HP Inc. (NYSE:HPQ) Bernstein's 39th Annual Strategic Decisions Conference 2023 June 1, 2023 9:00 AM ET

Company Participants

Enrique Lores - President and Chief Executive Officer

Conference Call Participants

Toni Sacconaghi - Bernstein

Toni Sacconaghi

Good morning, and welcome, everyone. I'm Toni Sacconaghi, Bernstein's IT hardware analyst. Really pleased to have HP CEO, Enrique Lores here with us today. I'm going to start just by reading HP's disclosure statement. Today's discussion includes forward-looking statements that involve risks, uncertainties and assumptions, which are further described in HP's SEC filings, including HP's 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.

One other just housekeeping item. If you would like to ask questions, you can do so. We've gone electronically for those of you who have come to the conference over the years. You can do so by scanning the bar code in the program agenda and following instructions from there. So without further ado, let's punch it.

So again, thank you, Enrique, for joining us today. You just reported earlier earnings earlier this week. So a busy week for you. So we're appreciative of your attendance.

Enrique Lores

Thank you for having me here.

Toni Sacconaghi

So maybe we can just start by - am I getting my right questions out. But maybe we can talk just a little bit about the quarter, which you just reported and you upheld your guidance for EPS and free cash flow for the year. Revenues were a little bit lighter than expected. Maybe you can talk a little bit about the demand environment that you're seeing out there?

Enrique Lores

Sure. Let me start with demand. And again, thank you for having me here. I think from a demand perspective, what we have seen is basically a continuation of what we had seen and what we had shared in previous quarters, both consumer demand and this, we started to see 3, 4 quarters ago and commercial demand have been soft.

I would say that on the positive side, even if they continue to be soft, we didn't get any surprises or we didn't get any further deterioration versus the plans that we had, which we start taking as a signal of stabilization and has a positive signal.

In fact, if any - the only deviation that we saw was that on the office side on the commercial side of print, the market was bigger than we were expecting, which had an impact both on hardware and supplies. And from an end-user demand perspective, we also saw probably some more strength in PC - in commercial PCs than we were expecting.

I think what is also important to highlight is, during the quarter, we drove channel inventory significantly down, which means that end user demand, what end users are buying was more than the shipments that we were making. And again, this is one of the reasons why when we project now demand and the business for the second half, we think second half is going to be stronger than what we saw in the first half.

Toni Sacconaghi

And just on the demand profile and linearity, you mentioned you saw a stabilization, was that both on the corporate and the consumer side. And if you think about linearity relative to your expectations in the quarter, was it essentially the same? And are you projecting aside from this inventory question, which we can talk about, are you projecting essentially kind of normal sequential seasonal behavior, i.e., a stable demand environment on both the consumer and commercial side?

Enrique Lores

Yes. And when it's stable, I mean stable versus our plan. Clearly, if we compare year-on-year, market continues to be down. I think the - especially on the commercial side, probably the strengthening was more at the end of the quarter. But again, it's versus our plan. So I wouldn't make also a big in out of it.

In terms of seasonality, which I think is what you were asking also what from an end-user demand perspective, we expect that second half will follow normal seasonality compared to what we were seeing pre-COVID and this is - this means that especially on the consumer side, driven by back-to-school driven by holidays, we expect to see stronger demand than what we saw in the first half. And since we will not be doing a similar level of channel inventory correction in the second half, this will translate into stronger shipments.

Right. And on the commercial side, where you maybe saw a little bit of incremental strength, there's a lot of debate in the marketplace about commercial health. HPE talked about actually some incremental weakening at large accounts in North America. To the degree that you're-- can you characterize what you're seeing in commercial either small or large accounts or by geography, about whether there may be pockets that are relatively stronger or weaker?

Enrique Lores

We - I don't think we saw any big differences per geography or per segment. Again, year-on-year, of course, continues to be weak. But on the other side, compared to what we are expecting is performing as per plan or slightly better.

Toni Sacconaghi

Okay. And maybe you can talk a little bit about the component price environment and what you are seeing there you talked on the call about doing some pre-buys because the component environment was favorable. So what is - what are you seeing now? What is your expectation for component pricing as we progress over the next couple of quarters?

Enrique Lores

Yes. So what we saw is that, as you said, component pricing, especially in terms of strategic areas was favorable. And this is why we decided to make some strategic buys because is a good decision for us in terms of economics and in terms of return. We expect this to continue through the next quarter through Q3 and then more stabilization in Q4

But it's always going to depend on what we see from a demand perspective. This is why also we mentioned that we expect in the second half to continue to do some of these strategic buys because, again, a good economic decision for the company.

