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

Good morning, good afternoon, folks. This is Simon Leopold, Raymond James data infrastructure analyst, and I'm pleased to add that you're able to join us today for one of our virtual gathering series, a fireside chat with a number of folks from the management at Hewlett Packard Enterprise, HPE. We have with us today the CFO, Tarek Robbiati; as well as Ian Fowlis, who's SVP of HPE Financial Services; and the CFO of Products and Services, Tim Murphy; as well as Nancy Lee, who's a member of the Investor Relations team. So I've prepared some questions, but certainly, if folks do have questions, they'd like to use either the Zoom features or you can e-mail me at [email protected] on the bottom of the welcome slide there. And I'll go through my questions, and we'll have, I think, a good focus on the financial situation, particularly trying to drill down some more on HPE Financial Services, a topic we've argued is not well appreciated, as well as digging into some of the details around the cash flow and the broader trends within the business. Before we do that, Nancy, you had some disclosures you wanted to open up with?

Thanks, Simon. Before we start, let me take a moment to read our disclosures. 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 Form 10-Q. Our actual results could differ significantly, and we assume no obligation to update. More details can be found on our website, investors.hpe.com, and our recent Q4 earnings announcement press release dated December 1. So with that, let me turn it back to you, Simon.

Well, thank you very much, Nancy. I had to do that on a call recently and gave me a newfound respect into how to get through those disclaimers. So appreciate you taking those duties today.

Why don't we start out some of the discussion in terms of where we are in the overall macro environment today? So how about if we start out by thinking about the pandemic as it looks like we're starting to emerge from that situation today with the availability of vaccines. So maybe we don't know the exact timing, but could you remind us of what essentially happened to the company during the pandemic and where you stand today?

Yes, Simon. Thank you. Good morning. Thank you for having us at Raymond James today. I hope everyone on the call is well and safe. And I'm very, very happy to be here with you with my team members and colleagues, Ian Fowlis and Tim Murphy and Nancy. So it's really a good way to start this discussion because, no question, the world in 2020 was nothing like we were expecting. And as you recall, in the second quarter, our second quarter, which runs from February to April, the pandemic started to force some permanent structural changes to how we run our business and how our organization operates. But that is also true for many other companies. But for us, what this actually truly meant is that some trends that we were talking about for a while have accelerated. And those trends, in summary, are all about digitization. Our customers' business was always a need for digitization, but that digitization was perceived to be doable at a at once elected pace. Now it's no longer the case. Very clearly, digitizing your company is a strategic imperative. And it's not a matter of how you could navigate this at pace. It's -- you have to do it and fast. And this is really the key learning from the pandemic for us. We, you recall in October 2019, had already announced a pivot of our strategy towards becoming the S2 cloud platform-as-a-service company. And all that COVID did for us was to essentially force us to do this at an accelerated pace. And so we have built a substantial amount of powerful solutions to cater for this new world. This new world requires all those solutions to be secure, to be connected everywhere you are. We live in a world that is much more distributed than ever. Just between us on the call, I'm sure that you can count about 20 different locations on the planet, and that's why connectivity becomes important. And obviously, any solutions we work through or develop and deliver in these cases has to perform. And so we put a lot of emphasis on building those solutions with Aruba Central, which is our connectivity, cloud-based management solution. It's extremely powerful. We put a lot of efforts in building HPE GreenLake Central. We also put a lot of effort in building our HPE Container Platform, Ezmeral, which we launched. And we are also building a number of additional GreenLake cloud services. That is just to name a few things that we have been doing. Operationally, in the products and services side, the traditional business, we were challenged in our supply chain as a result of the pandemic with the lockdown. It took us 2 quarters, Q3 and Q4, to remedy the situation. Now the backlog is back to a normalized level. And we are -- we have been fixing the supply chain execution. The good news about this is that in spite of the elevated backlog in Q3 and Q4, we didn't lose a single customer order, right? That's very telling about the strength of the HPE franchise, and we're delighted to be in a position to honor every single customer order, not lose one of them. But it has taken a lot of hard work from the entire organization. So we are also -- we had also during the pandemic to take some bold and deliberate actions to protect our financial position. And you recall that in May 2020, in our second quarter earnings announcement, we had announced a restructuring program, and we have been executing on that program ever since. We have made significant improvements in the supply chain as I mentioned a second ago, simplified our operating model and re-envisioned our go-to-market strategy to ensure that we deliver it in an integrated way that optimizes the customer experience. And so one of the things we've done, and clearly, you could double-click on it with it here, is we have really worked on establishing the new segments that we report against. But also as we establish these segments, we are operating on that basis with products and services being sold as bundles with each and every one of those segments with a dedicated sales force, which is a major step forward. So that is a backdrop that we have been operating in. Now on a forward-looking basis, we feel good. We expect the demand for our products and services to continue to stabilize now that the vaccinations are becoming more mainstream, so to speak. And clearly, that is going to -- we feel we're going to have a greater impetus now that digitization is the #1 priority on the agenda of CEOs in our customers, companies that we serve. So that, hopefully, I gave you a bit of an overview, Simon, to start this call. But I'll hand it over back to you with further questions you may have.

