Hewlett Packard Enterprise Co (HPE) Q3 2023 Earnings Call Transcript

Good afternoon, and welcome to the Third Quarter Fiscal 2023 Hewlett Packard Enterprise Earnings Conference Call. My name is Gary, and I'll be your conference moderator for today's call. At this time, all participants will be in listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Jeff Kvaal, Head of Investor Relations. Please go ahead.

Good afternoon, everyone. I'd like to welcome you to our fiscal 2023 third quarter earnings conference call with Antonio Neri, HPE's President and Chief Executive Officer; and Jeremy Cox, HPE's Interim Chief Financial Officer. Before handing the call to Antonio, let me remind you that this call is being webcast. A replay of the webcast will be available shortly after the call concludes. We have posted the press release and the slide presentation accompanying the release on our HPE Investor Relations webpage. Elements of the financial information referenced on this call are forward-looking and are based on our best view of the world and our businesses as we see them today. HPE assumes no obligation and does not intend to update such forward-looking statements. We also note that the financial information discussed on the call reflects estimates based on the 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 ending July 31, 2023. For more detailed information, please see the disclaimers on the earnings materials relating to forward-looking statements that involve risks, uncertainties and assumptions. Please refer to HPE's filings with the SEC for a discussion of these risks. For financial information, we have 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 otherwise noted, are presented on a year-over-year basis and adjusted to exclude the impact of currency. Finally, after Antonio provides his remarks, Jeremy will reference our earnings presentation throughout his prepared comments. Now with that, let me turn it to you, Antonio.

