10-Q 1 a2225780z10-q.htm 10-Q

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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: July 31, 2015

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



HEWLETT-PACKARD COMPANY
(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.)

3000 Hanover Street, 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 August 31, 2015 was 1,798,224,792 shares.


Table of Contents

HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Form 10-Q
For the Quarterly Period ended July 31, 2015
Table of Contents

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 Hewlett-Packard Company 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 revenue, margins, expenses, effective tax rates, net earnings, net earnings per share, cash flows, benefit plan funding, deferred tax assets, share repurchases, currency exchange rates or other financial items; any projections of the amount, timing or impact of cost savings or restructuring charges; any statements of the plans, strategies and objectives of management for future operations, including the previously announced separation transaction and the future performances of the post- separation companies if the separation is completed, as well as the execution of restructuring plans and any resulting cost savings, 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; 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, including the planned separation transaction; 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 execution, timing and results of the separation transaction or restructuring plans, including estimates and assumptions related to the cost (including any possible disruption of HP's business) and the anticipated benefits of

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implementing the separation transaction and restructuring plans; the resolution of pending investigations, claims and disputes; and other risks that are described herein, including but not limited to the items discussed in "Risk Factors" in Item 1A of Part II of this report and that are otherwise described or updated from time to time in HP's Securities and Exchange Commission reports. HP assumes no obligation and does not intend to update these forward-looking statements.

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Part I. Financial Information

ITEM 1.    Financial Statements and Supplementary Data.

Index

 
  Page

Consolidated Condensed Statements of Earnings for the three and nine months ended July 31, 2015 and 2014 (Unaudited)

  5

Consolidated Condensed Statements of Comprehensive Income for the three and nine months ended July 31, 2015 and 2014 (Unaudited)

 
6

Consolidated Condensed Balance Sheets as of July 31, 2015 (Unaudited) and as of October 31, 2014 (Audited)

 
7

Consolidated Condensed Statements of Cash Flows for the nine months ended July 31, 2015 and 2014 (Unaudited)

 
8

Notes to Consolidated Condensed Financial Statements (Unaudited)

 
9

Note 1: Basis of Presentation

 
9

Note 2: Segment Information

 
10

Note 3: Restructuring

 
18

Note 4: Retirement and Post-Retirement Benefit Plans

 
19

Note 5: Stock-Based Compensation

 
21

Note 6: Taxes on Earnings

 
23

Note 7: Balance Sheet Details

 
26

Note 8: Financing Receivables and Operating Leases

 
29

Note 9: Acquisitions and Divestitures

 
32

Note 10: Goodwill and Intangible Assets

 
34

Note 11: Fair Value

 
36

Note 12: Financial Instruments

 
39

Note 13: Borrowings

 
47

Note 14: Stockholders' Equity

 
50

Note 15: Net Earnings Per Share

 
53

Note 16: Litigation and Contingencies

 
54

Note 17: Guarantees

 
64

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Statements of Earnings

(Unaudited)

 
  Three months ended
July 31
  Nine months ended
July 31
 
 
  2015   2014   2015   2014  
 
  In millions, except per share amounts
 

Net revenue:

                         

Products

  $ 16,760   $ 18,190   $ 51,940   $ 54,712  

Services

    8,500     9,295     25,428     28,030  

Financing income

    89     100     273     306  

Total net revenue

    25,349     27,585     77,641     83,048  

Costs and expenses:

                         

Cost of products

    12,890     13,913     40,035     41,902  

Cost of services

    6,369     6,991     19,016     21,301  

Financing interest

    58     70     182     211  

Research and development

    893     887     2,568     2,571  

Selling, general and administrative

    2,962     3,388     9,096     9,989  

Amortization of intangible assets

    242     227     685     774  

Restructuring charges

    25     649     426     1,015  

Acquisition-related charges

    47     2     70     8  

Separation costs

    401         750      

Defined benefit plan settlement charges

    114         114      

Impairment of data center assets

    136         136      

Total operating expenses

    24,137     26,127     73,078     77,771  

Earnings from operations

    1,212     1,458     4,563     5,277  

Interest and other, net

    (108 )   (145 )   (421 )   (482 )

Earnings before taxes

    1,104     1,313     4,142     4,795  

Provision for taxes

    (250 )   (328 )   (911 )   (1,112 )

Net earnings

  $ 854   $ 985   $ 3,231   $ 3,683  

Net earnings per share:

                         

Basic

  $ 0.47   $ 0.53   $ 1.78   $ 1.95  

Diluted

  $ 0.47   $ 0.52   $ 1.75   $ 1.93  

Cash dividends declared per share

  $ 0.35   $ 0.32   $ 0.67   $ 0.61  

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

                         

Basic

    1,805     1,870     1,817     1,889  

Diluted

    1,828     1,899     1,842     1,913  

   

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

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Statements of Comprehensive Income

(Unaudited)

 
  Three months
ended July 31
  Nine months
ended July 31
 
 
  2015   2014   2015   2014  
 
  In millions
 

Net earnings

  $ 854   $ 985   $ 3,231   $ 3,683  

Other comprehensive income before taxes:

                         

Change in unrealized gains (losses) on available-for-sale securities:

                         

Unrealized gains (losses) arising during the period

    4     7     (9 )   6  

Gains reclassified into earnings

                (1 )

    4     7     (9 )   5  

Change in unrealized gains (losses) on cash flow hedges:        

                         

Unrealized gains (losses) arising during the period

    292     134     905     (105 )

(Gains) losses reclassified into earnings

    (159 )   125     (1,049 )   335  

    133     259     (144 )   230  

Change in unrealized components of defined benefit plans:        

                         

Losses arising during the period

    (75 )   (8 )   (75 )   (119 )

Amortization of actuarial loss and prior service benefit                

    108     67     324     196  

Curtailments, settlements and other

    97     2     99     42  

    130     61     348     119  

Change in cumulative translation adjustment

    (44 )   (22 )   (112 )   (63 )

Other comprehensive income before taxes

    223     305     83     291  

Provision for taxes

    (69 )   (86 )   (50 )   (123 )

Other comprehensive income, net of taxes

    154     219     33     168  

Comprehensive income

  $ 1,008   $ 1,204   $ 3,264   $ 3,851  

   

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

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Balance Sheets

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions, except par value
 
 
  (Unaudited)
   
 

ASSETS

             

Current assets:

             

Cash and cash equivalents

  $ 17,171   $ 15,133  

Accounts receivable

    12,753     13,832  

Financing receivables

    2,804     2,946  

Inventory

    6,700     6,415  

Other current assets

    12,570     11,819  

Total current assets

    51,998     50,145  

Property, plant and equipment

    11,028     11,340  

Long-term financing receivables and other assets

    8,733     8,454  

Goodwill

    33,025     31,139  

Intangible assets

    2,249     2,128  

Total assets

  $ 107,033   $ 103,206  

LIABILITIES AND STOCKHOLDERS' EQUITY

             

