Hewlett Packard Enterprise Co Q1 FY2022 Earnings Call

Good day. And welcome to the First 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 is being recorded for replay purposes. I would now like to turn the conference over to your host for today's call. Mr. Andrew Simanek, Vice President of Investor Relations. Please go ahead.

Thank you. Good afternoon. I'm Andy Simanek at Investor Relations for Hewlett Packard Enterprise. I'd like to welcome you to our fiscal 2022 first 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 in the slide presentation accompanying today's earnings release on our HPE investor relations webpage at investors.hpe.com. As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. For more detailed information, please see the disclaimers on the earnings materials relating to forward-looking statements that involve risks, uncertainties, and assumptions. For a discussion of some of these risks, uncertainties, and assumptions, please refer to HPE’s filings with the SEC, including its most recent Form 10-K and Form 10-Q. HPE assumes no obligation and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on information available at this time and could differ materially from the amounts ultimately reported in HPE’s quarterly report on Form 10-Q for the fiscal quarter ended January 31, 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.

Thanks, Andy. And good afternoon, everyone. Thank you for joining us today. Before I discuss our results, I would like to address the evolving situation in Ukraine and how we are responding. Our first priority in the region is the safety of our team members, our contingent workers, and their immediate families. We are conducting regular proactive outreach to our workforce in Ukraine to offer emergency assistance, making our security team available 24/7 to help. The HP Foundation has established a special giving campaign for our team members to support humanitarian efforts in Ukraine, which has already raised $150,000 in just over 24 hours. And we are expanding the time off we offer team members to volunteer so those in the regions can care for their families and participate in humanitarian relief activities. From the business perspective, we have suspended all shipments into Russia at this time and will continue to adhere to all relevant sanctions and export controls. Now let me review our results for the first quarter of fiscal 2022. Hewlett Packard Enterprise delivered a solid performance. The quarter was characterized by robust customer demand and profitability, demonstrating the strength of our differentiated edge-to-cloud strategy and our portfolio innovation. Our business pivot is further strengthening our growth and operating margins. As a result of our overall performance this quarter, we are increasing our outlook for non-GAAP diluted net earnings per share for the full fiscal year 2022. In Q1, we saw growth of 20% from the prior year period, including a 136% rise in other service orders. We increased total HP revenue by 2% year-over-year to $7 billion, despite continued industry-wide supply constraints which slowed our ability to convert orders and record-breaking backlog to revenue. We generated a non-GAAP gross profit margin of 33.9%, higher than the prior quarter and prior year. I'm particularly pleased that we delivered an 11% non-GAAP operating margin. Free cash flow was negative $577 million in the quarter, reflecting normal seasonality and proactive actions we continue to take to buffer inventories in order to meet robust customer demand and forward-looking growth. The performance we delivered this quarter was noteworthy in a micro environment that continues to be defined industry-wide by supply shortages and overloaded logistic channels. Our global operations team is mitigating the impact by prudently building inventory when appropriate and leaning on our long-standing supplier relationships. We continue to utilize our world-class supply chain engineering capabilities to adjust the type of components we use, shifting into those that are more readily available. We have not seen any noticeable order cancellations from customers due to elongated delivery times. And we continue to take pricing actions in this inflationary environment. As we discussed previously, we expect supply constraints to likely last well into the second half of calendar year 2022. Demand for our differentiated edge-to-cloud products and solutions continues to be very strong, with Q1 marking the third consecutive quarter we have generated a year-over-year order growth above 20%. This was also the second consecutive quarter where our as-a-service orders more than doubled year-over-year. Customers are turning to HP for a differentiated portfolio, adopting our solutions to drive their transformation at an increasingly faster pace. Several key technology trends that are shaping the IT industry are aligned directly with our strategy to become the best cloud company through our HP GreenLake platform offering. The edge is creating new sources of data. Our customers need secure connectivity to power emerging distributed enterprise with remote workforces while delivering a new digital experience to their stakeholders. The world is hybrid; cloud is an experience that customers increasingly expect to have wherever their worlds live. The result is a growing demand for multi-cloud experiences, including clouds that live on-premises at the edge, in colocation, or in a public cloud. We have entered the age of insight, and data is the most precious asset. Digital transformation is creating new possibilities for enterprises, and customers need solutions to extract insights from the data to accelerate business outcomes. When customers tell us they want to address this market shift, they are increasingly looking to do so through a flexible as-a-service consumption model that enables them to pay only for the IT they use. Customers seeking to capitalize on these market trends are turning to HP GreenLake as the platform of choice. As always, Tarek will provide details about the business results for each of our