HP Inc. — Q3 FY2018 Form 10-Q
Reporting period: Fiscal third quarter and nine months ended July 31, 2018. Amounts are in U.S. dollars; financial statements are unaudited. HP sells personal computers and related products and printing hardware, supplies, services and solutions.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $14.586B | $13.060B | $43.106B | $38.129B |
| Gross margin | 18.4% | 18.6% | 18.5% | 18.5% |
| Operating earnings | $1.080B | $0.955B | $3.017B | $2.629B |
| Operating margin | 7.4% | 7.3% | 7.0% | 6.9% |
| Net earnings | $0.880B | $0.696B | $3.876B | $1.866B |
| Diluted EPS | $0.54 | $0.41 | $2.36 | $1.09 |
- Q3 revenue grew 11.7% year over year (8.8% constant currency); nine-month revenue grew 13.1% (10.5% constant currency). Growth reflected Personal Systems, Printing, and favorable foreign exchange.
- Q3 segment revenue was $9.395B in Personal Systems (+12.0%) and $5.188B in Printing (+10.9%). Segment operating margins were 3.9% and 16.0%, respectively. Printing margin fell from 17.3%, while Personal Systems margin improved from 3.7%.
- Q3 gross margin declined 0.2 percentage points, reflecting higher commodity costs and a greater mix of lower-margin Commercial Hardware. For nine months, gross margin was flat.
- Nine-month net earnings included a $1.870B tax benefit, versus a $562M tax provision in the prior-year period. The reported increase in net earnings therefore substantially reflects tax items, including tax reform and audit resolutions, rather than operating earnings growth alone.
Cash flow, debt and liquidity
- For nine months, operating cash flow was $3.560B, up from $2.997B. Investing cash outflow was $803M and financing cash outflow was $3.559B; cash decreased $802M to $6.195B.
- Capital expenditures were $359M; operating cash flow less capital expenditures was approximately $3.201B.
- At July 31, cash and cash equivalents were $6.195B; short-term borrowings were $2.681B and long-term debt was $4.503B, for total borrowings of approximately $7.184B. Current assets of $21.776B were below current liabilities of $25.506B.
- HP repurchased $1.959B of shares and paid $680M in dividends during the nine months. The board authorized an additional $4.0B of repurchases; approximately $4.5B remained authorized at quarter-end.
- HP had $2.092B of commercial paper outstanding and a $4.0B committed revolving credit facility available through March 2023. It reported compliance with the facility’s financial covenants.
Changes, outlook and notable items
- Personal Systems growth was driven by notebook and desktop volume and higher average selling prices. Printing growth included Samsung printer business revenue, acquired November 1, 2017; HP cited lower-margin Samsung-branded entry-level products and higher costs as pressure on Printing margins.
- HP amended its Fiscal 2017 restructuring plan and expects 4,500–5,000 employee exits by the end of FY2019 and approximately $700M in aggregate pretax charges. It expected approximately $316M of future cash payments for cost-saving plans through FY2019.
- Management described forecast PC-client market declines, flat home-printing markets, competitive pricing, component availability, rising commodity costs, foreign-exchange volatility and global economic and trade uncertainty. It emphasized innovation, higher-value products, managed print, Instant Ink, graphics and 3D printing. The filing provides no specific consolidated revenue or EPS guidance.
- HP had not completed its accounting for the Tax Cuts and Jobs Act. It recorded a provisional $3.1B deemed-repatriation tax, payable over eight years, and said credits and other tax attributes were expected to reduce cash payments by more than half. The nine-month period also included $1.5B of tax benefits from audit settlements and a $126M loss on debt extinguishment.
- On August 1, 2018, HP announced an agreement to acquire U.K. office equipment dealer Apogee for approximately £380M, subject to regulatory review and customary closing conditions; the transaction was expected to close by year-end 2018.
- HP reported that no material loss was reasonably possible beyond amounts accrued for its disclosed contingencies. The potential Oracle litigation award of approximately $3.0B was not recognized and remained subject to appeal; any recovery would be shared with Hewlett Packard Enterprise under the separation agreement.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Confirm the final effects of tax reform, including the transition-tax cash payments, deferred-tax estimates and remaining audit exposures; HP disclosed $8.0B of unrecognized tax benefits.
- Assess whether revenue growth and segment profitability persist, particularly Printing margins after the Samsung acquisition and the effects of commodity costs and product mix.
- Track operating cash conversion, working capital, debt maturities and commercial-paper reliance alongside continued repurchases and dividends.
- Verify the closing and purchase terms of the Apogee acquisition and its expected effect on results and liquidity.
- Monitor material contingencies, including the Oracle appeal, India customs proceedings, employment matters and the printer-firmware class settlement process.
- Evaluate exposure to cybersecurity and systems-integration risks, which HP specifically highlighted as a risk-factor update.