Hewlett Packard Enterprise Company - Q1 2023

Transcript

Operator (participant)

Good afternoon, welcome to the Q1 2023 Hewlett Packard Enterprise Earnings Conference Call. My name is Anthony, I'll be your conference moderator for today's call. At this time, all participants will be in listen-only mode. We will be facilitating a question and answer session towards the end of the conference. Should you need assistance during the call, please signal a conference specialist by pressing the star key followed by zero. As a reminder, this conference is being recorded for replay purposes. I'd like to turn the presentation over to your host for today's call, Jeff Kvaal, Senior Director of Investor Relations. Please proceed.

Jeff Kvaal (VP, Head of Inestor Relation)

Thank you, Anthony, good afternoon, good evening, everyone. I'm Jeff Kvaal, I'm Head of the Investor Relations Team for Hewlett Packard Enterprise. I'd like to welcome you to our fiscal 2023 Q1 earnings conference call with Antonio Neri, HPE's President and Chief Executive Officer, Tarek Robbiati, HPE's Executive Vice President and Chief Financial Officer. Let me remind you that this call is being webcast. A replay of the webcast will be available shortly after the call concludes. We have posted the press release and the slide presentation accompanying the release on our HPE IR webpage. Elements of the financial information referenced on the call are forward-looking are based on our best view of the world and our businesses as we see them today. HPE assumes no obligation does not intend to update such forward-looking statements.

We also note that the financial information discussed on this call reflects estimates based on the information available at this time and could differ materially from the amounts ultimately reported in HPE's quarterly report on Form 10-Q for the fiscal quarter ended January 31st, 2023. For more detailed information, please see the disclaimers on the earnings materials related to forward-looking statements that involve risks, uncertainties, and assumptions. Please refer to HPE's filings with the SEC for a discussion of these risks. For financial information we've expressed on a non-GAAP basis, we have provided reconciliations to the comparable GAAP information on our website.

Please refer to the tables and slide presentation accompanying today's earnings release on our website for details. Throughout this conference call, all revenue growth rates, unless otherwise noted, are presented on a year-over-year basis and are adjusted to exclude the impact of currency. Finally, after Antonio provides high-level remarks, Tarek will be referencing the slides and our earnings presentation throughout his prepared remarks. With that, let me turn it to you, Antonio.

Antonio Neri (President and CEO)

Well, thanks, Jeff, good afternoon, everyone. Thank you for joining our earnings call. We begin our fiscal year 2023 from a position of great strength after delivering an outstanding 2022 Q4. I am extremely pleased with how we leveraged that strength to achieve impressive results in Q1. HPE posted a record-setting Q1 performance, extending our track record of consistently fulfilling our financial commitments. We generated our highest Q1 revenue since 2016 and our best ever non-GAAP operating profit margin. Our focus on growth opportunities and pricing discipline produced our highest ever non-GAAP diluted net earnings per share. Powered by our market-leading hybrid cloud platform, HPE GreenLake, we unlocked an impressive $1 billion in annualized revenue run rate, or AIR, for the first time.

Our results show the relevance of our strategy that addresses mega trends around edge, cloud, and AI reshaping our industry, the transformation of our industry-leading portfolio, and the outstanding execution of our team. In the Q1, total HPE revenue climbed 18% to $7.8 billion, significantly above the high end of our outlook. We once again expanded non-GAAP operating margin, this time to a record 11.8%, up 80 basis points year-over-year. Non-GAAP diluted net earnings per share increased 19% year-over-year to $0.63. Free cash flow was negative $1.3 billion, reflecting working capital needs in a quarter where we typically see use of cash. Our Q1 performance and the size of our order book position as well for fiscal year 2023.

Our quarterly results, combined with confidence in our strategy and execution, have led us to raise our revenue and EPS guidance for the full fiscal year. Tarek will provide more details in his remarks. From a macro perspective, the supply chain challenges we faced during several quarters continue to ease, and we expect more of that throughout fiscal year 2023. As we mentioned at the close of fiscal year 2022, we do not anticipate all supply shortages coming to an end, but we do expect supply availability to continue to improve. Our order book at the start of Q1 was larger than it was a year ago, and as we exit that quarter, it is more than twice the size of normalized historical levels. Our Intelligent Edge, HPC and AI, and as-a-service order books continue to stand at extremely elevated levels.

Against today's macroeconomic backdrop, demand for our solutions continue, though it is uneven across our portfolio. We also see more elongated sales cycles, specifically in compute, than we have seen in recent quarters. We are responding decisively to demand in the market, working to win deals across all geographies and all parts of our portfolio. The traction of our portfolio is the result of our winning strategy, aligned to major market trends around the edge, cloud, and AI. We continue to anticipate what comes next for our customers and invest in innovation to address their data-first modernization needs with an unmatched set of edge-to-cloud solutions. In addition to driving impressive organic innovation across our portfolio, we continue to be opportunistic in considering strategic acquisitions and partnerships that enhance what we can offer to our customers.

Today, we announce our agreement to acquire cloud security provider Axis Security, which will help fortify network security and strengthen our secure access service edge, or SASE, solutions, as we anticipate further customer demand for enhanced connectivity to our HPE Aruba Intelligent Edge solutions. Last week, we also announced our purchase of Athonet, which strengthened our private networking capabilities to help enterprises and telcos accelerate 5G deployments. Through these acquisitions, we are creating one of the most complete cloud portfolios in private 5G and wireless connectivity, areas we have identified for growth in coming years. These new private 5G capabilities will be integrated into our HPE GreenLake platform, enabling customers to combine their Wi-Fi and private 5G into one subscription they can scale according to demand. Earlier in the Q1, we also purchased technology from two companies that enhance our cloud computing and AI offerings.

