惠普企業 (HPE) 2016 Q2 法說會逐字稿

Good afternoon, and welcome to the second-quarter 2016 Hewlett Packard Enterprises earnings conference call.

My name is Amy, and I will 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.

Please proceed.

Good afternoon, I'm Andy Simanek, Head of Investor Relations for Hewlett Packard Enterprise.

I'd like to welcome you to our FY16 second-quarter earnings conference call, with Meg Whitman, HPE's President and Chief Executive Officer; Tim Stonesifer, HPE's Executive Vice President and Chief Financial Officer; and joining later, Mike Lawrie, Chairman and Chief Executive Officer of CSC.

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 approximately1 year.

We posted the press releases and the slide presentations accompanying today's earnings release on our HPE Investor Relations webpage, at www.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 and transaction 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 could differ materially from the amounts ultimately reported in HPE's quarterly report on Form 10-Q for the fiscal quarter ended April 30, 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, and thank you to everyone on the call for joining us today.

Hewlett Packard Enterprise completed our second full quarter as an independent Company, and I have to say that we've delivered the best performance since I joined.

In Q2, we saw our first quarter of as-reported year-over-year revenue growth since 2011 for the Hewlett Packard Enterprise businesses.

We also saw our fourth consecutive quarter of year-over-year constant currency revenue growth.

We delivered revenue of $12.7 billion, up more than 1% as reported, and 5% in constant currency, driven by excellent performance in Servers, Storage, Networking, and Converged Infrastructure, as well as outstanding performance in Enterprise Services.

Enterprise Group had a fabulous quarter, delivering 7% revenue growth on an as-reported basis and 10% in constant currency.

In fact, we grew on an as-reported basis in every one of EG's hardware business units, and in every region.

ES grew revenue year over year in constant currency for the second consecutive quarter, and expanded operating margins more than 3 points over the prior year.

That's the eighth consecutive quarter of year-over-year margin expansion.

Our Software business also delivered a strong quarter.

When adjusted for divestitures and acquisitions, Software delivered its third consecutive quarter of constant currency growth.

And in Financial Services, we saw double-digit volume growth over the prior year.

So, with strong performance across every one of our business segments, HPE delivered non-GAAP EPS of $0.42, at the high end of our previously provided outlook.

Free cash flow improved in the second quarter to $511 million, due to careful management of our working capital.

Tim will walk through the drivers of our cash flow and outlook shortly.

And we are seeing the benefits of our increased R&D and more focused product road maps, as we take share from our competitors.

In Storage, HPE is the only major vendor to gain share in external disc over the last two years, while EMC, NetApp, IBM and Dell lost share year over year.

Revenue in our 3PAR All-Flash business grew nearly triple digits, about two times faster than the market, and is once again expected to be larger and faster-growing than Pure.

In Networking, we are seeing an acceleration of our business, particularly since our acquisition of Aruba and our game-changing partnership with Unisplendour, a subsidiary of Tsinghua in China.

And our results are in stark contrast with the results Cisco reported last week.

In switching, HPE grew 18% year over year versus Cisco that was 3%.

And we are getting credit from the industry for our innovation, capturing the leading position in Gartner's most recent Magic Quadrant for wired wireless, upsetting Cisco's longstanding run in the top spot.

That is in addition to our leading positions in servers, storage and integrated systems.

And we're not taking our foot off the pedal.

Next month, at Discover Las Vegas, you'll be hearing more about some significant new innovations across our cloud, IoT and Composable Infrastructure product lines, as well as an update on the machine.

Last but certainly not least, earlier today, we made a major announcement that we are planning a tax free spinoff and merger of our Enterprise Services business with CSC, which is expected to create a pure play global IT service powerhouse with annual revenue of more than $26 billion.

The new Company will have more than 5,000 customers in 70 countries and employees in every region around the world.

The transaction is expected to deliver approximately $8.5 billion to HPE shareholders on an after-tax basis.

This includes an equity stake in the newly combined company valued at more than $4.5 billion, which represents approximately 50% ownership, cash dividend of $1.5 billion, and the assumption of $2.5 billion of debt and other liabilities.

We also expect the merger of the two businesses to produce first year synergies of approximately $1 billion post-close, with a run rate of $1.5 billion by the end of year one.

There is also an opportunity for additional synergies in subsequent years.

As owners of approximately 50% of the merged company, HPE shareholders will share in the value of the synergies, as well as future growth in earnings.

The cost to separate ES from HPE will be offset by lower costs associated with the previously announced FY15 restructuring program.

So there will be no incremental one-time cash payments beyond what we have already communicated.

I will serve on the Board of the new company, and HPE's Board of Directors will nominate half of the new Company's Board.

Mike Lawrie, the current Head of CSC, will become Chairman and CEO of the new Company.

And Mike Nefkens, the current EVP and General Manager of our Enterprise Services business, will become a key part of the new Company's executive team, and partner closely with Mike Lawrie on building the new organization.

Other executives and directors, as well as the name of the Company, will be announced at a later date.

The transaction is currently targeted to be completed by March 31, 2017.

For the combined CSC and Enterprise Services, this will create a new company that will be a pure play global IT services leader.

For customers, this means global access to world-class offerings in cloud, mobility, application development and modernization.

Business process services, IT services, big data and analytics, and security.

This is combined with deep industry experience in sectors that include financial services, transportation, consumer products, healthcare, and insurance.

HPE and this new Company will be closely connected moving forward, with agreements that will keep the two companies aligned for current customers and grow new business opportunities over time.

For the remaining Hewlett Packard Enterprise, this transaction creates significant incremental value by unlocking a faster growing, higher-margin and stronger free cash flow business.

HPE will now have $33 billion in annual revenue, and will focus on secure, next generation, software defined infrastructure that leverages a world-class portfolio of servers, storage, networking, Converged Infrastructure, as well as our Helion Cloud platform and software assets.

By bringing together leadership positions in these key data centered technologies, we will help customers run their traditional IT better while building a bridge to multi-cloud environments.

Beyond the data center, HPE is redefining IT at the edge with our next generation of Aruba and computing products for campus, branch and IoT applications.

In addition, through our Technology Services division, we can deliver consulting and support to customers, while HPE Financial Services offers financial flexibilities to customers to maximize their investments.

