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HEWLETT PACKARD CO - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge) HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations The following discussion should be read in conjunction with the Consolidated
Financial Statements and the related notes that appear elsewhere in this
document.
OVERVIEW
We are a leading global provider of products, technologies, software,
solutions and services to individual consumers, small- and medium-sized
businesses, and large enterprises, including customers in the government, health
and education sectors. Our offerings span:
º •
º personal computing and other access devices;
º • º multi-vendor customer services, including infrastructure technology
and business process outsourcing, technology support and maintenance,
application development and support services and consulting and
integration services;
º •
º imaging and printing-related products and services; and
º • º enterprise information technology infrastructure, including enterprise
server and storage technology, networking products and solutions, IT
management software, information management solutions and security
intelligence/risk management solutions.
We have seven business segments for financial reporting purposes: Personal
Systems (formerly known as the Personal Systems Group or "PSG"); Printing
(formerly known as the Imaging and Printing Group or "IPG"); Services;
Enterprise Servers, Storage and Networking ("ESSN"); Software; HP Financial
Services ("HPFS"); and Corporate Investments.
Our strategy and operations are currently focused on the following
initiatives:
Strategic Focus
The core of our business is our hardware and infrastructure products, which
include our PC, server, storage, networking, and imaging and printing products.
Our software business provides enterprise IT management software, information
management solutions and security intelligence/risk management solutions
delivered in the form of traditional software licenses or as
software-as-a-service that allow us to differentiate our hardware products and
deploy them in a manner that helps our customers solve problems and meets our
customers' needs to manage their infrastructure, operations, application life
cycles, application quality and security, business processes, and structured and
unstructured data. Our Converged Infrastructure portfolio of servers, storage
and networking combined with our Cloud Service Automation software suite enables
enterprise and service provider clients to deliver infrastructure, platform and
software-as-a-service in a private, public or hybrid cloud environment. Layered
on top of our hardware and software businesses is our services business, which
provides opportunities to drive usage of HP products and solutions, enables us
to implement and manage all the technologies upon which our customers rely, and
gives us a platform to be more solution-oriented, particularly in our focus
areas of cloud, security and analytics, and to be a better strategic partner
with our customers.
Leveraging our Portfolio and Scale
We offer one of the IT industry's broadest portfolios of products and
services, and we are leveraging that portfolio to our strategic advantage. For
example, we are able to provide servers, storage and networking products
packaged with services that can be delivered to customers in the
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Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
manner of their choosing, be it in-house, outsourced as a service via the
Internet, or via a hybrid environment. Our portfolio of management software
completes the package by allowing our customers to manage their IT operations in
an efficient and cost-effective manner. In addition, we are working to optimize
our supply chain by eliminating complexity, reducing fixed costs, and leveraging
our scale to ensure the availability of components at favorable prices even
during shortages. We are also expanding our use of industry standard components
in our enterprise products to further leverage our scale.
Addressing the Challenges Facing Our Business
Our business has experienced a multi-quarter decline in revenue and
operating margins. This decline in financial performance reflects a series of
challenges facing our business. Many of those challenges relate to structural
and execution issues, including the following: we need to align our costs with
our revenue trajectory; we need to address our underinvestment in R&D and in our
internal IT systems in recent years, which has made us less competitive,
effective and efficient; we need to implement the data gathering and reporting
tools and systems needed to track and report on all key business performance
metrics so as to most effectively manage a company of our size, scale and
diversity; and we need to rebuild our business relationships with our channel
partners. We are also facing dynamic market trends, such as the growth of
mobility, the increasing demand for hyperscale computing infrastructure, the
shift to software-as-a-service and the transition towards cloud computing, and
we need to develop products and services that position us to win in a very
competitive marketplace. Furthermore, we face a series of significant
macroeconomic challenges, including broad-based weakness in consumer spending,
weak demand in the SMB and enterprise sectors in Europe, and declining growth in
some emerging markets, particularly China.
We are addressing these challenges through consistency of leadership, focus,
execution and, most importantly, superior products, services and solutions.
During fiscal 2012, we implemented some leadership and organizational changes,
including consolidating our personal computer and printing businesses under the
same senior executive leadership, merging our global accounts sales organization
into ESSN, and centralizing all of our marketing and communications activities.
We also began implementing cost-reduction initiatives, including a company-wide
restructuring plan we expect to be implemented through the end of fiscal 2014.
In addition, we began making significant changes to our sales force to improve
our go-to-market selling activities and reduce cost, and we renewed our focus on
developing new products, services and solutions. We also began working to
optimize our supply chain, reduce the number of stock keeping units (SKUs) and
platforms, refine our real estate strategy, improve our business processes and
implement consistent pricing and promotions. During fiscal 2013, we will be
focused on working through the anticipated disruptions expected to accompany the
changes made in fiscal 2012 and continuing to implement our cost-reduction and
operational initiatives.
Investing in our Business
The cost-reduction and operational efficiency initiatives discussed above
are also intended to facilitate increased investment in our business. These
efforts will include optimizing our supply chain, reducing the number of stock
keeping units (SKUs) and platforms, continuing to refine our real estate
strategy, simplifying our go-to-market, improving business processes and
implementing consistent pricing and promotions. We expect to invest savings from
these efforts across our businesses, including investing to respond to market
trends and customer expectations, strengthen our position in our core markets,
accelerate growth in adjacent markets, and drive leadership in the three
strategic areas of cloud computing, security and information management. Over
time, we expect these investments to allow us to expand in higher margin and
higher growth industry segments and further strengthen our
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Financial Condition and Results of Operations (Continued)
portfolio of hardware, software and services to solve customer problems.
However, the rate at which we are able to invest in our business and the returns
that we are able to achieve from these investments will be affected by many
factors, including the efforts to address the execution, industry and
macroeconomic challenges facing our business as discussed above. As a result, we
may experience delays in the anticipated timing of activities related to these
efforts, and the anticipated benefits of these efforts may not materialize.
The following provides an overview of our key fiscal 2012 financial metrics:
HP(1) Personal
Consolidated Systems Printing Services ESSN Software HPFS
In millions, except per share amounts
Net revenue $ 120,357 $ 35,650 $ 24,487 $ 34,922 $ 20,491 $ 4,060 $ 3,819
Year-over-year
net revenue %
(decrease)
increase (5.4 )% (9.9 )% (6.5 )% (2.2 )% (7.1 )% 20.6 % 6.2 %
(Loss)
earnings from
operations $ (11,057 ) $ 1,706 $ 3,585 $ 4,095 $ 2,132 $ 827 $ 388
(Loss)
earnings from
operations as
a % of net
revenue (9.2 )% 4.8 % 14.6 % 11.7 % 10.4 % 20.4 % 10.2 %Net loss $ (12,650 )
Net loss per
share
Basic $ (6.41 )
Diluted $ (6.41 )
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º (1)
º HP consolidated net revenue includes a reduction of approximately
$3.2 billion primarily related to the elimination of intersegment net
revenue and revenue from our Corporate Investments segment. HP consolidated
(loss) earnings from operations includes amounts related to the impairment
of goodwill and purchased intangible assets, restructuring charges,
amortization of purchased intangible assets, corporate and unallocated
costs and eliminations, unallocated costs related to certain stock-based
compensation expenses, acquisition-related charges, and a loss from the
Corporate Investments segment.
Cash and cash equivalents at October 31, 2012 totaled $11.3 billion, an
increase of $3.3 billion from the October 31, 2011 balance of $8.0 billion. The
increase for fiscal 2012 was due primarily to $10.6 billion of cash provided
from operations, the effect of which was partially offset by $3.1 billion net
investment in property, plant and equipment, $2.6 billion of cash used to
repurchase common stock and pay dividends and $2.0 billion from the net
repayment of debt.
We intend the discussion of our financial condition and results of
operations that follows to provide information that will assist in understanding
our Consolidated Financial Statements, the changes in certain key items in those
financial statements from year to year, and the primary factors that accounted
for those changes, as well as how certain accounting principles, policies and
estimates affect our Consolidated Financial Statements.
The discussion of results of operations at the consolidated level is
followed by a more detailed discussion of results of operations by segment.
For a further discussion of trends, uncertainties and other factors that
could impact our operating results, see the section entitled "Risk Factors" in
Item 1A, which is incorporated herein by reference.
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Financial Condition and Results of Operations (Continued)
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General
The Consolidated Financial Statements of HP are prepared in accordance with
U.S. generally accepted accounting principles ("GAAP"), which require management
to make estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, net revenue and expenses, and the disclosure of contingent
assets and liabilities. Management bases its estimates on historical experience
and on various other assumptions that it believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Senior management has discussed the development, selection and
disclosure of these estimates with the Audit Committee of HP's Board of
Directors. Management believes that the accounting estimates employed and the
resulting balances are reasonable; however, actual results may differ from these
estimates under different assumptions or conditions.
The summary of significant accounting policies is included in Note 1 to the
Consolidated Financial Statements in Item 8, which is incorporated herein by
reference. An accounting policy is deemed to be critical if it requires an
accounting estimate to be made based on assumptions about matters that are
highly uncertain at the time the estimate is made, if different estimates
reasonably could have been used, or if changes in the estimate that are
reasonably possible could materially impact the financial statements. Management
believes the following critical accounting policies reflect the significant
estimates and assumptions used in the preparation of the Consolidated Financial
Statements.
Revenue Recognition
We enter into contracts to sell our products and services, and, while the
majority of our sales agreements contain standard terms and conditions, there
are agreements that contain multiple elements or non-standard terms and
conditions. As a result, significant contract interpretation is sometimes
required to determine the appropriate accounting, including whether the
deliverables specified in a multiple element arrangement should be treated as
separate units of accounting for revenue recognition purposes, and, if so, how
the price should be allocated among the elements and when to recognize revenue
for each element. We recognize revenue for delivered elements as separate units
of accounting only when the delivered elements have standalone value,
uncertainties regarding customer acceptance are resolved and there are no
customer-negotiated refund or return rights for the delivered elements. For
elements with no standalone value, we recognize revenue consistent with the
pattern of the associated deliverables. If the arrangement includes a
customer-negotiated refund or return right relative to the delivered item and
the delivery and performance of the undelivered item is considered probable and
substantially in our control, the delivered element constitutes a separate unit
of accounting. Changes in the allocation of the sales price between elements may
impact the timing of revenue recognition but will not change the total revenue
recognized on the contract.
We recognize revenue as work progresses on certain fixed-price contracts,
such as consulting arrangements. Using a proportional performance method, we
estimate the total expected labor costs in order to determine the amount of
revenue earned to date. We follow this basis because reasonably dependable
estimates of the labor costs applicable to various stages of a contract can be
made. Total contract profit is subject to revisions throughout the life of the
contract. We record changes in revenue to income, as a result of revisions to
cost estimates, and overall contract losses where applicable, in the period in
which the facts that give rise to the revision become known.
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Financial Condition and Results of Operations (Continued)
We recognize revenue on certain design and build (design, development and/or
constructions of software and/or systems) projects using the
percentage-of-completion method. We use the cost-to-cost method of measurement
towards completion as determined by the percentage of cost incurred to date to
the total estimated costs of the project. In circumstances when reasonable and
reliable cost estimates for a project cannot be made, we recognize revenue using
the completed contract method.
