Q3 2024 Summary
Published Jan 10, 2025, 5:10 PM UTC- HPE is experiencing strong momentum in the services attached to their AI systems, particularly in the enterprise segment, which is expected to grow and contribute positively to gross margins over time as deferred revenues are recognized.
- HPE is seeing no signs of cannibalization of traditional servers by AI-accelerated platforms, and continues to observe good growth and order patterns in traditional servers.
- HPE is well positioned across various AI market segments, including service providers, sovereign AI, and the growing enterprise AI segment, allowing them to capitalize on the AI opportunity without negatively impacting their traditional server business.
- Increasing share of lower-margin AI systems is pressuring overall server margins. AI systems now make up 30% of total Server revenue, up from 10% in Q3 FY'23, leading to operating margins at the low end of the target range of 11% to 13%. This shift may impact profitability.
- Recognition of services revenue for AI systems is largely deferred, which may delay positive impact on margins. The services component is "pretty much all deferred" and recognized over the length of the contract, potentially slowing margin improvement.
- Intense competition in the AI and server markets requires daily disciplined execution, posing risks to margins and profitability. The need to "execute every day with discipline" highlights the challenging market dynamics.
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Gross Margins and AI Impact
Q: Will AI server mix continue to pressure gross margins?
A: Marie Myers noted that while the AI server mix impacted gross margins this quarter, they expect profitability to improve as enterprise AI gains momentum, which has a more favorable margin profile. Additionally, the upcoming closure of the Juniper acquisition by end of calendar '24 or early '25 is expected to significantly boost both gross and operating margins, with over 50% of operating profit coming from networking. -
Free Cash Flow Guidance
Q: Why is free cash flow down, and what's the outlook?
A: Marie Myers explained that the year-over-year decrease in free cash flow was due to timing of working capital and normal seasonality. They expect benefits from working capital reversals in Q4 and stronger AI revenue conversion, keeping them on track for $1.9 billion in free cash flow for the full year. -
Server Margins Strength
Q: What drove the strong server margins this quarter?
A: Marie Myers highlighted that they shipped about $1.3 billion of AI servers, constituting around 30% of server revenue, with margins at 10.8%. The shift to Gen11 servers with richer configurations, successful passing through of commodity costs, and OpEx discipline contributed to the margin strength. -
AI Deal Lumpiness
Q: Were there unusually large AI deals in Q3?
A: Antonio Neri stated there were no unusually large deals; instead, bookings were more spread across the service provider space. The enterprise segment constituted mid-teens percentage of the $1.6 billion in AI bookings, consistent with prior quarters but with larger dollar amounts. They don't expect significant large deals in Q4, anticipating a continuation of current trends. -
Services Impact on Margins
Q: How will AI services affect margins over time?
A: Antonio Neri expressed optimism that the growing services attach rate in AI systems will contribute positively to gross margins as revenue is recognized over time. The introduction of HPE Private Cloud AI, which has a substantial services component, is expected to enhance margins in the server segment. -
Traditional Servers vs. AI Cannibalization
Q: Is AI cannibalizing traditional server sales?
A: Antonio Neri affirmed they've seen no signs of cannibalization in the traditional server market. Customers are not shifting legacy workloads to AI-accelerated platforms due to cost considerations and workload suitability. Traditional servers continue to show good growth and order patterns. -
AI Backlog and Enterprise Demand
Q: What's the composition of the AI backlog and enterprise projects?
A: Antonio Neri explained that the AI pipeline is multiple times the current backlog, indicating sustained momentum. The backlog is composed of mid-teens percentage from enterprise space, focusing on use cases with clear ROI in sectors like finance, manufacturing, and marketing. They are targeting these customers with offerings like HPE Private Cloud AI. -
HPE's AI Strategy and GreenLake
Q: What's HPE's focus in Gen AI and future deployments?
A: Antonio Neri identified their sweet spot as building, deploying, and running large AI systems, leveraging their expertise and services. The HPE GreenLake platform is central to their AI strategy, providing optimized infrastructure and configurations. The upcoming closure of the Juniper acquisition will add networking capabilities, positioning HPE to offer full-stack AI solutions to enterprise customers.