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Hewlett Packard Enterprise Co (HPE)·Q2 2016 Earnings Summary

Executive Summary

  • HPE delivered net revenue of $12.7B (+1% y/y; +5% cc) and non-GAAP EPS of $0.42, at the high end of guidance; GAAP EPS was $0.18 . Management called it “our best performance since I joined,” with first as-reported y/y revenue growth since 2011 driven by servers, storage, networking, and ES .
  • Enterprise Group revenue rose 7% y/y (10% cc), but margins fell 240 bps y/y to 11.7% on FX and heavier Tier 1 mix; Networking grew 57% y/y, Storage +2%, Servers +7% .
  • Guidance: Q3 non-GAAP EPS $0.42–$0.46 and FY16 non-GAAP EPS $1.85–$1.95 maintained; FY16 GAAP EPS raised to $1.68–$1.78 on H3C gain, while FY16 free cash flow cut to $1.7–$1.9B due to H3C divestiture and ES separation costs . CFO noted Q3 EPS guide midpoint is ~$0.04 below Street, primarily due to H3C timing .
  • Strategic catalyst: announced tax-free spin-off and merger of Enterprise Services with CSC, expected to deliver ~$8.5B to HPE shareholders and create a top-3 services player; HPE shareholders to own ~50% of the new entity; targeted completion by Mar 31, 2017 .

What Went Well and What Went Wrong

What Went Well

  • Enterprise Group grew 7% y/y (10% cc) with broad-based strength, “grew… in every one of EG’s hardware business units and in every region” .
  • Aruba-driven Networking surged 57% y/y (62% cc); adjusted for Aruba, networking was still up 17% cc; HPE cited leading Gartner positioning and outperformance vs. Cisco .
  • Storage delivered 3PAR all-flash revenue “near triple-digits,” with 10th consecutive quarter of external disk share gains; converged storage up 19% cc to 54% of portfolio .

What Went Wrong

  • Enterprise Group operating margin declined to 11.7% (−240 bps y/y) on FX, heavier Tier 1 mix, and incremental R&D investments .
  • Software revenue fell 13% y/y (10% cc), though operating margin expanded 7 pts y/y aided by TippingPoint divestiture; IT Management weakness persisted .
  • Financial Services revenue −2% y/y; operating margin fell 130 bps to 9.3%; ROE down 230 bps y/y to 12.7% .

Financial Results

MetricQ4 2015Q1 2016Q2 2016
Net Revenue ($B)$13.45 $12.72 $12.71
GAAP Diluted EPS ($)$0.75 $0.15 $0.18
Non-GAAP Diluted EPS ($)$0.55 $0.41 $0.42
Non-GAAP Operating Margin (%)10% 8% 8%
Gross Margin (%)—28.4% 28.7%

Segment revenue and margins:

SegmentQ2 2015 ($MM)Q1 2016 ($MM)Q2 2016 ($MM)Q2 2016 Op Margin (%)
Enterprise Group6,560 7,051 7,010 11.7%
- Servers3,332 3,568 3,561 —
- Storage740 810 752 —
- Networking556 863 874 —
- Technology Services1,932 1,810 1,823 —
Enterprise Services4,817 4,688 4,723 6.7%
Software892 780 774 24.8%
Financial Services805 776 788 9.3%

Key KPIs:

KPIQ2 2016Notes
Cash from Operations ($B)$1.1
Free Cash Flow ($MM)$511
Cash Conversion Cycle (days)27 (adjusted for H3C)
Shareholder Returns ($MM)$109 returned; $15 buybacks; $94 dividends
Buyback Authorization+$3B increase; $4.8B remaining
Financing Volume Growth+15% y/y (19% cc)

Guidance Changes

MetricPeriodPrevious GuidanceCurrent GuidanceChange
Non-GAAP EPS ($)Q3 2016—$0.42–$0.46 New
GAAP EPS ($)Q3 2016—$1.10–$1.14 New (reflects H3C gain and charges)
Non-GAAP EPS ($)FY 2016$1.85–$1.95 (Q1 guide) $1.85–$1.95 Maintained
GAAP EPS ($)FY 2016$0.75–$0.85 (Q1 guide) $1.68–$1.78 Raised (H3C gain and ES separation charges)
Free Cash Flow ($B)FY 2016$2.0–$2.2 (Q1 guide) $1.7–$1.9 Lowered (H3C −$0.2B 2H impact; ES separation −$0.3B, partly offset by WC)
Currency Impact (Revenue)FY 2016~3 pts headwind (Q1) ~3 pts headwind (unchanged) Maintained

