HP Inc. — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended July 31, 2019; comparisons are with the corresponding 2018 periods. HP sells personal computing products and printing hardware, supplies, solutions and services through Personal Systems, Printing and Corporate Investments. Amounts below are U.S. dollars.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Net revenue | $14.603B | $14.586B | $43.349B | $43.106B |
| Gross profit / margin | $2.905B / 19.9% | $2.688B / 18.4% | $8.246B / 19.0% | $7.972B / 18.5% |
| Operating earnings / margin | $1.079B / 7.4% | $1.018B / 7.0% | $2.933B / 6.8% | $2.837B / 6.6% |
| Net earnings | $1.179B | $880M | $2.764B | $3.876B |
| Diluted EPS | $0.78 | $0.54 | $1.80 | $2.36 |
- Q3 revenue was essentially flat year over year, or up 2% on a constant-currency basis. Nine-month revenue rose 1% (2% constant currency).
- Q3 operating earnings increased about 6%; nine-month operating earnings increased about 3%. Gross margin improved 1.5 percentage points in Q3 and 0.5 points year to date, primarily from lower Personal Systems supply-chain costs.
- Q3 net earnings included a $931M tax benefit despite only $248M of pretax earnings. HP recorded $1.1B of net discrete tax benefits for the three and nine months, chiefly from tax audit settlements. Q3 also included $784M of tax-indemnification expense within “Interest and other, net,” primarily reflecting resolution of tax matters. These unusual tax and indemnification items make reported net earnings less indicative of underlying operating trends.
- Nine-month net earnings fell 29%, largely against unusually large prior-year tax benefits associated with U.S. tax reform and audit settlements. The filing does not provide a clear normalized earnings comparison.
Segments and notable changes
- Personal Systems: Q3 revenue rose 3.1% to $9.690B; operating earnings increased 51% to $547M, with margin improving to 5.6% from 3.9%. Commercial revenue grew 9.9%, while Consumer revenue declined 11.5%. Higher volume was partly offset by lower average selling prices. Nine-month revenue increased 2.4% to $28.268B.
- Printing: Q3 revenue fell 5.3% to $4.912B and operating earnings declined 7.7% to $765M; margin was 15.6% versus 16.0%. Supplies revenue fell 7.1%, primarily on demand weakness, and printer unit volume declined 9.3%. Nine-month revenue decreased 2.7% to $15.084B. Apogee, acquired November 1, 2018, contributed to Commercial Hardware growth.
- HP cited PC and home-printing market weakness, competitive pricing, foreign-exchange headwinds and tariff and trade uncertainty. Personal Systems faced component availability and pricing pressures; Printing faced lower supplies demand, non-HP supplies competition and channel-management challenges.
Cash flow, liquidity and capital
- Nine-month operating cash flow was $4.066B, up from $3.560B. Investing used $211M, versus $803M used in the prior year; financing used $4.102B, versus $3.559B used.
- Cash and cash equivalents were $4.919B at July 31, 2019, down $247M from October 31, 2018. Capital expenditures were $475M. HP said operating cash flow, cash balances and capital-market access should cover expected near-term needs.
- Debt outstanding was approximately $5.1B, down from $6.0B at October 31, 2018; weighted-average borrowing rates were 4.6% and 4.3%, respectively. HP had no commercial paper outstanding, a $4.0B revolving credit facility available through March 2023, and $695M of uncommitted lines. HP reported compliance with credit-facility covenants.
- Current assets were $19.683B and current liabilities $24.579B at July 31. The resulting working-capital deficit was $4.896B; accounts payable was $14.648B. The cash conversion cycle was negative 36 days.
- HP repurchased $1.944B of shares and paid $734M in dividends during the nine months. Approximately $2.0B remained authorized for repurchases. The quarterly dividend was $0.32 per share.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management described strategic priorities including profitable PC growth, device and printing services, managed print, Instant Ink, Graphics and 3D printing. HP noted its historical fourth-quarter revenue seasonality but cautioned that past patterns are not reliable forecasts.
- The Fiscal 2017 restructuring plan was expected to exit approximately 4,500–5,000 employees by fiscal year-end 2019, with estimated aggregate pretax charges of about $700M. HP reported $141M of restructuring and other charges for the first nine months and expected approximately $119M of future cash payments under cost-saving plans.
- HP’s tax position remains material: gross unrecognized tax benefits were $896M at July 31, of which up to $780M could affect the effective tax rate if realized. The company cited ongoing tax audits and said it could not estimate the timing of cash settlements for uncertain tax positions. It expects payments of the one-time U.S. transition tax over eight years, beginning in fiscal 2019.
- HP stated that it had accrued adequate provisions for disclosed litigation and did not consider additional material losses reasonably possible as of July 31, while warning that litigation outcomes remain unpredictable. Notable matters include an unrecognized $3.0B jury award against Oracle under appeal, potential Indian customs duties and penalties, and newer patent claims. HP has no assurance it will collect the Oracle award; recovery would be shared with Hewlett Packard Enterprise under specified terms.
- Other risks include global economic weakness, tariffs and trade disputes, currency movements, intense competition, channel and inventory forecasting, supplier concentration, and pressure on printing supplies. HP said market-risk exposure had not changed materially since October 31, 2018. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Key facts for investors to verify
- How much Q3 and year-to-date earnings were driven by discrete tax benefits, audit settlements and the tax-indemnification adjustment, and what a comparable normalized result would be.
- Whether Printing supplies demand and consumer printer volumes stabilize, and whether Personal Systems commercial growth can offset consumer weakness and pricing pressure.
- Cash conversion, working-capital needs and the sustainability of cash generation alongside buybacks, dividends, restructuring payments and debt reduction.
- Progress and final costs of the Fiscal 2017 restructuring plan, and the realized contribution from the Apogee acquisition.
- Developments in tax audits and indemnification recoveries, the Oracle appeal, and other litigation or regulatory matters that could affect earnings or cash flows.