $6 to $8 of services revenue over time when we've proven that with Red Hat OpenShift. And through the first year of Gen AI, we already have north of $1.5 billion book of business on Gen AI in consulting. Second, it drives scale and adoption back to our software and our infrastructure in pulling software overall. So where are we excited about our growth model of consulting? One, we've done a lot of work to reposition our portfolio, our growth platforms, our offerings and service lines in consulting overall. Today, it's about 85% I would say, aligned to where the market is and moving. That is digital transformation, that's hybrid cloud, that's application modernization and that's business transformation overall. So we feel pretty good about that. We actually have a pretty small BPO business that arguably is getting disrupted tremendously. We view that as an opportunity going forward. Second, we're still excited. We have a lot of headroom to grow around those strategic partnerships I talked about earlier. It's about 40% of our business profile right now in consulting. We've moved up the league tables from being nowhere to being in the top 10. Our goal is to get into the top two or three, and that's driving tremendous growth. Three, we're investing significantly in our IBM Consulting Advantage platform. That's our Gen AI platform, leveraging Watson X, RHEL AI, OpenShift AI of really assetizing our human capital service-based offerings that deliver better value, increased win rates. And then finally, we've been pretty focused on the M&A side of the equation, just given the attractiveness of the assets we bought this year. But M&A is a key growth driver for us, and we're going to come out after market today with an acquisition announcement around OCI and our partnership with Oracle overall. So we feel pretty good about that. But long term, this is a tremendous growth opportunity. It has great synergistic value, and we're going to keep running those plays to gain share, which is what we've been doing. James Schneider And you mentioned the $1.5 billion of Gen AI consulting bookings. What are those? What kind of client priorities are you solving? What kind of work is it? And over what period of time does that revenue get recognized? James Kavanaugh Yes. Gen AI right now, first of all, excited about that secular growth opportunity. The way I kind of contextualize this and put it in perspective, what cloud did around the explosive growth of digital transformation for consulting about a decade ago. I think Gen AI now has the ability to kick start what I call digital transformation 2.0. If you look at it, $1.5 billion book of business overall, what's that centered around? That's centered around, first, data modernization, data architecture to leverage Gen AI platforms overall. It's around business transformation services, read that around redesigning digital labor, HR, procurement, finance operations and it's around customer service right now. Across all three, we're seeing significant value, 30% to 40% productivity improvements, 75% to 90% automation of tasks overall, higher quality, higher service delivery, higher margin profile for us overall. Now with that said, that $1.5 billion book of business overall, it is large transformational projects by design longer durations, lower revenue yield in the near term versus our traditional revenue yield. But what it's doing is it's one, building our backlog, which is up nicely, 5%, and it's enabling us very important to become the strategic provider of choice for our clients' Gen AI journeys overall, which I think is important because that has a long-term growth vector with a future multiplier opportunity for us to move forward. So we're pretty pleased about that. James Schneider I want to see if I can get to two more questions, perhaps one on the infrastructure because this is an area, specifically mainframe an area where I think people -- most investors are quite surprised of the performance of mainframe over the last five years plus, I think much better than people thought. What kind of demand -- where is the demand for mainframe coming from? Is it partly tied to AI? I think there's been some press reports about uses of AI running on a mainframe, which I think surprises a lot of people. Is that accurate? And then how should we think about the mainframe growth opportunity for IBM going forward over the next several years? James Kavanaugh Yes. Appreciate the question on mainframe. As the CFO, albeit infrastructure is 25% of our total composition of IBM revenue. It's a substantial portion of our profit and cash generation that fuels that investment flywheel into our software, our M&A, our innovation, our go-to-market, our ecosystem. So it is the most enduring platform that is very relevant for today's hybrid cloud and AI era overall. When you take a look at it, we, under Arvind's leadership about five, six years ago, we called a very strategic pivot of increasing significantly our investment in innovation. So today, the mainframe platform is the only platform that has pervasive encryption embedded in the system, the industry's only quantum safe encryption today cloud-native capabilities. We opened up mainframe, the Red Hat OpenShift and other cloud-native applications running on it. We've been putting Gen AI back in 2022 when we announced z16. We have the Telum chip with the AI accelerator on the chip, and we're getting a lot of great resonating from a client perspective. And it's always been the most sustainable energy efficiency. What's driving the value or the shift in the pivot for mainframe to growth? Mainframe over the last three cycles has generated 3 times the installed MIPS capacity and 80% of our clients are growing workloads. We haven't seen that for a long period of time. What's driving that? I think, one, definitely increasing capacity requirements just driven by the volatility of the markets and around digital transformations around enterprises; two, focus on every board, resiliency, cybersecurity, regulatory environment, sovereignty around the world, AI running on mainframe and around energy and sustainability, which is very -- all of those things play to the compelling value proposition, a mainframe. So when you look at it, mainframe is very relevant to AI today. We're working with probably 250-plus customers currently today on AI applications around everything from fraud detection to AML, to clearing and settlement loan prevention and to medical imaging, many different areas. So we feel pretty confident we're going to come out with our new mainframe first half of 2025. We think mainframe right now, we've proven it over the last two cycles now that it is a growth factor of IBM, and we think we're well positioned as we enter 2025 with the next mainframe cycle, and we're excited about it. James Schneider Great. And then maybe I'll sneak one financial question for a second. Clearly, you've done well on the margin expansion front, going from sort of low teens to high teens over the last several years. Give us a sense of the levers that you still have to pull from a cost rationalization and a margin leverage perspective. And where we think -- where should we expect margins to go over the next three, five years? James Kavanaugh Yes. Well, thank you for the question. I mean, operating leverage is an essential element of our financial and business model equation. We drive it three ways. Productivity and mix, that's at high-value software growing high single digit, 40-plus percent of IBM's revenue, almost two-third of our profit. Second, productivity, every dollar we invest, R&D, go-to-market, ecosystem. We expect to return multiplier on that. And third, G&A scale efficiency. The latter is where we've been very aggressively going after and leveraging becoming client zero inside IBM leveraging digitization and technology, embedding AI across all of our workflows, how we run HR, how we run finance, operations, et cetera, procurement supply chain optimization, real estate footprint, services, delivery, pyramid structures. We announced, what, 2022 at the time an extreme productivity program around G&A optimization. We said about $2 billion exit run rate by 2024. We entered this year. We were well in advance of that. We took that up to $3 billion exit run rate that has been instrumental in the last three years us increasing margins by 700 basis points overall. This year's second quarter, we were up by 220 basis points. We think we've got more headroom to go. We're going to aggressively go after that and deliver better client value, better client zero, better technology, better innovation and better shareholder value at the end of the day because it has tremendous multiple expansion opportunity for us. James Schneider Fantastic. I think sadly, we're out of time, but thank you very much, Jim, for being with us today. We appreciate it.

Hewlett Packard Enterprise Company (HPE) Goldman Sachs Communacopia + Technology Conference (Transcript)

Hewlett Packard Enterprise Company (NYSE:HPE) Goldman Sachs Communacopia + Technology Conference September 10, 2024 1:10 PM ET Great. Well, thank you, everybody. Welcome to the Hewlett Packard Enterprise keynote fireside chat at the Goldman Sachs Communacopia and Technology Conference. I have the privilege of introducing Antonio Neri, who is the Chief Executive Officer at Hewlett Packard Enterprise. Prior to becoming CEO in 2018, Antonio spent 23 years in various leadership roles in the combined Hewlett Packard Company, including as President, Executive Vice President and General Manager of HP's Enterprise Group. Before we start, I want to read a disclaimer on behalf of HPE. Antonio's remarks may contain forward-looking statements, so please refer to the Company's SEC filings, including its most recent Form 10-Q for a discussion of risk factors that relate to its business. My name is Mike Yang, and I cover hardware and communications technology here at Goldman. We have about 35 minutes for today's presentation. It's really a privilege to have you on stage. So, you've had a front seat to some of the biggest transformations, both at the Company but also the technology industry more broadly. I want to ask about the technology shift that we're undergoing today, which is really about accelerated compute. First, how would you characterize this technological shift relative to prior ones, such as the initial build-out of public cloud. What can we learn from the past and in what ways is AI different? Antonio Neri Well, thank you, Michael, and good morning, everyone. Thanks for having me today here. My generation is my -- where I come from, I think I have lived all the major inflection points that -- in the history of IT and computing itself. Obviously, from the original mainframe to PC client server to mobility to cloud and today, AI. And I will say that this feels a little bit different. There are low similarities, but they are different. In many ways, in the past was about connecting the world. It was about driving digital transformation of digitized enterprise. This is about transforming the -- really the way we work and obviously, our own personal lives. I think it's, in my view, is going to be the most disruptive technology, at least in my lifetime. And has the potential to really transform everything, including solving some of the biggest societal challenges we live. And HPE has been at the forefront of many innovations, including supercomputing, which obviously has used some of these unique capabilities for a long period of time. But now with generative AI, it's been democratized and be accessible to including consumers. So, it's an exciting time, but also we are early, early in that journey. Clearly, today, the companies that are invested in building this large language model -- models are driving a lot of the demand we see for accelerated computing, but we already see a significant uptick in enterprise and sovereign clouds. And I think on the sovereign space, obviously, it's not just a matter of sovereignty, is about bringing the cultural aspect to this new technology, which needs to be in the context of what those countries represent as well. And so, Hewlett Packard Enterprise is well positioned to participate in all of them with our unique innovation and the ongoing investments we continue to make in the business. So again, I left many of those transitions, and this is as exciting or more exciting than the previous one. Mike Ng That's great. Let's dive a little bit deeper into this AI opportunity. Last quarter, HP Enterprise demonstrated a lot of momentum in AI systems with orders of $1.6 billion, AI systems revenue of $1.3 billion, a backlog of $3.4 billion. How would you articulate HP Enterprise's AI strategy today? And who are the main customers who are consuming HP Enterprise's AI products? You mentioned enterprise and sovereign cloud as an area where you're getting a lot of momentum. Antonio Neri Yes. So clearly, we see a lot of momentum. We are very pleased with our results and we have done that with a lot of discipline, including the fact that the street is still digesting our results, I will say. The fact that on a year-over-year basis, we actually improved profitability when it comes down to the server business. In fact, we improved our operating margin 70 basis points. Notwithstanding that the mix of the server -- was obviously heavily weighted to the AI servers. But at the same time, we saw great momentum on the traditional servers where also we saw double-digit growth, both sequentially and on a quarter-over-quarter basis. And it's fair to say when you look at the profitability of our server business, it's the most profitable business the service segment today in the market. We see tremendous demand. Our pipeline is a multiple of what we already converted and the backlog is very healthy. But as I think of the AI market, I think about in three unique segments, and it's important we differentiate those segments. One is the service provider segment, which obviously includes the hyperscalers and what I call the Tier 2, Tier 3 segments. The Tier 2, Tier 3 are more focused on hosting. A lot of them are not in the United States. In fact, many of them are in Europe and in Asia. And they are there to serve a purpose, which is basically giving access to enterprises and other customers, and some of them are small language model builders to that accelerated computing. Obviously, that's where a lot of the demand is and also driven by these model builders, which consume a lot of accelerated computing and a lot of power. And so, getting access to that is very important on a time basis. The second segment is the sovereign cloud. And by the way, the first segment is, you can argue, if you take them all builders aside, is maybe 10, 20 customers at the most, and they are going to consume hundreds of thousands of GPUs, if not, at some point, exceeded the 1 million GPUs. The second segment of the market is a sovereign cloud and think about countries or geographies where they are going to build AI clouds of scale to give access to enterprises and the local customers to that technology. And those are maybe in the tens of customers, maybe 100, and they're going to consume each time tens of thousands of GPUs because ultimately, that's the size of the systems they're going to deploy. And we already won several of them, including the University of Bristol, the Japan AI ST and the like. And then there is the enterprise, which is still in the early stages, and that represented for us in the mid-teens on the order side and the revenue conversion. And that's still early stages, but we see the maturity use cases taking place. In fact, we see a tremendous traction in health care, in manufacturing and services in general. And to me, that's a big opportunity. And that's why we're chatting a little bit earlier that at HPE Discover, we introduced what I call an AI-in-the-box solution because the enterprise, they have no time to bring together infrastructure and all the software to develop these AI applications. And that's why our solution that was co-engineered with NVIDIA is basically a fully engineered solution from infrastructure to the application to the workflows that enterprise customers need. And that's early, and that's why it's so exciting because ultimately, a lot of those customer needs help upfront and on the back end of this, in addition to the technology and the software. Mike Ng That's great. And I was really impressed by what I saw at HPE Discover with private cloud AI, where you're really bringing together NVIDIA's Compute networking and software with HPE's Compute storage and cloud capabilities. Could you just expand a little bit more on what HPE private cloud AI is and how that may be differentiated relative to what else might be in the market for enterprises? Antonio Neri Yes. As you saw, is a solution specifically targeting the enterprise segment of the market and the premise was about simplicity and speed, speed to time to value. And that solution comes in four preconfigure solutions for inferencing, rag, small language model training or fine-tuning and large language model development, which not a lot of enterprises are going to do themselves, they're going to pick a model and then give context with their data. And we thought about that value proposition from how we can speed up the deployment of this technology and help customers in the enterprise space deliver the results on the return on investment. And therefore, it was all about the experience. They experienced us in our HPE GreenLake cloud. Today, we have 37,000 customers on the cloud platform, managing networking, server, storage and all the SaaS associated services, including private cloud. And basically, from there, it is basically with three clicks in less than 30 seconds, you are actually up and running. And we gave the full stack, including the RAG, the NVIDIA AI enterprise software, the NIMs including the agent blueprints for specific verticals. In fact, last week, we announced some incremental additions to that. And then obviously, is day zero, day one and day two all built in the same experience. And the day two is as important as day one, right, when you deploy this. So, we feel this is going to be an incredible flagship product for us and it's part of the GreenLake experience. We deployed that infrastructure, one of the four preconfigure either in a customer data center or in a colo, and we can offer a customer manager or a self or an HPE-managed services. And so, the differentiation is co-engineer ready in a SKU. They can order one single product number versus a reference architecture multiple components that custom has to put together. Mike Ng Great. So, HP Enterprise is a leader in exascale supercomputing. And I think the Company is responsible for manufacturing and selling the top three of the top five supercomputers, including: number one, which is Frontier; number two, which is Aurora. Can you talk a little bit about how HP Enterprises leadership in supercomputing helps support the broader AI strategy? One thing that certainly comes to mind for me is the success that you've gotten in sovereign AI, right? You mentioned a couple of those projects. Antonio Neri Well, I think in general, sovereign AI will look a little bit more like a supercomputer in many ways. But put aside that, I think HPE has decades of experience delivering AI scale capabilities in governments, in academia and very high-end enterprises that may need that supercomputer power. And as you said, our supercomputer business has brought the exascale barrier. That took 14 years from the petaflops to exaflop, and the Frontier system is capable to deliver a quintillion operations per second, which is 1 billion transactions. Think about how much you can do with that and how many problems you can go solve with that. And to give a sense, Frontier today runs on 60,000 GPUs and 40,000 CPUs, all in one cohesive system. And the magic of that is actually our networking fabric. We have a coherent fabric, which we call HPE Slingshot that allows us to bring all of this. And the most fundamental metric that customers look there is the ability to start and end the model without interrupting anything. And so, because of that, we now have to build and run this system of scale. But as you know, as we go forward, the amount of energy we're going to consume is significant. In fact, some of the systems consumes tens of megawatts just for one system. And as we transition to direct liquid cooling, which is foundational to what comes next, you need to have the manufacturing and the services capability to do it. And HPE has two amazing factories that are built directly quickly cooling, now for a number of years, which means the capital to build those factories has already been deployed years before. And therefore, we are ready to adopt these new technologies, whether it's from NVIDIA or any other silicon provider. Obviously, we have chatted about Blackwell now for some time. But the reality is we can build and service any system that's really quick cool. Now in addition to that, we have hundreds of patents in that space that makes us unique and different. But ultimately, you have to service the systems and the maintenance cycle of the systems is significantly higher. And that's why I believe, as we transition to this new set of technologies, not only we can deliver better performance which is obvious. But at the same time, lower the energy consumption, and HPE has a number of capabilities and patents there while we might do the maintenance and service, which is an opportunity for us to drive gross margin expansion as we go forward. Mike Ng Great. So, you've got experience in liquid cooling. You have the networking fabric with Slingshot. You're serving an existing customer in sovereign and you're in a good position to deliver maintenance and services. Are there any other product capabilities or services that you like to offer that you might have to develop in-house or pursue through M&A to service what's required in terms of AI infrastructure demand going forward? Antonio Neri Yes. I think when you think about the next generation of architectures, I do believe the networking component is going to be a core tenant of that architecture. And both through the organic investments we have made and the pending acquisition of Juniper, we will we have an amazing set of intellectual property to drive the next iteration of the architecture for accelerated computing. And I think this is where HPE think about not just the server or the rack, but we think about the whole data center as a package. And that's an opportunity for us once we close the Juniper transaction. In addition, we also have amazing software because one of the magics I will call it, is the software to manage contention through the networks. So, as we continue to grow and chain more and more GPUs together, and our Slingshot fabric already can support 80,000 GPUs in one cohesive system, we also need to make sure that the AI models run very efficiently because the worst thing you can do, Michael, is start the model and stop. That's a waste of time, energy and dollars and therefore, we now have to continue to run these models to scale without interruption. And that's value-added services that customers want and need, especially at that scale. As you go to enterprise, you're going to have hundreds of thousands of customers that will deploy these much more standardized solutions. And our opportunity there is the whole stack, including the services piece. But in the end, I don't think enterprises will deploy more than hundreds of GPUs at the time. And therefore, it's all about the speed of deployment and the ability to deliver that time to value the use case. Mike Ng Right. That makes a lot of sense. And if I could just ask about your positioning among hyperscalers for AI. I think you've had some notable wins there, but the natural question would be hyperscalers haven't historically worked with OEMs. So why work with HPE for AI? Antonio Neri It was very simple. It was the ability to provide a solution that was a data center level ready to run the models. It was not about selling just servers. We offer them as a part of GreenLake, a complete data center solution for them to run their models. That's why we got that business from one particular hyperscale. Mike Ng Okay. Great. And just kind of tying it back to financials, last quarter, HPE reported relatively stable operating margins within its service segment where the AI systems reside despite accelerating revenue contributions from these AI systems. How do you characterize the margin profile of the AI systems relative to the broader server segment? And what are the opportunities to improve the margins of AI systems over time? Antonio Neri Yes. So, at the operating margin level, because we don't disclose the gross margin, we actually improved operating margins by 70 basis points on a year-over-year basis, but the contribution of AI was significantly higher because last year, at this time, we only converted $300 million. This time, we converted $1.3 billion. So, with $1 billion more, let's put it this way, with $1 billion more revenue in the AI space, we actually improved 70 basis points on operating margins. And when you need to look at that, it's