Next quarter, we will begin selling scalable compute software technologies from TidalScale, introducing additional choice points for customers to meet their compute and data intensive workloads needs. We will also integrate the Pachyderm reproducible AI software with our supercomputing and AI solutions to further expand our AI at scale capabilities. We will continue to assess organic and inorganic investments that improve our competitive position in growth markets while driving higher level of recurring revenue and profitability. As always, we follow a disciplined return-based framework to build on our track record of creating sustainable long-term value for shareholders. Since we began the transformation of our business in 2018 to become the edge-to-cloud company, we have consistently grown our as-a-service business, underpinned by the HPE GreenLake platform.

The relevance of HPE GreenLake with customers, combined with our disciplined execution, has propelled both ARR and our as-a-service total contract value higher. Over the last two years, we have more than doubled our as-a-service total contract value, reaching nearly $10 billion through the end of this quarter. These milestones prove the momentum in our transformation. During the Q1, we once again increased our new HPE GreenLake logos, growing our customer base by 7%. While as-a-service orders this quarter declined 20% year-over-year, it is important to keep in mind that the order figure is compared to prior year growth of a record 136%. One HPE GreenLake customer we recently highlighted is the 2023 Ryder Cup, which announced HPE will deliver an intelligent, secure, and flexible high-performance network through our platform at the September 2023 golf event in Rome.

Our platform will enable the Ryder Cup to deliver the tournament as a service in a sustainable, cost-efficient way, while significantly enhancing the spectator experience and engagement. We have continued our investment in HPE GreenLake, expanding our cloud services portfolio and partner ecosystem. In December, at our HPE Discover Frankfurt customer event in Germany, we announced our latest enhancements, adding new cloud platform services, capabilities in the data analytics, developer, and sustainability areas. Our HPE GreenLake platform continued to attract business and drive performance across the portfolio. In every one of our key segments during the Q1, we produced more revenues as well as positive operating profit. Let me provide you a few highlights. In our Intelligent Edge segment, revenue increased 31% year-over-year. We continue to see customers switch to our HPE Aruba technology from other vendors.

We provide a single AI-driven cloud management experience, which is now part of HPE GreenLake platform, with ease of use and proven cost benefits. Year-over-year revenue growth was even higher in our HPC and AI segment, up 37%, as we book revenue associated with Frontier, the world's first exascale system. HPE is the clear market leader and has significant growth opportunities as enterprises scale AI models. AI will transform the IT landscape in the coming years and is a generational technology shift, like web, mobile, and cloud, that have the potential to disrupt existing business models. Supercomputing will be essential to enabling this disruption. For example, building a viable generative large language model for search would require a supercomputer to run the model continuously to stay current and improve accuracy.

Our HPC and AI business has strong IP and decades of experience that give HPE a competitive advantage in building large computing systems, which are required to increase commercial adoption of AI models globally. We recognize AI will become the dominant supercomputing workload when we acquired the market leader Cray in 2018. We continue to invest in key technology innovations that will enable these AI models at scale. Key examples are our acquisition of Determined AI in 2021 and Pachyderm early this year. Well, adding unique and differentiated software to help our customers train AI models and automate data pipelines. Customers recognize this leadership. For example, Aleph Alpha, a German startup building a commercial large language model, has turned to HPE. We're also working with customers across industry verticals such as life sciences, aerospace, to enable new breakthroughs with AI.

In the quarters ahead, we anticipate sharing more news on how we are scaling in this market and attracting new customers. I'm also pleased with the strong and steady performance of HPE Financial Services, which grew revenue 8% and financing volumes 21% year-over-year. Last month, we announced the retirement of our long-standing leader of this business, Irv Rothman, and the promotion of Gerri Gold to take the helm and further accelerate the business momentum. Gerri and her team recently launched a special financing program for customers who score high in ESG, and we are seeing great customer and partner response already. I am very proud of how our HPE team members have executed to achieve this quarter's exceptional performance, especially given the uneven macro environment.

We have kicked off fiscal year 2023 with another set of standout results, giving us the confidence to raise our revenue and non-GAAP earnings per share guidance for the full fiscal year. Our customers are responding to the hybrid cloud value proposition we uniquely provide as they seek better ways to derive value from data from edge to cloud. We are attracting more customers and executing with discipline. As we look forward, we remain laser-focused on executing our winning strategy, which is delivering unmatched innovation and significant results for our customers and shareholders. We are confident in our strategy and execution for the long term. Let me now ask Tarek to give details on our business segments and greater visibility into our updated financial outlook. Tarek, over to you.

Tarek Robbiati (EVP and CFO)

Thank you very much, Antonio. Q1 '23 was, as Antonio said, a record quarter for HPE. As usual, I will reference slides from earnings presentation to guide you through our performance. Antonio discussed key highlights for Q1 '23 on slide four. Let me discuss our Q1 performance details starting with slide five. We are very pleased that the execution of our strategy has driven record quarterly results in terms of revenue, non-GAAP gross margin, non-GAAP operating margin, and non-GAAP EPS for a Q1 of a financial year. These and other records I reference are primarily since we reset our strategy with our two thousand and seventeen spin-off transactions. Notably, revenues grew year-over-year across all our business segments, save for corporate in Q1 '23, as we benefited from improvements in the supply environment. Our supply chain execution is solid.

We have very strong momentum thanks to our substantial order book, and our investments are bearing fruit, and we are gaining share in specific market segments. In short, our strategy is working and working really well. Having said so, while we are optimistic about our fiscal year 2023, we're also realistic. Overall, we have experienced above trend demand through much of the past two years, as attested by our growing order book over the fiscal year 2020-2022 period. Now market demand has shifted from being steady across our portfolio to being uneven over the course of Q1 2023. More specifically, deal velocity for compute has slowed as customers digest the investments of the past two years, though demand for our storage and HPC AI solutions is holding, and demand for our Edge solutions remains healthy.

