Hewlett Packard Enterprise Co (HPE) Q3 2021 Earnings Call Transcript

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. 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.

Good afternoon. Manny Simanek, Head of Investor Relations for Hewlett Packard Enterprise. I'd like to welcome you to our fiscal 2021 Third 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 July 31st, 2021. Also, for financial information that has been expressed on a non-GAAP basis, we 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. 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.

Thanks, Andy. Good afternoon, everyone. Thank you for joining our call today. I am amazed by the resilience of our customers, partners, and team members. And I'm incredibly proud of the way Hewlett Packard Enterprise continues to serve the needs of our global communities during such unusual and evolving circumstances. We delivered a very impressive third quarter at HPE with strong orders growth, expanded margins, and record free cash flows. 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. 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 are also resuming stock repurchases. Revenue in Q3 was $6.9 billion, in line with our outlook and normal sequential seasonality. Our Q3 orders were up against strong double-digit 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 a record year-to-date free cash flow of $1.5 billion, up from $1.1 billion 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 deploying our best-in-class engineering capabilities to establish specific response plans. The impact of the pandemic continued to accelerate the shift we predicted two 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. We expect these trends to continue. Digital transformation is no longer a priority, but a 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 computed and mission-critical solutions business. Due to strong demand and execution, these growth businesses now make up nearly 25% of our total Company revenue. 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. From customer demands for secure connectivity have generated a backlog five 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 in innovating the edge. In June, we announced new AI ops, IoT, and security features for our Aruba Edge Services Platform or ESP, designed to streamline network operations, maximize IP efficiency, and more easily extend the network from the Edge to the cloud. Our Aruba ESP continues to gain traction with customers in different verticals. In the Third Quarter, customers including Save a Lot, Monument Health, and Circa Resorts and Casinos, all standardized their networks on Aruba ESP. In our High-Performance Computer & Mission Critical solutions business, revenue was up 9% year-over-year, driven by a record number of new orders. We also generated our record order book, which now exceeds $2.5 billion. The exponential growth in data, along with AI and big data analytics is driving an increased need for high-performance computing and mission-critical capabilities in enterprises of all sizes. To meet this demand, we bolstered our artificial intelligence capabilities with the acquisition of Determined AI, a step-up that delivers a powerful software stack that trains 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. For example, in Q3, HPE was awarded a $2 billion contract to be realized over a 10-year period with the National Security Agency to deliver high-performance computing solutions through the HPE GreenLake platform. The service will help the National Security Agency efficiently process data and provide 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 throughout the HPE GreenLake edge-to-cloud platform. This new cloud-based management service simplifies provisioning and automates the management of computing infrastructure wherever it resides. Our storage business is transforming into a cloud-native Software-Defined 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 Letra 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 recovery services, which will soon be available as a service through HPE GreenLake. With these acquisitions and immediate repositioning, HPE GreenLake is in a high-growth data protection market with a proven scale solution. HPE was the first to market four years ago, delivering cloud experiences on-premises in co-location or at the Edge with HPE GreenLake. Today, our HPE GreenLake edge-to-cloud platform has more than 1,100 customers. Our annualized revenue run rate this quarter was $705 million, 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 the 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-you-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 HPE Synergy, delivered through HPE 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 the power of the full HPE edge-to-cloud portfolio, as customers are turning to HPE for integrated solutions, a combined secure connectivity data insight capability, and cloud experiences. Woolworths Group, Australia and New Zealand's largest retailer, selected HPE GreenLake to power its new Wpay payment platform. They needed a solution that combined a powerful mission-critical architecture, with the ability to scale and also provided better cost efficiency back to Wpay and its Merchant Partners. Delivered through HPE GreenLake, their solution leverages our full edge-to-cloud portfolio, including HPE Aruba, HPE NonStop, HPE Primera, and HPE Synergy. HPE Pointnext services also provided expertise to oversee the Company's digital transformation. I believe this is a great example of the power of our HPE supply portfolio. To extend our leadership position in cloud services and further accelerate our pivot to as-a-service, we are relentless. We made several compelling announcements at HPE Discover in June. I am particularly excited about our new HPE GreenLake lighthouse offering. A secure cloud-native stack built with HPE Ezmeral software to autonomously optimize different workloads across the hybrid state, reducing time to deployment and operating costs. We also introduced Project Aurora, to secure the enterprise. Embedded in our HPE GreenLake edge-to-cloud platform, Project Aurora automatically and continuously verifies the attack integrity of the hardware, firmware, operating systems, platforms, and workloads, while also detecting advanced threats. Finally, demonstrating our continued commitment to assets that complement our capabilities, we acquired a data platform developer, Ampool. Ampool will accelerate the HPE Ezmeral analytics runtime to deliver high-performance analytics for engineers and business analysts. I am proud of HPE's performance in Q3 and year-to-date, and the significant progress we've made in becoming the edge-to-cloud Company. The momentum we have in the market compels us to move even further and faster. And our ability to transform with increasing speed is imperative. 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. Our vision to become the edge-to-cloud Company is of 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 disciplined, enabled, and 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 waiver from our commitment to being a force for good, and a strategic partner for our customers. We will continue to bring new innovations 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. I hope you will join us for our virtual Securities Analyst Meeting on October 28, 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.

