Q2 2020 Earnings Call
Good afternoon, and welcome to the second quarter 2020, Hewlett Packard Enterprise Earnings Conference call. My name is Iowa, and I'll be your conference moderator for today's call.
Hi, all participants will be in listen only mode.
Well be facilitating a question answer session towards the end of the culprit should you need assistance during the call. Please state your corporate specialist by pressing the star Keith followed by T. Rowe.
As a reminder, this conference is being recorded for replay purposes.
I'd now like to turn the presentation over to your host for today's call Mr. solely Alright, senior Vice President corporate development and Investor Relations. Please proceed.
Thank you and good afternoon, everyone. If it's totally correct, that's VP of corporate development and Investor Relations Hewlett Packard Enterprise.
I would like to welcome you to our fiscal 2022nd quarter earnings Conference call with Antonio Larry H.B., President and Chief Executive Officer, and Carrick, Robbiati, H.P. 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 H.P. Investor Relations Web page at investors.
<unk> Dot com.
As always elements of this presentation are forward looking at our 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 assumptions.
For a discussion of some of these risks uncertainties assumptions. Please refer to H.P. <unk> filings with the FCC, including his most recent forms 10-K.
H.P. he 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 reflect estimates based on information available at this time I could differ materially from the about open nothing reported an H.B. Its quarterly report on form 10-Q for the fiscal quarter ended April Thirtyth Twentytwenty.
Also for financial information has it 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 each house.
Throughout this conference call all revenue growth right 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 high level remarks.
Well be referencing the slides at our earnings presentation throughout his prepared remarks.
As mentioned the earnings presentation can be found posted to our website and is also embedded within the that kills player or this earnings call.
With that let me turn it over to Antonio.
[laughter] thing some really good afternoon, everyone. Thank you for joining us today I hope everyone is safe and healthy.
Pardon me, ladies and gentlemen, we seem to be experiencing some technical difficulties Antonio.
Your why maybe on mute.
Yeah. Thank you sorry, we have I had the polymer with my phone. So thanks Ali good afternoon, everyone. Thank you for joining us today.
Hope everyone is safe and healthy our fiscal Q2 results represent a full force it off operated during the call them up I just 19 crisis.
Fund that makes it sound like any other prices we face.
And he has brought significant economic disruption.
Businesses and communities are struggling supply chain productivity continues to be significantly constrained and the demand environment is uneven.
The market for a couple abilities like remote connectivity and virtual desktop solutions is thrown in the pre crisis in certain segments, and we had a well positions in those areas, but all customers are understandably cautious given so much uncertainty.
This is not the least amount makes how the significant impact on our financial performance this quarter given the economic looked down since February.
Overall Q2 revenue declined by 50% to $66 billion, which led to a 42% decline you know non-GAAP operating profit.
This was a thought for the by every measure and I'm of course disappointed in the results.
But I do not view, our Q2 performance reflects some of our capabilities no off the opportunity ahead of us.
Through these unsettling time I have been really proud Obama sponsored studies aligned to our purpose to along the way people live work.
We consider our responsibility to help the walls and I'll be glad this pandemic.
We have prioritized protecting the health and safety of our team members and supporting our customers and partners as we weathered the storm together.
At the outset, we moved quickly to mobilize crisis management teams around the world.
We took decisive steps to ensure our team member safety and well be.
We closed all of our sites and probably move team members to work from home except for those of the for me mission critical roles.
We expanded team member benefits to Copacabana by this 19 testing and treatment.
Mental health support and provide the tools and resources to keep people connected and productive.
We also responded with important initiatives to address key needs created by the pandemic.
We made substantial donations through Hps Foundation, and these ignite $2 billion in financing to H.B. financial services to customers and partners with financial hardships [noise].
Auto Ruben networking capabilities have been deployed in drive up and virtual health care clinics any schools. The other facilitate didn't distance learning.
And our high performance computing solutions are helping scientist a leading research institutions to speed up drug <unk> discovery with complex modeling and simulation.
Machine learning capabilities.
We joined forces with U.S. government and older High Tech companies to form the White House high performance compute the consortium given Corona Vitesse 19, researchers access to H.B.C. resources.
He also signed the open called me the plate Glanton free access to all of our patented technologies for the purpose of diagnosing preventing and treat into Vitesse [noise].
We have also adopted to deliver much needed capabilities and experience just wait our customers transformations as they navigate this difficult time.
Through and improve cells coverage model aligned to market segments are intelligent edge business continued to outperform the market, while expanding operating margins and demonstrate to 12% year over year growth in North America.
In addition, we getting traction of H.B. green like business.
Did you have to see awesome duration is very profitable strategic business and I've seen larger deals come in underscoring a growing interest in our also service offerings in fact, our annualized revenue run rate or they are our increased 17% to $520 million.
Well these are healthy songs off the need for customers. We continued to have called me also the crisis.
There continues to be significant supply constraints and delays in customer acceptance. This has impacted our ability to make deliveries to our customers.
Girls portfolio, we exited Q2 with more than $1.5 billion in backlog, you compute storage H.B.C. and mission critical systems as well level, though.
Represents two times they started called backlog.
Our team is doing everything we count to deliver on this oh these customer orders.
Topic will take you through our Q2 results in more detail.
But before he does that I want to take the time to a line actions, we will take to address the near term uncertainty and ensure H.B. is well positioned to emerge stronger more jobs and digitally enabled for a post quarter end of August 19 wells.
While the war they started to invasion, what the other covert it might look like we need to be prepare for different scenarios.
We know that is not going back to what used to be but he's only preparing for and building what comes next.
We need to adopt in order to keep our strategic momentum even as the water has changed dramatically we have taken a deliberate a set of actions to protect our financial foundation become a mortgage all organization and align our resources to critical core businesses and areas of growth accelerate our age the BLA BLA for <unk>.
[music].
We continue to analyze financial forecasts in customer trends to better understand when and how global economies would recover.
In the meantime, we've taken some immediate steps to reduce operating expenses that will protect a financial profile.
Effective July 1st we will implement a short term pain reduction for all team members, whether it is legally permitted through October 31st 2020.
