HP Inc. (Hewlett-Packard Company) — Q2 FY2013 Form 10-Q
Reporting period: Three and six months ended April 30, 2013. The quarter ended April 30 was HP’s second fiscal quarter. Financial amounts below are in U.S. dollars; dollar figures are in millions unless stated otherwise.
Business context and results
HP provides personal computing, printing, enterprise infrastructure, software, services and customer financing. Its seven reportable segments were Personal Systems, Printing, Enterprise Group, Enterprise Services, Software, HP Financial Services and Corporate Investments. HP reorganized its segment structure in fiscal 2013; prior-period segment data was recast, without changing consolidated results.
| Metric | Q2 FY2013 | Q2 FY2012 | Six months FY2013 | Six months FY2012 |
|---|---|---|---|---|
| Revenue | $27,582 | $30,693 | $55,941 | $60,729 |
| Gross profit | $6,527 | $7,152 | $12,857 | $13,875 |
| Gross margin | 23.7% | 23.3% | 23.0% | 22.8% |
| Operating earnings | $1,601 | $2,222 | $3,353 | $4,264 |
| Operating margin | 5.8% | 7.2% | 6.0% | 7.0% |
| Net earnings | $1,077 | $1,593 | $2,309 | $3,061 |
| Diluted EPS | $0.55 | $0.80 | $1.18 | $1.53 |
Cash flow, balance sheet and liquidity
- First-half operating cash flow was $6,118, compared with $3,666 a year earlier. Investing used $1,198 and financing used $2,981; cash increased by $1,939 to $13,240.
- Capital investment in property, plant and equipment was $1,400 in the first half, versus $1,963 in the prior-year period. HP repurchased $1,050 of stock and paid $541 in dividends.
- At April 30, cash was $13,240; total borrowings were approximately $26,800, down from $28,400 at October 31, 2012. Long-term debt was $19,863 and current borrowings were $6,928. HP reported a weighted-average borrowing rate of 2.79%.
- Current assets were $49,571 and current liabilities $44,658. HP reported $17.7 billion of available borrowing resources, including commercial paper capacity and uncommitted credit lines. Management said cash, expected operating cash flow and capital-market access should cover near-term outlays.
- HP said substantially all cash was held outside the United States, generally to support non-U.S. needs. Repatriation may incur U.S. tax or be restricted by local law.
- Moody’s long-term rating was Baa1 with a negative outlook; S&P rated HP BBB+ and Fitch A-. HP warned further downgrades could raise borrowing costs, reduce commercial-paper capacity and require additional collateral.
Material changes versus prior period
- Revenue fell 10.1% in Q2 and 7.9% in the first half; management cited weak demand, particularly in EMEA, softer IT spending and increased pricing competition. Constant-currency declines were 9% and 7%, respectively.
- Personal Systems revenue dropped 19.9% in Q2 and 14.0% year to date; operating margin fell to 3.2% and 2.9%, respectively. Notebook and consumer demand, market movement toward tablets, pricing pressure and higher component costs weighed on results.
- Enterprise Group revenue declined 9.6% in Q2 and 6.9% year to date, while operating margin fell to 15.9% and 15.7%. Enterprise Services revenue declined 7.6% and 7.3%, and margins declined to 2.6% and 1.9%, respectively.
- Printing revenue was down 0.8% in Q2 and 3.1% year to date, but operating margin improved to 15.8% and 15.9%, respectively, on mix, pricing and cost reductions. Software revenue declined modestly while operating margin improved to 19.1% in Q2 and 18.1% year to date.
- Consolidated operating earnings declined 27.9% in Q2 and 21.4% in the first half; net earnings declined 32.4% and 24.6%, respectively. Gross margin improved slightly, but higher restructuring charges and lower revenue contributed to the operating-margin decline.
- Operating cash flow rose by $2,452 year over year for the first half, aided by working-capital management and lower payments related to webOS contract cancellations. HP also reduced capital spending and repaid debt.
Outlook, management commentary and key risks
- HP did not provide a specific consolidated revenue, earnings or EPS forecast in the supplied filing text. Management described ongoing multi-quarter revenue and margin declines and said it was working to align costs, improve execution and invest in cloud, security, big data and mobility.
- The fiscal 2012 restructuring plan targets approximately 29,000 employee exits through fiscal 2014 and expected aggregate charges of about $3.6 billion. HP had eliminated approximately 18,800 positions by April 30. First-half consolidated restructuring expense was $538; expected restructuring cash payments were approximately $2.0 billion, including about $0.8 billion in the remainder of fiscal 2013.
- HP expected $6.0 billion of Global Notes to mature over the next four fiscal quarters and said it expected to have sufficient cash, operating cash flow and market access to repay them.
- Key business risks include continued PC-market contraction and substitution by mobile devices, competitive pricing, weak global and EMEA demand, product transitions, service-contract runoff and price declines, and execution risk in restructuring and strategic investments. HP also cited supplier, channel, cybersecurity, foreign-exchange, pension and credit-rating risks.
- Material legal and contingent matters include investigations and litigation related to Autonomy’s pre-acquisition accounting and disclosures; ongoing U.S. and U.K. investigations into Autonomy; investigations into the Russia GPO transaction and other international dealings; Indian customs-duty proceedings; copyright-levy disputes; and various securities, shareholder, employment and product lawsuits. HP stated that it believed its recorded legal provisions were adequate, but adverse outcomes could materially affect cash flow or results in a particular period.
- HP reported $2.8 billion of gross unrecognized tax benefits and approximately $2.3 billion of recorded tax liabilities and related interest and penalties, partially offset by deferred tax assets and interest receivable. It said up to $205 million of unrecognized tax benefits might decrease within 12 months.
Important facts for investors to verify
- Whether revenue declines and margin pressure persist, especially in Personal Systems, Enterprise Group and Enterprise Services, and whether Printing’s margin gains are sustainable.
- Progress, cash costs and realized savings from the 29,000-position restructuring plan, including the timing and uncertainty of expected benefits.
- Operating cash flow quality and sustainability, including the contribution from working-capital movements, and the capacity to fund debt maturities, restructuring, investment and shareholder returns.
- Debt refinancing and liquidity access given $6.0 billion of upcoming maturities, ratings under negative outlook and reliance on commercial-paper and capital markets.
- Developments and potential financial exposure from Autonomy, Russia GPO, India customs, copyright levies and other litigation; the filing does not provide a clear aggregate estimate of potential losses across these matters.
- Tax-audit outcomes, foreign cash repatriation implications, and financing-portfolio credit quality, including the trend in past-due and non-accrual receivables.