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Hewlett-Packard Enterprise Company (NYSE:HPE)
Q2 2018 Earnings Conference Call
May 22, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, everyone, and welcome to the second quarter Fiscal Year 2018 Hewlett-Packard Enterprise earnings conference call. My name is William and I will be your conference moderator for today's call. At this time, all participants will be in a listen only mode. We will be facilitating a question and answer session toward the end of the conference. Should you need assistance during the call, please signal a conference specialist by pressing the * key followed by 0. 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.

Andrew Simanek -- Head of Investor Relations 

Good afternoon. I'm Andy Simanek, Head of Investor Relations for Hewlett-Packard Enterprise. I'd like to welcome you to our Fiscal 2018 second quarter earnings conference call with Antonio Neri, 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 Antonio, let me remind you that this call is being webcast. A replay of the webcast will be made available shortly after the call for approximately one year. We posted the press release and the slide presentation accompanying today's earnings release on our HPE investor relations webpage at investors.hpe.com.

As always, elements of this presentation are forward-looking and are based on our best view of the world and our businesses as we see them today. For more detailed information, please say the disclaimers on the earnings materials relating to forward-looking statements that involve risks, uncertainties, and assumptions. For a discussion of some of these risks, uncertainties, and assumptions, please refer to HPE's filings with the SEC, including its most recent form 10-K.

HPE assumes no 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 on HPE's quarterly report on form 10-Q for the fiscal quarter ended April 30th, 2018.

Finally, for financial information that has been expressed on a non-GAAP basis, we have provided reconciliations to the comparable GAAP information on our website. Please refer to the tables and slide presentation accompanying today's earnings release on our website for details.

With that, let me turn the call over to Antonio.

Antonio Neri -- President and Chief Executive Officer

Thanks, Andy and good afternoon, everyone. Thanks for joining us today. Let me begin by saying that I'm very pleased with our strong performance in Q2. We continue to execute well across all business segments while delivering on a number of strategic initiatives. Revenue of $7.5 billion was up 10% from the prior year period. We experienced solid revenue growth across each business segment with particular strength in intelligent edge, high performance compute, storage, hyper converged, and composable infrastructure.

From a micro perspective, the IT market remains robust. We saw growth in all regions with particular strength in both EMEA and APJ. Currency was a larger year over year benefit, providing a three-point tailwind this quarter. Given our strong execution held by a $0.01, we delivered a non-GAAP EPS of $0.34 above our average range of $0.29 to $$0.33.

Looking at cashflow, our free cashflow was -$269 million in Q2. We remain confident in our full year outlook or approximately $1 billion in free cashflow and we'll provide more color on this in a moment.

Finally, in Q2, we begin executing against our $7 billion capital return plan we announced last quarter. We returned $1 billion to shareholders in the form of share repurchases and dividends and we announced that we are raising our dividend by approximately 50% starting in the current third quarter.

Looking forward, as a result of our performance in Q2 as well as the continued benefit from a lower tax rate, we are raising our Fiscal Year 18 non-GAAP EPS outlook to $1.40 to $1.50 from our previously provided outlook of $1.35 to $1.45. Tim will provide more details in a minute.

Before I turn to the business segment performance, I want to give you an update on our progress with HP Next. As a reminder, HP Next is our companywide initiative to rearchitect HPE to deliver on our strategy and drive a new wave of shareholder value. It's all about simplification, execution and innovation. Through this initiative, we are simplifying our operating model and the way we work. We are streamlining our offerings and business processes and modernizing our IT systems to improve our execution. We are shifting our investments in innovation toward high growth and higher margin opportunities.

Over the first half of this year, we have achieved some significant milestones across each of these areas. For example, we have reduced spans and layers between the CEO and the customer. We have significant streamline of our structure, empowering the front line to make key additions. And we have dramatically reduced SKUs and platforms across our volume and value segments, which simplifies our operation and makes us easier to work with. Moving into the second half of the year, we'll be concentrating our efforts on the next phase of the initiative, including building out our no touch sales model and accelerating our IT transformation to better service customers and partners.

The changes we are making through HP Next will not only improve our cost structure, they will also give us a significant long-term competitive advantage. I am very proud of the work we are doing here. While the decisions we are making are for the long-term, you already are already beginning to see the benefits in our financial results. In Q2, we delivered an operating margin of 8.6%, up 270 basis points from last year, due in part to the effective execution of HP Next.

Turning to our business segments, we saw solid performance across the board while continuing to deliver innovation in key areas of our platform. In Intelligent Edge segment, revenue grew 17% year over year, with strengths in both products and services. Wireless LAN revenue rebounded as expected after a softer Q1 and wire switching remains strong. While, still, a small portion of our overall product sales, we saw strong customer traction IoT systems, including a significant win with a global financial services company. These results bode well for our future.

Our customers tell us they want to take advantage of exploring the amount of usable data being created at the edge. We heard that. We continued to make investments to build out our Intelligent Edge platform. For example, in Q2, we strengthened our platform with the acquisition of Cape Networks. The Cape acquisition is the latest steps toward our vision of autonomous infrastructure enabled by artificial intelligence.

