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 our conference. As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Mr. Andrew Simanek, Vice President of Investor Relations, please proceed sir.

Great, thank you. Good afternoon everyone. I’m Andy Simanek, 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 Robbiati, 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 web page 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 30th, 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 in our 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.

Well thank you, Andy and good afternoon everyone. Thank you for joining today's earnings call. HPE's second quarter results reflect significant customer traction for our differentiated portfolio and underscore our progress in becoming the edge-to-cloud company. The macroeconomic environment of the last few months has presented enterprises around the world with strategic challenges that are usually not confronted all at once. The market shifts have certainly created a dynamic backdrop for our global customers 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. HPE's ability to address these customer needs was key to our performance in the second quarter. Once again, HPE 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 the 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 HPE GreenLake H2 Cloud 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 now -- 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…

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 1 and 2. So now let me discuss our Q2 performance details, starting with Slide 3. We continue to see robust demand across our differentiated edge-to-cloud portfolio with order growth up 20% year-over-year, the same as last quarter. This marks our 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 2022 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 and 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 $0.06. 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…

We will now begin the question-and-answer session. And the first question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Sorry about that, guys. Can you hear me?

Yes, we can Aaron.

We can.

Okay. Yes, sorry. Sorry about that. So I'll start with just the question on the backlog. 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 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.

Yes, good afternoon Charles, thank you for the -- Aaron, good afternoon for the question -- thank you for the question with regard 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, the 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.

I would say, Aaron, 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 supply and other issues alleviates. And if you think about the 3% to 4% guidance for the year, which is the guidance we provide at SAM versus the 1.5% we just reported, obviously, there will be low single-digit growth sequentially on that revenue.

Thank you.

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

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

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 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 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 disciplined 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 and on IP revenue. And you can see, therefore, that this has had a detrimental impact to gross margins for storage. Finally, HPC, the story there is a story that is we'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 segment. But it is the result 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 HPFS. The performance of HPFS 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 HPFS 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 up back things f or you the way you want it, Simon. But if not, we're welcome to take the conversation offline with you again.

Thank you. I’ll hop offline.

Thanks, Simon. Appreciate it. Operator, can we have the next one please?

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

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 on what you're seeing in that region? And also, I don't know if you sort of pointed out what the order impact on the order number was from the Russia exit as well? Thank you.

Yes. Thank you. Thank you for the question. As I said in my remarks, we continue to see ongoing persistent demand from our customers. I think it's a combination of them prioritizing IT spend. And honestly, the attraction to our portfolio. We have a very comprehensive portfolio from Edge to Cloud that is resonate 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 distributor enterprise, there's just 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 HPE 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 HPE GreenLake to basically deliver their managed hosted distributor 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 said that is because every customer we talk to, they are prioritizing digitizing their…

Yes. So, let me add on the last part of your question. So, the impact from Russia on orders was negligible. This was not something that has affected our orders. China and Russia together, obviously, with Belarus, impacted our revenue by $250 million, the majority of that impact relates to China. And the Russia impact specifically is related to the fact that we cannot operate any more in the country and serve existing customers with our services contracts, and therefore, this has been factored into the impact. I've described that totals for China and Russia, 1% impact on total operating profit margins and $0.06 on EPS overall. But again, the majority of these impacts were driven by the China disruptions on the supply side of the equation. And yes, I agree with Antonio on the -- totally agree on the resiliency of the demand. I simply want to add the fact that even though there could be a slowdown in the EU, the European governments are ramping up a number of initiatives that are all in our favor in the digital space, which gives us confidence for the medium to long-term.

And I will say, our diversification of our coverage around the globe also is a good positive thing for us.

Great. Thanks for that Samik. Can we get the next one please?

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

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 how those demand trends are breaking out across regions, if you're seeing any variability from 90 days ago? And you also sort of maintained your free cash flow guide, but EPS, you alluded to some of these impacts, the $0.06 that you alluded to, Tarek, but you're maintaining your free cash flow. What are some of the offsets that are allowing you to do that? And when you look at the second half free cash flow that needs to come in extremely strong, so can you talk about what levers we should expect within those free cash flow moving pieces that get you to your guide across the second half? Thank you.

Yes. Let me start and I would like Tarek to talk about the free cash flow, Wamsi. Listen, so far, so far, and I can only talk so far, I have not seen any major deviation from 90 days ago on demand, continue to be very strong. And that's why we use the word persistent. Persistent meaning is there, right? And then I think it depends 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 GreenLake because customers want to maybe preserve some CapEx and then would 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 award loads and data that cannot move outside their premises or a colocation or even moving 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?

