Marie Myers
Executive Vice President and Chief Financial Officer at Hewlett Packard Enterprise
Thank you, Antonio. I'm pleased to be with you today on my first earnings call as HPE's CFO. I've long admired HPE's impressive transformation, and there has never been a more exciting time to be part of this company. We have a growing addressable market, a proven strategy and a differentiated portfolio that is levered to long-term market trends around networking, hybrid cloud and AI. I believe we have a significant opportunity ahead of us. I'm excited to partner with Antonio and the rest of the outstanding HPE team to capitalize on this opportunity and drive value for our shareholders. And as Antonio mentioned, we have much to be proud of. Financial highlights in the quarter included record gross margins and expense discipline, which helped lift non-GAAP EPS to the high end of our guidance range.
Demand for our traditional server and storage products has stabilized. Demand for our HPE GreenLake offerings was evident in a healthy ARR growth and demand for our AI systems remains robust. However, demand in Intelligent Edge did soften due to customer digestion of strong product shipments in fiscal year '23, which is lasting longer than we initially anticipated and is the primary reason Q1 revenue came in below our expectations. GPU availability and deal timing also contributed. We are taking swift action to address these headwinds by curtailing costs and driving efficiencies across the business. With that, let's take a closer look at the details of the quarter. Revenue fell 14% year-over-year in constant currency to $6.8 billion.
Please recall, we had significant backlog consumption in Q1 '23, particularly in traditional servers and storage. Backlog has now largely normalized across our business with the exception of our APU products. We have strong momentum in HPE GreenLake. ARR exceeded $1.4 billion in Q1. Storage and networking software and services are the fastest growth elements of ARR. Our software and services mix rose 400 basis points year-over-year to 69%. ARR is the best indicator of our model transformation to our as-a-service offerings. This growth validates what our customers are telling us, that HPE GreenLake is a differentiated value proposition in the market.
Our Q1 non-GAAP gross margin was 36.2%. It rose 200 basis points year-over-year driven by a mix shift to Intelligent Edge and favorable input cost management. We are pleased that our non-GAAP gross margin is up 600 basis points from fiscal year '18 to a company record. This illustrates the ongoing pivot to higher growth, higher margin revenue across our portfolio. Given the current networking market dynamics, we are taking this moment to streamline and simplify our operations. We are focused on controlling the things we can control. Prudent cost management and disciplined execution are important regardless of the macro environment and are even more critical at times like these.
The benefits of our focus are already evident in our Q1 non-GAAP operating expenses, which declined 4.7% year-over-year at 9.5% sequentially to $1.7 billion. The strong Q1 non-GAAP gross margins and opex discipline led to Q1 non-GAAP operating margins of 11.5%, which is down only 30 basis points year-over-year despite less revenue scale. Favorable timing on some corporate expenses was a tailwind to Q1 operating expense and will appear in Q2. GAAP EPS of $0.29 and non-GAAP EPS of $0.48 exceeded the midpoint of our guidance range. Our diluted share count was approximately 1.3 billion, and non-GAAP diluted net earnings per share exclude $251 million in costs primarily from stock-based compensation expense, amortization of intangibles and noncash loss on investments.
As we manage the business with focus and discipline, we will also invest to capitalize on the sizable opportunities associated with moving through the interrelated inflection points in networking, hybrid cloud and AI all at the same time. HPE is evolving into a more simple, more agile company that is even better positioned to pursue our growth opportunities and to evolve our mix of products, services and software, and to drive structural higher profitability. Turning to our segment results. In addition to the new segments we discussed at SAM, we also created a new service segment that combines our prior compute and HPC and AI segment under one streamlined segment that offers solutions for our customers' training, tuning, and inferencing AI needs across their AI life cycle.
Server revenues were $3.4 billion in the quarter, which was down 23% year-over-year. This new segment had a difficult year-over-year compare as, in Q1 '23, the business made significant progress against its backlog and benefited from HPE Cray EX revenue for Frontier. We are capturing the robust growth in AI demand. Our cumulative APU orders since Q1 '23, which include APU attached products and services in our HPE Cray EX, XD and ProLiant systems, rose approximately $500 million sequentially to now $4 billion. Our pipeline is robust and GPU supply, while still constrained, is improving. Our APU product revenue increased sequentially to well over $400 million. We are now converting our APU orders into revenues, and yet very strong demand means our APU backlog is over $3 billion.
Our pipeline is well above that. AI revenue in the quarter included our first revenues from AI cloud offering and from our HPE GreenLake win with a large hyperscale customer. Our traditional high-performance computing and supercomputing revenue fell seasonally, sequentially following a strong Q4. Revenue from our traditional server business increased sequentially. We expect this trend to continue given a structural mix shift to higher AUP Gen11 and rising input costs. Gen11 servers nearly doubled sequentially to 30% of the mix in Q1. Including HPE, Cray XD takes the mix of next-generation servers to 44%. We are encouraged that our Gen11 pipeline is starting to include AI inferencing activity and enterprise applications. We expect AI inferencing to gather momentum in fiscal year '24.
As a reminder, our Gen11 services come with an attached subscription to our compute ops management software, which lifts our margin structure. Our Q1 operating margin was 11.4%. While up sequentially, the margin was down 430 basis points year-over-year given declining revenues. Intelligent Edge revenues were $1.2 billion or up 2% year-over-year. Demand for our campus switching and WiFi products eased materially, particularly in Europe and Asia, and was the largest contributor to our Q1 revenue gap. We continue to see mid-single-digit growth benefits from our existing backlog but expect these to normalize going forward as we are now approaching our typical range.
