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

Thank you so much for joining us. This is Katy Huberty, U.S. IT hardware analyst at Morgan Stanley. And I'm really pleased to be joined by Andy Simanek, Head of HPE, IR; and Jon Faust, Senior Vice President and CFO of HPE Aruba. Jon brings to the conversation incredible experience and knowledge from his 20-year career at HP, having previously served as CFO of the hybrid IT business as well as overseeing the finance -- finances during the HPE and HP Inc. separation, the spin merger transactions of the enterprise services and software businesses as well as leading the company-wide HPE next transformation program. Andy and Jon, thank you so much for joining us today. Before we jump into Q&A, we just have to go through a few disclosures. Please note that this webcast is for Morgan Stanley clients and appropriate Morgan Stanley employees only. This webcast is not meant for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. With that, I'm going to pass it to Andy to walk through some of the HPE statements before we turn it over to Jon.

Great. Thanks, Katy. So let me just take a quick moment to read our disclosures, which can be found in the viewer controlled slides you have in front of you. So you will hear some forward-looking statements in today's discussion. These are based on risks and assumptions that are described in our annual report on Form 10-K and our quarterly reports on Form 10-Q. Our actual results could differ materially, and we assume no obligation to update. More details can be found on our website at investors.hpe.com and our recent Q3 earnings announcement press release dated August 25. So with that, Katy, let me turn it back to you to start the Q&A.

Great. Perfect. So Jon, as companies are adjusting to a more hybrid workforce, CIOs are rethinking everything from remote work and collaboration, business continuity and security. For the Intelligent Edge business at HPE, how has COVID impacted demand over the last 6 to 9 months? And how is it reshaping how you think about longer term demand?

Yes. Thanks, Katy, and thanks for having me. So as you may recall, Aruba built a remote access point solution back in 2008 during the H5N1 avian flu crisis, right, primarily to support customers in the financial services industry that wanted to ensure business continuity during the epidemic. Now clearly, the COVID-19 pandemic has been far more disruptive. But with that has come a huge increase in working from home, right, which has turned -- which is, in turn, has created a dramatic increase in demand for those same Aruba RAP solutions, as they can really provide enterprise-class security and performance with consumer class ease of use. Also, Aruba recently announced a partnership with Comcast business, right, as they launched their Comcast Business Teleworker VPN offering. Now this is really a fantastic solution for organizations that enables them to provide employees with the same access to their corporate network at home that they used to enjoy in the office, and it's all powered by Aruba ESP or Edge Services Platform. So Aruba is really at the forefront of supporting businesses through this crisis. Now it's clear that in the post COVID-19 world, that will drive some changes to societal norms and also the demand trends that come along with that. I already mentioned the Aruba RAP solutions, but we're also seeing increased interest in Aruba's WiFi solutions as buildings are upgraded to support more devices and things on the network and to enable location-based services, including contact tracing, and also all the pull-through of our switching infrastructure to support the front end. So in the near term, we expect to see weakness in certain verticals like hospitality and travel. But the long term, we expect strong demand. And where there's going to be networking and processing at the Edge, we're confident that demand and growth will continue.

Speaking of longer-term intelligent, edge accounts for about 10% of HPE revenue. And along with the HPC business it's really important to driving a return to growth and confidence around longer-term revenue growth for the company. Talk about what drives your confidence in the 6% to 10% revenue growth through fiscal 2023 that was outlined at the Security Analyst Meeting last month.

Yes, sure. I mean the way we think about it, the explosion of data, devices and apps is driving demand for secure connectivity, analytics and cloud computing capabilities at the Edge, especially post COVID, right? As Keerti Melkote, our Founder and President, said at that same Security Analyst Meeting, our opportunity is to help customers connect, which is about a $40 billion TAM, driving at a 5% CAGR protect, which is about a $20 billion TAM and a 10% CAGR and also analyze and act, which refers to the edge compute side of the business, which is about a $12 billion TAM growing at a 24% CAGR, right? That, including the Aruba ESP or the Edge Service Platform that I mentioned earlier, delivers a secure cloud-managed experience with Zero Trust security and AI to automate operations, all with one pane of glass. So we really expect to take share with the product portfolio that's more differentiated than ever, right? We've got a customer first, customer last, human-centric service and support. We're the only provider with a complete edge-to-cloud offering that can also be delivered as a service. We've got a multi-vendor approach that eliminates lock-in and forced upgrades. And our AIOps for automation provides unrivaled depths of insight. So in our fiscal year '21, which we just started this month, we've got several growth drivers, including: one, WiFi with secure remote worker solutions and a Wi-Fi 6 Refresh, along with switching. We've now got SD-WAN accelerating, and that market growing at 23%, which is going to be captured by our recent Silver Peak acquisition. And we've got a new networking as a service opportunity that's new and exciting that's going to help to drive growth, too. So as a part of HPE's long-term financial model, we're projecting the Intelligent Edge segment to outgrow the market, given that strong differentiation and grow revenue at the 6% to 10% CAGR that you mentioned.

So again, reconciling that 6% to 10% growth versus 5% market growth, it sounds like it's a combination of market share gains as you've extended the portfolio as well as your mix and exposure to some of the higher growth segments. Is that fair?

