Business context and reporting period
Hewlett Packard Enterprise Company (HPE) filed this unaudited Form 10-Q for the fiscal quarter and six months ended April 30, 2019. HPE develops enterprise technology spanning edge to cloud and reports four segments: Hybrid IT, Intelligent Edge, Financial Services (FS), and Corporate Investments. Comparisons below are with the periods ended April 30, 2018, unless noted.
Financial results and liquidity
| Metric | Quarter | Six months |
|---|---|---|
| Net revenue | $7.15 billion, down 4.3% (2.2% constant currency) | $14.70 billion, down 2.9% (1.7% constant currency) |
| Gross margin | 32.2%, up 2.0 percentage points | 31.6%, up 2.4 percentage points |
| Earnings from continuing operations | $434 million | $890 million |
| Net earnings | $419 million; diluted EPS $0.30 | $596 million; diluted EPS $0.43 |
| Operating cash flow | Not presented for the quarter | $1.37 billion, versus $389 million |
| Capital expenditures | Not presented for the quarter | $1.53 billion; PP&E sale proceeds were $371 million |
Quarterly net earnings were below 2018’s $778 million and six-month net earnings were below $2.21 billion. The prior-year comparisons were materially affected by unusually large tax benefits and tax indemnification items; 2018 also included discontinued-operation losses. Thus, reported net income and effective tax rates are not straightforward indicators of underlying operating trends. HPE’s effective tax rate was 4.8% for the quarter and 45.6% for the six months; the corresponding 2018 rates were unusually high and significantly affected by discrete tax items.
At April 30, 2019, cash and cash equivalents were $3.59 billion ($3.79 billion including restricted cash); total current assets were $15.0 billion and current liabilities $16.1 billion. Current and long-term debt totaled approximately $12.45 billion ($2.11 billion current and $10.33 billion long-term). Six-month cash fell by $1.30 billion, principally reflecting $1.39 billion of share repurchases, $311 million of dividends, and investment spending, partly offset by operating cash flow. HPE reported $4.0 billion of revolving-credit commitments, $4.45 billion of available commercial-paper resources, and $1.55 billion of uncommitted credit lines.
Segment performance
- Hybrid IT: quarterly revenue $5.64 billion, down 4.4%; operating earnings $645 million, up 9.1%. Lower Tier-1 server and Pointnext revenue was partly offset by Storage growth.
- Intelligent Edge: quarterly revenue $666 million, down 5.7%; operating earnings $20 million versus $56 million. Aruba product weakness and North American sales execution issues weighed on results; services revenue grew.
- Financial Services: quarterly revenue $896 million, down 2.2%; operating earnings $77 million, up 6.9%. Six-month revenue increased 0.6% and operating earnings rose to $154 million.
- Corporate Investments: quarterly revenue $125 million, down 6.7%, with an operating loss of $29 million.
Material changes and management commentary
Revenue softness was concentrated in Hybrid IT, including lower Tier-1 server sales and Pointnext demand, and Intelligent Edge product sales. HPE said it was deliberately exiting less-profitable product categories and cited North American go-to-market execution challenges. Storage growth, including Nimble, and higher-margin product mix supported margins. Cost management and lower commodity costs also helped; higher R&D spending and acquisition-related charges partly offset those gains. HPE Next transformation costs declined to $54 million for the quarter and $132 million for the six months, from $120 million and $365 million, respectively.
Management said internally generated cash flows, cash balances, and capital-market access should generally support operating needs, investments, debt service, restructuring, and potential shareholder returns. The HPE Next initiative is expected to continue through fiscal 2020. HPE expects approximately $0.8 billion of future restructuring cash payments, including about $0.2 billion during the remainder of fiscal 2019. The filing provides no specific revenue or earnings guidance.
Outlook, risks, contingencies, and unusual items
- On May 16, 2019, after quarter-end, HPE agreed to acquire Cray Inc. for $35 per share in cash, in a transaction valued at approximately $1.3 billion net of cash acquired. Closing was expected by the first quarter of fiscal 2020, subject to approvals and customary conditions.
- HPE identified trade-policy changes, tariffs, and a May 2019 U.S. supply-chain security executive order as potential sources of higher costs, operational changes, lower demand, or reduced margins. Other cited risks include competition, execution, macroeconomic and geopolitical conditions, currency movements, suppliers, and product transitions.
- Unrecognized tax benefits were $8.8 billion; HPE said up to $6.4 billion could be reduced within 12 months, though up to $210 million of that amount would affect the effective tax rate if realized. HPE also reported approximately $1.5 billion of recorded uncertain-tax-position liabilities and related interest and penalties.
- A DXC indemnification arbitration concerning transferred lease obligations was completed, with the panel’s ruling pending. DXC asserted that the relevant threshold was exceeded by approximately $1.0 billion. HPE said it had recorded adequate litigation provisions and did not believe a material loss beyond recognized amounts was reasonably possible, while noting that litigation outcomes can affect results.
- HPE’s $1.4 billion of first-half repurchases reduced shares outstanding; $3.3 billion of authorization remained. The quarterly dividend declared was $0.1125 per share.
Important facts for investors to verify
- Whether Hybrid IT and Intelligent Edge revenue and operating trends improve, particularly server sales, Pointnext demand, and Aruba sales execution.
- How sustainable the gross-margin improvement is, given product mix, cost savings, commodity prices, currency, and rising R&D investment.
- The cash impact of capital spending, buybacks, dividends, and HPE Next restructuring, alongside debt maturities and liquidity needs.
- Developments in tax audits and indemnification matters, the DXC arbitration ruling, and other material litigation or contingencies.
- Cray acquisition closing, funding, integration, and expected contribution; the filing does not quantify expected synergies or earnings impact.