Finally, we will continue to leverage our portfolio of operations, security and big data software assets that deliver machine learning and deep analytics capabilities to customers.

Mike Lawrie has joined our call today, and will have much more to say about the deal in a moment.

But first, Tim is going to walk us through HPE's financial performance in detail.

Thanks, Meg.

Overall, we had a great quarter.

We grew revenue as reported and in constant currency, generated healthy cash flow, and delivered non-GAAP diluted net EPS at the high end of our guided range.

Revenue of $12.7 billion was up 1.3% year over year, and grew 4.9% in constant currency.

Our fourth consecutive quarter of constant currency growth, and as Meg mentioned, HPE businesses reported absolute revenue growth for the first time in five years.

We saw revenue growth and constant currency in every region, and outright growth in the Americas and APJ.

Our Americas performance continues to support cautious optimism for the remainder of the year, amongst an uneven macroeconomic environment.

In EMEA, we were still significantly impacted by currency.

However, we're seeing encouraging momentum in enterprise hardware.

And in APJ, China networking drove strong performance.

The top line currency impact to revenue was 4 points year over year, primarily due to hedging gains from the prior year.

Going forward, we expect the currency impact to significantly moderate throughout the second half of the year.

And we continue to anticipate an impact to revenue of approximately 3 points for the full year, as rates are now roughly in line with where they were when we originally guided the year.

Margins were largely stable in the quarter, with gross margin of 28.7%, up 10 basis points year over year and 30 basis point sequentially.

And non-GAAP operating profit margin was 7.9%, down 50 basis points year over year and 20 basis points sequentially.

Total non-GAAP operating expenses of $2.6 million were up 4.7% year over year, primarily due to increased FSC and R&D investments.

We delivered non-GAAP diluted net earnings per share of $0.42, at the high end of our guided range.

This primarily excludes $201 million for amortization of intangible assets, $161 million for restructuring, and $91 million of separation charges.

We delivered GAAP diluted net earnings per share of $0.18, $0.01 above our previously guided range.

Now turning to the business results, the Enterprise Group had a strong quarter, with excellent top line performance.

Our sales motion is hitting its stride, aided by the seamless launch of the HPE brand and our marketing efforts.

Revenue was up 7% year over year, or 10% in constant currency, and grew in all product groups.

For the remainder of the year, revenue growth will likely moderate, as we will not have the benefit of H3C and begin to face tougher compares.

Profitability in the quarter was 11.7%, down 240 basis points year on year.

This was primarily due to foreign exchange, heavier Tier 1 mix, and to a lesser degree incremental R&D investments.

A deal that exemplifies the strength of the Enterprise Group is a recently won project with Woolworths Limited, Australia's largest retail company.

Our solution, based on the ConvergedSystem 900 for SAP HANA, provides access to real-time data, enabling critical business decisions to be made immediately.

This competitive win against Lenovo, Fujitsu and Dimension Data with Cisco UCS also displaces the current outsource provider Wipro, and further secures HPE's relationship with Woolworths.

Servers revenue grew 7% year on year, or 10% in constant currency, primarily driven by strong Tier 1 sales in the Americas and core servers in APJ.

Based on our performance, we believe we took share in servers overall, density optimized servers, and rack.

From a regional perspective, we took share in the Americas and EMEA.

And this quarter, we started shipping our Hyper Converged HC 380, which enable mid-sized and remote office enterprises to easily deploy, manage and support virtual machines in a few clicks.

We continue to see Servers as a growth driver, given the strength of our portfolio, and anticipate healthy demand for compute through the remainder of the year.

In Storage, we grew revenue 2% year over year, and 5% in constant currency.

Converged Storage continued its strong growth trend, growing 19% year over year in constant currency and comprising 54% of the total portfolio.

3PAR All-Flash revenue grew near triple digits, and continues to drive mid-range share gains.

We estimate that we gained market share in the external disk for the 10th consecutive quarter, and expect Storage to gain share throughout the remainder of the year on the strength of the 3PAR portfolio and new logo wins, as we take advantage of the uncertainty surrounding the Dell/EMC merger.

Networking revenue grew 57% year over year as reported, or 62% in constant currency.

And when adjusted for Aruba, Networking was still up 17% in constant currency.

We had strong execution, with growth across all regions.

While Aruba continues to drive growth in wireless share, we also expect to take share in switching and routing, on the strength of H3C and Aruba campus switching pull-through.

Leading up to the transaction close with Tsinghua, H3C grew more than 50% year over year, validating the strategic moves we made to collaborate with a strong local partner.

In Technology Services, revenue did decline 6% year on year, or 2% in constant currency.

However, it was only down 1% in constant currency when adjusted for the discontinuation of HP Inc Attach, which remain in the FY15 results.

TS support, the most profitable and largest segment of Technology Services, grew orders in constant currency.

Based on this and the order growth we saw last year, we continue to expect TS revenue to return to growth in constant currency towards the end of the year.

Enterprise Services had another great quarter, as we continue to see the benefits of our restructuring cost actions and improving sales motion.

A great example of the deals we're winning is our recent selection from five other competitors for a 10 year, $0.5 billion contract to provide IT services, including infrastructure, mission critical systems, and applications to the US Strategic Command.

Revenue declined 2% year over year, but grew 1% in constant currency.

When adjusted for the Deutsche Bank win last year, both new business TCV and total TCV grew year over year.

Strategic Enterprise Services is gaining strength in both overall revenue and mix, delivering mid-double-digit growth year on year.

ABS continues to improve with a third consecutive quarter of year-on-year constant currency revenue growth, and ITO also grew in constant currency for the first time since the first quarter of 2012.

Operating profit improved 310 basis points year over year, to 6.7%, as the team continues to execute productivity improvements in delivery and sales.

We're also seeing the benefits from improving location mix, as well as increasing sold margins and healthy add-on sales.

We continue to track well against our longer-term goal of 60/40 low cost/high cost headcount mix, and completed the quarter with 47% of our headcount in low-cost centers.

The progress made on cost improvements, sales strength, and normal quarterly seasonality provides us with confidence that operating profit margins for the full year will now be towards the high end of our original 6% to 7% outlook.

Software declined 13% year over year, as reported, or 10% in constant currency.

