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Hewlett Packard Enterprise Co. (NYSE:HPQ) reported disappointing fiscal third-quarter results, particularly in terms of profit margins, raising concerns about the company's profitability in its expanding artificial intelligence (AI) server business. Adjusted gross margins came in at 31.8%, falling short of analysts' expectations of 33.4%. This marks a decline from the same period last year and was attributed to the "higher mix of AI server revenue," according to Chief Financial Officer Marie Myers. The market reacted negatively to the news, with shares falling about 3% in extended trading after closing at $18.77 in New York.
AI Server Demand Drives Revenue, But Margins Lag
HPE has been capitalizing on the growing demand for high-performance servers designed to handle AI tasks, a trend also benefiting competitors like Dell Technologies Inc. and Super Micro Computer Inc. In the quarter ending July 31, HPE reported $1.3 billion in revenue from its AI server business, a 39% increase from the previous quarter, exceeding analysts' estimates. Total revenue for the quarter increased 10% year-over-year to $7.71 billion, surpassing the $7.66 billion expected by analysts.
However, despite this sales momentum, the lower margins associated with AI servers—driven by the high cost of semiconductors from companies like Nvidia Corp.—remain a significant concern for investors. As analyst Woo Jin Ho from Bloomberg Intelligence noted, HPE's "weak AI-server margin" reflects a broader trend in the industry, which has also affected companies like Super Micro and Dell in recent quarters.
CEO Optimistic About Long-Term Profitability
While margins are currently a challenge, HPE's Chief Executive Officer Antonio Neri expressed optimism about the company's future. Neri stated that over time, HPE plans to sell more higher-margin products and services alongside its AI servers, potentially improving overall profitability. The company is also seeing growing demand for its AI server solutions from enterprises and government agencies, in addition to cloud service providers, which remain its primary customers.
HPE's strong sales momentum is expected to continue into the next quarter, with projected revenues of $8.1 billion to $8.4 billion. The company also anticipates adjusted earnings per share of 52 cents to 57 cents, compared to analysts' average estimate of 54 cents. These projections reflect the company’s efforts to balance revenue growth with profitability concerns.
Strategic Moves and Financial Flexibility
In addition to its AI server business, HPE reported a significant financial transaction this quarter. The company received $2.1 billion from the partial sale of its stake in H3C Technologies Co., a deal that will impact the company’s financials in the current quarter. Neri indicated that the cash influx would help fund HPE’s planned acquisition of Juniper Networks Inc., a strategic move expected to close by late 2024 or early 2025.