Thank you very much, Antonio. I'll start with a summary of our financial results for the third quarter of the 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 establish 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 the 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 charges totaling $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 expenses, we benefited from stronger operational performance in HPC and strong gains related to increasing valuations in our Pathfinder venture portfolio. As a result, we now expect other income and expenses for fiscal year '21 to be 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 from $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 in 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 topline 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 offering was 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 $17 million in one-time legal settlements that impacted margins by 2 points. We continue to perform strongly and contributed 7 points to the Intelligent Edge growth. In HPC & 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 $2.5 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 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. All-flash Arrays grew by over 30% year-over-year, led by Primera. The mix shift towards more software-rich platforms helped to 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 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 GreenLake enterprise customers, totaling 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 FY20 to FY23. 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 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 the new segmentation we implemented beginning of the fiscal year 2020. That gives us much better visibility into each business unit and enables 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 fueling 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 likely fraud involving a partner. Excluding these one-off charges, our operating margin would have been 10.2%. Turning to slide 9, we generated 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 to $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 includes 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 restructured 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's 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 the 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 for our 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 a demanding 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, which also reflects the strengthening demand environment and a substantial order book we have across the business. We expect the challenge supply chain conditions to persist until at least the middle of the 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 chance 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, our 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 '21 free cash flow guidance from $1.5 billion to $1.7 billion. That is a $600 million increase at the midpoint from our original 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 the 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 challenging supply environment, our order momentum and improved cash flow generation visibility give us the confidence to reinstate our share repurchase program. We are targeting up to $250 million of share repurchases in Q4 of fiscal year '21 and will 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 to deliver 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 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. 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.

We will now begin the question-and-answer session. We also request that you only ask one question. The first question will come from Amit Daryanani with Evercore. Please, go ahead.

Good afternoon, and thanks for taking my question. I guess the questions really around the free cash flow generation. I think you're implying based on the rates free cash flow guide, that we'll do around $100 million or so free cash flow in Q4, which I think will be one of the softest. Maybe just quantify some of the dynamics that are at play that's driving that power, have you talked about a few of them, but just quantify the headwind there. And secondly, the focus to this $2 billion in cash number longer-term. Maybe touch on what are the key levers to get to the $2 billion number, and how much of that is self-help versus revenue-driven? Thank you.

Sure. Thank you, Amit for the question. Yes, our free cash flow for Q4 is north of $100 million; it's actually implied in our guidance about $150 million 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. First of all, we have to continue to make investments in our inventory level to withstand the supply chain constraints that we flagged for several quarters now. Second, in Q4 of fiscal year '21, 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 hundred million 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 of fiscal year '21. Thirdly, we are still peaking on restructuring costs in fiscal year '21 and we feel very positive about our cost optimization and resource allocation program, which will wind down at the end of fiscal year '22. And so this is a nice segue to tell you about our guidance towards fiscal year '22 and the $2 billion targets that we have. We continue to expect revenue growth in fiscal year '22 with the momentum that carries out of fiscal year '21, and also the restructuring cost program winding down will be a key determinant of our generation of free cash flow in fiscal year '22. So hopefully I gave you color there. Does Antonio want to add something?

No, the only point I want to mention is that Tarek commented on the fact that the $1.7 billion we mentioned is almost the same figure we achieved in 2019. This indicates that we are essentially a year ahead of our commitment, as we stated we would return to normalized free cash flow in 2022. Even when financing these large deals that we will communicate later, it is not related to the NSA deal. We are already nearing the same numbers, which is why we are so pleased with the momentum we have. This momentum is driven by order growth and the actions we've taken, along with a strategic shift in our portfolio towards higher margins. This is reflected in our Q3 results, showing a record-breaking gross margin of 34.7%.

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

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

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.

Yeah, thanks, Simon, for the question. I will start, and then I will let Tarek comment. Listen, we take pricing actions all the time. In fact, we probably have the first to take pricing action in our industry, I would say. We continue to assess what is the right strategy by segment and making sure that we take those actions where appropriate. The fact of the matter is that we have increased pricing even concrete. That's a fact. And we do that in a context of, obviously, supply availability, steep in demand in the right portfolio, and obviously, inflationary costs associated with some of the commodities. At the same time, remember there is also new innovation against building our products, which has a structural impact in the sense that when you look at our infrastructure, new technologies drive two-thirds of the pricing in many ways in AOPs, but we could take close the actions all the time, Simon, and we will continue to do so. And that's part of the reason also while we see record-breaking margins but in addition to the fact that we're still in demand in the right place and driving that mix shift that we talked about before. So Tarek, I know you want to get more specific, probably.

