Tarek Robbiati
Executive Vice President and Chief Financial Officer at Hewlett Packard Enterprise
Thank you very much, Antonio.
I'll start with a summary of our financial results for the third quarter of fiscal year 2021. As usual, I'll be referencing the slides from our earnings presentation to guide you through our performance in the quarter.
Antonio discussed the key highlights on Slides 1 and 2, so now let me discuss our Q3 performance starting with Slide 3.
I'm pleased to report that we are experiencing very strong demand across all of our businesses. Q3 was marked by accelerating order growth, strong gross and operating margin expansion and robust cash flow generation. Building on the strength from the last quarter, we delivered Q3 revenues of $6.9 billion, up 3% from the prior quarter and in line with normal sequential seasonality, also in line with our outlook that factored in some of the expected supply chain constraints we flagged. We are working to ensure disruption is minimal by taking proactive measures and coordinating with our world-class suppliers to established tailored recovery plans.
I am particularly proud of our non-GAAP gross margin that hit another record level of 34.7%, up 40 basis points sequentially and up 420 basis points from the prior year period. This is driven by our deliberate actions to shift towards higher margin, software-rich offerings, strong pricing discipline and cost takeout. As previously indicated, we continue to invest in high-growth margin-rich areas of our portfolio, both in R&D and go to market, particularly in Aruba, software and as-a-service, which increased our non-GAAP operating expenses in the quarter.
We also booked two one-time charging totally [Phonetic] $28 million for a legal settlement and bad debt associated with likely fraud involving a channel partner in APJ. Even with these investments and one-time charges, our non-GAAP operating margin was 9.8%, up 190 basis points from the prior year, which translates to a 25% year-over-year increase in operating profit. We continue to be focused on driving further efficiencies in the business.
Within other income and expense, we benefited from stronger operational performance in HPC and strong gains related to increased valuations in our Pathfinder venture portfolio. As a result, we now expect other income and expense for fiscal year '21 to be an income of approximately $50 million.
With strong execution across the business and despite two unanticipated one-time charges, we ended the quarter with non-GAAP EPS of $0.47, up 31% from the prior year and above the higher end of our outlook range for Q3.
Q3 cash flow from operations was $1.1 billion and free cash flow was $526 million. This puts us at a record $1.5 billion of year-to-date free cash flow, up $1.1 billion from the prior year, driven primarily by an increase in operating profit.
Finally, the strength of our business has positioned us to contribute substantial capital to our shareholders. We paid $157 million of dividends in the quarter and are declaring a Q4 dividend today of $0.12 per share, payable in October. We are also announcing today the resumption of share buybacks as a result of greater free cash flow generation and visibility. I'll come back to capital allocation more broadly when we discuss the outlook.
Now, let's turn to our segment highlights on Slide 4.
Our growth businesses, which now represent nearly 25% of our total Company revenue, are executing strongly and experiencing record order levels.
In the Intelligent Edge, we accelerated our top-line momentum with record levels of orders and 23% year-over-year revenue growth. Switching was up over 20% year-over-year whereas wireless LAN experienced more acute supply constraints and was up mid single digits. Additionally, the edge-as-a-service offerings were up triple digits year-over-year, which reflects enabling software platforms as well as network-as-a-service. We also continue to see strong operating margins at 15.8% in Q3, up 540 basis points year-over-year, which included a $17 million one-time legal settlement that impacted margins by 2 points. Silver Peak continues to perform strongly and contributed 7 points to the Intelligent Edge growth. In addition, we started generating meaningful revenue synergies by cross-selling the Aruba portfolio, which reinforces the merits of the Silver Peak deal.
In HPC & MCS, demand strengthened even further with a record order level. Revenue grew 9% year-over-year, as we continued to achieve more customer acceptance milestones and deliver on more than $2.5 billion of awarded contracts, including the contract that Antonio mentioned with the NSA worth $2 billion over 10 years. We remain on track to deliver on our full year and three-year revenue growth CAGR target of 8% to 12%.
