惠普企業 (HPE) 2016 Q1 法說會逐字稿

Good afternoon and welcome to the first-quarter 2016 Hewlett Packard Enterprise earnings conference call. My name is Laura and I'll be your conference moderator for today's call.

(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.

Good afternoon. I'm Andy Simanek, Head of Investor Relations for Hewlett Packard Enterprise, and I'd like to welcome you to our fiscal 2016 first-quarter earnings conference call with Meg Whitman, HPE's President and Chief Executive Officer, and Tim Stonesifer, HPE's Executive Vice President and Chief Financial Officer.

Before handing the call over to Meg 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 web page 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 SEC reports, including its most recent Form 10-K.

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 can differ materially from the amounts ultimately reported in HPE's quarterly report on Form 10-Q for the fiscal quarter ended January 31, 2016.

Finally, for financial information that has been expressed on a non-GAAP basis we have included reconciliations to the comparable GAAP information. Please refer to the tables and slide presentation accompanying today's Earnings Release.

With that, let me turn it over to Meg.

Thanks, Andy. Good afternoon, everyone. Thank you for joining us today. We've now completed our first full quarter as an independent company and we're off to a very strong start. We are already seeing the benefits of being a smaller, more focused and agile company across a number of fronts. Our customers and partners understand our strategy and appreciate working with a simplified, faster moving organization.

Our employees are engaged and aligned. For example, we've created a single pan-HPE sales training and account planning program, which has already uncovered over 100 accounts where there are significant untapped cross-selling opportunities. Our innovation engine is firing on all cylinders, and you're going to see some amazing new introductions in the coming quarters in key areas of the portfolio, including servers, cloud, high-performance computing, IoT, all flash storage, Aruba and ConvergedSystems.

For our shareholders this focus is driving strong financial and operational performance. In Q1 we delivered our third consecutive quarter of growth in constant currency, with revenue of $12.7 billion, up 4% year over year. And when you exclude the impact from recent M&A activities we grew revenue on a constant currency basis in every one of our business segments for the first time since Q4 fiscal year 2010.

At the same time, we continued to make progress on our cost structure, particularly in ES, and delivered non-GAAP diluted net earnings per share of $0.41, at the top end of our previously provided range. Delivering strong cash flow is also a key priority for us. While Q1 was impacted by seasonality, separation payments and timing, we expect cash flow to improve as we move through the year, and remain confident in our full-year free cash flow outlook of $2 billion to $2.2 billion. Tim will walk through the specific Q1 cash flow drivers in a minute.

Finally, in line with our commitment to return cash to our shareholders, in Q1 we paid $1.3 billion including $1.2 billion for share repurchases and nearly $100 million in dividends. As a result, we've already exceeded our FY16 commitment of returning at least 50% of expected free cash flow to shareholders. And share repurchases will remain our preferred method to return cash to shareholders given current market conditions.

Overall, while there is more work to do to accelerate top-line growth, align our cost structure, and drive even closer collaboration and integration across our organization, I'm very pleased with where we stand today.

Now, let me turn to business performance. We had another strong quarter in Enterprise Group, with revenue up 7% year over year in constant currency. Our portfolio is truly the best we've had in years and is driving strong customer traction.

For example, today, HPE is the leading infrastructure provider for SAP HANA, with nearly twice the number of shipments over the next competitor. And this quarter we won a number of important deals, including one with Canadian communications company, Rogers, to help them transform their existing traditional IT to a hybrid infrastructure. We will provide a comprehensive solution including ConvergedSystems, CloudSystems, StoreOnce, 3PAR all flash and Technology Services.

We also signed a multi-year agreement with one of the world's largest food producers, JBS, to help them build an IT environment that supports faster business expansion, including consolidating their data centers and moving to the cloud. And just last week, at Mobile World Congress, we announced that Swisscom, Switzerland's leading telecommunications provider, will deploy new virtual network functions using HPE open NFE solutions.

This customer momentum is driving financial results, and each of our hardware business units performed well in Q1. In servers we delivered 5% year-over-year revenue growth in constant currency, maintained strong margins and also continued to make R&D investments. While we won't chase share for share's sake, we continue to see significant growth opportunity ahead as the clear market leader with the most comprehensive portfolio of offerings, from mission critical and high-performance computing to our new IoT and cloud line solutions.

Storage had another strong quarter with revenue up 3% year over year in constant currency, driven by continued strength in 3PAR. Converged Storage grew 17% year over year in constant currency and is now a solid 56% of storage revenue.

We had record revenue for 3PAR, driven by triple digit constant currency growth in all flash, which grew at 3 times the market rates. With the industry-leading all flash product and the broadest reach through our channel, we expect to gain share for the ninth quarter in a row in calendar Q4.

Turning to networking, the significant actions we took last year are paying off and we are very pleased with the performance overall. Networking revenue grew 62% year over year in constant currency. Normalized for the Aruba acquisition revenue grew double digits, driven by record China revenue as well as good performance in other regions.

As we've discussed before, we are seeing strength in China as customers anticipate the completion of the deal with Tsinghua that we announced last year. We are currently working through the final regulatory approval in China and we expect the deal to close by the end of May. Aruba also grew double digits at an operational level, and we saw strong pull through of HPE's switching portfolio to complement Aruba's wireless offerings.

