Good morning, good afternoon and good evening and welcome to the Second Quarter 2019 Hewlett Packard Enterprise Earnings Conference Call. My name is Jaime and I will be your conference moderator for today's call. At this time, all participants will be in a listen-only mode. We'll be facilitating a question-and-answer session towards the end of the conference. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Andrew Simanek, Head of Investor Relations. Please proceed.

Good afternoon. I'm Andy Simanek, Head of Investor Relations for Hewlett Packard Enterprise. I'd like to welcome you to our fiscal 2019 second quarter earnings conference call with Antonio Neri, HPE's President and Chief Executive Officer; and Tarek Robbiati, HPE's Executive Vice President and Chief Financial Officer. Before handing the call over to Antonio, let me remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately one year. We posted the press release and the slide presentation accompanying today's earnings release on our HPE Investor Relations webpage at investors.hpe.com. As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. For more detailed information, please see the disclaimers on the earnings materials relating to forward-looking statements that involve risks, uncertainties and assumptions. For a discussion of some of these risks, uncertainties and assumptions; please refer to HPE's filings with the SEC including its most recent Form 10-K. HPE assumes no obligations and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on 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 April 30, 2019. Also, for financial information that has been 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 noted otherwise, are presented on a year-over-year basis, and adjusted to exclude the impact of currency. Finally, please note that after Antonio provides his high-level remarks Tarek will be referencing the slides and our earnings presentation throughout his prepared remarks. As mentioned the earnings presentation can be found posted to our website and it is also embedded within the webcast player for this earnings call. With that let me turn it over to Antonio.

Thanks Andy. Good afternoon, everyone. Thank you for joining us. Our Q2 performance reflects our continued progress on shifting our portfolio to higher margin products and services to deliver positive and consistent earnings growth. As a result of this focus, we delivered strong growth and operating margin improvement, expanding non-GAAP EPS and grew cash flow versus the prior year. We also made a number of bold strategic moves to drive innovation, strengthen our culture and win new customers. While our Q2 revenue growth was impacted by a combination of both intentional and unanticipated factors, we delivered on our [some] [ph] commitment to grow revenue, and we are raising our EPS outlook for the year. In Q2, we deliver revenue of $7.2 billion, up 1% year-over-year excluding the Tier 1 sales and the currency impact. We grew in key businesses, including storage, high-performance compute, composable cloud, Aruba services and GreenLake orders. Strength in these areas partially offset continued intentional declines in Tier 1 sales and sales into China, as well as some market and execution factors, which I will talk more about in a minute. As we shifted the mix of our portfolio toward higher value solutions, our underlying profitability improved across the board. Our gross margin of 32.2% expanded 200 basis points and our non-GAAP operating margin of 8.9% was up 70 basis points year-over-year. All of this combined with favorable OI&E drove a strong non-GAAP EPS performance of $0.42 well above the midpoint of our outlook and positive free cash flow of $402 million, up over $650 million versus the prior year. From a macroeconomic perspective, we continue to see global demand driven by the need to process ever-growing amounts of data. However, like others in the industry, we did see some changes in market dynamics. For example, trade…

Thank you very much, Antonio. Now, let me provide more detail on our financial results for the quarter. As I did before, I'll be referencing the slides from our earnings presentation to better highlight our performance in the second quarter of our fiscal year. Starting with slide one, you'll see as Antonio said that we are on track to deliver our key financial metrics that we committed to at our Securities Analyst Meeting. Revenue grew in line with our commitment at SAM for constant currency growth excluding Tier 1. We continue to expand both gross and operating margins, enabling us to deliver non-GAAP earnings per share above our quarterly outlook. Most importantly, the quality of our earnings is improving. This has enabled us to deliver free cash flow of $402 million in Q2 and $212 million in the first half. This is the first time, we've achieved positive first half free cash flow as Hewlett Packard Enterprise since the company was spun-off from the Hewlett Packard Company in November 2015. Now let me take this opportunity to explain our revenue growth story in this quarter, as shown on slide two. This quarter, we continue to take deliberate actions to improve our profitability. We continued the wind down of our Tier 1 business. The business made up 5% of our total revenue in the prior year, and is now just under 2%, but at a much better gross margins. And as Antonio mentioned, we are selling fewer HPE products to our HPC business in China in order to optimize our HPC joint venture for profitable growth. I will talk about China and the HPC entity there in more details shortly. Currency was also a greater headwind to revenue this quarter. As you can see, after adjusting for deliberate actions in currency,…

[Operator Instructions] Our first question comes from Katy Huberty from Morgan Stanley. Please go ahead with your question.