Toni Sacconaghi

And can you comment on what areas you're doing the strategic buys in?

Enrique Lores

I don't think we shared the specific details, but you can think about the major components in terms of cost, and you will be doing a very good approach.

Toni Sacconaghi

Okay. So when I think of major components, I think, of microprocessors and memory, so we should be thinking along those lines, not specific-- very specific tiny little components. Okay. And is there an expectation though? I mean you're prebuying, which generally suggests component prices are good now, but we're less certain that they're going to be as good because there's a cost, your inventory goes up, and you commented that could impact your cash flow if you ultimately persisted that.

So implicit in that is some expectation that component prices will probably go up. Do you - is that embedded in your plan? And if you - is it Q4 or Q1 when you're thinking about that? And again, how do we reconcile that with that trade-off with working capital? Because if you believe it's Q1 and you're doing prebuys through Q4 and you have elevated inventory, that's going to pressure cash flow/

Enrique Lores

I think here there are two things. One is, what is going to happen with the cost of components overall? And there - and second is what type of deals because of our size, can we get from some big suppliers. And when demand is weak, we have more strong to drive these type of deals, and this is what we have been doing. In terms of projections as I said, we expect more stabilization to happen in Q4. And then in Q1, we will talk when we have our Analyst Day in a few months. But through Q4, we included everything in our guide.

Toni Sacconaghi

Okay. I want to dig into each of printing and PCs. But maybe before we do, we can just zoom out. How should investors think about sort of longer-term growth for HP as a company, kind of top line? Do you think margins go up in EPS? And maybe just to anchor that, if I look back to pre-pandemic levels, this year is going to be about 6% to 8% less than pre-pandemic levels, '18, '19, fiscal '18, '19 in terms of revenues. And - so is there - are we at kind of a cyclical lull was the pre-pandemic high? And how do we put that in the context of kind of normalized growth going forward?

Enrique Lores

We have not changed the projections that we have in terms of long-term growth for the company. Our plan is to grow revenue low single - single digit between 2% and 4%, grow operating profit faster than that and grow EPS faster than that. This is our long-term growth.

As you are saying through the pandemic, we had a big peak of incremental sales. Now we are going into the other side of the cycle. But if we look at the projection over the long term, we - this 2%, 4% is our goal. And if we look backwards, if we look at what has happened from since separation until now, we have been growing at the rate or even faster. So is it's a better presentation of what we can deliver.

Toni Sacconaghi

Yes. No, I was just thinking if - again, '18 and '19 were a little bit higher than '23 will be. And I think the PC market will be, I don't know, maybe the same. Maybe it's lower actually because the PC markets will be, let's say, 250 million, 60 million units, but part of that is inventory drawdown. So real demand is probably less than that?

Enrique Lores

Real demand will be more than that.

Toni Sacconaghi

Real demand will be more than that actually, yes. No. But your sell-in will be consistent with the 250, 260. So PC is kind of the same. And I think printing as a market has probably gone down some during that period.

So I'm just trying to think about what the sheer implications are for how you think about implicit in that 2 to 4. Do you think you need to - are you - do you believe your markets are growing at that rate? Or do you believe that they're growing less than that, and you have to gain share? How do we think about that?

Enrique Lores

I think is what we have shared before is in terms of market share, our plan is to grow - in terms of our growth compared to market is our plan is to grow at the same pace of market or faster. And a big part of our growth is going to come also from the expansion that we are doing into adjacencies where our market share is low where there is growth that is going to continue to help us from a growth perspective.

And if we think about the opportunities that hybrid work is bringing to us the opportunity of really expanding into areas like headsets or cameras or video conferencing rooms - and this is an example on PCs. This is going to help us to grow in that category as we also are expanding and growing our services businesses, both on the consumer side and on the office side.

The customer, we are going to be able to deliver more value and they capture more value. So this is also going to help us to grow. So there are multiple areas that will help us grow faster than - to achieve this level of growth that I was saying.

Toni Sacconaghi

Okay. Well, maybe we can talk a little bit about PC and we can explore some of those growth as well. So if you just think about sort of longer term or maybe near term and longer term kind of growth for the PC market, right? There's this big debate about PCs went down for a long time and then they went from 350 to 250 units, and then they spiked up during the pandemic and kind of back down to 260. How do you think about what happens to that 250 or 260 number from here? What did we learn from the pandemic? Or how did it change things? And how do you think about kind of normalized unit growth for PCs going forward?

