Hewlett Packard Enterprise Company — FY2015 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended October 31, 2015, with comparative results for FY2014 and FY2013; fourth-quarter figures are for the three months ended October 31, 2015. HPE provides enterprise hardware, software, services and customer financing across five segments: Enterprise Group (EG), Enterprise Services (ES), Software, Financial Services (FS) and Corporate Investments. HP Inc. spun off HPE on November 1, 2015. Accordingly, most historical financials are combined results from when HPE operated within its former parent, and may not reflect the costs or results of an independent company.
Financial performance and liquidity
| Metric | FY2015 | FY2014 | Change / context |
|---|---|---|---|
| Revenue | $52.107 billion | $55.123 billion | Down 5.5% reported; flat at constant currency |
| Gross profit / margin | $14.939 billion / 28.7% | $15.637 billion / 28.4% | Margin up 0.3 percentage points |
| Operating earnings / margin | $1.523 billion / 2.9% | $2.335 billion / 4.2% | Margin down 1.3 percentage points |
| Net earnings / diluted EPS | $2.461 billion / $1.34 | $1.648 billion / $0.90 | FY2015 earnings included substantial tax benefits |
| Cash from operations | $3.661 billion | $6.911 billion | Down $3.250 billion |
| Cash used in investing | $5.413 billion | $2.974 billion | Higher, principally from acquisitions |
| Cash and cash equivalents at year-end | $9.842 billion | $2.319 billion | Increase largely reflected separation capitalization |
| Total debt at year-end | $15.794 billion | $1.379 billion | Includes debt raised for the separation |
| Total assets | $81.270 billion | $65.071 billion | Increase reflected capitalization and transferred assets |
FY2015’s $991 million income tax benefit (versus a $596 million tax provision in FY2014) drove reported net earnings above pre-tax earnings of $1.470 billion. The effective tax rate was negative 67.4%; management cited approximately $1.6 billion of net tax benefits from year-specific items, including release of U.S. deferred-tax valuation allowances, partly offset by foreign valuation allowances and separation-related tax charges. The filing reports current assets of $31.173 billion and current liabilities of $22.151 billion at year-end.
Segment revenue and operating results (segment operating earnings exclude specified corporate and restructuring costs): EG revenue $27.907 billion and operating earnings $3.981 billion (14.3% margin); ES $19.806 billion and $1.019 billion (5.1%); Software $3.622 billion and $788 million (21.8%); FS $3.216 billion and $349 million (10.9%); Corporate Investments revenue $7 million and operating loss $542 million. Segment revenue includes intersegment activity; consolidated revenue eliminates it.
Fourth-quarter revenue was $13.448 billion versus $14.073 billion a year earlier; operating earnings were $119 million versus $826 million. Net earnings were $1.385 billion versus $516 million, with the quarter including a $1.275 billion tax benefit. The filing therefore shows a sharp decline in Q4 operating earnings despite higher reported net earnings.
Material changes versus prior periods
- ES revenue fell 11.6% for the year, reflecting contract runoff, weak account growth and currency effects; its operating margin improved from 3.7% to 5.1% on delivery efficiencies and better performance in underperforming contracts.
- EG revenue increased 0.6% reported (6.2% constant currency), led by Industry Standard Servers and the Aruba acquisition. Traditional storage, Business Critical Systems and Technology Services declined; BCS revenue fell 13%.
- Software revenue declined 7.9% reported (4.1% constant currency), amid lower license revenue, SaaS transition and sales execution challenges. FS revenue declined 8.1% reported, mainly due to currency and lower customer buyout activity.
- Cash from operations fell to $3.661 billion. Management attributed the reduction primarily to a smaller improvement in the cash conversion cycle than in FY2014 and lower cash from financing receivables. The reported cash conversion cycle improved to 23 days from 27 days.
- HPE issued $14.6 billion of senior notes in October 2015; approximately $14.5 billion of net proceeds was distributed to HP Inc. as part of the separation capitalization plan. Year-end debt consequently rose materially.
Outlook, management commentary, risks and unusual items
- Strategy and outlook: Management emphasized hybrid infrastructure, cloud, security, big data, applications and mobility, alongside improving operations and sales execution. The filing does not provide a clear quantified consolidated revenue or earnings forecast for FY2016.
- Restructuring: The 2015 Plan, approved in September, is expected to run through FY2018 and includes up to approximately 30,000 employee exits, primarily in ES. Estimated pre-tax charges are approximately $2.6 billion, including about $2.2 billion for workforce reductions and $400 million primarily for real estate consolidation. Management estimated approximately $3.0 billion of future cash payments under approved restructuring plans, including $1.2 billion in FY2016.
- Other unusual FY2015 charges: $797 million of separation costs, $954 million of restructuring charges, $225 million of defined-benefit plan settlement charges and $136 million for data-center asset impairment. Aruba was acquired in May for approximately $2.8 billion; total cash used for five acquisitions was $2.644 billion.
- Planned transactions: HPE expected the sale of a 51% interest in its H3C/China server, storage and technology services business to close in FY2016 Q1 for approximately $2.3 billion, subject to approvals and other conditions. The TippingPoint sale for approximately $300 million was also pending at filing time.
- Separation risks: HPE had no operating history as an independent public company. Standalone administrative costs, financing costs and transition-service requirements could differ from historical allocations. Agreements with HP Inc., including tax, indemnification, transition-services and contract-assignment provisions, may affect costs and operations. Tax-free treatment of the spin-off and related indemnity obligations are also risks.
- Tax and contingencies: HPE reported $27.6 billion of foreign earnings intended to be indefinitely reinvested and $4.901 billion of unrecognized tax benefits. Tax audits and disputes could change tax expense or cash flows. Management said it had adequate litigation provisions and that, at October 31, 2015, a material loss beyond recorded amounts was not reasonably possible; nevertheless, it noted litigation is unpredictable. Matters described include Autonomy-related litigation and investigations, India customs proceedings and other legal disputes.
- Operating and market risks: Management highlighted competitive pricing, migration to cloud and SaaS, shrinking legacy hardware and UNIX demand, foreign-exchange exposure, macroeconomic weakness, supplier concentration, contract execution, cybersecurity and the risk of restructuring not delivering expected savings. About 61% of FY2015 revenue came from outside the United States.
- Capital returns and credit: The board authorized a $3.0 billion share-repurchase program, with repurchases dependent on liquidity and other factors. A quarterly dividend of $0.055 per share was authorized for payment in January 2016; future dividends are discretionary. A $4.0 billion revolving credit facility was entered into November 1, 2015.
Important facts for investors to verify
- Separate recurring operating performance from the unusually large FY2015 tax benefit and other restructuring, separation, pension-settlement and impairment charges.
- Assess post-spin standalone costs, cash generation and the terms and remaining duration of transition services with HP Inc.; historical results include parent allocations.
- Track ES contract runoff and turnaround progress, Software’s license-to-SaaS transition, and whether EG server growth offsets declines in legacy storage and BCS.
- Confirm completion and final proceeds of the H3C and TippingPoint transactions, and review any resulting changes to revenue, earnings and strategic positioning.
- Review debt maturities, interest-rate exposure, restructuring cash payments, pension funding needs and the availability of cash held outside the United States.
- Monitor tax audit outcomes, spin-off tax treatment, indemnification arrangements and material litigation developments, including the Autonomy-related matters.
- Note that the auditor opined that the financial statements fairly presented the company’s financial position and results under U.S. GAAP; the filing did not include management’s internal-control effectiveness assessment or an auditor attestation because HPE was a newly public company.