Business Context and Reporting Period
This Form 10-Q covers Hewlett-Packard Company (HP) for the quarterly period ended July 31, 2006. HP is a global provider of products, technologies, solutions, and services, organized into seven business segments: Enterprise Storage and Servers, HP Services, Software, Personal Systems Group, Imaging and Printing Group, HP Financial Services, and Corporate Investments. The company is a large accelerated filer incorporated in Delaware.
Key Financial Metrics
| Metric | Three Months Ended July 31, 2006 | Nine Months Ended July 31, 2006 |
|---|---|---|
| Total Net Revenue | $21,890 million | $67,103 million |
| Net Earnings | $1,375 million | $4,501 million |
| Diluted EPS | $0.48 | $1.57 |
| Earnings from Operations | $1,510 million | $4,659 million |
| Operating Margin | 6.9% | 6.9% |
| Gross Margin | 24.8% | 24.2% |
| Cash and Cash Equivalents | $15,981 million (as of July 31, 2006) | N/A |
| Net Cash Provided by Operating Activities | N/A | $8,109 million |
| Total Debt (Short-term + Long-term) | $6,767 million | N/A |
Material Changes vs. Prior Period
- Revenue Growth: Total net revenue increased 5% year-over-year for both the quarter and the nine-month period. On a constant currency basis, revenue increased 6% for the quarter and 7% for the nine months.
- Profitability Surge: Net earnings for the quarter rose dramatically from $73 million in the prior year to $1,375 million. This improvement was driven by higher operating earnings and a significantly lower effective tax rate (20.9% vs. 92.9% in the prior year quarter).
- Tax Rate Impact: The prior year period included a $788 million tax charge related to the repatriation of foreign earnings under the American Jobs Creation Act. The current period benefited from favorable tax adjustments totaling $408 million related to IRS settlements for fiscal years 1993-1998.
- Segment Performance:
- Personal Systems Group (PSG): Revenue increased 8% (quarter) and 9% (nine months), driven by volume growth in consumer and commercial markets.
- Imaging and Printing Group (IPG): Revenue increased 5% (quarter) and 6% (nine months), led by strong printer supplies shipments.
- Software: Revenue increased 30% (quarter) and 26% (nine months), significantly boosted by the Peregrine Systems acquisition.
- Restructuring: Restructuring charges were minimal in the current period ($5 million for the quarter, $6 million for nine months) compared to $112 million and $119 million in the prior year periods, respectively.
Guidance, Outlook, and Risks
- Acquisitions: HP announced a pending acquisition of Mercury Interactive Corporation for approximately $4.5 billion in enterprise value, expected to close in the fourth calendar quarter of 2006. Recent completed acquisitions include Peregrine Systems and Scitex Vision.
- Share Repurchases: HP repurchased approximately 160 million shares for $5.0 billion in the first nine months of fiscal 2006. On August 15, 2006, the Board authorized an additional $6.0 billion for future repurchases.
- Restructuring Plans: HP is continuing a fiscal 2005 restructuring plan targeting the elimination of approximately 15,300 positions through the first quarter of fiscal 2007. Approximately 10,000 positions had been eliminated as of July 31, 2006.
- Key Risks:
- Competition and Pricing: Intense price competition in personal computers and printing markets pressures margins.
- Intellectual Property: Ongoing litigation regarding copyright levies in Europe (specifically Germany) and patent infringement claims (e.g., Compression Labs, Cornell University).
- Supply Chain: Reliance on third-party suppliers and single-source components creates risks of shortages or quality issues.
- Legal Proceedings: HP is cooperating with inquiries from the California Attorney General and the U.S. Attorney's Office regarding potential leaks of confidential information.
Investor Verification Checklist
- Tax Provision Volatility: Verify the sustainability of the low effective tax rate (11.5% for nine months) given the one-time favorable IRS settlements and the absence of the prior year's repatriation tax charge.
- Mercury Acquisition Integration: Assess the financial impact and integration risks of the pending $4.5 billion Mercury Interactive acquisition.
- European Copyright Levies: Monitor the outcome of ongoing litigation in Germany regarding copyright levies on multifunction devices and printers, which could impact future margins.
- Restructuring Execution: Track the progress of the 15,300 position reduction plan and the associated cost savings realization.
- Share Repurchase Strategy: Confirm the utilization of the new $6.0 billion repurchase authorization and its impact on diluted EPS.