segments. I will note a few highlights that underscore our performance this quarter, as well as our innovation interaction with customers. Customers' requirement for a unified operating experience across edge-to-cloud and the desire to consume IT in a flexible way is fueling the tremendous growth of our HP GreenLake edge-to-cloud age, which saw record demand in Q1 with as-a-service orders up 136% year-over-year. During the quarter, we added more than 100 new HP GreenLake customers, bringing the total count to over 1,350 customers who have adopted the HP GreenLake platform because of its compelling value proposition. One of the new HP GreenLake customers we announced in Q1 was Barclays, which is using HP GreenLake to deliver their private cloud platform as part of the bank's hybrid multi-cloud strategy and digital transformation across its global banking businesses. The traction we are seeing in the market for HP GreenLake is driving us to further accelerate the transformation of HPE into a national cloud company. On March 22, we will unveil significant new innovations and enhancements to our HP GreenLake platform to help customers manage their hybrid clouds more easily, protect and get more value from the data, and securely connect at the edge. Our as-a-service transformation is my number one priority, and it is already delivering results for our shareholders as evidenced by our Q1 performance and increased non-GAAP diluted net earnings per share guidance for the full fiscal year 2022. Our as-a-service offerings are accelerating momentum in key growth businesses. Our intelligent edge business segment grew revenues 11% year-over-year, and for the fourth consecutive quarter saw year-over-year growth of over 35%, driven by very strong demand in secure connectivity from edge-to-cloud. Our Aruba Edge cloud offerings continue to drive new customers. The Aruba Central cloud-native platform now manages more than 120,000 customers and more than 1.9 million network devices. In Q1, we announced that our Aruba Cloud managed branch offering is being adopted by Brasfield & Gorrie, one of the largest privately held construction companies in the United States. The company is using our networking portfolio to elevate their construction site innovation with impressive tools, like virtual reality views of projects before they are built. Also, in the quarter, we introduced the Aruba Edge Connect Microbranch, an industry-leading home office cloud-based networking solution that lets remote personnel work seamlessly and securely wherever they are located. Our High-Performance Compute and AI business also generated noteworthy product order growth of more than 20% year-over-year, which has increased our total order book to a record of approximately $2.7 billion. During the quarter, we announced a win with the United States Department of Energy, National Renewable Energy Laboratory to build new supercomputers that will advance R&D for tomorrow's clean energy systems. Our compute storage business experienced robust order growth and outstanding profitability. In Q1, nearly 10% of compute storage large orders were sold as a service. Compute generated more than 20% order growth year-over-year, expanded gross margins, and attractive operating margins up 240 basis points year-over-year driven by strong pricing discipline. Storage product order growth was more than 15% year-over-year for the fourth consecutive quarter. Innovation is unrelenting as we transform this segment into a data services business. For example, in Q1, our venture arm, Hewlett Packard Pathfinder, invested in BigID, a leading data intelligence platform to help organizations realize detailed insights into their sensitive personal and critical data and then act on it. Our HPE Pointnext Services team is helping customers navigate through their multi-generational IT journey while modernizing, building, and running the new hybrid IT space. In Q1, HP Pointnext Services orders increased mid-single digits year-over-year. Turning to our workforce, we reopened all of our United States offices last month to those who wish to return after careful analysis of information and guidance from public health officials. I was very pleased to meet team members in-person at our new cutting-edge Houston headquarters. You may have caught a glimpse of our Houston campus innovation in the video that ran before this call. We look forward to the official grand opening in April. Alongside advancing rewarding workplaces, I also believe that HP has a responsibility to become a more climate-resilient company. And we know it is a priority for our customers and shareholders. HPE Financial Services plays an important role in our sustainability strategy, providing asset upcycling to customers, which means reuse of millions of technology assets while freeing up capital for customers to reinvest in their businesses. Customers are choosing HPE in part because of our portfolio sustainability attributes. In fact, in fiscal year 2021, we drove nearly $900 million in revenue from sustainability-related customer engagements. I am proud of our team members not just for bringing breakthrough customer-centric innovation, but for how they're bringing it to market. They are making bold moves to maximize what we can do for our customers and shareholders. It is this type of collaboration and engagement that is compelling for business transformation. It is clear from strong customer feedback and momentum across our businesses that HPE is increasingly well positioned to capitalize on the edge-to-cloud mega trends that define our IT industry. HP GreenLake is at the center of our strategy to pivot the company, and it is generating record-breaking demand with impressive profitability across our business. These continue to be uncertain times. As we monitor the dynamic global stage, I am more confident than ever about our future and our ability to drive long-term sustainable profitable growth for our shareholders because of our strategy and differentiated innovation. Now I would let Tarek to talk you through the quarter’s performance in detail. Tarek?