My executive team and I will take the highest percentage reduction.
Yeah, that's the amount of reduction will vary by level.
For team members, who live in countries, where production cannot be mandatory due to local laws or regulations were implementing pay leaves.
In addition, we have implemented cost containment measures across the company restricted external height in through the end of our fiscal year and put solid increases on hold.
Additionally, our board of directors hub voluntarily the decided to forgo a percentage of its cash compensation for the remainder of the fiscal year 2020 to demonstrate its commitment to Hewlett Packard enterprise.
As we focus on preserving liquidity and improve our position to deliver for customers now and in the future.
In addition to does a short term majors today, we're announcing a cost optimization and prioritization plant.
This plan will help us focus on investments and realign the were forced to areas of growth that will accelerate our strategy.
Some other measures in the plan includes continued to streamline the problem before you're implementing new digital customer engagement models, and optimizing our workplace I strategy and experiences.
H.B. aspects the plan would be implemented through fiscal year 2022.
And as a result of the changes to the company's workforce real estate mobile and for the business process improvements, we estimate gross savings of at least $1 billion, an annualized net run rate savings of at least $800 million by fiscal year of 22 yearend.
In order to achieve this level of cost savings H.B. estimated cash funding payments between $1 billion to $1.3 billion over the next three years.
Tadic will provide further details in his remarks.
Well, we take the steps to secure a financial foundation and strengthen our operations. We have simplified our operating model and have a line into the financial segmentation. We introduced early this year.
Each of H.B. East businesses is critical to our go forward success.
Each care is an important part of the mission.
And our customer than my new and different products and services from US we must deliver.
Hi, I'm personally committed to delivering to help each of our businesses leverage its existing strengths and evolve.
Each of our business groups not report directly to me.
Oh spots of up to new organizational model, we created a green light cloud services group to US other Reits are also service capabilities.
We also added eight new softer team that will architect our softest rather just before the power are also service profit.
This new structure will provide for that accountability and improve our execution and transformation.
Oh the war emerges from the global pandemic business continuity will depend on solutions that advance IC resiliency empower multiple forces securely extend comic CBD.
We go to customer engagement and enable business model evolution.
These realities means that the digital transformation will be more critical than ever.
This is why we must assume a write off strategy to lever everything as a service edge the cloud.
We see that a growth in the cloud on and off premises and increasing the at the edge, where we are uniquely position.
The edge customers need persistent coming pivoted to bridge, the digital and physical words.
H.B. I don't have a central he's other quarter pottage strategy. It is the only cloud native simple to use in secure platform that unified network management for wired wireless and one networks and Tsum Fiveg and edge computing.
Thank you to the number of unique customers using a robust sensible increased to 65000.
Customers will also continue to need capabilities the hubs the power of the data or whatever the lives of usage across public and private clouds and colocations or in the traditional data center.
We continue to believe the cloud isn't expedience, nothing destination and as a service business models will extend the cloud experience everywhere for all opposite data.
Early this month, we announced the general availability of H.B., Great Lakes Central out advanced cloud native platform that provides customers with a consistent cloud expedias for all their application that data.
I know line operations consoles bronze manages and optimizes their entire hybrid cloud the state.
And in Q2, we made H.B. content from Gener available a new cloud nave to soft on the find stock is built using technologies from Hps acquisition of new data storage and my bar and deliver greater flexibility and lower cost for Cooper me deployments of cloud native and non cloud native application.
With persistent storage connectivity.
Next month.
Our first ever discover virtual expedience, we will showcase how H.B. he will help organizations and sure seamless business continuity through new technology capabilities, greater business intelligence and enhanced financial flexibility.
Joint by thousands of customers and partners, we will disclose how we should think differently about transformation in the future and willing to these new innovation to bring agility to customers often data up Cindy the everywhere.
These are great promise in what we can accomplish when we increased the speed of innovation and continue to bring to market differentiate the capabilities from age the cloud.
Our customers partners and communities need what H.B. can provide.
Our ability to execute our so did you pay but to offering our entire portfolio as a service by 2022, while we continue to what do you have to take that strengthen our core businesses is critical.
As we drive increased performance in our core businesses will be able to afford that align resources to new growth segments that we love civil rights, our strategy and paved the way to sustainable profitable growth.
One of our core beliefs are they each be he is the power of yes, we can and I'm confident in our ability to execute because I believe we have the right strategy the right leadership team and the right mindset to adopt and deliver it both ways.
We are focused we are making the necessary trade offs. So we can continue to invest into future. We are undertaking it with a sense of urgency and conviction in our strategy.
Without limiting it to topic to review the quarter's results Kotick.
[noise] [noise]. Thank you very much on Tonya I Hope you can all hear me, an oral safe and well.
I'll start with a summary of our financial results for the second quarter fiscal year 2020.
As I've done before I'll be referencing the slides our earnings presentation to highlight our performance in the quarter.
Also please note since last quarter, we're now reporting results according to our new segmentation.
I'm talking to discuss some of the key highlights of this quarter on slide one.
Now, let me discuss our financial performance starting slight too.
Our Q2 results were heavily impacted by the global covert 19 crisis.
As Antonio mentioned, our Q2 represented a full quarter of operating under Corbett 19.
Our revenues of $6 billion were down 15% year over year, primarily driven by supply chain disruption, which resulted in significantly higher levels of backlog.
Particularly in compute HPC M.C.S. and storage.
We also saw uneven demand with customers pushing out business activity as a navigated through the current economic crisis and locked out.
At the edge the market for capabilities like remote cloud connectivity and virtual desktop solutions was stronger than pre crisis in certain segments, and we're well positioned in those areas offsetting the decline in campus switching that resulted from lower business activity.
Despite the challenging backdrop, we managed to maintain relatively stable non-GAAP gross margins, which were down by 20 basis points year over year.
Our non-GAAP operating profit, however was down 42% year over year to 6.1% in operating margin terms and then our non-GAAP EPS of 22 cents was down 48% year over year.
