10-Q 1 hp-13117x10q.htm 10-Q Document
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
________________________________
FORM 10-Q
(Mark One)
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: January 31, 2017
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to            
Commission file number 1-4423
_________________________________________
HP INC.
(Exact name of registrant as specified in its charter)
Delaware
 
94-1081436
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. employer
identification no.)
1501 Page Mill Road, Palo Alto, California
 
94304
(Address of principal executive offices)
 
(Zip code)
(650) 857-1501
(Registrant’s telephone number, including area code)
________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý
 
Accelerated filer o
 
Non-accelerated filer o
 (Do not check if a smaller
reporting company)
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No ý
The number of shares of HP common stock outstanding as of January 31, 2017 was 1,693,380,110 shares
 




HP INC. AND SUBSIDIARIES
Form 10-Q
For the Quarterly Period ended January 31, 2017

Table of Contents
In this report on Form 10-Q, for all periods presented, “we”, “us”, “our”, “company”, “HP” and “HP Inc.” refer to HP Inc. (formerly Hewlett-Packard Company) and its consolidated subsidiaries.


2


Forward-Looking Statements
        This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I, contains forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, the results of HP Inc. and its consolidated subsidiaries (“HP”) may differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of net revenue, margins, expenses, effective tax rates, net earnings, net earnings per share, cash flows, benefit plan funding, deferred tax assets, share repurchases, foreign currency exchange rates or other financial items; any projections of the amount, timing or impact of cost savings or restructuring and other charges; any statements of the plans, strategies and objectives of management for future operations, including the execution of restructuring plans and any resulting cost savings, net revenue or profitability improvements; any statements concerning the expected development, performance, market share or competitive performance relating to products or services; any statements regarding current or future macroeconomic trends or events and the impact of those trends and events on HP and its financial performance; any statements regarding pending investigations, claims or disputes; any statements of expectation or belief, including with respect to the timing and expected benefits of acquisitions and other business combination and investment transactions; and any statements of assumptions underlying any of the foregoing. Risks, uncertainties and assumptions include the need to address the many challenges facing HP’s businesses; the competitive pressures faced by HP’s businesses; risks associated with executing HP’s strategy; the impact of macroeconomic and geopolitical trends and events; the need to manage third-party suppliers and the distribution of HP’s products and the delivery of HP’s services effectively; the protection of HP’s intellectual property assets, including intellectual property licensed from third parties; risks associated with HP’s international operations; the development and transition of new products and services and the enhancement of existing products and services to meet customer needs and respond to emerging technological trends; the execution and performance of contracts by HP and its suppliers, customers, clients and partners; the hiring and retention of key employees; integration and other risks associated with business combination and investment transactions; the results of the restructuring plans, including estimates and assumptions related to the cost (including any possible disruption of HP’s business) and the anticipated benefits of the restructuring plans; the resolution of pending investigations, claims and disputes; and other risks that are described herein, including but not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, the risks discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 31, 2016, and that are otherwise described or updated from time to time in HP’s other filings with the Securities and Exchange Commission (the “SEC”). HP assumes no obligation and does not intend to update these forward-looking statements.


3


Part I. Financial Information

ITEM 1. Financial Statements and Supplementary Data.
Index
 
Page


4


HP INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Earnings
(Unaudited)
 
Three months ended January 31
 
2017
 
2016
 
In millions, except per share amounts
Net revenue
$
12,684

 
$
12,246

Costs and expenses:
 

 
 

Cost of revenue
10,436

 
9,961

Research and development
296

 
292

Selling, general and administrative
1,017

 
1,037

Restructuring and other charges
63

 
20

Acquisition-related charges
16

 

Amortization of intangible assets

 
8

Total costs and expenses
11,828

 
11,318

Earnings from continuing operations
856

 
928

Interest and other, net
(81
)
 
(94
)
Earnings from continuing operations before taxes
775

 
834

Provision for taxes
(164
)
 
(184
)
Net earnings from continuing operations
611

 
650

Net loss from discontinued operations, net of taxes

 
(58
)
Net earnings
$
611

 
$
592

Net earnings (loss) per share:
 

 
 

Basic
 

 
 

Continuing operations
$
0.36

 
$
0.37

Discontinued operations

 
(0.04
)
Total basic net earnings per share
$
0.36

 
$
0.33

Diluted
 

 
 

Continuing operations
$
0.36

 
$
0.36

Discontinued operations

 
(0.03
)
Total diluted net earnings per share
$
0.36

 
$
0.33

Cash dividends declared per share
$
0.27

 
$
0.25

Weighted-average shares used to compute net earnings (loss) per share:
 

 
 

Basic
1,704

 
1,776

Diluted
1,721

 
1,785

The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.


5


HP INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Comprehensive Income
(Unaudited)
 
Three months ended January 31
 
2017
 
2016
 
In millions
Net earnings
$
611

 
$
592

Other comprehensive (loss) income before taxes:
 

 
 

Change in unrealized gains on available-for-sale securities:
 

 
 

Unrealized gains arising during the period
3

 

Change in unrealized components of cash flow hedges:
 

 
 

Unrealized (losses) gains arising during the period
(169
)
 
105

Gains reclassified into earnings
(71
)
 
(34
)
 
(240
)
 
71

Change in unrealized components of defined benefit plans:
 

 
 

Amortization of actuarial loss and prior service benefit
20

 
12

Other comprehensive (loss) income before taxes
(217
)
 
83

(Provision for) benefit from taxes
(14
)
 
16

Other comprehensive (loss) income, net of taxes
(231
)
 
99

Comprehensive income
$
380

 
$
691

The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.


6


HP INC. AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(Unaudited)
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions, except par value 
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
6,331

 
$
6,288

Accounts receivable
3,478

 
4,114

Inventory
4,555

 
4,484

Other current assets
3,411

 
3,582

Total current assets
17,775

 
18,468

Property, plant and equipment
1,730

 
1,736

Goodwill
5,622

 
5,622

Other non-current assets
3,065

 
3,161

Total assets
$
28,192

 
$
28,987

LIABILITIES AND STOCKHOLDERS’ DEFICIT
 

 
 

Current liabilities:
 

 
 

Notes payable and short-term borrowings
$
100

 
$
78

Accounts payable
10,951

 
11,103

Employee compensation and benefits
526

 
759

Taxes on earnings
267

 
231

Deferred revenue
952

 
919

Other accrued liabilities
5,791

 
5,718

Total current liabilities
18,587

 
18,808

Long-term debt
6,688

 
6,735

Other non-current liabilities
7,244

 
7,333

Commitments and contingencies


 


Stockholders’ deficit:
 

 
 

Preferred stock, $0.01 par value (300 shares authorized; none issued)

 

Common stock, $0.01 par value (9,600 shares authorized; 1,693 and 1,712 shares issued and outstanding at January 31, 2017 and October 31, 2016, respectively)          
17

 
17

Additional paid in capital
664

 
1,030

Retained deficit
(3,339
)
 
(3,498
)
Accumulated other comprehensive loss
(1,669
)
 
(1,438
)
Total stockholders’ deficit
(4,327
)
 
(3,889
)
Total liabilities and stockholders’ deficit
$
28,192

 
$
28,987

The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.