In that context, we're taking action to maintain our momentum for the second half of 2023 and fiscal year 2024. We intend to further our investments in software and services in all our business units, including in our HPE GreenLake Edge to Cloud platform, HPC AI, Storage, and Edge, to extend our share gains across our segments, all while retaining our cost discipline and productivity focus. We delivered Q1 revenue of $7.8 billion, which equates to robust 12% year-over-year growth and 18% in constant currency despite our exit from Russia and Belarus in Q2 2022. We did not experience the typical seasonal decline between Q4 and Q1, thanks to excellent supply chain execution on our large order book. Each of our segments, excluding only our corporate segment, grew revenue at least 8% in constant currency.

This revenue performance was well above our prior guidance for Q1 of $7.2 billion-$7.6 billion, and represented a record Q1 revenue level. We benefited from improvements in the supply environment, particularly in our compute segment. This allowed us to execute against our order book, which our customers greatly appreciated. The delivery times of our products and services across our portfolio are now almost back to pre-pandemic levels. Yet we continue to have more progress to make in supply chain productivity as our order book entering Q2 2023 is more than 2x normal level across our company. The combination of our large order book and improved supply environment gives us confidence that we can grow revenues well above the previously communicated guidance of 2%-4% revenue growth in constant currency for fiscal year 2023. More on that later.

As a result, we also remain confident in the longer term 2%-4% revenue CAGR outlook over the fiscal year 2022 to fiscal year 2025 period we provided at our 2022 securities analyst meeting last October. Our non-GAAP gross margin reached a Q1 record of 34.2%. This is up 30 basis points year-over-year and 110 basis points sequentially. Our margin structure has benefited from pricing actions we have taken over the course of the pandemic, combined with the beginnings of declines in commodities and logistics costs. Over the long term, our margin structure will continue to benefit as we continue to shift our mix of business to higher margin, software intensive as-a-service offerings. Our non-GAAP operating margins reached a record high 11.8%.

This is 80 basis points ahead of Q1 2022 and 30 basis points higher than Q4 2022. While strong revenue growth and gross margin performance are key drivers, this result would not have been possible without the strategic actions Antonio and I took in fiscal year 2020 to reallocate resources and optimize our cost structure. As mentioned during our last earnings call, Antonio and I remain determined to maintain our focus on productivity. Our top line and margin strength in Q1 translated to GAAP diluted net EPS of $0.38 and non-GAAP diluted net EPS of $0.63. Non-GAAP diluted net EPS easily exceeded our guidance range of $0.50-$0.58 and was another company record. Our Q1-2023 free cash flow was negative $1.3 billion. We typically have seasonal outflows in our Q1. We will discuss cash flow in more detail in a moment.

Having said that, we remain on track to generate between $1.9 billion and $2.1 billion in free cash flow in fiscal year 2023. Finally, we are continuing to return substantial capital to our shareholders. We paid $156 million in dividend this quarter and repurchased $73 million in stock. We intend to buy back at least $500 million worth of shares in fiscal year 2023, just like we did in fiscal year 2022. Turning on to our as-a-service business performance, we are very pleased to announce our ARR surpassed $1 billion in Q1 2023. This is an important milestone for our business that reflects that our as-a-service strategy is working. The supply chain challenges have slowed our ARR growth in prior quarters.

The benefits of easing supply challenges are beginning to appear in our results as ARR growth in constant currency accelerated from 25% in Q4 2022 to 31% in Q1 2023. We expect further acceleration through fiscal year 2023, as improving supply allows us to expedite delivery of as-a-service solutions to our customers. Our as-a-service order decline of 20% in Q1 is a function of a difficult compare to Q1 2022, in which orders grew 136% on strength from several large deals, including a large public cloud customer. We are comfortable with our robust pipeline of as-a-service business. We base this confidence on our 68% order growth in fiscal year 2022, the number of deals currently pending acceptance, and our current view of the sales funnel.

We therefore retain our three-year ARR target of 35%-45% CAGR from fiscal year 2022 to fiscal year 2025. Most importantly, we continue to make our as-a-service business more valuable with a growing mix of higher margin software and services recurring revenue. In Q1 '23, our mix of software and services increased another 150 basis points year-over-year to 65%, thanks to our cloud and SaaS offerings, particularly in Edge and storage. Let's now turn to our segment highlights on the next slide. I would like to remind you that all revenue growth rates on this slide are in constant currency. In the Intelligent Edge, we delivered a second consecutive record revenue quarter and surpassed the $1 billion revenue milestone for the first time. We grew our revenue 31% year-over-year.

We are outgrowing our main competitors and are taking share with our combination of wireless LAN, enterprise switching, and SD-WAN solutions, including in some of the largest enterprise customers. Customers are increasingly adopting our software-centric solutions, such as our Edge Services Platform and Automation Suite. Our operating margin of 21.9% was up 450 basis points annually and 860 basis points sequentially. We're benefiting from scale, and our prior price increases have worked through our order book. We are very, very pleased that our Edge business has exceeded the rule of 40 this quarter and feel very optimistic about the prospects of our Aruba business in fiscal year 2023 and beyond, given its substantial order book underpinned by a superior platform-based SaaS offerings. We retain confidence in our long-term targets of mid-teens revenue growth and mid-20% operating margins.

In HPC and AI, revenue grew 37% year-over-year. We successfully closed the balance of the Frontier deal in Q1, which contributed to the strength of this business in Q1 2023. While the segment is also now benefiting from easing supply chain, the lumpiness and long lead times of this business mean that operating margins will continue to fluctuate. As Antonio mentioned, we have been thinking strategically about and investing behind artificial intelligence for many years. This is true both organically and inorganically. The emergence of large language models such as ChatGPT and Bard and generative AI, some of which run on our systems, has prompted many questions from our customer base.

