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

Hello, and good morning or good afternoon, wherever you are dialing in into our bottom line matters, CFO call series. We really try to get the perspective, the financial perspective and part of the strategy and the financial strategy from the CFO calls that we've hosted and we've loved your participation in these, and we try to going to a little bit more in-depth into financial strategy, capital returns how the model is shipping out. Before we get started, I need to mention that conflict disclosures related to the individual companies or securities discussed on the call today can be found on the call invitation. Well, I'm really excited today to welcome Tarek Robbiati. You all know him. He was appointed EVP and CFO of HPE in 2018. So just ago, 4 years ago. And frankly, I have a lot of respect for anyone who's had the CFO role in the last 3 years because they were kind of crazy challenging to hold kind of leadership position through this period was kind of nuts. And we as analysts look at the numbers and how they move, but the CFO is managing these numbers and there's a lot that goes on between sort of the portfolio and then getting it all the way into the financials. And so I think sometimes we underestimate the amount of angst that maybe the job carries just because what we've gone through with COVID and supply chain and reshoring and everything else has been a little insane. So we're so glad to have someone with Tarek experience with us today. Previously, he was CFO of Sprint, where he drove Sprint recent transformation program. He was also CEO of Australian Financial Services Company, FlexiGroup, and has held various leadership roles at Telstra Corporation. Before we get started, however, I just need to pass it on to Jeff Kvaal, who is IR for HPE to go through the safe harbor statement, Jeff?

Thanks. You'll hear some forward-looking statements in our discussion today. These are based on risks and assumptions that are described in our SEC filings, including, but not limited to, our annual report on Form 10-K for the most recent fiscal year. Our actual results could differ materially from today's discussion, and we assume no obligation to make updates to any of our forward-looking statements. More details can be found on our website and our recent 4Q earnings announcement from November.

All right. Thank you, Jeff. And with that, Tarek, welcome. Thank you for spending your afternoon here with us. We really appreciate it.

Wamsi, thank you. Good afternoon to you, and thank you very much for the intro on the life and joy of a CFO in the past 3 years. I found that absolutely an accurate description, but believe me, it's as exciting as it is challenging, and I'm glad to be here today with you and your clients.

So Tarek, I guess the -- I mean, to get straight to the point is like when you think about what the economic backdrop is, right? It's kind of uncertain. And there seem to be a lot of different outcomes and scenarios that could play out. So as CFO, how are you thinking about these different outcomes? And how are you preparing HPE to handle these different outcomes.

It's a great way to start the conversation, Wamsi, and thank you for asking this question. And so needless to say, in a volatile macroeconomic environment, it's really important to engage into scenario planning as a CFO. And the guidance that we set at our Securities Analyst Meeting back in October 22 for fiscal year '23 that started November 1, was encapsulating a range of possible scenarios using at the time, the best understanding we had on the macro picture. Our guidance that we gave for total revenue growth of 2% to 4% remains unchanged. We're very comfortable even now in January 2023 about this guidance. And the reason why this is, is the dominant view that we developed back then is coming from our order book. And we are entering our fiscal year '23, with an order book that is even higher than the order book we ended fiscal year '22 with. But there is one more positive to add is that the supply environment is much better than it was in the early part of '22, thanks to a redirection of supply capacity away from consumer tech to the B2B space where we operate. And so we are entering fiscal year '23 with a very strong momentum. And I would say, not a benign supply environment, but a better supply environment than we had originally forecast. And therefore, we feel that our ability to convert the order book into revenue is stronger. Hence, our confidence in attaining the guidance that we foreshadowed that time of 2% to 4% top line growth in constant currency.

Okay. That's a great start. So maybe just to dig a little deeper, Tarek, like if we were to think about the various scenarios that could play out. And I think people are more worried about downside scenarios in general across most companies. And so if we had a more deeper versus a more shallow recession. Is there a way to think about -- so what are some of the levers? I know at the Analyst Day, you had mentioned sort of like rightsizing the company and actions that were taken. But as you think about maybe a shallow versus a deeper recession? Is there a way to think about how that might changed the margin profile of the company if, let's say, for every incremental point of sort of maybe headwind that you might experience?

Yes. So look, we've taken the tough medicine at HPE 3 years ago at the beginning of the pandemic in 2020. And we did run a cost optimization and resource allocation, capital allocation program that was very deep in the company. And we feel that we are rightsized. And so in November 22, when we announced our full year results. We reiterated the notion that we don't foresee a restructuring moving forward. But having said that, we have to keep the discipline on hiring the discipline on discretionary expenses and so on and so forth. So really, to the extent that there is a lid on spend and that at the same time, we continue to convert our order book we can, in simple terms, weather the storm of a recession. Now how long the recession will be is anyone's guess. So I can only take it a quarter at a time, but we feel good about at least the next couple of quarters, then we'll have to determine whether the environment is significantly deteriorating beyond what we foreshadowed. But so far, so good. We don't see the environment deteriorating beyond what we anticipated. So for example, one of the things we factored in our guidance is the impact of foreign exchange rates. You know Wamsi that about 55% of our revenue comes from overseas. The rates have changed between October 22 and now for the better. So the headwinds that we saw from FX is not as strong that we anticipated. And so this is helping a little bit. Whether this stays the same or not, it's anyone's guess, but they are -- we've planned for the worst as we should, and we are executing to the best we possibly can.

