Yahoo Finance Hewlett Packard Enterprise Company (NYSE:HPE) Q1 2024 Earnings Call Transcript
Hewlett Packard Enterprise Company (NYSE:HPE) Q1 2024 Earnings Call Transcript February 29, 2024
Hewlett Packard Enterprise Company beats earnings expectations. Reported EPS is $0.48, expectations were $0.45. Hewlett Packard Enterprise Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon, and welcome to the First Quarter Fiscal 2024 Hewlett Packard Enterprise Earnings Conference Call. My name is Gary, and I'll be your conference moderator for today's call. At this time, all participants will be in listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Shannon Cross, Senior Vice President and Chief Strategy Officer and Investor Relations. Please proceed.
Shannon Cross: Good afternoon. I'd like to welcome you to our fiscal 2024 first quarter earnings conference call with Antonio Neri, HPE's President and Chief Executive Officer; and Marie Myers, HPE's Chief Financial Officer. After 25 years on Wall Street and over 20 years covering HP, I'm very excited to join HPE as Chief Strategy Officer. I look forward to working with Jeff Kvaal and the rest of the IR team, and I look forward to seeing many of you in the months ahead. Before handing the call to Antonio, let me remind you that this call is being webcast. A replay of the webcast will be available shortly after the call concludes. We have posted the press release and the slide presentation accompanying the release on our HPE Investor Relations web page.
Elements of the financial information referenced on this call are forward-looking and are based on our best view of the world and our businesses as we see them today. HPE assumes no obligation and does not intend to update any such forward-looking statements. We also note that the financial information discussed on this call reflects estimates based on information available at this time and could differ materially from the amounts ultimately reported in HPE's quarterly report on Form 10-Q for the fiscal quarter ended January 31, 2024. For a more detailed information, please see the disclaimers on the earnings materials relating to forward-looking statements that involve risks, uncertainties and assumptions. Please refer to HPE's filings with the SEC for a discussion of these risks.
For financial information we have expressed on a non-GAAP basis, we have provided reconciliations to the comparable GAAP information on our website. Please refer to the tables and slide presentation accompanying today's earnings release on our website for details. Throughout this conference call, all revenue growth rates, unless otherwise noted, are presented on a year-over-year basis and adjusted to exclude the impact of currency. Finally, Antonio and Marie will reference our earnings presentation and their prepared comments. Before handing the call to Antonio, let me remind you that this call is being webcast. A replay of the webcast will be available shortly after the call concludes. We have posted the press release and the slide presentation accompanying the release on our HPE Investor Relations web page.
With that, let me turn it over to Antonio.
Antonio Neri : Thank you, Shannon. Good afternoon, and thank you for joining us today. In the first quarter, we are proud to have outpaced our profitability expectations while advancing our long-term strategy. We also continue to scale our recurring revenue, achieving the second highest year-over-year growth rate since we started tracking ARR in late 2019. This is a promising indicator for our ongoing portfolio shift to higher-margin revenues. But overall, Q1 revenue performance did not meet our expectations. During this call, I will address three key points. First, I will touch on our revenue, which was lower than expected in large part because network and demand softened industry-wide and because the timing of several large GPU acceptances shifted.
Additionally, we did not have the GPU supply we wanted, curtailing our revenue upside. Second, I will address how we are streamlining our reporting segments, accelerating a new specialized sales model, managing our spending and reinforcing execution discipline. Third and most importantly, I will discuss the progress we're making in executing our long-term strategy, which we remain confident in. Let me first address revenue in the quarter. Similar to peers in the market, we saw campus networking product demand weakened and the decline later in the quarter was greater than expected. This was a large headwind relative to our expectations. Customers are taking longer to digest prior orders than we had anticipated, which partially offset the benefit of our backlog entering the quarter.
And Europe and Asia were areas of relative softness. We expect weakness in the networking market to persist, which is likely to impact revenue through fiscal year 2024. That said, we anticipate some improvement late in fiscal year 2024 as inventory clears and we ramp into the purchasing season for state and local education customers in the United States. AI server demand remains very strong, evidenced by our growing cumulative order book. However, GPU availability remains tight, and our delivery timing has also been affected by the increasing length of time customers require to set up the data center space, power and cooling requirements needed to run these systems. As a result, overall AI server orders conversion was below our expectations.