not just the product aspect of it is the services aspect of it. And that's why when you look at our earnings, we start disclosing in our composition between product and services, how much contribution comes from each of them. And I do believe as we grow enterprise, we grow sovereign and we shift to directly to cooling, there will be more services opportunity as we go along the way. And so -- but we are very committed, Michael, to maintain our profitability within the ranges we guided a well back in our long-term ranges, which is 11% to 13%. And so, when you look at the total server and AI segment, operating margin was 10.8%. So, we'll argue kind of there. But there is obviously a backlog. You mentioned that $3.4 billion. We have an amazing pipeline, and we believe we are operating with discipline, and that's the key here. And I think you need to find the right balance to drive profitable growth in each of the segments and be able to deliver those results in addition to generate the right cash through the working capital because the amount of inventory you have to manage through these transitions. Mike Ng Yes. I appreciate those new disclosures, breaking down AI system orders and revenue by products and services because I think the observation was there's probably 10% to 15% of orders coming from services, but it hasn't really shown up in revenue. Antonio Neri Well, it's all deferred, right? So that's the reality. Now normally, when you sign a contract like that, you can go for three years and all that revenue gets deferred over the three years. Mike Ng Right. One area that you called out and was a very -- was -- an area of strength in the quarter was in traditional compute. Could you talk a little bit about what you're seeing there? Are we at a point where there should be an inflection in traditional compute demand? Antonio Neri Well, I do believe the traditional server or the traditional compute is a recovery. And I think there is a little bit of pent-up demand in the market to modernize that infrastructure. But at the same time, we saw on our side, that our transition to Gen11, which is our latest generation of products, although we are already working on Gen12, is accelerating. In fact, we said that 60% of our server business has already transitioned to Gen11. And when you look at the Gen11 versus the previous generation, obviously, it's more dense, structurally has a different set of cost and AUP, and then obviously, we start seeing already a slight uptick in commodity costs. So, from that perspective, we feel good about it. In fact, the traditional server grew double digits, both sequentially and on a year-over-year basis. Now remember, that server also goes into a private cloud. And so, you get the benefit of selling the server as a stand-alone or the benefit of selling it as a part of private cloud stack. And so, in any case, everything needs to compute at some point in time. And also, I believe, which is very important to understand is that, it makes no economical sense to move a legacy work load to a server that has accelerated computing. It's not necessary. It's a waste of resource and dollars. And that's why we have not seen cannibalization from the AI business to the traditional legacy business. I don't think that will be the case. Unless you rearchitect the application, when you build a lot of AI. But the reality is that the AI application in the end will be more users and inferencing solution than maybe a traditional work of doing transaction type of work. Mike Ng Great. That's really helpful. And on the traditional server side, are you seeing any notable areas of demand when you think about individual customer verticals, whether that's government, enterprise, service provider or of that format? Antonio Neri For sure, government. I mean we're a large provider to the government, and we do many things there. I think health care as well, that's another area. But I will say, it's more by workload, I would say. One of the things we saw quite a bit of traction is with large OLTP workloads like SAP and others. That when you think about the economics of that and think about how much data you need to move for ultimately running on the same infrastructure pretty much unless you're running out of space and power, it is actually depending on the size of your instance is cheaper to run on-prem than off-prem. Mike Ng Okay. Great. Shifting gears to storage. Could you talk a little bit about the transitioning that's happening in the storage portfolio, migrating more to HPE Alletra, some of the mix shifts that are happening between first-party storage solutions versus third-party solutions. Maybe you can just set the groundwork for... Antonio Neri Yes. Well, it's an intentional strategy. Historically, the Company, if you go back 20 years, we have had a mix of offerings between owned IP and non-IP. And over the last number of years have been very intentional to drive to our own IP products and obviously make the R&D investments to drive that shift. This is what we refer as HPE Alletra and Alletra MP and MP stands for multi-protocols. But from a market trend perspective, obviously, AI will demand different type of protocols, and would remind also more storage capacity. So, my view is that as we go forward with Alletra MP, we have an opportunity to expand our footprint beyond the traditional market we have been participating, which is the traditional block market. And so we have multiple, I will say, inflection point. Number one is our own installed base to Alletra MP in the block space. We have a fantastic solution that can compete with anyone on price performance. In fact, in many ways, deliver better performance with a guarantee 100% availability and type of as-a-service models that people are looking for. But that same infrastructure was architected in a scale-out software-defined way that allows us to go from block to file to object without changing the infrastructure. And that's a big issue for customers because you don't want to buy this infrastructure for block and that the infrastructure for file and our object and manage two different sets of experiences, two different control planes. By the way, all of this we built inside GreenLake. So, when you deploy that Alletra MP hardware, if you will, is a scale out, so you keep adding capacity. And the only thing it just will change is the operating system that runs on it. And that I call it bits are downloaded from GreenLake on the hardware. So, you may have this capacity for block and you need more capacity for the object -- is the same hardware, but it's just the operating system that sits on it is now for file an object. But the control plane and the large cycle management is exactly the same inside HPE GreenLake. So, this is an exciting transition for us. And we actually wrap all of that with secondary storage with our own solution with backup and recovery and ransomware protection services with Zerto. And we have unique partnerships. There are very few now and very curated where we believe are complementary to what we do but not to offer everything to everyone. And I also will say, while we do all of that, it's fair to recognize that also we are changing the business model. So, the hardware piece of this, again, consistent architecture is a CapEx model. But when you download the software, whether it's for block file an object, that's a SaaS component. Therefore, on a, let's say, on a $1,000 average price, a portion of that $1,000 is deferred over the length of the license, which is a SaaS kind of approach. So that's important. Remember that this is also included in the private cloud for AI. So inside, you have a ProLiant server and you have HPE Alletra MP fully certified with NVIDIA. And in both cases, you may have a switch, which today is HPE Aruba for the Alletra MP offering. Mike Ng Let's talk about Intelligent Edge, a segment of the business that saw a tremendous amount of demand immediately following the pandemic with a lot of network upgrades, but it also led to a period of inventory digestion by customers. Where are we in that inventory digestion period? I believe we're mostly done with it at this point, but could you just share what you're seeing from a customer demand perspective in wireless LAN and Aruba? Antonio Neri Well, I think we have done a remarkable job on the acquisition of Aruba, which I did in 2015. Just to give a sense, when I acquired Aruba, it was mainly a wireless company, a WiFi company, and the size of the business in 2015 was $750 million. I reverse integrated our campus switching because Aruba is a campus-and-branch focused company. And combined, they were $1.6 billion. At the end of 2023, we were $5.3 billion. So, we did a great job in -- more than 2.5x if you will, almost 3x the revenue of that business. And -- but you said it, right, obviously, COVID drove demand for modernizing the campuses, people come back to offices and the like. But now, we believe we have passed the trough. And last quarter, we saw sequential orders and revenue growth, which is an important signal that the market is in recovery, and we expect that to continue for the next several quarters. And so that's another positive momentum we think we're going to have as we enter 2025, in addition to the fact that we expect to close the Juniper transaction by the end of calendar 2024 or early calendar 2025. And that will give us, for the first time in the history of the Company, and I will say, even the history of HPE, if you go back, a full intellectual property stack from the silicon because our campus switching is 90% our own silicon, 100% of it. So, from the silicon to the infrastructure to the operating system, to the software, the security and the services, to cover the edge to cloud spectrum through this modernization that we need because of AI, in an AI-driven approach for the $180 billion TAM, which basically we can cover the entire TAM. And remember, the combination of these two companies will be an $11 billion business, so more than double the current networking segment as reported, and it's going to be representing 35% or so of the Company's revenue, or more than 50% of the Company's profit. So clearly, we are shifting the look of our portfolio to higher growth, higher margin areas on a control point that's essential as we go through this inflection point from the architecture perspective. So, we feel good, momentum is there, recover in the market, in line with the peers, by the way. The Juniper transaction closing around that time line, I just said. And the combination of the two assets giving us a different financial profile. But most importantly, a different IP that gives us the relevance in this new market. Mike Ng And Intelligent Edge is one of the higher-margin segments within the organization, mid-20s long-term EBIT margins. Could you discuss some of the factors that are going to impact margins over the near to midterm within Intelligent Edge? Why is mid-20s the right long-term margin profile? Antonio Neri A couple of things. As I said, at the hardware level, we own much of our IP except the radio access piece of it, which obviously we work with Broadcom and Qualcomm. But on the other stuff on the campus switching is our own IP. But a lot of the momentum we see is the experience. Aruba was conceived with a cloud-native approach in a mobile-first approach, which allows customers not only to provide connectivity but to build experiences around that connectivity. And we see tremendous structure in each of the verticals whether you take hospitality or whether you take health care or whether you take manufacturing into the IoT space. And we have been very diligent in adding to adjust its market along the way. So again, Aruba was a WiFi, reverse integrated in campus switching. Then we added SD-WAN through the acquisition of Silver Peak. SASE is a necessity at the edge, through the SSE, the secured service edge. So now, we have the true consolidation of the network layer. We expanded into private 5G, which is a huge demand for manufacturing and other verticals, and into the IoT. So, we believe we have a full comprehensive approach there. We added, on top of that, the cloud layer, and that's one of the reasons why Aruba is growing so much inside HPE GreenLake and our ARR is $1.7 billion and growing close to 40%. And then obviously, the AI Ops, which is this AI driven. But Juniper brings the complementarity with Mist in one segment of the market in the campus and branch, and then into the cloud and the service provider space, and in the enterprise data center switching space. Mike Ng Yes. On capital allocation, HPE put out a target to return 65% to 75% of free cash flow to shareholders over the next few years. Can you talk about how you're balancing the return of cash shareholders with reinvesting in the business and M&A? And what's your appetite for more M&A, particularly given the backdrop of some of the pending deals? Antonio Neri Yes. So first of all, we always return capital to shareholders. I think about the -- been 6.5 years as a CEO, in the first six years or so, we returned almost $11 billion of capital to shareholders. That's -- when you think about our free cash flow, approximately around $2 billion, right? That's in line to generation of cash, although we had obviously the spinoff at the time before I became CEO. That said, obviously, the first thing is to pay dividend. And dividend is a very critical component of our capital allocation. This past quarter, we paid $0.13, at the beginning of the year, we raised the dividend by 8%. So that's consistent. In terms of share buybacks, it's an allocation between share buybacks and investment where it makes sense. We do that on a stringent return on invested capital. And also understand we need to make investments in the business. And we felt that this time, doubling the networking business was the right time because of what we see in AI and because of the ability to change dramatically our financial profile. And by the way, that transaction is a no-brainer for shareholder because in the end, we are committed at least $450 million of synergies, which pace for the deal itself. So, I believe that's a no-brainer. But obviously, as we go forward, our goal is to deliver that 65% to 75%. And the first thing is that in year one post-close, the transaction is already accretive on a non-GAAP basis. Obviously, we're going to drive the synergies as aggressive as we can. But already, year one post-close, this is going to be accretive for shareholders on a non-GAAP basis. And then obviously, pay down the debt, which our commitment is to bring them down to 2x EBITDA. And we have plans to do that. And so, that's the journey we are going to be. And honestly, as ultimately, this company had done what we said, and I'm very confident in our team to go execute the strategy. Mike Ng Antonio, it's been such a privilege to have you on stage. Thank you for joining us here at the conference.

UiPath Inc. (PATH) Piper Sandler Growth Frontiers Conference (Transcript)

Right. Well, we've reached the bottom of the hour, so I think we're ready to go. So, my name is [indiscernible]. I'm joined here with Ashim Gupta, the CFO. [indiscernible] So, I think most investors here understand the story, understand the name, so we don't need to go into what it is and what you do. But maybe to set the stage, Q1 was a reset quarter. We talked about execution, slips maybe a little bit, macro was tighter. Q2 was much better. Execution improved, macro stable, so help us understand what you're pointing out here? Ashim Gupta Yes. First, thanks for having me. When you look at the Company today, I think second quarter was about getting back to our roots, being lean, being scrappy. When we say scrappy, that means like making fast efficient decisions that are meant for the customer. So, if you look at our evolution, I'll just step back. We're, to me, a great company, $1.5 billion, $1.551 billion of the ARR, growing 19%. We have 606 revenue accounting. So, our revenue is growing 10%, but that moves up and down. You look at it over a trailing 12-month period, correlates very good, correlates very well. We're going to generate $325 million of cash flow. We just increased that $25 million. So, when you take a company like that and you say, from first quarter to second quarter, what were the focus areas, I would put it in three buckets. First is getting back to our roots in terms of less of a big company mindset. We've built a lot of central organizations. Central organizations do two things, one is they tend to spend money and so your margins get depressed, but the second is they put you further away from the field. They put you further away from the customer. And while that may sound soft, that is very tangible, in a place where you want to connect to make sure the narrative is there, especially in a world where everybody is getting hit with so many different narratives. Second piece was just continuing to deliver and do fundamentals on our execution. Less PowerPoints going into the details deeper on deal inspection, pipeline generation and execution overall. You saw some of the things we talked about in the first quarter are sales compensation. That's an easy fix. It doesn't require four weeks or seven weeks' worth of effort. So just getting into that mindset around that. And the third is, frankly, continuing our leadership in our product road map and our narrative. When you think about the agentic wave that is there, we are quickly positioned today to capture that area. We believe that AI and automation are fundamentally linked together. Our customers say that. One of our -- one of the CIOs have said, "We start with AI, we end in automation." So, continue to execute against our product road map. Rolling out Autopilot, which has great early adoption in that area and continuing to innovate in areas like intelligent document processing, process orchestration, which we see as really having tangible benefits to the Company. Unidentified Analyst Next. And maybe sticking on macro for one second. Q1, it was deal scrutiny and sales elongation were kind of the number one talked about kind of priority here. It sounds like Q2 was -- it's not getting better necessarily, but it's not worsening. So, what are you seeing in underlying budgets, underlying spending? And then, what are you projecting out for the back half of the year and how that's going to change? Ashim Gupta Yes. Stable that we, is the way we've characterized it. We really have seen no change. I do want to define quickly what that means to us. That means that things are variable, right? Different parts of the market act differently in different areas, like we saw pockets of strength in certain industry verticals. And then the next quarter, it kind of -- it tends to like move around. The second piece of what we mean is the lower end of the market, that commercial segment, the SMB segment, that is where we see outsized pressure just generally in terms of decisions. With respect to budgets, budgets are there. You have to win them based on ROI, and that, to me, puts us in a really good position, which is why I think we continue to grow 19% at scale. What we have to be -- where budgets are flowing is where they see ROI coming, and so that scrutiny around that is important. What we do see is the AI confusion continues in the market. People are just throwing out the buzzwords, and so it's taking time for customers to walk through. And so, when we show the demos, when we show our product road map, that's where we win. Unidentified Analyst Makes sense. And it's a perfect segue to the next question. Kind of it wouldn't be a keynote without talking AI. But every software vendor from contact center vendors to Salesforce and everybody else is talking about AI. And so, it leads to this confusion to your point of where do people fit in this AI ecosystem, AI landscape? So, in your view, how do you pitch to investors where you fit in this ecosystem? And then why you win? Essentially what's your differentiation? Ashim Gupta I would put three bullets for everybody to remember. First is AI has been an authentic part of our platform for over five years. If you look at the way that we can see a screen, it's beyond screen script and its true computer vision. That patent AI capabilities that has been built in. If you look at intelligent document processing, that has used natural language processing for a while in terms of interpreting and reading documents. And Daniel has been talking about, he used to call it Semantic Automation, Daniel, our CEO and Founder. Semantic Automation is basically akin to what ChatGPT does. And so, we've already been working to infuse it. So that's bullet one. The second piece is, AI inherently is linked to automation. So, one of our customers, I mentioned and says, "This conversation starts with AI. It ends with automation." And so that is where you get ROI. You can have intelligence, you can have insights, you need to be able to take action, that is where our automation platform stays. The third piece, I would say, is really in this agentic wave. If you look at what our platform does, our platform is able to execute automated tasks from deterministic to increasing probabilistic. And as you move to a probabilistic mindset, you start moving into that agentic area. And so, I'll just characterize it really quick. If you take a workflow and you have a workflow that is there, there's a series of steps that are completed. Some of those work -- some of those steps are done through rules based. That is where you can infuse AI like computer vision. Some of them, you want to be able to make a decision like how to summarize an e-mail, right? Those capabilities exist in the market. What doesn't exist in the market is be able to integrate it into a workflow and then govern the entire workflow. That is where UiPath platform really shines. Unidentified Analyst Got it. And so, when you are in these bake-offs for automation and process automation specifically, how often are customers putting you up against an internally built solution or something they can say, "Hey, we can leverage all these new LLMs, all this new AI tech and build it ourselves." Ashim Gupta Great question. The first thing is we don't compete against them generally because our platform is open. So, we have document processing. Where you see it the most is around document understanding, right? We don't feel the need to create the capability to summarize an e-mail, to read an e-mail, we can leverage that in open-source technology. And if a customer wants to give that to us, that's great. In document processing, we -- they can use our IDP because our models are already trained. They use both specialized general and specialized AI to be able to do that. If customers want to infuse their own AI, we allow them to. What customers still need is the ability to act across. So, you can have AI that gives you LLMs that can read the e-mail. They can't book the service call in a call center, right? They can't automatically route the call in a contact center. They can't submit the customs form in a manufacturing plant. That is where our platform can integrate no matter where a customer brings in their own AI or leverages our AI capabilities. Unidentified Analyst Makes sense. One kind of piece of AI, let's talk about more and more, is essentially the value of the data underneath, and you can kind of see competitive moats being created by who has the data and differentiated data. So, can you talk about the data advantage that you guys have that differentiate this model? Ashim Gupta First of all, UiPath that's been around for 17 years. Daniel has been -- so when you look at the number of screens that we can see, that is just unprecedented in terms of how many screens we actually have, everything from homegrown applications to international applications to your normal mainstream applications that are there. In addition to data, we also have -- in addition to data on screens, documents, we have hundreds and thousands of thousands of documents. If you go to our IR website, we actually posted, I think, two great demos. We had one on our earnings, but you can see one that's there. The IRS, we can understand tax forms in a really differentiated way. That's why the IRS commissioner is standing on stage with UiPath talking about how our platform is their productivity tool as they go forward. Plasma screening. When you do blood banks, to be able to read and to be able to assess blood, you lose 20% of donations just because of false reads. That -- we're able to start doing those types of use cases. And as we're doing them, we're able to capture that data so we can scale that across health care. Unidentified Analyst Makes sense. And one thing that we bring more and more is the breadth of AI decisions can sometimes slow down decision-making or it just takes longer for customers to decide what they actually want to do. When you're in those bake-offs, do you have a NorthStar metric of time to value, productivity savings? Like what are customers evaluating you specifically? Ashim Gupta Our save is the most common metric that's there that can be translated into dollars very easily. And then from there, it can either be they can reinvest that savings into capacity or into productivity. That's