We record estimated reductions to revenue for customer and distributor
programs and incentive offerings, including price protection, promotions, other
volume-based incentives and expected returns. Future market conditions and
product transitions may require us to take actions to increase customer
incentive offerings, possibly resulting in an incremental reduction of revenue
at the time the incentive is offered. Additionally, certain incentive programs
require us to estimate, based on historical experience and the specific terms
and conditions of the incentive, the number of customers who will actually
redeem the incentive.
Under our revenue recognition policies, we establish the selling prices used
for each deliverable based on the vendor-specific objective evidence ("VSOE"),
if available, third-party evidence, if VSOE is not available, or estimated
selling price if neither VSOE nor third-party evidence is available. We
establish VSOE of selling price using the price charged for a deliverable when
sold separately and, in rare instances, using the price established by
management having the relevant authority. Third-party evidence of selling price
is established by evaluating largely similar and interchangeable competitor
products or services in standalone sales to similarly situated customers. The
best estimate of selling price ("ESP") is established considering internal
factors such as margin objectives, pricing practices and controls, customer
segment pricing strategies and the product life cycle. Consideration is also
given to market conditions such as competitor pricing strategies and industry
technology life cycles. When determining ESP, we apply management judgment to
establish margin objectives and pricing strategies and to evaluate market
conditions and product life cycles. We may modify or develop new go-to-market
practices in the future. As these go-to-market strategies evolve, we may modify
our pricing practices in the future, which may result in changes in selling
prices, impacting both VSOE and ESP. The aforementioned factors may result in a
different allocation of revenue to the deliverables in multiple element
arrangements from the current fiscal year, which may change the pattern and
timing of revenue recognition for these elements but will not change the total
revenue recognized for the arrangement.
Warranty Provision
We provide for the estimated cost of product warranties at the time we
recognize revenue. We evaluate our warranty obligations on a product group
basis. Our standard product warranty terms generally include post-sales support
and repairs or replacement of a product at no additional charge for a specified
period of time. While we engage in extensive product quality programs and
processes, including actively monitoring and evaluating the quality of our
component suppliers, we base our estimated warranty obligation upon warranty
terms, ongoing product failure rates, repair costs, product call rates, average
cost per call, and current period product shipments. If actual product failure
rates, repair rates or any other post sales support costs were to differ from
our estimates, we would be required to make revisions to the estimated warranty
liability. Warranty terms generally range from 90 days to three years for parts
and labor, depending upon the product. Over the last three fiscal years, the
annual warranty provision and actual warranty costs have averaged approximately
3.1% of annual net product revenue.
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Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Business Combinations
We allocate the fair value of purchase consideration to the tangible assets
acquired, liabilities assumed and intangible assets acquired, including
in-process research and development ("IPR&D"), based on their estimated fair
values. The excess of the fair value of purchase consideration over the fair
values of these identifiable assets and liabilities is recorded as goodwill.
When determining the fair values of assets acquired and liabilities assumed,
management makes significant estimates and assumptions, especially with respect
to intangible assets.
Critical estimates in valuing certain intangible assets include but are not
limited to future expected cash flows from customer contracts, customer lists,
distribution agreements, and acquired developed technologies and patents;
expected costs to develop IPR&D into commercially viable products and estimating
cash flows from projects when completed; brand awareness and market position, as
well as assumptions about the period of time the brand will continue to be used
in our product portfolio; and discount rates. Management's estimates of fair
value are based upon assumptions believed to be reasonable, but which are
inherently uncertain and unpredictable and, as a result, actual results may
differ from estimates.
Other estimates associated with the accounting for acquisitions may change
as additional information becomes available regarding the assets acquired and
liabilities assumed, as more fully discussed in Note 6 to the Consolidated
Financial Statements in Item 8, which is incorporated herein by reference.
Valuation of Goodwill and Purchased Intangible Assets
We review goodwill and purchased intangible assets with indefinite lives for
impairment annually and whenever events or changes in circumstances indicate the
carrying value of an asset may not be recoverable. The provisions of the
accounting standard for goodwill and other intangibles allows us to first assess
qualitative factors to determine whether it is necessary to perform the two-step
quantitative goodwill impairment test. For our annual goodwill impairment test
in the fourth quarter of fiscal 2012, we performed a quantitative test for all
of our reporting units. Due to the recent trading values of our stock price, we
believed it was appropriate to have recent fair values for each of our reporting
units in order to assess the reasonableness of the sum of these fair values as
compared to our market capitalization. In the first step, we compare the fair
value of each reporting unit to its carrying value. We determine the fair value
of our reporting units using a weighting of fair values derived most
significantly from the income approach and to a lesser extent the market
approach. Under the income approach, we calculate the fair value of a reporting
unit based on the present value of estimated future cash flows. Cash flow
projections are based on management's estimates of revenue growth rates and
operating margins, taking into consideration industry and market conditions. The
discount rate used is based on the weighted-average cost of capital adjusted for
the relevant risk associated with business-specific characteristics and the
uncertainty related to the business's ability to execute on the projected cash
flows. Under the market approach, we estimate the fair value based on market
multiples of revenue and earnings derived from comparable publicly-traded
companies with similar operating and investment characteristics as the reporting
unit. The weighting of the fair value derived from the market approach ranges
from 0% to 50% depending on the level of comparability of these publicly-traded
companies to the reporting unit. When market comparables are not meaningful or
not available, we may estimate the fair value of a reporting unit using only the
income approach. If the fair value of the reporting unit exceeds the carrying
value of the net assets assigned to that unit, goodwill is not impaired and no
further testing is required. If the fair value of the reporting unit is less
than the
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carrying value, then we must perform the second step of the impairment test to
measure the amount of impairment loss, if any. In the second step, the reporting
unit's fair value is allocated to all of the assets and liabilities of the
reporting unit, including any unrecognized intangible assets, in a hypothetical
analysis that calculates the implied fair value of goodwill in the same manner
as if the reporting unit was being acquired in a business combination. If the
implied fair value of the reporting unit's goodwill is less than the carrying
value, the difference is recorded as an impairment loss. We also compare the
fair value of purchased intangible assets with indefinite lives to their
carrying value. We estimate the fair value of these intangible assets using an
income approach. We recognize an impairment loss when the estimated fair value
of intangible assets with indefinite lives is less than the carrying value.
We review purchased intangible assets with finite lives for impairment
whenever events or changes in circumstances indicate the carrying value of an
asset may not be recoverable. Recoverability of these intangible assets is
assessed based on the estimated undiscounted future cash flows expected to
result from the use of the asset. If the undiscounted future cash flows are less
than the carrying amount, the purchased intangible assets with finite lives are
considered to be impaired. The amount of the impairment is measured as the
difference between the carrying amount of these assets and the fair value.
In order to assess the reasonableness of the calculated fair values of our
reporting units, we also compare the sum of the reporting units' fair values to
our market capitalization and calculate an implied control premium (the excess
of the sum of the reporting units' fair values over the market capitalization).
We evaluate the control premium by comparing it to control premiums of recent
comparable transactions. If the implied control premium is not reasonable in
light of these recent transactions, we will reevaluate our fair value estimates
of the reporting units by adjusting the discount rates and/or other assumptions.
As a result, when there is a significant decline in our stock price, as occurred
during fiscal 2012, this reevaluation could correlate to lower estimated fair
values for certain or all of our reporting units.
Except for Services, Software and Corporate Investments, our reporting units
are consistent with the reportable segments identified in Note 19 to the
Consolidated Financial Statements in Item 8, which is incorporated herein by
reference. The enterprise services ("ES") and technology services ("TS")
businesses are the reporting units within the Services segment. ES includes the
Infrastructure Technology Outsourcing ("ITO") and Application and Business
Services ("ABS") business units. The Software segment includes two reporting
units, which are Autonomy Corporation plc ("Autonomy") and the legacy HP
software business. The webOS business is also a separate reporting unit within
the Corporate Investments segment.
Determining the fair value of a reporting unit or an indefinite-lived
purchased intangible asset is judgmental in nature and involves the use of
significant estimates and assumptions. These estimates and assumptions include
revenue growth rates and operating margins used to calculate projected future
cash flows, risk-adjusted discount rates, assumed royalty rates, future economic
and market conditions and determination of appropriate market comparables. We
base our fair value estimates on assumptions we believe to be reasonable but
they are unpredictable and inherently uncertain. Actual future results may
differ from those estimates. In addition, we make certain judgments and
assumptions in allocating shared assets and liabilities to determine the
carrying values for each of our reporting units.
During fiscal 2012, we determined that sufficient indicators of potential
impairment existed to require an interim goodwill impairment analysis for the ES
reporting unit. As a result, we recorded an
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Financial Condition and Results of Operations (Continued)
impairment charge within the Services segment as discussed in Note 7 to the
Consolidated Financial Statements in Item 8, which is incorporated herein by
reference.
Our annual goodwill impairment analysis, which we performed during the
fourth quarter of fiscal 2012, resulted in an impairment charge for goodwill and
intangible assets related to the Autonomy reporting unit within the Software
segment as discussed in Note 7 to the Consolidated Financial Statements in
Item 8, which is incorporated herein by reference. Other than the impairment
charges discussed for the ES and Autonomy reporting units during fiscal 2012,
there was no impairment for HP's remaining reporting units. The excess of fair
value over carrying value for each of our reporting units as of August 1, 2012,
the annual testing date, ranged from approximately 9% to approximately 330% of
carrying value. The Autonomy and the legacy HP software reporting units have the
lowest excess of fair value over carrying value at 10% and 9%, respectively.
In order to evaluate the sensitivity of the fair value calculations on the
goodwill impairment test, we applied a hypothetical 10% decrease to the fair
values of each reporting unit. This hypothetical 10% decrease resulted in the
Autonomy and the legacy HP software reporting units having fair values below
their carrying values of 1% and 2%, respectively. For the remaining reporting
units, excess fair values over carrying values range from approximately 25% to
approximately 290% of the carrying values.
We will continue to evaluate goodwill on an annual basis as of the beginning
of our fourth fiscal quarter and whenever events or changes in circumstances,
such as significant adverse changes in business climate or operating results,
changes in management's business strategy or further significant declines in our
stock price, indicate that there may be a potential indicator of impairment.
During the third quarter of fiscal 2012, we approved a change to our
branding strategy for personal computers which triggered an interim impairment
review of the "Compaq" trade name indefinite-lived intangible asset. As a
result, we recorded an impairment charge within the Personal Systems Group as
discussed in Note 7 to the Consolidated Financial Statements in Item 8, which is
incorporated herein by reference. In conjunction with the change in branding
strategy, we also revised our assumption as to the useful life of the "Compaq"
trade name, which resulted in a reclassification of the asset from an
indefinite-lived intangible to a finite-lived intangible with a remaining useful
life of approximately five years.
Restructuring
We have engaged, and may continue to engage, in restructuring actions, which
require management to utilize significant estimates related to the timing and
the expenses for severance and other employee separation costs, including
enhanced early retirement programs, realizable values of assets made redundant
or obsolete, lease cancellation and other exit costs. We accrue for severance
and other employee separation costs under these actions when it is probable that
benefits will be paid and the amount is reasonably estimable. The rates used in
determining severance accruals are based upon existing plans, historical
experiences, and negotiated settlements. If the actual amounts differ from our
estimates, the amount of the restructuring charges could be materially impacted.
