Hewlett Packard Enterprise Co Q2 FY2022 Earnings Call

Good day and welcome to the Second Quarter Fiscal 2022 Hewlett Packard Enterprise Earnings Conference Call. My name is Chuck and I’ll be your conference moderator for today’s call. At this time, all participants will be in a listen-only mode. We will be facilitating a question-and-answer session towards the end of our conference. As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Mr. Andrew Simanek, Vice President of Investor Relations, please proceed, sir.

Great, thank you. Good afternoon everyone. I’m Andy Simanek, Head of Investor Relations for Hewlett Packard Enterprise. I’d like to welcome you to our fiscal 2022 second quarter earnings conference call, with Antonio Neri, HPE’s President and Chief Executive Officer; and Tarek Robbiati, HPE’s Executive Vice President and Chief Financial Officer. Before handing the call over to Antonio, let me remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately one year. We posted the press release and the slide presentation accompanying today’s earnings release on our HPE Investor Relations web page at investors.hpe.com. As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. For more detailed information, please see the disclaimers on the earnings materials relating to forward-looking statements that involve risks, uncertainties, and assumptions. For a discussion of some of these risks, uncertainties, and assumptions, please refer to HPE’s filings with the SEC, including its most recent Form 10-K and Form 10-Q. HPE assumes no obligation and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on information available at this time and could differ materially from the amounts ultimately reported in HPE’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 30th, 2022. Also, for financial information that has been expressed on a non-GAAP basis, we have provided reconciliations to the comparable GAAP information on our website. Please refer to the tables and slide presentation accompanying today’s earnings release on our website for details. Throughout this conference call, all revenue growth rates, unless noted otherwise, are presented on a year-over-year basis and adjusted to exclude the impact of currency. Finally, after Antonio provides his high-level remarks, Tarek will be referencing the slides in our earnings presentation throughout his prepared remarks. As mentioned, the earnings presentation can be found posted to our website and is also embedded within the webcast player for this earnings call. With that, let me turn it over to Antonio.