Technology Services revenue was down 3% in constant currency although TS support performed better. Total orders grew year over year excluding China where we are seeing some customers delaying renewals until the Tsinghua transaction closes. Unlike networking or servers, these are long-term contracts and we believe some customers are waiting to work directly with the new entity.

We also saw constant currency double-digit order growth in new solutions like data center care and proactive care. We expect TS performance to improve throughout the year driven by a better mix of new, faster growing support solutions.

In cloud, following a major wave of product releases across our HPE Helion portfolio in the second half of 2015, we are seeing strong customer traction. In fact, since separation, Helion has gained over 200 customer wins, including some of the world's largest banks, service providers and industrials. This momentum reinforces our belief that our strategy of helping customers transform to a hybrid infrastructure is a winning approach for us.

Enterprise Services continues to execute well against its turnaround strategy. ES is building a more diversified customer base, stabilizing revenue, and significantly reducing its cost structure. For example, during the quarter we grew new business TCV by 4% year over year in constant currency.

This includes an agreement with Sabre to provide virtualization, automation and security services, hardware and software to support faster product development, and extend Sabre's position in the global travel industry. And it includes an agreement with Avon to transform key elements of the leading beauty company's global IT infrastructure by offering dedicated data center services, cross-functional support, network management and security services. This builds on the progress we've made over the past three years.

Remember that in FY13, just three customers made up approximately 65% of ES operating profit. Today, no account makes up more than 10%. We also continued to make progress on our cost structure by exiting high-cost data centers, improving low-cost location mix, and rebalancing our workforce.

As a result, Q1 revenue grew slightly in constant currency, marking the first quarter with constant currency growth since Q3 of 2012. We also had our seventh consecutive quarter of year-over-year margin expansion. Q1 operating margin of 5.1% improved 2.1 points year over year, driven largely by delivery cost actions. Overall, I believe we are taking the right steps to achieve our long-term goal of a sustainable market competitive cost structure with a 7% to 9% operating profit margin.

In Software we continued to make progress aligning the portfolio and go to market to our four transformation areas, increasing efficiency and accelerating SaaS. This has included the divestiture of several software businesses that were not core to our strategy, including iManage, LiveVault and TippingPoint, which we expect to close later this month.

In Q1, Software returned to growth, with revenue up 1% in constant currency when adjusted for recent M&A activity. The ADM ITOM business was down slightly in constant currency as continued headwinds in license and support were nearly offset by professional services and record revenue growth in SaaS, which grew over 20% year over year. Big data was strong with revenue up double digits when normalized for currency and divestitures, driven by triple-digit growth in vertical license. Security performance was also strong across both license and SaaS.

Financial Services continues to provide our customers with the financing flexibility they need to take on their biggest IT challenges. At the same time, the team does a great job managing this business to minimize our risk and maximize our return. Financial Services revenue grew 3% in constant currency in Q1 and financing volume also increased to 3% year over year.

Before I hand it over to Tim to provide further insight into the financials, I want to highlight some of the exciting product announcements from the quarter. One of the most important benefits of being a smaller, more focused company is that we are able to be very targeted in our investments and to even more effectively put our resources towards the most important high potential opportunities that support our strategy.

As we've discussed before, we prioritize organic investments to maintain a strong technology pipeline. At Discover in December we unveiled HPE Synergy, a new category of infrastructure designed to run both traditional and cloud-native applications for organizations running a hybrid infrastructure. Synergy, powered by our OneView software, represents a critical step in delivering our vision for hybrid infrastructure.

We also introduced our new IoT Edgeline systems and Aruba networking sensors specifically designed to help customers more efficiently collect, process and analyze IoT data. The new solutions are key elements of our strategy of delivering more connectivity and computing power at the network edge, and you can expect more IoT announcements coming up this year.

And in January, HP expanded its network function virtualization portfolio. We announced HPE Service Director, a new end-to-end service operation solution designed to help communications service providers manage services in NFE deployments by bridging traditional and new virtualized environments.

In addition to organic investments we are also investing in key partnerships. In January, HPE and Scality announced an enhanced partnership designed to accelerate the adoption of software-defined storage. And we announced a new partnership with Microsoft, appointing Azure as a preferred public cloud partner for HPE customers, while HPE now serves as a preferred partner in providing infrastructure and services for Microsoft's hybrid cloud offerings.

As a result of this commitment to innovation our products and services are being recognized as leaders in the industry. For example, we are now named a leader in 26 different Gartner Magic Quadrants, including integrated systems, modular servers, storage disk arrays, and wired and wireless infrastructure. Forrester has ranked Enterprise Services as a leader in workplace services and positioned HPE as a leader in its recent private cloud report. And IDC ranked us as a leader in application modernization services.

Looking forward you can expect this momentum in investment and innovation to continue. Later this month we will announce a new market-changing hyper-converged offering based on our industry-leading pro lineup virtualization server. Our new solution will offer customers installation in minutes, a consumer-inspired simple, mobile-ready user experience, and automated IT operations, all at 20% lower cost than Nutanix. We believe this new system will allow us to quickly become a top player in the $5 billion high-growth, hyper-converged market.

Also later this month, we will refresh our server portfolio to include a game-changing new technology called Persistent Memory, which was invented by our server group. This new technology will enable an ecosystem of new applications supporting non-volatile memory and is a key milestone on our journey to the machine.

So, overall I'm very pleased with our first quarter as an independent company. We are already seeing the benefits of being a smaller, more focused organization and I'm excited about what's ahead. On that note I will hand the call over to Tim.