For a full description of our restructuring actions, refer to our discussions of
restructuring in the Results of Operations section and Note 8 to the
Consolidated Financial Statements in Item 8, which are incorporated herein by
reference.
Stock-Based Compensation Expense
We recognize stock-based compensation expense for all share-based payment
awards, net of an estimated forfeiture rate. We recognize compensation cost for
only those shares expected to meet the
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service and performance vesting conditions on a straight-line basis over the
requisite service period of the award. These compensation costs are determined
at the aggregate grant level for service-based awards and at the individual
vesting tranche level for awards with performance and/or market conditions.
Determining the appropriate fair value model and calculating the fair value
of share-based payment awards requires subjective assumptions, including the
expected life of the share-based payment awards and stock price volatility. We
utilize the Black-Scholes option pricing model to value the service-based stock
options granted under our principal option plans. To implement this model, we
examined our historical pattern of option exercises to determine if there were
any discernable activity patterns based on certain employee populations. From
this analysis, we identified three employee populations to which to apply the
Black-Scholes model. We determined that implied volatility calculated based on
actively traded options on HP common stock is a better indicator of expected
volatility and future stock price trends than historical volatility.
We issued performance-based restricted units ("PRUs") representing
hypothetical shares of HP common stock. Each PRU award reflected a target number
of shares that may be issued to the award recipient. We determine the actual
number of shares the recipient receives at the end of a three-year performance
period based on results achieved versus goals. The performance goals for PRUs
granted in fiscal year 2012 are based on our annual cash flow from operations as
a percentage of revenue and on our annual revenue growth. The performance goals
for PRUs granted prior to fiscal year 2012 are based on our annual cash flow
from operations as a percentage of revenue and on a market condition based on
total shareholder return ("TSR") relative to the S&P 500 over the performance
period. We use our closing stock price on the measurement date to estimate the
fair value of the PRU awards granted in fiscal year 2012. We use historic
volatility for PRU awards granted prior to fiscal year 2012, as implied
volatility cannot be used when simulating multivariate prices for companies in
the S&P 500. We estimate the fair value of PRUs granted prior to fiscal year
2012 using the Monte Carlo simulation model, as the TSR modifier contains a
market condition. We update the estimated expense, net of forfeitures, for the
cash flow and revenue growth performance against the goal for that year at the
end of each reporting period.
The assumptions used in calculating the fair value of share-based payment
awards represent management's best estimates, but these estimates involve
inherent uncertainties and the application of management judgment. As a result,
if factors change and we use different assumptions, our stock-based compensation
expense could be materially different in the future. In addition, we are
required to estimate the expected forfeiture rate and recognize expense only for
those shares expected to meet the service and performance vesting conditions. If
our actual forfeiture rate is materially different from our estimate, the
stock-based compensation expense could be significantly different from what we
have recorded in the current period. See Note 2 to the Consolidated Financial
Statements in Item 8 for a further discussion on stock-based compensation.
Taxes on Earnings
We calculate our current and deferred tax provisions based on estimates and
assumptions that could differ from the final positions reflected in our income
tax returns filed during the subsequent year. We record adjustments based on
filed returns when we have identified and finalized them, which is generally in
the third and fourth quarters of the subsequent year for U.S. federal and state
provisions, respectively.
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We recognize deferred tax assets and liabilities for the expected tax
consequences of temporary differences between the tax bases of assets and
liabilities and their reported amounts using enacted tax rates in effect for the
year in which we expect the differences to reverse. We record a valuation
allowance to reduce the deferred tax assets to the amount that we are more
likely than not to realize.
We have considered future market growth, forecasted earnings, future taxable
income, the mix of earnings in the jurisdictions in which we operate and prudent
and feasible tax planning strategies in determining the need for a valuation
allowance. In the event we were to determine that we would not be able to
realize all or part of our net deferred tax assets in the future, we would
increase the valuation allowance and make a corresponding charge to earnings in
the period in which we make such determination. Likewise, if we later determine
that we are more likely than not to realize the net deferred tax assets, we
would reverse the applicable portion of the previously provided valuation
allowance. In order for us to realize our deferred tax assets, we must be able
to generate sufficient taxable income in the tax jurisdictions in which the
deferred tax assets are located.
Our effective tax rate includes the impact of certain undistributed foreign
earnings for which we have not provided U.S. taxes because we plan to reinvest
such earnings indefinitely outside the United States. We plan foreign earnings
remittance amounts based on projected cash flow needs as well as the working
capital and long-term investment requirements of our foreign subsidiaries and
our domestic operations. Based on these assumptions, we estimate the amount we
will distribute to the United States and provide the U.S. federal taxes due on
these amounts. Further, as a result of certain employment actions and capital
investments we have undertaken, income from manufacturing activities in certain
countries is subject to reduced tax rates, and in some cases is wholly exempt
from taxes, for fiscal years through 2024. Material changes in our estimates of
cash, working capital and long-term investment requirements in the various
jurisdictions in which we do business could impact our effective tax rate.
We are subject to income taxes in the United States and approximately 80
foreign countries, and we are subject to routine corporate income tax audits in
many of these jurisdictions. We believe that our tax return positions are fully
supported, but tax authorities are likely to challenge certain positions, which
may not be fully sustained. However, our income tax expense includes amounts
intended to satisfy income tax assessments that result from these challenges.
Determining the income tax expense for these potential assessments and recording
the related assets and liabilities requires management judgments and estimates.
We evaluate our uncertain tax positions in accordance with the guidance for
accounting for uncertainty in income taxes. We believe that our reserve for
uncertain tax positions, including related interest, is adequate. The amounts
ultimately paid upon resolution of audits could be materially different from the
amounts previously included in our income tax expense and therefore could have a
material impact on our tax provision, net income and cash flows. Our reserve for
uncertain tax positions is attributable primarily to uncertainties concerning
the tax treatment of our international operations, including the allocation of
income among different jurisdictions, and related interest. We review our
reserves quarterly, and we may adjust such reserves because of proposed
assessments by tax authorities, changes in facts and circumstances, issuance of
new regulations or new case law, previously unavailable information obtained
during the course of an examination, negotiations between tax authorities of
different countries concerning our transfer prices, execution of Advanced
Pricing Agreements, resolution with respect to individual audit issues, the
resolution of entire audits, or the expiration of statutes of limitations.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
See Note 14 to the Consolidated Financial Statements in Item 8 for a further
discussion on taxes on earnings.
Allowance for Doubtful Accounts
We determine our allowance for doubtful accounts using a combination of
factors to ensure that we have not overstated our trade and financing
receivables balances due to uncollectibility. We maintain an allowance for
doubtful accounts for all customers based on a variety of factors, including the
use of third-party credit risk models that generate quantitative measures of
default probabilities based on market factors, the financial condition of
customers, the length of time receivables are past due, trends in overall
weighted-average risk rating of the total portfolio, macroeconomic conditions,
significant one-time events and historical experience. Also, we record specific
provisions for individual accounts when we become aware of specific customer
circumstances, such as in the case of bankruptcy filings or deterioration in the
customer's operating results or financial position. If the circumstances related
to the customer change, we would further adjust our estimates of the
recoverability of receivables either upward or downward. The annual provision
for doubtful accounts has averaged approximately 0.10% of net revenue over the
last three fiscal years. Using our third-party credit risk model at October 31,
2012, a 50-basis-point deterioration in the weighted-average default
probabilities of our significant customers would have resulted in an
approximately $23 million increase to our trade allowance at the end of fiscal
year 2012.
Inventory
We state our inventory at the lower of cost or market. We make adjustments
to reduce the cost of inventory to its net realizable value, if required, at the
product group level for estimated excess, obsolescence or impaired balances.
Factors influencing these adjustments include changes in demand, rapid
technological changes, product life cycle and development plans, component cost
trends, product pricing, physical deterioration and quality issues. Revisions to
these adjustments would be required if these factors differ from our estimates.
Fair Value of Financial Instruments
We measure certain financial assets and liabilities at fair value based on
valuation techniques using the best information available, which may include
quoted market prices, market comparables and discounted cash flow projections.
Financial instruments are primarily comprised of time deposits, money market
funds, corporate and other debt securities, equity securities and other
investments in common stock and common stock equivalents and derivative
instruments.
Cash Equivalents and Investments: We hold time deposits, money market funds,
mutual funds, other debt securities primarily consisting of corporate and
foreign government notes and bonds, and common stock and equivalents. In
general, and where applicable, we use quoted prices in active markets for
identical assets to determine fair value. If quoted prices in active markets for
identical assets are not available to determine fair value, then we use quoted
prices for similar assets and liabilities or inputs that are observable either
directly or indirectly. If quoted prices for identical or similar assets are not
available, we use internally developed valuation models, whose inputs include
bid prices, and third party valuations utilizing underlying asset assumptions.
Derivative Instruments: As discussed in Note 10 to the Consolidated
Financial Statements in Item 8, we mainly hold non-speculative forwards, swaps
and options to hedge certain foreign currency
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
and interest rate exposures. When active market quotes are not available, we use
industry standard valuation models. Where applicable, these models project
future cash flows and discount the future amounts to a present value using
market-based observable inputs including interest rate curves, credit risk,
foreign exchange rates, and forward and spot prices for currencies. In certain
cases, market-based observable inputs are not available and, in those cases, we
use management judgment to develop assumptions which are used to determine fair
value.
Retirement Benefits
Our pension and other post-retirement benefit costs and obligations are
dependent on various assumptions. Our major assumptions relate primarily to
discount rates, salary growth and long-term return on plan assets. We base the
discount rate assumption on current investment yields of high-quality
fixed-income investments during the retirement benefits maturity period. The
salary growth assumptions reflect our long-term actual experience and future and
near-term outlook. Long-term return on plan assets is determined based on
historical portfolio results and management's expectations related to the future
economic environment, as well as target asset allocations. Actual results in any
given year will often differ from actuarial assumptions because of economic and
other factors.
Our major assumptions vary by plan and the weighted-average rates used are
set forth in Note 16 to the Consolidated Financial Statements in Item 8, which
is incorporated herein by reference. Each assumption has different sensitivity
characteristics, and, in general, changes, if any, have moved in the same
direction over the last several years. For fiscal 2012, changes in the
weighted-average rates for the HP benefit plans would have had the following
impact on our net periodic benefit cost:
º •
º A decrease of 25 basis points in the long-term rate of return would
have increased our net benefit cost by approximately $61 million;
º •
º A decrease of 25 basis points in the discount rate would have
increased our net benefit cost by approximately $78 million; and
º • º An increase of 25 basis points in the future compensation rate would
have increased our net benefit cost by approximately $23 million.
Loss Contingencies
We are involved in various lawsuits, claims, investigations and proceedings
that arise in the ordinary course of business. We record a provision for a
liability when we believe that it is both probable that a liability has been
incurred and the amount can be reasonably estimated. Significant judgment is
required to determine both probability and the estimated amount. We review these
provisions at least quarterly and adjust these provisions to reflect the impact
of negotiations, settlements, rulings, advice of legal counsel and updated
information. Litigation is inherently unpredictable and is subject to
significant uncertainties, some of which are beyond our control. Should any of
these estimates and assumptions change or prove to have been incorrect, it could
have a material impact on our results of operations, financial position and cash
flows. See Note 18 to the Consolidated Financial Statements in Item 8 for a
further discussion of litigation and contingencies.