However, it was up 2% in constant currency when adjusted for acquisitions and divestitures.

Sales strength in security and big data was partially offset by declines in IT management.

On a product level, we had encouraging results in Voltage, Fortify and IDOL.

The team continues to focus on disciplined cost controls, decreasing OpEx dollars year over year and growing operating profit dollars.

Operating profit margin expended 7 points year over year.

However, the largest contributor to OpEx and margin improvement was a one-time benefit from the TippingPoint divestiture.

HPE Financial Services revenue declined 2% year over year, but grew 1% in constant currency.

Operating profit declined 130 basis points year over year, to 9.3%, as the lower residual sales pressured margin rates.

Financing volume grew 15% year over year, or 19% in constant currency, primarily due to favorable movement in our cost of funds, which has enabled us to price more competitively.

Return on equity was down 230 basis points year on year, to 12.7%.

Cash flow was strong in the quarter, due to judicious working capital management.

Cash flow from operations was $1.1 billion, up 101% year over year, on an adjusted basis.

Free cash flow was $511 million, up from negative $106 million last year, again on an adjusted basis.

When adjusted for the sale of H3C, the cash conversion cycle was 27 days, down four days quarter over quarter.

The largest contributor to cash conversion cycle improvement was BPO, which increased five days sequentially, adjusted for H3C, as we continue to improve payment terms with our vendors.

This is partially offset by DSO, which increased two days sequentially, while DOI was flat through the quarter.

Given the momentum in our working capital initiatives, we now expect our cash conversion cycle will reach the low 20 day range by the year end.

Now let's turn to capital allocation.

In the quarter, we returned $109 million of cash to shareholders.

Due to the ES CSC transaction, we were largely prohibited from repurchasing shares, and only bought $15 million of shares.

We also paid $94 million as part of our normal dividend.

We continue to see our shares as very attractively priced, and will be back in the market this month.

Along those lines, our Board of Directors recently increased our share repurchase authorization by $3 billion, which now stands at $4.8 billion remaining.

During our Q1 earnings call, we committed approximately $2 billion of the proceeds from the H3C transaction to share repurchases.

We now expect to complete roughly half of those this fiscal year, with the remainder to be completed in FY17.

As you'll recall, share repurchases resulting from the H3C transaction are in addition to our commitment to return 100% of our original FY16 free cash flow outlook to shareholders.

Now I would like to provide an update on recent M&A activity.

First, we announced the sale of our majority stake in Mphasis to Blackstone, as we continue to refine our capital strategy and make improvements to our go to market model.

We expect this transaction to close in the fourth quarter of this year.

In addition, during the quarter, we closed the sale of 51% of H3C to Tsinghua in the beginning of May.

Remember that our prior guidance did not include the impact of this transaction.

We now think that we can offset the EPS impact with the share repurchases we completed in the first quarter and the incremental share repurchases to be completed later this year.

Going forward, we will recognize only 49% of H3C earnings and receive a corresponding cash payment.

This will reduce cash flow by approximately $200 million on the second half of FY16.

However, roughly half of that will be received as a cash payment in FY17.

Finally, I would like to discuss the cash impact of ES CSC transaction to HPE.

There will be no incremental one-time uses of cash beyond what we have already communicated.

We expect total one-time separation payments of around $900 million, with $300 million in FY16 and the remainder in FY17.

As an offset, we will reduce the $2.6 billion of restructuring payments associated with our 2015 structuring plan by roughly $1 billion, as we are achieving our targeted savings more efficiently and will no longer need to fund ES actions after the transaction closes.

We have gained valuable experience in the HPE/HPI separation that gives us confidence in executing this spin quickly and efficiently.

In total, the FY16 free cash flow will be reduced by $300 million, due to the H3C divestiture and current year ES separation payments that will be partially offset by working capital improvements.

Let's go to guidance.

We expect non-GAAP diluted net earnings per share to be $0.42 to $0.46 in Q3 of 2016.

And continue to expect full-year FY16 non-GAAP diluted net earnings per share of $1.85 to $1.95.

We expect GAAP diluted net earnings per share to be $1.10 to $1.14 in Q3 of 2016, and now expect full-year FY16 GAAP diluted net earnings per share of $1.68 to $1.78, reflecting the new ES separation charges and gain on sale of H3C.

And we now expect full-year FY16 free cash flow of $1.7 billion to $1.9 billion.

With that, I will turn it back over to Meg.

Thanks, Tim.

Now I would like go into more detail on the deal we announced today with CSC, which I think will be very beneficial to customers, employees and shareholders of both companies.

As today's results confirm, Enterprise Services is a stronger and more robust business that it has been in many years.

As a result of customer diversification efforts and other improvements, ES delivered stable constant currency revenue for the first two quarters of FY16, which were the first quarters of year-over-year constant currency revenue growth since FY12.

Overall, ES is on track to achieve its long-term goal of a market competitive cost structure and operating margins.

So by bringing together the best of these two organizations, we will create a pure play services leader, ready to compete and win against all the current players.

The new Company will have greater agility, focus, and the ability to drive faster outcomes for our customers.

It will also have a top-notch management team, quite literally the best in the business.

And that management team will be 100% focused on ensuring a smooth transition, with no disruption for ES and CSC customers.

With that, let me turn it over to Mike Lawrie.

Mike and I have gotten to know each other quite well, and I can tell you he is a world class CEO with incredible talent and unbridled passion for his business.

Once the deal closes, I look forward to working with him to build our new Company.

Mike?

Thank you, Meg.

I am excited about the great potential this merger brings to our people, to our clients, to our partners and investors, both at CSC and HPE's Enterprise Services division.

And let me tell you why.

Over the past few years, our two organizations have been embarked on critical turnarounds and broad-based transformations.

Not everyone is aware of this, but Meg and I joined our respective companies within about six months of each other.

And I am pleased to be able to say that in recent years, both our organizations have been on upward trajectories, with significant improvements in financial performance and in client satisfaction scores.

And the progress has been real, and it has been measurable.

Both of our companies separated last year, within a month of one another, into more client focused, pure play entities aimed at specific markets and core industries.

And today's announcement, the coming together of these two organizations, is the next logical step, building on their progress to date and significantly accelerating their transformation.