In Compute, revenue grew 4% quarter-over-quarter, reflecting normal sequential seasonality despite previously anticipated supply chain tightness. Operating margins of 11.2% were up 190 basis points from the prior year due to disciplined pricing and the right-sizing of the cost structure in this segment.
Within Storage, revenue grew 1% year-over-year and 3% quarter-over-quarter, ahead of normal sequential seasonality, driven by strong growth in software-defined offerings. Nimble grew 10% year-over-year, with ongoing strong dHCI momentum, growing double-digits year-over-year. All-flash arrays grew by over 30% year-over-year, led by Primera. The mix shift towards more software-rich platforms helped drive Storage operating margins to 15.1%, up 10 basis points year-over-year, offset by continued investments in our cloud data services. With respect to Pointnext operational services, including Nimble services, revenue grew for the third consecutive quarter year-over-year as reported, with both order and revenue growth expected for fiscal year '21.
Within HPE Financial Services, revenue was flat year-over-year and sequentially. While our bad debt loss ratio did increase slightly to 94 basis points this quarter, it was entirely due to a one-time $11 million reserve charge related to the already mentioned likely fraud in APJ by a channel partner. Absent this one-off event, our bad debt loss ratio would have improved to just 61 basis point, aligned to pre-pandemic levels.
More importantly, we continue to see improved cash collections above pre-pandemic levels. Our operating margin was 11.1%, up 300 basis points from the prior year and our return on equity at 18.3% is well above the 15% plus target set at SAM.
Slide 5 highlights the key metrics of our growing as-a-service business. We have made significant progress since our Analyst Day last October by adding over 200 new enterprise GreenLake customers to over 1,100 today, and increasing our TCV by over $1 billion to our current lifetime TCV of well over $5 billion. For Q3 specifically, our ARR was $705 million, which was up 33% year-over-year as reported and total as-a-service orders were up 46% year-over-year. It is also important to note that the mix of our ARR is becoming more and more software-rich as we build out our GreenLake Cloud platform, which is improving our margin profile. We look forward to providing more disclosure around our software and services mix at our Analyst Day later this fall, which I believe reinforces a significant value-add of GreenLake. Overall, based on strong customer demand and recent wins, I am very happy with how this business is executing and progressing towards achieving our ARR growth target of 30% to 40% CAGR from FY '20 to FY '23.
Slide 6 highlights our revenue and EPS performance to date, where you can clearly see the strong rebound from last year and sustained momentum for the last three quarters. The demand environment continues to strengthen. And with the operational execution of our cost optimization and resource allocation program, we have increased non-GAAP EPS in Q3 by 31% year-over-year.
Turning to Slide 7, we delivered another record non-GAAP gross margin rate in Q3 of 34.7% of revenues, which was up 40 basis points sequentially and up 420 basis points on the prior year. This was driven by strong pricing discipline and a positive mix shift towards high-margin software-rich businesses like the Intelligent Edge and next-generation Storage offerings. We have also benefited from our new segmentation we implemented beginning of fiscal year 2020, that gives us much better visibility into each business unit and enables the better resource allocation and discipline to drive operating leverage.
Moving to Slide 8, you can also see we have expanded non-GAAP operating profit margins substantially from pandemic lows to 9.8%, which is up 190 basis points from the prior year period. We are driving further productivity benefits and delivering the expected savings from our cost optimization plan, while simultaneously increasing our investment levels in R&D and field selling costs, which are critical to fuel our long-term innovation engine and revenue growth targets. As mentioned previously, Q3 operating expenses also included one-time charges not included in our guidance, totaling $28 million for a legal settlement and the likely fraud scheme involving a partner. Excluding these one-off charges, our operating margin would have been 10.2%.