Current liabilities:

             

Notes payable and short-term borrowings

  $ 11,034   $ 3,486  

Accounts payable

    15,549     15,903  

Employee compensation and benefits

    3,348     4,209  

Taxes on earnings

    629     1,017  

Deferred revenue

    6,277     6,143  

Accrued restructuring

    330     898  

Other accrued liabilities

    11,866     12,079  

Total current liabilities

    49,033     43,735  

Long-term debt

    14,468     16,039  

Other liabilities

    16,089     16,305  

Commitments and contingencies

             

Stockholders' equity:

             

HP stockholders' equity

             

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

         

Common stock, $0.01 par value (9,600 shares authorized; 1,801 and 1,839 shares issued and outstanding at July 31, 2015 and October 31, 2014, respectively)

    18     18  

Additional paid-in capital

    2,101     3,430  

Retained earnings

    30,764     29,164  

Accumulated other comprehensive loss

    (5,848 )   (5,881 )

Total HP stockholders' equity

    27,035     26,731  

Non-controlling interests

    408     396  

Total stockholders' equity

    27,443     27,127  

Total liabilities and stockholders' equity

  $ 107,033   $ 103,206  

   

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

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Statements of Cash Flows

(Unaudited)

 
  Nine months
ended July 31
 
 
  2015   2014  
 
  In millions
 

Cash flows from operating activities:

             

Net earnings

  $ 3,231   $ 3,683  

Adjustments to reconcile net earnings to net cash provided by operating activities:

             

Depreciation and amortization

    3,054     3,259  

Stock-based compensation expense

    476     432  

Provision for doubtful accounts

    38     38  

Provision for inventory

    227     166  

Restructuring charges

    426     1,015  

Deferred taxes on earnings

    898     (129 )

Excess tax benefit from stock-based compensation

    (124 )   (49 )

Other, net

    675     65  

Changes in operating assets and liabilities (net of acquisitions):

             

Accounts receivable

    1,199     1,662  

Financing receivables

    192     340  

Inventory

    (467 )   (369 )

Accounts payable

    (358 )   1,196  

Taxes on earnings

    (1,075 )   292  

Restructuring

    (1,006 )   (1,050 )

Other assets and liabilities

    (3,505 )   (919 )

Net cash provided by operating activities

    3,881     9,632  

Cash flows from investing activities:

             

Investment in property, plant and equipment

    (2,642 )   (2,897 )

Proceeds from sale of property, plant and equipment

    310     702  

Purchases of available-for-sale securities and other investments

    (180 )   (1,007 )

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

    246     1,224  

Payments made in connection with business acquisitions, net of cash acquired

    (2,617 )   (20 )

Proceeds from business divestitures, net

    156      

Net cash used in investing activities

    (4,727 )   (1,998 )

Cash flows from financing activities:

             

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

    2,633     86  

Issuance of debt

    5,993     2,005  

Payment of debt

    (2,642 )   (4,853 )

Settlement of cash flow hedges

    (32 )    

Issuance of common stock under employee stock plans

    303     243  

Repurchase of common stock

    (2,582 )   (1,978 )

Excess tax benefit from stock-based compensation

    124     49  

Cash dividends paid

    (913 )   (875 )

Net cash provided by (used in) financing activities

    2,884     (5,323 )

Net increase in cash and cash equivalents

    2,038     2,311  

Cash and cash equivalents at beginning of period

    15,133     12,163  

Cash and cash equivalents at end of period

  $ 17,171   $ 14,474  

Supplemental schedule of non-cash investing and financing activities:

             

Purchase of assets under capital leases

  $ 70   $ 113  

Stock awards assumed in business acquisitions

    31      

   

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

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

(Unaudited)

Note 1: Basis of Presentation

        In the opinion of management, the accompanying unaudited Consolidated Condensed Financial Statements of Hewlett-Packard Company and its consolidated subsidiaries ("HP") contain all adjustments, including normal recurring adjustments, necessary to present fairly HP's financial position as of July 31, 2015 and October 31, 2014, its results of operations for the three and nine months ended July 31, 2015 and 2014 and its cash flows for the nine months ended July 31, 2015 and 2014.

        The results of operations for the three and nine months ended July 31, 2015 and cash flows for the nine months ended July 31, 2015 are not necessarily indicative of the results to be expected for the full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with HP's Annual Report on Form 10-K for the fiscal year ended October 31, 2014, including "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk" and the Consolidated Financial Statements and notes thereto included in Items 7, 7A and 8, respectively, included therein.

Principles of Consolidation

        The accompanying unaudited Consolidated Condensed Financial Statements include the accounts of HP and other subsidiaries and affiliates in which HP has a controlling financial interest or is the primary beneficiary. HP accounts for investments in companies over which HP has the ability to exercise significant influence but does not hold a controlling interest under the equity method, and HP records its proportionate share of income or losses in Interest and other, net in the Consolidated Condensed Statements of Earnings. HP presents non-controlling interests as a separate component within Total stockholders' equity in the Consolidated Condensed Balance Sheets. Net earnings attributable to the non-controlling interests are eliminated within Interest and other, net in the Consolidated Condensed Statements of Earnings and are not presented separately as they were not material for any period presented. HP has eliminated all intercompany accounts and transactions.

Reclassifications

        HP has implemented certain segment and business unit realignments in order to align its segment financial reporting more closely with its current business structure. Reclassifications of certain prior-year segment and business unit financial information have been made to conform to the current-year presentation. None of the changes impacts HP's previously reported consolidated net revenue, earnings from operations, net earnings or net earnings per share ("EPS"). See Note 2 for a further discussion of HP's segment realignment.

Use of Estimates

        The preparation of financial statements in accordance with United States ("U.S.") generally accepted accounting principles ("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.

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 1: Basis of Presentation (Continued)

Accounting Pronouncements

        In April 2015, the Financial Accounting Standards Board ("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, wherein the arrangements that do not convey a software license to the customer are accounted for as service contracts. HP is required to adopt the guidance in the first quarter of fiscal 2017; however early adoption is permitted as is retrospective application. HP is currently evaluating the impact of these amendments on its Consolidated Condensed Financial Statements.

        In April 2015, the FASB amended the existing accounting standards for imputation of interest. 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 is required to adopt the guidance in the first quarter of fiscal 2017. Early adoption is permitted. The amendments should be applied retrospectively with the adjusted balance sheet of each individual period presented, in order to reflect the period-specific effects of applying the new guidance. HP is currently evaluating the timing and the impact of these amendments on its Consolidated Condensed Financial Statements.

        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 standard 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 2018. In accordance with this deferral, HP is required to adopt these amendments in the first quarter of fiscal 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 these amendments and the transition alternatives on its Consolidated Condensed Financial Statements.

