The venerable tenacity of the system supplier HPE

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Companies large and small that depend on Hewlett Packard Enterprise to build their systems and to certify them for an absolutely enormous amount of software and to support them for a long life in the field should send thank-you letters to the venerable systems manufacturer. Every business HPE does is tough, and while it’s tough enough to generate income in a hyperscale world, it’s even harder to make a few dollars to save for a rainy day.

And every year, quarter after quarter, through so many reorganizations and turnarounds that it’s hard to keep track of things, HPE stays in the game, grinding it down meter by meter. You can’t help but respect that. It is the triumph of looking forward to the future through the experience of the past. It also points out the place any IT vendors who might soar now need to go. Any surviving IT company must struggle to stay relevant after becoming venerable.

And to be fair, HPE under Chief Executive Officer Antonio Neri has steadily improved the company as it has doubled in on the core systems business it focuses on. But it’s never easy, is it?

For the quarter that ended in July, HPE sales soared 1.2 percent to just under $ 6.9 billion, and net income was $ 392 million, or 5 percent of sales, almost infinitely above the meager $ 9 million that the company posted last year.

Sales of ProLiant servers, which are now part of the Compute group along with HPE’s relatively small data center network, fell 8.4 percent to $ 3.1 billion during the reporting period, which is a little surprising when you consider the Supply chain constraints look at parts and manufacturing that all OEMs and ODMs in the IT sector deal with. Revenue here may be declining, but operating income rose 9.1 percent to $ 347 million, and that’s exactly what HPE is aiming for. In all fairness, the server space is going to be a lot more profitable for business than the HPC and AI cluster space unless five decades of history turn around. Which it won’t.

The High Performance Computing & Mission Critical Systems group, which combines the supercomputer businesses SGI and Cray with the high-end Superdome NUMA servers, had sales of $ 741 million, an increase of 11.1 percent. But operating income here is low at just $ 29 million, down a substantial 38.3 percent.

We’ve said it before and will say it again: someone has to invest in HPC and now in AI architectures because that work needs to be done but this is a very tough market to capitalize on unless You are the semiconductor manufacturer in charge of the compute engines or the memory chips or maybe the flash drives. To illustrate this point, the Compute Group’s operating income was 11.2 percent of sales compared to 3.9 percent of sales for the HPC & MCS Group’s operating income.

So it’s wonderful that the HPC and MCS business has grown, fueled by “a record number of new orders,” as Neri put it in a conference call with Wall Street analysts going through the numbers, and it’s wonderful that that Order Book has $ 2.5 billion deals in prospect in the next few years, and it’s wonderful that HPE has an 80 percent win rate on exascale-class systems when it bids when you do the math that 3.9 percent of $ 2.5 billion is only $ 98 million. Profit margins on these businesses need to increase, but that cannot happen until the “Shasta” systems are more widespread in corporations, governments, and universities, where smaller businesses generate slightly higher profits.

Always the bet when it comes to the profitability of HPC and now AI. Intel and Nvidia make most of the profits from these HPC and AI systems. And competition for compute engines will make iron cheaper, but not necessarily increase HPE’s profit margins. In fact, we doubt that it will. If anything, the compute engine vendors, who face increasing competitive pressures as more CPUs, GPUs, and FPGAs come into play, will rely more, not less, on the margins of their OEM partners.

As I said, send thank you letters.

And HPE will suffer from the shift in the next few years from transactional equipment sales on its IT customers’ capital budgets to the necessary and good new GreenLake subscription model that will go with HPE on the operating expense budget of retaining ownership of the equipment while they are paid in a cloud form. HPE added 200 new GreenLake customers, bringing the total to 1,100, and the annualized run rate on GreenLake sales was $ 705 million, up 33 percent from last year. In our opinion, this puts a strain on hardware sales, just as it has done with every major software vendor when it switched from perpetual licensing to subscription licensing. At some point everything will level out. As with the $ 2 billion deal HPE struck with the US National Security Agency just this week to raise prices for all types of HPE equipment to be installed in a private NSA data center price.

Neri is targeting an average annual growth rate for this GreenLake business that will be between 30% and 40% between fiscal 2020 and fiscal 2023, inclusive.

It gets very complex to track sales of systems, but right now the GreenLake numbers are going into the appropriate HPE groups and departments based on the labels on the devices and according to the proper revenue recognition. At some point, far in the future, all equipment may be sold this way. Why not? Why own it when you can take advantage of all the advantages of ownership – control, location, security – without pressure on your balance sheet. It makes sense to us. Let HPE’s bottom line take the heat.

As always, we care about how the core systems business is performing at HPE, and this table, which we’ve updated with the latest operating income for servers, networks, and storage, gives you an idea:

Add all that together, HPE’s core systems business declined 3.6 percent to just over $ 5 billion, but operating income rose 3.6 percent to $ 554 million, or about 11 percent of sales. We don’t have any operating profit data that dates back to 2009, but we’ll see if we can find it and update it.

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