Enrique Lores

Yes. So our expectation is that once we go through this - the correction that we are going through now, the PC market is going to go back to growth. And we think that because, first, the overall market size and the installed base has grown significantly from what it was before the pandemic. There are more PCs in the world and maybe and people are using them.

If we look at time people are spending in front of the PCs, time spent in front of the PCs is growing versus time spent in front or using other types of devices. On top of that, the installed base, especially on the enterprise side and the commercial side has been aging. And we know this is going to be an opportunity. There is going to be an opportunity of refreshing that installed base.

So for all these multiple factors, we think that PCs will go back to growth. Exactly when will happen, it's going to depend on when we see the economy turn in and going more on the positive side. But '24, '25,for sure, we believe there is going to be growth again on PC.

Toni Sacconaghi

And do you think about a normalized unit growth rate for the PC market over time?

Enrique Lores

We haven't - we are working on multiple scenarios. We haven't shared the specific number, but we think it will be similar or close to what we were seeing before the pandemic. But again, what do we need to...

Toni Sacconaghi

Yes, it really depends what time frame before the pandemic because there was a period between 2011 and 2017, where PCs were declining. I just want to maybe push you a little bit on the installed base because we get this question a lot. There were obviously a lot more PCs sold during the pandemic than normal. And I think the big question is how do we know that those weren't accelerated replacements in the sense that I had a 3-year old PC, I would have replaced it after 5 years. But because I had to work at home, I replaced it sooner.

And so I got this unit sooner rather than later. Now obviously, if they were all new units we probably wouldn't - we wouldn't be seeing such a big deceleration, I don't think, in the marketplace. We'd be seeing some because you wouldn't be having the same number of new units. But I think there is - when I've tried to model this and many investors and I have sort of tried to brainstorm on this, it's just kind of fundamental question of, was the unit sold during the pandemic, a new unit to the installed base? Or was it an accelerated replacement unit, the person who had a 2-year old PC and said it was fine for when I use it once a week, but I'm using it every day.

So how do you a, what do you believe? Because you did mention the installed base grew. And how do you get confident that that's the number? Because I think most PC OEMs have actually been surprised at the magnitude of the contraction. Everyone knew that pandemic was not sustainable. But I think Gartner, IDC, most of the PC OEMs have underestimated how steeply things have fallen off over the last 6 or 7 quarters. So that - anything that you can share on why - how you think about new user growth versus replacement would be really helpful?

Enrique Lores

I think two points. One is, I think it's a combination of both. Clearly, some of the PCs that were both through the pandemic was - were an acceleration of sales that would happen in the future. But also there were significant incremental sales because people were working both in the home and in the office. We saw an increase of PCs in many areas like education. So there was both acceleration of sales but also increase of penetration.

And when we look at the deceleration that we have seen, again, some of this is because of this acceleration of sales that happened, but also the impact of the economic slowdown has been significant. And when we look at many of our commercial customers of our enterprise customers, they have slowed down significantly their hiring plans. They are slowing down investments in improved infrastructure improvements, and this is also having an impact on the slowdown that we are seeing today. So it's a combination of multiple factors.

Toni Sacconaghi

Now have you - have you seen any - because when I think about sort of what happened during the pandemic and I remember we talked about this 2 or 3 years ago at the conference, Chromebooks and education exploded initially, and then they kind of fell off.

Are you starting to see improvement in Chromebook and would improvement in Chromebook be the leading indicator, right? Because Chromebooks, a, happen first; and b, they probably have the shortest replacement cycle, right? So if there was going to be this rebound, is it logical to believe we would see it first in Chromebook or is that logic, not good? And then second question, is there anything you're seeing in Chromebook that yet that would foreshadow a broader recovery?

Enrique Lores

So we - so the answer is yes, we are starting to see some recovery on Chromebooks. We - which is really driving or driven by the need to replace some of the Chromebooks that were sold 2, 3 years ago. I'm not sure if I would take this as a leading indicator because education market has its own dynamics and whether it's funding available or not to schools. But clearly, we are seeing an increase of the demand of Chromebook during the last few months. Now Chromebooks continued to be a relatively small part of our business. So from - it's not like this has a huge impact, not on revenue.

Toni Sacconaghi

5%....

Enrique Lores

Not on margins.

