HP Enterprise finally gets an AI bump, but server margins are a concern

By Therese Poletti

Executives tout booming AI-server sales, but warn that will weigh on profit margins

Hewlett Packard Enterprise is finally seeing a boost from artificial intelligence, in the form of server sales, but margins are a bit of a concern in what is becoming a competitive arena.

HPE reported a sizeable beat in its fiscal-second quarter earnings Tuesday, and investors were pleased with the company's progress in AI. Executives noted that sales of HPE's AI servers doubled sequentially to over $900 million in the quarter, fueling a nearly 16% jump in its shares in after-hours trading.

"I am very pleased that our AI system-product revenue more than doubled sequentially," HPE Chief Financial Officer Marie Myers told analysts. AI servers are part of its overall server business segment.

While HPE (HPE) saw its total server revenue jump 18% in its fiscal second quarter to $3.86 billion - indeed, the bright spot in the quarter - operating margins in servers fell to 11% of revenue, down from 14.4% a year ago. That was a similar pattern investors saw last week with Dell Technologies Inc. (DELL).

More: Why Dell's stock had its worst day since 2018 despite strong AI demand.

HPE also said that the shift of more sales coming from AI servers would weigh on its profit margins, and predicted that non-GAAP gross margins would be below its previous expectations of 35% for the full 2024 fiscal year, citing the product-mix shift to more AI servers from networking. Operating margins for the year will be flattish, Myers noted.

Analysts asked more about margins, but one also noted that HPE's margins were holding up better than competitors Dell or Super Micro Computer Inc. (SMCI). Executives said there was "aggressive pricing" in the market. "It's a pretty competitive market out there," Myers said. "But clearly, we're managing it very well."

Also read: Super Micro's stock one of S&P 500's biggest laggards after Dell's earnings.

HPE also said it is engaging in more cost management to drive efficiencies across its business, including accelerating its own use of AI, such as using HPE-specific large language models and chatbots for its sales and service representatives.

Both Myers and HPE CEO Antonio Neri noted that the company will see more of a boost to its services business as customers need more help deploying AI servers, including the need for liquid cooling, as they move toward adopting Nvidia Corp.'s (NVDA) new Blackwell systems, which consumer massive amounts of power.

"People are coming to realize that running the systems at scale requires unique services capabilities," Neri said. He also said that HPE has three different ways to cool systems, and that it has been developing liquid-cooling systems for a long time. Liquid cooling is a thermal management technique used to help remove the intense heat from servers and chips.

HPE has been in the supercomputer business for years, and in 2019 it bought Cray Inc. for $1.3 billion, the remaining vestige of supercomputer pioneer, Cray Research, which developed some of the earliest liquid-cooled systems in the 1980s.

So while HPE investors are finally seeing a pop in the company's stock related to its AI offerings, they are also seeing that not every company will have massive AI profits. It appears that Nvidia is still reaping the fattest margins of all related to AI. Other hardware makers can only hope for a smaller piece of that massive AI pie.

-Therese Poletti

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06-04-24 2130ET

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