CONSTANT CURRENCY PRESENTATION
Revenue from our international operations has historically represented, and
we expect will continue to represent, a majority of our overall net revenue. As
a result, our revenue growth has been
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
impacted, and we expect will continue to be impacted, by fluctuations in foreign
currency exchange rates. In order to provide a framework for assessing how each
of our business segments performed excluding the impact of foreign currency
fluctuations, we present the year-over-year percentage change in revenue
performance on a constant currency basis, which assumes no change in the
exchange rate from the prior-year period. This constant currency disclosure is
provided in addition to, and not as a substitute for, the year-over-year
percentage change in revenue on an as-reported basis.
RESULTS OF OPERATIONS
The following discussion compares the historical results of operations for
the fiscal years ended October 31, 2012, 2011, and 2010. Unless otherwise noted,
all comparative performance data included below reflect year-over-year
comparisons.
Results of operations in dollars and as a percentage of net revenue were as
follows for the following fiscal years ended October 31:
2012 2011(1) 2010(1)
In millions
Net revenue $ 120,357 100.0 % $ 127,245 100.0 % $ 126,033 100.0 %
Cost of sales(2) 92,385 76.8 % 97,418 76.6 % 95,852 76.1 %
Gross profit 27,972 23.2 % 29,827 23.4 % 30,181 23.9 %
Research and development 3,399 2.8 % 3,254 2.6 % 2,959 2.3 %
Selling, general and
administrative 13,500 11.2 % 13,577 10.6 % 12,822 10.2 %
Amortization of purchased
intangible assets 1,784 1.5 % 1,607 1.3 % 1,484 1.2 %
Impairment of goodwill and
purchased intangibles
assets(3) 18,035 15.0 % 885 0.7 % - -
Restructuring charges 2,266 1.9 % 645 0.5 % 1,144 0.9 %
Acquisition-related charges 45 - 182 0.1 % 293 0.2 %
(Loss) earnings from
operations (11,057 ) (9.2 )% 9,677 7.6 % 11,479 9.1 %
Interest and other, net(4) (876 ) (0.8 )% (695 ) (0.5 )% (505 ) (0.4 )%
(Loss) earnings before
taxes (11,933 ) (10.0 )% 8,982 7.1 % 10,974 8.7 %
Provision for taxes (717 ) (0.5 )% (1,908 ) (1.5 )% (2,213 ) (1.7 )%
Net (loss) earnings $ (12,650 ) (10.5 )% $ 7,074 5.6 % $ 8,761 7.0 %
--------------------------------------------------------------------------------
º (1)
º In connection with organizational realignments implemented in the first
quarter of fiscal 2012, certain costs previously reported as Cost of sales
have been reclassified as Selling, general and administrative expenses to
better align those costs with the functional areas that benefit from those
expenditures.
º (2)
º Cost of products, cost of services and financing interest.
º (3) º For the period ended October 31, 2012, represents a goodwill and intangible
asset impairment charge of $8.8 billion associated with the Autonomy
reporting unit within the Software segment, a goodwill impairment charge of
$8.0 billion associated with the ES reporting unit within the Services
segment and an intangible asset impairment charge of $1.2 billion
associated with the "Compaq" trade name within the Personal Systems
segment. For the period ended October 31, 2011, includes impairment charges
to goodwill and purchased intangible assets associated with the
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
acquisition of Palm, Inc. on July 1, 2010 recorded as result of the
decision announced on August 18, 2011 to wind down the webOS device
business.
º (4) º For fiscal 2011, includes $276 million of charges in connection with the
acquisition of Autonomy, which is primarily comprised of the $265 million
net cost of British pound options bought to limit foreign exchange rate
risk.
Net Revenue
The components of the weighted net revenue change were as follows for the
following fiscal years ended October 31:
2012 2011(1)
Percentage Points
Personal Systems (3.1 ) (0.9 )
Printing (1.3 ) -
Enterprise Servers, Storage and Networking (1.2 ) 1.5
Services (0.6 ) 0.3
Corporate Investments/Other 0.1 (0.7 )
HP Financial Services 0.2 0.4
Software 0.5 0.4
Total HP (5.4 ) 1.0
--------------------------------------------------------------------------------
º (1)
º Reflects certain reclassifications made to historical results to conform to
the current year presentation as noted in Note 19 to the Consolidated
Financial Statements in Item 8.
Fiscal 2012
In fiscal 2012, total HP net revenue decreased 5.4% (decreased 4.4% on a
constant currency basis). U.S. net revenue decreased 4.5% to $42.1 billion,
while net revenue from outside of the United States decreased 5.9% to
$78.2 billion. HP's revenue decreased due primarily to a weak customer demand
environment resulting in volume declines in our hardware businesses and printing
supplies coupled with contractual rate declines on ongoing contracts in
Services. The Software segment contributed favorably to the total HP net revenue
change as a result of the acquisition of Autonomy in October 2011. An analysis
of the change in net revenue for each business segment is included under
"Segment Information" below.
Fiscal 2011
In fiscal 2011, total HP net revenue increased 1.0% (decreased 0.9% on a
constant currency basis). U.S. net revenue decreased 1.0% to $44.1 billion,
while net revenue from outside of the United States increased 2.0% to
$83.1 billion. As reflected in the table above, the ESSN segment was the largest
contributor to HP net revenue growth as a result of balanced growth across all
regions. ESSN segment net revenue growth was helped by the strong performance in
products related to our 3PAR Inc. ("3PAR") and 3Com Corporation ("3Com")
acquisitions. An analysis of the change in net revenue for each business segment
is included under "Segment Information" below.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Gross Margin
Fiscal 2012
In fiscal 2012, total HP gross margin decreased by 0.2 percentage points.
Gross margins were impacted by continued margin pressure in Services and
competitive pricing in our hardware businesses, along with an unfavorable mix of
lower-margin revenue in ESSN and unfavorable currency impacts.
Personal Systems gross margin decreased in fiscal 2012. The decrease was
driven by higher component costs combined with an unfavorable currency impact.
These negative impacts to gross margin were partially offset by lower warranty
and logistics costs, benefits from insurance proceeds related to flooding in
Thailand in July 2011 and an increased level of component vendor rebates.
Printing gross margin declined in fiscal 2012 due to an unfavorable currency
impact driven by the strength of the Japanese yen and from lower ink supplies
volumes as a result of demand declines in all regions. These effects were
partially offset by our focus on higher-end inkjet printers combined with a
higher mix of supplies.
Services gross margin decreased in fiscal 2012 due primarily to lower than
expected revenue, contractual rate declines on ongoing contracts, a lower than
expected resource utilization rate and additional costs associated with certain
contract deliverable delays. These effects were partially offset by a continued
focus on operating improvements and cost initiatives that favorably impacted the
cost structure of all business units.
ESSN gross margin decreased in fiscal 2012 due primarily to competitive
pricing pressures, particularly in Industry Standard Servers ("ISS") and, to a
lesser extent, in Networking.
Software gross margin decreased in fiscal 2012 due primarily to a lower mix
of license revenue, the effect of which was partially offset by a highly
profitable software deal entered into in the fourth quarter of fiscal 2012.
HPFS gross margin increased in fiscal 2012 due primarily to lower bad debt
expense, the effect of which was partially offset by lower margins on
end-of-term activities, including buyouts and lease extensions.
Fiscal 2011
In fiscal 2011, total HP gross margin decreased by 0.5 percentage points.
The decline was driven by a lower gross margin in the Services, Printing and
Corporate Investments segments, the effect of which was partially offset by a
favorable commodity pricing environment in the Personal Systems and ESSN
segments, and a favorable mix from higher Software and Networking revenue.
Personal Systems gross margin increased in fiscal 2011 primarily as a result
of a favorable commodity pricing environment, combined with lower warranty
costs.
Printing gross margin declined in fiscal 2011 due primarily to increased
logistics costs and supply chain constraints in LaserJet printer engines and
toner as a result of the earthquake and tsunami in Japan, and an unfavorable
currency impact driven primarily by the strength of the yen. In addition,
Printing gross margin declined due to a continuing mix shift in Consumer
Hardware and Commercial Hardware toward lower price point products, coupled with
a lower mix of supplies revenue. These effects were partially offset by
reductions in Printing's cost structure as a result of continued efforts to
optimize our supply chain.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Services gross margin decreased in fiscal 2011 due primarily to lower than
expected revenue, rate concessions arising from recent contract renewals, a
lower than expected resource utilization rate and a higher mix of lower-margin
Infrastructure Technology Outsourcing revenue. These effects were partially
offset by a continued focus on operating improvements and cost initiatives that
favorably impacted the cost structure of both our enterprise services and
technology services businesses.
ESSN gross margin increased in fiscal 2011 primarily as a result of lower
product costs and a higher mix of networking products, the effect of which was
partially offset by price declines as a result of competitive pressure.
Software gross margin decreased in fiscal 2011 due primarily to rate
declines in licenses and services.
HPFS gross margin decreased in fiscal 2011 due primarily to lower portfolio
margins from a higher mix of operating leases, the effect of which was partially
offset by lower bad debt expense as a percentage of revenue and higher margins
on lease extensions and buyouts.
Corporate Investments gross margin decreased in fiscal 2011 primarily as a
result of the impact of the wind down of the webOS device business, which
resulted in expenses for supplier-related obligations, sales incentive programs
and inventory write downs.
Operating Expenses
Research and Development
Total research and development ("R&D") expense increased in fiscal 2012 due
primarily to additional expense from the acquisition of Autonomy and
innovation-focused spending for storage, networking and HP converged cloud.
These effects were partially offset by the elimination of R&D expense associated
with the former webOS device business. In fiscal 2012, R&D expense increased for
ESSN, Software, Personal Systems, Printing and Services and decreased for
Corporate Investments.
Total R&D expense increased in fiscal 2011 due primarily to additional
expenses from acquired companies. In fiscal 2011, R&D expense increased for
ESSN, Corporate Investments and Software and decreased for Services and Personal
Systems. The increase for ESSN was driven by acquisition investments and
innovation-focused spend in networking and storage products. The increase for
Corporate Investments was due to investments in the development of webOS and
webOS devices during the first three quarters of fiscal 2011.
Selling, General and Administrative
Total selling, general and administrative ("SG&A") expense decreased in
fiscal 2012 due primarily to lower marketing costs. Included in SG&A was
$103 million in net gains from the sale of real estate. In fiscal 2012, SG&A
expense as a percentage of net revenue was mostly flat for each of our segments
except for Corporate Investments, which experienced a decrease.
Total SG&A expense increased in fiscal 2011 due primarily to higher field
selling costs as a result of our investments in sales resources to grow revenue.
The increase in fiscal 2011 was partially offset by $334 million in net gains on
the sale of real estate and a $77 million net gain on the divestiture of our
Halo video collaboration products business. In fiscal 2011, SG&A expense as a
percentage of net revenue increased for each of our segments except for HPFS,
Services and Printing, each of which experienced a decrease.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Impairment of Goodwill and Purchased Intangible Assets
In fiscal 2012, we recorded goodwill impairment charges of $8.0 billion and
$5.7 billion associated with the Services segment and the acquisition of
Autonomy, respectively. In addition, we recorded intangible asset impairment
charges of $3.1 billion and $1.2 billion associated with the acquisition of
Autonomy and the "Compaq" trade name, respectively.