Toni Sacconaghi

Right. And how would you characterize sort of the pricing dynamics that you're seeing in the marketplace in PCs today, you commented on the earnings call that there was channel inventory clearing. And so I presume you were seeing more aggressive pricing. Was that limited to consumer? And how is the overall pricing environment? How do you think about it going forward?

Enrique Lores

Yes. When we look at pricing, we saw fairly aggressive prices in the consumer space to support the reduction of inventory. We think this will be continuing for a while. But we expect that in Q3 and Q4, we will start seeing some of pricing as the inventories will go back to a more normal [ph] situation.

Toni Sacconaghi

And what's the pricing dynamic on the commercial side?

Enrique Lores

Has been much more stable. We haven't seen the level of aggressiveness we have seen in consumer.

Toni Sacconaghi

Are you seeing any companies mix down because of the budgetary pressures that you alluded to?

Enrique Lores

There has been a mix down on companies also in some specific segments. And this is why we saw some pressure on ASPs on commercial. But if we look at in the prices per category, we have not seen that the aggressiveness that we see in consumer.

Toni Sacconaghi

Right. And on the channel inventory side, you talked about a reduction in the quarter. Do you expect a similar reduction in Q3 and then for it to be complete?

Enrique Lores

No, the reduction - there is going to be some reduction in Q3. It's going to be smaller than the reduction that we saw in Q1 and Q2. This is why - we said during the call channel inventory, which remains slightly elevated, it's not where we would like it to be, but we don't need to do a similar reduction to what we did before.

Toni Sacconaghi

So is it not likely then that we could see or should see above seasonal growth in Q3 as well as in Q4 because if you're drawing down less in Q3 and then even less in Q4, should we not see above seasonal growth in both Q3 and Q4?

Enrique Lores

We think that in Q3, we'll be close to seasonal because there is still going to be a reduction. And then in Q4 will probably be in terms of shipments above normal seasonality.

Toni Sacconaghi

Okay. And your PC margins, historically, you guided for 3 to 5, now your official guidance is 5% to 7% operating margins. you're- I think, guiding for above the range for the second half of the year, implicit in your guidance, I think, about the range for Q3 and then better than that for Q4. So do we are you confident that's kind of the right level of normalized operating margin for PCs? And what happens if the corporate environment gets tougher?

Enrique Lores

So for our guide of...

Toni Sacconaghi

Or component prices go up?

Enrique Lores

Yes. We think that 5% to 7% continues to be the right margin for PC there are going to be - there could be potentially some headwinds that you are saying in terms of pricing in some specific areas. But at the same time, both the work that we are doing to reduce our cost structure, the work that we're doing to expand into adjacencies with better margins, we will compensate for those tensions. And this is why we continue to guide the PC business to be between 5% and 7%, which, as you said, is a significant improvement from where we were before the pandemic, but we are very confident in this range going forward.

Toni Sacconaghi

Just maybe this is related to pricing, maybe this isn't what was interesting to me was during the pandemic. So if I looked at the kind of last 10 years of the PC industry, there's been tremendous consolidation in market share. And so you and Lenovo and Dell, in particular, have gained a lot of share, growing much faster than the marketplace. That sort of stopped during the pandemic. The big 3 weren't gaining share. Why did that happen? And what happens from a share perspective going forward?

Enrique Lores

Sure. I think what happened during the pandemic is the market dynamics change and the availability of components was critical to people to ship. And clearly, this didn't allow us to maintain the growth of share that we have been doing before.

If we look at what we project going forward, our estimate is that we think that the big 3, specifically will grow share and the dynamics will be more similar to what they were before. As I shared during the pandemic, clearly, the way our company is structured and the way our processes are designed, we operate much better in an environment where demand is key, where we need to go and capture the demand and deliver that to our customers. This is how our key processes are designed. And this is why one of the reasons where you see us growing a share as the situation from a component perspective has been more normalized.

Toni Sacconaghi

But intuitively, why is that in Enrique right? Because you would think if you're in a more constrained environment, I'm a supplier, Enrique is always going to buy a bunch from me. He's at the top of the list, right? So that just seems counterintuitive to me. And in an environment like that, you would almost think that maybe smaller people would be driven out. So what was the dynamic at play there?

Enrique Lores

Is because we were not talking about shortfalls of 10%, 20%, where you can allocate that. The share for all saw significantly many components that it would have meant to stop shipping to some of the players to really prioritize the big players.

I think this is votes where more of the dynamics that we were saying at that point. But again, going forward, we don't think this is going to have an impact and the dynamic is going to come back to what we were seeing before.