We believe AI at scale is a high-growth market, and that the building and refinement of AI models will require unique computational capabilities that our Cray supercomputers and HBI solutions are extremely well-positioned to enable. We intend to invest organically and inorganically, as attested by our acquisition of Pachyderm to fully grasp this opportunity. With regards to storage, we are pleased to report 10% annual growth where we are bolstering our portfolio to grow market share. HPE Alletra remains one of our fastest-growing new products introductions ever and grew well above triple digits in Q1. HPE Alletra contributed to double-digit growth in our own IP products, which is driving a mix shift to higher margin, software intensive as-a-service revenue.

We continue to invest in R&D for our own IP products in this business unit, and as a result, our Q1 operating margin of 12% is down 190 basis points year-over-year. Compute revenues grew 19% year-over-year to $3.5 billion. The segment benefited from the multi-sourcing and demand steaming initiatives we have discussed in prior calls, as well as steadily improving supply availability. Our dynamic pricing strategy has helped us navigate a volatile supply climate while driving industry-leading gross margins. Our compute operating margin of 17.6% exceeded our long-term outlook of 11%-13% for the fifth consecutive quarter, which attests to our best-in-class performance. We do believe our compute operating margins are peaking and should gradually return to our target range of 11%-13%.

While we are seeing commodities costs decreasing, leading to increased competitive price pressure, we have for the first time three concurrent and differentiated platforms being sold in the market, Gen10 Plus, and Gen11, which would allow a gradual management of pricing and margins over time. In our Pointnext Operational Services business combined with storage services, orders declined mid to high single digits and revenues were flat year-over-year driven by uneven demand. As you know, this is a key component of recurring revenues and profit for each of our segments. HPE Financial Services revenues rose 8% year-over-year and financing volume of $1.6 billion grew 21% in constant currency. Our operating margins fell 300 basis points year-over-year due to the higher interest rate climate that we will gradually offset over time through pricing.

Time and time again, our HPFS business has proven resilient in a downturn, thanks to the quality of the underwriting of the book of business. Throughout the pandemic, I'd like to remind you, our annual loss ratio never exceeded 1%. Our loss ratio is back to pre-pandemic levels of approximately 50 basis points. Slide 8 highlights our revenue and non-GAAP diluted net EPS performance. We are very pleased that the progress we are making against our edge-to-cloud strategy is evident in the financial results we have delivered on both the top and bottom lines. We have grown both our revenue and non-GAAP diluted net EPS to record or near record levels in Q1 2023. This illustrates not only the commercial success of our products in the marketplace, but also our ability to generate healthy margins.

I am particularly pleased to see that our focus on supply chain execution has enabled the attainment of record revenues despite a substantial year-over-year headwind from foreign exchange rates that impacted revenue growth by 550 basis points in Q1 2023. Slide 9 illustrates the progress we have made in our gross margin structure. Our Q1 2023 non-GAAP gross margin is up 30 basis points year-over-year. We generated $2.7 billion in gross profit in Q1 2023, which is yet another quarterly record. Our gross profit and margin are a testament to the success of our strategic pricing actions through the period of supply challenges in fiscal year 2020 to fiscal year 2022. It is also illustrative of the long-term favorable mix shift we are driving.

Despite a strong compute quarter, our revenue mix of compute at 44% was flat year-over-year. This illustrates that we have a larger revenue base as our higher margin segments are growing rapidly and our as-a-service strategy is gaining momentum. Slide 10 illustrates our non-GAAP operating margins progress, which reached 11.8% in Q1 2023. This is up 30 basis points sequentially and 80 basis points year-over-year. It is also a record quarterly non-GAAP operating margin for the company. Our very strong Q1 revenue performance and our resilient gross margins are the leading contributors to the operating margin expansion.

Unlike many tech companies that have announced layoffs recently, we have strong momentum at HPE with a combination of our improved cost structure, substantial order book, and outstanding execution delivering profitable growth that is increasingly recurring at higher margins as our as-a-service transformation continues to unfold. Let me reiterate that Antonio and I are determined to maintain this focus on profitable growth and productivity for the future. Let's now turn to discuss H3C. As you know, we have chosen to exercise our put options on our shares in H3C. We took this decision after carefully weighing the financial implications of remaining in the joint venture with the risk-reward profile of exercising the put. We are confident that we have made the decision that is in the best interest of our shareholders.

HPE and our partner, Unisplendour, continue to have constructive discussions to reach agreement on the determination of the final purchase price of HPE shares in H3C and enter into a share purchase agreement. We will keep you updated. Please keep in mind that our decision to exercise the put is distinct from the commercial agreements with H3C. We intend to continue to do business in China through both our direct sales and through H3C, and we remain committed to serving our customers in China. I would like to remind you that we will continue to recognize the value of the dividends we receive from H3C in our financials until the transaction is complete, and I'm happy to report H3C results remains healthy despite uncertainty in the Chinese economy. Our first fiscal year from a cash flow perspective is typically a down quarter for cash flow.

In Q1 '23, we had outflows of $800 million in cash flow from operations and $1.3 billion in free cash flow. Working capital was a use of cash due to timing of receipts, payments, and continued investments in inventory, which has driven our cash flow conversion cycle from a negative 14 days in Q4 to a positive 15 days in Q1 '23. More specifically, our accounts payable balance was reduced by $2.2 billion quarter-over-quarter, and was the main driver for negative operating cash flow and affected our cash flow conversion cycle. We have made significant investment in HPFS volumes to drive future growth in subsequent quarters.

We expect to generate significant free cash flow in the remainder of fiscal year 2023 and reiterate our guidance of $1.9 billion-$2.1 billion in free cash flow for the full year. Let's turn to our outlook slide on slide 13. As we have mentioned, demand for our products and services was more uneven in Q1 2023 across our business than it was in Q4 2022. Having said that, we also believe our portfolio differentiation will continue to drive market share gains and are entering Q2 2023 with a substantial order book relative to pre-pandemic levels. We had strong momentum in Q1 2023, and we are now turning our focus to invest in sustaining that momentum in the second half of 2023 and fiscal year 2024 in a context of continuous macroeconomic uncertainty.