Thank you, Jeff, and good afternoon. Thank you to everyone for joining us today. HPE had another strong quarter. We saw increases in revenue, gross margin, and earnings per share year-over-year, along with solid free cash flow. Our results reflect our strategic shift towards higher growth and higher margin areas of our portfolio that are important to our customers. This shift led to a 120 basis points year-over-year expansion in non-GAAP gross margin, driven largely by strong performance in segments like Intelligent Edge, which achieved its fifth consecutive record quarter, and HPE GreenLake, which continues to support our strategic transition by generating higher recurring revenue and gross profit across our product lines. In the third quarter, our Intelligent Edge business accounted for 20% of total company revenue and was our largest source of operating profit at 49%. The HPE GreenLake hybrid cloud platform is accelerating our service pivots, delivering an annualized revenue run rate of $1.3 billion, representing a 48% year-over-year increase. Our strategic focus on edge computing, hybrid cloud, and AI via HPE GreenLake is proving effective, and we are meeting our financial targets. Due to our momentum and strong execution this fiscal year, we are raising our full year non-GAAP diluted net earnings per share guidance. The GAAP guidance for full year diluted earnings per share will remain unchanged. We are increasing our non-GAAP diluted net earnings per share guidance to $2.30 at the midpoint, while keeping our constant currency revenue growth guidance for the full year at 4% to 6% and free cash flow guidance at $1.9 billion to $2.1 billion. We'll provide more details later in the call, including on a GAAP basis. Our view of the macro environment has not changed in recent months. Customers still prioritize their data-driven digital transformations, even amid some economic uncertainty. While the broader IT market faces challenges, demand for our products and services grew in the third quarter across all key segments, particularly in high-growth areas like AI and HPE GreenLake. We continue to see strong interest in our AI and supercomputing solutions from enterprise customers integrating artificial intelligence into their operations. This has resulted in significantly increased demand for our HPC & AI business segment, as customers recognize HPE's unique capabilities in delivering exceptional performance for AI at scale, including through our leading supercomputers designed with sustainability in mind to facilitate AI model training. HPE total revenue for the third quarter rose 3.5% year-over-year to $7 billion, surpassing the midpoint of our forecast. Non-GAAP gross margin increased by 120 basis points from a year ago to 35.9%, approaching the record level achieved in the previous quarter. Higher profitability in the third quarter also contributed to a 2% year-over-year increase in non-GAAP diluted net earnings per share, reaching $0.49. We generated $955 million in free cash flow, an increase of nearly $370 million. The HPE GreenLake cloud platform is crucial to our financial success, as our hybrid cloud services continue to attract new customers and encourage existing ones to expand their contracts. HPE GreenLake orders surged 122% year-over-year, bringing in nearly $1.5 billion in total contract value since last quarter, with our cumulative booked contract value now just under $12 billion. The size and strength of HPE GreenLake is clear, serving 27,000 unique customer logos and 3.4 million connected devices, and over 1,100 partners are selling HPE GreenLake, making it one of the industry's largest partner ecosystems for as-a-service offerings. As we grow our recurring revenue, we are also increasing the share of high-margin software and services, which grew by 2 percentage points sequentially to 68% of total ARR mix, up from 66% in the previous quarter, with ongoing contributions from SaaS offerings related to HPE Ezmeral Software, storage, and HPE Aruba Networking, as well as operational services and OpsRamp. We are well-positioned to continue growing the software and services mix within our ARR. For instance, we experienced a double-digit increase in demand for HPE operational services this quarter, contributing to future recurring revenues. The impressive gross margin in our as-a-service offerings has bolstered our overall company gross margin. These results underscore the significance of HPE GreenLake’s distinctive value, delivering a unified hybrid cloud experience that enables customers to access, analyze, and extract value from their data, regardless of its location—be it at the edge, in colocation or data centers, or in the public cloud. Now, I want to point out a few key takeaways from our business segment results. First, HPE's performance in the Intelligent Edge segment was particularly strong this quarter. Intelligent Edge revenue rose 53% year-over-year, with operating profit more than doubling in what was another outstanding quarter for this segment. I'm especially pleased that our Intelligent Edge SaaS revenues are also continuing to grow in double digits. We are capturing market share due to improved supply availability, high shipment volumes, and strong demand for our SaaS edge solutions. The momentum in Intelligent Edge was consistent globally, with revenue rising in double digits across all regions in the third quarter. A notable example is the University of Maryland, which needed a more robust cloud-based policy-driven wired and wireless network for enhanced automation, better device visibility, and more secure access for students and faculty. They chose HPE Aruba Networking for a campus-wide upgrade to improve their network flexibility, visibility, and security through our SaaS platform, HPE Aruba ClearPass. The HPC & AI business segment also saw a significant uptick in demand this quarter as we capitalized on AI opportunities and fulfilled orders that exploit our complete AI value proposition, from training to tuning to inference. Consequently, we ended the quarter with the largest HPC & AI order book to date. Our AI growth has also boosted our total HPE order book, which has now surpassed pre-pandemic levels, driven by exceptional demand for our AI solutions and improvements in demand across our four product segments. HPE stands out due to our unique AI software, specialized networking fabric, service offerings, and industry-leading sustainable supercomputers. Our open AI supplier ecosystem offers customers a comprehensive solution for enterprise-level AI workloads, covering large-scale model development, training, tuning, and inferencing. Through the GW4 Alliance in the UK, HPE secured a contract from UK Research and Innovation to develop Isambard 3, a supercomputer employing the latest