Okay. No, I'm glad you brought up the FX point because it is on a lot of investors' minds. You had guided 2% to 4% adjusted for FX. Foreign exchange rates, you could argue, I mean, for calendar year anyway, probably are maybe 3 to 4 points better in many instances versus 90 days ago.

That's right. That's right.

Would you expect that to kind of flow through to upside to your 2% to 4% kind of guidance range?

I'd like to think so, but it's too early to tell you on a definite form. It really much depends on the Fed policy on exchange rates. So I don't believe that the relaxation of the monetary policy is going to happen quickly. So in that context, I do expect, therefore, that with the economies worldwide that are not in as bad a shape as originally anticipated, even if you take Europe or Japan, I do believe that, for the next 6 months, we can withstand some of the FX stocks that we originally anticipated. So our guide on revenue growth of 2% to 4% in constant currency remains. We will let you know, obviously, at our Q1 earnings, whether there is a different picture. But so far, so good. We're confident we can attain 2% to 4% top line growth in fiscal year '23. And our guidance, obviously, on the EPS front doesn't change. It is also very much the same as what we said at SAM, and we are reiterating this, which is a guide of $1.96 to $2.04, $2 at the midpoint of the guide for our EPS target in fiscal year '23.

So Tarek, just to be clear, right, the 2% to 4% at constant currency, that what was the currency expectation back in SAM from a headwind perspective?

So what we -- you recall in our materials at SAM, we expected the FX to be at least a $0.30 headwind to our EPS on a full year basis, right? That was a chart that we shared with you and the analyst community on that day. We still expect at least 30%, but it's not edging upwards. So it is under control, and we can absorb that 30% given the strength of the order book that we have. The underlying cost of commodities that is serving our compute business, in particular. So we feel that we can absorb any FX changes to the level they are currently being observed in the market, and I hope that makes sense to you. If it deteriorates maturity more then we'll have to rethink our thesis. But so far, so good. That 30% headwind -- that $0.30, excuse me, $0.30 headwind is something we can withstand, and we can manage. It's not edging forward. It's actually well within what we had estimate.

Wouldn't that Tarek, be a tailwind given that, if rates were at a certain rate during SAM, you were expecting a $0.30 headwind to EPS. Now which have moved more favorably. So you should see that headwind become less of a headwind in -- as you go through the course of the year, if FX rates stay here?

That's correct. And so this is why our revenue guide is between 2% to 4%, right? So if you take the midpoint of 3%, we are very comfortable at that midpoint of adjusted for currency. And to the extent that there are no further FX deteriorations, which will be good on the margin side because, as you know, positive FX trends are effectively charging the EPS forward given the mix of revenue that we have by geography, right? So this is good. So I'm feeling that the impact of foreign exchange is very well contained in the revenue guidance that we gave. And we feel that, to the extent that the FX is not going to be as negative as we thought it would be, there could be some upside even at the bottom line level. For the moment, we are where we are.

Okay. Understood. Maybe just to shift gears a little bit. End of the year, every company is looking at IT budgets. It looked like a fairly difficult time to be setting budgets for most CIOs. So how would you characterize the spending environment? And maybe if you could talk about sort of what you're hearing from the customer base in terms of large customers, small customers, maybe geographically? Like what are you hearing about the way that they're thinking about their own IT budgets as you look into '23.

So the major backdrop for the IT industry is the exclusion of data. right? So data continues to be generated in incredible quantities starting from the edge where the data is mainly generated, the periphery of the enterprise, if you prefer, in simple language. That data requires to be processed, made sense of, understood and acted upon. And so if you really think about that thesis, it's imperative for companies to think of themselves as being digital service providers of some sort, whether you're a manufacturer, a retailer, a hospitality business, a health care business, you face the same problem. You got that data to handle, you got to digitize your business, your processes and so on. To a large extent, this is a massive secular tailwind for us as a company who provides the equipment to be able to digitize other businesses. At the same time, obviously, people are concerned around recessions. And they have to find a way to address their digital needs and meet their budgets. And so this is where our as a service transformation and our GreenLake offering comes incredibly handy. So you can decide to purchase the equipment upfront, and that is what we do for a large proportion of our business or you can decide to sign up to a GreenLake contract, which is a service contract, where we provide you with the infrastructure and you pay for it over time. We have the ability to do so, thanks to our balance sheet and our HPFS Financial Services business but you enter into a different world also in moving with a GreenLake contract because this isn't a lease. It's not at all a simple pay over time for your infrastructure offering. It is an SLA-based offering that delivers business outcome with a lot of automation delivered by HPE through our HPE GreenLake cloud platform. And that is a benefit to our customers because what we're also hearing from our customers is that, they don't want to manage every new generation of technology. They want the technology to run and deliver for them to business outcomes that they need to continue to grow themselves. So we are, in a sense, even in an environment where spend is more scrutinized, we have the ability to continue to generate orders, thanks to our as-a-Service strategy. And the reason why we embarked on that strategy is precisely to move away from a very cyclical business to be delivering much more of a recurrent sustainable, profitable growth for our own company, which benefits also our customers, which is highlighting the perfect item we have between what customers want and our strategy and how we deliver it.