Our total channel inventory is within the normal range overall, inclusive of a pocket in the SMB business. We also continue to make progress in our new TAMs of data center networking, private 5G and SASE. The Intelligent Edge portfolio of subscription revenue grew well above 50% as we are benefiting from growing attach from our strong fiscal year '23 revenue growth. We are pleased with our 29.4% operating margin, which was up 1,000 basis points year-over-year. The new Hybrid Cloud segment includes our storage businesses and now the HPE GreenLake portion of our Server business. Revenues of $1.2 billion were down 10% year-over-year. Our traditional storage business was down year-over-year on difficult compares, given backlog consumption in Q1 '23. Total electro subscription revenue grew over 100% year-over-year and is an illustration of our long-term transition to an as-a-service model across our businesses.
We are starting to see AI server demand pull through interest in our file storage portfolio. We are also already seeing some cross-selling benefits of integrating the majority of our HPE GreenLake offering into a single business unit. Our operating margin was 3.8%, which was down 200 basis points year-over-year. Lower revenues and a high mix of third-party product impacted margins in the traditional storage business. Our HPE Financial Services revenue was down 2% year-over-year and financing volume was $1.4 billion. Our operating margin of 8.5% was up 130 basis points year-over-year. We are successfully passing through interest rate increases, and our asset management margins are returning to normal. Our Q1 loss ratio remained steady at 0.5%. Turning now to cash flow and capital allocation.
We generated $64 million in cash flow from operations and consumed $482 million in free cash flow this quarter. HPE typically consumes cash in the first half of the year and generates cash in the second half. Our first quarter free cash flow benefited from some prepayments associated with pending HPE GreenLake deals and HPE Cray XD shipments. Our cash conversion cycle was seven days, which is a reduction of eight days from Q1 '23. Our days payable and days of inventory were both higher, given the lower revenue and strong demand for APUs. We returned $172 million in capital to shareholders in Q1, primarily through our dividend. Before I discuss our outlook, let me first recap the key drivers that factor into our expectations for Q2 and the full year.
For server, we expect improving GPU supply to drive sequential revenue increases through fiscal year '24. Given improving supply and the timing of installations, we expect segment revenue and therefore, corporate revenue to be heavily weighted to the second half of the year. We expect the blended margin of the new segment to be flattish for the remainder of the fiscal year. For Intelligent Edge, we expect the market to remain soft throughout the year. Our cost reduction efforts will take time to show their benefits, which will result in margin pressure in Q2. Later in our fiscal year, we expect our normal channel inventory position and seasonal strength in the education market to be a modest revenue tailwind. We expect the full year margin to be in the mid-20% range.
For Hybrid Cloud, we expect sequential increases through the year as our traditional storage business improves and HPE GreenLake momentum continues. We expect meaningful progress through the year. With that context, let me turn to our outlook. For Q2, we expect revenues in the range of $6.6 billion to $7 billion or up slightly sequentially at the midpoint. We expect GAAP diluted net EPS to be between $0.20 and $0.25, and our non-GAAP diluted net EPS between $0.36 and $0.41. In part, given the higher prepayments in Q1, we expect negative free cash flow in Q2. Let me remind you that we have two drivers of potential lumpiness in our business. One is the timing and customer acceptances of large Cray wins, including Cray XD wins, which should ramp beginning in Q2. The second is the start of certain large HPE GreenLake deals.
For some of these large deals, our segments recognize the related hardware on installation. In our consolidated results, we eliminate the segment revenue and recognize it over time. Both large deals and higher eliminations are indicators of our confidence in the second half of the fiscal year. For fiscal year '24, we are revising our outlook, primarily given the current networking market headwinds. Let me remind you that we are excluding the H3C earnings and gain on sale from our non-GAAP results beginning in fiscal year '24. We now expect revised ranges for constant currency revenue and non-GAAP operating profit growth of 0% to 2%, GAAP diluted net EPS of $1.81 to $1.91 and non-GAAP diluted net EPS of $1.82 to $1.92.
The mix shift from Intelligent Edge to Server should also weigh on our gross margins. We now expect the full year non-GAAP gross margin to be slightly down from our prior full year expectation of 35%. We expect the impact of the cost actions we have initiated to materialize in the second half and leave fiscal year '24 opex to be flat to down from fiscal '23 opex. We expect our operating margin to be flattish year-over-year. We now expect OI&E to be $200 million to $250 million headwind versus our prior $300 million expectation, given better Q1 free cash flow and more favorable interest rate assumptions. We expect the effect on currency to be immaterial.
We expect free cash flow to be at least $1.9 billion in fiscal year '24. We expect significantly stronger free cash flow in the second half of the year led by improvements in inventories as AI service shipments ramp. We reiterate our commitment to our dividend, which was raised 8% from fiscal year '23 to fiscal year '24; debt repayment to maintain an investment-grade credit rating; and in long term, returning capital to shareholders through share repurchases. To conclude, we executed well in Q1 amidst a challenging market backdrop. We are pleased with our margin and EPS results while understanding our slower networking product demand and GPU availability and timing impacted our revenue performance.
We have taken prompt action to further reduce our costs and continue to manage our expenses prudently while we advance our long-term strategy. AI server demand is strong. Demand has stabilized for our traditional server and storage products, and our HPE GreenLake momentum is robust. We will continue to invest in IT inflections, networking, hybrid cloud and AI, to drive our pivot to higher growth, higher margin revenue. I look forward to engaging with you in the months ahead, as does our new Chief Strategy Officer, Shannon Cross, who has joined us following a distinguished career as a Wall Street analyst and now has oversight of our IR function. We will appreciate your input and questions along the way, and we can get started with that right now.
I'll open it up now for your questions about the quarter.
