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 |
For the quarterly period | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF |
For the transition period from to
Commission file number:number 1-4423
HEWLETT-PACKARD COMPANY
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 94-1081436 (I.R.S. employer identification no.) | |
3000 Hanover Street, Palo Alto, California (Address of principal executive offices) | 94304 (Zip code) |
(650) 857-1501
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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 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 markcheckmark whether the registrant is an accelerated filer (as defined in ruleRule 12b-2 of the Exchange Act). Yes ý No o
Indicate theThe number of shares outstanding of each of the issuer's classes ofHP common stock outstanding as of the latest practicable date.February 28, 2005 was 2,895,553,951 shares.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
INDEX
| | | Page No. | |||||
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Part I. | Financial Information | |||||||
Item 1. | Financial Statements | |||||||
Consolidated Condensed | 3 | |||||||
Consolidated Condensed Balance | 4 | |||||||
Consolidated Condensed | 5 | |||||||
Notes to Consolidated Condensed Financial Statements (Unaudited) | 6 | |||||||
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 35 | ||||||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | |||||||
Item 4. | Controls and Procedures | |||||||
Part II. | Other Information | |||||||
Item 1. | Legal Proceedings | |||||||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | |||||||
Item 6. | Exhibits | |||||||
Signature | ||||||||
Exhibit Index |
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, contains forward-looking statements that involve risks, and 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, earnings, revenue, expensescash repatriation, benefit obligations, share repurchases or other financial items; any statements of the plans, strategies and objectives of management for future operations, including the execution of restructuring plansplans; any statements regarding management and remediation of execution issues;organizational structure; any statements concerning developments,expected development, performance or market share relating to products or services; any statements regarding future economic conditions or 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. The risks,Risks, uncertainties and assumptions referred to above include macroeconomic and geopolitical trends and events; the outcome of pending legislation; the execution and performance of contracts by customers, suppliers customers and partners; employeedisruptions in relationships with customers, suppliers and partners resulting from management issues;transition; the challenge of managing asset levels, including inventory; the difficulty of aligning expense levels with revenue changes; assumptions related to pension and other post-retirement costs; information technology systems risks, including system migration risks and other risks that are described herein and that are otherwise described from time to time in HP's Securities and Exchange Commission reports filed after HP's Annual Report on Form 10-K for the fiscal year ended October 31, 2003,2004, except as to items that are specifically superseded by "Factors that Could Affect Future Results" set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of this report. HP assumes no obligation and does not intend to update these forward-looking statements.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Consolidated Condensed StatementStatements of Earnings(In millions, except per share amounts)
(Unaudited)
| | Three months ended January 31 | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Three months ended July 31, | Nine months ended July 31, | | 2005 | 2004 | |||||||||||||||||
| | 2004 | 2003 | 2004 | 2003 | | In millions, except per share amounts | ||||||||||||||||
Net revenue: | Net revenue: | Net revenue: | |||||||||||||||||||||
Products | $ | 14,892 | $ | 13,792 | $ | 46,938 | $ | 42,670 | Products | $ | 17,041 | $ | 15,870 | ||||||||||
Services | 3,903 | 3,440 | 11,280 | 10,183 | Services | 4,321 | 3,536 | ||||||||||||||||
Financing income | 94 | 116 | 298 | 355 | Financing income | 92 | 108 | ||||||||||||||||
Total net revenue | 18,889 | 17,348 | 58,516 | 53,208 | Total net revenue | 21,454 | 19,514 | ||||||||||||||||
Costs and expenses: | Costs and expenses: | Costs and expenses: | |||||||||||||||||||||
Cost of products | 11,392 | 10,248 | 35,281 | 31,484 | Cost of products | 13,071 | 11,912 | ||||||||||||||||
Cost of services | 2,997 | 2,505 | 8,632 | 7,404 | Cost of services | 3,409 | 2,739 | ||||||||||||||||
Financing interest | 54 | 57 | 139 | 166 | Financing interest | 57 | 40 | ||||||||||||||||
Research and development | 862 | 895 | 2,647 | 2,744 | Research and development | 878 | 889 | ||||||||||||||||
Selling, general and administrative | 2,738 | 2,785 | 8,273 | 8,305 | Selling, general and administrative | 2,704 | 2,578 | ||||||||||||||||
Amortization of purchased intangible assets | 146 | 141 | 438 | 420 | Amortization of purchased intangible assets | 167 | 144 | ||||||||||||||||
Restructuring charges | 9 | 376 | 101 | 610 | Restructuring charges | 3 | 54 | ||||||||||||||||
Acquisition-related charges | 6 | 40 | 30 | 252 | Acquisition-related charges | — | 15 | ||||||||||||||||
In-process research and development charges | 28 | — | 37 | — | |||||||||||||||||||
Total costs and expenses | 20,289 | 18,371 | |||||||||||||||||||||
Total costs and expenses | 18,232 | 17,047 | 55,578 | 51,385 | |||||||||||||||||||
Earnings from operations | Earnings from operations | 1,165 | 1,143 | ||||||||||||||||||||
Earnings from operations | 657 | 301 | 2,938 | 1,823 | |||||||||||||||||||
Interest and other, net | Interest and other, net | 20 | 10 | 33 | 41 | Interest and other, net | 25 | 11 | |||||||||||||||
Gains (losses) on investments and other, net | 1 | (24 | ) | 5 | (41 | ) | |||||||||||||||||
(Losses) gains on investments | (Losses) gains on investments | (24 | ) | 9 | |||||||||||||||||||
Dispute settlement | Dispute settlement | — | — | (70 | ) | — | Dispute settlement | (116 | ) | — | |||||||||||||
Earnings before taxes | Earnings before taxes | 678 | 287 | 2,906 | 1,823 | Earnings before taxes | 1,050 | 1,163 | |||||||||||||||
Provision for (benefit from) taxes | 92 | (10 | ) | 500 | 146 | ||||||||||||||||||
Provision for taxes | Provision for taxes | 107 | 227 | ||||||||||||||||||||
Net earnings | Net earnings | $ | 586 | $ | 297 | $ | 2,406 | $ | 1,677 | Net earnings | $ | 943 | $ | 936 | |||||||||
Net earnings per share: | Net earnings per share: | Net earnings per share: | |||||||||||||||||||||
Basic | $ | 0.19 | $ | 0.10 | $ | 0.79 | $ | 0.55 | Basic | $ | 0.32 | $ | 0.31 | ||||||||||
Diluted | $ | 0.19 | $ | 0.10 | $ | 0.78 | $ | 0.55 | Diluted | $ | 0.32 | $ | 0.30 | ||||||||||
Cash dividends declared per share | Cash dividends declared per share | $ | 0.16 | $ | 0.16 | $ | 0.32 | $ | 0.32 | Cash dividends declared per share | $ | 0.16 | $ | 0.16 | |||||||||
Weighted-average shares used to compute net earnings per share: | |||||||||||||||||||||||
Weighted average shares used to compute net earnings per share: | Weighted average shares used to compute net earnings per share: | ||||||||||||||||||||||
Basic | 3,037 | 3,048 | 3,043 | 3,048 | Basic | 2,908 | 3,050 | ||||||||||||||||
Diluted | 3,057 | 3,071 | 3,077 | 3,063 | |||||||||||||||||||
Diluted | 2,936 | 3,088 | |||||||||||||||||||||
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Consolidated Condensed Balance Sheet(In millions, except par value)Sheets
| | January 31, 2005 | October 31, 2004 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | July 31, 2004 | October 31, 2003 | | In millions, except par value | |||||||||||||
| | (Unaudited) | | | (Unaudited) | | ||||||||||||
ASSETS | ASSETS | ASSETS | ||||||||||||||||
Current assets: | Current assets: | Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 13,985 | $ | 14,188 | Cash and cash equivalents | $ | 13,302 | $ | 12,663 | |||||||||
Short-term investments | 311 | 403 | Short-term investments | 298 | 311 | |||||||||||||
Accounts receivable, net of allowance for doubtful accounts of $278 and $347 as of July 31, 2004 and October 31, 2003, respectively | 8,465 | 8,921 | Accounts receivable | 8,665 | 10,226 | |||||||||||||
Financing receivables, net of allowance for doubtful accounts of $132 and $119 as of July 31, 2004 and October 31, 2003, respectively | 2,923 | 3,026 | Financing receivables | 2,810 | 2,945 | |||||||||||||
Inventory | 6,745 | 6,065 | Inventory | 7,120 | 7,071 | |||||||||||||
Other current assets | 8,283 | 8,351 | Other current assets | 9,520 | 9,685 | |||||||||||||
Total current assets | 40,712 | 40,954 | Total current assets | 41,715 | 42,901 | |||||||||||||
Property, plant and equipment, net of accumulated depreciation of $7,262 and $6,817 at July 31, 2004 and October 31, 2003, respectively | 6,245 | 6,482 | ||||||||||||||||
Property, plant and equipment | Property, plant and equipment | 6,690 | 6,649 | |||||||||||||||
Long-term financing receivables and other assets | Long-term financing receivables and other assets | 7,678 | 8,030 | Long-term financing receivables and other assets | 6,949 | 6,657 | ||||||||||||
Goodwill | Goodwill | 15,603 | 14,894 | Goodwill | 15,850 | 15,828 | ||||||||||||
Purchased intangible assets, net | 4,143 | 4,356 | ||||||||||||||||
Purchased intangible assets | Purchased intangible assets | 3,939 | 4,103 | |||||||||||||||
Total assets | Total assets | $ | 74,381 | $ | 74,716 | Total assets | $ | 75,143 | $ | 76,138 | ||||||||
LIABILITIES AND STOCKHOLDERS' EQUITY | LIABILITIES AND STOCKHOLDERS' EQUITY | LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||||||
Current liabilities: | Current liabilities: | Current liabilities: | ||||||||||||||||
Notes payable and short-term borrowings | $ | 2,803 | $ | 2,511 | ||||||||||||||
Notes payable and short-term borrowings | $ | 2,212 | $ | 1,080 | Accounts payable | 8,234 | 9,377 | |||||||||||
Accounts payable | 8,483 | 9,285 | Employee compensation and benefits | 1,685 | 2,208 | |||||||||||||
Employee compensation and benefits | 1,600 | 1,755 | Taxes on earnings | 1,438 | 1,709 | |||||||||||||
Taxes on earnings | 1,388 | 1,599 | Deferred revenue | 3,150 | 2,958 | |||||||||||||
Deferred revenue | 4,236 | 3,665 | Accrued restructuring | 158 | 193 | |||||||||||||
Accrued restructuring | 256 | 709 | Other accrued liabilities | 10,105 | 9,632 | |||||||||||||
Other accrued liabilities | 8,603 | 8,545 | ||||||||||||||||
Total current liabilities | 27,573 | 28,588 | ||||||||||||||||
Total current liabilities | 26,778 | 26,638 | ||||||||||||||||
Long-term debt | Long-term debt | 4,907 | 6,494 | Long-term debt | 4,408 | 4,623 | ||||||||||||
Other liabilities | Other liabilities | 3,985 | 3,838 | Other liabilities | 5,436 | 5,363 | ||||||||||||
Commitments and contingencies | Commitments and contingencies | Commitments and contingencies | ||||||||||||||||
Stockholders' equity: | Stockholders' equity: | Stockholders' equity: | ||||||||||||||||
Preferred stock, $0.01 par value (300 shares authorized; none issued) | — | — | Preferred stock, $0.01 par value (300 shares authorized; none issued) | — | — | |||||||||||||
Common stock, $0.01 par value (9,600 shares authorized; 3,030 and 3,043 shares issued and outstanding at July 31, 2004 and October 31, 2003, respectively) | 30 | 30 | Common stock, $0.01 par value (9,600 shares authorized; 2,902 and 2,911 shares issued and outstanding, respectively) | 29 | 29 | |||||||||||||
Additional paid-in capital | 24,257 | 24,587 | Additional paid-in capital | 21,849 | 22,129 | |||||||||||||
Retained earnings | 14,569 | 13,332 | Retained earnings | 16,011 | 15,649 | |||||||||||||
Accumulated other comprehensive loss | (145 | ) | (203 | ) | Accumulated other comprehensive loss | (163 | ) | (243 | ) | |||||||||
Total stockholders' equity | 38,711 | 37,746 | Total stockholders' equity | 37,726 | 37,564 | |||||||||||||
Total liabilities and stockholders' equity | Total liabilities and stockholders' equity | $ | 74,381 | $ | 74,716 | Total liabilities and stockholders' equity | $ | 75,143 | $ | 76,138 | ||||||||
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Consolidated Condensed StatementStatements of Cash Flows(In millions)
(Unaudited)
| | Three months ended January 31 | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Nine months ended July 31, | | 2005 | 2004 | |||||||||||||||||
| | 2004 | 2003 | | In millions | |||||||||||||||||
Cash flows from operating activities: | Cash flows from operating activities: | Cash flows from operating activities: | ||||||||||||||||||||
Net earnings | $ | 2,406 | $ | 1,677 | ||||||||||||||||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||||||||||||||||
Depreciation and amortization | 1,793 | 1,926 | Net earnings | $ | 943 | $ | 936 | |||||||||||||||
Provisions for bad debt and inventory | 290 | 363 | Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||||||||||||||
(Gains) losses on investments and other, net | (5 | ) | 41 | Depreciation and amortization | 612 | 565 | ||||||||||||||||
In-process research and development charges | 37 | — | Provision for bad debt and inventory | 133 | 94 | |||||||||||||||||
Acquisition-related charges | 30 | 252 | Restructuring charges | 3 | 54 | |||||||||||||||||
Restructuring charges | 101 | 610 | Acquisition-related charges | — | 15 | |||||||||||||||||
Deferred taxes on earnings | 217 | (184 | ) | Deferred taxes on earnings | 230 | 101 | ||||||||||||||||
Other, net | 21 | 57 | Other, net | 1 | 61 | |||||||||||||||||
Changes in assets and liabilities: | Changes in assets and liabilities: | |||||||||||||||||||||
Accounts and financing receivables | 1,020 | 1,300 | Accounts and financing receivables | 1,598 | 667 | |||||||||||||||||
Inventory | (950 | ) | (633 | ) | Inventory | (198 | ) | (520 | ) | |||||||||||||
Accounts payable | (843 | ) | 530 | Accounts payable | (1,143 | ) | (2,317 | ) | ||||||||||||||
Taxes on earnings | (211 | ) | (72 | ) | Taxes on earnings | (281 | ) | (102 | ) | |||||||||||||
Restructuring | (535 | ) | (971 | ) | Restructuring | (59 | ) | (271 | ) | |||||||||||||
Other assets and liabilities | (270 | ) | (1,222 | ) | Other assets and liabilities | (281 | ) | 865 | ||||||||||||||
Net cash provided by operating activities | 3,101 | 3,674 | Net cash provided by operating activities | 1,558 | 148 | |||||||||||||||||
Cash flows from investing activities: | Cash flows from investing activities: | Cash flows from investing activities: | ||||||||||||||||||||
Investment in property, plant and equipment | (1,387 | ) | (1,493 | ) | Investment in property, plant and equipment | (575 | ) | (425 | ) | |||||||||||||
Proceeds from sale of property, plant and equipment | 348 | 216 | Proceeds from sale of property, plant and equipment | 156 | 132 | |||||||||||||||||
Purchases of investments | (511 | ) | (369 | ) | Purchases of available-for-sale securities | (1,678 | ) | (214 | ) | |||||||||||||
Maturities and sales of investments | 785 | 640 | Sales of available-for-sale securities and other investments | 1,469 | 183 | |||||||||||||||||
Net cash paid for business acquisitions | (847 | ) | (71 | ) | Maturities of available-for-sale securities | 224 | 249 | |||||||||||||||
Payments made in connection with business acquisitions, net of acquisition costs | (7 | ) | (224 | ) | ||||||||||||||||||
Net cash used in investing activities | (1,612 | ) | (1,077 | ) | ||||||||||||||||||
Net cash used in investing activities | (411 | ) | (299 | ) | ||||||||||||||||||
Cash flows from financing activities: | Cash flows from financing activities: | Cash flows from financing activities: | ||||||||||||||||||||
Decrease in notes payable and short-term borrowings, net | (179 | ) | (257 | ) | Issuance (repayment) of commercial paper and notes payable, net | 111 | (89 | ) | ||||||||||||||
Issuance of debt | 9 | 776 | Issuance of debt | — | 9 | |||||||||||||||||
Payment of debt | (224 | ) | (556 | ) | Payment of long-term debt | (11 | ) | (151 | ) | |||||||||||||
Issuance of common stock under employee stock plans | 538 | 441 | Issuance of common stock under employee stock plans | 262 | 270 | |||||||||||||||||
Repurchase of common stock | (1,104 | ) | (549 | ) | Repurchase of common stock | (637 | ) | (256 | ) | |||||||||||||
Dividends | (732 | ) | (733 | ) | Dividends | (233 | ) | (244 | ) | |||||||||||||
Net cash used in financing activities | (1,692 | ) | (878 | ) | Net cash used in financing activities | (508 | ) | (461 | ) | |||||||||||||
(Decrease) increase in cash and cash equivalents | (203 | ) | 1,719 | |||||||||||||||||||
Increase (decrease) in cash and cash equivalents | Increase (decrease) in cash and cash equivalents | 639 | (612 | ) | ||||||||||||||||||
Cash and cash equivalents at beginning of period | Cash and cash equivalents at beginning of period | 14,188 | 11,192 | Cash and cash equivalents at beginning of period | 12,663 | 14,188 | ||||||||||||||||
Cash and cash equivalents at end of period | Cash and cash equivalents at end of period | $ | 13,985 | $ | 12,911 | Cash and cash equivalents at end of period | $ | 13,302 | $ | 13,576 | ||||||||||||
Supplemental schedule of noncash financing activities: | Supplemental schedule of noncash financing activities: | Supplemental schedule of noncash financing activities: | ||||||||||||||||||||
Net issuances of common stock for employee benefit and other plans | $ | 84 | $ | — | Net issuances of restricted stock | $ | 84 | $ | 31 |
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 1: Basis of Presentation and Significant Accounting Policies
Basis of Presentation
In the opinion of management, the accompanying Consolidated Condensed Financial Statements forof 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 JulyJanuary 31, 2004,2005, and its results of operations for the three and nine months ended July 31, 2004 and 2003, and its cash flows for the ninethree months ended JulyJanuary 31, 20042005 and 2003.2004. The Consolidated Condensed Balance Sheet as of October 31, 20032004 is derived from the October 31, 20032004 audited financial statements.