Thank you very much, Antonio. I'll start with a summary of our financial results for the first quarter of fiscal year 2022. As usual, I'll be referencing the slides from our earnings presentation to guide you through our performance. Antonio discussed the key highlights on slide one. So now let me discuss our Q1 performance details starting with Slide 2. We're off to a good start delivering against our commitments for fiscal year '22 with strong momentum continuing to build across the business. The demand continues to be robust for our differentiated edge-to-cloud portfolio with order growth up 20% year-over-year, marking our third quarter in a row with order growth at or above 20% year-over-year. This bolsters our confidence in achieving both our fiscal year '22 revenue outlook of 3% to 4% adjusted for currency and our longer-term 2% to 4% revenue CAGR outlook provided at our 2021 securities analyst meeting. We delivered Q1 revenues of $7 billion, up 2% year-over-year and in-line with our outlook of normal sequential seasonality, despite a continuously challenging supply environment. As a result, our backlog further increased to record levels with a firm order book that shows no signs of double ordering or any noticeable cancellations. We were particularly pleased with the quality of our earnings, including the resiliency of our gross margins despite the ongoing supply constraints that are driving up material and logistics costs. We delivered a non-GAAP gross margin of 33.9%, up 90 basis points sequentially and 20 basis points year-over-year, driven primarily by strong pricing discipline and our continued mix shift towards higher-margin, software-rich offerings. Non-GAAP operating margin has also been resilient at 11%, slightly down 30 basis points year-over-year, but up 130 basis points sequentially. We're achieving all of the expected savings from our cost actions announced mid-pandemic while continuing to make investments in our high-growth, margin-rich areas of our portfolio to fuel further revenue and profitability. Within other income and expense, we benefited from further strong gains related to increased valuations in our investment portfolio and robust operational performance in HPC. As a result, we now expect non-GAAP other income and expense for fiscal year '22 to be an income of approximately $25 million versus prior guidance of a $20 million to $40 million expense. As a result of our strength in margins that more than offset the continued supply challenges, we delivered non-GAAP EPS of $0.53, well above the high end of our outlook range of $0.42 to $0.50 for Q1. As previously indicated, we expect free cash flow to be in-line with our typical seasonality that is lowest in Q1, with a use of cash of $577 million for this quarter. We also continue to take strategic inventory actions to navigate the current supply environment. Our inventory is now up $2.5 billion year-over-year to $5.3 billion in support of the substantial order book that we have. This will better position us to convert orders into future revenue and cash flow. Finally, we continued to return substantial capital to our shareholders. We paid $155 million of dividends in the current quarter and are declaring a Q2 dividend today of $0.12 per share, payable in April. We also repurchased $129 million in shares during Q1, reflecting our confidence in future cash flow generation. Slide 3 highlights key metrics of our growing as-a-service business. We made meaningful progress during Q1. We added more than 100 customers and well over $500 million of total contract value that brings the current total TCV to more than $6.5 billion. Total as-a-service orders were up 136% year-over-year. As a proof point of our as-a-service pivot momentum, as-a-service order growth has accelerated every quarter going back to Q1 of last year. Our ARR was up 23% year-over-year to $798 million, with supply constraints limiting some installations. While our ARR growth might be somewhat volatile in the current supply environment, the strong order growth over the last several quarters is the best indicator of the long-term health of this business. This gives us confidence in delivering our 35% to 45% CAGR target from fiscal year '21 to fiscal year '24, with increasing margins as our mix of both software and services continue to increase to 64% in Q1, up more than 4 points year-over-year. Now let's turn to our segment highlights on Slide 4. Our growth businesses continue to show improving top-line momentum and record levels of backlog fueled by strong demand. In the Intelligent Edge, demand for our secure connectivity solutions continued unabated with orders growing more than 35% year-over-year, the fourth consecutive quarter. Despite increasing supply constraints, revenue grew 11% year-over-year with strength across the portfolio. Both wired switching and wireless LAN grew approximately 10%, with Aruba Services up even stronger driven by our Edge-as-a-Service offerings up strong double digits. We also delivered strong operating margins of 17.4%, representing a 650 basis point sequential improvement despite higher component and logistics costs, demonstrating that our price actions are sticking. In HPC and AI, demand remains robust with product order growth of more than 20% year-over-year, driving our awarded contracts total to another record level of approximately $2.7 billion. Revenue grew 4% year-over-year, but was impacted by two large customer acceptance delays that impacted growth by