Business Context and Reporting Period
This filing is a Quarterly Report on Form 10-Q for Hewlett-Packard Company (HP) for the quarterly period ended July 31, 2007. HP is a global provider of products, technologies, software, solutions, and services organized into seven business segments: Enterprise Storage and Servers, HP Services, HP Software, Personal Systems Group, Imaging and Printing Group, HP Financial Services, and Corporate Investments.
Key Financial Metrics
| Metric | Three Months Ended July 31, 2007 | Nine Months Ended July 31, 2007 |
|---|---|---|
| Total Net Revenue | $25,377 million | $75,993 million |
| Net Earnings | $1,778 million | $5,100 million |
| Diluted EPS | $0.66 | $1.87 |
| Operating Cash Flow (9mo) | $6,006 million | |
| Cash and Cash Equivalents | $12,450 million (as of July 31, 2007) | |
| Total Debt (Short + Long Term) | $8,612 million (as of July 31, 2007) | |
| Share Repurchases (9mo) | $8,847 million |
Material Changes vs. Prior Period
- Revenue Growth: Net revenue increased 15.9% year-over-year for the quarter and 13.2% for the nine-month period. Growth was driven by the Personal Systems Group (28.6% quarterly increase) and HP Software (74.2% quarterly increase, largely due to the Mercury acquisition).
- Profitability: Net earnings rose 29.3% for the quarter and 13.3% for the nine-month period compared to the prior year. Operating margin improved to 8.3% for the quarter from 6.9% in the prior year.
- Acquisitions: HP completed the $4.9 billion acquisition of Mercury Interactive Corporation in November 2006, significantly impacting the HP Software segment. Additional acquisitions included Opsware (pending) and SPI Dynamics (completed August 1, 2007).
- Restructuring and Pension: The nine-month period included a $407 million restructuring charge, primarily related to the 2007 U.S. Enhanced Early Retirement (EER) program. This was partially offset by a $517 million net gain from pension curtailments and settlements resulting from modifications to U.S. defined benefit plans.
- Liquidity: Cash and cash equivalents decreased by approximately $4.0 billion from the prior fiscal year-end, primarily due to $8.8 billion in share repurchases and $4.9 billion in net cash paid for acquisitions.
Guidance, Outlook, and Risks
- Capital Strategy: HP continues to repurchase shares to manage dilution and opportunistically. As of July 31, 2007, approximately $4.8 billion remained under the share repurchase authorization.
- Cost Reduction: Management is focused on consolidating data centers and real estate locations to reduce IT and real estate costs, with savings reinvested in sales force expansion.
- Legal and Regulatory Risks:
- Copyright Levies: Ongoing proceedings in the EU (specifically Germany) regarding levies on multifunction devices and printers could result in substantial costs.
- Leak Investigation: HP settled civil claims with the California Attorney General regarding the "leak investigation" for $14.5 million and consented to an SEC cease and desist order. Stockholder derivative lawsuits remain pending.
- IRS Disputes: HP received a Notice of Deficiency from the IRS for fiscal years 1999 and 2000, asserting additional taxes and potential reductions in refund claims totaling approximately $361 million if sustained.
- Product Litigation: Various class actions are pending regarding inkjet printer "smart chips," floppy disk controllers, and drum kit replacements.
Investor Verification Checklist
- Mercury Integration: Verify the realization of synergies and revenue growth from the Mercury Interactive acquisition within the HP Software segment.
- Restructuring Execution: Monitor the completion of the 2007 U.S. Enhanced Early Retirement program and the associated cash outflows versus the recorded accruals.
- Legal Exposure: Assess the potential financial impact of the German copyright levy rulings and the outcome of the IRS dispute regarding tax refunds and deficiencies.
- Share Repurchase Impact: Evaluate the effect of the aggressive $8.8 billion share repurchase program on liquidity and future capital flexibility.
- Pension Plan Changes: Confirm the long-term cost savings from the modification of the U.S. defined benefit pension plan and the associated curtailment gains.