Thanks, Meg. Good afternoon, everyone. We have now completed our first quarter as a standalone company and overall I'm pleased with our performance. As part of the separation process, we developed a clear financial architecture for HPE where each business segment has a specific role in driving overall Company performance.

Enterprise Group is our growth engine. Enterprise Services is committed to stabilizing revenue and expanding margins. Software provides high margins and strong cash flow. And Financial Services provides a consistent annuity-based revenue stream. After only one quarter it's already clear that each business is executing against this framework and, as a result, is driving solid financial performance at the HPE level.

First-quarter revenue was $12.7 billion, down 2.5% year over year but up 3.8% in constant currency. And as Meg said, this marks our third consecutive quarter of year-over-year constant currency growth.

Clearly, currency was a significant headwind this quarter. You might recall that we saw the most significant movement in currencies during our first fiscal quarter last year, which drove a large rate translation impact this year and a total currency impact of 6 points year over year. Going forward, currency will still be a significant impact in Q2 and then moderate in the second half. And we still anticipate a currency headwind of approximately 3 points to revenue for the full year.

Looking at performance by geography, we had some challenges in the Americas which grew 1% year over year in constant currency, with increased weakness in January, particularly in US hardware, as macro uncertainty caused a slowdown in global account spending. EMEA delivered growth of 4% year over year in constant currency driven by balanced growth across EG hardware. APJ saw the best growth at 9% year over year in constant currency due to strength in servers and record China networking revenue.

The gross margin was 28.4%, down 1.2 points sequentially due to normal seasonality, and up 70 basis points year over year, primarily driven by continued productivity improvements in Enterprise Services. Non-GAAP operating expenses of $2.6 billion were up 3% year over year driven by R&D as we continue to make targeted investments. Non-GAAP operating profit was 8.1%, down 1.5 points sequentially and down 40 basis points year over year.

Non-GAAP diluted net earnings per share was $0.41, at the top of our guided range. Non-GAAP EPS primarily excludes pre-tax charges of $311 million for restructuring charges, $218 million for amortization of intangible assets, and $79 million for separation costs. We delivered GAAP diluted net earnings per share of $0.15, $0.02 above our previously provided outlook range of $0.09 to $0.13 due primarily to tax indemnification adjustments related to the separation.

Free cash flow was negative $831 million, down 70% year on year on an adjusted basis that reflects the estimated HPE contribution to the combined HP Company free cash flow last year. As we discussed during the Q4 earnings call, Q1 is usually our lowest cash flow quarter, due primarily to earnings seasonality in ES and Software, as well as normal annual bonus compensation payments. You can see the seasonal pattern in our adjusted fiscal year 2015 results when our free cash flow for Q1 was a use of approximately $500 million. In addition to normal seasonality, in Q1 2016 we had higher separation payments year over year, which are now largely complete, and higher usage of working capital.

Let me explain what's happening with working capital. The cash conversion cycle was 31 days, up 8 days sequentially. This was above our targeted levels of mid 20 days, primarily due to payables that were impacted by intra-quarter purchasing linearity and strategic buys that provide an economic benefit to the Company.

These items are largely timing related and we continue to more aggressively manage our working capital and expect the cash conversion cycle to improve throughout the year and return to our targeted levels. With all that in mind, we remain committed to our free cash flow outlook of $2 billion to $2.2 billion for the full year.

Turning to capital allocation, in the first quarter we paid approximately $1.2 billion for share repurchases, including $1.1 billion through an accelerated share repurchase program and an additional $132 million on the open market as part of our ongoing share repurchase program. We also distributed $96 million as part of our normal dividend. To date we have already returned over 60% of our free cash flow outlook to shareholders, and now we are raising our commitment and expect to return at least 100% of our free cash flow outlook to shareholders in fiscal year 2016.

Separately, as Meg noted, we expect the Tsinghua transaction to close near the end of May. When the deal closes we expect to receive cash of just over $2 billion that is net of some initial tax on the sale. We are planning to use the vast majority of this cash to opportunistically repurchase shares. The timing of the repurchases may not be linear and will be dependent on several factors including market conditions and availability of US cash.

Now, turning to the business results, the Enterprise Group delivered healthy growth and stable profitability, in line with our financial architecture. As Meg discussed, we are investing in innovation across EG to deliver best-in-class solutions in growing markets, while maintaining cost discipline and solid profitability.

Revenue grew 1% year over year as reported, or 7% in constant currency, with strength across all hardware groups. Profitability was down 1.8 points to 13.4% primarily due to FX and to a lesser extent product mix.

Servers revenue was down 1% year over year as reported but grew 5% in constant currency. Growth was driven by strong Tier 1 and by core sales in both EMEA and APJ. This was somewhat offset by pressure in the Americas towards the end of the quarter. Our R&D investments continue to pay off with our industry-leading offerings and high-performance compute that now exceeds a $1 billion run rate and strong double-digit growth in mission-critical x86 servers.

Looking forward, we continue to see opportunities for profitable revenue growth and share expansion in the server market. We have the most comprehensive and compelling server portfolio with solutions for every work load. And we are aggressively taking advantage of the uncertainty in the markets surrounding our competitors.

Storage revenue declined 3% year on year as reported but grew 3% in constant currency. The unified 3PAR architecture, combined with our excellent channel partnerships, continues to drive revenue growth and share gains while our competitors are distracted and contracting.