more than 10 points in Q1 and are now on track to be delivered in Q2. Our Q1 operating profit was obviously also impacted by these pushouts, and we expect operating margins to return to more in range with historical levels going forward. In compute, order growth was up over 20% year-over-year for the third consecutive quarter, while revenue growth was flat, reflecting the difficult supply environment. We have been very focused on executing a dynamic pricing strategy that has been effective in managing the increased supply and logistics costs. The results are showing up in our operating margin performance at 13.8%, up 240 basis points year-over-year and 440 basis points sequentially, well above our long-term target of 11% to 13%. Within storage, product order growth was up in the high teens year-over-year. This was the fourth quarter in a row of 15% or better year-over-year product order growth. Revenue was down 3%, reflecting increasing supply constraints, particularly for our owned IP products. As a result, we had an unfavorable revenue mix that pressured our margins this quarter. We expect both our revenue growth rates and margins to improve over the next few quarters as we continue to shift our portfolio towards higher-margin products and supply constraints ease. With respect to Pointnext Operational Services, including storage services, orders grew mid-single digits year-over-year as reported, similar to levels for the total fiscal year '21. As you know, this is very important for the long-term health of our most profitable business. Within HPE Financial Services, volume increased 11% year-over-year, and revenue was down 1%. Our write-offs as a percentage of assets, excluding the impact of two frauds in the UK and Asia Pacific, were 47 basis points, which is below pre-pandemic levels. Our profitability also continues to benefit from higher residual value realizations and lower borrowing costs as we continue to securitize our U.S. portfolio via the ABS market. Our operating margin was 12.4%, up 260 basis points from the prior year, and our return on equity at 19.7% remains well above the 18% plus target set at SAM 2021. Slide 5 highlights our revenue and EPS performance, where you can clearly see the strong rebound from last year and sustained momentum entering fiscal year '22, and this despite a more supply-constrained environment versus a year ago. We are also delivering a better quality of earnings with our portfolio mix continuing to shift to our higher growth and higher margin execute our edge-to-cloud strategy. Turning to Slide 6. We delivered non-GAAP gross margins in Q1 of 33.9%, up both year-over-year and sequentially despite all of the increased component and logistic costs. This was driven by both strong pricing discipline and the favorable mix shift we've been driving towards edge and our as-a-service business. Moving to Slide 7. You can see our non-GAAP operating margin this quarter of 11%, representing a 130 basis point sequential increase. We also delivered roughly the same operating profit versus last year despite a more challenging supply environment while continuing to invest significantly more in both R&D and our go-to-market for the future, thanks to a much better quality of earnings and gross margins. Turning to Slide 8. Our free cash flow was a use of cash of $577 million. This is more aligned to our typical pre-pandemic seasonality if you look at Q1 in fiscal year '20 or the prior years. Cash flow in Q1 of this year has also been uniquely impacted by the supply chain environment as we have strategically continued building inventory levels. This will better position us to begin converting orders and generate healthy amounts of cash in the back half of the year, reflecting also our typical seasonality. We therefore continue to expect to deliver fiscal year '22 free cash flow of $1.8 billion to $2 billion. Now turning to our outlook on Slide 9. Given our strong performance in Q1 and building momentum across the business, I am pleased to announce that we are raising our full year non-GAAP diluted net EPS outlook range for fiscal year '22 by $0.07 at the midpoint to $2.03 to $2.17. From a top-line perspective, we were very pleased with the continued strength in orders and growing backlog that gives us confidence in future revenue growth in fiscal year '22 and beyond. We do also want to remain prudent in the short term given the ongoing supply challenges that we continue to believe will likely last well into the second half of the calendar year. As a result, we still have strong confidence in our fiscal year '22 revenue outlook of growth of 3% to 4% and expect to end the year with elevated levels of backlog, which bodes well for fiscal year '23. More specifically, for Q2 2022, we expect revenue to be in-line with our normal sequential seasonality of down low to mid-single digits and are comfortable with current consensus. As a result, for Q2 '22, we expect GAAP diluted net EPS of $0.18 to $0.26 and non-GAAP diluted net EPS of $0.41 to $0.49. So overall, I am very pleased with our first quarter of fiscal year '22. Our edge-to-cloud strategy is resonating with customers and driving strong demand across our portfolio. This enabled us to deliver a good start to the fiscal year with increasing momentum and a raised outlook. We are very well positioned to capitalize on the ongoing opportunity and deliver against all of our financial commitments set at SAM 2021. Now with that, let's open it up for questions. Thank you.

