Hewlett Packard Enterprise Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
September 1, 2021

There are 9 speakers on the call.

Operator

Good afternoon, and welcome to the Third Quarter Fiscal 2021 Hewlett Packard Enterprise Earnings Conference Call. My name is Matt, 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 toward the end of the conference. As a reminder, this conference is being recorded for replay purposes.

Operator

I would now like to turn the presentation over to your host for today's call, Mr. Andrew Simonek, Vice President of Investor Relations. Please proceed.

Speaker 1

Good afternoon. Randy Simonik, Head of Investor Relations for Hewlett Packard Enterprise. I'd like to welcome you to our fiscal 2021 Q3 earnings conference call with Antonio Neri, HPE's President and Chief Executive Officer and Tarek Robiotti, HPE's Executive Vice 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 1 year. We posted the press release and the slide presentation accompanying today's earnings release on our HPE Investor Relations webpage at investors.

Speaker 1

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 ks and Form 10 Q. HPE assumes no obligation and does not intend to update any such forward looking statements.

Speaker 1

We also note that the financial information discussed on this call reflects 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 July 31, 2021. 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, we will be referencing the slides in our earnings presentation throughout our prepared remarks.

Speaker 1

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

Thanks, Andy. Good afternoon, everyone. Thank you for joining our call today. I'm amazed by the resilience of our customers, partners and team members, and I'm incredibly proud of where Hewlett Packard Enterprise continues We delivered a very impressive Q3 at HPE, With strong orders growth, expanded margins and record free cash flow. Overall, I am pleased to see how our differentiated portfolio is resonating with the market, and our edge to cloud strategy is driving improved momentum across our businesses.

Speaker 2

Based on the strength of our Q3 performance and our confidence about our momentum in the market, we are Again, raising our fiscal year 2021 EPS and free cash flow outlook, and we're also resuming stock repurchases. Revenue in Q3 was $6,900,000,000 in line with our outlook and normal sequential seasonality. Our Q3 orders were up Strong double digits year over year and our year to date order volume has increased 11%, Showing the strength of our edge to cloud offerings, we significantly expanded our non GAAP gross and operating margins, Driving our year to date non GAAP operating profit and earnings per share, up 28% And 27% year over year, respectively. We generated record year to date free cash flow of $1,500,000,000 Up $1,100,000,000 year over year, putting us well ahead of the original outlook we announced last October. I am particularly pleased that we were able to deliver these results while mitigating against industry wide supply constraints By taking proactive inventory measures, working closely with our suppliers and deploy our best in class engineering capabilities to establish The impact of the pandemic continued to accelerate the shift we predicted years ago To an edge centric cloud enabled and data driven world, now more than ever, there is a greater need for secure connectivity, Faster insights from data and a cloud experience everywhere.

Speaker 2

We expect these trends to continue. Digital transformation is no longer a priority, Strategic imperative. To help our customers transform their businesses and be future ready today, We have been focused on doubling down in key areas that are resonating strongly in the market. We had a record number of orders in both Our Intelligent Edge business and high performance computing and mission critical solutions business. Due to strong demand and execution, these growth businesses Now make up nearly 25 percent of our total company revenue.

Speaker 2

Our Intelligent Edge business accelerated its momentum again in Q3 With 23% year over year revenue growth, driven by a record number of new orders, strong customer demand for secure connectivity Has generated a backlog 5 times greater than at the close of Q3 last year, as customers increasingly look for solutions to collect, Connect, analyze and act on data at the edge. We are leaning into this demand and continue to invest and innovate at the edge. In June, we announced new AIOps, IoT and security features for Aruba Edge Services Platform, or ESP, Designed to streamline network operations, maximize IT efficiency, and more easily extend the network from the edge to the cloud. Araruba ESP continues to gain traction with customers in different verticals. In the Q3, customers including Save A Lot, Monument Health and Silca Resorts and Casinos all standardize their networks on Aruba ESP.

