Good afternoon, and welcome to the Third Quarter Fiscal 2024 Hewlett Packard Enterprise Earnings Conference Call. My name is Gary, and 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. [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, Paul Glaser, Head of Investor Relations. Please proceed.

Good afternoon. I'm Paul Glaser, Head of Investor Relations for Hewlett Packard Enterprise. I would like to welcome you to our fiscal 2024 third quarter earnings conference call, with Antonio Neri, HPE's President and Chief Executive Officer; and Marie Myers, HPE's Chief Financial Officer. Before handing the call to Antonio, 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 Investor Relations web page. Elements of the financial information referenced on this call are forward-looking and are based on our best view of the world and our businesses as we see them today. HPE assumes no obligation 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 July 31, 2024. For more detailed information, please see the disclaimers on the earnings materials relating 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 have 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 adjusted to exclude the impact of currency. Finally, Antonio and Marie will reference our earnings presentation in their prepared remarks. With that, let me turn it over to Antonio.

Thank you, Paul, and welcome to your new role leading investor relations at HPE. And thank you, all, for joining us today. HPE delivered a strong third quarter performance. We generated impressive revenue growth with notable acceleration of AI systems revenue conversion, as well as higher operating margin from the prior quarter. Net revenue was $7.7 billion, up 10% year-over-year and at the high end of our guidance. Non-GAAP diluted net earnings per share rose $0.01 from a year ago to $0.50 in Q3, $0.02 above the high end of our guidance. We generated a free cash flow of more than $660 million, and will pay a dividend of $0.30 per share. Based on our year-to-date performance, we are raising our full year GAAP and non-GAAP earnings per share guidance. Marie will provide further details in her remarks. Lastly, we are also pleased to have received the first payment of $2.1 billion in proceeds from the sale of part of our equity position in H3C. Overall, the demand environment this quarter has improved. We saw sequential and year-over-year orders growth, but with some geographic variation. Demand was strong in North America, Asia-Pacific, Japan and India, while Europe and the Middle East lagged. We are aggressively going after the opportunities presented by better market conditions and are well-positioned in a competitive and dynamic environment as we close our fiscal year. I am very proud of the progress we have made in delivering on our edge-to-cloud vision over the last several years, which is generating this performance momentum. We have accelerated innovation across all pillars of our strategy. Networking, hybrid cloud, and AI delivered through a unified cloud-native and AI-driven experience as a part of our HPE GreenLake cloud platform. Today, almost 37,000 unique customers use our HPE GreenLake cloud to manage…

Thank you, Antonio, and good afternoon. We are pleased with our performance this quarter and we did what we said we would do. We delivered strong top-line revenues, grew revenues sequentially in each segment, prudently managed costs, improved profitability sequentially, and delivered non-GAAP diluted net earnings per share that exceeded the high end of our guidance range. As Antonio said, we are pleased to have received the $2.1 billion in proceeds from the partial sale of the H3C equity position. Today's results highlight our ability to deliver amidst a dynamic macro environment. While some customers remain cautious and prioritize mission-critical projects, we are encouraged by the recovery in enterprise demand we are seeing in North America, followed by modest improvement across the other geographies. We remain excited about HPE's position across AI, hybrid cloud, and networking. HPE is well-positioned for the AI opportunity. This quarter, our AI systems backlog increased and we grew AI systems revenues approximately 40% sequentially. We continue to win deals with both model builders and sovereigns and are well-positioned to address enterprise AI demand. In traditional servers, we are seeing signs of a recovery as both demand and revenue increase sequentially. In hybrid cloud, we see an improvement in storage, led by the strong demand for our HPE Alletra MP offering, and we continue to drive ARR growth. We are encouraged by the early and strong customer response to our Private Cloud AI offering that we announced at Discover, which we expect to drive AI adoption in the enterprise. Lastly, results were solid in networking. Improving sequential demand in WLAN, data center networking and switching, along with continued growth in security and services, keeps us optimistic heading into the fourth quarter. We continue to make progress towards our strategic goals. Our recently announced acquisition of Morpheus…

We will now begin the question-and-answer session. [Operator Instructions] The first question is from Meta Marshall with Morgan Stanley. Please go ahead.

