HP Inc. (Hewlett-Packard Company) — Q1 FY2014 Form 10-Q
Reporting period: Three months ended January 31, 2014; comparative period ended January 31, 2013. Unless stated otherwise, dollar amounts are in millions. The filing cautions that quarterly results are not necessarily indicative of the full year.
Business context
HP reported seven segments: Personal Systems, Printing, Enterprise Group, Enterprise Services, Software, HP Financial Services, and Corporate Investments. It reorganized certain segment reporting in FY2014; prior-period segment data were recast, with no effect on consolidated results.
Financial results and liquidity
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Net revenue | $28,154 | $28,359 | Down 0.7%; up 0.3% constant currency |
| Gross profit / margin | $6,418 / 22.8% | $6,330 / 22.3% | Margin up 0.5 percentage points |
| Operating earnings / margin | $1,997 / 7.1% | $1,752 / 6.2% | Margin up 0.9 points |
| Net earnings / margin | $1,425 / 5.1% | $1,232 / 4.3% | Up 15.7% |
| Diluted EPS | $0.74 | $0.63 | Up 17.5% |
| Operating cash flow | $2,990 | $2,562 | Up $428 |
- Cash and cash equivalents were $16,165 at January 31, 2014, versus $12,163 at October 31, 2013. Total assets were $105,025.
- Cash used for property, plant and equipment purchases was $997; proceeds from property sales were $450, making net investment $547. Investing cash outflow was $217.
- Financing cash inflow was $1,229, including $2,005 of debt issuance; HP repurchased $565 of stock and paid $278 in dividends.
- Total borrowings were approximately $24.6 billion, up from $22.6 billion at October 31, 2013; weighted-average interest rate was 2.9%. Cash less borrowings implies approximate net debt of $8.4 billion.
- Current assets were $50,684 and current liabilities $43,611. HP reported $17.6 billion of available borrowing resources, including commercial paper capacity and uncommitted lines, subject to market and credit conditions.
- Cash conversion cycle improved to 16 days from 23 days. Management said this was below its expected long-term sustainable level.
Material changes and segment performance
- Revenue weakness was concentrated in Enterprise Services (down 7.3%), HP Financial Services (down 9.1%), Printing (down 2.2%), and Software (down 3.7%). Personal Systems rose 3.6%; Enterprise Group rose 0.6%.
- Enterprise Services operating margin fell to 1.0% from 1.3%, amid key-account runoff, contract price declines, currency effects, and weak services demand. Enterprise Group margin fell to 14.4% from 15.4%, reflecting pricing pressure and higher memory costs.
- Personal Systems operating margin rose to 3.3% from 2.8%; Printing to 16.8% from 16.3%; HP Financial Services to 11.6% from 10.6%. Software margin declined to 15.8% from 16.3%.
- Consolidated revenue decline reflected Enterprise Services runoff and adverse currency, particularly yen weakness, partially offset by commercial PC growth and an intellectual-property sale. Management attributed higher gross and operating margins partly to the IP sale, real-estate sale gain, restructuring savings, lower amortization, and service delivery efficiencies.
Outlook, management commentary, risks and unusual items
- No specific consolidated revenue or earnings guidance for the next quarter or full year is provided in the supplied filing text. Management described continued market, competitive, macroeconomic, and execution challenges, including PC-to-mobile shifts, cloud and SaaS transitions, hardware pricing pressure, and weak public-sector and services demand.
- HP’s FY2012 restructuring plan targeted approximately 34,000 position eliminations through FY2014 and estimated aggregate charges of $4.1 billion. About 28,300 positions had been eliminated by January 31, 2014. HP expected approximately $1.6 billion of future restructuring cash expenditures, including about $1.1 billion in the remainder of FY2014; payments may extend through FY2021.
- HP expected approximately $545 million of additional non-U.S. pension contributions and $110 million of U.S. non-qualified and post-retirement benefit payments during the remainder of FY2014.
- Approximately $5.5 billion of notes were scheduled to mature over the next four fiscal quarters; HP disclosed that $2.0 billion was repaid in March 2014 and $2.5 billion was scheduled to mature in FY2014 Q3.
- Material contingencies include ongoing FCPA investigations, including advanced discussions with U.S. enforcement agencies; Autonomy-related investigations and shareholder litigation; a South Carolina contract dispute involving approximately $275 million in claimed damages; Indian customs proceedings seeking approximately $403 million in duties and penalties; and European copyright levy proceedings. HP stated it had recorded provisions it considered adequate, but outcomes remain uncertain.
- Unrecognized tax benefits were $3.5 billion; HP said existing benefits could be reduced by up to $1.2 billion within 12 months as tax matters are resolved. The filing also describes uncertain tax audit outcomes and potential cash-flow or earnings effects.
- HP cited potential credit-rating downgrades, currency and economic volatility, supplier and execution risks, restructuring costs, litigation, and technology transitions as risks. Moody’s outlook remained negative; HP’s ratings had not changed during the quarter. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the revenue and margin improvement is sustainable apart from the IP and real-estate sale benefits, restructuring savings, and currency effects.
- Whether Enterprise Services can stabilize revenue and improve its low operating margin, and whether Personal Systems and Enterprise Group can withstand pricing and component-cost pressures.
- Cash conversion cycle sustainability, upcoming debt maturities, refinancing access, and the effect of the negative credit outlook on borrowing costs and liquidity.
- Actual restructuring cash costs and realized savings, alongside planned pension contributions and tax settlements.
- Developments and potential financial exposure in the FCPA, Autonomy, South Carolina, India customs, copyright levy, and other legal matters.