Hewlett Packard Enterprise Company — Q1 FY2017 10-Q
Reporting period: Three months ended January 31, 2017; comparisons are with the three months ended January 31, 2016. Amounts are in U.S. dollars. HPE reported five segments: Enterprise Group, Enterprise Services, Software, Financial Services and Corporate Investments.
Financial results and liquidity
- Revenue: $11.407 billion, down 10.4% year over year (down 9.0% at constant currency). Products were $4.246 billion; services $7.068 billion; financing income $93 million.
- Profit and margins: Gross profit was $3.299 billion and gross margin 28.9%, versus $3.612 billion and 28.4%. Operating earnings were $463 million, with a 4.1% operating margin, compared with $384 million and 3.0%. Net earnings were unchanged at $267 million; diluted EPS rose to $0.16 from $0.15. The effective tax rate was 22.6%, versus 16.3%.
- Cash flow: Operating cash use was $1.464 billion, versus $75 million in the prior-year quarter; investing cash use was $1.157 billion and financing cash use was $508 million. Cash declined $3.129 billion to $9.858 billion. Operating cash flow included approximately $1.9 billion of pension funding related to the planned Enterprise Services transaction.
- Balance sheet and debt: At January 31, cash and cash equivalents were $9.858 billion; current assets $25.525 billion and current liabilities $21.686 billion. Short- and long-term borrowings totaled approximately $15.8 billion, down from $16.1 billion at October 31, 2016. HPE reported $4.164 billion of commercial-paper program capacity and $1.740 billion of uncommitted credit lines available.
- Capital returns and investment: HPE repurchased 27 million shares for $641 million and paid $109 million in dividends. Capital expenditures were $923 million. The declared dividend was $0.13 per share, versus $0.11.
Material changes versus the prior-year quarter
- Revenue fell across Enterprise Group (11.9%), Enterprise Services (11.4%) and Software (7.6%); Financial Services revenue grew 6.1%.
- Enterprise Group’s decline reflected the H3C divestiture, softer server and storage demand, competitive pricing and execution challenges. Enterprise Services was affected by the MphasiS divestiture, weak EMEA demand and runoff of large contracts.
- Despite lower revenue, consolidated gross and operating margins improved. Management cited Enterprise Services delivery efficiencies, restructuring savings and improved expense management. Enterprise Group operating margin declined, while Enterprise Services and Software margins improved.
- Separation costs increased to $276 million from $79 million, partly offsetting lower restructuring charges ($177 million versus $311 million) and lower intangible amortization ($101 million versus $218 million).
Outlook, management commentary and risks
- No specific consolidated revenue, earnings or EPS guidance is provided in the supplied filing text. Management said cash, expected operating cash generation and capital-market access should cover anticipated near-term needs, while noting liquidity and borrowing access could be affected by business, market and economic conditions.
- HPE continued preparations for the tax-free spin-off and merger of Enterprise Services with CSC, targeted for around April 1, 2017, including a planned $3.0 billion cash dividend to HPE. HPE expected approximately $900 million of separation costs. It had paid approximately $1.9 billion for pension funding associated with the transaction; the final amount remained subject to determination at closing.
- The Software spin-off and merger with Micro Focus was anticipated for September 1, 2017, with a planned $2.5 billion cash dividend to HPE and approximately $700 million of expected separation costs. Both transactions remained subject to customary closing conditions and tax-related requirements; failure to qualify for intended tax treatment could create significant tax liabilities.
- HPE completed its $349 million SGI acquisition during the quarter; SimpliVity was acquired for $650 million in February 2017. In March, HPE agreed to acquire Nimble Storage for approximately $1.0 billion in cash.
- Management highlighted cloud migration, SaaS adoption, competitive pricing, hardware demand weakness and sales execution as ongoing challenges. The fiscal 2015 restructuring plan could involve up to approximately 30,000 employee exits by the end of 2018, with estimated aggregate pre-tax charges of approximately $2.6 billion.
- Unrecognized tax benefits were $11.7 billion; HPE said they could be reduced by up to $2.7 billion within 12 months, although audit outcomes and payment timing were uncertain. The filing also describes ongoing litigation and investigations, including an India customs dispute and Washington, D.C. Navy Yard-related claims. An Oracle jury award of $3.0 billion was in favor of HP Inc., not HPE alone; appeals were pending, and any recovery is subject to the parties’ sharing arrangement.
Most important facts for investors to verify
- Whether the Enterprise Services and Software transactions close on schedule, meet tax-free requirements and deliver the stated cash distributions after separation costs and pension funding.
- Whether revenue and margins stabilize in Enterprise Group and Enterprise Services, given demand, pricing, currency and execution pressures.
- How recurring restructuring, acquisition and separation costs affect reported earnings and cash generation; operating cash flow was materially negative this quarter.
- The final pension funding and liability transfer amounts associated with Enterprise Services, and the treatment of its planned transaction financing.
- Developments in tax audits, uncertain tax positions and significant litigation, including the India customs matter and the appealed Oracle award.