Hewlett Packard Enterprise Company (HPE) — Q3 FY2016 Form 10-Q
Reporting period: Three and nine months ended July 31, 2016. The interim financial statements are unaudited. HPE became an independent public company on November 1, 2015, so prior-year results are combined and may not be fully comparable to results as a standalone company.
Key financial results
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Revenue | $12.210 billion | $13.057 billion | $37.645 billion | $38.659 billion |
| Gross margin | 29.3% | 28.7% | 28.8% | 28.3% |
| Operating earnings | $2.497 billion | $244 million | $3.373 billion | $1.404 billion |
| Net earnings | $2.272 billion | $224 million | $2.859 billion | $1.076 billion |
| Diluted EPS | $1.32 | $0.13 | $1.64 | $0.59 |
| Operating cash flow | Not separately reported for the quarter | $2.746 billion | $3.819 billion |
Q3 revenue declined 6.5% year over year (4.4% lower on a constant-currency basis); nine-month revenue fell 2.6% on a reported basis but rose 1.4% at constant currency. The $2.169 billion H3C divestiture gain was the principal reason operating earnings and margins rose sharply; reported Q3 operating margin was 20.5%, versus 1.9% a year earlier. Gross margin improved, while management cited ongoing competitive pricing pressure in hardware.
Segments and operating trends
- Enterprise Group: Q3 revenue fell 7.6% to $6.476 billion, primarily reflecting the H3C divestiture and currency. Networking revenue was down 22% for the quarter, while WLAN products led by Aruba grew. Nine-month revenue was nearly flat.
- Enterprise Services: Q3 revenue declined 5.0% to $4.725 billion, while operating margin improved to 8.3% from 5.7%, attributed mainly to delivery efficiencies and restructuring-related cost savings. Weak EMEA demand, contract runoff and pricing pressure remained challenges.
- Software: Q3 revenue fell 18.1% to $738 million and operating margin declined to 17.8% from 20.5%. Management cited the shift toward SaaS, sales execution challenges and divestitures/transfers of businesses.
- Financial Services: Q3 revenue was up 0.6% to $812 million, but operating margin fell to 9.9% from 10.8%, including pressure from lower asset-management activity and higher IT costs.
Balance sheet, liquidity and capital allocation
- At July 31, 2016, cash and cash equivalents were $10.743 billion; total assets were $78.821 billion and stockholders’ equity was $32.826 billion.
- Debt was approximately $16.3 billion, up from $15.8 billion at October 31, 2015. The weighted-average borrowing rate was 3.4%. HPE reported no senior notes maturing in the next 12 months.
- Available resources included $4.180 billion under commercial paper programs and $1.538 billion of uncommitted credit lines; HPE also had a $4.0 billion revolving credit facility.
- Nine-month operating cash flow declined to $2.746 billion from $3.819 billion. Investing activities provided $630 million, including divestiture proceeds; financing activities used $2.198 billion, including $2.662 billion of share repurchases and $281 million of dividends paid.
- HPE reported $2.8 billion of net proceeds from business divestitures during the nine months. It repurchased 155 million shares for $2.7 billion and had $3.3 billion of remaining repurchase authorization at quarter-end.
Outlook, transactions and material items
- No specific near-term revenue or earnings guidance is provided in the supplied filing text. Management said cash, expected operating cash flow and capital-market access should cover expected near-term cash needs, while noting access and borrowing costs may be affected by business and market conditions.
- The planned Enterprise Services spin-off and merger with CSC was targeted for completion by March 31, 2017. HPE estimated approximately $8.5 billion of after-tax value to shareholders and about $900 million of separation costs.
- On September 7, 2016, after quarter-end, HPE announced the planned spin-off and merger of non-core software assets with Micro Focus, targeted for the second half of FY2017. HPE estimated approximately $8.8 billion of after-tax value to shareholders and about $700 million of separation costs. Both transactions remained subject to closing conditions, approvals and tax-related requirements.
- HPE sold 51% of H3C in May 2016 for approximately $2.6 billion and recorded a $2.169 billion gain, retaining a 49% equity-method interest. HPE recorded a $72 million Q3 loss from equity interests, including $58 million of estimated basis-difference amortization.
- HPE completed the MphasiS divestiture on September 1, 2016, after the reporting date, for a value of $824 million. At July 31, the disposal group was classified as held for sale.
- Restructuring charges were $369 million in Q3 and $841 million for the nine months. HPE expected approximately $2.2 billion of future restructuring cash payments, including $300 million in the remainder of FY2016. The FY2015 plan is expected to reduce approximately 30,000 employees by the end of 2018.
- The effective tax rate was 5.6% for Q3 and 7.4% for the nine months, reflecting lower-tax jurisdictions and foreign tax credits, among other items. Unrecognized tax benefits were $11.1 billion at July 31, up from $4.9 billion at October 31; the increase primarily reflected joint and several liabilities with HP Inc. and intercompany royalty matters. Separately, HPE reported approximately $3.7 billion of recorded liabilities and related interest and penalties for uncertain tax positions.
- HPE disclosed a $3 billion Oracle jury award to HP Inc. in the Itanium litigation. Under the separation agreement, HPE may share equally in any recovery after reimbursement of specified pre-separation prosecution costs; the award is subject to Oracle’s stated intent to appeal.
- Other risks include execution, timing and tax treatment of the proposed separations; competitive and cloud/SaaS market shifts; restructuring execution; currency exposure; and resolution of tax, litigation and other contingencies. HPE said its disclosure controls were effective and there were no material changes to internal control over financial reporting in the quarter.
Important facts for investors to verify
- How much of reported earnings growth reflects the non-recurring H3C gain, versus continuing operations and segment performance.
- Whether revenue and margins stabilize in Enterprise Group and Software, and whether Enterprise Services cost savings can continue as revenue declines.
- Completion conditions, timing, separation costs, tax treatment and realized value of the CSC and Micro Focus transactions.
- The potential cash and earnings effects of uncertain tax positions, including liabilities shared with or indemnified by HP Inc.
- Restructuring cash outlays, the pace of share repurchases and dividends, and the trend in operating cash flow relative to debt and other commitments.
- Developments in the Oracle appeal and other disclosed litigation and regulatory matters.