HP Inc. (Hewlett-Packard Company) — Q2 FY2011 Form 10-Q
Reporting period: Quarter and six months ended April 30, 2011. Comparisons are with the corresponding 2010 periods. Amounts are in U.S. dollars; financial statement figures are in millions unless noted. HP reports seven segments spanning enterprise services, infrastructure and software, personal systems, imaging and printing, financial services, and corporate investments.
Financial performance
| Metric | Q2 FY2011 | Q2 FY2010 | First half FY2011 | First half FY2010 |
|---|---|---|---|---|
| Net revenue | $31.632bn | $30.849bn | $63.934bn | $62.026bn |
| Earnings from operations | $2.968bn | $2.858bn | $6.362bn | $5.861bn |
| Net earnings | $2.304bn | $2.200bn | $4.909bn | $4.450bn |
| Diluted EPS | $1.05 | $0.91 | $2.23 | $1.84 |
| Gross margin | 24.6% | 23.6% | 24.5% | 23.3% |
| Operating margin | 9.4% | 9.3% | 10.0% | 9.4% |
| Net margin | 7.3% | 7.1% | 7.7% | 7.2% |
- Q2 revenue rose 2.5% reported (1.3% constant currency); first-half revenue rose 3.1% (2.9% constant currency). Revenue outside the U.S. accounted for approximately 66% of sales.
- For the first six months, operating cash flow was $7.032bn, versus $5.498bn. Investing used $1.582bn, compared with $3.940bn, largely reflecting lower acquisition spending. Financing used $3.641bn, versus $706m.
- Cash and cash equivalents were $12.738bn at April 30, up from $10.929bn at October 31, 2010. Total borrowings were approximately $22.9bn, up from $22.3bn; stated weighted-average borrowing rates were 2.1% and 2.0%, respectively.
- Current assets were $56.075bn and current liabilities $51.370bn. HP reported $14.4bn of available borrowing resources, including commercial paper programs and uncommitted credit lines, plus $299m available under receivables facilities. A $5bn debt issuance on May 31, 2011 occurred after quarter-end.
- HP repurchased $5.0bn of shares in the first half and had $5.9bn of remaining authorization at April 30. Cash dividends declared were $0.16 per share for the first half.
Material changes and segment trends
- Enterprise Servers, Storage and Networking (ESSN): Q2 revenue increased 14.9% to $5.556bn and operating earnings rose 22.8% to $766m. Growth reflected servers, networking and storage; reported networking growth was substantially influenced by the 3Com acquisition, and storage included 3PAR.
- Personal Systems Group (PSG): Q2 revenue fell 5.4% to $9.415bn, but operating earnings increased 14.6% to $533m and margin improved to 5.7%. Consumer market softness, particularly notebooks, weighed on sales; commercial revenue grew.
- Imaging and Printing Group (IPG): Q2 revenue rose 5.5% to $6.745bn and operating earnings rose 4.2% to $1.144bn. Supplies growth supported sales, while lower-priced product mix and yen-related currency effects pressured margin.
- Services: Q2 revenue increased 1.5% to $8.977bn; operating earnings declined 2.9% to $1.361bn and margin fell to 15.2%. Management cited rate concessions, lower-than-expected revenue, and mix shifts.
- HP Software: Q2 revenue rose 17.0% to $764m, while operating earnings declined 7.8% to $154m and margin fell to 20.2%, reflecting acquisition and sales/R&D investment costs.
- HP Financial Services: Q2 revenue increased 17.2% to $885m and operating earnings rose 20.3% to $83m, with lower bad-debt expense contributing.
- HP stated that gross-margin expansion reflected lower component costs and a more favorable mix, including higher networking and software revenue. Comparisons are affected by acquisitions and fiscal 2011 segment realignments; prior-period segment data were reclassified.
Outlook, management commentary, risks and contingencies
- Outlook: The filing provides no quantitative earnings or revenue guidance. HP described strategic priorities in cloud computing, connectivity, software, higher-value services, WebOS devices, printing innovation, and operational efficiency. In May 2011, it announced planned changes to its services business, including accelerated investment in higher-value services and alignment with overall strategy.
- Restructuring: First-half restructuring charges were $316m. The fiscal 2010 Enterprise Services plan was expected to cost approximately $1bn, including about 9,000 position reductions; approximately 4,400 positions had been eliminated by April 30. HP expected most infrastructure charges through FY2012 and most related cash payments through Q2 FY2012.
- Japan earthquake and tsunami: HP expected a short-term adverse effect on revenue and operating profit from reduced Japanese demand, printing supply constraints, and higher logistics costs. The filing did not quantify the expected impact.
- Legal and regulatory matters: HP disclosed ongoing U.S. and German investigations concerning the Russia GPO transaction and potential FCPA issues. Indian customs authorities sought approximately $370m plus penalties in one principal matter, with additional smaller claims; HP said it would contest the notices. Copyright levy and product-related litigation also remained outstanding. HP said it believed its recorded provisions were adequate and that an additional material loss beyond recognized amounts was not reasonably possible as of April 30, while cautioning that litigation outcomes are unpredictable.
- Tax matters: Gross unrecognized tax benefits were $1.9bn, of which up to $1.2bn could affect the effective tax rate if realized. HP said it was reasonably possible that unrecognized benefits could decrease by up to $246m within 12 months. The first-half effective tax rate was 20.7%; discrete tax items provided a $157m net benefit.
- Other risks: HP highlighted intense price competition, consumer PC softness, product transitions and technology shifts, supplier and component risks, foreign-exchange and macroeconomic exposure, execution of services contracts and restructuring, acquisition integration, and cybersecurity and data-protection risks. HP reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue and margin trends persist, especially the contrast between strong ESSN growth and declining PSG and Services performance; assess acquisition and currency contributions.
- Whether HP can sustain operating cash generation as the cash conversion cycle lengthened to 25 days from 17 a year earlier, with receivable days rising to 53 from 43.
- The effect of continued share repurchases, debt maturities and the May 31 $5bn issuance on leverage, liquidity, and capital allocation.
- Actual financial effects of the Japan disruption and progress, costs, and savings from the Enterprise Services restructuring and planned services changes.
- Developments in the Russia GPO investigation, India customs claims, copyright levies, and tax audits and unrecognized tax benefits.