Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended January 31, 2006 for Hewlett-Packard Company (HP). HP is a global provider of products, technologies, solutions, and services, organized into seven business segments: Enterprise Storage and Servers, HP Services, Software, Personal Systems Group, Imaging and Printing Group, HP Financial Services, and Corporate Investments. The Technology Solutions Group (TSG) aggregates the first three segments.
Key Financial Metrics
| Metric | Q1 2006 | Q1 2005 |
|---|---|---|
| Total Net Revenue | $22,659 million | $21,454 million |
| Gross Margin | 23.2% | 22.9% |
| Earnings from Operations | $1,492 million | $1,165 million |
| Net Earnings | $1,227 million | $943 million |
| Diluted EPS | $0.42 | $0.32 |
| Cash and Cash Equivalents | $11,934 million | $13,302 million (end of period) |
| Operating Cash Flow | $1,846 million | $1,558 million |
| Total Debt (Short + Long Term) | $5,048 million | $5,223 million (Oct 31, 2005) |
Material Changes vs. Prior Period
- Revenue Growth: Net revenue increased 6% year-over-year (8% on a constant currency basis). Growth was driven by the Personal Systems Group (+8%) and Imaging and Printing Group (+8%), while HP Services (-2%) and HP Financial Services (-11%) declined.
- Profitability: Operating earnings increased 28% to $1.492 billion. Operating margin improved to 6.6% from 5.4% in the prior year.
- Accounting Changes: HP adopted SFAS 123R (Share-Based Payment) effective November 1, 2005. This resulted in a $144 million pre-tax stock-based compensation expense, reducing net income by $85 million compared to the prior accounting method (APB 25).
- Acquisitions: HP acquired Peregrine Systems, Inc. for approximately $588 million and Scitex Vision Ltd. assets, contributing to Software and Imaging segment growth. These acquisitions resulted in $50 million in in-process research and development (IPR&D) charges.
- Restructuring: HP recorded $15 million in restructuring charges, primarily related to true-ups of facility accruals for prior plans, partially offset by a $13 million curtailment gain on the U.S. retiree medical program.
Guidance, Outlook, and Risks
- Share Repurchases: HP repurchased 48 million shares for $1.4 billion during the quarter. Additionally, HP entered a Prepaid Variable Share Purchase Program (PVSPP) prepaying $1.7 billion for future share repurchases. On February 14, 2006, the Board authorized an additional $4.0 billion for repurchases.
- Restructuring Outlook: HP expects to terminate approximately 15,300 employees through the first quarter of fiscal 2007. Approximately 6,500 employees had exited as of January 31, 2006. Future cash expenditures for restructuring are estimated at $1.1 billion.
- Key Risks:
- Currency: A strengthening U.S. dollar against the euro and yen negatively impacted reported revenue.
- Legal Proceedings: Significant ongoing litigation includes copyright levy disputes in Germany (VG Wort), class actions regarding floppy disk controllers and inkjet printer "smart chips," and patent disputes with Gateway (recently settled via a binding term sheet for $47 million).
- Competition: Aggressive pricing pressures and commoditization in the PC and printing markets continue to challenge margins.
Investor Verification Checklist
- Verify the impact of the new SFAS 123R accounting standard on future quarterly earnings and cash flow classifications.
- Monitor the progress of the 15,300 employee restructuring plan and associated cost savings realization.
- Review the status of the German copyright levy litigation and potential financial exposure.
- Assess the integration progress of the Peregrine and Scitex acquisitions and their contribution to Software and Imaging margins.
- Track the execution of the $1.7 billion prepaid share repurchase program and the new $4.0 billion authorization.