Well thank you, Andy and good afternoon everyone. Thank you for joining today's earnings call. HPE's second quarter results reflect significant customer traction for our differentiated portfolio and underscore our progress in becoming the edge-to-cloud company. The macroeconomic environment of the last few months has presented enterprises around the world with strategic challenges that are usually not confronted all at once. The market shifts have certainly created a dynamic backdrop for our global customers and have made it harder for them to realize their goals in the short term. But more than ever, organizations need technology partners to help them weather challenges while successfully digitizing and transforming their businesses in order to increase their market competitiveness. HPE's ability to address these customer needs was key to our performance in the second quarter. Once again, HPE generated significant orders growth, steady revenue, and sustained profitability, even as tight supply conditions continued across global industries. We are seeing persistent demand from our customers, underscoring both their IT spending prioritization and the attraction to our compelling portfolio. Very strong customer demand in the second quarter drove orders growth higher, rising 20% year-over-year, which makes this the fourth quarter in a row that HPE has logged year-over-year orders growth of 20% or better. Our HPE GreenLake H2 Cloud platform contributed to as-a-service orders doubling year-over-year, the third straight quarter of triple-digit growth. We continue to see a great deal of customer interest in our platform, which is evident in our sales pipeline. Our orders backlog across the business is high quality, and we are now seeing particular strength in our Intelligent Edge and Compute segments, with orders climbing 45% and 23%, respectively. HPC and AI orders grew more than 18%, bringing backlog there to an impressive record of approximately $3 billion. Total HPE revenue rose 1.5% year-over-year to $6.7 billion against a record backlog of orders in the midst of industry supply constraints. ARR climbed 25%. We have momentum across the portfolio with our as-a-service model differentiating us. This quarter, though, through a combination of supply constraints limiting our ability to fulfill orders as well as some areas where we could have executed better, we did not fully translate the strong customer orders into higher revenue growth. I am confident that we have identified where we can strengthen and expect continued improvement as we move into the back half of the year. Importantly, the quarter's biggest standout, even if we were somewhat limited by supply chain, is that we maintained non-GAAP gross margins of 34%, thanks to disciplined execution and timely pricing actions. Non-GAAP diluted net earnings per share was $0.44, which together with our Q1 results, makes the first half of 2022, the second strongest EPS half-year performance at HPE on a continuing operations basis. As Tarek will detail for you, we are reaffirming our full-year outlook of revenue growth of 3% to 4% and our long-term 2024 revenue CAGR outlook. We are also reaffirming our full fiscal year free cash flow guidance of $1.8 billion to $2 billion. As announced in February, we suspended all shipments to and sales in Russia and Belarus. We have now determined that it's no longer tenable for us to maintain operations in these countries. Therefore, today, we are announcing the closing of our operations in both countries and we'll proceed with an orderly managed exit. Our business in these countries represents less than 2% of HPE's total revenue in fiscal year 2021. We have booked a $126 million pre-tax charge related to the impact of Russia on our business, which is included in our second quarter GAAP earnings per share results. We expect less significant additional charges in the third quarter related to winding down these operations, partially to reflect this necessary action and partially to unfavorable foreign exchange movements. We are updating our full fiscal year non-GAAP diluted net earnings per share to between $1.96 and $2.10. In the short term, we recognize the supply and logistics constraints, rising inflation and evolving economic and geopolitical conditions are all contributing to a dynamic environment. However, enterprise demand continues to persist across our entire portfolio. We are focused on translating the demand we see in the market and a high-quality backlog into profitable growth while continuing to closely manage our inventory position. When even the supply of low-value components can be hard to secure in today's environment, we will continue to be disciplined and prudent in our decision-making to deliver on our commitments. As we look to the future, we are strengthening the scale and resilience of our supply chain, including opening a new factory in the Czech Republic for next-generation HPC and AI technologies, which will help us address the very solid demand we have for these specialized solutions. There is no question that we have positioned HPE well to help our customers double down on digital transformation. HPE GreenLake is at the center of our strategy to deliver edge-to-cloud solutions to enable customers' data-first modernization strategies. I hope many of you will join us later this month to see firsthand how our strategy comes to life when we host HPE Discover live in Las Vegas for the first time in three years. We will have a lot to show you as it has been an exciting few months for our customers and for HPE. In March, we announced features on HPE GreenLake that deliver greater choice and simplicity. We added 12 new cloud-native services, with now more than the total of 50 cloud new services available through the platform. We also continue to expand our partner ecosystem, increasing the number of partners actively selling HPE GreenLake this quarter by more than 50% from the same period last year. In addition, partners who sold multiple HPE GreenLake deals in the quarter increased by 2.5 times year-over-year. At the edge, our capabilities are in high demand as organizations need to securely connect distributed workforces and create engaging experiences. We are focused on delivering cloud-native services that can more easily embed automated networks to absorb evolving networking configurations. And with the convergence of Aruba Central and HPE GreenLake, more than 120,000 Aruba customers now have access to the HPE GreenLake platform. As customers adopt hybrid multi-cloud solutions, we know they also need a secure and flexible on-premises cloud solution. We were recently selected as the prime provider for Google's cloud distributed hosted solution. HPE GreenLake will enable Google to deliver an on-premises cloud experience for organizations with strict data residency, security, and privacy requirements. Our hybrid cloud offerings have attracted nearly 150 new customers in Q2, including BMW Group, who is using HPE GreenLake to streamline and unify the company's data management across its global locations in the cloud and Worldline, the world's fourth largest provider who chose HPE GreenLake to implement their major performance upgrade to its payment platform as it continues to deliver against a cashless economy vision. HPE Financial Services had a unique hand in the Worldline upgrade to HPE GreenLake, with our asset renewal program funding approximately 25% of the refresh. From a data perspective, we continue to make meaningful enhancements that allow customers to extract more insights from their data to accelerate business outcomes. For instance, we are creating sophisticated AI models to generate and share insights in distributed environments. In April, we introduced HPE Swarm Learning, which enables users to share learnings through an AI model at the edge and from distinct sites without compromising data privacy. One university in Germany is already using HPE Swarm Learning to more accurately diagnose colon cancer by applying AI learnings that can predict cancerous genetic alterations. Early this week, Frontier, an HPE designed and built system became the world's first and the fastest exascale supercomputer, taking the number one ranking on the world's top 500 list of supercomputers, exceeding the 1 exaflop performance threshold for the first time. To put this in perspective, this performance is three times faster than the number two supercomputer. HPE has deployed four of the top 10 supercomputers and ranked first, second, third, and fourth on the Green 500 list of the most energy-efficient supercomputers in the world. Our service pivot is also innovative in the way it helps our customers meet their sustainability goals. HPE Relay helped customers reduce their carbon footprint by more than 30% versus traditional IT models. Later this month, when we release our Living Progress Report, we will share more about our efforts to support our customers' goals while pushing ourselves in the industry to improve our own. Few of us could have predicted that the challenges of the last several years would require enterprises to adopt so dramatically. I spend at least 50% of my time with customers around the world, and I can tell you that when they think about how they are going to reimagine their futures, they see HPE as an even more relevant innovation partner than ever before. As I reflect on Q2 and look ahead to the future, I am confident in our ability to deliver on our commitments. We have the right strategy to capitalize on market trends, with an expansive edge-to-cloud portfolio that's connected through our market-leading HPE GreenLake platform. We have significant momentum with our customers. And perhaps most importantly, we have a truly stellar team. I am proud of the 60,000 team members who make our results possible and who help us deliver on our purpose as a company. This team will continue to innovate and execute in ways that will further set us apart and continue to create value for our shareholders. With that, let me turn it over to Tarek to walk you through the details of our business segment results and overall performance.