In fiscal 2011, we recorded $885 million impairment charges to goodwill and
purchased intangible assets associated with the acquisition of Palm, Inc. on
July 1, 2010 as a result of the decision announced on August 18, 2011 to wind
down the webOS device business.
For more information on our impairment charges, see Note 7 to the
Consolidated Financial Statements in Item 8, which is incorporated herein by
reference.
Restructuring Charges
The increase in restructuring costs for fiscal 2012 was due primarily to
charges of $2.1 billion for the restructuring plan announced in May 2012 (the
"2012 Plan"), the effect of which was partially offset by lower charges in the
fiscal 2008 and fiscal 2010 ES restructuring plans. Restructuring charges for
fiscal 2012 were $2.3 billion. These charges included $2.1 billion costs related
to the 2012 Plan, $106 million costs related to our fiscal 2008 restructuring
plan and $75 million costs related to our fiscal 2010 ES restructuring plan.
The decrease in restructuring costs for fiscal 2011 was due primarily to
lower charges in the fiscal 2008 and fiscal 2010 ES restructuring plans.
Restructuring charges for fiscal 2011 were $645 million. These charges included
$326 million of severance and facility costs related to our fiscal 2008
restructuring plan, $266 million of severance and facility costs related to our
fiscal 2010 ES restructuring plan and $33 million related to the decision to
wind down the webOS device business.
Restructuring charges for fiscal 2010 were $1.1 billion. These charges
included $650 million of severance and facility costs related to our fiscal 2010
ES restructuring plan, $429 million of severance and facility costs related to
our fiscal 2008 restructuring plan, $46 million and $18 million associated with
the Palm and 3Com restructuring plans, respectively, and an increase of
$1 million related to adjustments to other restructuring plans.
For more information on our restructuring charges, see Note 8 to the
Consolidated Financial Statements in Item 8, which is incorporated herein by
reference.
As part of our ongoing business operations, we incurred workforce
rebalancing charges for severance and related costs within certain business
segments. Workforce rebalancing activities are considered part of normal
operations as we continue to optimize our cost structure. Workforce rebalancing
costs are included in our business segment results, and we expect to incur
additional workforce rebalancing costs in the future.
Amortization of Purchased Intangible Assets
The increase in amortization expense in fiscal 2012 was due primarily to
amortization expenses related to the intangible assets purchased as part of the
Autonomy acquisition. This increase was partially offset by decreased
amortization expenses related to certain intangible assets associated with prior
acquisitions reaching the end of their amortization periods.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The increase in amortization expense in fiscal 2011 was due primarily to
increased amortization of purchased intangible assets from acquisitions
completed during fiscal 2010. This increase was partially offset by decreased
amortization expenses related to certain intangible assets associated with prior
acquisitions reaching the end of their amortization periods.
For more information on our amortization of purchased intangibles assets,
see Note 7 to the Consolidated Financial Statements in Item 8, which is
incorporated herein by reference.
Acquisition-Related Charges
In fiscal 2012, we recorded acquisition-related charges of $45 million. The
decrease in acquisition-related charges was due primarily to lower consulting
and integration costs associated with the Autonomy acquisition, fewer
acquisitions, and lower retention bonuses associated with acquisitions completed
in fiscal 2011 and 2010.
In fiscal 2011, we recorded acquisition-related charges of $182 million. The
decrease in acquisition-related charges was due primarily to lower consulting,
integration and acquisition costs associated with the Electronic Data Systems
Corporation and 3Com acquisitions, the effect of which was partially offset by
consulting and integration costs associated with the Autonomy acquisition.
Interest and Other, Net
Interest and other, net expense increased by $181 million in fiscal 2012.
The increase was driven primarily by higher interest expense due to higher
average debt balances and higher currency transaction losses.
Interest and other, net expense increased by $190 million in fiscal 2011.
The increase was driven by $276 million of charges incurred in connection with
the acquisition of Autonomy, which is primarily comprised of the $265 million
net cost of British pound options bought to limit foreign exchange rate risk.
The increase was also as a result of higher interest expenses due to higher
average debt balances, the effect of which was partially offset by lower
litigation costs and lower currency transaction losses.
Provision for Taxes
Our effective tax rates were (6.0)%, 21.2% and 20.2% in fiscal 2012, 2011
and 2010, respectively. Our effective tax rate generally differs from the U.S.
federal statutory rate of 35% due to favorable tax rates associated with certain
earnings from our operations in lower-tax jurisdictions throughout the world.
The jurisdictions with favorable tax rates that have the most significant
effective tax rate impact in the periods presented include Singapore, the
Netherlands, China, Ireland and Puerto Rico. We plan to reinvest some of the
earnings of these jurisdictions indefinitely outside the United States and
therefore have not provided U.S. taxes on those indefinitely reinvested
earnings.
In addition to the above factors, the overall tax rates in fiscal 2012 and
2011 were impacted by nondeductible goodwill impairments and increases in
valuation allowances against certain deferred tax assets.
For a full reconciliation of our effective tax rate to the U.S. federal
statutory rate of 35% and further explanation of our provision for taxes, see
Note 14 to the Consolidated Financial Statements in Item 8, which is
incorporated herein by reference.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Segment Information
A description of the products and services, as well as financial data, for
each segment can be found in Note 19 to the Consolidated Financial Statements in
Item 8, which is incorporated herein by reference. We have realigned segment
financial data for the fiscal years ended October 31, 2011 and 2010 to reflect
changes in HP's organizational structure that occurred at the beginning of the
first quarter of fiscal 2012. We describe these changes more fully in Note 19.
We have presented the business segments in this Annual Report on Form 10-K based
on the distinct nature of various businesses such as customer base, homogeneity
of products and technology. The discussions below include the results of each of
our segments.
Effective November 1, 2012, we created the Enterprise Group segment
consisting of the business units within our ESSN segment and our TS business
unit, which is a part of our existing Services segment. The remaining business
units in our Services segment, ITO and ABS, will comprise a new Enterprise
Services segment.
Printing and Personal Systems Group
Printing and Personal Systems segments were realigned beneath a newly formed
Printing and Personal Systems Group during fiscal 2012. We describe the results
of the business segments within the Printing and Personal Systems Group in more
detail below.
Personal Systems
For the fiscal years ended October 31
2012 2011 2010
In millions
Net revenue $ 35,650 $ 39,574 $ 40,741
Earnings from operations $ 1,706 $ 2,350 $ 2,032
Earnings from operations as a % of
net revenue 4.8 % 5.9 % 5.0 %
The components of the weighted net revenue change by Personal Systems
business units were as follows for the following fiscal years ended October 31:
2012 2011
Percentage Points
Notebook PCs (6.3 ) (3.2 )
Desktop PCs (3.4 ) (0.7 )
Workstations (0.2 ) 1.1
Other - (0.1 )
Total Personal Systems (9.9 ) (2.9 )
Personal Systems net revenue decreased 9.9% (decreased 8.8% when adjusted
for currency) in fiscal 2012. The revenue decline was due primarily to a decline
in unit volumes, the effect of which was partially offset by a nominal increase
in average selling prices ("ASPs"). ASPs increased due primarily to a mix shift
toward higher-end models, the effect of which was partially offset by
unfavorable currency impacts. Unit volume was down 11% due primarily to
continued demand weakness in both the consumer and commercial markets. In fiscal
2012, net revenue from Notebook PCs decreased 12% while net revenue from Desktop
PCs decreased 9% as a result of the overall market decline.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Workstations revenue decreased 3% due to weak demand in the commercial PC
market. In fiscal 2012, net revenue for consumer clients decreased 15% while
commercial client revenue decreased 6%.
Personal Systems earnings from operations as a percentage of net revenue
decreased 1.1 percentage points in fiscal 2012. The decrease was due primarily
to a gross margin decline resulting from higher component costs combined with an
unfavorable currency impact. These negative impacts to gross margin were
partially offset by lower warranty and logistics costs, benefits from insurance
proceeds related to flooding in Thailand in July 2011 and an increased level of
component vendor rebates. In addition, operating expenses as a percentage of net
revenue increased due primarily to the decline in revenue coupled with increased
investments in research and development, the effects of which were partially
offset by a decrease in administrative expenses.
Personal Systems net revenue decreased 2.9% (decreased 4.7% when adjusted
for currency) in fiscal 2011 due primarily to softness in the consumer PC
markets, the effect of which was partially offset by strength in commercial
businesses. Unit volume was up 2% due primarily to the continued commercial
refresh cycle, the effect of which was partially offset by a decline in volume
in the consumer business. In fiscal 2011, Workstations revenue increased 24% due
to the ongoing corporate refresh cycle and strength in the commercial PC market.
Net revenue from Desktop PCs decreased 2% while Notebook PCs revenue decreased
6% as a result of consumer market softness. In fiscal 2011, net revenue for
consumer clients decreased 15% while commercial client revenue increased 9%. Net
revenue in Other decreased 7% due primarily to the wind down of the handheld
business and decreased sales of consumer warranty extensions. For fiscal 2011,
the favorable impact on Personal Systems net revenue from unit increases was
offset by a 5% decrease in ASPs due primarily to the competitive pricing
environment.
Personal Systems earnings from operations as a percentage of net revenue
increased 0.9 percentage points in fiscal 2011. The increase was driven by
improvements in gross margin resulting primarily from a favorable component
pricing environment and lower warranty costs. Partially offsetting the increase
in gross margin was an increase in operating expenses as a percentage of net
revenue due primarily to unfavorable currency impact and increased selling
costs.
Printing
For the fiscal years ended October 31
2012 2011 2010
In millions
Net revenue $ 24,487 $ 26,176 $ 26,176
Earnings from operations $ 3,585 $ 3,927 $ 4,357
Earnings from operations as a % of
net revenue 14.6 % 15.0 % 16.6 %
The components of the weighted net revenue change by Printing business units
were as follows for the following fiscal years ended October 31:
2012 2011
Percentage Points
Supplies (3.9 ) 0.0
Consumer Hardware (1.5 ) 0.0
Commercial Hardware (1.1 ) 0.0
Total Printing (6.5 ) 0.0
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Printing net revenue decreased 6.5% (decreased 6.3% when adjusted for
currency) in fiscal 2012, driven by broad-based consumer demand weakness in all
regions. Printer unit volume declined 15%, while average revenue per unit
increased by 8%. Net revenue for Supplies decreased 6% in fiscal 2012 driven by
demand declines in all regions, the effects of which were partially offset by
growth in large format printing supplies. Net revenue for Consumer Hardware
decreased 14% in fiscal 2012, due primarily to a decline in consumer demand.
Inkjet unit volume reductions of 18% were partially offset by a higher mix of
high value inkjet units reflecting an increase in average revenue per unit of
6%. Net revenue for Commercial Hardware decreased 5% in fiscal 2012. The net
revenue decline was driven by volume declines of 8%, due primarily to a weak
worldwide demand environment impacting our LaserJet printer business. These
negative impacts were offset by higher average revenue per unit of 2% and net
revenue growth in both large format printers and our managed print services
business.