Thank you, Antonio, and thank you, Simon, for the question. We have, in this context where you have a constrained 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 of 34.7%. Some of our competitors didn't take that action, and it's down to them and up to them. But we feel that the current environment is calling for additional actions that approach to pricing. And we see an encouraged, balanced pricing behavior across the market. So more specifically, with respect to our units in AUP and Compute, I'm sure someone will ask the question. AUP was up to mid to high single-digits quarter-on-quarter reflecting pass-through of commodity costs 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. In 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.

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

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

Yeah. Thanks for taking the question. I'm going to ask for one clarification real quick. How would you define normal seasonality in fiscal Q4? And then the longer-term question would be, Tarek you've done a phenomenal job of driving gross margin leverage in the Company. I'd just love to hear your thoughts on, as you think about the mix of visitors going forward, where do you think ultimately gross margin can actually go? What's the normalized gross margin in your mind, given the mix that HP's driving?

So, let me pick up the first question 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 are 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 this. 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, 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. But 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 on 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%. 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.

Perfect. Thanks, Aaron. Operator, can we go to the next question, please?

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 the 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, and how confident are you that these orders won't be canceled or lost to other vendors? Thank you.

We are very confident because we have taken proactive measures and will continue to do so in our discussions with suppliers. Our inventory has increased by $1.3 billion, and we believe our engineering team is top-notch and can adapt as needed. Looking at our order book, I see significant potential for growth, which depends on our daily conversion. So far, we have not experienced any cancellations. To clarify, this is not a perishable situation, as customers understand that the current challenges are not just about supply but also about the need for enhanced computing and data insight capabilities. Despite our Intelligent Edge business ending with a five times backlog in that unique market segment, we still achieved 23% growth in constant currency, and 27% overall. As Tarek mentioned, we anticipate continued revenue growth, especially in 2022. Regarding margins, they should improve over time due to a favorable mix shift, and Aruba is crucial to us. Overall, our edge-to-cloud vision and strategy are clearly resonating with customers who require secure connectivity in a hybrid environment, a cloud experience everywhere, and immediate data insights. We have all the necessary elements to accelerate this strategy because it is proving effective.

And 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 remain strong. What we didn't convert in Q3 will convert in Q4 and subsequent quarters. 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 a low-single-digit percentage number. But the momentum is very strong in Q4 and also for '22, that's the interesting bit. In the environment that we're operating in, the demand is very solid, and with the supply constraints, we don't see them ending before the first half of calendar year '22. 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.

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

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

Great, and congrats on solid progress on the ARR side and in the cash flow. My question is on the HPC segment. You suggested the full-year HPC revenue will grow within your target range of 8% to 12%. Is that on a revenue basis or order basis? And in this revenue, it would imply fiscal Q2 will see at least 50% growth. Am I doing the math correctly? If so, what's driving such growth? I understand revenue could be quite lumpy in this business. Thanks.

Let me start by saying that this business can be unpredictable because it requires booking the order, building, shipping, and installing it. Most importantly, the customer has to accept the order, meaning the workload must be active in production. We typically see this trend speed up in the second half of the year due to the acceptance process. Therefore, we expect a significant increase during that time and are confident that we can achieve the 8 to 12% growth for 2021 that we committed to at the beginning of the year. We have several deals currently in the testing phase, and I am quite optimistic about the customer acceptances, which will enable us to recognize revenue. This situation is not related to supply availability since the systems have already been shipped and deployed. It’s just about completing the cycle for the customer to get the necessary performance, and there’s quite a bit of fine-tuning involved after deployment. As Tarek mentioned, demand remains exceptionally strong. Apart from the $2 billion award we announced yesterday, we continue to secure multiple million-dollar deals in various areas, which we have been announcing throughout the quarter. This demonstrates the strength of our portfolio in high-performance computing, particularly in AI and machine learning capabilities. Additionally, we have $2.5 billion in awarded business, which I don’t consider backlog; it’s business that will be delivered over the next 12 to 18 months, particularly for the large Exascale systems, which are remarkable technological achievements.

Great, thanks Sidney for the question. Can we go to the next one, please?

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

Thank you very much. I was wondering if you can quantify how the shift to GreenLake and recurring revenue in as-a-Service is impacting revenue. If there's any way to sort of quantifying where you would have been if you hadn't sort of made the shift at this point. And I'm also curious with regard to GreenLake, how are your customer conversations going? Not sure how many quarters ago you said we're shifting everything to at least have an option 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 the cloud? Thank you.

