HPE CEO points to 'cyclicality' in networking behind margin dip

Shares of Hewlett Packard Enterprise (HPE) are slipping on Thursday despite the company beating third quarter earnings expectations. HPE CEO Antonio Neri sits down with Yahoo Finance Executive Editor Brian Sozzi to discuss the latest earnings and the company's outlook as AI becomes more widely adopted.

Neri explains that HPE had "terrific" revenue growth during its third quarter. In particular, the AI business converted more revenue this quarter than its second quarter, improving its operating margins on the server side by 70 basis points year over year — the highest margins for servers in the industry, he says. However, the company's overall gross margins are down, which Neri attributes to a dip in revenue on the networking side of the business. He tells Yahoo Finance, "That has to do with the cyclicality we see in this current period of the market in the networking business, in line with the peers that have announced in the prior few weeks."

As the AI race heats up, Neri says that HPE leaders are "very disciplined" in their approach to business, specifically when it comes to pricing and operating expenses. He attributes this outlook to the growth of HPE's server business despite a "very competitive" market.

Nvidia's (NVDA) most recent earnings disappointed investors looking for returns on their AI plays, despite posting a beat on both the top and bottom lines. While many worry that this could be the burst of the AI bubble, Neri disagrees. He argues that the issue will come down to "the adoption of AI in the enterprise, which ultimately is what the realization of the value really happened." He adds, "And that's why HP is uniquely positioned to accelerate time to value to these transformative technologies," pointing to the synergy of the networking hybrid cloud and AI through its GreenLake platform.

Looking forward, Neri believes HPE will complete its transaction to acquire Juniper Networks, an AI networking company, by early 2025 in the US. He highlights that the move has already received a regulatory approval in the EU, UK, India, and Japan. Once the acquisition is finalized, he believes the company will "change dramatically":

"Our current networking business, which is very much focused on the campus of branch segment of networking, is approximately $5 billion. When we add Juniper, we're gonna double, so it's gonna be more than $10 billion revenue with a significant higher margin profile, obviously, because that's the industry standard for networking. And it ultimately gives us the intellectual property and talent to deliver a modern AI-driven fabric, which obviously is required for both cloud and AI. And so from a shareholder perspective, we're gonna deliver significant value through the synergies."

This post was written by Melanie Riehl

Video Transcript

We're tracking shares of H PE after the company's latest earnings report stuck under some pressure here.

Some focus on on margins and, uh, how the company's Alec might shake out.

But let's get right to H PE CEO Antonio Neri, who always gives us some time to talk about the company's business.

Antonio always nice to to see you.

You know a lot of the reports the analyst reports been reading, uh, after the quarter, calling out, uh, the gross margin pressure in the quarter.

Let's just start on what is exactly driving that and and is it tied anyway to the A I server ramp?

Well, good morning, Brian.

Thanks for having me again.

Uh, we did what we said we would do.

We had a horrific revenue growth, uh, in the third quarter, up 10% year over year and obviously was on the heel of a significant old book on the A I side where we book an additional $1.6 billion and we converted more revenue this quarter and the prior quarter.

However, the the story is as followed.

Number one is that despite that order conversion, we actually improve operating margins 50 basis points quarter of a quarter.

And on the server side, which the vast majority of the business is, we actually improved operating margin by 70 basis points here every year.

Now, when you look at the company overall gross margin, obviously they are down.

But it mainly because of the less revenue we got from the HP networking business, not because of the A I business.

And that has to do with the cyclicality we see in this current period of the market in the networking business, in line with the the P that have announced in the prior, uh, few weeks.

So the story is, we prove operating margins.

We exceeded our top of the guidance on EPS.

Uh, and the reason why gross margins is mainly down is because of the mix of networking revenue down.

What are the margins for investors?

Not too familiar.

Um, with your business, what are the margins on A I related products compared to some of the, uh, traditional products that you serve?

And then what's the the outlook for those A. I related margins.

Yeah, well, our server segment reported a 10.8% operative margins, uh, again, up 1070 basis points year over year, which is the highest operative margins in the industry when it comes down to servers and you can do the analysis against the other vendors that participate in the market.

Our mix also had a very favourable traditional servers, um, mix because of the huge growth we saw on the, uh, year over year and sequential basis on the traditional servers, which Brian tell us that there is no cannibalization from the A i servers into the traditional servers.

And that makes sense because when you look at the type of workloads that run on one infrastructure versus to the other one, it makes no sense to move traditional workloads into accelerated compute because you will be paying a higher TCO comparing to using accelerated computing for, uh, you know, training these models and eventually doing infer it.

So our our our gross margin are very solid.