Printing earnings from operations as a percentage of net revenue decreased
by 0.4 percentage points in fiscal 2012. Gross margin declined in fiscal 2012
due to an unfavorable currency impact driven by the strength of the Japanese yen
and from lower ink supplies volumes as a result of demand declines in all
regions. These effects were partially offset by our focus on higher-end inkjet
printers combined with a higher mix of supplies. Operating expenses as a
percentage of net revenue increased due to the decline in revenue and
investments in research and development, the effects of which were partially
offset by declines in marketing and administrative expenses.
Printing net revenue remained flat (decreased 1.0% when adjusted for
currency) in fiscal 2011. Net revenue for Commercial Hardware increased 3% in
fiscal 2011 due primarily to double-digit net revenue growth in the graphics
business, coupled with strong performance in transactional laser products in
emerging geographies. These effects were partially offset by supply chain
constraints in LaserJet printers as a result of the earthquake and tsunami in
Japan. Net revenue for Supplies decreased 1% in fiscal 2011, driven by slower
demand, particularly in Europe. These effects were partially offset by growth in
large format printing supplies. Net revenue for Consumer Hardware decreased 4%
in fiscal 2011, driven primarily by overall reductions in consumer electronics
spending and competitive pricing pressures reflected in a mix shift towards
lower-priced products and a decline in the average revenue per unit of 6%.
Printing earnings from operations as a percentage of net revenue decreased
by 1.6 percentage points in fiscal 2011, due primarily to a decline in gross
margin, the effect of which was partially offset by lower operating expenses as
a percentage of net revenue. The gross margin decline in fiscal 2011 was due
primarily to increased logistics costs and supply chain constraints in LaserJet
printers as a result of the Japan earthquake and tsunami, an unfavorable
currency impact driven primarily by the strength of the yen, a continued mix
shift in Consumer Hardware and Commercial Hardware to lower price point products
coupled with a lower mix of supplies. These effects were partially offset by
reductions in Printing's cost structure as a result of continued efforts to
optimize our supply chain. The decrease in operating expenses as a percentage of
net revenue in fiscal 2011 was due primarily to reduced marketing and
administrative expenses, the effect of which was partially offset by higher
field selling cost expenses.
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Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Services
For fiscal years ended October 31
2012 2011 2010
In millions
Net revenue $ 34,922 $ 35,702 $ 35,276
Earnings from operations $ 4,095 $ 5,203 $ 5,714
Earnings from operations as a % of net
revenue 11.7 % 14.6 % 16.2 %
The components of the weighted net revenue change by Services business units
were as follows for the following fiscal years ended October 31:
2012 2011
Percentage Points
Infrastructure Technology Outsourcing (1.5 ) 0.7
Application and Business Services (0.5 ) (0.3 )
Technology Services (0.2 ) 0.8
Total Services (2.2 ) 1.2
Services net revenue decreased 2.2% (decreased 0.5% when adjusted for
currency) in fiscal 2012 due to revenue decreases in all business units. ITO net
revenue decreased by 3% in fiscal 2012. Contractual rate declines on ongoing
contracts, increased deal selectivity designed to meet threshold margins and
strategic fit, and an unfavorable currency impact contributed to the decrease in
revenues. These effects were partially offset by an increase in product-related
revenue and increased revenue from cloud and security offerings. The deal
selectivity and contractual rate declines mentioned above are expected to
adversely affect revenue in future periods. ABS net revenue decreased by 2% in
fiscal 2012. The decrease was driven by declines in short-term project work
combined with an unfavorable currency impact, the effect of which was partially
offset by increases in sales of cloud and information management and analytics
offerings. TS net revenue decreased by 1% in fiscal 2012, due primarily to
revenue declines in our support business driven by an unfavorable currency
impact. Support contract renewals remained steady while declines in third-party
hardware support were offset by growth in project services.
Services earnings from operations as a percentage of net revenue decreased
by 2.9 percentage points in fiscal 2012. The decrease was due primarily to a
gross margin decline driven by lower than expected revenue, contractual rate
declines on ongoing contracts, a lower than expected resource utilization rate
and additional costs associated with certain contract deliverable delays. These
effects were partially offset by a continued focus on operating improvements and
cost initiatives that favorably impacted the cost structure of all business
units.
Services net revenue increased 1.2% (decreased 1.3% when adjusted for
currency) in fiscal 2011 due to revenue increases in ITO and TS business units.
ITO net revenue increased by 2% in fiscal 2011. An increase in product-related
revenue and a favorable currency impact were partially offset by a shortfall in
short-term project contracts with existing clients. TS net revenue increased by
3% in fiscal 2011, due primarily to growth in our consulting business and a
favorable currency impact, the effect of which was partially offset by reduced
sales of third-party hardware. ABS net revenue decreased by 1% in fiscal 2011.
The decrease was driven by the ExcellerateHRO divestiture completed at the end
of the third quarter of fiscal 2010, declines in short-term project work and
weakness in public sector spending. These effects were partially offset by a
favorable currency impact.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Services earnings from operations as a percentage of net revenue decreased
by 1.6 percentage points in fiscal 2011. Operating margin decreased due
primarily to lower than expected revenue, rate concessions arising from recent
contract renewals, a lower than expected resource utilization rate and a higher
mix of lower-margin Infrastructure Technology Outsourcing revenue. The decrease
in operating margin was partially offset by a reduction in bad debt expense and
a continued focus on operating improvements and cost initiatives that favorably
impacted the cost structure of both our enterprise services and technology
services businesses.
Enterprise Servers, Storage and Networking
For the fiscal years ended October 31
2012 2011 2010
In millions
Net revenue $ 20,491 $ 22,064 $ 20,246
Earnings from operations $ 2,132 $ 2,997 $ 2,814
Earnings from operations as a % of
net revenue 10.4 % 13.6 % 13.9 %
The components of the weighted net revenue change by ESSN business units
were as follows for the following fiscal years ended October 31:
2012 2011
Percentage Points
Industry Standard Servers (4.2 ) 4.7
Business Critical Systems ("BCS") (2.2 ) (1.0 )
Storage (1.1 ) 1.3
Networking 0.4 4.0
Total ESSN (7.1 ) 9.0
ESSN net revenue decreased 7.1% (6.4% when adjusted for currency) in fiscal
2012 due primarily to revenue decreases in ISS, BCS and Storage. In fiscal 2012,
ISS net revenue decreased by 7% driven by declines in unit volume and average
unit prices. The declines were due primarily to competitive pricing pressures
and macroeconomic challenges in EMEA. These effects were partially offset by
increased demand for public and private cloud offerings. BCS net revenue
decreased by 23% in fiscal 2012 mainly as a result of lower demand for our
Itanium-based servers, the impact of which was slightly offset by growth in
NonStop servers. Storage net revenue decreased 6% in fiscal 2012, due primarily
to revenue declines in storage tape and networking products, the effect of which
was partially offset by strong growth in 3PAR products and StoreOnce data
deduplication solutions. Networking net revenue increased 4% in fiscal 2012 due
to higher market demand for our core data center products, the effect of which
was partially offset by competitive pricing pressures and the divestiture of our
video surveillance business.
ESSN earnings from operations as a percentage of net revenue decreased by
3.2 percentage points in fiscal 2012 driven by a decrease in gross margin
coupled with an increase in operating expenses as a percentage of net revenue.
The decrease in gross margin was due primarily to competitive pricing pressures,
particularly in ISS and, to a lesser extent, in Networking. The increase in
operating expenses as a percentage of net revenue was driven by an increase in
research and development costs and field selling costs, the effect of which was
partially offset by lower administrative and marketing expenses.
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Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
ESSN net revenue increased 9.0% (7.0% when adjusted for currency) in fiscal
2011 due to growth in Networking and ISS. Total revenue from server and storage
blades increased by 11% in fiscal 2011. ISS net revenue increased by 8% in
fiscal 2011, driven primarily by unit volume growth coupled with increased
average unit prices due to favorable demand for the latest generation of ISS
products. The revenue increase was also driven by expansion in our converged
infrastructure solutions and strong demand from public and private cloud
customers. Networking net revenue increased by 50% due largely to our
acquisition of 3Com in April 2010, strong market demand for our core data center
products and the impact of our continued investments in sales coverage. Storage
net revenue increased by 7% in fiscal 2011 driven primarily by strong
performance in products related to our acquisition of 3PAR in September 2010 and
growth in scale out storage arrays, entry-level arrays and StoreOnce data
deduplication products. BCS net revenue decreased by 9% in fiscal 2011 mainly as
a result of orders being delayed or cancelled following an announcement by an
alliance partner that it intends to cease software development for our
Itanium-based servers. The impact from reduced sales of Itanium-based servers
was partially offset by higher demand for the latest generation of BCS scale-up
x86 products and growth in NonStop servers.
ESSN earnings from operations as a percentage of net revenue decreased by
0.3 percentage points in fiscal 2011 driven by an increase in operating expenses
as a percentage of net revenue, the effect of which was partially offset by an
increase in gross margin. The increase in operating expenses as a percentage of
net revenue was due primarily to additional expenses associated with
acquisitions and investments in R&D and sales coverage. The gross margin
increase was driven by lower product costs and a higher mix of networking
products, the effect of which was partially offset by price declines as a result
of competitive pressure.
Software
For the fiscal years ended October 31
2012 2011 2010
In millions
Net revenue $ 4,060 $ 3,367 $ 2,812
Earnings from operations $ 827 $ 722 $ 787
Earnings from operations as a % of
net revenue 20.4 % 21.4 % 28.0 %
Software net revenue increased 20.6% (21.3% when adjusted for currency) in
fiscal 2012 due to revenues from acquired companies, primarily Autonomy, which
was acquired in October, 2011. In fiscal 2012, net revenue from services,
support and licenses increased by 71%, 16% and 8%, respectively.
Software earnings from operations as a percentage of net revenue decreased
by 1.0 percentage points in fiscal 2012 due primarily to a decrease in gross
margin and a slight increase in operating expenses as a percentage of net
revenue. The gross margin decline was due primarily to a lower mix of license
revenue, the effect of which was partially offset by a highly profitable
software deal entered into in the fourth quarter of fiscal 2012.
Software net revenue increased 19.7% (18.1% when adjusted for currency) in
fiscal 2011 due to revenues from acquired companies as well as growth in the
organic business. The revenue growth was driven by good performance from our
security and management suite offerings. In fiscal 2011, net revenue from
services, licenses and support increased by 26%, 23% and 16%, respectively.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Software earnings from operations as a percentage of net revenue decreased
by 6.6 percentage points in fiscal 2011. The operating margin decline was due
primarily to the impact of deferred revenue write-downs and integration costs
associated with acquisitions and investments in sales coverage and R&D, the
effect of which was partially offset by the capitalization of certain software
development costs.
HP Financial Services
For the fiscal years ended October 31
2012 2011 2010
In millions
Net revenue $ 3,819 $ 3,596 $ 3,047
Earnings from operations $ 388 $ 348 $ 281
Earnings from operations as a % of
net revenue 10.2 % 9.7 % 9.2 %
HPFS net revenue increased by 6.2% in fiscal 2012. The net revenue increase
was due primarily to portfolio growth, along with higher buyout activity and
higher end-of-lease revenue from residual expirations in line with portfolio
growth. The effects of these changes were partially offset by unfavorable
currency movements.