7


HP INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
(Unaudited)
 
Three months ended January 31
 
2017
 
2016
 
In millions
Cash flows from operating activities:
 

 
 

Net earnings
$
611

 
$
592

Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
 

 
 

Depreciation and amortization
84

 
79

Stock-based compensation expense
75

 
61

Provision for doubtful accounts
(2
)
 
11

Provision for inventory
(2
)
 
34

Restructuring and other charges
63

 
20

Deferred taxes on earnings
67

 
526

Other, net
23

 
(15
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
614

 
704

Inventory
(69
)
 
202

Accounts payable
(116
)
 
(1,104
)
Taxes on earnings
(75
)
 
(534
)
Restructuring and other
(51
)
 
(31
)
Other assets and liabilities
(455
)
 
(647
)
Net cash provided by (used in) operating activities
767

 
(102
)
Cash flows from investing activities:
 

 
 

Investment in property, plant and equipment
(101
)
 
(120
)
Proceeds from sale of property, plant and equipment
69

 

Purchases of available-for-sale securities and other investments
(56
)
 

Maturities and sales of available-for-sale securities and other investments
2

 
9

Net cash used in investing activities
(86
)
 
(111
)
Cash flows from financing activities:
 

 
 

Short-term borrowings with original maturities less than 90 days, net
35

 
26

Proceeds from debt, net of issuance costs
5

 
4

Payment of debt
(27
)
 
(2,155
)
Settlement of cash flow hedges
(4
)
 
(11
)
Net transfer of cash and cash equivalents to Hewlett Packard Enterprise Company

 
(10,375
)
Net payments related to stock-based award activities
(34
)
 
(3
)
Repurchase of common stock
(386
)
 
(797
)
Cash dividends paid
(227
)
 
(221
)
Net cash used in financing activities
(638
)
 
(13,532
)
Increase (decrease) in cash and cash equivalents
43

 
(13,745
)
Cash and cash equivalents at beginning of period
6,288

 
17,433

Cash and cash equivalents at end of period
$
6,331

 
$
3,688

Supplemental schedule of non-cash investing and financing activities:
 

 
 

Net assets transferred to Hewlett Packard Enterprise Company
$

 
$
22,197

Purchase of assets under capital leases
$
40

 
$
40

The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.

8


HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 1: Basis of Presentation
Separation Transaction
On November 1, 2015, Hewlett-Packard Company completed the separation of Hewlett Packard Enterprise Company (“Hewlett Packard Enterprise”), Hewlett-Packard Company’s former enterprise technology infrastructure, software, services and financing businesses (the “Separation”). In connection with the Separation, Hewlett-Packard Company changed its name to HP Inc. (“HP”) and entered into a separation and distribution agreement as well as various other agreements with Hewlett Packard Enterprise that provide a framework for the relationships between the parties, including among others a tax matters agreement, an employee matters agreement, a transition service agreement, a real estate matters agreement, a master commercial agreement and an information technology service agreement. For more information on the impacts of these agreements, see Note 5, “Stock-Based Compensation”, Note 6, “Taxes on Earnings”, Note 13, “Litigation and Contingencies” and Note 14, “Guarantees, Indemnifications and Warranties”.
Basis of Presentation
The accompanying Consolidated Condensed Financial Statements of HP and its wholly-owned subsidiaries are prepared in conformity with United States (“U.S.”) generally accepted accounting principles (“GAAP”). The interim financial information is unaudited, but reflects all normal adjustments that are necessary to provide a fair statement of results for the interim periods presented. This interim information should be read in conjunction with the Consolidated Financial Statements for the fiscal year ended October 31, 2016 in the Annual Report on Form 10-K filed on December 15, 2016. The Consolidated Condensed Balance Sheet for October 31, 2016 was derived from audited financial statements.
Principles of Consolidation
The Consolidated Condensed Financial Statements include the accounts of HP and its subsidiaries and affiliates in which HP has a controlling financial interest or is the primary beneficiary. All intercompany balances and transactions have been eliminated.
Reclassifications
Effective at the beginning of its first quarter of fiscal year 2017, HP implemented an organizational change to align its business unit financial reporting more closely with its current business structure. The organizational change resulted in the transfer of a portion of LaserJet printers from Commercial to Consumer within the Printing segment. HP reflected this change to its business unit information in prior reporting periods on an as-if basis which resulted in the reclassification of revenues between the Commercial and Consumer business units of Printing. The reporting change had no impact to previously reported segment net revenue, consolidated net revenue, earnings from continuing operations, net earnings or net earnings per share (“EPS”). See Note 2, “Segment Information”, for a further discussion of HP’s business unit realignments.
HP has reclassified certain prior-year amounts to conform to the current-year presentation as a result of the adoption of Accounting Standards Update (“ASU”) 2015-03, “Simplifying the Presentation of Debt Issuance Costs” and ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”.
Use of Estimates
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in HP’s Consolidated Condensed Financial Statements and accompanying notes. Actual results could differ materially from those estimates. 
Recently Adopted Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board (“FASB”) issued guidance which amends the existing accounting standards for share-based payments, including the accounting for income taxes and forfeitures, as well as the classifications on the statements of cash flows. HP early adopted the amendments in the first quarter of fiscal year 2017. Beginning November 1, 2016, stock-based compensation excess tax benefits or tax deficiencies are reflected in the Consolidated Condensed Statements of Earnings as a component of the provision for taxes, whereas they previously were recognized as additional paid in capital in the stockholders’ deficit in the Consolidated Condensed Balance Sheets. HP has elected to continue to estimate forfeitures expected to occur to determine the stock-based compensation expense. Additionally, the Consolidated Condensed Statements of Cash Flows now present excess tax benefits as an operating activity rather than as a financing activity, while the payment of withholding taxes on the settlement of stock-based compensation awards is presented as a financing activity rather than as an operating activity, with prior periods adjusted accordingly. The implementation of this guidance did not have a material impact on the Consolidated Condensed Statements of Cash Flows for the three months ended January 31, 2016. See Note 6, “Taxes on Earnings, for additional impact on the Consolidated Condensed Financial Statements.

9

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 1: Basis of Presentation (Continued)

In May 2015, the FASB issued guidance which amends the existing disclosures for investments measured at net asset value (“NAV”) per share (or its equivalent), as a practical expedient for fair value. This amendment removes the requirement to categorize these investments within the fair value hierarchy. The amendment also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the NAV practical expedient. HP has adopted the guidance in the first quarter of fiscal year 2017. Other than the change in presentation of certain pension-related assets that use NAV as a practical expedient, which requires retrospective application, the adoption of this new guidance did not have an impact on the Consolidated Condensed Financial Statements.
In April 2015, the FASB amended the existing accounting standards for intangible assets. The amendments provide explicit guidance to customers in determining the accounting for fees paid in a cloud computing arrangement. HP has adopted the guidance prospectively in the first quarter of fiscal year 2017. The implementation of this guidance did not have an impact on the Consolidated Condensed Financial Statements.
In April 2015, the FASB amended the existing accounting standards for the presentation of debt issuance costs. The amendments require that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by these amendments. HP has adopted the guidance in the first quarter of fiscal year 2017. The adoption resulted in the reclassification of unamortized debt issuance costs related to HP's U.S. Dollar Global Notes from "Other non-current assets" to "Long-term debt" within the Consolidated Condensed Balance Sheets of $23 million for the year ended October 31, 2016.
Recently Issued Accounting Pronouncements Not Yet Adopted
In January 2017, the FASB issued guidance which simplifies the accounting for goodwill impairment. The updated guidance eliminates Step 2 of the impairment test, which requires entities to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value, determined in Step 1. HP is required to adopt the guidance in the first quarter of fiscal year 2021 using a prospective approach. Earlier adoption is permitted. HP is currently evaluating the timing and the impact of this guidance on the Consolidated Condensed Financial Statements.
In January 2017, the FASB amended the existing accounting standards for business combinations. The amendments clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. HP is required to adopt the guidance in the first quarter of fiscal year 2019. Earlier adoption is permitted. HP is currently evaluating the timing and the impact of this guidance on the Consolidated Condensed Financial Statements.
In August 2016, the FASB issued guidance which amends the existing accounting standards for the classification of certain cash receipts and cash payments on the statement of cash flows. HP is required to adopt the guidance in the first quarter of fiscal year 2019. Earlier adoption is permitted. HP is currently evaluating the timing and the impact of this guidance on the Consolidated Condensed Financial Statements.    
In June 2016, the FASB issued guidance which requires credit losses on financial assets measured at amortized cost basis to be presented at the net amount expected to be collected, not based on incurred losses. Further, credit losses on available-for-sale debt securities should be recorded through an allowance for credit losses limited to the amount by which fair value is below amortized cost. HP is required to adopt the guidance in the first quarter of fiscal year 2021. Earlier adoption is permitted. HP is currently evaluating the timing and the impact of this guidance on the Consolidated Condensed Financial Statements.
In February 2016, the FASB issued guidance which amends the existing accounting standards for leases. Consistent with current guidance, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification. Under the new guidance, a lessee will be required to recognize assets and liabilities for all leases with lease terms of more than twelve months. HP is required to adopt the guidance in the first quarter of fiscal year 2020 using a modified retrospective approach. Earlier adoption is permitted. HP is currently evaluating the timing and the impact of this guidance on the Consolidated Condensed Financial Statements. 
In January 2016, the FASB issued guidance which amends the existing accounting standards for the recognition and measurement of financial assets and financial liabilities. The updated guidance primarily addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. HP is required to adopt the guidance in the first quarter of fiscal year 2019. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption, with other amendments related specifically to equity securities without readily determinable fair values applied prospectively. HP is currently evaluating the timing and the impact of this guidance on the Consolidated Condensed Financial Statements.

