Hewlett Packard Enterprise Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 31, 2022

There are 11 speakers on the call.

Operator

Good day, and welcome to the Second Quarter Fiscal 2022 Hewlett Packard Enterprise Earnings Conference Call. My name is Chuck, and I'll be your conference moderator for today's call. At this time, all participants will be in a listen only mode. We will be facilitating a question and answer session towards the end of the conference. As a reminder, this conference call is being recorded For replay purposes, I would now like to turn the presentation over to your host for today's call, Mr.

Operator

Andrew Simonek, Vice President of Investor Relations. Please proceed, sir.

Speaker 1

Great. Thank you. Good afternoon, everyone. I'm Andy Samanek, Head of Investor Relations for Hewlett Packard Enterprise. I'd like to welcome you to our fiscal 2022 Q2 Earnings conference call with Antonio Neri, HPE's President and Chief Executive Officer and Tarek Robiotti, HPE's Executive Vice President and Chief Financial Before handing the call over to Antonio, let me remind you that this call is being webcast.

Speaker 1

A replay of the webcast will be made available shortly after the call for approximately one We posted the press release and the slide presentation accompanying today's earnings release on our HPE Investor Relations webpage at investors. Hpe.com. As always, elements of this presentation are forward looking and are based on our best view of the world and our businesses as we see them For a discussion of some of these risks, uncertainties and assumptions, please refer to HPE's filings with the SEC, including its most recent Form 10 ks and Form 10 Q. HPE assumes no obligation and does not intend to update any such We also note that the financial information discussed on this call reflects estimates based on information available at And could differ materially from the amounts ultimately reported in HPE's quarterly report on Form 10 Q for the fiscal quarter ended April 30, 2022. Also for financial information that has been expressed on a non GAAP basis, we have provided reconciliations to the Comparable GAAP information on our website.

Speaker 1

Please refer to the tables and slide presentation accompanying today's earnings release on our website for details. Finally, after Antonio provides his high level remarks, Tarek will be referencing the slides and earnings presentation throughout his prepared remarks. As mentioned, the earnings presentation can be found posted to our website and is also embedded within the webcast player for this earnings call. With that, let me turn it over to Antonio.

Speaker 2

Well, thank you, Andy, and good afternoon, everyone. Thanks for joining today's earnings call. HP's 2nd quarter results reflect significant customer traction for our differentiated portfolio and underscore our progress in becoming the H2 Cloud company. The macroeconomic environment of the last few months has presented enterprises around the world with strategic challenges That are usually not confronted all at once. The market shifts have certainly created a dynamic backdrop for our global customers I have made it harder for them to realize their goals in the short term.

Speaker 2

But more than ever, organizations need Technology partners to help them weather challenges while successfully digitizing and transforming their businesses in order to increase their market competitiveness. HP's ability to address these customer needs was key to our performance in the Q2. Once again, HP generated significant orders growth, Stating revenue and sustained profitability, even as tight supply conditions continue across global industries. We are seeing persistent demand from our customers, underscoring both their IT spending prioritization And there are traction to our compelling portfolio. Very strong customer demand in the 2nd quarter drove orders growth higher, Rising 20% year over year, which makes this the 4th quarter in a row that HP has logged year over year orders growth of 20 Our HPE GreenLake H2 Cloud platform contributed to as a service orders doubling year over year, The 3rd straight quarter of triple digit growth.

Speaker 2

We continue to see a great deal of customer interest in our platform, which is evident in our sales pipeline. Our orders backlog across the business is high quality, and we are now and we are seeing particular strength in our Intelligent Edge and Compute segments, With orders climbing 45% and 23%, respectively. HPC and AI orders grew more than 18%, Bringing backlog there to an impressive record of approximately $3,000,000,000 Total HP revenue rose 1.5 percent year over year to $6,700,000,000 against a record breaking backlog of orders in the midst of industry supply constraints. AIR climbed 25%. We have momentum across the portfolio with our as a service model differentiating us.

Speaker 2

This quarter though through a combination of supply constraints limiting our ability to fulfill orders as well as some areas where we We did not fully translated the strong customer orders into a higher revenue growth. I am confident that we have identified where we can strengthen and expect continued improvements as we move into the back half of the year. Importantly, the quarter's biggest standout, even if we were somewhat limited by supply chain, is that we maintained non GAAP gross margins of 34%, thanks to disciplined execution and timely pricing actions. Non GAAP diluted net earnings per share was $0.44 Which together with our Q1 results makes the first half of twenty twenty two the 2nd stronger EPS half year Our full year outlook of revenue growth of 3% to 4% and our long term 2024 revenue CAGR outlook. We are also reaffirming our full fiscal year free cash flow guidance of $1,800,000,000 to $2,000,000,000 As announced February, we suspended all shipments to and sales in Russia and Belarus.

Speaker 2

We have now determined that it's no longer tenable for us to maintain operations in these countries. Therefore, today, we are announcing the closing of our operations in both countries, and we'll proceed with an orderly managed exit. Our business in these countries represent less than 2% of HP's total revenue in fiscal year 2021. We have booked $126,000,000 pre tax charges related to the impact of Russia To our business, which is including our 2nd quarter GAAP earnings per share results, we expect less significant additional charges in the 3rd quarter related to winding down These operations, partially to reflect this necessary action and partially to unfavorable foreign exchange movement, We are updating our full fiscal year non GAAP diluted net earnings per share to between $1.96 to $2.10 which is the guidance we provided at our Security Analyst Meeting last October. In the short term, we recognize the supply and logistics constraints, rising inflation and evolving economic and geopolitical conditions All contributed to a dynamic environment.