Thank you very much, Antonio. I'll start with a summary of our financial results for the second quarter of fiscal year 2022. As usual, I'll be referencing the slides from our earnings presentation to guide you through our performance. Antonio discussed the key highlights on Slide 1 and 2. So now let me discuss our Q2 performance details, starting with Slide 3. We continue to see robust demand across our differentiated edge-to-cloud portfolio with order growth up 20% year-over-year, the same as last quarter. This marks our fourth quarter in a row with order growth of 20% or better year-over-year. This maintains our confidence in achieving both our fiscal year 2022 revenue outlook of 3% to 4% growth adjusted for currency and our long-term 2% to 4% revenue CAGR outlook provided at our 2021 Securities Analyst Meeting. We delivered Q2 revenues of $6.7 billion, up 1.5% year-over-year and in line with our outlook of normal sequential seasonality and despite a more challenging supply environment that limited upside. The unexpected COVID-related shutdowns in China and the ceasing of support services contracts in Russia impacted our revenue by more than $250 million in the quarter, our total operating margins by more than one point and EPS by approximately $0.06. Given the delta between our order and revenue growth rates, our backlog further increased to new record levels and yet remains very high quality. The order book is firm and most importantly, has been priced to preserve gross margins. We are particularly pleased with the resiliency of our non-GAAP gross margins despite the inflationary environment and ongoing supply chain disruptions that are driving up material and logistics costs. We delivered non-GAAP gross margin of 34.2%, up 30 basis points sequentially and down just 10 basis points year-over-year, driven primarily by strong pricing discipline and our continued mix shift towards higher-margin software-rich offerings. Non-GAAP operating margins were 9.3%, reflecting the revenue impact from incremental supply constraints and our exit from Russia that reduced operating leverage. We expect operating margins to expand in the short term as we drive more leverage from revenue growth and benefit from investments in the high-growth, margin-rich areas of our portfolio. Within other income and expense, we benefited from robust operational performance in H3C and further gains related to increased valuations in our Pathfinder investment portfolio. As a result, we now expect non-GAAP other income and expense for fiscal year 2022 to be an income of approximately $75 million versus prior guidance of an approximately $25 million income. Given our strength in gross margin and despite the approximately $0.06 impact from China and Russia, we delivered non-GAAP diluted net earnings per share of $0.44, near the midpoint of our outlook range of $0.41 to $0.49 for Q2. We also delivered GAAP earnings per share of $0.19. This includes $126 million of disaster charges related to Russia, primarily consisting of an increased reserve for financing lease assets. With the decision to already exit Russia that we have announced today, we expect to record a less significant GAAP-only charge in Q3 that has been factored into our updated outlook already. As previously indicated, we expected free cash flow to be in line with our normal seasonality, that is a use of cash in the first half, and Q2 was a use of cash of $211 million. We have made significant investments in working capital during the first half, reflecting our strategic inventory actions to navigate the current supply environment. This will better position us to convert orders into future revenue and cash flow, while working capital is expected to become a tailwind in the second half. Finally, we continue to return substantial capital to our shareholders. We paid $156 million of dividends in the current quarter and are declaring a Q2 dividend today of $0.12 per share payable in July. We also repurchased $58 million in shares, bringing our year-to-date total capital returns to $498 million, reflecting our confidence in future cash flow generation. Slide four highlights key metrics of our growing as-a-service business. We continue to see very strong momentum across our as-a-service portfolio, where we introduced 12 new cloud services this quarter and converged Aruba Central with the HPE GreenLake platform to create a unified operational experience for all users. Total as-a-service orders were up 107% year-over-year, marking the third quarter in a row with orders more than doubling. Our ARR was up 25% year-over-year to $829 million, with supply constraints continuing to limit some installations. While our ARR growth is 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 2021 to fiscal year 2024, with increasing margins as our mix of both software and services continues to increase to 64% in Q2, up more than 5 points year-over-year with our expanding cloud and SaaS offerings. Let's now turn to our segment highlights on Slide 5. 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 accelerated with orders growing 45% year-over-year, the fifth consecutive quarter with growth of more than 35%. Despite increased supply disruptions in China, revenue grew 9% year-over-year, outperforming the competition and demonstrating particular strength in Silver Peak and our Edge-as-a-Service offerings, both up strong double digits. We delivered operating margins of 12.6%, reflecting higher component and logistics costs, resulting in lower operating leverage. We expect margins to improve next quarter with higher levels of revenue that also benefit from previous price actions that are sticking. In HPC and AI, demand remains robust with order growth of 18% year-over-year, driving our awarded contracts total to another record level of just under $3 billion. Revenue grew 5% year-over-year and was impacted by one large customer acceptance delay that impacted growth by more than six points and has now been delivered in Q3. Importantly, our Q2 operating profit was impacted by the ramp in project costs for a couple of mega deals expected to close by the end of the year that will return operating margins to more in range with historical levels. In Compute, order growth remained robust and was up over 20% year-over-year for the fourth consecutive quarter, while revenue growth was up 1%, reflecting a more difficult supply environment. We continue to be very focused on executing a dynamic pricing strategy that has been effective in managing the increased supply and