Speaker 2

In our high performance compute and emission critical solutions business, revenue was up 9% year over year, driven by a record number of new orders. We also generated a record order book, which now exceed $2,500,000,000 The exponential growth in data, along with AI and big data analytics, All driving an increased need for high performance computing and mission critical capabilities in enterprises of all sizes. To meet these demands, we bolster our artificial intelligence capabilities with the acquisition of Determine AI, a startup that delivers a powerful software Stack that to train AI models faster at any scale using its open source machine learning platform. We also continue to see an increasing number of customers accessing our high performance computing solutions as a service through HPE GreenLake. With our HPE GreenLake cloud services for HPC, customers gain powerful, specialized computing and AI capabilities With a sustainable cloud experience.

Speaker 2

For example, in Q3, HPE was awarded a $2,000,000,000 contract to be realized over a 10 year period With the National Security Agency to deliver high performance computing solutions through the HP GreenLake platform. The service will help the National Security Agency Efficiently process data and unlock new insights in sustainable new ways. Our core businesses generated robust year over year orders growth, As well as strong profitability and free cash flow in the quarter. Year to date, computer storage orders are up mid single digits, With Q3 operating margins of 11.2% and 15.1% respectively, We continue to offer more of our core capabilities as a service. In Q3, we introduced unified compute operations as a service Through our HPE GreenLake Edge to Cloud platform, this new cloud based management service simplifies provisioning And automates the management of compute infrastructure wherever it resides.

Speaker 2

Our storage business is transforming into a cloud native Data Services business through organic innovation and targeted acquisitions. In May, we introduced our new cloud data services available Through HPE GreenLake, as well as our new HPE Alletra cloud native data infrastructure. And just this week, we closed the acquisition of Zerto, An industry leader in cloud data management and protection and ransomware of data recovery services, which will be soon available As a service through HPE GreenLake. This acquisition immediately positions HPE GreenLake in the high growth data protection market with a proven scaled solution. HPE was the first to market 4 years ago in delivering an as a service cloud experience On premises, in a co location or at the edge with HPE GreenLake.

Speaker 2

Today, our HPE GreenLake edge to cloud platform has more than 1100 customers. Our annualized revenue run rate this quarter was $705,000,000 up 33% year over year, Driven by strong as a service orders growth, up 46% year over year. Organizations across sectors, including retail, healthcare, Financial Services and Public Sector are turning to HPE GreenLake. For instance, we helped Liberty Mutual shift from a traditional CapEx IT spend To a new pay as we go model, creating a cloud experience on premises to provide transparency into consumption, while improving their speed in adapting To capacity demands, they standardized critical workloads on HP Synergy delivered to HP GreenLake, Resulting in a reduced data center footprint and significant cost savings, including a monthly unit rate well below public cloud alternatives. We also see in the power of the full HPE H2 Cloud Portfolios, customers are turning to HPE for integrated solutions I combined secure connectivity, data insight capabilities and cloud experiences.

Speaker 2

Woolworths, Group Australia and New Zealand's largest retailer, Selected HPE could relate to power its new W Pay payment platform. They needed a solution that combine a powerful mission critical architecture With the ability to scale and also provide a better cost efficiency back to WPA and its merchant partners. Delivered through HPE GreenLake, their solution leverages our full H2 Cloud portfolio, including HP Aruba, HPE Nonstop, HPE Primera and HPE Synergy. HPE Pointnext Services also provided expertise to accelerate the company's digital transformation. I believe this is a great example of the power of our HPE H2 Cloud portfolio.

Speaker 2

To extend our leadership position We made several compelling announcements at HP Discovery in June. I am particularly excited about our new HP GreenLake Lighthouse offering, a secure cloud native stack built with HP EthernetL software To autonomously optimize different workloads across hybrid estates, reducing time to deployment and operating costs. We also introduced Project Aurora to secure the enterprise embedded in our HPE GreenLake H2 Cloud platform. Project Aurora automatically and continuously verifies and attests the integrity of the hardware, firmware, operating systems, platforms and workloads, while also detecting advanced threats. And finally, demonstrating our continued commitment to acquiring assets that complement our own capabilities, we acquired data platform developer, Ampol.

Speaker 2

On Paul, we'll accelerate HPE Ezmeral analytics runtime to deliver high performance analytics for engineers and business analysts. I am proud of HP's performance in Q3 year to date and the significant progress we have made in becoming the H2 Cloud company. The momentum we have in the market compel us to move even further and faster, and our ability to transform with increasing speed is imperative. The transformation is my number one priority. At this pivotal moment, our purpose to advance the way people live and work has never been more important.