Toni Sacconaghi

Right. And if you think about the share that the big 3 can have, which is, I guess, about 60% share today, realistically, where can that share number go and why?

Enrique Lores

So we - I don't want to set a goal for that because, as I have said many times, our goal is not to grow share for the sake of growing share. Our goal is profitable growth. This is how we design our company, and this is what we want to achieve.

Will we grow share as a consequence of that? Probably yes. But what is important for us is to make sure that we grow share in segments where there is more value that we grow share in the commercial categories, in premium categories where margins are more attractive, and this is what we are planning to do.

Toni Sacconaghi

Okay. Speaking of sort of new opportunities, maybe we could talk a little bit about Poly. So you haven't really talked about Poly and its contribution to HP on your earnings calls. You haven't talked about it growing. If we look at competitors like Logitech, they've actually followed - fallen pretty significantly. Is that how we should be thinking about what's happening with Poly that Poly is sort of following the pattern of what happened to PCs in terms of very strong growth and now a period of digestion and negative growth?

And given that, how is that impacting your ability to try and improve profit and because it's obviously much more difficult to improve profit when top line is coming down. So maybe just an update on how Poly has been doing relative to your expectations? And given the sort of tough demand environment for PC-related accessories, how does that impact your initial plans and going to profitability?

Enrique Lores

Yes. Let me start from contribution, probably is contributing to the PC business at the operating profit level. So we - is benefiting or - is making a positive contribution. Clearly, as you are saying, the market is going through a difficult period and a difficult situation and probably it's not immune to trends that we see in that space.

On the other side, from a medium- and long-term perspective, we continue to see a tremendous opportunity with Poly. As we shared during the call, we had a big reseller event in Chicago a few weeks ago. We invited our top resellers from everywhere in the world. We had 1,500 resellers. And you should have seen the excitement they have about the opportunity this brings, how can they connect to - how can they use this to sell additional products to their customers, which is exactly the same thing that we see. And we think that the - what we call the hybrid work trend is here to stay. And Poly is going to- Poly integration into HP is going to be a big beneficiary of that trend.

Toni Sacconaghi

And Enrique, when you say that Poly is contributing to PCs, does that mean it's profitable? Or does that mean it's accretive to PC margins today?

Enrique Lores

Both is accretive to PC margin and is profitable.

Toni Sacconaghi

Okay. And if we think about...

Enrique Lores

In terms of the size, it's relatively small.

Toni Sacconaghi

Yes, of course, of course.

Enrique Lores

No. But I think, if I recall correctly, Poly's operating margins maybe peaked at '18 or '19. And then initially, at the beginning of the pandemic, volumes fell and then they had problems getting components, their margins were like maybe 11 or 12, which is still much better than the PC business, right? So they'd be accretive. But so yes, under normal circumstances, they should be accretive, but given the volume challenges that Poly has, that's why I was asking the question.

Toni Sacconaghi

Yes. But I think also, as we have integrated, there has been a lot of course, that we have been able to remove. So this also...

Enrique Lores

Right.

Toni Sacconaghi

And if you think about Poly's level of profitability going forward at least over the next couple of years, I know you're taking out costs from synergies. You're probably investing to try and drive growth. How do we think about Poly's level of profitability? Because again, it was closer to 20 at one point, maybe in the mid- low to mid-teens when you bought it. What is a realistic level given kind of your growth aspirations for Poly? Is it at the higher end or lower end? And obviously, it's accretive either way to your PC business?

Enrique Lores

It's a question really hard to answer because we have totally integrated the business now. So if we look at investments, we were investing from the HP side, they were investment from their side. Now we have combined both investments. If I look at the sales teams, we have totally integrated the sales teams into our - so having - we don't have any more granularity that the company had independently. But when we look at the specific lines of business, they are both accretive at the gross margin level and at the operating level.

Toni Sacconaghi

And what opportunities about Poly most excite you? Is it corporate? Is it a category? Is it bundling? Is it - where - what are the most exciting opportunities to you from Poly?

Enrique Lores

Yes. There are two. One is the opportunity that we see in videoconferencing rooms. As I have shared before, I think we discussed about this in the past. Our estimate is that in the world, there are 90 million rooms. And only about 10% of them have a video conferencing system. We think this is going to change significantly in the coming years. And when we talk to customers, most of them are investing in equipping the rooms because they're going to have people working in the office, people working from home or people working from multiple offices. That's a very big opportunity for us.

