HP Inc. (Hewlett-Packard Company) — FY2014 Form 10-K
Business context and reporting period
The filing covers the fiscal year ended October 31, 2014; quarterly figures are also provided for the three months ended October 31, 2014. HP was a diversified global technology company operating Personal Systems, Printing, Enterprise Group (EG), Enterprise Services (ES), Software, HP Financial Services (HPFS), and Corporate Investments. Approximately 65% of FY2014 revenue came from outside the United States.
On October 6, 2014, HP announced plans to separate into Hewlett-Packard Enterprise (infrastructure, software, services and financing) and HP Inc. (printing and personal systems), targeted for completion by the end of fiscal 2015, subject to approvals and tax-related conditions.
Financial performance and liquidity
| Metric | FY2014 | FY2013 |
|---|---|---|
| Revenue | $111.454 billion | $112.298 billion |
| Gross profit / margin | $26.615 billion / 23.9% | $25.918 billion / 23.1% |
| Operating earnings / margin | $7.185 billion / 6.4% | $7.131 billion / 6.4% |
| Net earnings / diluted EPS | $5.013 billion / $2.62 | $5.113 billion / $2.62 |
| Cash from operations | $12.333 billion | $11.608 billion |
| Cash and cash equivalents at year-end | $15.133 billion | $12.163 billion |
| Total debt at year-end | $19.525 billion | $22.587 billion |
- Revenue declined 0.8% year over year (0.4% on a constant-currency basis). Gross margin improved 0.8 percentage points, while operating margin was unchanged. Net margin was 4.5%, versus 4.6%.
- Net cash used in investing activities was $2.792 billion and in financing activities was $6.571 billion. Capital spending was $3.853 billion, partly offset by $843 million of property-sale proceeds. HP repurchased $2.728 billion of shares and paid $1.184 billion in dividends.
- Cash, cash equivalents and short- and long-term investments totaled approximately $15.5 billion at year-end. Current assets were $50.145 billion and current liabilities $43.735 billion. Debt-to-equity was 0.72x, down from 0.82x; the weighted-average interest rate was 2.7%.
- Cash conversion cycle improved to 4 days from 17 days, with management cautioning that the FY2014 level was below its expected sustainable rate.
Segment results and material changes
| FY2014 segment | Revenue | Operating earnings | Operating margin | Revenue change vs. FY2013 |
|---|---|---|---|---|
| Personal Systems | $34.303 billion | $1.270 billion | 3.7% | +6.6% |
| Printing | $22.979 billion | $4.185 billion | 18.2% | -3.8% |
| Enterprise Group | $27.814 billion | $4.008 billion | 14.4% | -1.0% |
| Enterprise Services | $22.398 billion | $803 million | 3.6% | -6.9% |
| Software | $3.933 billion | $872 million | 22.2% | -2.2% |
| HP Financial Services | $3.498 billion | $389 million | 11.1% | -3.6% |
| Corporate Investments | $302 million | $(199) million | Not meaningful | Not meaningful |
Segment operating earnings exclude corporate and unallocated costs, stock-based compensation, intangible amortization, restructuring and acquisition-related charges; figures therefore do not sum to consolidated operating earnings.
- Personal Systems growth reflected commercial PC demand, including customers refreshing systems after Windows XP support ended; unit volume rose 8.2%, partly offset by lower average selling prices. Management cited signs of stabilization in the PC market.
- Printing revenue fell mainly on lower supplies volume, while its operating margin rose to 18.2% from 16.5%, supported by cost improvements, mix and currency effects.
- EG revenue and margin declined amid weakness in Business Critical Systems and traditional storage and competitive pricing. Industry Standard Servers and Networking grew.
- ES continued to face large-contract runoff, weak new-account growth, contractual price declines and pressured public-sector spending. Revenue fell, but its operating margin improved to 3.6% from 2.8% through delivery efficiencies, contract improvements and restructuring savings.
- Software revenue declined as customers shifted from licenses and support toward SaaS; SaaS revenue grew 5%, while operating margin increased to 22.2%.
Supplemental fourth-quarter figures: revenue was $28.406 billion, versus $29.131 billion in Q4 FY2013; net earnings were $1.330 billion, versus $1.414 billion; diluted EPS was $0.70, versus $0.73. Q4 FY2014 restructuring charges were $604 million.
Outlook, risks, contingencies and unusual items
- Separation: Completion was targeted for the end of FY2015, but remained conditional. HP warned of execution costs, business disruption, employee-retention challenges, possible tax costs and uncertainty that the transaction would deliver expected benefits.
- Restructuring: HP increased the expected workforce reductions under its 2012 plan from 34,000 to 55,000 positions. It estimated total plan charges of $5.54 billion, of which $4.908 billion had been incurred by year-end; FY2014 restructuring expense was $1.619 billion. Approximately $1.8 billion of future restructuring cash payments were expected, including $1.0 billion in FY2015, and additional charges were expected in FY2015.
- Liquidity and credit: Following the separation announcement, S&P and Fitch assigned negative outlooks and Moody’s placed HP under review for downgrade. HP noted that prior downgrades had raised borrowing costs and reduced commercial-paper capacity. Approximately $2.5 billion of notes were scheduled to mature in FY2015.
- Taxes: HP reported $3.5 billion of recorded liabilities and related interest and penalties for uncertain tax positions in its contractual-obligations discussion; the tax note separately reports $4.128 billion of unrecognized tax benefits. HP also disclosed $42.9 billion of indefinitely reinvested foreign earnings and ongoing tax audits and disputes.
- Litigation and investigations: HP disclosed copyright-levy proceedings, employment and securities litigation, Autonomy-related investigations and shareholder claims, and an India customs-duty dispute. A U.S. subsidiary pleaded guilty to FCPA violations; HP reported approximately $31 million paid to the SEC and $77 million in DOJ fines and penalties. In the South Carolina contract dispute, the state had sought approximately $275 million; the parties submitted a settlement agreement for approval in December 2014.
- Pensions: The U.S. defined-benefit plan mortality-table change increased the projected benefit obligation by approximately $870 million. Total FY2014 funded-status deficits disclosed were $1.777 billion for U.S. defined-benefit plans, $3.650 billion for non-U.S. plans and $382 million for post-retirement plans.
- Unusual tax transaction: HP received $10.4 billion of advance royalties under a multi-year intercompany licensing arrangement. The related $9.9 billion of deferred intercompany royalty revenue is eliminated in consolidated results; the transaction contributed to a $1.3 billion net U.S. long-term deferred tax asset.
- Other principal risks include intense price competition, PC and printing market transitions, cloud/SaaS adoption, foreign currency exposure, reliance on suppliers and distribution partners, cybersecurity, and macroeconomic weakness. HP reported no goodwill impairment in FY2014; Software had the smallest disclosed goodwill fair-value cushion, 18% over carrying value (6% under a hypothetical 10% fair-value decline).
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; controls were reported effective as of October 31, 2014.
Important facts for investors to verify
- Whether the separation was completed on schedule and on tax-free terms, and the costs, allocations and standalone financial profiles of the resulting companies.
- Whether revenue and cash generation stabilize, especially in ES, EG, Printing supplies and Software licenses/support; assess reported performance alongside currency effects and product mix.
- Actual restructuring charges, cash payments, position reductions and realized savings compared with HP’s expanded plan estimates.
- Debt maturities, credit-rating developments, commercial-paper access and the location and availability of cash held outside the United States.
- Resolution and potential cash impact of tax audits, the disclosed tax positions, FCPA matters and significant litigation or contract disputes.
- Progress in reducing pension deficits and whether goodwill assumptions, particularly for Software, remain supportable.