Hewlett Packard Enterprise Company (HPE) Earnings Call Transcript & Summary

Welcome to the Hewlett Packard Enterprise Virtual Conference Call. My name is Jenny. I'll be your operator for today's call. [Operator Instructions] I will now turn the call over to Jared Weisfeld. You may begin.

Great. Thank you, everyone, for taking the time to join us on such short notice. My name is Jared Weisfeld, U.S. technology sector specialist at Jefferies. We are pleased to have the CFO and Treasurer of Hewlett Packard Enterprise with us this afternoon. The format of today's webinar and conference call will be as follows: Tarek and Kirt will give a brief presentation, and then I will moderate a fireside chat with Q&A. And with that, I'll turn it over to the team at HPE.

Thank you, Jared, for having us and good afternoon, good evening for everyone on the line. This is Tarek Robbiati speaking. I'm here with my Treasurer and colleague, Kirt Karros, and we're delighted to have the opportunity to be standing here in front of you. We wish we could have done this in person, but we're delighted to have the opportunity to interact with you at least virtually to talk to you about the company, where we stand in the light of the recent events and the coronavirus pandemic. So we thought about putting in a very short presentation here to give you sufficient opportunity to ask questions and interact with us during this call. But we want to talk to you today about our business, recap some fundamentals with respect to our company, in terms of revenue, costs, the balance sheet and our liquidity profile and also highlight our financial services company because we believe there is a fair bit of things that we would need to dispel, perceptions that exist with respect to our financial services company, which I'm sure you're keen to find out about. So let me start with the first slide. And recapping our revenue profile, if the team could move the first slide, that would be great. Okay. So on the first slide -- hopefully, you can all see it. On the first slide, we would like to highlight our revenue base and particularly the sources of our revenue and the kind of revenue that we have in our company. If you look at our portfolio, HPE is well diversified and has a high mix of recurring revenue and profit. Our revenue spans across a number of large markets and geographies where we have leadership positions. And within each of those segments, we are shifting resources and strengthening our portfolio in key growth areas, such as High Performance Compute, Hyper Converged, storage and at the edge. Also, and it's very important to remember, that Pointnext OS, Aruba as a Service, CMS and Financial Services make up approximately 1/3 of our revenue but most importantly, 75% of our profit on a recurring basis, and this provides good visibility in any particular year. So let me elaborate on that. Our most profitable business, Operational Services, is an [ all ] contract with a 3-year terms on average. Financial Services also offers lease terms that average 3 years. It is also worth highlighting our ARR, which is our annualized run rate of revenue, of $511 million at the end of Q1 2020, and this is expected to grow at a 30% to 40% CAGR over the next 3 years. So altogether, it's important that we take stock at this point, which is really important. We do have highly predictable and recurring revenues and profit stream. Also in my dialogue with various investors, I was asked to comment on industry exposure either by industry vertical or by customer company size. So let me take this opportunity to say from a customer segment and industry vertical perspective, we have a fairly limited exposure to those more sensitive segments or vertical industries that are sensitive to a recession and those most heavily impacted by coronavirus 19. Across HPE, roughly 85% of our total products and services are sold to enterprises, large enterprises or public sector customers, with only 15% going to SMBs. We also have a relatively low exposure to travel, hospitality and energy sectors, which in total account for less than 15% of our verticals where we are more heavily exposed to manufacturing and distribution, public sector and education, communication, media and entertainment and financial services. So hopefully, this put things in perspective on the revenue front, no doubt you will have questions, we'll be more than happy to address them as the call carries on. But let's turn on to the cost side and the description of our business and the actions we're taking with respect to cost. So as we foreshadowed in the first quarter earnings announcement, we are taking near-term actions to protect our profitability in fiscal year '20, while continuing to make critical, long-term investments. And this point is important. No matter how deep and difficult this crisis is, we have to continue to make these critical, long-term investments because this will come to an end at some point, and we're comfortable it will