Yes, sure. So first Wamsi, if you want a rough rule of thumb when you're looking at EPS changes and how these EPS dollars translate or sense translates into free cash flow, every cent of EPS is essentially $13 million 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. So the lowering of our guidance back to the SAM 2021 guide is very much contained in the free cash flow guide that we gave you. 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 2019, 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 2019. And we had very little time to turn around and offset the impact of that arbitration case, and yet we came into our guide that we gave at the time. And really look also at the trends on operating free cash flow that we highlighted to you as part of this call, you will observe that our seasonality is very much in line with fiscal year 2019 and fiscal year 2020. Fiscal year 2021 was a different story because in fiscal year 2021, you add the impact of restructuring costs that were affecting free cash flow. 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 2021. So, lots of puts and takes there, but we are happy to reaffirm the free cash flow guide of $1.8 billion to $2 billion.

This way -- one thing for me to say is that we are exactly what we were at the October Security Analyst Meeting, where we guided 3% to 4% revenue growth; the EPS guidance we just provided today, which is $1.96 to $2.10; and a free cash flow of $1.8 billion to $2 billion. And knowing the seasonality of our business, 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, it's 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 earning correlation to free cash flow is the same we provided as one. And in terms of restructuring, just to be clear on that one, we are very pleased with the progress we've made, which obviously was there, we refer to 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.

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

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

Yes, 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 of other companies. So, if I look at Cisco, they, I would say, objectively performed quite a bit worse on supply than you guys did. You had some sort of a middle of the road impact, not too bad of an impact from what 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.

Sure. I'm going to start. But I think -- I don't think you can look quarter-by-quarter. Honestly, you have to look at the half and then in the second half. If you look at our performance in Q1, we did very well. And on the balance, I think we are pleased with the first half. Listen, and then there is a lot of puts and takes here because factory locations plays a role. So sometime you're in the right side of the location, sometimes you're not. And obviously, for us, the impact of Shenzhen and Shanghai was there in April, and Tarek quantified that for you, that impacted not just the compute business, every line of business because other 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 make strategic choices about components two to three years ago. And those -- 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 set up 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 dividend that we collect, but not the revenue. And then when you look at the segment, call it, the server category, it is compute plus HPC plus H3C, as the way market share gets reported. So that's why I look at this from a half performance. We made it better in Q1, maybe a little bit less so in Q2. Again, some of our competitors, namely Dell, as you said, on some aspects. But on a balance, not that far off, again, Cisco definitely we did well on every metric you want to look at it. And -- but in the end, we are focused on the full year to deliver that guidance of 3% to 4% and obviously exit the year with still quite a large backlog, which bodes well for 2023.

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

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

Great. Okay, guys. So I am going to leave it there. Thank you very much for the answers.

Sure. Thanks, Rod. Next question, please?

The next question will come from Irvin Liu with Evercore ISI. 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 rearchitect 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?

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 multigenerational IT journey here. That they have to modernize. The fact that data has gravity and obviously, some industry are more regulated than others. Then you talk about latency and experience that really matters. 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 HPE GreenLake business, which again grew 107% in Q2. And obviously, that -- those bookings eventually will unwind from the balance sheet and through the P&L. And the other important fact here that Tarek show in one of his 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 events is super strong. The fact that we keep adding capabilities, the mix is shifting and that's totally accretive to our gross margin as we go forward. 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 we just -- that you just highlighted.

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

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

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 reach 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 times are taking in advance of revenue recognition, how much catch-up profitability might you get? And what does the margin profile look like a business that's expected for the back half of the year? Thanks.

Sure. Listen, I'm continuing to be incredibly bullish about this business. Supercomputing is necessary to advance AI and deep learning solutions to solve some of the biggest societal challenges and honestly, climate and other. As I think about the current situation we are in, we have almost $3 billion in backlog. A couple of two quarters ago, we were talking about $2.5 billion and maybe a year, $1 billion, $1.5 billion. 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, including the number three supercomputer called Lumi, that's in Europe. We have also supercomputers in France, in 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 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 world load. 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 gets accepted. So, -- but in terms of margins, I will let Tarek comment on this. Obviously, have to look at long-term, not just quarter-by-quarter because that's not how this business works.

Yes, that's right. 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.

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

Well, thanks, everyone. I know there's a lot going on a lot of news today to cover, but I appreciate you making the time. Again, walk away from this quarter, feel 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 the 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.

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