HP 2010 Q3 Form 10-Q Summary
Business context and reporting period
Hewlett-Packard Company and subsidiaries reported the quarter and nine months ended July 31, 2010. Amounts below are in U.S. dollars; financial statement figures are in billions unless otherwise noted. HP operates across services, enterprise storage and servers, software, personal systems, imaging and printing, financial services, and corporate investments.
Financial performance and liquidity
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $30.729 | $27.585 | $92.755 | $83.775 |
| Operating earnings | $2.323 | $2.213 | $8.184 | $7.003 |
| Net earnings | $1.773 | $1.671 | $6.223 | $5.248 |
| Diluted EPS | $0.75 | $0.69 | $2.60 | $2.15 |
| Operating margin | 7.6% | 8.0% | 8.8% | 8.4% |
| Gross margin | 23.8% | 23.8% | 23.4% | 23.5% |
- Revenue grew 11.4% in Q3 and 10.7% year to date as reported; constant-currency growth was 10.6% and 8.1%, respectively. Product revenue drove most of the increase.
- Q3 operating margin declined 0.4 percentage points, principally reflecting higher restructuring and acquisition-related charges; year-to-date operating margin improved 0.4 points. Net margin was 5.8% for Q3 versus 6.1% and 6.7% year to date versus 6.3%.
- Operating cash flow was $8.771 billion for the first nine months, down from $9.946 billion. Investing used $6.293 billion, including $4.017 billion net for acquisitions; financing used $1.039 billion. Cash increased $1.439 billion to $14.718 billion.
- Capital investment in property, plant and equipment was $2.901 billion year to date. Cash flow from operations less this investment was approximately $5.870 billion.
- At July 31, cash and cash equivalents were $14.718 billion; current assets were $54.365 billion and current liabilities $49.288 billion. Short-term borrowings were $7.842 billion and long-term debt $12.204 billion, for total borrowings of approximately $20.0 billion, compared with $15.8 billion at October 31, 2009.
- Share repurchases used $7.079 billion in the first nine months; dividends paid were $590 million. HP declared dividends of $0.16 per share in Q3.
Material changes versus comparable periods
- Personal Systems Group revenue grew 17.5% in Q3 and 19.7% year to date, led by notebooks and desktops. Enterprise Storage and Servers revenue rose 19.1% and 20.1%, driven mainly by industry-standard servers; business-critical systems declined.
- Imaging and Printing revenue increased 9.0% in Q3 and 6.9% year to date. Its operating margin was 16.9% in Q3 versus 17.0%; year-to-date margin fell to 17.0% from 17.9%, with a lower supplies mix and increased marketing costs among the pressures.
- Services revenue grew modestly, while operating margin improved to 15.9% in Q3 from 15.3% and to 15.8% year to date from 14.0%, reflecting cost actions, delivery efficiencies, and EDS synergies.
- HP completed the acquisitions of 3Com for approximately $3.3 billion in April and Palm for approximately $1.8 billion in July. Acquisition-related goodwill and intangible valuations remained preliminary. HP agreed on September 2 to acquire 3PAR for approximately $2.3 billion, subject to closing conditions.
- Inventory rose to $7.206 billion from $6.128 billion at October 31. Management attributed lower operating cash flow largely to inventory buildup and a smaller reduction in receivables.
Outlook, management commentary, risks, and unusual items
- The filing gives no specific consolidated revenue, earnings, or EPS guidance. Management emphasized investments in sales coverage, products, emerging markets, networking, and mobile devices, alongside ongoing cost and efficiency programs.
- HP began a multi-year enterprise-services restructuring plan expected to cost approximately $1 billion, including elimination of about 9,000 positions. It recorded $520 million of charges through July 31; about 900 positions had been eliminated. The filing expected most remaining severance charges by Q2 fiscal 2011 and most cash payments through Q4 fiscal 2012.
- Q3 restructuring charges totaled $598 million. HP also disclosed a $40 million Palm restructuring charge and an expected $39 million 3Com restructuring plan. Prior EDS restructuring actions remained in progress.
- HP cited intense pricing and competitive pressure, uncertain global demand, component-cost and supply risks, inventory management, currency movements, acquisition integration, and execution of restructuring plans as risks. It also disclosed a search for a permanent CEO and noted that leadership transition could disrupt operations and create uncertainty.
- HP disclosed $2.0 billion of gross unrecognized tax benefits; up to $980 million could affect its effective tax rate if realized. It considered a reduction of up to $290 million reasonably possible within 12 months. The nine-month effective tax rate was 19.8%, versus 18.1%.
- Material legal matters include a $55 million settlement with the U.S. Department of Justice of federal contracting allegations, without admission of wrongdoing; Indian customs-duty notices seeking approximately $370 million plus penalties and a further $5.3 million plus penalties; and ongoing U.S. and German investigations concerning alleged conduct in a Russian government transaction. HP said it was contesting the India notices and cooperating with investigators.
- HP settled the EDS Sky litigation for £318 million inclusive of interest and costs, and paid $75 million to settle Cornell patent claims. Proposed settlements in several U.S. inkjet-printer cases were subject to court approval and provided for customer e-credits capped at $5 million in aggregate per settlement.
- Subsequent events: HP commenced a $3 billion debt offering on September 8, 2010. Its board authorized an additional $10 billion of share repurchases on August 29, beyond the $4.9 billion remaining under the prior authorization at July 31.
- Management concluded disclosure controls were effective as of July 31 and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether revenue growth and improving year-to-date operating earnings convert into sustained margins and cash flow, particularly as product mix and pricing change.
- Whether inventory levels normalize and operating cash generation recovers after the year-to-date decline.
- Acquisition integration, final purchase-price valuations, and realized contribution from 3Com and Palm; also verify the status and financing of the 3PAR transaction.
- Actual restructuring costs, workforce reductions, savings, and cash-payment timing compared with the enterprise-services plan.
- Debt and liquidity trends, including the subsequent $3 billion note offering and the scale and timing of authorized repurchases.
- Developments in tax audits and the India customs, Russia-related, copyright-levy, and other litigation contingencies, whose final outcomes and financial effects may differ from current estimates.