3PAR all flash grew triple digits again, driving 3PAR revenue growth of 21% year over year in constant currency, significantly outperforming the market. 3PAR plus XP plus EVA was up 15% year over year in constant currency. We estimate that we've gained solid market share in the fourth calendar quarter and expect storage to continue to be a growth driver in constant currency throughout the remainder of the year.

Networking revenue grew 54% year over year as reported, or 62% in constant currency, and expanded operating margins, driven by the acquisition of Aruba and strong execution across all regions. When adjusted for Aruba, networking revenue was still up double digits in constant currency.

The Aruba acquisition continues to prove to be a key strategic move for HPE and has transformed our networking business. Consistent with our acquisition strategy, Aruba continues to drive growth in wireless and has also been integral in returning switching to double-digit growth year over year.

ES revenue declined 9% year over year as reported or 3% in constant currency. However, approximately 1 point of the decline was due to the discontinuation of HPI-related service contracts that were supported by TS last year. Encouragingly, TS support, which has significantly higher margins than consulting, continued to stabilize, and revenue was only down 2% year over year in constant currency, including the HPI impact. Orders were down slightly in constant currency but up excluding China where signings have been delayed ahead of the Tsinghua deal close date.

Enterprise Services executed well against its plan to stabilize the top line and expand margins. Revenue declined 6% year over year but grew slightly in constant currency. Applications and business services, which you'll recall is the higher margin business within ES, continued to improve with the second consecutive quarter of year-over-year revenue growth in constant currency, driven by strong apps performance and stabilization in business process services. Strategic Enterprise Services revenue was up double digits year on year, with strong growth in Helion-managed cloud.

Overall, TCV was up nearly 30% year over year in constant currency, driven by strong renewals, as well as growth in new logos and add-ons. ES operating profit improved 2.1 points year over year to 5.1% as the team continued to execute productivity improvements and delivery and sales, and improved new deal profitability. We also had a benefit from a one-time divestiture of a non-core business.

We continue to make progress against the cost takeout plan we laid out at our Analyst meeting. We now have approximately 45% of our workforce in low-cost locations and are well on our way to our longer-term goal of 60%. Given the progress we have made on bookings and cost improvements, along with our normal quarterly seasonality, we remain confident in our full-year operating profit outlook of 6% to 7% and revenue of down 2% to flat year over year in constant currency.

Software executed well in the quarter, improving revenue and delivering strong profitability, while continuing to become more tightly integrated with the rest of the HPE portfolio and go-to-market approach. Revenue declined 10% year over year as reported, or 6% in constant currency, but was up 1% when adjusted for acquisitions and divestitures in constant currency. We saw strong performance in big data and also some growth in security offset by declines in IT management.

SaaS had a very good quarter growing double digits in constant currency when adjusted for divestitures, driven by ADM ITOM and security. Operating profit was 17.4%, down 60 basis points year over year, due primarily to currency and higher mix of professional services. The team continues to focus on disciplined cost controls but is still making strategic R&D investments in growth areas that align well with the broader HPE portfolio.

In Financial Services, revenue declined 3% year over year but grew 3% in constant currency as we began to see more impact from the volume growth we delivered last year. Financing volume in the quarter declined 4% year over year but was up 3% in constant currency. Operating profit improved 1.7 points year over year to 12.9% as we were able to adjust bad debt reserves to reflect the improved loss rates and our high-quality portfolio. Return on equity was up 1 point year over year to 18.1%.

Now turning to our outlook, we will not formally update our fiscal year 2016 outlook for the impact of Tsinghua transaction until after it closes, but I wanted to give you some information about how to think about the potential impact. We now anticipate the deal to close near the end of May and expect the transaction will impact fiscal year 2016 EPS operationally by approximately $0.05. This includes some stranded costs from corporate administrative functions that we will mitigate in the near term.

After the transaction closes, we will update our fiscal year 2016 free cash flow and EPS outlook, including any expected benefit from share repurchases made with sale proceeds. Also, we do have an EPS benefit from our share repurchases completed in Q1 and still feel confident in the underlying operating performance of the business, but it's too early in the year to change our full-year outlook given the softness in January and near-term market uncertainty.

With that in mind, we expect non-GAAP diluted net earnings per share to be $0.39 to $0.43 in Q2 2016, and continue to expect full year fiscal 2016 non-GAAP diluted net earnings per share of $1.85 to $1.95. We expect GAAP diluted net earnings per share to be $0.13 to $0.17 in Q2 2016, and continue to expect full-year fiscal 2016 GAAP diluted net earnings per share of $0.75 to $0.85.

Now, let's open it up for questions.

(Operator Instructions)

Our first question will come from Sherri Scribner of Deutsche Bank.

Hi. Thank you. Good job on the operating margins. I was hoping you could you give us some detail about how you're thinking about margin, particularly in the Enterprise Group, as we move through fiscal 2016, and some of the other operating margins. I know you've commented on Enterprise Services but wanted to get your sense about the Enterprise Group in particular with the new products coming out.

Sure, Sherri. We did see some margin deterioration year over year. If you'll look at the margins for EG in total they were at 13.4%. Most of that was driven by FX, so keep in mind in the first quarter last year the euro, as an example, was at $1.24, and the average accounting rate in the first quarter this year was $1.08. So, we still saw significant pressure from an FX perspective when you look at the first quarter.