be. So what did we do in the first quarter? We extended the HPE Next program to fiscal year '21. We already explained that in our earnings announcement. And we expect incremental savings while maintaining the original net cash impact. How can we maintain the original net cash impact? Well, because some of the savings are avoided costs, so we're not going to do some things that we intended to do. Therefore, there are no restructuring costs attached to those avoided costs. And others were already in plan as part of HPE Next, and we feel that we have sufficient offsets to be able to say that we will maintain the original net cash impact outlook that we have flagged to the market. As we do so, we will continue also to align the cost structure of our company to the new revenue profile and the savings that we are realizing, particularly in the back-end operations of our business. Finally, we are in full swing with respect to the Cray integration, and we believe that there are great opportunities that will come from the integration of Cray, particularly around expense reduction. We expect, as we foreshadowed, triple-digit millions in annualized run rate cost synergies through Cray by the end of fiscal year '21. Turning on to our liquidity. I want to reassure everyone on the call with Slide 3 that we have a very robust balance sheet and investment-grade credit rating. As of the 31st of January 2020, we had $3.2 billion of cash, and we also have a revolving credit facility of $4.75 billion over and above the cash reserves we had at the end of Q1. So in total, we have $8 billion of liquidity that we can tap and meet all our financial commitments for the subsequent 12 months. We are very committed to maintaining our investment-grade credit rating. This is paramount. And this revolving credit facility is a 5-year facility that we're able to secure across all the banks that finance HPE, and all the banks have reaffirmed their commitment to the facility over the past few days. We have no borrowing outstanding under HPE's commercial paper program. And also more recently, after our first quarter earnings announcement, we were able to issue $755 million of asset-backed debt securities to partially refinance $3 billion of debt maturing in October 2020 -- I apologize, we did do this on the 20th of February 2020, our earnings announcement was on March 3. So this was before the earnings announcement. But nonetheless, what was interesting from this asset-backed issuance is that we were able to do so at a very low-cost of capital of 1.9%, which attests of the quality of our HPFS asset book, and we'll come back to that in a moment. Further information can be found about our liquidity position in our 10-Q that is available online. Moving on to the next slide. When you look at our overall cash and debt balances across the company, the operating company has net cash of $200 million, $2.5 billion in cash, offsetting $2.3 billion in debt. The financing company has a net worth of $700 million. The result of that -- the results -- this is the result of a book of $13 billion and gross debt of $11.7 billion. Now I'm sure you are going to ask the question how is the book going to perform in a downturn, and this is why we want to highlight to you on the next slide what is actually -- what we can foresee with respect to the performance of our book in HPFS. So we have highlighted on Slide 6, the default rates of this book since 2007, including the global financial crisis. This book has been performing extremely well since 2007. So over the past 13 years, the performance has been world-class and continues to be world-class. The percentage of assets that were subject to write-offs is well under 1% of the size of the book of $13 billion. You can see here on this chart on Slide 6 the performance even during the worst moments of the global financial crisis, the impairment losses did not exceed the 1% mark. We are very comfortable with the quality of that book. And the fact that we test the asset-backed securities market is also an indication of the quality of that book. Particularly when you think about it in terms of customer concentration, this is a book that is incredibly diversified, with the top 10 customers representing 15% of the assets. The largest customer that we have is in the technology sector and has a percent -- represents a 2.5% of the loan assets of HPE Financial Services. The second largest is in health care, and it represents 1.8% of the Financial Services loan asset. So the serviceability of that book and our ability to realize the value from that book, in our mind, is extremely strong, and we have no concerns around it. So I pause here, and I will turn it back on to Jared. Hopefully, you were able to follow. I apologize, but I couldn't see the slides moving on the website. Everything will be reposted for all of you online and will be available in the replay. But Kirt and I are now available to take any questions from Jared or the audience. Thank you.