And we have a very aggressive innovation road map to support that growth in terms of improving the experience in the room, connecting the room to the PCs. So you have an integrated experience, which is one of the reasons why we think we have a strong opportunity in that category.

The second big opportunity is in what we call personal remote connectivity. So enabling bundling PCs with headsets with cameras to offer a more complete environment where for people working remotely is another big opportunity that we are driving.

Toni Sacconaghi

I mean is that latter one more consumer or more commercial-oriented?

Enrique Lores

More commercial oriented. On the consumer side, we also have a plan to grow our presence in what we call peripheral, which is why we bought HyperX about 18 months ago, and it's really focused on gaming. But again, it's another growth opportunity in that space.

Toni Sacconaghi

If we switch to printing, how has the pandemic changed printing?’

Enrique Lores

I think there has been two major impacts. One is clearly the office market is going to be smaller than we were projecting. We have shared before that our expectation is that it will be around 80% of what we were projecting at that point, and we continue to think that this is a realistic expectations. And we are getting close to that now.

On the other side, we saw - during the pandemic, we saw a big growth on what we call the home business, people printing at home. And it is not as big as it was during the pandemic, but continues the business continues to be bigger than the projections that we had before the pandemic.

Toni Sacconaghi

And how do we think about the relative offsets of that, right? Because a 20% hit to your commercial business is really significant. And so do you believe that\- so do you believe that the consumer business is going up 25, seeming they're roughly the same size. I know commercial is bigger in revenue and probably a little less in profit.

But if we just sort of say for simple math, they're kind of the same size, if office is 20% less, do we really think that consumer is going to be 25% more? Or how do we think about HP being able to grow that business on a go forward?

Enrique Lores

Several things. Our consumer business is bigger than our commercial business. In fact, commercial is an opportunity for us to grow because our share - our average share is lower. And second, from a margin perspective, our consumer business is more profitable than the commercial business because we are fully vertically integrated on the consumer side, is LHP technology from the ink to the cartridges to the printing systems on the commercial side, we were with a big OEM and the margins are shared between us and under the company.

Toni Sacconaghi

Right. But still, even if one is bigger than the other, if it was 60-40 and there's probably total system economics and hardware I'm pretty sure, commercial is bigger. But even if it's 60-40, if 40 is going down 20%, it still presents a challenge for the other 60 to have to grow to make up for that?

Enrique Lores

Right. So I think we - as you know, we don't disclose the...

Toni Sacconaghi

Right, right, right. I think I'm not trying to...

Enrique Lores

No, I understand. I think what you can see is how resilient the print business has been during the last 3 years. And especially in terms of operating profit, clearly, it has worked. It's a combination of how we have managed the mix. It's also a result of all the work that we have been doing to rebalance profitability between hardware and supplies, create a more profitable line of business on the hardware side, accelerate the growth into subscriptions and services. So all this is also contributing to the print side, and you can see that in the results....

Toni Sacconaghi

Right, The operating profit has been remarkable, and it's been above your target range of 16 to 18, which is actually a little bit higher than your long-term historical average. And I think one of the questions we get most frequently is how is that given that if you just look at supplies as a percentage of mix, it's actually relatively low versus history and supplies are the most profitable part of the business. So why is that in terms of the profitability so elevated given the lower supplies mix.

And I think more importantly, do you believe it's sustainable. I mean, clearly, you don't believe '19 is sustainable or you would have taken your guidance up. But maybe you can explain what's happening now and then how we think about profitability going forward.

Enrique Lores

Yes. I think there are two things that support the high margin that we have on print. One is prices continue to be elevated from where they were before the pandemic across both segments, but especially in the office side.

Toni Sacconaghi

Are you still seeing that in consumer where you simply...

Enrique Lores

Compared to pre-pandemic gains, but we have clearly seen much more aggressive pricing, especially the last two quarters, driven by - mostly by the exchange rate and how aggressive some of our Japanese competitors can be DCs.

Toni Sacconaghi

And is that mix adjusted? Or is that just absolute when you say pricing is better? Is it because your mix is richer or is it because like-for-like because of inflation and other factors like-for-like printers are...

Enrique Lores

Both factors. Well, price by price is higher, but also mix as a consequence of the changes of mix we have been driving has been positive because this is the reason why prices are better. We have been doing a lot of work, and we shared that 4 years ago that we needed to rebalance profitability on the print side. We've had, at that point, 25% of customers that were unprofitable and that we needed to change our model. And we have the work that we have done on that space is clearly paying off.