We will now begin the question-and-answer session. Our first question will come from Shannon Cross with Cross Research. Please go ahead.

Thank you very much. I wanted to maybe dig a little bit more into linearity during the quarter and what you're hearing from customers in terms of demand given all the geopolitical challenges. You talked about backlog increasing to record levels. I'm wondering, how much of that do you think are customers planning ahead? Or thinking about longer lead times versus near-term demand that's not just being able to be met right now? And I don't know, just what are you hearing because are customers sort of shifting the way that they think about how they're buying at this point in time? And I guess just the final sort of question within that is, how does this benefit or does it benefit your GreenLake and your as-a-service strategy? Thank you.

Well, thanks, Shan. So as you can imagine, I spend a lot of time talking to customers. In fact, 50% of my time is with customers and partners. And the one consistent theme is that we said in our quarter has 13 weeks and every week has been super strong. We put specific goals for our sales force every week that we track very closely. Tarek runs a very tight process on that. And we have always exceeded every week's forecast. The feedback is driven by the following: number one, obviously, we know digital transformation is getting stronger and stronger out there, and it's driven by the fact that you've got to digitize your process to be competitive. And number two, data continues to explode everywhere, and that means that they need more capacity to store the data, but most importantly, process that data at a pace we haven't seen before. And that's a combination of AI, analytics, deep learning at scale and obviously, a lot of compute power. The third piece, obviously, as I said in my remarks, is that the edge continues to grow very, very rapidly. And in order to transform in a digital environment, you need connectivity. Without being connected, you don't have the on-ramp through this digital transformation. Of course, customers are concerned about inflationary costs going forward. They monitor what's happening out there. But in the end, I think all of this, when you balance the demand for these trends, and I talk about the trends, right, in the mega trends. And then the fact that customers want to consume more flexibly and don't want to put all that CapEx to work, GreenLake is getting significant attention. And that's why I said when I think about the future of this company, the product is HPE GreenLake. Everything gets delivered through HPE GreenLake, whether it's a connectivity through a subscription model, whether it's computer storage that you can consume elastically with data services running on top of it, whether it's the services to operate in HPE GreenLake, HPE GreenLake is becoming a platform of choice for many customers because it offers that flexibility in an architecture that's edge-to-cloud. And that's inclusive, by the way, of the public cloud. And that's why when you see the innovation we're going to bring in the next 2 weeks, it includes the public cloud in the way we manage that. So overall, I will say, great execution by our team. Customers need more IT now more than ever. And obviously, we are doing a good job, I will say, in the quality of earnings, pricing elasticity, and everything we have done, which is the result of the profitability you saw.

Great. Thank you, Shannon. Appreciate the question. Operator, can we have the next one, please?

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

Yes, thank you. Congrats on the really solid gross margin performance in a very tough environment where others are really seeing a lot of pressure on their GP dollars and gross margins. I was hoping you can talk about the sustainability of these gross margins through the rest of the year, especially in light of the increasing DRAM and NAND cost? And it seems as though some of the logistics are really not letting up so far? And maybe you can share some color on your ability to take incremental price actions and maybe share some color on what you've already been able to pass through in terms of pricing? Thank you.

Wamsi, thank you for the questions. Yes, indeed, I'm very pleased with our gross margin performance this quarter, and we outperformed our competitors. It's pretty obvious when you look at what they have reported. The resiliency of our gross margin is there for everyone to see, despite the ongoing supply constraints that everyone has been facing with. So we feel that this performance can be sustained, but you have to adopt different pricing strategies across different segments. So we have to be incredibly dynamic in our compute segment that we have been, and this translates into significant operating profit margins at 13.8%, which is even higher than the long-term outlook that we put forward for that segment at SAM 2021. In the rest of our portfolio, we have significant differentiation at the edge, in storage, and also in HPE Financial Services and HPC. So there, the pricing strategy is different. We take a harder look at how much value can be extracted given that our portfolio there is more differentiated. But everyone's contributing here to making sure that the gross margins are sustainable. Finally, I want to highlight to you that as-a-service contributes and will continue to contribute in the long run to enhance gross margins. That's why we highlighted to you all in the slide presentation the mix shift in the composition of the ARR. The more we continue to drive as-a-service growth, the better it is for gross margins ultimately. But it's a dynamic environment. And to your point, you will see some pressure on some commodities. We feel we are well equipped with our inventory levels to withstand the pressure from these commodities. And this is why we buffered up inventory to the levels that we reported knowing that this is obviously to meet a substantial order book that is much higher than what we have experienced in prior years. As Antonio said, the demand in the quarter has surprised us from its strength and resiliency standpoint.

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

Your next question will come from Tim Long with Barclays. Please go ahead.

Thank you. Yeah, I was hoping to just follow up on some of the as-a-service business and deals. You mentioned getting some large deals and more backlog building there. Could you talk a little bit about the complexion of what you're seeing from a solution set or a customer base driving that? And maybe a little bit on kind of what you see from pipeline on some of the customers looking to more take on the as-a-service type of offering as opposed to just kind of the standard of the build and buy? Thank you.