Our GAAP, yes was a loss of 64 cents, primarily due to an eight 865 million noncash goodwill impairment charge associated with legacy goodwill allocated to the H.B.C. and Mcs business segment, which impacted GAAP net S. Bye.
67 cents.
This impairment was not driven by the crane business, which continues to perform consistent with our expectations.
Cash flow from operations this quarter was $100 million impacted by reduced profitability and inventory buildup.
Free cash flow was negative $402 million compared to a positive $402 million for the prior year period, which was impacted by higher financing volumes.
Taking all the breeder seemed to break out we're taking decisive and prudent actions to matters, our costs and expenses further improve our liquidity and focus on opportunities to emerge stronger in deposed covert 19 world.
Turning to slide three.
Antonio outlined for you some of the near term cost takeout measures were implementing including reductions in pay across our workforce unpaid leave in places where pay reductions are not legally permitted and hiring restrictions.
I also mentioned the actions were committing to today to further strengthen our financial profile in the medium and long term and accelerate our strategy.
Today, we are announcing a cost optimization and prioritization plan to reflect the current revenue environment and to position ourselves as a more resilient company ready to address the needs of our customers in a post go read 19 world.
We remain confident that we have the right strategy and are taking the right actions to secure our financial Foundation.
Support our path to sustainable profitable growth.
More specifically.
Our plan is designed to rightsize, our cost structure to the near normal.
To allocate resources in alignment with our new segmentation and growth areas to drive increased efficiencies three investment individualization and automation.
And finally to accelerate our pivot to as a service to drive long term sustainable profitable growth.
Overall, these new cost efficiencies will be captures from simplifying and evolving our product portfolio strategy and go to market.
Cost saving from supply chain optimization.
Increased penetration off remote customer support new initiatives to leverage digital marketing and consolidating our real estate footprint.
In terms of a timeline, we expect the plan will be implemented through fiscal year Twentytwenty too.
And estimate that it will deliver annualized run rate savings of at least $800 million by fiscal year 22 and.
Having said that we expect to achieve the majority of the savings by the end of fiscal year 21.
In order to achieve this level of cost savings, we estimate cumulative cash funding payments of between 1 billion to $1.3 billion over the next three years.
We'll now move to slide four that shows our performance in the quarter in accordance with our new segmentation.
Let me hit a few key points.
In the intelligent edge segment, we declined 2%. However, we saw over 12% year over year growth in North America.
Showing that the changes we made to our North America sales leadership and go to market segmentation are paying off even in the midst off a challenging business environment.
Why campus switching decline single digits due to increased emphasis on working from home. We grew the wireless line product business, 7% year over year due to high demand for our remote access solutions and why five six certified access points with 35% year over year growth in North America.
Furthermore, we expanded gross margins and also grew operating margins by 570 basis points year over year to 11%.
The bottom line is that we gained share in both camper switching and wireless Lan markets, while significantly improving profit margins.
In compute revenue declined 19% this quarter driven by lower conversion rates, even as order backlog grew to two times, our average historical backlog and lower unit growth, which was negative double digits this quarter.
Our ability to fulfill orders was impacted by component shortages, we supply chain logistics further disrupting our ability to fulfill demand due to the corona virus pandemic.
As the supply chain constraints alleviate we expect to execute against our high backlog.
In high performance compute and mission critical systems revenue declined 18%, primarily as a result of delayed installation and customer acceptance on account of covert 19th.
Similar to compute this resulted in an elevated backlog, but we expect to see a stronger uptick in revenues in the second half of the year as we execute against the order book.
Our HPC business has been actively involved in cobiz related research activity and he's provided providing covert 19 researchers worldwide with access to the world's most powerful HPC resources to advance the pace a scientific discovery in the fight to stop the virus.
Furthermore, we announced the 2023 delivery of the world's fastest excess scale supercomputer and it's got be done for the United States Department of energy at a record breaking speed of to exit flops 10 times faster than today's most powerful supercomputer.
Most importantly, the Cray integration remains on track to deliver the F. why 20 revenue targets and triple digit run rate synergies by fiscal year 21.
Within storage, we declined 16% year over year due to higher backlog similar to compute but had notable strength in big data showing a growth of 61% year over year.
[noise] nimble services revenues grew 20% year over year, we service intensity at record highs as customers at high margin value added services.
For operational services, which is included across compute HPC M.C.S. as storage revenue declined by less than 1% year over year, while orders were down 5% year over year, driven by the drop in compute units.
On the positive side, our services intensity, which is the ratio of attached revenue per hardware units sold continued to be strong with double digit growth in storage and HPC M.C.S. services driven by Craig.
This demonstrates that the underlying profitability of the units, we sell and the attach rates continues to be robust.
In advisory and professional services revenue was down 8% well, we significantly improved operating margins by 6.2 points year over year.
Due to our re entry in select countries combined with an increase in remote delivery of projects from 65% to 90%.
Which helped to control costs and drive an improvement in chargeability levels of staff.
Within H.B. financial services financing volume grew 10% year over year. Despite the impact of Corbin 19, and our net portfolio of assets was up 4% this quarter with longer contract terms supporting Green Lake.
We maintained a solid return on equity of approximately 15% again this quarter.
Our bad that loss ratio this quarter was 0.5%, which is best in class in this industry.
We'll obviously continue to closely monitor the impairment losses as liquidity constraints could affect some of our customers' ability to pay in upcoming quarters.
We will tighten our underwriting guidelines as necessary to ensure we can manage through this crisis and any impairment losses remained within our level of comfort.
Our communications and media solutions business that is included in our corporate investment segment is a strategically important business to us providing software and services capabilities to telco service providers.
CMS is showing improved momentum.
We saw strong double digit software order growth with EMEA growing, 45% and Japan growing 70% this quarter.
Revenue gain momentum growing 2% sequentially.
We also expanded operating margins by 170 basis points year over year this quarter.
We also recorded our first Fiveg core win with a tier one carrier in the United States.
The strategic win validates our five you strategy with multi vendor integration and true cloud Native Telco network solutions.
Slide five shows our growing air our profile I introduced at our Securities analysts meeting in October 2019.