10

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 1: Basis of Presentation (Continued)

In May 2014, the FASB amended the existing accounting standards for revenue recognition. The amendments are based on the principle that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued an accounting standards update for a one-year deferral of the effective date, with an option of applying the standard on the original effective date, which for HP is the first quarter of fiscal year 2018. In accordance with this deferral, HP is required to adopt these amendments in the first quarter of fiscal year 2019. The amendments may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of initial application. HP is continuing to evaluate the impact of this guidance and the transition alternatives on the Consolidated Condensed Financial Statements.
Note 2: Segment Information
HP is a leading global provider of personal computing and other access devices, imaging and printing products, and related technologies, solutions and services. HP sells to individual consumers, small and medium-sized businesses (“SMBs”) and large enterprises, including customers in the government, health and education sectors.
HP’s operations are organized into three segments for financial reporting purposes: Personal Systems, Printing and Corporate Investments. HP’s organizational structure is based on a number of factors that the chief operating decision maker uses to evaluate, view and run its business operations, which include, but are not limited to, customer base and homogeneity of products and technology. The segments are based on this organizational structure and information reviewed by HP’s chief operating decision maker to evaluate segment results. The chief operating decision maker uses several metrics to evaluate the performance of the overall business, including earnings from operations, and uses these results to allocate resources to each of the segments.
A summary description of each segment is as follows:
Personal Systems provides Commercial personal computers (“PCs”), Consumer PCs, Workstations, thin clients, Commercial tablets and mobility devices, retail point-of-sale systems, displays and other related accessories, software, support and services for the commercial and consumer markets. HP groups Commercial notebooks, Commercial desktops, Commercial services, Commercial tablets and mobility devices, Commercial detachables, Workstations, retail point-of-sale systems and thin clients into commercial clients and Consumer notebooks, Consumer desktops, Consumer services and Consumer detachables into consumer clients when describing performance in these markets. Described below are HP’s global business capabilities within Personal Systems:
Commercial PCs are optimized for use by customers including enterprise and SMBs, with a focus on robust designs, security, serviceability, connectivity, reliability and manageability in networked environments. Additionally, HP offers a range of services and solutions to enterprise and SMBs to help them manage the lifecycle of their PC and mobility installed base.
Consumer PCs are Notebooks, Desktops and hybrids that are optimized for consumer usage, focusing on multi-media consumption, online browsing, gaming and light productivity.
Printing provides Consumer and Commercial printer hardware, supplies, media, solutions and services, as well as scanning devices. Printing is also focused on imaging solutions in the commercial markets. HP groups Office, Graphics and 3D printers into Commercial Hardware and Home printers into Consumer Hardware when describing performance in these markets. Described below are HP’s global business capabilities within Printing:
Office Printing Solutions delivers HP’s office printers, supplies, services, and solutions to SMBs and large enterprises. HP goes to market through its extensive channel network and directly with HP sales. Ongoing key initiatives include design and deployment of A3 products and solutions for the copier and multifunction printer market, printer security solutions, PageWide solutions and award-winning JetIntelligence LaserJet products.
Home Printing Solutions delivers a compelling set of innovative printing products and solutions for the home and home business or small office customers utilizing both HP’s Ink and Laser technologies. Initiatives such as Instant Ink and Continuous Ink Supply System provide business model innovation to benefit and expand HP’s existing customer base while new innovations like Sprocket drives print relevance for a mobile generation.
Graphics Solutions is reinventing the graphics industry by offering large-format, commercial and industrial solutions to print service providers and packaging converters through the largest portfolio of printers and presses (HP DesignJet, HP Latex Printers, HP Scitex, HP Indigo and HP PageWide Presses).
3D Printing delivers HP’s Multi-Jet Fusion 3D Printing Solution designed for prototyping and production of functional parts and functioning on an open platform facilitating the development of new 3D printing materials.

11

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 2: Segment Information (continued)

Corporate Investments include HP Labs and certain business incubation projects.
The accounting policies HP uses to derive segment results are substantially the same as those used by the Company in preparing these financial statements. HP derives the results of the business segments directly from its internal management reporting system. Segment net revenue includes revenues from sales to external customers and intersegment revenues that reflect transactions between the segments on an arm’s-length basis. HP’s consolidated net revenue is derived and reported after the elimination of intersegment revenues from such arrangements.
HP does not allocate certain operating expenses (credits), which it manages at the corporate level, to its segments. These unallocated amounts include certain corporate governance costs and market-related retirement credits, stock-based compensation expense, amortization of intangible assets, restructuring and other charges, acquisition-related charges, defined benefit plan settlement charges (credits) and intersegment eliminations.
Business Unit Realignment
Effective at the beginning of its first quarter of fiscal year 2017, HP implemented an organizational change to align its business unit financial reporting more closely with its current business structure. The organizational change resulted in the transfer of a portion of LaserJet printers from Commercial to Consumer within the Printing segment. HP reflected this change to its business unit information in prior reporting periods on an as-if basis which resulted in the reclassification of revenues between the Commercial and Consumer business units of Printing. The reporting change had no impact to previously reported segment net revenue, consolidated net revenue, earnings from continuing operations, net earnings or net earnings per share.
Segment Operating Results from Continuing Operations
 
Personal
Systems
 
Printing
 
Corporate
Investments
 
Total
Segments
 
Intersegment
Eliminations
and
Other
(1)
 
Total
 
In millions
Three months ended January 31, 2017
 

 
 

 
 

 
 

 
 

 
 

Net revenue
$
8,224

 
$
4,483

 
$
2

 
$
12,709

 
$
(25
)
 
$
12,684

Earnings (loss) from operations
$
313

 
$
716

 
$
(23
)
 
$
1,006

 
 

 
 

Three months ended January 31, 2016
 

 
 

 
 

 
 

 
 

 
 

Net revenue
$
7,467

 
$
4,642

 
$
3

 
$
12,112

 
$
134

 
$
12,246

Earnings (loss) from operations
$
229

 
$
787

 
$
(23
)
 
$
993

 
 

 
 

_______________________________________________________________________________
(1) 
For the three months ended January 31, 2016, the amount includes the recognition of revenue previously deferred in relation to sales to the pre-Separation finance entity.

