Financial Performance Overview

Hewlett Packard Enterprise (HPE) reported mixed financial results for the three and nine months ended July 31, 2019 compared to the prior-year periods. Total net revenue decreased 7.0% and 4.3% respectively, primarily due to declines in the company’s Hybrid IT and Financial Services segments.

However, gross margin improved significantly, increasing 3.4 percentage points to 33.9% in the third quarter and 2.7 percentage points to 32.4% for the nine-month period. This was driven by cost savings initiatives, a shift to higher-margin products, and lower commodity costs in the Hybrid IT segment.

Despite the gross margin improvement, operating margin declined 7.4 percentage points in the third quarter due to higher acquisition, transformation and R&D costs. For the nine-month period, operating margin decreased 1.0 percentage point.

Segment Performance

The Hybrid IT segment, which includes servers, storage and related services, saw the largest revenue declines of 9.2% and 5.5% respectively. This was primarily due to lower sales of Tier-1 servers, decreased revenue from China, and weaker demand for industry standard servers and HPE Pointnext services.

However, Hybrid IT earnings from operations as a percentage of revenue increased, rising 2.5 percentage points in the third quarter and 2.0 percentage points year-to-date. This was driven by the gross margin expansion, partially offset by higher operating expenses.

The Intelligent Edge segment, which includes the HPE Aruba networking business, also saw revenue declines of 2.9% and 1.5% respectively. This was due to lower sales of campus switching products, partially offset by growth in HPE Aruba Services. Intelligent Edge earnings from operations margin decreased significantly, down 8.0 percentage points in the third quarter and 5.8 percentage points year-to-date, due to higher operating expenses and lower gross margins.

The Financial Services (FS) segment experienced revenue declines of 4.3% and 1.1% respectively, driven by lower rental revenue and unfavorable currency impacts. However, FS earnings from operations margin increased, up 0.9 percentage points in the third quarter and 0.6 percentage points year-to-date, due to higher gross margins from lease extensions and buyouts, as well as lower operating expenses.

The smaller Corporate Investments segment, which includes the Communications and Media Solutions business, saw revenue declines of 3.0% and 7.7% respectively, with losses from operations remaining high at 19.2% and 22.0% of revenue.

Cash Flow and Liquidity

HPE generated $2.6 billion in operating cash flow for the first nine months of fiscal 2019, up $927 million from the prior-year period. This was driven by higher pre-tax earnings, partially offset by unfavorable working capital changes.

Cash, cash equivalents and restricted cash decreased by $1.0 billion to $4.1 billion, primarily due to $2.4 billion in share repurchases and dividend payments, as well as $1.7 billion in capital expenditures, partially offset by the operating cash flow.

HPE maintains a strong liquidity position, with $4.3 billion available under its commercial paper programs and $1.4 billion in uncommitted credit lines as of July 31, 2019. The company’s debt-to-equity ratio in the FS segment remained stable at 7.0x.

Outlook and Risks

HPE is in the midst of executing its HPE Next transformation initiative, which aims to streamline the company’s offerings, business processes and investments towards higher growth and margin solutions and services. This has provided some benefits, such as the gross margin expansion, but has also resulted in higher transformation and acquisition-related costs that have pressured operating margins.

Looking ahead, HPE will need to navigate ongoing market challenges, including weakness in Tier-1 servers, China, and industry standard servers, as well as sales execution issues in the Intelligent Edge business. Currency fluctuations also continue to be a headwind.

Key risks facing the company include the uncertain macroeconomic environment, competitive pressures, the ability to successfully execute transformation initiatives, and potential changes in customer buying patterns and technology trends. HPE’s large international operations also expose it to foreign exchange and geopolitical risks.

Overall, HPE delivered improved profitability in the quarter despite revenue declines, demonstrating progress in its strategic shift towards higher-margin products and services. However, the company still faces significant operational and market headwinds that will require continued focus and execution to overcome. Investors will be watching closely to see if HPE can sustain the gross margin improvements while managing costs and investing for future growth.