I'm pleased to report that our Q2 20, EMR came in at $520 million, representing 17% year over year growth and inline with our expectations.
Our HP Aruba Central SAS platform continue to grow revenue triple digit year over year this quarter.
As we progress towards building our go to market as a service motion and remain focused on offering a full suite of differentiated solutions that can be consumed as a service. We are reiterating our air our growth guidance of 30% to 40% compounded annual growth rate from F., why 19 to F. wide 22.
Slide six highlights our EPS performance to date non-GAAP diluted net earnings per share was 22 cents in Q2 with headwinds from reduced operating leverage suspension of our share buybacks and a lower but expected contribution from Hawaii any.
Consistent with our guidance that Sam we expect do I need to be approximately negative 100 million for fiscal year 20.
Turning to gross margin on slide seven we delivered non-GAAP gross margin of 32% in Q2 fiscal year, 20, which was down 20%, which was down excuse me 20 basis points year over year.
Commodity costs, where a tailwind to gross margin this quarter, even as the supply demand balance turned into a more inflationary commodities environment at the start of the quarter.
Moving to slide eight non-GAAP operating margin was 6.1% in Q2 fiscal year 20, and non-GAAP operating income was down 42% year over year.
This clearly demonstrates the imperative to rightsize our business.
To reflect the new revenue profile, we are facing as a result of the covert 19 impact.
Turning to slide nine our cash flow from operations was $100 million impacted by reduced profitability from to compute and storage businesses, which were heavily impacted this quarter and higher than normal working capital.
Free cash flow was a use of $402 million for the quarter driven by year over year gross.
Which was impacted by financing volumes.
Higher than normal backlog, and resulting inventory buildup triggered a reduction in our cash conversion cycle from minus 17 days in the prior quarter to minus five days this quarter.
We expect our cash conversion cycle to improve through the rest of the year as we execute against the backlog and supply chain constraints alleviate both of which help us reduce our high inventory levels.
Now moving onto slide 10, I want to spend a moment on the strength of our balance sheet and Im investment grade credit rating, which is a competitive advantage in this environment.
As of our April Thirtyth quarter end, we had approximately $5.1 billion off cash and cash equivalents, having successfully raised two point $25 billion in senior notes in April 2020 at a low cost of capital.
We also have an undrawn revolving credit facility, a four point $75 billion at our disposal.
So in total we have approximately $10 million off liquidity.
We remain committed to maintaining our investment grade rating, which was reaffirmed by the rating agencies in April 2020.
Bottom line, we have a strong cash position and ample credit available during these uncertain times to support and invest in our business.
Let me recap for you our key takeaways for this quarter on slide 11, but before I do that it's worth spending a couple of minutes on capital allocation.
In Q2, we returned $305 million to shareholders into form of share repurchases and dividends.
We repurchased $151 million in chairs and paid a cash dividend of $154 million.
In April 2020, we took the decision to suspend share buybacks in the light up the current environment, where liquidity is of Paramount importance.
Subsequently in April we announced our regular dividend payment for Q3 20 payable in July.
Finally, let me summarize the key takeaway for you this quarter.
Our fiscal Q2 results represent a full quarter of operating under the covert 19 crisis and were heavily impacted by the crisis, both on the demand and supply side.
As a result, we haven't act that short term actions and long term cost optimization and privatization plans to reflect the current revenue environment and to position ourselves as a more resilient company in a post kogut world.
Our boss balance sheet with approximately $10 billion up liquidity and investment grade credit rating gives us flexibility not only to whether the current storm, but to continue to invest in key growth initiatives.
We remain confident that we have the right strategy and are taking the right actions to secure our financial foundation and support our path to sustainable profitable growth.
Now turning to outlook.
Since the crisis began.
We've been stress testing, our model and running scenarios based on various assumptions.
Just like everybody else does.
Given the level of uncertainty around the duration of the crisis and the rate and the shape of the recovery, there's a wide range of possible outcomes for the year.
We have taken prudent and decisive steps with the latest being our cost optimization of privatization plan. So that we are prepared for the different outcomes.
Due to the uncertainty and consistent with our April 620, 20, 8-K filing where we withdrew our fiscal year 20 financial guidance, we will not be providing any Q3 or fiscal year 20 guidance.
Now with that.
Let me hand over to Antonio and open it up for questions and Tanya.
So thank you topic and I know nancy's going out on the rate. This so nancy while we don't get stuff that.
We will now begin the question and answer session asked a question you May Press Star then one on your Touchtone phone. If you are using speakerphone. Please pick up your handset before pressing Mickey.
Lets try your question. Please press Star then too.
We also request, but you only ask one question and one follow up question.
Our first question comes from Katy Huberty with Morgan Stanley.
Thank you good afternoon, and the color on backlog is helpful. But I wonder whether you could also give some color on how orders trended through the fiscal second quarter and what you've seen from an order perspective.
In the month of May and then just related to that you specifically said that the H.P.C.
Business and conversion rates would tick up in the second half that you stopped short of giving a similar timeline for compute and storage. So just any color as to when you think orders will begin to convert and in those two segments as well.
Yes, hi, guys and thanks for the question so the order that intake or whatever for it as the orderly now to do was fairly stay the ive to say I'm you know.
We normally plan a quarter there in 13 weeks. The first week is the previous backlog from the previous quarter.
The backlog from the previous quarter, and then 12 weeks right and we plan to selling out of the early on and I will say, we hit or exceeded our orderly now that the intake every every week over the quarter.
And so this really came down to our ability to convert the order book into revenue and and then the case of H.B.C. High performance computing, a limit I remind everyone that in order for us to convert that order into a revenue we have to build it obviously, we have to ship it.
But we have to install it and we have to turn it on.
And once the customer accepts that you know installation, which in many cases is fairly large installations, you're talking about a number of clusters. That's what only we can recognize revenue and so the impact on HPC was twofold was not being able to go to customer size because customers were locked out like we are.
And a and they'll be able to install and deliver and turn it on and obviously the same challenge we have in computing and storage, we supply chain constraints in capacity because of the social distancing and obviously in the components level that we so obviously, a major disruption and as a reminder, wish.