Certain reclassifications have been made to prior year amounts in order to conform to the current year presentation. In addition, a reclassification of certain information technology ("IT") infrastructure costs was made from selling, general and administrative expenses to cost of products, cost of services and research and development expenses to better align the IT costs with the functional areas they support. The impact of these reclassifications is an increase in cost of sales offset by an equal reduction of operating expenses, with no impact to consolidated or segment level earnings from operations.
The results of operations for the three and nine months ended JulyJanuary 31, 20042005 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 "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, of the Hewlett-Packard Company Annual Report on Form 10-K for the fiscal year ended October 31, 2003.2004.
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statementsHP's Consolidated Condensed Financial Statements and accompanying notes. Actual results could differ materially from those estimates.
Revenue Recognition
General
HP recognizes revenue when persuasive evidence of a sales arrangement exists, delivery occurs or services are rendered, the sales price or fee is fixed or determinable and collectibility is reasonably assured. The following policies apply to HP's major categories of revenue transactions.
Products
Product revenue consists mainly of revenue fromWhen a sales arrangement contains multiple elements, such as hardware and software product salesproducts, licenses and/or services, HP allocates revenue to each element based on its relative fair value. Fair value for software is determined based on vendor specific objective evidence ("VSOE") or, in the Imagingabsence of VSOE for all the elements, the residual method when VSOE exists for all the undelivered elements. In the absence of fair value for a delivered element, HP first allocates revenue to the fair value of the undelivered elements and Printing, Personal Systems, Enterprise Storagethe residual revenue to the delivered elements. Where the fair value for an undelivered element cannot be determined, HP defers revenue for the delivered elements until the undelivered elements are delivered. HP limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or subject to customer-specified return or refund privileges.
HP ceases revenue recognition on delinquent accounts based upon a number of factors, including customer credit history, number of days past due and Serversthe terms of the customer agreement. HP resumes revenue recognition and Software businesses, excluding therecognizes any associated deferred revenue generatedwhen appropriate customer actions are taken to remove accounts from service-related solutions in these businesses, which is included in services revenue as discussed below.delinquent status.
Products
Under HP's standard terms and conditions of sale, HP transfers title and risk of loss transfer to the customer at the time product is delivered to the customer and revenue is recognized accordingly, unless customer acceptance is uncertain or significant obligations remain. HP reduces revenue for estimated customer returns, price protection, rebates and other offerings that occur under sales programs established by HP directly or with HP's distributors and resellers. HP recognizes revenue allocated to software licenses at the inception of the license. Revenue from the sale of equipment under sales-type leases and direct-financing leases is recorded as product revenue at the inception of the lease. HP accrues the estimated cost of post-sale obligations, including basic product warranties, based on historical experience at the time HP recognizes revenue.
Revenue from software consists of software licensing and post-contract customer support. Software revenue is allocated to the license and support elements using vendor specific objective evidence of fair value ("VSOE") or, in the absence of VSOE for all the elements, the residual method when VSOE
exists for all the undelivered elements. The price charged when the element is sold separately generally determines VSOE. In the absence of VSOE of a delivered element, HP first allocates revenue to the fair value of the undelivered elements and the residual revenue to the delivered elements. HP recognizes revenue allocated to software licenses at the inception of the license. HP recognizes revenue allocated to post-contract customer support ratably over the term of the contract.
Services
Services revenue consists mainly of revenue from the HP Services business. In addition, services revenue also includes revenue generated from service related solutions in the Imaging and Printing, Personal Systems and Software businesses.
HP recognizes revenue from fixed pricefixed-price support or maintenance contracts, including extended warranty contracts and software post-contract support contracts, ratably over the contractualcontract period and recognizes the costs associated with these contracts as incurred. For time and material contracts, HP recognizes revenue and costs as services are rendered. HP recognizes revenueRevenue from fixed pricefixed-price consulting arrangements is recognized over the contractualcontract period on a proportional performance basis, as determined by the relationship of contractactual costs incurred to date andto the estimated total contract costs, which arewith estimates regularly revised during the life of the contract. For fixed price outsourcing contracts, HP recognizes revenue ratably over the contractual service period for fixed price contracts and recognizeson the costs associated with these contracts as incurred. For all other outsourcing contracts, HP recognizes revenue as earned on an output or consumption basis andfor all other outsourcing contracts. HP recognizes costs associated with theseoutsourcing contracts as incurred. HP amortizes revenue andincurred, unless such costs associated withrelate to the transition phase of the outsourcing contractscontract, in which case HP generally amortizes those costs over the contractual service period. Losses on fixed price contractsconsulting and outsourcing arrangements are recognized in the period that the contractual loss becomes evident.probable and estimable. HP records amounts invoiced to customers in excess of revenue recognized as deferred revenue until the revenue recognition criteria are met. HP records revenue that is earned and recognized in excess of amounts invoiced on fixed pricefixed-price contracts as trade receivables.
Financing
HP recognizes revenue from the sale of equipment under sales-type leases and direct-financing leases as product revenue at the inception of the lease. HP earns associated financing interest income on an accrual basis under an effective interest method. HP ceases revenue recognition on delinquent accounts based upon a number of factors, including customer credit history, number of days past due and the terms of the customer agreement. HP resumes revenue recognition and recognizes any associated deferred revenue when appropriate customer actions are taken to remove accounts from delinquent status. HP recognizes revenue from operating leases on an accrual basis as services revenue aswhen the rental payments become due.
Multiple Element ArrangementsFinancing Income
When elements such as hardware, softwareFinancing income is produced by sales-type and consulting servicesdirect-financing leases and is recognized on the accrual basis under the effective interest method. Certain financing receivables for which HP recorded specific reserves are contained in a single arrangement, or in related arrangementsplaced on nonaccrual status. Nonaccrual assets are those receivables with the same customer,specific reserves and other delinquent accounts for which it is likely that HP allocates revenuewill be unable to each element based on its relative fair value, provided that such element meets the criteria for treatment as a separate unit of accounting. The price charged when the element is sold separately generally
determines fair value. In the absence of fair value for a delivered element, HP allocates revenue firstcollect all amounts due according to the fair valueterms of the undelivered elements and allocatescustomer agreement. Income recognition is discontinued on these receivables. Financing receivables are removed from nonaccrual status when appropriate customer actions are taken to remove the residual revenue to the delivered elements.accounts from delinquent status.
In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a delay of revenue recognition for the delivered elements until the undelivered elements are fulfilled. HP limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services or subject to customer-specified return or refund privileges.
Stockholders' Equity
Stock-Based Compensation
HP applies the intrinsic-value-based method prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for employee stock-based
compensation. Accordingly, HP generally recognizes compensation expense only when it grants options with a discounted exercise price. HP recognizes any resulting compensation expense ratably over the associated service period, which is generally the option vesting term.
HP has determined pro forma net earnings and earnings per share informationamounts as if the fair value method described inrequired by Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock BasedStock-Based Compensation," had been applied to its employee stock-based compensation. The fair value of stock options and stock purchase rights were estimated on the date of grant using the Black-Scholes option pricing model.
The pro forma effect on net earnings and net earnings per share as if the fair value of stock-based compensation had been recognized as compensation expense on a straight-line basis over the vesting period of the stock option or purchase right werewas as follows for the three and nine months ended July 31, 2004 and 2003:follows:
| Three months ended July 31, | Nine months ended July 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 2003 | 2004 | 2003 | ||||||||||
| (In millions, except per share data) | |||||||||||||
Net earnings, as reported | $ | 586 | $ | 297 | $ | 2,406 | $ | 1,677 | ||||||
Add: Stock-based employee compensation expense included in reported net earnings, net of related tax effects | 10 | 10 | 22 | 24 | ||||||||||
Less: Total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects | (194 | ) | (217 | ) | (556 | ) | (629 | ) | ||||||
Pro forma net earnings | $ | 402 | $ | 90 | $ | 1,872 | $ | 1,072 | ||||||
Basic net earnings per share: | ||||||||||||||
As reported | $ | 0.19 | $ | 0.10 | $ | 0.79 | $ | 0.55 | ||||||
Pro forma | $ | 0.13 | $ | 0.03 | $ | 0.62 | $ | 0.35 | ||||||
Diluted net earnings per share: | ||||||||||||||
As reported | $ | 0.19 | $ | 0.10 | $ | 0.78 | $ | 0.55 | ||||||
Pro forma | $ | 0.13 | $ | 0.03 | $ | 0.61 | $ | 0.35 | ||||||
| Three months ended January 31 | |||||||
---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | ||||||
| In millions, except per share amounts | |||||||
Net earnings, as reported | $ | 943 | $ | 936 | ||||
Add: stock-based compensation included in reported net earnings, net of related tax effects | 11 | 6 | ||||||
Less: stock-based compensation expense determined under the fair-value based method for all awards, net of related tax effects | (142 | ) | (174 | ) | ||||
Pro forma net earnings | $ | 812 | $ | 768 | ||||
Basic net earnings per share: | ||||||||
As reported | $ | 0.32 | $ | 0.31 | ||||
Pro forma | $ | 0.28 | $ | 0.25 | ||||
Diluted net earnings per share: | ||||||||
As reported | $ | 0.32 | $ | 0.30 | ||||
Pro forma | $ | 0.28 | $ | 0.25 | ||||
StockShare Repurchases
HP repurchases shares of its common stock underhas a systematic program to manage the dilution created by shares issued under employee stock plans and for other purposes.share repurchase program. This program authorizes repurchases of common stock in the open market or in private transactions. HP had authorization for futurepaid $586 million and $256 million in connection with share repurchases of approximately $2.1 billion at July 31, 2004 and $1.2 billion of common stock under the program at October 31, 2003. In May 2004, the Board of Directors of HP authorized an additional $2.0 billion for future repurchases of HP's outstanding shares of common stock. HP repurchased 2429 million shares for an aggregate price of $500 million in the third quarter of fiscal 2004 and repurchased 5112 million shares, for an aggregate price of $1.1 billion in the first three quarters of fiscal 2004. HP repurchased 10 million shares for an aggregate price of $203 million in the third quarter of fiscal 2003 and repurchased 30 million shares for an aggregate price of $549 million in the first three quarters of fiscal 2003. For additional information on share repurchasesrespectively, during the third quarter of fiscal 2004, see "Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities—Issuer Purchases of Equity Securities."
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51," which addresses consolidation by business enterprises of variable interest entities ("VIEs") either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations on proposed modifications to FIN 46 and re-issued FIN 46 ("Revised Interpretation") resulting in multiple effective dates based on the nature as well as the creation date of the VIE. The Revised Interpretation for all VIEs was effective for HP's second quarter of fiscal 2004. HP has not entered into any material arrangements with VIEs created after January 31, 2003. Further, HP evaluated the provisions under the Revised Interpretation on its arrangements prior to February 1, 2003 and determined that HP did not create any material VIEs, including Special Purpose Entities, which have an impact on its financial position, results of operations and cash flows.