The new Company will be a global top three leader in IT services, one that is uniquely positioned to lead clients in their digital transformations.

Our organizations are highly complementary.

HPE Enterprise Services has a proud legacy, and brings focus and agility and the ability to drive faster outcomes for clients, along with a first rate sales organization.

CSC brings deep industry expertise, innovation and next-generation technologies, and an exceptional partner network, among other strengths.

And together, as an agile, technology independent services pure play, we will be better positioned to innovate and compete and win against both emerging and established players.

We will have substantial scale to serve customers more efficiently and effectively worldwide.

We will have a highly competitive cost structure to take advantage of our distinct growth opportunities, resulting in the capital capacity to invest and grow both organically and inorganically.

We will strengthen and grow client relationships that cover more than three-quarters of the Fortune 500, with less than 15% overlap across our top accounts.

We will leverage a combined portfolio that will include leading solutions in areas like managed security, cloud IP, enterprise applications, and big data and analytics, along with combined BPO leadership in healthcare and insurance, and banking and capital markets.

But most importantly, this great leap forward in our transformation will enable our people to better innovate, to compete and adapt to an ever-changing marketplace.

Employees will become part of a very strong and focused global enterprise that is positioned for success, one that enables them to take advantage of the diverse career development and growth opportunities of a larger global enterprise.

And as a pure play services leader, our new Company will be able to operate independent of any single hardware provider, establishing the right partnerships for success.

And at the same time, CSC and HPE will have long-term agreements in place to ensure that current customer commitments continue to be met, and our relationship will be stronger and our collaboration deeper.

Before I hand it back to Meg, I would just like to take a moment to thank the teams at both companies for their hard work and resilience in driving our respective transformations.

Through your efforts, we are at a place where we can bring our two great organizations together.

That includes our team at CSC, and also the HPE Enterprise Services team under Mike Nefkens.

I am pleased that Mike has agreed to stay with the Company in a senior position, reporting to me, and that he will be playing a crucial role in helping build and grow our new Company.

And I am looking forward to working with Meg as a member of the new Company's Board.

So let me just reiterate my excitement about our two organizations coming together to better serve clients around the world and deliver value for our shareholders.

We recognize that we are just at the beginning of this process, with a lot of work to do.

By staying laser focused and working in the same collaborative spirit that has gotten us to this point, we can get to the finish line faster and in a great position to launch the new Company.

My colleagues at CSC and I look forward to working with everyone at HPE Enterprise Services.

So now, let me hand it back to you, Meg.

Thank you, Mike.

I look forward to a close relationship and what I believe will be a game changing new Company in the global IT services market.

Mike will stay with us during the Q&A portion of the call.

Now, I will open it up to questions.

(Operator instructions)

Our first question is from Maynard Um, Wells Fargo.

Meg, can you talk about the remaining portions of your business?

It seems it is definitely more transactional.

Do you anticipate that we should think about more transactions happening here, whether it is accelerated M&A or spinoffs or a sale?

How should we think about that?

And then I have a follow-up.

Thanks, Maynard.

So we are actually very excited about what will become a standalone Hewlett Packard Enterprise.

Our focus is going to be on next gen software defined infrastructure with a world-class portfolio of servers, storage, networking, converged infrastructure, hyper-converged, Helion -- our Helion Cloud platform and our software assets.

And you probably have guessed by now that I am now a devotee of focus.

And this is going to be a laser-like focused Company that, as I think you know, is higher growth, higher margin, with more robust free cash flows.

And it's going to be well-capitalized.

So we don't necessarily think there is a need for acquisitions, but if we find the right companies, we certainly will move.

And let me just recap the kind of acquisitions that have worked well for this Company in the past.

Complementary technologies that we can put through our excellent distribution and support system.

So think 3PAR, 3COM, Aruba.

All three of those acquisitions have been fantastic for Hewlett Packard Enterprise, and so we will keep our eyes out for those kinds of acquisitions.

Unfortunately, there are not a lot of those around, but to the extent we see them, we will not hesitate to move.

And as Tim said, remember our capital allocation strategy is returns-based.

Right now, we really think there is incredible value in our stock price.

And Tim announced we're going to be buying back using 100% of our free cash flow, in addition to half of the H3C proceeds.

And we just got an increase in authorization of share buyback from our Board.

Great.

And then on the margin outlook for ES and servers, how should we be thinking -- should we be thinking more along the lines of 7% to 9% margins now for the ES business, and low teens digits on the server side?

Thank you.

Or I'm sorry, the EG group.

Thanks.

Yes, sure.

I would say on ES, as we talked about, we feel much more comfortable at the 7% range for this year.

Again, we have a lot of momentum in that business.

A lot of the activities that the team has done through the transformation are starting to feed through to the P&L.

So 7% to 9% is what we would have.

It may be conservative, but again, we need to get some -- continue to execute, and there is more work to do there.

So we are prudent at the 7% to 9%.

On the EG front, margins were down about 240 basis points.

That's primarily driven by foreign exchange, some tier 1 mix, and to a lesser degree the R&D investments we have made.

We are a little bit heavy in tier 1 right now.

If you'll recall, we launched the cloud line -- product line where we're seeing a lot of momentum, we launched that in the second half of last year.

So we are a little bit heavier weighted in tier 1. We expect that to normalize in the second half.

I think margins there will be stable in the near term.

And if you look longer term, we may even see some expansion, or we would expect to see some expansion, as you think about further growth in Aruba, converged storage, and those types of areas.

And then Maynard, don't forget about when we get -- in March 31 of 2017, the combined Company of CSC and our Enterprise Services division, we announced $1.5 billion of synergies on an ongoing basis.

And we're really confident of that.

And Mike, I might just ask you to comment on what you think, in terms of the synergies of the new Company.

Yes, we have taken a pretty deep look at this and have categorized this.

So we feel that we really have got a very actionable plan that we can begin to execute, once we close the transaction at the end of March.

So Meg, I think that number is a very strong number.

Great, thank you, Maynard.

Can we have the next question, please?

The next question is from Toni Sacconaghi, Bernstein.

Yes, thank you.

I have a couple questions related to services and the transaction.

I guess the first question is, why now, Meg?

The business has a lot of momentum in terms of profit improvement.

