HPE – Q1 Tally Suggests the Breakup Was Healthy

John McIntyreby John McIntyre | 3/7/16

After a one-year shakedown cruise in anticipation of its becoming a separate entity in the Great HP Breakup, the newly-launched Hewlett Packard Enterprise Company (HPE) reported on the first quarter of its operations on March 3 – and those results were a mix of positive and negative indicators. In the earnings conference call, President & CEO Meg Whitman told investors “[for] our first full quarter as an independent company … we’re off to a very strong start,” Whitman asserted that the company was benefiting from “being a smaller, more focused and agile company … a simplified, faster-moving organization … [whose] employees are engaged and aligned.”

Whitman went on to pronounce that “Our innovation engine is firing on all cylinders, and you’re going to see some amazing new introductions in the coming quarters in key areas of the [firm’s] portfolio.” Financial earnings reports are, in part, about transforming qualitative employee metrics such as being “focused,” engaged,” aligned,” and “firing on all cylinders” into quantitative performance numbers. See the press release here.

Depending on how much of an accountant you are or your point of comparison, HPE’s first quarter performance looks either highly encouraging or even stellar, or possibly merely tepid. Investors, however, liked what they saw and heard, and voted with their feet – HPE stock rose 13.5 percent the day after the announcement on a big buying surge – and their opinion always matters, accountants or not. The company generally met or slightly exceeded most analysts’ estimates, which no doubt helped power the rise. One can’t help but think that some of HPE’s stock buyers compared the firm’s generally positive report to HP Inc.’s (HPQ) downbeat Q1 report the week before, in which revenues and earnings declined 12 percent year-over-year, and Dion Weisler, HP’s president and CEO, stated that he sees “some tough quarters ahead,” – in stark contrast to Whitman’s “firing on all cylinders… [and] amazing new introductions in the coming quarters … .”

Currency adjustments played a big role in analyzing HPE’s results: while three of the four operating groups reported revenue declines in non-constant currency, only one (Software) declined in constant currency. Tim Stonesifer, HPE CFO, characterized currency woes as “a significant headwind,” adding that currency will still be an issue in Q2 and then is expected to moderate in the second half. Stonesifer says the company anticipates a “currency headwind,” of about 3 points in revenue for the FY.

What did HPE report?

  • On the top line, net revenues declined 3 percent year-over-year to $12.7B, but actually grew 4 percent when adjusted for constant currency (CC); the company’s operating units performed as follows:
Unit Net Rev., $M % of HPE Rev. Growth year-over-year Growth year-over-year, CC Non GAAP OP $, M Non GAAP % rev. Non GAAP OP % rev., year-over-year
Enterprise Group $7,051 53% 1% 7% 944 13.4%  (1.8) pts
Enterprise Services $4,688 35% (6%) 0% 238 5.1%  2.1
Software $780 6% (10%) (6%) 136 17.4%  (0.6)
Financial Services $776 6% (3%) 3% 100 12.9%  1.7
Totals, HPE $12, 724* (3%) (3%) 4% 1,029 8.1%  (0.4)

[*HPE also includes “Other” revenues including investments, etc. in total Q1 revenues, and OP $ totals ($1,029M) include several reconciliation adjustments for the current and prior periods.]

  • Enterprise Group represents the clear majority of HPE’s business at slightly over $7B, and it grew revenues at 1 percent year-over-year, but a strong 7 percent in CC and delivered $944M in operating profit (non-GAAP), 13.4 percent of operating revenue. However the unit’s operating profit dropped by $114M, down 1.8 points of operating revenue year-over-year (non-GAAP). Enterprise Group consists of primarily hardware products including “Converged Systems, Cloud Systems, StoreOnce, 3PAR All-Flash and Technology Services,” and sells engineered/integrated systems built from HP components such as servers, storage, and networking – all of which showed year-over-year revenue growth – especially 3PAR All-Flash, which the company says grew at three times the market rate. Whitman claimed HPE is the leading infrastructure provider for SAP HANA, with nearly double the number of shipments over its next competitor, and that HPE is gaining share in the server market, seizing share from Lenovo and targeting opportunities opened by the Dell-EMC deal.
  • HPE’s second largest unit, Enterprise Services (ES), is the business and technology services group consisting of HP’s legacy consulting and outsourcing business and the integration of the acquired EDS outsourcing operations. HPE describes this important unit as in “turnaround,” restructuring to diversify its customer base, stabilize its revenues, and significantly reducing its cost structure by exiting high-cost data centers, improving low-cost location mix, and rebalancing the workforce. HPE states that in FY13, three customers represented roughly 65 percent of ES operating profit; now, HPE says, no account makes up more than 10 percent. ES reported slightly increased revenues (0.1 percent) in CC of $4.688B – the first quarter with constant currency growth since Q3 of 2012 according to Whitman. ES orders were down slightly in CC but up excluding China, where the company is closing a major deal but wrangling with slow Chinese regulatory approvals.