Speaker 2

Our vision to become the edge of cloud company is proving its tremendous relevance, and our portfolio is winning in the marketplace. Fueled by our purpose, vision and portfolio, we have the opportunity to build a more digitally enabled inclusive world. We have a mandate to imagine new digital transformation strategies that support our own ESG goals and those of our customers, Leading to better business outcomes and societal impact, we will never waver from our commitment to being a force for good and a strategic partner for our customers. We will continue to bring bold new innovation to our customers, and we will continue to create value for our shareholders. And I'm grateful for the incredible team, and I'm confident in and excited about the future.

Speaker 2

I hope you will join us for our Virtual Security Analyst Meeting on October to hear more about our position in the market, our priorities and our outlook for the year ahead. I will now turn it over to Tarek.

Speaker 3

Thank you very much, Antonio. I'll start with a summary of our financial results for the Q3 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 12. So now let me discuss our Q3 performance, starting with Slide 3.

Speaker 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 $6,900,000,000 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 reflect. We're working to ensure disruption is minimal by taking proactive measures That hit another record level of 34.7%, up 40 basis points sequentially And up 4 20 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.

Speaker 3

As previously indicated, we continue to invest in high growth margin rich areas of our portfolio, Both in R and 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 2 one time charging, totally $28,000,000 for a legal settlement and bad debt 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 H3C and strong gains related to increased valuations in our Pathfinder Venture portfolio.

Speaker 3

As a result, we now expect other income and expense for fiscal year 2021 to be an income of approximately 50,000,000 With strong execution across the business and despite 2 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 $1,100,000,000 and free cash flow was $526,000,000 This puts us at a record $1,500,000,000 All year to date free cash flow, up $1,100,000,000 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 100 $7,000,000 of dividends in the quarter and are declaring a Q4 dividend today of $0.12 per share payable in October. We We are also announcing today the resumption of share buybacks as a result of greater free cash flow generation and visibility.

Speaker 3

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% Whereas wireless LAN experienced more acute supply constraints and was up mid single digits.

Speaker 3

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 5.40 basis points year over year, which included A $17,000,000 one time legal settlement that impacted margins by 2 points. TILOPY 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 and MCS, demand strengthened Even further with a record order level, revenue grew 9% year over year as we continue to achieve More customer acceptance milestones and deliver on more than $2,500,000,000 of awarded contracts, including the contract that Antonio mentioned with the NSA worth $2,000,000,000 over 10 years.

Speaker 3

We remain on track to deliver on our full year and 3 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 percent were up 190 basis points from the prior year due to disciplined pricing and the rightsizing 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.

Speaker 3

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 3rd consecutive quarter year over year as reported with both order and revenue growth expected for fiscal year 2021. 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 $11,000,000 reserve charge related to the already mentioned likely fraud in APJ by a channel partner.

Speaker 3

Absent this one off event, our bad debt loss ratio would have improved to just 61 basis points 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 1100 today And increasing our TCV by over $1,000,000,000 to a current lifetime TCV of well over $5,000,000,000 For Q3 specifically, our ARR was $705,000,000 which was up 33% year over year as reported And total as a service orders were up 46% year over year.

Speaker 3

It is also important to note that the mix 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 Our 30% to 40% CAGR from FY 2020 to FY 2023. Slide 6 highlights our revenue and EPS performance 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.

Speaker 3

Turning to Slide 7, we delivered another record non GAAP gross Margin rate in Q3 of 34.7 percent of revenues, which was up 40 basis points sequentially and up 420 basis points from 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 a better resource allocation and discipline to drive Moving to Slide 8, you can also see we have expanded non GAAP operating profit margins substantially from pandemic close 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 and 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 $28,000,000 for a legal settlement and the likely Fortescue involving a partner.

Speaker 3

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 $2,900,000,000 of cash flow from operations and And $1,500,000,000 of free cash flow, which is up $1,100,000,000 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 1 $150,000,000 in Q4 financing for a very large deal that is predominantly GreenLake and will benefit our ARR margins for years to come.

Speaker 3

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 31, 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 $750,000,000 of financial services related debt through the ABS market. The refinancing of higher costs 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.