Going out for the rest of the year we would expect the margins to stabilize and maybe get a little bit of a lift, particularly as we continue to grow the storage business, as well as the networking business. As you know, those businesses have a healthier margin profile, so as we continue to grow those, we should see some lift there.

And then the only other major comment I'd make is on the ES business. Again, we saw some great performance there in the first quarter, margins at 5.1%, up 210 basis points year over year. The efforts that the team continues to execute upon as they're transforming that business, and the seasonality in that business, we would expect those margins to improve over the course of the year and settle, on average, in the range of 6% to 7%, as we talked about at the Analyst meeting in September.

Okay, perfect. And then just thinking about your free cash flow guidance, now you're planning to spend 100% of your free cash flow returning that to shareholders, does that change your acquisition strategy? What are you thinking about acquisitions this year? Thank you.

We continue to execute a returns-based capital allocation strategy. Given where the stock price has been trading, this is one of the best return on investments that we can actually make. And as I said when we were on our road show for the new Hewlett Packard Enterprise, our first choice from an innovation perspective is organic innovation. Look at the success of the 3PAR all flash storage array -- internally homegrown, growing 3 times the rate of the market, and gives that benefit of a common architecture from top to bottom. The benefit of doing organic innovation is you don't end up with a Frankenstein of architectures.

The second choice would be acquisitions that look like 3PAR, 3Com and Aruba. These have been very successful acquisitions for us. They are additional complementary technology that goes through our excellent distribution system. But, again, where the stock is trading right now, we think that this makes a lot of sense to buy back shares, which is why we've decided to go to 100% of the free cash flow.

Thank you.

The next question will come from Kulbinder Garcha of Credit Suisse.

Thanks. I just have a couple of clarifications, actually. Maybe for Meg, first of all, and Tim touched upon this. You talked about how you're seeing constant currency revenue growth for several quarters, all businesses are growing since the end of 2010. Are we now at the point whereby this business might sustainably, in constant currency and revenue terms, just grow? I'm not asking for a number of percentage growth rate but do you think you have that visibility? Because the reason why I ask is, Tim also mentioned visibility in January, and obviously we can see what the markets have been doing in the macro. So, I'm curious as to how we see sustainable growth of the business.

And then also, just for Tim, on the Enterprise Services margin guidance and the growth guidance for this year, given the contract value growth, given the mix shift you're seeing in the business, the cost changes you're putting through very well, why isn't that guidance we've seen with Enterprise Services now very conservative? Is there some caution you're reflecting in that guidance in the balance of the year on the Enterprise Services side specifically? Many thanks.

On the overall growth rate of the Company, remember we said at the beginning of this year that we would grow Hewlett Packard Enterprise in revenues in constant currency. And we are on track to do that, as you can see from Q1. Again, from an as reported basis the compares get better in the second half of the year because we've worked through those big currency fluctuations in Q1 of last year.

I think your question is can we see accelerated growth. I think we just are a little concerned about the macroeconomic environment. We saw a slowdown in the US in the last three weeks of January. Linearity appears to be back on track but it's early in the game. So, I think we're just being a bit cautious here.

We like our product portfolio, we like our go-to-market changes, we like our innovation engine. There's a lot of things that we're feeling very good about but the macroeconomic environment still has pockets of weakness. Russia continues to be a big challenge, the Ukraine, parts of Latin America. China right now for us is doing well but that can change at any minute.

So, we feel great about the stated goal of growth in constant currencies. And let's see how the macroeconomic and the political environment changes over time.

Sure. And then on the ES point, again we feel great about the progress we've made in the first quarter. We have the delivery centers in motion. We continue to move folks from high-cost countries to low-cost countries. So, the team has done a tremendous job in transforming the business.

Now, to your question, as we continue to progress in the year, we're going to continue to see pricing pressure in that business. It's very competitive. We're going to continue to invest in the business, particularly in that go-to-market motion. And also given the fact that it's really just the first quarter, so we have nine more months to go. There is some market uncertainty out there so we just felt it prudent to stick with the 6% to 7%.

Thank you.

The next question comes from Toni Sacconaghi of Bernstein.

Yes, thank you. I'm wondering if you can update us on the status of expected restructuring and separation charges. I think as of last call you had talked about $1.7 billion in cash impact this year, and that you expected it to be front-end loaded. It ended up being less than one quarter of the year's total. So, I'm wondering if, A, you can give us an update on how many people came out in the quarter, what that expectation is for the year. And are we incorrect in what I just played back in terms of understanding that this didn't appear to be more front-end loaded, in fact it felt less than linear and why that might be?

Sure, Toni. A couple of things that I'd say about the restructuring. We are on track so as we called out at the Analyst meeting we'll be about $1.2 billion in cash. So we are on track for that this year. And then as far as how many folks that we've taken out so far, we'll be 3,000 in the first quarter. We don't really guide on what we're going to take out for the entire year. But the only thing I'd say is we are on track and that $1.2 billion in cash for this year still remains there.

And separation? That was $600 million, I believe, and you did $79 million in the quarter. Where do you stand on that?

No, we did $300 million. You're right, it's $600 million in separation for the year, and we did $300 million in the first quarter.

Okay. But the cash impact was only $79 million or was it grouped in another group?

No, the cash impact was a $300 million payment.

Finally, you mentioned a benefit from a divestiture in ES. Was that a margin benefit? And is that part of the reason for not being more optimistic about margins over the course of the year? Or was that either immaterial or a revenue impact?