Yes. No, I appreciate that. I guess one of the aspects that we're struggling with right now is it does seem that during the pandemic, data center and spending, in particular, suffered. So if we think back to your April quarter year-over-year declines, we're double digit, and we've seen this trajectory of improvement. So as we think about the setup for 2020, did we have activity that was pushed out, you've had some catch-up that you've talked about that helped in your most recent quarter. How do you see the setup for data center spending in the recovery environment, do you see that a reversal and some catch-up as we get to the easier comparisons in April?

It's a great question. So I think if we step back to before the pandemic, there was always the continuous trend of having for our customers to manage a hybrid environment between their data centers and the cloud. And as the world shut down, there was immediate needs that had to be met more and more with as-a-service offerings, and the cloud benefited from it, and so did we. We benefited from it with our GreenLake as-a-service offerings, which essentially brings the cloud experience to your premises, right? And we can -- we were able to continue to operate very well in that space, on-premises of our customers, whether these are their own offices or colocations. And so we saw the as-a-service market on-prem growing really fast. In fact, it's growing now faster than the public cloud at a 58% CAGR. That was what we posted in our Q4 announcement. And given this, we continue to see gradual improvement in customer spending because no matter where you want to place your workload in a hybrid estate, you got to think about security, connectivity, sovereignty of the data, performance, and you've got to digitize, right? So you go back to this fundamental issue. You've got to digitize your business to make your business model more resilient. This is why we feel there will be a second wind or renewed impetus on data center spend moving forward into fiscal year '21.

And the other topic that, I guess, comes out of this macro recovery relates to supply chain shortages. So my colleagues who follow the semiconductor space, I've talked at length about the overall issues within technology because production slowed down, inventory was drawn down. And so now we're hearing fairly consistent commentary about difficulty obtaining the components that everyone needs to build the platforms. What are you seeing? And what's your thinking about a recovery in the supply chain?

So the worldwide supply chains across our industry and also other industries have been disrupted by the pandemic, but also China decoupling, right? So there's very clearly a decoupling of supply chain. And the world used to be flat with everything magically making it across the world from different countries into manufacturing sites and eventually stuff will be produced. Now we have to think slightly differently because of the pandemic and because of the geopolitical situation. We are all forced to think about China supply chain decoupling, therefore, making our supply chains more resilient. And this is a period where supply chain inventories are volatile for many as people redesign their supply chains. That is why, Simon, by the way, for the past 2 quarters, we said we're going to be running a little bit hot on our inventory levels, right? Because we wanted to avoid having a supply chain that is victim of shortages, as we have experienced back in the late parts of 2019. And so we -- it's very, very important for us, as long as the business flows have been stabilized, that we continue to have sufficient inventory across all the component parts that we need to manufacture our solutions. So far, so good. We do experience some shortages in some specific components, but it's not constraining as it used to be more than a year ago back in 2019.

So Tarek, the follow-up to that is that some of the pushback we get from investors is a worry about the working capital. And so the idea, as you just said, we have to build inventory. We have to restock the inventory during this period. How much of this challenge was incorporated in the free cash flow forecast that you offer to the analysts back at the SAM in the fall?

So absolutely. It's -- obviously, it does have some repercussions on free cash flow. And all of those challenges were factored into our guidance on free cash flow. We feel very good about our free cash flow guidance for fiscal year '21. There will be no changes to that as we go along. I don't foresee that inventory challenges will affect that, given the level of inventories that we stocked up with at the end of Q3 and the end of Q4 of fiscal year '20.

That's really very helpful. Also, during the pandemic, HP announced some cost-reduction efforts. And given the point of time we are, could you, first of all, remind us what initiatives you undertook to reduce operating expenses and where we stand on this program?

Yes, thank you. So the program aims at delivering annualized net run rate savings of $800 million from the FY '19 baseline and with an objective to attain those $800 million net run rate savings by the end of fiscal year '22, with most of the savings being realized by the end of fiscal year '21, the fiscal year we are in right now, right? And so timing is everything, right? And the more -- the faster you go, the more you benefit in a year with those savings. We've gone to extreme length and detail in building a program to deliver those savings. And you will see that unfold over the next quarters as we report. Particularly, what has happened is we have simplified the business. We have reallocated resources very deliberately in the areas of growth. We have rebalanced our go-to-market sales force across those. We have taken big strides on reducing our real estate footprint, which reduces overhead costs, and you will see that in our reporting. In a world where we are all working from home, you don't need to spend much time in the office, this is a stranded cost. Even before the pandemic, we were running our real estate at a 65% utilization rate. And so you can imagine with the pandemic that our utilization rate has plummeted. So we are completely rethinking our real estate portfolio. We do need offices. We do need presence in the markets. But the way the offices are going to function, they're going to be more a center of collaboration, brainstorming and gathering than actual cubicle where we all work because we can work from anywhere we are in the world and from our homes, in particular. And this is why some acquisitions we made like Silver Peak is spot on from a timing standpoint because it is allowing that connectivity across all the locations that we have. And it's a saving for our customers. It's also a saving for us, quite frankly, because we can connect more people wherever they are without having to spend on real estate. So I think you're going to see this over time as we report and as we realize those run rate savings moving forward. Our margins, operating profit margins should tick up over the upcoming quarters.

