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Hewlett-Packard (HPE) Q2 Earnings in Line, Revenues Beat

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Shares of Hewlett-Packard Enterprise Company (HPE - Free Report) soared nearly 12% during yesterday’s afterhours trading session after the company announced robust results for the second quarter of fiscal 2016 as well as major progress on its ongoing restructuring initiative.

Quarterly Results

This was the second quarterly earnings release by Hewlett-Packard Enterprise post its split from Hewlett-Packard Company. Notably, Hewlett-Packard Company split itself into two standalone companies — HP Inc. (HPQ - Free Report) and Hewlett-Packard Enterprise — effective Nov 1, 2015. Post the split, Hewlett-Packard Company’s PC and printer business operates under HP Inc., while Hewlett-Packard Enterprise specializes in commercial tech products.

During the second quarter of fiscal 2016, Hewlett-Packard Enterprise’s earnings met the Zacks Consensus Estimate while revenues beat the same.

Revenues

Hewlett-Packard Enterprise reported total revenue of $12.711 billion, above the Zacks Consensus Estimate of $12.419 billion and up 1.3% year over year. Notably, this was the first time in the last five years that the company’s revenues witnessed year-over-year growth. The improvement was mainly driven by a strong performance at the Enterprise Group segment.

On a constant currency basis, revenues increased 5% year over year, representing the fourth consecutive quarter of revenue growth.

Segment-wise, revenues at the Enterprise Group were up 7% from the year-ago quarter to $7.010 billion, driven primarily by higher contributions from Networking (up 57%), Servers (7%) and Storage (2%), partially offset by a 6% decline in Technology Services.

Enterprise Services revenues were down 2% to $4.723 billion. Revenues were hurt by a 3% decline in Application and Business Services, and a 1% dip in IT Outsourcing.

Software revenues were down 13% to $774 million mainly due to a weak performance at the IT Management division, which more than offset sales growth at Security and Big Data.

Financial Servicesrevenues fell 2% year over year to $788 million.

Operating Result

Hewlett-Packard Enterprise’s non-GAAP gross margin was up 10 basis points (bps) on a year-over-year basis to 28.7%. However, as a percentage of revenues, the company’s non-GAAP operating margin contracted 50 bps to 7.9% mainly due to higher operating expenses.

Non-GAAP net income came in at $731 million or 42 cents per share, compared with $805 million or 44 cents per share reported a year ago. Non-GAAP earnings were, however, in line with the Zacks Consensus Estimate.

Balance Sheet and Cash Flow

Hewlett-Packard Enterprise ended the fiscal second quarter with $9.010 billion in cash and cash equivalents, compared with $8.505 billion at the end of the previous quarter. Long-term debt during the quarter was $15.247 billion, compared with $15.229 billion last quarter.

Hewlett-Packard Enterprise used a net cash of $1.121 billion for operational activities during the first half of fiscal 2016. Moreover, during the period, the company repurchased $1.212 billion shares and paid dividends worth $190 million.

Guidance

Hewlett-Packard Enterprise reiterated its earnings guidance for the full year. The company still expects non-GAAP earnings per share between $1.85 and $1.95 (mid-point: $1.90). The Zacks Consensus Estimate for non-GAAP earnings is pegged lower at $1.89.

Moreover, the company still expects to return at least 100% of free cash flow to shareholders in fiscal 2016. Apart from this, the company also intends to use a major portion of the proceeds from the Tsinghua transaction (approximately $2 billion) for share repurchases.

For fiscal third quarter, the company expects to report GAAP earnings per share in the range of $1.10 to $1.14 (mid-point: $1.12) and non-GAAP earnings of 42–46 cents. The Zacks Consensus Estimate is currently pegged at 49 cents.

Spin-Off and Merger of Enterprise Services Business

Yesterday, the company took a step toward restructuring its struggling IT services business as it announced the spin-off of the Enterprise Services segment, following which the segment will merge with Computer Sciences Corporation . The transaction is expected to allow Hewlett-Packard Enterprise to focus on faster growing businesses and unlock value for shareholders.

The transaction, which is scheduled to close in Mar 2017, will deliver approximately $8.5 billion to Hewlett-Packard Enterprise’s shareholders on an after-tax basis. This includes $4.5 billion in the form of equity in the combined company, $1.5 billion in cash dividend and $2.5 billion of debt assumption.

Our Take

Hewlett-Packard Enterprise reported strong second-quarter fiscal 2016 results, wherein the top line surpassed the Zacks Consensus Estimate and earnings came in line. Moreover, revenues witnessed year-over-year growth for the first time in five years.

In our opinion, the parent company’s (Hewlett-Packard Company) initiative to split the business has already started reaping benefits for Hewlett-Packard Enterprise. We believe that splitting the businesses has ensured a customized approach for two different kinds of businesses, which might not have been possible as a single entity.

Hewlett-Packard has done considerably well in the enterprise class server and storage markets. The company focuses its resources on the high-margin software and security markets as well. We believe that the company’s traction in the cloud, security and Big Data segments will drive growth, going forward.

Furthermore, Hewlett-Packard Enterprise’s strategic divestments and initiatives to return value to shareholders in the form of dividend and share repurchases are positives.

However, macroeconomic challenges and tepid IT spending remain near-term concerns. Competition from International Business Machines (IBM - Free Report) and Oracle further add to its woes.

Currently, Hewlett-Packard Enterprise carries a Zacks Rank #3 (Hold).

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