Hewlett Packard Enterprise Company (HPE) Earnings Call Transcript & Summary

Yes. It's mainly synergies kind of what we're seeing from a synergy perspective, I think it's really important to emphasize that we're not only looking at synergies and ways to improve the new companies coming together. But we continue to invest aggressively in silicon development and new products and leaning into things like Helios and that to be able to drive growth going forward. And I think that it's really important for that because we spent $14 billion on this acquisition. And having spent 20-some-odd years on the sell side, I've seen a lot of failed acquisitions. This 1 is really going well. And I think that's because the company, the Board, the management team made a commitment to really look at the integration drive for success, invest where it's required. And I think that's important because legacy tech companies, which we used to be, now we're a growth company, so we're going to change our sweatshirts or whatever. But these kind of companies had a tendency of buying companies and kind of, I don't know, kind of forgetting about them or letting them live on their own and then just moving on to the next thing. And when there was a downturn cutting investment dollars on that, and that's absolutely not what's happened here. And I think it's really important because we want to make sure we're good shepherds of shareholder dollars.

Okay. Let's switch gears to cloud and AI. We'll start on the traditional server side. You mentioned orders up 75% year-over-year in traditional servers. Can you articulate for this audience your confidence in the durability of demand here. And I'll ask the question of units versus ASPs but anything you can share just on what is underlying the confidence in the growth in demand?

Yes. I think there's a few things. And I mean, for those of you who know me, I've been around quite a while, and I truly believe there's something different here. Like there is a new TAM developing. And this is different than some of the other -- oh, they're going to move it on-prem because of whatever from a cloud perspective, I think there are key drivers here that are actually creating incremental demand beyond what we've already seen. I would say the first is because customers need to invest in AI technology, they need space in their data center. So I do think that there's some refresh going on in the older stuff running databases and whatever, just because you can consolidate servers and when you consolidate servers, you save on space, power, et cetera. So there's a bit of that. But more importantly, what we're seeing and what we're hearing from customers is this idea of being able to contain token costs and security of data. So from a token cost perspective, if you bring in -- we're drinking our own champagne here because my group is actually working on this. We're putting out effectually what you call an AI factory or what have you or, in this case, is PCI, which is our private cloud AI hardware, putting open weight models on top, having an intelligent router that basically says, if you're a cutting-edge software developer, you can go up to the -- hit a frontier model and spend for tokens. If you're me sitting there doing sort of basic corporate stuff, I never need to leave the cloud. So our costs in that case are just managing buying the hardware and managing the hardware as opposed to paying 1 of the token providers. So we're doing that or the large. So that's something that we announced, for instance, that we were awarded a $3.5 billion enterprise deal after the end of the quarter. And we wanted to highlight that I mean the number is great, but more it's this concept, and we're seeing many of these -- maybe not as big, but many of these opportunities come through from an RFP perspective where large retailers, large technology companies, large banks, large pharma, they're all looking at this and going, wow, our Tonkin costs are going to ramp substantially, how do we manage it, how do we control it. And I've talked to transformation officers and CFOs across the country, different industries who are all working on this. So I think this is absolutely a new reason for people to be buying hardware, and I think it's very sustainable. The other thing I would say is that there's absolutely concern about data sovereignty and security. And you don't necessarily want all of your data going up and somehow becoming the sum total of human knowledge. So from that perspective, people are really focused on gating things off to the best of their abilities. So it will be -- I think it's interesting, but in terms of how this market is going to develop, it seems to us, and maybe this is anecdotal, but it's ramping faster in the U.S. but it's ramping -- but we hear things -- again, HPE is in like 160 countries and everywhere. When I talk to some of the country managers, you hear anecdotes of more demand out there, but we've really started to see this ramp. And I think it's sustainable. And I'm pretty excited about it because it's cool to be in hardware again or at least in server again.

Talking more about that $3.5 billion enterprise hyperscale deal where you were engaging in some on-prem use cases. Similar to the Oracle question, what drove HPE's win in that particular deal? And maybe more broadly, when thinking about going after this enterprise and even sovereign AI opportunity. How much of your sales motion is led by the breadth of your portfolio in both compute, storage and networking?