12

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 2: Segment Information (continued)

The reconciliation of segment operating results to HP consolidated results was as follows:
 
Three months ended January 31
 
2017
 
2016
 
In millions
Net Revenue:
Total segments
$
12,709

 
$
12,112

Intersegment net revenue eliminations and other
(25
)
 
134

Total net revenue
$
12,684

 
$
12,246

Earnings from continuing operations before taxes:
 

 
 

Total segment earnings from operations
$
1,006

 
$
993

Corporate and unallocated costs and eliminations
4

 
24

Acquisition-related charges
(16
)
 

Stock-based compensation expense
(75
)
 
(61
)
Restructuring and other charges
(63
)
 
(20
)
Amortization of intangible assets

 
(8
)
Interest and other, net
(81
)
 
(94
)
Total earnings from continuing operations before taxes          
$
775

 
$
834

Net revenue by segment and business unit was as follows:
 
Three months ended January 31
 
2017
 
2016
 
In millions
Notebooks
$
4,890

 
$
4,205

Desktops
2,534

 
2,527

Workstations
491

 
444

Other
309

 
291

Personal Systems
8,224

 
7,467

Supplies
3,007

 
3,101

Commercial Hardware
886

 
964

Consumer Hardware
590

 
577

Printing
4,483

 
4,642

Corporate Investments
2

 
3

Total segment net revenue
12,709

 
12,112

Intersegment net revenue eliminations and other
(25
)
 
134

Total net revenue
$
12,684

 
$
12,246


Note 3: Restructuring and Other Charges
Summary of Restructuring Plans
HP’s restructuring activities for the three months ended January 31, 2017 and January 31, 2016 summarized by plan were as follows:

13

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 3. Restructuring and Other Charges (Continued)

 
Fiscal 2017 Plan
 
Fiscal 2015 Plan
 
Fiscal 2012 Plan
 

 
Severance
 
Infrastructure and other
 
Severance and PRP(1)
 
Infrastructure and other
 
Severance and EER(2)
 
Infrastructure and other
 
Total
 
In millions
 

Accrued balance as of October 31, 2016
$
24

 
$

 
$
21

 
$
4

 
$
7

 
$
2

 
$
58

Charges
24

 
1

 
6

 

 
1

 

 
32

Cash payments
(8
)
 
(1
)
 
(24
)
 
(2
)
 
(2
)
 

 
(37
)
Non-cash and other adjustments

 

 
1

 

 

 

 
1

Accrued balance as of January 31, 2017
$
40

 
$

 
$
4

 
$
2

 
$
6

 
$
2

 
$
54

Total costs incurred to date as of January 31, 2017
$
48

 
$
1

 
$
162

 
$
27

 
$
1,075

 
$
44

 
$
1,357

Reflected in Consolidated Balance Sheets

 

 

 

 

 

 

Other accrued liabilities
$
40

 
$

 
$
4

 
$
2

 
$
6

 
$

 
$
52

Other non-current liabilities

 

 

 

 

 
2

 
2



 

 

 

 

 

 

Accrued balance as of October 31, 2015

 

 
39

 

 
21

 
3

 
63

Charges

 

 
15

 
5

 

 

 
20

Cash payments

 

 
(12
)
 

 
(19
)
 

 
(31
)
Non-cash and other adjustments

 

 

 
(4
)
 

 
(1
)
 
(5
)
Accrued balance as of January 31, 2016
$

 
$

 
$
42

 
$
1

 
$
2

 
$
2

 
$
47

_______________________________________________________________________________
(1) 
PRP represents Phased Retirement Program.
(2) 
EER represents Enhanced Early Retirement.
Fiscal 2017 Plan
On October 10, 2016, HP’s Board of Directors approved a restructuring plan (the “Fiscal 2017 Plan”) which it expects will be implemented through fiscal year 2019. HP estimates that it will incur aggregate pre-tax charges between $350 million and $500 million relating to labor and non-labor actions. HP estimates that approximately half of the expected cumulative pre-tax costs will relate to severance and the remaining will relate to infrastructure, non-labor actions and other charges, as described below. HP expects between 3,000 and 4,000 employees to exit by the end of fiscal year 2019.
Fiscal 2015 Plan
In connection with the Separation, on September 14, 2015, HP’s Board of Directors approved a cost savings plan (the “Fiscal 2015 Plan”) which includes labor and non-labor actions. The Fiscal 2015 Plan was considered substantially complete as of October 31, 2016. Approximately 3,000 employees exited by the end of fiscal year 2016.
Fiscal 2012 Plan 
The severance and infrastructure cash payments associated with the restructuring plan initiated by HP in fiscal year 2012 (the “Fiscal 2012 Plan”) are expected to be paid through fiscal year 2021. The Fiscal 2012 Plan is considered substantially complete as of October 31, 2016 and we do not expect any further activity associated with this plan.
Other Charges
Other charges include non-recurring costs, including those as a result of Separation, and are distinct from ongoing operational costs. These costs primarily relate to information technology costs such as advisory, consulting and non-recurring labor costs. HP incurred $31 million of other charges for the three months ended January 31, 2017. There were no other charges incurred for the three months ended January 31, 2016.


14

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 4. Retirement and Post-Retirement Benefit Plans
The components of HP’s pension and post-retirement benefit (credit) cost recognized in the Consolidated Condensed Statements of Earnings were as follows:
 
Three months ended January 31
 
U.S.
Defined
Benefit Plans
 
Non-U.S.
Defined
Benefit Plans
 
Post-
Retirement
Benefit Plans
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
In millions
Service cost
$

 
$

 
$
12

 
$
12

 
$

 
$

Interest cost
117

 
136

 
4

 
6

 
4

 
5

Expected return on plan assets
(169
)
 
(183
)
 
(8
)
 
(12
)
 
(6
)
 
(8
)
Amortization and deferrals:
 

 
 

 
 

 
 

 
 

 
 

Actuarial loss (gain)
18

 
14

 
10

 
6

 
(2
)
 
(3
)
Prior service benefit

 

 
(1
)
 
(1
)
 
(5
)
 
(4
)
Net periodic benefit (credit) cost
(34
)
 
(33
)
 
17

 
11

 
(9
)
 
(10
)
Settlement loss

 
1

 

 

 

 

Total periodic benefit (credit) cost
$
(34
)
 
$
(32
)
 
$
17

 
11

 
$
(9
)
 
$
(10
)
Employer Contributions and Funding Policy
HP’s policy is to fund its pension plans so that it makes at least the minimum contribution required by local government, funding and taxing authorities.
During fiscal year 2017, HP anticipates making contributions of approximately $26 million to its non-U.S. pension plans, approximately $33 million to its U.S. non-qualified plan participants and approximately $9 million to cover benefit claims under HP’s post-retirement benefit plans. During the three months ended January 31, 2017, HP contributed $11 million to its non-U.S. pension plans, paid $6 million to cover benefit payments to U.S. non-qualified plan participants, and paid $1 million to cover benefit claims under HP’s post-retirement benefit plans.
HP’s pension and other post-retirement benefit costs and obligations depend on various assumptions. Differences between expected and actual returns on investments and changes in discount rates and other actuarial assumptions are reflected as unrecognized gains or losses, and such gains or losses are amortized to earnings in future periods. A deterioration in the funded status of a plan could result in a need for additional company contributions or an increase in net pension and post-retirement benefit costs in future periods. Actuarial gains or losses are determined at the measurement date and amortized over the remaining service life for active plans or the life expectancy of plan participants for frozen plans.

