HP Inc. (Hewlett-Packard Company) — Q1 FY2010 Form 10-Q
Reporting period: Three months ended January 31, 2010; comparisons are with the three months ended January 31, 2009 unless otherwise stated. HP provides personal computing, printing, enterprise technology, software, services and financing.
Financial results and key metrics
| Metric | Q1 FY2010 | Prior-year quarter | Change / context |
|---|---|---|---|
| Net revenue | $31.177 billion | $28.807 billion | +8.2% reported; +5.4% constant currency |
| Gross profit / margin | $7.115 billion / 22.8% | $6.734 billion / 23.4% | Margin down 0.6 percentage points |
| Operating earnings / margin | $3.003 billion / 9.6% | $2.497 billion / 8.7% | Operating earnings +20.3% |
| Net earnings | $2.250 billion | $1.856 billion | +21.2%; net margin 7.2% versus 6.4% |
| Diluted EPS | $0.93 | $0.75 | +24.0% |
| Operating cash flow | $2.407 billion | $1.126 billion | Increase of $1.281 billion |
| Capital investment in property and equipment | $821 million | $816 million | Operating cash flow less this investment was $1.586 billion |
| Cash and cash equivalents | $13.547 billion | $13.279 billion at Oct. 31, 2009 | Quarter-end increase of $268 million |
| Debt | $15.9 billion | $15.8 billion at Oct. 31, 2009 | Weighted-average borrowing rate 2.7% |
Current assets were $51.697 billion and current liabilities $40.873 billion at January 31, 2010. HP reported $17.7 billion of available borrowing resources, including $16.2 billion under commercial paper programs and $1.5 billion under other programs; $6.4 billion of credit facilities supported commercial paper capacity. HP reported no material unconsolidated special-purpose entities.
Material changes and segment performance
- Products revenue rose to $21.003 billion from $18.629 billion; services revenue was nearly flat at $10.067 billion versus $10.089 billion. Financing income increased to $107 million from $89 million.
- Personal Systems Group revenue increased 20.4% to $10.584 billion, with operating earnings of $530 million and a 5.0% margin. Growth reflected recovering U.S. PC demand and strength in China and other emerging markets; competitive pricing and lower-end product mix pressured average selling prices and gross margin.
- Enterprise Storage and Servers revenue grew 11.2% to $4.391 billion and operating earnings rose 36.0% to $552 million. Industry-standard server revenue was strong; storage and business-critical systems revenue declined.
- Services revenue declined 1.1% to $8.651 billion, while operating earnings increased 21.4% to $1.364 billion and margin improved to 15.8% from 12.9%, reflecting cost controls, delivery efficiencies and EDS synergies.
- Imaging and Printing revenue rose 3.8% to $6.206 billion, but operating earnings declined 4.6% to $1.054 billion and margin fell to 17.0% from 18.5%, primarily due to mix shifting toward lower-margin hardware from supplies.
- HP Software revenue was flat at $878 million; operating earnings increased to $167 million from $140 million. HP Financial Services revenue increased 13.1% to $719 million and operating earnings rose to $67 million from $41 million.
Consolidated gross margin fell as growth in lower-margin PC and printer hardware outweighed cost improvements, particularly in Services. Operating margin improved through higher operating leverage and cost controls. Research and development expense decreased to $681 million from $732 million; selling, general and administrative expense increased to $2.932 billion from $2.893 billion, primarily reflecting investment in sales resources.
Cash, capital allocation and balance-sheet developments
- Operating cash flow improved substantially year over year, driven by higher earnings and lower cash use to pay operating liabilities, partly offset by inventory and other working-capital movements. Inventory increased to $6.630 billion from $6.128 billion at October 31, 2009.
- Investing activities used $711 million, including $821 million of property and equipment investment. Financing activities used $1.428 billion, including $2.713 billion for share repurchases and $189 million in dividends, partly offset by $1.319 billion from employee stock-plan share issuances.
- HP repurchased 53.6 million shares in the quarter at an average $50.60 per share. The board authorized an additional $8.0 billion of repurchases in November 2009; $9.2 billion remained authorized at January 31.
- HP’s cash conversion cycle was 16 days, compared with 14 days at October 31, 2009. Days of sales outstanding improved to 42 from 48, while inventory days increased to 25 from 23.
Outlook, management commentary, risks and unusual items
- The supplied filing provides no quantified company-wide revenue or earnings guidance. HP cautions that the quarter’s results are not necessarily indicative of full-year results.
- HP expected its approximately $2.7 billion cash acquisition of 3Com to close in fiscal Q2 2010, subject to closing conditions and required competition clearances. U.S. and EU regulatory clearance and 3Com shareholder approval had been obtained, but remaining conditions were noted.
- Restructuring charges were $131 million in the quarter. HP expected approximately $412 million of additional charges under the 2008 HP/EDS plan and approximately $5 million under the 2009 plan; the plans included workforce reductions and facility-related actions.
- A material EDS-related litigation development: a UK court ruled in January 2010 that EDS UK was liable on certain claims in the Sky dispute. HP paid £200 million voluntarily in February and was ordered on March 1, 2010 to make a further £70 million interim payment. Final damages had not been quantified, and HP planned to seek leave to appeal.
- Other contingencies include copyright-levy disputes, product-related class actions, employment matters, intellectual-property litigation and environmental obligations. HP said it believed its provisions were adequate, but warned that adverse resolutions could materially affect cash flows or results in a period.
- The effective tax rate was 19.8%, up from 18.0%; the quarter included $92 million of net discrete tax benefits. Gross unrecognized tax benefits were $1.9 billion, of which up to $940 million could affect the effective tax rate if realized. HP said up to $115 million could be reduced within 12 months.
- Key stated risks include intense pricing competition, economic uncertainty and demand variability, inventory and supplier constraints, product quality and security issues, foreign-exchange exposure, execution of restructuring and acquisitions, pension assumptions, tax audits, and legal and environmental contingencies. HP said market-risk exposure had not changed materially since October 31, 2009.
Important facts for investors to verify
- Confirm whether PC and printer revenue growth can be sustained without further gross-margin pressure from pricing and product mix.
- Track Services revenue trends and whether margin gains from cost actions and EDS synergies persist.
- Review operating cash conversion, inventory growth and working-capital trends against earnings growth.
- Assess the final amount and timing of damages in the Sky litigation, the appeal process and any related reserve or cash-flow impact.
- Verify completion, purchase accounting and integration costs for the proposed 3Com acquisition, along with the remaining restructuring charges and expected savings.
- Monitor tax-audit outcomes, unrecognized tax benefits, pension funding requirements, debt and liquidity resources, and the pace of share repurchases.