Let me reiterate that our guidance incorporates our current thinking on the macroeconomic picture, inflationary pressure, our exit from Russia and Belarus in 2022, and foreign exchange risk. I would like to remind you that approximately 50% of our revenue is generated in foreign currencies. For Q2 2023, we expect revenues in the range of $7.1 billion-$7.5 billion. At the midpoint of the range, this represents 9% year-over-year growth in reported dollars. We expect GAAP diluted net EPS of $0.27-$0.35, and non-GAAP diluted net EPS of $0.44-$0.52. This outlook assumes the current level of demand we have been experiencing remain unchanged, and that we continue to make progress on the delivery of our order book. To sum it up, I am very pleased with our Q1 results and guidance for Q2.

We also understand some of our end markets are likely to remain uneven in the near term. We had indicated at our last earnings announcements that our financial performance in fiscal year 2023 is likely to be more weight to the first half of the year than is typical. Given the strong Q1 performance, momentum, and substantial order book we continue to have, we are lifting our full year guidance accordingly. We are now targeting 5%-7% revenue growth adjusted for currency, which is at the midpoint twice our prior revenue growth guidance, non-GAAP operating profit growth of 5%-6%, GAAP diluted net EPS of $1.40-$1.48, non-GAAP diluted net EPS of $2.02-$2.10, and free cash flow of $1.9 billion-$2.1 billion.

Specifically for INE, we benefited in Q1 2023 from one-off foreign exchange gains that accounted for $0.02-$0.03 per share. These are unlikely to repeat in the rest of the fiscal year. Given the high interest rate environment is expected to remain unchanged, we expect our INE to be an expense of $20 million-$40 million on a full year basis. This explains our fiscal year 2023 EPS guidance range of $2.02-$2.10, which incorporates $0.06 of the $0.09 beat in Q1 2023. In terms of capital returns, we will return approximately 60% of free cash flow to shareholders via dividends and repurchases. We are maintaining our dividend and expect to repurchase at least $500 million worth of shares in fiscal year 2023. To conclude, our results speak for themselves, and we continue to execute better than the competition.

While many tech companies are playing defense with layoffs, we see fiscal year 2023 as an opportunity to accelerate the execution of our strategy. Antonio and I look forward to continuing our execution momentum through fiscal year 2023 and beyond. With that, let's open it up for questions. Thank you.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. We also request that you only ask one question. Our first question will come from Aaron Rakers with Wells Fargo. You may now go ahead.

Aaron Rakers (Managing Director, Technology Analyst)

Yeah. Thanks for taking the question, congrats on the solid performance. I guess I wanted to ask a question more strategically in kind of thinking about the product portfolio. you guys and many others obviously talking a lot about ChatGPT, GPT and generative AI.

In the conversation on today's call, you alluded to the fact that you're well positioned with some of your HPC and your high performance, you know, compute platforms. I wanna make sure I understood what you're saying a little bit, you know, correct. Are you participating in some of the infrastructure in some of the cloud opportunities or how do you see yourself participating in kind of these AI investments that really seem to be driving this narrative around meaningful deployments of accelerated compute? Thank you.

Antonio Neri (President and CEO)

Well, thank you, Aaron. Obviously, AI is now, it's front and center in the IT community because of what we saw in the last couple of months. As I said, you know, has the potential to disrupt every industry. We cannot talk about what specific cloud, that is one specific cloud they use our specific Cray systems. I will say we have a bigger opportunity than that because when I think about the deployment of these large language models, that requires supercomputing capacity. At that point, when you think about what we did with Frontier, is how we make that accessible to every enterprise of every size.

We as a company have a unique opportunity that happens every so often where there is a massive inflection point like AI and LLM, like, right, the large language model, with a unique differentiation in our IP, which is a combination of organic assets that we built over a number of years and the acquisition of Cray. As Tarek said in his remarks, we are assessing the, you know, what is the type of business model we can deploy as a part of our other service model by offering what I call a cloud supercomputing, you know, IS layer with a platform as a service that ultimate developers can develop, train, and deploy these large models at scale.

That's why we said early on, we will talk more about that in the subsequent quarters. We are very well positioned, and we have a very large pipeline of customers. Last week I was in Europe. I was amazed to see the large pipeline of customers that they are demanding that. I mentioned one specific customer, Aleph Alpha, which is already coming to us to do that.

Operator (participant)

Thank you, Anthonio. Or, thank you, Aaron.

Aaron Rakers (Managing Director, Technology Analyst)

Aaron. Yeah.

Antonio Neri (President and CEO)

Next question, Anthony, please.

Operator (participant)

Our next question will come from Meta Marshall with Morgan Stanley. You may now go ahead.

Meta Marshall (Managing Director)

Great. Thanks. you know, you noted obviously seeing some weakness kind of in the environment. Just wanted to get a sense of either customer type or vertical or just kind of segment that you expect to kind of see, be the source of that kind of, weakness throughout the year. Are you seeing more people kind of opt for GreenLake subscription offerings as a result of kind of more macro sensitivity? Thanks.

Antonio Neri (President and CEO)

Sure. I mean, I don't think there is one specific geography or one specific segment. You know, I will say, as we said in the early remarks, right? The compute business, obviously, we see a little bit more unevenness, if you will, with longer sell cycles, because also they are digesting all what they acquired last year because of the supply chain and the costs rising. When you look at the rest of the segments, you know, as Tarek said and I said, the Intelligent Edge business, the connectivity business is very solid. We exited once again Q1 with a, you know, an extremely elevated book of orders. HPC, we just talked about it, right? We see an amazing pipeline in front of us.

