Hewlett Packard Enterprise Company — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended July 31, 2019. HPE is a global technology company focused on solutions spanning edge to cloud, organized into Hybrid IT, Intelligent Edge, Financial Services and Corporate Investments.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Revenue | $7.217B | $7.764B | $21.920B | $22.906B |
| Gross margin | 33.9% | 30.5% | 32.4% | 29.7% |
| Operating earnings (loss) from continuing operations | $(76)M | $490M | $814M | $1.084B |
| Net earnings (loss) | $(27)M | $451M | $569M | $2.665B |
| Diluted EPS | $(0.02) | $0.29 | $0.41 | $1.76 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $2.565B | $1.638B |
Q3 revenue fell 7.0% year over year (5.4% at constant currency); nine-month revenue declined 4.3% (3.0% at constant currency). The Q3 operating loss included sharply higher acquisition, disposition and other related charges, principally a one-time charge associated with the DXC arbitration. The nine-month prior-year net result benefited from substantial discrete tax benefits, making the year-over-year net earnings comparison unusually large.
- Segments, Q3 revenue / operating earnings: Hybrid IT $5.549B / $704M; Intelligent Edge $762M / $37M; Financial Services $888M / $77M; Corporate Investments $130M / $(25)M.
- Hybrid IT revenue declined 9.2%, while operating earnings increased to $704M, supported by lower commodity costs, cost management and a more favorable product mix.
- Intelligent Edge revenue declined 2.9% and operating earnings fell to $37M from $101M, reflecting switching sales execution challenges, competitive pricing and higher R&D and selling costs.
- Financial Services revenue declined 4.3%, but operating earnings rose 6.9% to $77M. Corporate Investments revenue declined 3.0% and its operating loss remained $25M.
Balance sheet, cash flow and capital
- At July 31, 2019, cash and cash equivalents were $3.693B; cash, cash equivalents and restricted cash totaled $4.011B. Current assets were $15.117B and current liabilities $17.158B.
- Reported debt comprised $2.207B of notes payable and short-term borrowings and $10.453B of long-term debt, totaling $12.660B.
- Nine-month investing cash outflow was $1.399B, including $2.153B of property, plant and equipment investment, partly offset by asset-sale proceeds and returned financial collateral. Financing cash outflow was $2.239B.
- HPE repurchased $1.965B of common stock and paid $461M in dividends during the first nine months. Remaining repurchase authorization at July 31 was $2.7B.
- Management said operating cash flow, cash balances and capital-market access were expected to cover near-term needs. A new $4.75B five-year revolving credit facility was entered into on August 16, 2019, after quarter-end.
Material changes, outlook and risks
- Management attributed revenue weakness to lower Tier-1 server sales, reduced China revenue, demand weakness in standard servers and services, storage market weakness, switching sales execution issues, lower Financial Services rental revenue and unfavorable currency. HPE also described exiting less-profitable product categories and markets as a deliberate strategy.
- Gross margin improved, but Q3 operating performance was weighed down by $563M in acquisition, disposition and other related charges, including the arbitration-related charge, and $170M in transformation costs. R&D expense rose 11% in Q3.
- HPE Next is expected to continue through fiscal 2020. HPE reported $310M of net HPE Next charges in the first nine months and estimated $682M of future restructuring cash payments, including $110M through the remainder of FY2019. No specific revenue or EPS guidance is provided in the supplied filing text.
- On August 15, 2019, an arbitration panel awarded DXC $632M plus $34M of pre-judgment interest and post-award interest. HPE said it had recorded a charge for the full award in its July 31 financial statements. The filing separately describes the award as $666M plus post-award interest.
- HPE agreed to acquire Cray for $35 per share in cash, in a transaction valued at approximately $1.3B net of cash acquired, subject to regulatory and other closing conditions; completion was expected by Q4 FY2019.
- Tax outcomes remain a consideration: HPE reported $2.6B of unrecognized tax benefits and continuing tax matters, including joint and several pre-separation liabilities with HP Inc. The filing also describes ongoing litigation and investigations; management stated that it believed recorded provisions were adequate, while noting that outcomes could materially affect a particular period.
- Other disclosed risks include competition, macroeconomic and geopolitical conditions, foreign-exchange exposure, execution of transformation plans, product transitions, suppliers and customer demand. Management reported disclosure controls as effective and no material change to internal control over financial reporting during the first nine months.
Important facts for investors to verify
- Whether revenue stabilizes in Compute, China, HPE Pointnext and Aruba switching, and whether HPE Nimble Storage and Aruba Services growth continues.
- The full accounting and cash-payment impact of the DXC arbitration award, including post-award interest and any related indemnification or recovery.
- Progress and remaining costs of HPE Next, including expected savings, restructuring cash payments and the fiscal 2020 completion timeline.
- Cash conversion and working capital: DSO increased to 37 days from 34 a year earlier, while operating cash flow improved for the nine-month period.
- Cray acquisition closing, funding and integration, alongside HPE’s substantial buybacks, dividends and reported debt.
- Developments in tax audits, indemnification balances and material litigation, which may create earnings or cash-flow volatility.