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spk10: 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. Should you need any assistance during the call, please press to signal a conference specialist by pressing the star key followed by zero. 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. Andrew Simonik, Vice President of Investor Relations. Please proceed, sir.
spk07: Great, thank you. Good afternoon, everyone. I'm Andy Simonik, Head of Investor Relations for Hewlett Packard Enterprise. I'd like to welcome you to our fiscal 2022 second quarter earnings conference call with Antonio Neri, HPE's President and Chief Executive Officer, and Tarek Robiadi, HPE's Executive Vice President and Chief Financial Officer. Before handing the call over to Antonio, let me remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately one year. 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 today. For more detailed information, please see the disclaimers on the earnings materials relating to forward-looking statements that involve risks, uncertainties, and assumptions. 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-K and Form 10-Q. HPE assumes no obligation and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on information available at this time 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. Please refer to the tables and slide presentation accompanying today's earnings release on our website for details. Throughout this conference call, all revenue growth rates, unless noted otherwise, are presented on a year-over-year basis and adjusted to exclude the impact of currency. 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.
spk05: Well, thank you, Andy, and good afternoon, everyone. Thanks for joining today's earnings call. HP's second quarter results reflect significant customer traction for our differentiated portfolio and underscore our progress in becoming the edge-to-cloud company. The microeconomic 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 and have made it harder for them to realize their goals in the short term. 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. HB's ability to address these customer needs was key to our performance in the second quarter. Once again, HP generated significant orders growth, steady revenue, and sustained profitability, even as tight supply conditions continued across global industries. We are seeing persistent demand from our customers, underscoring both their IT spending prioritization and their attraction to our compelling portfolio. Very strong customer demand in the second quarter drove orders growth higher, rising 20% year over year. which makes this the fourth quarter in a row that HP has logged year-over-year orders growth of 20% or better. Our HP GreenLake H2Cloud platform contributed to as-a-service orders doubling year-over-year, the third straight quarter of triple-digit growth. 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 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 billion. Total HP revenue rose 1.5% year-over-year to $6.7 billion, 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 asset service model differentiating us. This quarter, though, through a combination of supply constraints, limiting our ability to fulfill orders, as well as some areas where we could have executed better, we did not fully translate 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 44 cents, which together with our Q1 results makes the first half of 2022 the second strongest EPS half-year performance at HPE on a continuing operations basis. I started with detail for you. We are reaffirming 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 $1.8 billion to $2 billion. As announced, In February, we suspended all shipments to and sells in Russia and Belarus. We have now determined that it is 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 will proceed with an orderly managed exit. Our business in these countries represent less than 2% of HP's total revenue in fiscal year 21. We have booked $126 million pre-tax charges related to the impact of Russia to our business, which is including our second quarter GAAP earnings per share results. We expect less significant additional charges in the third 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 are all contributed to a dynamic environment. However, enterprise demand continues to persist across our entire portfolio. We are focused on translating the demand we see in the market and our high-quality backlog into profitable growth, while continuing 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. 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 three 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 HP GreenLake that deliver greater choice and simplicity. We added 12 new cloud native services, We now have more than a total of 50 cloud new services available through the platform. 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 sold multiple HP GreenLake deals in the quarter increased by 2.5 times year over year. At the edge, our capabilities are high-demand. as organizations need to securely connect distributed workforces and create engaging experiences. We are focused on delivering cloud-native services that can more easily embed into automated networks to absorb evolving networking configurations. And with the convergence of Aruba Central and HP GreenLake, more than 120,000 Aruba customers now have access to the HP GreenLake platform. 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 private provider for Google's cloud distributed hosted solution. HPE GreenLake will enable Google to deliver an on-premises cloud experience for organizations with strict data residency, security, and privacy requirements. Our hybrid cloud offerings have attracted nearly 150 new customers in Q2. including BMW Group, who is using HP GreenLake to streamline and unify the company's data management across its global locations in the cloud, and Worldline, the world's fourth-largest payment provider, who chose HP 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 Worldline upgrade to HP GreenLake, with our asset renewal program funding approximately 25% of the refresh. From a data perspective, we continue to make meaningful enhancements that allow customers to extract more insights from the data to accelerate business outcomes. 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. One university in Germany is already using HP Swarm 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 first and the fastest exascale supercomputer, taking the number one ranking on the world's top 500 list of supercomputers. exceeding the one exafloat performance threshold for the first time. To put this in perspective, this performance is three times faster than the number two supercomputer. HP has deployed four of the top ten supercomputers and ranks first, second, third, and fourth on the green 500 list of the most energy efficient supercomputers in the world. Our service pivot is also innovative in the way it helps our customers meet their sustainability goals. HP GreenLake helped customers reduce their carbon 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 of the last several years would require enterprises to adapt so dramatically. I spend 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. 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 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. 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.