And for example, if we look at the percentage of printers now that represent this new model we have more than 50% of the printers that we ship every quarter. So it's a very significant change that has had a very important impact in the business. And when we look forward, we continue to have an opportunity to improve that percentage

And as I said before, our goal is to capture more value per customer. And when I - when we look at the opportunity, we have to shift that customer relationship to a subscription model as part of that sell additional services, whether it's car - whether it's paper or the printer itself. All this is going to help us to continue to manage the profitability of the print business and stay in this 16% to 18%.

Toni Sacconaghi

Right. And I sort of interrupted you. And Enrique, you were saying in terms of why the margins are strong now, you were saying there were two reasons and one was that hardware ASPs were better. Maybe you said the second reason, but I know you were saying one and then I...

Enrique Lores

One is market prices are higher. Second is the mix that we have driven and the work we have done to rebalance profitability has also helped to...

Toni Sacconaghi

So should we think about supplies margins then have not really changed. So really, the improvement -- so the mix is a little bit worse, the supplies margins are the same. So therefore, really the - really strong profitability is attributable to the work that you've done on the hardware side, which is realizing better price, better mix, et cetera.

Enrique Lores

Yes. But as technology in there is the improvement on the hardware side has two drivers. One is what has happened from the market perspective...

Toni Sacconaghi

Right...

Enrique Lores

What we have done...

Toni Sacconaghi

Yes. Okay. You mentioned the 25% unprofitable. Do you have an updated metric in terms of the 25% to do you even know just behaviorally if people's behavior change, if they buy a different kind of hardware upfront or if they're on a subscription model, that they sign up for a certain level and then they go up or down. Like do you have enough of a data series to be confident about the durability of that?

Enrique Lores

We have been running the subscription program now for 6 years, coming years. So we start having significant data about in how behavior changes when they are not in the program and when they are in the program. So [indiscernible] have a lot of data about customers.

Toni Sacconaghi

But it wasn't - but initially, the subscription program was kind of sort of volunteered, right? You bought a printer and then you could subscribe to HP Inc. whereas it's a little more locked now. And in the sense that you buy an HP+ printer, there's been, in some cases, maybe a little bit of criticism that is not fully transparent that you have to be on a subscription. And then consumers are on a subscription and they feel like they were sort of locked into that, and that might be different from I volunteer to do a subscription, right?

And initially, when you had the program, it was - I'm signing up for HP+. Now you're sort of buying contractually into a system, but you're not - some consumers go, yes, I didn't really realize like it was going to cost me this. And that's why I'm asking if you have enough of a tail for HP+, which was launched, I guess, 2.5 years ago, whether you have enough of a tail of how consumers' acceptance around subscriptions actually trends.

Enrique Lores

So one clarification, when - when someone signs up for HP +, they are not forced into the subscription program. They have a choice to join the subscription program or to buy HP supplies transactionally. Both models are possible...

Toni Sacconaghi

We use some printers where you had to buy...

Enrique Lores

No, we use the infrastructure to validate that the cartridges that the buyer HP cartridges- but if they buy them transactions. Well, they work.

Toni Sacconaghi

Right, right. Okay. That's fair. But has there - have you seen any change in behavior from consumers who sort of proactively opted into that versus bought a printer where they have to use HP Inc.?

Enrique Lores

No. What the major change we have seen is when - which is a very positive trend for us when consumers subscribe to the program, they pre more. So the same consumer the transactionally then registers to the program and is in the program, they start printing more. And the other thing we have changed is with the same consumer subscribe to the paper program, they print even more.

And this is why we think that driving the change to subscriptions because of the ease of use that this brings and the convenience is a very positive or is a positive driver of consumption for us - and we have large numbers to support...

Toni Sacconaghi

Right. And when we think about sort of the longer-term model, I think you've guided for supplies to decline low to mid-single digit on a go-forward basis. So for the printing business to grow given that supplies is two thirds of the revenue, that would sort of imply that hardware has to grow at mid-single digits, a, is that really realistic? And b, how else do we think about contributors to growth for the printing business? Going back to the objective of HP to grow kind of 2% to 4% top line overall/

Enrique Lores

I think the - if we think about the role that print plays in the portfolio, as we shared before, from a revenue perspective, it will grow at the rate that the market will grow. Our goal is to grow operating profit dollars. And this is why the reduction of nonprofitable customers, the shift into subscriptions, additional services we're going to be building is going to be so important because this is what will drive us or get us to the goal that we have.