Great. And the last macro topic I wanted to get your thoughts on are related to the weaker U.S. dollar and how that affects financials for HP Enterprise.

Yes. I mean, we are a global business. A large chunk of our business is done overseas. I think there's still substantial volatility in FX rate around the world. It's too early to tell whether this will have a -- represents a tailwind for us. Obviously, from a cost-reduction standpoint, it does not, right? It actually is a headwind. But we feel that in any event, there is too much volatility at this stage to really say it's going to flip one way or the other. We're very happy with the way we stand from an FX standpoint. We do have an extensive hedging program in our treasury team that hedges on a 24-month window, currency fluctuations with, at any point in time, 12-month hedge. So we feel very comfortable with where FX rates are going, and this does not have any bearing on our guidance that we gave you at EPS for fiscal year '21 and for Q1 '21.

Great. And then I want to pivot more to HPE-specific trend. One of the big topics within our sector in terms of kind of discussion is focusing on how much recurring revenue there is. And could you just remind us in terms of your business how you measure your recurring revenue, profitability of this recurring revenue and how you see this trending?

Yes. So look, we are very well diversified as a company with -- we have a high mix of recurring revenue and profit. As a reminder, our Pointnext OS services organization, our Aruba software-as-a-service business, our CMS, Communication Media and Solutions business, our Financial Services business, all together, make approximately 1/3 of our revenue and, most importantly, about 75% of our profits. And these are recurrent revenue streams and which gives us a good visibility into future quarters. Now one of the most profitable parts of our company is Pointnext OS or operational services. It is an all contract-based business with 3-year terms on average and strong renewal rates. These renewal rates and the contract terms tend to be extending with GreenLake as we pivot the company more and more as a service, which is a good thing. And financial services, and you'll hear from Ian, I'm sure, is a very high-quality financial services business. Our portfolio performed extremely well during the global financial crisis. And it's no different today with the pandemic. The lease terms that we offer are on average of 3 years, and the loss ratios that we have are very, very well under control. So there's quite a bit of our company's revenue that is recurring, and that's good news. It is giving certainty of profit. To some extent, it gives also good visibility on cash flow generation moving forward.

So I want to drill down into HP Financial Services next. And candidly, we ask these questions because we think that there's some pushback in the investment community as to why would you want to do this? And so I'd like to try to dig a little bit more deeply, particularly because on paper, it seems to saddle HP with a bunch of debt. So why don't we think a little bit about what actions you took during the pandemic? So if we reflect back on 2020 and customers were facing financial challenges, and you, at that time, announced some incentives, some programs. Help us understand what you did in terms of reaching out, supporting your customer base, and how this might have played into the goodwill and the general trends within the business?

Sure. So let me start by just talking about FS in broad terms, particularly around the capital structure, and then I hand over to Ian. Ian will tell you chapter and versus what has happened to HPFS during the pandemic. So yes, it's true, we have debt in HPE, but we also have a book of $13 billion, and that debt has to be looked in conjunction with the book, right? And so what we have been doing from a capital structure standpoint is to push the debt to become of a different nature, more asset-backed type of debt and with that asset-backed debt coming in at much cheaper cost of capital. So we are at our fourth or fifth issuance right now of ABS debt. Ian, I think that's the right number. It's the fourth time we go to market.

February will be our fourth issuance, yes.

That's right. And so as you can see, the debt becomes more and more structurally secured at a lower cost of capital and at the HPEFS level, which frees up the debt capacity over time for HPE. But let me ask Ian to address the details of the operations of HPFS, which is something very interesting.

Sure. Thanks, Tarek. Yes, FY '20 for us was an interesting year. As Tarek said, we started the year with a $13 billion book of assets. We ended the year with a $13 billion book of assets. But in my 25 years in this business, it was probably the most interesting year we had. From a standpoint of what did we do to address the pandemic, I really break it into sort of almost 2 separate work streams. That was how did we support customers who were looking to continue to acquire equipment, and how did we support the customers that were on our books already in that $13 billion portfolio. So as you mentioned, Simon, we did launch a $2 billion program, which was really targeted at new customer acquisition of product. And that can be financing, that can be some of our asset management capabilities. That was pretty well received, I would say, throughout the year. And it addressed all sorts of different areas of the pandemic. So you highlighted supply chain. One of the interesting things about what we do is we have leases, leases mature, equipment is returned. We were able to turn that equipment, that certified preowned equipment, back into the market. And as supply chain shortages were there, we were able to help satisfy customer demand for product using our certified preowned equipment that was off the back end of a lease that customers just couldn't get enough on the new side. So a lot of offers in fiscal '20, both on the financing side as well as on the certified preowned asset management side, which was addressing a lot of supply chain challenges. The second one was really how did we support the customers that had some sort of financial distress. We didn't really go out and proactively offer something. We were much more on a reactive side. We set up an internal desk. We ended up getting of the $13 billion portfolio, about $1 billion worth of requests to offer payment deferrals to customers. The most standard offer we gave was sort of a 90-day deferral. We gave people sort of 90-day payment relief, and that was really in that March through May to June time frame and then turn the leases back on sort of after that 90-day period. Did that on about $1 billion of the portfolio, so about 8% of the portfolio kind of took us up on that. It was much more in sort of the small to medium space in the portfolio. Those payments have obviously been turned back on. The performance of the business in Q4 was quite good. And I would tell you, our cash collections has actually returned to the pre-pandemic levels by Q4. So yes, we saw some payment disruption in Q2 and Q3 for us. But by the time we exited Q4, we are collecting back at the pre-pandemic level. So the business performed almost better than expected considering the backdrop.