their choice. The second common metric that you see is data quality. So, one thing that happens is humans tend to make more mistakes, right, than rules-based and agentic-based type of processes. So, when we are able to do that, we're able to infuse those types of capabilities, and people are looking at just general data quality and capacity that we're creating for their workforce. Unidentified Analyst And so Q1 and Q2, you kind of talked about this focus on shifting away from quantity of customers to more quality of customers, focusing on landing bigger, stickier, higher-quality customers. How has that impacted your go-to-market motion? Are you seeing more direct, more partner? Any sort of learnings as you're going through this? Ashim Gupta Yes, great question. So, we have 10,800 customers. We did have our first quarter of new logo of growth, like net customer adds that are there. At the same time, we don't treat that metric in the same way we don't degrade the metric depending on the trend. Our focus is not on quantity, and what I define as quantity is we can go out and get 1,005-person law firms, right? But they're going to be high cost to acquire and they're going to have limited propensity to scale or to expand. Our focus is going on great logos. Earlier this year, we landed Workday. That's a logo that is incredible for us to be able to go after, right? Has a lot of large enterprise, has a lot of value. They're using their own internal applications, but they still need UiPath. That speaks to our AI and our differentiated capability that's there. That's really what we're focused on. We do love our partner ecosystem to go and bring you UiPath's platform to as many of the smaller businesses as possible. And that is an area when we're talking about execution that we can continue to do a better job of giving a better partner program and having a more coordinated strategy, which is one of the items that we're working on. Unidentified Analyst Makes sense. And one thing you've talked about is this call it, platformization, is a key driver of your NRR. Essentially, the ability to not just sell one point solution, but multiple suites of your products underneath. Where are we at in terms of penetration of multiple suites within customers? And then, how far could this go? Could this be every single customer adopts every single platform? Or kind of what's the vision there? Ashim Gupta Yes. So, we really believe that end-to-end automation is a differentiating factor. There are some people who have RPA, but they don't have document processing. There are people who have document processing that don't have test automation. We have everything in our platform. There are people who have Process Mining that don't have RPA, right? We have Process Mining. We're listed in Gartner, Everest, Forrester as leaders in many of these categories. To answer your question specifically, the penetration is improving. When you look at our top -- our 1 million-plus customers, we have 291 customers that have $1 million more of ARR. That is growing 15%. The majority of those customers use multiple elements of our platform already. Our $100,000 cohort, customers with $100,000 or more, that's greater than 2,000 customers. They're starting to just use more of our platform. And then, we have a tail of customers that we are moving along the chain to be able to use multiple areas of our platform. And so that is a key strategy for us. Unidentified Analyst Makes sense. And one thing we're hearing is essentially, these like transformational budgets are where we're seeing pressure. So, customers are willing to say, "Hey, we want to do the document processing, but we're going to maybe stick there for a little bit longer." Are you seeing that in your sales cycle specifically, where it's -- the point solution land is still very similar, but you're just not seeing that same kind of acceleration of expansion? Ashim Gupta No, I don't think so. I think it's really just around deal timing and deal scrutiny overall. I will tell you like where you look at our pipeline, our win rates continue to be very high. So, it's not like some comes and says, "Here's a $0.5 million deal, but I can afford $100,000." That's not really what it is. It's a $0.5 million deal. Well, we now have 50 people that are going and having an opinion on the future. We love UiPath, and we've just got to take it through the process. That's a difference that I see today. Unidentified Analyst Got it. And one debate, I've heard a couple of investors having and may not pertain to you as much, but there's pushback of there's a big IT outage and because they were essentially all on one IT vendor, their whole platform went down. And so, there's some debate is does that create a less willingness to say, adopt a full suite offering, and they'd rather stick with point solution? Ashim Gupta Cyber, yes. Like -- I shouldn't say that actually. In cyber, I don't know because I'm not a cyber expert. For me, what I've heard from customers is that our automation platform works end to end. The openness of our architecture allows them to be able to integrate different aspects of their own platforms and their own staff within us. And then the third piece of it is when you just look at where we are, our cloud disposition, we're a cloud-first company, but we have -- we support on-prem, hybrid and cloud. When you start looking at it that way, many customers have a lot of flexibility already. They don't feel locked in with UiPath. Unidentified Analyst Makes sense. And so, kind of getting to the new products that you announced here in Q2. It was GenAI capabilities, specialized LLMs. And then Autopilot, I feel like was the big one. But help us understand what are you most excited about, about the new products here? And then how should we think about the contribution of these new products to revenue and kind of back up? Ashim Gupta So look, just to start with, what's the total cost of ownership? If we all agree that ROI is a key element of it, total cost of ownership is your base of an ROI discussion. 80% of the cost is development. So what Autopilot does is bring natural language, again, to Copilot or, again, to many areas so that you can develop automation faster. That's kind of the first piece. The second is, it enables democratization. It doesn't mean democratization of just development, democratization of usage. So if you look at some of the demos that we have on our website, now a business user can access an automation that has been built in a way that it feels like an application that they're interacting with. That's another area that autopilot really helps because it can prompt you, right? An example is, send me my travel documents. Can understand that. You can give you a front end using our autopilot capabilities, that's able to be there. What is great is we've also put in the Microsoft Copilot as a plug-in. We don't compete against Microsoft Copilot. Microsoft Copilot is for Microsoft. UiPath Autopilot is for our platform. But there's tons of use cases where they work together, and that's another reason why Microsoft's actually called us their preferred automation vendor. Unidentified Analyst Yes, and that makes a ton of sense. Maybe on -- you talked about in Q2, where the innovation in the pipeline is going to be accelerating here as you focus on more products. As we think about these coming to market, are they going to be more focused on how do we cross-sell and upsell the existing base? Or should we expect some of these adjacencies in GenAI to help you land that new customers and adjacent offering? Ashim Gupta Look, I think first your road map is fundamental for you to be able to continue to land new customers and to expand, and we feel very well positioned there. The second piece of it is, we're really on our early products. Our first focus is adoption. Like one of the feedbacks that we've gotten from CIOs and CEOs is like we're getting nickel-and-dime for every feature that's coming out of here. So, I think there could be short-term gain with long-term loss. Our goal is to really go drive adoption, make sure there is good value in that area, and then be able to decide what is the best monetization engine that we have there. We see everything -- the reason why we're investing is we do believe there is an ROI for us. It's a question of how do you extract it? More automations going in, more documents getting processed or direct monetization? As long as we get adoption, both of those can be true. Unidentified Analyst Makes sense. And you brought up a point that we hear a bunch of investors is the Microsoft dynamic. Essentially, this has always been, call it, a Bogeyman in the space of how are you competitive with them? How are you coopetition with them? So, help us understand where you compete, why you see them as a competitor or maybe not as a competitor and how you kind of shape that up? Ashim Gupta So first, I want to -- let's say at a couple of like kind of based features. Microsoft sit on stage with us and said, we are their preferred-out automation vendor. They are -- they take to their marketplace, and they retire, they incentivize their sales force to support our sales. That's not an outright competitor in any shape or form. Where Microsoft does have capabilities that does compete with us is in personal productivity. So, let's define the two of them. Fortune 500 health care company. Personal productivity has download by e-mail attachments and store them in this folder. Enterprise-grade productivity is, take 162 process -- a step process for processing to clean that costs thousands of dollars for each transaction and automate that workflow going through the system. Microsoft competes on Area 1. They do not compete on Area 2 on the claims processing as an example. Second, the majority of our ARR and value is in that area, too, right? That isn't there. So that's kind of the way that I would frame it. Now Microsoft comes in and they will go through and they will look at that productivity space. We can also do the same thing. Is that a high-value area for us? No. So, we're open to that being more of a competitive area. Frankly, it's the enterprise-grade productivity that has driven our growth and will continue to drive our growth. Unidentified Analyst Makes sense. We do have 5L minutes left, I'll open it up and see if there's any questions out in the audience. Unidentified Analyst [indiscernible] How are you guys thinking about incentivizing yourself to maybe drive that cross-sell a little bit better [indiscernible], funneling activities or [indiscernible]? Ashim Gupta So, the first piece is we do incentivize them on net new ARR. And like I said, if the majority of your 1 million-plus customers are formed through multiple in some of the platform, sometimes the smell itself will lead people to the kitchen, so to speak. I don't have to incentivize them further. At the same time, we do measure them. So, we put the metrics out in the -- both at like a different territory levels. Just talk about what is your cross-sell goal that is there? We have the same discussion from a cloud standpoint, right? What we don't want to do is, we want people to be selling the platform, but we don't want to artificially be putting capabilities into an account that are not going to get utilized that will lead to down sell. So net new ARR is still our fundamental metric, but providing visibility and tracking on how is our pipeline progressing, that's the second area. Unidentified Analyst Maybe sticking with go-to-market for a second. Your AI suite has fundamentally changed. You're seeing a bunch of innovation there. How do you think about your use case or suite that spear in your go-to-market? Essentially, what are you landing with customers most often? And what resonates to get those kind of new customers onboard? Ashim Gupta Look, RPA is still the area that people will go to. I think one of the negatives of the AI generation as it feels like anything that was -- any other technology is considered old school. And I don't think that's true. If you look at Gartner's latest market projection, RPA is going to have a 17% CAGR over three years. That's a great healthy market to be going after that shows the need and the value that is there. So, I think the first thing is RPA is a good entry point for many of our customers. The second thing is SAP. So, we've talked about our SAP partnership. If you look at different customers, and I can't name them publicly, but we're already seeing traction we're in their S/4HANA migration to keep a cleaner core, let customization of their cloud instance. And by helping with our using our test automation platform, they're able to do that. That is a great engine in my mind of attracting new customers and new capabilities. And the third is test suite. So testing is a very low barrier to entry for us. It's what our software already does. We landed the largest test suite deal of the in our history in this quarter. Really going into Salesforce testing. So, testing that company is Salesforce instant and some of their ERP instances as they're doing migrations. Those are three great avenues for us. Unidentified Analyst Makes sense. And maybe as a last question here, you still have a bunch of cash on your balance sheet. You just upsized the repurchase kind of -- how are you thinking about your capital allocation going forward? Is there any sort of appetite for large transformative kind of deals? Or is this going to be return capital to shareholders? Ashim Gupta On the M&A front, I think we're going to be opportunistic, and we'll look at tuck-ins. We've demonstrated that. I don't think we feel like we need to do it to prove a point. I think it's got to be real value at the right economic value, and that's the discipline that we want to drive. In terms of the share buyback, we're really pleased with the progress we've made, almost completing -- almost doing 34 million shares, bringing that back. That shows a real commitment. As you said, we -- our Board has [indiscernible] $0.5 billion of an increase. Look, we look at our stock and we're going to be opportunistic about it and return -- do the best thing for shareholders as well as for the Company, in total. I'll end that with, again, $1.5 billion, growing 19%, $325 million in cash generation. And we still are saying there's more efficiency to be had, and there is more growth in our minds that can lead from better execution. That's a great company to invest in we'll be the first to invest in. Unidentified Analyst Yes, makes a ton of sense. Well, I think we're up on our time. So Ashim, thank you so much for your time, and thank you all for being here and listening.

Fiverr International Ltd. (FVRR) Management presents at Goldman Sachs Communacopia + Technology Conference (Transcript)

Okay. So in the interest of time, we're going to get started with our next one. It's my pleasure to welcome Fiverr to the conference. We have Jinjin Qian, EVP, Strategic Finance. Jinjin, thank you so much for being part of the conference. Okay. All right. So I think to set the table for those in the room who may not be familiar with the story, maybe talk a little bit about the journey the company has been on both pre-IPO and through its life cycle as a public company, just in terms of level setting, what the company is focused on, what you've been building and where the current state of the company sits right now? Jinjin Qian Sure. Yeah. For those who are not familiar with us, so we have been around for over a decade now. Our current founder, CEO, started the company 14 years ago with the mission of making freelancing services as accessible as you purchase something on Amazon. And we started with only eight categories. Until today, we cover pretty much everything you can imagine in the digital services with over 700 categories. And yeah, we went public in 2019, and since then we've been consistently growing. The company is three times as large. Revenue-wise, turned profitable and right now, kind of a few kind of strategic focus of the company is, one, going up markets, continue to drive bigger spend, be more relevant for larger customers. Second is the investment around AI, both platform-wise as well as category-wise. And then lastly is to expanding the platform into kind of more diversified revenue stream, more value-added products, which continue to be a growth driver for us. Eric Sheridan Maybe just following up with that with one other big picture question. You're still very early innings in what could be a very large market opportunity when you look at that. When you talk to customers and the team tries to think about what frictions remain, when you think about product and client education, what do you guys see as the key unlocks that can capitalize on that potential, penetration rate opportunity? And maybe it goes back to some of what you said. But just in terms of what do you need to build and how the market needs to evolve to actually experience that penetration rate opportunity? Jinjin Qian Yeah. I think we're in the very early innings of this market. I think freelancing remains a very old school business. I think over 90% of the freelancing is still done in offline fashion, through word-of-mouth, through your individual network. I think what we've experienced in the last few years with COVID, definitely accelerated the awareness and adoption of this market, but there's still a long way to go. I think there's a lot of -- I think SMBs are the first to adopt this because they are more cost conscious and they're more nimble. I think larger organizations, I think there's multiple decision makers within the company. There's a lot more processes and they're a little slower to adopt this. But we see this as very similar kind of a going upmarket trajectory where larger companies are more and more open to taking the flexible workforce as a very integral part of their workforce strategy. Eric Sheridan Okay. We'll come back to some of those topics in the big picture, but just maybe to level set, one of the enduring conversations we've been having on earnings calls over the last 12 months has been the current demand environment you find yourself in. So level set on what were the key messages coming out of Q2 earnings on the current demand environment that the company finds itself in and what you might be watching for what might improve that demand environment going forward? Jinjin Qian Sure. Yeah. So overall, it is a challenging macro, and we talk about overall SMB sentiment being relatively weak. The overall hiring environment, especially professional staffing is down double-digit year-over-year. So it is challenging. That said, I think there are a few things. I think one, we are doing a number of things to generate growth catalysts even under this macro, including our expansion into the professions and longer-term engagements, including what I talk about like expanding into product -- value-added product revenues. At the same time, like hopefully, with interest rate changing that will lead to some of the pickup in the SMB sentiment. If that happens, definitely, that will help our business. I think historically, if you look at the macro data, I think temp staffing usually leads full-time staffing, leads the overall GDP cycle. So if the GDP cycle starts to turn, like I think we will be the first one to kind of see the uplift on upswing. Eric Sheridan Okay. Maybe one follow-up on this just in terms of cohort trends. In terms of, again, key messaging coming out of Q2, things that you're going to be watching for how those might change around elements of buyer frequency, retention, spend per buyer and sort of level set us there on what current trends you're seeing and what you might be monitoring probably those might change in the forward periods? Jinjin Qian Yeah. I think there are a few things. I think on the spend per buyer versus active buyer, I think we've made the conscious choice in the last few quarters and years to really focus on higher-value buyers. These the segment of buyers with better engagement, better retention longer term. And in the current macro where overall demand is not very strong. I think leaning into the product is really focused on that segment gives us the ability to be more efficient and really growing the spend, and you've seen that in the growth of spend per buyer. Very in the -- very robust and consistent manner even under this macro. So that strategy is working really well for us. And I think the second is we believe our leaning into the complex and longer term going forward, will further allow us to grow the spend. So looking out for the rest of this year and going forward, I think you'll continue to expect growth in spend. I think we have a long runway for that, and continue to see also take rate expansion to continue. Eric Sheridan Okay. Generative AI has been a sort of controversial topic around this space because initially, there was a view that Generative AI might be quite disruptive. And then you as a company have given a lot of examples where people needing more AI skills can actually be a driver for the business platform. Talk a little bit about the journey the company has been on, around Generative AI and how the founder is sort of putting the company sort of aimed from a strategic standpoint to capitalize on AI as a theme? Jinjin Qian Yes. It's a really exciting time for us. I think one is as a horizontal marketplace that connects talent to help filling skill gaps, I think GenAI and the huge technology wave really creates that opportunity for us to lean into the technology, helping SMBs to get connected with AI expert, which is a scarcity today. And for small companies to be able to build customized GPT ads to leverage GenAI technology to strengthen their marketing capabilities without hiring full-time and can instantaneously just come to Fiverr and use those services. So we've seen AI services grow tremendously over the past 12-plus months. Second is leveraging AI throughout the platform. We've launched Neo for a while now, and Neo is becoming almost like a Copilot throughout the funnel, whether it's top of the funnel search, being on the side to help buyers better -- get matched with longer-term search queries, where sometimes it's hard to express all your needs in a search bar. The Neo can pop up where you can actually have a more natural language dialogue, and Neo can parse out that information and get matched with the underlying metadata and provide you recommendations. So that turns out to be a lot more intuitive, especially for complex projects and buyers who are new to the platform. And we're seeing wherever Neo touches, the conversion rates really make a difference. We're also having Neo impacting how brief it's written and gets sent over to sellers, how reviews are getting written in a more longer form and more quality reviews, which we will now help conversion from the top of the funnel. So, Neo continues to be a key investment for us. Eric Sheridan One of the questions I get from investors, I'm not sure there's a great answer to this, but just how to think about Neo scaling and becoming a greater portion of the business in the next 6, 12, 18, 24 months. How should we think about what holds that back or how many different aspects of the platform Neo can be aimed at over the longer term? Jinjin Qian Yeah. I think the signals we've seen so far is existing users who know the platform well tend to take longer to adopt. They stick to what they know and they're very comfortable. But new buyers really find Neo kind of being a game changer, help them navigate to the relevant products, especially now we have many different offerings of Fiverr from the longer term to the short term to the brief and match, things like that. And we believe, down the road, we see Neo allow us to unlock the tremendous amount of data like on Fiverr platform. I think Fiverr is really unique in the sense that the entire transaction lives on Fiverr, right, like not only preorder, like after the order, the communications, the dialogue, the briefing documents, the draft, the edits, the comments and to the final delivery, all lives on Fiverr. So we have this whole wealth of data on Fiverr, frankly, it didn't get all its full potential in the past. Now with Neo, it's almost like a crawler going into this whole information and then Neo can really digest and help us understand who can do what for whom, and that will unlock a lot of the opportunity for us, especially as we go into complex projects where hiring becomes multidimensional, more with tangible and intangible input, I think Neo really is great there. Eric Sheridan Okay. Great. You guys are always putting out a pretty heavy cadence of product and strategy. You did a winter 2023 release into the summer 2024 release. Can you just maybe level set for the audience about some of the key products and initiatives that were launched around those releases? And how you think they fit into the broader strategic goals of where the company wants the platform to go longer term? Jinjin Qian We've already talked about Neo, which is obviously a big part, starting from beginning of the year and throughout this year. This is an investment. I think another exciting thing for us is we launched this professions catalog just a month ago. I think historically, Fiverr