Note 2: Segment Information

        HP is a leading global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses ("SMBs") and large enterprises, including customers in the government, health and education sectors. HP's offerings span the following:

    personal computing and other access devices;

    imaging- and printing-related products and services;

    enterprise information technology ("IT") infrastructure, including enterprise server and storage technology, networking products and solutions, and technology support and maintenance;

    multi-vendor customer services, including technology consulting, outsourcing and support services across infrastructure, applications and business process domains; and

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Segment Information (Continued)

    software products and solutions, including application testing and delivery, big data analytics, enterprise security, information governance, IT operations management and marketing optimization.

        HP's operations are organized into seven segments for financial reporting purposes: Personal Systems, Printing, Enterprise Group ("EG"), Enterprise Services ("ES"), Software, HP Financial Services ("HPFS") and Corporate Investments. HP's organizational structure is based on a number of factors that management 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 management to evaluate segment results.

        The Personal Systems segment and the Printing segment are structured beneath a broader Printing and Personal Systems Group ("PPS"). While PPS is not a reportable segment, HP may provide financial data aggregating the Personal Systems and the Printing segments in order to provide a supplementary view of its business.

        A summary description of each segment follows.

        The Printing and Personal Systems Group's mission is to leverage the respective strengths of the Personal Systems business and the Printing business by creating a unified organization that is customer-focused and poised to capitalize on rapidly shifting industry trends. Each of the segments within PPS is described below.

        Personal Systems provides commercial personal computers ("PCs"), consumer PCs, workstations, thin clients, tablets, retail point-of-sale systems, calculators and other related accessories, software, support and services for the commercial and consumer markets. HP groups commercial notebooks, commercial desktops, commercial services, commercial tablets, workstations and thin clients into commercial clients and consumer notebooks, consumer desktops, consumer services and consumer tablets 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 SMB customers, and for connectivity, reliability and manageability in networked environments.

    Consumer PCs include multi-media notebooks, desktops, hybrids, and tablets.

        Printing provides consumer and commercial printer hardware, supplies, media, software and services, as well as scanning devices. Printing is also focused on imaging solutions in the commercial markets. HP groups LaserJet, large format printers and commercial inkjet printers into Commercial Hardware and consumer inkjet printers into Consumer Hardware when describing performance in these markets. Described below are HP's global business capabilities within Printing.

    LaserJet and Enterprise Solutions deliver HP's LaserJet and enterprise products, services and solutions to SMBs and large enterprises. Managed Print Services provides printing equipment, supplies, support, workflow optimization and security services for SMBs and enterprise customers around the world, utilizing proprietary HP tools and fleet management solutions as well as third-party software.

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Segment Information (Continued)

    Inkjet and Printing Solutions deliver HP's consumer and SMB inkjet solutions (hardware, supplies, media, and web-connected hardware and services). Ongoing initiatives and programs such as Ink in the Office and Ink Advantage and newer initiatives such as Instant Ink provide innovative printing solutions to consumers and SMBs.

    Graphics Solutions deliver large format printers (Designjet, Large Format Production, and Scitex Industrial), specialty printing, digital press solutions (Indigo and Inkjet Webpress), supplies and services to print service providers and design and rendering customers.

    Software and Web Services delivers a suite of solutions and services, including photo storage, printing offerings such as Snapfish and web-connected printing services.

        The Enterprise Group provides servers, storage, networking and technology services that, when combined with HP's cloud solutions, enable customers to manage applications across public cloud, virtual private cloud, private cloud and traditional IT environments. Described below are HP's business units and capabilities within EG.

    Industry Standard Servers offers a range of products from entry-level servers through premium ProLiant servers, which run primarily Windows, Linux and virtualization platforms from software providers such as Microsoft Corporation ("Microsoft") and VMware, Inc. ("VMware") and open sourced software from other major vendors while leveraging x86 processors from Intel Corporation ("Intel") and Advanced Micro Devices, Inc. ("AMD").

    Business Critical Systems offers HP Integrity servers based on the Intel® Itanium® and x86 processors, HP Integrity NonStop solutions and mission-critical x86 ProLiant servers.

    Storage offers traditional storage and Converged Storage solutions. Traditional storage includes tape, storage networking and legacy external disk products such as EVA and XP. Converged Storage solutions include 3PAR StoreServ, StoreOnce and StoreVirtual products.

    Networking offers wireless local area network, mobility and security software, switches, routers and network management products that span data centers, campus and branch environments and deliver software-defined networking and unified communications capabilities.

    Technology Services provides support services and technology consulting to integrate and optimize EG's hardware platforms, and focuses on cloud, mobility and big data. These services are available in the form of service contracts, pre-packaged offerings or on a customized basis.

        Enterprise Services provides technology consulting, outsourcing and support services across infrastructure, applications and business process domains. ES is comprised of the Infrastructure Technology Outsourcing ("ITO") and the Application and Business Services ("ABS") business units.

    Infrastructure Technology Outsourcing delivers comprehensive services that encompass the management of data centers, IT security, cloud computing, workplace technology, networks, unified communications and enterprise service management.

    Application and Business Services helps clients develop, revitalize and manage their applications and information assets.

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Segment Information (Continued)

        Software provides application testing and delivery, big data analytics, enterprise security, information governance, IT operations management, and marketing optimization solutions for businesses and enterprises of all sizes. HP's software offerings include licenses, support, professional services and software-as-a-service.

        HP Financial Services provides flexible investment solutions, such as leasing, financing, utility programs and asset management services, for customers to enable the creation of unique technology deployment models and acquire complete IT solutions, including hardware, software and services from HP and others. Providing flexible services and capabilities that support the entire IT lifecycle, HPFS partners with customers globally to help build investment strategies that enhance their business agility and support their business transformation. HPFS offers a wide selection of investment solution capabilities for large enterprise customers and channel partners, along with an array of financial options to SMBs and educational and governmental entities.

        Corporate Investments includes HP Labs and certain cloud-related business incubation projects amongst others.

Segment Policy

        HP derives the results of the business segments directly from its internal management reporting system. The accounting policies HP uses to derive segment results are substantially the same as those the consolidated company uses. Management measures the performance of each segment based on several metrics, including earnings from operations. Management uses these results, in part, to evaluate the performance of, and to allocate resources to, each of the segments.

        Segment revenue includes revenues from sales to external customers and intersegment revenues that reflect transactions between the segments on an arm's-length basis. Intersegment revenues primarily consist of sales of hardware and software that are sourced internally and, in the majority of the cases, are financed as operating leases by HPFS. HP's consolidated net revenue is derived and reported after the elimination of intersegment revenues from such arrangements.