Speaker 3

Bottom line, Our improved free cash flow outlook and cash position ensure we have ample liquidity to run our operations, continuing to invest in our business to drive growth and return 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 4th guidance increase since SAM in October 2020. We now expect to deliver 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 $1,300,000,000 year to date that also reflects the strengthening demand environment and a substantial order book we have across the business.

Speaker 3

We expect the challenged supply chain conditions to persist until at least the middle of calendar year 2022 And I have factored these into our revenues, costs and cash flow outlook. From a top line perspective, although we remain prudent given the Supply Chain environment, we are very pleased with the accelerating Q3 order momentum across all segments of the business. More specifically for Q4 2021, we expect revenue to be above our normal sequential seasonality from Q3 and are comfortable with current consensus levels. For Q4 'twenty one, 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'm very pleased to announce that we are also raising fiscal year 2021 free cash flow guidance To $1,500,000,000 to $1,700,000,000 that is a $600,000,000 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 2019. 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.

Speaker 3

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 $250,000,000 of share repurchase in Q4 of fiscal year 2021, and we'll update investors on our capital management policy for fiscal year 2022 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 and 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.

Speaker 3

So overall and to conclude, I am very proud of the progress we have made year to date in 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 of compute and storage is demonstrating momentum with 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.

Speaker 3

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.

Operator

We will now begin the question and answer session. The first question will come from Amit Daryanani with Evercore. Please go ahead.

Speaker 4

Good afternoon, and thanks for taking my question. Yes, I guess, my question is really around the free cash flow generation. I think you're implying based on the rates free cash flow guide That will be around $100,000,000 or so pretax in Q4. That I think would be one of the softest pieces you've seen. So maybe just quantify some of the dynamics that are at That's driving that car.

Speaker 4

I hope you talked about a few of them, but just quantify the headwind there. And then secondly, the focus for you folks has always been Getting to this $2,000,000,000 free cash flow number longer term, maybe touch on what are the key levers to get to this $2,000,000,000 number? And how much of that is self help versus revenue driven? Thank you.

Speaker 3

Sure. Thank you, Amit for the question. So Yes. Our free cash flow for Q4 is north of $100,000,000 actually implied in our guidance about $150,000,000 in Q4. And this figure reflects a different seasonal profile that we have had this year in terms of our revenue and expense profile, But also a couple of very important dynamics that I would like to underscore.

Speaker 3

First of all, we have to continue to make investments in our inventory level We stand the supply chain constraints that we flagged for several quarters now. 2nd, in Q4 of fiscal year 2021, In my script, I described a very, very large GreenLake deal that will impact free cash flow in Q4, but that will generate substantial ARR revenue in subsequent quarters. This is a deal in several 100,000,000 of dollars that we have not announced yet, but it is already something that we're Financing and this is affecting therefore free cash flow already as of Q4 fiscal year 2021. Thirdly, we are still peaking On restructuring costs in fiscal year 2021, and we feel very positive about our cost optimization and resource allocation program, which We'll wind down at the end of fiscal year 2022. And so this is a nice segue to tell you about our guidance Towards fiscal year 2022 and the $2,000,000,000 target that we have, we continue to expect revenue growth in fiscal year 2022 with the momentum that carries Out of fiscal year 2021 and also the restructuring cost program winding down will be a key determinant Of our generation of free cash flow in fiscal year 'twenty two.

Speaker 3

So hopefully, I gave you color there. Antonio, you want to add something?

Speaker 2

No. The only thing I will say, Amit, is that Listen, Tarek made this comment in his remarks. It's the fact of the matter on the high end, on the top end of that guidance, we give you EUR 1,700,000,000 It's almost the same number we achieved in 2019. And therefore, in many ways, we are almost a year ahead of our Commitment, because if you recall, we said we're going to return to normalized free cash flow in 2022. And the reality, Even when you finance this large deal that eventually we're going to communicate has nothing to do with NSA deal.

Speaker 2

We are already almost at the same number. So that's why we are so pleased on the momentum that we have. But it's a momentum based on the order growth and all they You have taken any deliberate shift in our portfolio to higher margins and that's what you see in our numbers in Q3, right, is Record breaking gross margin of 34.7%.

