HP Inc. (Hewlett-Packard Company) — Q3 FY2014 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended July 31, 2014; comparisons are with the corresponding 2013 periods. HP reported seven segments: Personal Systems, Printing, Enterprise Group, Enterprise Services, Software, HP Financial Services, and Corporate Investments. Unless otherwise stated, financial amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Net revenue | $27.585B | $27.226B | $83.048B | $83.167B |
| Gross margin | 24.0% | 23.4% | 23.6% | 23.1% |
| Operating earnings / margin | $1.458B / 5.3% | $1.855B / 6.8% | $5.277B / 6.3% | $5.208B / 6.3% |
| Net earnings / margin | $985M / 3.6% | $1.390B / 5.1% | $3.683B / 4.4% | $3.699B / 4.4% |
| Diluted earnings per share | $0.52 | $0.71 | $1.93 | $1.89 |
- Q3 revenue rose 1.3% year over year (0.9% on a constant-currency basis); nine-month revenue declined 0.1% (up 0.4% constant currency).
- Q3 operating earnings and net earnings fell despite higher revenue and gross margin. HP attributed the lower operating margin chiefly to increased restructuring charges and R&D investment; Q3 restructuring charges were $649M versus $81M a year earlier.
- For the nine months, operating margin was flat as improved gross margin, lower intangible amortization, and segment improvements were offset by higher restructuring, R&D, and SG&A expenses.
- Segment trends: Personal Systems revenue grew 11.8% in Q3 and operating margin improved to 4.0%; Printing revenue fell 3.8% but operating margin rose to 18.4%; Enterprise Services revenue fell 6.4% while operating margin improved to 4.1%. Enterprise Group revenue grew 1.9%, but operating margin declined to 14.0%. Software revenue declined 5.0%; HP Financial Services revenue fell 2.7% and operating earnings declined 20.2%.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $9.632B, up from $8.792B. Investing cash outflow was $1.998B and financing cash outflow was $5.323B; cash increased $2.311B.
- Cash and cash equivalents at July 31 were $14.474B, compared with $12.163B at October 31, 2013. HP said cash and short- and long-term investments totaled $14.8B.
- Capital expenditures were $2.897B; proceeds from property sales were $702M. HP repurchased $1.978B of shares and paid $875M in dividends during the nine months.
- Outstanding borrowings were approximately $19.8B, down from $22.6B at October 31, 2013; weighted-average interest rates were 2.8% and 3.0%, respectively. Current liabilities were $42.476B and current assets $49.287B.
- HP reported $17.5B of available borrowing resources, including $16.2B under commercial paper programs and $1.3B in uncommitted credit lines. Ratings were unchanged; Moody’s outlook remained negative.
- The cash conversion cycle improved to 8 days from 18 days a year earlier. Management cautioned that the quarter’s level was below its expected sustainable rate and was affected by factors including expanded receivables factoring and supplier payment terms.
Material changes, outlook, and risks
- Restructuring: In May 2014, HP expanded its 2012 plan by 11,000–16,000 additional positions. As of July 31, it expected to eliminate 45,000–50,000 positions overall and estimated aggregate plan charges of about $4.5B. Approximately 36,000 positions had been eliminated; restructuring cash payments are expected to extend through fiscal 2021. HP estimated about $1.3B of future cash expenditures for approved plans.
- Management outlook and commentary: No specific consolidated revenue or earnings guidance is provided in the supplied filing text. Management said the pace of PC market contraction was slowing, while citing ongoing pressures from cloud and SaaS transitions, competitive pricing, weak printing supplies demand, Enterprise Services contract runoff, and execution challenges. HP continued investing in cloud, security, big data, and mobility.
- Tax matters: HP reported $4.0B of unrecognized tax benefits, of which up to $1.9B could affect its effective tax rate if realized. It said these benefits could decrease by up to $1.3B within 12 months, while timing and outcomes of tax audits remain uncertain.
- Legal and other contingencies: HP disclosed ongoing Autonomy-related investigations and shareholder litigation; copyright-levy disputes in Europe; a South Carolina contract dispute seeking about $275M; and India customs proceedings with assessments and penalties described in the filing. HP stated it had recorded adequate provisions and that, as of July 31, a material loss beyond recognized amounts was not reasonably possible, while noting litigation outcomes are inherently uncertain.
- FCPA resolution: HP reported paying the SEC approximately $31M and agreeing to pay the DOJ approximately $77M, alongside compliance, reporting, and cooperation obligations. Further proceedings and other investigations were ongoing.
- Principal stated risks include competitive and pricing pressure, market transitions, execution of restructuring and turnaround plans, macroeconomic and foreign-exchange exposure, supplier and product-quality disruptions, services-contract performance, cybersecurity, tax uncertainty, litigation, and maintaining credit ratings.
Important facts for investors to verify
- Whether Personal Systems growth and PC-market stabilization can offset continuing declines in Printing supplies and Enterprise Services revenue runoff.
- Whether the enlarged restructuring plan achieves expected savings on schedule, and how its charges and cash payments affect future margins and cash flow.
- The sustainability of operating cash flow and the improved cash conversion cycle, including the contribution from receivables factoring and extended supplier payment terms.
- Debt maturities and refinancing needs, available commercial-paper capacity, and any effect of a credit-rating change on funding costs or liquidity.
- Developments in the $4.0B of unrecognized tax benefits, major legal matters, and the financial and compliance consequences of the FCPA resolution.
- HP stated that its disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.