And do you have a little bit of a tailwind at this juncture as some of the payments are catching up?

I would say because the majority of the activity really was sort of all rebooked through the end of the summer months, I would say we are sort of as we enter Q1 here, we are sort of a steady state. And looks like where we exited Q4 with the cash collections level will be sustained as we go through Q1.

Now, Tarek, I think, alluded to the default rates in the prior economic crisis, 2008, 2009 as sort of the benchmark. But if I recall, the numbers are pretty low. But could you help us quantify where we are and how that compares as a percent?

Sure. Sure. We historically run about 50 basis points from a loss rate. And we were basically on track through our first 2 fiscal quarters. We did see a little bit of pressure in the second half of the fiscal year, and we exited the year at about 0.7%. If you compare that back to the last economic crisis, we were -- we saw maybe about a 10 basis point increase, where here, we're seeing about a 20 basis point increase. So we were a little less immune, I would say, to the pandemic as we were back in that last economic crisis. Our loss rate for Q4 tipped just over 1%. And we would expect to see that loss rate in Q1 come back down under 1%, and by the end of this fiscal year, return back to sort of that more 0.5 point level.

Great. And thinking back, pre-pandemic, the return on equity on this business, I think, was in the neighborhood of 15%. How has it been impacted? And when do we return to normalized levels?

So we fell just below 15%. We were in that kind of 13% to 15% range for fiscal '20. I would believe that we will exit fiscal '21 at or slightly above the 15%. So it's climbing back up. Obviously, a lot of that will depend upon the success of the vaccines and how quickly the world is back to normal. But we are seeing a favorable progress in the loss rates, and really, it was that increased loss rate that drove the return on equity below the 15% level last year.

And then apart from the financial contributions of HP Financial Services, how does this business unit really fit into the company strategically? Why is it important that you do it other than what it provides to the bottom line?

Yes. Look, I mean, our value proposition has never been to sort of go out and offer customers low-rate financing. Our value proposition is to build that long-term relationship with the customer, deep ingrained with the customer and bring both financing and what we consider our asset management solutions. So as I mentioned earlier, the certified preowned. We look at a customer and go deep into that customer with all sorts of opportunity. And so I think as you look at that from the standpoint of HPE, our goal really is to drive more HPE products through those customers and HP services. So we are behind the GreenLake solution from a financing perspective, and I think we do play a vital role as HPE moves forward.

Let me add to that. I think it's really, really important to underscore the fact that HPFS is the major enabler of our as-a-service pivot. And think about customers who have budget constraints for their IT budget. Thanks to the asset management business that Ian referred to, we are able to augment the investment capacity that our customers have to digitize their business, right? And so what HPFS does is lock, stock and barrel, they can buy back on a sale and leaseback basis the legacy infrastructure, freeing up investment capacity for GreenLake solutions at our customers. And that's what they do increasingly, right? And this is why it is such a great enabler, aside from a financial standpoint, offsetting the capital intensity that comes with GreenLake. So it's a very, very important enabler to our strategy. There was also a question that comes with the chat line. I'm happy to answer any question comes through the chat line. It's important that we -- from a process standpoint, we answer them collectively because I don't want to have a selective disclosure issue. But one of the question which was very pertinent on the HPFS side is where were the deferrals? And how did you handle the deferrals of the contracts. And essentially, what people ask for is, in some cases, relief on payments, and this has allowed us to extend the contracts in time towards the tail end of the contract duration, there was an extension, which actually meant that this is very good for the asset management business and very good for the profitability of HPEFS. And this is why Ian mentioned to you that he sees the return on equity equation going back north of the 15% mark into fiscal year '21.

Now one of the other topics that comes up, and Tarek, you mentioned this, is you've got debt from HP Financial Services that's asset-backed. When we think about how to value the stock, we've backed out this debt when we calculate the enterprise value. But it's very important to understand how do the credit agencies treat HPE Financial Services when they think about your credit rating?

Yes. So look, the credit agencies associate the debt that we have with the book of HPEFS for the most part, right? So we have about $15 billion of debt today, and $13 billion of that is attributable to HPFS. And so they look at this through, they see through that debt, so to speak. And they rate us on the basis of their classic credit analysis around the debt-to-EBITDA ratio. And we are very, very much engaged with the credit agencies because we really are jealously protecting our investment-grade credit rating ratio moving forward. It's a healthy thing to do, particularly as cash is readily available. You can borrow. But over time, over the long term, nobody truly knows what the inflation trajectory is going to look like for the economy. And that's why we are careful in maintaining our investment-grade credit rating and engaging with rating agencies as we manage our balance sheet.

