Hewlett Packard Enterprise Co. — Q3 FY2020 Form 10-Q
Business context and reporting period. HPE is a global technology company focused on edge-to-cloud solutions, including compute, storage, networking, services and customer financing. This unaudited quarterly report covers the three and nine months ended July 31, 2020; comparisons are with the corresponding 2019 periods. COVID-19 was materially affecting customer demand, supply chains and service delivery.
Key financial results
| Metric | Q3 FY2020 | Q3 FY2019 | Nine months FY2020 | Nine months FY2019 |
|---|---|---|---|---|
| Revenue | $6.816B | $7.217B | $19.774B | $21.920B |
| Gross margin | 30.3% | 33.9% | 31.7% | 32.4% |
| Operating earnings (loss) | $12M | $(76)M | $(474)M | $814M |
| Net earnings (loss) | $9M | $(27)M | $(479)M | $569M |
| Diluted EPS | $0.01 | $(0.02) | $(0.37) | $0.41 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $1.493B | $2.565B |
- Q3 revenue fell 5.6% year over year (4.1% in constant currency). Nine-month revenue declined 9.8% (8.5% in constant currency).
- Q3 GAAP operating margin was 0.2%, versus negative 1.1%. Nine-month operating margin was negative 2.4%, versus 3.7%.
- Management’s non-GAAP measures showed Q3 net earnings of $419M and diluted EPS of $0.32; nine-month non-GAAP net earnings were $1.279B and diluted EPS $0.98. These exclude specified charges and adjustments and are not GAAP results.
Balance sheet, liquidity and capital
- At July 31, cash and cash equivalents were $8.465B; including restricted cash, cash totaled $8.937B, up from $4.076B at October 31, 2019.
- Current assets were $21.383B and current liabilities $21.610B. Short-term borrowings and current debt were $5.727B; long-term debt was $13.730B. Total carrying debt was approximately $19.5B, compared with $13.8B at October 31, 2019.
- Nine-month operating cash flow was $1.493B, down from $2.565B. Investing activities used $1.154B; financing activities provided $4.522B, primarily reflecting debt issuance.
- HPE issued $4.0B of senior notes during the period. In August 2020, after quarter-end, it redeemed $3.0B of notes originally due in October 2020. A $4.75B revolving credit facility had no borrowings outstanding at July 31.
- HPE paid $464M in dividends during the nine-month period. It repurchased $355M of stock in the period, then suspended repurchases in April because of COVID-19 uncertainty.
Material changes and operating drivers
- Revenue declines reflected weak demand and COVID-related restrictions, supply-chain constraints, customer-site access and installation delays, pricing pressure and unfavorable currency movements. Management said supply-chain execution improved in Q3 and backlog challenges had significantly eased, though demand remained weak and uncertain.
- Q3 segment revenue declined in Storage (10.1%), Intelligent Edge (12.4%), Financial Services (8.7%), Advisory and Professional Services (6.6%) and Compute (0.3%); HPC & MCS revenue rose 2.5%, partly due to the Cray acquisition. Storage, Compute and HPC & MCS operating margins also declined year over year.
- Gross margin fell in Q3, primarily from commodity and supply-chain costs, competitive pricing and lower revenue against fixed overhead, partly offset by a mix shift toward higher-margin offerings. Lower operating expenses helped Q3 operating results.
- Nine-month results included an $865M non-cash goodwill impairment in HPC & MCS, reflecting reduced projected growth and profitability in the COVID-19 environment. Nine-month transformation costs were $646M; acquisition, disposition and related charges were $55M.
Outlook, risks and unusual items
- HPE said the duration and financial effects of COVID-19 could not be predicted and provided no clear numerical revenue or earnings guidance in the supplied filing text. Management believed cash, operating cash flow and access to capital markets would cover near-term needs, while warning that market access and borrowing costs could worsen.
- The May 2020 cost optimization and prioritization plan is expected to run through FY2022. HPE estimates at least $1.0B of gross savings and at least $800M of annualized net run-rate savings by FY2022, relative to its FY2019 exit; it expects approximately $1.3B of cash funding over three years. These are estimates, not guaranteed outcomes. HPE also expects about $1.2B of future restructuring cash payments across approved plans.
- HPE agreed to acquire Silver Peak Systems for approximately $925M in cash, subject to approvals and other closing conditions; it expected completion in Q4 FY2020.
- Credit and collection risks warrant attention: HPE reported $25M of Financial Services bad-debt expense in Q3 and $58M for nine months, and said COVID-19 affected some customer collections. Inventory rose to $3.469B from $2.387B at fiscal year-end.
- HPE disclosed ongoing litigation and tax matters. It stated that, as of July 31, it did not believe a material loss beyond recorded provisions was reasonably possible; litigation outcomes remain uncertain. A court of appeals reversed in part and affirmed in part a prior HPE win in Oracle’s Terix case, remanding it for further proceedings. Unrecognized tax benefits were $2.2B.
- Other unusual items include highly variable effective tax rates, discrete tax benefits, and substantial hedge-related other comprehensive losses in Q3. HPE cautioned that changes in economic conditions could trigger further goodwill impairment.
Investor facts to verify
- Whether demand, supply-chain capacity, backlog and customer collections improved after July 31, 2020.
- Progress and actual cash costs and savings from the restructuring and cost optimization plans.
- Debt levels, refinancing effects, liquidity and the use of cash following the August note redemption and any Silver Peak acquisition closing.
- Whether HPC & MCS or other reporting units required additional goodwill impairment as forecasts changed.
- Subsequent developments in material litigation, tax exposures and Financial Services receivable quality.