No that did have an impact from a margin perspective. I'd say it was not really material. It does have some impact on the margin, to your point, but overall we feel very good about the health of the ES margins.

Thank you.

The next question will come from Katy Huberty of Morgan Stanley.

Thanks, good afternoon. Just quickly two questions. One, bad debt reserves, you mentioned, was a benefit to Financial Services margins in the quarter. Was that a one-time benefit or does that flow through to future quarters?

And then, secondly, the sale to Tsinghua is taking longer than expected. Can you just talk about what milestones are left to get that deal completed, and just some context around why it's been delayed? Thank you.

Sure. I'll hit the bad debt reserve and then I'll let Meg talk about Tsinghua. The bad debt reserve was a one-time benefit. I think it was about 150 basis points of the improvement. And it's primarily driven by the fact that we adjusted reserves. We're still very conservative but if you look at our loss reserves as a percentage of expected or historical losses, it's still about 2 times, which is very conservative in the financial services business.

Yes, Katy, let me talk a little bit about Tsinghua. O you recall, we originally thought this would close roughly at the end of February and now we are confident that the deal is going to close near the end of May. And we're working through some final Chinese regulatory approvals. So, all the US approvals have been received, CFIUS, et cetera. Only the China securities regulatory committee remains. They call that the CSRC in China, which is a bit like our SEC.

There's been a couple of things going on there. One is they have a new head of the CSRC. Two, there is a big backlog of deals, and they're working through that backlog. But we feel confident. We expect that deal to close at the end of May. As you can imagine, we've been in contact with all of the appropriate regulatory people and obviously our partners at Tsinghua. So, that's the way we think about it right now.

There's also, as you know, a fair amount of volatility in the markets in China and I think that, frankly, is slowing things down a little bit in China. And, by the way, the H3C revenue over there is doing great. We had a record revenue for our China networking business and I take that as a positive sign. It means that the Chinese government is still leaning into H3C, and that product and that business is being very well received in the China market.

And our next question will come from Tim Long of BMO Capital Markets.

Thank you. Just two, if I could. First quickly, Meg mentioned a few times the January weakness. Is this just macro, any parts of your business or verticals that it hit more meaningfully?

And then on to the networking business, I think you mentioned Aruba helping the switching business get back to double-digit growth. Could you just talk a little bit about is that AC driven? Or what is it that's helping those two businesses do such a good job of cross-selling? Thank you.

The January weakness, we saw the last three weeks in January slow significantly in the United States. Actually, not that dissimilar from what I believe Cisco referred to on their call. And I don't have a good explanation of that except for one or two things. One is, remember, the opening week in the market in 2016 was really tough, right? And I think companies are quite now extra sensitive to volatility in the market. They're quite quick to be cautious and pull back purchases.

From a vertical perspective, obviously the weakest vertical was oil and natural gas. We saw that across the board. And a lot of our oil and natural gas customers are in the United States so that was a challenge and will probably continue.

What I will say is, while I'm cautious about it, it looks like February has returned to the linearity that we would have expected. Oil and natural gas continues to be a bit weak but there's been some strength in other parts. So, I'm not quite sure what happened in those last three weeks but that would be my guess.

Turning to Aruba and why it has helped our networking switch business, it's because the customers now believe we're completely committed to the networking business. We are all-in on networking. And while we had HP networking before, I think people thought -- well, maybe they're not 100% committed, maybe a bit below scale. With the acquisition of Aruba they've gained a great deal of confidence in our product road map and in our commitment to the business. So, Aruba, I think, has cast a really nice glow over the rest of our HP networking business.

Okay, thank you very much.

Our next question is coming from Maynard Um of Wells Fargo.

Hi, thank you. I was just wondering if you could just help us a little more in terms of granularity around quarterly free cash flow and the charges. In particular, do you think that in the next quarter that your free cash flow will end up being positive and then continue to grow off of that? And then, secondly, just on Enterprise Services, are there any metrics you can provide or plan to give us at some point to give us some comfort on revenue stabilization, whether it's book to bill or some other metrics? Thanks.

Sure. On the quarterly free cash flow, we're not going to guide on a quarterly basis. But if you think about it, obviously first quarter for us is seasonally low, and that's primarily driven by earnings seasonality, which is driven by the profiles in ES and Software, as well as the timing of that bonus payment which happens in the first quarter of every year. It's a one-time payment. We saw that same seasonality last year.

Now, going forward, what I would say is we're going to get improvements every quarter in primarily four areas. One, earnings improvement. Obviously we are back-end loaded from an earnings perspective, particularly in the second half. So, as those earnings improve obviously our free cash flow will improve.

The bonus payment's behind us now so that is no longer a drag as you go forward. The cash conversion cycle, we were disappointed with the 31 days, but when you look at the fundamentals of our terms and mix, we're confident that that will get back to the mid 20-day range, so that will drive a significant amount of improvement.

And then, lastly, the separation. To Toni's question, we had $600 million of separation charges planned for the year. We paid out $300 million of that in the first quarter, so that becomes less of a drag.

As we progress through every quarter, similar to last year, you will see improvement. I think if you look at the seasonality of last year, that would probably give you a pretty good reflection of how it may play out this year.

