Business context and reporting period
Hewlett-Packard Company’s unaudited Form 10-Q covers the three and six months ended April 30, 2015, compared with the corresponding 2014 periods. HP reported seven segments: Personal Systems, Printing, Enterprise Group, Enterprise Services, Software, HP Financial Services and Corporate Investments. The company was preparing to separate into Hewlett-Packard Enterprise and HP Inc., then targeted for completion by fiscal year-end 2015.
Unless stated otherwise, amounts are U.S. dollars. Financial statement amounts are in millions; segment and liquidity figures are rounded where appropriate.
Key financial metrics
| Metric | Q2 FY2015 | Q2 FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Net revenue | $25.453 billion | $27.309 billion | $52.292 billion | $55.463 billion |
| Gross profit | $6.108 billion | $6.605 billion | $12.376 billion | $13.023 billion |
| Gross margin | 24.0% | 24.2% | 23.7% | 23.5% |
| Operating earnings / margin | $1.431 billion / 5.6% | $1.822 billion / 6.7% | $3.351 billion / 6.4% | $3.819 billion / 6.8% |
| Net earnings | $1.011 billion | $1.273 billion | $2.377 billion | $2.698 billion |
| Diluted EPS | $0.55 | $0.66 | $1.29 | $1.40 |
| Operating cash flow | Not separately provided | Not separately provided | $2.208 billion | $5.985 billion |
- Q2 revenue fell 6.8% year over year, or 2.2% on a constant-currency basis; six-month revenue fell 5.7%, or 2.3% constant currency. HP attributed the difference largely to unfavorable foreign exchange.
- Q2 net earnings declined 20.6%; six-month net earnings declined 11.9%. Operating margin contracted 1.1 percentage points in Q2 and 0.4 points for the first half.
- For the six months, cash used in investing was $1.639 billion and cash used in financing was $934 million; cash decreased $365 million to $14.768 billion.
- At April 30, cash and cash equivalents were $14.768 billion; current assets were $48.883 billion and current liabilities $43.186 billion. The current ratio was approximately 1.13.
- Borrowings totaled approximately $21.1 billion at April 30, versus $19.5 billion at October 31, 2014. This included $5.594 billion of notes payable and short-term borrowings and $15.464 billion of long-term debt. Cash exceeded borrowings by about $3.7 billion, before considering other liquidity needs.
- Six-month capital spending on property, plant and equipment was $1.726 billion; net of $211 million in asset-sale proceeds, net PP&E investment was about $1.5 billion. HP repurchased $2.230 billion of shares and paid $595 million in dividends during the period.
Material changes and segment performance
- Revenue declines were broad-based, with Enterprise Services the largest contributor to the consolidated decline. Q2 segment revenue changes included Enterprise Services down 15.5%, Personal Systems down 5.3%, Printing down 6.5%, Software down 8.1%, and Enterprise Group down 1.1%. Enterprise Group revenue rose 4.7% on a constant-currency basis, led by Industry Standard Servers, up 11%.
- Enterprise Services revenue fell as large contracts ran off and demand remained soft, particularly in EMEA. Its operating margin nevertheless improved to 4.0% in Q2 from 2.6%, reflecting delivery efficiencies, improved underperforming contracts and lower operating expenses.
- Printing’s Q2 operating margin fell to 18.3% from 19.5%, amid competitive pricing, lower supplies volume and weaker printer revenue. Personal Systems margin declined to 3.0% from 3.5%; notebook growth was offset by desktop weakness and lower average selling prices.
- Management cited currency pressure, competitive pricing and changing demand as recurring challenges. For the first six months, gross margin improved 0.2 percentage points, but operating margin fell, in part because of separation costs and the prior-year intellectual-property sale.
- Operating cash flow fell $3.777 billion year over year for the first half. HP attributed the decrease to higher pension contributions, weaker working-capital cash generation, lower contract-manufacturer receipts, higher accrued-expense payments, lower earnings and currency effects.
Outlook, management commentary, risks and unusual items
- Separation: HP continued to target completion by the end of fiscal 2015, subject to board, tax, regulatory and other conditions. It estimated total separation charges and net foreign tax expenses of about $2.6 billion across FY2015 and FY2016. Expected separation-related cash payments were up to $2.2 billion; separation-related capital expenditures were estimated at about $300 million for FY2015, including about $200 million in the remainder of the year. These estimates and timing remain subject to change.
- Restructuring: Q2 restructuring charges were $255 million and first-half charges $401 million. HP had incurred $9.371 billion of total restructuring costs to date and expected total costs of $9.555 billion. Under the 2012 plan, HP expected to eliminate about 55,000 positions through FY2015; approximately 47,600 had been eliminated by April 30. HP estimated about $0.9 billion of future restructuring cash payments.
- Financing and post-quarter events: HP established a $5 billion delayed-draw term loan facility on April 30, with maturity generally tied to November 1, 2015 or completion of the separation. No amount was drawn at quarter-end; HP borrowed $2.5 billion on May 15. HP completed its approximately $3 billion cash acquisition of Aruba Networks in May and announced an agreement for Unisplendour to acquire 51% of a new China-focused H3C business for about $2.3 billion, subject to closing conditions.
- Tax uncertainty: HP reported $4.2 billion of unrecognized tax benefits, of which up to $2.3 billion would affect its effective tax rate if realized. A foreign tax authority had proposed an approximately $680 million assessment relating to an intercompany transaction; HP was contesting it. HP said tax matters could materially affect earnings or cash flows, and estimated unrecognized tax benefits could decrease by up to $1.5 billion within 12 months.
- Litigation and contingencies: Disclosed matters included Autonomy-related investigations and shareholder litigation, copyright-levy proceedings, employment claims, and an Indian customs dispute involving affirmed assessments and penalties of approximately $386 million for products and $17 million for parts, which HP was appealing. HP stated it had recorded adequate provisions and that, as of April 30, it was not reasonably possible that material losses had been incurred beyond recognized amounts; it also cautioned that litigation outcomes are inherently unpredictable.
- Principal operating risks: HP highlighted ongoing PC-market and desktop weakness, mobility and cloud transitions, software-as-a-service adoption, competitive pricing, contract runoff in services, execution and restructuring risks, supplier and inventory exposure, foreign-exchange volatility, macroeconomic weakness, cybersecurity, and risks that the separation could be delayed, more costly than expected, or fail to deliver expected benefits. Credit-rating agencies had placed HP on negative watch or under review; further downgrades could increase borrowing costs and constrain commercial-paper access.
- Guidance: The provided filing text does not give a clear numerical revenue or earnings forecast for the next quarter or full year. Management’s stated outlook primarily addresses the separation, restructuring, pension funding and related costs.
Most important facts for investors to verify
- Whether revenue and profitability stabilize, particularly in Enterprise Services, Printing, Personal Systems and Software, and how much of reported weakness reflects currency versus underlying demand.
- Whether operating cash flow recovers from the first-half decline and how working capital, pension contributions and separation payments affect liquidity.
- The final separation timetable, total separation and foreign-tax costs, tax-free treatment, and the resulting capital structure and cash needs of each company.
- Debt and refinancing exposure after the $2.5 billion post-quarter term-loan draw, including credit ratings, commercial-paper availability and upcoming maturities.
- Resolution or changes in the $680 million foreign tax assessment, uncertain-tax-position balances, and material litigation or customs claims.
- Completion and financial effects of the Aruba acquisition and proposed H3C transaction, including integration, financing and closing conditions.