        HP periodically engages in intercompany advanced royalty payment and licensing arrangements that may result in advance payments between subsidiaries. Revenues from these intercompany arrangements are deferred and recognized as earned over the term of the arrangement by the HP legal entities involved in such transactions; however, these advanced payments are eliminated from revenues as reported by HP and its business segments. As disclosed in Note 6, in the first quarter of fiscal 2015, HP executed an intercompany advanced royalty payment arrangement resulting in advanced payments of $8.2 billion, while during fiscal 2014 HP executed a multi-year intercompany licensing arrangement and intercompany advanced royalty payment arrangement which resulted in combined advanced payments of $11.5 billion. In these transactions, the payments were received in the U.S. from a foreign consolidated affiliate, with a deferral of intercompany revenues over the term of the arrangements, approximately 5 years and 15 years, respectively. The impact of these intercompany arrangements is eliminated from both HP consolidated and segment revenues.

        Financing interest in the Consolidated Condensed Statements of Earnings reflects interest expense on debt attributable to HPFS. Debt attributable to HPFS consists of intercompany equity that is

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Segment Information (Continued)

treated as debt for segment reporting purposes, intercompany debt, and borrowing- and funding-related activity associated with HPFS and its subsidiaries.

        HP does not allocate to its segments certain operating expenses, which it manages at the corporate level. These unallocated costs include certain corporate governance costs, stock-based compensation expense, amortization of intangible assets, restructuring charges, acquisition-related charges, separation costs, defined benefit plan settlement charges and impairment of data center assets.

Segment Realignment

        Effective at the beginning of its first quarter of fiscal 2015, HP implemented an organizational change to align its segment financial reporting more closely with its current business structure. This organizational change resulted in the transfer of third-party multi-vendor support arrangements from the Technology Services ("TS") business unit within the EG segment to the ITO business unit within the ES segment.

        HP has reflected this change to its segment information retrospectively to the earliest period presented, which has resulted in the removal of intersegment revenue from the TS business unit within the EG segment and the related corporate intersegment revenue eliminations, and the transfer of operating profit from the TS business unit within the EG segment to the ITO business unit within the ES segment. This change had no impact on HP's previously reported consolidated net revenue, earnings from operations, net earnings or net EPS.

        In connection with the acquisition of Aruba Networks, Inc. ("Aruba") in the third quarter of fiscal 2015, HP recorded approximately $1.8 billion of goodwill, $628 million of intangible assets and $149 million of in-process research and development. HP reports the financial results of Aruba's business in the Networking business unit within the EG segment. As of July 31, 2015, other than the EG segment, there have been no material changes to the total assets of HP's other individual segments since October 31, 2014.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Segment Information (Continued)

Segment Operating Results

 
  Personal Systems
and Printing
Group
   
   
   
   
   
   
 
 
  Personal
Systems
  Printing   Enterprise
Group
  Enterprise
Services
  Software   HP
Financial
Services
  Corporate
Investments
  Total  
 
  In millions
 

Three months ended July 31, 2015

                                                 

Net revenue

  $ 7,246   $ 5,042   $ 6,680   $ 4,773   $ 821   $ 783   $ 4   $ 25,349  

Intersegment net revenue and other

    245     66     327     203     79     23         943  

Total segment net revenue

  $ 7,491   $ 5,108   $ 7,007   $ 4,976   $ 900   $ 806   $ 4   $ 26,292  

Earnings (loss) from operations

  $ 222   $ 910   $ 912   $ 297   $ 185   $ 87   $ (148 ) $ 2,465  

Three months ended July 31, 2014

                                                 

Net revenue

  $ 8,368   $ 5,514   $ 6,666   $ 5,328   $ 873   $ 833   $ 3   $ 27,585  

Intersegment net revenue and other

    281     76     206     262     86     22         933  

Total segment net revenue

  $ 8,649   $ 5,590   $ 6,872   $ 5,590   $ 959   $ 855   $ 3   $ 28,518  

Earnings (loss) from operations

  $ 346   $ 1,026   $ 963   $ 231   $ 203   $ 79   $ (115 ) $ 2,733  

Nine months ended July 31, 2015

                                                 

Net revenue

  $ 23,046   $ 15,911   $ 19,683   $ 14,179   $ 2,452   $ 2,348   $ 22   $ 77,641  

Intersegment net revenue and other

    729     193     866     607     211     66         2,672  

Total segment net revenue

  $ 23,775   $ 16,104   $ 20,549   $ 14,786   $ 2,663   $ 2,414   $ 22   $ 80,313  

Earnings (loss) from operations

  $ 770   $ 2,973   $ 2,952   $ 639   $ 502   $ 262   $ (416 ) $ 7,682  

Nine months ended July 31, 2014

                                                 

Net revenue

  $ 24,638   $ 17,063   $ 19,852   $ 16,054   $ 2,610   $ 2,534   $ 297   $ 83,048  

Intersegment net revenue and other

    717     176     623     833     236     58         2,643  

Total segment net revenue

  $ 25,355   $ 17,239   $ 20,475   $ 16,887   $ 2,846   $ 2,592   $ 297   $ 85,691  

Earnings (loss) from operations

  $ 915   $ 3,145   $ 2,923   $ 439   $ 534   $ 279   $ (92 ) $ 8,143  

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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
July 31
  Nine months ended
July 31
 
 
  2015   2014   2015   2014  
 
  In millions
 

Net Revenue:

                         

Total segments

  $ 26,292   $ 28,518   $ 80,313   $ 85,691  

Elimination of intersegment net revenue and other

    (943 )   (933 )   (2,672 )   (2,643 )

Total HP consolidated net revenue

  $ 25,349   $ 27,585   $ 77,641   $ 83,048  

Earnings before taxes:

                         

Total segment earnings from operations

  $ 2,465   $ 2,733   $ 7,682   $ 8,143  

Corporate and unallocated costs and eliminations

    (128 )   (265 )   (462 )   (637 )

Stock-based compensation expense

    (160 )   (132 )   (476 )   (432 )

Amortization of intangible assets

    (242 )   (227 )   (685 )   (774 )

Restructuring charges

    (25 )   (649 )   (426 )   (1,015 )

Acquisition-related charges(1)

    (47 )   (2 )   (70 )   (8 )

Separation costs

    (401 )       (750 )    

Defined benefit plan settlement charges

    (114 )       (114 )    

Impairment of data center assets

    (136 )       (136 )    

Interest and other, net

    (108 )   (145 )   (421 )   (482 )

Total HP consolidated earnings before taxes

  $ 1,104   $ 1,313   $ 4,142   $ 4,795  

(1)
Acquisition-related charges in the current period primarily include a non-cash inventory fair value adjustment charge as well as professional service and legal fees associated with the acquisition of Aruba.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Segment Information (Continued)

        Net revenue by segment and business unit was as follows:

 
  Three months ended
July 31
  Nine months ended
July 31
 
 
  2015   2014   2015   2014  
 
  In millions
 

Notebooks

  $ 3,993   $ 4,359   $ 12,887   $ 12,671  

Desktops

    2,700     3,395     8,411     10,012  

Workstations

    507     579     1,546     1,660  

Other

    291     316     931     1,012  

Personal Systems

    7,491     8,649     23,775     25,355  

Supplies

    3,455     3,660     10,740     11,321  

Commercial Hardware

    1,250     1,401     3,870     4,150  

Consumer Hardware

    403     529     1,494     1,768  

Printing

    5,108     5,590     16,104     17,239  

Total Printing and Personal Systems Group

    12,599     14,239     39,879     42,594  

Industry Standard Servers

    3,335     3,097     9,860     9,104  

Technology Services

    1,881     2,074     5,800     6,282  

Storage

    784     796     2,361     2,438  

Networking

    823     672     1,941     1,960  

Business Critical Systems

    184     233     587     691  

Enterprise Group

    7,007     6,872     20,549     20,475  

Infrastructure Technology Outsourcing

    3,036     3,494     9,039     10,592  

Application and Business Services

    1,940     2,096     5,747     6,295  

Enterprise Services

    4,976     5,590     14,786     16,887  

Software

    900     959     2,663     2,846  

HP Financial Services

    806     855     2,414     2,592  

Corporate Investments

    4     3     22     297  

Total segment net revenue

    26,292     28,518     80,313     85,691  

Eliminations of intersegment net revenue and other          

    (943 )   (933 )   (2,672 )   (2,643 )

Total net revenue

  $ 25,349   $ 27,585   $ 77,641   $ 83,048  

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 3: Restructuring

    Summary of Restructuring Plans

        HP's restructuring activities summarized by plan were as follows:

 
   
   
  Nine months ended
July 31, 2015
   
  As of
July 31, 2015
 
 
   
  Three
months
ended
July 31,
2015
Restructuring
Charges
   
 
 
  Balance,
October 31,
2014
  Restructuring
Charges
  Cash
Payments
  Other
Adjustments
and Non-Cash
Settlements
  Balance,
July 31,
2015
  Total
Costs
Incurred
to Date
  Total
Expected
Costs to Be
Incurred
 
 
  In millions
 

Fiscal 2012 Plan

                                                 

Severance and EER

  $ 955   $ 14   $ 385   $ (898 ) $ (73 ) $ 369   $ 4,778   $ 4,910  

Infrastructure and other

    98     18     55     (96 )   (3 )   54     570     590  

Total 2012 Plan

    1,053     32     440     (994 )   (76 )   423     5,348     5,500  

Other Plans:

                                                 

Severance

    7     (4 )   (4 )       (1 )   2     2,625     2,625  

Infrastructure

    54     (3 )   (10 )   (12 )   (1 )   31     1,423     1,423  

Total Other Plans

    61     (7 )   (14 )   (12 )   (2 )   33     4,048     4,048  

Total restructuring plans

  $ 1,114   $ 25   $ 426   $ (1,006 ) $ (78 ) $ 456   $ 9,396   $ 9,548  

Reflected in Consolidated Condensed Balance Sheets:

                                                 

Accrued restructuring

  $ 898                           $ 330              

Other liabilities

  $ 216                           $ 126              

    Fiscal 2012 Restructuring Plan

        On May 23, 2012, HP adopted a multi-year restructuring plan (the "2012 Plan") designed to simplify business processes, accelerate innovation and deliver better results for customers, employees and stockholders. As of July 31, 2015 HP estimated that it would eliminate approximately 55,000 positions in connection with the 2012 Plan through fiscal 2015, with a portion of those employees exiting the company as part of voluntary enhanced early retirement ("EER") programs in the U.S. and in certain other countries. HP estimates that it will recognize approximately $5.5 billion in total aggregate charges in connection with the 2012 Plan. HP expects approximately $4.9 billion to relate to workforce reductions, including the EER programs, and approximately $590 million to relate to infrastructure, including data center and real estate consolidation, and other items. As of July 31, 2015, HP had recorded $5.3 billion in aggregate charges of which $4.8 billion related to workforce reductions and $570 million related to infrastructure, including data center and real estate consolidation, and other items. HP expects to record the majority of the remaining charges through the end of fiscal 2015 as the accounting recognition criteria are met. Certain charges related to the closure and consolidation of data centers and other real estate that were included as part of the 2012 Plan will continue to be incurred beyond fiscal 2015. As of July 31, 2015, HP had eliminated approximately 51,500 positions for which a severance payment has been or will be made as part of the 2012 Plan. The severance- and infrastructure-related cash payments associated with the 2012 Plan are expected to be paid out through fiscal 2021.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 3: Restructuring (Continued)

        On August 20, 2015, HP adjusted its previous estimate of 55,000 positions to be eliminated under the 2012 Plan by up to an additional 5% without an increase to the earlier estimated aggregate amount to be recognized as a result of the impacted positions being currently located in lower cost severance regions.

    Other Plans

        Restructuring plans initiated by HP in fiscal 2008 and 2010 were substantially completed as of July 31, 2015. Severance- and infrastructure-related cash payments associated with the other plans are expected to be paid out through fiscal 2019.

Note 4: Retirement and Post-Retirement Benefit Plans

        HP's net pension and post-retirement benefit cost (credit) recognized in the Consolidated Condensed Statements of Earnings was as follows:

 
  Three months ended July 31  
 
  U.S.
Defined
Benefit Plans
  Non-U.S.
Defined
Benefit Plans
  Post-
Retirement
Benefit Plans
 
 
  2015   2014   2015   2014   2015   2014  
 
  In millions
 

Service cost

  $   $   $ 82   $ 78   $ 1   $ 1  

Interest cost

    141     142     155     187     7     8  

Expected return on plan assets

    (197 )   (203 )   (292 )   (290 )   (10 )   (9 )

Amortization and deferrals:

                                     

Actuarial loss (gain)

    13     4     107     81     (2 )   (2 )

Prior service benefit

            (5 )   (6 )   (5 )   (10 )

Net periodic benefit (credit) cost

    (43 )   (57 )   47     50     (9 )   (12 )

Settlement loss

    96     1         2          

Special termination benefits

            9     5     1      

Net benefit cost (credit)

  $ 53   $ (56 ) $ 56   $ 57   $ (8 ) $ (12 )

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 4: Retirement and Post-Retirement Benefit Plans (Continued)


 
  Nine months ended July 31  
 
  U.S.
Defined
Benefit Plans
  Non-U.S.
Defined
Benefit Plans
  Post-
Retirement
Benefit Plans
 
 
  2015   2014   2015   2014   2015   2014  
 
  In millions
 

Service cost

  $   $   $ 249   $ 233   $ 3   $ 3  

Interest cost

    427     426     471     555     21     24  

Expected return on plan assets

    (630 )   (608 )   (884 )   (858 )   (28 )   (26 )

Amortization and deferrals:

                                     

Actuarial loss (gain)

    39     12     323     239     (8 )   (7 )

Prior service benefit

            (15 )   (18 )   (15 )   (30 )

Net periodic benefit (credit) cost

    (164 )   (170 )   144     151     (27 )   (36 )

Curtailment gain

                (5 )        

Settlement loss

    96     1     3     4          

Special termination benefits

            22     33     1     (11 )

Net benefit (credit) cost

  $ (68 ) $ (169 ) $ 169   $ 183   $ (26 ) $ (47 )

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 the second quarter of fiscal 2015, HP lowered its initial estimates related to expected contributions in fiscal 2015 by $52 million due to favorable foreign currency exchange rates and a change in the estimated local funding requirements. As a result, HP expected its fiscal 2015 contributions to be approximately $641 million to its non-U.S. pension plans, approximately $32 million to cover benefit payments to U.S. non-qualified plan participants and approximately $43 million to cover benefit claims under HP's post-retirement benefit plans.