is -- you can do a well-scoped project on Fiverr, but longer-term engagement on Fiverr is difficult because if you don't have a well-defined project at what time, deliver what, historically, you can't really purchase that on Fiverr. With the professions catalog, now one -- you can engage with a freelancer for like a few months or even like 6, 12 months engagement where you can pay from an ongoing basis, monthly by monthly. Second, it allows us to open top of the funnel traffic for higher related keywords that historically, we don't really compete on. So we are starting to really build up these professions catalog pages and work on the SEOs. And hopefully, we'll see some of that throughput next year. Eric Sheridan Okay. one area if you look back over the last couple of earnings reports has been you continue to produce upside in terms of take rate. Maybe talk a little bit about, obviously, there's things like Promoted Gigs, Seller plus value-added services. What are the drivers of some of the take rate dynamics that you'd like to highlight? And broadly, how do you think about take rate continuing to evolve in the years ahead? Jinjin Qian Yeah. We included a chart in the recent shareholder letter to breakdown kind of the take rate component. There is about 26% of the transaction-related commission rates, and that has been pretty consistent and stable. And really, the driver behind the consolidated take rate is from those value-added products you mentioned. I think advertising the Promoted Gigs is one thing. We continue to expand the presence of the product, not only just on the search and browsing pages, but also in the search bar, as you auto compete or complete, there is a few gigs down there. As buyers and seller communicate next to the inbox, there's a few gig slots for you to inspire you for the next purchase. So products like this allow us to continue to expand the advertising product. There's also a Seller Plus, which is a seller subscription product allows you to get access to advanced analytics, dedicated success manager, which is very popular among our sellers. We also initiated a kick-start program, which is kind of a part of the Seller Plus, but really cater towards new sellers. Because right now, like we see great adoption of Seller Plus among experienced sellers who do a lot of volume on Fiverr. But for new sellers, we're trying to bring more benefits specifically to help them jump start their business on Fiverr. Lastly, I think most recent earnings, we talked about the acquisition of AutoDS, which is a drop shipping platform, great platform. We see a lot of synergies like drop shipping related categories are some of the fastest-growing categories on Fiverr because of e-commerce sites like SHEIN and Temu and the growth of TikTok like drop shipping is becoming super popular. We have over 160,000 drop shippers who come to Fiverr and purchase services. So with this acquisition, we see lots of cross-sell opportunities. We can sell the software solutions to these drop shippers that are already on Fiverr. We can also sell Fiverr services to the AutoDS subscribers on the other hand. So these are all different ways for us to really grow the take rate and bring more values to our community. Eric Sheridan Maybe just one following up there and then maybe I have another one that follows up on take rate. But in terms of AutoDS, how is that emblematic of the strategy around M&A overall? When you've done M&A, when you've chosen inorganic growth versus building it yourself, maybe talk a little bit about what the company's decision path is there? And framing up sort of a strategic viewpoint around M&A in general? Jinjin Qian Yeah, definitely. So I think our overall M&A is -- there's a few areas like we're focused on. One is continuing to doubling on the categories, category expansion and doubling on the categories is growing faster. I would say AutoDS is part of that and great synergy. Second is in terms of tech tuck-ins, like obviously, AI is a big topic. But in general, like businesses that are -- allow us to strengthen the underlying marketplace dynamics would be another area. International expansion, that's another area. I think overall, especially in this market, we are very disciplined on M&A. I would say it has to be accretive overall to the business with great growth potential would be like a focus, I think. And just to say M&A is just part of our overall capital allocation, right, with M&A alongside our organic investments on the product and services alongside the buybacks and other things would be overall capital allocation probably. Eric Sheridan Maybe just coming back to take rate, if the environment were to improve from a macro standpoint and volume were to pick up and you would see both buyer growth and buyer cohort velocity on frequency, how do you think about price elasticity and take rate in an environment where volume might be better? Could there be a coiled spring in the business that could have a multitier effect on the potential for revenue growth? Or are there areas where maybe you would go a little slower on value-added services or price because you were in an environment that might be quite stimulative of volume? How you think about the interplay of a better volume environment versus a better take rate environment and price elasticity? Jinjin Qian I think it's less of a kind of a supply demand elasticity in the sense that I think the take rates upside that you've seen is really driven by product expansion, rather than really squeezing economics from the buyer sellers. That said, I think if overall macro comes back, there are definitely going to be more leaning into driving that demand, capturing that demand. So in terms of a product strategy roadmap like allocation, that perspective, I would say there will be more kind of going into capturing that demand. But I don't think -- I think the take rate like we command today is really because the product that we built that really helps the buyer sellers, like they don't really have to purchase, right, like the Promoted Gigs or the Seller Plus. It is -- they find it useful. So I think in a time when the overall macro is relatively soft, I think we accelerated some of the roadmaps on Promoted Gigs and Seller Plus and allow us to really grow that piece of the business. Eric Sheridan Maybe sticking with that theme, given what you know now about the demand environment, what are sort of the key messages from the company in terms of thinking about margin progression through the remainder of this year and into next year? Jinjin Qian Yeah. We laid out our kind of three-year target. We always said our long-term EBITDA margin is going to be 25%, but this is the quarter we kind of put a 2027 target on it. I think we feel very comfortable with the target. It will be more of a kind of linear kind of path towards that goal. I think -- for us, it's -- growth is always a priority. That said, under this macro like we're kind of very pragmatic about driving margin expansion and believe when the macro actually turns, then we will be at a very strong kind of position where we can go back to strong growth while we have a very solid bottom line profile. I think in addition to the 25% margin target, we also laid out a three-year kind of free cash flow target. We see a very tangible path of driving free cash flow and free cash flow per share for the next three years. Even with some macro uncertainties, fluctuations, we believe there's multiple ways of getting to that number with multiple levers for us to pull. So we believe the numbers we laid out is kind of not based on which we think is very tangible. Eric Sheridan So just sticking with that, if the macro environment were to improve, and you've laid out the sort of more linear margin trajectory going out to 2027, should we think about incremental outperformance in the business being reinvested in support of that growth? Is that the right way to think about the interplay between those factors? Because you've been very adamant as a company that when growth comes back, we want to invest behind growth or growth first. I just want to understand how that would dovetail with what you've talked about now in terms of a multiyear margin trajectory? Jinjin Qian Yeah. I think if -- I think -- I mean our investments always very data-driven discipline, right? Like if macro is stronger, like there's definitely going to be using that to invest into growth more. But at the same time, there is more ROI to be driven from. So from a margin perspective, I don't think margin will get depressed if macro is stronger rather like we will see continued margin expansion with revenue upside. The other side, if macro turns out to be more volatile, there's definitely lever to be pulled to deliver that margin expansion as well while continue to managing the macro environment. Eric Sheridan Maybe just one follow-up there. So if the demand environment improves and there's growth to be invested in, is the primary lever on the marketing side of the equation? It's product platform that's all being put in place irrespective of the macro environment. So it's really just about leaning in on the marketing side against what you see on the advanced side? Is that the more causal relationship? Okay. You obviously are generating a lot of free cash flow. You've done a buyback now. How are you thinking about capital allocation priorities going forward? How do you think about the free cash flow you'll generate? And what management's broad message is on what's the priorities of use of that free cash flow? Jinjin Qian Yeah. I think we laid out there are kind of four priorities. Number one is investing in the product to drive growth and innovation. Number two is optimize balance sheet. We have a convert coming out due next year. So there's different options to that. Obviously, the default is kind of using the cash we have enough to cover it, but we are also evaluating other options there. Third is buyback. We announced our first ever buyback in April of $100 million, and we just completed it. So buyback will continue to be part of the capital allocation mix that, that we think about and lastly is M&A. I think overall strategy is, we feel like we have a very strong -- we have over $700 million in cash, and we can kind of invest in growth while drive shareholder value. And I think part of the reason laying out the free cash flow target and free cash flow per share target is to have a framework that I think use of the balance sheet is going to be one way for us to deliver that consistent growth in free cash flow per share for the next few years. Eric Sheridan Got it. Okay. We only have a few minutes left. But in terms of all we've talked about so far today, maybe put a finer point on what are the key priorities on both the investing side and the operating side for the management team as they think about exiting 2024 and going into 2025? And how do you think about some of the biggest potential levers for growth over the medium term? Jinjin Qian Yeah. I think from a managing the business side of things, I think it's a lot less volatile than the market itself. I think our strategy has been very consistent. If you look at our past since IPO, I think we've laid out the mission whether it's going up market, whether it's investing in the technology. It's been very consistent. I would say it's -- we're going to continue executing against that. I think a few priorities we mentioned, one, continue to grow going upmarket, which includes leaning to complex services, leaning to longer engagement, leaning to the Pro side of things. We didn't really talk too much about Pro. But that going upmarket continue to be the case. Second priority will be AI. We spent some time there. And then lastly is to drive revenue diversification, drive the -- expand the product portfolio within the value-added products. I would say that will be kind of some of the product priorities going to next year. And then at the same time, we'll be very -- stay very disciplined and drive bottom line upside. Eric Sheridan Maybe I will ask one follow-up, even though that was kind of the last one I wanted to hit. But, Pro, you talked about it there. In terms of building scale on the Pro side of the business, what do you guys see as pretty critical I mean either the investment side or the execution side to achieve success on going upmarket? Jinjin Qian Yeah, I think we have kind of been doing this for about two years now, and I think we are seeing very good signals, and we kind of try different models. But what we find most effective and efficient is what I call farming, the high potential users from the very wide top of the funnel that we enjoy. And the Pro team is really good at customer segmentation and identify customers with potential than providing high touch in combination of product, whether it's team, whether it's a better catalog, whether it's brief and match like better matching algos to really drive more usage. I think on Pro, on average account their spend three times to five times more compared to broader marketplace. So we find that very successful. So with the recent summer release, we also started launching out a more comprehensive loyalty program for the Pro, giving some of the 5%, some of the incentives for Pro. Think about 5% is almost encouraging buyer fees for the next transaction, right, for the customer. So we really believe there's a lot of potential there. Like, we surveyed our customer, right, for small business they spend at least $1,500, for a medium business they spend at least $15,000 a year on freelancing services compared to our current spend of a couple of hundred dollars, there's huge potential there, and we're just scratching the surface. So I think we really believe that, that is going to be a strong growth driver. I mean you see it in the spend per buyer metric over the past few years already. But that will continue driving the growth. Eric Sheridan Okay. All right. I think we're going to leave it there with a few minutes left. Jinjin, thank you so much for being part of the conference. Please join me in thanking Fiverr for being part of the conference this year.

HP Inc. (HPQ) Goldman Sachs Communacopia + Technology Conference (Transcript)

Great. Well, welcome to the HP Inc. fireside chat at the Goldman Sachs Communacopia and Technology Conference. I have the privilege of introducing Enrique Lores, CEO of HP. Enrique has been in HP for nearly 35 years. And prior to taking over as CEO in 2019, he served as President of the Printing business, helped to architect the separation of the Hewlett Packard company in 2015 and held multiple executive roles across the organization. My name is Mike Ng, and I cover hardware here at Goldman Sachs and we have about 35 minutes for today's presentation, inclusive of investor Q&A. Before we get started, I just want to read off some disclaimers. Today's discussion includes forward-looking statements that involve risks, uncertainties and assumptions, which are further described in HP's SEC filings, including HP Form 10-K and 10-Q. HP assumes no obligation and does not intend to update any such forward-looking statements. For more information, please visit HP's Investor Relations web page at investor.hp.com. Thank you so much, Enrique, for making yourself available today. Yes, of course. So HP is a market leader in PCs and Print's with a very broad portfolio of solutions for consumer and commercial buyers. Could you just give us an overview of your vision for the company, its key priorities as well as recent initiatives that it's investing in? Enrique Lores Sure. And again, thank you for the time. I think as you said, we are the leaders today in two large categories, Printing and PC. And where we see the future is really about how do we integrate all the portfolio of products that we have to deliver consistent experiences to customers to enable hybrid work. We think that in the future, the way of working is going to be hybrid, and hybrid means spending some time at work, sometime in the office and being able to work seamlessly between both environments. And our aim is to -- by integrating AI into our portfolio be able to enable those experiences in a way that will significantly improve productivity for employees. That's the goal that we have as a company. Michael Ng Great. And last month, we just went through HP's fiscal third quarter '24 earnings. Since it's so fresh on investors' minds. I was just wondering, if you could give us a little bit of a postmortem on earnings. What are you seeing in the demand and pricing environment? When should we think about PCs and Print returning to more levels of normal seasonality? Enrique Lores Sure. It's a very long question, so I'll try to cover all the elements. First of all, I think the most important thing of earnings last week or that the company returned to growth. And we have been not growing for a few quarters now. And the fact that we were able to grow is probably the most important thing. Growth was driven by PCs, mostly by commercial PCs, which is what we are expecting and easily shows the fact that the PC market has stabilized, and we are starting to grow again, which is the expectation that we explained at the beginning of the year. We expect the PC market to be to slightly grow in 2024 and to grow more in 2025. On the other side, we shall continue to see decline on the Print side. The decline continues to be smaller, so we declined that now than we did a few quarters ago. But it's true that the print market didn't grow as much as we were expecting. We were expecting it to be flat through the year and now we are expecting it to slightly decline. But the combination of both, we still drove growth. From a regional perspective, we saw fairly consistent performance in Europe, in the U.S. and in many parts of Asia probably where we saw the biggest aviation to the numbers were China, where we continue to see significant decline. And on the other side, we saw significant growth in India, which we see as a future of future. As a source of future growth in the future. Michael Ng Yes. And to be fair, the more sober outlook on Print wasn't just HP, but I think a lot of industry marketing analysts like thought something similar where print has been up to this point? Enrique Lores Yes. I think the overall market was expecting the Print market to be flat through the year. And I think collectively, we have seen this is not going to happen. We expect now it to grow next year, but in 2040, it will not grow. Michael Ng Right. Let's talk a little bit more about the industry PC market. To your point, we're beginning to see signs of stabilization, flat to slight growth this year, which is actually a very sharp improvement relative to what we've seen in the last couple of years. But could you expand a little bit more on your outlook for industry PC volumes over the next couple of years? What does refresh demand look like in -- and PC's and et cetera? Enrique Lores So we think, as I was mentioning before, that growth is going to continue in '25 and beyond. In fact, we expect the market to grow in '25 more than it will grow in '24. And this is really driven by multiple things. First of all, there is a large and aging installed base on PCs. Many of these PCs were bought during COVID and now we are four, five years after they were bought, and they will have to be replaced. Second, we also see an opportunity driven by the Windows 11 refresh that is only starting now. And this is what is behind some of the strength that we see on the commercial side. Microsoft has announced the day that they will start discontinuing their support from the previous versions, and this always ties the replacement and upgrade. And third, some this year, more in '25, more in '26. We think that the introduction of AI PCs, especially a software vendors will start taking advantage of the new functionality and new capabilities. This is going to be also an accelerator of demand on the PC side. So these are the different factors. In the short-term, what we see is clearly demand in the commercial side picking up. We started to see that in Q1. In Q2, we saw this in Q3, and we expect it to continue in Q4, while consumer is specially, we think about normal seasonality, slightly below normal seasonality, we continue to see a softer demand on the consumer side than what we see in commercial. Michael Ng Great. And I want to hit all of those summary points in turn. Maybe just starting to talk about the installed base, right? When I look at the installed base from 2014 to 2019, I think the PC installed base had declined a little bit each year. There was obviously a big growth during the pandemic. What's the right way to think about the shape of the installed base curve in the future? Ours -- a lot of the new systems that were put into place during the pandemic, will those stay in place? Or will the installed base actually decline over the next couple of years? Enrique Lores I think if we think about the combination of factors I mentioned before, Windows 11 get the aging of the products, the introduction of new capabilities with AI PC, they are going to be driving a refreshment of the installed base starting in commercial, but also having an impact in consumer. And this is why we think this is going to be a source of growth for the next years and why we think the market is going to continue to expand. If we think about the total size of the PC space, we still see many countries where there is a lot of growth where penetration is very low. So this is another factor that is going to be driving growth in the coming years. If we think about total numbers in the globe, we think there are at least around two billion people that don't have access to computers today that we think we'll have in the next three to five years, and that's another source of growth of the category. Michael Ng Great. And one area of strength that you called out was commercial, right? Two consecutive quarters of growth in commercials after several quarters of declines. What are you hearing from your commercial customers in the conversations that you're having? What does that tell you about the health of overall enterprise IT spending? And is this commercial momentum sustainable? Enrique Lores We think the momentum is sustainable. We think we are only at the starting phases of the refresh, both because of aging and also because of Windows 11, both of them are just starting. When I look at the variables that we use to project the future and what is going to be the performance in the coming quarters. For example, the size of the opportunities and the size or the funnel that we have. Funnel now is significantly bigger than it was a year ago and tells us that really the opportunity is still ahead of us and that we are going to see growth -- solid growth in the commercial side in the coming quarters. Michael Ng Yes. And based on conversations that I've had with investors, it feels like the Windows end of life is a hard line, right? And it feels like there's this cold spring of replacement demand that will happen irrespective of when it starts. Enrique Lores And as part of the funnel of opportunities that we see, we track which ones are driven by Windows 11. And probably a couple of quarters ago, we started this to start growing and we expect this to continue to grow. So this clearly confirms that the opportunity is there. And if we look at previous cycles, clearly, the opportunity always accelerate when Microsoft announced his take and the pricing of the new support, which has happened during last quarter, and therefore, this is going to be driving demand in the coming quarters. Michael Ng That's great to see. Let's talk about the other side of PC demand, which is on the consumer side, which has been a little bit more mixed. We haven't seen a sharp inflection yet. I think there have been 12 consecutive quarters of decline. You'd think we'd be approaching the bottom. But why do you think consumer PC demand has been a little bit slower to recover? And when should we expect that growth to return more meaningfully? Is it going to be AI PC that's going to be that new product innovation that drives that demand? Enrique Lores Yes. First of all, let me kind of share the split. Our business is close to 75% commercial, 25% consumer. So for us the Commercial PC business is way more relevant not only in units, but especially in pricing where we see higher prices, higher ASPs and therefore, also better margins on the commercial side. But going to consumer, I think it's a combination of multiple things. One is overall consumer spend in hardware categories has been soft. And PCs are just one more element of where consumers are spending money. And we think this is probably the major driver of it is not an area where consumers have been spending their money, and this has had an impact on demand overall. At some point though, we think refresh will have to happen. For similar reasons, both aging, but also we think that AI is going to have an impact also on the consumer side. And more and more applications will start taking advantage of that, whether it's in gaming or in other areas, this will drive demand. And we think it will also have an impact on in consumer. Michael Ng Great. Maybe we can shift gears and talk a little bit about