logistics costs and gives us a very high-quality backlog. The results are showing up in our operating margin performance at 13.9%, up 270 basis points year-over-year and 10 basis points sequentially, well above our long-term target set at SAM 2021 of 11% to 13%. Within Storage, we achieved another record level of product backlog that is skewed towards our own IP margin-rich products. Revenue was down 2%, reflecting supply constraints for our own IP products. As a result, we continue to have 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 work through our favorable backlog mix and steer more demand towards our new Electra and Block Storage offerings. With respect to Pointnext operational services, including storage services, orders again grew mid-single digits year-over-year as reported, similar to levels for the total fiscal year 2021. As you know, this is very important for the long-term health of our most profitable business. Within HPE Financial Services, volume increased 2% year-over-year with strong performance in GreenLake and revenue was flat. Our profitability continues to benefit from higher residual value realization as customers tend to extend the use of their systems in a supply-constrained environment. Our operating margin was 12.6%, up 180 basis points from the prior year, and our return on equity at 20.4% remains well above the 18%-plus target set at SAM 2021. Slide six highlights our revenue and EPS performance where you can see we've maintained relatively constant levels from last year despite incremental supply constraints, in particular, from the China shutdowns and also from ceasing support services contracts in Russia. As a reminder, this combines for more than a $250 million impact to revenue and a one-point impact to total operating margins and an approximately $0.06 impact to EPS in Q2. In spite of these headwinds, we delivered a better quality of earnings across our portfolio as we continue to execute our Edge to Cloud strategy. The improved quality of earnings can be seen on Slide seven, where we delivered non-GAAP gross margins in Q2 of 34.2% showing their resilience in spite of the increased component and logistics costs. This was driven by both our strategic pricing actions and the favorable mix shift we've been driving towards edge and our as-a-service business. Moving to Slide eight, you can see our non-GAAP operating margin this quarter of 9.3%, reflecting the reduced operating leverage from supply challenges and our exit from Russia. However, we are achieving much better efficiency in our sales and office investments when measuring productivity on an orders basis. Given our high-quality backlog, we are also continuing to invest more in both R&D and our go-to-market for future growth. On Slide nine, let's spend some time reminding everyone about our unique setup in China through H3C. As disclosed in an 8-K in late April, we have extended our existing food option that is struck at 15 times trading 12-month earnings through to October 31st, 2022. We did this to enable the new investors at the Unigroup level to complete their restructuring, which is proceeding as planned before determining a longer term path forward for our stake. We value our presence in China, the second largest and fastest-growing IT market, although we will balance prior to execution of any extension, the strategic and financial benefits of a continuous involvement in China with rising risks, including geopolitical risk. H3C makes up a significant portion of our P&L and cash flow and you can see that we are generating growing value to shareholders with our unique setup. Our equity interest rose 21% in fiscal year 2021 and has grown 32% in this Q2 of fiscal year 2022. We will keep you up to date as we arrive at a longer-term solution for this valuable asset. Turning to Slide 10, our free cash flow was a use of cash of $211 million. This is aligned to our normal pre-pandemic seasonality with the first half being a use of cash followed by a strong generation of free cash flow in the second half. The first half of this year has also been uniquely impacted by the supply chain environment as we strategically built inventory levels in Q1 that were flat in Q2. We are taking further strategic actions to improve supply chain visibility and attain operational and financial benefits. This will put us in a better position to begin converting orders and generating healthy amounts of cash as working capital will turn into a tailwind in the back half of the year. We will need to demonstrate strong execution in the second half, but we have a path forward and expect to deliver fiscal year 2022 free cash flow of $1.8 billion to $2 billion. Now turning to our outlook on Slide 11. We are revising our fiscal year 2022 non-GAAP outlook range back to our original outlook provided at SAM of $1.96 to $2.10. This reflects the impacts of a more unfavorable currency movement since last October, the exit of the business in Russia, and the COVID-related disruptions in China to this date, offset by the other income and expense benefit we've received in the first half. From a top-line perspective, we are very pleased with the continued strength in orders and growing backlog that gives us confidence in future revenue growth in fiscal year 2022 and beyond. We do want to remain prudent in the short term, given the ongoing supply challenges that we believe will likely last well into next year. Currency is also expected to now be a two-point headwind to revenue for the full year, as opposed to the 50 basis points at the start of our fiscal year. As a result, we still have strong confidence in our fiscal year 2022 revenue growth outlook of 3% to 4% adjusted for currency and expect to end the year with elevated levels of backlog, which bodes well for fiscal year 2023. More specifically, for Q3 2022, we expect revenue to be up low single-digits sequentially. This is slightly below our normal seasonality to reflect our expectations that the China shutdowns will have a lingering impact in the short term. As a result, for Q3 2022, we expect GAAP diluted net EPS of $0.22 to $0.32 and non-GAAP diluted net EPS of $0.44 to $0.54. Overall, I'm pleased with how we are executing in a strong demand but challenging supply environment during the first half of fiscal year 2022. With our high-quality backlog, we are very well positioned to capitalize on the ongoing Edge to Cloud 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. And the first question will come from Aaron Rakers with Wells Fargo. Please go ahead.