Whitman outlined a long-term target to achieve a sustainable and competitive ES cost structure with a 7 to 9 percent operating profit margin, up from this quarter’s 5.1 percent – which was up 2.1 percent year-over-year – and represents the seventh consecutive quarter of year-over-year margin improvement despite what Stonesifer observes as “pricing pressure in that business.” Stonesifer noted that ES made progress in its cost reduction plan, as about 45 percent of its workforce is now in low-cost locations with a longer-term goal of 60 percent. He said the full-year for ES revenue is expected to be down 2 percent to flat in CC year-over-year.

Stonesifer explained that ES applications and business services sales continued to improve with the second consecutive quarter of year-over-year revenue growth in CC, driven by strong apps performance and stabilization in business process services. ES’ Strategic Enterprise Services revenue was up double digits year-over-year, due to growth in Helion-managed cloud offerings. He added that overall, TCV was up nearly 30 percent year-over-year CC, powered by renewals, as well as growth in new logos and add-on business. Whitman added that in ES, activity in cloud, big data, and security practices grew over 30 percent year-over-year in Q1 and touted that Forrester has ranked ES as a leader in workplace services and a leader in a private cloud report.

  • The Software group includes software products and SaaS offerings in big data, security, operations management, applications services sectors and related services and support. Part of the “focus” in this unit includes the divestiture of several software businesses including iManage, LiveVault and TippingPoint. Software was HPE’s worst performing and weakest unit, showing a 6 percent year-over-year CC revenue decline, a $21M fall in year-over-year OP and a .6 point drop in OP year-over-year (non-GAAP), though the firm says it saw record revenue growth in SaaS, which grew over 20 percent year-over-year, and big data exhibited a double-digit revenue spurt (normalized.)
  • Financial Services is HPE’s financing operations, enabling sales in the company’s products and services units. The smallest of HPE’s units, it grew 3 percent year-over-year in CC, and also enhanced its year-over-year income by $10M and its OP year-over-year (non-GAAP) by 1.7 pts on increased financing volume.

So while HPE’s smaller units exhibited contradictory outcomes, the Enterprise Group carried the company’s water to Wall Street. HPE owns the No. 1 worldwide slot in server sales according to IDC, with approximately 28 percent unit market share. Geographically, Asia Pacific Japan (APJ) saw the best growth at 9 percent year-over-year in constant currency, driven by strong server shipments and record China networking revenue. In cost shifts, Stonesifer says Non-GAAP operating expenses of $2.6 billion increased 3 percent year over year driven by numerous R&D investments, though he revealed that the head count reduction in Q1 was 3,000.

HPE – a Lot of Moving Parts

HPE is still a $50B-class company comprised of several large divisions, each with a number of variable moving parts, so a simple summary conclusion isn’t easy to spell out. A few things seemed clear though;

  • The company has a number of hot product segments that it is capitalizing on as much as possible – primarily in emerging technology hardware categories, and is an important – if not dominant – player in many categories.
  • It appears the company is progressing in better managing the cost structure in its ES unit, and applying a more cohesive marketing focus across its ES offerings. HPE’s overall earnings could be nicely enhanced if ES achieves its targeted improvements in operating margins in 2016 despite an essentially flat revenue forecast.
  • While the company’s top absolute line numbers are adversely affected by currency dynamics, the firm appears to be addressing that predicament — and the underlying business kinetics are predominantly positive.
  • The contrast between the tone and positive accompanying financial data announced by HPE vs. the results from HPQ appear to validate the decision to split the company in two, though it is really too early to draw a firm conclusion on that point. By fall 2016 though, that picture will be much clearer and far less muddied by the messy accounting and restructuring asterisks permeating the Q1 report.
  • Based on Wall Street’s reaction, Whitman and her team are succeeding in selling what HPE is doing to investors (and probably its Board), but The Street are a fickle audience that will certainly call Whitman et. al to task if elements of the optimistic outlook fall flat.

John McIntyre serves as a senior analyst for BPO Media. With more than 40 years of experience in the printing industry as an analyst, product developer, strategist, and marketer, he has covered the printing and supplies sectors for prominent market research firms such as Lyra Research, InfoTrends, and BIS Strategic Decisions, and served with major OEMs such as Samsung, NEC, ACT, and Diablo Systems/Xerox. McIntyre is the former managing editor of Lyra’s Hard Copy Supplies Journal and has been a popular speaker at industry conferences on key issues such as market and business strategies, distribution channels, supplies channels, and the impact of emerging technologies. McIntyre also served as a member of the IEEE 1680.2 (EPEAT II) standards development committee.