AI PCs. I think the expectation is that AI PC shipments as a percentage of total shipment should actually be pretty modest this year. But should grow to 40% to 60% of shipments industry-wide over the next few years. Can you talk a little bit about how you expect AI PCs to drive unit growth? What will be the impact on ASPs? Are there going to be any specific software or features that AI PCs will enable that will help drive that adoption? Enrique Lores Yes. So let me start with the projections, and then I will talk about the value proposition. So our projection is that three years from now, AI PCs will be around 50% of shipments in the market and that they will drive between a 5% and 10% ASP increase of the total PC category. So very relevant in terms of both size and impact they will have from an average price perspective. AI PC bring three clear benefits over traditional PCs. First of all, is latency. Today, when you access one of the AI applications in the cloud, there is a delay between you asking your question and then you getting the response. This is very different when you run the model locally, and this is a strong benefit for customers. Second is cost, running these applications in the cloud, and this is especially relevant for business customers is expensive. If you run them locally, you don't have the cost of running all the compute calculations in the cloud, and it is has another significant advantage. And third, and especially for small and medium companies, the fact that you don't need to upload your data, you don't need to upload your data, you can run the model with your data locally. It's another significant advantage from a security perspective. So speed, security and cost are the three advantages that the AI PCs will bring. And what we need to do now is the hardware is starting to be available. We need applications to start taking advantage of that. And this is what we are driving. We are working both with a key software developers, but also with many small companies to make sure they understand the opportunity and they use and take advantage of it because this is what is required to really take advantage of applications that are already available, for example, our real-time translation, you can dialogue with your PC using whatever language you want to use. And in the other side, have someone used it a different language and the PCs locally will be running real-time translation. That's an application that we have today. Microsoft has many applications that are also starting to take advantage of that. And in the coming months, we are going to see more and more applications really bring into live the possibility that the AI PCs offer. Michael Ng Yes. We've only scratched the surface at this point. One other factor that... Enrique Lores And we -- sorry, we have said that for a while. Sometimes hype doesn't help. We have said for many, many quarters, the impact in '24 is going to be small. There will be more in '25, more in '26 and the adoption is following our cycle, sometimes hype helps, sometimes it doesn't. In this case, it's not helping. Michael Ng Yes. And if I could just follow-up on that. What are the gating factors to drive more AI PC adoption? Are we looking for more powerful chips on the processor side? Is it more on the application layer that you think is the gating factor? Enrique Lores Until now has been availability of product. We -- because there are AI PC and what we call next-generation AI PC. Next-generation AI PCs are only starting to be available, we made the first announcement in June with Qualcomm, and in July with AMD and shipments are only starting. And you need at least 40 TOPS. TOPS is Trillions of Operations Per Second in the PC to really show the benefit to customers, and these units are only starting to be available. And ISVs or software vendors are only starting to develop the applications for those. These are kind of have been the two -- have been the two limiting factors until now. Michael Ng Great. That's very clear. The other factor that you mentioned at the onset around things that are impacting PC demand is China. And there has been some noticeable weakness there, particularly the last quarter, can you just talk about what you're seeing in the region? Is it really just a function of weaker macro? Or is there something more to talk about there? Enrique Lores I think the biggest thing is weaker macro. When we look at and I'm sure you do much more analysis than we do in terms of what is the situation in the country. But when you look at the situation on real estate, the situation in unemployment, unemployment of young people, clearly, the country is going through a significant -- through a difficult period of time, and this is impacting demand overall, especially on the print side, in the PC side, we have seen declined above 10% market-wise, in both consumer and commercial, and this is really mostly driven by macro. Michael Ng Okay. And if you think globally, are there any differing trends as you look by industry vertical? Enrique Lores Well, there are some spaces where we have seen faster growth. For example, in the overall federal and government space across the world is where we have seen the fastest growth in Q -- last quarter. Grew -- they were growing more than 6%, so it's very significant growth. The next sector was enterprise. So large corporations that are really driving the refresh. We also saw significant growth about 5%, and then SMB, small companies grew less, but also grew between 2% and 3%. So there has been growth across all segments. And then in terms of verticals, we saw significant growth in the defense space, driven by all the investments that companies and countries are doing in this category, and this is probably one of the verticals where we see the highest growth. Michael Ng Okay. Great. And rounding out some of the discussions around Personal Systems, maybe we can talk a little bit about Poly. Poly has a robust video conferencing solutions offering. How should investors think about the growth opportunity for Poly? Does it simply correlate with what we're seeing in commercial PCs, or is it a more nuanced discussion on that? And where do you see the opportunity? Enrique Lores I think it's similarly in terms of where CIOs decide to do their investments. In the case of Poly, one of the most important businesses, video conferencing -- systems for videoconferencing rooms. And we have shared before, we've seen between 10% and 15% of the meeting rooms in the world have today a videoconferencing system. Because of hybrid work, we think this number is going to grow significantly. And this is really what is going to be driving one of the key growth opportunities for Poly. We have seen growth this quarter, and we expect to continue to see growth in Q4 and in the coming quarters. And we really see this as a great growth opportunity for the company. And it's also relevant not only from a financial perspective, but also from the opportunity we have to improve the experience to our customers. If any of us have participated multiple times in a video conference -- in a video conference, we know how painful the experience is, especially some people are in the room, some people are connected. So from an innovation and experience perspective, there is a lot of room for improvement, and this is why it also make us think that it will help us to differentiate our solutions going forward. Michael Ng Great. And could you talk about opportunities that you have to attach more accessories and peripherals to your PCs or your Poly sales? And how does that impact the financial profile of the segment, right? Because I think peripherals are higher margin. So how much room do you have there? Enrique Lores I think the overall attach opportunity continues to be a very good opportunity for us. During the last two years, we have made very good progress in some of the areas, for example, attaching services and this has been one of the drivers of better margin. And going forward, with growth in the commercial side, the opportunity to attach things like headsets or speakers or cameras is a significant opportunity. And this is why we decided to invest in this space, both in the commercial side and in the gaming side, because consumers spend significant amount of money in peripheral. And this was an area where we were underrepresented and now, we have some portfolio in both cases that will help us to drive growth. For example, something I have shared before is in the gaming side, gamers spend 3x more money in peripheral than they do in their PC. And with HyperX, we have now a very strong portfolio of gaming peripherals, which are margin accretive for us where we see growth opportunity by improving a touch. So it's a solid opportunity going forward. Michael Ng Excellent. Let's shift gears to Print, a segment that has been very durable, I think, with the margin profile that has surprised people for several years now. How would you characterize where the print market sits today? What does end user demand look like, if there are any comments you can make about commercial versus consumer? That would be great. Enrique Lores Sure. I think when we talk about Print, it's important to differentiate the different segments that we have in Print because in Print, we have three different opportunities. There is an opportunity in the consumer side, which is a market that has been declining for some time and a market where we have been driving a change of business model to compensate for the decline. And we have made very good progress reducing our dependency on supplies by shifting our model to subscriptions to services and by units that we call profit upfront, where we sell printers and supplies together. And in both cases, we have made good progress. For example, in our subscription program, we have now around 13 million subscribers that pay us every month for the option to get supply delivered at their homes. And this means these customers are more profitable or more accretive to us than traditional customer space, a big and important change in order to protect profitability in a category that is declining. Second category in Print is office. The office category went down through COVID as people were not in the office, and we are expecting that category to be flattish in the coming years. Declining in developed markets, grow in growing markets. This is the category where we have seen in '24, the bigger deviation versus plan. We were expecting it to grow in '24. It is not going to be growing and this is what is driving the defense performance in Print that we were expecting. And then the last category in Print is industrial, which is a market that is growing, we are growing in the market. We are the leaders in that space, and we see continued opportunity to grow in the coming years. So very different dynamics in the three sectors. Michael Ng Great. Maybe if we can narrow in on the comments around office. Which element kind of surprised the downside this year that led to the slower-than-expected growth? And do you see some of the fluctuation in the yen becoming more favorable to competitive intensity on the go forward? Or is it too early at this point? Enrique Lores I think what we have seen in the office side are from one side, we have seen less sales of hardware because I think companies have dedicated the right investments toward other areas, including PCs, where we have not seen a change, which is a positive trend is in terms of number of pages printed. We actually have seen usage behaving as we were expecting, which gives us confidence in the future because it's not that suddenly, people have stopped printing. The number of pages printed continue to be aligned to our expectations. What we have seen is a reduction of new printers being bought, which we think is temporary because at some point, also customers need to drive the upgrade. So that's a big change. And then the second, from a competitive perspective is what you said. Yen has been probably the weakest position versus dollar, it has been in a very, very long time, and this has allowed some of our Japanese competitors, which are the -- probably the larger number of competitors in the market to be more aggressive, and this has been driving prices down from a hardware perspective also in the category. Michael Ng And then on some of the subscription initiatives, incredibly successful. Instant Ink has done really well, 13 million subscribers to your point. But you've also been doing other things in terms of instant paper, big tank, which is one of the profitable initiatives. I guess where are we in terms of the adoption of some of these new products? How much more room is there to grow beyond the 13 million subscribers and then obviously, the profit upfront is slightly different? Enrique Lores Yes. We continue to see opportunities to grow our subscription businesses, driven by two things. One is 13 million is a good number, but we think we can continue to grow both by expanding into more geographies, but also by increasing penetration in some of the countries where we already have the program. But also, we see an opportunity to grow by offering additional subscriptions. And you mentioned paper, we launched the paper subscription about a year ago. It has been growing fairly fast. And we sell paper not based on price, but based on convenience. And what we have learned is that these subscription programs offer a significant convenience to our customers, and they are willing to pay a premium to have ink or to have paper delivered at home and not having to go and buy them. And only a few months ago, we launched the all-in program where we include the printer in the program and is starting to show us that the opportunity to add services and other subscriptions continues to be there. Michael Ng Great. And one area of consistent outperformance, at least relative to my expectations in Print over the last couple of quarters has been in industrial graphics. And it's not something that I had always thought of when I think about HP's printing business. But clearly, there's an opportunity there, and it's growing really well. I think there have been four consecutive quarters of industrial graphics revenue growth. Maybe you can just level set and talk a little bit about that business. How is it able to deliver such strong growth against the backdrop of what feels like an overall more sluggish like Print market? Enrique Lores Sure. And before I go there, one more comment on subscriptions. Another reason why subscriptions are important is customer satisfaction is much higher than in traditional model. So we measure that very carefully and we see that it has significantly high Net Promoter Score than any of our other businesses, which also shows the opportunity to continue to grow. Now shifting to industrial. We are very pleased with the performance of that business. And the growth is driven by two things. One is technology innovation, and we continue to accelerate to drive technologies that make printing faster and cheaper and to print in a larger number of substitutes. And this is really one of the key drivers of growth. And when we talk about industrial, we are talking about printers that are as large as this room. So printers that are five, seven, eight meters long, and two meter wide and two or three or four meters. So what we build are printing factories for our customers. It's not a small printer that you have at home is real industrial equipment. So one growth vector has been technology. The other growth vector is the benefits they bring to the end users. When you print using one of the traditional technologies, the time it takes from, for example, a new package between the time it is designed until it is available to manufacturers is between three, six, and even nine months. When you do it digitally, the time get significantly reduced. So in a world like where we are today that everybody wants to move faster, wants to launch new programs, new campaigns, new products faster, doing this digitally with -- in this case, with digital printers, it brings a very significant advantage. And this is really what is behind the growth that we continue to see in industrial digital printing. And in terms of applications over the last years, we have expanded our offering from marketing pressures to really -- to label flexible packaging, corrugated packaging. So almost anything that you can think in terms of industrial documents or industrial packaging, we can now produce, and this has been another big driver of growth. Michael Ng Great. Why don't I ask one more question before I -- before I see if there are any audience questions, but as I mentioned at the onset, print margins have been very strong. Cost savings have been an important initiative to drive that. Could you elaborate a little bit more on how you're managing costs, the Future Ready program, I think, has been very successful. So maybe you can just discuss that? Enrique Lores Yes. You have heard me saying many times in a company like us, there are always opportunities to drive cost. And once you do certain things, you realize that you could do more, and this has been the dynamic that we have built in the company that really helps us to be more productive and more competitive every day. And as you said, the Future Ready program has been very effective in terms of -- we started identifying a set of areas where we thought we could opportunity -- we had an opportunity to reduce our cost and we have been driving those very hard. And these are basically 3. One is portfolio simplification and opportunities we had to simplify our portfolio. Second is adoption of digital technologies to become more efficient from a process perspective and the rest are just efficiencies across the full company. And every quarter, we execute on those, we identify new opportunities, and we drive them stronger. And this is why this quarter, we decided to raise the goal that we had for this year. This year, our original goal was to accomplish 70% of the goal that we have on the 3-year program, and we will be close to 80% by the end of '24. Michael Ng Great. Why don't I see if there are any questions from the audience. We've got one up here, if you could please get a mic runner. You can try again? Unidentified Analyst There's a lot of discrepancy in back and forth in the marketplace about the PC cycle. I think that's probably an understatement. It's interesting because when we talk to executives or listen to executives, I don't think you're wildly bullish, but you seem to be, as a group, more positive than the investment side of the equation narrative. Certainly, on the commercial side, you said we were a little bit more cautious on the consumer side, but you seem to be -- it seems like there's some probability that is better than we think. Why do you think that disconnect sort of exists in your opinion? Enrique Lores I mean, it's hard to answer what the other side will think. I think between both vendors and analyst, the position is fairly similar. There are small differences, but I think we have a similar view. I think where we need to do a better job convincing the market, especially around the value proposition that the AI PCs are going to bring and to convince that really there will be an engine of refresh in the category. If I had to summarize one, that will be the major discrepancy because in terms of aging and in terms of Windows 11 refresh, I think the divisions are fairly aligned. Michael Ng Why don't we close out, and I'll ask you a closing question. What are the key priorities and strategies for HP over the next 12 to 24 months? How are you thinking about operational execution, but also capital allocation? Enrique Lores Sure. I think the priorities are totally consistent with previous conversations. We need to -- our aspiration is to continue to drive the company to grow. We want to grow faster than the two markets where we are, and improve profitability faster by continuing to drive efficiencies across the full company. And that's the financial model that we have put in place. And then in terms of capital allocation, we will remain consistent with the approach that we have followed over the last few years. Our goal is to return to shareholders 100% of free cash flow, while our leverage ratio will be below two and the less opportunities with better ROI show up, which is what we have been doing now for the last three or four years. And we know it's an important component of the value proposition that we have to our investors. And I think we -- when we look at the future, given the opportunities that hybrid work is going to bring that the AI is going to bring, we remain very confident in our ability to execute and to drive these going forward. Michael Ng Great. Enrique, it's been such a privilege, be able to spend some time with you today. Thank you so much.

Alphabet Inc. (GOOG) Goldman Sachs 2024 Communacopia and Technology Conference (Transcript)

All right. I know people are still finding their seats, but in the interest of time, let's -- we'll get started on our next session. I'm going to start with a safe harbor. I'm going to introduce Thomas Kurian, who's going to join me up on stage, walk through a slide presentation, and then we'll do some Q&A. Some of the statements that Mr. Kurian may make today could be considered forward-looking. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please refer to Alphabet's Form 10-K and 10-Q, including the risk factors discussed therein. Any forward-looking statements that Mr. Kurian makes are based on assumptions as of today, and Alphabet undertakes no obligation to update them. Thomas Kurian joined Google Cloud as CEO in November of 2018. He has deep experience in enterprise software, hired to Google Cloud, he's spent 22 years at Oracle, where most recently, he was President of Product Development. Thomas, welcome to the stage. Thomas Kurian Thank you, Eric for that warm introduction. We at Google Cloud are the organization that takes the innovation that Google is making in infrastructure, our data and digital platforms, cybersecurity and AI, and brings it to enterprises, small companies, startups and governments. We do that through a global infrastructure, 40 regions, 121 zones connected around the world. On that infrastructure, we've built world leading AI training and inferencing systems, a collection of leading frontier AI models, not just from Google, but also partners like Anthropic and many others, and a suite of tools. We make that available to customers in five important product offerings. Infrastructure for them to build their own foundational models or to tune and adapt existing foundational models and modernize their IT systems, development tools to connect AI models into enterprise systems so that they can build agents and applications, data analysis to connect any kind of data to any kind of model, as well as to use AI to speed up and make it easier for people to do analysis. Cybersecurity, integrating AI into a security operations work bench to help people prevent, defend, respond, resolve cyber threats materially faster. And then obviously, we've integrated AI deeply into our applications portfolio. Google Workspace, but we're also introducing new applications powered by AI. Starting with AI infrastructure. For 11 years now, Google has built world leading AI systems. We are in our sixth generation of accelerator technology, and we offer customers a choice of our accelerators as well as NVIDIA's. They're assembled into super high scale systems that offer extremely good performance, 3 times competitors for training, 2.5 times competitors on a cost performance basis for inference, and as you get larger and larger clusters, reliability becomes a bigger issue because the larger the number of machines, you end up with failures and needing to restock your model training. There are many advances we've made there. As an example, in addition to the software on top of these systems, we've introduced water cooling. We now offer close to 1 gigawatt of water cooling in production that's 70 times the number two. We've seen huge growth as a result in our AI infrastructure, 150 times more compute instances can be connected to a single storage volume, which means you get super dense training clusters. We've seen 10 times growth year-over-year in people using our systems for training. Here are examples of customers. 90% of AI unicorns run on our cloud for training and inference. 