Speaker 2

However, enterprise demand continues to persist across our entire portfolio. We are focused on translating the demand that we see in the market and our high quality backlog into profitable growth, We'll continue to closely manage our inventory position. When even the supply of low value components can be hard to secure in today's environment, We will continue to be disciplined and prudent in our decision making to deliver on our commitments. As we look to the future, we are strengthening the scale and resilience of our supply chain, including opening a new factory in the Czech Republic for next generation HPC and AI technologies, which Will help us address the very solid demand we have for these specialized solutions. There is no question that we have positioned HP well to help our customers double down On digital transformation, HP GreenLake is at the center of our strategy to deliver edge to cloud solutions to enable customers' data first modernization strategies.

Speaker 2

I hope many of you will join us later this month to see firsthand How our strategy comes to life when we host HP Discover Live in Las Vegas for the first time in 3 years. We will have a lot to show you as it has been an exciting few months for our customers and for HPE. In March, we announced Features on HPE GreenLake that deliver greater choice and simplicity. We added 12 new cloud native services. We now have more than In total, 50 cloud new services available through the platform.

Speaker 2

We also continue to expand our partner ecosystem, Increasing the number of partners actively selling HP GreenLake this quarter by more than 50% from the same Period last year. In addition, partners who saw multiple HP GreenLake deals in the quarter increased by 2.5 times year over year. At the Edge, our capabilities are high demand as organization need to securely connect distributed workforces and create engaging experiences. We are focused on delivering cloud native services that can more easily embed intra automated networks to absorb evolving networking configurations. And with the convergence of Aruba Central and HPE GreenLake, more than 120,000 Aruba customers Now I have access to the HPE GreenLake platform.

Speaker 2

As customers adopt hybrid multi cloud solutions, we know They also need a secure and flexible on premises cloud solution. We were recently selected as the product provider for Google's cloud distributed hosted solution. HPE GreenLake will enable Google to deliver an on premises cloud experience for organization with strict Our hybrid cloud offerings have attracted nearly 150 new customers in Q2, Including BMW Group, who is using HPE GreenLake to streamline and unify the company's data management across its global And we're aligned the world's 4th largest payment provider who chose HPE GreenLake to implement a major performance upgrade to its payment platform as it continues to deliver against a cashless economy vision. HPE Financial Services had a unique hand in the world line upgrade to HPE With our asset renewal program funding approximately 25% of the refresh. From a data perspective, we continue to make meaningful enhancement that allow customers to extract more insights from the data to accelerate business outcomes.

Speaker 2

For instance, we are creating sophisticated AI models to generate and share insights in distributed environments. In April, we introduced HPE Swarm Learning, which enables users to share learnings through an AI model at the edge And from distinct sites without compromising data privacy. 1 university in Germany is already using HPE's Form Learning to more accurately diagnose colon cancer by applying AI learnings that can predict cancerous genetic alterations. And early this week, Frontier, an HP designed and built system, became the world's 1st and the fastest exascale supercomputer, Taking the number one ranking on the World Top 500 list of supercomputers, exceeding the 1 exaflop performance threshold for the first time. To put this in perspective, this performance is 3 times faster than the number 2 supercomputer.

Speaker 2

HP has deployed 4 of the top 10 And ranks 1st, 2nd, 3rd and 4th on the Green 500 list of the most energy efficient supercomputers in the world. Our auto service pivot is also innovative in the way it helps our customers meet their sustainability goals. HP Relay helped customers reduce their cargo footprint by more than 30% versus traditional IT models. Later this month, when we release our Live in Progress report, we will share more about our efforts to support our customers' goals, While pushing ourselves and the industry to improve our own, few of us could have predicted that the challenges Over the last several years, we require enterprises to adapt so dramatically. I spent at least 50% of my time with customers around the world And I can tell you that when they think about how they are going to reimagine their futures, they see HPE as an even more relevant and essential partner Than ever before.

Speaker 2

As I reflect on Q2 and look ahead to the future, I am confident in our ability to deliver on our commitments. We have the right strategy to capitalize on market trends with an expansive edge to cloud portfolio that's connected through our market leading HP GreenLake platform. We have significant momentum with our customers. And perhaps most importantly, we have been we have a truly stellar team. I am proud of the 60,000 team members who make our results possible and who help us deliver on our purpose as a company.

Speaker 2

This team will continue to innovate and execute in ways that will further set us apart and continue to create value for our shareholders. With that, let me turn it over to Tarek to walk you through the details of our business segment results and overall performance.

Speaker 3

Thank you very much, Antonio. I'll start with a summary of our financial results for the Q2 of fiscal year 2022. As usual, I'll be referencing the slides from our earnings presentation to guide you through our performance. Antonio discussed the key highlights on slide 12. So now let me discuss our Q2 performance details, starting with slide 3.