I understand the $8.5 billion consideration, but this business is going to earn over $1 billion in net income this year, could be closer to $1.3 billion, $1.4 billion, going forward.

So you're ascribing a value of 6.5 to 8 times to that business, when operating profit under your previous plan would have been growing pretty healthily.

So I guess the question is, why now, when you are at the cusp of improvement and arguably could have gotten paid for that in your stock price?

And how did you determine the value?

And I have a follow-up, please.

Yes, sure.

We are actually very pleased with the turnaround that we have executed in enterprise services.

And I would say the time is right now because we believe this industry actually will consolidate, and it is better to be on the front end of a consolidation play than the back end of the consolidation play.

And while there is more margin expansion here, we actually think the ability to accelerate the turnaround of ES will happen in the combined entity of CSC and ES.

And recall that our shareholders will own 50% of this new entity, so they will be party to that -- a 50% of the synergies, 50% of the operational improvements, 50% of the synergy improvement.

So in some ways, the shareholders get the best of both worlds.

They get to maintain a position in Hewlett Packard Enterprise in a more focused, software defined data center and edge strategy, and they get to ride the upside -- half the upside that they would've gotten had it stayed with us.

And my view is, the upside will be bigger with CSC and ES together.

And I guess the other reason is, why now, is the business is in a good position.

2 years ago, we were struggling in this business.

We have diversified the revenue.

We have taken cost out.

Revenue has stabilized.

We have developed some new product lines, and I think combined with CSC, it is going to be a powerhouse IT services company.

And just to follow up along those lines, Meg, I am trying to understand what will really be incremental from the merger.

You had outlined 30,000 person headcount reduction as part of your original ES plan, and growth savings of $2.7 billion.

And so I would like to understand, when the deal is consummated, how much of that will have been captured?

And then is the $1.5 billion you're talking about just the continuation of what was already in the plan?

Or is it truly incremental?

Because at least by my math, a lot of it doesn't feel like it is incremental, because I do not think you're going to be done with your original restructuring plan by March 31, 2017.

So we will not be done with the entire restructuring plan, but we will be done with a big chunk of it.

Basically, probably, I would say 60% of it, maybe almost 70% of it, and that $1.5 billion of synergy is incremental.

And it's things like, between the two companies' 95 data centers, okay, we definitely do not need 95 data centers.

Multiple offshore locations and delivery centers.

We will be able to consolidate delivery centers and leverage our position in India and China and Costa Rica and other places.

We will be able to leverage our selling teams that will be able to, I think, do more in the context of this combined entity.

So our estimate is those $1.5 billion of synergies is completely incremental, and we will probably 60% to 70% of the way through the transformation and the cost reduction.

Thank you.

Great.

Thank you, Tony.

Can we have the next question, please?

The next question is from Sherri Scribner of Deutsche Bank.

I was hoping to get a little detail on the impact of the HC3 divestiture on the second half results.

Primarily, is it going to show up in terms of lower revenue in the networking number?

Or should we also see an impact to servers and storage from that divestiture?

Yes, sure.

You will see that in the second half.

It is about $0.05.

We're estimating most of that is from operating profit.

There is some stranded costs that we need to take out, now that the deal is closed.

You will see most of that show up in the networking and a little bit in TS, as well.

Okay, but on the revenue side, it will mostly be on the networking?

Correct.

(multiple speakers) [I don't think] there will be much impact at all or servers or storage or converged infrastructure or the Helion Cloud platform or our software, or frankly ES.

Okay, perfect.

And then thinking about the divestiture of the services business, how will you structure your private cloud solutions, going forward?

Will they sit on the HPE side?

Will they sit on the new business side?

And how will you offer those solutions to your customers?

Yes, so the Helion Cloud platform, as a whole, will sit on the Hewlett Packard Enterprise side.

So for example, private cloud, we're the world leader in private cloud, in our Helion CloudSystem platform that is built on open stack.

And then, of course, the software business around CSA and other products, in terms of one pane of glass to manage a multi-cloud environment will sit with Hewlett Packard Enterprise.

However, virtual private cloud and managed private cloud is today delivered by ES, and in the future will be delivered by CSC ES.

And we're just going to be working very closely together to make sure that there is a seamless offering in the marketplace when someone wants a private cloud, plus VPC or MPC.

And then obviously, we have a relationship with Azure and CSC has a relationship with AWS.

So the new Company will be able to offer both to customers, which I think is going to be a real benefit.

And Mike, do you want to add anything to that?

I think that's the real benefit, is we're going to be able to provide our clients a wide range of solutions.

I'm anxious to be able to get access to some of the investments that, Meg, you and the Company have made over the past couple of years.

Because you have got some leading solutions, and that all can be brought now to our customers through the sales force and the delivery forces that we have as a result of the combined companies.

Great, thank you, Sherri.

Can we have the next question, please?

The next question is from Katy Huberty at Morgan Stanley.

Good afternoon.

Tim, can you just clarify, in the free cash flow guidance for this yea?

Should we subtract the $300 million from the $2 billion to $2.2 billion range?

Or do you expect to offset some of that $300 million hit?

And then what is the normalized free cash flow with all the divestitures, in comparison to that $3.7 billion number that you talked about at the analyst day?

And then I have a follow-up.

Yes, sure.

We are reducing the guide from $2 billion to $2.2 billion, down to $1.7 billion to $1.9 billion.

So that is a new guide for the year.

And if you think about that, it is really three components.

There's $200 million of pressure from the H3C divestiture, so that does not show up in our free cash flow.

There is about $300 million that are related to the separation costs now for the ES transaction.

And then those will be partially offset by working capital improvement.

So we continue to see momentum, particularly if you look at extended payment terms, if you look at just being a little bit more disciplined around payment exceptions and things of that nature.

So net-net, we will reduce the guide by $300 million.

I think about it as primarily driven by the H3C divestiture.

From a normalized perspective, I would say normalized would probably be around maybe [3.5], north of [3.5], [3.8], something like that.

Okay.

And then Meg, one of the reasons HP originally purchased DDS was the potential of revenue synergies, as that business pulled more HP systems and software.

As you look to separate those businesses, are there revenue dis-synergies that we should now think about?

Thanks.

Yes, no, we don't believe that that will be case.

You are right, one of the predicates of the EDS acquisition was pull-through of our infrastructure business as well as our software business.