We have only deployed one exascale system, and we have few to go, because we are delivering all of them to the Department of Energy. Then as I said earlier, right, we have an opportunity to grow that business through another service model. That said, what customers are telling me is that they need a hybrid cloud experience. We see, in some cases, repatriation of workloads on-prem, but they want the same cloud experience with the same consumption model. That's what GreenLake does extremely well, is a true hybrid cloud experience for loads and workloads where data compliance and cost plays a big role. That's why we see the momentum we have. The fact that we doubled, the total contract value from Q1 2021 to Q1 2023 from $5 billion to $10 billion, it tells you the momentum.

What I'm really pleased is the fact that two-third of that momentum is in software and services, which means we will be more resilient as we go forward to weather some of these challenges because it's a recurring revenue. We count in that, just to be clear, through Software as a Service subscription and consumption, which is exactly the way it's supposed to be. That's why we are very bullish about our GreenLake. The fact that we crossed $1 billion ARR is just a testament that we have a winning strategy.

Thank you, Meta. Next question, please.

Operator (participant)

Our next question will come from Samik Chatterjee with J.P. Morgan. You may now go ahead.

Samik Chatterjee (Managing Director, Equity Research Analyst)

Yep. Hi, thanks for taking the question. Congrats on the execution here. I guess my question was more on the full year guide. I understand some of the headwinds in certain segments that you're calling out, but the revenue guide goes up by about sort of 300 basis points for the year. The operating profit growth sort of goes up by 100 basis points. While I understand some of the headwinds, what maybe I can use some help on is really understand the mix implications of how you're thinking about it, just given the more lower sort of flow through that we're seeing to operating profit growth for the full year guide. Thank you.

Tarek Robbiati (EVP and CFO)

Sure. Thank you for remarking that our revenue guide at the midpoint is effectively doubling from the prior guide that we gave. The prior guide that we gave was 2%-4%. We're now guiding 5%-7%, so at the midpoint it is 6%, which is double what we gave previously. In giving that guide, we factor in a number of elements. First of all, the macro environment. Second of all, foreign exchange rates. And third of all, our desire to continue to invest to perpetrate the momentum that we have in the second half and in fiscal year 2024. There's always something else that we have to think about for the end of the year, and we're not done yet.

I also wanna flag that we believe that commodity costs are coming down in particular areas, which should effectively come with added pricing pressure in compute. This is also something that we have factored into our guidance. If you really think about our non-GAAP operating profit growth, the prior guide was at 4%-5% growth, and now we're guiding 5%-6% growth. We feel comfortable with the information we have on the macro, foreign exchange rates, et cetera, that our guide is appropriate.

Antonio Neri (President and CEO)

Thank you, Samik. Next question.

Operator (participant)

Our next question will come from Kyle McNealy with Jefferies. You may now go ahead.

Kyle McNealy (SVP, TMT Equity Research)

Great. Thanks for the question. It was a great quarter for Intelligent Edge. Can you help us understand how we should think about big quarter here in Q1? Is that level sustainable going forward, or was there some big deals or particular activity that you would call out that isn't likely to repeat? Your guidance implies it decelerates from here, but can you give us a sense for how we should model this going forward and how frequently you might see growth ahead of your mid-teens growth guidance? Thanks.

Antonio Neri (President and CEO)

Yeah. Thanks, Kyle. No, there was not a unique deal. This is the continuous momentum we have had now for a number of quarters. You know, the book of business in this particular business segment continued to be extremely elevated. As Tarek said, we continue to gain share. I think it's because we have a unique value proposition, which is a cloud native offer for all aspect of connectivity. We announced now the acquisition of Athonet, which we will integrate the Private 5G through the same control plane. Today, we announced the acquisition of Axis Security, which is the secure access, secure edge at the top.

When we think about the book of business, the incredible pipeline we have ahead of us, the execution of the team, the ease of the supply, although in this particular business there is a little bit more constraint on the supply, compared to the other businesses. You know, we talk about the rule of 40, and this was the rule of 50 something, I guess. But the fact of the matter is that, as Tarek said, we expect to grow double digits, right? In the mid-twenties on operating profit. This business is now humming and is gonna be one of the most important growth engine as we go in the future. As Tarek said, you know, it's also allowing us to be less, you know, reliance on the rest of the portfolio, which is very, very critical. This comes with a high gross margin, obviously.

Tarek Robbiati (EVP and CFO)

I would simply add to what Antonio said. Look, you know, the Edge have broken the $1 billion revenue bar. I think now we are entering a phase with all the additions that we're making to the portfolio. We're entering a phase of a new watermark level. We have built at the Edge with Antonio and the management team, one of the most comprehensive portfolio of the entire industry, and it is really, really winning shares even in the largest customer segments, thanks to the Edge to Cloud platform that Aruba has built and that powers GreenLake in everything we do.

Antonio Neri (President and CEO)

I hope the market will take notice of that and give us a little bit of recognition about the work we have done in this particular segment. Thank you, Kyle. Next question, please.

Operator (participant)

Our next question will come from Simon Leopold with Raymond James. You may now go ahead.

Simon Leopold (Managing Director, Senior Equity Analyst)

Thanks for taking the question. I know this is gonna be a bit of a tricky one, but I wanna see if you could help us understand why your views sound more optimistic than your other IT exposed peers, whether it's around in particular the compute side of the business or the storage. I get Intelligent Edge, so I'm not really pushing there, but just the contrast in your outlook on storage and compute versus some of your peers. Can you help us understand that?

Antonio Neri (President and CEO)

Sure. Thank you, Simon. Well, first of all, let me start by saying we have a unique strategy and a very diversified portfolio. Some of our competitors don't have the breadth and depth of our portfolio. Some of them are just playing compute and storage. Some of them play just in storage. Some of them only play in networking. By the way, let's remind ourselves that one-third of our recurring revenues come from services, which is unique in our space. We have a unique portfolio, which is incredibly relevant in the mega trends we see in the market. We have done really well, I will say, Simon, is we brought all that unique portfolio in an integrated solution and experience through HPE GreenLake. That HPE GreenLake is a winning strategy for us because it's very hard to do.