However, the AI contribution to ARR is increasing. We continue to prioritize profitability. I am pleased that we have delivered non-GAAP gross margin of 36.2%, which is up 200 basis points year-over-year and above 600 basis points from fiscal year 2018. This performance helped our Q1 non-GAAP diluted net earnings per share grow to $0.48, which was above the midpoint of our guidance range despite lower-than-expected revenue, illustrating the positive impact of our pivot to higher growth, higher margin revenue. We know that the current environment will require continued discipline in how we execute. We are accelerating new specialized sales motions to maximize opportunities and improve order linearity across our portfolio. Improved cost management will remain an important competency for us in fiscal year 2024.
We also found opportunity to streamline our reporting segments. We have now combined the Compute and HPC and AI segments into a single server segment that integrates general-purpose computing, high-performance computing, supercomputing, and AI systems. This will enable us to maximize the opportunities across the entire AI life cycle, from training to tuning to inferencing and execute with agility. And as previously discussed, we have simplified our hybrid cloud strategy by putting all related products, software and services into one business unit. Our new hybrid cloud segment will further accelerate customer adoption of the HPE GreenLake hybrid cloud platform. Turning to our strategy. While we are experiencing cyclicality in submarkets, I am more confident than ever in our long-term strategy that is aligned to key market mega trends.
In edge, over the last several quarters, we have gained share in the campus networking markets and our strategic investments have played off. Most recently, we have seen strong growth in SASE, an offering bolstered by our acquisition of Silver Peak in 2020 and Axis Security in 2023. Our sales pipeline for our private 5G offering is also growing rapidly, following our acquisition of Athonet in 2023. In hybrid cloud, HPE GreenLake continues to resonate in the marketplace and was the private driver of the highest Q1 year-over-year rise in ARR over the 4-plus years we have been reporting it. Our ARR grew 41% year-over-year to more than $1.4 billion in Q1, and we continue to expect ARR growth of 35% to 45% as we look ahead. We're also capitalizing on cross-selling opportunities when customers come to us for our AI solutions and realize we can meet their storage needs as well.
In AI, we are capturing the explosion in demand for AI systems. Our cumulative accelerator processing unit orders rose to $4 billion in the quarter, driven by demand across HPE Cray EX and XT solutions, as well as HPE ProLiant Gen11 AI-optimized servers. AP orders represent nearly 25% of our total server orders since the first quarter of fiscal 2023. Our pipeline is large and growing across the entire AI life cycle from training to tuning to inferencing. We are starting to see AI demand pull-through for other solutions, including storage. We expect our server and hybrid cloud segments to grow sequentially through the fiscal year. Server revenue stands to benefit from AI system demand, improving GPU supply, and our continued mix shift to HPE ProLiant Gen11.
Hybrid cloud will benefit from continued HPE GreenLake storage demand and the rising productivity of our specialized sales force. Our customers continue to validate our value proposition. As one example, we are building for A&E, one of the world's largest energy providers, a new HPE Cray EX supercomputer that will reach more than half an exaflop performance. The system will be one of the most powerful in the world for enterprise use and will accelerate AI-driven scientific discovery to advance efforts in energy. We also have been awarded the deal for Poland's most powerful supercomputer system located at the Academic Computer Center Cipher Net of the AGH University of Science and Technology. Based on the HPE Cray EX supercomputer and HPE Slingshot Interconnect Fabric with NVIDIA Grace Hopper GPUs, the system will be used to support modeling simulation and AI-driven scientific research needs, including training and tuning of large language models.
We're also seeing growth in AI inferencing. For example, Coles Supermarkets, a leading Australian retailer, implemented an HPE ProLiant Gen11 AI inferencing solution in Q1, which helps with video imaging to reduce store stock lost to theft and scanning at the checkout. In the quarter, we expanded our strategic collaboration with NVIDIA targeting the enterprise segment of the market. We introduced a preconfigured solution for enterprise customers to fine-tune AI large language models with their private data to accelerate inferencing. Our HPE machine learning development environment software and unique HPE supercomputer and IP are critical parts of the solution, alongside NVIDIA AI enterprise software. We have built a strong and growing sales pipeline for this new offering.
We also continue to build out our HPE GreenLake hybrid cloud platform services. Earlier this quarter, we announced an expanded HPE GreenLake for file storage that is designed for generative AI. This solution is highly differentiated through a high-performant file system solution specifically designed for AI applications. We believe it better positions us to take market share in storage by addressing the previously underserved segment of the file market. Innovation like this continue to attract customers to HPE GreenLake platform, which connects 3.8 million network devices and supports more than 31,000 customer organizations, up approximately 8% from last quarter. One new HPE GreenLake customer is the U.S. Navy Fleet Numerical Meteorology and Oceanography Center, which produces critical models of weather and ocean conditions for the U.S. and coalition forces worldwide.