And by the way, that has been realized.

So we've got a commercial agreement with the new Company, CSC ES, that will keep those level of pull-through the same for 3 years.

Now, we hope we will actually be able to do more with CSC, because we haven't really had access to their book of business.

And they've got a very strong business, and as Mike said, they are interested in our products and software, and we have to go in and earn that business.

But that is one of the things that we intend to do.

So at a very minimum, baseline will be maintained, and there's an upside in terms of earning more business with CSC.

Can we have the next question, please?

The next question is from Brian Alexander, Raymond James.

Could you just clarify whether you're still expecting constant currency revenue growth for all of FY16, adjusting for the H3C divestiture?

And if so, how do you think the second half will compare to the first half?

Thanks.

Sure, yes, we do still expect to see revenue growth for the total year, in constant currency.

The one thing that I would say is that the growth rates will be a little bit more normalized, if you will, in the second half.

There will be less FX pressure, as an example.

Because again, if you look at the second quarter, most of that FX pressure was driven by the hedge gains that we received in the second quarter of last year that did not repeat this year.

So that will tend to normalize.

So we expect to grow, but it will be a little bit more muted, I would say, versus the first half, because again, the compares get a little bit tougher, too, as well, in the second half.

Okay, thank you.

Thank you, Brian.

Can we have the next question, please?

Next question, Kulbinder Garcha, Credit Suisse.

My question is for is for Meg.

Meg, you mentioned earlier on that you are a devotee, I think, of focus.

And we have seen HPE go from being a $100 billion business to a $50 billion business to now a $33 billion business.

My question would be, then, why would the remaining assets, do they belong together?

Has any thought been given around optimizing the remaining portfolio further?

For example, I think most people would understand that you have a reasonably sub-scale software business.

Does that really belong with HP Enterprise?

Have you thought about pruning even further, going forward?

Or do you think this is really the asset base and technology base that HP Enterprise required to thrive long-term?

Yes, so we're happy with the performance of the overall portfolio.

You saw the growth in EG.

Software grew in constant currency when you normalized for M&A.

And when you think about the software defined data center, I'm really quite happy with the performance of the assets.

So obviously, over time, we continue to ensure that we've got the right set of assets.

Someone earlier on the call asked whether we would do M&A or some divestiture?

Listen, we're going to continue to optimize the set of assets that we have, but we're really happy with the current portfolio.

Thank you.

Great, thank you Kulbinder.

Can we have the next question, please?

The next question is from Rod Hall at JPMorgan.

Thanks for taking my question.

I guess I have two.

One, I wanted to see if you guys could walk us through the -- you said $4.5 billion of equity value, I think for 50% in the new entity.

Can you just walk us through your calculation on that?

How you are getting there?

And then the second question, I wanted to go back to the synergies question, and ask whether you think there will be any revenue dissynergy?

Is there overlap in revenues that would create some dissynergy there that we should be netting against the $1.5 billion incremental?

Thank you.

Yes, so I will get Mike Lawrie to address the revenue dis-synergies.

He mentioned that we have a very small overlap of customers, only 15%, but you might talk about that.

Correct.

Yes, we just don't see that much dissynergy here.

With the -- when we went through the top 200 accounts, we had less than a 15% overlap.

So it is really two different customer sets.

So when you think about it, it makes a lot of sense, because many of our losses were HPE's gains, and vice versa, although it was mostly losses on our side.

So when you think about it, it really is truly a new market opportunity for us.

And that is why we do not think there will be very many revenue dis-synergies, and why there is such an opportunity to expand the business that we're doing together.

And then let me walk through, at a high level, the deal mechanics, and then I will ask Chris Hsu, who is our Chief Operating Officer, who helped negotiate this deal, to give a bit more detail.

So we'd started out with, what is the value of the enterprise services asset?

And as you saw from the release, the headline value there is $8.5 billion.

Now, we wanted to make sure we did a 50/50, merger of equals, tax-free spin merge of enterprise services into this new entity.

And so obviously, we made some -- we negotiated some adjustments to that.

So first of all, the new Company -- and I am calling it, for shorthand, CSC ES, will pay Hewlett Packard Enterprise, the future standalone Hewlett Packard Enterprise, $1.5 billion of cash after the deal closes.

And we will assume $2.5 billion of liability, pension liability, as well as an old EDS $300 million bond.

And then ES, or Hewlett Packard Enterprise, will actually subsidize some of that pension liability with offshore cash.

So Chris, do you want to add any more detail to that?

Sure, Meg.

Meg, you hit most of the high points.

We started with negotiating, like Meg said, the $8.5 billion.

And at the time that we did the value, the equity value of CSC was about $4.6 billion.

And we then developed a -- in order to get to the 50/50 merger of equals, to make this a tax-free spin under an RMT structure, we then developed a set of upfront considerations that Meg went through, with the cash dividend and then some transfer of liabilities.

So that was roughly $3.9 billion.

So the two components, the $3.9 billion of upfront considerations, plus the $4.6 billion of equity considerations in CSC stock, essentially makes up the $8.5 billion in total valuation.

Now, the equity considerations that CSC will essentially issue stock at the time of the transaction, and that stock will essentially result in the Company being 50/50.

And the price or the total value at the time of close will depend on where CSC is trading at that point in time.

Perfect, thank you.

The next question, please?

The next question is from Steve Milunovich at UBS.

Thank you.

I wanted to go back to this question about the pull-through.

I would think that ES, while some of it is very independent, would have pulled through a fair amount of your EG business, particularly as we move more to cloud.

And I'd like you to talk a little bit more about the commitments that you have.

Are you the favored hardware supplier for the new Company?

And I guess part of the point of being a pure services company is that they are fairly agnostic.

And so do you lose that over time?

So it is not obvious to me that you absolutely maintain what you have, and it's just a question of if it gets better, I'm a little worried, obviously, about whether it could get worse.

And then conversely, what is getting rid of the services business, or half of it, do for you on the HPE side?

What can you do now that you were not able to do previously?

Sure.

So actually, we are very -- this was a very important part of the deal.

Because the last thing I wanted to do was combine CSC with ES and then lose the infrastructure pull-through.

That would not have been of value to Hewlett Packard Enterprise.