Okay. No, that's very helpful context, Tarek. So maybe just to switch gears a little bit back on to some of the things that you've said before in terms of the orders remain quite healthy. And I know you're not kind of commenting as much on backlog anymore. But I was curious to get your take on there's obviously some of the '23 guide that you feel comfortable about because it is driven by backlog on revenue front. But can you also talk about bookings, that would be more of an indicator maybe of '24 as we think forward and investors think about sort of further out how to think about it. Are you seeing any pause on new bookings? And do you think that customers pull forward bookings because of supply constraints, how did that play out?

So there is an element of orders pulled forward, and that's okay. This is typical from an industry where you have to plan for the long run. We do believe that the demand is obviously has peaked in '22. And you recall that we had 8 quarters of consecutive order growth and in some cases, lapping double-digit growth across every segment of our business, right? So it's sort of a natural that we hit a pause recession or no recession, that would have come anyway. So I think that now there is a little bit of a, I would say, more sick inspection around placing orders. But relative to our internal expectations, the order level remains reasonable. And we were not expecting orders to grow year-over-year in our planning. No, we did not. We are expecting orders to come off the peak that we've witnessed in '22. But yet, we feel comfortable that we will still have at the end of fiscal year '23, a very substantial order book just like we had at the end of fiscal year '22. So we feel really good about our ability to generate revenues. Now there is a much prolonged recession, we will have to revise the leases, but so far so good.

Okay. No, that's helpful. And then if I could just ask you about when you think about the budget planning cycle, right. And there were the supply constraints that created some of the equipment to not get delivered in, let's call it, in calendar '22, which will get delivered in '23. So do you think that the dollars for that were earmarked by the customers in the '22 budget? Or do you think they would ask for that money for a product or a server that might get delivered in '23? So if that made sense. I mean it's essentially that you had approval to buy a server, let's say, in '22, you placed an order. You couldn't really get the server delivered in '22. Now it's going to get delivered in '23. Do you think that the buyer has to go back to get reapproved in '23? And if so, have you seen any indication that, that's either happening or not happening?

No. Sorry, if you're thinking, for example, I can interpret your question in 2 ways, order cancellations or I can interpret it that if you didn't spend your budget as a customer in '22, you lost it and then you had to start again with an approval in '23. So the use it or lose it is often happening in government sectors, right, because they have very specific government budgets, and it does happen anyway. But as far as we are concerned, we have not seen a lot of orders taken down, canceled and rebooked in fiscal year '23, even in the government sectors. The cancellation level of our order book are really de minimis. So they are not very important. We are lucky in a sense or a function of our brand and our reputation that we have in the marketplace, customers have been waiting for the HP product because it's better quality and the reputation that we have around quality is also allowing some degree of patients. But our real priority is to deliver on every order we have in the order book and not lose any single one of them. And so far in Q4 of '22, we've been very successful in Q1 of '23, we will be also successful because the supply availability has been redirected to the B2B sector. On the thing that we have to remember is in the consumer tech industry, the 3 vectors or 4 vectors that drive the demand for tech components are mobile phones. So the mobile phone industry, particularly in China, where there's a material slowdown in the high single-digit rates. The PCs industry, you know the sector better than I do, but it's experiencing a decline in the high teens range. That's the second one. The third one is bitcoin. Everybody reads the news about Bitcoin, and it's taking I would say, significant beating. It was too speculative for my personal taste, and now people are starting to realize that there are some pitfalls coming with Bitcoin. So they spend less money buying machines that mine bit going all the time. And the fourth one is game consoles, which are also a form of entertainment that is a derivation from the PC, as we all know. And the reality is that this is where the result of inflation. Inflation hits consumers worldwide much harder. And therefore, you could see that they decided to deprioritize their spend in these consumer tech areas. We benefit from it. And so we have everything that we need, more or less, there are a couple of components that we're missing left and right, but on the whole we [Audio Gap] and avoid any cancellations because there is a limit to how much of a customer can exercise patients, right? And we are not testing that limit. We're delivering on the orders.