HPE Cray XD supercomputers, HPE Slingshot Interconnect, and NVIDIA Grace CPU-GPU Superchip. This system will provide researchers with specific capabilities to train AI models and expedite research in fields such as clean energy and drug discovery. Additionally, we were selected by the Tokyo Institute of Technology to build its next-generation supercomputer, TSUBAME 4.0, which integrates AMD CPUs and NVIDIA GPUs to enhance AI-driven scientific discoveries. Recursion Pharmaceuticals, a prominent tech-bio company, utilizes AI to expedite drug discovery and turned to HPE's software to scale its foundational model initiatives, significantly accelerating training across over 25 petabytes of biological and chemical data. We are witnessing exciting outcomes from AI initiatives on our supercomputers. For instance, the LUMI supercomputer built by HPE, featuring AMD CPUs and GPUs, is the fastest system in Europe and the third-fastest globally. It has facilitated generative AI projects like developing the largest finished language model and has aided researchers in early detection and diagnosis of cancers. We continue making strides toward exascale supercomputing, enabling unmatched scale and performance for larger AI models. This quarter, in collaboration with the Lawrence Livermore National Laboratory, we began constructing El Capitan, one of the largest upcoming exascale supercomputers, expected to achieve two exaFLOPS of peak performance and empower researchers to apply AI toward U.S. national security and medical advancements. We are also seeing demand rebound in our Storage and Compute segments. Storage demand was strong year-over-year, with our cloud-native HPE Alletra portfolio growing revenue significantly. Storage SaaS revenue increased by double digits as we continue to intentionally promote more of HPE's own IP through HPE GreenLake. Our Compute segment performed well despite ongoing market challenges, with sequential unit demand improving in the quarter. We expect demand for AI inference solutions to grow in the coming months, and our new HPE ProLiant Gen 11 servers optimized for AI workloads are well-positioned to meet this growing need. During the third quarter, we began shipping these servers, which enhance AI inference performance by over five times compared to previous versions. Recently, we also expanded our portfolio for enterprise tuning and inference solutions with NVIDIA and VMware to expedite customers' generative AI deployments. To summarize our major segments, HPE Financial Services saw a 7% year-over-year increase in revenue and a 6% rise in financing volume. This segment continues to play a strategic role as we increase our as-a-service volumes through HPE GreenLake. We are effectively strengthening our innovation from edge to cloud, setting HPE up for future success. In June, we hosted over 10,000 customers and partners at our HPE Discovery event, where we introduced new edge, hybrid cloud, and AI solutions to empower customers to meet their business objectives and maintain a competitive edge. At HPE Discover, we announced our entry into the AI public cloud market with HPE GreenLake for large language models. This service, available by the end of this calendar year, will allow various enterprise customers to privately train and tune their data using our leading AI supercomputer infrastructure and software. We also enhanced our hybrid cloud offerings at HPE Discover with new HPE GreenLake hybrid cloud services, including an IT Operations Management solution acquired through OpsRamp. Additionally, we expanded our collaboration with Equinix, a leader in the colo market, enabling customers to transition from production to deployment within days by utilizing HPE GreenLake for private cloud enterprise stack. Two new HPE GreenLake for private cloud enterprise clients are Swisslog, a global logistics solutions leader, and a media conglomerate that operates over 30 news brands across Europe. Swisslog chose HPE GreenLake for private cloud enterprise to expedite its warehouse automation with an advanced on-premises private cloud that can deliver secure and efficient service. The media company aims for a modern on-premise private cloud to support its digital transformation by leveraging data to enhance subscriber experiences. HPE GreenLake will enable the company to achieve operational agility, reduce risk, and address IT skill gaps. We expanded our HPE GreenLake private cloud offerings at HPE Discover with the introduction of HPE GreenLake for Private Cloud Business Edition, which allows customers to create virtual machines across hybrid clouds on demand. This is a new extension of our hyperconverged portfolio, incorporating automation and hybrid cloud software into the private cloud solution. Earlier this quarter, we previewed a sustainability dashboard on the HPE GreenLake platform, along with an extensive range of sustainability services aimed at helping organizations minimize their carbon emissions associated with hybrid IT. Customers recognize that the hybrid IT estate can significantly contribute to their operational emissions and have prioritized measuring and reducing their carbon footprint. Our continued focus on innovation strengthens the HPE GreenLake hybrid cloud value proposition, reinforcing our industry leadership, expanding our total addressable market, and positioning us well to maintain momentum across edge computing, hybrid cloud, and AI going forward. We have been refining our strategy for several years, and even amidst a dynamic market, it is evident that our approach, coupled with strong execution and a dedicated team, distinguishes us. Our third-quarter results showcase the strides we've made in transitioning our portfolio to higher growth, higher margin areas critical to customer transformation. Our focus on software and services-rich businesses has led to acquiring new customers, increasing recurring revenue, improving margins, and boosting earnings per share and free cash flow. This is why we are raising our non-GAAP diluted net earnings per share guidance again. In spite of some slowdown in sectors of the IT industry, our HPE team has executed our strategy, delivering unique innovations and a diverse portfolio to customers worldwide. This positions us to excel in the market and provide value to our shareholders. I'm excited to work closely on these priorities with Jeremy Cox, whom I appointed as our Interim Chief Financial Officer earlier this month. Jeremy brings a wealth of experience in finance, a customer-focused mindset, and a proven track record of operational excellence, making him well-suited for this role while we conduct a search for a permanent CFO. Jeremy will now provide a more detailed account of our financial results for the quarter. Jeremy, welcome. The floor is yours.