That's great. I appreciate it. I think to start generally with respect to COVID-19, most investors that I speak with are more worried on the demand side than the supply side. And while we see that you're generally exposed broadly to networking, server and storage product trends, the impact that COVID-19 is having on businesses vary greatly by vertical. For example, physical retail, travel and lodging are more exposed given shutdowns, while other verticals may be less affected. Do you have any insight into your true end market exposure beyond the product line view?

Yes, Jared, no doubt, this is the top of mind in all our conversations that we've had with The Street so far. Well, let me start first by saying that what's most important at this stage is the health and safety of our employees, our customers and our partners. This is our #1 priority. We have taken great steps to ensuring their safety. On the demand front, I'd say it probably is too early to assess the impact of coronavirus 19, but we're monitoring the situation very, very closely. Overall, we remain very confident in our strategy and expect continued long-term success as end demand normalizes in. Aruba, and you probably recall when you look at our Q1 results, Aruba, High Performance Compute, Hyper Converged and GreenLake continue to grow very solidly. Our view on the long-term health of these markets has not changed. We don't think this is going to be affected. What I would say is that we are extremely fortunate in terms of our global diversification and the limited exposure to industry verticals that are likely to be hit hard by the current situation. From a -- like I said a moment ago, from a customer segment and industry vertical perspective, we had a fairly limited exposure to those more sensitive to recession and also those most heavily impacted by coronavirus 19, such as travel and hospitality. Look, roughly 85% of our total products and services are sold to enterprises or public sector customers. And we only have 15% going to SMB. We also have a relatively low exposure, again, on travel, hospitality, but also very little exposure to the energy sector, which is highly leveraged. This is accounting for less than 15% of our verticals. Our exposure, and I'm repeating myself, is more around manufacturing and distribution, public sector and education, communication, media and entertainment and very much financial services. So what we're seeing more and more from folks who are looking at the current situation is they're looking to work from home. And this is an opportunity for us, quite honestly. We see very high demand for Aruba's remote access solutions, which enable the remote creation of the same wireless and wide access with the right security characteristics and the network experience, just like you have it in the office. So this is a software deployment, not involving the hardware deployment. But essentially, what we do is with the Aruba access solutions, we established, for those who are technical, a secure tunnel back to the controller of a VPN concentrator in the company head office. And that helps a lot of communications for our customers. And over the past 5 to 7 days, the demand for Aruba remote access solutions has skyrocketed. We have had multiples of normal quarterly demand. So we're trying to balance that demand and supply, obviously. And to do so, we have to upgrade a whole bunch of things on the software and other models to convert those access points to be part of a VPN for an enterprise, and we're moving inventory across regions to meet that demand. We're also expediting production of these solutions with our suppliers. So overall, our situation is more robust compared to our competitors, and we are prioritizing shipments, needless to say, to health care providers, hospitals and clinics above all, and this is absolutely obvious. Also, our marketing team is becoming incredibly creative, and we're leveraging new platforms to conduct virtualized events, engage with customers in a distributed way during this dynamic period. There's a lot coming on. And I wanted to let you know that whilst demand remains uncertain, there are things that we are doing to navigate this uncertainty, and we feel comfortable with our actions.

That's extremely helpful. Maybe sort of on that last point with respect to -- you talked about a few expedites and optimizing the supply chain. Have you seen any normalization from a supply chain perspective with much of the Asian workforce returning?

Yes, that's a really important question. Thanks for asking it. So the outbreak, if you look back at the outbreak of coronavirus, for those of you who have followed it, it started literally around end of January and Chinese New Year, right? This is what started to impact component manufacturing, and this has resulted in constrained supply and higher quarter end backlogs than what we would see normally. Now let me tell you that the entire senior management team and myself are very focused on our supply chain and working very closely with all our suppliers to mitigate the challenges as much as possible. We are seeing some good progress in China factories. Most of the China factories, for those who have followed the news, were not at capacity. Some of them were literally closed during the month of February. They are now resuming to full capacity, but we are keeping a close eye on production of certain critical components that could remain a headwind. So look, I can't quantify the impact. It's an evolving situation, very dynamic situation. We continue to monitor it very closely, and we're focused on minimizing any impacts from supply chain and the time it takes for the supply chain globally to get back to a normalized state.