Speaker 1

Perfect. Thanks, Amit, for the question. Operator, can we go to the next one?

Operator

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

Speaker 3

Thank you for taking the question. I wanted to see if you could discuss what you've done and what you plan to do in regards to price increases and help us understand How this affects your sales growth and margins? Thank you.

Speaker 2

Yes. Thanks, Simon, for the question. I'll go start it, and then I will let Alex comment. Listen, we take pricing actions all the time. In fact, we probably are the 1st to take pricing action in our industry, I will say.

Speaker 2

We continue to assess what is the right strategy by segment and making sure that We take those actions where appropriate. And the fact of the matter is that we have increased price and even increased. That's a fact. And we do that in a context of obviously supply availability, steel and demand in the right portfolio and obviously inflationary costs With some of the commodities. At the same time, remember there is also new innovation that gets built in our products, which have Structural impact in the sense that when you look at our infrastructure, right, new technologies drives 2 thirds of the pricing in many ways In the AUPs, we could take closer actions all the time, Simon, and we will continue to do so.

Speaker 2

And that's part of the reason also why we see Record breaking margins, but in addition to the fact that we are still in the demand in the right place and driving the mix shift that we talked So, Tarek, I know you want to get more specific probably.

Speaker 3

Thank you, Antonio, and thank you, Simon, for the question. We have in this context where you have a Constraint supply environment to be very careful around managing pricing, right? And we have taken action that is translating in this record level of Gross margin at 34.7 percent. Some of our competitors didn't take that action, and It's down to them and up to them. But we feel that this current environment is calling for a decent approach to pricing, And we see an encouraged balanced pricing behavior across the market.

Speaker 3

So more specifically, With respect to our units in AUPs and Compute, I'm sure someone will ask the question. AUP was up mid to high single digits quarter on quarter, Passing pass through of commodity cost and richer configurations, as always configurations that are richer play a big role in the AUP, But also pricing in this case and units were flat quarter over quarter given some expected supply chain constraints. So we feel pretty good about performance In computing that regard, it's still a business that we have to manage very, very carefully on a day to day basis because the Supply environment being volatile forces us to do so, but we still see scope for continuous gross margin improvement across the board and in compute as well.

Speaker 1

Perfect. Thanks for the question, Simon. Operator, can we go to the next one?

Operator

The next question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Speaker 5

Yes. Thanks for taking the question. I'm going to ask for one clarification real quick. Just how would you define normal seasonality in fiscal 4Q? And then Kind of the longer term question would be, Tarek, you've done a phenomenal job of driving gross margin leverage in the company.

Speaker 5

I'd just love to hear your thoughts on As you think about the mix of business going forward, where do you think ultimately gross margin can actually go? What's the normalized gross margin in

Speaker 3

And on the normalized seasonality, typically, what you observe in terms of sequential quarter over quarter growth, I would say it's somewhere in the low single digits around the 1% to 2% range between Q3 and Q4. So Q4 and Q3 growth is about that level. Like I said in my script, I'm comfortable with the current consensus on revenue for Q4, and we feel pretty good about The order book is very, very solid. Antonio underscored this, across the board our order book is super solid. Now the question is, How much of that can be really accelerated in terms of conversion in Q4 and it's every day is another day.

Speaker 3

So we're working through that. And this obviously has an impact on gross margins, right, because the more you wait for fulfilling an order, the more you can have an adverse impact on gross margins. Well, we feel fairly comfortable with us managing this dynamic and particularly leveraging or pulling the levers Across the board that we have such as our revenue mix, I want to highlight to you the continuous growth in Aruba. This level of growth in Aruba and our Intelligent Edge business of 23% comes with very high calorie revenue and we feel very, very comfortable and pleased with that trend. Also our growth in Storage, which comes with very high calorie gross margin revenue, is pleasing at 3%.

Speaker 3

We took share from some of our main competitors. And this gives you an idea that we have a few strings in our bow, so to speak, to actually continue to drive gross margins to better levels.

Speaker 1

Perfect. Thanks, Aaron. Can we go to the next question please, operator?

