Friends hi-fi system not very good, what do you do or say?

So personal and revealing a situation; I'll tag on to previous comments:

1. Depends on the nature of your relationship; how close you both are.
2. Depends if he's aspiring to be an audiophile.
3. Depends on if he's asking for your "honest evaluation."

I usually just let my set sound for itself. I'd invite him over for listening and let him hear what you perceive as a great system.  If a difference is obvious to him; he'll notice and say something. But it could also be his ability to discern music and sound is so different from yours he prefers a bright or boosted sound to details and refinement.

Funny that's just how I got into audio; a neighbor came by I showed him my new Sony and Boston Acoustic system with speakers buried in a bookshelf.  He kindly invited me over for a listen to his "audiophile" tube system with electrostatic speakers. In those 30 minutes, my mind was blown at the steep difference between his sound and mine. I immediately began my plotting to refine my system, approach and knowledge because I now knew what I was missing.

Or you can just say, "That's an interesting system," and smile.

If someone is interested in this hobby, and proud of their system, it is highly unlikely that a first-time listener to that system would be unable to find something complimentary to say about it. It is also pretty easy to steer the conversation toward a general fascination with the number of variables effecting sound quality, how it's a never-ending journey, how we grow accustomed to even the best systems, how the same system can make distinctly different impressions on us depending on our mood, the time of day, volume levels, etc. 

If you feel compelled to make any comments at all, I would ask them questions like,

• "how do you like the sound of your system, and what do you like most about it?"
• "how often are you able to listen?"
• "how do you like the source you are using (i.e., turntable, CD player, digital streaming, etc.)"
• "what new music have you heard lately?"

Rather than judge right out of the gate, try to understand first. 

You might realize it is a pretty good system for the money they are able to spend, or for the types of music they enjoy or, you might realize they simply don't know how to put together a good sounding system.  Even if you don't like it, simply enjoy your visit with your friend. 

OTOH, if they have heard your system and recognize you as an authority on audio systems, and if they really want your opinion then, baby steps.  With any feedback, it works much better if you try to find and start with something positive.  Find something, anything, you like about their system and compliment them, i.e., "I used to use those footers and really liked them" or "I always wanted to try those, what do you think?"  Develop some level of trust and rapport first and then provide your honest critical feedback in measured doses.  Even if pretty much everything about their system sucks, you could start with, "if I were trying to improve this system, I would consider new speakers" then "let's talk about what type of sound you like best and the options in your price range."

You said the person is a "friend" so treat them like one.

In the first visit never say any negative things about my friends system. It will hinder their aspirations to learn this hobby. You will loose the opportunity to share what you have if they took it personal.They will not incite you again.

I've been there. Say it's nice, then let them listen to yours. Let them draw their own conclusions.