So we have negotiated a deal that I think is very fair.

It allows CSC to continue to work with people they've worked with in the past, but we've also got a commitment from them for the next 3 years.

Beyond that, I am very confident that the work we will do in Hewlett Packard Enterprise will earn our way to that commitment.

Think about our server lineup, our storage lineup, our networking lineup, our wired wireless LAN lineup, our converged infrastructure, hyper-converged and Helion Cloud platform.

But we do have, if you will, a safety net for the next 3 years.

But I also -- one of the benefits of a pure play services company is to be able to work with best-of-breed, and I know Mike wants to continue to do that.

So I think we have struck a good thing that protects us in the near-term, but gives Mike the flexibility he needs to do solutions that are right for his customers.

On the other side of it is, we do business today with some of ES's competitors.

Think about Deloitte or Accenture or Capgemini or the Indian players, and we want to continue to grow that.

And there -- just like for Mike, there is a benefit to being a pure play, there will be benefit for us, in terms of being primarily a software defined infrastructure company and software company.

So we imagine growing the business with those players, as well.

And by the way, this interestingly happened with the HPE/HP Inc split.

When HP Inc became a separate company, all of a sudden, a lot of competitors who used to think they were competitors, to some degree, with our Company all of a sudden were very interested in the HP Inc offering.

So we think that could happen to us, as well.

Great, thank you, Steve.

Can we have the next question, please?

The next question is from Amit Daryanani, RBC Capital Markets.

Thanks, good afternoon guys.

Meg, the biggest question we keep getting right now is, what drove the transaction at this point for you guys?

And really broadly, as you look at HPE post this transaction and after March 31, what do you think your revenue growth and EPS targets would look like, relative to IT spend over time?

Yes, listen, part of the benefit of this transaction is focused on a smaller number of businesses that I think play into a sweet spot in IT spend.

So the objective of standalone HPE will be all about helping customers optimize and modernize their traditional IT spend, which by the way is still 88% of the spend in the marketplace, and transition to a multi-cloud environment.

And also deploy, obviously, the software assets.

So we're not giving revenue guidance and EPS guidance for the standalone Company, and I am certain we will closer to March 31.

But we expect to go at or above the market rate, as we did this quarter.

I think it is important to look at our results this quarter, for enterprise group and software.

I think they are the best indication that we have got a winning company here.

We outgrew the market.

We outgrew every single competitor.

Gained share in every single one of our -- against our infrastructure competitors.

And I think what you have now is the enterprise group and software on a roll.

And the investments that we have made in R&D, the investments we have made in a fire in the belly sales force.

We have done a complete transformation of our sales force around not only our channel, but also direct selling.

And then if you think about how we've optimized marketing spend over the last couple of years, we're doing better in demand gen digital marketing than we had ever done.

So I think you've got a little powerhouse in software defined infrastructure and software.

Perfect, thank you, Amit.

Can we have the next question, please?

The next question is from Ittai Kidron, Oppenheimer.

Thanks.

This is Ittai.

Question for Tim.

Tim, I wanted to drill down a little bit into your third-quarter guidance, especially on the EPS, which is below the Street by about $0.04.

How much of this is the H3C transaction?

I think you about talked about a $0.05 loss there.

And is that also the reason you're looking for a very fourth quarter weighted EPS upside?

Can you walk us through some of the elements for that variability?

Sure.

So if you take our third-quarter guide, we're at -- the midpoint is about $0.44.

The primary delta versus consensus right now is really driven by the H3C transaction, to your point.

That's probably about, I would say, $0.03 or $0.04.

So that implies a ramp in the fourth quarter, and that is really -- think about it in three ways.

One, it is typical seasonality.

So when you look at our ES business and our software business, those businesses tend to be back end loaded.

So that will drive a lot of the improvement.

The second component is around the H3C transaction from a stranded cost perspective.

So now that the deal is closed, there is some overhead costs that we need to take out of the system.

That generally takes a little bit of time, not too dissimilar to the dissynergy story we had around the separation.

And then the third component is driven by the share repurchases.

So there is more of an impact in Q4 versus Q3 on the share repurchase front.

So those are really the key drivers to the ramp in the fourth quarter, but we have got clear plans.

For sure, we need to go out and execute, but we feel good about the total year.

And that is why we held our total-year guide of $1.85 to $1.95.

That's great.

Then as a follow-up, on EG margins, for two quarters in a row now, they are down on a year-over-year basis.

And I understand that FX is a part of that, but how do we think about the timeline by which we go back towards the 15% range?

Is that even possible, given the mix of solutions?

And maybe you can walk us through that?

And when does TS start contributing for this, from a growth standpoint, revenue not just margin?

Sure.

I would say, from a margin perspective, for sure FX has had a factor, has been a factor, particularly if you look at the first half of the year.

And that will tend to have less of an impact, going forward.

We do have a heavy mix of tier 1 right now.

Again, we launched cloud line in the second half of last year.

So right now, when you look at our total mix from a tier 1 perspective, it is a little bit heavy.

Again, that will tend to normalize.

So I would expect the margins in EG to be stable.

And I am not going to give margin guidance here, but again, as we continue to grow Aruba, as we continue to grow storage, that is going to help the margin front.

On the TS front, that business will also stabilize.

So we had -- we were down in revenue 1% in constant currency when you adjust for the HPI transaction.

But we do expect revenue growth in the latter part of the year.

And the way to think about that is, obviously, that is an annuity type business, given the contracts.

So what we are going to start seeing in the second half is that those negative growth orders that we had in 2014, that is replaced by positive growth that we saw in 2015.

That feeds our 2016 revenues.

So we do expect TS revenue to be flat, on a year-over-year basis, for the total year.

And that will also help from a margin perspective, as well.

Very good, good luck.

Great.

Thank you, Ittai.

Can we have the next question, please?

The next question is from Jim Suva at Citi.

Thank you, and congratulations on a lot of work and the big surprise.

Regarding the divestiture of H3C, aside just from the pure mechanics of selling 51%, and what goes on with the entity transactions, and how it accounts for [financially].

For a pure sales perspective, was there an impact in this quarter and an impact in the next quarter, as far as transactions, whether they be accelerated or deferred?

Or anything we should think about, as far as closing the transactions around the H3C transaction?