Great. Thanks, and congrats on the results. Maybe just on the Server margins, given the AI revenue contribution, they were a little bit higher than expected. Could you just break down? Is this from kind of better ProLiant margins, better kind of proprietary Cray margins, just better pricing discipline? Just a little bit more insight into the margin strength we saw there? Thank you.

Yeah, sure. Good afternoon, Meta, and thanks for your question on Server margins. First of all, as I said in my prepared remarks, we did, in fact, ship about $1.3 billion of AI servers in the quarter. So that constituted around about 30% of Server revenue. And despite that, our margins were at 10.8%. And to your point, what was it driven by? So, first of all, we're well on track on the shift to Gen11, and in itself, Gen11 has richer configurations and, therefore, comes with a higher margin profile. Also, I think we've been pretty successful at passing through those commodity costs, and despite the fact that we're in a pretty competitive both CPU and GPU environment. And then lastly, I'd say you would have seen that our OpEx was down sequentially and you're seeing the impact, frankly, of that OpEx discipline show up in the margins as well, Meta.

Okay. Thank you, Meta. Next question, please.

The next question is from Samik Chatterjee with JPMorgan. Please go ahead.

Hi, thanks for taking my question, and I apologize in advance if there's some background noise because I'm at the airport. I guess, we're getting the most questions today on the gross margin. And Marie, I know you outlined the factors there in terms of the AI server mix. But hoping you can flesh that out a bit more in terms of was there anything outside of the AI server mix that impacted gross margins at the company level in the quarter itself? And as we think about sort of your operating discipline going into the next quarter, should we be expecting sort of further moderation in the gross margins and more operating discipline to help maintain that operating margin outlook? And if I can just add on there, the AI order execution that you're seeing, you mentioned lumpy deals with customers. Is that impacting your thinking on gross margins for the aggregate company as we look forward as well in terms of where -- which verticals those orders are coming from? Thank you.

Hey, Samik, good afternoon. So, I think I've got most of your questions. I'll hit it up in terms of gross margins and what we've seen. So first of all, I would say just if you step back and think about gross margins at a high level, from a year-on-year perspective, just to remind everybody that obviously the contribution from our networking revenue is lowest. Obviously, that's impacted gross margins from a year-on-year basis. Now, when you look sequentially, as I mentioned in prepared remarks, the AI mix of servers, we converted at a much faster pace. And obviously, that's really driven margin -- gross margin in the quarter. Now, I would add to your point, we've been offsetting it with prudency on OpEx. You've seen that we're going to continue to do that. I think I mentioned that in my guide comments. And then, also, we continue to have a mindset about being very disciplined on cost and price as we pursue profitable growth. I think we talked about the fact we're selective on deals. And you see that frankly, if you look at the quality of our receivables, you'll see it in our receivables. Now, a couple of things to sort of bear in mind as we go forward. As we see enterprise AI gain momentum, that's going to have a more favorable impact on gross margins. So, we do expect that we'll see improving profitability as the market moves in that direction. And then finally, Samik, just to sort of bear in mind that we're getting closer to the close of Juniper. We expect to see that the end of calendar '24, beginning of '25. In itself, that transaction is going to have a significant impact on both gross and operating margins. And we expect that more than 50% of the company's operating profit will come from networking. So that's how I'd sort of leave it with you in terms of thinking about margins. And as we said, we'll continue to focus on managing OpEx and being very prudent on deals.

Thank you, Samik. Gary, next question, please.

The next question is from Amit Daryanani with Evercore. Please go ahead. Amit, your line is open on our end, perhaps it's muted on yours.