Thank you. Good afternoon. First, just a couple of clarifications on EPS in the quarter, what would be the net impact of shipping fewer units into China? And then offset by the higher H3C earnings that flow through OI&E. And similarly, what was the impact of one time asset sales on EPS in the quarter? Then I have a follow up.

Hi, Katy. When you look at overall, our business in China, you can look at page two and see the contribution it makes from a revenue standpoint. And what comes at the bottom by way of OI&E. What we explained today is that the revenue that comes from the products we sell through H3C is at preferential prices. And therefore you can assume that that revenue is relatively low gross margin. So from the top line side, the impact to the EPS is practically negligible. Within the OI&E side, you do get the benefit of the equity interest that comes from H3C from selling their products in China plus, of course, our products through their channels in China. And we received a pretty high equity interest in the quarter, but that was not the sole driver for our performance in OI&E, there were other drivers there as well, such as currency hedges, one off asset sales, and of course, the contribution of our H3C business in China. So on the whole, it's a mix of factors that have driven up OI&E. And from the top line, the contribution to EPS growth is negligible.

And what was the impact of the one-time asset sales in OI&E?

Relatively on a EPS standpoint less than $0.01.

Okay, thank you. And then just as a follow up, given such strong free cash flow in the quarter, why not raise the full year and flow through that strength? I guess you knew you were going to get that question.

Yes. It's pretty obvious. The thing we remind ourselves of where we were on a free cash flow basis when we started this fiscal year. In the first quarter we did flag that for the first time working capital would be a contributor to cash in this fiscal year as opposed to a use of cash. So in the performance on a free cash flow basis, you have the three components. Number one, the cash earnings, which are more stronger thanks to the improvement in gross margin and everything we’ve done from a cash earning standpoint. Number two, the working capital, which is a very important part of the free cash flow equation. And number three, we are having less transformation costs than originally anticipated. The guidance that we provided on free cash flow is sufficiently wide $1.4 billion to $1.6 billion. And we’re comfortable with that level of guidance at this stage, we may want to choose during the course of the year to calibrate some investments. And that's why we're not changing the guidance.

Thank you.

Thank you, Katy. Can we go to the next question, please?

Our next question comes from Shannon Cross from Cross Research. Please go ahead with your question.

Thank you very much for taking my question. I just wanted to understand a bit more of what's going on in North America with Aruba? It seems like a pretty abrupt change from a business that was doing pretty well and you were highlighting significantly. So, I guess, if you can give us any more color as to, what went wrong and then the specific steps you're taking to improve the go to market? Thank you.

Yeah, thanks for the question. And good afternoon. Listen, we drove solid growth in EMEA and APJ and we continue to see the momentum going. What we uncover in North America was the market dynamic and the demand shifted in different segments of the market. And we have to make some quick adjustments on how we cover those markets where the growth is, understanding that now there is a transition on new technology with Wi-Fi 6 and other software capabilities that we just introduced to the market. But at the core of the channel was nothing more than making sure our resources and covering the market are in line what the growth is. And there was that. The second was the elongated sales cycles that we saw. And the third one was also the fact that, as people assess what's going on here in North America, particularly with global trade, we saw this elongated cycles in the decision making. And that had an impact on a few deals that shifted from Q2 to Q3. And so that come all together in a way that drove that decline in North America. But I'm really confident, A, number one, we know exactly what it is, and we have taken active action to address it. Number two, is the fact that our products and services are very differentiated. And we feel comfortable about that. But to be fair, we could have executed better in that specific segment of the business. And the good news, we know what to do. And we have put in place the changes that are needed.