Toni Sacconaghi

Right. Okay. So top line growth in and of itself is not essential to your plan in printing, right? So you can get to 2% to 4% growth, printing maybe is not growing. PCs are growing above that range, and you can get there. Is that sort of how you think about growth the most...

Enrique Lores

Yes. I mean in terms of revenue growth, where we have opportunities in the office side that even if the market will be smaller, our share is also lower. So clearly, we have room to grow in that space.

Toni Sacconaghi

And Enrique, maybe you can give us just a little update on - when you first became CEO in 2019, there was - you talked about the prevalence of kind of clones in the marketplace and Reman [ph] and how that was pressuring the PC business. Maybe you can give us an update on what's happening in the aftermarket for supplies and what may have changed since then. Obviously, you've taken many actions yourselves in terms of introducing the HP+ program. But just the level of activity around Reman and Clone and both on the consumer and on the commercial side/

Enrique Lores

Yes. It's one of the things big announcements that we made 4 years ago was that we needed to start gaining share in the supplies aftermarket because we have been losing against loan, especially on the toner side. And we shared that we were going to be putting in place on the office side on Toner, a lot of the same technologies and processes that we have been using for Inc for many years.

4 years later, what I can say is that work really paid off results. We have been growing share both for Inc and Toner during the last years, and we clearly saw a change in the trajectory of Toner, which is -- has had a positive impact on our results. And this is a combination of work we have done to protect our IP from a legal perspective, technologies we have built in the print test that detect if the cartridges that are being installed are violating HP IP. And if that is the case, the printer doesn't work with activities in marketing activities in program, we really change the trajectory of that, and we have been gaining share of supplies.

Toni Sacconaghi

Right. Okay. Maybe you can just give us an update on some of the growth opportunities in printing on graphics and A3 in particular. I think those are probably the biggest areas/

Enrique Lores

Sure. On the graphics side, we continue to see the opportunity - a medium long-term opportunity very real. There are still a lot of documents that are printed using analog technologies, and there is a conversion into digital technologies happening where we see more of opportunity now to grow is in the packaging space, both flexible packaging, folded carton, labeling, all these are areas where we think there is going to be a sustainable growth for many years. This is where we have been also redesigning our portfolio to capture them, focus much more in high-end industrial equipment. And we both from a margin perspective and from a growth perspective, we think this is going to be a positive contributor to print for many years.

Toni Sacconaghi

And for A3?

Enrique Lores

Sorry, thank you. And then in A3, I mentioned before, growing share in our fees is one of the opportunities that we have. Our office share is lower than average, and our share, specifically in A3 is even lower. So we have an opportunity to grow that.

You were asking before about what are the changes that we have seen in the office side. One of them is we are seeing a shift from A3 into A4 in the office side. As less people are in the office, the need for bigger equipment, more centralized printer has been reduced, and we are seeing a trend to more distributed printing in the office that favors A4 versus A3.

But despite of that, from a share perspective, A3 is still a good opportunity to grow. And when we announced two quarters ago, the creation of what we call the workplace the Workforce Solutions team. One of the priorities is to drive this growth because a lot of it is going to happen in a contractual way, it's not going to be transactional. It's going to be part of a contract.

Toni Sacconaghi

Great. We just have a minute or two left. Maybe you can just talk a little bit about acquisitions. I think in the past, maybe last year or a couple of years ago, you talked about consolidation in this industry being inevitable. I think referring specifically to print.

So has the industry evolved from a consolidation perspective that you thought? And I think you also said you were more likely to be an initiator of that consolidation. So maybe you can provide an updated perspective on how you think about the industry and what that means in terms of potential M&A for HP?

Enrique Lores

Sure. From an industry perspective, we continue to think that at some point consolidation is going to happen. But we also said that from an M&A perspective, we are going to be more focused on doing M&A that will support our growth opportunities because we think there is more value to be created there. And probably is a good example of where we see opportunities that will not only drive short-term opportunities because of the short-term value because of cost synergies, but also that will support our growth plan.

And since you brought up M&A, I think what is important to highlight is that our capital allocation approach has not changed. Our plan continues to be to return 100% of free cash flow to investors - is there are many opportunities that bring better return, we will do it. And always under the umbrella of making sure that our leverage ratio remains under to within those parameters with this - this is the parameter we will use to allocate capital.

Toni Sacconaghi

Great. Well, we're at the end of our time. Enrique, as always. Thank you for your participation.

Enrique Lores

Thank you.

Question-and-Answer Session

End of Q&A