        During the nine months ended July 31, 2015, HP contributed $575 million to its non-U.S. pension plans, paid $22 million to cover benefit payments to U.S. non-qualified plan participants, and paid $29 million to cover benefit claims under HP's post-retirement benefit plans. During the remainder of fiscal 2015, HP anticipates making additional contributions of approximately $66 million to its non-U.S. pension plans and approximately $10 million to its U.S. non-qualified plan participants and expects to pay approximately $14 million to cover benefit claims under HP's post-retirement benefit plans.

        In January 2015, HP offered certain terminated vested participants of the U.S. HP Pension Plan the option of receiving their pension benefit in a one-time voluntary lump sum window. Approximately 50% of the eligible participants elected to receive their benefits and as a result the pension plan trust paid $827 million in lump sum payments to these participants during the three months ended July 31, 2015. As a result of the lump sum program, HP incurred a settlement expense of $96 million and a remeasurement of the U.S. defined benefit plans was required. As a result of the remeasurement, there was a reduction in the projected benefit obligation that was partially offset by a related decline in plan assets such that the net funded status of the plan improved by $107 million as compared to October 31, 2014. The remeasurement also resulted in an additional net periodic benefit cost of $45 million for fiscal 2015. During the three months ended July 31, 2015, HP recognized $18 million of the additional

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 4: Retirement and Post-Retirement Benefit Plans (Continued)

net periodic benefit cost as well as the settlement expense in Defined benefit plan settlement charges in the Consolidated Condensed Statements of Earnings.

        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 are 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 include HP's principal equity plans as well as various equity plans assumed through business combinations. HP's principal equity 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 July 31
  Nine months
ended July 31
 
 
  2015   2014   2015   2014  
 
  In millions
 

Stock-based compensation expense

  $ 160   $ 132   $ 476   $ 432  

Income tax benefit

    (52 )   (42 )   (154 )   (138 )

Stock-based compensation expense, net of tax

  $ 108   $ 90   $ 322   $ 294  

    Restricted Stock Awards

        Restricted stock awards are non-vested stock awards that may include grants of restricted stock or restricted stock units. For the nine months ended July 31, 2015, HP granted only restricted stock units.

        A summary of restricted stock award activity is as follows:

 
  Nine months ended
July 31, 2015
 
 
  Shares   Weighted-
Average Grant Date
Fair Value Per Share
 
 
  In thousands
   
 

Outstanding at beginning of period

    40,808   $ 24  

Granted and assumed through acquisition

    25,532   $ 36  

Vested

    (18,996 ) $ 25  

Forfeited

    (2,760 ) $ 28  

Outstanding at end of period

    44,584   $ 30  

        During the three months ended July 31, 2015, HP assumed approximately 8 million shares of restricted stock units through acquisition with a weighted-average grant date fair value of $33 per share.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 5: Stock-Based Compensation (Continued)

        At July 31, 2015, there was $847 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 1.4 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. The weighted-average fair value and the assumptions used to measure fair value were as follows:

 
  Three months
ended July 31
  Nine months
ended July 31
 
 
  2015   2014   2015   2014  

Weighted-average fair value of grants per option(1)

  $ 6.28   $ 7.53   $ 7.90   $ 7.44  

Expected volatility(2)

    26.7 %   27.6 %   26.3 %   33.2 %

Risk-free interest rate(3)

    1.6 %   1.6 %   1.7 %   1.8 %

Expected dividend yield(4)

    2.3 %   1.9 %   1.8 %   2.1 %

Expected term in years(5)

    5.2     5.2     5.8     5.7  

(1)
The weighted-average fair value was based on stock options granted during the period.

(2)
For all awards granted in fiscal 2015, expected volatility was estimated using the implied volatility derived from options traded on HP's common stock. For awards granted in fiscal 2014, expected volatility for awards subject to service-based vesting was estimated using the implied volatility derived from options traded on HP's common stock, whereas for performance-contingent awards, expected volatility was estimated using the historical volatility of 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 dividend yield represents a constant dividend yield applied for the duration of the expected term of the award.

(5)
For awards subject to service-based vesting, the expected term was estimated using historical exercise and post-vesting termination patterns; and for performance-contingent awards, the expected term represents an output from the lattice model.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 5: Stock-Based Compensation (Continued)

        A summary of stock option activity is as follows:

 
  Nine months ended July 31, 2015  
 
  Shares   Weighted-
Average
Exercise
Price
  Weighted-
Average
Remaining
Contractual
Term
  Aggregate
Intrinsic
Value
 
 
  In thousands
   
  In years
  In millions
 

Outstanding at beginning of period

    57,853   $ 27              

Granted and assumed through acquisitions

    8,290   $ 37              

Exercised

    (10,918 ) $ 19              

Forfeited/cancelled/expired

    (16,483 ) $ 40              

Outstanding at end of period

    38,742   $ 26     5.3   $ 275  

Vested and expected to vest at end of period

    36,443   $ 26     5.3   $ 260  

Exercisable at end of period

    17,635   $ 25     4.1   $ 142  

        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 third quarter of fiscal 2015. The aggregate intrinsic value is the difference between HP's closing stock price on the last trading day of the third quarter of fiscal 2015 and the exercise price, multiplied by the number of in-the-money options. Total intrinsic value of options exercised for the three and nine months ended July 31, 2015 was $23 million and $192 million, respectively.

        At July 31, 2015, there was $61 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 1.7 years.

Note 6: Taxes on Earnings

    Provision for Taxes

        HP's effective tax rate was 22.6% and 25.0% for the three months ended July 31, 2015 and 2014, respectively, and 22.0% and 23.2% for the nine months ended July 31, 2015 and 2014, 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 U.S.