Speaker 3

We continue to see robust demand across our differentiated edge to cloud portfolio, with order growth up 20% year over year, the same as last quarter. This marks our 4th quarter in a row with order growth of 20% or better year over year. This maintains our confidence in achieving both our fiscal year 'twenty two revenue outlook Our 3% to 4% growth adjusted for currency and our longer term 2% to 4% revenue CAGR outlook provided at our 20 21 Securities Analyst Meeting. We delivered Q2 revenues of $6,700,000,000 up 1.5 year over year and in line with our outlook of normal sequential seasonality, despite a more challenging supply environment that limited upside. The unexpected COVID related shutdowns in China and seizing the support of Russia services contracts Impacted our revenue by more than $250,000,000 in the quarter, our total operating margins by more than 1 point and EPS by approximately 0 point 0 $6 Given the delta between our order and revenue growth rates, our backlog further increased to new record levels And yet remains very high quality.

Speaker 3

The order book is firm and most importantly has been priced to preserve gross margins. We are particularly pleased with the resiliency of our non GAAP gross margins, despite the inflationary environment And ongoing supply chain disruptions that are driving up material and logistics costs. We delivered non GAAP gross margin of 34.2%, Up 30 basis points sequentially and down just 10 basis points year over year, driven primarily by strong pricing discipline and our continued mix shift towards higher margin software rich offerings. Non GAAP operating margins We're 9.3%, reflecting the revenue impact from incremental supply constraints and our exit from Russia that reduce operating leverage. We expect operating margins to expand in the short term as we drive more leverage from revenue growth and benefit from investments in the High growth, margin rich areas of our portfolio.

Speaker 3

Within other income and expense, we benefited from robust operational performance in And further gains related to increased valuations in our Pathfinder investment portfolio. As a result, We now expect non GAAP other income and expense for fiscal year 2022 to be an income of approximately $75,000,000 versus gross margin and despite the approximately $0.06 impact from China and Russia, we delivered non GAAP diluted net earnings per share of $0.44 Near the midpoint of our outlook range of $0.41 to $0.49 for Q2. We also delivered GAAP earnings per share of $0.19 This includes $126,000,000 of disaster charges related to Russia, primarily consisting of an increased reserve for financing lease assets. With the decision to early exit Russia That we have announced today, we expect to record an additional and less significant GAAP only charge in Q3 that has been factored into our updated outlook already. As previously indicated, we expected free cash flow to be in line with our normal That is a use of cash in the first half and Q2 was a use of cash of $211,000,000 We have made significant investments in working capital during the first half, reflecting our strategic inventory actions to navigate the current supply environment.

Speaker 3

This will better position us to convert orders into future revenue and cash flow, while working capital is expected to become a tailwind in the second half. Finally, we continue to return substantial capital to our shareholders. We paid $156,000,000 of dividends in the current quarter and are declaring a Q2 dividend today of $0.12 per share payable in July. We also repurchased $58,000,000 in shares, bringing our year to date total capital returns To $498,000,000 reflecting our confidence in future cash flow generation. Slide 4 highlights key metrics of our growing as a service business.

Speaker 3

We continue to see very strong momentum across our as a service portfolio, where we introduced 12 new cloud services this quarter and converged Aruba Central with the HPE GreenLake platform to create a unified operational experience Total as a service orders were up 107% year over year, marking the 3rd quarter in a row With orders more than doubling. Our ARR was up 25% year over year to $829,000,000 With supply constraints continuing to limit some installations. While our ARR growth is somewhat volatile in the current Supply environment, the strong order growth over the last several quarters is the best indicator of the long term health of this business. This gives us confidence in delivering our 35% to 45% CAGR target from fiscal year 2021 to fiscal year 2024 with increasing margins As our mix of both software and services continues to increase to 64% in Q2, up more than 5 points Year over year with our expanding cloud and SaaS offerings. Let's now turn to our segment highlights on Slide 5.

Speaker 3

Our growth businesses continue to show improving top line momentum and record levels of backlog fueled by strong demand. In the Intelligent Edge, demand for our secure connectivity solutions accelerated with orders growing 45% year over year, the 5th 2nd quarter with growth of more than 35%. Despite increased supply disruptions in China, Revenue grew 9% year over year, outperforming the competition and demonstrating particular strength in Silver Peak and our Edge as a service offerings both up strong double digits. We delivered operating margins of 12.6%, reflecting higher component and logistics costs resulting in lower operating leverage. We expect margins to improve next quarter with higher levels of revenue that also benefit In HPC and AI, demand remains robust with order growth of 18% year over year, Driving our awarded contracts total to another record level of just under $3,000,000,000 Revenue grew 5 year over year and was impacted by 1 large customer acceptance delay that impacted growth by more than 6 points And has now been delivered in Q3.

Speaker 3

Importantly, our Q2 operating profit was impacted by the ramp in project costs For a couple of mega deals expected to close by the end of the year that will return operating margins to more in range with historical levels. In Compute, order growth remained robust and was up over 20% year over year for the 4th consecutive quarter, While revenue growth was up 1%, reflecting a more difficult supply environment. We continue to be very focused on executing A dynamic pricing strategy that has been effective in managing the increased supply and logistics costs and gives us a very high quality backlog. The results are showing up in our operating margin performance at 13.9%, up 270 basis points year over year and 10 basis points sequentially, well above our long term target set at SAM 2020 1 of 11% to 13%. Within storage, we achieved another record level of product backlog that is skewed towards our owned IP margin rich products.

