Hewlett Packard Enterprise Company — Q3 FY2021 Form 10-Q
Reporting period: Three and nine months ended July 31, 2021. Amounts are in U.S. dollars; financial statements are unaudited. HPE provides edge-to-cloud technology products and services across six reportable segments.
Financial performance
| Metric | Q3 FY2021 | Q3 FY2020 | Nine months FY2021 | Nine months FY2020 |
|---|---|---|---|---|
| Revenue | $6.897 billion | $6.816 billion | $20.430 billion | $19.774 billion |
| GAAP gross margin | 34.5% | 30.3% | 34.1% | 31.7% |
| GAAP operating earnings (loss) | $282 million | $12 million | $782 million | $(474) million |
| GAAP operating margin | 4.1% | 0.2% | 3.8% | (2.4)% |
| Net earnings (loss) | $392 million | $9 million | $874 million | $(479) million |
| Diluted EPS | $0.29 | $0.01 | $0.66 | $(0.37) |
| Non-GAAP operating margin | 9.8% | 7.9% | 10.4% | 8.4% |
| Non-GAAP diluted EPS | $0.47 | $0.36 | $1.44 | $1.13 |
Q3 revenue increased 1.2% year over year, but declined 1.9% on a constant-currency basis. Nine-month revenue rose 3.3% reported and 1.2% on a constant-currency basis. Management attributed reported growth partly to favorable foreign exchange; product shipment constraints weighed on results. Gross-margin gains reflected pricing discipline, lower supply-chain overhead and a shift toward higher-margin offerings.
Segment trends: In Q3, Intelligent Edge revenue grew 26.8% and operating margin rose to 15.8%; HPC & MCS revenue grew 11.1%, but its operating margin fell to 3.9% from 7.0%. Compute revenue declined 8.9%, while its margin improved to 11.2%. Storage revenue grew 3.9% with a 15.1% margin. Financial Services revenue grew 4.1% and its margin increased to 11.1%.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $2.915 billion, compared with $1.493 billion a year earlier. Free cash flow, a non-GAAP measure defined by HPE as operating cash flow less net capital investment, was $1.457 billion versus $337 million.
- Q3 operating cash flow was $1.130 billion and free cash flow was $526 million, versus $1.472 billion and $924 million, respectively, in Q3 FY2020.
- Cash and cash equivalents were $5.293 billion at July 31, 2021; cash, cash equivalents and restricted cash totaled $5.652 billion, up from $4.621 billion at October 31, 2020.
- Total debt was $16.225 billion, comprising $3.736 billion of notes payable and short-term borrowings and $12.489 billion of long-term debt. HPE reported no borrowings under its $4.75 billion revolving credit facility.
- Inventory increased to $3.942 billion from $2.674 billion at October 31, 2020. Management cited strategic component purchases and preparations for planned shipments; days of inventory supply rose to 79 from 48 at fiscal year-end.
- HPE paid $0.12 per share in Q3 and declared another $0.12 quarterly dividend. Share repurchases remained suspended through July 31; the company expected to resume them in Q4 FY2021, with $2.1 billion of authorization remaining.
Changes, outlook and notable items
- Q3 GAAP net earnings and operating earnings improved substantially year over year; the nine-month comparison also turned profitable. The prior-year nine-month results included an $865 million goodwill impairment charge.
- Management said the demand environment was improving and reported traction across its portfolio, while warning that material constraints reduced unit shipments. HPE did not provide specific forward revenue or earnings guidance in the supplied filing text.
- HPE expects transformation programs to continue through FY2023. It reported $733 million of transformation costs in the first nine months of FY2021 and estimated approximately $870 million of future cash payments under approved restructuring plans as of July 31, 2021.
- HPC & MCS goodwill was a key sensitivity: its reporting unit had goodwill of approximately $3.6 billion and only an 8% fair-value cushion over carrying value at the November 2020 impairment test. A hypothetical 10% fair-value decline would eliminate that cushion; further impairment could be material.
- HPE entered an agreement to acquire Zerto for $374 million; the acquisition closed August 31, 2021, after quarter-end. HPE also completed the $117 million acquisitions of Determined AI and Ampool during Q3.
- After quarter-end, HPE expected to redeem $500 million of 3.5% Notes and $800 million of Floating Rate Notes due October 2021. It issued $753 million and $1.0 billion of asset-backed securities in June and March, respectively.
- Tax indemnification income included benefits associated with recovery of Brazilian PIS and COFINS taxes. The nine-month effective tax rate was 2.8%, reflecting favorable jurisdictional rates and significant discrete tax items. Unrecognized tax benefits were $2.1 billion; HPE said up to $75 million could be reduced within 12 months.
Risks, contingencies and unusual items
- COVID-19, supply-chain and component availability, currency movements, customer acceptance timing, competition and macroeconomic conditions could affect operations and cash flows. HPE said it could not fully predict COVID-19’s future effect on collections.
- HPC & MCS revenue depends in part on delivery timing and customer acceptance milestones, and the segment’s profitability weakened. Goodwill impairment remains a potential material risk if forecasts or business conditions deteriorate.
- HPE is involved in ordinary-course litigation and investigations. In the Oracle Itanium matter, a judgment for HP Inc. of approximately $3.8 billion was affirmed by a California appeals court; Oracle sought further review. Under separation terms, HPE may share in any recovery after reimbursement of specified costs. The Oracle Terix case was set for trial in November 2021. HPE said it had recorded adequate provisions and did not believe a material loss beyond recognized amounts was reasonably possible as of July 31, 2021.
- Other disclosed matters include employment class actions, customs proceedings in India and environmental obligations. HPE cautioned that litigation outcomes are inherently unpredictable.
- HPE reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Investor verification points
- Assess how much reported revenue growth and margin improvement reflects currency, pricing, cost savings and mix versus underlying volume growth; review the non-GAAP reconciliations alongside GAAP results.
- Track component constraints, inventory growth and the cash conversion cycle, including the sustainability of working-capital cash-flow benefits.
- Monitor HPC & MCS delivery milestones, profitability and goodwill headroom, as well as the timing and economics of the Zerto acquisition.
- Verify execution and cash requirements for restructuring, planned share repurchases, dividends, debt redemptions and asset-backed financing.
- Follow tax resolution and Brazilian tax recoveries, uncertain tax positions, and material litigation developments, including Oracle matters.