Hewlett Packard Enterprise Company — Q3 FY2018 Form 10-Q
Reporting period: Quarter and nine months ended July 31, 2018. Amounts are in U.S. dollars; financial statement figures are in millions unless noted.
Business context
HPE provides technology products and services spanning cloud, data center and intelligent-edge markets. Following the 2017 separations of Enterprise Services and Software, it reports four segments: Hybrid IT, Intelligent Edge, Financial Services and Corporate Investments. The filing compares results with the corresponding 2017 periods.
Key financial results
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net revenue | $7,764 | $7,501 | $22,906 | $21,211 |
| Gross margin | 30.7% | 29.3% | 29.8% | 30.3% |
| Earnings from continuing operations before interest and taxes | $516 | $201 | $1,174 | $849 |
| Net earnings (loss) | $451 | $165 | $2,665 | $(180) |
| Diluted EPS | $0.29 | $0.10 | $1.69 | $(0.11) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1,638 | $504 |
- Revenue and segments: Q3 revenue rose 3.5% year over year (1.2% on a constant-currency basis); nine-month revenue rose 8.0% (5.6% constant currency). Q3 segment revenue increased in Hybrid IT (2.7%), Intelligent Edge (10.4%) and Financial Services (3.5%).
- Profitability: Q3 operating margin improved to 6.6% from 2.7%, while nine-month operating margin increased to 5.1% from 4.0%. Q3 gross margin benefited from product mix, higher Compute prices and easing DRAM cost increases. Nine-month gross margin declined amid lower-margin solutions and higher variable compensation.
- Net earnings and taxes: Nine-month net earnings included a reported $3.092 billion tax benefit. The filing attributes major discrete tax items to settlement of pre-separation tax liabilities, U.S. tax reform and other tax matters. The resulting 1,003.9% effective tax rate is not representative of ordinary operating performance.
- Cash and liquidity: Cash and cash equivalents were $5.193 billion at July 31, down $4.386 billion from October 31, 2017. Current assets were $17.467 billion and current liabilities $17.407 billion. Nine-month operating cash flow was $1.638 billion; capital expenditures were $2.129 billion.
- Debt and capital returns: Short-term borrowings and current debt totaled $2.326 billion; long-term debt was $9.963 billion. HPE repaid $2.538 billion of debt and repurchased $2.585 billion of stock in the first nine months. It declared dividends of $0.375 per share for the period and had $5.7 billion of buyback authorization remaining.
Material changes versus the prior comparable period
- Revenue growth reflected higher Compute average selling prices and demand, Storage growth including Nimble Storage, campus switching and Financial Services asset-management activity.
- Q3 Hybrid IT operating earnings rose to $661 million from $482 million. Intelligent Edge revenue grew, but operating earnings fell to $91 million from $104 million as margins narrowed and R&D and selling costs increased.
- For the nine-month period, operating cash flow increased by $1.1 billion, principally because the prior-year period included $1.9 billion of pension funding associated with the Everett transaction.
- HPE spent $2.585 billion on repurchases and paid $406 million in dividends during the nine months; cash fell from $9.579 billion to $5.193 billion.
Outlook, risks and unusual items
- HPE Next is expected to continue through fiscal 2020. HPE estimated approximately $0.9 billion of aggregate pre-tax restructuring charges, including about $0.7 billion for workforce reductions and $0.2 billion for infrastructure. Workforce changes were expected to be completed during fiscal 2019. The company reported $499 million of HPE Next charges for the first nine months, net of real-estate sale gains.
- Management stated that operating cash flows, cash balances and access to capital markets are expected to support near-term needs, including investment, debt, restructuring, dividends and repurchases. It cautioned that capital-market access and borrowing costs could be affected by market and business conditions.
- Risks include competitive pricing, foreign-exchange fluctuations, commodity costs, inventory and working-capital needs, execution of HPE Next, and uncertainty in tax estimates. HPE had not completed its accounting for the Tax Act; adjustments could materially affect tax expense and the effective tax rate.
- HPE disclosed a DXC arbitration claim seeking indemnification for approximately $1.0 billion of alleged excess transferred lease obligations; HPE disputes the claim. Other notable matters include an India customs proceeding involving substantial asserted duties and penalties, and the Oracle Itanium litigation, in which an approximately $3 billion award to HP Inc. remained subject to appeal and any recovery would be shared under the separation agreement.
- The filing reports no material change in market-risk exposure since October 31, 2017, and states that disclosure controls were effective.
Important facts for investors to verify
- How much of reported nine-month earnings and tax benefits is recurring, and what will the final Tax Act and pre-separation tax accounting be?
- Whether HPE Next delivers expected savings and completes workforce and infrastructure actions within the stated timetable and cost estimate.
- Whether Intelligent Edge and Financial Services can sustain revenue growth while improving segment margins and managing bad-debt exposure.
- How cash generation, inventory levels and capital spending develop relative to buybacks, dividends, debt maturities and restructuring payments.
- The outcome and potential financial exposure of the DXC arbitration, tax indemnifications, and other material litigation and contingencies.