Speaker 3

Revenue was down 2%, reflecting supply constraints for our own IP products. As a result, we continue to have unfavorable revenue mix That pressured our margins this quarter. We expect both our revenue growth rates and margins to improve over the next few quarters as we work through our favorable backlog mix and More demand towards our new Alletra and block storage offerings. With respect to Pointnext Operational Services, including storage services, Orders again grew mid single digits year over year as reported similar to levels for total fiscal year 2021. As you know, this is very important for the long term health of our most profitable business.

Speaker 3

Within HB Financial Services, volume increased 2% year over year with strong performance in GreenLake and revenue was flat. Our profitability continues to benefit from higher residual value realization as customers tend to extend the use of their systems in a supply constrained environment. Our operating margin was 12.6%, up 180 basis points from the prior year, and our return on equity at 20.4% Remains well above the 18 plus percent target set at SAM 2020 1. Slide 6 highlights our revenue and EPS performance, where you can see we've maintained relatively constant levels from last year despite Supply constraints, in particular from the China shutdowns, and also our ceasing to support services contracts in Russia. As a reminder, this combines for more than a $250,000,000 impact to revenue and a one point impact to total operating margins And an approximately $0.06 impact to EPS in Q2.

Speaker 3

In spite of these headwinds, we delivered a better quality of earnings Across our portfolio, as we continue to execute our edge to cloud strategy. The improved quality of earnings can be seen on slide 7, where we delivered non GAAP gross margins in Q2 of 34.2%, showing their resilience in spite of the increased component and logistics costs. This was driven by both our strategic pricing actions and the favorable mix shift we've been driving towards Edge and our as a service business. Moving to Slide 8, you can see our non GAAP operating margin this quarter of 9.3%, reflecting the reduced operating leverage from Supply challenges and our exit from Russia. However, we are achieving much better efficiency in our sales and office investments When measuring productivity on an orders basis.

Speaker 3

Given our high quality backlog, we are also continuing to invest I'll spend some time reminding everyone about our unique setup in China through H3C. As disclosed in an 8 ks in Late April, we have extended our existing put option that is struck at 15 times trading 12 month earnings through to October 31, 2022. We did this to enable the new investors at the We value our presence in China, the 2nd largest and fastest growing IT market. Although we will balance prior to execution of any extension, The strategic and financial benefits of a continuous involvement in China with rising risks, including geopolitical risk. HVC makes up a significant portion of our P and L and cash flow, and you can see that we are generating growing value to shareholders with our unique Sata, our equity interest rose 21% in fiscal year 2021 and has grown 32% in this Q2 of We will keep you up to date as we arrive at a longer term solution for this valuable asset.

Speaker 3

Turning to Slide 10, our free cash flow was a use of cash of $211,000,000 This is aligned to our pre pandemic seasonality with the first half being a use of cash, followed by strong generation of free cash flow in the second half. The first half of this year has also been uniquely impacted by the supply chain environment, as we strategically built inventory levels in Q1 That were flat in Q2. We are taking further strategic actions to improve supply chain visibility and attain operational and financial benefits. This will put us in a better position to begin converting orders and generate healthy amounts of cash as working capital will turn into a tailwind in the back half of the year. We will need to demonstrate strong execution in the second half, but we have a path forward And expect to deliver fiscal year 2022 free cash flow of $1,800,000,000 to $2,000,000,000 Now turning to our outlook on Slide 11.

Speaker 3

We are revising our fiscal year 2022 non GAAP outlook range back to our original outlook provided at SAM $1.96 to $2.10 This reflects the impacts of a more unfavorable currency movements since last October, The exit of the business in Russia, the COVID related disruptions in China to this date, offset by the other income and expense benefit we've received in the first half. From a top line perspective, we are very pleased with the continued strength in orders and growing backlog that gives us Confidence in future revenue growth in fiscal year 2022 and beyond. We do want to remain prudent in the short term given the ongoing supply To now be a 2 point headwind to revenue for the full year as opposed to the 50 basis points at the start of our fiscal year. As a result, we still have strong confidence in our fiscal year 2022 revenue growth outlook of 3% to 4% adjusted for currency And expect to end the year with elevated levels of backlog, which bodes well for fiscal year 2023. More specifically, for Q3 'twenty two, we expect revenue to be up low single digits sequentially.

Speaker 3

This is slightly below our normal seasonality to reflect our expectations that the China shutdowns will have a lingering impact in the short term. As a result, for Q3 2022, we expect GAAP diluted net EPS of $0.22 to $0.32 And non GAAP diluted net EPS of $0.44 to $0.54 So overall, I'm pleased with how we are executing in a strong demand, but challenging supply environment during the first half of fiscal year 'twenty two. With our high quality backlog, We are very well positioned to capitalize on the ongoing edge to cloud opportunity and deliver against all of our financial commitments Seth at Sam 2021. Now with that, let's open it up for questions. Thank you.

Operator

We will now begin the question and answer We also request that you only ask one question. And the first question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Speaker 4

Yes, I am. Sorry about that guys. Can you hear me?

Speaker 1

Yes, we got you, Aaron. We can.