Thank you very much, Antonio. I'm honored to take on the responsibility of Interim CFO as we move through this process. I'll start with a summary of our financial results for the third quarter of FY 2023. Antonio highlighted key aspects on Slide 4. Let’s review Slide 5, which presents our financial highlights. We are actively diversifying our business towards our higher-growth, higher-margin portfolio of Intelligent Edge, HPC & AI, and HPE GreenLake solutions. This shift is evident in the 120 basis point year-over-year increase in non-GAAP gross margins. We achieved a solid quarter despite ongoing pressure in the IT market. Cycle times are still lengthened, and the digestion of prior orders will have some short-term impact, especially in Compute and, to a lesser extent, in Storage. Nonetheless, we recorded a 3.5% year-over-year revenue growth in constant currency to $7 billion, exceeding the midpoint of our Q3 revenue guidance, which included a modest contribution from AI revenue. We are observing positive signs of stabilization, including a sequential uptick in demand across our four product segments, with our largest customers showing renewed interest in the market. Intelligent Edge revenues are growing rapidly, both year-over-year and sequentially, and we are witnessing strong AI demand reflected in our as-a-service orders. Our non-GAAP gross margin increased by 120 basis points year-over-year to 35.9%, just 30 basis points shy of our high point of 36.2% from last quarter. Our margin structure illustrates the shift towards higher-margin, software-intensive recurring revenue, such as Intelligent Edge, where the edge mix improved by 450 basis points year-over-year. Our Q3 non-GAAP operating margin was 10.3%, down 120 basis points sequentially and 20 basis points year-over-year. The sequential decline was mainly due to Compute operating margins returning to just below our long-term target range of 11% to 13%, following six consecutive quarters above this range. We anticipate that the impact of Compute operating margin fluctuations on HPE’s overall operating margins will lessen as our revenue mix transitions to our higher-growth, higher-margin businesses. Our Intelligent Edge business achieved a record-high operating margin of 29.7%. We remain focused on productivity and expect revenue growth to surpass OpEx growth over time. Our strong Q3 performance led to a GAAP diluted net EPS of $0.35 and a non-GAAP diluted net EPS of $0.49, which is up $0.01 year-over-year, despite the cyclicality in Compute. It was also $0.01 above the high end of our Q3 guidance range of $0.44 to $0.48. Our Q3 free cash flow stood at $955 million. We continue to return substantial capital to our shareholders, with $154 million in dividends and $187 million in stock repurchases this quarter. To date, we have returned $831 million in capital to shareholders this year. Moving to Slide 6, our as-a-service revenue strategy continues to gain strong momentum, with ARR reaching $1.3 billion in Q3 '23. The benefits from as-a-service deals acquired in previous quarters are becoming apparent, though the larger AI-as-a-service deals secured in Q3 have yet to translate into revenue. Year-over-year ARR growth in constant currency has accelerated from 25% in Q4 '22 to 31%, 38%, and now 48% in Q3 '23. This 48% growth exceeds our long-term target of 35% to 45% and should be seen as a sign of our long-term momentum rather than a new growth trajectory. The fastest-growing elements within ARR are Storage and Edge. We are enhancing HPE GreenLake's value proposition with a larger share of higher-margin, recurring software and services revenue. Antonio mentioned that in Q3, our software and services mix rose to 68% and is expected to keep increasing. Although this mix has traditionally leaned towards services, software now constitutes half of the total. We expect software growth to outpace services growth moving forward, which should also lead to rising as-a-service margins. Transitioning to Slide 7, our Q3 as-a-service order growth was strong, achieving a remarkable 122% year-over-year growth in orders, raising our cumulative as-a-service TCV to nearly $12 billion, driven primarily by AI demand. A substantial portion of our AI orders are executed under the as-a-service model, and the strength shown this quarter should enhance our long-term ARR growth outlook of 35% to 45%. Order growth may vary due to the unpredictability of sizable as-a-service deals. Now, let's review our segment highlights on the following slide. All revenue growth rates discussed on this slide are in constant currency. In Intelligent Edge, we saw revenues grow 53% year-over-year and 8% sequentially, marking record revenues for the fifth consecutive quarter. Customers increasingly embrace our software-centric solutions, including Edge Connect SD-WAN software and the Aruba Central management platform. We have expanded the Axis Security and SASE funnel sixfold since the acquisition. Our operating margin of 29.7% was up over 1,300 basis points year-over-year and 280 basis points sequentially. We are benefiting from revenue scale and prior pricing actions, which help us gain visibility into the sustainability of our mid-20% margin target over time. Although we are progressing with our order book, we expect to carry an above-normal order book into FY '24. In HPC & AI, revenue grew 3% year-over-year. Discussions about large language models and generative AI that started in Q1 have led to wins in Q2, now translating into as-a-service orders in Q3. AI remains the primary driver of our 122% year-over-year growth in as-a-service dollars and has also contributed to the sequential growth in our total order book, which I'll touch upon shortly. We anticipate that AI deals will yield gross margin rates above historical averages. We believe that developing and operating sizable AI models necessitate unique computational capabilities, including both silicon and software, which our HPE Cray supercomputers and HPC & AI solutions are exceptionally equipped to provide. Our Q3 operating margin performance was just below breakeven. The early phase of the AI market, coupled with shortages of certain crucial components and extended lead times, suggests that operating margins in HPC & AI will continue to fluctuate. We will address our revenue growth outlook, investment, and margin improvement at our Securities Analyst Meeting. Storage revenues declined by 2% year-over-year but increased by 3% sequentially. HPE Alletra revenue has grown triple digits in Q3 for the fifth consecutive quarter and has become one of our leading revenue products, indicating that growth rates may begin to normalize. This product is shifting our Storage mix towards higher-margin, software-intensive revenue and is a key contributor to our ARR growth. We will keep investing in R&D and our proprietary IP products in this segment, including our new file-as-a-service and HPE Alletra MP offerings. Our Q3 operating margin of 10.7% is down 360 basis points year-over-year as we transition to HPE Alletra, which includes a substantial portion of ratable revenue that delays recognition of revenue into future periods. Compute revenue fell by 10% year-over-year to $2.6 billion and was down 5% sequentially. The elongation of deals that we have previously discussed was most apparent in the Compute segment as some customers digest earlier investments. Also contributing to this decline