Turning to Slide 9, we generated a record year-to-date levels of cash flow with $2.9 billion of cash flow from operations and $1.5 billion of free cash flow, which is up $1.1 billion year-over-year. This was primarily driven by increased operating profit. I would like also to underscore that this year, our free cash flow seasonality will be different than in prior years. We expect increased Financial Services volume that include more than $150 million in Q4 financing for a very large deal that is predominantly GreenLake and will benefit our ARR and margins for years to come. We also have further restructuring payments and growing working capital needs, as we continue to buffer our inventory levels in the light of the disruption in the global IT supply chain.
Now moving on to Slide 10, let me remind everyone about the strength of our diversified balance sheet. As of July 31st, the operating company net cash balance turned positive due to our strong free cash flow. Furthermore, we made additional progress during the quarter, securitizing over $750 million of financial services related debt through the ABS market. The refinancing of higher cost unsecured debt with ABS financing allows us to boost access to financing market at a cheaper cost of debt capital, as well as diversify and segregate our balance sheet between our operating company and our Financial Services business. Bottom line, our improved free cash flow outlook and cash position ensure we have ample liquidity to run operations, continuing to invest in our business to drive growth and return capital to shareholders.
Now turning to our outlook on Slide 11. I'm very pleased to announce that we are once again raising our full year guidance to reflect the continued momentum in the demand environment and our strong execution. This will be the fourth guidance increase since SAM in October 2020. We now expect to deliver fiscal year '21 non-GAAP diluted net earnings per share between $1.88 and $1.96.
With respect to supply chain, as indicated last quarter, industry-wide tightening somewhat constrained our supply as expected. We continue to take proactive inventory measures where possible and you can see our efforts in inventory balances that increased $1.3 billion year-to-date that also reflects the strengthening demand environment and a substantial order book we have across the business. We expect the challenged supply chain conditions to persist until at least the middle of calendar year 2022 and have factored these into our revenues, costs and cash flow outlook.
From a top-line perspective, although we remain prudent given the challenged supply chain environment, we are very pleased with the accelerating Q3 order momentum across all segments of the business. More specifically for Q4 '21, we expect revenue to be above our normal sequential seasonality from Q3 and are comfortable with current consensus levels.
For Q4 '21, we expect GAAP diluted net EPS of $0.14 to $0.22, and non-GAAP diluted net EPS of $0.44 to $0.52.
Additionally, given our record levels of free cash flow year-to-date and confidence in our raised outlook, I am very pleased to announce that we are also raising fiscal year '21 free cash flow guidance to $1.5 billion to $1.7 billion, that is a $600 million increase at the midpoint from our original SAM guidance, with the top end of this free cash flow guidance range at the peak levels attained in fiscal year '19.
As you recall, at the end of the first half of fiscal year 2020, we suspended our share buybacks to preserve liquidity in the context of the global pandemic disruption. Although we continue to operate in a challenged supply environment, our order momentum and improved cash flow generation visibility give us confidence to reinstate our share repurchase program. We are targeting up to $250 million of share repurchases in Q4 of fiscal year '21 and we'll update investors on our capital management policy for fiscal year '22 at SAM in October. As a reminder, we always follow a disciplined return-based capital allocation framework to maximize long-term shareholder value. Our number one priority remains delivering sustainable profitable growth through both organic and inorganic M&A investments while remaining committed to paying dividends to our shareholders. In addition, we will consider opportunistic share buybacks when we see a favorable return for doing so.
So, overall and to conclude, I am very proud of the progress we have made year-to-date in fiscal year '21. It's clear that our edge-to-cloud strategy is resonating with customers and driving improved momentum across all of our businesses. Our growth businesses in the Intelligent Edge and HPC MCS have accelerated top-line performance with record levels of orders. Our core business and -- of Compute and Storage is demonstrating momentum, robust orders and improved margins, and our as-a-service ARR is accelerating. All of this translates to improving revenue momentum, strong profitability growth and record levels of free cash flow. We look forward to closing out our fiscal year much leaner, better resourced and positioned to capitalize on the strong demand environment.
Lastly, as Antonio mentioned, we look forward to having you join us for our virtual Securities Analyst Meeting in late October, where we will provide an update on our strategy, business insights and financial outlook.
Now with that, let's open it up for questions.