Speaker 4

Okay. Yes, sorry about that. So I'll start with just the question on the backlog. As you kind of thought about the guidance for

Speaker 5

the full year and obviously some moving parts around FX and China, etcetera, But how has your assumptions changed at all with regard to the backlog build? Are you assuming any kind of backlog Reduction through the course of this fiscal year? And if not, what's your current views on kind

Speaker 4

of peaking levels of backlog at this point? Thank you.

Speaker 3

Yes, good afternoon, Kyle. Thank you for the Aaron, good afternoon for the question. Thank you for the question With regards to our backlog, I would say our backlog has not peaked yet. When you have 4 consecutive quarters of 20% growth And the delta between the backlog growth, order growth and the revenue being what it is, Backlog has not peaked and will probably peak towards the end of this fiscal year. Our assumptions on Converting that backlog into revenue are contained in the guidance that we gave for this fiscal year of 3% to 4% revenue growth adjusted for currency.

Speaker 3

I want to reiterate to you that the FX impact in that guidance It's a 2% headwind as opposed to a 50 basis point headwind that we originally forecast.

Speaker 2

I would say, Adam, obviously, we're going to enter 2023 with an elevated backlog, which bodes us well for the future revenue growth of the company. As I said in my remarks, we continue to be very confident in our CAGR outlook that we provided at some for the next 3 years. But obviously, as we go forward, the backlog will be reduced as supply and other issues Olivier, and you think about the 3% to 4% guidance for the year, which is the guidance we provided Sam versus the 1.5% we just reported, Obviously, there will be low single digit growth sequentially on that revenue. Thank you.

Speaker 1

Great. Thanks for the question, Aaron. Chuck, can we go to the next one, please?

Operator

Yes, sir. The next question will come from Simon Leopold with Raymond James. Please go ahead.

Speaker 6

Thanks for taking the question. I wanted to see if you could help me get a little bit better insight into what's allowed you to Basically, you better on gross margin than we expected, given the input costs and the foreign exchange. What I'm looking for in this question is an understanding of much of this is about mix? How much of it is about your ability to raise prices and pass that on to customers? And how are you thinking about the outlook For the gross margin, given what you've done so far in terms of price increases and what you're thinking about on foreign exchange?

Speaker 6

Thank you.

Speaker 3

Sure. So let me try and unpack this for you. So first of all, when you really look at Our business across the various segments, Aruba is continuing to do extremely well, and We outperformed the competition, specifically Cisco in the Q2 and the order book in Aruba is absolutely substantial. As you can observe, Aruba growth, and you know Aruba comes with higher gross margin, has a favorable impact on the mix. The second thing I would point out to you is with respect to compute, the disciplined pricing actions that we've taken now for several quarters with compute Continue to bear fruit.

Speaker 3

Compute operating profit margins at well above 13 Well above our long term guidance have also been better than what our main competitor in that space, Dell, has delivered For their total ISG margins, that include compute, storage and networking. So compute It is performing much, much better than the rest of the industry. 3rd, when you really look at the gross margin mix again across the other segments, Particularly storage and HPC, there are 2 different stories there. With respect to storage, you have a mix between Our own IP product and 3rd party product that has been unfavorable to us, meaning that there were more third party product revenues and On IP revenue, and you can see therefore that this has had a detrimental impact to gross margins for storage. Finally, HPC, the story there is a story that is we always been saying, it's a lumpy business, and it's a matter of revenue scale.

Speaker 3

We had one slippage of a deal that has affected growth by 6 points in the quarter. That deal has closed into Q3. And really, the fundamental question for HPC is the delivery of substantial mega deals that we have planned for the second half. And So if you take all of this into account, and you look at overall gross margins for the company, the story is different by segments, but It is the results of a number of actions that we have taken in Aruba and in Compute, offset by product mix shift in storage and Revenue delays in HPC, on the whole, very pleased to have our gross margins where they are at 34.2%, up sequentially And better than last year. And finally, let me add to this, the performance of HBFS.

Speaker 3

The performance of HBFS is outstanding. You can see that while there is not much revenue growth, and this is not a gross margin business, it's a business that delivers Substantial amounts of profit by way of operating profit margins. And the return on equity there in HPEFS It's very, very strong, north of 20%, which is better than our long term outlook of 18% plus that we gave you at SAM 2020 1. So I hope this gave you color and I've unpacked things for you the way you wanted, Simon. But if not, you're welcome to take the conversation offline with you again.

Speaker 6

Thank you. I'll follow-up.

Speaker 1

All right. Sounds good. Thanks, Simon. Appreciate it. Operator, can we have the next one, please?

Operator

The next question will come from Samik Chatterjee with JPMorgan. Please go ahead.

Speaker 7

Yes. Hi. Thanks for taking my question. I guess I just wanted to Ask more on the demand side here, and you had another quarter of strong orders. Maybe if you can give us a bit more color on what you're seeing on a geographic Particularly, I think investors have been concerned about the momentum in enterprise in Europe and ex Russia, if you can give any color of what And also I don't know if you sort of pointed out what the order number impact on the order number was from the Russia exit as Thank you.

Speaker 2

Yes. Thank you. Thank you for the question. As I said in my remarks, we continue to see ongoing persistent demand from our customers. I think it's a combination of them prioritizing IT spend and honestly the attraction to our portfolio.

