Hewlett Packard Enterprise Company — Q2 FY2020 Form 10-Q
Reporting period: Three and six months ended April 30, 2020. Unless stated otherwise, financial amounts are in U.S. dollars; figures are in millions.
Business context and performance
HPE provides technology products and services spanning edge to cloud, including servers, storage, networking, consulting and financing. The quarter was its first full quarter operating amid COVID-19. HPE reorganized its reportable segments in fiscal 2020; prior-period segment results were recast, with no change to consolidated results.
Key financial metrics
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Net revenue | $6,009 | $7,150 | $12,958 | $14,703 |
| Gross profit | $1,914 | $2,305 | $4,196 | $4,651 |
| Gross margin | 31.9% | 32.2% | 32.4% | 31.6% |
| Operating income (loss) | $(834) | $434 | $(486) | $890 |
| Operating margin | (13.9%) | 6.1% | (3.8%) | 6.1% |
| Net income (loss) | $(821) | $419 | $(488) | $596 |
| Diluted EPS | $(0.64) | $0.30 | $(0.38) | $0.43 |
| Operating cash flow | Not separately provided for the quarter | $21 | $1,369 |
- Q2 revenue fell 16.0% year over year (14.6% in constant currency); six-month revenue declined 11.9% (10.7% in constant currency). Products drove most of the Q2 decline: product revenue was $3,320 versus $4,410; services were $2,574 versus $2,624.
- Q2 GAAP results included an $865 goodwill impairment charge for HPC & MCS. Q2 non-GAAP net earnings were $285, or $0.22 per diluted share; six-month non-GAAP net earnings were $860, or $0.66 per diluted share. These company-defined measures exclude specified items and are not substitutes for GAAP results.
- At April 30, cash and cash equivalents were $5,131, versus $3,753 at October 31, 2019; cash, cash equivalents and restricted cash totaled $5,990. Six-month operating cash flow was $21, investing cash outflow was $104, and financing cash inflow was $1,997.
- Inventory rose to $3,476 from $2,387. HPE attributed the increase to lower inventory consumption amid component access constraints and purchases to support planned shipments. Days of inventory supply rose to 76 from 41 year over year.
- Short- and long-term debt totaled $16,715 at April 30, 2020 ($5,162 current and $11,553 long-term), compared with $13,820 at October 31, 2019. HPE issued $2.25 billion of senior notes in April; it plans to redeem $3.0 billion of notes maturing in October 2020.
- HPE reported $6.0 billion of deferred revenue and remaining performance obligations; it expected to recognize approximately 34% of remaining performance obligations as revenue during the rest of fiscal 2020.
Material changes and segment trends
- Revenue declined across all segments in Q2. Compute fell 20.4%, Storage 17.6%, and HPC & MCS 18.3%; Financial Services fell 7.0%. Intelligent Edge fell 2.9%. A & PS revenue fell 8.8%, but its operating result improved to $2 from a $14 loss.
- Compute and HPC & MCS were affected by supply constraints, lockdown-related installation and customer-acceptance delays, and pricing pressure. Storage also faced uneven demand and the expiration of a one-time legacy contract. Intelligent Edge was affected by switching-market weakness and currency.
- Q2 gross margin decreased 0.3 percentage points, reflecting competitive pricing, lower revenue absorption of fixed overhead, and COVID-related supply-chain costs. The six-month gross margin increased 0.8 points, helped by product and service mix, delivery efficiencies and lower commodity costs.
- Goodwill impairment reduced HPC & MCS goodwill by $865; $3.6 billion remained allocated to that reporting unit. HPE cited COVID-19-related reductions in projected growth and profitability. Further deterioration could trigger additional impairment.
- Six-month operating cash flow fell $1.3 billion year over year, primarily due to lower earnings and unfavorable working capital. HPE’s cash conversion cycle was negative five days, versus negative 21 days a year earlier.
Outlook, risks and unusual items
- HPE said it could not predict the extent or duration of COVID-19’s effects and did not provide a clear financial forecast in the supplied filing text. Management cited uncertainty in customer demand, supply chains, customer-site access, collections and capital markets.
- On May 19, 2020, after quarter-end, the board approved a cost optimization plan expected to run through fiscal 2022. HPE estimated at least $1.0 billion of gross savings and at least $800 million of annualized net run-rate savings by fiscal year-end 2022, relative to fiscal 2019 exit, with $1.0–$1.3 billion of cash funding over three years. Savings and costs are estimates, not guarantees.
- HPE extended its HPE Next transformation initiative to fiscal 2021. Six-month transformation costs were $289, including $248 of restructuring charges. HPE expected approximately $345 of future cash payments for approved restructuring plans as of April 30.
- HPE suspended share repurchases on April 6 in response to uncertainty. It repurchased 25.3 million shares for $355 during the first six months and had $2.1 billion of remaining authorization.
- Liquidity sources included an undrawn $4.75 billion revolving credit facility and stated available commercial-paper programs and uncommitted lines. HPE said cash, expected operating cash flow and market access were expected to cover near-term needs, while warning that pandemic conditions could constrain market access and collections.
- Other exposures include $2.2 billion of unrecognized tax benefits and ongoing litigation and environmental matters. HPE stated it did not believe a material loss in excess of recorded amounts was reasonably possible as of April 30; litigation outcomes remain inherently uncertain.
Most important facts for investors to verify
- Whether revenue, customer acceptance and supply-chain performance recover as COVID-19 restrictions and demand conditions change.
- Whether the HPC & MCS outlook stabilizes and whether further goodwill impairment is required.
- Cash generation, inventory levels, receivable collections and financing-portfolio credit quality, including COVID-related collection effects.
- Debt repayment and refinancing plans, liquidity availability, and the cost and execution of the new savings plan.
- Progress against stated savings targets and the impact of restructuring, temporary employee cost measures and suspended repurchases.