So with that in mind, you've reiterated the point that investment grade's important. What is your ability to raise debt, given that objective?

We have a fair bit of investment capacity, which we can put to use. It's not so much the capacity that matters. The capacity matters if you -- for a particular purpose. It's really more the purpose. What would you use that for? If you were to acquire a profitable business, then you have more investment capacity. If you're acquiring a highly dilutive business that burns money, then obviously, you have less to work with. And so we are very conscious of this, and we pay a lot of attention to how do we use our investment capacity for. And I would say this explains to you also why we spent so much time to return HPE to positive free cash flow at the end of fiscal year '20 because obviously, nobody wants to burn cash. And whenever that happens on a sustained basis, you're in trouble. But also, there was a need to protect our investment capacity for the future as we look into continuing to grow the company inorganically.

Now nobody can necessarily say when we're going to see increased inflation. But clearly, this is the topic that's beginning to come up. We heard Chairman Powell the other day talking about the prospect that eventually inflation becomes an issue. What does inflation mean to HPE Financial Services and the business overall?

Ian, do you want to take that one?

So the lease portfolio itself is hedged. So from the standpoint of inflation, I mean, we write leases in local currency in all the markets. So -- and we obviously then price to markets. So if rates do rise, we would obviously increase our rates out to the market. So I would say there's probably little to no risk other than it does take time for the pricing to catch up. So we tend to benefit as rates fall, and you do tend to see a little bit of compression as rates rise.

So before I pivot to my next question, I wanted to insert one of the questions we received on Zoom. And this is just if you could refresh us regarding your thinking on the H3C joint venture, and maybe just remind folks who are less familiar what exactly that is, and where it shows up on the income statement?

Sure. So thank you, Simon. So we have a 49% stake in a company called H3C in China, which is a very prominent company in China that manufacture servers, storage and networking solutions. So we sell to H3C some of our products that they on sell into China, and we resell some of their products in other markets around the world, particularly networking products. You don't see explicitly those 2 business flows because they are part of our Compute and Storage segments that we report for what we on -- what we sell on to H3C. And what is being resold for H3C is shown into the Edge segment under Aruba. But most of the economics are visible through our OI&E line. This is where we book a minority contribution. And we feel very, very good about our business in H3C. No one has a setup with serious management rights on a technology company in China like we do. Our 49% stake has paid dividends in excess of $200 million to us in cash in fiscal year '20, which is a really good result. We have a put option, although that is exercisable all the way onto May 2022 to sell all or part of our position. And so far, so good. H3C is making a lot of money in China, even in spite of the pandemic. The results of H3C are visible for all of you if you want to look at them through a listed parent called Unisplendour that is listed in the Chinese stock market. And you will see how good the trends of H3C are in that business. And this is why we're not in a rush to exercise our put option. We keep taking a look at it. We have some time to make a decision, and it continues to accrete value as we speak.

Great. I really appreciate that. Now where I wanted to go next was to dig into the free cash flow forecast that you've offered The Street. So as a reminder, $900 million to $1.1 billion of free cash flow in fiscal '21. And we talked a little bit about the supply chain and component issues already. But what really maybe would be helpful is, let's just step back. What are really the key risks and variables, maybe do some sensitivity, that you see could influence this target either higher or lower? What's the [indiscernible]

Yes. So we feel very good about our free cash flow guidance of $900 million to $1.1 billion for fiscal year '21 for several reasons. First of all, our business is doing much better at the end of fiscal year '20 than it was in the second quarter of fiscal year '20. The momentum that we're seeing on orders is set to continue. That is a very important point for fiscal year '21. Vaccines are going to be rolling out. So business activity will get progressively back to normal. That is also a very good tailwind on our earnings. Also in terms of tailwinds, remember, the restructuring program will also start to deliver benefits and increasingly so. Yes, there are costs attached to the restructuring program that are headwinds, but the benefits will progressively outweigh the cost. And from a headwind standpoint, we have to take into account working capital needs, inventory. Inventory does affect cash to some extent between periods, but we feel pretty good about our inventory position as we mentioned. There is also a fair bit of working capital that is a headwind that is relating to our HPC and MCS business. Those supercomputers are very large machines, require us to buy the components and start to build them on site. Some of these systems are huge. I mean, they literally are the size of 2 basketball courts put together. And so you don't build them in a factory and then ship them. It's not possible. You build them on site, so you incur the cost on-site, and then eventually, you recoup that. So that is a short-term headwind. That will materialize in revenues moving forward. We had an excellent Q4 with HPC, MCS. We're winning every day more and more of these very large systems. There are announcements that we're making every -- very regularly every other week, there is a win. And it's important, therefore, from our standpoint, that we seize that opportunity, right? There's a pipeline of $5 billion of deals in the HPC, MCS space. Our win rate has been spectacular. We win 4 out of 5 of them worldwide, and we need to continue to seize that opportunity. So all of those puts and takes have been factored into our $900 million to $1.1 billion guidance on free cash flow. And again, I feel extremely positive about it given our planning, given where we stand, and most importantly, the momentum we continue to have in our business into fiscal year '21.