Sorry about that, guys. Can you hear me?

Yes, we can, Aaron.

We can.

Okay. Yes, sorry. Sorry about that. So I'll start with just the question on the backlog. As you kind of thought about the guidance for the full year and obviously, some moving parts around FX and China, etc., but how has your assumptions changed at all with regard to the backlog build? Are you assuming any kind of backlog reduction through the course of this fiscal year? And if not, what's your current views on kind of peaking levels of backlog at this point? Thank you.

Yes, good afternoon Charles, thank you for your question about our backlog. I want to mention that our backlog has not reached its peak yet. We have experienced four consecutive quarters of 20% growth, and given the differences between the backlog growth, order growth, and revenue, the backlog has still room to grow and will likely peak towards the end of this fiscal year. Our expectations for converting that backlog into revenue are reflected in the guidance we provided for this fiscal year, which anticipates 3% to 4% revenue growth adjusted for currency. I want to emphasize that the impact of foreign exchange on that guidance is a 2% headwind, compared to the 50 basis point headwind we originally predicted.

I would say, Aaron, obviously, we're going to enter 2023 with an elevated backlog, which bodes us well for the future revenue growth of the company. As I said in my remarks, we continue to be very confident in our CAGR outlook that we provided at SAM for the next three years. But obviously, as we go forward, the backlog will be reduced when supply and other issues alleviate. And if you think about the 3% to 4% guidance for the year, which is the guidance we provide at SAM versus the 1.5% we just reported, obviously, there will be low single-digit growth sequentially on that revenue.

Thank you.

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

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

Thanks for taking the question. I wanted to see if you could help me get a little bit better insight into what allowed you to basically do better on gross margin than we expected given the input costs and the foreign exchange. What I'm looking for in this question is an understanding of how much of this is about mix? How much of it is about your ability to raise prices and pass that on to customers? And how are you thinking about the outlook for the gross margin given what you've done so far in terms of price increases and what you're thinking about on foreign exchange? Thank you.

