HP INC quarterly report, Q2 FY2010

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HP Inc. (Hewlett-Packard Company) — Form 10-Q Summary

Reporting period: Second quarter and first six months of fiscal 2010, ended April 30, 2010. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise indicated.

Business context

HP reports seven segments: Services, Enterprise Storage and Servers (ESS), HP Software, Personal Systems Group (PSG), Imaging and Printing Group (IPG), HP Financial Services (HPFS), and Corporate Investments. Its strategy emphasizes operational efficiency, growth investment, and broader enterprise offerings. HP completed its 3Com acquisition during the quarter and agreed to acquire Palm.

Financial performance

  • Revenue: Second-quarter revenue was $30.849 billion, up 12.7% year over year (8.4% on a constant-currency basis). First-half revenue was $62.026 billion, up 10.4% (6.9% constant currency).
  • Earnings: Second-quarter operating earnings were $2.858 billion versus $2.293 billion; net earnings were $2.200 billion versus $1.721 billion. Diluted EPS was $0.91 versus $0.71. First-half net earnings were $4.450 billion versus $3.577 billion, and diluted EPS was $1.84 versus $1.46.
  • Margins: Second-quarter gross margin was 23.5%, unchanged year over year; operating margin improved to 9.3% from 8.4%, and net margin to 7.1% from 6.3%. First-half gross margin declined 0.2 percentage points to 23.2%; operating margin rose to 9.4% from 8.5%, and net margin to 7.2% from 6.4%. Management attributed gross-margin pressure mainly to stronger sales of lower-margin PC and printer hardware, partly offset by services cost improvements.
  • Cash flow: First-half operating cash flow was $5.498 billion, down from $6.090 billion. Investing cash use was $3.940 billion, including $2.512 billion net cash paid for acquisitions and $1.771 billion of capital investment. Financing cash use was $706 million. Cash increased $852 million to $14.131 billion.
  • Liquidity and debt: At April 30, cash and cash equivalents were $14.131 billion; current assets were $51.695 billion and current liabilities $42.271 billion. Short-term borrowings were $3.934 billion and long-term debt $13.728 billion; total borrowings were approximately $17.7 billion, versus $15.8 billion at October 31, 2009. HP reported approximately $15.8 billion of available borrowing resources, including commercial paper, credit facilities and other programs.
  • Capital returns: HP spent $4.511 billion on share repurchases in the first half and declared $0.16 per share in dividends. Remaining repurchase authorization at April 30 was $7.4 billion.

Material changes versus prior comparable periods

  • Growth was led by PSG, up 21.3% in the quarter, and ESS, up 31.4%; PSG’s and ESS’s quarterly operating earnings increased to $465 million and $571 million, respectively.
  • Services revenue rose 2.5%, while operating margin improved to 15.9% from 13.8%, reflecting cost controls, delivery efficiencies and EDS synergies. HP Software revenue declined 1.0%, although operating margin improved to 18.6% from 17.8%.
  • IPG revenue increased 8.1%, but operating margin declined to 17.2% from 18.2%, primarily because of a higher hardware mix and increased marketing. HPFS revenue rose 17.8% and operating earnings rose to $69 million from $46 million.
  • First-half restructuring charges increased to $311 million from $240 million. SG&A expense rose in dollars, principally due to greater sales and marketing investment, while its share of revenue fell.
  • Working capital metrics improved: DSO fell to 43 days from 48 and the cash conversion cycle to 17 days from 24; inventory days were unchanged at 25.

Outlook, commentary, risks and unusual items

  • Acquisitions: HP acquired 3Com on April 12 for approximately $3.3 billion; its preliminary allocation included $1.248 billion of goodwill and $987 million of amortizable intangible assets. HP’s announced Palm acquisition, with an enterprise value of approximately $1.2 billion, remained subject to customary closing conditions and shareholder approval; HP expected closing in fiscal Q3 2010.
  • Restructuring: On June 1, 2010, HP announced a multi-year enterprise services restructuring: approximately 9,000 positions to be eliminated and 6,000 added, with an expected aggregate charge of about $1 billion through fiscal 2013. The company also continued earlier EDS and product-business restructuring programs.
  • Legal and regulatory matters: In June 2010, HP reported settling the Sky/EDS litigation for £318 million, with a final £48 million payment remaining after interim payments. HP also agreed in May to pay $75 million to settle the Cornell patent case. Indian authorities issued customs-duty notices seeking approximately $370 million plus penalties and an additional $5.3 million plus penalties; HP said it would contest them and had deposited $16.7 million and agreed to a provisional bond. These matters may affect cash flows and results; the filing does not establish final outcomes for the India claims.
  • Taxes: The first-half effective tax rate was 20.1%, up from 18.3%. Gross unrecognized tax benefits were $1.9 billion, of which up to $890 million could affect the effective tax rate if realized; HP said these could decrease by up to $120 million within 12 months. The filing also describes ongoing tax audits and related uncertainties.
  • Principal risks: HP highlighted intense price competition, economic uncertainty, supplier and component availability, execution and integration of acquisitions, currency movements, IT security and data protection, service-contract performance, intellectual-property claims, environmental obligations, and litigation. Management stated that disclosure controls were effective and that market-risk exposure had not materially changed since October 31, 2009.
  • Guidance: The supplied filing text does not provide a clear numerical revenue or earnings forecast for the next quarter or full year. Management cautioned that quarterly results are not necessarily indicative of full-year results.

Important facts for investors to verify

  • Whether revenue growth and improved operating margins persist, particularly in PCs, servers, Services and printing supplies, and how product mix affects gross margin.
  • 3Com and any Palm acquisition results, integration costs, purchase-price adjustments, and expected benefits.
  • Cash generation relative to acquisition spending, share repurchases, capital investment and rising borrowings.
  • Final exposure and payment timing for the Sky settlement, India customs notices, and other legal and tax contingencies.
  • Restructuring charges, implementation progress, and whether the projected cost savings offset the approximately $1 billion enterprise services charge.