Pretty much three servers every minute and so one that supply chain stops is pretty pretty the significant so in terms of going forward.
Our priority one two and three continues to be clear the backlog and that's how I am I think about it throughout Q2, we've made progress in the recovery I will say, China is pretty much back to normal, but obviously they are cleaning the backlog himself.
Because they have to you know first of the coveted the labor and then obviously the pen also sub suppliers for the components think about cables connector transistors, you name it and so for US the majority backlog right now is in the bucket and then in the regional factories.
For the vast majority the old performing a capacity, except one or two where you know the the rules and regulations all the shelter in place are demanding that that is a a stringent process on social distances, which obviously impacts the capacity in the factory lines, but the fact that is all up and running so.
I am optimistic about the weeks to come so I'll take this a week of the time, obviously, we continue to focus in the order intake I cannot comment in May because the I think you asked a question on my because we had a good three right now but in Q2 the older valuables fairly steady and we expect you know not just HPC, but compute the storage.
We continue to to make progress and that's why Q3 will be different than Q2.
Our next question comes from Wamsi Mohan with Bank of America Merrill Lynch.
Hi, Thank you Antonio you commented on Rightsizing, the cost structure to a new normal a few years ago H.B.E. index was supposed to be though.
Last restructuring program and I know Nolan could have anticipated go at 19, but is it your view that you will not get back to pre coal would levels because of secular and market challenges or is there a different interpretation to that.
Yeah. Thanks, Thanks, I want to see great question. So since you mentioned a it's been exit let me start with a I mean I was the architect of H.B. next to in the in the 2017 here as you know we launched it in the fall of 2017, I will say H.B. next was a great success story, but.
Because that allow us to re architect the company in the key areas interim of simplification or processes and streamlining our go to market model remember, we we went from a worldwide yield to country to more a geo model, where we removed layers and honestly and allow us to reinvest back in innovation and that's what I announced another investment for.
Billion dollars of the edge and whenever we start seeing the results of that you know with a great numbers. Despite the challenges. So that was a success and remember we committed to the liberty $300 million Signets savings and which with it. We did ahead of schedule now to your point. This is a crisis. Unlike anyone we have faced in.
And I will say 2017, I said listen we don't envision another cost optimization plan, but this is a cost optimization driven by their pandemic, but honestly I see a an opportunity to go faster enough people to our strategy, which has to offer everything that's the service. It is a very unfortunate that we have this.
Let me just cosan tremendous economic disruption and obviously a huge impact two communities.
On the business perspective, we are more convicted than ever in our strategy and we see it you know the demand for pervasive ubiquity conductivity. A you know that's why they know access points are very strong for US you know all cloud the cloud experienced deployed everywhere from the edge the cloud and the ability to consume it as a service and this.
It is where we see tremendous momentum with Hbgary Lake. So for me is right size, our cost structure to the new normal and we don't know exactly what the new normal is at this point in time.
You know because we didn't know what that recovered it looks like.
You know is about allocating resources for the areas for growth, we see in the future and also increased efficiency because we learned a lot commitment in Q1 I talked about it we learned quite a lot and we extend that the H.B. mix, which is now part to these cost optimization and put into recession plan and digitized.
Everything you know I believe this will cause incredible structural impacts in the way people are going to work and my expectation is at least 50% about employees will never come back to an office and the office will look completely different which means you know our offices will be more centered of innovation and collaboration.
What do you come to do your regular work every day and that requires you know a recycling or real estate footprint, but even issue of any size. The footprint also required new experiences and therefore investment associated with that but when you bring it all together and they need to freescale and upscale and allocate resources in the right.
Life.
I believe we have an alternative to accelerate that strategy and.
Drive to the <unk> long term sustainable profitable growth.
Okay, Thanks Antonio and.
The negative operating leverage on compute was was quite significant in the quarter.
How much I thought would you say was a supply driven issue versus demand driven issue and how do you think investors should think about the trajectory of that given that you also have the significant cost actions starting to kick in <unk>.
Sure definitely was a a supply chain driven although demand continue to be a uneven as we've discussed before.
Particularly in compute you know I will say the you know you have to look at this way up the the shortfall in the revenue is pretty much all supply chain driven because I made the comment early on that a linear attitude in the order intake was pretty steady, but up but in that order that you had to do you have the you know you have to look at that.
Customer segments, obviously, when you sell to I call. It cloud companies, which are more software companies that deliver their bodies into the cloud. Those are continues to be steady. If you think about enterprise I'll say those that were pretty steady a SMB. Obviously it was the biggest challenge you know.
And the transactional business because fundamentally das segment of that market will significantly disruptive.
So think about the future right. Obviously, we already we are under a micro situation, but you know, let's remind ourselves that the compute platform go through through innovation cycle themselves, even those commoditized and as I think about the Gen 10, you remember the Gen 10, we actually toll everywhere.
One that we said that two thirds, though that structural change was permanent because of the ability to a touch richer configuration as we go toward co. Gen 10.5 engine 11.
Which is happening the next 18 months, you're going to see more than that you're going to see a again the same cycle, where the density or this products that meet the month of memory and storage you could put inside these compute platform will continue to increase and that's a good for us because obviously that as a peak, but right now our our focus is.
Really around.
You know clearly the backlog.
On the compute side and on HPC side, both fitness installation and obviously.
They have a backlog there as well.
Okay. Our next question.
Comes from Toni Sacconaghi well sorry.
Ah yes. Thank you.
I have two questions as well.
First it it sounds like you're saying there was really de minimis impact from Corona virus on demand and this was largely supply chain driven and if you had the supply.
And you kept backlog at normal levels. He would have done 700 million more in revenue in Q2, and it sounds like if production's up and running if you're able to bring down your backlog to normal levels that should boost Q3 revenues 700 million relative to normal.
Seasonality so.
Am I thinking about that correctly and.
How much progress do you think you can make on bringing your backlog.
Down to normal levels over the course of Q3, and then I have a follow up.