HPFS earnings from operations as a percentage of net revenue increased by
0.5 percentage points in fiscal 2012. The increase was due primarily to an
increase in gross margin. The increase in gross margin was due primarily to
lower bad debt expense, the effect of which was partially offset by lower
margins on end-of-term activities, including buyouts and lease extensions.
Operating expenses as a percentage of net revenue were flat due to our continued
focus on cost efficiencies.
HPFS net revenue increased by 18.0% in fiscal 2011. The net revenue increase
was due primarily to portfolio growth as a result of higher customer demand, a
higher operating lease mix due to higher service-led financing volume, higher
end-of-lease revenue from residual expirations in line with portfolio growth,
and higher early buyout revenue and favorable currency movements.
HPFS earnings from operations as a percentage of net revenue increased by
0.5 percentage points in fiscal 2011 due primarily to a decrease in operating
expenses as a percentage of revenue, the effect of which was partially offset by
a decrease in gross margin. The decrease in operating expenses was due primarily
to continued improvement in cost efficiencies. The decrease in gross margin was
the result of lower portfolio margins from a higher mix of operating leases, the
effect of which was partially offset by lower bad debt expense as a percentage
of revenue and higher margins on lease extensions and buyouts.
Financing Originations
For the fiscal years ended October 31
2012 2011 2010
In millions
Total financing originations $ 6,590 $ 6,765 $ 5,987
New financing originations, which represent the amount of financing provided
to customers for equipment and related software and services, including
intercompany activity, decreased 2.6% and increased 13.0% in fiscal 2012 and
fiscal 2011, respectively. The decrease was driven by lower financing associated
with HP product sales and services offerings, along with unfavorable currency
impact.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Portfolio Assets and Ratios
HPFS maintains a strategy to generate a competitive return on equity by
effectively leveraging its portfolio against the risks associated with interest
rates and credit. The HPFS business model is asset intensive and uses certain
internal metrics to measure its performance against other financial services
companies, including a segment balance sheet that is derived from our internal
management reporting system. The accounting policies used to derive these
amounts are substantially the same as those used by the consolidated company.
However, certain intercompany loans and accounts that are reflected in the
segment balances are eliminated in our Consolidated Financial Statements.
The portfolio assets and ratios derived from the segment balance sheet for
HPFS were as follows for the following fiscal years ended October 31:
2012 2011
In millions
Portfolio assets(1) $ 13,054 $ 12,699
Allowance for doubtful accounts(2) 149 130
Operating lease equipment reserve 81 84
Total reserves 230 214
Net portfolio assets $ 12,824 $ 12,485
Reserve coverage 1.8 % 1.7 %
Debt to equity ratio(3) 7.0x 7.0x
--------------------------------------------------------------------------------
º (1)
º Portfolio assets include gross financing receivables of approximately
$7.7 billion and $7.3 billion at October 31, 2012 and October 31, 2011,
respectively, and net equipment under operating leases of $2.4 billion and
$2.7 billion at October 31, 2012 and October 31, 2011, respectively, as
disclosed in Note 11 to the Consolidated Financial Statements in Item 8, which is incorporated herein by reference. Portfolio assets also include
capitalized profit on intercompany equipment transactions of approximately
$0.9 billion and $1.0 billion at October 31, 2012 and October 31, 2011,
respectively, and intercompany leases of approximately $2.1 billion and
$1.7 billion at October 31, 2012 and October 31, 2011, respectively, both
of which are eliminated in consolidation.
º (2)
º Allowance for doubtful accounts includes both the short-term and the
long-term portions of the allowance on financing receivables.
º (3)
º HPFS debt consists of intercompany equity that is treated as debt for segment reporting purposes, intercompany debt and debt issued directly by
HPFS. At October 31, 2012 and 2011, debt allocated to HPFS totalled
$11.3 billion and $10.8 billion, respectively. The allocated intercompany
debt to equity ratio above is comparable to that of other similar financing
companies.
At October 31, 2012 and 2011, HPFS cash balances were approximately
$700 million and $500 million, respectively.
Net portfolio assets at October 31, 2012 increased 2.7% from October 31,
2011. The increase resulted from higher levels of new financing originations in
fiscal 2012, the effect of which was partially offset by an unfavorable currency
impact. The overall percentage of portfolio asset reserves increased as a
percentage of the portfolio assets.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
HPFS recorded net bad debt expenses of $54 million and $60 million in fiscal
2012 and fiscal 2011, respectively.
Corporate Investments
For the fiscal years ended October 31
2012 2011 2010
In millions
Net revenue $ 108 $ 208 $ 214
Loss from operations $ (238 ) $ (1,619 ) $ (358 )
Loss from operations as a % of net
revenue (220.4 )% (778.4 )% (167.3 )%
Net revenue in Corporate Investments in fiscal 2012 relates primarily to
business intelligence solutions and the former webOS device business. In fiscal
2012, the revenue decrease was a result of lower sales due to the wind down of
the webOS device business announced in August 2011.
Corporate Investments reported a smaller loss from operations in fiscal 2012
due primarily to the absence in the current period of charges recognized in the
prior period related to the wind down of the webOS device business. The loss
from operations in Corporate Investments was also due to expenses carried in the
segment associated with corporate strategy, global alliances and HP Labs.
Net revenue in Corporate Investments in fiscal 2011 relates primarily to
mobile devices associated with the Palm acquisition, business intelligence
solutions and licensing of HP technology to third parties. In fiscal 2011, the
revenue decrease was due primarily to lower business intelligence solutions
revenue, the effect of which was partially offset by revenue from webOS devices.
Business intelligence solutions revenue declined mainly due to lower revenue
from consulting services.
Corporate Investments reported a higher loss from operations in fiscal 2011
due to $755 million of expenses primarily for supplier-related obligations and
sales incentive programs related to winding down the webOS device business. The
loss from operations in Corporate Investments was also due to expenses carried
in the segment associated with corporate development, global alliances and HP
Labs, which expenses increased from fiscal 2010 and were partially offset by a
gain on the divestiture of HP's Halo video collaboration products business.
LIQUIDITY AND CAPITAL RESOURCES
Our cash balances are held in numerous locations throughout the world, with
substantially all of those amounts held outside of the United States. Amounts
held outside of the United States are generally utilized to support non-U.S.
liquidity needs, although a portion of those amounts may from time to time be
subject to short-term intercompany loans into the United States. Most of the
amounts held outside of the United States could be repatriated to the United
States but, under current law, would be subject to United States federal income
taxes, less applicable foreign tax credits. Repatriation of some foreign
balances is restricted by local laws. Except for foreign earnings that are
considered indefinitely reinvested outside of the United States, we have
provided for the U.S. federal tax liability on these earnings for financial
statement purposes. Repatriation could result in additional income tax payments
in future years. Where local restrictions prevent an efficient intercompany
transfer of funds, our intent is that cash balances would remain outside of the
United States and we would meet liquidity needs through ongoing cash flows,
external borrowings, or both. We utilize a variety of tax planning and financing
strategies in an effort to ensure that our worldwide cash is available in the
locations in which it is needed. We do not expect restrictions or potential
taxes on repatriation of amounts held
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
outside of the United States to have a material effect on HP's overall
liquidity, financial condition or results of operations.
LIQUIDITY
We use cash generated by operations as our primary source of liquidity; we
believe that internally generated cash flows are generally sufficient to support
business operations, capital expenditures and the payment of stockholder
dividends, in addition to discretionary investments and share repurchases. We
are able to supplement this near-term liquidity, if necessary, with broad access
to capital markets and credit line facilities made available by various foreign
and domestic financial institutions. Our liquidity is subject to various risks
including the market risks identified in the section entitled "Qualitative and
Quantitative Disclosures about Market Risk" in Item 7A.
For the fiscal years ended October 31
2012 2011 2010
In billions
Cash and cash equivalents $ 11.3 $ 8.0 $ 10.9
Total debt $ 28.4 $ 30.6 $ 22.3
Available borrowing resources(1)(2) $ 17.4 $ 14.6 $ 13.8
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º (1)
º In addition to these available borrowing resources, we are able to offer
for sale, from time to time, in one or more offerings, an unspecified
amount of debt securities, common stock, preferred stock, depositary shares
and warrants under a shelf registration statement filed with the SEC in May
2012 (the "2012 Shelf Registration Statement").
º (2)
º Available borrowing resources does not include £2.2 billion ($3.6 billion)
in borrowing resources under our 364-day senior unsecured bridge term loan
agreement that was entered into in August 2011 and terminated in November
2011.
Our cash position remains strong, and we expect that our cash balances,
anticipated cash flow generated from operations and access to capital markets
will be sufficient to cover cash outlays expected in fiscal 2013.
Cash Flows
The following table summarizes the key cash flow metrics from our
consolidated statements of cash flow:
For the fiscal years ended October 31
2012 2011 2010
In millions
Net cash provided by operating
activities $ 10,571 $ 12,639 $ 11,922
Net cash used in investing activities (3,453 ) (13,959 ) (11,359 )
Net cash used in financing activities (3,860 ) (1,566 ) (2,913 )
Net increase (decrease) in cash and cash
equivalents $ 3,258 $ (2,886 ) $ (2,350 )
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Operating Activities
Net cash provided by operating activities decreased by approximately
$2.1 billion for fiscal 2012 as compared to fiscal 2011. The decrease was due
primarily to lower net earnings and higher utilization of cash resources for
payment of accounts payable, the impact of which was partially offset by lower
investment in inventory and higher cash generated from collections of accounts
and financing receivables. Net cash provided by operating activities increased
by approximately $0.7 billion for fiscal 2011 as compared to fiscal 2010. The
increase was due primarily to higher cash generated through the utilization of
operating assets, primarily accounts and financing receivables, and lower
utilization of cash resources for payment of accounts payable, the impact of
which was partially offset by decreases in net earnings and cash utilized as a
result of higher inventory levels.
Our key working capital metrics are as follows:
October 31
2012 2011 2010
Days of sales outstanding in accounts receivable 49 51
50
Days of supply in inventory 25 27 23
Days of purchases outstanding in accounts payable (53 ) (52 )
(52 )
Cash conversion cycle 21 26 21
Days of sales outstanding in accounts receivable ("DSO") measures the
average number of days our receivables are outstanding. DSO is calculated by
dividing ending accounts receivable, net of allowance for doubtful accounts, by
a 90-day average net revenue. Our accounts receivable balance was $16.4 billion
as of October 31, 2012.
Days of supply in inventory ("DOS") measures the average number of days from
procurement to sale of our product. DOS is calculated by dividing ending
inventory by a 90-day average cost of goods sold. Our inventory balance was
$6.3 billion as of October 31, 2012.
Days of purchases outstanding in accounts payable ("DPO") measures the
average number of days our accounts payable balances are outstanding. DPO is
calculated by dividing ending accounts payable by a 90-day average cost of goods
sold. Our accounts payable balance was $13.4 billion as of October 31, 2012.
Our working capital requirements depend upon our effective management of the
cash conversion cycle, which represents effectively the number of days that
elapse from the day we pay for the purchase of raw materials to the collection
of cash from our customers. The cash conversion cycle is the sum of DSO and DOS
less DPO.