Cape expands Aruba AI power networking capabilities with a sense of base network insurance solutions that improves network performance, reduces disruption and significantly provides IT management for our customers. We also introduce Net Insight, another complementary AI-based analytics, reduces disruption insurance solution for optimizing network performance. Net Insights uses machine learning to continuously monitor the network and deliver insights in the event of anomalies. It also recommends how best to optimize the network for today's mobile first and replace critical IoT devices.

Looking forward, we see significant potential in Intelligent Edge. This will continue to be a key area of investment for us. Turning to Hybrid IT, revenue was $6 billion, up 7% year over year with solid performance across all segment. Compute grew 6% year over year and 9% if you exclude tier one. We saw very strong growth in high-performance computer, composable infrastructure, and hyper convert, offset by the continued decline in our customized commodity server sells to tier one vendors, a business we are moving away from.

Our focus continues to be on providing solutions that deliver high value differentiation to our customers and to our profitable share for HPE. We continue to prioritize investment in those higher margin, higher growth segments of the market. For example, just last week, we announced the acquisition of Plexxi. Plexxi provides innovative software-defined networking technology, which we plan to integrate into both SimpliVity, our hyper converge offering, and Synergy, our composable infrastructure offering. With Plexxi, we will enable customers to move and manage their data more quickly and effectively and also significantly reduce CapEx and OpEx by up to 50% in some cases.

Storage performed very well, up 24% year over year with a nimble acquisition and up 14% organically. All-flash continued to perform well, growing 20% year over year as the market continues to transition and we benefit from our strong position with both 3PAR and Nimble. And earlier this month, we introduced the next generation in storage platform, which is guaranteed to deliver the best storage efficiency of any all-flash array on the market.

Data center's working revenue was up 2% year over year with good execution within our existing install base. Finally, turning to services, HP Pointnext revenue grew 1% year over year in Q2. We saw it pick up in orders in deals that flip from Q1 and strong customer traction from our newest offering called HP GreenLake. HP GreenLake is a suite of paper use solutions available for top customers or loads like big data, SAP HANA and Edge Computing. The offering simplifies the IT experience and gives customers choice of where workloads should live and how to flexibly consume them. This is an offering we will continue to expand. Look for updates soon.

And in Q2, we also continued to strengthen our advisory capabilities, building on our acquisition of cloud technical partners with the acquisition of RedPixie. RedPixie is a UK-based cloud consulting company with deep Microsoft Azure expertise, which perfectly complements CTP's strong AWS relationship. We are excited about the capabilities this acquisition brings to HPE and already seeing them open doors to new and bigger deals.

HP Financial Services also performed well in the quarter, with revenue up 5% year over year, leading with strong growth in our asset management business. Customers are responding well to the actions we are taking, both from an operational and innovation perspective. They believe in our strategy, in the powerful portfolio of products and services we are building. That confidence can be seen in some recent wins.

For example, in Q2, we won a major high-performance compute deal with the US Department of Energy. This is just the latest example of the strength of HPE's HPC portfolio and the value it brings to the US government in the nation, in international competition over computing power. We also won a new project with Time Warner, where Aruba was selected for the state of the art Hudson Yard Digital Workplace Project in New York City.

And we announced a new supercomputer installation at KU Leuven, a Flemish research university, consistently ranked as one of the top five most innovative universities in the world. We have collaborated with the university to develop a deploy a new supercomputer specifically built to develop AI workloads. It will be used to build applications that drive scientific breakthroughs, economic growth and innovation in Belgium.

Next month, we will host our annual HPE Discover conference in Las Vegas, bringing together thousands of customers and partners from around the world. We'll be making some exciting announcements at events and I look forward to seeing many of you there.

So, as is said earlier, I'm very pleased with our performance in the first half of Fiscal Year 18. All of our business segments perform well. We made solid progress on HP Next and continue to invest in innovation that will further strengthen and differentiate our company into the future.

Looking ahead to the rest of the year, as we indicated last quarter, we expect the growth rate to moderate given tougher competitors, lacking acquisitions, and a smaller currency tailwind. While we see a more challenging second half, we have got great momentum and I'm confident that we will deliver on our annual Fiscal Year 18 outlook.

With that, I will turn it over to Tim.

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

Thanks, Antonio. Our Q2 financial results were strong, with robust revenue growth, significantly improved operating margins and better than expected earnings. Total revenue for the quarter was $7.5 billion, up 10% year over year and 6% in constant currency. Topline performance was driven by good market dynamics, solid execution, and both favorable year over year compares and exchange rates.

From a portfolio mix perspective, we're seeing solid growth in our value offerings and our core volume business is growing better than expected. From a macro perspective, IT spending continues to be quite healthy with solid customer demand across all businesses and geographies. The pricing environment remains competitive but has continued to be more rationale and passing through elevated commodities cost.

DRAM cost increases have also started to flatten. Currency drove a 330-basis point tailwind to revenue year over year. With that said, rates have moved somewhat unfavorably in the last month, so currency will not be as large of a benefit in the second half if these rates hold. We now expect closer to a 2-point benefit to revenue in Fiscal Year 18.