Sorry. Good afternoon. Thanks for taking my question. Marie, I was hoping you can talk a bit more about the free cash flow numbers. It was down a fair bit year-over-year. Maybe you can just talk about what is driving the downtick in free cash flow. Is there a way to think about the headwind you're seeing from the AI ramps versus the strategic pre-buys? Just talk about what those buckets are? And then, related to free cash flow, I think last quarter, it was at least $1.9 billion for the full year. I think this time it's $1.9 billion. So, seems like a bit of a downtick. Maybe I'm overthinking it, but could you just talk about how do you think about that October quarter free cash flow number as well? Thank you.

Yeah, sure. No worries, Amit. And so, yeah, I think you probably are -- just in terms of where we're at in cash flow, let me hit Q3 and then I'll go into Q4. So, from a Q3 perspective, it's really driven by a couple of things. Firstly, the timing of working capital, and also just some of the normal seasonality that we see. And then, as we get into Q4, we do expect to see some of the benefits of working capital. So, we'll see a reversal in CCC, and that will benefit free cash flow. And then, obviously, we're going to see that stronger conversion of AI revenue. I think I mentioned in my prepared remarks that we're going to see a sequential improvement in the shipment of AI revenue. So, you can see that will also have an impact on our free cash flow. So, for the full year, Amit, I'd just say we are still on track for $1.9 billion. It's just as you could imagine, we're in Q3 now, we're getting into Q4, we sort of tightened up the expectations given where we're at in the year. So, still on track for $1.9 billion, Amit.

Very good. Thank you, Amit. Next question, please.

The next question is from Toni Sacconaghi with Bernstein. Please go ahead.

Yes, thank you. You did mention repeatedly the lumpiness of AI server deals, and I'm wondering if there was any unusually large deals in Q3, or whether you're anticipating your AI bookings to be significantly different in Q4. And then just on the free cash flow, Marie, net income is going to be about $2.5 billion to $2.6 billion. Free cash flow is going to be about $1.9 billion. That's about 75% realization. I think since HPE split-off, free cash flow realization has actually been even lower than that. How do we think about that going forward? I presume free cash flow realization will be less than [1%] (ph) for next year and maybe even the following year because of Juniper integration charges? Or where is the pathway to where we can see free cash flow to net income being positive?

Yeah. Thank you, Toni. This is Antonio. I'm going to take the first part. The quick answer is no. There have not been very, very large deals or lumpy deals. It's been more spread and more uniform across the service provider space. And on the enterprise side, because obviously, we talk about this, the percentage of bookings relative to the $1.6 billion was -- as a mix, was in the mid-teens. So, very consistent with the prior year's quarter. However, obviously, the dollars are much larger, right, because now this quarter, we book $1.6 billion. So, I actually argue this is a good thing. And we don't expect significant super-large deals, I'd call it, in Q4 based on what we have visibility in the pipeline, but more a continuation of what we saw in Q3. And Marie, you want to talk about the free cash flow?

Yeah. No, just, Toni, I mean, I think in terms of your comments on free cash flow, from an FY '24 perspective, I mean, in terms of bridging net earnings to free cash flow, it's the normal puts and takes for the year, so working capital, CapEx, et cetera. and sort of employee benefits. So, there is no specific charges in there in terms of our working capital -- sort of our net earnings for the year to free cash flow. In terms of '25, what we said, Toni, I think in the transaction stays the same. And look, honestly, we'll be guiding '25 when we do our next earnings call. So, I'll provide more color around free cash flow for '25 as we get into the next call.

All right. Thank you, Toni. Next question, please.

The next question is from Mike Ng with Goldman Sachs. Please go ahead.

Hey, good afternoon. Thank you for the question. I just had a question about the mix of products and services for the AI systems orders and revenues that you guys disclosed on Slide 12. I guess, I was struck by two things. First, the growing share of services as a percentage of AI system orders, should we expect that to continue over time? And what are some of the key services you're selling with AI systems? And then, second, the very little services revenue that's being recognized to-date, as you recognize that services revenue in AI systems, should that improve the margins for server margins and AI system margins? And how much can that improve margins by? Thank you.