In December 2003, the FASB issued revised SFAS No. 132 (revised 2003), "Employer's Disclosure about Pensions and Other Post-Retirement Benefits." SFAS 132(R) revised employers' disclosure about pension plans and other post-retirement benefit plans. SFAS 132(R) requires additional disclosures in annual financial statements about the types of plan assets, investment strategy, measurement dates, plan obligations, cash flows, and components of net periodic benefit cost of defined benefit pension plans and other post-retirement benefit plans. The annual disclosure requirements are effective for fiscal years ending after December 15, 2003. SFAS 132(R) also requires interim disclosure of the elements of net periodic benefit cost and the total amount of contributions paid or expected to be paid during the current fiscal year if significantly different from amounts previously disclosed. The interim disclosure requirements of SFAS 132(R) were effective for HP's second quarter of fiscal 2004. HP early adopted the interim disclosure requirements in its Consolidated Condensed Financial Statements for the three months ended January 31, 2005 and 2004, as disclosedrespectively. In addition, HP had an accelerated share repurchase program (the "Program") with an investment bank which began in Note 11.September 2004 and was completed in November 2004. Under the Program, approximately 72 million shares were purchased for $1.3 billion, including the final $51 million price adjustment paid in November 2004. As of January 31, 2005, HP had authorization for remaining future repurchases of approximately $2.3 billion.
Recent Pronouncements
In March 2004,FASB Staff Position ("FSP") No. 109-2, "Accounting and Disclosure Guidance for the Emerging Issues Task ForceForeign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("EITF"FSP 109-2") reached a consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." EITF 03-1, provides guidance on other-than-temporary impairment models for marketable debt and equity securities accounted for under SFAS No. 115,109, "Accounting for Certain Investments in DebtIncome Taxes," with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the "Jobs Act") on income tax expense and Equity Securities," anddeferred tax liabilities. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 124, "Accounting for Certain Investments Held by Not-for-Profit Organizations," and non-marketable equity securities accounted for under109. HP expects to make its repatriation determination in the cost method. The EITF developed a basic three-step model to evaluate whether an investment is other-than-temporarily impaired. The provisions of EITF 03-1 will be effective for HP's fourthsecond quarter of fiscal 2004 and will be applied prospectively2005. Accordingly, as provided for in FSP 109-2, HP has not adjusted its tax expense or deferred tax liability to all current and future investments. Quantitative and qualitative disclosures required by EITF 03-1 for investments accounted for under SFAS No. 115 are effective for HP's fiscal year ending 2004. HP does not expectreflect the adoptionrepatriation provisions of EITF 03-1 to have a material effect on HP's results of operations and financial condition.the Jobs Act.
In May 2004, the FASB issued FASB Staff PositionFSP No. 106-2 ("FSP 106-2"), "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003" (the "Act""Medicare Act"). FSP 106-2 supersedes FSP 106-1, "Accounting and Disclosure Requirements Related to theThe Medicare Prescription Drug, Improvement and Modernization Act of 2003," and provides authoritative guidance on accounting for the federal subsidy specified in the Act. The Act provides for acertain federal subsidy equal to 28% of certain prescriptionsubsidies on drug claims for sponsors ofbenefits in retiree health care plans with drug benefits that are at least actuarially equivalent to those to be offered under Medicare Part D, beginning in 2006.plans. In the third quarter of fiscal 2004, HP has concluded that the prescription drug benefits provided under its plans are at least actuarially equivalent to the prescription drug benefits offered under Medicare Part D.
adopted FSP 106-2 provides that: 1)retroactive to December 8, 2003, the effect of the federal subsidy should be accounted for as an actuarial experience gain; 2) since the federal subsidy is exempt from federal taxes, any plan-related temporary income tax difference should exclude the effect of the subsidy; and 3) the effective date of FSP 106-2 is the first interim or annual period beginning after June 15, 2004, with early adoption encouraged.
HP has elected to adopt early the provisions of FSP 106-2 on a retroactive basis with measurement as of the enactment of the Medicare Act. As the annual measurement date for HP's postretirement benefit plans is September 30, HP's 2004 fiscal year expense is impacted by approximately 10 months. The expected subsidy reduced HP's accumulated postretirement benefit obligation ("APBO") by approximately $133 million, which HP recognized as a reduction in the unrecognized net actuarial loss. HP amortizes the unrecognized net actuarial loss and is amortizing over the average remaining service lifelives of HP's employees eligible for postretirement benefits.employees. The adoption of FSP 106-2 also affects service and interest costs associated with the plans and reduced the net periodic postretirement cost by approximately $10 million in fiscal 2004. The expenseThese amounts shown in Note 11 reflectwere based on the effectsestimated impact of the Medicare Act, pending issuance of final regulations. The final regulations, which were issued on January 21, 2005, are currently being evaluated and HP's estimates may be subject to revision upon the completion of this evaluation during the second quarter of fiscal 2005.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. HP expects to adopt SFAS 123R in the fourth quarter of fiscal 2005, beginning August 1, 2005. Under SFAS 123R, HP must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. HP is evaluating the requirements of SFAS 123R and expects that the adoption of SFAS 123R on August 1, 2005 will have a material impact on HP's consolidated results of operations and earnings per share. HP has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.
The adoption of the following recent accounting pronouncements did not have a material impact on HP's results of operations and financial condition:
In March 2005, the FASB issued FSP No. 46(R)-5, "Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities" ("FSP 46(R)-5"), which provides guidance for a reporting enterprise on whether it holds an implicit variable interest in a variable interest entity (VIE) or potential VIE when specific conditions exist. FSP 46(R)-5 is effective the first period beginning after March 3, 2005 and, accordingly, will be adopted by HP on May 1, 2005. HP is currently evaluating the effect that the adoption of FSP 106-2. HP may adjust these amounts in the future, as detailed regulations necessary46(R)-5 will have on its consolidated results of operations and financial condition but does not expect it to implement the Act have not been issued.a material impact.
Note 2: Net Earnings Per Share ("EPS")
HP's basic earnings per share ("EPS")EPS is calculated using net earnings and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes the effect offrom potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options.options and the assumed conversion of convertible notes.
The reconciliation of the numerators and denominators of the basic and diluted EPS calculations was as follows for the three and nine months ended July 31, 2004 and 2003:follows:
| | Three months ended July 31, | Nine months ended July 31, | | Three months ended January 31 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2004 | 2003 | 2004 | 2003 | | 2005 | 2004 | ||||||||||||||
| | (In millions, except per share amounts) | | In millions, except per share amounts | ||||||||||||||||||
Numerator: | Numerator: | Numerator: | ||||||||||||||||||||
Net earnings | $ | 586 | $ | 297 | $ | 2,406 | $ | 1,677 | Net earnings | $ | 943 | $ | 936 | |||||||||
Adjustment for interest expense on zero-coupon subordinated convertible notes, net of taxes | — | — | 6 | — | Adjustment for interest expense on zero-coupon subordinated convertible notes, net of taxes | 2 | 2 | |||||||||||||||
Net earnings, adjusted | $ | 586 | $ | 297 | $ | 2,412 | $ | 1,677 | Net earnings, adjusted | $ | 945 | $ | 938 | |||||||||
Denominator: | Denominator: | Denominator: | ||||||||||||||||||||
Weighted-average shares used to compute basic EPS | 3,037 | 3,048 | 3,043 | 3,048 | Weighted-average shares used to compute basic EPS | 2,908 | 3,050 | |||||||||||||||
Effect of dilutive securities: | Effect of dilutive securities: | |||||||||||||||||||||
Dilutive common stock equivalents | 20 | 23 | 26 | 15 | Dilution from employee stock plans | 20 | 30 | |||||||||||||||
Zero-coupon subordinated convertible notes | — | — | 8 | — | Zero-coupon subordinated convertible notes | 8 | 8 | |||||||||||||||
Dilutive potential common shares | 20 | 23 | 34 | 15 | Dilutive potential common shares | 28 | 38 | |||||||||||||||
Weighted-average shares used to compute diluted EPS | 3,057 | 3,071 | 3,077 | 3,063 | Weighted-average shares used to compute diluted EPS | 2,936 | 3,088 | |||||||||||||||
Net earnings per share: | Net earnings per share: | Net earnings per share: | ||||||||||||||||||||
Basic | $ | 0.19 | $ | 0.10 | $ | 0.79 | $ | 0.55 | Basic | $ | 0.32 | $ | 0.31 | |||||||||
Diluted | $ | 0.32 | $ | 0.30 | ||||||||||||||||||
Diluted | $ | 0.19 | $ | 0.10 | $ | 0.78 | $ | 0.55 | ||||||||||||||
In the thirdfirst quarter of fiscal 20042005 and 2003, HP excluded2004, options to purchase 413approximately 316 million and 357 million shares, respectively, and in the first nine months of fiscal 2004 and 2003, options to purchase 290 million and 365286 million shares, respectively, of HP stock were excluded from the calculation of diluted net earnings per shareEPS because the effect was antidilutive. Stock options are antidilutive when the exercise price of thesethe options wasis greater than the average market price of the common shares for the respective period, and therefore the effect would have been antidilutive.
Note 3: Acquisitions
In the first nine months of fiscal 2004, HP made acquisitions for an aggregate purchase price of approximately $538 million in net cash. The largest of these transactions was the acquisition of Triaton GmbH (with subsidiaries in Singapore, China and Brazil), Triaton France SAS and Triaton N.A, Inc. (USA) (collectively "Triaton"). Triaton is one of Germany's largest independent information technology ("IT") service providers. This acquisition is intended to increase HP's capacity to deliver its Adaptive Enterprise offerings, with customers benefiting from added managed services, customer support and consulting and integration capabilities. The remaining acquisitions primarily provide technology-management software that is intended to enhance the automation capabilities of the HP OpenView software portfolio and add breadth to the HP Adaptive Enterprise portfolio. In addition, in the first nine months of fiscal 2004, HP paid approximately $309 million in cash for additional shares of Digital GlobalSoft Limited, a consolidated subsidiary of HP ("DGS"), to increase HP's ownership from 50.1% to approximately 96.4%. DGS is a globally-focused software development and IT services company. This subsidiary enhances HP's capability in IT services, including expertise in life cycle services such as migration, technical and application services.
HP recorded approximately $747 million of goodwill and $225 million of amortizable purchased intangible assets in connection with these acquisitions. In accordance with SFAS No. 141 "Business Combinations," HP allocates the purchase price of its acquisitions to the tangible assets, liabilities and intangible assets acquired, including in-process research and development ("IPR&D"), based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill. The fair value assigned to intangible assets acquired is based on valuations prepared by independent third party appraisal firms using estimates and assumptions provided by management. The goodwill recorded as a result of these acquisitions is not expected to be deductible for tax purposes. HP has included the results of operations of these transactions prospectively from the respective dates of the transactions. HP has not presented the pro forma results of operations of the acquired businesses because the results are not material to HP's results of operations individually or in the aggregate.
Indigo
HP issued approximately 53 million non-transferable contingent value rights ("CVRs") in connection with the acquisition of Indigo N.V. in March 2002 that entitle each holder to a one-time contingent cash payment of up to $4.50 per CVR, based on the achievement of certain cumulative revenue results over a three-year period. The liability related to the CVRs will be recorded as additional goodwill as payout thresholds are achieved. The future cash pay-out, if any, of the CVRs will be payable after a three-year period that began on April 1, 2002 and could result in a maximum obligation of $237 million. HP has not incurred a liability associated with the CVRs as of July 31, 2004.
Note 3: Balance Sheet Details
Balance sheet details were as follows:
Accounts and Financing Receivables
| January 31, 2005 | October 31, 2004 | |||||
---|---|---|---|---|---|---|---|
| In millions | ||||||
Accounts receivable | $ | 8,921 | $ | 10,512 | |||
Allowance for doubtful accounts | (256 | ) | (286 | ) | |||
$ | 8,665 | $ | 10,226 | ||||
Financing receivables | $ | 2,915 | $ | 3,066 | |||
Allowance for doubtful accounts | (105 | ) | (121 | ) | |||
$ | 2,810 | $ | 2,945 | ||||
HP has revolving trade receivables-based facilities to sell certain trade receivables to third parties on a non-recourse basis. The facility with the largest volume is one that is subject to a maximum amount of 525 million euros (approximately $690 million) based on receivables not yet collected by the third party (the "Euro Program"). Trade receivables of approximately $1.8 billion were sold during the first quarter of fiscal 2005, including approximately $1.2 billion under the Euro Program. The aggregate receivables sold but not yet collected by the third parties were approximately $334 million at January 31, 2005, of which approximately $241 million related to the Euro Program. Fees associated with these facilities do not generally differ materially from the cash discounts offered to these customers under alternative prompt payment programs.
Inventory
| January 31, 2005 | October 31, 2004 | ||||
---|---|---|---|---|---|---|
| In millions | |||||
Finished goods | $ | 5,236 | $ | 5,322 | ||
Purchased parts and fabricated assemblies | 1,884 | 1,749 | ||||
$ | 7,120 | $ | 7,071 | |||
Note 4: Goodwill and Purchased Intangible Assets
Goodwill
Goodwill allocated to HP's reportablebusiness segments as of OctoberJanuary 31, 20032005 and changes in the carrying amount of goodwill for the ninethree months ended JulyJanuary 31, 20042005 are as follows:
| Enterprise Storage and Servers | Software | Enterprise Systems Group | Imaging and Printing Group | Personal Systems Group | HP Services | HP Financial Services | Total | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In millions) | ||||||||||||||||||||||||
Balance at October 31, 2003 | $ | — | $ | — | $ | 5,390 | $ | 1,508 | $ | 2,324 | $ | 5,522 | $ | 150 | $ | 14,894 | |||||||||
Reallocation (See Note 13) | 4,794 | 596 | (5,390 | ) | — | — | — | — | — | ||||||||||||||||
Goodwill acquired during the period | 11 | 168 | — | — | — | 568 | — | 747 | |||||||||||||||||
Goodwill adjustment | (14 | ) | (2 | ) | — | (3 | ) | (7 | ) | (12 | ) | — | (38 | ) | |||||||||||
Balance at July 31, 2004 | $ | 4,791 | $ | 762 | $ | — | $ | 1,505 | $ | 2,317 | $ | 6,078 | $ | 150 | $ | 15,603 | |||||||||
| HP Services | Enterprise Storage and Servers | Software | Personal Systems Group | Imaging and Printing Group | HP Financial Services | Total | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| In millions | ||||||||||||||||||||
Balance at October 31, 2004 | $ | 6,270 | $ | 4,810 | $ | 759 | $ | 2,327 | $ | 1,510 | $ | 152 | $ | 15,828 | |||||||
Goodwill acquired during the period | 5 | — | — | — | — | — | 5 | ||||||||||||||
Goodwill adjustment | 17 | — | — | — | — | — | 17 | ||||||||||||||
Balance at January 31, 2005 | $ | 6,292 | $ | 4,810 | $ | 759 | $ | 2,327 | $ | 1,510 | $ | 152 | $ | 15,850 | |||||||
The goodwill reallocation shown in the table above relates to the reorganization of HP's reportable segments discussed in Note 13. The goodwill formerly included in the Enterprise Systems Group was allocated between Enterprise Storage and Servers and Software based on a relative fair value approach.