Tim, did you have something to add on that? I'm just looking at the body language, and it looked like you had something to say regarding the trends here?

No. I think it was a -- we spent a little bit of time talking at SAM about just the health of the HPC, MCS business. And we talked about almost $2 billion of exascale contracts already won today. As Tarek mentioned, a $5 billion pipeline of future deals. We had record revenue in Q4 in that business. We had almost 25% year-over-year growth. And so as we laid out at SAM kind of the investment thesis that this is a business we see that's going to be growing a lot, and it's really based off of unique technology and capability we have. We have really software -- great software assets like our Shasta software. It's a unique IP that really allows AI solutions and interconnections that our customers, our governments around the world are really interested in. And so it's been exciting. It's been an exciting space. We obviously had the acquisition of Cray last year, which added to that capability. And we have seen a great win rate in this space, and it's fun to be a part of a business that's really growing, winning. And as more customers see this AI capability that they want, we see just a lot of supercomputing request, whether it be for weather or for medicine that are constantly popping up. And so being on the front line and being a part of that business and driving it each day, it's been a lot of fun.

Great. I guess we did touch on some of the components and the inventory issue. One of the other questions that we've heard from investors regarding the challenges to free cash flow is as the organization pivots to GreenLake and as a service, the thought process here is that this pressures some of the free cash flow in that you own equipment, you buy equipment that sits on your balance sheet. And while you're getting essentially the subscription fees, it does create some near-term headwinds. Can you help us understand the materiality of that issue?

Yes. So I want to remind everybody about the construct of GreenLake and how it works, right? So when we report to you our ARR, our annualized revenue run rate, this does not include the hardware revenue that is associated to a capital lease construct, right? So our mix of lease types is 50% capital, 50% operating lease. So if it is an operating lease, the amortization of the hardware is baked into the ARR. If it is a capital lease, the revenue is recognized upfront. And we only recognize in the ARR the interest charge. And so you can dial up more the operating lease that is beneficial to the ARR. The drawback of it is that it does trigger a CapEx expense that is affecting over time free cash flow. But on the whole, when you take all the puts and takes into consideration, it's much -- it is a happy problem to have, put it this way, right? Because the more GreenLake customers we have by way of operating lease or capital lease, the more recurring revenue we have, the more momentum we have in earnings in the business. And so I don't have a problem dialing up aggressively GreenLake, and that's what we are doing. That's why our ARR is growing at the 30% CAGR that we flashed when we first started explaining GreenLake because it is going to be triggering a very strong revenue momentum in our business moving forward. And by the way, any sort of capital intensity that stems from GreenLake is factored into our guidance, our free cash flow. And again, I feel very comfortable with our fiscal year '21 free cash flow guidance of $900 million to $1.1 billion.

And so you've talked about some longer-term targets in the past. Could you help us build a bridge between the fiscal '21 forecast and the longer-term free cash flow objectives?

Yes. So in simple terms, as a reminder, when we spoke about free cash flow at SAM, we guided for fiscal year '21 saying there will be $900 million to $1.1 billion of free cash flow generated in fiscal year '21. And we also, in that number, factored in the cost of our restructuring program to deliver those $800 million of net run rate savings that we explained. We also highlighted that we are finishing our next-gen IT implementation in fiscal year '21. And so at the end of fiscal year '21, the majority of those restructuring costs and next-gen IT costs would have been incurred. The momentum in the business carrying forward into fiscal year '22 lead us to believe that in fiscal year '22, we will exceed the free cash flow high that we attained back in fiscal year '19, which was $1.7 billion. And so we are very comfortable about our free cash flow trajectory and the fact that it more than doubles over the period between fiscal year '20 and fiscal year '23. And that is what we explained at SAM, and I'm happy to reiterate today.

Great. Now I appreciate that. And that sort of sets me up to ask you this next question because we always ask for more is maybe some thoughts on the dividend policy and share repurchase plans. Help us understand maybe the equation and thought process you use between these 2 areas of returning capital?

Sure. So first and foremost, what is very important for us is that we continue to innovate and drive growth. This is a sector, tech sector. If you don't innovate, you die. Period. So it's really, really important that we keep the innovation going and that we invest for the growth. Now in saying that, we do recognize the importance of capital returns for our shareholders and we have, particularly in mind, the dividend policy. And so we do believe that our investors need to be remunerated. And this is why we kept dividends, and we have built now a track record of paying dividends quarter after quarter for our investors. And we kept that track record during the pandemic when it was at its peak. With respect to share buybacks, share buybacks are effective when the growth has been dialed, where we have to dial up the growth. And if there is excess cash, then we will look at share buybacks again at the right time. But we need to be in a position where we have exhausted all the avenues that fuel the growth. And then any excess cash will be put to use at the right time by way of share buyback. In the meantime, dividends continue, and we will continue to return as much dividends as possible to our shareholders as we progress moving forward.

And that answer, I think, dovetails nicely into asking you about your thoughts on acquisitions. So you're not among the most acquisitive companies I follow, but you've done a couple of deals. Silver Peak being the most recent for SD-WAN and SASE space, but how do you think about selecting deals? Are there certain elements where is something too big? Do you have to be immediately accretive? What's the thought process? What are your key criteria on acquiring companies?