60% of all AI funded start-ups ever, use our infrastructure for training or inference. We're also seeing traditional companies now building both high-performance and generative AI models on our cloud. An example is Ford Motor Company. They're using our deep learning technology to build simulations for wind tunnel and for virtual wind tunnel simulation, replacing a traditional approach was called computational fluid dynamics. Midjourney, a leader in AI foundation models, trains in our TPU, serves on NVIDIA GPUs, both in our cloud. It's an example of having that diverse portfolio allows them to choose the best combination across the platform. In addition to having a foundational model, you need to connect it to your enterprise systems. We offer a foundational platform for people to do that. There are a number of differentiators I'll touch on three important ones. First, we offer an open platform. In addition to Google's frontier models, we offer leading open source as well as third-party models, Anthropic, Cohere, AI21 Labs, Runway and many others. This allows enterprises to choose a standard platform because they get the choice of models. We also have built AI for many years into our products and we offer advanced capability as a result in this platform. Additional services like grounding to improve the accuracy of the answers. We've improved -- we've introduced something called high fidelity, adaptation, distillation, for example, take a large model and shrink it down. All of these additional services, we offer the customers through an end-to-end platform. You can use that to connect to any cloud, any SaaS application or any enterprise system. We monetized compute instances on a consumption basis. We monetize our AI developer platform by pricing on a token basis, but people also pay for the additional services, grounding, distillation, fine tuning, adaptation and so on. There are many developers using our platform, over 2 million of them. As people migrate from proof-of-concept to production, we see a ramp in usage. An example, last week, we spoke to -- with Accenture. We're working with them in many of the Fortune 500 companies. 45% of the projects have now gone live. And as a result, we see a ramp in API requests. Here are examples of people using our developer platform. Just a couple of examples. Bayer in health care is using our generative AI tools to power search document creation, image analysis to help radiographers, for example, with tumor detection and comparison. Similarly, Samsung used our distillation tools to build a specific version of Gemini and Imagine to power the Galaxy S24 smartphones, which are now in hundreds of millions of hands. Models need to be connected to data. We offer two important things with our data platform. First, the ability to connect any data on any cloud to a model with super low latency. So structured data, unstructured data, semi-structured data can be connected to any model with super low latency. Secondly, for those people who want to do analysis, we've introduced a capability we call a data agent. It helps you do all the tasks that you need for analysis, but using a conversational interface. It helps you migrate data, stage it, aggregate it, visualize it, it even builds you charts and spreadsheets. We monetize this in two ways. First, because we've made it easier for people, it drives a lot more query volume on our analytical platform, big quarry. Secondly, because we've opened up analysis from being the domain of people who know SQL, Python, etc. It also drives a lot more end user subscription growth because we can sell more seats in an organization. We see growth in our analytical platform. BigQuery now runs 80% more ML operations in just the last six months. It's also being used not just to process structured data, there's been a 13 times growth in multimodal data, because of the capabilities of the Gemini model to process multi-model data. Many customers are using it. Two examples, UPS Capital. They run millions of calculations in real-time on streaming data to analyze package movements, locations to detect if you're going to deliver a package in an area of risk. They also adjust and drive, for example, calculations detect if somebody is doing fraudulent things like stealing packages. Second, Hiscox, one of the largest syndicates in Lloyd's of London, introduced the first AI enhanced lead underwriting model. So when they ensure property risk, it just take them months to calculate the entire portfolio. A single property took three days. It takes a few seconds now. What used to take months now takes a matter of days. What are we doing in cybersecurity? We started with a foundation that's super secure. And if you look at our reliability, we have about a quarter of the downtime of the other players. In cyber, as measured by Cisco and others, we have a really secure cloud, half the number of vulnerabilities as other clouds. So we started with a very strong foundation. We then applied tools that we have built to help organizations prevent, detect and respond to cybersecurity threats. How do we do that? From our Mandiant acquisition, from the millions of endpoints that run Chrome, and from our broad network, we collect summarize threat intelligence from around the world, that is fed into an AI model to help you prioritize the threats you're likely to face. It then compares it with the configuration of your existing systems to see where are you likely to be attacked from. It then helps you generate the remediation. We call that the run book to remediate it. It writes the audit file for your audit submission. It helps you then validate that you fix the issue, that cycle speeds up the ability for people to identify remediate and respond to threats. We're seeing growth because we have helped people speed up how quickly they can use our tools to detect and respond to threats. We've seen a 4x increase in customer adoption, 3 times the volume of data ingested, an 8 times increase in threat hunting. We monetize this based on the volume of data we're processing and the number of threat hunts or queries that are happening on the system. Many customers use this platform. Two examples. Fiserv is running this powered by our AI capabilities to speed up how they summarize threats, find answers, detect, validate and respond. If you look at Apex Fintech, it's a fintech company. They wanted to speed up how quickly they can run threat hunting rules. And so they're using our AI system to write extremely complex threat detection processes, took them many hours. Now it's taking a few seconds. Finally, we have a broad applications portfolio. We've integrated AI into Google Workspace to improve productivity. I'll talk about that in the question-and-answer session, but we're also introducing new applications. One example is applications we're introducing to help people in customer experience and customer service. Think of it as you can go on the web, on a mobile app, you can call a call center or be at a retail point of sale, and you can have a digital agent, help you assist you in searching for information, finding answers to questions using either chat or voice calls. Our differentiation is in three important capabilities. Number one, we can handle multi-channel, all the four channels I talked about, web, mobile point-of-sale, call center in a single system. Secondly, multi-modal. For instance, you call the telephone company to say, I'd like to trade in my phone. It can send you a chat, please upload an image of your phone. Your screen is cracked, here's how much I can reimburse you for. That's a multimodal conversation. Voice, text, and image. We have that capability because of the capabilities of our foundational model Gemini to process multimodal information. Second, if you work in call centers, there are times where you need to follow a strict order of control of questions. For example, if you're in a bank, you have to verify identity, you need to be able to guarantee you asked a set of questions to verify identity for KYC. At the same time, you may ask the bank, tell me what's the best mortgage offering I have. Can you compare it across these different products you offer? The first requires deterministic control. The second requires something called generative control. We're the only ones that allow you to do that. Lastly, imagine you call the bank and you asked a question about your balance, bank balance. You don't need it to be right 90% of the time. You need that answer to be right 100% of the time. We have a technique to answer with 100% accuracy. All of these is driving growth in our customer experience platform. Here, we monetize based on the value we save for users, either the costs we're displacing or the reach expansion we're giving their agents. We've seen growth across all the dimensions, the adoption of agents, digital agents, the volume of traffic going to these agents, etc. Examples of customers using our customer experience platform. If you call Verizon, you're talking to our chat system and our call system, 60% containment rate, high rate of call deflection. If you drive a General Motors vehicle and you hit OnStar, you're talking to our conversational AI system. So across this portfolio, we've integrated AI. We monetize it in different ways, and we're focused on three important things: winning new customers, winning more projects within the customer, upselling new products. Winning more customers, for example, Radisson. We help them use our generative AI technology to speed up marketing content creation by 2x. They then bring that online. And most importantly, they saw a 20% lift because the ads were really tailored, that's step one. We then often go to other parts of the portfolio. For example, if we're working with a retailer, we can help them now that they've automated the content creation process. We can help them with retail commerce and conversational shopping, a second project. And then to tailor the ads to different customer segments will sell them our analytical platform, BigQuery for segmentation and personalization. So that's the process we go through to win customers. We've trained our go-to-market organization. We continue to focus on thoughtful geographical expansion of our fields. We're teaching them to be specialists. Many of these solutions are not bought in the IT organization. They are bought by the Head of Customer Service, the Head of Commerce, the head of Finance, and so you have to learn to sell outside of the IT organization. So we've taught them how to specialize by industry as well as specialized from a solution selling point of view. We've taught them how to do a business value methodology, so they can easily measure what productivity benefits we're going to give, how much reach they're going to get, what cost savings they can generate. And finally, we don't -- we're not a big consulting shop. We're not a services organization. So we work with a broad partner ecosystem. Because we don't conflict with the partner ecosystem, we've invested in them. We've invested in technology, commercial incentives, training and certifications, as well as go-to-market incentives. Just to give you an example, if you look at the leading ISP and SaaS vendors, 75% of them are building with us, using our AI tools. Leading system integrators, Accenture has doubled the number of people certified on our AI systems in just the last year. All of this, winning new customers, driving new projects, expanding and upselling product has driven growth for us. 5 times revenue growth in five years. We are now the fourth largest enterprise software company in the world on a standalone basis. While we grew top line, we also had great discipline in managing our costs. We've invested thoughtfully in engineering. We've invested thoughtfully in a go-to-market organization and we delivered operating income growth at the same time. We continue to see strong business momentum. We're capturing customers faster. We're doing larger deals. Customers have increased their adoption of our products by 30% in just the last year. We have very strong support from the ecosystem. And we are being patient with AI, and we think it will monetize because of the many different parts of the portfolio in which we have integrated AI, and the many different ways in which we're monetizing AI, we think it will help us continue to accelerate our presence in the market. Okay. First of all -- thank you, Thomas. Okay. Why don't we jump right into it. Maybe start with a big picture question. A lot has evolved over the last couple of years in terms of both the industry, the public cloud space and even within Google Cloud. To level set, can you give us your world view of where we sit in cloud adoption and usage and how you see Google Cloud's position evolve competitively? Thomas Kurian Geographically, we're seeing growth in many, many markets. For example, in Asia and Latin America, many organizations are going straight to the cloud rather than starting on premise and then lifting to the cloud. Industry-wise, they were early movers, for example, retailers, communication service providers. Now we're seeing many other industries, utilities, mining, natural resources, a number of them moving. So we see that happening. We also see that the -- historically, all cloud computing projects were controlled in the IT department. Increasingly, the adoption is being driven by business initiatives. For example, the Head of Private Wealth Management will say, I want to use data and AI to streamline how my organization does research. And so those projects increasingly are being driven not just in IT, but by business buyers. We are still very early. If you count all the machines and data centers today versus how many are being consumed to the cloud. We're still early. And so that gives us -- we have a strong presence. We've obviously grown a lot. When I started, most people told me that we didn't have a chance. We're now the fourth largest enterprise software company. Eric Sheridan Understood. How do you frame Google Cloud's differentiated offering to win new business and grow wallet share? Maybe you could talk a little bit about some of the products and the services that are aimed at tackling some of the themes you highlighted in your presentation. Thomas Kurian We've always focused our product strategy, customer in. So when we started, we said we introduced a concept in 2019 called multi-cloud. What was that meant to be? It basically said you should be able to use our technology in concert with other cloud providers and you should be able to standardize on our solution. So for instance, we introduced a database that runs across on-premise environments all of the major clouds, that's driven companies like Workday to standardize on it, because they can then use it no matter where their application is running. So that's one example. It broadens our total addressable market because it allows us to play in all clients, so that's number one. Second, we also said we need to offer more than just compute and infrastructure. We need to go up the stack to offer solutions in databases, analytics, cyber, etc. So if you look at those areas, we've also taken a different approach. If you look at our analytical system, it allows people to analyze data across multiple clouds, without moving the data and copying it to Google. So you can get a single place to run your analysis no matter where your data sets. Albertson is an example. They have migrated to our analytical systems. Many of their applications are on other clouds. Again, it allows us to win more customers, win more projects. Third, we wanted to upsell products and services. So when you look at our strength in data and analytical processing, now we bring generative AI along with it. It allows people to do analysis using generative AI much more quickly and efficiently. One of the largest telecommunications companies in the United States is using our analytical system along with our Vertex AI platform and Gemini to run very important, but simple calculations. Take as an example, take all the calls coming into my call center, which are recorded for quality purposes, summarize the calls, and compare them with the data from my billing system to tell me if the call is coming in are because of complaints about bills. So that first part, the process using Gemini. The second part is analyzed in BigQuery. And because we offer that combination, it's another one of these strategic advantages that we offer. Eric Sheridan Okay. I want to turn next to go-to-market. Are there differences competitively of how you're taking your products to market and how you work with channel partners today, and how has that evolved over the last 12 to 18 months? Thomas Kurian Great question. Our go-to-market fundamentally, we've been very disciplined on how we're taking to market. There are two important things. First of all, the way you sell an AI solution is not the same way of selling a compute server feeds and speeds. So we've done three important things. First, we've identified our go-to-market around key buyers. So for example, when we say, we're selling cybersecurity, we're selling it to the CISO of a company. When we sell customer service, we're help -- typically selling to the head of customer service or the head of e-commerce. So we specialize around buyers. We've taught our teams to sell as a solution. A solution is what's the value proposition, how much cost and productivity advantages can it give me. And that's a different sales methodology than selling infrastructure. In order to do that effectively, though, you can't specialize around everything. You have to be disciplined in how you specialize for specific buyers and product offerings while getting global scale to our front line, so we do that very well. And lastly, early on, we made a decision, we're not going to offer a huge number of services from our professional services. We have a very focused team. They work on our largest accounts. But it allows us to partner very well with independent software vendors because we're not in the competing with them in core apps. It also helps us work very well with system integrators. Eric Sheridan Okay. You talked a lot about AI in your presentation. Can you lay out your vision of how generative AI capabilities will be adopted and utilized by customers across the infrastructure, model and application layers and how you view the relative sizing of those opportunities? Thomas Kurian So we offer, as I said, five different capabilities. Broad-brush (ph), you can think about we offer infrastructure for people to use to build their own models or to tune existing models. Second, we help people with our AI developer platform to build their own agents. We have people building insurance agents, research analysis agents, customer service agents of their own. We've also provided packaged agents, a data agent, a cybersecurity agent, a collaboration agent for helping you write things and increasingly, we are specializing them by industry. So for example, an insurance agent is different than a nursing agent. All three monetized in different ways. Early on, just like any other, if you look at the internet, first, people lay the infrastructure, over time, monetization moves up. And so that diversification allows us to capture value in many ways and over time, I think you'll see similar things. Eric Sheridan Okay. Maybe I'll turn to Vertex AI next. How are you seeing customers using Google Cloud to build scaled applications in a generative AI world and what types of models are customers gravitating to across various use cases? Thomas Kurian We see a huge range of models. Some people are using large models because they want very complex reasoning. Others like Samsung, for example, when I mentioned, they are focused on super task specific models. We allow people to get that range of capability in the platform, and we give them tools to then tailor the model for their specific need. In addition to that, though, you need other services to be able to use a model. And so what Vertex gives you is the breadth of services. For example, if I'm answering a question, can you validate the answer, either against the Internet or against my own data set or, for example, in financial services against Moody's, Bloomberg, Thomson Reuters, and other well high-quality data sources, that's grounding. We make that available as a service, so you don't have to do it yourself. We offer technologies, for example, to shrink the model size. So that you can say, I took a general model and chewed it just for my needs. Example of a customer doing that is Samsung and that reduces cost. It also improves latency and it shrinks down the cycle, the response time for these applications. Most importantly, we've connected all these services together. So for example, if you don't know how to ground, you can just delegate to a service we call adaptive grounding. And our systems will say, we got a response. This one, I don't think needs to be grounded. However, the other answer needs to be grounded and that saves people a lot of cost because they're always worried about, we'll have to pay each time I send a request. I will also have to ground the answer. So all of these are built into Vertex. As a result, we've seen huge growth with it, as I pointed out earlier. Eric Sheridan Okay. Maybe turning to custom silicon. Can you discuss Alphabet strategy around silicon partnerships versus building your own custom chips for AI workloads? Thomas Kurian We've always worked on high scale compute systems for AI. We partner closely with NVIDIA. We're also in discussions with many others. But just -- as an example, we offer an integrated high scale system. There are a number of pieces to that system. People often get focused on the chips. It's not just the chips. It's, for example, how much memory, high bandwidth memory do you have. If you're doing training for a dense model, you need more. If you're training a sparse model, you don't need as much memory. What's the optical switching you have to interconnect a very large cluster with low latency. What's cooling technology. And then as you move up the stack, can I program in a high level framework like PyTorch or something like that. Can I use a framework like JAX, which is a compiler framework that will compile that down. If you're going to a GPU to CUDA (ph), if you go into a TPU differently. And so that entire stack is what we offer customers, that's why many leading companies use us for high scale training, but also in [Technical Difficulty]. Eric Sheridan Okay. Can you give us an update on workspace and other applications in your portfolio and how you see them in the broader generative AI offerings for clients? Thomas Kurian So from a productivity point of view, we see three types of adoption patterns. With Workspace, which is our communication collaboration portfolio, we do have many organizations adopting it for their professional workforce. To help them write, to take notes and meetings, to create content. For example, we have many of them using it to create marketing content, to translate marketing content in many languages. We've introduced a new product called Google Vids, which allows you to create short videos for training people and for -- to do, for example, all hands meetings. So there's a lot of that full professional workforce. And we see people like Randstat, Woolworths, etc., adopting it. Second, we have very specific parts of organizations that are super high value for an organization. For example, if you're in a hospital, as a hospital company, nurses are the critical path. Because nurses determine how many hospital beds you can have, they control the revenue of the organization. So we work with nursing staff, for example, to do live hand-off of patients. It saves about 6 hours in a 24 hour day. And one of the leading hospitals was talking at a conference today that they estimate when rolled out, it will save them $250 million. Insurance, handling claims. We're working with the largest health insurance company in Germany. They have a huge amount of claims coming in, on average, a claim, they need to read 800 policy documents to determine if the claim is not -- is valid or not. They use our technology. It helps take 23 to 30 minutes down to 3 seconds. So productivity in these specific places are extremely high value, and then we also see productivity in certain roles that are scarce. When I say it's scarce. For example, cyber is one example. There's not enough cyber analysts to go around. So introducing AI capability there scales productivity in a very different way. And so we're working on all three dimensions, the professional workforce, frontline or first-line workers as well as scarce teams. And there's a lot of thought we put in to find what are the roles that are scarce because they monetize faster. Eric Sheridan Okay. Maybe I'll end on one big picture one. When you think about the opportunities you laid out today in your presentation and in our conversation, what are the primary areas of investment that you're calling out when you're thinking about aligning investments against the goals and milestones that you and the team want to accomplish with Google Cloud? Thomas Kurian I mean we've shown a track record for many years now of being very thoughtful on how we're making investments. They broadly span what do we need to do in engineering, to broaden our product portfolio and deepen it. What do we do with our go-to-market organization, to expand it and build specialization. What do we need to do in our data centers to expand our geographical footprint as well as grow our infrastructure. We've had very close relationships also with partners and we incent partners and we have made investments in the channel. All of that is balanced. We are doing -- we do a lot of systematic planning. We look over multiple years on where technology is going, and we make thoughtful decisions based on all of that. Eric Sheridan Okay. Thomas, I always appreciate the opportunity to chat. Please join me in thanking Thomas Kurian for being part of the conference.