One thing is to offer just a subscription model on some sort of solution, but when you leverage in a true as-a-service model across all line of businesses, let me remind you, architecturally, I drove a vision with the team that everything we do

Tarek Robbiati (EVP and CFO)

Whether you consume it as a service or you consume it in traditional way, that the entire experience is delivered now to HPE GreenLake. Whether you deploy a compute node somewhere, you know, whether in the colo premise or at the edge, you need a subscription to that compute node. Whether it's the storage business, now you ask about the storage. This ProLiant HPE Alletra, and Tarek mentioned this, is the fastest ProLiant in the history of the company. It has grown triple digits on a consistent basis, you will see more announcement about this platform going forward. It was conceived to be a SaaS-led offer. That's why it's fueling also the recurring revenue as we go forward. I think the combination of that gives the customers a unique experience.

Instead of buying three different things from people, they can consume it all through one integrated experience. That's why we are confident. Now on the compute side, obviously, the compute business go through their own processes and cycles, right? Because we have CPUs that come on and off at different time of the year or years. Tarek said we have three concurrent platforms going on. That gives us a lot of flexibility to attack specific customer segments with different config and pricing. Generation 11 is unique because we address three specific needs, the hybrid cloud need, the security need, and the workload optimization. It comes with unique technologies that actually lift the AUP up, because now it's more structural. We are adding DDR5 memory, which basically means more content in through the server.

That's why we believe we can manage through this transition. I mean, if you look at the performance of that business was, it was best in class, you know. 90% year-over-year revenue growth and an amazing 17.6% operating profit. When you look at some of our competitors, as a combined business, don't even come to the same number we delivered just in compute.

Jeff Kvaal (VP, Head of Inestor Relation)

Simon, thanks very much. Let's move to the next question, please.

Operator (participant)

Our next question will come from Amit Daryanani with Evercore. You may now go ahead.

Amit Daryanani (Senior Managing Director)

Yep, thanks for the question and congrats on the quarter. You know, I was wondering if you could just talk about what's the timing for the H3C transaction from here, and then how do you think about the usage of the proceeds that you get from here? I think if you sell the stake you have, it would be dilutive by about $0.17-$0.18 to your EPS line. I'm just wondering, how do you think about using the proceeds and offsetting the dilution potentially? Thank you.

Tarek Robbiati (EVP and CFO)

Yes. Thank you, Amit, for the question on H3C. We exercised the put, as you recall, towards the end of the calendar year of 2022. We are right now in the process of agreeing the value of our stake with our partners of Unigroup. This process is gonna take a few month. We expect it to complete towards the end of calendar year 23. We feel reasonably good about the prospects. For the meantime, we continue to consolidate H3C and benefit from the dividends that we receive from the company. We are not deconsolidating H3C at this stage. It's most likely gonna be the case of the end of fiscal year 23 when that will happen.

At that point, we will advise both on the impact of dilution from deconsolidation and also the use of proceeds once we receive them. I would like to also emphasize that we continue to have commercial agreements with H3C, notwithstanding the exercise of the put. Those commercial agreements are distinct from the exercise of the put, and we will continue to generate value through those commercial agreements that we have with H3C. Yeah, as always, I mean, listen, we're gonna apply the same discipline for returning capital to shareholders and continue to invest in the business at the appropriate time. Until we finish this process, right, it's just hypothesizing. We have to go through the process and complete the agreement.

Antonio Neri (President and CEO)

Amit, thank you. Let's next question, please.

Operator (participant)

Our next question will come from Sidney Ho with Deutsche Bank. You may now go ahead.

Sidney Ho (Equity Research Analyst)

Great. Thanks for taking my question, and congrats on the strong results. I also have a question on the full year guide being up 3%-6%, I think it's 5%-7%. Obviously impressive compared to your peer who just down-ticked earlier today. If I look at the midpoint, take the midpoint of your fiscal Q2 guidance, it would assume the second half of the year will be down slightly from the first half, which is kind of unseasonal, right? It's normal seasonality is up, let's call it, 5%.

Can you talk about what's embedded in your second half revenue guidance? Is that all driven by your view on the macro side? Any one-time item that we should be thinking about in the first half? Maybe how we should think about the backlog helping... Delivering from your backlog help offset some of the demand weakness from a half-over-half basis standpoint? Thanks.

Tarek Robbiati (EVP and CFO)

A lot of question into one question, but I will try my best. First and foremost, the revenue growth that we are targeting for the full year is 5%-7%, which at the midpoint is 6, which is double what we originally anticipated. That is because of all the puts and takes in our portfolio and the way we see supply easing on one side, also demand continuing unevenly, although, across our portfolio. If you really look at our EPS guide, one thing I would like to emphasize for everyone on the call is that we did beat the midpoint of our guide by $0.09, and $0.03 of that beat pertained to OI&E and had to do with foreign exchange gains that are not operational.

We continue to view OI&E on the full year basis being an expense of $20 million-$40 million due to elevated interest expenses. There is also in our guidance the potential impact from FX volatility. What is baked into our guidance is just that our current view, to the best of our knowledge of the macro environment, the impact of interest rates, and also the impact of foreign exchange rates that we see at this stage, knowing that things can evolve. It's also important to note that this is our Q1. We still have you know, 9 months to go, and we wanna make sure that we remain prudent in the current circumstance where the macro environment remains uncertain.

Jeff Kvaal (VP, Head of Inestor Relation)

Sidney, thanks very much. We'll take 2 more questions. Anthony?

Operator (participant)

Our next question will come from Wamsi Mohan with Bank of America. You may now go ahead.