spk08: Thank you very much, Antonio. I'll start with a summary of our financial results for the second quarter 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 one and two, so now let me discuss our Q2 performance details, starting with slide three. 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 fourth quarter in a row with order growth of 20% or better year-over-year. This maintains our confidence in achieving both our fiscal year 22 revenue outlook of 3% to 4% growth adjusted for currency and our longer-term 2% to 4% revenue CAGR outlook provided at our 2021 Securities Analyst Meeting. We delivered Q2 revenues of $6.7 billion, 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 million in the quarter, our total operating margins by more than one point, and EPS by approximately six cents. Given the delta between our order and revenue growth rates, our backlog further increased to new record levels and yet remains very high quality. 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 were 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. Within other income and expense, we benefited from robust operational performance in H3C 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 22 to be an income of approximately $75 million versus prior guidance of an approximately $25 million income. Given our strength in gross margin and despite the approximately six cents impact from China and Russia, we delivered non-GAAP diluted net earnings per share of 44 cents near the midpoint of our outlook range of 41 cents. to 49 cents for Q2. We also delivered GAAP earnings per share of 19 cents. This includes $126 million of disaster charges related to Russia, primarily consisting of an increased reserve for financing lease assets. With the decision to orally 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 seasonality, that is a use of cash in the first half, and Q2 was a use of cash of $211 million. We have made significant investments in working capital during the first half, reflecting our strategic inventory actions to navigate the current supply environment. 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 million 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 million in shares, bringing our year-to-date total capital returns to $498 million, reflecting our confidence in future cash flow generation. Slide 4 highlights key metrics of our growing as-a-service business. 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 for all users. Total as a service orders were up 107% year-over-year, marking the third quarter in a row with orders more than doubling. Our ARR was up 25% year-over-year to $829 million, 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 21 to fiscal year 24 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. 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 fifth consecutive 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 from previous price actions that are sticking. 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 billion. Revenue grew 5% year over year and was impacted by one large customer acceptance delay that impacted growth by more than six points and has now been delivered in Q3. 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 fourth 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 2021 of 11% to 13%. Within storage, we achieved another record level of product backlog that is skewed towards our owned IP margin-rich products. 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 steer more demand towards our new Elettra 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 21. As you know, this is very important for the long-term health of our most profitable business. Within HPE 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 2021. Slide six highlights our revenue and EPS performance, where you can see we've maintained relatively constant levels from last year, despite incremental supply constraints, in particular from the China shutdowns, and also our ceasing to support services contracts in Russia. As a reminder, these combined for more than a $250 million impact to revenue and a one point impact to total operating margins and an approximately six cents impact to EPS in Q2. 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. Given our high-quality backlog, we are also continuing to invest more in both R&D and our go-to-market for future growth. On slide 9, let's spend some time reminding everyone about our unique setup in China through H3C. As disclosed in an 8K in late April, we have extended our existing put option that is struck at 15 times trading 12-month earnings through to October 31st, 2022. We did this to enable the new investors at the Unigroup level to complete their restructuring, which is proceeding as planned, before determining a longer-term path forward for our stake. We value our presence in China, the second 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&L and cash flow, and you can see that we are generating growing value to shareholders with our unique setup. Our equity interest rose 21% in fiscal year 21, and has grown 32% in this Q2 of fiscal year 22. We will keep you up to date as we arrive at a longer term solution for this valuable asset. Turning to slide 10, our free cash flow was a use of cash of $211 million. This is aligned to our normal 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 $1.8 to $2 billion. Now turning to our outlook on slide 11, we are revising our fiscal year 2022 non-GAAP outlook range back to our original outlook provided at SAM of $1.96 to $2.10. This reflects the impacts of a more unfavorable currency movement 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 challenges that we believe will likely last well into next year. Currency is also expected to now be a two-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 2022, we expect revenue to be up low single digits sequentially. 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 22, we expect gap diluted net EPS of 22 to 32 cents and non-gap diluted net EPS of 44 to 54 cents. 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 22. 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 set at SAM 2021. Now with that, let's open it up for questions. Thank you.
spk10: We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. And to withdraw your question, please press star then two. We also request that you only ask one question. And we'll pause momentarily while we assemble our roster. And the first question will come from Aaron Rakers with Wells Fargo. Please go ahead.
spk00: Aaron, are you there?
spk03: Yeah, I am. Sorry about that, guys. Can you hear me? Yeah, we got you, Aaron. Okay, yeah, sorry. Sorry about that. So I'll start with just the question on the backlog. You know, as you kind of thought about the guidance for the full year and obviously some moving parts around FX and China, et cetera, but how has your assumptions changed at all with regard to the backlog build? Are you assuming any kind of backlog reduction, you know, through the course of this fiscal year? And if not, what's your current views on kind of peaking levels of backlog at this point? Thank you.