Regionally HPE's performance in the Americas continue to be solid, growing 3% in constant currency. Most of the growth came from the US, Canada, and Brazil with strength in storage and the intelligent edge. Revenue growth in Europe continue to be strong, up 9% in constant currency, with double-digit growth in UK, France, and Italy.

Performance in EMEA was strong across all business units with double-digit growth in compute, storage, in Aruba products and services. Asia Pacific grew 9% in constant currency with strong in China, Australia, and Singapore.

Turning to margins, the gross margin of 30.4% was up 90 basis points year over year and 200 basis points sequentially. Non-GAAP operating profit of 8.6% was up 270 basis points year over year and 90 basis points sequentially. We continue to execute well this quarter with HPE Next savings driving most of the improvement. DRAM was also less of a pressure point as compared to prior quarters and we continued to gain traction on the pricing front.

Going forward, margin improvement will be driven primarily by delivering the cost savings from HPE Next and delivering our value portfolio offerings, which have higher margins. Non-GAAP diluted net earnings per share of $0.34 is just above the high-end of our previous outlook of $0.29 to $0.33 due to strong operational performance and a tax rate benefit of approximately a penny.

The Q2 non-GAAP tax rate was 9.6%, which is just below our previously provided tax range of 11% to 15% due to various one-time reductions in non-US tax expense. For the full year, we now expect our tax rate to be at the lower end of the 11% to 15% range, but we are still working through many variables associated with tax reform. GAAP diluted net earnings per share was $0.49 above our previously provided outlook range of $0.10 to $0.14, primarily due to releasing reserves we've been holding associated with HPQ tax risks that were part of our separation agreement, which has now been settled.

Now, turning to the business units -- in hybrid IT, revenue was up 7% year over year and 4% in constant currency. Revenue performance was strong and balanced across all businesses in all regions. Operating margins were 10.3%, up 220 basis points year over year and 70 basis points sequentially and in line with our expectations.

Compute revenue was up 6% year over year and 9% excluding tier one. We continue to see higher AUPs driven by passing through more DRAM costs, increasing our Gen10 mix and delivering richer tax configurations.

We saw continued momentum in our value bass with high-performance compute growing over 20%, hyper converge up triple digits, and Synergy gaining increasing customer traction. As mentioned earlier, revenue growth in our volume business was higher than planned, driven by strong growth in core rack.

Storage revenue was up 24% year over year with continued momentum in the organic business, up 14% year over year. We saw strong double digit growth and coverage storage driven by nimble and big data storage that has become a meaningful part of the portfolio. All-flash arrays grew 20% year over year. While the overall storage market remains competitive, we like our current position and expect to take 50 basis points of share this quarter, which will be the tenth time in the last 12 quarters where we've gained and maintained share.

Data center networking revenue was up 2% with good execution primarily from our installed base in the Americas. HPE Pointnext revenue was up 1% year over year with operational growth for the seventh consecutive quarter. Overall orders grew 1% with even better growth and operational services, which was driven by our new HPE GreenLake flexible capacity offerings. Service intensity remains strong, but attached orders continue to be under pressure from lower hardware growth and richer hardware configurations.

In the intelligent edge, revenue was up 17% year over year and 14% in constant currency. Operating margins of 6.5% were up 360 basis points sequentially due to the operating leverage from higher revenue but were down 110 basis points year over year due to significant investments in sales and R&D. Aligned to our strategy of pivoting to the intelligent edge, we've been making significant go to market and R&D investments that have given us the leadership position in this high-growth market opportunity.

Aruba product grew 18% with continued strong growth and campus switching and a rebound in wireless LAN, despite tough compares in the prior year. We've also started to see good traction in our edge compute business. Aruba Services was up 10% on installed base growth due to strong attach of our software platform like ClearPass and Airwave.

HPE Financial Services revenue grew 5% year over year and 1% in constant currency, driven by strong residual sales and growth in our direct business that was somewhat offset by lower operating release mix. Volume was flat as growth in our direct business was offset by the pressure in our indirect business. Operating profit declined 90 basis points year over year to 7.9% due to one-time items.

Now, turning to cashflow. Free cashflow was -$269 million in Q2. The cash conversion cycle was in line with expectations and decreased sequentially by one day to -22 days. Both inventory and payables were elevated in the quarter due to strategic positioning of key commodities and somewhat higher pricing. We also entered the quarter with an operating company net cash balance of 3.5%. Looking forward, we're still on track to achieve our free cashflow outlook of approximately $1 billion in Fiscal Year 18as the second half benefits from a few items.

First, we expect cash earnings to ramp, aligned with normal seasonality and the cost savings from HPE Next. Second, working capital will be a source of cash versus the use of cash in the first half with the cash conversion cycle improving to the negative-high 20-day range, similar to our Q4 exit range. Last, we have fewer one-time payments and expect incremental real estate sales toward the end of the year.