Sure. Well, one of the marquee customers is actually your bank, Barclays, quite interesting. They needed a partner to take them to this hybrid journey. In their case, they have tens and tens of thousands of VMs. So in their case, they wanted flexibility to scale up and down in a private cloud environment and yet integrate the public cloud as they go forward. So they felt that, obviously, with GreenLake, they get the best of both worlds: an experience and a cost on-prem that's very competitive and the ability to move VMs back and forth as they need. But the reality is that, that is driven by many factors. Number one, let's start with the edge. So obviously, a lot of the as-a-service now at the edge is done in a subscription model. You subscribe to the Aruba Cloud Platform now inside GreenLake. And then, basically, you can provision connectivity with a few clicks. But now we are seeing growth in what we call the NaaS environment, the Network-as-a-Service, where customers don't just want the subscription, but they want the full consumption, including the hardware and services in a managed services approach. They don't want to be in what I call the day 2 of the run part. So that comes with a lot of services. And that's why Tarek mentioned the combination of software and services is increasing. If you look at the colocation or the edge where the cloud is moving as well, or data center, obviously, private cloud is one aspect; is that infrastructure-as-a-service component. But a lot is also workload-optimized solutions, whether it's what else like VDI or whether it's SAP-as-a-Service, or Machine Learning as a Service. So we see existing workloads and new loads also being consumed as a service in these locations. So those are the type of deals. And remember, it's not just the hardware and software, it's the services that come with it because what we're seeing from our customers, and we talked about some of the previous customers as well, they want HPE to run their solution end-to-end, which the managed services piece comes as well with it. So it's a combination of Infrastructure-as-a-Service, connectivity, and then as well, this workload optimization with more and more management as well as a hybrid estate, which includes the public cloud. And last but not least, if you think about data, data is a major component. Data has a gravitational force. And at the same time, they want to apply these new techniques. That's why we see a lot of growth in the AI machine learning space, both in the enterprise space and at scale through HPC. And that's why on the HPC side, we are very, very pleased with the momentum. As we know, that business becomes a little bit lumpy because of the customer acceptances. But this year, we're going to deliver some of the most amazing systems you can imagine at massive scale, where customers can process data we have not imagined before. So it's a combination of all things that's what resulted in 136% growth. And that's why we are very excited about the momentum. But what excites me the most, honestly, is the innovation we're going to continue to bring in the platform called HPE GreenLake. And to the question that Shannon asked me earlier, that's why it's my priority number one, because it's working, it's driving more growth in the bookings and better profitability.

Great. Thanks, Tim, for the question. Operator, next one, please?

The next question will come from Meta Marshall with Morgan Stanley. Please go ahead.

Great. I wanted to dig into the intelligent edge upside. You noted that order growth was still stronger than the revenue growth that you guys were able to post. And so kind of two parts of the question are just is some of the order growth that you're seeing still kind of return to office plans? Are we really starting to kind of move past this return-to-office driven growth? And then on the second piece, just on the revenue upside that you were able to post, is that some kind of loosening of availability for networking chips? Or is there anything that led to kind of outperformance in that segment or losing the supply chain in that segment more than others? Thanks.

Sure. Well, thank you for the question. And I will start, and Tarek can add on. If you go back to 2018 when I became CEO, I said that the edge is the next frontier, and we will invest in innovation over the next 40 years. We are now seeing the results of that investment because we have a unique value proposition in an as-a-service model that actually is accelerating our momentum there. And you saw the numbers, right, 35% growth for the fourth consecutive quarter. This is not just a data point in the chart; there are four of them in the data in the chart that are driving strong demand. I think the pandemic has accelerated the need for that distributed connectivity. In fact, this quarter, we announced a new offer, the Edge Connect offer, which basically gives the customer the ability to manage the workforce wherever they are in a seamless, secure, integrated way and provision their connectivity wherever they are. But listen, the scale or the platform we have, I think is unmatched. We already have more than 120,000 customers consuming more and more services. They may start with Wi-Fi; they are in LAN; now they're in WAN. That's why we made the acquisition of Silver Peak more than 15 months ago. And soon, we're going to add 5G too. So in my view, this is just a buildup of momentum. And the architecture of that business is about unification of the connectivity, which makes it simpler to run the operations, the network operations, whatever that connectivity is. The security layer, which obviously is super important and then the analytics, because ultimately what customers like about our offer is the ability to use the data that we actually can provide through the network on performance and characteristics that allow them to deliver a better experience. And when you have almost 2 million devices, there are a lot of datapoints. In fact, you should know the scale; every hour, we process almost 2 billion datapoints. And that's done around the globe in 13 different geos. And that gives the ability of the customer to provide these unique experiences. But again, that comes also with an improvement in operating margins, which is 17.4%, which is actually sequentially at 650 basis points. I think on the supply, obviously, we have been working for some time. I can tell you we continue to place orders at least four, if not five quarters ahead of demand because we are so confident about this business to continue to grow. We have to work through, sometimes we get a little bit better matching to what we have; sometimes we may have some orders unconverted. But in the long term, this is going to continue to be a shining story for us.