Yeah, thanks, Mike. Yeah, listen, we are very pleased with the services attached momentum on the AI systems portion of our business, which I believe will continue to grow as we grow the enterprise segment of the market, because that segment of the market comes with more rich services day zero, day one and day two services like we call it. And yesterday was the first day it became available out of HPE Private Cloud AI, and that has quite a bit of services component with it. And so -- but right now, as we started disclosing last quarter, the services component of that which you saw in one of the slides, as Marie was providing her remarks, much of that is pretty much all deferred. So, unless we are doing an installation and that gets recognized immediately, most of that is the maintenance that gets recognized over the length of the contract. And therefore, over time, we expect that will be contributing positive to our gross margins in the segment that we recognize that revenue, which obviously is the Server segment of the market. So, yes, but I'm positive on both gross margin accretion as we recognize the revenue and more services as we start selling the HPE Private Cloud in the enterprise space.

Thank you, Mike. Next question, please.

The next question is from Simon Leopold with Raymond James. Please go ahead.

Thank you very much. I wanted to see, Antonio, if you could talk a little bit about the trends with traditional servers, given we hear these arguments that AI-accelerated platforms would cannibalize traditional servers, but you're seeing good growth and good order patterns. How should we think about the risk that maybe that cannibalization eventually happens, or how are you really thinking about traditional versus AI? Thank you.

Yeah. Thank you, Simon. We have seen no signs of cannibalization into the traditional server market. And remember, I always try to bring a segment point of view, right? So, the segment point of view in the AI space, you have three segments. You have the service providers, model builders, which obviously include the hyperscalers, and there we have not sold traditional servers in a long time once we made the decision in 2017 to not participate in that market. And then, you have the sovereign space, which is now going up in term of interest, but the sales cycles are longer because of the government engagements and the procurement, but there, generally speaking, there is no traditional service per se. It's a combination of architectures and GPUs and CPUs in a unique form factor. And then last but not least, we have the enterprise. And the enterprise, while it's growing, has been very much focused on the AI applications. And for customers to move a traditional workload, call it, legacy workloads and the like, to a accelerated compute, the question is why you will do that when, A, you need to use the accelerated compute to either fine-tune the model or to do inferencing; and second, from a PCO perspective, there is no clear view that, that will be cost less. And so that's why when I think about workloads and customer segments, we don't see signs of cannibalization from the AI deployments into the traditional workloads.

Thank you, Simon. Gary, next question, please.

The next question is from Wamsi Mohan with Bank of America Merrill Lynch. Please go ahead.

Yeah, thank you so much. Antonio, I was wondering if you could just share some color on why the -- on what the AI backlog composition is across maybe your portfolio where you're seeing more strength versus not. And within the enterprise demand commentary that you're calling out, can you share some color on what kind of projects are being evaluated? I know you called out some verticals like healthcare and financial services. Curious if you could provide some color on that as well. Thank you so much.

Yeah. So, first of all, the pipeline we have in front of us is multiples of the current backlog, which is a positive news, because that tells you the momentum will continue in the next few quarters. Second is that the backlog composition, as I said, in the mid-teens is the enterprise space and the rest is the traditional service provider space. On the service provider space is basically compute capacity to train models or to do hosting for that matter, in large colos. And then, on the enterprise space is really focused on the use cases where they see clear line of sight for the return on that investment, and there are several use cases by segment that customers by verticals that they are driving. Obviously, many of them are very obvious. And now we are seeing a little bit more sophistication in some of those use cases and the maturity of. And that's why our Private Cloud AI offering is targeting those type of customers, because ultimately comes with entire stack from the, what I call, the workloads at the top, specifically designed for the verticals, down into the training models, all the way down to the infrastructure. They are sized for that type of deployment. And then, on the sovereign AI, obviously, we see now a significant interest. We are working across multiple geos on several opportunities. A lot of them are basically to open AI clouds for sovereign reasons or privates and compliance reasons on data. And a lot of them actually want to look a little bit like supercomputers in many ways because many of those systems are designed to do both AI large language models, and that's very obvious with some of the deployments we have done in the European Union and the one we're going to do now for the U.K. And other ones are basically for traditional supercomputing. So, the infrastructure in the end is the same. All of these systems are very much liquid cooled systems. And so, that's an opportunity for us. But on the enterprise side, I think you can see now expansion from traditional bots and customer service into other areas in finance, manufacturing, marketing, where they can see the clear return on that investment. And we're helping them even upfront through a partner ecosystem to define those use cases, because ultimately, it goes beyond just deploying IT, but they're really to realize the business value.