And sort of a follow-up on that when you think about sort of cash costs required to run the business in this environment, when you think about the resiliency of your financial model in this challenging business and macro environment, how you're thinking about managing OpEx in this tough environment and ensuring that effective cost controls are in place until demand rebounds.

So our financial model is very, very robust, in my view. If you look at our portfolio, we're well diversified. We have a high mix of recurring revenue and profit. And people tend to overlook Pointnext OS and CMS as well as our HPFS business and Aruba as a Service. If you really look at our entire portfolio, we have a substantial amount of recurring revenue and profit. We're also diversified geographically, and that's important because anyone will form a view as to where coronavirus travels around the globe, and we are well diversified around the globe where we have leadership positions. And within the segments that we serve, we're shifting resources and strengthening our portfolio in the key growth areas, such as HPC, Hyper Converged, storage and at the edge. HPC is very promising. It's one of the most promising subsegments of the Compute business. And we were, I would say, very prescient in acquiring Cray a year ago. So very pleased with that. And it's showing, and it's going to continue to show in the future. When you look at Pointnext OS, again, Aruba as a Service, CMS and Financial Services, let me reiterate, they make more than 75% of our profit on a recurring basis, which gives us good visibility into any 1 year in fiscal year '20. So don't forget, let me say it again, OS is a contract-based business with 3 year terms on average. And the same holds true for Financial Services. So on the whole, our business is fairly robust, to your point, and resilient, Jared, with highly predictable and recurring revenues and profit streams.

I just want to come back to the capital structure for a minute just because leverage is a factor, continues to be a theme that's reverberating across all sectors within TMT. And I think you've done an excellent job in the overview with respect to talking about financeco, gross debt and gross cash. But just a real quick overview with respect to breakdown of debt between opco and finco because I think, in general, I think investors are screening debt-to-cap, and you're getting looped in with potentially a perception that you're more levered than you actually are. So I think just a quick high-level summary with respect to the breakdown between opco and finco would be really helpful and maybe tying into that sort of if you can give any perspective on how the financing business performed during the -- during tough economic times, such as the global financial crisis of 2008, I think that could help mitigate a lot of fears that some investors might have.

Yes. So as we showed you on Slide 5, the vast majority of the debt of the company is associated with finco. And we've been very, very careful in ensuring, with respect to our capital structure, that we maintain our investment-grade credit rating. This is absolutely paramount in these days, the #1 priority for the CFO and the treasurer is liquidity. And Kirt and I and the whole team here at HPE are riveted on making sure that we have the right liquidity. We feel very good about our financing company debt because the book is very, very strong, incredibly well diversified and has performed. The only -- the best indication of resilience in the book is the track record, including the darkest days of the GFC. So the debt -- if someone may -- or simplifying and think about being -- HPE being a highly geared company, that is not true because, when you really look at us, you have to take into account the book from HPFS and whether that book is serviceable and whether that book will perform. We are very comfortable with the serviceability of that book and its ability to perform because it is highly diversified in itself. You have $13 billion with a very, very low concentration. And the -- most of the customers who have used HPFS to finance their IT equipment are investment-grade themselves. And that is very true for -- the vast majority of them being also AAA quite, frankly. So we feel very, very comfortable with the performance of the book and the ability to offset the debt. And that's how our financing business works. You have assets, you have debt. And the question is how do you feel comfortable about the asset side of the balance sheet. We feel extremely comfortable with the strength of our book of HPFS. Also, I want to highlight that we continue to be focused on generating meaningful level of free cash flow this year. Some companies in the world haven't been in that position where they can generate free cash flow, and the tech sector has plenty of them. And we feel we're in a much better position than if you look at high-growth companies with a high cash burn rate. We're maybe not growing as fast as these companies. We don't have that high growth, I grant you that, but we don't have the cash burn rate that some of these players have. We actually generate a fair bit of cash, and that's something to be taken into account. We're also very careful around share buybacks, M&As, even the funding of incremental leases in HPFS and dividends because we know in these circumstances, the #1 priority is liquidity. And this is why we restructured our revolving credit facility recently and upped it to $4.75 billion. That was done in February. Kirt, maybe you want to add to that.