They turned to HPE GreenLake to improve predictability, accuracy and speed of their modeling while reducing costs. This week, I attended the Mobile World Congress where AI and private 5G were the key topics among telcos and service providers alike. With our pending acquisition of Juniper Networks, HPE's portfolio will expand to better serve these unique customers from the edge of the network to core 5G to cloud. Customers were very interested in our integration of Athonet private 5G capabilities into our Intelligent Edge portfolio as well as in our cloud OpenRAN and VRAN solutions. They were also very eager to explore the massive new market opportunity AI inferencing presents at the edge of the network. That is one of the reasons why we're so excited about our pending Juniper Networks acquisition.
Combining our complementary portfolios will supercharge HPE's edge-to-cloud strategy, accelerating our entire portfolio with AI-enabled innovation. When our proposed acquisition closes, we will create a new networking innovator, with our comprehensive portfolio for and partners. The transaction is expected to double the size of our networking business, which will be the core foundation of covering the anticipated $180 billion market opportunity with our combined IP. From a financial perspective, this transaction is also compelling for our shareholders. In the first year post close, we expect accretion to non-GAAP earnings per share and, in the long term, higher non-GAAP gross and operating margins. We are working to secure regulatory approvals in several jurisdictions.
We are hopeful that regulators will recognize that this acquisition is centered around driving further innovation for our customers. We continue to expect that the transaction will close later this calendar year or in early calendar 2025. In summary, Q1 2024 was a mixed quarter for HPE. We achieved strong profitability and drove new record ARR growth with overall revenue short-term expectations, given the softening networking market, GPU deal timing and, to some extent, GPU availability. We are focused on execution as we navigate the fluctuations demand we see in certain areas of the market. Marie will take you through our adjusted guidance, which reflects our latest thinking about the year ahead. This quarter is a moment in time and does not at all dampen our confidence in the future ahead of us.
We have taken the right actions to maximize value for our shareholders. The work we are doing now, combined with our technological edge and our strategy that has never been more relevant, will position us to convert on the long-term opportunities in front of us across edge, hybrid cloud, and AI. Before we transition, I'm delighted to welcome Marie Myers as our new CFO. Having worked with her at HP before the separation, it is a pleasure to partner with her again. I am passion for and skill ad, fueling innovation and performance. I am confident that Marie is a great fit for this role and expect she will help drive the next phase of growth and shareholder return for HPE. I will now turn the call over to her for details about our segments and our outlook.
Marie?
Marie Myers : Thank you, Antonio. I'm pleased to be with you today on my first earnings call as HPE's CFO. I've long admired HPE's impressive transformation, and there has never been a more exciting time to be part of this company. We have a growing addressable market, a proven strategy and a differentiated portfolio that is levered to long-term market trends around networking, hybrid cloud and AI. I believe we have a significant opportunity ahead of us. I'm excited to partner with Antonio and the rest of the outstanding HPE team to capitalize on this opportunity and drive value for our shareholders. And as Antonio mentioned, we have much to be proud of. Financial highlights in the quarter included record gross margins and expense discipline, which helped lift non-GAAP EPS to the high end of our guidance range.
Demand for our traditional server and storage products has stabilized. Demand for our HPE GreenLake offerings was evident in a healthy ARR growth and demand for our AI systems remains robust. However, demand in Intelligent Edge did soften due to customer digestion of strong product shipments in fiscal year '23, which is lasting longer than we initially anticipated and is the primary reason Q1 revenue came in below our expectations. GPU availability and deal timing also contributed. We are taking swift action to address these headwinds by curtailing costs and driving efficiencies across the business. With that, let's take a closer look at the details of the quarter. Revenue fell 14% year-over-year in constant currency to $6.8 billion. Please recall, we had significant backlog consumption in Q1 '23, particularly in traditional servers and storage.
Backlog has now largely normalized across our business with the exception of our APU products. We have strong momentum in HPE GreenLake. ARR exceeded $1.4 billion in Q1. Storage and networking software and services are the fastest growth elements of ARR. Our software and services mix rose 400 basis points year-over-year to 69%. ARR is the best indicator of our model transformation to our as-a-service offerings. This growth validates what our customers are telling us, that HPE GreenLake is a differentiated value proposition in the market. Our Q1 non-GAAP gross margin was 36.2%. It rose 200 basis points year-over-year, driven by a mix shift to Intelligent Edge and favorable input cost management. We are pleased that our non-GAAP gross margin is up 600 basis points from fiscal year '18 to a company record.