Operator

Our next question will come from Wamsi Mohan with Bank of America. Please go ahead. Yes, thank you. You sound very bullish on order momentum, and it seems like You can't capitalize on the full strong demand given some of these supply chain impacts. Is there any way to quantify the magnitude of sort of what is this Revenue impact perhaps in the quarter and what you're expecting for maybe the next few quarters?

Operator

And how confident are you that these orders Won't be canceled or lost to other vendors. Thank you.

Speaker 2

Well, we are very confident in the sense that We have taken proactive actions. We continue to take proactive actions. You can imagine a person involved with some of these conversations with suppliers. But if you look at our order buffering, sorry, inventory buffering we talk, right, our inventory is up 1,300,000,000 And at the same time, right, we have, I think, one of the best in class engineering team that they can swap things as we go along the way. That said, as I look at this order book, there is so much potential upside here.

Speaker 2

It's all about the daily conversion. And so far, we have not seen any cancellations. Just to be clear, when people ask me, hey, this is perishable, no. I can tell you the answer is definitely no. I think it's because also customers realize it's not just a supply constraint, But I need to provision more compute and data insight capabilities.

Speaker 2

And then as I said earlier, Even despite the fact that our Intelligent Edge business exited with a 5 times backlog on that unique segment of the market, We still delivered 23% in constant currency, 27% growth. And that's why what Tarek said, we expect revenue to continue to grow, And in particular, 2022. And then to the question that was asked earlier about margin, the margin She's strengthening over time because of the mix shift. And that Aruba is very important to us. But fundamentally, I think our edge Cloud vision and strategy is absolutely resonating in the market because customers need 3 things.

Speaker 2

They need Secure connectivity in this cyber world, they need a cloud experience everywhere, and then they need data insights yesterday, in my view. And then we need to be able to consume it as a service in an elastic way. We have all the 4 ingredients, and that's why we are going to accelerate further and faster this strategy because it's working.

Speaker 3

And Wamsi, if I can add to Antonio's comments. In my mind, there is no point crying over spilled milk. If we could have converted more, we would have converted more, but it doesn't really matter. The order momentum and the order book remains strong. And while we didn't convert in Q3, we've converted in Q4 and subsequent quarters.

Speaker 3

To specifically give you an idea of where we would have ended in Q3, we probably would have ended above seasonal trends that we see between Q2 and Q3 by Low single digit percentage number, but the momentum is very strong in Q4 and also for 2022. That's the interesting bit. In the environment that we're operating in, the demand is very solid and the supply constraints, we don't see them ending before the First half of calendar year 'twenty two. So we just have to navigate this as the capacity of all our Manufacturing partners is not back to pre pandemic levels and that will still take a good 2 to 3 quarters.

Speaker 1

Great. Thank you, Wamsi, for the question. Operator, can we go to the next one, please?

Operator

Our next question will come from Sidney Ho with Deutsche Bank. Please go ahead.

Speaker 6

Great. And congrats on solid progress on the ARR side and the cash flow. My question is on the HPC segment. You suggested the full year HPC revenue

Speaker 3

will grow within your target range

Speaker 6

of 8% to 12%. Is that on a revenue basis or order basis? And if this revenue, it would imply Cisco Q4 will Am I doing the math correctly? If so, what's driving such growth? I understand revenue could be quite lumpy in this business.

Speaker 6

Thanks.

Speaker 2

Yes, let me start and Tarik is welcome to us. Listen, as you said, right, this business is lumpy because of the time it takes to book the order, to build the ship and Solid and then most importantly, customer accept order, meaning the workload that was intended to run on is active, is in production. And we normally see this trend accelerate in the back half of the year because of the way the acceptances work. So we absolutely expect a significant uptick here, and that's why we are very confident in our ability Deliver for the year 2021, the 8% to 12% growth that we committed since the beginning actually 2021. And we have a number of deals that are all now running the what we call the testing cycles And fairly confident about the customer acceptances, which will allow us to recognize revenue.

Speaker 2

This has nothing to do with supply availability in many ways, Because obviously those systems in many ways has already shipped and they're already deployed. It's just getting through the cycle for the customer to get the performance that they need And there is quite a bit of tuning that gets done when the systems are deployed. But to Tarek's point, the demand is unbelievable strong. Put aside the $2,000,000,000 award that we got yesterday we announced yesterday, we continue to win Multiple multimillion dollar deals in many aspects, and you can see some of those as we announced throughout the quarter. That's the power of the portfolio we have in high performance computing and specifically tuned for these AI and deep learning capabilities.