were decreasing average unit prices from the record high in Q1 '23. However, as mentioned before, we noticed a sequential improvement in demand. After six quarters of above-plan operating margins in Compute, this quarter's 10.9% was just below our long-term margin target of 11% to 13%. HPE Financial Services revenues improved by 7% year-over-year, and financing volume reached $1.7 billion, growing 6% in constant currency, propelled by HPE GreenLake. Our operating margins were down 340 basis points year-over-year due to rapid interest hikes and a higher cost of funds, which we anticipate will gradually offset over time through pricing adjustments, along with lower asset management margins as supply issues ease. HPE Financial Services has consistently demonstrated resilience during downturns, thanks to the quality underwriting of our portfolio. Throughout the pandemic, our annual loss ratio never went over 1%, and our Q3 loss ratio of 0.48% was even lower than that of the full year 2019 prior to the pandemic. Slide 9 highlights our revenue and non-GAAP diluted net EPS performance. The progress we are making on our edge-to-cloud strategy is reflected in the financial results we delivered, both on the top and bottom lines. We have maintained our revenue this quarter while expanding non-GAAP diluted net EPS year-over-year despite a challenging spending landscape, our transition towards a recurring revenue model, and persistent foreign exchange pressures. Foreign exchange had a 280 basis point adverse effect on revenue growth in Q3. On Slide 10, we present a new visualization of our portfolio shift, indicating the growing significance of the Intelligent Edge business for HPE. Three years ago, Intelligent Edge accounted for just 10% of our revenue, but it now represents 20%. The trajectory of operating profit is even more pronounced. Edge contributed over 10% of our operating profit three years ago and is currently 49% of total segment operating profit. We will provide our forward-looking perspective at our Securities Analyst Meeting. Slide 11 illustrates the progress we have made on our gross margin structure. Our Q3 non-GAAP gross margin is up 120 basis points year-over-year despite foreign exchange challenges. The year-over-year growth in our non-GAAP gross profit and margin reflects the success of our strategic portfolio shift and the pricing strategies HPE has implemented. Slide 12 shows our non-GAAP operating margin, which was 10.3% in Q3. This represents a decrease of 20 basis points year-over-year, also impacted by foreign exchange challenges, and a 120 basis point decrease sequentially. While the primary reason for the sequential decline was the reversion of Compute operating margins towards our target range, we also made specific targeted investments during the quarter to support our pivot. Our intentional shift in portfolio mix, coupled with pricing strategies and a focus on productivity, positions us to enhance operating margins in FY '23. On Slide 13, as earlier announced, we exercised the put option on our shares in H3C and signed a purchase agreement that values our 49% stake in H3C at $3.5 billion. The next phase is to secure the necessary regulatory approvals and meet certain conditions to close the transaction. We expect to finalize this process in the first half of calendar year 2024; however, this timeline could be extended based on our agreement's terms. We will update our plans for the use of proceeds once the transaction is finalized. You can expect that we will apply the same disciplined returns-based framework for assessing investments, capital returns, and maintaining an investment-grade credit rating that we have communicated previously. Finally, we continue to benefit from H3C dividends in FY '23, and we will provide an update on our expectations for H3C dividends at our Securities Analyst Meeting in October. Now moving to Slide 14, we generated $1.5 billion in cash flow from operations and $955 million in free cash flow. Our Q3 free cash flow improved by about $670 million sequentially and nearly $370 million year-over-year. Similar to our performance in Q4 '22, we anticipate generating significant free cash flow for the rest of FY '23 and are reiterating our guidance of $1.9 billion to $2.1 billion in free cash flow for FY '23. The timing of receipts and payments along with inventory investments has kept our cash conversion cycle steady sequentially at 23 days. We expect to end the year with a neutral cash conversion cycle. Now, let’s discuss the outlook on Slide 15. As mentioned, the overall IT market remains under pressure. Macro uncertainties are impacting some of our end markets; however, customer investments are increasing in areas such as Edge and HPC & AI. We believe our portfolio differentiation will continue to drive market share growth. We are entering Q4 with an order book that has more than doubled compared to pre-pandemic levels, having increased from over 1.5 times pre-pandemic levels at the start of Q3, primarily propelled by strong AI orders. The assumptions in our guidance, which reflect our current perspectives on the macroeconomic landscape, demand, inflationary pressure, supply conditions, and foreign exchange rates, remain mostly unchanged. Throughout the fiscal year, we've indicated that our financial performance is likely to be skewed toward the first half of the year. We believe this framework is appropriate for FY '23. For Q4, we anticipate revenues within the range of $7.2 billion to $7.5 billion. We expect GAAP diluted net EPS between $0.36 and $0.40, and non-GAAP diluted net EPS between $0.48 and $0.52. We are reiterating our earlier fiscal year 2023 guidance for revenue growth of 4% to 6% in constant currency. We now expect foreign exchange to pose a 300-basis-point adverse effect on revenue growth, up from our prior estimate of 250 to 300 basis points. Furthermore, we reaffirm our expectation that the margin strength from our portfolio mix adjustment will lead to non-GAAP operating growth of 6% to 7%. We are maintaining our GAAP diluted net EPS guidance of between $1.42 and $1.46 due to variances in tax rates and additional amortization of intangibles from recent acquisitions. Our non-GAAP diluted net EPS guidance has been raised from a range of $2.06 to $2.14 to between $2.11 and $2.15. We continue to project free cash flow between $1.9 billion and $2.1 billion. For OI&E, we benefited this year from increased interest income and lower foreign exchange hedging costs than previously expected. The combination of these and other anticipated advantages during the second half of this fiscal year suggests OI&E will be a positive $50 million to $70 million for the full year, up from an earlier expectation of neutrality. Regarding capital returns, we are maintaining our dividend and expect to return approximately 60% of free cash flow to shareholders through dividends and repurchases. In conclusion, the uneven demand in the end market so far in FY '23 presents an opportunity for HPE to demonstrate our distinct portfolio led by HPE GreenLake Hybrid Cloud, Intelligent Edge, and HPC & AI. We will continue to take necessary steps to accelerate our product portfolio and the company towards greater growth and higher-margin recurring revenues. We look forward to updating you on HPE's outlook beyond FY '23 during our Securities Analyst Meeting in October. Now, let's open the floor for questions.