spk08: 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 four 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. I want to reiterate to you that the FX impact in that guidance is a 2% headwind as opposed to a 50 basis point headwind that we originally forecast.
spk05: 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 SAM for the next three years. But obviously, as we go forward, the backlog will be reduced as supply and other issues alleviate. And you think about the 3 to 4 percent guidance for the year, which is the guidance we provide at SAM versus the 1.5 percent we just reported, obviously, there will be low single-digit growth sequentially on that revenue.
spk03: Thank you.
spk07: Great. Thanks for the question, Aaron. Chuck, can we go to the next one, please?
spk10: Yes, sir. The next question will come from Simon Leopold with Raymond James. Please go ahead.
spk09: Thanks for taking the question. I wanted to see if you could help me get a little bit better insight into what allowed you to basically do 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 how much of this is about mix, how much of it is about your ability to raise prices and pass that on to
spk08: 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 thank you 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 We outperformed the competition, specifically Cisco in the second quarter, 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 discipline pricing actions that we've taken now for several quarters with compute continue to bear fruit. 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 is performing much, much better than the rest of the industry. Third, when you really look at the gross margin mix again across the other segments, particularly storage and HPC, there are two different stories there. With respect to storage, you have a mix between our own IP product and third-party product that has been unfavorable to us, meaning that there were more third-party product revenues than own 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 we've always been saying. It's a lumpy business, and it's a matter of revenue scale. We had one slippage of a deal that has affected growth by six 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 HPEFS. The performance of HPEFS 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 is very, very strong, north of 20%, which is better than our long-term outlook of 18%. plus percent that we gave you at SAM 2021. 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. Thank you.
spk07: I'll follow up. All right. Sounds good. Thanks, Simon. Appreciate it. Operator, can we have the next one, please?
spk10: The next question will come from Sameek Chatterjee with JP Morgan. Please go ahead.
spk06: Yep. 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 basis, 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 you're seeing in that region. And also, I don't know if you –
spk05: um sort of pointed out what the order number impact on the order number was from the russia exit as well thank you yeah thank you thank you for the question as i said in my remarks uh we continue to see ongoing persistent demand from our customers i think it's a combination of them prioritizing i.t spend and honestly the attraction to our portfolio 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 four consecutive quarters. That's simply remarkable. And yet we just delivered 9% revenue growth. So that tells you the strength of the demand. As you think about this distributed enterprise, there's a new way to work. 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 control. And the fact that one of the major clouds is leveraging HP GreenLake to basically deliver their managed hosted distributed cloud is a testament of that differentiation. The other thing, obviously, anything related to data is simply very strong. I think the demand for big data, analytics, AI, machine learning will 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 SASE approach, also provides an alternative to that. 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 HP GreenLake, which is a data-first modernization approach. Our demand is super strong, 20%, four consecutive quarters. for HPE is pretty remarkable. And our order backlog, as we said early on, is high quality, which means 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 price that backlog to preserve gross margins. And that's why it gave us the confidence not only to grow revenue, but to continue to deliver our operating margins commitments, ultimately EPS commitments. The impact of Russia and Belarus, because you have to combine these two, is less than 2% of the revenue on a continuous basis. If you look at 2021 in terms of EPS, Tarek explained it and unpacked it for you, which we were able to kind of offset in many ways. with an overperformance in Q1. So, Tarek, any comments on your side?
spk08: Yeah, 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 million. The majority of that impact relates to China. And the Russia impact specifically is related to the fact that 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've described the totals for China and Russia, 1% impact on total operating profit margins and 6 cents on EPS overall. But again, the majority of these impacts were driven by the 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.
spk05: And I will say our diversification of our coverage around the globe also is a good positive thing for us.
spk07: Great. Thanks for the question, Samik. Can we go to the next one, please?
spk10: The next question will come from Wamsi Mahon with Bank of America. Please go ahead.
spk04: Yes, thank you. I hear your comments about the confidence around the demand trajectory and that orders continue to be very strong. But as you look into the second half, can you talk about, you know, 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 six cents 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. So can you talk about what levers we should expect within those free cash flow moving pieces that gets you to your guide across the second half? Thank you.
spk05: Yeah, let me start, and I would like Tarek to talk about the free cash flow. 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. It continues to be very strong, and that's why we use the word persistent. Persistent meaning, you know, it's there, right? And then... I think, depending on what happens here in the 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 the enterprise side. If anything, I will argue it will have a positive impact to our Green Lake because customers will want to maybe preserve some capex and they could 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 gives us a very strong foundation to build from there as we look forward. Tarek, you want to talk about the free cash flow question?