Wamsi Mohan (Senior Equity Research Analyst)

Yes, thank you. Can you talk a little bit about how much incremental orders in your backlog you were able to satisfy versus what you had anticipated going into the quarter, given the fact that some of these supply chain improvements came through the course of the quarter? Can you also maybe help us think through what you're expecting from a FX headwind now in fiscal 2023 relative to your SAM guide of a $0.30 headwind to EPS? Thank you.

Tarek Robbiati (EVP and CFO)

Thanks, Wamsi. I will answer the first part, and Tarek the second part. I mean, not enough. I mean, the fact of the matter is that we made some progress, but not enough progress against that very strong order book, and that's why we exit Q1 with 2x normal historical levels. We expect that to continue to improve, obviously, throughout the years as supply continue to ease. Again, you know, we have a good pipeline in front of us, the goal is to continue to fill that order book. When you ask me about how much progress we made in Q1, not enough. You know, if you look at our Intelligent Edge business is extremely elevated. Our HPC business, when I look about the future, deliveries we have to deliver is always very, very strong.

Storage is good, and compute is still there. We have work to do, more work to do. On FX, I think Oh, yes. Thank you, Antonio Neri, and thank you, Wamsi Mohan. This gives me the opportunity to remind everybody that at SAM last October, we flagged at least a $0.30 headwind from foreign exchange this fiscal year. Quite honestly, the headwind we have experienced in this quarter of 550 basis points is above what we anticipated. We still feel that we can attain our new guide on revenue growth and EPS, notwithstanding the current FX headwinds. You know, things can always evolve, and this is why we remain prudent in our full year guide with regards to revenue and EPS growth.

That 30%+ EPS impact from FX has risen, but we are managing it and factoring it into our new guide. I mean, on that point, right, I think it's simply remarkable because, you know, we have to cover all of that $0.30, Tarek, right, operationally.

Wamsi Mohan (Senior Equity Research Analyst)

Yeah.

Tarek Robbiati (EVP and CFO)

The fact that we are raising a midpoint from the $2, which included that $0.30 headwind, now $2.06, it shows you that the mix of the business is going the right direction, the expansion of the margins and the productivity we continue to drive, despite the fact FX actually got worse at the time.

Wamsi Mohan (Senior Equity Research Analyst)

Yeah.

Tarek Robbiati (EVP and CFO)

That 550 basis point is pretty significant. I think, from our vantage point, we are doing all the right things, and we are confident with that guidance where we just provided to you.

Jeff Kvaal (VP, Head of Inestor Relation)

Thanks very much, Wamsi. Anthony, our last question, please.

Operator (participant)

Our final question will come from Ananda Baruah with Loop Capital. You may now go ahead.

Ananda Baruah (Senior Equity Analyst)

Hey, good afternoon, guys. Really appreciate it. Antonio, would love to get any context you could provide, going back to the AI and large language model conversation. Is there any useful way for us to think about the required resources, you know, sort of difference in what you're seeing for those applications relative to, you know, kind of typical high-performance compute application resources? Are you also seeing, for those AI type projects, are you also seeing, any impact to the storage attach? Is there any networking attach impact there as well? Would just love context on those things. Thanks a lot.

Tarek Robbiati (EVP and CFO)

No, thank you. Well, we have been in the AI business now for many years, right? We have been in the specific AI at scale business. One of the key differentiations we have in that business, actually several, right? Number one is the, what you refer as networking, I call it interconnect fabric. The ability to connect 40,000 GPUs at scale requires a unique differentiated fabric. That's what the Frontier system is all about.

Antonio Neri (President and CEO)

As I think about the next generation of this, we can easily double to 80,000 GPUs because our software and our silicon scales to those levels. That's unique value proposition that you don't get in the traditional commoditized cloud environments. The other key differentiation we have is the programming environment we acquired through the Cray acquisition. When you develop these AI models, you have to deploy it, and you have to manage it at scale to take advantage of that massive set of capabilities. That also is a unique software value proposition that's very hard to duplicate. Last but not least, to be able to leverage, you know, all these wonderful capabilities, you have to be able to prepare the data.

The data pipeline requires a lot of work upfront because it has to be, you know, clean and compliant and all of that. That's why acquisitions like Determined AI and Pachyderm, in particular now, allows us to automate that data pipeline. We are not stopping there. We continue to move up and build what I call the platform as a service for developers, so they can take advantage of this automation for the data, train the models, and then deploy the model. If they need the supercomputing type of capabilities, we will be there for them. That's why I said early on, we are a unique point in time where an inflection in the market intersects a unique set of capabilities which we intend to fully capitalize top to bottom.

Not just on the hardware level, but all the way to the software level. You will hear more about that as we come to the next months and quarters. I'm really excited about that opportunity because we already have customers coming to us, we need that. They are generally enterprise customers that deploy these large-scale models that they don't want to spend hundreds of millions of dollars, but they want to use it as an end service. Okay. Well, thank you everyone. I always appreciate you making the time to talk to us. I know today was an incredible busy day about all the earnings being posted. Let me remind you a couple of things. I mean, first of all, today results is not the a coincidence.

It's a combination of many things we have done over a longer period of time. It is the fact that we have a unique strategy. We have been consistently executing with discipline at all levels, driving cost discipline, productivity, investing organically and inorganically to bolster our unique portfolio aligned to those trends we discussed today. you know, we generate a record-setting performance in the Q1 for our shareholders. It was the highest revenue quarter since 2016. We delivered the best non-GAAP operating profit and the highest ever EPS net diluted earnings per share. I believe we are very well positioned to navigate this uneven market. As always, there is always more work to do. No question about that.

I think we have a world-class team, a unique culture, and customers want us to be there for them through this transition. Thank you very much, and I look forward to see you at the next call or in one of the conference calls we do with you.

Operator (participant)

Ladies and gentlemen, this concludes our call for today. Thank you.