Note 5: Stock-Based Compensation
HP’s stock-based compensation plans permit the issuance of restricted stock awards, stock options and performance-based awards.
Stock-based compensation expense and the resulting tax benefits were as follows:
 
Three months ended January 31
 
2017
 
2016
 
In millions
Stock-based compensation expense
$
75

 
$
61

Income tax benefit
(24
)
 
(22
)
Stock-based compensation expense, net of tax
$
51

 
$
39

Restricted Stock Awards
Restricted stock awards are non-vested stock awards that may include grants of restricted stock or restricted stock units. For the three months ended January 31, 2017 and January 31, 2016, HP granted only restricted stock units. HP uses the closing stock price on the grant date to estimate the fair value of service-based restricted stock units. HP estimates the fair value of restricted stock units subject to performance-adjusted vesting conditions using a combination of the closing stock price on the grant date and the Monte Carlo simulation model. The weighted-average fair value and the assumptions used to measure the fair

15

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 5: Stock-Based Compensation (Continued)

value of restricted stock units subject to performance-adjusted vesting conditions in the Monte Carlo simulation model were as follows:
 
Three months ended January 31
 
2017
 
2016
Weighted-average fair value(1)
$
20

 
$
13

Expected volatility(2)
30.5
%
 
32.5
%
Risk-free interest rate(3)
1.4
%
 
1.2
%
Expected performance period in years(4)
2.9

 
2.9

_______________________________________________________________________________
(1) 
The weighted-average fair value was based on performance-adjusted restricted stock units granted during the period.
(2) 
The expected volatility was estimated using the historical volatility derived from HP’s common stock.
(3) 
The risk-free interest rate was estimated based on the yield on U.S. Treasury zero-coupon issues.
(4) 
The expected performance period was estimated based on the length of the remaining performance period from the grant date.
A summary of restricted stock award activity was as follows:
 
Three months ended January 31, 2017
 
Shares
 
Weighted-Average
Grant Date Fair Value
Per Share
 
In thousands
 
 
Outstanding at beginning of period
28,710

 
$
13

Granted
13,476

 
$
16

Vested
(10,044
)
 
$
13

Forfeited
(224
)
 
$
14

Outstanding at end of period
31,918

 
$
14

At January 31, 2017, there was $298 million of unrecognized pre-tax stock-based compensation expense related to non-vested restricted stock awards, which HP expects to recognize over the remaining weighted-average vesting period of 1.6 years.
Stock Options
HP utilizes the Black-Scholes-Merton option pricing formula to estimate the fair value of stock options subject to service-based vesting conditions. HP estimates the fair value of stock options subject to performance-contingent vesting conditions using a combination of a Monte Carlo simulation model and a lattice model, as these awards contain market conditions. HP did not grant any stock options for the three months ended January 31, 2017. The weighted-average fair value and the assumptions used to measure fair value for the three months ended January 31, 2016 were as follows:
 
Three months ended January 31, 2016
Weighted-average fair value(1)
$
4

Expected volatility(2)
36.4
%
Risk-free interest rate(3)
1.9
%
Expected dividend yield(4)
3.4
%
Expected term in years(5)
6.0

_______________________________________________________________________________
(1) 
The weighted-average fair value was based on stock options granted during the period.
(2) 
The expected volatility was estimated using the leverage-adjusted average of the term-matching volatilities of peer companies due to the lack of volume of forward traded options, which precluded the use of implied volatility.
(3) 
The risk-free interest rate was estimated based on the yield on U.S. Treasury zero-coupon issues.

16

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 5: Stock-Based Compensation (Continued)

(4) 
The expected dividend yield represents a constant dividend yield applied for the duration of the expected term of the award.
(5) 
Due to the lack of historical exercise and post-vesting termination patterns of the post-Separation employee base, the expected term was estimated using the simplified method; and for performance-contingent awards, the expected term represents an output from the lattice model.
A summary of stock option activity was as follows:
 
Three months ended January 31, 2017
 
Shares
 
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic Value
 
In thousands
 
 
 
In years
 
In millions
Outstanding at beginning of period
28,218

 
$
12

 
 
 
 

Granted

 
$

 
 
 
 

Exercised
(630
)
 
$
11

 
 
 
 

Forfeited and expired
(226
)
 
$
16

 
 
 
 

Outstanding at end of period
27,362

 
$
12

 
4.8
 
$
83

Vested and expected to vest at end of period
26,376

 
$
12

 
4.8
 
$
82

Exercisable at end of period
17,370

 
$
11

 
3.8
 
$
71

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that option holders would have realized had all option holders exercised their options on the last trading day of the first quarter of fiscal year 2017. The aggregate intrinsic value is the difference between HP’s closing stock price on the last trading day of the first quarter of fiscal year 2017 and the exercise price, multiplied by the number of in-the-money options. The total intrinsic value of options exercised for the three months ended January 31, 2017 was $3 million.
At January 31, 2017, there was $14 million of unrecognized pre-tax, stock-based compensation expense related to unvested stock options, which HP expects to recognize over the remaining weighted-average vesting period of 1.5 years.
Note 6: Taxes on Earnings
Tax Matters Agreement and Other Income Tax Matters
In connection with the Separation, HP entered into the tax matters agreement (“TMA”) with Hewlett Packard Enterprise, effective on November 1, 2015, that governs the rights and obligations of HP and Hewlett Packard Enterprise for certain pre-Separation tax liabilities. The TMA provides that HP and Hewlett Packard Enterprise will share certain pre-Separation income tax liabilities. In certain jurisdictions, HP and Hewlett Packard Enterprise have joint and several liability for past income tax liabilities and accordingly, HP could be legally liable under applicable tax law for such liabilities and required to make additional tax payments.
In addition, if the distribution of Hewlett Packard Enterprise’s common shares to the HP stockholders is determined to be taxable, Hewlett Packard Enterprise and HP would share the tax liability equally, unless the taxability of the distribution is the direct result of action taken by either Hewlett Packard Enterprise or HP subsequent to the distribution, in which case the party causing the distribution to be taxable would be responsible for any taxes imposed on the distribution.
Upon completion of the Separation on November 1, 2015, HP recorded income tax indemnification receivables from Hewlett Packard Enterprise for certain income tax liabilities that HP is jointly and severally liable for, but for which it is indemnified by Hewlett Packard Enterprise under the TMA. The actual amount that Hewlett Packard Enterprise may be obligated to pay HP could vary depending on the outcome of certain unresolved tax matters, which may not be resolved for several years. The net receivable as of January 31, 2017 was $1.6 billion. In connection with the TMA, Interest and other, net for the three months ended January 31, 2017 includes income of $9 million for changes in the tax indemnifications amounts.
Provision for Taxes
HP’s effective tax rate for continuing operations was 21.2% and 22.0% for the three months ended January 31, 2017 and January 31, 2016, respectively. HP’s effective tax rate generally differs from the U.S. federal statutory rate of 35% due to favorable tax rates associated with certain earnings from HP’s operations in lower-tax jurisdictions throughout the world. HP has not provided U.S. taxes for all foreign earnings because HP plans to reinvest some of those earnings indefinitely outside the United States.