Great. Thank you for the question, Meta. Can we go to the next one, please, operator?

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

Thanks for taking my question. I have a couple of questions on the ARR side. ARR didn't grow on a sequential basis for the first time in a while. I know you talked about supply challenges limiting some of the installations. Is there a seasonality element to the ARR growth? That's question number one. And secondly, GreenLake Services growth continued to accelerate more than double for the second consecutive quarter. Can you walk us through how long it takes for GreenLake orders to flow into the ARR calculation? I assume it's different for every business segment. Thanks.

Let me begin by addressing the question about seasonality. I don’t believe there is any seasonality impacting our growth. Our trajectory is positive, and it’s mainly about completing those installations. Sometimes delays are due to supply issues or customer readiness, but ultimately, it's all about having the systems available for installation. Regarding our confidence in the 35% to 45% compound annual growth rate we've committed to, we are optimistic about our momentum and expect things to align over time. On the services side, we consistently see a 100% attach rate of Pointnext services with GreenLake, and this momentum will continue to contribute to our deferred revenue. Additionally, we've introduced managed services as many new deals are coming through. Earlier, there was a question about our pipeline, which remains very strong with several significant deals in progress. The managed services element enhances our attachment rates since customers prefer not to handle round-the-clock operations alone. They want the GreenLake platform along with the necessary services for their operations. Tarek, perhaps you can provide more insight on how this translates into annual recurring revenue.

The simple answer to your question about how long it takes to see an order flow into ARR and revenue is this. Our GreenLake model is appliance-driven, which means we deliver a complete solution that includes standard hardware platforms along with services and software. To start recognizing revenue, it's crucial that we deliver the right hardware. Once we deliver the appliance, revenue is recognized based on the duration of the contract. We've mentioned before that the services revenue, which constitutes the majority of the ARR, is recognized over the contract's duration. This duration typically ranges from 36 to 60 months. Therefore, it takes time to develop the ARR. However, it's important to highlight the total contract value on our balance sheet. This quarter, we increased our total contract value by $500 million, bringing it to $6.5 billion, which will be recognized over the next 60 months at most. This explains the relationship between orders, revenue, and ARR recognition.

Which is a great question because, obviously, if you look at our ARR, again, at $800 million this quarter. And our total contract value $6.5 billion, and more than 64% now is software and services. Over time, you will see the impact it has on our results, both quality of the revenue mix and quality of the earnings because, as Tarek said, obviously, everything we do through GreenLake is accretive. And so that's why we are excited about the momentum we have on GreenLake.

Great. Thanks, Sidney for the question. Operator, next one please?

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

Thank you for taking the question and congratulations on the results. I wanted to discuss how you are approaching the full year revenue guidance of 3% to 4% in relation to backlog build. Looking at the midpoint of the revenue guidance, it suggests that you anticipate a stronger second half compared to what we've seen in previous years. My question is about your assumptions regarding the backlog build. When do you expect it to peak, and do you plan to start shipping against that backlog? Is this factored into your revenue growth expectations for this year?

Great question. In Q1, we saw orders grow by 20% while revenue increased by 2%. This indicates that our orders are growing significantly faster than revenue. However, we have mentioned that we will face supply challenges, particularly in logistics, which may persist into the second half of '22. This situation is more about timing than anything else. We are optimistic about achieving 3% to 4% revenue growth, but this will depend on our ability to obtain the right supply at the right time and in the right mix. It's important to remember that our portfolio is quite large, and not all orders are equal, as Tarek noted earlier. As we move forward, we will continue to evaluate any developments. We are confident that the second half will improve, and we hope that this momentum continues into '23 due to strong demand.

Yes, I’d like to add to Antonio's response. When we provided guidance at SAM, we indicated our target for 3% to 4% revenue growth in fiscal year '22, with the latter half of the year contributing more than the first. This outlook remains unchanged. In fact, the strength of our orders has exceeded our expectations at SAM, which came as a bit of a surprise since orders have remained robust for 13 weeks in Q1. Examining our situation from two angles: first, we're significantly increasing our inventory to meet the strong order demand. Additionally, as Antonio mentioned, there is a noticeable difference between order growth and revenue growth, indicating we're not at peak backlog yet. This suggests positive implications for both fiscal year '22 and '23. Lastly, I want to draw your attention to the effect of foreign exchange rates. During our meeting at SAM in October, we anticipated a 50 basis point headwind from foreign exchange rates. Currently, the scenario has shifted with a stronger dollar, and we now foresee a full point headwind, but we are still confident in reiterating our 3% to 4% revenue growth projection due to the strength of our order book. I hope you can understand the connection between orders and revenue, backlog, inventory accumulation, and our revenue guidance based on constant currency.