Thank you, Wamsi. Last question, please.

And the final question is from Ananda Baruah with Loop Capital. Please go ahead.

Hey, guys, yeah, good afternoon. Really appreciate you taking the question. Maybe, Antonio, actually just dovetailing from there, like I'd love any more insight you can give a context around, like what's the HPE sort of sweet spot right now for business you win in GenAI, like what types of deployments or workloads? And then, how do you see that -- do you see that changing, or how do you see that evolving over the next few years as well? And that's it for me. Thanks, guys.

Well, I think right now, one of the key sweet spots is we now have to build and deploy and run these large systems. That requires a unique expertise. That's why you see the services portion being attached to those assistants. And ultimately, you need expertise both in the manufacturing space. And again, we're going to host our AI Day in one of, what I believe is, the largest footprints in the world where you can see how this gets done. And then, on the services side, you should not underestimate the services expertise needed to run. But for enterprise, where is the next big thing is -- in my view, is all about the simplicity. And several of the patterns we are actually filing and getting done are actually in areas like ease of use, automation, obviously, security. These are all spaces where we are actually building all those capabilities in our offer. And remember, all of this gets built inside HPE GreenLake as we deploy these optimized infrastructure and configurations. And that's why for me, GreenLake is an important component of our AI strategy, because ultimately, we manage a lot of the deployment on-prem through enterprise customers, specifically, through HPE GreenLake. And that's an accelerator and a way to upsell, cross-sell, build, ultimately, customers' confidence and control of the data, which is the fundamental value when it comes down to AI. And then, next year, once we close the Juniper transaction, we're going to add another key component, which is the networking piece. And it's very important that we recognize that AI, A, is a hybrid workload. The core foundation of that across hybrid is the network. And HPE will have unique IP and capabilities in that space in addition to the traditional server storage, which is now certified for AI, and then the GreenLake software and services attached to it. And that's how I want to think about it. Independent businesses are all accretive to AI, but then when we get to a solution, HPE will have the full-stack solution to offer to our enterprise customers.

Thank you very much. Antonio, any comments?

Yeah, no, thank you very much for the time. Again, I will say we delivered a strong quarter. We drove very strong revenue growth. We said what -- we did what we said. And honestly, I'm very confident about the next quarter and what comes next after the Juniper acquisition. I'm super-pleased that we also closed the first tranche of our H3C put option. Obviously, that took a lot of work in an environment that's complex. And as you think about our ability to deliver profitable growth is there. I understand the questions around margins, but when I think about margins, on the server side, we are consistently driving a stable around 11% or so operating margins. We think about that way more than gross margin because ultimately it's all about cash. And then, ultimately, on the networking and hybrid cloud is about both gross margin, because of our content is more software and services, while we'll deliver on the bottom-line. So, I think our strategy all coming together, but it's very competitive dynamic there and we have to execute every day with discipline, which is what we did again this quarter. And again, we raised guidance for the full year on the EPS side of the house. So, thank you very much for your time. And I look forward to hosting some of you at our facility in Wisconsin on October 10.

Very good. Thank you, everyone, for joining today.

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