The goodwill adjustment shown in the table above relates primarily to the reduction of a restructuring liability and asset impairments associated with the fiscal 2002 and 2001 pre-acquisition Compaq restructuring plans. The reduction of the restructuring liability and asset impairments adjusted original estimates to actual costs incurred at various locations throughout the world.
In accordance with SFAS No. 142, "Goodwill and OtherPurchased Intangible Assets" HP reviews goodwill and purchased intangible assets with indefinite lives (specifically, the Compaq tradename) for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recovered. HP is currently in the process of performing its annual impairment test for goodwill and purchased intangible assets with indefinite lives as of August 1, 2004. HP will complete this analysis in the fourth quarter of fiscal 2004.
HP's finite-lived purchased intangible assets consist of customer contracts, customer lists and distribution agreements, which have weighted average useful lives of approximately nine years, and developed and core technology, patents and product trademarks, which have weighted average useful lives of approximately six years.
HP's purchased intangible assets at July 31, 2004 and October 31, 2003associated with completed acquisitions are composed of:
| July 31, 2004 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| Gross | Accumulated Amortization | Net | ||||||
| (In millions) | ||||||||
Customer contracts, customer lists and distribution agreements | $ | 2,222 | $ | (572 | ) | $ | 1,650 | ||
Developed and core technology and patents | 1,701 | (679 | ) | 1,022 | |||||
Product trademarks | 89 | (40 | ) | 49 | |||||
Total amortizable purchased intangible assets | 4,012 | (1,291 | ) | 2,721 | |||||
Compaq trade name | 1,422 | — | 1,422 | ||||||
Total purchased intangible assets | $ | 5,434 | $ | (1,291 | ) | $ | 4,143 | ||
October 31, 2003 | |||||||||
---|---|---|---|---|---|---|---|---|---|
| Gross | Accumulated Amortization | Net | ||||||
| (In millions) | ||||||||
Customer contracts, customer lists and distribution agreements | $ | 2,040 | $ | (371 | ) | $ | 1,669 | ||
Developed and core technology and patents | 1,663 | (457 | ) | 1,206 | |||||
Product trademarks | 84 | (25 | ) | 59 | |||||
Total amortizable purchased intangible assets | 3,787 | (853 | ) | 2,934 | |||||
Compaq trade name | 1,422 | — | 1,422 | ||||||
Total purchased intangible assets | $ | 5,209 | $ | (853 | ) | $ | 4,356 | ||
| January 31, 2005 | October 31, 2004 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Gross | Accumulated Amortization | Net | Gross | Accumulated Amortization | Net | ||||||||||||
| In millions | |||||||||||||||||
Customer contracts, customer lists and distribution agreements | $ | 2,340 | $ | (726 | ) | $ | 1,614 | $ | 2,340 | $ | (637 | ) | $ | 1,703 | ||||
Developed and core technology and patents | 1,707 | (848 | ) | 859 | 1,704 | (775 | ) | 929 | ||||||||||
Product trademarks | 93 | (49 | ) | 44 | 93 | (44 | ) | 49 | ||||||||||
Total amortizable purchased intangible assets | 4,140 | (1,623 | ) | 2,517 | 4,137 | (1,456 | ) | 2,681 | ||||||||||
Compaq trade name | 1,422 | — | 1,422 | 1,422 | — | 1,422 | ||||||||||||
Total purchased intangible assets | $ | 5,562 | $ | (1,623 | ) | $ | 3,939 | $ | 5,559 | $ | (1,456 | ) | $ | 4,103 | ||||
Estimated future amortization expense related to finite-lived purchased intangible assets at JulyJanuary 31, 20042005 is as follows:
Fiscal year: | (In millions) | In millions | ||||
---|---|---|---|---|---|---|
2004 (remaining 3 months) | $ | 145 | ||||
2005 | 558 | |||||
2005 (remaining 9 months) | $ | 421 | ||||
2006 | 508 | 523 | ||||
2007 | 441 | 458 | ||||
2008 | 386 | 396 | ||||
2009 | 321 | |||||
Thereafter | 683 | 398 | ||||
Total | $ | 2,721 | $ | 2,517 | ||
Note 5: Restructuring Charges and Workforce Rebalancing
First Quarter 2005 Workforce Rebalancing
In the first quarter of fiscal 2005, HP incurred approximately $60 million in workforce rebalancing charges within certain business segments, primarily for severance and related costs. Of this amount, approximately $20 million had been paid as of January 31, 2005 and the remainder is expected to be paid by the end of fiscal 2005.
Fiscal 2003 Restructuring Plans
In the second, third and fourth quarters ofDuring fiscal 2003, HP's management approved and implemented plans to restructure certain of its operations. These actions included workforce reductions associatedplans were entered into with the intent of better managing HP's cost structure to align it betterand aligning certain of its operations more effectively with current business conditions, as well as costs ofconditions. The initial charge for these actions totaled $752 million and included $639 million relating to severance and other employee benefits for workforce reductions, $42 million for vacating duplicative facilities (leased or owned) and contract termination costs. The second
quarter action also includedcosts, and asset impairments of $71 million associated with the identification of duplicative assets and facilities (leased or owned) relating to the acquisition of Compaq.Compaq Computer Corporation ("Compaq").
The total amountOriginal estimates of costs expected to be incurred, costs incurred to date and costs incurred in the three and nine months ended July 31, 2004 associated with the fiscal 2003 actions by type of cost and operating segment are as follows:
| Total amount of costs expected to be incurred | Total amount of costs incurred to date | Costs incurred in the three months ended July 31, 2004 | Costs incurred in the nine months ended July 31, 2004 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In millions) | ||||||||||||
By Type: | |||||||||||||
2Q03 Action | |||||||||||||
Employee severance and other employee benefits | $ | 135 | $ | 135 | $ | — | $ | — | |||||
Asset impairments | 74 | 74 | (8 | ) | 3 | ||||||||
Other related restructuring activities | 51 | 46 | 8 | 17 | |||||||||
Total | $ | 260 | $ | 255 | $ | — | $ | 20 | |||||
3Q03 Action | |||||||||||||
Employee severance and other employee benefits | $ | 330 | $ | 330 | $ | (12 | ) | $ | (12 | ) | |||
Asset impairments | — | — | — | — | |||||||||
Other related restructuring activities | — | — | — | — | |||||||||
Total | $ | 330 | $ | 330 | $ | (12 | ) | $ | (12 | ) | |||
4Q03 Action | |||||||||||||
Employee severance and other employee benefits | $ | 178 | $ | 178 | $ | (16 | ) | 16 | |||||
Asset impairments | — | — | — | — | |||||||||
Other related restructuring activities | 23 | 20 | — | 7 | |||||||||
Total | $ | 201 | $ | 198 | $ | (16 | ) | $ | 23 | ||||
Total FY03 Actions | |||||||||||||
Employee severance and other employee benefits | $ | 643 | $ | 643 | $ | (28 | ) | $ | 4 | ||||
Asset impairments | 74 | 74 | (8 | ) | 3 | ||||||||
Other related restructuring activities | 74 | 66 | 8 | 24 | |||||||||
Total | $ | 791 | $ | 783 | $ | (28 | ) | $ | 31 | ||||
By Segment: | |||||||||||||
2Q03 Action | |||||||||||||
Enterprise Storage and Servers | $ | 12 | $ | 12 | $ | — | $ | — | |||||
Software | 1 | 1 | — | — | |||||||||
Personal Systems Group | 27 | 27 | — | — | |||||||||
HP Services | 135 | 135 | — | — | |||||||||
Other infrastructure costs | 85 | 80 | — | 20 | |||||||||
Total | $ | 260 | $ | 255 | $ | — | $ | 20 | |||||
3Q03 Action | |||||||||||||
Enterprise Storage and Servers | $ | 109 | $ | 109 | $ | — | $ | 4 | |||||
Software | 10 | 10 | — | — | |||||||||
Personal Systems Group | 22 | 22 | (12 | ) | (22 | ) | |||||||
HP Services | 120 | 120 | — | 3 | |||||||||
Other infrastructure costs | 69 | 69 | — | 3 | |||||||||
Total | $ | 330 | $ | 330 | $ | (12 | ) | $ | (12 | ) | |||
4Q03 Action | |||||||||||||
Enterprise Storage and Servers | $ | 32 | $ | 32 | $ | (2 | ) | $ | 9 | ||||
Software | 2 | 2 | — | — | |||||||||
Personal Systems Group | 2 | 2 | (7 | ) | (26 | ) | |||||||
HP Services | 92 | 92 | (7 | ) | 16 | ||||||||
Other infrastructure costs | 73 | 70 | — | 24 | |||||||||
Total | $ | 201 | $ | 198 | $ | (16 | ) | $ | 23 | ||||
Total FY03 Actions | |||||||||||||
Enterprise Storage and Servers | $ | 153 | $ | 153 | $ | (2 | ) | $ | 13 | ||||
Software | 13 | 13 | — | — | |||||||||
Personal Systems Group | 51 | 51 | (19 | ) | (48 | ) | |||||||
HP Services | 347 | 347 | (7 | ) | 19 | ||||||||
Other infrastructure costs | 227 | 219 | — | 47 | |||||||||
Total | $ | 791 | $ | 783 | $ | (28 | ) | $ | 31 | ||||
The charges for the second, third and fourth quarters of fiscal 2003 are associated primarily with severance, early retirement and other employee benefits related to the termination or early retirement of approximately 2,300, 4,600 and 1,7009,000 employees worldwide, respectively, across many regions and job classes.classes were included in the 2003 workforce reduction plans. As of JulyJanuary 31, 2004,2005, approximately 2,300, 4,600 and 1,2008,300 of these employees had been terminated, placed in the workforce reduction programs or had retired, respectively.retired. An additional 100 employees are expected to leave during fiscal 2005, bringing the total estimated number of employees for the 2003 plans to 8,400, a reduction of 600 employees from the original estimate. HP expects to pay out the majority of the remaining costs relating to severance and other employee benefits in connectionduring fiscal 2005, with the fourth quarter actions by the end ofpayments under phased retirement plans required in certain international locations continuing through fiscal 2004. HP has terminated substantially all of the
employees associated with the second and third quarter actions have been terminated and HP has paid substantially all accrued costs related to severance and other related employee benefits.
2010. HP anticipates the remaining costs of vacating duplicative facilities and contract terminations associated with the second and fourth quarter actions to be substantially settled by the end of fiscal 2005.
HP made certain reclassifications between the operating segments to the total amount of costs expected to be incurred, total amount of costs incurred to date, and costs incurred in the three and nine months ended July 31, 2004 related to the fiscal 2003 restructuring plans. These changes were due primarily to adjustments of original estimates to actual costs by segment.
Fiscal 2002 Restructuring Plans
In fiscal 2002, HP's management initiated and approved plans to restructure the operations of both the pre-acquisition HP and pre-acquisition Compaq organizations. Consequently, HP recordedaddition, approximately $1.8 billion of costs associated with exiting the activities of pre-acquisition HP such as severance, early retirement and other employee benefits, costs of vacating duplicative facilities (leased or owned), contract termination costs, asset impairment charges and other costs associated with exiting activities of HP. HP accounted for the cost to restructure its pre-acquisition organization under EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity," and included these costs as a charge to the results of operations for the fiscal year ended October 31, 2002. HP recorded approximately $960$1 million of similar restructuring costs in connection with restructuring the pre-acquisition Compaq organization, and accounted for the costs to restructure pre-acquisition Compaq under EITF Issue No. 95-3, "Recognition of Liabilities in Connection with Purchase Business Combinations." HP recognized these costs as a liability assumed in the purchase business combination and included them in the allocation of the cost to acquire Compaq. In the three and nine months ended July 31, 2004, HP recorded $37 million and $70 million, respectively of additional costs, net of reductions, in estimated severance and other employee benefits and other restructuring costs related to the 2003 plans have not yet been accrued and will be charged to expense as the restructuring activities occur during fiscal 2005.
Fiscal 2002 restructuring plans. Additionally, in the third quarter of fiscal 2004,and 2001 Restructuring Plans
On May 3, 2002, HP recorded an adjustment to reduce goodwill for $47 million related to true-ups to the fiscal 2002 restructuring plans.
The severance, early retirement costs and other employee benefits related to the termination or planned early retirement of 17,600 employees worldwide across many regions, business functions and job classes. As of July 31, 2004, HP had terminated substantiallyacquired all of the employees includedoutstanding stock of Compaq. At that time, both HP and Compaq had restructuring liabilities for 2001 restructuring plans, of which $3 million and $65 million, respectively, remain at January 31, 2005. Restructuring plans established in 2002 in connection with the workforce reduction program or they had retired.Compaq acquisition resulted in additional restructuring liabilities aggregating $2.7 billion. Of this amount, an aggregate $1.8 billion was recorded as restructuring charges during fiscal 2002, 2003 and 2004, while $960 million was recorded as of the acquisition date as part of the Compaq purchase price allocation. At January 31, 2005, the remaining restructuring liabilities for the HP and Compaq-related 2002 restructuring plans were $23 million and $100 million, respectively. The 2001 and 2002 restructuring plans are substantially complete, although minor revisions to previous estimates are recorded as necessary. The aggregate $191 million restructuring liability as of January 31, 2005 primarily relates to facility lease obligations. HP expects to pay the majority of the remaining balance of the severance accrual by the end of fiscal 2004. HP anticipates paying the other related restructuring activities, which consist primarily of contractualout these obligations such as facility leases, over the life of the related obligations. HP expectsobligations, which extend to settle a substantial portion of these obligations by the end of fiscal 2005.
Fiscal 2001 Restructuring Plan
As part of the acquisition of Compaq, HP acquired the remaining obligations of Compaq's existing restructuring plans of $259 million, which Compaq initially recorded in its 2001 fiscal year. The2010.
remaining balance of fiscal 2001 plans consists primarily of severance and other employee benefits as well as other restructuring costs associated with the pre-acquisition Compaq plan. In the third quarter of fiscal 2004, HP recorded an adjustment to increase goodwill for $5 million related to true-ups to the fiscal 2001 restructuring plans. HP expects to settle the majority of the remaining balance of the severance accrual by the end of fiscal 2004. HP anticipates paying the other related restructuring activities, which consist primarily of contractual obligations such as facility leases, over the life of the related obligations. HP expects to settle a substantial portion of these obligations by the end of fiscal 2005.