Okay. Okay. That's helpful context. And then the other side of supply constraints and clearly, this is very elevated in the semiconductor industry. But there's a pricing element of it that ASPs can do something that's atypical you can have significant increases in times of when you just need to procure something and your business is gated by you're willing to pay whatever. How much of that did you see? And as you think about the new orders coming in, are those also reflecting that kind of a pricing environment? Has the pricing environment moderated? How should we be thinking about this? The cyclical part of -- I know there's a structural component to the AUPs, but the cyclical component, maybe if you could just talk about that for a second.

Yes. So we had a fiscal year '22 in the compute business, an order book that has grown on both dimensions, units and AUPs, right? And there was a very strong AUP growth in fiscal year '22, driven by the shortage of components, but also driven by a structural shift to richer configs. And I would say between pricing and richer structural config, the mix is about 50-50. And so we were able to pass on some of the increased costs such as logistics costs and commodities cost by way of pricing yet we are also able to see customers wanting to buy a richer config as opposed to 2 smaller configs to cater to their needs. But we expect that the AUPs will come under pressure, right, because it is as logical as, for example, logistics costs are really receding globally because the supply chain globally has become a little bit more stable across every industry, and we no longer have those issues around the maritime logistics cost being out of control. So we expect AUPs to come down over time, but the structural richer config drivers of AUP to continue to be strong. Just the pricing side of the driver is going to be coming down as we see more supply and competitive dynamics are at play.

So I guess message is that there's a 50-50 kind of split between sort of the secular and the cyclical. The cyclical is moderating. Some of that is just supply availability being better. But for things like memory pricing, for instance, which is just collapsing, right, you've seen both DRAM, NAND pricing, just completely collapse here. For things like that, is that not part of the structural piece of it? Would you say that's also part of the cyclical piece? Or is there a part of the structural piece, which is the other 50%, which is richer configuration. But in that richer configuration now you can, I guess, spec up in memory for the same price or you could have a lower ASP with sort of maybe the similar memory that people were projecting. What trend are you seeing in there in terms of how customers are basing their buying decisions?

So a lot of the trends around RAMs are driven by the need to spec up more than lowering the unit price of the computer. And the reason why this is, is that most of the applications, particularly we are entering a decade of artificial intelligence. Most of the requirements are on processing data and you process this data with in compute bower terms, you need a lot of memory to do that, right? So that's what's happening. It's about specking up to cater to the data need for the most part, I would say, on the RAM side. Is that an inflationary environment or deflationary environment, I would say, on balance, the volume uptake is greater than the actual downward pressure on price. And so it becomes a much more of a config structural change that we're witnessing there as opposed to pricing pressure that we're experiencing in that space.

Okay. Understood. We'll come back to compute in a second, but I do want to make sure that I hit up another thing that's very topical for people, which is H3C. And obviously, you've shared some recent news regarding H3C. Curious what was the thought process around arriving at that decision? And as you think about the execution risk of that, do you see any in terms of the challenge of maybe getting that getting that investment back to you in terms of the exercise of the put.

Yes. So as a reminder to everyone on the call, we had the opportunity to exercise a put option to sell our stake of 49% stake in H3C to the current owners of Unigroup or our JAC Capital and Wise Road Capital, who are leading the consortium of investors in China. And -- we formed a view that it was in the interest of our shareholders to exit our stake and our ownership in H3C, and therefore, we exercised the put option before the end of the calendar year, before it's expiry. And really, it was a financial criteria that dictated the decision. The option essentially gave us a view of value for the trailing 12 months ending April 2022. So if you take the view of earnings, we have a clear view of what the value of our stake is. The decision for us was do we roll the dice and continue to extend with a higher multiple and realize a higher IRR on a future exit based on what we've locked in today. And you have to balance that decision with opportunity costs of what you're going to do with that capital. And we felt that we were not going to be able to reap the benefits in excess of what we believe are the risks. And so we decided to exercise our put option. So the process is a relatively extended process where we have to agree on the value of the stake with the counterparty, but also have to seek regulatory approvals in China to be able to receive our money. So far, we have not sensed any sort of resistance. No matter what the relationship with JAC capital and Wise Road remains very solid. We -- I want to remind everybody that it's just a new phase in that relationship because we continue to have commercial agreements that are lasting for a number of years, 3 years forward. maintaining the commercial relationships between HPE and HCC, where we continue to sell to H3C a number of products from HPE and where we HP onsell some of the H3C products outside China on behalf of H3C. So it's just a different turn to the relationship. I feel pretty comfortable about, a, the prospects of collecting the cash and b, carrying on with the relationship on a different footing.

So Tarek, like can you put some time frame around when you think that you might be able to collect that cash and you mentioned opportunity costs. So what are the opportunities that this opens up?