Hewlett Packard Enterprise (HPE) had a quarter that would make most CFOs blush: revenue up 34%, adjusted operating profit more than doubled, and earnings per share that blew past what Wall Street had penciled in. But here's the twist: the company's stock still took a hit in premarket trading on Thursday. Why? Because even when you're riding the AI wave, supply constraints are like that uninvited guest who shows up to the party and eats all the snacks.
Let's break down the numbers. For its fiscal third quarter, HPE reported revenue of $12.2 billion, beating the Street's estimate of $11.91 billion. Adjusted operating profit came in at $2 billion, more than double what it was a year ago. Adjusted earnings per share hit $1.11, comfortably above the 93 cents analysts were expecting. On paper, this is a home run.
The engine behind this growth? Artificial intelligence and networking. Orders are growing faster than revenue, which is a nice problem to have, but it's also a sign that demand is outstripping what HPE can actually deliver. Normalized orders surged 42%, and the company's backlog hit an all-time high. But here's the catch: supply constraints are still getting in the way of turning all that demand into actual shipped products.
Gross margins also crossed a psychological threshold, with adjusted gross margin topping 40%. But management is already pouring cold water on that, saying margins will likely moderate back toward historical levels as AI systems become a bigger slice of the pie and traditional server margins settle down.
Inventory swelled to $11.8 billion at the end of the quarter, up both sequentially and year-over-year. That's not necessarily a bad sign; it reflects higher commodity costs and some strategic buying to support the growing backlog. HPE is essentially stocking up to make sure it can deliver when supply chains loosen up.
In terms of shareholder returns, HPE returned $324 million to common shareholders during the quarter, including $189 million in dividends and $100 million in share repurchases. The company also ended the quarter with net leverage of 1.8 times, below its 2-times target, after receiving about $1.4 billion from H3C transactions and repaying a term loan. And later this month, HPE plans to retire $1.25 billion of notes following the sale of its telco solutions business.
Hewlett Packard Business Performance
Drilling into the segments, networking revenue rose 10% on a normalized basis to $2.9 billion, but orders jumped 36%, about 3.5 times faster than revenue. Data center networking revenue actually fell 6% due to shipment timing, but strong demand from hyperscalers and NEO cloud customers pushed networking backlog to a record.
The AI story is particularly compelling. Networks-for-AI orders reached $2.2 billion, which already exceeds HPE's fiscal 2026 target. So, the company raised its year-end goal to $2.5 billion-$3 billion. To secure supply, HPE more than doubled its networking purchase commitments sequentially. That's a bold move, but it shows how serious the company is about capturing this market.
Cloud and AI revenue hit a record $9 billion, up 25%, while server revenue rose 35% sequentially, driven by higher average selling prices that offset supply-constrained volumes. AI Systems orders increased more than 30% sequentially to $2.4 billion, and backlog rose 14% to another record. AI Systems revenue was nearly $1.6 billion, and the company expects fourth-quarter revenue to improve as that backlog converts.
Cloud and AI operating margin also improved significantly, rising 460 basis points sequentially to 17% in the third quarter. But again, management expects that to moderate to the mid-teens in the fourth quarter. It's a pattern: strong results now, but a cautious outlook on margins as the mix shifts.
Supply Constraints Limit Demand Fulfillment
HPE's CEO was candid about the challenges. Ongoing supply constraints continue to limit the company's ability to meet the increased customer demand. He expects server demand to remain exceptionally strong, with HPE's pipeline sitting at multiples of its current backlog. That's a lot of potential revenue just waiting for the supply chain to catch up.
The CFO added some color, revealing that after the quarter ended, HPE secured a multibillion-dollar server deal with a hyperscaler customer. That's a big win, and it underscores the demand environment. The company expects AI Systems revenue to improve sequentially in the fourth quarter, driven by the timing of backlog conversion.
Hewlett Packard Guidance Raised
Looking ahead, HPE raised its guidance for the fiscal fourth quarter and full year. For Q4, the company expects adjusted EPS of $1.20-$1.30, above the $1.07 analyst estimate. Revenue is projected at $13.9 billion-$14.8 billion, compared with the $12.961 billion consensus. That's a massive beat if it materializes.
However, total operating margin is expected to decline sequentially in the fourth quarter, mainly because of a higher mix of AI Systems and pricing factors. Networking revenue is expected to grow 11%-13%, supported by stronger orders and improved supply-chain conversion. Cloud and AI revenue is projected to increase 60%-72%.
For fiscal 2026, HPE raised its adjusted EPS outlook to $3.75-$3.85 from $3.35-$3.45, above the $3.43 estimate. Revenue guidance was also increased to $45.957 billion-$46.986 billion from $44.242 billion-$45.614 billion, compared with the $44.944 billion analyst estimate. The guidance increase reflects continued growth in AI infrastructure investments and strategic partnerships, including an expanded collaboration with Oracle Corp. (ORCL).
HPE also expects free cash flow of at least $3.75 billion in fiscal 2026 and plans to return at least 75% of fourth-quarter free cash flow to shareholders. That's a shareholder-friendly move.
And for fiscal 2027, HPE is already setting expectations: revenue growth of 13%-17%, including networking growth of 14%-17% and Cloud and AI growth of 14%-18%. Operating profit is projected to rise 14%-18%, with an operating margin of 14%-15%. Networking margin is expected to remain in the mid-to-high 20% range, while Cloud and AI margin is projected at approximately 13%.
Operating expenses are expected to decline in fiscal 2027 as variable compensation normalizes, while Catalyst transformation efficiencies and Juniper integration synergies provide additional savings. The Juniper integration is ahead of schedule, with HPE targeting $600 million in annual run-rate savings by fiscal 2028. Integration costs are tracking below plan.
So, what's the takeaway? HPE is firing on all cylinders when it comes to demand, but the supply chain is the bottleneck. The company is doing what it can to secure supply and convert backlog, but until that improves, there's a limit to how much of that demand can turn into revenue. Investors seem to be focusing on that constraint, sending shares down 3.30% to $50.12 in premarket trading on Thursday, according to market data.
It's a classic case of good news and bad news wrapped into one earnings report. The good news is that AI is driving unprecedented demand. The bad news is that HPE can't fully capitalize on it just yet. But with a raised outlook and a clear path to growth, the company is positioning itself well for when supply catches up.