Okay, thank you. And then, Tarek, can you talk a bit about the gross margin improvement, more on the operational side? I'm curious as to how much you think is sustainable? How much more you think you can do? And again, some of the specific things you're doing maybe within the supply chain to take costs out? Thank you.

Yes, certainly. So expanding gross margins is very important. And I'm glad that you're focusing on it, it demonstrates that we're not a commoditizing business. And there's a lot of richness in the portfolio of software defined offerings we provide to our customers. The trends are very positive, and we expanded gross margins now for five quarters in a row, we’re up to 32.2% in Q2, and this is up 200 basis points year-over-year and up 110 basis points sequentially, if I'm not mistaken. If you look at what has driven up the improvement, it is primarily pivoting the portfolio mix to higher revenue, rich -- margin rich revenue. That was two thirds of the improvement in gross margin. And the remaining one third came from supply chain efficiencies, the work we're doing with HPE Next, addressing manufacturing overhead and of course, lower commodity costs. So specifically, to your point, when you're asking about sustainability of that gross margin improvement, it is not prone entirely to commodity costs rising because the revenue mix is shifting to higher differentiated revenue streams that command the gross margin premium. And therefore we feel very good about the upside we have in gross margin overall as we continue to accelerate the pivot of our portfolio towards revenues that are higher gross margin.

Thank you.

Perfect, thanks, Shannon. Can we go to the next question, please?

Our next question comes from Toni Sacconaghi from Bernstein. Please go ahead with your question.

Yes, thank you. I think on your last earnings call, you had talked about an expectation that revenue growth would accelerate throughout the remainder of the year, and that Aruba’s growth would also accelerate throughout the year. And I hear you that things have changed. I'm just trying to maybe dimension the magnitude. So based on your Aruba statement it feels like you may be missed Aruba by $60 million. You may be missed your top line relative to that statement by $200 million or more. And so, I guess, I'm trying to understand of that other 140, how much of that was something that you think got pushed out because deals didn't close and you'll get them back next quarter? Or how much of that is the reflection of weakening demand? And given that trade really only started to rear its head like on after the quarter closed in early May, is that a potential incremental concern or headwind for Q3? So maybe you can help me dimension sort of what the magnitude of kind of the levers that you expressed were in terms of the disappointment relative to your expectations? And then, why don't some of them carry over if they are weaker demand and if we haven't really maybe seen the impact of trade hesitancy in full yet?

Yes, Tony, thanks for the question. So, the market dynamics at the beginning of the quarter were certain that we felt we could accelerate. And at the end of the quarter, we saw a different story, because obviously, the uncertainty continued to be in the market. And as I said, that had an impact on elongated sales cycles, which translated in some deals shifting from Q2 to Q3, and those deals will come as we go along. Definitely, we continue to drive solid growth against our strategic initiatives. And obviously, you saw some of the numbers we quoted with Aruba services and we quoted HCI and compostable cloud and even GreenLake which had the largest quarter ever. But no question we could have executed better in some aspects of this particular on the -- as we said just a minute on the Aruba product in North America. But the reality, I cannot put a specific number associated with each of them was a combination of the market dynamics changing from the beginning of the quarter, some deals slipping to from Q2 to Q3. And then obviously, some execution aspects that we could have done better. And -- but we believe, we have the handle on the execution challenges, because that are in our control, and we know exactly which segments of the market and we have made or continue to make the changes. But the demand for ever growing amount of data, and the pipeline that we have out there continue to reflect the fact that we actually will continue to deliver on our commitment to some, which is to grow the company and obviously grow the Intelligent Edge, which is, as I said in my opening remark, is a big opportunity for the company. So, overall, I think, you know, that's how I characterize this quarter. And there are things we have in our controlling and things we have not in our control. But the pipeline, the fact that data continue to explode, and the fact that we have these deals shifting from one quarter to the other give us the understanding and the confidence that we will execute as we go along.

Okay, thank you for that. Just to follow-up, I was wondering if you could tell us what operational services revenue growth was in the quarter. And what the operational services order growth rate was, if we exclude nimble, because that's not part of how you define operational services as you report it. And you said last quarter that, this good book-to-bill would help growth rate in operational services. When do you expect operational services to show positive growth?