Sure. And I think one other thing of note here, when we talk about kind of opco and finco, to take note of is that $13 billion portfolio, it's a very fairly short-dated portfolio. So the average life of a typical lease is 4 years and under. And when you look at our cap structure and our liabilities, we have longer-term debt. So we have in our cap structure today, originally 10-year debt, 20, 30 years. So the roll-off of those receivables, we generate about $6 billion plus of gross receipts off of those receivable balance. So as that cash comes in, as Tarek alluded to, we make decisions about underwriting in the future. But the actual cash and availability that we have as a company is far and surplus situation to our existing liabilities. And so I think when we think about the situation in terms of prioritizing spend, the inflows again will be far and surplus of the outflows.

I'd like to follow up on a couple of those points because I think they're really important, especially with respect to liquidity, we're seeing a lot of corporates proactively draw down on revolvers. We're seeing a lot of private equity portfolio companies tell their -- private equity companies tell their portfolio companies to proactively draw down on the revolver. So just -- you alluded to this a little bit. Can you give us just a quick overview with respect to your debt maturity profile? And sort of in addition to that, from a funding requirement perspective, do you expect your pension funding to present any significant headwinds given the recent moves in assets and interest rates?

Sure. I can tackle that as well. Again, when we lay out our maturities schedule, we think we're very comfortable in terms of the maturities coming due. So we proactively raise these $750 million that Tarek mentioned there in February in our ABS program. That was partly to prefund $3 billion maturity we have coming due in October. So with that, when we look at available pools of capital, certainly, the intent today would be to go out to the market sometime between now and October and refinance the remaining portion of that maturity. We have at our disposal, obviously, besides the ABS market that's obviously challenged at this particular moment, but we would hope that would open up at some point in the next 6 months. But even if it doesn't, we've got the unsecured market that we certainly could tap. And cash on hand, we've got about $3.2 billion as of quarter end. And then we have our unsecured revolver that is on tap versus full capacity of that of $4.75 billion. So we think we have plenty of liquidity sources to meet any maturities near term. And then I think you also mentioned on the pension front. It's kind of an interesting dynamic right now. Obviously, lots of volatility in the marketplace. So we've got -- as everybody is aware, you've got a dynamic of both equity markets and the credit markets behaving kind of in tandem here where the odd dynamic is we have an increase in interest rates. And so we're having the bond portfolios obviously under pressure and the equities as well. But when you look at our overall funded pension plan, you -- at the end of the year, we were roughly about a $900 million deficit. Ironically, because of the increase in interest rates that we've had in this environment, our actual funded status for pension plans have actually probably improved from year-end. And again, that dynamic, even if you think about the dramatic decrease in potentially equity values of some of the plans, the liabilities have reduced because of the increase in rates. So things will normalize going forward. But I think overall, we feel very comfortable with our pension deficit at year-end. These plans are more mature, so they tend to be more weighted towards debt versus equity. And we don't foresee any near-term challenge on funding, what we've laid out at the beginning of the year, that we basically have $180 million of funding needs for those plans. I don't anticipate that we would have any change to that for this year.

And as you can see, you can hear from Kirt, we are very clear and anticipate on any such funding needs that we have. And our liquidity profile, I would say, has been sized to make sure that we can withstand any sort of needs that we have to fund the operations, fund our business and then also the pension side of the company. So we feel extremely comfortable with the status that we currently are at.