Great, thanks. Appreciate the question. Operator, next one, please?

Our next question will come from Amit Daryanani with Evercore. Please go ahead.

Thanks for taking my question. I guess I have to ask a free cash flow question now. I guess, Tarek, down $600 million free cash flow or thereabouts, it's somewhat more severe than what I would think normal seasonality should be. So maybe you can just flesh out how much of this you think is seasonal versus perhaps things driven by working capital inefficiencies, and there's a big spike or drop in these other assets and liabilities; maybe you can just start what happened there as well. And then importantly, as I go through the year, do I think about April being somewhat more muted in free cash flow as well and in the back half being better? Or what does that cadence look like?

Okay. So Tarek?

Okay. Regarding your question, the negative $577 million free cash flow is primarily due to working capital. Our inventory has increased significantly to $5.3 billion, which has negatively affected the cash flow conversion cycle. Currently, our cash flow conversion cycle stands at a positive 20 days, up by 17 days compared to the previous quarter, as we ramp up inventory to meet order demand. While there is some seasonality in play compared to prior years, particularly fiscal year '21 is not a relevant reference; you should look back to the first quarter of fiscal year '20 and earlier for insights into free cash flow seasonality moving forward. We remain confident in our ability to generate free cash flow as we tackle the backlog and lower inventory levels, which is why we have reaffirmed our free cash flow guidance of $1.8 billion to $2 billion for fiscal year '22. There was another part of your question regarding the movements in other assets and liabilities, and I think Andy would like to address that.

Yeah, so that's generally related to our comp plans where we pay out our bonus in the first quarter. So that's one of the reasons why if you look at our typical seasonality. As Tarek said, going back to fiscal year '20, a year before, you'll generally see Q1 is always a use of cash. Great. Well, thank you, Amit. I appreciate the question. I think operator, we have time for one more, please.

Our final question will come from Kyle McNeely with Jefferies. Please go ahead.

Hi, thanks for squeezing me in. Great job on the results in such a difficult environment for everyone else. We have some recent survey work that we did that shows enterprises are expecting a higher-than-normal level of refresh activity in the coming year, specifically for servers and storage. We assume that some of that might be catch-up on upgrading aging infrastructure coming out of the pandemic. But are you seeing that type of activity come through in helping the results? And what would be your expectation for refresh and upgrade activity for the balance of the year 2022?

Sure, Kyle. Yeah. Of course, customers are now thinking about what else they need to succeed in this new environment. Definitely, the pandemic put a halt on their expenses because, obviously, at the beginning of the pandemic, everybody was in preservation mode, on liquidity. But at the same time, I think there is a component of modernization, which I call it better than refresh. And also the need to deploy these new technologies. It's not anymore about a cloud mandate. It's about what they're going to do with that data because cloud is just a means to the end, right? It's all about accelerating speed and agility. But what customers are looking for is what type of things they need to do with that data. So it’s a combination of data exploring, connectivity required in this digital world and the fact that you need to stay up to these new ways to deliver IT, while the transition of this journey to the multigenerational IT. Because many of these customers have a lot of complexity. They have legacy assets that they have a lot of data with applications that are not really replatformed. They cannot replatform. They are older ones that, honestly, they need to, what I call, cloudify, but most importantly, we need to deploy these new technologies around data. So that's why our vision to become the edge-to-cloud platform company is so spot on because it's aligned to those megatrends of connectivity, cloud, and data that you can consume as-a-service. And that's why the future of the company long-term is GreenLake, which drives the rest of the portfolio with higher margins and obviously, more recurring revenues for us and for our shareholders.

Well, great. Thank you, Kyle for the question and everybody else participating. Antonio, maybe I’ll turn it back to you for some closing remarks.

I am very pleased with our Q1 performance; it was a solid start. The quarter was marked by strong customer demand and significant profitability, highlighting the effectiveness of our strategy and our innovative portfolio. We are well positioned to leverage our strengths. However, we must remain vigilant in these interesting times. Our priority is to fulfill our commitments and contribute positively to society, as our company has a unique value and culture. I take pride in not only what we achieve but also in how we achieve it. I hope you all stay safe and well, and I look forward to speaking with you soon. Thank you for your time today.

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