Summary of all Restructuring Plans
The activity in the accrued restructuring balances related to all of the plans described above was as follows for the nine months ended July 31, 2004:first quarter of fiscal 2005:
| | | | | | | As of January 31, 2005 | ||||||||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Balance, October 31, 2003 | Adjustments | Cash Payments | Non-cash Settlements | Goodwill Adjustments | Currency Impact | Balance, July 31, 2004 | | Balance, October 31, 2004 | Three months ended January 31, 2005 charges (reversals) | Cash payments | Non-cash settlements and other adjustments | Balance, January 31, 2005 | Total costs and impairments incurred to date | Total expected costs and asset impairments | |||||||||||||||||||||||||||||
| | (In millions) | | In millions | |||||||||||||||||||||||||||||||||||||||||
Fiscal 2003 plans: | Fiscal 2003 plans: | Fiscal 2003 plans: | |||||||||||||||||||||||||||||||||||||||||||
Employee severance and other employee benefits | $ | 239 | $ | 4 | $ | (177 | ) | $ | — | $ | — | $ | 1 | $ | 67 | Employee severance and other benefits charges (by segment): | |||||||||||||||||||||||||||||
Other related restructuring activities | 37 | 24 | (37 | ) | — | — | — | 24 | Enterprise Storage and Servers | $ | 153 | $ | 153 | ||||||||||||||||||||||||||||||||
Asset impairments | — | 3 | — | (3 | ) | — | — | — | Software | 13 | 13 | ||||||||||||||||||||||||||||||||||
Personal Systems Group | $ | (9 | ) | 42 | 42 | ||||||||||||||||||||||||||||||||||||||||
Total | 276 | 31 | (214 | ) | (3 | ) | — | 1 | 91 | HP Services | 349 | 349 | |||||||||||||||||||||||||||||||||
Other infrastructure | 79 | 79 | |||||||||||||||||||||||||||||||||||||||||||
Fiscal 2002 plans: | |||||||||||||||||||||||||||||||||||||||||||||
Employee severance and other employee benefits | 230 | 24 | (198 | ) | — | 5 | 1 | 62 | |||||||||||||||||||||||||||||||||||||
Other related restructuring activities | 190 | 46 | (104 | ) | — | (20 | ) | — | 112 | Employee severance and other benefits | $ | 57 | $ | (9 | ) | $ | (19 | ) | $ | 1 | $ | 30 | $ | 636 | $ | 636 | |||||||||||||||||||
Asset impairments | — | — | — | 32 | (32 | ) | — | — | Asset impairments | — | (6 | ) | — | 6 | — | 71 | 71 | ||||||||||||||||||||||||||||
Infrastructure—other related restructuring activities | 21 | 3 | (3 | ) | — | 21 | 70 | 71 | |||||||||||||||||||||||||||||||||||||
Total | 420 | 70 | (302 | ) | 32 | (47 | ) | 1 | 174 | ||||||||||||||||||||||||||||||||||||
Total | $ | 78 | $ | (12 | ) | $ | (22 | ) | $ | 7 | $ | 51 | $ | 777 | $ | 778 | |||||||||||||||||||||||||||||
Fiscal 2001 plans: | |||||||||||||||||||||||||||||||||||||||||||||
Employee severance and other employee benefits | 26 | — | (7 | ) | — | — | — | 19 | |||||||||||||||||||||||||||||||||||||
Other related restructuring activities | 85 | — | (12 | ) | — | 5 | — | 78 | |||||||||||||||||||||||||||||||||||||
Total | 111 | — | (19 | ) | — | 5 | — | 97 | |||||||||||||||||||||||||||||||||||||
Fiscal 2002 and 2001 plans | Fiscal 2002 and 2001 plans | 210 | 15 | (37 | ) | 3 | 191 | $ | 3,330 | $ | 3,330 | ||||||||||||||||||||||||||||||||||
Total restructuring plans | Total restructuring plans | $ | 807 | $ | 101 | $ | (535 | ) | $ | 29 | $ | (42 | ) | $ | 2 | $ | 362 | Total restructuring plans | $ | 288 | $ | 3 | $ | (59 | ) | $ | 10 | $ | 242 | ||||||||||||||||
At JulyJanuary 31, 20042005 and October 31, 2003, HP included2004, the long-term portion of the restructuring liabilityliabilities of $106$84 million and $98$95 million, respectively, is included in otherOther liabilities in the accompanying Consolidated Condensed Balance Sheet.Sheets.
Note 6: Financing Receivables and Operating Leases
Financing receivables represent sales-type and direct-financing leases resulting from the marketing of HP's and complementary third-party products. These receivables typically have terms 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 net financing
receivables, which are included in financing receivables and long-term financing receivables and other assets, were as follows:
| January 31, 2005 | October 31, 2004 | ||||||
---|---|---|---|---|---|---|---|---|
| In millions | |||||||
Minimum lease payments receivable | $ | 5,318 | $ | 5,328 | ||||
Allowance for doubtful accounts | (189 | ) | (213 | ) | ||||
Unguaranteed residual value | 392 | 394 | ||||||
Unearned income | (435 | ) | (396 | ) | ||||
Financing receivables, net | 5,086 | 5,113 | ||||||
Less current portion | (2,810 | ) | (2,945 | ) | ||||
Amounts due after one year, net | $ | 2,276 | $ | 2,168 | ||||
Equipment leased to customers under operating leases was $2.4 billion at January 31, 2005 and $2.3 billion at October 31, 2004, and is included in machinery and equipment. Accumulated depreciation on equipment under lease was $1.0 billion at January 31, 2005 and $0.9 billion at October 31, 2004.
Note 7: Guarantees
Indemnifications
In the ordinary course of business, HP enters into contractual arrangements under which HP may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of HP or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial.
Warranty
HP provides for the estimated cost of product warranties at the time it recognizes revenue. HP engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers; however, product warranty terms offered to customers, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product class failures outside of HP's baseline experience, affect the estimated warranty obligation. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions to the estimated warranty liability would be required.
The changes in HP's aggregate product warranty liability are as follows:
| In millions | |||
---|---|---|---|---|
Product warranty liability at October 31, 2004 | $ | 2,040 | ||
Accruals for warranties issued | 619 | |||
Adjustments related to pre-existing warranties (including changes in estimates) | (3 | ) | ||
Settlements made (in cash or in kind) | (599 | ) | ||
Product warranty liability at January 31, 2005 | $ | 2,057 | ||
Deferred Revenue
The components of deferred revenue are as follows:
| January 31, 2005 | October 31, 2004 | |||||
---|---|---|---|---|---|---|---|
| In millions | ||||||
Deferred support contract services revenue | $ | 2,888 | $ | 2,780 | |||
Other deferred revenue | 1,652 | 1,568 | |||||
Total deferred revenue | 4,540 | 4,348 | |||||
Less current portion | 3,150 | 2,958 | |||||
Long-term deferred revenue | $ | 1,390 | $ | 1,390 | |||
Deferred support contract services revenue represents amounts received or billed in advance primarily for fixed-price support or maintenance contracts. These services include stand-alone product support packages, routine maintenance service contracts, upgrades or extensions to standard product warranty, as well as high availability services for complex, global, networked, multi-vendor environments. These service amounts are deferred at the time the customer is billed and then recognized ratably over the contract life or as the services are rendered.
Other deferred revenue represents amounts received or billed in advance for contracts related primarily to consulting and integration projects, managed services start-up or transition work, as well as minor amounts for training, and product sales. HP recognizes the majority of these amounts as revenue based on the proportional performance method.
Note 8: Borrowings
Notes Payable and Short-Term Borrowings
Notes payable and short-term borrowings, including the current portion of long-term debt, were as follows:
| January 31, 2005 | October 31, 2004 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
| Amount Outstanding | Weighted Average Interest Rate | Amount Outstanding | Weighted Average Interest Rate | ||||||
| In millions | |||||||||
Current portion of long-term debt | $ | 2,035 | 6.8% | $ | 1,861 | 7.1% | ||||
Commercial paper | 323 | 2.2% | 306 | 2.2% | ||||||
Notes payable to banks, lines of credit and other | 445 | 2.9% | 344 | 2.4% | ||||||
$ | 2,803 | $ | 2,511 | |||||||
Notes payable to banks, lines of credit and other includes deposits associated with banking-related activities of approximately $299 million and $241 million at January 31, 2005 and October 31, 2004, respectively.
Long-Term Debt
Long-term debt was as follows:
| January 31, 2005 | October 31, 2004 | ||||||
---|---|---|---|---|---|---|---|---|
| In millions | |||||||
U.S. Dollar Global Notes | ||||||||
$1,500 issued June 2000 at 7.15%, due June 2005 | $ | 1,500 | $ | 1,499 | ||||
$1,000 issued December 2001 at 5.75%, due December 2006 | 998 | 998 | ||||||
$1,000 issued June 2002 at 5.5%, due July 2007 | 997 | 997 | ||||||
$500 issued June 2002 at 6.5%, due July 2012 | 498 | 498 | ||||||
$500 issued March 2003 at 3.625%, due March 2008 | 498 | 498 | ||||||
4,491 | 4,490 | |||||||
Euro Medium-Term Note Programme | ||||||||
€750 issued July 2001 at 5.25%, due July 2006 | 976 | 954 | ||||||
Series A Medium-Term Notes | ||||||||
$200 issued December 2002 at 3.375%, due December 2005 | 200 | 200 | ||||||
$50 issued in December 2002 at 4.25%, due December 2007 | 50 | 50 | ||||||
250 | 250 | |||||||
Other | ||||||||
$300, Medium-Term Notes assumed from Compaq, issued at 7.65%, due August 2005 | 300 | 300 | ||||||
$505, U.S. dollar zero-coupon subordinated convertible notes, issued in October and November 1997 at an imputed rate of 3.13%, due 2017 ("LYONs") | 341 | 338 | ||||||
Other, including capital lease obligations, at 3.96%-9.17%, due 2005-2023 | 89 | 108 | ||||||
430 | 446 | |||||||
Fair value adjustment related to SFAS No. 133 | (4 | ) | 44 | |||||
Less current portion | (2,035 | ) | (1,861 | ) | ||||
$ | 4,408 | $ | 4,623 | |||||
HP may redeem some or all of the Global Notes, Medium Term Notes, Series A Medium Term Notes and the Euro Medium-Term Notes (collectively, the "Notes"), as set forth in the above table, at any time at the redemption prices described in the prospectus supplements relating thereto. The Notes are senior unsecured debt.
The LYONs are convertible by the holders at an adjusted rate of 15.09 shares of HP common stock for each $1,000 face value of the LYONs, payable in either cash or common stock at HP's election. At any time, HP may redeem the LYONs at book value, payable in cash only. In December 2000, the Board of Directors authorized a repurchase program for the LYONs that allowed HP to repurchase the LYONs from time to time at varying prices. The last repurchase under this program occurred in fiscal 2002.
HP established a $4.0 billion U.S. commercial paper program in December 2000. Hewlett-Packard International Bank PLC, a wholly-owned subsidiary of HP, established a $500 million Euro Commercial Paper/Certificate of Deposit Programme in May 2001.
HP's $1.7 billion 364-day credit facility expiring in March 2004 and $1.3 billion three-year credit facility expiring in March 2005 were replaced with a $1.5 billion 364-day credit facility and a $1.5 billion five-year credit facility, respectively, in March 2004 (together, the "Credit Facilities"). Interest rates and other terms of borrowing under the Credit Facilities vary, as applicable, based on HP's external credit ratings. The Credit Facilities, which are subject to weighted average commitment fees of eight basis points per annum on the unused portion, are senior unsecured committed borrowing arrangements and available for general corporate purposes, including supporting the issuance of commercial paper. At January 31, 2005, no amounts were outstanding under the Credit Facilities.
HP also maintains, through various foreign subsidiaries, lines of credit from a number of financial institutions.
HP registered the sale of up to $3.0 billion of debt or global securities ("Global Notes"), common stock, preferred stock, depositary shares and warrants under a shelf registration statement in March 2002 (the "2002 Shelf Registration Statement"). In December 2002, HP filed a supplement to the 2002 Shelf Registration Statement, which allows HP to offer from time to time up to $1.5 billion of Medium-Term Notes, Series B, due nine months or more from the date of issuance (the "Series B Medium-Term Note Program"). As of January 31, 2005, HP has not issued Medium-Term Notes pursuant to the Series B Medium-Term Note Program.
HP registered the sale of up to $3.0 billion of Medium-Term Notes under its Euro Medium-Term Note Programme filed with the Luxembourg Stock Exchange and has offered such notes as set forth in the table above. HP can denominate these notes in any currency including the euro. However, these notes have not been and will not be registered in the United States.
At January 31, 2005, HP has available borrowing resources of up to $12.7 billion under the 2002 Shelf Registration Statement, credit facilities and other programs described above.
Note 9: Income Taxes
Provision for Taxes
HP's effective tax rate was 10.2% and 19.5% for the three months ended January 31, 2005 and 2004, respectively. HP's effective tax rate generally differs from the U.S. federal statutory rate of 35% due to the tax rate benefits of certain earnings from operations in lower-tax jurisdictions throughout the world for which no U.S. taxes have been provided because such earnings are planned to be reinvested indefinitely outside the U.S. However, other items further reduced the effective tax rate for the 2005 period, including $61 million in net adjustments to previously estimated tax liabilities. An agreement with the Internal Revenue Service resulted in a $105 million adjustment primarily to reduce accruals of U.S. taxes on earnings outside the U.S. This was partly offset by $44 million in net unfavorable adjustments to other previously estimated tax liabilities, predominantly in non-U.S. jurisdictions. Also benefiting the effective tax rate for the first quarter of fiscal 2005 was the dispute settlement with Intergraph Hardware Technologies Company ("Intergraph"). HP recorded a pre-tax charge of $116 million related to this settlement. As the settlement is deductible from U.S. taxable income at the statutory rate of 35%, the effective tax rate for the first quarter of fiscal 2005 was reduced by an additional 2.4%.
American Jobs Creation Act of 2004—Repatriation of Foreign Earnings
The American Jobs Creation Act of 2004 (the "Jobs Act"), enacted on October 22, 2004, provides for a temporary 85% dividends received deduction on certain foreign earnings repatriated during a one-year period. The deduction would result in an approximate 5.25% federal tax rate on the repatriated earnings. To qualify for the deduction, the earnings must be reinvested in the United States pursuant to a domestic reinvestment plan established by a company's chief executive officer and approved by the company's board of directors. Certain other criteria in the Jobs Act must be satisfied as well. The maximum amount of HP's foreign earnings that qualify for the temporary deduction is $14.5 billion. For HP, the one-year period during which the qualifying distributions can be made is fiscal 2005.