So we are acquisitive, but we are disciplined in doing so. Okay. What I would say to you is that we've done a couple of acquisitions that were midsized like Cray that was mentioned by Tim, and Silver Peak, the most recent one. And we were very disciplined in ensuring that what we buy is obviously on strategy, so accretive to our strategic agenda and accelerating to our strategic agenda. But at the same time, from a financial standpoint, we're disciplined with respect to what we pay. And we have very clear return hurdle rates that we need to meet when we make an acquisition. And I've got to tell you, and I have said that on numerous occasions that I feel the market overvalues growth and undervalues cash. And in these days, I think what we've seen in the financial markets, it's diplomatically a bit unusual. But at some point, it will revert back. Valuations have to revert back to more reasonable multiples than what we are observing currently. But what we are observing currently is the fact that there is way too much liquidity in the system, and that liquidity has to find a use. Having said that, we're not falling into that trap. We have to remain disciplined and look at acquisitions that are meeting our hurdle rates and that are accretive to our company.

Great. And I think certainly, part of the narrative around HP Enterprise has been the transition towards emphasizing GreenLake and as a service. And so this seems important, sort of bringing us back to partly where we started. So what do you see as the advantages to the business model to pivot more of your business to as a service as opposed to platform sales?

Sure. Thanks, Simon. I think the best person to answer this question is Tim, and I will ask him if it's okay to take it from here. Tim?

Yes. Thanks, Tarek. So it's a great question. Tarek introduced earlier on the call the idea of giving customers kind of a public cloud experience on-prem. And that's really what GreenLake delivers. And the interesting data point is that IDC and a lot of the market research shows that 70% of the current workloads and future workloads are still staying on-prem. And that might be a little bit of a shocking statistic to some of our listeners, but -- and they may ask why. Well, I mean there's factors such as data gravity, security and latency concerns, app entanglement that happens. And then there's compliance and regulatory challenges as well. And so we see a very growing business on -- with this Green -- with our GreenLake solutions and as-a-service solutions. And that's represented with some of the numbers that Tarek quoted earlier. I mean, we're seeing 30% growth in this business right now. And why is it important to HPE? Well, one of it is -- the main reason is it creates a really sticky relationship with the customer at the end of the day. When you know a customer's environment very closely, when you're offering them unique payment term options, when you're offering them software capability through our GreenLake Central portal that allows them to provision workloads, allows them to meter and monitor their applications, it provides a really close relationship. And we've seen customers that as we move them to GreenLake, we have almost a 99% stickiness with that customer going forward. And it creates an ongoing business relationship at good profitability levels, I might add, for us at HPE. And customers are really interested in this because of the flexibility it offers. We talked earlier on the call on, Ian and Tarek did, about payment and flexibility in cash flow, the ability to only use what you need instead of overprovisioning and paying. And so that flexibility, along with our ability to kind of meet them where they want to be with their workloads, whether that be at the data center, whether that be in a colo or an edge environment, all those things have led to kind of this business' growth. And so we're really pleased with it. We have a book -- we have almost 900 accounts running GreenLake today, almost a $4 billion book of business in total TCV. And so this has been an area that we continue to believe will grow, and it's been a good complement to offering our customers a unique experience on-prem.

And Tim, are there any generalizations we can draw in terms of maybe the verticals or a subset of what types of customers are most likely to embrace GreenLake?

Yes, it's a great question, Simon. I mean, so far, what we've seen is it's definitely been the enterprises and public sectors have been some of the first movers when it comes to these GreenLake as-a-service offerings. I mean we, really, across enterprise customers, have seen it in many different areas, whether it be in automotive or financial services and as well as a lot of different public sector customers. I think one of the things we're working on is now kind of deploying some of our offerings and creating pricing kind of through quick quote tools and other things to actually try to drive these as-a-service offerings down into the SMB and commercial space as well because we do believe that the economics make sense for commercial and small and medium business customers as much as they do for enterprise. But I would say that definitely first movers have been enterprise and public sector.

And I know you mentioned metering, and maybe you can double-click on that in answering the following. But help us understand how is your as a service different from what your competitors offer? And how is it different from a typical leasing arrangement?

Yes. No, that's a great question. I mean, I think one of the things HPE's been -- was one of the first movers in this and as-a-service offering. And we came out several years back in this space. And when you think about some of the things that the public cloud does, a lot of it has to do with creating software platforms for people to develop their apps, giving them ability to do provisioning of service applications, looking at their workloads, metering, how much they're spending on things, being able to provision things instantly from one workload to another. All that requires software and investment, and HPE has been on the forefront, investing for almost 3 years in this space. So when somebody says, "Hey, how does this differ from leasing?" It's really the combination of all the flexibility and financial payment term results that Ian talked about earlier, combined with all the investment of the software, portals and capabilities that we bring. And so when you bring those things together, plus you're bundling world-class products that have unique owned IP and services that -- locations that service customers across the globe, you kind of add all those value propositions together. That's why we see a competitive advantage right now in this space.