17

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 6: Taxes on Earnings (Continued)

During the three months ended January 31, 2017, HP recorded $1 million of net tax benefit related to discrete items to the year in the provision for taxes for continuing operations. This amount included a tax benefit of $17 million related to uncertain tax positions and a tax benefit of $19 million related to restructuring and other charges. These tax benefits were offset by $26 million related to the state tax provision to return adjustments and $9 million related to various other items.
During the three months ended January 31, 2016, HP recorded $54 million of net tax benefits related to discrete items in the provision for taxes for continuing operations. This amount included a tax benefit of $41 million arising from the retroactive research and development credit provided by the Consolidated Appropriations Act of 2016 signed into law in December 2015, a tax benefit of $6 million on restructuring and other charges, and a tax benefit of $39 million related to the provision to return adjustments. These tax benefits were offset by tax charges of $27 million related to uncertain tax positions and $5 million related to various other items.
During the three months ended January 31, 2017, in addition to the discrete items mentioned above, HP recorded excess tax benefits of $6.8 million on stock options, restricted stock and performance share units, which are reflected in the Consolidated Condensed Statements of Earnings as a component of the provision for income taxes as a result of the early adoption of ASU 2016-09 -“Improvements to Employee Share- Based Payment Accounting”. See Note 1, “Basis of Presentation”, for more details regarding the guidance.
Uncertain Tax Positions
As of January 31, 2017, the amount of unrecognized tax benefits was $10.8 billion, of which up to $3.8 billion would affect HP’s effective tax rate if realized. The amount of unrecognized tax benefits increased by $10 million for the three months ended January 31, 2017. HP continues to record its tax liabilities related to uncertain tax positions and certain liabilities for which it has joint and several liability with Hewlett Packard Enterprise. HP recognizes interest income from favorable settlements and interest expense and penalties accrued on unrecognized tax benefits in the provision for taxes in the Consolidated Condensed Statements of Earnings. As of January 31, 2017, HP had accrued $203 million for interest and penalties.
HP engages in continuous discussions and negotiations with taxing authorities regarding tax matters in various jurisdictions. HP expects to complete resolution of certain tax years with various tax authorities within the next 12 months. It is also possible that other federal, foreign and state tax issues may be concluded within the next 12 months.

18

HP INC. AND SUBSIDIARIES
Consolidated Condensed Statements of Earnings (Continued)
(Unaudited)

Note 7: Supplementary Financial Information
Accounts Receivable
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions
Accounts receivable
$
3,578

 
$
4,221

Allowance for doubtful accounts
(100
)
 
(107
)
 
$
3,478

 
$
4,114

The allowance for doubtful accounts related to accounts receivable and changes were as follows:
 
Three months ended January 31, 2017
 
In millions
Balance at beginning of period
$
107

Provision for doubtful accounts
(2
)
Deductions, net of recoveries
(5
)
Balance at end of period
$
100

HP has third-party arrangements, consisting of revolving short-term financing, which provide liquidity to certain partners in order to facilitate their working capital requirements. These financing arrangements, which in certain circumstances may contain partial recourse, result in a transfer of HP’s receivables and risk to the third party. As these transfers qualify as true sales under the applicable accounting guidance, the receivables are derecognized from the Consolidated Condensed Balance Sheets upon transfer, and HP receives a payment for the receivables from the third party within a mutually agreed upon time period. For arrangements involving an element of recourse, the recourse obligation is measured using market data from the similar transactions and reported as a current liability in the Consolidated Condensed Balance Sheets. The recourse obligations as of January 31, 2017 and October 31, 2016 were not material. As of January 31, 2017 and October 31, 2016, HP had $104 million and $149 million, respectively, outstanding from the third parties, which is reported in Accounts receivable in the Consolidated Condensed Balance Sheets. The costs associated with the sales of trade receivables for the three months ended January 31, 2017 and January 31, 2016 were not material.
The following is a summary of the activity under these arrangements:
 
Three months ended January 31
 
2017
 
2016
 
In millions
Balance at beginning of period
$
149

 
$
93

Trade receivables sold
2,449

 
1,876

Cash receipts
(2,493
)
 
(1,877
)
Foreign currency and other
(1
)
 
(3
)
Balance at end of period
$
104

 
$
89


19

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 7: Supplementary Financial Information (Continued)

Inventory
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions
Finished goods
$
2,977

 
$
3,103

Purchased parts and fabricated assemblies
1,578

 
1,381

 
$
4,555

 
$
4,484

Other Current Assets
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions
Value-added taxes receivable
$
761

 
$
795

Supplier and other receivables
1,742

 
1,700

Prepaid and other current assets
908

 
1,087

 
$
3,411

 
$
3,582

Property, Plant and Equipment
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions
Land, buildings and leasehold improvements
$
2,338

 
$
2,421

Machinery and equipment, including equipment held for lease
3,729

 
3,663

 
6,067

 
6,084

Accumulated depreciation
(4,337
)
 
(4,348
)
 
$
1,730

 
$
1,736


20

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 7: Supplementary Financial Information (Continued)

Other Non-Current Assets
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions
Tax indemnifications receivable(1)
$
1,628

 
$
1,591

Deferred tax assets
249

 
254

Other
1,188

 
1,316

 
$
3,065

 
$
3,161

_______________________________________________________________________________
(1) 
In connection with the TMA discussed under Note 6, “Taxes on Earnings”.
Other Accrued Liabilities
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions
Other accrued taxes
$
688

 
$
755

Warranty
706

 
729

Sales and marketing programs
2,213

 
2,312

Other
2,184

 
1,922

 
$
5,791

 
$
5,718

Other Non-Current Liabilities
 
As of
 
January 31, 2017
 
October 31, 2016
 
In millions
Pension, post-retirement, and post-employment liabilities
$
2,627

 
$
2,705

Deferred tax liability
1,198

 
1,116

Tax liability
1,794

 
1,910

Deferred revenue
866

 
865

Other
759

 
737

 
$
7,244

 
$
7,333

Note 8: Fair Value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date.
Fair Value Hierarchy
HP uses valuation techniques that are based upon observable and unobservable inputs. Observable inputs are developed using market data such as publicly available information and reflect the assumptions market participants would use, while unobservable inputs are developed using the best information available about the assumptions market participants would use. Assets and liabilities are classified in the fair value hierarchy based on the lowest level input that is significant to the fair value measurement:
Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2—Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs.
Level 3—Unobservable inputs for the asset or liability.
The fair value hierarchy gives the highest priority to observable inputs and lowest priority to unobservable inputs.

The following table presents HP’s assets and liabilities that are measured at fair value on a recurring basis:

21

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Fair Value (Continued)

 
As of January 31, 2017
 
As of October 31, 2016
 
Fair Value Measured Using
 
 
 
Fair Value Measured Using
 
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
 
In millions
Assets:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Cash Equivalents and Investments:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Time deposits
$

 
$
2,280

 
$

 
$
2,280

 
$

 
$
2,092

 
$

 
$
2,092

Money market funds
2,541

 

 

 
2,541

 
2,568

 

 

 
2,568

Marketable equity securities
5

 
6

 

 
11

 
5

 
4

 

 
9

Mutual funds
44

 

 

 
44

 
44

 

 

 
44

Other debt securities

 

 

 

 

 
2

 

 
2

Derivative Instruments:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate contracts

 
4

 

 
4

 

 
48

 

 
48

Foreign currency contracts

 
166

 

 
166

 

 
266

 
11

 
277

Other derivatives

 
1

 

 
1

 

 

 

 

Total Assets
$
2,590

 
$
2,457

 
$

 
$
5,047

 
$
2,617

 
$
2,412

 
$
11

 
$
5,040

Liabilities:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Derivative Instruments:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate contracts
$

 
$
8

 
$

 
$
8

 
$

 
$

 
$

 
$

Foreign currency contracts

 
230

 
9

 
239

 

 
94

 
1

 
95

Other derivatives

 

 

 

 

 
2

 