We will now begin the question-and-answer session. The first question is from Simon Leopold with Raymond James. Please go ahead.

Great. Thanks for taking the question. I wanted to see if you could put the AI wins in the same terms you did at the analyst section you had in June when you told us you had $1.6 billion in awards. That was a combination of CapEx and recurring deals that would be spread out over a number of years. So, what I'm looking for is an update on that and how much of the AI are you expecting in that fourth quarter? And sort of what's the timeframe for seeing the benefits? Thank you.

Thanks, Simon. Well, all those deals we talked through came through. They were booked, and the pipeline continues to be super strong. In fact, I will say the pipeline we came in, we exit is pretty much the same. So that means throughout the quarter, we booked those deals, and we exit pretty much with the same pipeline we came in. So clearly, the momentum in the business is significant. But as you can see, our progress is showing up in as-a-service, which you saw the 122% as-a-service order growth, which is very significant, and that fuels our order book to be now more than 2 times pre-pandemic levels, and we exit the HPC & AI quarter with the largest ever order book we have ever had. Now we start now shipping some of those orders, those wins, but it's a long way to go. And remember that there's two components related to that. Number one is availability of supply, which obviously in the AI space is constrained. Number two is the fact that when you deploy these deals, you have to install it and then drive acceptances, which means elongated times for revenue recognition. And then maybe in a specific win or two, there are other conditions related to the contractual agreements. So the net of this is that what we discussed at the end of Q2 and then during the HPE Discover came all through, and then what I'm really pleased with is the quality of the deals we are getting. And I just referenced a half a dozen or so in my opening remarks to give a sense of the type of customers we're winning to make sure you understand the proof points associated with that. And so, as we go forward, we expect this momentum to accelerate, but revenue recognition will be different than what I call the demand bookings in our systems because, obviously, that takes time. In any case, the other thing I will say is that one of the reasons why customers are coming to us is because we have a complete life cycle of solutions from training to tuning to inferencing. So, on the training side, obviously, these are companies that develop their own language models, whether it's startups or large unique customers. On the tuning side, which I believe will be one of the biggest opportunities will be when customers use these foundational models that you can get in the market we're going to offer over time, five unique of them in our AI public cloud instance. So they can tune those models with their data in a private, secure, responsible way. And then number three, which I'm really excited about because it would be an accelerator of both Compute and Edge, is going to be the AI inferencing. And so all those three will move concurrently. And so you have to look at this not just the next quarter, but on a mid- to long-term basis, call it two, four, and then eight quarters.

Thank you, Simon. Gary, could we have the next question, please?

The next question is from Aaron Rakers with Wells Fargo.

Thank you for the question, and congratulations on the results. I would like to expand on Simon's question. In the context of last quarter and what was disclosed at the analyst event, there was mention of significant hyperscale cloud opportunities within the pipeline. I'm interested in what you're observing in that sector. Should we anticipate further growth in that area? Additionally, could you provide some context regarding HPE Enterprise's positioning in the cloud, where it hasn't historically had a significant presence? What factors are contributing to your success in these expanding opportunities?

Certainly, Aaron. In the third quarter, we secured a significant contract with a large hyperscaler, and we have yet to begin the building and shipping process, which indicates the scale of this opportunity. Looking ahead to 2024, we see more prospects in this area. The primary reason these clients choose us is our distinctive intellectual property. Our networking fabric operates within an open ecosystem that supports NVIDIA and other accelerators, allowing for a flexible mix depending on the AI workload. For example, we might combine NVIDIA GPUs with AMD CPUs in some cases or utilize only NVIDIA, and in instances like the Aurora system at Argonne Laboratory, we use all Intel components. This flexibility gives customers the performance and supply options they seek. Furthermore, we have deep expertise in AI, having been engaged in it for a decade with select clients. Our goal is to democratize AI for every enterprise, which is reflected in the growth of HPE GreenLake's as-a-service AI bookings, as clients find it challenging to create these solutions independently. Sustainability is also becoming critical for customers deploying AI, as they want to manage their carbon footprint. Additionally, our data center services are vital for executing large-scale AI solutions. Companies developing large language models are drawn to us not only for our offerings but also for our established routes to market that can help them connect with enterprises more effectively than they could on their own. Overall, our approach is centered around a software-led strategy that leverages our supercomputer in a cloud-like experience, supported by the necessary services and software to deliver this level of capability.

Thank you, Aaron. Gary, could we have the next question, please?

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

Great. Thanks. Maybe taking a second on the Intelligent Edge business. Can you just kind of give a sense of what is the biggest forward driver that you're seeing? I think people understand kind of the catch-up spend and the backlog release that has been done, but just what you're kind of seeing in ongoing kind of orders today? And is that Wi-Fi 6? Is it still kind of return to work? Just what are the biggest drivers that you're seeing to kind of help continue the growth of that business? Thanks.

