HPE Earnings: Revenue Decline Continues Amid Currency Headwinds And Challenging Business Environment

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Hewlett-Packard Enterprise (NYSE:HPE) announced its fiscal Q1 results on Thursday, February 23. The results were in line with our expectation, as the company’s revenues declined by 10% year-on-year (4% decline after adjusting for the effects of divestitures and currency). All its operating segments, with the exception of financial services, reported high single-digit declines in revenues.

HPE’s management said that it faced multiple challenges in Q1. First and foremost, the company faced a significant challenge on both the top and bottom lines from foreign exchange rates, particularly the strengthening of the U.S. Dollar versus the Euro and the Yen. Secondly, revenue was impacted by a tough market environment, particularly in core servers and storage business. Thirdly, a challenging industry-wide commodities market, particularly tight NAND supply, impacted sales in storage and compute businesses and elevated DRAM pricing. Below we provide an overview of the key takeaways from the company’s earnings release.

For precise figures, please refer to our full analysis for Hewlett Packard Enterprise

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 Outlook For Q2 And 2017

For the fiscal 2017 second quarter, Hewlett-Packard Enterprise estimates GAAP diluted net EPS to be in the range of ($0.03) to $0.01 and non-GAAP diluted net EPS to be in the range of $0.41 to $0.45. Fiscal 2017 second quarter non-GAAP diluted net EPS estimates exclude after-tax costs of approximately $0.44 per diluted share, related primarily to separation costs, restructuring charges and the amortization of intangible assets.

For fiscal 2017, Hewlett-Packard Enterprise estimates GAAP diluted net EPS to be in the range of $0.60 to $0.70 and non-GAAP diluted net EPS to be in the range of $1.88 to $1.98. Fiscal 2017 non-GAAP diluted net EPS estimates exclude after-tax costs of approximately $1.28 per diluted share, related primarily to separation costs, restructuring charges and the amortization of intangible assets.

Decline in Enterprise Group Revenues Continues

The Enterprise Group is HPE’s largest revenue division. The Server and Storage division, together with the networking division, makes up nearly 39% of HPE’s value, according to our estimates. The company’s Enterprise Group (EG) revenue declined by 12% year over year (6% adjusted for currency). The revenues declined due to a shift in company strategy to focus on the critical, higher-margin, higher-growth areas of the portfolio. But this focus drove improved year-over-year operating margins in EG when adjusted for currency and divestitures.

During Q1, server revenue declined 12% year-on-year (11% in CC) to $3.1 billion. The growth in high-performance and mission-critical computing was offset by pressure in the core servers and service provider verticals, which is facing intense competition from white-box servers that are manufactured to design by Asian ODMs. Execution challenges also impacted server sales during the first quarter. The company stated that it was making improvements in the channel with some process re-engineering, and focusing more on SMBs through distributors and value-added resellers. Furthermore, the company continues to make investments in products like Synergy (in Blade segment) that will revitalize its competitiveness. HPE anticipates taking back share in the server market through new product launches and expanding its portfolio through strategic acquisitions.

Storage revenue declined by 13% year-on-year (12% in CC) to $730 million as contraction in the legacy portfolio continued during the quarter. Additionally, results were also meaningfully impacted by NAND supply constraints that are expected to lessen as the year progresses. For the Networking division, revenues declined by 33% (6% in CC). However, 10% growth in Aruba’s revenues and some market share gains helped the company to offset the decline in legacy network installation.

The Technology Services (TS) division, which includes virtualization, cloud deployment and security, reported a 2% quarter-over-quarter (4% in CC) decline in revenues to $1.94 billion. Orders also grew year-over-year for the third consecutive quarter for TS, which will help the division post growth throughout fiscal 2017.

A culmination of the aforementioned factors resulted in the company reporting a 12% decline (6% in constant currency) in revenues to $6.32 billion during the quarter. Operating margins were down 70 basis points year-over-year and 60 basis points sequentially to 12.7%. However, operating margins were up year-over-year when adjusted for currency and the H3C divestiture.

Profitability At Enterprise Services Improves Amidst Decline In Revenues

HPE’s Infrastructure Technology Outsourcing (ITO) and Application and Business Services (ABS) businesses have been under pressure as competition in the underlying industries has been relentless. As a result, the revenues for this segment declined by 11% year-over-year (6% in CC) to $4 billion. Within this vertical, ITO declined by 8% year-over-year (7% in CC) to $2.84 billion and ABS revenues declined by 17% year-over-year (3% in CC) to $1.89 billion. However, its cost actions also delivered strong margin expansion. However, the corrective steps taken by HPE to merge this business with CSC in the future should help the company to improve its cost matrix and realize better cash flows in the future. This transaction is expected to be completed by April this year.

Software Revenues Decline

The Software division is HPE’s third-largest vertical and makes up nearly 9% of HPE’s value, according to our estimates. Software revenue declined by 8% year-over-year (1% in constant currency) to $721 million. The company continues to focus on disciplined cost controls and, as a result, the operating margin improved 400 basis points to 21.4% during the quarter.

Within this segment, license revenue declined by 9% (1% in constant currency), support revenue declined by 9% (1% in constant currency), professional services revenue declined by 7% (5% in constant currency) and software-as-a-service (SaaS) revenue grew by 4%( up 6% in constant currency).

Financial Services Reports Growth Once More

HPE Financial Services revenue grew 7%, its third consecutive quarter of year-over-year growth driven by strong volume from last year and an increase in operating lease mix. However, operating profit declined 340 basis points year-over-year to 9.5%, primarily due to a bad debt reserve release in the prior year

We are in the process of updating our HPE model. At present, we have a $24 price estimate for the stock, which is slightly below the current stock price.

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