The cash conversion cycle for fiscal 2012 decreased by five days compared to
fiscal 2011. The decrease in DSO was due primarily to improved collections, an
increase in cash discounts and a decline in extended payment terms. Additionally
our DSO benefited from the current-period DSO calculation containing a full
quarter of revenue from our Autonomy acquisition versus the approximately one
month of revenue that was included in the prior-period DSO calculation. These
favorable impacts to DSO were partially offset by revenue linearity. The
decrease in DOS was due to lower inventory balances in most segments as of
October 31, 2012. The increase in DPO was primarily due to improved purchasing
linearity.
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
The cash conversion cycle for fiscal 2011 increased by five days as compared
to fiscal 2010. The increase in DSO was primarily the result of unfavorable
impact on receivables from the Autonomy acquisition, extended payment terms and
an increase in unbilled and aged accounts receivables, the effect of which was
offset by a favorable currency impact due to the strengthening U.S. dollar. The
increase in DOS was a result of higher inventory levels at October 31, 2011 due
primarily to a macro economic slowdown impacting our consumer businesses, the
timing of shipments in our commercial hardware businesses and strategic
purchases of certain components. DPO remained flat year over year.
Investing Activities
Net cash used in investing activities decreased by $10.5 billion for fiscal
2012 as compared to fiscal 2011, due primarily to lower investments in
acquisitions in 2012. Net cash used in investing activities increased by
approximately $2.6 billion for fiscal 2011 as compared to fiscal 2010, due
primarily to higher investments in acquisitions in 2011.
Financing Activities
Net cash used in financing activities increased by approximately
$2.3 billion for fiscal 2012 as compared to fiscal 2011. The increase was due
primarily to lower net proceeds from the issuance of U.S. Dollar Global Notes
and an increase in net repayment of commercial paper, the impact of which was
partially offset by lower cash paid for repurchases of our common stock. Net
cash used in financing activities decreased by approximately $1.3 billion for
fiscal 2011 as compared to fiscal 2010. The decrease was due primarily to higher
net proceeds from the issuance of debt and a decrease in cash paid for
repurchases of our common stock, the impact of which was partially offset by
higher net repayment of commercial paper and a decrease in cash received from
the issuance of common stock under employee stock plans.
For more information on our share repurchase programs, see Item 5 and
Note 15 to the Consolidated Financial Statements in Item 8, which are
incorporated herein by reference.
CAPITAL RESOURCES
Debt Levels
For the fiscal years ended October 31
2012 2011 2010
In millions, except
interest rates and ratios
Short-term debt $ 6,647 $ 8,083 $ 7,046
Long-term debt $ 21,789 $ 22,551 $ 15,258
Debt-equity ratio 1.25x 0.79x 0.55x Weighted-average interest rate 2.95 % 2.4 % 2.0 %
We maintain debt levels that we establish through consideration of a number
of factors, including cash flow expectations, cash requirements for operations,
cash needed to support our financing business, investment plans (including
acquisitions), share repurchase activities, overall cost of capital, and
targeted capital structure.
Short-term debt and long-term debt decreased by $1.4 billion and
$0.8 billion, respectively, for fiscal 2012 as compared to fiscal 2011. The net
decrease in total debt is due primarily to fewer acquisitions, and lower levels
of share repurchases coupled with maturities in some obligations. In fiscal
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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
2011, short-term debt and long-term debt increased by $1.0 billion and
$7.3 billion, respectively, as compared to fiscal 2010. The net increase in
total debt is due primarily to investments in acquisitions and share
repurchases.
During fiscal 2013, $5.5 billion of U.S. Dollar Global Notes will mature. We
expect to have sufficient cash, cash from operations and access to capital
markets to repay those maturing global notes.
Our debt-equity ratio is calculated as the carrying value of debt divided by
the carrying value of equity. Our debt-equity ratio increased by 0.46x in fiscal
2012, due primarily to a decrease in shareholders equity by $16.2 billion at the
end of fiscal 2012. Our debt-equity ratio increased by 0.24x in fiscal 2011, due
primarily to the issuance of $11.6 billion of U.S Dollar Global Notes and a
decrease in shareholders equity by $1.8 billion at the end of fiscal 2011.
Our weighted-average interest rate reflects the average effective rate on
our borrowings prevailing during the year; it factors in the impact of swapping
some of our global notes with fixed interest rates for global notes with
floating interest rates. For more information on our interest rate swaps, see
Note 10 to the Consolidated Financial Statements in Item 8, which is
incorporated herein by reference. The low weighted-average interest rate over
the past three years is a result of a combination of lower market interest rates
and swapping some of our fixed-interest obligations associated with some of our
fixed-rate U.S. Dollar Global Notes for variable-rate obligations through
interest rate swaps in a declining rate environment.
For more information on our borrowings, see Note 13 to the Consolidated
Financial Statements in Item 8, which is incorporated herein by reference.
Available Borrowing Resources
At October 31, 2012, we had the following resources available to obtain
short-term or long-term financings if we need additional liquidity:
At October 31, 2012
In millions
2012 Shelf Registration Statement(1) Unspecified
Commercial paper programs(1) $16,135
Uncommitted lines of credit(1) $ 1,301
--------------------------------------------------------------------------------
º (1)
º For more information on our available borrowings resources, see Note 13 to
the Consolidated Financial Statements in Item 8, which is incorporated
herein by reference.
Credit Ratings
Our credit risk is evaluated by three independent rating agencies based upon
publicly available information as well as information obtained in our ongoing
discussions with them. The ratings as of October 31, 2012 were:
Standard & Poor's Moody's Investors Fitch Ratings
Ratings Services Service Services
Short-term debt ratings A-2 Prime-2 F2
Long-term debt ratings BBB+ A3 A-
69
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Table of Contents
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Our credit ratings were downgraded by Fitch Ratings Services to F2 and A- in
the fourth quarter of fiscal 2012. Moody's Investors Service subsequently
downgraded our long-term debt from A3 to Baa1 in November 2012. Our credit
ratings remain under negative outlook by Moody's Investors Service. While we do
not have any rating downgrade triggers that would accelerate the maturity of a
material amount of our debt, these downgrades have increased the cost of
borrowing under our credit facilities, have reduced market capacity for our
commercial paper, and may require the posting of additional collateral under
some of our derivative contracts. In addition, any further downgrade in our
credit ratings by any of the three rating agencies may further impact us in a
similar manner, and, depending on the extent of the downgrade, could have a
negative impact on our liquidity and capital position. We will rely on
alternative sources of funding, including drawdowns under our credit facilities
or the issuance of debt or other securities under our existing shelf
registration statement, if necessary, to offset reductions in the market
capacity for our commercial paper.
CONTRACTUAL AND OTHER OBLIGATIONS
The impact that we expect our contractual and other obligations as of
October 31, 2012 to have on our liquidity and cash flow in future periods is as
follows:
Payments Due by Period
1 Year or More than
Total Less 1-3 Years 3-5 Years 5 Years
In millions
Principal payments on
long-term debt(1) $ 26,811 $ 5,638 $ 7,411 $ 5,824 $ 7,938
Interest payments on
long-term debt(2) 5,346 600 1,035 815 2,896
Operating lease
obligations 3,242 752 1,141 556 793
Purchase obligations(3) 1,632 1,131 448 53 -
Capital lease obligations 354 59 251 11 33
Total $ 37,385 $ 8,180 $ 10,286 $ 7,259 $ 11,660
--------------------------------------------------------------------------------
º (1)
º Amounts represent the expected principal cash payments relating to our
long-term debt and do not include any fair value adjustments or discounts
and premiums.
º (2)
º Amounts represent the expected interest cash payments relating to our long-term debt. We have outstanding interest rate swap agreements accounted
for as fair value hedges that have the economic effect of modifying the
fixed-interest obligations associated with some of our fixed global notes
for variable rate obligations. The impact of these interest rate swaps was
factored into the calculation of the future interest payments on long-term
debt.
º (3)
º Purchase obligations include agreements to purchase goods or services that
are enforceable and legally binding on us and that specify all significant
terms, including fixed or minimum quantities to be purchased; fixed,
minimum or variable price provisions; and the approximate timing of the
transaction. These purchase obligations are related principally to
inventory and other items. Purchase obligations exclude agreements that are
cancellable without penalty. Purchase obligations also exclude open
purchase orders that are routine arrangements entered into in the ordinary
course of business, as they are difficult to quantify in a meaningful way.
Even though open purchase orders are considered enforceable and legally
binding, the terms generally allow us the option to cancel, reschedule, and
adjust our requirements based on our business needs prior to the delivery
of goods or performance of services.
70--------------------------------------------------------------------------------
Table of Contents
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
Income Tax Obligations
In addition to the above, at October 31, 2012, we had approximately
$2.3 billion of recorded liabilities and related interest and penalties
pertaining to uncertainty in income tax positions, which will be partially
offset by $338 million of deferred tax assets and interest receivable. These
liabilities and related interest and penalties include $81 million expected to
be paid within one year. For the remaining amount, we are unable to make a
reasonable estimate as to when cash settlement with the tax authorities might
occur due to the uncertainties related to these tax matters. See Note 14 to the
Consolidated Financial Statements in Item 8, which is incorporated herein by
reference, for additional information on taxes.
Restructuring Funding Commitments
As a result of our approved restructuring plans, we expect future cash
expenditures of approximately $2.7 billion. We expect to make cash payments of
approximately $1.6 billion in fiscal 2013 with remaining cash payments through
fiscal 2016. In addition to these cash expenditures, we expect to fund
approximately $833 million of the enhanced early retirement program ("EER")
announced in May 2012 through use of our U.S. pension plan assets. The use of
plan assets to fund the U.S. EER in fiscal 2012 did not cause us to increase our
funding to our U.S. pension plan. See Note 8 and Note 16 to the Consolidated
Financial Statements in Item 8, which are incorporated herein by reference, for
additional information on our restructuring plans and pension activities,
respectively. We expect to use a combination of cash from operations and our
available borrowing resources to meet our near-term funding commitments.
Guarantees and Indemnifications
See Note 12 to the Consolidated Financial Statements in Item 8, which is
incorporated herein by reference, for additional information on liabilities that
may arise from guarantees and indemnifications.
Litigation and Contingencies
See Note 18 to the Consolidated Financial Statements in Item 8, which is
incorporated herein by reference, for additional information on liabilities that
may arise from litigation and contingencies.
Off-Balance Sheet Arrangements
As part of our ongoing business, we have not participated in transactions
that generate material relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities ("SPEs"), which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. As of October 31, 2012, we are not involved in any
material unconsolidated SPEs.
HP has third-party financing arrangements in order to facilitate the working
capital requirements of certain partners consisting of revolving short-term
financing. The total aggregate capacity of the facilities was $1.5 billion as of
October 31, 2012, including a $0.9 billion partial recourse facility entered
into in May 2011 and an aggregate capacity of $0.6 billion in non-recourse
facilities. For more information on our revolving trade receivables-based
facilities, see Note 4 to the Consolidated Financial Statements in Item 8, which
is incorporated herein by reference.
71--------------------------------------------------------------------------------
Table of Contents
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