Speaker 2

We have a very comprehensive portfolio From Edge to Cloud, that is resonating in the market. And Tarek just talked a little bit about the strength of the Edge, Which grew now in excess of 40% for 4 consecutive quarters. That's simply remarkable. And yet, we just delivered 9% revenue growth. So that tells you the strength of the demand.

Speaker 2

As you think about this distributed enterprise, I think the other area, obviously, as customers continue to assess their hybrid multi cloud journeys, Which is now here to stay, they see HP GreenLake as a very solid alternative to what I call flexibility choice and And the fact that one of the major clouds is leveraging HPE GreenLake to basically Deliver their managed, hosted, distributed cloud is a testament of that differentiation. The other thing, obviously, anything related to data It's simply very strong. I think the demand for big data, analytics, AI and machine learning We'll continue to grow. And that's because customers need to extract insights from the data, which I think is the most valuable thing they have. Obviously, Cybersecurity Aruba with our SD WAN and our SaaS approach also provides an alternative to that.

Speaker 2

So I think as I look forward, I personally believe and being at the World Economic Forum for the last week and listening, I think the potential slowdown is more a consumer issue more than an enterprise issue. And the reason why I say that is because every customer I talk to, they are prioritizing digitizing their businesses, Modernizing their businesses, deploy cloud as an experience in this multi cloud approach, because it's all about speed and agility. And obviously, as I said before, extract every bit of insight from the data. And that's our strategy against the trends we see with HPE GreenLake, which is a data first modernization approach. Our demand is super strong, 20% 4 consecutive quarters for HPE is Pretty remarkable.

Speaker 2

And our order backlog, as we said early on, is high quality, which means is order The order book is firm. We don't see any major cancellation that will concern us at all. And last but not least, to Tarek's point, We priced our backlog to preserve gross margins. And that's why it give us the confidence not only to grow revenue, but continue Deliver our operating margins commitments and ultimately EPS commitments. The impact of Russia is And Belarus, because you have to combine these 2, is less than 2% of the revenue on a continuous basis.

Speaker 2

If you look at 2021, in terms of EPS, Tarek explained it and unpack it for you, which whatever kind of offset in many ways With the over performance in Q1. So Tarek, any comments on your side?

Speaker 3

Yes. So let me add on the last part of your question. So the impact from Russia on orders was negligible. This was not something that has affected our orders. China and Russia together, obviously with Belarus impacted our revenue by 250,000,000 The majority of that impact relates to China.

Speaker 3

And the Russia impact specifically is related to the fact We cannot operate anymore in the country and serve existing customers with our services contracts, and therefore, This has been factored into the impact I described, that totals for China and Russia, 1% impact on total operating profit margins And $0.06 on EPS overall. But again, the majority of these impacts were driven by the China disruptions on the Supply side of the equation. And yes, I agree with Antonio on the totally agree on the resiliency of the demand. I simply want to add the fact that even though there could be a slowdown in the EU, The European governments are ramping up a number of initiatives that are all in our favor in a digital space, Which gives us confidence for the medium to long term.

Speaker 2

And I will say our diversification of our coverage around the globe Also, it's a good positive thing for us.

Speaker 3

Okay. Great.

Speaker 1

Thanks for the questions, Samik. Can we go to the next one, please?

Operator

The next question will come from Wamsi Mahone with Bank of America. Please go ahead.

Speaker 8

Yes, thank you. I hear your comments about As you look into the second half, can you talk about how those demand trends are breaking out across regions, if you're seeing any variability from 90 days ago. And You also sort of maintained your free cash flow guide, but EPS you alluded to some of these impacts, the $0.06 that you alluded to Tarek, But you're maintaining your free cash flow. What are some of the offsets that are allowing you to do that? And when you look at the second half free cash flow, That needs to come in extremely strong.

Speaker 8

So can you talk about what levers we should Back within those free cash flow moving pieces that get you to your guide across the second half? Thank you.

Speaker 2

Yes, let me start, and I would like Tarek to talk about the free cash flow, Wamsi. Listen, so far, so far, and I can only talk so far, I have not seen Any major deviation from 90 days ago on demand continue to be very strong and that's why we use the word persistent. Persistent meaning is there, right? And then I think depends on what happens here in Back half of the year with some of the other policies, Tarek mentioned some of them in Europe. But obviously, as we think about inflation, interest rates and whatnot, That may or may not have an impact, but as I said earlier, Wamsi, I think it's mostly on the consumer side and enterprise side.

Speaker 2

If anything, I will argue it will have a positive impact To our GreenLake, because customers want to maybe preserve some CapEx, and they're going to use more of the as a service model And still deal with the reality that this is a hybrid multi cloud journey and therefore for those workloads and data that cannot move Outside their premises or a co location or even move it from the edge for that matter, GreenLake is perfectly suited for that. And that's why it's a combination of our solutions now 50 plus cloud native services. The fact that Google is going to use our solution is a very strong endorsement. But I think we are positioned to capture either way. And I think our backlog give us a very strong foundation to build from there as we look forward.

Speaker 2

Tarek, you want to talk about the free cash flow question?

Speaker 3

Yes, sure. So first, Wamsi, if you want a rough rule of thumb, when you're looking at EPS changes and how these EPS dollars translate or cents translates into free cash flow. Every A cent of EPS is essentially $13,000,000 to $15,000,000 right? So when you look at the lowering of our guidance Is very much contained in the guidance we gave at the free cash flow level. So the lowering of Our guidance back to the SAM 2021 guide is very much contained in the free cash flow guide that we gave you.