Sure, let me explain this for you. First, when we look at our business across the various segments, Aruba is performing exceptionally well and we outperformed Cisco in the second quarter. The order book for Aruba is substantial, and its growth positively impacts our gross margin due to a favorable mix. Additionally, the disciplined pricing strategies we've implemented in the compute segment over the past few quarters are paying off, resulting in operating profit margins above 13%, which is significantly better than our long-term guidance and also surpasses what Dell has achieved in their total ISG margins, which include compute, storage, and networking. So, compute is doing much better than the industry average. Third, examining the gross margin mix in the other segments, particularly Storage and HPC, reveals two different situations. In storage, we have seen an unfavorable mix between our own IP products and third-party products, resulting in a higher proportion of revenues from third-party products and lower IP revenue, which has negatively impacted gross margins. For HPC, it continues to be a variable business with revenue dependent on scale. A single deal slipped this quarter, affecting growth by six percentage points, but that deal has now closed and we expect significant mega deals in the second half to drive revenue. Overall, when you look at the gross margins for the company, the story varies by segment. However, it stems from the successful strategies we’ve applied in Aruba and Compute, offset by the product mix issues in storage and revenue delays in HPC. I'm pleased that our gross margins are at 34.2%, which is an increase compared to previous quarters and better than last year. Lastly, the performance of HPFS is remarkable. Although there hasn't been much revenue growth, HPFS is a profit-driven business with strong operating profit margins, and its return on equity exceeds 20%, surpassing our long-term outlook of over 18%, as indicated at SAM 2021. I hope this clarifies things for you, but I'm open to continuing this discussion privately if needed.

Thank you. I’ll hop offline.

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

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

Hi. Thanks for taking my question. I guess I just wanted to ask more on the demand side here and you had another quarter of strong orders, maybe if you can give us a bit more color on what you're seeing on a geographic basis, particularly, I think investors have been concerned about the momentum in enterprise in Europe and ex-Russia, if you can give any color on what you're seeing in that region? And also, I don't know if you sort of pointed out what the order impact on the order number was from the Russia exit as well? Thank you.

Thank you for the question. As I mentioned earlier, we are seeing strong and consistent demand from our customers. This is largely due to their focus on prioritizing IT spending and the attractiveness of our comprehensive portfolio that spans from Edge to Cloud. Tarek highlighted the impressive performance of our Edge segment, which has experienced growth exceeding 40% for four consecutive quarters. This growth, along with our overall 9% revenue increase, underscores the strong demand we are experiencing. In terms of enterprise distribution, there is a new way of working emerging. Customers are actively evaluating their hybrid multi-cloud journeys, which are now a permanent fixture. They view HPE GreenLake as a reliable option that offers flexibility, choice, and control. The fact that one of the major clouds is utilizing HPE GreenLake to provide their managed hosted distributor cloud speaks volumes about our differentiation in the market. Furthermore, anything related to data is seeing exceptional demand. The need for big data, analytics, AI, and machine learning will continue to rise as customers seek to extract insights from their most valuable asset—data. Our cybersecurity solutions, particularly with Aruba's SD-WAN and SASE approach, also offer a robust alternative. Looking ahead, I believe that any potential slowdown we observe is more of a consumer issue than an enterprise one. Every customer we engage with is focused on digitizing and modernizing their businesses while leveraging cloud solutions for speed and agility. Our strategy, centered around HPE GreenLake and a data-first modernization approach, is performing well. Our demand remains exceptionally robust at 20% growth for four consecutive quarters, and our order backlog is solid, indicating a reliable order book without significant cancellations that would raise concerns. Additionally, as Tarek mentioned, we have structured our backlog pricing to maintain gross margins, which reinforces our confidence in growing revenue while fulfilling our operating margin and EPS commitments. The impact from Russia and Belarus combined is less than 2% of our revenue on a continual basis. In terms of EPS for 2021, Tarek provided clarity on how we managed to offset some impacts with strong performance in Q1. Tarek, do you have any further comments?