I wouldn't think so, if I am understanding your question correctly.

Remember now, H3C is 51% -- in China, is 51% owned by Unisplendour, a subsidiary of Tsinghua.

So the CEO is a great guy by the name of Tony Yu, who is running the business.

We have the Chairman and the CFO.

But it is really going to depend on the momentum in that H3C business, in the China market.

And what I will tell you is, the momentum is really good.

We had a very good second quarter there, even though the transaction hadn't closed.

And I was just in China two weeks ago, and I will tell you Tsinghua is incredibly committed to this.

The management team is fired up.

They feel like they control their own destiny in China.

And so I cannot predict what the revenue will do there, but I am feeling really good about our 49% ownership of a business that I think there is a lot of commitment, on behalf of Tsinghua and the management team, to make successful.

Okay.

And then as a follow-up, regarding the pull-through of the -- I think you mentioned a 3 year agreement with CSC.

Is that just on the HP services that goes to CSC?

Or is CSC also, with their other existing businesses, having an agreement to refer HP for their products?

No, it is really around -- so we sell a certain amount -- Hewlett Packard -- the enterprise group and software, mostly the enterprise group, sells a lot of their products to enterprise services in an inter-company transfer today.

And we want to make sure that that business stays for the next 3 years, and we have a chance to earn more business.

So think about it.

It's servers, storage, networking, converged infrastructure, the Helion Cloud platform and TS, as well as software.

So that is how the agreement is structured.

Does that answer your question?

Yes, it does.

Thank you very much.

The other thing I would add is they are playing in a $2.5 billion ITO market today that we do not participate in.

So it may even be a growth opportunity for HPE.

Perfect, great, thank you, Jim.

Can we have the next question, please?

The next question in from Wamsi Mohan at Bank of America Merrill Lynch.

Yes, thank you.

Apart from the separation costs associated with this ES transaction, can you talk about any potential cost dis-synergies or stranded costs associated with this deal?

And I have a follow-up.

Yes, sure.

So the overall separation cost will be $900 million.

Again, $300 million of that will be incurred in 2016, and $600 million of that will be incurred -- roughly $600 million will be incurred in 2017.

Again, there is no incremental one-time cash costs associated with this.

We will reduce the 2015 restructuring plan by about $1 billion, and that will offset the cost for here.

As far as the stranded cost number, we will work those costs out through the system.

I think the good news is what we have learned in the last separation was how to do this and how to do it efficiently.

So I would just say, on the stranded cost piece, if I look at project planning and what have you, we have that much more clearly defined.

We know who owns it, and we how that is going to come out of the system and when that comes out of the system.

Yes, and also [said], I think there is a real benefit to having done one separation.

The first time you do it, you get the best advice you can and you learn how to do it.

This time, we have this thing down to a science.

And so I think a number of the same people are going to work on this separation, and I'm highly confident we're going to be able to work off those stranded costs, probably faster than we did in version 1.0.

Okay, great.

And as my follow-up, Tim, on normalized free cash flow, given the higher transactional nature of the business post-ES, I am a little surprised you have a fairly tight range of [3.5] to [3.8], if I heard you right.

How should we think about the volatility of that number?

And then just longer term normalized CapEx spend for HPE in a post-ES world?

Thanks.

Yes, let me just clarify, the [3.5] to [3.8], that was [16] with ES in it.

So if you are looking to pull ES out from a normalized perspective, that is not what I was talking about.

I was talking about our current guide, with current separation and current restructuring, what have you.

In general, if you strip out ES, I'd think about, obviously, ES has more CapEx than the other businesses.

From a normalized CapEx perspective, I think you could see our CapEx go down by $500 million or $600 million.

That is what we typically use for ES.

So that's how I'd think about it, from a normalized perspective.

Again, we will give some more color when we do SAM in October, but I think CapEx is a big driver.

As I said, I think what we're doing, by the announcements we made today, is unlocking the value of these two companies.

And remember, EG plus software plus our financial services business is a faster growing, higher margin, more robust free cash flow business.

And I think now that, with a super-focused mission, we are going to see some real benefits there.

And then obviously, by consolidating CSC with ES, I think we're going to get real cost synergies there.

Thank you.

Great, thank you.

I think we have time for one more question, please.

Your next question is from Simona Jankowski at Goldman Sachs.

Maybe just the last question, then, on the fundamentals that you're seeing out there.

It sounded like you attribute the strong performance in EG mostly to share gains, but can you also comment on the demand environment?

And then just relative to those share gains, you touched a little bit on what drove that, such as retooling the sales force, et cetera.

Can you comment, in a little bit more detail, on any other factors driving your success there?

Whether it is related to solution selling or pricing or products, anything of that nature?

Thank you.

Sure.

So listen, it is an uneven macroeconomic environment.

I think Tim said that at first.

And so different countries go up and down, different regions.

But overall, I think we feel very comfortable with our position in the traditional IT market, and then in our ability to provide solutions in a multi-cloud environment.

So I think demand can go up and down, but our objective is in whatever the market is doing, we want to make sure we at least hold or gain share.

And we did that in the last quarter.

And I do not think there's new to add as to why.

First of all, I think the R&D investments that we've made over the last 4 years are paying off.

So the development cycle in servers, storage, networking, those kinds of things, hyper-converged, these are long-term investments.

What you started three years ago actually comes to market now or even next year.

So that investment in R&D is paying off, and I will tell a dollar spent on internal R&D is the best dollar we spend at HP.

It is fantastic.

Second is, when you retool a sales force, that take some time, as well.

And I would say we are much farther along than we have been, and there is more work to do.

And then as I said, marketing, we have retooled our entire demand generation.

We've retooled -- and by the way, the launch of Hewlett Packard Enterprise gave us a chance to tell people the story of the enterprise side of this business.

Because prior to that, if you had asked man on the street, what is HP, they'd say a printing and PC company.

So I think that's actually been beneficial.

And then turnarounds takes 5 years.

(laughter) I said it when I started, and we're rounding the bend into the end of the fifth year.

And so it is gratifying that we saw as-reported growth for the first time in 5 years.

Thank you.

Great, thank you, Simona.

I think that wraps up today's call.

Thank you very much.

Ladies and gentlemen, this concludes our call for today.

Thank you.