Hewlett Packard Enterprise Co quarterly report, Q1 FY2019

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Hewlett Packard Enterprise Company — Q1 FY2019 Form 10-Q

Reporting period: Three months ended January 31, 2019. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. Comparisons are with the three months ended January 31, 2018.

Business context and results

HPE provides technology products and services focused on infrastructure from edge to cloud. Its reporting segments are Hybrid IT, Intelligent Edge, Financial Services (FS), and Corporate Investments. In December 2018, HPE acquired BlueData, an AI, machine-learning, and big-data infrastructure software provider; results are included in Hybrid IT.

  • Revenue: $7.553 billion, down $121 million, or 1.6% (down 1.3% on a constant-currency basis). Products were $4.791 billion, services $2.650 billion, and financing income $112 million.
  • Profit and margins: Gross profit was $2.346 billion; gross margin improved to 31.1% from 28.3%. Earnings from continuing operations were $456 million versus $228 million, with a 6.0% margin versus 3.0%. Net earnings were $177 million versus $1.436 billion; diluted continuing-operations EPS was $0.13 versus $0.92.
  • Taxes and comparability: Pretax earnings were $655 million versus a prior-year pretax loss of $657 million. The current quarter recorded a $478 million tax provision, while the prior year recorded a $2.139 billion tax benefit. Prior-year results included substantial discrete Tax Act and pre-Separation tax benefits; current-year tax expense included discrete charges. These items make net income and EPS comparisons unusually tax-sensitive.
  • Cash flow: Operating cash flow was $382 million versus $142 million. Investing cash use was $616 million and financing cash use was $945 million. Cash, cash equivalents, and restricted cash declined $1.179 billion to $3.905 billion.
  • Debt and liquidity: Current borrowings and notes payable were $2.073 billion and long-term debt was $10.280 billion, or $12.353 billion in total reported debt. Cash and cash equivalents were $3.781 billion; restricted cash was $124 million. HPE reported $4.041 billion of commercial-paper program capacity, $1.583 billion of uncommitted credit lines, and a $4.0 billion revolving credit facility.
  • Capital returns: HPE repurchased 55 million shares during the quarter for approximately $0.8 billion; $3.9 billion remained authorized. Cash dividends paid were $157 million. The dividend declared per share was $0.1125 versus $0.15 in the prior-year quarter.

Material changes and segment performance

  • Hybrid IT: Revenue of $5.970 billion fell 3.1%, primarily from lower Tier-1 server sales and HPE Pointnext services. Operating earnings rose to $675 million from $572 million; operating margin increased to 11.3% from 9.3%. Storage revenue grew, including HPE Nimble, partially offsetting declines elsewhere.
  • Intelligent Edge: Revenue rose 4.6% to $686 million, while operating earnings fell to $9 million from $34 million and margin declined to 1.3% from 5.2%. Higher R&D and field-selling costs weighed on profitability.
  • Financial Services: Revenue increased 3.5% to $919 million and operating earnings rose to $77 million from $71 million. Higher asset-management activity supported results; new financing volume declined 3.3% to $1.389 billion.
  • Corporate Investments: Revenue fell 13.2% to $118 million; operating loss widened to $28 million from $26 million.
  • HPE’s transformation costs declined to $78 million from $245 million. Research and development expense increased 20% to $466 million, partly reflecting investment in product development. Acquisition, disposition, and related charges increased to $63 million, primarily due to litigation accruals and disposition costs.

Outlook, risks, and unusual items

  • HPE gave no specific quarterly or full-year revenue, earnings, or EPS guidance in the supplied filing text. Management said internally generated cash flow, cash balances, and access to capital markets are expected to cover anticipated near-term cash needs, while noting capital-market access and borrowing costs may be affected by business and market conditions.
  • The HPE Next transformation is expected to continue through fiscal 2020. HPE reported $83 million of net HPE Next charges in the quarter and estimated approximately $1.38 billion of total plan costs; about $0.8 billion of future cash payments across approved restructuring plans was expected, including $0.3 billion through the remainder of FY2019.
  • Tax uncertainty is significant: unrecognized tax benefits were $8.9 billion, although up to $1.1 billion would affect the effective tax rate if realized. HPE said up to $6.4 billion of existing unrecognized benefits could potentially be reduced within 12 months, without materially affecting the effective tax rate. Tax Act implementation and federal and state interpretation remain risks.
  • DXC sought indemnification from HPE for transferred lease obligations, claiming the $250 million threshold was exceeded by approximately $1.0 billion. Arbitration began in February 2019; HPE disputes the claim and intends to defend it.
  • Other disclosed matters include legacy India customs proceedings seeking approximately $370 million plus penalties and an employment class action. HPE stated it did not believe a material loss in excess of recorded amounts was reasonably possible for its legal matters overall. In a separate Oracle copyright case, judgment was entered for HPE in February 2019, dismissing Oracle’s claims.
  • HPE adopted ASC 606 in the quarter; it increased current-quarter revenue by $8 million and had no material balance-sheet effect at January 31. The company also recorded a $2.3 billion retained-earnings adjustment upon adopting guidance for income taxes on intra-entity asset transfers.

Key facts for investors to verify

  • Whether the improved gross and operating margins can persist despite Hybrid IT revenue weakness and rising R&D investment.
  • The drivers of the large year-over-year net earnings and EPS decline, particularly the discrete tax items and tax-indemnification adjustments.
  • Cash generation after capital investment, share repurchases, dividends, and restructuring payments; cash and restricted cash fell by $1.179 billion in the quarter.
  • Progress in Intelligent Edge profitability and the trend in Hybrid IT Compute and Pointnext revenue.
  • The outcome and potential financial exposure from the DXC arbitration, tax matters, and other contingencies, as well as HPE’s substantial unrecognized tax benefits.
  • Execution, total cost, cash timing, and expected benefits of the HPE Next plan.