HP 10-Q Summary — Fiscal Q1 2015
Issuer and period: The filing is for Hewlett-Packard Company, the predecessor to the planned separation into Hewlett-Packard Enterprise and HP Inc.; it is not a standalone post-separation HP Inc. filing. The unaudited quarter ended January 31, 2015, compared with the quarter ended January 31, 2014. Unless stated otherwise, amounts are in U.S. dollars.
Business context and financial performance
HP operated across Personal Systems, Printing, Enterprise Group, Enterprise Services, Software, HP Financial Services and Corporate Investments. Revenue was pressured by currency movements, Enterprise Services contract runoff, lower Printing supplies revenue and the prior-year intellectual-property sale. Management reported revenue down 2.5% excluding currency effects.
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Net revenue | $26.839 billion | $28.154 billion | Down 4.7% |
| Gross profit / margin | $6.268 billion / 23.4% | $6.418 billion / 22.8% | Margin up 0.6 points |
| Operating earnings / margin | $1.920 billion / 7.1% | $1.997 billion / 7.1% | Earnings down 3.9%; margin flat |
| Net earnings / net margin | $1.366 billion / 5.1% | $1.425 billion / 5.1% | Earnings down 4.1%; margin flat |
| Diluted EPS | $0.73 | $0.74 | Down $0.01 |
| Cash dividends declared per share | $0.32 | $0.29 | Up $0.03 |
Gross margin improvement reflected, among other factors, Printing mix and currency benefits and improved service delivery in Enterprise Services. Competitive pricing remained a pressure. Operating earnings also reflected $80 million in separation costs and $146 million in restructuring charges; neither item was present at the same level in the prior-year comparison (separation costs were zero in Q1 FY2014).
Cash flow, liquidity and debt
- Operating cash flow was $744 million, versus $2.990 billion a year earlier. HP attributed the decrease primarily to weaker working-capital and financing-receivable cash flows.
- Capital expenditures were $947 million; proceeds from property sales were $130 million. Cash used in investing activities was $838 million, versus $217 million in the prior-year quarter.
- Cash and cash equivalents ended at $12.919 billion, down from $15.133 billion at October 31, 2014. HP reported cash and short- and long-term investments of $13.3 billion, down approximately $2.2 billion from the prior quarter-end.
- Total borrowings were approximately $19.1 billion, down from $19.5 billion at October 31, 2014. Current liabilities were $42.529 billion and current assets $48.198 billion. HP said $2.5 billion of notes were scheduled to mature within 12 months, including $750 million in March 2015.
- Financing cash outflow was $2.120 billion, including $1.571 billion of share repurchases, $304 million of dividends paid and $612 million of net debt payments. HP had $3.3 billion remaining under its share-repurchase authorization.
Management said operating cash flow, existing cash and capital-market access were expected to cover near-term cash requirements. Ratings agencies had placed HP on negative watch or review following the separation announcement; HP cautioned that further downgrades could raise borrowing costs, reduce commercial-paper capacity or require additional collateral.
Segment changes versus prior year
- Personal Systems: Revenue was $8.544 billion, up 0.2%; operating margin rose to 3.7% from 3.3%. Notebook growth offset lower desktop revenue, currency impacts and declining average selling prices.
- Printing: Revenue was $5.543 billion, down 4.7%; operating margin increased to 19.2% from 16.8%. Supplies revenue declined 5% and printer unit volumes fell 4%; graphics growth and cost initiatives supported profitability.
- Enterprise Group: Revenue was $6.981 billion, up 0.2%; operating margin increased to 15.6% from 14.4%. Industry Standard Servers grew 7%, while Networking fell 11% and Business Critical Systems fell 9%.
- Enterprise Services: Revenue was $4.993 billion, down 10.8%, while operating margin improved to 3.0% from 1.1%. Key-contract runoff, weak account growth, currency and contractual price declines weighed on revenue; delivery efficiencies supported margins.
- Software: Revenue was $871 million, down 4.9%; operating margin improved to 18.0% from 15.8%. License revenue declined 16%, with SaaS growth flat.
- HP Financial Services: Revenue was $803 million, down 7.7%; operating margin declined to 11.2% from 11.6%, mainly reflecting lower asset-management activity and portfolio revenue.
- Corporate Investments: Revenue fell to $16 million from $288 million and the segment recorded a $124 million operating loss, principally reflecting the prior-year IP sale and higher incubation and corporate costs.
Segment reporting was realigned to move third-party multi-vendor support arrangements from Enterprise Group to Enterprise Services. Prior-year segment information was recast; consolidated results were unchanged.
Outlook, significant items and risks
- Separation: HP targeted completion of its split into Hewlett-Packard Enterprise and HP Inc. by the end of fiscal 2015, subject to approvals and tax-related conditions. Estimated separation charges were approximately $1.3 billion in FY2015 and $500 million in FY2016. HP also estimated about $950 million of gross incremental foreign cash taxes in FY2015, anticipated approximately $200 million of foreign tax credits, and expected $300 million of separation-related capital expenditure in FY2015. The filing provides no standalone quarterly earnings guidance.
- Subsequent acquisition announcement: On March 2, 2015, HP agreed to acquire Aruba Networks for $24.67 per share in cash, an estimated $3.0 billion equity value and approximately $2.7 billion net of cash and debt. Closing was expected in the second half of FY2015, subject to customary conditions.
- Restructuring: HP recorded $146 million of charges in the quarter. Under its 2012 plan, HP had recorded approximately $5.1 billion of an estimated $5.54 billion total cost and had eliminated approximately 43,700 of an estimated 55,000 positions. Remaining payments were expected to extend through FY2021.
- Tax exposures: Unrecognized tax benefits were $4.2 billion; HP said up to $2.3 billion could affect its effective tax rate if realized and that the balance might decrease by up to $1.5 billion within 12 months. A foreign tax authority had proposed an approximately $680 million assessment relating to an intercompany transaction; HP was contesting it.
- Litigation and contingencies: HP described ongoing copyright-levy, employment, customs, FCPA-related, shareholder and Autonomy-related matters. India customs proceedings involved demands of approximately $370 million plus penalties. A South Carolina contract dispute was settled; HP paid approximately $44.1 million on February 2, 2015. HP stated that it believed recorded provisions were adequate, but litigation outcomes could affect results or cash flows.
- Business risks: Management highlighted competitive pricing, currency volatility, macroeconomic weakness, PC and printing market shifts, cloud and SaaS transitions, Enterprise Services execution, supplier and inventory risks, and the possibility that separation costs, timing or tax treatment differ from expectations.
Most important facts for investors to verify
- Whether cash generation recovers after the sharp year-over-year decline in operating cash flow, and how much reflects working-capital timing.
- Progress in Enterprise Services turnaround and whether revenue runoff continues despite improved operating margins.
- Separation timetable, actual separation charges and foreign tax cash costs, and the tax-free status and final terms of the transaction.
- Funding and closing conditions for the Aruba acquisition, alongside scheduled debt maturities and credit-rating developments.
- Developments in the $680 million proposed tax assessment, India customs case, Autonomy investigations and other significant contingencies.
- Whether Printing supplies declines and competitive pricing continue to offset margin and cost improvements.