HP continues to evaluate whether it will repatriate foreign earnings under the repatriation provisions of the Jobs Act. Up to $14.5 billion is being considered for possible repatriation. HP's estimate of the range of tax expense it would accrue on a maximum repatriation eligible for the temporary deduction remains between $850 million and $925 million. HP expects to make its repatriation determination by the end of its second fiscal quarter of 2005.
Deferred tax assets were as follows:
| January 31, 2005 | October 31, 2004 | ||||
---|---|---|---|---|---|---|
| In millions | |||||
Deferred tax assets—short term | $ | 3,454 | $ | 3,744 | ||
Deferred tax assets—long term | 2,129 | 2,111 | ||||
Total deferred tax assets | $ | 5,583 | $ | 5,855 | ||
Note 10: Comprehensive Income (Loss)
The changes in the components of other comprehensive income, net of taxes, were as follows:
| Three months ended January 31 | |||||
---|---|---|---|---|---|---|
| 2005 | 2004 | ||||
| In millions | |||||
Net earnings | $ | 943 | $ | 936 | ||
Change in net unrealized gains on available-for-sale securities | 17 | 18 | ||||
Change in net unrealized gains on cash flow hedges | 63 | 27 | ||||
Change in cumulative translation adjustment | — | 8 | ||||
Comprehensive income | $ | 1,023 | $ | 989 | ||
The components of accumulated other comprehensive loss, net of taxes, were as follows:
| January 31, 2005 | October 31, 2004 | |||||
---|---|---|---|---|---|---|---|
| In millions | ||||||
Net unrealized gains on available-for-sale securities | $ | 40 | $ | 23 | |||
Net unrealized losses on cash flow hedges | (52 | ) | (115 | ) | |||
Cumulative translation adjustment | 30 | 30 | |||||
Additional minimum pension liability | (181 | ) | (181 | ) | |||
Accumulated other comprehensive loss | $ | (163 | ) | $ | (243 | ) | |
Note 11: Retirement and Post-Retirement Benefit Plans
HP's net pension and post-retirement benefit costs were as follows:
| Three months ended January 31 | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. Defined Benefit Plans | Non-U.S. Defined Benefit Plans | Post-Retirement Benefit Plans | |||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | ||||||||||||||
| In millions | |||||||||||||||||||
Service cost | $ | 86 | $ | 80 | $ | 60 | $ | 52 | $ | 19 | $ | 14 | ||||||||
Interest cost | 69 | 68 | 78 | 65 | 26 | 26 | ||||||||||||||
Expected return on plan assets | (71 | ) | (61 | ) | (106 | ) | (85 | ) | (7 | ) | (7 | ) | ||||||||
Amortization and deferrals: | ||||||||||||||||||||
Actuarial loss | 11 | 10 | 27 | 23 | 8 | 7 | ||||||||||||||
Prior service cost (benefit) | 1 | 1 | — | — | (2 | ) | (2 | ) | ||||||||||||
Net periodic benefit cost | $ | 96 | $ | 98 | $ | 59 | $ | 55 | $ | 44 | $ | 38 | ||||||||
Employer Contributions
HP previously disclosed in its consolidated financial statements for the year ended October 31, 2004 that it expected to contribute approximately $850 million to its pension plans and $60 million to its post-retirement plans in fiscal 2005. As of January 31, 2005, approximately $540 million and $15 million of contributions have been made to pension plans and post-retirement plans, respectively. HP presently anticipates contributing an additional $320 million to its pension plans and $45 million to its post-retirement plans during the remainder of fiscal 2005.
Note 6: Balance Sheet Details
The balance sheet details were as follows at July 31, 2004 and October 31, 2003:
Inventory
| July 31, 2004 | October 31, 2003 | ||||
---|---|---|---|---|---|---|
| (In millions) | |||||
Finished goods | $ | 5,010 | $ | 4,653 | ||
Purchased parts and fabricated assemblies | 1,735 | 1,412 | ||||
$ | 6,745 | $ | 6,065 | |||
Note 7: Guarantees
Indemnifications
In the ordinary course of business, HP enters into contractual arrangements under which HP may agree to indemnify the third party in an arrangement from any losses incurred relating to services performed on behalf of HP or for losses arising from certain events as defined within the particular contract, which may include litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments, if any, or if made or required related to these indemnifications, have been immaterial.
Warranty
HP provides for the estimated cost of product warranties at the time it recognizes revenue. HP engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers; however, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product class failures outside of HP's baseline experience, affect the estimated warranty obligation. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions to the estimated warranty liability would be required. The standard warranty service period for HP ranges from one to three years.
The changes in HP's aggregate product warranty liabilities are as follows for the nine months ended July 31, 2004:
| (In millions) | |||
---|---|---|---|---|
Product warranty liability at October 31, 2003 | $ | 1,987 | ||
Provisions for warranties issued | 1,853 | |||
Adjustments related to pre-existing warranties (including changes in estimates) | (95 | ) | ||
Settlements made (in cash or in kind) | (1,786 | ) | ||
Product warranty liability at July 31, 2004 | $ | 1,959 | ||
Deferred Revenue
HP also offers fixed-price support or maintenance contracts, including extended warranties, to its customers. The change in deferred revenue associated primarily with support or maintenance and similar service contracts was as shown in the table below for the nine months ended July 31, 2004. HP has not separated extended service revenue from routine maintenance service revenue, as doing so is not practical.
| (In millions) | |||
---|---|---|---|---|
Balance at October 31, 2003 | $ | 2,535 | ||
Additions to deferred revenue | 4,465 | |||
Recognition of revenue | (3,997 | ) | ||
Balance at July 31, 2004 | $ | 3,003 | ||
Note 8: Borrowings
Notes Payable and Short-term Borrowings
Notes payable and short-term borrowings, including the current portion of long-term debt, the related average interest rates and amounts remaining available for future borrowings, were as follows at July 31, 2004 and October 31, 2003:
| July 31, 2004 | October 31, 2003 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Amount Outstanding | Average Interest Rate | Amount Available | Amount Outstanding | Average Interest Rate | Amount Available | ||||||||||
| (In millions) | |||||||||||||||
Current portion of long-term debt | $ | 1,583 | 6.9 | % | $ | — | $ | 281 | 6.3 | % | $ | — | ||||
Commercial paper | 366 | 2.3 | % | 4,134 | 437 | 2.0 | % | 4,063 | ||||||||
Notes payable to banks, lines of credit and other | 263 | 2.6 | % | 2,187 | 362 | 1.7 | % | 2,058 | ||||||||
Credit facilities | — | — | 3,000 | — | — | 3,000 | ||||||||||
$ | 2,212 | $ | 9,321 | $ | 1,080 | $ | 9,121 | |||||||||
HP established a $4.0 billion U.S. commercial paper program in December 2000. Hewlett-Packard International Bank PLC, a wholly-owned subsidiary of HP, established a $500 million Euro Commercial Paper/Certificate of Deposit Programme in May 2001.
Notes payable to banks, lines of credit and other includes deposits, primarily by banks, of $104 million and $192 million as of July 31, 2004 and October 31, 2003, respectively.
HP also maintains, through various foreign subsidiaries, lines of credit from a number of financial institutions.
HP established a $1.7 billion 364-day senior unsecured committed borrowing facility in March 2003 and a $1.3 billion three-year credit facility in March 2002 (together, the "Credit Facilities"). HP replaced the Credit Facilities with a $1.5 billion 364-day senior unsecured committed borrowing facility and a $1.5 billion five-year credit facility in March 2004 (together, the "New Credit Facilities"). Interest
rates and other terms of borrowing under the New Credit Facilities vary, as applicable, based on HP's external credit ratings. The New Credit Facilities are available for general corporate purposes, including supporting the issuance of commercial paper.
Long-term Debt
Book value of long-term debt, with related maturities and interest rates, and amounts registered but unissued under the applicable registration statement or available for future borrowings under the Euro Medium-Term Note Programme (in each case, as shown in the Amount Available column) were as follows at July 31, 2004 and October 31, 2003:
| July 31, 2004 | October 31, 2003 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Amount Outstanding | Amount Available | Amount Outstanding | Amount Available | |||||||||
| (In millions) | ||||||||||||
2002 Shelf Registration Statement: | |||||||||||||
U.S. dollar Global Notes, issued in June 2002 at 5.5%, due July 2007 | $ | 997 | $ | 996 | |||||||||
U.S. dollar Global Notes, issued in June 2002 at 6.5%, due July 2012 | 498 | 498 | |||||||||||
U.S. dollar Global Notes, issued in March 2003 at 3.625%, due March 2008 | 498 | 497 | |||||||||||
1,993 | $ | 1,000 | 1,991 | $ | 1,000 | ||||||||
2000 Shelf Registration Statement: | |||||||||||||
U.S. dollar Global Notes, issued in June 2000 at 7.15%, due June 2005 | 1,499 | 1,498 | |||||||||||
U.S. dollar Global Notes, issued in December 2001 at 5.75%, due December 2006 | 997 | 997 | |||||||||||
Series A Medium-Term Notes, issued in September 2001 at a floating rate, due September 2004 | 60 | 60 | |||||||||||
Series A Medium-Term Notes, issued in December 2002 at 3.375%, due December 2005 | 200 | 199 | |||||||||||
Series A Medium-Term Notes, issued in December 2002 at 4.25%, due December 2007 | 50 | 50 | |||||||||||
2,806 | — | 2,804 | — | ||||||||||
Euro Medium-Term Note Programme: | |||||||||||||
Euro Medium-Term Notes, issued in July 2001 at 5.25%, due July 2006 | 906 | 2,093 | 870 | 2,128 | |||||||||
Other | |||||||||||||
Medium-Term Notes, assumed from Compaq, issued at 7.65%, due August 2005 | 300 | 300 | |||||||||||
U.S. dollar zero-coupon subordinated convertible notes, issued in October and November 1997 at an imputed rate of 3.13%, due 2017 (LYONs) | 335 | 328 | |||||||||||
Notes payable, issued at various dates in multiple currencies at 4.5%-9.17%, due 2003-2005 | 7 | 218 | |||||||||||
Other | 106 | 98 | |||||||||||
748 | — | 944 | — | ||||||||||
Fair value adjustment related to SFAS No. 133 | 37 | 166 | |||||||||||
Less current portion | (1,583 | ) | (281 | ) | |||||||||
$ | 4,907 | $ | 3,093 | $ | 6,494 | $ | 3,128 | ||||||
HP registered the sale of up to $3.0 billion of debt or global securities ("Global Notes"), common stock, preferred stock, depositary shares and warrants under a shelf registration statement declared effective in March 2002 (the "2002 Shelf Registration Statement"). In December 2002, HP filed a supplement to the 2002 Shelf Registration Statement, which allows HP to offer from time to time up to $1.5 billion of Medium-Term Notes, Series B, due nine months or more from the date of issuance (the "Series B Medium-Term Note Program"). HP may redeem some or all of the Global Notes, set forth in the table above, and any Series B Medium-Term Notes issued under the 2002 Shelf Registration Statement at any time at the redemption prices described in the prospectus supplements relating thereto. As of July 31, 2004, HP has not issued Medium-Term Notes pursuant to the Series B Medium-Term Note Program.
HP also registered the sale of up to $3.0 billion of debt or global securities, common stock, preferred stock, depositary shares and warrants under a shelf registration statement declared effective in March 2000 (the "2000 Shelf Registration Statement"). In May 2001, HP filed a supplement to the 2000 Shelf Registration Statement, which allowed HP to offer from time to time up to $1.5 billion of Medium-Term Notes, Series A, due nine months or more from the date of issuance. HP may redeem some or all of the Global Notes and Series A Medium-Term Notes issued under the 2000 Shelf Registration Statement, as set forth in the table above, at any time at redemption prices described in the prospectus supplements relating thereto. HP will not issue additional securities under the 2000 Shelf Registration Statement.
HP registered the sale of up to $3.0 billion of Medium-Term Notes under its Euro Medium-Term Note Programme filed with the Luxembourg Stock Exchange and has offered such notes as set forth in the table above. HP may denominate these notes in any currency including the euro. However, these notes have not been and will not be registered in the United States. HP may redeem some or all of the Euro Medium-Term Notes at any time at redemption prices described in the prospectus supplements relating thereto.
In 1997, HP issued $2.0 billion face value of zero-coupon subordinated convertible notes due in 2017 (the "LYONs"), convertible by the holders at an adjusted rate of 15.09 shares of HP common stock for each $1,000 face value of the LYONs, payable in either cash or common stock at HP's election. At any time, HP may redeem the LYONs at book value, payable in cash only. Under a previous repurchase program authorized in December 2000, HP repurchased approximately $1.5 billion face value of LYONs. HP did not repurchase any LYONs in the nine months ended July 31, 2004 and 2003.
Note 9: Income Taxes
HP's effective tax rate was approximately 14% and 17% for the three and nine months ended July 31, 2004, respectively. HP's effective tax rate was a benefit of approximately 3% and a provision of approximately 8% for the three and nine months ended July 31, 2003, respectively. HP's effective tax rates differed from the United States federal statutory rate of 35% in all periods due primarily to tax rate benefits of certain earnings from operations in lower-tax jurisdictions throughout the world for which no United States taxes have been provided because such earnings are planned to be reinvested indefinitely outside the United States. The effective tax rate for the three and nine months ended July 31, 2004 was reduced further by net favorable adjustments to previously estimated tax liabilities of
$101 million and $147 million, respectively, which decreased the provision for taxes per share by approximately $0.03 and $0.05, respectively. The adjustments recorded in the third quarter of fiscal 2004 consisted primarily of a net favorable revision to estimated tax accruals upon filing the 2003 U.S. income tax return and the resolution of certain outstanding matters with the tax authorities. Additional net favorable adjustments during the second quarter of fiscal 2004 were attributable primarily to a reduction in taxes on foreign earnings due to a change in regulatory policy. Excluding these adjustments, our tax rate would have been approximately 28% and 22% for the three and nine months ended July 31, 2004, respectively.
The effective tax rate in the fiscal 2003 periods reflected the tax benefits related to restructuring charges incurred primarily in higher-tax jurisdictions. The effective tax rate for the nine months ended July 31, 2003 also was affected by a benefit of $131 million due to the reversal in the second quarter of fiscal 2003 of a valuation allowance previously provided on a deferred tax asset related to a U.S. capital loss carryforward, the realization of which was previously uncertain.