Well, thank you for the question. I'm incredibly proud of the work we have done in the Intelligent Edge business segment. This is the opportunity I highlighted in 2018, where I said we would invest over the next four years to build the right solutions that ultimately will allow customers to drive what I call a data-first digital transformation. So, it's a combination of things: number one, return to work, obviously, you need to have the right connectivity; number two, in order to process the data, you need to connect devices and things that are essential, right, in order to provide the right cloud experience on those types of workloads and applications. But our portfolio is unique because we provide edge to cloud networking capabilities. Our strength obviously has been always in the campus and branch. We see that transition to Wi-Fi 6. In fact, we shipped more than $30 million ports so far with Wi-Fi 6. By number of access points and ports, we are one of the largest, if not the largest, I will say. And also now that drives the 26 million ports we drove in the switching side, which was the thesis when I acquired Aruba in 2015. Over time, we have made these all cloud-native and we have added to it. And so, as we look forward, what I'm excited about is that we are delivering more capabilities and expanding our time with the same experience. So, we added Software-Defined Wide Area Network. Three, four years ago was a niche market, and now it is a very large market worth more than $5 billion in the TAM, and that's why we did the acquisition of Silver Peak. Now that's integrating the same control plane with HPE GreenLake as part of the Aruba experience. And now we just completed the acquisition of Axis Security. So, it takes Axis Security and Silver Peak and now we're going to offer the most comprehensive SSE framework at the edge. And then also we are integrating Athonet, which provides both core 5G software-defined solutions and private 5G at the edge. All of this comes under a cloud-native model in a subscription-based model, which will continue to fuel growth as we think about 2024 and 2025. Bottom line, it is one of the most comprehensive portfolios in the market and no surprise, obviously, with the growth we have, obviously, we are converting more of our order book. But we exited Q3 and we expect to exit Q4 with a significantly elevated order book as we enter 2024. And you can see the results right now represent 20% of the company revenue and almost half of the company profit. And so, the mix shift has really worked for us in this particular part of the portfolio as it is now with GreenLake as well.

Thank you, Meta. Gary?

The next question is from Asiya Merchant with Citi. Please go ahead.

Thank you for taking my questions. Storage has shown a sequential increase, which is encouraging, and it appears that HPE Alletra is gaining traction. As you look towards the fourth fiscal quarter, could you share your thoughts on your storage portfolio in terms of revenue expectations as well as when you anticipate margins will return to the target levels, which are significantly higher than current figures? Thank you.

So, let me start and I will pass it to Jeremy. The team and I drove an intentional strategy to pivot that portfolio, which was a conglomerate of different offerings that we built over 15 years or so to one consistent architecture that allows customers to consume data services, both primary and secondary in a cloud-native way and a subscription-based model. So, HPE Alletra is our primary storage that now covers pretty much all the price segments of the price bands, if you will, of the traditional storage from general purpose to business critical to mission-critical. And we address block and file. In the future, we're also going to address the object piece. So as a customer, you can now subscribe to HPE GreenLake, deploy one consistent back-end infrastructure, whether it's in a colocation, or the edge, or in your own data center and consume hybrid cloud data services. And you can put block types of solutions or file and then eventually object, which is a significant CapEx reduction for customers because they don't have to buy three different ways to deploy it. And an OpEx reduction because obviously, it's very efficient to manage in a cloud type of experience. And so, this business went from zero to in excess of $1 billion very quickly. And it's amazing that it's one of the fastest-growing products in our portfolio, growing triple digits. But what I'm really pleased about is that it comes with a significant subscription, which is growing double digits. So maybe, Jeremy, you want to take the second part of the question, how we see this evolve, in particular from a margin perspective.

Sure. And that's where I'll pick up, Antonio, it was on Alletra. I think we've previously talked to you guys about how this product is really a combination now of a higher software component and that software component does have an element of taking what was prior product revenue and deferring that onto the balance sheet, about 14% is deferred onto the balance sheet. And so, as we see that work off over time as that product is deployed out, we'll start seeing an inflection point, and that should positively impact revenue as we look forward, particularly into FY '24. And that also has an impact on the margin line, too, as that deferral is deferring software-based revenue that has a higher margin concentration to it. So we would expect to see our operating margins start to recover back to kind of historical levels as well as we look forward to 2024.

And as Jeremy said, right, so there is a specific component that is ratable here. So, we are going through that transition. But for two consecutive quarters, we saw demand improving, Q1 to Q2 and Q2 to Q3, and that's very positive. And we expect that to show up as we go forward as we transition those orders into revenues.

Thank you, Asiya. Gary?

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

Hi, thank you for taking my question. You mentioned several times in your prepared remarks about the cyclicality in the Compute business, which presents a challenge. Can you share your thoughts on our position in the cycle? Should we expect more downside to revenue and margins as we approach the fiscal fourth quarter? You did mention an improvement in demand, so I'm curious if that suggests fiscal Q3 is the near-term low point for the business. Additionally, many investors are asking how much of the demand improvement you're seeing heading into fiscal '24 can help offset the benefits from the backlog this year and still allow for growth in fiscal '24. Any early insights on that would be appreciated. Thank you.