Okay, Toni. So overall, we feel good about the long-term opportunity and profitability of Pointnext. Revenue in Q2 was down 3% year-over-year, mainly due to the continued exit of low margin countries in the advisory and professional services business. This will become less dilutive as the year progresses. Our book-to-bill ratio was 1.12 which is an indicator of future revenue growth. And in my script I've indicated that as GreenLake continues to grow there is an elongation of the cycle that we could see for recognizing the revenues pertaining to Pointnext OS. And we need several quarters off a book-to-bill ratio at current levels to be seeing Pointnext OS, operational services revenue growing. So when you look at this, what's important and what we do as we drive the book-to-bill ratio to be at or above current levels, we also drive operational services orders in nimble. And when you take the combination of operational services orders plus the nimble services orders the combination grew 1% in constant currency as we have the tailwinds of new attached offerings across our portfolio. GreenLake is really the only on-prem consumption driven offering in the market and it was up 39% year-over-year plus thing that we also announced the strategic partnership with Google cloud and Nutanix and this is to expand the GreenLake echo systems for several quarters ahead of us. So we feel good about this, it will take us a bit of time, maybe Antonio wanted to add.

Yes, no just a couple of comments, Tony. So our book-to-bill ratio is what I've really measured going forward in each aspects of the portfolio because obviously when you're at these levels over time depending on the mix of what gets booked, it will drive revenue growth. And if you look at our book-to-bill ratio in Q1 was lower than Q2 even though it was above the revenue. So that means we have seen an acceleration of the book-to-bill ratio quarter-over-quarter and year-over-year and as that matures becomes in the balance sheet over time you are going to see that balance sheet translated into revenue. And the other thing let's remind ourselves that GreenLake while it has potentially a longer elongated cycle because of the way the revenue gets recognized, let's remind yourself, it has 100% attach rate of operational services. Every time you sell a GreenLake it comes with hardware and 100% attach of operational services. So, as GreenLake grows, so grows our attach rate and attach rate gets recognized in the traditional way we recognize our deferred revenue for operational services. So that's why I'm very encouraged and very pleased with the performance of operational services where the book-to-bill ratio and the GreenLake because that drives 100% attach rate.

Great. Thank you, Tony. Can we get to the next question, please?

Our next question comes from Aaron Rakers from Wells Fargo. Please go ahead with your question.

Thanks for taking the question, one question and one quick follow up, as well. First on the server side of the market, I'm just curious of how you are currently seeing component pricing, particularly DRAM pricing flow through the model, whether or not you actively reduce your pricing or if you plan to do so going forward? And kind of underneath to that, how do we think about unit growth within the server category is that -- when do we expect that to maybe trend to the positive?

Thanks for the question. So the overall commodity environment continue to be favorable and there is an oversupply now compared to last year's as you recall there was shortages and costs going up. The DRAM prices are down, but let's remind our self that that does not translate in a lower AUP because at the same time we said our AUPs are two third structural because more and more options in the form of memory and flash get attached to these units. And so we have talked about this before, the fact that units get sold with more and more options even though the AUP of the components go down it does not translate in a lower AUP at the system level and that’s why this quarter we again grew our compute revenue by 4% excluding Tier 1 obviously which we're intentionally declining. And despite the decline on commodity cost and that commodity cost takes time to find its way in the in the system and I always make this analogy, is when the cost goes up is like when you take off with the plane it goes up fast, when you land the plane it takes longer and this is exactly the same way. And because our unique portfolio in the compute because we have probably one of the richest portfolio in term of what I call volume and value and in value we have probably the most complete in term of mission critical, in term of in memory solutions HPC, obviously, and things like blade and compostable. We have a unique mix that bright higher value AUPs and higher attach. So it will take long time to get these numbers the lower costs in the system AUP, but at the same time, more and more options will get attached. The second part of the question was about the units. And now we are in a very low single-digit declines. And as we said before, by the end of the year, we believe this is going to be a non-event and from there on obviously, as we continue to drive this pivot to the higher value products and services, particularly in the product side we're going to see growth in that and we start to see the momentum in some of these areas like I quoted right so compostable cloud 78%, high performance compute continue to be very strong, another 25% growth. And obviously, as we close the Cray transaction that will add more to it at the larger, larger amount of scale of units, because these are big amount of systems. And then obviously, the hyper converged infrastructure as well, which are the core is a compute platform with a bunch of storage attached to it.