Speaker 3

The reason why we gave you this free cash flow guide was because of the working capital assumptions that we had made At the beginning of our fiscal year. So I feel comfortable that we are within the free cash flow guide. Now the second part of your question Is what makes you confident that in the second half you can generate this quantity of free cash flow given where you are at the end of the first half. I would simply say to you that we expect 1st and foremost working capital to become a tailwind In the second half as opposed to the first where it was a headwind because of the inventory actions that we've taken. And by the way, we've done this before.

Speaker 3

In fiscal year 2019, I want to remind everybody, we generated in the first half $200,000,000 of free cash flow. And in the second half, We generated $2,200,000,000 so more than 10 times more than what we generated in the first half. This was offset By $666,000,000 that we had to pay for an arbitration case that we lost at the time in fiscal year 2019, and we had very little time to turn around and offset The impact of that arbitration case, and yet we came into our guide that we gave at the time. And really look also at the trends on operating free cash flow that we highlighted to you as part of this call, You will observe that our seasonality is very much in line with fiscal year 2019 and fiscal year 2020. Fiscal year 2021 was a different story because in fiscal year 2021, you add the impact of restructuring costs that were affecting free cash flow.

Speaker 3

And if you will observe the detail of our press release with the tables that we provided you, you will see that our restructuring costs are Down overall relative to fiscal year 2021. So lots of put and takes there, but we are happy to reaffirm the free cash flow guide of 1.8 To $2,000,000,000

Speaker 2

Best way one thing for me to say it is that we are exactly what we were at the October Security Analyst Meeting, where we guided 3% to 4% revenue growth. The EPS guidance we just provided today, which is $196,000,000 to 2.10 And a free cash flow of $1,800,000,000 to $2,000,000,000 And knowing the seasonality of our business, we say at the time this year will be a normal seasonality business as you take the 2 years of COVID out of As you take the 2 years of COVID out of the way, we are very confident to deliver that number. It's exactly what Tarek said The working capital is going to turn favorable to us. And as we continue to drive the backlog down over time, that will help us So the earning correlation to free cash flow is the same we provided at Sam. And in terms of restructuring, Just to be clear on that one, we're very pleased with the progress we've made, which obviously was what we referred at the time reallocating resources

Speaker 6

To the areas of growth, you can

Speaker 2

see the areas of growth being HPC, AI, Edge and GreenLake obviously, which are paying off to us. And on track to deliver the $800,000,000 net savings that we committed at the time.

Speaker 1

Great. Thanks, Wamsi, for the question. Appreciate it. Can we go to the next one please, Chuck?

Operator

Yes. The next question will come from Rod Hall with Goldman Sachs. Please go ahead.

Speaker 3

Yes. Hi, guys. Thanks for

Speaker 5

the question. I guess in the ongoing spirit of trying to make sense of an incredibly complicated supply situation, I wanted to come back and kind of maybe juxtapose your performance here against a couple other companies. So if I look at Cisco, they, I would say objectively performed quite a bit worse on supply than you guys did. You had some sort of a middle of the road impact, not too bad of an impact from what And then if I look at Dell, they had almost no impact, although Dell did call out some looking forward issues with server supply. So I just wonder if you could dig into that a little bit for us and kind of help us understand some of the puts and takes around supply, maybe why those Differences of performance emerged?

Speaker 5

And then I have a follow-up.

Speaker 2

Sure. I'm going to start, but I think I don't think you can look Quarter by quarter, honestly, you have to look at the half and then the second half. If you look at our performance in Q1, we did very well. And on a balance, I think we are pleased with the first half. Listen, and then there is a lot of puts and takes here because Factory locations plays a role.

Speaker 2

So sometimes you're in the right side of the location, sometimes you're not. And obviously for us the impact of Shenzhen and Shanghai was there in April and Tarek quantified that for you. That impacted not just the compute business, every line of business because of other products come from that side. Some of our vendors may did not have the same impact. So that's why it's important.

Speaker 2

The other one is that you made Strategic choice is about components 2 to 3 years ago. And there are some suppliers more impacted than other ones. And therefore, you need to go in The details of the product itself and configurations and whatnot. And last but not least, when you look at our performance, let's remind ourselves we have a unique Sadaf in China. And that Sadaf basically says we cannot consolidate the China revenue That our partner today delivers.

Speaker 2

And when you look at the China growth, I can tell you our H3C business is Performing exceptionally well in China. However, the only thing we recognize on that is the dividend that we collect, but not the revenue. And then when you look at the segment, call it the server category, it is compute plus HPC plus H3C As the way market share gets reported. So that's why I look at this from a half performance. We made it Better in Q1, maybe a little bit less so in Q2 against some of our competitors, namely Dell, as you said, on some aspects.

Speaker 2

But on a balance, not that far off. Again, Cisco, definitely, we did well on every metric you want to look at it. And Pat, in the end, we're focused on the full year to deliver that guidance of 3% to 4% and obviously exit the year with still quite A large backlog, which bodes well for 2023.

Speaker 3

Yes. I want to add also, Rod, that in What you said, it's really important to look at what happens at the bottom line and at the margin level. And when you really look at how we've outperformed Dell on the margin level, Q1 and Q2, considering it's simply the compute margins alone compared to their ISG margins, is very telling.