Yeah, Thanks, Tony help as well yeah, I think if they came in the ride parameters. The only think I will say is that definitely the vast majority will supply chain and as I said in my earlier comment the previous question there will some demand, obviously, but particularly in SMB and some elements of the midmarket.
Well enterprise was a little more steady and we so up to the man for example that consumes compute.
For example in solutions like VDI, which was in high demand Oh, even big data storage, which at the end Tony is a compute is a compute platform with a level of this capacity to it or is this these attached to it.
So in that context, you asking absolutely. The right question at this is what I'm money. It really focus with the team which is a setting on my priority one two and three is clear the backlog and as I said earlier, you know we focus the quarter than 13 weeks, you know, where we entered the backlog, which was the 1.5 billion or may 1st and what we're going to exit.
On July 31st as the new orders come in because fundamentally you know.
We expect the oldest called man and that we haven't yet it decline associated without a coverage so I I feel pretty.
Optimistic about it but however is going to come down to our ability to get the supply and the right place and ability to execute even that cycle times, though we need and obviously as you know we have a very global diversified supply chain and we have made some cities of moves to move products Bill.
It's around the globe.
Even if they are for all that region. So we can answer the right that backlog and ER. So a this is gonna be the name of the game, but generally as I think about the last four weeks and I think about the next four weeks and then the next four weeks after that we continue to see progress, but a you know there's a little things who knows you know if there is.
Free stuff the quarter and gliders I'm more concerned right now Tony to be honest with you if something happened in one of these location, where we have the factory and you go into <unk> I know the sheltering of this social distances back to have an impact in terms of the velocity behind with components from China I will say that's for the Basel.
Majority is going up solution into right direction, and obviously the logistics side as we reopened countries and flights.
Across the globe that will help as well.
Okay. Thank you for that but maybe you could I mean is it unrealistic to think you could close you could get backlog to normal levels and then.
My My second question is if you're really saying that you.
No. This was largely the supply not demand disruption I'm still a little.
I'm I'm I'm, having difficulty reconciling or the new.
Sort of H.P. next to because.
On your Q4 call you are pretty unequivocal there wouldn't be another H.B. next to you felt you were in the right place on cost you.
You said last quarter, you were doing a little bit more on cost, but it wasn't structural it wasn't another H.B. next and now you're you know you are undertaking.
A a you know significant multiyear structural change and.
You know a that that doesn't feel consistent with.
With the statement that you know this is really a supply issue and be a it. It makes me wonder like are you more worried about your competitive position or are you worried that the I.T. environment is going to be weaker for awhile.
Yeah. Thanks on it so my remarks about will happen in in Q2 was about the supply chain and less of so on the demand I cannot forecast right now what the demand. These on the backend and this is where do you know in other markets. We said we have look in the pipeline we are looking out there.
I'll make indicators, which obviously all of you provide and others and so I would not make any further comment because on the demand in either no in October November I don't know what that will look like.
But I'm just applying to your question about what happened in Q2 definitely was based on the order intake we had.
It was the vast majority was the supply chain problem.
And there were pockets of uneven demand, which obviously will accentuated in SMB space, which was quite significant but remember we serve.
Global customers, we serve large enterprise midmarket and SMB and in that low verticals. So you have to look at this from multiple perspective, but the definitely than Q2 was the vast majority was a definitely a supply chain any that demand we saw pockets of growth.
Despite the dynamic other corona buyers, which you know Aruba definitely was.
Despite the 2% decline year over year, we so bright spots in wireless line up 7% North Americas, a geo 12% the remote access points, we couldn't ship a enough of it I mean, we then have all of it.
Be the I was another one so I think that was Q2 as I think about Q3 is all about cleaning the backlog and and the reason away I feel more confident in Q3 and obviously in the results that Q2, because usually expect continuous improvement as a as of the demand. Other note what the Telia Tony right now.
Because obviously it depends also in the global recovery of the economy, and then ultimately customer going to assess where they want to spend the money, but right now.
You know that's what we are.
And then in term of H.B. next.
I made that comment.
You know at the beginning of H.B. next now let's be clear I mean, nobody expected I caught on a bite us 90, but as I said in one of my comments I think two caseys question.
Actually what was once the question was I believe this is in a downturn. This is what do you go doubled on your strategy and these were investing in the right place now so when the recovery takes place you come out on the other and stronger and so that's fundamentally what we'll do in is really obviously.
Yes in the costs that we sizing for the situation, we have and in the short term we have taken some painful action you know for me as a CEO, telling our employees, we're going to consolidate is not a and easy thing to do I don't think that lightly but until then you know allocate them the right people and the right resources the right investment.
Into the future now the wheel in a downturn is the biggest opportunity because I think the strategist outs salute is spot on in a more convicted than ever.
Thanks, Tony.
Okay. Operator next question.
Our next question comes from Shannon Cross with Cross research.
Thank you very much for taking my questions. My first one is I realize you're not giving guidance on but can you provide some parameters for us to consider I'm thinking about opex. How much is variable how material do you think that salary reductions will be relative to sort of the overall base run rate of Opex and.
You know is there a significant amount of revenue that sort of just sitting out there waiting to be recognized its and its customers come back and can be trained and can accept and I don't know maybe thinking about backlog in terms of your confidence level that you're not going to lose those orders to competitors are you know that they're pretty from orders just anything kind of.
I missed it.
Have some ideas how to think about it you know was that that the trough quarter for instance, thank you.
Sure. Let me start and then I will ask started to talk about more the the first part of your question. Obviously again it goes back to the Tonys question the confidence to clear the backlog and this is where we again we're focusing.
I feel better about it then you know six weeks ago, but as I said earlier right. We have taken a day by day week by week. It looks a promising and we continue to make progress every day every week.
In terms of or there is what is the size of revenue I cannot give you a right now, but I will sell you'll remember HPC deals are normally multimillion dollar deals sometimes a mid a double digit deals.
Those are all waiting to be deployed and installed.
And they are all over the world and so obviously, we have a fantastic services organization and ready to go as soon as the customer <unk>. Let US then so those are the things you need to think about it but I hope everybody. Appreciate we given you a complete direction of what was the backlog and what we're doing about it I think I'm going to go.