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

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

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

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

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

Yes. Let me start and I would like Tarek to talk about the free cash flow, Wamsi. Listen, so far, so far, and I can only talk so far, I have not seen any major deviation from 90 days ago on demand, continue to be very strong. And that's why we use the word persistent. Persistent meaning it's there, right? And then I think it depends on what happens here in the back half of the year with some of the other policies, Tarek mentioned some of them in Europe. But obviously, as we think about inflation, interest rates and whatnot, that may or may not have an impact. But as I said earlier, Wamsi, I think it's mostly on the consumer side and the enterprise side. If anything, I will argue, it will have a positive impact on our GreenLake because customers want to maybe preserve some CapEx and then would use more of the as-a-service model. And still, deal with the reality that this is a hybrid multi-cloud journey, and therefore, for those workloads and data that cannot move outside their premises or a colocation or even moving from the edge for that matter, GreenLake is perfectly suited for that. And that's why it's a combination of our solutions, now 50-plus cloud-native services, the fact that Google is going to use our solution is a very strong endorsement. But I think we are positioned to capture either way. And I think our backlog gives us a very strong foundation to build from there as we look forward. Tarek, you want to talk about the free cash flow question?

Yes, certainly. When considering changes in EPS and how those dollars translate into free cash flow, you can think of every cent of EPS as being equivalent to $13 million to $15 million. Our reduced guidance is directly aligned with the free cash flow expectations we initially provided. The reason for this guidance is based on our working capital assumptions established at the start of the fiscal year, and I am confident we will meet this free cash flow target. Regarding your second question about our ability to generate this amount of free cash flow in the second half given our position at the end of the first half, I can say we expect working capital to positively contribute in the second half, unlike the first half where it was a challenge due to inventory decisions we made. We have successfully navigated similar situations before; for example, in fiscal year 2019, we generated $200 million in free cash flow in the first half, followed by $2.2 billion in the second half, which was over ten times our first-half performance. This was despite having to pay $666 million for an arbitration case we lost that year, with limited time to recover from its impact, yet we still met our guidance. Additionally, if you look at the trends in operating free cash flow we mentioned during this call, you will see that our seasonality mirrors what we experienced in fiscal years 2019 and 2020. Fiscal year 2021 was different due to restructuring costs affecting free cash flow, but our restructuring costs have overall decreased compared to that year. There are many factors at play, but we are pleased to reaffirm our free cash flow guidance of $1.8 billion to $2 billion.

We are maintaining our guidance from the October Security Analyst Meeting, which includes a revenue growth expectation of 3% to 4%, an EPS range of $1.96 to $2.10, and a free cash flow target of $1.8 billion to $2 billion. Considering the seasonality of our business, we anticipate a return to normal patterns following the two years impacted by COVID, and we are confident in achieving these figures. Tarek mentioned that our working capital is expected to improve, and as we reduce our backlog over time, this will positively affect our results. The connection between earnings and free cash flow remains consistent as previously stated. Regarding our restructuring efforts, we are pleased with the progress we have made, particularly in reallocating resources towards areas of growth such as HPC, AI, edge, and GreenLake, which are yielding results and are on track to deliver the $800 million in net savings we committed to.

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

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

Yes, hi guys. Thanks for the question. I guess in the ongoing spirit of trying to make sense of an incredibly complicated supply situation, I wanted to come back and kind of maybe juxtapose your performance here against a couple of other companies. So, if I look at Cisco, they, I would say, objectively performed quite a bit worse on supply than you guys did. You had some sort of a middle of the road impact, not too bad of an impact from what I can tell in the numbers. And then if I look at Dell, they had almost no impact. Although Dell did call out some looking-forward issues with server supply. So, I just wonder if you could dig into that a little bit for us and kind of help us understand some of the puts and takes around supply, maybe why those differences of performance emerged? And then I have a follow-up.

Sure, I will start. However, it's important to look at the performance over the half-year rather than on a quarter-by-quarter basis. In Q1, we performed quite well, and overall, we are satisfied with the first half of the year. There are various factors at play here related to factory locations; sometimes we benefit from being in the right location, and other times we don’t. The impact of the situations in Shenzhen and Shanghai was significant in April, affecting not just our compute business but all lines because other products also come from that area. Some of our vendors were less impacted, which highlights the importance of these dynamics. Additionally, strategic choices made about components two to three years ago have led to varying impacts among our suppliers. This requires a detailed understanding of our products and configurations. It's also worth noting that in China, our situation is unique as we cannot consolidate the revenue generated by our partner. Our H3C business is excelling in China, but we only recognize the dividends we receive and not the revenue itself. When we consider the server segment, which includes compute, HPC, and H3C, we see it as a half-year performance review. We improved in Q1 but may have seen a slight decline in Q2. Compared to some competitors, like Dell, who faced minimal impact but have flagged potential future issues with server supply, we are not far off in overall performance. Cisco has performed well across all metrics. Ultimately, we remain committed to achieving our full-year guidance of 3% to 4% and entering next year with a substantial backlog, which is promising for 2023.