This illustrates the ongoing pivot to higher growth, higher margin revenue across our portfolio. Given the current networking market dynamics, we are taking this moment to streamline and simplify our operations. We are focused on controlling the things we can control. Prudent cost management and disciplined execution are important regardless of the macro environment and are even more critical at times like these. The benefits of our focus are already evident in our Q1 non-GAAP operating expenses, which declined 4.7% year-over-year at 9.5% sequentially to $1.7 billion. The strong Q1 non-GAAP gross margins and OpEx discipline led to Q1 non-GAAP operating margins of 11.5%, which is down only 30 basis points year-over-year despite less revenue scale.
Favorable timing on some corporate expenses was a tailwind to Q1 operating expense and will appear in Q2. GAAP EPS of $0.29 and non-GAAP EPS of $0.48 exceeded the midpoint of our guidance range. Our diluted share count was approximately 1.3 billion, and non-GAAP diluted net earnings per share exclude $251 million in costs primarily from stock-based compensation expense, amortization of intangibles and noncash loss on investments. As we manage the business with focus and discipline, we will also invest to capitalize on the sizable opportunities associated with moving through the interrelated inflection points in networking, hybrid cloud, and AI all at the same time. HPE is evolving into a more simple, more agile company that is even better positioned to pursue our growth opportunities and to evolve our mix of products, services and software and to drive structural higher profitability.
Turning to our segment results. In addition to the new segments we discussed at SAM, we also created a new service segment that combines our prior compute and HPC and AI segment under one streamlined segment that offers solutions for our customers' training, tuning, and inferencing AI needs across the AI life cycle. Server revenues were $3.4 billion in the quarter, which was down 23% year-over-year. This new segment had a difficult year-over-year compare as in Q1 '23, the business made significant progress against its backlog and benefit from HPE Cray EX revenue for Frontier. We are capturing the robust growth in AI demand. Our cumulative APU orders since Q1 '23, which include APU attached products and services in our HPE Cray EX XD and ProLiant Systems, rose approximately sequentially to now $4 billion.
Our pipeline is robust and GPU supply, while still constrained, is improving. Our APU product revenue increased sequentially to well over $400 million. We are now converting our APU orders into revenues, and yet very strong demand means our APU backlog is over $3 billion. Our pipeline is well above that. AI revenue in the quarter included our first revenues from AI cloud offering and from our HPE GreenLake win with a large hyperscale customer. Our traditional high-performance computing and supercomputing revenue fell seasonally, sequentially following a strong Q4. Revenue from our traditional server business increased sequentially. We expect this trend to continue, given a structural mix shift to higher AUP Gen11 and rising input costs. General servers nearly doubled sequentially to 30% of the mix in Q1.
Including HPE, Cray XD takes the mix of next-generation servers to 44%. We are encouraged that our Gen11 pipeline is starting to include AI inferencing activity and enterprise applications. We expect AI inferencing to gather momentum in fiscal year '24. As a reminder, our Gen11 services come with an attached subscription to our compute ops management software, which lifts our margin structure. Our Q1 operating margin was 11.4%. While up sequentially, the margin was down 430 basis points year-over-year, given declining revenues. Intelligent Edge revenues were $1.2 billion or up 2% year-over-year. Demand for our campus switching and Wi-Fi products eased materially, particularly in Europe and Asia, and was the largest contributor to our Q1 revenue gap.
We continue to see mid-single-digit growth benefits from our existing backlog but expect it to normalize going forward as we are now approaching our typical range. Our total channel inventory is within the normal range overall, inclusive of a pocket in the SMB business. We also continue to make progress in our new TAMs of data center networking, private 5G and SASE. The Intelligent Edge portfolio of subscription revenue grew well above 50% as we are benefiting from growing attach from our strong fiscal year '23 revenue growth. We are pleased with our 29.4% operating margin, which was up 1,000 basis points year-over-year. The new hybrid cloud segment includes our storage businesses and now the HPE GreenLake portion of our server business. Revenues of $1.2 billion were down 10% year-over-year.
Our traditional storage business was down year-over-year on difficult compares, given backlog consumption in Q1 '23. Total Electro subscription revenue grew over 100% year-over-year and is an illustration of our long-term transition to an as-a-service model across our businesses. We are starting to see AI server demand pull through interest in our file storage portfolio. We are also already seeing some cross-selling benefits of integrating the majority of our HPE GreenLake offering into a single business unit. Our operating margin was 3.8%, which was down 200 basis points year-over-year. Lower revenues and a high mix of third-party product impacted margins in the traditional storage business. Our HPE Financial Services revenue was down 2% year-over-year and financing volume was $1.4 billion.