Moving to capital allocation, as part of our $7 billion capital return plan through Fiscal Year 19, which we announced in Q1, we returned $1 billion to shareholders during the quarter. This includes $907 million of share repurchases and $116 million of dividend payments. As previously communicated, we raised our quarterly dividend by 50%, which will be payable in July.

We also announced today that we'll be redeeming $1.6 billion of our bounds maturing in October at the end of June. The bond redemption is consistent with our capital allocation approach, which includes maintaining an investment grade credit rating. Going forward, we intend to run the operating company with net cash neutral to positive and we'll maintain financial flexibility through barring capacity as needed.

Now turning to our outlook, consistent with our approach in Q1, we are increasing our non-GAAP earnings outlook for Fiscal Year 18 by $0.05, due to our operational performance in Q2 and a favorable tax rate that we now expect to be at the low end of our 11% to 15% guidance for the year. As a result, we expect Fiscal Year 18 non-GAAP diluted net earnings per share of $1.40 to $1.50. We expect our Fiscal Year 18 GAAP diluted net earnings per share to be $1.70 to $1.80.

For Q3 18, we expect non-GAAP diluted net earnings per share of $0.35 to $0.39 and we expect GAAP diluted net earnings per share to be $0.19 to $0.23. So, overall, I'm pleased with the performance in the quarter and I'm looking forward to focusing on delivering our full-year commitments.

Before we open up the call for questions, as Antonio mentioned, I just wanted to remind everyone that we have our IR Summit coming up in June at our Discover customer event in Las Vegas and I hope many of you will be able to join us.

Now, let's open it up for questions.

Questions and Answers:

Operator

Thank you. And we will now begin the question and answer session. To ask a question, you may press * and then 1 on your touchstone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press * then 2. We do also request that you limit yourself to one question and a single follow-up question.

And our first questioner today will be Sherri Scriber with Deutshce Bank. Please go ahead.

Sherri Scribner -- Deutsche Bank -- Analyst

Thank you. I think Antonio and Tim, you both mentioned that DRAM cost increases have started to flatten. Can you remind us how you're feeling about DRAM and NAN as we move into the second half of the year I think when we talked about it last quarter, that's going to be somewhat of a pressure on revenue. How are you thinking about that as we move into the second half?

Antonio Neri -- President and Chief Executive Officer

Sure. Thanks, Sherri. We've still seen a flattening of the DRAM costs. We still see what I call nominal, low single-digit cost increases. We are able to pass those along for two reasons. One is stronger execution in our go to market, more disciplined approach and second, our competitors are becoming more rational about pricing in general. It's going to be a very low-cost increase and we feel confident to pass those along.

The AUPs, obviously, continue to be elevated for two reasons. One is the DRAM, as we talked before. Two is the richer configurations -- particularly on the compute side, the compute side are driving a rich configuration of memory, obviously flash, NAN in terms of storage. That's why we see the increased AUPs. Those are not going to change anytime soon, also because customers try to reach more efficiencies in their data centers, particularly to deploy the private cloud. The other one is some of these workloads demand that level of configuration, particularly as you move to AI and data analytics.

Sherri Scribner -- Deutsche Bank -- Analyst

Okay. Great. Then just looking at the storage business, it seems like you guys have definitely recovered in that business versus some issues you had last year. How are you feeling about the storage business as we move into the second half? Do you think these revenue growth levels are sustainable or do you expect them to come back in a bit? Thank you.

Antonio Neri -- President and Chief Executive Officer

Sure. Storage performed very well, up 24% year over year with inclusion of Nimble and 14% organically, which is to your point, we actually executed way better than last year. Last year, we had some execution challenges, particularly in North America. We think we have addressed those issues and when I think about the opportunity in the market, obviously all flash continue to be a significant opportunity. This quarter we grew 20%. We are really excited about our portfolio.

The combination of Nimble and 3Par with the simplicity of our value proposition, with cloud capabilities built into it and most importantly with our AI technologies built into it, both in Nimble and 3Par because now we scaled that solution to 3Par actually is something that's resonated with customers. So, as I look forward, we expect to see solid organic growth in storage, but let's remind ourselves next quarter we are going to have the lapping of the Nimble acquisition to the portfolio. I think the growth rate will be a little bit more moderated, but we're very confident about our ability to execute with this portfolio because we have true value differentiation.

Sherri Scribner -- Deutsche Bank -- Analyst

Thank you.

Andrew Simanek -- Head of Investor Relations 

Thank you, Sherri. Can you have the next question, please.

Operator

And our next question will be Katie Huberty with Morgan Stanley. Please go ahead.

Katie Huberty -- Morgan Stanley -- Managing Director

Thank you. Good afternoon. You've beat revenue and EPS two quarters in a row. The majority of the $0.05 full-year guidance is tax related. Can you just comment on why you're not assuming strong operational trends continue for the remainder of the year? Just as a related follow-up to that, when you talk about tough compares in the back half of the fiscal year and lapping acquisition, does that end in a company that's not growing topline or do you think the topline can continue to grow in the back half just at lower rates?