Okta, Inc. (OKTA) CEO Todd McKinnon presents at Goldman Sachs Communacopia + Technology Conference (Transcript)

Todd McKinnon - Chairperson of the Board, Chief Executive Officer, Co Founder I think we can go ahead and kick it off. Thanks for joining us this afternoon at the Okta session at the GS Communacopia and Technology Conference. I'm Gabriela Borges, I cover security here at Goldman and delighted to have on stage with me Todd McKinnon, CEO, Chairperson of the Board and Co-Founder of Okta. Thanks for your time. Todd McKinnon Yes, thanks for having me. I'm excited to be here. Hi, everyone. So, Todd, when we met for the first time a couple of years ago now, you talked about wanting to re-prioritize and upgrade the level of innovation in the R&D organization at Okta. And I fast forward then to Okta in this time last year and the number of product announcements that the company talked about was significantly higher than at least what I could recall in prior years. So talk to us a little bit about the evolution of the R&D organization and how that fits into your evolution of Okta as an identity platform today versus perhaps at the time of the IPO or at the time of its founding? Todd McKinnon The space we're in is very, it's a critical space identity and it's critical for security and does a lot of things for companies. It's also a space that I think the industry, identity speaking and particularly the security industry, we haven't done a good enough job making it super easy to snap everything together and get really positive outcomes for fast, high ROI, positive outcomes for customers. I'm speaking broadly of the industry over the history of it, not specifically of Okta in the recent period, which I'll get to in a second. So all of that, the point of all of that is I think that R&D and innovation is incredibly important and one of the things I'm most proud of over the last few years is the progress and the velocity and innovation we've had at Okta. I think one of our main priorities for this year is reaccelerating growth, and the job is not -- we can't say we have great R&D and not re-accelerate growth. The job of re-accelerating growth is the most important, and R&D is an input of that, but we still have to deliver that outcome. But that being said, I am very proud of the innovation. I think that there's a couple things that are behind that. One is that I think we had some growth and some maturity, and we got our processes in R&D better in terms of investing in tools and technologies and capabilities to have an R&D organization scale. We've done a good job there. But I think one of the biggest things we did was when we bought Auth0, a few years ago, it actually, we had a ton of capacity into the company. And so, particularly, the team that was working on Okta could really, instead of having to focus so much on customer identity, they could really double down on privileged and governance and some of the new areas we've recently launched or have interaction with so it's sometimes things are simple and in that simple case or sometimes part of the reason is simple and a simple reason there is that we just got more capacity and we could focus some of those teams on those new product areas. And I think that things in the R&D pipeline are good. They're in the market now. And now it's about us executing and actually using that foundation to drive reaccelerated growth. Gabriela Borges As you think about what the long-term roadmap for Okta looks like, what's the next technical challenge that you're excited to solve for your customers given that you now have all of these different products? Is there any governance privilege access? Are there inter protection, et cetera. What's next on the roadmap? Todd McKinnon We can broadly speak there's specifics, but broadly speaking we can make it a lot simpler for customers to get value out of identity and get value out of everything else in the security ecosystem and everything else in their technology ecosystem. So a simple example I'll give you is right now it's very hard for a company to comprehensively across all of their SaaS applications and on-premise applications and cloud infrastructure and on-premise infrastructure actually guarantee that every user interaction and every machine-to-machine interaction is coming from a known and trusted network. Internally at Okta over the last year, we've gone through a comprehensive assessment of this and completely locked down all access to known IP addresses and it's actually quite challenging to do and very, very few companies actually do it. And I think the reason why is because there's not good standards for how this should work. Every SaaS application, every piece of infrastructure Implement IP range restrictions differently in a non-standard way, some of them don't support it, some support of it, limited support, some of them do it a different way. And so it's really non-standardized. So when you get a company that's trying to lock down their whole environment to be one of the most secure organizations in the world, it's quite challenging. So one of the innovations I'm excited about is thinking about how we can help the industry standardize that and get this flat, consistent ecosystem so that customers, when they want to adopt the modern identity, when they want to go to zero trust, when they want to have these things we all talk about, they know that they're going to get complete value in tons of control and visibility right out of the box, which isn't the case today. So that's a broad, there's various different ways on how we do that, but it's an area I'm excited about. Gabriela Borges Are you talking about essentially going tomorrow for a whitelisting approach to IP identities? And if so, how is that technically different from what you currently do with SaaS identities or user identities? Todd McKinnon So, user, I think it's the right approach for security architecture is multiple layers. So there's, you want strong person identity, biometrically authenticated in an efficient and resistant way, and you want whitelisted, you want managed and secured devices that are only, access is only permitted from managed and secured devices. You want the ability to have flexibly have a policy so that in the case that you do have to relax those restrictions, you can do it only for the applications that are high risk and the workloads that are high risk. So it's like multiple layers and a policy engine that can make it all possible. And one of the layers beyond just biometric, phishing resistant authenticated users and a trusted device that's managed and known and secured by endpoint security, you also at the network layer, you want to have a controlled network perimeter and trusted validated network and that's where the IP whitelisting comes in. The challenge is that the things I'm talking, the thing I just talked about are kind of well-known in zero trust conversations about like the things you need to do for zero trust user identity and zero trust security. The challenging thing is when you try to go to this, you try as a company, you're trying to not only secure the users but also every API integration and every machine to machine integration, then there's really not a -- there's not the equivalent of standards for phishing resistant MFA for inbound API calls. It's not specified very clearly, you kind of store some token in a certain way. It's really hard to get all of your network of the web of machine and machine interactions all come from your trusted corporate network because half of them are other SaaS providers that aren't on your corporate network. Not only are you your own applications, not on your own network, because they're in a SaaS provider's data center. But the things that are calling them, agents or other SaaS apps, or your forecasting tool call in Salesforce, is not on your corporate network. So then how do you do it? It gets really, really hard. And this is an example of a complexity that people aren't able to deal with seamlessly out of the box, that if we, I think, we standardized things more, made it really clear to SaaS providers how this should work, made it really clear, in terms of the protocols for how machines should integrate with each other, we could simplify it all, have customers get much quicker time to value by installing all these products and make it better for everyone. Gabriela Borges And how do you think about where some of this functionality naturally falls between what some of your competitors and network security are doing versus what your core competencies are on the identity side? Todd McKinnon I don't actually, I think about that, but only in a second order type of thinking. The first order is how do you solve the problem for the customer? And the second, in solving that, you get down to what's the best approach and what should each party do and what should the network people do and what should the identity people do and what should the endpoint people do and what the overlap should be. And then you kind of think about all right, if this is the right complete solution for the customer, then what do we have the right to win? How does identity fit into that? And I think it's kind of, when you take it from that approach, it becomes pretty clear who should do what. That doesn't mean that all the vendors are kind of sticking to that. There's a lot of people trying to poke into other people's lanes. But when you actually look at what people are doing and how they should be integrated, interacting, it's fairly clear, at least from a customer perspective, what they want each player to focus on. Gabriela Borges That makes sense. One of the things where, or one of the dynamics where I think you do have a right to win that you've consistently talked about is the level of integrations that you have, especially versus someone like a Microsoft. Talk a little bit about how your integration network is architected and how do you think about maintaining and extending that ecosystem over time? Todd McKinnon Yes, it's related to the, I think, and if you really zoom out, I think this what I've been talking about here on how we're, our goal is to standardize more things and we want it to seamlessly plug together and get good security outcomes and good productivity outcomes and technology usage outcomes for customers. That's really an extension of what we've been about from the beginning. It's just taken to the next level. So in the very early days of Okta, we were the first to market with this concept of, there were some identity standards out there, this thing called SAML and this thing called W S Federation. And there's various, other things people are trying to standardize. We were the first company that said, we're going to like guarantee you a customer that we're going to build you a single sign-on system that worked with everything. And we're not going to bother you at all with different protocols or different standards. We're going to guarantee you that it works. And we're going to take care of like managing the complexity of different standards. And by the way, 90% of the applications didn't support any standard. So we had to do really kind of down and dirty things about screen scraping and how we could make these applications look like they support a single sign-on when they didn't, and that's what we did. And the way the company grew and got momentum is that customers really liked that, the fact that we had so many customers, and just the fact that more and more apps built support for these standards. And we had this kind of this system where we could, as they brought new standard interfaces online, we could swap out our maybe non-ideal screen scraping integration and go for the standards. And then the standard evolved, and we evolved, and it kind of grew from there. And so the dimensions of how integrated, there are really two of them. There's the breadth, how many applications. And we talk about this number, 7,000 - 8,000, which is quite wide at this point. But probably as important is the depth dimension, which is there's one thing for an application to be integrated to identity from a single sign-on perspective, meaning you click the button and you actually can sign you in. There are all these other capabilities that make an integration deep, namely not only can it sign you in, but actually it can actually replicate the user accounts so IT doesn't have to manually do it. Or another one is if it's an HR system, can it do employee onboarding, can it take that business process and copy it not only from HR into your single sign-on system but copy that account into all the other systems downstream that might need that account. And so there's this depth of integration as well. And so when you talk about standards and standardizing machine-to-machine integration, or when we talk about standardizing how, we're talking about standardizing like how log files can be collected and how companies can get centralized visibility out about identity threats. Or we talk about a product we have called identity threat protection, which is all about, okay, you log in, but Okta keeps monitoring your device management, your endpoint security system, your network security system, and anything that's detected during your login session, any kind of malware, any kind of network intrusion, we automatically shut down your identity session and then we log you out of everything else. That's not single sign-on, that's like some kind of continuous session monitoring plus integration with CrowdStrike, and Zscaler, and Netscope, and Palo Alto Networks, that's a very deep integration. And so, our competitive differentiation has always been breadth of integration and depth of integration, and we're pushing that forward on all fronts, even to the extreme, where we want to create new kinds of standards, enhance the existing standards, so that it all just works together. And so, companies say, all right, I'm going to pick this endpoint, and this network, and this identity, and this application, and this HR system, and it just works. And I don't have to worry about how do I secure the machine-to-machine interactions, the APIs that are going to call this, how do I worry about the difference between my employee users, and my contractor users, and my partner users, it's just too complicated. And the more standardized and systematic we can make it, the bigger the pie it's going to be for everyone. And we'd love it, by the way, if this maybe sounds counterintuitive. We'd love it if all of our competitors and all the zero trust people and all the security people had the same idea and wanted to rush to standardize everything. Even if maybe that meant that our identity competitors could do some of the stuff we could do. Maybe in the short term, that wouldn't sound like a good thing for Okta. But I think for customers, if they knew that it would be standardized, that's going to accelerate the velocity and the purchasing so much, we have the best product, so the bigger pie is going to make us much more successful. Gabriela Borges That makes sense. I want to come back to where we started this conversation, which is your point on R&D. Ultimately, the goal is to re-accelerate revenue growth. If I think through the bull case for the stock, which we subscribe to, it's Okta being a 15% plus, 20% plus revenue grower. I compare that to the 9% growth in CRPO that you're guiding to for 3Q. Help us understand how to separate out some of the macro headwinds that may be impacting the business today versus some of the secular growth opportunities that we spent the last 15 minutes talking about? Todd McKinnon In that, I think big picture, our conversation with customers, our interactions in the market, our competitive position, they're all very positive, consistent, very similar to what we've heard in the past. When we talk about macro headwinds, we're really, in my conversation with investors, I reiterate this over and over, is that macro headwinds, we're talking about an environment that's been consistent for over a year now. It's not getting worse, it's not getting better, it just kind of is what it is. In fact, at some point, we're going to have to start calling it macro, stop calling it macro headwinds and just call it the new normal. And so I think that being said, there are realities in what we're seeing in the business. We think that big deals particularly, if a couple years ago they would have taken two approvals, now it takes four. There's extra scrutiny in the purchase. The deals get done, the projects are as big, they are as strategic, it's just a little harder, a little slower. And so that is a thing, I think, which makes sense, right? Because Okta, the company, is doing the same thing. We're being more careful about what we buy. We're making sure that we don't have redundant capabilities. We're making sure that we pick a solution in an area and use it and get value out of it before we buy some more. So I think a bunch of companies are doing the same thing. And when we're working in the field and sales cycles, we're working with them and accommodating them. In terms of like, the base of business we have, that shows up in the numbers. Particularly, it impacts the net retention rate. Because a couple years ago, we would have seen, if a company needed, had 1,000 seeds or 1,000, a bucket of 1,000 monthly active users on the customer at any side, they were very optimistic. And everybody was like, yes, we'll probably buy 1,500. And we'll grow into it. And now, it's like, if they need 1,000, they say, oh, we're going to buy 750. And we'll make sure we get to 1,000 before we buy 1,000 at the next renewal. So I think you're seeing in the net retention rate, you're seeing where in the past, there was like a tail end to that, now you're seeing that tail end is gone. And it's like, the net retention is kind of more, instead of maybe people over buying, it's like they're actually buying maybe even a little less than what they need. But we think that will over time, as cohorts have been doing that for now over a year. So ultimately, eventually, that's going to normalize out. And that'll be more of a normal thing that we won't be comparing against the past period. I think we're going to have to, in terms of the guidance, I think the Q3 CRPO guide is there's the normal kind of guidance process in how we think about an achievable guidance and in guidance we're confident in. There's also in that number, some conservative for any kind of security incident hangover that we're going to come up on the anniversary of the security incident we had in October. And I think it's probably, I think the last quarter that we're going to have that conservative built in. We haven't seen big quantifiable impact. We haven't seen any quantifiable impact. So that'll probably be appropriate time to reconsider factoring that into the guidance. And then the other thing about the guidance for Q3 is that the second half of our year is the majority of our bookings. And so we're going to get a much, I think we're going to do it in Q3 earnings, we're going to do a revenue guide for next year, we're going to have a much better kind of view on how the second half of this year is going to go and we'll be in a position to update the guidance then. Gabriela Borges I'll ask the follow up here. And you mentioned eventually you get the stabilization in the cohorts. Is that a way to think about perhaps your typical deal length relative to the excess buying of the 2021, maybe 2022 cohort as to when more tangibly you would see a normalization in the cohorts? Todd McKinnon Like what, yes, when is, I think it's a gradual thing, meaning, and I don't, I haven't done the analysis, we haven't done the analysis to like know exactly when it peaks and when the trend is and all that stuff. I will say that the buying behavior and everyone saw this not only in our results but in the overall market in the second half of '22, calendar '22, so second half fiscal '23, so that means we're eight quarters or five quarters in, six quarters in, so I think it's getting to a point where somewhere near the peak of it right now or that we're starting to get to the time where some of those people that didn't over buy are representing more and more of the cohort, so I think that's a positive trend for the future. Gabriela Borges And do you look at internal data on customer utilization of their offer preference and any comments on how that utilization --? Todd McKinnon Yes, we definitely seen it, we definitely seen the utilization compared to what they bought, the utilization is a higher rate over the last six quarters as the over buying is slowed down, so that's a good sign as well. For a long time it's interesting, for a long time it was, I think in retrospect it's obvious it was because of this over buying, for a long time it was, we were surprised about relatively speaking the utilization rates looked low, and I think this is because people were over buying, I was like yes, we're going to grow, we're growing, yes, okay. So let's assume that the macro environment is unchanged here earlier coming on the new normal and you have incremental stability in the cohort sizes or in the cohort expansion rates, what else do you need to see or do you need to underwrite that's within your control to be able to bridge up to a faster normalized growth rate? Todd McKinnon I think there's a few a couple key things that we're really focused on. And so really three things. One is that just we are seeing a lot of progress in large enterprise and there's a lot of potential there for us. So it's one of the things that when people ask me like what investors not understand about Okta. I think people overestimate how penetrated we are in the large enterprise and I would say that we're, we have a lot of potential there. We talk about 40% of the, we have some kind of footprint in 40% of the global 2000 but even that 40% there's a lot of room to expand that the usage in terms of number of seats and number of products. So I think of Okta as a company that was successful in mid-enterprise with tons of potential growth and some traction but tons more potential in the large enterprise. I think the reason that kind of it was okay so in your control like how do we make that happen. Part of it is the products, some of this R&D innovation gets better and we're able to particularly with things like connecting to on-premise resources, doing governance, identity governance with on-premise resources, that product's getting better and we have more capabilities to do that. So there's definitely a product component. Some of these new products that we have that are more directly contribute to immediate security outcomes like Identity Threat Protection with Okta AI or Identity Security Posture Management, you can see those being really in short term, valuable from a security perspective to a large enterprise. Identity Security Posture Management scans your entire identity ecosystem and tells you where the problems are. Very actionable, very quickly. Different than identity provider which you have to implement and integrate and customers, especially in a large enterprise, can look at that and say, that's great, but it might take me six to 12 months to get value out of it. Different equation when you say, Identity Security Posture Management can give me value very quickly. So products innovation, the other thing about the large enterprise too is that there's an amount, people have the idea that, oh, the large enterprise is like adopted cloud and their cloud transformation is done. Ironically, some of the largest enterprise had the most IT investment, so they had the most on-premise infrastructure. So there's some of the things with the largest amount of cloud transformation to go. And that just is what it is and as the technology forces of better cloud infrastructure, AI, how do you run your AI workloads? Do they do that in the cloud infrastructure versus on-prem? A lot of this change in evolution is driving them to modernize and upgrade. And I think that's a positive trend for Okta in a large enterprise. We've always seen from the company early days, there's a strong correlation with change in the technology stack with a company's proclivity to want to adopt Okta. So that's a positive impact there. The example, I think a good example of a recent deal I was involved in, just to make it very concrete for everyone. So, this company is a very large company and this is a significant transaction for Okta. And the reason it was happening is very simple. The Broadcom Computer Associates Identity products, Broadcom was raising the price of them. And the company that I was working with, that just catalyzed this thing is an old thing. We instead of paying so much more money, we want to look at modern alternatives. It wasn't just that. They also want to have more diversity in their ecosystem away from relying so much on Microsoft. They wanted to move to some cloud infrastructure. And so all these changes together, it was like, we really should look at a modern identity platform. So thus, we have this opportunity for this big deal. That's the kind of thing, the more that happens, the more people look at modernizing their identity. And when they're moving off of legacy identity, for a lot of reasons we talk about all the time, we're the pretty clear choice. And that's a good thing. So that's one thing. The other, you talked about things that are in our control. I think we have to continue to do a good job of selling value from a security perspective. And these new security products help. Security Posture Management, identity for your protection, privilege access. Traditionally, Okta was thought of as IT enablement. And we can help companies have a great end user experience. Yes, of course, there's a security benefit with multifactor. But it's really kind of convenient. And we can help you get new projects rolled out. And if you want to get the SaaS app adopted, it'll be better. But now, in terms of value profit, immediate helping these companies with security issues, we have a better set of products. And we have to continue to be good at selling that value and positioning the company that way. That's something we're working very hard on. And then third thing I'll say is that in the customer identity realm, we have to continue to get better and have success selling customer identity, not to just the CIO or the CISO, but also to the digital officer, marketing, product officer, technical officer. The idea is that identity can help all of these departments. We've traditionally been good with companies that are very, the IT group controls a lot of the technology or a lot of the decisions around customer identity. A good example is a great customer of ours called JetBlue. And IT there owns the employee identity, but also the TrueBlue loyalty app. And so we have a great deployment there of Okta customer identity. It's a great customer for us. If it's like a tech company, it's likely that the product organization or the engineering organization makes the customer identity decision. And we have to continue to be able to do that at scale, because it's harder for us. We grew up selling to IT and security. There's a I think like a lot of part of that, a big part of the market is those people building it themselves and we are often a better way, we have to continue to do that. So those three things, large enterprise, selling security and Non IT buyers are three things that are important for us. Gabriela Borges So all those things connect with the go-to-market and I think you've commented on this year being a better year for sales productivity versus last year. We've seen time and time again in SaaS that sometimes SaaS companies that do really well with the midmarket coming up market ends up taking longer than they expect. So talk to us about how you're investing in the move up market and the move to build more sponsors at the customer et cetera. What are some of the key milestones we should be looking at? Todd McKinnon All the bit like we do all the things that are I would call that you would expect like the kind of people we hire in the sales team, the relationships with, this is a really important one, really working on the relationships and the alignment with global systems integrators. Because one thing about large enterprises, that the global systems integrators are very important to help them make decisions and execute on things. We're in, you call them basic things like making sure that the marketing and the advertising is dedicated at that, those influential buyers and these organizations. The thing that might not be as obvious is that's very important is that you have to have really successful customer references, and we work really hard to make these accounts that are large enterprise accounts incredibly successful and then so they'll be advocates for us. A good example of this is FedEx, right? We have 350,000 users of FedEx and the CISO there is, I work with them very frequently and talk to them all the time and we're, we've really worked hard to prove that, to make sure that they're incredibly successful with Okta and that word gets around and a lot of this is, it's not just the technical environment and the evolution and the ability to upgrade, it's also when those people look around at other large enterprises because they don't, as they it makes sense, right? It's like when they look for inspiration, they don't look for the small companies and so the more examples like FedEx or the, and we're getting a pretty good roster of these kind of referenceable customers so that portends well for the future. Gabriela Borges Absolutely. I want to end here with a question on Okta AI. Give us a couple of examples of some of the most impactful applications today either on the product side or for your own internal organization. And then what do you think is most promising in the next three to five years, perhaps something that has been quite ready for prime time today that may be in the future? Todd McKinnon So the one that we've shipped is this, I talked about it already, but at core of Identity Threat Protection is Okta AI and it's a little bit of machine learning, a little bit of GenAI algorithms to really, at the core of what it's trying to do is it's trying to figure out what pattern of signals from, remember, this product has way more signals because I talked about how deeply integrated it is, it has way more signals than we've ever had before. It not only has the context from your login, but it also has the context from other layers of the security stack, it has risk scores from endpoint, it has the network security risk being fed into it, it has mobile device management status being fed into it, so it really gets a lot more data and then it can do a lot, it can have more sophistication, it does have more sophistication in on the kind of patterns it looks for that detects anomalous activity. And it takes a lot of refinement because a lot of customers in early beta, it's like typical things right like too many notifications, too many false positives, so we had to tune it to make sure that it didn't have too many false positives and get it right. For now that it's GA it's like, hits the mark there. So that's an important one. That's kind of like maybe what you'd expect, right? If you had been at this conference three or four years ago, someone would have said a similar thing about machine learning and pattern recognition and threat detection, right? So that's good that we're doing that, and probably a more novel one and more from a like, oh, that's different perspective, more interesting, is we're working on something called governance analyzer with Okta AI, and it's pretty cool. It's basically training the model on the anonymous policy setups and configurations of thousands of Okta customers and generating a suggested setup for a company. So it's like, you have these apps, you have these resources, you have these users, so this is how you should set it all up, this should be your security policy, this should be how you lock things down, this is what companies do, this is what companies don't do. And it's pretty amazing. It's like, wait, what? It's all set up for me? Of course, they've got to check it and like make sure it's right and but it's not something customers expect from a tool like this, and that kind of stuff is pretty exciting, just from a technology perspective, like a technologist, it's like, that's pretty cool. Gabriela Borges I agree, absolutely. Please join me in thanking Todd for his time. Todd, thank you.