 
2

Total Liabilities
$

 
$
238

 
$
9

 
$
247

 
$

 
$
96

 
$
1

 
$
97

There were no transfers between levels within the fair value hierarchy during the three months ended January 31, 2017.
Valuation Techniques
Cash Equivalents and Investments: HP holds 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. HP values cash equivalents and equity investments using quoted market prices, alternative pricing sources, including net asset value, or models utilizing market observable inputs. The fair value of debt investments was based on quoted market prices or model-driven valuations using inputs primarily derived from or corroborated by observable market data, and, in certain instances, valuation models that utilize assumptions which cannot be corroborated with observable market data.
Derivative Instruments: From time to time HP uses forward contracts, interest rate and total return swaps and option contracts to hedge certain foreign currency and interest rate exposures. HP uses industry standard valuation models to measure fair value. Where applicable, these models project future cash flows and discount the future amounts to present value using market-based observable inputs, including interest rate curves, HP and counterparty credit risk, foreign currency rates, and forward and spot prices for currencies and interest rates. See Note 9, “Financial Instruments” for a further discussion of HP’s use of derivative instruments.
Other Fair Value Disclosures
Short- and Long-Term Debt: HP estimates the fair value of its debt primarily using an expected present value technique, which is based on observable market inputs using interest rates currently available to companies of similar credit standing for similar terms and remaining maturities, and considering its own credit risk. The portion of HP’s debt that is hedged is reflected in the Consolidated Condensed Balance Sheets as an amount equal to the debt’s carrying amount and a fair value adjustment representing changes in the fair value of the hedged debt obligations arising from movements in benchmark interest rates. The estimated fair value of HP’s short- and long-term debt was $6.9 billion as of January 31, 2017, compared to its carrying amount of $6.8 billion at that date. The estimated fair value of HP’s short- and long-term debt was $7.1 billion as of October 31, 2016 compared to its carrying value of $6.8 billion at that date. If measured at fair value in the Consolidated Condensed Balance Sheets, short- and long-term debt would be classified in Level 2 of the fair value hierarchy.

22

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Fair Value (Continued)

Other Financial Instruments: For the balance of HP’s financial instruments, primarily accounts receivable, accounts payable and financial liabilities included in Other accrued liabilities on the Consolidated Condensed Balance Sheets, the carrying amounts approximate fair value due to their short maturities. If measured at fair value in the Consolidated Condensed Balance Sheets, other financial instruments would be classified in Level 2 or Level 3 of the fair value hierarchy.
Non-Marketable Equity Investments and Non-Financial Assets: HP’s non-marketable equity investments and non-financial assets, such as goodwill, intangible assets and property, plant and equipment, are recorded at fair value in the period of acquisition and a subsequent impairment charge is recognized. If measured at fair value in the Consolidated Condensed Balance Sheets, non-marketable equity investments and non-financial assets would generally be classified within Level 3 of the fair value hierarchy.

Note 9: Financial Instruments
Cash Equivalents and Available-for-Sale Investments
 
As of January 31, 2017
 
As of October 31, 2016
 
Cost
 
Gross
Unrealized
Gain
 
Gross
Unrealized
Loss
 
Fair
Value
 
Cost
 
Gross
Unrealized
Gain
 
Gross
Unrealized
Loss
 
Fair
Value
 
In millions
Cash Equivalents:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Time deposits
$
2,280

 
$

 
$

 
$
2,280

 
$
2,092

 
$

 
$

 
$
2,092

Money market funds
2,541

 

 

 
2,541

 
2,568

 

 

 
2,568

Total cash equivalents
4,821

 

 

 
4,821

 
4,660

 

 

 
4,660

Available-for-Sale Investments:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Marketable equity securities
1

 
6

 

 
7

 
1

 
3

 

 
4

Mutual funds
35

 
9

 

 
44

 
35

 
9

 

 
44

Other debt securities

 

 

 

 
2

 

 

 
2

Total available-for-sale investments
36

 
15

 

 
51

 
38

 
12

 

 
50

Total cash equivalents and available-for-sale investments
$
4,857

 
$
15

 
$

 
$
4,872

 
$
4,698

 
$
12

 
$

 
$
4,710

All highly liquid investments with original maturities of three months or less at the date of acquisition are considered cash equivalents. As of January 31, 2017 and October 31, 2016, the carrying amount of cash equivalents approximated fair value due to the short period of time to maturity. Time deposits were primarily issued by institutions outside the United States as of January 31, 2017 and October 31, 2016. The estimated fair value of the available-for-sale investments may not be representative of values that will be realized in the future.

23

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 9: Financial Instruments (Continued)

Contractual maturities of investments in available-for-sale debt securities were as follows:
 
As of January 31, 2017
 
Amortized
Cost
 
Fair Value
 
In millions
Due in one year
$

 
$

Due in one to five years
$

 
$

Due in more than five years
$
35

 
$
44

Equity securities in privately held companies include cost basis and equity method investments and are included in Other non-current assets on the Consolidated Condensed Balance Sheets. These amounted to $17 million and $16 million as of January 31, 2017 and October 31, 2016, respectively.
Derivative Instruments
HP uses derivatives to offset business exposure to foreign currency and interest rate risk on expected future cash flows and on certain existing assets and liabilities. As part of its risk management strategy, HP uses derivative instruments, primarily forward contracts, interest rate swaps, total return swaps and, at times, option contracts to hedge certain foreign currency, interest rate and, to a lesser extent, equity exposures. HP may designate its derivative contracts as fair value hedges or cash flow hedges. HP classifies cash flows from its designated derivative contracts with the activities that correspond to the underlying hedged items on the Consolidated Condensed Statements of Cash Flows. For derivatives not designated as hedging instruments, HP categorizes those economic hedges as other derivatives. HP recognizes all derivative instruments at fair value in the Consolidated Condensed Balance Sheets.
As a result of its use of derivative instruments, HP is exposed to the risk that its counterparties will fail to meet their contractual obligations. Master netting agreements mitigate credit exposure to counterparties by permitting HP to net amounts due from HP to counterparty against amounts due to HP from the same counterparty under certain conditions. To further limit credit risk, HP has collateral security agreements that allow HP to hold collateral from, or require HP to post collateral to, counterparties when aggregate derivative fair values exceed contractually established thresholds which are generally based on the credit ratings of HP and its counterparties. If HP’s or the counterparty’s credit rating falls below a specified credit rating, either party has the right to request full collateralization of the derivatives’ net liability position. The fair value of derivatives with credit contingent features in a net liability position was $90 million and $2 million as of January 31, 2017 and October 31, 2016, respectively, all of which were fully collateralized within two business days of the related request.
Under HP’s derivative contracts, the counterparty can terminate all outstanding trades following a covered change of control event affecting HP that results in the surviving entity being rated below a specified credit rating. This credit contingent provision did not affect HP’s financial position or cash flows as of January 31, 2017 and October 31, 2016.
Fair Value Hedges
HP enters into fair value hedges, such as interest rate swaps, to reduce the exposure of its debt portfolio to changes in fair value resulting from changes in interest rates by achieving a primarily U.S. dollar London Interbank Offered Rate (“LIBOR”)-based floating interest expense.
For derivative instruments that are designated and qualify as fair value hedges, HP recognizes the change in fair value of the derivative instrument, as well as the offsetting change in the fair value of the hedged item, in Interest and other, net on the Consolidated Condensed Statements of Earnings in the period of change.
Cash Flow Hedges
HP uses forward contracts and at times, option contracts designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in its forecasted net revenue and, to a lesser extent, cost of revenue, operating expenses, and intercompany loans denominated in currencies other than the U.S. Dollar. HP’s foreign currency cash flow hedges mature generally within twelve months; however, hedges related to longer term procurement arrangements extend several years and forward contracts associated with intercompany loans extend for the duration of the loan term, which typically range from two to five years.
For derivative instruments that are designated and qualify as cash flow hedges, HP initially records changes in fair value for the effective portion of the derivative instrument in accumulated other comprehensive loss as a separate component of stockholders’ deficit on the Consolidated Condensed Balance Sheets and subsequently reclassifies these amounts into earnings

