Hewlett Packard Enterprise Co (HPE)·Q3 2016 Earnings Summary

Executive Summary

• EPS landed above company guidance while revenue contracted modestly; non-GAAP EPS was $0.49 vs guidance $0.42–$0.46, helped by a ~$0.04 tax benefit; revenue was $12.2B, down 6% y/y and down 1% ex-divestitures/currency .
• Gross margin expanded to 29.3% (+60 bps y/y, +60 bps q/q) and non-GAAP operating margin rose to 8.8% (+30 bps y/y, +90 bps q/q) on Enterprise Services and Enterprise Group execution .
• The quarter’s key strategic catalyst: HPE announced a spin-merge of non-core Software assets with Micro Focus valued at ~$8.8B (HPE shareholders to own ~50.1% of the combined company; HPE to receive $2.5B cash; ~$700M one-time separation costs) targeted to close by 2H FY17 .
• FY16 EPS guidance was updated higher on GAAP and narrowed higher on non-GAAP; Q4 EPS outlook set at $0.58–$0.63 non-GAAP; free cash flow outlook reaffirmed at $1.7–$1.9B .

What Went Well and What Went Wrong

• What Went Well

  • “Overall, we had a strong quarter” with profitability progress: gross margin 29.3%, non-GAAP operating margin 8.8%; non-GAAP EPS $0.49 at/above the high end pre-tax, before ~$0.04 tax benefit .
  • Enterprise Services margin hit 8.3% (+260 bps y/y) with cost actions, better mix, and deal profitability; Technology Services returned to 1% growth; Aruba networking grew 20% (networking +12%) and 3PAR all-flash grew 70% at record levels .
  • Strategic portfolio moves (Micro Focus spin-merge; SGI acquisition; Docker/SUSE partnerships) sharpen focus on hybrid IT and edge; “setting up HPE for long term success” while unlocking value for shareholders .

• What Went Wrong

  • Top-line softness: total revenue down 6% y/y (down 1% adjusted for divestitures/currency); Enterprise Group revenue down 8% y/y as core servers faced pressure and storage legacy declines offset converged growth .
  • Europe/UK macro and Brexit impacted demand (pause in UK public sector), and Japan weakened; currency was a ~210 bps revenue headwind y/y .
  • Software revenue declined 18% y/y (down 3% adjusted), and software margins fell 270 bps y/y to 17.8% as revenue declines outpaced OpEx reductions .

Financial Results

Overall performance vs prior periods:

Segment and business unit revenue:

KPIs and operating drivers:

Non-GAAP adjustments and impact:

• GAAP to non-GAAP: Q3 non-GAAP EPS of $0.49 excludes, among others, amortization ($0.12), restructuring ($0.22), separation ($0.08), and adjusts for the H3C gain (−$1.26), taxes, and other items; GAAP EPS was $1.32 .
• CFO noted ~$0.04 per-share favorability from tax benefits tied to recent divestitures in the quarter .

Guidance Changes

Other forward items:

• Post software/software-ES separations, RemainCo expected to be faster-growing, higher-margin with stronger FCF; operating net cash $5.3B at quarter-end .

Earnings Call Themes & Trends

Management Commentary

• “Overall, we had a strong quarter… profitability was very encouraging… our non-GAAP EPS was $0.49… at the high-end of our previously guided range” — Meg Whitman (CEO) .
• “Gross margin of 29.3% was up 60 bps both year-over-year and sequentially… non-GAAP operating profit of 8.8%… up 30 bps y/y and 90 bps sequentially” — Tim Stonesifer (CFO) .
• “We announced plans for a spin-off and merger of our non-core software assets with Micro Focus… valued at about $8.8 billion… including a 50.1% ownership… and a $2.5 billion cash payment to HPE” — Meg Whitman .
• “Operating profit [ES] improved 260 basis points year-over-year to 8.3%, the highest since the second quarter of 2011” — Tim Stonesifer .

Q&A Highlights

• Storage softness vs peers: management cited a softer market and legacy declines offsetting converged growth; entry storage portfolio refresh (StoreVirtual 3200, MSA 2040) to address gaps; continued share gains expected .
• Capital return vs M&A: prioritizing ROI-based buybacks; selective M&A where complementary (e.g., SGI) while continuing to invest organically .
• Competitive positioning vs Cisco/Dell: focus on speed, agility, delevered balance sheet, and complete converged stack (including storage) vs competitors; Aruba momentum cited .
• Separation costs: ~$700M one-time after-tax to separate software for Micro Focus; complexity across 650 IT systems and 150 legal entities in 60 countries .
• Brexit impact: observed a temporary demand pause in the UK; hedging couldn’t fully offset pound move; orders picking up late in the quarter .

Estimates Context

• S&P Global consensus estimates were unavailable during this session; unable to quantify beat/miss vs Street for revenue and EPS. HPE’s non-GAAP EPS of $0.49 was above its guidance range of $0.42–$0.46; revenue was $12.2B (−6% y/y; −1% adj.) .
• Where estimates are needed for portfolio decisions, we recommend refreshing with current S&P Global consensus before trading.

Key Takeaways for Investors

• Profitability outperformed despite modest revenue pressure; mix, pricing discipline, and ES execution drove margin expansion; watch for sustainability into Q4 given macro and currency headwinds .
• The Micro Focus spin-merge is a material catalyst: $2.5B cash to HPE, 50.1% ownership for shareholders, and ~$700M separation costs; sharpened focus on hybrid IT and edge should support multiple re-rating post-close .
• Growth engines show durability: Aruba and all-flash 3PAR continue to gain share; SGI adds scale in HPC; TS returned to growth; these support mid-term mix shift to higher margin businesses .
• Guidance implies a solid Q4 EPS step-up (non-GAAP $0.58–$0.63) and FY16 FCF $1.7–$1.9B; capital returns remain a priority (>$3B expected in FY16) .
• Near-term risks: Europe/UK softness post-Brexit, core servers pressure, and continued software revenue declines until spin-merge close .
• Actionable: bias to buy on dips into Micro Focus close if execution on margins persists; monitor Q4 order linearity in UK/EMEA and storage entry product ramp for confirmation of growth stabilization .