But back to Kotick to talk about the first part to the question synthetic.
Oh.
Thank you <unk> it's a.
Quite difficult to coal a bottom or trough quarter.
Given that Evan on certainty.
That is currently.
Visible. It's one thing I, we know is that the uncertainty is high and its everyone's guess what the shape of the recovery will be.
So please bear that in mind.
And in most people and economies, we talk to and I spend a lot of time talking to many experts as I'm sure you did.
Our not thinking in terms of a V shaped recovery more into or himself a U shape recovery.
And that's what we are.
Modeling and this is why we have come up with the cost prioritization.
Plan that I'm, telling you mentioned and as he said we need to take a everyday as it comes so in terms of cost take out there is.
As part of our plan the goal is to achieve.
The vast majority of the 800 million net on rates savings.
By fiscal year 21, although we said this number will be visible by fiscal year 22.
And the reason why we said this is because of this level of uncertainty that exist in the shape of the economic recovery there was referring to you before.
So while we are doing is where supplementing.
Run rate reductions.
With temporary pay cuts.
And actions that we can take otherwise to protect their financial profile of the company and enhance our liquidity moving forward.
But you Antonio.
Thanks static so next question please.
Our next question comes from Gary I'll, all with Deutsche Bank.
Thanks for I think you, let me ask question and and I.
I guess I guess first of all like to ask Phil Green like.
Obviously, it's nice to the business so grew.
Year on year, but I'm wondering why you're confident in an acceleration that growth. It seems like as the business gets bigger it'd be hard seen growth rate, but seems like you're kind of back anymore that growth to get that debts at 34% compound annual growth rate.
Sure. Thank you journal.
I think we have a unique differentiated value proposition with HP getting lake and with H.B. within traditional H.B. couldn't like central which is a through cloud native platform, where do you can.
You know deployed the ride makes for makes to cloud and consumer as a service and deliver that will load optimized solutions a in a standardized way. It is a true differentiation for us and what we have seen in the last several months is a continuous growth in our pipeline and there.
Well it to convert the pipeline into larger deals larger deals you know some of these deals in particular, the two or three which are triple digits to give a sense and so for us and those who they are multi year right. So for us that's a an exciting because remember we said many times when we.
We sign I agree like deal, we work with a customer in a in a multiyear deal and the pull through for infrastructure that goes with it.
And services attach is higher.
The serves the touched report next point next or operational services hundred percent by the way attach and the margins are higher so fundamentally we're confident in reaffirming the annualized run rate revenue of 30, 40% the tarek talked earlier.
Because it's a function of getting these continues momentum and larger deals.
For many large cap companies. So I think that's what we see and now we have pillar more for the mid market as well for SMB and what the customers are looking for is the ability to scale up and down based on their needs.
And also a more and more help someone else Russell them. They don't want to be endeavor unsided they want to be more in the innovation site.
Got it appreciate that and just one well just one more for me I think I get a sense from the cash spend for extra debt cost realignment that fiscal fiscal year 21 is gonna be seems like the bulk of the this spending by I guess I'd like to get an idea for whether it's going to be casegoods hold our opex driven if there's if it.
And represent the general mix on your cost generally or if it's going to be weighted one way or another thanks.
I'm going to give that to topic.
Yeah. Thank you I Tanya.
With respect to cash or cash flow I M. I'd like also to ask your question on due for clarification purposes with respect to cash. So what has driven our cash flow performance. In Q2 is the increase in inventory levels and the change in the cash conversion cycle, we've stocked up a lot of inventory.
And the backlog is there also reflection of the fact that we stocked up a lot of inventory and our cash flow conversion cycle, which was a favorable minus 17 days a drops to the less favorable minus five days because of our stocking up eight inventory terms.
Could you. Please for my benefit repeat your question on costs and walk you were trying to get to hear I did not quite understand. Thank you. Yeah. So so in terms of your your your annualized net run rate savings what areas. Their business are there was going to come from.
Okay.
So <unk> by and large where we're going to leave no stone unturned, that's a the message but effectively if you look at what the plan is about it's fundamentally around realigning resources to the segments that we started to report.
Back into first quarter and areas our growth that we see driving better product T.D. levels across those segments.
Changing fundamentally the way, we engage with customers from marketing and sales standpoint.
Rethinking our supply chain to create it in such way that is more resilient than before yet agile and efficient.
Rethinking also our workforce management practices, because quite frankly, I don't know what's your situation is like but we've been working.
I am very effectively.
From home for the past three month, almost and so this is pointing.
To us the need to think about.
This new normal and what does it mean from a workforce management standpoint, and our real estate footprint. So you can rethink your real estate footprint now that the world is much more distributed and connected than ever before so I hope I have provided sufficient color dry.
Question back to you on Tanya.
Yeah. Thanks static next question I know, we got into the top of the hour.
Well, we are five minutes over.
Do we have any more questions on the line operator.
Our next question comes from Aaron Rakers with Wells Fargo.
Hi, This is Jack on for Air on I was wondering if you could go into little bit about how we should think about portfolio. Some occasion in regard to the cost optimization plan.
Yeah. So obviously from the portfolio optimization I think about you know the work we have done underage Phoenix and continuing dot work to streamline number of platform as options, we have done a phenomenal job there.
But two topics point is all about where we're build this products and fundamentally where we also designed this products. So there is an opportunity there to continue to drive that optimization and put them into the I think about our portfolio as a way to us at a rate as a service model obviously on one end.
We have a fantastic cloud platform called HP Aruba that we continue to invest over central though we continue to invest a and these are 100% softer ride with access points and switching that comes with it I think that way and obviously through the subscription model.
The other thing as a obviously on the core business is how we drive the are the best workload optimized solutions that they are fully automated and provision from the cloud use in H.B. Guinea Lake Central So that's another component of that so that's how we think about it and and all.
Obviously, there is a lot of they work with do even in a quarter businesses. While people may think is hardware and iguana give an example, and the recent introduction of our distributed hyper converge infrastructure is actually all software is 100% softer in many ways and as I think about the future of how the war will occur.