That's a good question. I think in terms -- and I have actually asked why we won this because it's great. I think we want it because we can do services, we can do installation, we can maintain it. My speculation here is that maybe some of these companies are going to a little stretched with all the growth, everything they have to do. And so they wanted a really real trusted partner that can come in and build the data center for them and help them out. So to be clear, this was a hyperscaler, but these are traditional server margins. So we're very happy about the development of this business because, obviously, we all know that AI server tends to be a very low-margin opportunity. This is not. And the other deals that we're seeing out there are similar. So I think the interesting thing about HPE when it comes to our customers, one, we are like the Fortune 200 in terms of the customer base, Fortune 500. We have a really marquee set of customers. I'm sure our competition has good customers as well, but I was personally surprised when I came from the sell side and saw who we work with because it's pretty impressive. So from that perspective, I think our existing customer base will be a really good area to mine as they go and they look at more inferencing options. I think that from our product perspective, we are the only 1 that can bring networking and server storage services, we have a professional services arm HP finance. So we have the ability to finance things. And again, if you're a Fortune 200 customer and you want to lease something, we're going to be happy to do it because you have a really good credit quality. And then we have this enormous channel. And that's another thing I think that's underappreciated at this company. The channel that we had originated out of Compact and has been expanded over the years. It's a global, deep, very close relationship channel. And I think that's something that's also going to be really beneficial because 1 of the things that as you move a little bit down from maybe the super big customers can manage all of this stuff once you get it out there on their own. But you move down, they're going to be partners that are going to need help and solutions. And I think what we have will be will be good. In terms of cross sales, I think that's still something that we can candidly do better, but it's an area where between networking and server, we're definitely starting to see some cross-selling.

Let's touch on the AI server opportunity. You've been very focused and deliberate about maintaining margins in that opportunity set with a focus on enterprise and sovereign, but saw some nice orders in the quarter, $2.4 billion in the quarter, almost $7 billion in backlog. How should we think about the mix potentially changing now that you're getting more scale in the business and you're seeing some attractive opportunities, both from a engagement with the hyperscale and neuro clouds on the AMD Helio side? Like is there an opportunity to change your mindset on the AI server framework?

I think it will be really interesting to see how it plays out. I do think Helios provides a margin uplift when you combine in the networking and the server technology. So I'm excited about what we can do there. I think that overall, we are maintaining a balanced approach. We're not -- we won't -- we still bid for a lot of these. But if the margin is really not there. We don't need empty calorie revenue. I don't think investors necessarily want that. And we're really focused as well on driving our free cash flow, so you have to manage our working capital. And think people probably saw we took our working capital -- or sorry, we took our free cash flow target this year up to $3.75 billion in fiscal '26 and at least -- and at least $5 billion next year. So this company is a cash-generating engine. It's a Board decision, obviously, in terms of return on cash flow, but a return of cash. But the bias has always been to give it back to shareholders. And obviously, we've said in fourth quarter, we're going to get back at least 75% of our free cash flow through share repurchase and dividends. So I think that's also a very important balance that we look at in terms of how much working capital do we want to tie up. For instance, you saw our inventory went up this quarter. That position because we do expect AI server revenue to be up in fourth quarter. And we do have some big deals. We expect growth in fiscal '27 AI server business. You've seen some of -- they've been press released that we had some big wins from, for instance, the U.S. government and some of the labs.

Talking more about those U.S. government and lab wins and we'll call it the sovereign opportunity more broadly, really where the legacy of Cray seems to have a competitive advantage. You had mentioned earlier that things seem to be ramping faster in the U.S. and internationally, but HP also does have a very significant international footprint in EMEA in particular. Can you talk about your outlook for the sovereign AI buyer, maybe both domestic and international to come to market and how the profile of that type of buyer might look different from the Neo cloud opportunities you may have walked away from earlier?