24

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 9: Financial Instruments (Continued)

in the period during which the hedged transaction is recognized in earnings. HP reports the effective portion of its cash flow hedges in the same financial statement line item as changes in the fair value of the hedged item.
Other Derivatives
Other derivatives not designated as hedging instruments consist primarily of forward contracts used to hedge foreign currency-denominated balance sheet exposures. HP uses total return swaps to hedge its executive deferred compensation plan liability. For derivative instruments not designated as hedging instruments, HP recognizes changes in fair value of the derivative instrument, as well as the offsetting change in the fair value of the hedged item, in Interest and other, net in the Consolidated Condensed Statements of Earnings in the period of change.
Hedge Effectiveness
For interest rate swaps designated as fair value hedges, HP measures hedge effectiveness by offsetting the change in fair value of the hedged item with the change in fair value of the derivative. For foreign currency options and forward contracts designated as cash flow hedges, HP measures hedge effectiveness by comparing the cumulative change in fair value of the hedge contract with the cumulative change in fair value of the hedged item, both of which are based on forward rates. HP recognizes any ineffective portion of the hedge in the Consolidated Condensed Statements of Earnings in the same period in which ineffectiveness occurs. Amounts excluded from the assessment of effectiveness are recognized in the Consolidated Condensed Statements of Earnings in the period they arise.
The hedge ineffectiveness fair value and cash flow hedges recognized in earnings were not material for the three months ended January 31, 2017 and January 31, 2016.
Fair Value of Derivative Instruments in the Consolidated Condensed Balance Sheets
The gross notional and fair value of derivative instruments in the Consolidated Condensed Balance Sheets were as follows:
 
As of January 31, 2017
 
As of October 31, 2016
 
Outstanding
Gross
Notional
 
Other Current Assets
 
Other
Non-Current
Assets
 
Other
Accrued
Liabilities
 
Other
Non-Current
Liabilities
 
Outstanding
Gross
Notional
 
Other
Current
Assets
 
Other
Non-Current
Assets
 
Other
Accrued
Liabilities
 
Other
Non-Current
Liabilities
 
In millions
Derivatives designated as hedging instruments
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fair value hedges:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest rate contracts
$
2,500

 
$

 
$
4

 
$

 
$
8

 
$
2,000

 
$

 
$
48

 
$

 
$

Cash flow hedges:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Foreign currency contracts
12,174

 
131

 
20

 
156

 
40

 
11,852

 
203

 
63

 
52

 
12

Total derivatives designated as hedging instruments
14,674

 
131

 
24

 
156

 
48

 
13,852

 
203

 
111

 
52

 
12

Derivatives not designated as hedging instruments
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Foreign currency contracts
3,808

 
12

 
3

 
40

 
3

 
3,934

 
11

 

 
31

 

Other derivatives
152

 
1

 

 

 

 
150

 

 

 
2

 

Total derivatives not designated as hedging instruments
3,960

 
13

 
3

 
40

 
3

 
4,084

 
11

 

 
33

 

Total derivatives
$
18,634

 
$
144

 
$
27

 
$
196

 
$
51

 
$
17,936

 
$
214

 
$
111

 
$
85

 
$
12

Offsetting of Derivative Instruments
HP recognizes all derivative instruments on a gross basis in the Consolidated Condensed Balance Sheets. HP does not offset the fair value of its derivative instruments against the fair value of cash collateral posted under its collateral security agreements. As of January 31, 2017 and October 31, 2016, information related to the potential effect of HP’s master netting agreements and collateral security agreements was as follows:

25

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 9: Financial Instruments (Continued)

 
In the Consolidated Condensed Balance Sheets
 
 
 
 
 
 
 
 
 
 
 
Gross Amounts Not Offset
 
 
 
 
 
Gross Amount
Recognized
(i)
Gross Amount
Offset
(ii)
Net Amount
Presented
(iii) = (i)–(ii)
 
Derivatives
(iv)
 
Financial
Collateral
(v)
 
 
 
Net Amount
(vi) = (iii)–(iv)–(v)
 
In millions
As of January 31, 2017
 

 
 

 
 

 
 

 
 

 
 
 
 

Derivative assets
$
171

 
$

 
$
171

 
$
148

 
$
16

 
(1) 
 
$
7

Derivative liabilities
$
247

 
$

 
$
247

 
$
148

 
$
70

 
(2) 
 
$
29

As of October 31, 2016
 

 
 

 
 

 
 

 
 

 
 
 
 

Derivative assets
$
325

 
$

 
$
325

 
$
88

 
$
189

 
(1) 
 
$
48

Derivative liabilities
$
97

 
$

 
$
97

 
$
88

 
$
2

 
(2) 
 
$
7

_______________________________________________________________________________
(1) 
Represents the cash collateral posted by counterparties as of the respective reporting date for HP’s asset position, net of derivative amounts that could be offset, as of, generally, two business days prior to the respective reporting date.
(2) 
Represents the collateral posted by HP through re-use of counterparty cash collateral as of the respective reporting date for HP’s liability position, net of derivative amounts that could be offset, as of, generally, two business days prior to the respective reporting date.

26

HP INC. AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 9: Financial Instruments (Continued)

Effect of Derivative Instruments in the Consolidated Condensed Statements of Earnings
The pre-tax effect of derivative instruments and related hedged items in a fair value hedging relationship for the three months ended January 31, 2017 and January 31, 2016 were as follows:
 
 
(Loss) Gain Recognized in Earnings on Derivative and Related Hedged Item
Derivative Instrument
 
Location
 
Three months ended January 31, 2017
 
Three months ended January 31, 2016
 
Hedged Item
 
Location
 
Three months ended January 31, 2017
 
Three months ended January 31, 2016
 
 
 
 
In millions
 
 
 
 
 
In millions
Interest rate contracts
 
Interest and other, net
 
$
(52
)
 
$
14

 
Fixed-rate debt
 
Interest and other, net
 
$
52

 
$
(14
)
The pre-tax effect of derivative instruments in cash flow hedging relationships for the three months ended January 31, 2017 was as follows
 
(Loss) Gain Recognized in
Other Comprehensive
Income (“OCI”) on Derivatives (Effective Portion)
 
Gain (Loss) Reclassified from Accumulated OCI Into
Earnings (Effective Portion)
 
Three months ended January 31, 2017
 
Three months ended January 31, 2016
 
Location
 
Three months ended January 31, 2017
 
Three months ended January 31, 2016
 
In millions
 
 
 
In millions
Cash flow hedges:
 

 
 

 
 
 
 

 
 

Foreign currency contracts
$
(169
)
 
$
105

 
Net revenue
 
$
76

 
$
78

 
 

 
 

 
Cost of revenue
 

 
(40
)
 
 

 
 

 
Interest and other, net
 
(5
)
 
(4
)
Total
$
(169
)
 
$
105

 
 
 
$
71

 
$
34

As of January 31, 2017, HP expects to reclassify an estimated accumulated other comprehensive loss (“AOCI”) of $32 million, net of taxes, to earnings within the next twelve months associated with cash flow hedges along with the earnings effects of the related forecasted transactions. The amounts ultimately reclassified into earnings could be different from the amounts previously included in AOCI based on the change of market rate, and therefore could have a different impact on earnings.
The pre-tax effect of derivative instruments not designated as hedging instruments in the Consolidated Condensed Statements of Earnings for the three months ended January 31, 2017 and January 31, 2016 was as follows:
 
Gain Recognized in Earnings on Derivatives