Sure. So first of all, I think it's important to recognize that the traditional general-purpose Compute business goes through these cycles, right? Last year, we obviously had a significant demand uptick because of the supply chain challenges. Customers are absorbing that; in some cases, we still need to deploy some of those products and the like. But we saw signs of stabilization, and we saw demand improvement at the unit level, which is super, super important because demand at the unit level also drives attach. And as I referenced in my remarks, that unit demand together with the storage demand and obviously, the acceleration we saw in HPE GreenLake drove double-digit growth in operational services, which obviously is important as we think about ratable revenue and profit as we look into the future. Now, we have this unique expectation of the company because in the past, we wanted to give you visibility of what is general-purpose Compute and what is HPC and supercomputers. But when you combine the two, it is what I refer to as the server category. Because in the end, there is a server component associated with that. And there is different IP you bundle depending on whether it's general purpose or a supercomputer. And the combination of general-purpose compute, as you refer, and HPC and supercomputers demand clearly improved very nicely quarter-over-quarter. I think as I think about 2024 as a server category, I think you're going to see the continued improvement in demand on HPC & AI. I think the AI inference related to Compute will be announced to the rate for Compute. And then we have to see the evolution of price in the commodity space, which you will expect some time in '24. That curve will end up again because as demand stabilizes and improves, the cost of commodity will start going up. And remember, we also have a transition in the making from what I call Gen 10 and Gen 10.5 to Gen 11. And Gen 11 also comes with a higher, we call it, product intensity. So as more options and the options come with larger memory and larger types of storage and obviously more GPU embedded in the traditional compute, it will drive, over time, AUPs up. I don't know if Jeremy, do you have anything to add?

I’d like to address the margin aspect. In these cycles, we have demonstrated our ability to maintain pricing even when commodity prices decline, which affects our average unit price. As the market rebounds, we have successfully positioned ourselves as price leaders to capitalize on that. We anticipate that as conditions evolve, combined with the point made about Gen 11 providing an average unit price premium, our expectation remains that the operating profit will continue to reflect our long-term target range of 11% to 13%.

Let me emphasize an important point. If you look back two or three years, the cyclical nature of the business at that time will be different compared to our current total company revenue and profit. I want to highlight that as we shift our focus towards edge computing, hybrid cloud, and now AI, we anticipate improvements in our margins. The strong performance stemming from this mix shift more than compensates for the cyclicality we experienced in Compute, which is clearly demonstrated in our Q3 results where our margins improved by 120 basis points. Two years ago, our company margins were around 33%, in 2022 they rose to the 34% range, and in 2023, we are now in the high 35% range. This indicates that our business composition is structurally evolving, and we plan to keep driving this mix shift. That is why we believe that our focus on software and services, particularly in Intelligent Edge, hybrid cloud, and now AI through a software-led strategy, will be crucial for maintaining this progress. We also expect to manage the cyclical nature of Compute more effectively.

Thank you, Samik. Gary, could we make this our last question, please?

And our final question will come from Wamsi Mohan with Bank of America. Please go ahead.

Yes, thank you. Antonio, you're exiting this year with a high single-digit decline in revenues and Edge clearly is doing extremely well and some benefit from backlog. How confident are you that HPE can grow revenues in fiscal '24, given the current exit trajectory of the business? You also noted some stabilization. So curious to get just some high-level thoughts, not explicit guidance, maybe, but just some directional commentary on how you could see that playing out.

I think your comment is related to Q4, right? So obviously, we are going to lap a very high quarter because last year in Q4, we were able to convert more of that order book related to the fact that supply started improving in Q4, and you saw that in Q1. So to me, it's just a lapping of the numbers. But that said, we're going to talk about this at the Security Analyst Meeting, we expect revenue to continue to improve in fiscal year '24. We're going to tell you exactly what that will look like. But I will say that while revenue will improve year-over-year, and remember, in Q1, we're also going to have a big lap because Q1 revenue was $7.8 billion, the fact of the matter on a yearly basis, right, this year, we are growing 4% to 6%. And Jeremy talked about the headwind we saw in the FX, which is now 300 basis points. So, we are growing faster than what we guided you at the beginning of the year, which was 2% to 4%. We are now growing 4% to 6%. And we expect our revenue to continue to improve because of the momentum we have in the businesses, but we'll guide you with a specific percentage at the Security Analyst Meeting. But the other important part is that the mix of our revenue is changing, and the gross margin mix is changing, and also the way we generate free cash flow is changing. And so, more to come when we talk at the Security Analyst Meeting, okay? I know that, unfortunately, you have to cover a lot of companies today, and I understand HP Inc. is about to start the call. I hope you can see from this quarter results how our strategy is working. We are delivering on our commitments. We always do what we say. And we are shifting successfully our portfolio. And so, despite some aspects of the market being a little more challenged than others, we continue to grow revenue, we continue to expand margins, and we'll continue to improve our net earnings per share on a non-GAAP basis. So, I'm looking forward to seeing you at the Security Analyst Meeting in October. We're going to have it in New York, so it's a little bit more accessible. So, I hope to see you soon. And if you have any questions, we'll follow up with you offline. Thank you for your time today.

Ladies and gentlemen, this concludes our call for today. Thank you for attending. You may now disconnect.