Also, we have a benefit from their services business attached to that to that segment.

But the reality is that our operative margins are best in class when it comes down to the server, how competitive are or how competitive is the A I server market.

Are you willing to give up margin just to get your products in the hands of consumers that that need these A I related products right now, and they can't wait for them.

No, we're not giving up any painful or less margin.

We're actually very disciplined the way we approach the business, both on the pricing side and then on the OPEC side, the cost structure of the company.

That's one of the reasons why our margins were up on the server business.

And so it is very competitive.

But remember that there are three segments in the A. I business.

That is the service provider segment, which is driving in our role.

The book more than 80% of our orders and these are, you know, companies that they didnt doing, hosting or doing model training.

You know what I call the model builders?

But on the enterprise side, our order book now represents of the Total A I, uh, orders that we got in the backlog, which are actually our backlog went up quarter record.

And now we see higher interest both on the sovereign side and on the enterprise side on the sovereign side.

Obviously It's a little bit longer cycle because of the procurement and the and the strategy that countries have to put in place because they want to train their own, you know, data in the country not to move it around the world.

Uh, and that takes time.

But on the enterprise side, we see now an acceleration of maturity, of use cases in the deployment.

And that's why we see the meetings.

Now, remember, IHP Discover we introduced, uh, a what I call an A I in the box, which is the HP Private Cloud A I, uh this is a full turkey solution, uh, designed to either do fine tuning inference in or rag type of workloads, um, and then ultimately do it as a part of our HP Green Lake platform, which, by the way, had a terrific growth.

Another 3000 customers added to the platform.

We have now 37,000 customers on the platform that drove the subscription on the platform up 39% year over year.

There's been some concern on the street and maybe Antonio.

It came after that, uh, NVIDIA earnings report a week or so ago that a I related spending has slowed down a touch.

Now it's not falling off a cliff, obviously.

I mean, that's not the case at all.

But are you seeing any incremental signs that things will will slow down over the next couple quarters?

I don't see it.

And that's why I give you the insight about these three segments.

Uh, you know, in the enterprise space we are in the early stages in the sovereign.

We haven't really seen large deployments yet.

And on the sovereigns on the service provider side, we will continue to see very strong demand.

As this model get more sophisticated, more parameters are being built into it, which would require even more accelerated compute as we go forward.

And so to me, I, I think it's gonna come down.

Really, Brian, to the adoption of a I in the enterprise, which ultimately is what the realisation of the value really happened.

And that's why HP is uniquely positioned to accelerate time to value to these transformative technologies.

But personally, I don't see it and remember that our strategy is all synergistic.

We are, uh, you know, in the process of closing the juniper transaction that will drive a different financial profile for the company.

We're gonna double the networking business.

Uh, and networking is the core foundation to deliver these hybrid cloud and A I services going forward.

And so for me, networking, hybrid cloud and A I through Green Lake are all synergistic.

And that's why I'm very optimistic about, uh, Q four and as it locate into 2025.

Yeah, you mentioned that juniper.

And that's what I want to.

I want to drill down a little bit more on, uh, Antonio does the street.

Are they modelling correctly?

That integration of that business, I mean, And then how does your you know, how does the financial profile of a of a company like H PE change?

You know, if we're having this conversation a year from now, how will the company's financials look different?

Well, we are very pleased with the progress we have made through the, uh, regulatory approval and the planning of a successful integration to give, uh, a short update.

Brian, we have got in the European Union, the UK, India, Japan and many other jurisdictions.

Approvals.

Uh, obviously, we we need to wait for the United States.

Uh, and we believe we are on track to close the transaction by the end of calendar 2024 or early calendar 2025.

And when that that happens, the profile of the company changed dramatically because our current networking business, which is very much focused on the campus of branch segment of networking, is approximately $5 billion.

When we are juniper, we're gonna double.

So it's gonna be more than $10 billion revenue with a significant higher margin profile, obviously, because that's the industry standard for for networking and ultimately gives us the intellectual property and talent to deliver a modern A I driven fabric, which obviously is required for both cloud and a I.

And so, from a shareholder perspective, we're gonna deliver significant significant value through the synergies that we committed at the beginning of the transaction announcement, which were $450 million.

But we believe there is even more opportunities beyond that on the revenue a CRE we're gonna drive going forward.

Well, good luck on that Integration, Antonio, I hope to see you at the Goldman Sachs Tech conference last, uh, coming up in a in a few days.

That's always a fun one.

Lots of cool happenings there.

Antonio Neri.

Uh, H PE CO.

Always nice to see you.

We'll talk to you soon.

Thank you, Brian.