Balls, we're going to live in a more distributors model you know today or.
It's very centralize in the sense you, how your mobile phone or your mobile device connected to some sort of cloud to cloud can be you'll data center can be somebody else cloud, but fundamentally the cloud experience will exceed that will be extended all the way to the edge and that's why we helpline in that portfolio to continue to invest.
In the ruble central with integration of Fiveg and the integration of edge computing. So it's a combination of freeing up resources in the traditional business to reallocate those resources in those areas that will drive the long term sustainable profitable growth built based on the what do we have done a NHP next and also continues to.
Digitize everything.
We have and we can.
Okay.
So next question please.
Our next question comes from Simon Leopold with Raymond James.
Thanks for taking the question.
My sense is is that the quarter you just reported was primarily supply and the uncertainty you're expressing about the outlook maybe reflects a more of a shift towards demand. So I thought it would be helpful. If you could give us a better understanding of what youre customer verticals typically look.
Like in other words, how much is federal government how much is the SMB market, how much financial services, because I think even even if we can't make predictions I think all of us have some sense of which verticals are healthier than than others. I. Appreciate it. Thank you.
Sure. Thanks, Simon I think you know I will say, let me start where the bought a SMB obviously has been a significant challenge we all witness every day.
That's what has driven the big chunk of the unemployment that we see here in the United States.
So obviously.
That will take time to recover and general middle market get served through what we call a transactional engine.
And then so high velocity engine.
In the enterprise if you take a by vertical I think telco has been fairly steady.
Now to talk about a portfolio that we have called communication media solutions you heard some of the numbers you submit is growing 40, and 70, 70%, it's all software and services and obviously drags infrastructure, because eventually have to virtualize whatever infrastructure to put their financial so it was actually was for instead.
Maybe a strong you know we have a very large.
Footprint and this is where the diversification of our Geo and verticals actually is helping us a little bit.
Generally facade and telco are very large for us.
Where retail not so much and I think we tell obviously was more impacted but I will say a telco all communication media and entertainment financial services.
The strong obviously oil and gas not so much because we know that the price another oil.
And then as the think about a transportation, obviously impacted us well, but I will say the number of deals and the size of the deals with generally the same the it'll get does sell cycles was consistent but we align our plans based on the linear attitude I talked earlier.
Q2 was fairly steady.
And so far so whether they know the first hub will supply chain and the second half is the mine is to be seen again pedic talked early on about the shape of the recovery.
And I agree with topic I told you subscribe to the you recovered or the question is how far the two sides of the you are and how deep the U.S., but right now it fills.
I feel stay the in those areas and as a failure focus is the backlog.
Okay. Next question I think this is the last one more question I think this is the last question I think we have and another question on the line.
Our final question comes from Amit Daryanani with Evercore ISI.
Thanks, Hi, this is urban loot dialing in for on it.
As I look at your cost optimization and prioritization plan that was announced today that will result in a $1 billion to $1.3 billion total cash payment through fiscal 2022.
Now is it fair to say that the cost savings plan will essentially pushed back the timing or related to the achievement of your normalized free cash flow target of $2 billion by let's say another two to three years.
Yeah. Thanks for the question I'm going to pass it to topic.
Thank you are talking out so.
The most important thing in our cost optimization and privatization plan.
Is to achieve those $800 million off net run rate savings.
And hold them as long as possible in the cost structure, So day weekend.
Effectively C.
More margins in our business.
You know with respect to free cash flow last year, if were not for a.
Legal settlements that we paid we would have exceeded.
2 billion dollar free cash flow Mark so.
That was that what that business was capable back then with a certain revenue base and.
What you've heard from Antonio is that we're rightsizing the business to what is potentially a new revenue base and it's too early to tell whether that new revenue base will come back to the free pandemic revenue levels.
Moving forward, but what's very important right now is our focus is to ensure that we right size, our business and deliver those run rate savings so that we can emerge.
Stronger after this crisis subsides.
Thank you.
Yeah, Thanks, Tata and again I just want to you know.
Last year was a unique yet in the sense that we will pretty much on track and actually I will out here, we deliver the normalized free cash flow because we're able to take care of a unique circumstances with a settlement.
In arbitration, so when you add it all up it was a in excess of $2 billion and I get it comes down to our ability to drive the the operating cash the cash from operations would generally tends to be but a strong obviously this quarter because we couldn't convert we couldn't deliver that but let me remind again that.
Cost of transition and.
So is it prioritization is not just about recycling buddies about shifting investments to the strategy, which I answer earlier to Tony I think is the opportunity we have now and therefore.
Making that happen in the lower part of this whatever the lower is is the right strategy. So you become stronger on the other end so to wrap it up thanks again for joining us today and the for your questions. Let me make a few comments the to wrap the call. You know I said earlier. These are implicitly then to the challenge the times, where all of us.
Not just the business, but obviously the economy and the communities technology and digital transformation in my view or more critical than ever to enable what I think is gonna be New award the new distributor world, where the workforce as would be will be located in different ways and honestly, there will be new ways to run.
Businesses, I think our strategy to deliver a cloud experience from the age through the cloud is more rather than ever and or the quota that is to securely connect people in thing as we see a you know more than 50 million devices being connected to the and that sort of every single day, but at the same time, we need to analyze the.
The faster into us sort of red business outcomes for our customers.
I think that measure we announced today a will allow us to protect not only our balance sheet and continue to preserve the liquidity, which as you. So.
One of the slides, we have a very robust balance sheet with capacity up to $10 billion. So that's not the issue, but fundamentally my goal is to adopt the organization to be more agile to align our resources to the critical core businesses of growth and ultimately to accelerate the strategy, which I'm very convicted.
[noise], which would result in a long term sustainable profitable growth and a I want you to take a away that this work is being done with sense of urgency.
Whether we are the first to announce it and other people doesn't matter. We believe that this is the right thing to do and that time is important. So again. Thank you for joining us the call today and I hope to you stay safe with you and your family and we'll talk.
So take care.
Ladies and gentlemen, this concludes our call first of all of you may now disconnect. Thank you.