Earnings Call Themes & Trends

TopicPrevious Mentions (Q4 2015 and Q1 2016)Current Period (Q2 2016)Trend
Enterprise Group GrowthEG up 2% as reported, 9% cc in Q4; Servers +5% cc; Storage flat cc; Networking +43% cc; EG op margin 14% EG +7% y/y (10% cc); Servers +7%; Storage +2%; Networking +57%; margin 11.7% (FX, Tier 1 mix) Growth continued; margin pressure intensified
Storage/3PAR3PAR all-flash triple-digit growth; ~$500M run-rate; share gains 3PAR all-flash near triple-digits; 10th consecutive external disk share gains Sustained outperformance
Networking/ArubaAruba-led cross-sell; China improving ahead of Tsinghua 57% y/y growth (62% cc); adjusted +17% cc; Gartner leadership; outperform Cisco Accelerating
ES TurnaroundQ4 ES margin 8.2% best since 2011; bookings strength ES margin 6.7% (+310 bps y/y); constant currency revenue +1%; announced ES spin-merger with CSC Structural unlock via spin-merger
Currency Headwinds~3 pts FY16 headwind; biggest movement prior-year Q1 4 pts y/y top-line impact in Q2 (hedge gains lapped); FY16 ~3 pts expected Moderating in 2H
Hyper-converged/Hybrid ITAnnounced HPE Synergy; persistent memory; hyper-converged strategy (20% lower cost than Nutanix) Shipped Hyper Converged HC 380; positioning hybrid infrastructure solutions Execution progressing
China/H3C TransactionExpected close near end of May; ~$0.05 EPS operational impact; equity accounting thereafter Closed in early May; Q3 guide below Street by ~$0.04 due to H3C timing; −$200M 2H FCF impact Transition effects in 2H
Capital AllocationFY16 return ≥100% FCF; ~$2B H3C proceeds to buybacks Buybacks paused pre-CSC deal; Board +$3B authorization to $4.8B; plan to resume Larger authorization; timing dependent

Management Commentary

  • “Hewlett Packard Enterprise completed our second full quarter as an independent company… delivered revenue of $12.7 billion, up more than 1% as reported and 5% in constant currency… outstanding performance in enterprise services” — Meg Whitman .
  • “Networking revenue grew 57% year-over-year… when adjusted for Aruba, networking was still up 17% in constant currency” — Tim Stonesifer .
  • “We are planning a tax-free spin-off and merger of our enterprise services business with CSC… expected to deliver approximately $8.5 billion to HPE’s shareholders” — Meg Whitman .
  • “We expect non-GAAP diluted net earnings per share to be $0.42 to $0.46 in Q3 2016… and full year fiscal 2016 non-GAAP diluted net EPS of $1.85 to $1.95” — Tim Stonesifer .

Q&A Highlights

  • Street vs guidance: CFO noted Q3 non-GAAP EPS midpoint (~$0.44) is ~$0.04 below consensus, primarily due to H3C; expects Q4 ramp on seasonality, stranded cost removal, and buybacks .
  • ES margins: Management comfortable with 7–9% ES margin range; sees constructive trajectory with CSC synergy plan of ~$1.5B run-rate post close .
  • H3C impact: Revenue impact mostly in networking; ~$0.05 EPS headwind in 2H; minimal impact to servers/storage .
  • Free cash flow: FY16 FCF cut to $1.7–$1.9B; drivers: H3C −$200M (2H), ES separation −$300M, partly offset by working capital improvements; normalized FCF (with ES) ~$3.5–$3.8B .
  • Pull-through with CSC: Three-year commercial agreement to maintain EG/software pull-through levels; opportunity to expand via CSC relationships .

Estimates Context

  • SPGI consensus data was unavailable due to provider limit at the time of review; therefore, we compare results to company guidance and management commentary instead. Values retrieved from S&P Global were unavailable at runtime.
  • Management indicated Q3 2016 EPS guidance midpoint was ~$0.04 below Street due to H3C timing, implying near-term estimate downgrades; Q2 2016 non-GAAP EPS was at the high end of the company’s 0.39–0.43 outlook .

Key Takeaways for Investors

  • Near-term: Expect pressure on EG margins from Tier 1 mix and FX; watch for Q3 EPS miss vs Street implied by guidance and for Q4 rebound on seasonality and buybacks .
  • Structural catalyst: ES spin-merger with CSC unlocks value (~$8.5B), positions HPE as higher-margin, faster-growing infra/software pure play; shareholder ownership ~50% of new services entity .
  • Networking momentum: Aruba-led growth and China (H3C) dynamics driving outsized networking performance; monitor post-divestiture revenue normalization .
  • Storage leadership: 3PAR all-flash continues to gain share with triple-digit growth; expect continued storage mix and margin support .
  • Cash flow outlook reset: FY16 FCF reduced to $1.7–$1.9B; working capital actions (CCC to low-20s by year-end) are key to offset transition impacts .
  • Capital returns: Buybacks to resume; Board increased authorization by $3B to $4.8B; opportunistic repurchases tied to market and U.S. cash availability .
  • Currency: FY16 revenue headwind ~3 pts; Q2 impact was 4 pts due to lapping prior-year hedging gains; expect moderation in 2H .