Speaker 2

And by the way, we have $2,500,000,000 of awarded business, which I don't consider a backlog is business that will be delivered over the next 12 months, 18 months, Particularly the large exascale systems, which are an amazing feat of technology, I will say.

Speaker 1

Great. Thanks, Sydney, for the question. Can we go to the next one, please?

Operator

The next question will come from Shannon Cross with Cross Research. Please go ahead.

Speaker 7

Thank you very much. I was wondering, if you can quantify how the shift to GreenLake and recurring revenue and as a service is Impacting revenue, if there's any way to sort of quantify where you would have been if you hadn't sort of made this shift at this point. And I'm also curious with regard to GreenLake, How are your customer conversations going? I'm not sure how many quarters ago you said we're shifting everything to at least have an option as From a subscription standpoint, so I'm just wondering if it's still kind of a push to customers or is there more of a pull from them as they look at alternatives to cloud? Thank you.

Speaker 2

Well, thank you, Shah. I mean, we are incredibly bullish about this business. I think we have a competitive advantage and the competitive advantage Come from many aspects. 1 is the software. Software that makes this consumption model a true consumption model, unlike Some of the other ones that we're trying to catch up, which is more a financial engineering in many ways.

Speaker 2

Understand everybody is getting into this space, But we have years of leadership here. And the conversation goes as simple as this. I want the cloud experience on prem and at the edge, And we can bring that through GreenLake, because it's a true cloud experience that you can consume elastically on a per unit measure that we can measure all the way to core Levels. And be able to automate the whole experience through a softer stack, which obviously HPS model now It's becoming a very important component of that, and that's why Tarek made the comment earlier. As we go through the SAM end of October, we're going to give a little better Because the software content of AIR continues to increase.

Speaker 2

Aruba, by definition, Shannon is already all software, right? And He said that a 3 triple digit growth is happening in that business because you are subscribing to get connectivity. And our platform is a cloud platform of scale because we manage now more than 1,500,000 devices. But it's more of a pull, I will say. When customers are becoming way more sophisticated about their hybrid estate, where they should host the data And whether they should run the workloads, they realize that the vast majority are still on premise and many of them will stay on premise.

Speaker 2

It's just economics and physics, and we can deliver the same experience on prem and still give them a hybrid experience by managing the workloads and data sit Outside there, the 4 walls. And GreenLake is absolutely resonating. That's why you see us catering everything to GreenLake, Whether it's connectivity, whether it's data services, whether it is elastic computing, and more workload to my services as we go along. And that's why I said earlier, this is all about acceleration on that. And between now March, you're going to see a massive acceleration.

Speaker 2

That's why it's my number one priority. And by the way, as revenue is accretive from a gross margin perspective, so Tarek, you may want

Speaker 3

to talk about that. Yes, absolutely. So Saan, what I would say is, if you refer back to Slide 5 of our investor presentation, we show you the Stack of revenue that composes our ARR, right? So our GreenLake revenue is Across all segments of compute, HPC MCS, storage, Aruba and also HBFS as you can infer from that slide. And the more we drive GreenLake by way of software, the more accretive it is to the overall gross margin of the company.

Speaker 3

That's a key lever to drive gross margin moving forward. We're driving gross margin across every single swim lane through the revenue mix And across also that revenue mix horizontally by way of pivoting the company to become an as a service company. So far, What I could tell you is that the GreenLake gross margin is substantially higher than the average gross margin of the company that we posted today. And we look forward Antonio and I to update you and every other member of the analyst community at our virtual SAM event in October, Highlighting to you where we see the ARR growing and its mix by segment moving forward and in composition how much of it is software How much of it comes from other types of revenue streams such as Pointnext OS, which are very important to the profitability of the company.

Speaker 1

Great. Thanks, Shannon. Next question please, operator.

Operator

Our next question will come from Katy Huberty with Morgan Stanley. Please go ahead.