Sure. Well, to be clear, when I talked about the fact that things were starting more in the U.S., that was really the inferencing understood. So the traditional server purchases this idea. There was an article in the FT, by the way, today talking about Layton and Watkins that are bringing on -- I don't know if they are our customer shan't heard. But they are buying NVIDIA GPUs, putting them on-prem basically in a colo and managing it themselves so that they can reduce token costs. So just -- that's something that I think has got legs and it's kind of starting in the U.S. From a sovereign perspective, we do -- we work with sovereigns all over the world, and we have very close relationships stemming from Gray and frankly, from HPE as well because HPEcompact server business had long-standing government relationships. I think from a margin perspective, if you think about the continuum, the more you do for a customer, the higher your margin. So if you're with a hyperscaler wrapping metal around an NVIDIA stack, margin is probably not that great. As you go up and some of these sovereigns are pretty sophisticated. A lot of them need a lot of help. And so that's kind of how you think about the margin there. We've -- I think we've got several areas where we're talking to people, whether it's on Helios, whether it's on our existing NVIDIA kind of racks that especially in Europe, where there's a lot of interest. I mean governments are looking at wanting to have their own clouds within their own borders whether it's for defense or government kind of activity or it's literally to help jump start some of the start-ups and that was in their own country. So there's a lot of demand out there. There's probably some questions about where the dollars come from from a government perspective. But in general, we see that as a really healthy market.

Great. I'll ask 1 more, and then I'll open it up to see if there's any questions from the audience. Just talking about your cloud and AI segment level margin outlook for fiscal '27 guiding to 13% next year. You delivered 17% this quarter, but maybe some onetime items in there. Can you talk about the various impacts that are driving, whether it be mix, whether it be supply, anything to consider when talking about that margin framework?

Yes. I think, look, if you look at the company, we did a 40% gross margin this quarter, pretty high. There were some deals, some things that came through. It's not really a component pricing situation. It was more like composition of deals, and that benefited us this quarter. I think as we look forward, there's always a balancing act between sort of units and ASPs and then margin, which flows through to EPS, which flows through to cash flow. And in cash flow, you also want velocity, right? Because these whether it's a server business or it's a PC business, which we obviously don't own, you can really speed up your cash conversion cycle. So you want to make sure that you're driving a sufficient amount of units through the model. I think we've we're definitely kind of leaning when we see growth next year to be more of a combination of ASP increase in units as opposed to this year, it's been definitely driven a bit more by [indiscernible] So that can have a little bit of pressure on margin. The other thing I would point out is that we do expect our AI server revenue to be up year-over-year, and that does have a lower margin profile than traditional servers. Now stay tuned if we keep seeing the kind of growth rates that we're seeing in traditional server and the -- some of these deals that are coming over the pipe, maybe there's some opportunity there. We do continually strive to drive for the most gross profit dollars we can at the company.

Okay. Any questions we can get at microphone over here? The $3.5 billion [indiscernible] ?

It's for their internal usage. Yes. So just think about -- just like us, and we put -- I mean we use PCAI they're using more of a traditional server approach, and it's for inferencing.

Do you have any example of what they're using this PCAI 4 or the -- rather the compute for internally, just to contextualize?

I don't. I mean it's an order that they place. I mean I would say internally, what we use ours for is basically my chat doesn't -- if I use chat HP. It doesn't go outside it just stays internal. So I don't actually incur any token costs.

What would like the duration of a deal like that be? Because that's a big deal [indiscernible] ?

Server deal. So it's a fairly quick turnaround.

Okay. Are there more of them like that in the pipeline?

Well, I don't know if they're $3.5 billion ones, but there are several large enterprise customers with multi-hundred dollar deals that are out there that we're looking at. I mean it's pretty -- the amount of investment dollars that people seem to be -- again, it's early, but it's -- I think it's going to -- I think there's there's legs here. The amount of money that people seem to be wanting to put into on-prem is pretty impressive. I believe it's a predominantly CP of the margin -- they were a traditional server margins.

With a couple of seconds here. Do you want to plug the networking day again and let this audience know about any expectations for a...

Yes, I think -- we're going to have the network Investor Day, September 30 in the Bay Area. And basically, we want to explain who HPE Networking is now. We'll have Rami will have all of his direct reports. And I think it will be a good opportunity for people to ask a lot of the same questions you're asking now and hopefully get answers from the subject matter experts as opposed to me.

Thank you, Shannon. Thanks. Appreciate it.