Microsoft Corporation (MSFT) Goldman Sachs Communacopia + Technology Conference (Transcript)

Excellent, excellent. Thank you very much. A real delight to be able to host the CTO of Microsoft, Kevin Scott, as our next speaker. I'm sure the discussion is going to be fascinating. I'm told that, Kevin, this is -- this maybe the first time ever at an investor conference, a Chief Technology Officer of the world's, I think still the most valuable company -- and I'll let Kevin jump into his intro in a second, but I have to share with you that a little known piece of trivia. If we're talking about generative AI in such a big way and if this thing has become such a mainstream thing, it was a magical meeting that was perhaps facilitated between Sam Altman and Satya Nadella by none other than my guest here. So we owe our interest in generative AI and how it's become such a mainstream thing to Kevin. So, Kevin -- In some part. So tell us a little bit about your background and how you got to be the CTO of Microsoft, and we have some questions to jump into. Kevin Scott Yes. It's sort of a circuitous journey. But like the short story is grew up in the '70s and '80s in rural Central Virginia. I was super lucky to come of age when the personal computing revolution was happening, like I said, a computer science, I thought it was going to be a college professor for a really long time. And then I left academia. I dropped out of my PhD program and joined this startup called Google in about a year before their IPO. And yes, I did a whole bunch of different things at Google. It's the place where I first built AI system. So I did a bunch of stuff on both the search and the advertising side, like building large-scale machine learning systems, like for a while ran the ads quality system. So like this big machine learning system that did CTR prediction for advertising, which was the thing that made the ad auction actually work. Yes, small business. And then I helped build this advertising company called AdMob, but I left Google to do a start-up, which got acquired by Google 3 years later. I was at Google for a while, and then I went to LinkedIn, like I helped to -- I ran engineering and operations at LinkedIn helped take the company public. And then I joined Microsoft when Satya acquired LinkedIn. Kash Rangan That's great. And you ended up as CTO of Microsoft. That's a very unlikely story. Yes. For someone who considered a PhD in English Literature at some point in your life, this is quite a fascinating thing. Kevin, can you share with us your view of where we are with generative AI today? How do you see it evolving over time? And is there at all a way to think about how this builds upon old AI that you developed at Google, if that's even a way to think about, building one on top of the other? Kevin Scott Yes. So I think we're still in relatively early innings. The interesting thing that's happened over the past decade in particular is AI systems have started behaving more like proper platforms. So the first AI systems that I built were relatively narrow. So if you wanted to solve a problem, like how do you calculate the effective CPM for an ad so you can rank them in an auction, you have a very narrow set of data about the ads and how people are clicking on them and you use a relatively simple algorithm that's running at really big scale, and like you build a model and you run a bunch of experiments and it's sort of a closed feedback loop. And the model gets better and better and better over time, but only at the narrow thing that you trained it to do. And if you want to do a lot of machine learning, like in the past, like you had to have a whole bunch of different teams running a bunch of those like little vertical loops. And I think the thing that has really started to accelerate over the past handful of years is you have with generative AI these frontier models that really are quite useful for a huge variety of different tasks and applications and product context, which means that you can think about them as a platform, like a database or like any other piece of infrastructure that you use to build things. It doesn't mean that you have zero work to do. There's still a nontrivial amount of work that you have to do to go make something valuable out of this bag of capabilities that is modern generative AI. And I still think, to a certain extent, the hardest part about all of this is just having classic product sensibility, like understanding what a customer need is and what problem you're really solving and then just attending to that with hair-on-fire urgency to try to do something valuable for somebody else. But the problem that you don't have right now is the one that I had when I wrote my first machine learning program, which is I had to sit down and spend 6 months reading a bunch of papers and writing a bunch of really complicated code, just so I could do a relatively basic thing. And that thing that was my first ML program in 2004. So depressingly long time ago. A high school kid could do it in like 2 hours on a Saturday. I mean it's just sort of shocking like how much capability is now in the hands of people who want to create new things with AI. And so like I think that's where we're at. And like the thing not to lose sight of, although I really would encourage folks not to get too swept up in hype, but there is a very real thing happening with these AI systems where they're becoming like very much more powerful over time. And like I've said this a bunch of times in public and I say it all the time internally, like we are demonstrably not at the point of diminishing marginal returns on how capable these AI systems can get. And I think Dario was on stage right before us, I think all of the people who are sitting on the frontier like evolving this particular new infrastructure can really see that like there's still a lot of power yet to be built and a lot of capability to be put in the hands of developers where 5 years from now, 10 years from now, like somebody will be sitting on stage telling some story about the impossible thing that they couldn't do in 2024 that now a high school kid can do in a Saturday afternoon, like -- that I'm sure of. Kash Rangan That's where you see the things that we take for a very complicated abilities to become table stake. Kevin Scott Yes. I mean it is -- I mean I know you all are investors, I usually say this to like product makers. The thing that's going to be really interesting over the next handful of years is seeing the companies and the entrepreneurs and the creative people sort of prospecting at that boundary of hard to -- or impossible to hard. I think in every platform shift that you get, whether it's the PC revolution, the Internet revolution, the mobile revolution, the first things that happen is like you get this amazing new bag of capabilities and people go off and build trivial things. And then they very quickly realize that things that have enduring value are the things that are just on the verge of impossible, like they're ridiculously hard to do, but at least they're not impossible anymore. And like that's where the really interesting stuff lives. And you can see it model generation by model generation, like things face-shifting from impossible to just hard. And that's a good spot to focus your attention. Kash Rangan Got it. You've lived through a few tech cycles. How do you compare and contrast this AI cycle that we're going through to Internet mobile cloud? Kevin Scott Yes. I think there are a lot of similarities to all of the all of these big revolutions, like it's sort of catalyzed by infrastructure, like you've got a new thing that makes a whole bunch of things possible that were impossible or extremely difficult or costly before. Because it's -- they are all platform revolutions, they're not narrow, so it's not a thing that one company is doing and it's like, okay, I've got some secret infrastructure that only I have and only I can like imagine what the possibilities of the infrastructure are. So we just, in parallel, like we have a huge community of people being inspired in a bunch of different ways by what the infrastructure is going to allow them to do, which I think is really interesting and exciting and invigorating, like the thing that makes me happiest about being in the spot that I'm in, is seeing what creative people are going to choose to do with this. It also, interestingly, I think all of these things have changed the way that software development happens. So it not only opens up new possibilities for what software can be developed. It also changes the means of production of software itself. So if you think about all of those previous revolutions, like you get a brand-new tool set and all of a sudden a type of software gets easier to write, like you're just sort of excited as a software developer that like, oh, my God, now I've got this thing and like it's just like all of this stuff that irritated me before is like easier now. And so like those 2 things constructively interfere with one another. So like you're off chasing new ideas, but you're chasing it with a toolset that's made you more productive than you were before. And so that's truly an exciting moment to be in. And I don't -- we'll sort of see over the coming years. These are things that are very hard to predict. But all of this may be happening faster than what we saw in the previous revolutions. But one thing that's relatively certain, if you sort of believe that we're in a big platform shift, trillion-dollar companies that are brand-new are getting created right now. And usually, like the folks who move early, like latch onto the possibility, get into that learning loop where they are experimenting and learning and understanding what the valuable is versus what the trivial is, are the ones who have real advantages in building those durable super valuable things. Kash Rangan Got it. If this question sounds very intelligent, it is because Marco Argenti, our CIO, asked me to ask this question of you. I wish he'd been here sitting on stage with you, but he has another commitment. It goes like this. We have seen exponential improvements in LLM models so far. There's a race for attributes, parameters, modes and data size. Is the rate of change slowing down? Is this generation of models the path to AGI? Or do we need a fundamentally different evolution of the transformer architecture to continue making progress towards that goal? So clearly, that question did not come from me. Marco, thank you, in case you read the transcript of this. Kevin Scott Yes. Look, I mean again you all will have to be the judge of this over the coming weeks or months, but I think there's some super exciting things that are coming, coming in the last half of this year that lots of folks have been working super hard on. I don't see -- just I've said over and over again, like I don't think we're at the point of diminishing marginal returns on the current paradigm. I think we have -- I think we have a pretty clear path to building infrastructure that is -- stays on the same path of performance gains that we've seen. And like multiple dimensions. So it's capability, it's cost, it's like sort of power performance of systems. It's like just sort of a bunch of things and like entire ecosystem of really smart people tackling all of the different parts at all the layers of the stack just trying to improve things. I mean that said, you are not wrong to suggest that there probably are some disruptive innovations that will change things again, like we should hope for it. Like I hope the transformer is not the last interesting discovery in ML architectures. I hope not. And we even have a proof point. We all have 2-watt AI machine sitting between our ears, which is dramatically more efficient than the things that we're building right now. So you should hope that we make some discoveries over the intervening years that bridge the gap between what we're doing and what biology knows how to do. So the things are not independent. We're not, at least from what I can see, we're not at the point where we're about to stall on progress of the increasing the capability of the infrastructure because we don't have the next idea for what needs to be done to make it more powerful. Kash Rangan Got it. There's been a lot of talk about small language models versus large language models and the role and the relative positioning of these 2. How do you shake out on this SLM versus LLM? And a follow-up question that I wanted to ask, about open source. Where does open source fit into all this as well? Kevin Scott Yes. I mean we can sort of like start with the fundamental principle that I think answers them both, like I'm pro-developer. I think do whatever you need to do to get the interesting application written so that you can do something someone cares about. Being dogmatic about what tool you use to solve a problem is kind of nuts. And you can practice a bunch of wishful thinking about what you would like developers to do, but I'm sure you all know developers, they're the orneriest people on the planet, highly opinionated and they're going to experiment with a bunch of different things and they will they will choose the tool that makes the most sense for them to solve the problem that they're trying to solve. So in that sense, like you even look at Microsoft developers building Copilots. The way that a Copilot is architected is that you are typically using a frontier model to do the bulk of the interesting work there. But you also use a bunch of smaller models in parallel like you have a fairly robust orchestration layer that decides how to route-request which model to let you achieve the performance that you need on a bunch of different dimensions for the application you're trying to write. Like sometimes you need to send something to a small model because you're not going to get a better answer from the large model and it's just much cheaper or much faster to make the inference request to the small thing. Sometimes you're trying to do something on device locally, you don't -- you can't afford a network call into the cloud to invoke a large model. And so I think having that flexibility to architect the actual AI applications using the right mix of models is an important thing for developers to be able to have. But the large models are very important and they are the things that are -- I mean, they sit on the frontier. And so again, if you are looking at building the most ambitious thing possible, you, I think, need to have one of them in your portfolio of tools so that you can be attempting only the things that they enable. But it's not a dichotomy, like not either/or. And same thing with open source. I think open source is just making tremendous progress. It's super encouraging as a developer, I think, to see how fast the open source community is building really interesting things. And there are a bunch of people at Microsoft and Microsoft Research inside of my team who are building things like Phi, which is like a really capable SLM. And it's open source for folks to use as they choose. And again, with developers, they just -- they want choice. They want to be able to experiment. They want to -- they don't want to be told what their toolset is. They want to be able to experiment and choose. Kash Rangan Got it. So at Goldman, we have this acronym IPA, infrastructure build-out, then platforms and applications. That's where we've seen other computing cycles more or less evolve. Do you see that as a similar way in which generative AI progresses or am I hallucinating? Kevin Scott Yes. Look, I think -- so what I'm seeing right now, and this is the place where it is like a really unusual revolution. So like you definitely have these things that are that are sort of independent of one another execution wise. So there's a bunch of infrastructure stuff that you need to go pour concrete, sign leases, get power in place, solve a bunch of electrical engineering problems, solve a bunch of cooling problems, like get the right silicon and the right places design the network fabrics. And all of these things operate on different time lines. And then you have the software stack that sits on top of that like your low-level systems layer. And then you have your middleware and applications stacks that sit on top of that. Things are moving so fast right now that it is kind of hard to imagine a world where you go do the infrastructure build-out and you wait until it's done until you make the substantial decisions and deployments on the next layer up. So all of this stuff is really feeding into each other in a way that I haven't quite seen before, where you are just making big decisions on things that really want to move super slow, but where you have to make the move fast because the technology is just sort of evolving at such an incredible pace. It's really, really interesting. And I will say, I think you guys have Jensen coming on later. Yes. I mean, everybody in the ecosystem is moving materially faster right now than they were 3 or 4 years ago, materially faster. Kash Rangan Because the science and the technology is moving rapidly or is it -- what is driving that? Kevin Scott Look, I think it's the feedback loop. I think you've got a bunch of really smart people who can respond very well to urgency. And the place that we're in right now with infrastructure is people ask all the time, are you building too much or building too little? And so far, it's -- Kash Rangan That's what they want to know. Are we going too fast, too quickly, how much are you going to spend? Kevin Scott Yes. I want to know it too. But so far, demand for the infrastructure has materially outpaced our ability to supply it. And so like we are building at a pace where based on our understanding of where demand is going to be, we're trying to sort of intercept things. Like I just said, there are a bunch of slow moving things in the equation that we've just really had to try to make move much, much faster than they were moving before. And the thing that I will say, I think the whole ecosystem is responding incredibly well. Do I wish it were faster? Yes, I wish it were faster. But thank God, it's so much faster than it was like 4 years ago, because we would really be in a pickle then. Kash Rangan Got it. I want to get your views on compute costs. Generally with tech cycles, things -- the underlying inputs become cheaper. You got mass market, standardization, et cetera. How important -- given the high cost of compute here, how important do you think it is to bring down compute costs? And if you think it is, what are the developments that might support that view? Kevin Scott Yes. So it's super important always to bring down the cost of compute. One of the things that has supported all of these platform revolutions that we talked about, personal computing, Internet, smartphone, cloud, all of them has been this ability from silicon to networks to like the low-level software layers that empower the layers running on top of them to get exponentially cheaper over time. And I think we are definitely seeing that. I don't know exactly what the number is right now, but back in May when I was giving my keynote at Build, the anecdote that we gave the audience was, at that point in time, GPT-4 had gotten 12x cheaper like per token to do inference on than at launch time. And so part of that is because the hardware had gotten a lot better. And part of it is because the infrastructure had been tuned within an inch of its life, everything from numeric kernels where people are writing the moral equivalent of a bunch of assembly code to like extract every ounce of performance out of the chips that you've got. And then just foundational improvements to the algorithms that are running on top of the like hardware layer. And I think this is just going to continue over time. So the important thing to realize is things are already getting on a price performance basis, like way cheaper than they were. And there's super good stuff coming from hardware to system software to algorithms that should keep that trend moving. We just got to keep pushing super hard on it, because like if you really, really want all of this stuff to be ubiquitous, you need it to be as cheap as possible so everyone can use as much of it as makes sense. Kash Rangan Kevin, you piqued my interest by saying super good stuff coming. So to the extent that you can share with us, what is the high-level super conceptually maybe the things that are giving you that conviction? Kevin Scott Unfortunately, very little that I could talk about. Kash Rangan That's all right. I don't want to create problems. We'll just take that as a granted. Kevin Scott Yes, if we were off the record, I can share. So yes, look, I think the thing that ought to give everyone, we'll have things that are coming shortly that will be super visible that I think will be very encouraging for people looking for signs of progress. But you can just even -- even looking at what's happening on a week-by-week basis is like all of this competition is happening where Meta is doing great stuff with Llama and Anthropic is doing super good stuff. And Google is doing -- I mean, so there are these objective benchmarks for how everyone is performing, and people, because of competition and because the science and the sort of engineering is happening at such an incredible pace, like just every week things are getting better. And the point that I -- the point that I have been trying to make for a while to all of the folks inside of Microsoft is there is a weird nature of how the frontier progresses, which is you go build gigantic supercomputing environments, which are like big capital projects that take a very long time to build, and then you put them in the hands of people who are going to train a frontier model on them. And then they optimize their workload on that environment and then they do this extraordinary work. And then you get a new frontier model. And because of the nature of the way all of this unrolls, is you're just applying dramatically more compute to the problem. And it just happens in these like increments because of the way that you're building all of the systems. And so, yes, the thing that people forget sometimes is between the updates, you can get into this mode where you've convinced yourself, well, progress is only linear, this benchmark only got this much better, and you sort of forget that like, you look at our partner, OpenAI, what the big updates have been, like the jump from GPT-2 to 3 and from 3 to 4, and I can't say anything about like what's next and when, but like it's not like work stopped after GPT-4. So you -- the thing that we have seen for the past 6 years with generative AI is like, every couple of years or so, just because of the lockstep way that all of this stuff gets built, you get a major new update to the frontier. Kash Rangan So [Brett and Kendra], would love to, when he's ready to officially announce the good stuff, we'll love to host you back at our Goldman Sachs AI symposium. Just putting it out there. Always putting a plug for the firm. How dependent is your AI strategy on OpenAI? Because you also have your internal AI with the CEO of AI. How do these things work with the... Kevin Scott Yes. I think OpenAI, by any objective measure, has been one of the most consequential partnerships Microsoft has ever had. And we're a company that's had a lot of consequential partners. So we're super grateful. And I think we've been able to do things in a pretty extraordinary way just because it's like 2 really capable companies trying to push a big platform shift forward rather than one trying to do everything. So we don't even think about it in to say like we're sort of super dependent and like there's -- it's like -- it's a complicated bag of problems that we're collectively trying to solve. And just like with the PC revolution where you had Microsoft and Intel and a whole bunch of OEMs like doing this -- I mean you just sort of think about this is before my time at Microsoft. I've only been there for like a little under 8 years now. The mission of the company since, like at the point where it was founded, was to put a personal computer on every desk and in every house. And that's at the time where people didn't even know what a personal computer was. And so through that partnership, the entire ecosystem was able to deliver that mission, which is just completely audacious. And I think this is another mission like really unlocking the full potential of AI to create value for people everywhere is another equally large thing. I just don't think it gets done by like 1 entity. It's a lot of people working very hard in the same direction. Kash Rangan And hence, that's why you have your own AI CEO internally and then you have -- Kevin Scott We do. I mean Microsoft has had AI researchers working on AI since the 1990s. We're working on artificial intelligence when I was an intern at Microsoft Research in 2001. Yes. Microsoft Research reports to me now, and 23 years ago, I was an intern at Microsoft Research. Kash Rangan Any intern at Goldman Sachs, just take that as an inspiration. Kevin Scott But like -- so there's a lot of AI that Microsoft is doing that is very complementary to what OpenAI is doing. And we were doing it before, it's going to continue for the foreseeable future because it's a really large surface area. There are a lot of problems that need solving. Kash Rangan Good to know that. This, again, I'll preamble this thing, this is a Marco Argenti question, so it's going to sound very erudite. Right, Belinda? We seem to be moving chatbots to agents very quickly. What's the vision with regards to AI performing more and more complex long-running tasks? Do we see a future where AI-powered agents will be able to perform tasks that require planning, decision-making and execution across multiple environments and systems? This man, what a beautiful question. This is like poetry, right? So the answer to the question is yes. And I guess why do I believe that? So look, I think one is like it's just necessity. So in order for AI systems to be fully useful, they do need to be able to do longer-term planning. They need to have memory. They need to be able to actuate products and services and interfaces on behalf of users. And I think there's a bunch of good work that's been happening, everything from orchestration layers where like you're giving developers really good frameworks for figuring out how to uplift the basic capabilities of models to help them do more of this sort of long-range like multistep tasks. And then the models themselves, I think, are getting like more capable of synthesizing plans on their own. I mean you can even see a little bit of this, like if you go to a ChatGPT right now and you ask it to give you a plan for something, like you can articulate like pretty comprehensive plans for very complicated things. And so the next thing that you would want after that is for the agent to be able to say like, "Okay, I see the plan, go do that." And I think that's... Yes. Look, I think lots of people are working on filling out that hole and the capability of these systems. So yes, I think lots of good stuff coming on that front. Kash Rangan Got it. We have 2 minutes. I don't have any more questions. Is there a question that you want to create yourself and answer for yourself? Yes. I don't know. So I think the -- not necessarily a question, but just a thing that I will leave everyone with. I think the thing that we've seen over and over again with building hard things is you want to strike the right point between aggressive pessimism and aggressive optimism. You just don't want to get yourself caught up in hype in either direction. So the thing that we, inside of Microsoft, is like we're trying to do very hard things with these very complicated models is you want teams to be as ambitious as humanly possible and how they're putting this stuff to work. You really want to find the things that are like just went from impossible hard. You probably don't want to like spend a whole bunch of your energy doing a bunch of incremental things because optimizing an incremental thing when the underlying model infrastructure is getting more and more powerful so quickly probably means that the model is going to be able to do a whole bunch of this incremental stuff. And this was a lesson we learned years ago, like in the very, very early days of our partnership with OpenAI. I would have teams inside of Microsoft that would like take GPT-3 and they would go build this, fine-tune, super optimized thing, and it was like 3% better than it on some benchmark and a little bit cheaper. And they'd be like, yay, victory. And then GPT-4 came, it's like, crap, like what do we do now? Yes. So you just -- you want to be on the frontier with your ambitions. And like it's a good spot to be. Kash Rangan That's great. We are right at the top of our allocated time. On that note, thank you so much for giving us a perspective.