Speaker 7

Yes, thank you. Speaking of GreenLake, the $2,000,000,000 NSA contract is a great success story for that business. Should we assume that the $2,000,000,000 of revenue is recognized ratably over the 10 year contract or will there still be Lumpiness like you've seen in HPC historically? And then also, when does that start to impact the financial model? Then I have a follow-up.

Speaker 2

Yes, I think it will be definitely recognized over time. There will be periods will be a little bit more lumpy because of the Sure. But it start recognizing here in 2022 immediately. In fact, we're expecting here the first order happening now and start shipping soon. But obviously, the one thing you need to understand about this deal is not just about selling infrastructure and consumer as a service Through HPE GreenLake is a true as a service model and managing it at the same time.

Speaker 2

So we are operating the whole environment, which is very different than it used to be in the past.

Speaker 1

Thanks, Katie. I know you had a follow-up, but we'll catch you after the call. Operator, can we get to the next question, please?

Operator

Our next question will come from Matt Sheerin with Stifel. Please go ahead. Pardon me, Mr. Sheeran, your line might be muted.

Speaker 1

No problem. Operator, can we just go ahead to the next one?

Operator

Yes. Our next question will come from Kyle McNealy with Jefferies. Please go ahead.

Speaker 8

Hi, thanks a lot for the question. Congrats on the strong results in But I'm curious on where you think we can go from here. It's been growing at faster than what the market's typically grown at in the past. We realized that Wi Fi 6 adoption curve is helping that, but how sustainable do you think this 20% plus growth rate is that we're seeing now? And should we expect some Acceleration in there or is there potential for continued momentum or acceleration with Wi Fi 6 upgrades?

Speaker 2

Listen, I expect this business to continue to grow double digits, right? And we are very confident with that forecast. And honestly, maintaining or improving even the level of profitability because as Tarek made the comment earlier, right, This quarter was impacted by a settlement on a legal matter that has been going on for a decade. And so I'm pleased that that finally has completed, Which was $17,000,000 that we booked for this and it has nothing to do with Aruba. It just happened way before Aruba for that matter.

Speaker 2

And so the reason why I'm confident is because we have a unique value proposition. The value proposition of Aruba is a mobile first, cloud first, Which is based on 3 layers. 1 is the unification of the network for whatever type of connectivity you need, which WiFi, to your point, WiFi 6 is now being adopted, and we are, I think, the largest vendor shipping WiFi of access points. 2nd is obviously LAN, 3rd is 1, and that's why this acquisition of Cerro Peak has been incredible well received by our customers and very timely Because it's integrated now in the same control plane. And going forward, we're going to integrate more solutions like 5 gs and edge computing.

Speaker 2

And that's why this edge to cloud platform is so essential, but the Aruba Edge platform is what allows us to deliver the entire edge to cloud Because now that the platform also serves as the back end to deliver IaaS For customers on prem and at the edge for compute and storage too, including data services or workload optimized solutions. So super pleased. And remember what I said, we execute Q3 2021 with a 5 times backlog on our normal run rates in Aruba, And the bookings were very, very strong, super strong.

Speaker 1

Great. Thanks, Kyle, for the question. I think that It takes us about time, so that will be our final question. Antonio, why don't I turn it over to you for any final remarks that you have?

Speaker 2

Yes. So again, thank you for making the time today. Again, we are very pleased with our Q3 results, which again was marked by the Order strong momentum, in line revenue expectations, but most importantly, strong improvement in gross and operating margin and record Year to date orders and free cash flow. And that give us the confidence to once again For the 4th time in the year to raise EPS and free cash flow and enter 2022 with Good visibility about what we think is going to happen. I'm particularly bullish about the IT spend cycle.

Speaker 2

People ask me, what do you think the delta It's going to do nothing on demand. I can tell you that now. It may have some impact on supply availability, but nothing on demand. Let me be clear about that. And the reason why is because customers need to digitize their business, they need to create a more IT or system environment And honestly, they need to extract insight from the data at the pace we've never seen before.

Speaker 2

And our edge to cloud platform strategy is resonating. So Thank you for making the time to be with us today, and I hope to catch up at the end of October at the Securities and Analyst Meeting.

Speaker 1

Perfect. Thank you. Operator, I think we can go ahead and close out the call.

Operator

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

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Earnings Conference Call
Hewlett Packard Enterprise Q3 2021
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