Speaker 2

Yes, I think on that note, I mean delivering 13.9% on what people refer as a commoditized business Compared to a 10.2%, which includes server storage and networking, I think it's pretty remarkable. But I think it also shows our strategy to drive Profitable revenue growth, not just revenue, for the second revenue.

Speaker 5

Great. Okay, guys. I'm going to leave it there. Thank you very much for the answers. Sure.

Speaker 1

Thanks, Rod. Next question please.

Operator

Your next question will come from Ervin Liu with Evercore ISI. Please go ahead.

Speaker 9

Hi. Thank you for the question. So the large delta between your orders growth and revenue trajectory suggests that there still remains a large amount of So demand, given this dynamic, do you envision a scenario where customers begin to perhaps re architect their infrastructure So that a larger mix of their IT workloads, whether that's compute, storage, networking, HPC Are delivered via cloud native GreenLake as a service models?

Speaker 2

That's a great question. We see that more and more. Obviously, I think what customers are battling is the fact they are going through a multi generational IT journey here That they have to modernize. The fact that data has gravity and obviously some industry are more regulated than others. Then you talk about latency and experience that really matters.

Speaker 2

Cost, obviously, is another big component because at scale, they need to comprehend the cost aspect of it. And GreenLake is an amazing platform we have developed over the years to give them access, flexibility and control against In a way, they are moving away from branding IT to more innovating on IT. And that's why This data first modernization approach is so relevant. And that's why we already have more than $6,000,000,000 in the balance sheet Related to the HP GreenLake business, which again grew 107% in Q2. And obviously, Those bookings eventually will unwind from the balance sheet and through the P and L.

Speaker 2

And the other important fact here The Tarek show in one of the slides is the fact that our mix of GreenLake is shifting every single quarter To more software end services, which obviously comes with a significant higher margin than just the hardware. So that's why I think about The order momentum is super strong. The marquee type of customers across every industry is super strong. The fact that we keep adding capabilities, the mix is shifting. And that's totally accretive to our gross margin as we go forward.

Speaker 2

And this is one of the key moments of our company transforming into a relevant Platform that customer can use as they go through this journey that we just you just highlighted.

Speaker 1

Great. Thanks, Irvin, for the question. Operator, let's go to the last one, please.

Operator

Our last question will come from Kyle McNealy with Jefferies, please go ahead.

Speaker 10

Hi, thanks very much for the question. Can you give us a sense for the deferred revenue position in HPC and AI with The business you already have lined up and scheduled to deliver, you obviously already have one that was reached acceptance in Q3 already. And maybe give us a sense for the operating margin level that, that revenue is expected to come in at. Do you expect I mean, given that the project costs At times are taken in advance of revenue recognition. How much catch up profitability might you get?

Speaker 10

And what does the margin profile look like,

Speaker 2

a business that's expected Sure. Listen, I'm continuing to be incredibly bullish about this business. Supercomputing is necessary to advance AI and deep learning solutions to solve some of the biggest societal Challenges and honestly, climate and other. As I think about the current situation we are in, We have almost $3,000,000,000 in backlog. A couple of 2 quarters ago, we were talking about $2,500,000,000 and maybe a year $1,000,000,000 $1,500,000,000 So we have been continuing to grow the momentum with customers.

Speaker 2

By the way, it's all over the world. If you look at the wins, Including the number 3 supercomputer is a computer called Lumi that's in Europe. We have also supercomputers in France and Germany and so forth. So we are clearly the market leader there. However, this business It's lumpy as we said, right?

Speaker 2

From the time you book the order to time you recognize revenue, it can be several quarters. And the reason that's the case is because there are large installations and customers need to go through their own process to validate the workload. And over time, right, we're going to have a quarter, you're going to see a massive growth in revenue, which is not Linear in many ways as many of those customers' systems get accepted. So but in terms of margins, I will let Tarek comment on this. Obviously, you have to look in the long term, not just quarter by quarter, because that's not how this business works.

Speaker 3

Yes, that's right. You said very well, Antonio. I'll add to the margin part of the question, the saying, Our Q2 operating profit margin was affected by the ramp in project related costs, and they were recognized ahead of revenue for A couple of very large mega deals that we're expecting to close by year end. And therefore, as a result of that, we expect operating margins Return to more in range with historical levels on this business and we feel pretty good about these prospects.

Speaker 1

Great. Thanks, Kyle, for the last question. Antonio, I'll turn it over to you for some closing remarks.

Speaker 2

Well, thanks, everyone. I know there's a lot going on, a lot of news Today to cover, but I appreciate you making the time. Again, walk away from this Feeling good about the momentum we have with the persistent demand that we see in the market with an amazing Set of solutions that are attracting customers, a testament of that is 20% again bookings, with a backlog that give us the confidence to And honestly, I'm optimistic about the future, about the opportunity to innovate for our customers and to deliver the value to our shareholders. So again, thanks for your time today. I know there will be follow-up calls after this call and appreciate you making the time.

Speaker 1

Thanks, everyone.

Operator

Ladies and gentlemen, this concludes our call for today. Thank you.

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Earnings Conference Call
Hewlett Packard Enterprise Q2 2022
00:00 / 00:00