spk08: Yeah, 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 translate into free cash flow, every cent of EPS is essentially $13 to $15 million, 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. Our guidance back to the SAM 2021 guide is very much contained in the free cash flow guide that we gave you. And 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 first 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. In fiscal year 19, I want to remind everybody, we generated in the first half $200 million of free cash flow And in the second half, we generated $2.2 billion, so more than 10 times more than what we generated in the first half. This was offset by $666 million that we had to pay for an arbitration case that we lost at the time in fiscal year 19, 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 19 and fiscal year 20. Fiscal year 21 was a different story because in fiscal year 21, you had the impact of restructuring costs that were affecting free cash flow. 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 coming down overall relative to fiscal year 21. So lots of put and takes there, but we are happy to reaffirm the free cash flow guide of $1.8 to $2 billion.
spk05: This way, one thing for me to say is that we are exactly what we were at the October security analysis meeting, where we got a 3% to 4% revenue growth The EPS guidance we just provided today, which is 196 to 210, and a free cash flow of $1.8 to $2 billion. And knowing the seasonality of our business, which we say at the time this year will be a normal seasonality business as you take the two years of COVID out of the way, we are very confident to deliver that number. It's exactly what Tarek said, is 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 as well. So the earnings 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 the what we refer at the time, reallocating resources to the areas of growth, you can 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 million net savings that we committed at the time.
spk07: Great. Thanks, Wamsi, for the question. Appreciate it. Can we go to the next one, please, Chuck?
spk10: Yes, sir. The next question will come from Rod Hall with Goldman Sachs. Please go ahead.
spk02: Yeah. Hi, guys. Thanks for 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 perform 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 I can tell in the numbers. 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. And then I have a follow-up.
spk05: Sure, I'm going to start, but 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 play a role. So sometimes you're on 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 a lot of products come from that side. Some of our vendors did not have the same impact. So that's why it's important. The other one is that you made strategic choices about components two to three years ago. And there are some suppliers more impacted than other ones. And therefore, you need to go into 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 setup in China. And that setup basically says we cannot consolidate the China revenue that our partner today delivers. 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 dividends 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. But on a balance, not that far off. Again, Cisco definitely did well on every metric you want to look at it. But 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 bought well for 23.
spk08: 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 simply the compute margins alone compared to their ISG margins, it's very telling.
spk05: Yeah, 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 sake of revenue.
spk02: Great. Okay, guys, I'm going to leave it there. Thank you very much for the answers.
spk07: Sure. Thanks, Rod. Next question, please.
spk10: The next question will come from Ervin Liu with Evercore ISI.
spk01: Please go ahead. 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 unfulfilled 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?
spk05: 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 industries are more regulated than others, Then you talk about latency and experience that really matters. 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 all the needs. In a way, they are moving away from running 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 billion 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 into the P&L. And the other important fact here that Tarek showed in one of the slides is the fact that our mix of GreenLake is shifting every single quarter to more software and 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 accreted to a gross margin as we go forward. and this is one of the key moments of our company, transforming into a relevant platform that customers can use as they go through this journey that you just highlighted.
spk07: Great. Thanks, Irvin, for the question. Operator, let's go to the last one, please.
spk10: Our last question will come from Kyle McNeely with Jefferies. Please go ahead.
spk11: 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 the project costs, at times are taken in advance of revenue recognition, how much catch-up profitability might you get, and what does the margin profile look like of business that's expected for the back half of the year? Thanks.
spk05: Sure. Listen, I'm continuing to be incredibly bullish about this business. You know, supercomputing is necessary to advance AI and deep learning solutions to solve some of the biggest societal challenges, and honestly, climate, As I think about the current situation we are in, we have almost $3 billion in backlog. A couple of two quarters ago, we were talking about 2.5 and maybe a year, a billion, a billion and a half. So we have been continuing to grow the momentum with customers. By the way, it's all over the world. If you look at the wins, you know, including the number three 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 is lumpy, as we said, right? From the time you book the order to the 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 customer systems get accepted. But in terms of margins, I will let Tarek comment on this. Obviously, you have to look at a long-term, not just quarter by quarter, because that's not how this business works. Yeah, that's right.
spk08: You said very well, Antonio. I'll add to the margin part of the question, 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 to return to more in range with historical levels on this business. And we feel pretty good about these prospects.
spk07: Great. Thanks, Kyle, for the last question. Antonio, I'll turn it over to you for some closing remarks.
spk05: 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, you know, walk away from this quarter 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 gives us the confidence to deliver on our commitments. And honestly, I'm optimistic about the future, about the opportunity to innovate for our customers and to deliver their value to our shareholders. So, again, thanks for your time today. I know there will be follow-up calls after this call, and I appreciate you making the time. Thanks, everyone.
spk10: Ladies and gentlemen, this concludes our call for today.
spk05: Thank you.
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