Our operating margin of 8.5% was up 130 basis points year-over-year. We are successfully passing through interest rate increases, and our asset management margins are returning to normal. Our Q1 loss ratio remained steady at 0.5%. Turning now to cash flow and capital allocation. We generated $64 million in cash flow from operations and consumed $482 million in free cash flow this quarter. HPE typically consumes cash in the first half of the year and generates cash in the second half. Our first quarter free cash flow benefited from some prepayments associated with pending HPE GreenLake deals at HPE Cray XD shipments. Our cash conversion cycle was seven days, which is a reduction of eight days from Q1 '23. Our days payable and days of inventory were both higher, given the lower revenue and strong demand for APUs. We returned $172 million in capital to shareholders in Q1, primarily through our dividend.
Before I discuss our outlook, let me first recap the key drivers that factor into our expectations for Q2 and the full year. For server, we expect improving GPU supply to drive sequential revenue increases through fiscal year '24. Given improving supply and the timing of installations, we expect segment revenue and therefore, corporate revenue to be heavily weighted to the second half of the year. We expect the blended margin of the new segment to be flattish for the remainder of the fiscal year. For Intelligent Edge, we expect the market to remain soft throughout the year. Our cost reduction efforts will take time to show their benefits, which will result in margin pressure in Q2. Later in our fiscal year, we expect our normal channel inventory position and seasonal strength in the education market to be a modest revenue tailwind.
We expect the full year margin to be in the mid-20% range. For hybrid cloud, we expect sequential increases through the year as our traditional storage business improves and HPE GreenLake momentum continues. We expect meaningful progress through the year. With that context, let me turn to our outlook. For Q2, we expect revenues in the range of $6.6 billion to $7 billion or up slightly sequentially at the midpoint. We expect GAAP diluted net EPS to be between $0.20 and $0.25 and our non-GAAP diluted net EPS between $0.36 and $0.41. In part, given the higher prepayments in Q1, we expect negative free cash flow in Q2. Let me remind you that we have two drivers of potential lumpiness in our business. One is the timing and customer acceptances of large Cray wins, including Cray XD wins, which should ramp beginning in Q2.
The second is the start of certain large HPE GreenLake deals. For some of these large deals, our segments recognize the related hardware on installation. In our consolidated results, we eliminate the segment revenue and recognize it over time. Both large deals and higher eliminations are indicators of our confidence in the second half of the fiscal year. For fiscal year '24, we are revising our outlook, primarily given the current networking market headwinds. Let me remind you that we are excluding the H3C earnings and gain on sale from our non-GAAP results beginning in fiscal year '24. We now expect revised ranges for constant currency revenue and non-GAAP operating profit growth of zero to 2%. GAAP diluted net EPS of $1.81 to $1.91 and non-GAAP diluted net EPS of $1.82 to $1.92.
The mix shift from Intelligent Edge to server should also weigh on our gross margins. We now expect the full year non-GAAP gross margin to be slightly down from our prior full year expectation of 35%. We expect the impact of the cost actions we have initiated to materialize in the second half and leave fiscal year '24 OpEx to be flat to down from fiscal '23 OpEx. We expect our operating margin to be flattish year-over-year. We now expect OI&E to be $200 million to $250 million headwind versus our prior $300 million expectation, given better Q1 free cash flow and more favorable interest rate assumptions. We expect the effect on currency to be immaterial. We expect free cash flow to be at least $1.9 billion in fiscal year '24. We expect significantly stronger free cash flow in the second half of the year led by improvements in inventories as AI service shipments ramp.
We reiterate our commitment to our dividend, which was raised 8% from fiscal year '23 to fiscal year '24. Debt repayment to maintain an investment-grade credit rating, and in long term, returning capital to shareholders through share repurchases. To conclude, we executed well in Q1 amidst a challenging market backdrop. We are pleased with our margin and EPS results while understanding our slower networking product demand and GPU availability and timing impacted our revenue performance. We have taken prompt action to further reduce our costs and continue to manage our expenses prudently while we advance our long-term strategy. AI server demand is strong. Demand has stabilized for our traditional server and storage products, and our HPE GreenLake momentum is robust.
We will continue to invest in IT inflections, networking, hybrid cloud and AI to drive our pivot to higher growth, higher margin revenue. I look forward to engaging with you in the months ahead, as does our new Chief Strategy Officer, Shannon Cross, who has joined us following a distinguished career as a Wall Street analyst and now has oversight of our IR function. We will appreciate your input and questions along the way, and we can get started with that right now. I'll open it up now for your questions about the quarter.
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