Now the number I have in my head was a metric of essentially 5% of sales by fiscal '23, and you had some good growth rates off of a small emerging base. But how can -- maybe update us on what you think are good longer-term targets for GreenLake and as a service as a percent of revenue?

Yes, certainly. I mean, so the 5%, if you look at it right now, we already have about 5% of our business running on GreenLake and as a service. And with the growth rate we're seeing at 30%, it's very equivalent to the growth rate you're seeing in other public cloud companies. I know Microsoft announced just the other day and had similar growth. So we're -- we expect this business to continue to ramp. Obviously, we continue to keep an eye on the U-shaped recovery that we're seeing in the market. So I'll probably reserve from mentioning exactly where we think we'll be by the end of '23. But with the 30% growth we're seeing and already being 5% of our business, we believe that this business will continue to grow and be a big piece of our business going forward.

Great. Last couple of questions before we run out of time. We recently have published our own channel checks, talking to distributors and value-added resellers. And we do get a sense that a recovery is coming in place. And I think the biggest debate is does recovery show up in the April quarter, the July quarter, the October quarter? Nobody is debating whether or not we see it. Could you maybe give us a perspective of how you see, particularly compute and storage trending in calendar '21 relative to the long-term targets that you disclosed at the analyst meeting back in the fall?

Yes. Thanks, Simon. So no, we're -- we just -- we believe that we'll -- we're in line with the guidance we provided at SAM. I think one of the things we tried to do for the investor community in SAM with Antonio and Tarek presenting was to really talk about the value proposition each of the businesses drive at the end of the day. We talked earlier about HPC, MCS and the tremendous growth we're seeing in that business. And Tarek talked about some of the working capital commitments that we have to make to that big growth business. When you look at compute on the other side, I mean, here is a $14 billion a year business product plus services. We believe that we have unique capabilities in our workload optimization, our security. We've been #1 in market share in that business for a while, and this business really is not going to be a high-growth business. It is going to be a slower-growth business, but it offers tremendous free cash flow overall for the company. And there's pockets of growth that we're definitely seeing in the compute space when you think about Tier 2, service providers, when you think about the 5G rollout in telco. So we see some pockets of slowing in compute and other pockets really accelerating. But the cash flow -- free cash flow generation that we tried to kind of highlight at SAM gives us a really nice OP rate kind of in that 10% to 12% range that we guided in SAM. And we see AUPs increasing right now on our boxes. And so that's been a nice outlook. When you think about the Storage business, I mean, this is a business that I do think is sometimes a little bit underappreciated by investors. We have a $5 billion product in service storage business, which is almost the equivalent size of NetApp inside HPE. And this business has a lot of unique IP. We talked earlier about acquisitions, Nimble, 3PAR, SimpliVity, all acquisitions in the past that offered really unique capability in both block and hyper-converged storage space, specific AI capabilities through our infosite assets and offers a really nice OP rate, one of the most profitable business inside HPE and has very high service attached at very rich margins. So we think about each of our 3 businesses, it really, at the end of the day, they each offer unique value proposition to investors, compute and storage being slower growth, higher profit, better free cash flow, where the HPC, MCS offers a real growth trajectory for investors to be interested in. So hopefully, I answered your question, Simon.

You did. I got one last question I want to ask that came in over e-mail. And I know we talked about components earlier, but you're just bringing up the storage business and the strength there. One of the topics we're getting asked about is the debate about the rising cost of NAND. So that's an input cost. We didn't address that specifically. Maybe if you could just give us some thoughts on how that -- how you're thinking about increasing component costs in memory and DRAM for servers as well.

Tim, why don't you start, and I'll add some comments in the end. Go ahead.

Yes. Thanks, Tarek. So we did -- we are seeing the spot rates increase in the memory space. That's been driven by demand, whether it be automotive or in the mobile phone area. And we're keeping a close eye on it. Certainly, we believe we will pass those rising costs on to our customers. And we've already taken some pricing actions in February as we see DRAM moving up on the memory side. I would remind you that we've done a lot of strategic buying in this space as well. Tarek talked about earlier some of the inventory position that we're holding. I mean, one of the unique things when you have the cash and the balance sheet that we have, you're able to go out and do some strategic buys. Now that's a little bit of a hit in working capital, but it really gives you a favorability in profit. So as memory rises, we also have healthy inventory balance sheets that allow us to be very competitive in our pricing against our competition and continue to win in that business space. Tarek, any comments you wanted to finish with?

I think you said it well. I think it's -- this space is where the volatility in our cost structure is, and that's why we spend a lot of time and money making sure we smooth that volatility with strategic buys. We've been doing that for the past 2 to 3 quarters, and we'll continue to do so as we move along.

Well, folks, we crossed over the 1-hour mark. And I'm very grateful for your time and appreciate the level of detail. A lot of really great discussion. So for the folks who joined to listen, thank you, to Tarek, Tim, Ian, Nancy. This is Simon Leopold. We're going to sign off now, but thank you very much for joining us today. We'll have a replay available for, I believe, 90 days. And if anybody has follow-up questions, feel free to direct them to either me or you can reach out to Nancy as well. But thank you very much for joining us.

Thank you.

Thank you.

Appreciate it.

Thank you.

Have a great day. Bye-bye.