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

Yeah. So, as far as the $0.05 goes, I'd say $0.02 of the $0.05 was operational. Again, we continue to perform very well, particularly in the volume piece of the portfolio. That's growing faster than we had expected. As far as why we aren't passing more through. Again, we have a quite a bit of execution left in the second half. We still have six months to go and we feel it's just prudent to pass along the operational performance we're seeing and then we're trying to be as transparent as we can on the tax front as we're still working through all those changes.

As far as the growth goes, yeah, I think we can continue to grow. If you look at the 10% growth that we had in Q2, I'd say about 3.5 points of that was tailwind from FX. We had a couple of points of tailwind from the compares with Nimble and SimpliVity and then we had 4.5 points of execution. I think it's really a combination because I do think our go to market motion is working better. I do think our geo-model we pivoted to this year is working very well, but we also have better markets. We have strong customer demand. We have a better pricing environment. So, that plays into it as well.

As I look forward into the second half, rates have moved a little bit unfavorably for us. If those rates hold, we would get less of a tailwind. We obviously lose the favorable compares. The other point I would make out is we're doing about half of the tier one business in the second half of the year that we did versus the first half. That's about 2.5 points of headwind, no margin impact, and then we have tougher compares overall. I think moving forward, we can certainly grow, but it's obviously not going to be at that 10% rate given the reason they just laid out.

Antonio Neri -- President and Chief Executive Officer

Antonio, I want to add a couple of things here -- one is if you go back to where we guided, we said zero to 1% growth. It's obvious we're going to grow faster than that for the year. I think that's one area. The second is we are very, very confident in our portfolio. I think as we continue to contribute from volume to value, we will see also an improvement there because the growth areas we see are hyper-converged in areas like private cloud, high-performance compute and so forth. We believe this company absolutely can grow and definitely this year will be above the guidance we give you for the full year.

Katie Huberty -- Morgan Stanley -- Managing Director

Thank you.

Andrew Simanek -- Head of Investor Relations 

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

Operator

Our next questioner today will be Tony Sacconaghi with Bernstein. Please go ahead.

Toni Sacconaghi -- Bernstein -- Analyst

Thank you. You provided an update on HPE Next and some of the accomplishments so far. I think the target was to try and deliver $250 million in net savings this year and $800 million over the next three years. Could you provide an update on where you think you are in terms of the savings capture rate so far this year and whether we should still be thinking about a $250 million savings for the year? I have a follow up, please.

Antonio Neri -- President and Chief Executive Officer

Sure, Toni, thanks for the question. We are confident we are on track to deliver $250 million for the years. Now, just as a reminder, HP Next is the initiative I launched to rearchitect the company to deliver on our vision or strategy. Our goal with this was all about simplification, innovation, and execution. We have made good progress on many fronts.

One is the operating model simplification in the go to market is paying off in terms of not just the savings but actually improve the execution. Second we have reduced already quite significantly a number of platforms and options which translates in lower amounts of skills to our customers and partners, which allows us to better plan and execute in our supply chain.

Then third is the culture of the company as well. So, from my standpoint, we are on track with what we said we're going to do. To me, this is going to be the competitive advantage that Hewlett-Packard Enterprise will have going forward. For me, this is not just a way to return shareholder value, but really to improve the way we execute our business every single day. The reality is the market is moving really fast. They need to react to those opportunities quickly. Have a lean, mean, end to end value chain is absolutely essential.

So, now, we're going to enter the second phase of this, which is the transformation in the processes in IT modernization, which actually will give us the incremental step forward on executing even better and more simply in front of the market opportunity. Tim, do you want to add anything?

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

No, I think you nailed it.

Toni Sacconaghi -- Bernstein -- Analyst

So, the follow-up -- it still looks like if we believe Pointnext has about 30% operating margins, which is historically where it's been, it still looks like operating margins on servers, storage, and the data center networking is in the 1% to 2% range right now. That probably suggests that server margins are negative still.

How should investors just think about what a normalized margin for these businesses are or has the whole server market moved to a market where we shouldn't be thinking about it that way and that we're really looking at a blended margin between support and servers are really becoming the vehicle to selling high margin support and we shouldn't be thinking about discreet profitability for each of those.

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

Thanks for the question, Toni. I would say this -- I think your math is correct. You're in the low single-digit range for the hardware businesses. I'm not really going to comment about where those are going, but I'll give you color. If you look at our overall margin of 8.6%, as we've talked about all year, we do think that continues to improve over the course of the year and that's really a combination of the increased cost savings from HPE Next. That's a combination of the acquisitions as they become more and more accretive as continue to grow those businesses and right size those cost envelopes.

Then to Antonio's point, as we continue to pivot toward the value portion of our portfolio, where we have higher margins and higher attached, that obviously gives us some rate lift as well. We'd expect those to continue through the course of a year on a normalized, if you will, basis, two or three years down the road, I think a couple calls ago, there's a couple hundred points of improvement and I still think that's true because even as we exit '18, we're still going to have HPE Next savings and we'll continue to pivot toward the value portion of the portfolio.