Yes, that's correct. And on top of that, I mean, we continue -- HPE continues to invest in the Aruba business, and we're laser-focused now on scaling it and the opportunities to grow revenue and take market share are there, right? First is connectivity. Organizations need to connect users and IoT at the edge. And this means connecting them with edge using land infrastructure, but also connecting them to the cloud. So edge-to-cloud connectivity is one of the biggest opportunities. And Aruba is one of the only vendors with that complete edge-to-cloud portfolio. And now with the acquisition of Silver Peak, the portfolio is even stronger and more aligned to customer needs and wants than it's ever been. In addition, there are subsegments within networking, which we also expect to out percent that 5% CAGR. And one adjacent opportunity is the need to protect infrastructure at the edge, right? So it's Edge Security where we expect strong growth to continue. From IoT to an always-on mobile workforce, organizations are more exposed to attacks than ever before. And security starts with visibility to all devices, right? Devices -- you can't secure what you can't see, right? So Aruba ClearPass solutions were recently named a Customer's Choice by Gartner for device visibility, control and attack responses for the enterprise and the Pentagon, even recently deployed ClearPass, which we can talk about. Another opportunity is analyzing data and acting upon it, as I was mentioning earlier. And we recently announced our Edge Services Platform, ESP, which gathers and acts upon data. Can analyze data across domains and identify issues and abnormalities and self optimized all before users notice any impact. And in addition, we continue to be led by the founder of the company, Sir Keerti Melkote, and we found that the culture and our customer first, customer last mantra has really resonated with customers, especially during this crisis, right? With so many unknowns and uncertainty, our customers know that they can count on us to support them through the crisis and beyond. And we know that being customer-centric is a differentiator for us.

That's great color. Just looking backwards for a moment, Intelligent Edge revenue has declined in recent quarters. Can you just talk about what contributed to those declines? How much of that was macro versus company-specific product cycle factors? And then looking forward, what are the steps that the company has taken or needs to take and the expected timing for returning the business to growth?

Yes, sure. So we believe our performance in our Q3 was in line with the market. And we actually think that we outpaced the market in our first half, and we're about up about 1% year-over-year in revenue. So we're pretty pleased with our performance to date. In our last earnings announcement, we said that we expected sequential growth in areas where we were already seeing strong demand, including the public sector and education verticals. And we'll provide an update on all of that in our upcoming Q4 earnings announcements in a couple of weeks. Longer term, we continue to see the edge is a significant opportunity, right? And we're well positioned to take advantage of that. Like I was mentioning before, the explosion of data, devices and applications will drive demand for secure connectivity, analytics, cloud computing capabilities at the edge, especially in a post COVID world. So in our fiscal year '21, which we just started and as Antonio and Tarek and Keerti, all mentioned at our Security Analyst Meeting just recently, we've got several growth drivers, right? So including WiFi with Secure Remote Worker Solutions and the WiFi 6 Refresh, the Silver Peak acquisition that I was mentioning earlier, and just accelerating in that SD-WAN market that's growing pretty rapidly and then the networking as a service opportunity.

And Jon, earlier in the conversation, you mentioned Aruba ESP, which was launched back in June and is essentially an AI-based platform for network automation. Talk about what the uptake of that product has been since the launch earlier this year?

Yes. The adoption to date has been great, and it's really resonating with customers. One example, and I mentioned it just briefly earlier and was just recently announced is the Pentagon, right, which, of course, is the headquarters of the United States Department of Defense. They're working to modernize their classified and unclassified networks to support over tens of thousands of devices daily, right? And ESP will provide the Pentagon with an automated networking infrastructure and eliminate manual processes like port mapping and initial switch configuration. Another example is Nobu Hospitality, which is a luxury lifestyle brand. They're standardizing on Aruba ESP as their edge-to-cloud foundation for their hotel chain. So that's going to give them the ability to generate actionable analytics where the data is created and deliver new on property experiences for guests, right, which was critical to their decision. And we've also seen a very strong reception for the addition of Silver Peak, whose advanced SD-WAN offerings have strengthened our overall Aruba ESP offering that has created even more interest from customers and partners.

That's great. If you can sell to the Pentagon, I think you can sell to anyone. We also talked about the Silver Peak acquisition as one of the catalysts over the next year. That acquisition closed on October 15, and it provides HPE a really strong position in the SD-WAN market, which you mentioned is growing 23%. Just elaborate on the strategic rationale, why that deal made sense now and some of the financial implications of folding that business into Aruba from a revenue growth and margin standpoint.

Yes, great question. So the combination of Aruba and Silver Peak will really help to accelerate cloud transformation for enterprises with the comprehensive edge-to-cloud networking solution that covers all aspects of wired, wireless LAN and wide area networking or WAN. Silver Peak's, simple, intuitive, self-driving WAN really delivers -- really can deliver significant cost savings while maintaining application performance for rapid business recovery, which is going to be incredibly relevant, right, in the post COVID-19 world. It also complements our existing work from home and branch office solutions to deliver one of the industry's most comprehensive portfolios designed to securely connect any edge to any cloud. And from a financial perspective, we expect the combination to drive significant revenue opportunities be accretive to our gross margin. And as Tarek mentioned during the announcement, be neutral to HPE's non-GAAP EPS in our fiscal year '22.

Speaking of profitability, let's just dive into the profit trends in Intelligent Edge. If we look at year-to-date fiscal '20 through the first 3 quarters, margins were down a little bit, but you've seen nice operating margin expansion. Just walk through some of the puts and takes and what's driving those margin trends, particularly pressure at the gross margin level and expansion at the operating margin.