        In the three and nine months ended July 31, 2015, HP recorded discrete items resulting in net tax benefits of $164 million and $349 million, respectively. These amounts included a tax benefit of $122 million and $237 million, for the three and nine months ended July 31, 2015, respectively, on separation charges and a tax benefit of $23 million and $75 million for the three and nine months ended July 31, 2015, respectively, on combined restructuring and acquisition-related charges. The nine month period ended July 31, 2015, also included a tax benefit of $47 million arising from the retroactive research and development credit provided by the Tax Increase Prevention Act of 2014 signed into law in December 2014. Additionally, in the three and nine months ended July 31, 2015, HP recorded various other discrete tax benefits of $19 million and tax charges of $10 million, respectively.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 6: Taxes on Earnings (Continued)

        In the three and nine months ended July 31, 2014, HP recorded discrete items resulting in net tax benefits of $88 million and $53 million, respectively. These amounts include tax benefits of $100 million and $145 million related to restructuring charges, respectively.

    Uncertain Tax Positions

        HP is subject to income tax in the U.S. and approximately 105 other countries and is subject to routine corporate income tax audits in many of these jurisdictions. In addition, HP is subject to numerous ongoing audits by federal, state and foreign tax authorities. The U.S. Internal Revenue Service ("IRS") is conducting an audit of HP's 2009, 2010 and 2011 income tax returns. HP has received from the IRS Notices of Deficiency for its fiscal 1999, 2000, 2003, 2004 and 2005 tax years, and Revenue Agent's Reports ("RAR") for its fiscal 2001, 2002, 2006, 2007 and 2008 tax years. In addition, HP expects the IRS to issue RARs for 2009, 2010 and 2011 tax years relating to certain tax positions taken on the filed tax returns, including matters related to the U.S. taxation of certain intercompany loans. While these RARs may be material in amount, HP believes it has valid positions supporting its tax returns and, if necessary, it will rigorously defend such matters.

        With respect to major foreign and state tax jurisdictions, HP is no longer subject to tax authority examinations for years prior to 1999. HP is subject to a foreign tax audit concerning an intercompany transaction for fiscal 2009. The relevant taxing authority has proposed an assessment of approximately $680 million. HP is contesting this proposed assessment.

        HP believes it has provided adequate reserves for all tax deficiencies or reductions in tax benefits that could result from federal, state and foreign tax audits. HP regularly assesses the likely outcomes of these audits in order to determine the appropriateness of HP's tax provision. HP adjusts its uncertain tax positions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular audit. However, income tax audits are inherently unpredictable and there can be no assurance that HP will accurately predict the outcome of these audits. The amounts ultimately paid on resolution of an audit could be materially different from the amounts previously included in the Provision for taxes and therefore the resolution of one or more of these uncertainties in any particular period could have a material impact on net income or cash flows.

        As of July 31, 2015 and October 31, 2014, the amount of unrecognized tax benefits was $11.1 billion and $4.1 billion respectively, of which up to $2.4 billion and $2.2 billion would affect HP's effective tax rate if realized as of the respective periods. The $7.0 billion increase in the amount of unrecognized tax benefits for the nine months ended July 31, 2015 primarily relates to the timing of intercompany royalty income recognition which does not affect HP's effective tax rate. HP recognizes interest income from favorable settlements and interest expense and penalties accrued on unrecognized tax benefits in Provision for taxes in the Consolidated Condensed Statements of Earnings. As of July 31, 2015, HP had accrued $254 million for interest and penalties.

        HP engages in continuous discussion and negotiation with taxing authorities regarding tax matters in various jurisdictions. HP does not expect complete resolution of any IRS audit cycle within the next 12 months. However, it is reasonably possible that certain federal, foreign and state tax issues may be concluded in the next 12 months, including issues involving transfer pricing and other matters. Accordingly, HP believes it is reasonably possible that its existing unrecognized tax benefits may be reduced by an amount up to $1.1 billion within the next 12 months.

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 6: Taxes on Earnings (Continued)

    Deferred Tax Assets and Liabilities

        Current and long-term deferred tax assets and liabilities included in the Consolidated Condensed Balance Sheets are as follows:

 
  As of  
 
  July 31, 2015   October 31, 2014  
 
  In millions
 

Current deferred tax assets

  $ 3,242   $ 2,754  

Current deferred tax liabilities

    (216 )   (284 )

Long-term deferred tax assets

    899     740  

Long-term deferred tax liabilities

    (2,965 )   (1,124 )

Net deferred tax assets net of deferred tax liabilities

  $ 960   $ 2,086  

        HP periodically engages in intercompany advanced royalty payment and licensing arrangements that may result in advance payments between subsidiaries in different tax jurisdictions. When the local tax treatment of the intercompany licensing arrangements differs from U.S. GAAP treatment, deferred taxes are recognized. In the first quarter of fiscal 2015, HP executed an intercompany advanced royalty payment arrangement resulting in advanced payments of $8.2 billion, while during fiscal 2014, HP executed a multi-year intercompany licensing arrangement and an intercompany advanced royalty payment arrangement which resulted in combined advanced payments of $11.5 billion, the result of which was the recognition of net U.S. long-term deferred tax assets of $2.1 billion and $1.7 billion in the respective periods. In these transactions, the payments were received in the U.S. from a foreign consolidated affiliate, with a deferral of intercompany revenues over the term of the arrangements, approximately 5 years and 15 years, respectively. Intercompany royalty revenue and the amortization expense related to the licensing rights are eliminated in consolidation.

        Separation costs are expenses associated with HP's plan to separate into two independent publicly-traded companies. These costs include finance, IT, consulting and legal fees, real estate, and other items that are incremental and one-time in nature. HP is recording a deferred tax asset on a portion of these costs and expenses as they are incurred through fiscal 2015. HP expects a portion of these deferred tax assets associated with separation costs and expenses will be eliminated, as non-deductible expenses, at the time the separation is executed. Furthermore, HP concluded on the legal form of the separation and in May, 2015 announced that Hewlett Packard Enterprise Company ("Hewlett Packard Enterprise") will be the spinnee in the U.S. Accordingly, HP expects to effect certain internal reorganizations of, and transactions among, its wholly-owned subsidiaries and operating activities in preparation for the legal form of separation. As a result, in future periods, HP expects to record the impact of separation-related activities, which may result in adjustments to increase certain deferred tax assets and could have a material impact on HP's operations.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 7: Balance Sheet Details

        Balance sheet details were as follows:

    Accounts Receivable, Net

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Accounts receivable

  $ 12,953   $ 14,064  

Allowance for doubtful accounts

    (200 )   (232 )

  $ 12,753   $ 13,832  

        The allowance for doubtful accounts related to accounts receivable and changes were as follows:

 
  Nine months ended
July 31, 2015
 
 
  In millions
 

Balance at beginning of period

  $ 232  

Provision for doubtful accounts, net of recoveries

    24  

Deductions

    (56 )

Balance at end of period

  $ 200  

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 7: Balance Sheet Details (Continued)

        HP has third-party revolving short-term financing arrangements intended to facilitate the working capital requirements of certain customers. The maximum, utilized and available program capacity under these revolving short-term financing arrangements was as follows:

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Non-recourse arrangements:

             

Maximum program capacity

  $ 1,068   $ 1,083  

Utilized capacity(1)(2)

    (598 )   (613 )

Available capacity

  $ 470   $ 470  

Partial-recourse arrangements:

             

Maximum program capacity

  $ 1,805   $ 1,877  

Utilized capacity(1)(2)

    (1,318 )   (1,500 )

Available capacity

  $ 487   $ 377  

Total arrangements:

             

Maximum program capacity

  $ 2,873   $ 2,960  

Utilized capacity(1)(2)

    (1,916 )   (2,113 )

Available capacity

  $ 957   $ 847  

(1)
Utilized capacity represents the receivables sold to third parties, but not collected from the customer by the third parties.