Antonio Neri -- President and Chief Executive Officer

The other thing I would add, Toni, if you look at our Q2 performance, we improved our Hybrid IT margins by 20 basis points in that business. And obviously, like I said before, the Russianization of platforms and options give us improved profitability on the hardware side.

It is obviously that obviously a big chunk of our profitability comes from services, but let's remind ourselves that profitability and service business is not just attached. It's what we call services led opportunities and we pivot that portfolio quite significant in the last two to three years and we see now the momentum and the way customers want to consume a more subscription-based model.

That's why things like HP GreenLake as well. But to Tim's point, we will continue to drive that rigor and discipline and our cost structure and ultimately the simpler we innovate in our portfolio, the easier it is to go sell it to improve the pull through for services and as well for the rest of the HP portfolio.

Andrew Simanek -- Head of Investor Relations 

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

Operator

The next question will be Simon Leopold with Raymond James. Please go ahead.

Victor Chu -- Raymond James -- Analyst

Hey, guys. This is Victor Chu in for Simon Leopold. I wanted to ask about free cashflow. It seems like FCS seems like it will have quite a sharp step up in the back half of the year to get to your $1 billion target. I was hoping you would give us more color around that, what parts of working capital are you expecting to drive the cash conversion in the second half of the year.

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

Sure. We're still confident with $1 billion for Fiscal Year 18. Q2 came in at -$269 million, which to be honest with you, was lighter than we expected. I think on the last call, I said Q2 would be flattish. We had a higher mix of one-time payments and unfavorable movements that was rated to the VAT taxes. So, those are more timing than anything else.

As you know in this business, free cashflow is very seasonal. If you look at the last couple of years, we typically have negative free cashflow in the first half of the year and then we generate a significant amount in the second half of the year and I don't think 2018 is going to be any different.

It's really driven by four things. First of all, you can look at the earnings ramp. That's reflected in our EPS guide. That's a combination of HPE Next savings as well as typically seasonality so that will obviously generate more free cash flow. From working capital perspective, we actually had a cash usage in the first half of the year, we're going to generate cash in the second half of the year I think the indicator to look at there is our cash conversion cycle. As we said in the prepared remarks, we'd expect that to end in the negative high-20 day range. We expected that to be very consistent with where we exited Q4 of 17 and that generates a significant amount of cash.

Other assets and liabilities -- we had some unfavourability in the first half, I would expect that to come back in the second half. Nothing has structurally changed when you think about the balance sheet. I'll go back to the VAT examples we should be collecting on those receivables in the second half of the year.

Then lastly, we're going to have fewer one time payments. If you look at the SAM presentation that we laid out, we had about $1.1 billion of one-time cash payments, roughly $800 million of that has been taken care of in the first half of the year, so that provides us a tailwind in the back half of the year and then we will have, to your point, we will have some real estate gains in the second half of the year. There's a lot of moving parts and free cashflow. That's why it's very difficult to forecast on a quarter basis, but given those comments, we feel really good about the dollars for Fiscal Year 18.

Victor Chu -- Raymond James -- Analyst

Thank you. That's very helpful.

Andrew Simanek -- Head of Investor Relations 

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

Operator

Our next questioner today will be Shannon Cross with Cross Research.

Shannon Cross -- Cross Research -- Analyst

My question is with regard to AI -- I'm just curious how you see some of the new offerings you've launched and some of the new acquisitions fitting into this, particularly I'm curious as to how you're going to monetize them because everybody talk about AI and what it's going to do to the industry, but I'm wondering how it helps you from a competitive standpoint over time. And I have a follow up.

Antonio Neri -- President and Chief Executive Officer

Sure. Thank you for the question. I'm actually very excited about AI. We see this every day. I spend 50% talking to customers. It's kind of interesting because what they're looking for is to monetize that data faster and trying to understand they should be doing with that data from the business perspective. So, AI gives you that vehicle to accelerate outcomes from the data standpoint. We already have very strong offerings both in memory solutions -- think about our Superdome X and as well at HP Apollo 6500, which is an AI-designed platform.

How we monetize is very simple. We provide services upfront, which is basically the advisory capability, how to implement AI in their environment and number two, how we design and implement the right solution for them and we already have many, many platforms with AI embedded in terms of it in terms of solution development kits their data scientist using whatever tools they want, whether it's cloud data or whatever it is.

So, this is a good opportunity for us and also, we are using AI inside our portfolio. So, we talk about the future of hybrid IT being adaptive. We are delivering AI technologies inside our own software defined infrastructure. An example that, obviously, is Info site, but you're going to see more and more of that embedded at the edge as well as our cloud orchestration capabilities.

Shannon Cross -- Cross Research -- Analyst

Tim, can you talk a bit about how we should think about the model changing as you move to flexible capacity or flexible consumption models over time. We sat in software obviously to SaaS and now we're seeing these two devices that service over time. Thanks.

