HP Inc. 2016 Q3 Form 10-Q Summary
Business context and reporting period
HP Inc. reported unaudited results for the three and nine months ended July 31, 2016. Following the November 1, 2015 separation of Hewlett Packard Enterprise (HPE), HP’s continuing business comprised Personal Systems, Printing and Corporate Investments. Prior-year continuing results exclude HPE; total net earnings comparisons are also affected by HPE results presented as discontinued operations.
Key financial metrics
| Metric | Three months ended July 31, 2016 | Nine months ended July 31, 2016 |
|---|---|---|
| Net revenue | $11.892 billion, down 3.8% year over year (down 0.7% constant currency) | $35.726 billion, down 8.9% (down 3.8% constant currency) |
| Gross profit / margin | $2.172 billion / 18.3%, down 0.5 percentage points | $6.707 billion / 18.8%, down 0.5 percentage points |
| Earnings from continuing operations | $1.117 billion | $2.886 billion |
| Net earnings | $783 million; diluted EPS $0.45 | $2.004 billion; diluted EPS $1.15 |
| Operating cash flow | Not presented for the quarter | $2.532 billion, versus $3.881 billion in prior-year period |
- Q3 net earnings from continuing operations were $843 million, compared with $700 million a year earlier. Total net earnings fell from $854 million because discontinued operations recorded a $60 million loss versus $154 million of earnings.
- Cash and cash equivalents were $5.636 billion at July 31, down from $7.584 billion at October 31, 2015. Current assets were $17.402 billion and current liabilities $18.114 billion.
- Debt was $6.835 billion, comprising $75 million of short-term borrowings and $6.760 billion of long-term debt, versus $8.871 billion at October 31, 2015. HP had a $4.0 billion committed revolver available through April 2019 and $833 million of additional uncommitted borrowing resources; it reported compliance with facility covenants.
- For the nine-month period, investing activities used $116 million and financing activities used $14.213 billion, including a $10.375 billion net cash transfer to HPE. HP repurchased $1.159 billion of stock and paid $646 million in dividends.
- HP reported a $3.926 billion stockholders’ deficit at July 31, compared with $28.151 billion of equity at October 31; the change reflects the separation and related balance-sheet changes.
Material changes versus the prior comparable period
- Printing revenue declined 14.3% in Q3 and 15.8% year to date. Supplies revenue fell 17.8% in Q3, affected by the shift to a demand-led sales model, currency, prior-year channel inventory build and weaker demand. Printing operating margin rose to 20.4% in Q3, partly supported by divestiture gains.
- Personal Systems Q3 revenue was nearly flat at $7.512 billion, with notebook growth offset by declines in desktops and other areas. Segment operating margin improved to 4.4% from 2.8%. Nine-month revenue decreased 7.8%.
- Consolidated gross margin declined 0.5 percentage points in both comparison periods, reflecting currency, mix and lower Supplies revenue; operational improvements and favorable pricing partly offset these pressures.
- SG&A decreased 32.0% in Q3 and 21.4% year to date, principally from software-asset divestiture gains, lower corporate costs and savings initiatives. Divestitures to Open Text generated a $280 million Q3 gain and a separately disclosed $103 million gain for the earlier transaction year to date (including $56 million in Q3).
- Year-to-date operating cash flow was lower than the prior-year period, but the comparison is not like-for-like: 2015 cash flow included HPE’s pre-separation operations, while 2016 does not.
Outlook, management commentary, risks and unusual items
- Management gave no specific financial guidance in the supplied filing text. It anticipated continued PC-market headwinds and cited weak demand, competitive pricing, foreign-exchange effects and the Supplies sales-model transition as pressures. Its stated priorities included profitable growth in Personal Systems, higher-value printing products, contractual printing models and operating efficiencies.
- Management said cash, expected operating cash generation and capital-market access should cover expected near-term outlays. It expected approximately $200 million of future cash payments under the Fiscal 2015 restructuring plan and approximately $120 million of remaining separation-cost payments, expected in the rest of fiscal 2016.
- Brexit was identified as a source of potential market uncertainty, exchange-rate volatility and weaker macroeconomic conditions. Other cited risks included competitive pressure, demand weakness, currency movements, execution of restructuring and strategy, suppliers and distribution, and international operations.
- A California jury awarded HP approximately $3.0 billion in its Oracle litigation on June 30, 2016. The court had not entered judgment by the filing date and Oracle stated it intended to appeal. HP and HPE are to share any recovery equally after HPE is reimbursed for specified pre-separation prosecution costs.
- HP reported a $1.155 billion tax-indemnification receivable from HPE under the separation tax matters agreement; the amount may change as tax matters are resolved. Unrecognized tax benefits totaled $9.6 billion, including accrued interest and penalties of $153 million.
- HP said it had adequate provisions for litigation and that, as of July 31, 2016, a material loss in excess of recognized amounts was not reasonably possible. It also disclosed ongoing tax, Autonomy-related, anti-corruption, environmental and other legal matters. Approximately 17,000 terminated vested pension participants elected lump-sum payments; settlement expense was expected in Q4 fiscal 2016.
- Disclosure controls were deemed effective, and HP reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the Q3 earnings and margin performance reflects divestiture gains, and how sustainable are underlying segment margins?
- Whether Printing revenue stabilizes as the Supplies sales-model and channel-inventory changes run their course.
- The status, final judgment, appeal and potential cash timing of the Oracle award, including HP’s sharing arrangement with HPE.
- The collectability and timing of the HPE tax-indemnification receivable, and exposure from uncertain tax positions and related disputes.
- Cash-flow generation and liquidity after separation-related transfers, debt repayment, restructuring payments, dividends and share repurchases.