Deferred tax assets were as follows at July 31, 2004 and October 31, 2003:
| July 31, 2004 | October 31, 2003 | ||||
---|---|---|---|---|---|---|
| (In millions) | |||||
Deferred tax assets—short term | $ | 2,498 | $ | 2,938 | ||
Deferred tax assets—long term | 3,004 | 2,859 | ||||
Total deferred tax assets | $ | 5,502 | $ | 5,797 | ||
Note 10: Comprehensive Income
Comprehensive income includes net earnings as well as other comprehensive income. HP's other comprehensive income consists of changes in unrealized gains and losses on available-for-sale securities and derivative instruments and the change in cumulative translation adjustment and minimum pension liability.
Comprehensive income, net of taxes, for the three and nine months ended July 31, 2004 and 2003 was as follows:
| Three months ended July 31, | Nine months ended July 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 2003 | 2004 | 2003 | ||||||||
| (In millions) | |||||||||||
Net earnings | $ | 586 | $ | 297 | $ | 2,406 | $ | 1,677 | ||||
Change in net unrealized (losses) gains on available-for-sale securities | (12 | ) | 16 | (18 | ) | 36 | ||||||
Change in net unrealized gains on derivative instruments | 5 | 98 | 54 | 4 | ||||||||
Change in cumulative translation adjustment | 20 | 6 | 24 | 7 | ||||||||
Change in additional minimum pension liability | (2 | ) | — | (2 | ) | — | ||||||
Comprehensive income | $ | 597 | $ | 417 | $ | 2,464 | $ | 1,724 | ||||
The components of accumulated other comprehensive loss, net of taxes, were as follows as of July 31, 2004 and October 31, 2003:
| July 31, 2004 | October 31, 2003 | |||||
---|---|---|---|---|---|---|---|
| (In millions) | ||||||
Net unrealized gains on available-for-sale securities | $ | 25 | $ | 43 | |||
Net unrealized losses on derivative instruments | (33 | ) | (87 | ) | |||
Cumulative translation adjustment | 33 | 9 | |||||
Additional minimum pension liability | (170 | ) | (168 | ) | |||
Accumulated other comprehensive loss | $ | (145 | ) | $ | (203 | ) | |
Note 11: Pension and Post-Retirement Benefit Plans
The following represents the net periodic pension and post-retirement benefit costs and related components in accordance with SFAS 132(R) as described in Note 1:
Components of Net Pension and Post-Retirement Periodic Benefit Cost
| U.S. Defined Benefit Plans | Non-U.S. Defined Benefit Plans | Post-Retirement Benefit Plans | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three months ended July 31, | ||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||||
| (In millions) | |||||||||||||||||||
Service cost | $ | 80 | $ | 71 | $ | 52 | $ | 42 | $ | 14 | $ | 12 | ||||||||
Interest cost | 67 | 65 | 65 | 51 | 21 | 25 | ||||||||||||||
Expected return on plan assets | (62 | ) | (53 | ) | (86 | ) | (55 | ) | (7 | ) | (6 | ) | ||||||||
Amortization and deferrals: | ||||||||||||||||||||
Actuarial loss | 8 | 15 | 23 | 21 | 3 | 5 | ||||||||||||||
Prior service cost (benefit) | — | 1 | (1 | ) | — | (3 | ) | — | ||||||||||||
Net periodic benefit cost | $ | 93 | $ | 99 | $ | 53 | $ | 59 | $ | 28 | $ | 36 | ||||||||
| U.S. Defined Benefit Plans | Non-U.S. Defined Benefit Plans | Post-Retirement Benefit Plans | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Nine months ended July 31, | ||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2004 | 2003 | |||||||||||||||
| (In millions) | |||||||||||||||||||
Service cost | $ | 240 | $ | 213 | $ | 158 | $ | 126 | $ | 42 | $ | 35 | ||||||||
Interest cost | 199 | 196 | 197 | 152 | 73 | 75 | ||||||||||||||
Expected return on plan assets | (185 | ) | (161 | ) | (259 | ) | (163 | ) | (21 | ) | (19 | ) | ||||||||
Amortization and deferrals: | ||||||||||||||||||||
Actuarial loss | 22 | 47 | 70 | 63 | 17 | 17 | ||||||||||||||
Prior service cost (benefit) | 2 | 2 | (1 | ) | — | (7 | ) | (1 | ) | |||||||||||
Net periodic benefit cost | $ | 278 | $ | 297 | $ | 165 | $ | 178 | $ | 104 | $ | 107 | ||||||||
Employer Contributions
HP previously disclosed in its consolidated financial statements for the year ended October 31, 2003 that it expected to contribute approximately $1.0 billion to its pension and other post-retirement plans in fiscal 2004, of which approximately $930 million related to pension contributions and the remainder to payments of other post-retirement benefits. As of July 31, 2004, HP had made $470 million of contributions to pension plans and $40 million in payments of other post-retirement benefits. HP presently anticipates contributing an additional $60 million to fund its pension and post-retirement plans during the remainder of fiscal 2004, of which $45 million relates to pension funding and the remainder to payments of other post-retirement benefits, for a total of $570 million in pension and other post-retirement funding in fiscal 2004.
Note 12: Litigation and Contingencies
Pending Litigation and Proceedings
Stevens v. HPCopyright levies. (renamedAs described below, proceedings are being pursued against HP in certain European Union ("EU") member countries seeking to impose levies upon equipment (such as printers and multi-function devices) alleging that these devices enable producing private copies of copyrighted materials. The total levies due, if imposed, would be based upon the number of products sold, and the per-product amounts of the levies, which will vary. Some EU member countries that do not yet have levies on digital devices are expected to implement similar legislation to enable them to extend existing levy schemes, while some other EU member countries are expected to limit the scope of levy schemes and applicability in the digital hardware environment. HP, other companies and various industry associations are opposing the extension of levies to the digital environment and advocating compensation to rights holders through digital rights management systems.Erickson v.
Two non-binding arbitration proceedings instituted in June 2001 and June 2002, respectively, were brought in Germany before the arbitration board of the Patent and Trademark Office. VerwertungsGesellschaft Wort ("VG Wort"), a collection agency representing certain copyright holders, brought the proceedings against HP, which relate to whether and to what extent copyright levies should be imposed in accordance with copyright laws implemented in Germany relating to multi-function devices and printers that allegedly enable the production of copies by private persons. The published tariffs on these devices in Germany range from 10 to 613.56 euros per unit. Non-binding proposals were presented in the proceedings, both of which HP rejected. In May 2004, VG Wort filed a lawsuit against HP in the Stuttgart Civil Court in Stuttgart, Germany seeking levies on multi-function devices ("MFDs"). A decision in this matter was issued on December 22, 2004. The court held that HP is liable for payments regarding photocopiers sold in Germany, but did not determine the exact amount payable per unit. The court further stated that HP should furnish information regarding the number of MFDs sold in Germany up to December 2001 and the number of copies per minute that various MFDs can produce. Finally, the court held that a levy of a maximum of 1.5% of the price was due on the bundle "LJ8150 MFP plus Scanner-Module C4166B," and that the individual elements of this bundle were not part of the claim. VG Wort appealed this decision in January 2005 to the Higher Regional Court of Baden-Wuerttemberg. In July 2004, VG Wort filed a separate lawsuit against HP in the Stuttgart Civil Court seeking levies on printers. A decision in this matter was issued on December 22, 2004. The court held that HP is liable for payments regarding all printers using ASCII code sold in Germany, but did not determine the amount payable per unit. The court further stated that HP should furnish information regarding the number of printers sold in Germany since April 2001 and the number of copies per minute that various printers can produce. HP appealed this decision in January 2005 to
the Higher Regional Court of Baden-Wuerttemberg. In September 2003, VG Wort filed a lawsuit against Fujitsu Siemens Computer GmbH ("FSC") in Munich State Court seeking levies on PCs. This is an unfair business practices consumer class action filedindustry test case in Germany, and HP has undertaken to be bound by a final decision. A decision in this matter was issued on December 23, 2004 stating that PCs are subject to a levy and that FSC should furnish information as to the Superiornumber of PCs sold in Germany since January 1, 2001. Further, FSC must pay 12 euros plus compound interest for each PC sold in Germany from March 24, 2001. FSC appealed this decision in January 2005 to the Higher Regional Court of California in Riverside County on July 31, 2000. Consumer class action lawsuits have been filed, in coordination withBavaria.
In April 2001, the original plaintiffs, in 32 additional states. The various plaintiffs throughout the country claim to have purchased different models of HP inkjet printers over the past four years. The basic factual allegation of these actions is that affected consumers who purchased HP printers received half-full or "economy" ink cartridges instead of full cartridges. Plaintiffs claim that HP's advertising, packaging and marketing representationsOrganization for the Collective Management of Works of Literature, the Organization for the Collective Management of Works of Plastic Arts and their Applications, and the Organization for the Collective Management and Protection of Intellectual Property of Photographers brought five proceedings against Hewlett-Packard Hellas EPE and Compaq Computer EPE in Greece relating to whether a levy of 2% should be payable upon computer products, including central processing units, monitors, keyboards, mice, diskettes, printers, ledscanners and related items in accordance with Greek copyright law, before its amendment in September 2002. These proceedings are pending before the consumers to believe they would receive full cartridges. These actions seek injunctive relief, disgorgementCourt of profits, compensatory damages, punitive damages and attorneys' fees under various state unfair business practices statutes and common law claimsFirst Instance of fraud and negligent misrepresentation.Athens or before the Court of Appeal of Athens.
In the initial California matter, the court granted summaryApril 1998, Auvibel s.c.r.l., a Belgian collection agency, filed an appeal of a judgment in HP's favor with the Court of Appeal in Brussels relating to a dispute as to whether and denied class certification. In Octoberto what extent copyright levies should be imposed upon CD-writers and CD media. The case has been removed from the court's list of 2003,pending cases, without prejudice to the California appellate court affirmedparties' right to reinstate the lower court's decisions and dismissed plaintiff's appeal. The matter was certified as a class action, however, in North Carolina state court, where it was filed asHughes v. Hewlett-Packard Company. HP prevailed atmatter.
Based on industry opposition to the trialextension of this case, which concluded in September 2003. The litigation is not in trial in other jurisdictions. In total, twentylevies to the digital environment, HP's assessments of the consumer class actions have been dismissed,merits of various proceedings and HP's estimates of the units impacted and levies, HP has accrued amounts that it believes are adequate to address the matters described above. However, the ultimate resolution of these matters, including the number of units impacted, the amount of levies imposed in two states plaintiffs' motions for class certification have been denied.various jurisdictions and the availability of HP to recover such amounts through increased prices, remains uncertain.
Alvis v. HP is a nationwide defective product consumer class action that was filed in state court in Jefferson County, Texas by a resident of Eastern Texas in April 2001. In February 2000, a similar suit captionedLaPray v. Compaq was filed in state court in Jefferson County, Texas. The basic allegation is that HP and Compaq sold computers containing floppy disk controllers that fail to alert the user to certain floppy disk controller errors. That failure is alleged to result in data loss or data corruption. The plaintiffscomplaints inAlvis andLaPray seek injunctive relief, declaratory relief, unspecified damages and attorneys' fees. In July 2001, a nationwide class was certified in theLaPray case, which the Beaumont Court of Appeals affirmed in June 2002. In May 2004, the Texas Supreme Court reversed the certification of the nationwide class in theLaPray case and remanded the case to the trial court. The trial court has schedulednot set a new class certification hearing in November 2004.hearing. A class certification hearing was held on July 1, 2003 in theAlvis case, and the court granted plaintiffs' motion to certify a nationwide class action. HP filed an appeal of that certification with the 9th Court of Appeals in Beaumont, Texas, which heard oral
arguments on HP's appeal and received a supplemental briefing based upon theLaPray opinion from the Texas Supreme Court. On August 31, 2004, the 9th Court of Appeals in Texas reversed the lower court's decision certifying a nationwide class and remanded the case to the trial court. A class certification hearing was held on January 6, 2005. On January 12, 2005 the court notified the parties that it will certify a Texas-wide class action for injunctive relief only. On June 4, 2003,Barrett v. HP andGrider v. Compaq were each filed in state court in Cleveland County, Oklahoma, with factual
allegations similar to those inAlvis andLaPray, respectively.. The plaintiffscomplaints inBarrett andGrider seek, among other things, specific performance, declaratory relief, unspecified damages and attorneys' fees. On November 5, 2003, the court heard HP's motion to dismissBarrett v. HP andGrider v. Compaq, which motion was subsequently denied. On December 22, 2003, the court entered an order staying both theBarrett andGrider cases until the conclusions of theAlvis andLaPray actions. On July 28, 2004, the Courtcourt lifted the stay inGrider, but took under advisement the plaintiff's motion to lift the stay inBarrett. A class certification hearing inGrider is currently scheduled for April 19, 2005. On November 5, 2004,Scott v. HP was filed in state court in San Joaquin County, California, with factual allegations similar to those inLaPray, and on January 27, 2005,Jurado v. HP was filed in state court in San Joaquin County, California, with factual allegations similar to those inAlvis. The complaints inScott andJurado seek a California-only class certification, injunctive relief, unspecified damages (including punitive damages), restitution, costs and attorneys' fees. In addition, the Civil Division of the Department of Justice, the General Services Administration Office of Inspector General and other Federal agencies are conducting an investigation of allegations that HP and Compaq made or caused to be made false claims for payment to the United States for computers known by HP and Compaq to contain defective parts or otherwise to perform in a defective manner relating to the same alleged floppy disk controller errors. HP agreed with the Department of Justice to tollextend the statuestatute of limitations on its investigation until DecemberJune 6, 2004.2005. HP is cooperating fully with this investigation.
Neubauer, et al. v. Intel Corporation, Hewlett-Packard Company, et al.andNeubauer, et al. v. Compaq Computer Corporation are separate lawsuits filed on June 3, 2002 in state court in Madison County, Illinois, alleging that HP and Compaq (along with Intel) misled the public by suppressing and concealing the alleged material fact that systems that use the Intel Pentium 4 processor are less powerful and slower than systems using the Intel Pentium III processor and processors made by a competitor of Intel. The court in the HP action has certified an Illinois class as to Intel but denied a nationwide class, and proceedings have been stayed pending resolution of plaintiffs' appeal of this decision. The plaintiffs seek unspecified damages, restitution, attorneys' fees and costs and certification of a nationwide class against HP and Compaq. The class action certification against Compaq has been postponed. In each action, HP and Compaq have filed motions to dismiss the cases, which the court has denied. HP and Compaq also have filed forum non conveniens motions, which are pending.Skold, et al. v. Intel Corporation and Hewlett-Packard Company is a lawsuit that was initially filed in state court in Alameda County, California to which HP was joined on June 14, 2004, based upon factual allegations similar to those in theNeubauer cases. On February 22, 2005, the parties stipulated to transfer this case to state court in Santa Clara County, California. The plaintiffs seek unspecified damages, restitution, attorneys' fees and cost and certification of nationwide class.