Antonio Neri -- President and Chief Executive Officer

I think you're asking the question from the business model perspective or the financial perspective? If it's financial, I will ask Tim here to comment. What we see is customers like the ability to consume on prem in a utility-based model. What that means is they want a full integrated solution with the hardware or infrastructure they need, with the software or services to run it the most efficient way. In many ways, we talk about how we bring that public cloud experience and economics on prem and that experience includes the consumption-based model. Depending on the scale, we can provide the customers a very competitive solution on premises. It's not just infrastructure as a service but also outcome as a service. Think about back half recovery as a service, SAP HANA as a service and so on. We already have those available and we see a significant interest and significant uptick in service.

From the financial side, we have crafted what I think is a very strong and simple solutions for our customers leveraging our financial portfolio which provide that embedded financing but is a services-led organization and the way we've finally treated them is no different than any subscription-based model. Tim, maybe you want to comment on that.

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

Over time, it will improve our recurring revenue and will also improve our profitability.

Andrew Simanek -- Head of Investor Relations 

Thank you, Shannon. Can we move on to the next question?

Operator

The next questioner will be Jim Suva with Citigroup. Please go ahead.

Jim Suva -- Citigroup -- Analyst

Thank you very much and good job on the results and execution. I have a question on the Hybrid IT reporting segment, specifically the Pointnext or the service revenues. If I do the math correctly, that is up about 1% year over year with currency down 1% year over year. Why would revenues for Pointnext be down year over year when overall your company results are so strong or how do we bridge the gap between those differences?

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

I think that's a factor of the contracts rolling off and given the fact that a lot of these are three-year contracts, you have some timing from a translation and effects perspective.

Jim Suva -- Citigroup -- Analyst

Okay. So, should we expect Pointnext to be challenged with the timing of context rolling of?

Antonio Neri -- President and Chief Executive Officer

No. When we book the orders, we book it as whatever the currency was at the time, but at the same time, we are booking our orders with what I call more favorable currency. The mix of this is going to dictate what the outcome is but we're still confident that we will continue to drive the growth in this portfolio driven by these new offerings. That's why we are very keen to continue to drive that consumption-based model that Shannon asked the question for because that has grown significantly faster than what we are poting here as w hole segment.

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

I would say another thing to look at is services intensity. So, service intensity was up 35% in Q2 so we continue to have more attached dollars per units.

Jim Suva -- Citigroup -- Analyst

Thank you so much for the clarification and detail.

Andrew Simanek -- Head of Investor Relations 

Can we move on to the next question please?

Operator

The next question will be Steve Milunovich with UBS. Please go ahead.

Steve Milunovich -- UBS -- Managing Director

Thank you. First of all, on the tax rate for Fiscal 19 I think you said the tax rate would go up this year. We were thinking maybe 18% but does that come down a couple points now?

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

We'll give you guys more color at SAM because we're still working through the impact in Fiscal Year 18. To your point, the last year we guided, we said 16% to 20%, so you're right in the middle there. I'm not going to give you the guidance here for 19 but we'll give you full transparency in October at SAM.

Steve Milunovich -- UBS -- Managing Director

I wonder if you can elaborate more on your on the trends you're seeing? Is Azure stack out there and some volume? How's your Microsoft relationship? I think you actually need new servers if an account were to use Azure with yoyr products and talk with your software offerings. I think you have some fairly good orchestration software.

Antonio Neri -- President and Chief Executive Officer

Sure. Thanks for the question. We see good traction in the private cloud segment. We offer a multi-cloud type of solution. Obviously, we have the VMware. We have now a very strong integration between the VMware stack and our HP Synergy. We see significant traction of Synergy with VMware in particular segments like the financial sector, where they need large deployments of large VM farms that ultimately they can manage a significant amount of workload.

The other one is Azure Stack. It's still a little bit early, but we see good promise. We have done slightly different implementation on that because we have better engineering integration and we already provide different types of solution, whether it's HP reliant or what is now with availability of HP SimpliVity as well with a hyper-based solution.

And by the way, with our offering of HP OneSphere, we also provide OpenStack and Coupa environment for all those customers who want to absolutely raid deployment of containers. In the end, we have platform called HP OneView that manages any type of infrastructure, whether it is a traditional tier three approach, converge, hyper converge and composable and now with the inclusion of Plexxi, which we announced that last week, we're actually now virtualizing the network fully integrated natively.

And then with HP OneSphere, we provide it through cloud in a hybrid IT environment where you deployed a container or even an open source type of solution. We see the traction across them and we wrap all of that with our consumption based model. We talk about HP GreenLake and that's where the customers are very interested to work with us.

Andrew Simanek -- Head of Investor Relations 

Thanks, Steve. Can we go to the next question, please?

Operator

Our next question with be Amanda Bruja with Loop Capital. Please go ahead.

Ananda Bruja -- Loop Capital -- Analyst

Thanks for taking the question. Two if I could and I'll ask them at the same time -- the first is with regards to long-term competitive advantages, it makes sense how it improves your processes and your get to market, could you speak specifically to what you see as some of the competitive advantages relative to the marketplace and your competition. The second question, I believe there was a comment, the second half will be more challenging. I was wondering if you could tease out what some of the challenges you see in the second half. Thanks.