On the last conference call, you talked about targeting value-enhancing acquisitions to improve your competitive positioning. With the broader market decline, clearly, valuations are more powerful. But how are you balancing M&A with liquidity given the broader uncertainty? And when you think about capital preservation versus opportunistic buybacks sort of throwing all that in there, as you -- basically at a high level, when you think about managing and preserving liquidity, how do you balance that with respect to either potential M&A or opportunistic buybacks given where your share price is?

Look, as we highlighted with Kirt a second ago, we have a strong balance sheet and cash flow, and we intend to continue to maintain that strength. In this market environment, liquidity preservation is a priority, given the uncertainty. And so when you take this and you make it a top of mind, then thinking about buybacks is -- we put it in a certain perspective. We think at this time, it is difficult to do so. I was asked a question in our earnings announcement, and my answer was, look, given the uncertainties we're seeing, we have to preserve liquidity moving forward. And look around, look around in the marketplace, a couple of companies that are very well-known to investors who have executed buybacks or in the process of executing buybacks and have been downgraded with their investment grade. From a credit rating standpoint, they lost their investment-grade credit rating. And the justification for the downgrade from Standard & Poor and other rating agency was that executing materially large buybacks is a form of aggressive financial management. We're not going to do that. We have to remain prudent. We're thinking about buybacks. We stand by what we said at the end of Q1, and we will continue to think about that strategically and prudently for the benefits of our shareholders. With respect to M&A, the same consideration applies. I think right now, we start to see some real -- really attractive valuations. Before we were in a situation where the market was overvaluing growth and undervaluing cash. That has been my belief all along. And that's why we have been very disciplined in our approach to M&A. We were very, very clear with Antonio around what is it that we need to think about in terms of hurdle rates, accretion/dilution criteria when we look at an M&A acquisition, and we haven't changed, and we won't change on that front. I have to add that in the current circumstances, I see it very hard for assets to trade, quite frankly. There may be some, but this could be fire sales. And when we have fire sales, and there are fire sales for a reason, we are not going to, in any event, deviate from our M&A selection criteria just for the sake of doing M&A in the short term.

No, that makes a lot of sense. I'd say probably lastly, when you think about -- can you talk about your ability to manage your high profit services business remotely in this work from home environment?

That's a really great, great question. And so before we get into remote resolution of cases, we want to paint the picture of what we have done is to optimize the costs and reduce our exposures to acts of God, which is what we're facing right now. So we did already implement remote monitoring solutions, such as InfoSight, to proactively resolve and self-heal some of the infrastructure solutions that our customers have running in their data centers. Out of 10 issues that cannot be proactively resolved are self-resolved by the customer. And the reason why we're comfortable in saying this is that this is a result of a wealth of knowledge, diagnosing tools and public forums that we run to help our customers wherever they are. And if anything cannot be resolved remotely, then specific cases raised and our team intervenes, and in some cases, it requires physical interaction then we'll intervene physically. From the cases that are raised, I would say, 38% of those cases that are raised are also resolved remotely. 12% are resolved by sending a part directly to the customer requiring no HPE on-site presence, and only the remaining 50% of those cases are raised to require a form of on-site solution. So -- and all of that is encapsulated with the service level agreements that underpin our contracts, but those rarely carry penalties or create revenue risk for us.

Great. I think that's it from our end. To the extent you have any closing remarks you'd like to conclude with.

No, I just want to thank you, Jared, and Jefferies, and I want to thank everyone on the call for your patience. We are living difficult times, no doubt. We feel that we are well equipped as a company to withstand this shock, and we will continue to update you in the future. And last but not least, I want to make sure that everybody individually who is on this call, who will listen to the webcast later on, take all the necessary precautions to stay safe, and we wish you the very best. Should you have any questions, our IR team is available to you. I'm available to you by e-mail. I'm working remotely from home, but it's amazing what you can do even with remote communications nowadays. So my very best wishes to everybody and please all stay safe. Thank you very much for being on the call with us today.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.