Let me talk a little bit about ES and your question about confidence in the revenue trajectory, which, remember, we said is negative 2% to flat in constant currency. I think there's a couple things going on here. One is, this is the first quarter of constant currency revenue growth. Not huge amounts, 0.1%, but relative from whence we've come in that business it gives us a lot of confidence. It's the first quarter of constant revenue growth since Q3 of FY12.

And ABS, which happens to have a higher level of profitability than ITO, posted its second consecutive quarter of year-over-year constant currency growth. SES -- as I mentioned, that's our cloud, big data, security practices -- grew over 30% year over year in Q1. And we saw some benefits from strong strategic Enterprise Services signings in FY15.

I think we have also worked through the vast majority of the key account revenue run-off that we've talked about for the last couple of years. These were three or four very big ES customers that have now really run-off and have become quite predictable.

And then I've got to give the finance team and the operations team in ES credit. We are much better now at forecasting revenue than we have been. It's a very granular account by account forecast profit, forecast of revenue by type of practice, and that gives us a lot of confidence. As we sit here today and we look out at the landscape and we see a book-to-bill ratio of roughly 1, we feel good about that negative 2% to flat.

Your next question comes from Steve Milunovich of UBS.

Thank you. Two things. First of all, if you could comment on the EMC Dell deal. I'm sure you're going to say that it's an opportunity to gain share but do you have any proof points of that at this early date?

And then, second, you're going to be spending about $4 billion on stock repurchase here over time. And it's at a time when IBM's had its biggest year of M&A, Dell and EMC are getting together, and there's probably more consolidation. Cisco is making a play for the data center. And you're very hardware-centric so it seems like you should be making some acquisitions here. Are you comfortable with the strategic position that leaves you in?

Yes. Let me talk a little bit about Dell EMC. It is interesting to note how different HP and Dell -- we have taken very different strategies in this environment. There's no question. My view of this is predicated upon the speed that this market is changing.

So, we decided to get smaller while they got bigger. We decided to lean into new technology while they are doubling down on old technology in a cost takeout play. They levered up, while we delevered. And we're super focused on being fast and nimble for our customers. Both strategies may work. I happen to like our hand better than the Dell EMC hand.

So, how are we taking advantage of the disruption in the marketplace? We learned a lot about how to do this in the context of the IBM sale of their server business to Lenovo. We have a very focused channel play -- actually it's called Smart Choice -- and we have a big opportunity to go take Dell and EMC business, much as we took a lot of the Lenovo business that would have gone to Lenovo.

We're seeing good results in the marketplace. We're rolling out our full sales efforts. You're going to start to see even more advertising in digital as we capitalize on another one to two years of uncertainty as this deal closes and they work through the integration.

The other thing is, as you think about it, we continue to invest in innovation. You have to think about Dell EMC, in many ways, as owned by private equity. You can do your own calculation on what you think the debt interest payments are going to be. For perspective, the entire EMC R&D budget is $2.7 billion.

So we feel good about our hand. Two completely different strategies but I like where we are.

In regards to M&A, as I said, our first priority is organic innovation, and you're starting to see that innovation engine really kick into gear. We started this, Steve, you'll remember, four years ago. As we cut costs over the last four years almost every single quarter year over year we spent more money on innovation and it's paying off.

That doesn't say we won't do acquisitions, but I would reiterate it's returns-based and it is focused on companies like 3PAR, like 3Com, like Aruba, that are complementary technology, that fit into our overall four transformation areas as we go forward. So, I think we've got the right strategy here, we're thoughtful about it, but if the right acquisition comes along and we feel like the price is appropriate, we'll go ahead and do it.

For what it's worth I think the stock is too cheap, too. Thanks.

We appreciate that, which is why we're backing up the truck.

Next we have Simona Jankowski of Goldman Sachs.

Hi. Thank you very much. Just actually following up on that comment of backing up the truck, is the new target of returning 100% or more of free cash flow this year inclusive of the proceeds from the Tsinghua sale or would that be on top? And then I have a question, as well.

No, the Tsinghua proceeds after the transaction would be on top of that.

And that would be targeted for this year, as well, in terms of buyback or is that market dependent?

That's really market dependent. It's hard to tell. I don't mean to be evasive but it really depends on market conditions, it depends on the availability of US cash. There are multiple variables in the overall equation. But we are committed to returning a vast majority of that to share repurchases.

Okay. And then, Meg, on the hyper-converged product you mentioned, is that an organic product? And how meaningful do you expect it to be for revenues this year?

Yes, it is an organic product developed in house, in record time, and we're quite excited about this. The hyper-converged market is big. It's growing fast. It's also getting pretty crowded. You've seen a lot of announcements over the last couple of months. But we very much like this product from a side-by-side comparison and features and functionality to our competitors, feel really good about it. And I think it means that we can be a leader in this quite large and fast-growing part of the market.

Thank you.

The next question will come from Wamsi Mohan of Bank of America Merrill Lynch.

Yes, thank you. Tim, in your working cap comments you noted headwinds from intra-quarter linearity and some opportunistic purchases. What regions? Was it primarily just the US that drove that linearity difference or were there other regions that drove that difference? And what components were you procuring opportunistically? And I have a follow-up.

It was primarily the US but we did see some pressures across the globe. And, again, if you think about timing challenges and free cash flow and cash conversion cycle, it's both sales and purchasing linearity. This time around it was the purchasing linearity and then we also made some strategic buys.

