Business Context and Reporting Period
This summary covers the Annual Report on Form 10-K for Hewlett-Packard Company (HP) for the fiscal year ended October 31, 2006. HP is a global provider of personal computing, imaging and printing products, enterprise IT infrastructure, and IT services. Operations are organized into seven segments: Enterprise Storage and Servers (ESS), HP Services (HPS), Software, Personal Systems Group (PSG), Imaging and Printing Group (IPG), HP Financial Services (HPFS), and Corporate Investments. ESS, HPS, and Software are aggregated under the Technology Solutions Group (TSG).
Key Financial Metrics
| Metric | Fiscal 2006 | Fiscal 2005 |
|---|---|---|
| Net Revenue | $91,658 million | $86,696 million |
| Gross Profit | $22,231 million (24.3% margin) | $20,256 million (23.4% margin) |
| Earnings from Operations | $6,560 million (7.2% margin) | $3,473 million (4.0% margin) |
| Net Earnings | $6,198 million | $2,398 million |
| Diluted EPS | $2.18 | $0.82 |
| Cash and Cash Equivalents | $16,400 million | $13,911 million |
| Long-term Debt | $2,490 million | $3,392 million |
| Total Assets | $81,981 million | $77,317 million |
Cash Flow: Net cash provided by operating activities was $11.35 billion. Net cash used in investing activities was $2.79 billion, and net cash used in financing activities was $6.08 billion, driven primarily by $6.1 billion in share repurchases.
Material Changes vs. Prior Period
- Revenue Growth: Net revenue increased 6% year-over-year (7% on a constant currency basis). Growth was driven by the Personal Systems Group (9% increase) and Imaging and Printing Group (6% increase), while HP Financial Services declined 1%.
- Profitability Surge: Net earnings more than doubled to $6.2 billion. This was significantly aided by a favorable effective tax rate of 13.8% (down from 32.3% in 2005), largely due to a $565 million favorable tax adjustment from the settlement of IRS examinations for fiscal years 1993-1998.
- Restructuring: Restructuring charges dropped significantly to $158 million in 2006 compared to $1.68 billion in 2005. The 2005 charges were primarily due to a major workforce reduction plan approved in the fourth quarter of that year.
- Stock-Based Compensation: HP adopted SFAS 123(R) in fiscal 2006, resulting in a $536 million pre-tax stock-based compensation expense, compared to $104 million in 2005 under the previous accounting standard.
Guidance, Outlook, Risks, and Unusual Items
- Outlook and Strategy: Management continues to focus on cost structure optimization, including consolidating 85 data centers into six and reducing real estate footprint. The company expects to reinvest savings from restructuring into business operations.
- Acquisitions: HP completed the acquisition of Mercury Interactive Corporation in November 2006 for approximately $4.8 billion to strengthen its IT management software portfolio. Pending acquisitions include Knightsbridge Solutions and Bitfone Corporation.
- Share Repurchases: HP repurchased approximately 190 million shares for $6.1 billion in fiscal 2006. As of October 31, 2006, approximately $5.6 billion remained authorized for future repurchases.
- Key Risks:
- Competitive Pressure: Intense price competition in PC and printer markets continues to pressure margins.
- Supply Chain: Reliance on single-source suppliers (e.g., Intel for processors) creates vulnerability to shortages or price increases.
- Legal and Regulatory: Ongoing investigations regarding the "leak investigation" (spygate) resulted in a $14.5 million settlement with the California Attorney General. HP faces potential liabilities from copyright levies in Europe and environmental regulations (WEEE Directive).
- Foreign Currency: A stronger U.S. dollar negatively impacted reported revenue and margins.
Important Facts for Investor Verification
- Tax Rate Volatility: Verify the sustainability of the 13.8% effective tax rate, which was heavily influenced by a one-time $565 million tax benefit from IRS settlements.
- Mercury Integration: Monitor the integration costs and revenue synergies from the $4.8 billion Mercury Interactive acquisition completed post-fiscal year-end.
- Restructuring Completion: Confirm the final costs and headcount reductions associated with the fiscal 2005 restructuring plan, with approximately 1,000 positions remaining to be eliminated in fiscal 2007.
- Legal Contingencies: Track the status of the "leak investigation" regulatory inquiries and stockholder derivative lawsuits, as well as the outcome of copyright levy proceedings in Germany and the EU.
- Stock-Based Compensation Impact: Assess the ongoing impact of SFAS 123(R) adoption on future earnings, as the full expense recognition for stock options is now reflected in the income statement.