Well, thank you, Shannon. I mean, we are incredibly bullish about this business. I think we have a competitive advantage. And the competitive advantage comes from many aspects. One is the software. Software that makes this consumption model a true consumption model, unlike some of the other ones that are trying to catch up, which is more financial engineering in many ways. Understand everybody's getting into the 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 our software stack, which obviously HBS 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 end of October, we are going to give a little better disclosure of that because the software content with ARR continues to increase. Aruba by definition, Shannon, is really old software, right? And he said that the triple-digit growth is happening in our business because you are subscribing to get connectivity. Our platform is a cloud platform that scales because we manage now more than 1.5 million devices. But it's more than a pull, I would say. When customers are becoming way more sophisticated about the hybrid state, whether hosted data, and whether software or traditional. They realize that the vast majority is still on-premise. And many of them will stay on-premise. It's just economics and physics. We can deliver some experience on-prem and still give them a hybrid experience by managing the workloads outside the four walls. GreenLake is absolutely resonating, and that's why you see us catering everything to GreenLake, whether it's connectivity, whether it's data services, whether it is elastically computed, and more world-optimized services as we go along. And that's why I said earlier, this is all about acceleration on that. And between now and March, you're going to see a massive acceleration. And 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 want to talk about that.

Yeah, absolutely. So, Shannon, what I would say is, if you refer back to Slide 5 of our investor presentation, we showed the stack of revenue that composes our AUR, right? So our GreenLake revenue is across all segments, our Compute HPC MCS, storage, Aruba, and also HPFS, 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. That's a key lever to drive gross margin moving forward. We're driving gross margin across every single stream 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 can tell you is that the GreenLake gross margin is substantially higher than the average gross margin of the Company that we posted today. 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. It's mixed by segment moving forward, and in composition, how much of it is software and how much of it comes from other types of revenue streams, such as Pointnext services, which are very important to the profitability of the Company.

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

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

Yes. Thank you. Speaking of GreenLake, the $2 billion NSA contract is a great success story for that business. Should we assume that the $2 billion 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.

I think it will be definitely recognized over time. There will be periods that will be a little bit lumpier because of the infrastructure, but we will start recognizing here in 2022 immediately. In fact, we're expecting here the first order to happen now and start shipping soon. But obviously, the one thing you need to understand about this deal, it's not just about selling infrastructure and consumer-as-a-Service through HPE GreenLake; it's the true as-a-Service model and management at the same time. We are operating the whole environment, which is very different from what it used to be in the past.

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

Our next question will come from Matt Sheerin with Stifel. Please go ahead.

Hi, thanks a lot for the question. Congrats on the strong results in Intelligent Edge. But I'm curious about where you think we can go from here. It's been growing at a faster pace than what the market's typically grown at in the past. We realize 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 deceleration in there, or are there potential for continuing momentum or acceleration with the Wi-Fi 6 upgrade?

Listen, I expect this business to continue to grow double digits, right? We're 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 been completed, which was $17 million that we booked for this and has nothing to do with Aruba. It just happened way before Aruba for that matter. The reason why I'm confident is that we have a unique value proposition. The value proposition of Aruba is mobile-first, cloud-first, which is based on three layers. One is the unification of the network for whatever type of connectivity you need, which is Wi-Fi. To the point, Wi-Fi 6 is now being adopted, and we are, I think, the largest vendor shipping Wi-Fi access points. Second is obviously LAN; third is WAN. That's why this acquisition has been incredibly well-received by our customers and very timely because it's integrated now in the same control plane. Going forward, we're going to integrate more solutions like 5G and Edge computing, and that's why this edge-to-cloud platform is essential. The Aruba Edge platform is what allows us to deliver the entire edge-to-cloud platform because now that platform also serves as the backend to deliver iAS for customers on-prem and at the Edge for compute instances, including data services or workload-optimized solutions. Super pleased. And remember what I said, we exit Q3 2021 with a five times backlog on a normal run rate in that Aruba, and the bookings were very, very strong, super strong.

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

Yes. So again, thank you for taking the time today. Again, we are very pleased with our Q3 result, which again was marked by the stronger momentum in line with revenue expectations, but most importantly, strong improvement in gross and operating margin, and record year-to-date orders and free cash flow. That gives us the confidence to, once again, for the fourth time in the year, 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 spends cycle. People ask me, what do you think the Delta virus is going to do? It is 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. The reason why is because customers need to digitize their business; they need to create a more IT environment, and honestly, they need to extract insight from the data at a pace we've never seen before, and our edge-to-cloud platform strategy is resonating. So thank you for taking the time to be with us today, and I hope to catch up at the end of October at the Securities Analyst Meeting.

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

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