(2)
HP reflects the amounts transferred to, but not yet collected from, third parties in Accounts receivable in the Consolidated Condensed Balance Sheets. These amounts, included in the utilized capacity are as follows:

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Non-recourse arrangements

  $ 6   $ 78  

Partial-recourse arrangements

    284     381  

Total arrangements

  $ 290   $ 459  

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 7: Balance Sheet Details (Continued)

        The activity related to HP's revolving short-term financing arrangements was as follows:

 
  Nine months
ended
July 31, 2015
 
 
  In millions
 

Balance at beginning of period(1)

  $ 459  

Trade receivables sold

    7,828  

Cash receipts

    (7,964 )

Foreign currency and other

    (33 )

Balance at end of period(1)

  $ 290  

(1)
Beginning and ending balance represents amounts for trade receivables sold but not yet collected.

    Inventory

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Finished goods

  $ 4,284   $ 3,973  

Purchased parts and fabricated assemblies

    2,416     2,442  

  $ 6,700   $ 6,415  

    Property, Plant and Equipment

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Land

  $ 535   $ 540  

Buildings and leasehold improvements

    9,083     9,048  

Machinery and equipment, including equipment held for lease

    16,860     16,664  

    26,478     26,252  

Accumulated depreciation

    (15,450 )   (14,912 )

  $ 11,028   $ 11,340  

        For the nine months ended July 31, 2015, the change in gross property, plant and equipment was due primarily to purchases of $2.7 billion, which were partially offset by sales and retirements totaling $2.0 billion and unfavorable currency impacts of $0.4 billion. Accumulated depreciation associated with the assets sold or retired was $1.7 billion.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 7: Balance Sheet Details (Continued)

    Other Liabilities

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Pension, post-retirement, and post-employment liabilities

  $ 5,305   $ 6,379  

Deferred revenue—long-term

    4,317     3,931  

Deferred tax liability—long-term

    2,965     1,124  

Tax liability—long-term

    1,618     2,861  

Other long-term liabilities

    1,884     2,010  

  $ 16,089   $ 16,305  

Note 8: Financing Receivables and Operating Leases

        Financing receivables represent sales-type and direct-financing leases of HP and third-party products. These receivables typically have terms ranging from two to five years and are usually collateralized by a security interest in the underlying assets. Financing receivables also include billed receivables from operating leases. The components of financing receivables were as follows:

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Minimum lease payments receivable

  $ 6,751   $ 6,982  

Unguaranteed residual value

    220     235  

Unearned income

    (529 )   (547 )

Financing receivables, gross

    6,442     6,670  

Allowance for doubtful accounts

    (96 )   (111 )

Financing receivables, net

    6,346     6,559  

Less: current portion(1)

    (2,804 )   (2,946 )

Amounts due after one year, net(1)

  $ 3,542   $ 3,613  

(1)
HP includes the current portion in Financing receivables and amounts due after one year, net in Long-term financing receivables and other assets in the accompanying Consolidated Condensed Balance Sheets.

    Credit Quality Indicators

        Due to the homogenous nature of its leasing transactions, HP manages its financing receivables on an aggregate basis when assessing and monitoring credit risk. Credit risk is generally diversified due to the large number of entities comprising HP's customer base and their dispersion across many different industries and geographic regions. HP evaluates the credit quality of an obligor at lease inception and monitors that credit quality over the term of a transaction. HP assigns risk ratings to each lease based

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 8: Financing Receivables and Operating Leases (Continued)

on the creditworthiness of the obligor and other variables that augment or mitigate the inherent credit risk of a particular transaction. Such variables include the underlying value and liquidity of the collateral, the essential use of the equipment, the term of the lease and the inclusion of credit enhancements, such as guarantees, letters of credit or security deposits.

        The credit risk profile of gross financing receivables, based on internally assigned ratings, was as follows:

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Risk Rating:

             

Low

  $ 3,333   $ 3,536  

Moderate

    3,036     3,022  

High

    73     112  

Total

  $ 6,442   $ 6,670  

        Accounts rated low risk typically have the equivalent of a Standard & Poor's rating of BBB– or higher, while accounts rated moderate risk generally have the equivalent of BB+ or lower. HP classifies accounts as high risk when it considers the financing receivable to be impaired or when management believes there is a significant near-term risk of impairment.

    Allowance for Doubtful Accounts

        The allowance for doubtful accounts for financing receivables is comprised of a general reserve and a specific reserve. HP maintains general reserve percentages on a regional basis and bases such percentages on several factors, including consideration of historical credit losses and portfolio delinquencies, trends in the overall weighted-average risk rating of the portfolio, current economic conditions and information derived from competitive benchmarking. HP excludes accounts evaluated as part of the specific reserve from the general reserve analysis. HP establishes a specific reserve for financing receivables with identified exposures, such as customer defaults, bankruptcy or other events, that make it unlikely HP will recover its investment. For individually evaluated receivables, HP determines the expected cash flow for the receivable, which includes consideration of estimated proceeds from disposition of the collateral, and calculates an estimate of the potential loss and the probability of loss. For those accounts where a loss is considered probable, HP records a specific reserve. HP generally writes off a receivable or records a specific reserve when a receivable becomes 180 days past due, or sooner if HP determines that the receivable is not collectible.

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Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 8: Financing Receivables and Operating Leases (Continued)

        The allowance for doubtful accounts related to financing receivables and changes were as follows:

 
  Nine months ended
July 31, 2015
 
 
  In millions
 

Balance at beginning of period

  $ 111  

Provision for doubtful accounts

    15  

Deductions

    (30 )

Balance at end of period

  $ 96  

        The gross financing receivables and related allowance evaluated for loss were as follows:

 
  As of  
 
  July 31,
2015
  October 31,
2014
 
 
  In millions
 

Gross financing receivables collectively evaluated for loss

  $ 6,189   $ 6,378  

Gross financing receivables individually evaluated for loss

    253     292  

Total

  $ 6,442   $ 6,670  

Allowance for financing receivables collectively evaluated for loss

  $ 79   $ 92  

Allowance for financing receivables individually evaluated for loss

    17     19  

Total

  $ 96   $ 111