Yes. I want to emphasize, Rod, that it's really important to consider the impact on the bottom line and the margin level. When you examine how we've outperformed Dell in terms of margins during Q1 and Q2, particularly when looking solely at compute margins compared to ISG margins, it’s quite revealing.

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

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

Sure. Thanks, Rod. Next question, please?

The next question will come from Irvin Liu with Evercore ISI. Please go ahead.

Hi. Thank you for the question. So the large delta between your orders growth and revenue trajectory suggests that there still remains a large amount of unfulfilled demand. Given this dynamic, do you envision a scenario where customers begin to perhaps rearchitect their infrastructure so that a larger mix of their IT workloads whether that's compute, storage, networking, HPC are delivered via cloud-native GreenLake as-a-service models?

That's a great question. We're noticing this increasingly. Customers are facing a multigenerational IT journey where modernization is essential. The concept of data gravity, combined with varying levels of regulation across different industries, complicates matters. Latency and user experience are crucial considerations, and cost is a significant factor as well, especially at scale when they need to understand expenses. GreenLake is an exceptional platform that we've developed over the years, offering access, flexibility, and control to meet diverse needs. Customers are transitioning from managing IT to innovating on it, highlighting the relevance of our data-first modernization strategy. Currently, we have over $6 billion on our balance sheet related to the HPE GreenLake business, which experienced a 107% growth in Q2. Those bookings will eventually flow through the balance sheet and into the profit and loss statement. Additionally, as Tarek demonstrated in his presentation, our GreenLake mix is evolving each quarter towards increased software and services, which typically yield much higher margins than hardware alone. This strong order momentum and the presence of major customers signify our success. We're continually adding new capabilities, and this shift in mix is beneficial for our gross margin moving forward. We're at a pivotal moment in our company, transforming into a vital platform that supports customers throughout this journey.

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

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

Hi, thank you for the question. Can you provide an update on the deferred revenue situation in HPC and AI with the existing business scheduled for delivery? You already have one project that reached acceptance in Q3. Also, could you share the expected operating margin level for that revenue? Considering the project costs associated with advancing revenue recognition, how much catch-up profitability do you anticipate? Lastly, what does the margin profile look like for the business expected in the second half of the year? Thank you.

Sure. Listen, I'm continuing to be incredibly bullish about this business. Supercomputing is necessary to advance AI and deep learning solutions to solve some of the biggest societal challenges and honestly, climate and other. As I think about the current situation we are in, we have almost $3 billion in backlog. A couple of quarters ago, we were talking about $2.5 billion and maybe a year, $1 billion, $1.5 billion. So, we have been continuing to grow the momentum with customers. By the way, it's all over the world. If you look at the wins, including the number three supercomputer called Lumi, that's in Europe. We have also supercomputers in France, in Germany and so forth. So, we are clearly the market leader there. However, this business is lumpy, as we said, right, from the time you book the order to the time you recognize revenue, it can be several quarters. And the reason that's the case is because there are large installations and customers need to go through their own process to validate the workload. And over time, right, we're going to have a quarter, you're going to see a massive growth in revenue, which is not linear in many ways as many of those customer systems get accepted. So, but in terms of margins, I will let Tarek comment on this. Obviously, have to look at long-term, not just quarter-by-quarter because that's not how this business works.

Yes, that's right. You said very well, Antonio. I'll add to the margin part of the question saying, our Q2 operating profit margin was affected by the ramp in project-related costs, and they were recognized ahead of revenue for a couple of very large mega deals that we're expecting to close by year-end. Therefore, as a result of that, we expect operating margins to return to more in range with historical levels on this business, and we feel pretty good about these prospects.

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

Well, thanks, everyone. I know there's a lot going on and a lot of news today to cover, but I appreciate you making the time. Again, walking away from this quarter, I feel good about the momentum we have with the persistent demand that we see in the market with an amazing set of solutions that are attracting customers. A testament to that is 20%, again, bookings with a backlog that gives us the confidence to deliver on our commitments. Honestly, I'm optimistic about the future, about the opportunity to innovate for our customers and to deliver value to our shareholders. So again, thanks for your time today. I know there will be follow-up calls after this call, and I appreciate you making the time.

Thanks, everyone.

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