Antonio Neri -- President and Chief Executive Officer

Sure. As I said before, we truly believe. I believe that HP Next will be a competitive differentiator for us because one of the drivers we see in this industry is the ability to provide an integrative experience. With the hard work we have done over the last six and a half years and position of Hewlett-Packard Enterprise clearly in this space where we can compete and win, we have the opportunity to deliver a whole integrated new experience.

It is the opportunity of a lifetime. I've been at the company for 23 years. Unfortunately, I know every system, every process for good or bad and I know we have tremendous upside, not only to improve our cost structure, but really improve our growth through better execution once we have this integrated experience.

Let me give an example of that. Now we're going to have a simple, much better integrated experience with configurations. We're going to have a low touch model for more of the transactional side, particularly as you think about the midmarket and SMB. We're going to have a streamline platform for the supply chain, which actually improves not just quote to cash, but the finance side of the execution, but all of this translates into value for our customers and for our shareholders because obviously, we're allowed to make everything we can in that execution.

From the growth standpoint, again, like I said before, we are confident we will beat our guidance we give as them, which was zero to 1%, but obviously we're going to have tougher compares. The currency is not going to be as strong as its tailwind. We have the acquisition now in the full run rate. I'm very confident in our organic growth because our portfolio is very, very strong. It's going to come down to how well we are going to execute and we are executing better and where we see the opportunity in terms of balancing growth with the profitability which we just increased again on EPS.

Ananda Bruja -- Loop Capital -- Analyst

Both of those are very helpful. Thanks so much.

Andrew Simanek -- Head of Investor Relations 

I think we have time for one more question.

Operator

That question will be from Aaron Rakers with Wells Fargo. Please go ahead.

Aaron Rakers -- Wells Fargo -- Analyst

Thank you. I do have a follow-up as well. I want to go back to Tony's earlier progression with regard to your savings you expect to generate from HP Next. I'm curious how much have you realized of the $250 million thus far in the first half of the year and if you look at some of the progress of things you're going to execute on, going to one ERP system versus ten, 400 sales comp plans down to 25, etc., I'm just curious can you help us understand what has been done and what you're planning to execute on in the second half. Then I have a follow-up.

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

I'll answer the financial component then flip it to Fabio. If you look at the $250 million, I would say that a third of that is in the first half and two-thirds will be coming in the back-half of the year. As Antonio mentioned, we are on track to deliver that.

Antonio Neri -- President and Chief Executive Officer

In terms of what has been done, we already initiated the platform simplification. We said 26 platforms down to seven on the Volume side and 27 down to 9, so we are well on on our way. We are not completely done on that but well on our way. In terms of the manufacturing side, we have not yet initiated the full transition.

So, in the back half of this year, particularly in the latter part of the year, we're going to implement the new SAP instance and with that foundation with a common data master, we're going to move to the simplification of our supply chain in number of notes, which the vast majority is going to happen in 2019.

In terms of our core plans, we executed much of that, we executed 2019 in terms of sales plans, which also is one of the reason we are executing better because you're telling the sellers exactly where to focus and how they're going to get paid and that's a motivator in many ways and that's why we have better execution.

Very confident where we are today, but there's still a significant amount of work to be done. It is a journey to be laid out for the next three years and much of this will be dependent on the IT transformation driving, particularly on the low touch, no touch, which is going to come in the latter part of 2018 and that will improve our execution or go to market in the latter part as we continue to pivot from volume to volume growth.

Aaron Rakers -- Wells Fargo -- Analyst

That's very helpful and maybe this is somewhat tied to the follow up -- as I look at the cash conversion cycle, one thing that stands out is you had 40% year over year in your inventory carried on the balance sheet on this last quarter. Is there strategic purchases being made in the inventory are you holding more than given these initiatives or what's really driving that increase on the inventory side?

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

It's a little bit of both. We were carrying some excess buffer stock to make sure we had enough inventory to meet customer demand and then you have to remember we have elevated ERAM costs as well. So, that has significant impact.

Aaron Rakers -- Wells Fargo -- Analyst

Thank you very much.

Andrew Simanek -- Head of Investor Relations 

Thank you, Aaron. Thanks everyone for joining us today. With that, we can close out the call.

Operator

Ladies and gentlemen, this will conclude our call for today. Thank you for attending.

Duration: 56 minutes

Call participants:

Andrew Simanek -- Head of Investor Relations 

Antonio Neri -- President and Chief Executive Officer

Tim Stonesifer -- Executive Vice President and Chief Financial Officer

Sherri Scribner -- Deutsche Bank -- Analyst

Katie Huberty -- Morgan Stanley -- Managing Director

Toni Sacconaghi -- Bernstein -- Analyst

Victor Chu -- Raymond James -- Analyst

Shannon Cross -- Cross Research -- Analyst

Jim Suva -- Citigroup -- Analyst

Steve Milunovich -- UBS -- Managing Director

Ananda Bruja -- Loop Capital -- Analyst

Aaron Rakers -- Wells Fargo -- Analyst

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