That's perfect. A quick follow-up, you mentioned in the call that you obviously have this put option for the H3C asset, I think at 15 times trailing 12 months net income that actually equates to a relatively large number. So I'm curious of how you think about evaluating that put option relative to the strategic nature of that relationship or how you just think about that with that now being on the table?

Yes, look, it's important to realize that China is a very critical market for us. It's the largest and fastest growing IT market in the world. And we have a unique structure there with a fully operational business that makes money. And it's a structure that not many Western companies can actually claim they have. Starting May 2019, we can exercise that put option to sell part or all of our 49% stake. And if you take the minimum of the put value at 15 times trailing 12 months and earnings you get to the figures that you have in mind. But it's important to understand the contribution of H3C to the overall profit pools at UNIS, which is a listed company in China is actually generating and what is that contribution of UNIS underneath H3C on a niche unit, alongside the other entities that UNIS has. And I invite you to just take a look at this and you will form your own view as to the value of our put and what it represents for us. So, let me add a commentary on this. I mean, obviously there is a financial aspects of this and then there is the strategic aspect of this. We are incredibly pleased with this relationship and the setup in China. And it has proven to be very important and critical in the times we are living today. Because we can participate in the second largest market growing faster than any other market. And so, we are actually collecting the benefits of that growth in a unique setup that shows up in our EPS growth as we talked earlier. And obviously we have to assess a couple of things right, how that market evolves and how we participate in the market. Ultimately, what is the source of a potential use of that cash to continue to drive the growth in the company. Right now, as we said, in the opening remarks, we have no intent to sell the put option. But as always, we will continue to evaluate what is the best for the company, for our shareholders, understanding what's going on in that market and understanding how we continue to participate.

Thank you.

Perfect. Thanks, Aaron. So we're coming up on the bottom of the hour. So I think we have time for just one more question, please.

And our final question today comes from Jim Suva from Citi Investment Research. Please go ahead with your question.

Thank you very much. I have one question and it's probably the CEO and CFO both want to chime in on it. But it appears that on this conference call you were a lot more vocal about the H3C operations, put options, especially to put options have been in the past. And maybe I'm just hearing that a little different. But it seems like you're a lot more vocal about that. Why is that? Is that because of the China U.S. friction? Or is that because of perhaps a lot of the guide and beat was due to this other income line? Or how should we think about, it appears to be a change in the verbalization around this line item on your income statement? Thank you.

Thanks for the question. I think, we felt that it was a need to provide more clarity and education on our setup. Honestly, as I go back, and listen to the type of questions and so forth, we felt we probably haven't done a good job explaining this setup and the value of this unique relationship. That's why we decided to show it to you. It has nothing to do with the U.S. China relationship. It had to do to how we drive value for shareholders. And we believe this is driving significant value for shareholders. But we didn't explain it to the extent that Tarek did today, because we felt, we didn't do a good job before. So that's why we're bringing it up. And it just happened at the same time, with everything going on in China. Now, probably people will think, well, maybe the setup is unique and it's more valuable in the context of what we see. But really, it was all about educating you in understanding this setup in the context of the valuation and the value we drive for our shareholders. And I thought Tarek did a very good job explaining that. Because it's very unique, we don't see anything out there like this. Tarek, I don't know if you want to add anything else.

Absolutely. I will simply add that this is -- at the beginning of this month this is the first time where we can exercise the put option. And that's the reason why we talked to you about it today.

Thank you so much for the details, that make sense. I appreciate it.

Thank you.

Great. Thank you, Jim. I think with that we can close out the call. I know there's a heavy earning scheduled today. So appreciate everybody join us and we'll look forward to talking to you next time. Thank you.

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