Okay, thanks. And, Meg, just to follow-up on the last question around hyper-converged, where do you think those dollars in hyper-converged take away from over the next several years? And do you view it as cannibalistic to any of your converged offerings? Thanks.

There certainly is some cannibalism there, probably the converged infrastructure play. But I would say that this is part of a migration to the next-generation data center. What we're seeing from customers of all size, if your company is older than 5 or 10 years, you are trying to figure out how you're going to take your existing infrastructure to the next generation of IT. This is part of the sale of -- okay, you can get more out of your existing IT if you transform to a hybrid infrastructure, and this is one of the core hardware components and software-defined components that allows you to get the most out of this next-generation of IT.

Listen, our business is cannibalistic, right? New products come in to replace old products. But we think we can get an increased share of that data center spend, which we see actually growing. And overall the margins on CS are accretive to servers and to the EG group in general.

The next question comes from Jim Suva of Citigroup.

Thank you very much. My question is regarding the services segment. Recently, both the federal government as well as the military has talked about some big contracts coming up for renewal, as well as potentially breaking them up into smaller pieces. We're just wondering, is there any risk there for HP about any of these contracts coming up, specifically midyear or second half to where then we'll enter another realm of some large contracts running off?

No. Actually, we think that it's an opportunity for us because some of the contracts, at least the ones I'm aware of, are actually owned by many of our competitors. Those competitors -- I know one in particular that's going to break from one into three, and we have a really very good opportunity to get one out of those three that's right in our sweet spot.

As has been widely reported, the US Navy and Marines contract comes up. I can't remember if it's in 2017 or 2018. I think it's the end of 2017, beginning of 2018 we have to start rebidding that. But we know how to do that. We've done it for years. So, actually I think we're on the right side of most of these federal contracts that are breaking up.

Thank you very much.

The next question will come from Shannon Cross of Cross Research.

Thank you very much. I'll just stick with one question. Meg, can you talk a bit about what you're seeing on the cloud? I know you've signed the deal with Microsoft, and you've talked a lot about a hybrid cloud, but maybe you can talk a bit about what you're hearing from customers in terms of their thoughts about moving to an Azure or AWS solution versus maybe using more of a hybrid one. And then also how you're thinking about server impact this year and going forward from cloud, given last year was so strong and you still have benefit, I think, this year from Gen 9. Thanks.

What we're hearing from customers is there's almost universal acceptance that their environments will be hybrid. And there's almost universal acceptance that it has to start with an analysis of the apps. How many apps does a customer want to have? Is there opportunities to reduce the number of apps and consolidate? And then what instantiation do you want that app to be on?

Some apps are going to stay locked down in a customer's data center untouched by anyone's hands other than their own employees. But some apps will go to a private cloud on-prem, a virtual private cloud, a managed private cloud, and then obviously to the public cloud. And we're seeing workloads move because even going from a traditional data center to the private cloud can be a 20% to 30% savings to a customer for that workload, which is meaningful.

As you know, we are the leader in private cloud. It is the first step that many customers take. And then they think -- okay, what would I like, what of my apps would I like to have in a virtual private cloud and a managed private cloud. I think there is an inexorable march from data center-only apps to private cloud, VPC, MPC and ultimately to the public cloud.

One of the other things we're doing here is developing our multi-cloud management layer, or one pane of glass, our orchestration and automation of your multi-cloud environment. How do you deploy workloads to these different clouds quickly and efficiently.

So, I think we've got the right strategy here. I think it was smart to get out of our spending on public cloud. I think that game has moved to Azure and AWS and maybe someday Google. And we're really pleased with our Azure partnership. So, that's working well.

The other thing I would say is, recall that we have built our cloud operation on Helion open stack. Our Version 2.0 of what we call HOS -- Helion Open Stack 2.0 -- is a significant improvement from 1.1 where we had some installer challenges. We're getting a lot of good feedback around HOS 2.0 as well as our carrier grade open stack which is, of course, of interest to the telcos. We had a very good Mobile World Congress show. I was there for three days. Our open NFE solution, we have 60 POCs across the globe and a couple of very big customer wins.

So, I feel like we're on the right strategy. The world's changing at breakneck speed. But we feel good about our strategy and I feel good actually about having chosen open stack. Two or three years ago I was getting a little concerned because I wasn't sure how fast open stack was going to mature, but it seems like it's finally hitting the knee of the curve and the adult supervision that a number of big companies have provided is actually helping.

Great. And server thoughts?

We actually see growth in high-performance compute, growth in tier 1, tier 2, tier 3, tier 4 service provider, and in some parts of the world core server growth. But we've got to make sure that we have the best server road map and the best opportunity for customers to run existing applications or cloud-native apps. Hence, HPE Synergy which allows a developer to basically compose the infrastructure they need for their app. HPE Synergy isn't exactly cloud, by any stretch of the imagination, but it is, in fact, the next generation of infrastructure for the software-defined data center.

I would also say that we are gaining share in that market. There's no question about it. We did a great job, I think, in grabbing share from Lenovo, as I said earlier, when those servers moved from IBM. And we are all over this Dell EMC opportunity.

In a flat to declining market, which probably core servers are, at least over the next five years; we have to gain share. But there are real pockets of growth in the market, as well. And HPC, by the way, high performance compute, we're like the last man standing there. We're investing in HPC and it's a core competency for the Company.

Great. Thank you, everyone, for joining today. And, operator, I think we can conclude the call.

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