Hewlett Packard Enterprise Co. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2017 ended July 31, 2017. Amounts are in U.S. dollars; financial statements are unaudited. HPE completed the separation of Enterprise Services into DXC Technology on April 1, 2017. The Software separation with Micro Focus closed on September 1, 2017, after quarter-end.
Business context and financial results
HPE reported continuing operations across Enterprise Group (servers, storage, networking and technology services), Software, Financial Services, and Corporate Investments. Enterprise Services is reported as discontinued operations for periods presented.
- Quarter revenue: $8.209 billion, up 2.5% year over year (3.2% in constant currency). Products were $4.854 billion; services $3.253 billion; financing income $102 million.
- Quarter earnings: Continuing-operations earnings were $248 million, or $0.15 diluted EPS. Net earnings, including an $83 million discontinued-operations loss, were $165 million, or $0.10 diluted EPS. Operating earnings were $147 million.
- Quarter margins: Gross margin was 33.0%, down from 36.4%. Operating margin was 1.8%; the prior-year 33.0% reflected a $2.169 billion H3C divestiture gain.
- Nine-month revenue and earnings: Revenue was $23.210 billion, down 7.3% (6.5% in constant currency). Continuing-operations earnings were $16 million; the $196 million discontinued-operations loss resulted in a net loss of $180 million, or $0.11 diluted loss per share. Gross margin was 34.3%, versus 36.3%.
- Cash flows, nine months: Operating cash flow was $63 million, investing cash flow was negative $4.424 billion, and financing cash flow was negative $869 million. Operating cash flow fell $2.7 billion year over year, primarily due to a $1.9 billion pension contribution related to the DXC transaction and lower earnings.
- Liquidity and debt at July 31: Cash and cash equivalents were $7.757 billion; current assets were $23.143 billion and current liabilities $18.279 billion. Short- and long-term borrowings totaled $16.596 billion, compared with $15.695 billion at October 31, 2016. HPE also reported $2.632 billion of restricted cash held in escrow for the Software separation; this was not included in cash and cash equivalents.
- Capital returns and investment: HPE repurchased $1.936 billion of shares and paid $323 million in dividends during the nine months. It received a $3.0 billion cash dividend from DXC. Business acquisitions used $2.050 billion in cash.
Material changes versus the prior comparable period
- Quarter revenue rose, led by Aruba networking and Nimble Storage, while nine-month revenue declined, principally because of lower server sales to Tier 1 service-provider customers and the prior-year H3C divestiture.
- Enterprise Group revenue increased 2.7% in the quarter but decreased 7.6% for the nine months. Its operating margin fell to 9.3% in the quarter from 12.8%, and to 10.2% for the nine months from 12.7%.
- Financial Services revenue increased 10.5% for the quarter and 9.1% for the nine months, mainly from higher rental revenue and lease activity; operating margins declined in both periods.
- Software revenue declined 2.7% for the quarter and 7.3% for the nine months, amid SaaS migration, lower services activity, and separation-related disruption. Software operating margin improved to 24.9% for the quarter from 17.8%.
- Higher commodity costs, competitive pricing pressure and unfavorable currency movements reduced gross margin. The quarter also included higher restructuring, separation, acquisition and transformation costs.
Outlook, commentary, risks and unusual items
- Management highlighted cloud migration, SaaS adoption, competition, pricing pressure, weaker traditional server and storage demand, and sales-execution challenges. It emphasized cost structure, channel execution and product innovation as priorities. The filing provides no specific revenue or EPS guidance.
- Management said operating cash generation, cash balances and access to capital markets should generally support operations, capital spending, acquisitions, restructuring, debt maturities, dividends and repurchases. HPE expected to refinance $1.1 billion of notes due in October 2017.
- Following the September 1 Software separation, Seattle SpinCo’s $2.6 billion term loan funded a $2.5 billion dividend to HPE; Seattle retained the debt. HPE stated that tax effects of the separations could materially lower its GAAP effective tax rate.
- Tax items were unusually volatile: the effective tax rate was negative 306.6% for the quarter and 96.8% for the nine months. The quarter included a $164 million tax benefit related to the DXC transaction; the nine-month period included $473 million of valuation allowances on U.S. state deferred tax assets. Unrecognized tax benefits were $11.2 billion; recorded liabilities and related interest and penalties for uncertain tax positions were approximately $4.2 billion.
- HPE settled a foreign tax audit for $455 million, payable in semiannual installments over three fiscal years. It said existing unrecognized tax benefits could be reduced by up to $2.5 billion within 12 months, though timing and outcomes remain uncertain.
- Approved restructuring plans were expected to require about $600 million of future cash payments. HPE expected up to approximately 13,400 employee exits under its 2015 plan by the end of 2018.
- Significant legal matters include the India customs proceedings, employment class actions, and an Oracle appeal concerning a $3 billion jury award to HP Inc.; any recovery from Oracle is uncertain and would be shared under the separation agreement. HPE said it had adequate litigation provisions and no reasonably possible material excess loss as of July 31, 2017.
- Other risks include potential tax liabilities if either separation fails to qualify for intended tax treatment, international and foreign-exchange exposure, supplier and market risks, and the possibility of additional pension funding needs.
Important facts for investors to verify
- How the September 1 Software separation and $2.5 billion dividend affect post-quarter cash, debt, continuing revenue and earnings.
- Underlying server, storage and networking demand, gross-margin trends, and whether acquisition contributions offset legacy-business declines.
- Cash conversion and liquidity after pension funding, acquisitions, share repurchases, dividends and separation-related payments.
- Refinancing of the October 2017 notes and the company’s debt and cash position after the spin-off transactions.
- Resolution and cash consequences of tax audits, separation tax matters and uncertain tax positions.
- Restructuring costs and execution, and the eventual outcome of material litigation and indemnification arrangements.