Tyler v. HP is a lawsuit filed in state court in Santa Clara, California on February 17, 2005, alleging that HP engaged in wrongful business practices (including unfair competition, deceptive advertising, fraud and breach of warranty) relating to HP's use of "smart chips" that allegedly signal to the customer that certain inkjet printer cartridges need to be replaced before they are really empty, and include an expiration date that is allegedly not documented in marketing materials provided to consumers. On February 22, 2005, a lawsuit captionedObi v. HP was filed in state court in Los Angeles, California with similar allegations. These actions seek class certification (nationwide, California or both), restitution, damages (including enhanced damages), injunctive relief, interest, costs and attorneys' fees.
Hanrahan v. Hewlett-Packard Company and Carleton Fiorina is a lawsuit filed on November 3, 2003, in the United States District Court for the District of Connecticut on behalf of a putative class of persons who sold common stock of HP during the period from September 4, 2001 through November 5, 2001. An amended complaint was filed on March 7, 2005. The lawsuit seeks unspecified damages and generally alleges that HP and Ms. Fiorina violated the federal securities laws by making statements during this period which were misleading in failing to disclose that Walter B. Hewlett would oppose the proposed acquisition of Compaq by HP prior to Mr. Hewlett's disclosure of his opposition to the proposed transaction. A motion to transfer the action to federal court in California is pending, and no lead plaintiff has yet been appointed.
On December 27, 2001,Cornell University and the Cornell Research Foundation, Inc. filed an actiona complaint, amended on September 6, 2002, against HP in United States District Court for the Northern District of New York alleging that HP's PA-RISC 8000 family of microprocessors, infringesand servers and workstations incorporating those processors, infringe a patent assigned to Cornell patentResearch Foundation, Inc. that describes a way of executing microprocessor instructions. HP has answered and counterclaimed. This action seeks declaratory and injunctive relief and other relief.unspecified damages. On March 26, 2004, the court issued a ruling interpreting the disputed claimsclaim terms in Cornell's patent.the patent at issue. Discovery is ongoing, and no trial date has been set.
Digwamaje et al. v. Bank of America et al. is a purported class action lawsuit that names HP and numerous other multinational corporations as defendants. It was filed on September 27, 2002 in United States District Court for the Southern District of New York on behalf of current and former South African citizens and their survivors who suffered violence and oppression under the apartheid regime. The lawsuit alleges that HP and other companies helped perpetuate, and profited from, the apartheid regime during the period from 1948-1994 by selling products and services to agencies of the South African government. Claims are based on the Alien Tort Claims Act, the Torture Protection Act, the Racketeer Influenced and Corrupt Organizations Act and state law. The complaint seeks, among other things, an accounting, the creation of a historic commission, compensatory damages in excess of $200 billion, punitive damages in excess of $200 billion, costs and attorneys' fees. HP has filed a motion to dismiss this action, which was heard on November 6, 2003. The court has not yet issued its decision.
Intergraph Hardware Technologies Company v. HP, Dell & Gateway is a lawsuit filed in United States District Court for the Eastern District of Texas, Marshall County, on December 16, 2002. The suit accuses HP of infringement of three patents related to cache memory. Intergraph Hardware Technologies Company ("Intergraph") seeks damages (including enhanced damages), an injunction, prejudgment interest, costs and attorneys' fees. The complaint was served on HP on April 1, 2003. On May 21, 2003, HP answered and counterclaimed for a declaratory judgment that the patents are not infringed by HP and that the patents are invalid and unenforceable. Intergraph has obtained significant settlements from other defendants relating to similar causes of action, and Gateway and Dell are no
longer defendants in this matter. Fact discovery (except willfulness) closed on April 21, 2004. A claim construction hearing was held on May 7, 2004 and the court issued a ruling on the claim construction hearing on July 1, 2004. Trial is scheduled to begin in February 2005. Expert discovery is ongoing. On May 28, 2003, HP sued Intergraph Corporation, the parent of Intergraph, in United States District Court for the Northern District of California, San Francisco Division, accusing Intergraph Corporation of infringement of four HP patents related to computer-aided design. A claim construction hearing is scheduled for October 8, 2004, and HP expects trial to begin in mid-2005. HP seeks damages, an injunction, prejudgment interest, costs and attorneys' fees. On April 1, 2004, HP sued Intergraph Corporation in the Mannheim State Court in Mannheim, Germany, for infringement of two European Union patents related to computer-aided design. HP seeks damages, an injunction and costs. On April 19, 2004, HP sued Z/I Imaging, a subsidiary of Intergraph Corporation, and Intergraph Corporation, in United States District Court for the District of Delaware, accusing Z/I Imaging of infringement of two patents related to image scanning technology. On April 19, 2004, HP sued Intergraph Corporation in United States District Court for the Eastern District of Texas for infringement of one patent relating to computer-aided design. In both cases, HP seeks damages, an injunction, prejudgment interest, costs and attorneys' fees. On May 8, 2004, Intergraph sued HP in United States District Court for the Eastern District of Texas, Tyler County, for infringement of another patent related to cache memory management. Intergraph seeks an injunction, declaratory relief and attorneys' fees. Trial in that matter is expected to begin on October 24, 2005.
Initial proceedings are being pursued against HP in certain European Union ("EU") member countries seeking to impose levies upon equipment (such as printers, DVD writers, and multi-function devices) alleging that these devices enable producing private copies of copyrighted materials. Two non-binding arbitration proceedings instituted in June 2001 and June 2002, respectively, were brought in Germany before the arbitration board of the Patent and Trademark Office. VerwertungsGesellschaft Wort, a collection agency representing certain copyright holders ("VG Wort"), brought the proceedings against HP, which relate to whether and to what extent copyright levies should be imposed in accordance with copyright laws implemented in Germany relating to multi-function devices and printers that allegedly enable the production of copies by private persons. Non-binding proposals were presented in the proceedings, both of which HP rejected. In May 2004, VG Wort filed a lawsuit against HP in the Stuttgart State Court in Stuttgart, Germany seeking levies on multi-function devices. A decision is expected on October 12, 2004 in that proceeding. In July 2004, VG Wort filed a separate lawsuit against HP in the Stuttgart State Court seeking levies on printers. A preliminary hearing in this matter is scheduled for October 2004. In April 1998, Auvibel s.c.r.l., a Belgian collection agency, filed an appeal of a judgment in HP's favor with the Court of Appeal in Brussels relating to a dispute as to whether and to what extent copyright levies should be imposed upon CD-writers and CD media. The case has been removed from the court's list of pending cases, without prejudice to the parties' right to reinstate the matter. In April 2001, the Organization for the Collective Management of Works of Literature, the Organization for the Collective Management of Works of Plastic Arts and their Applications, and the Organization for the Collective Management and Protection of Intellectual Property of Photographers brought five proceedings against HP Hellas and Compaq Computer E.P.E. in Greece relating to whether a levy of 2% should be payable upon computer products, including central processing units, monitors, keyboards, mice, diskettes, printers, scanners and related items in accordance with Greek copyright law, before its amendment in September 2002. These proceedings are
pending before the Court of First Instance of Athens or before the Court of Appeal of Athens. The levies, if imposed, would be based upon the number of products sold, and the per-product amounts of the levies vary. Some EU member countries that do not yet have levies on digital devices are expected to implement similar legislation to enable them to extend existing levy schemes, while some other EU member countries are expected to limit the scope of levy schemes and applicability in the digital hardware environment. HP, other companies and various industry associations are opposing the extension of levies to the digital environment and advocating compensation to rights holders through digital rights management systems.
HP v. EMC Corporation ("EMC") is a lawsuit filed in United States District Court for the Northern District of California on September 30, 2002, in which HP accuses EMC of infringing seven HP patents. HP seeks damages, an injunction, prejudgment interest, costs and attorneys' fees. On July 21, 2003, EMC filed its answer and a cross-claim asserting, among other things, that numerous HP storage, server and printer products infringe six EMC patents. EMC seeks a permanent injunction as well as unspecified monetary damages, costs and attorneys' fees for patent infringement. The court issued an order construing disputed claim terms on June 23, 2004. Discovery is ongoing. Trial is expected in mid-2005.late 2005. On November 27, 2004, HP filed a second lawsuit against EMC in United States District Court for the Northern District of California, in which HP accuses additional models of certain EMC products of infringing the same seven HP patents. HP seeks damages, an injunction, prejudgment interest, costs and attorneys' fees. EMC also filed suit against StorageApps, a company acquired by HP in fiscal 2001, in United States District Court in Worcester, Massachusetts on October 20, 2000. The suit accused StorageApps of infringement of EMC patents relating to storage devices, and sought a permanent injunction as well as unspecified monetary damages for patent infringement. The court held a hearing to construe the disputed claims terms of EMC's three patents in the suit on July 21-22, 2003 and issued its claim construction ruling on September 12, 2003. Following a trial in May 2004, the jury found that three of EMC's patents are valid and infringed. The damages phase of the litigation has commenced, and no date for a trialparties have agreed to binding arbitration on the issue of damages has yet been scheduled.
Neubauer, et al. v. Intel Corporation, Hewlett-Packard Company, et al. andNeubauer, et al. v. Compaq Computer Corporation are separate lawsuits filed on June 3, 2002 in state court in Madison County, Illinois, alleging that HP and Compaq (along with Intel) misled the public by suppressing and concealing the alleged material fact that systems that use the Intel Pentium 4 processor are less powerful and slower than systems using the Intel Pentium III processor and processors made by a competitor of Intel. The court in the HP action has certified an Illinois class as to Intel but denied a nationwide class. The plaintiffs seek unspecified damages, restitution, attorneys' fees and costs and certification of a nationwide class against HP and Compaq. The class action certification hearing againstdamages. HP is currently scheduled for November 29 and 30, 2004. The class action certification hearing against Compaq is currently scheduled for February 15 and 16, 2005. In each action, HP and Compaq have filed motions to dismissappealing the cases, which the court has denied. HP and Compaq also have filed forum non conveniens motions, which are pending.Skold, et al. v. Intel Corporation and Hewlett-Packard Company is a lawsuit in state court in Alameda County, California to which HP was joined on June 14, 2004, based upon factual allegations similar to those in theNeubauer cases. The plaintiffs seek unspecified damages, restitution, attorneys' fees and cost and certificationjudgment of nationwide class.liability.
Forgent NetworksCompression Labs, Inc. v. HP et al. is a lawsuit filed by Compression Labs, Inc., a subsidiary of Forgent Networks ("CLI"), on April 22, 2004 against HP as well as 3027 other companies in United States District Court for the Eastern District of Texas. The complaint accuses HP of patent infringement with respect to HP's products that implement JPEG compression. JPEG is a standard for data compression used in HP's PCs,computers, scanners, digital cameras, PDAs, printers, plotters and non-photo-software. CLI seeks unspecified damages, an injunction, interest, costs and attorneys' fees. CLI is involved in litigation involving alleged infringement of the same JPEG patent in eight other cases pending in the Eastern District of Texas, the Northern District of California and the District of
printers. Forgent seeks damages, as injunction, costs and attorneys' fees.Delaware. The Judicial Panel on Multidistrict Litigation recently transferred eight of these lawsuits, including those involving HP, to the Northern District of California for coordinated or consolidated pretrial proceedings. Separately, HP has alerted government regulators of Forgent'sCLI's participation in the JPEG standardization process and current licensing activities. HP has also entered into a joint defense arrangement with many of the other co-defendants.
Hewlett-Packard Development Company, LP v. Gateway, IncInc.. is a lawsuit filed on March 24, 2004 by HP's wholly-owned subsidiary, Hewlett-Packard Development Company, LP ("HPDC"), against Gateway, Inc. ("Gateway") in U.S. District Court in the Southern District of California, allegingCalifornia. The suit originally alleged infringement of six patents relating to various notebook, desktop and enterprise computer technologies. On April 2, 2004, HPDC filed an amended complaint, adding infringement allegations for four additional patents. HPHPDC seeks an injunction, unspecified monetary damages, interest and attorneys' fees. On May 6, 2004, HPDC and HP filed a complaint with the U.S. International Trade Commission ("ITC") against Gateway, alleging infringement of seven additional computer technology patents. HP seeks an injunction. On May 10, 2004, Gateway filed an answer in the Southern District of California action and a counterclaim, alleging infringement of five Gateway patents relating to computerized television, wireless, computer monitoring and computer expansion card technologies. Gateway seeks an injunction, unspecified monetary damages, interest and attorneys' fees. Claim construction began in December 2004 and is scheduled to resume in June 2005. On May 6, 2004, HPDC and HP filed a complaint with the United States International Trade Commission ("ITC"), alleging that Gateway infringes seven computer technology patents. Claim construction hearings have been held, and trial is scheduled to begin on March 21, 2005. Four patents remain at issue. HP seeks an injunction. On October 21, 2004, HPDC filed suit in the United States District Court for the Western District of Wisconsin against eMachines, a wholly-owned subsidiary of Gateway, alleging infringement of five HPDC patents relating to personal and desktop computers. On February 17, 2005, the action was transferred to the Southern District of Texas (Houston division). Three patents remain in suit. HPDC seeks an injunction, unspecified monetary damages, interest and attorneys' fees. On February 22, 2005, eMachines filed a declaratory judgment action against HPDC in the Southern District of Texas on the same three patents.
On July 2, 2004, Gateway filed a complaint with the ITC, against HP, alleging HP's infringement of three patents relating to audio control, imaging and computerized television technologies. The claim construction hearing was held in February 2005 and trial is scheduled to begin on May 23, 2005. Gateway seeks an injunction. Also on July 2, 2004, Amiga Development LLC ("Amiga"), an entity affiliated with Gateway, filed a lawsuit against HP in United States District Court for the Eastern District of Texas, alleging infringement of three patents relating to computer monitoring, imaging and decoder technologies. Gateway seeks an injunction, unspecified monetary damages, interest and attorneys' fees.
Hanrahan v. Hewlett-Packard Company HP and Carleton Fiorina isHPDC have answered and counterclaimed, alleging infringement by Amiga and Gateway of four HPDC patents related to personal computer technology. On August 18, 2004, Gateway filed a lawsuit filed on November 3, 2003,declaratory relief action against HPDC in the United States District Court for the Southern District of ConnecticutCalifornia seeking a declaration of non-infringement and invalidity of the above-referenced four HPDC patents relating to personal computer technology. HPDC answered and counterclaimed and alleged infringement of the same four patents. HP seeks an injunction, unspecified monetary damages, interest and attorneys' fees. Claim construction began in December 2004 and is scheduled to resume in June 2005.
Digwamaje et al. v. Bank of America et al. is a purported class action lawsuit that names HP and numerous other multinational corporations as defendants. It was filed on September 27, 2002 in United States District Court for the Southern District of New York on behalf of a putative class of personscurrent and former South African citizens and their survivors who sold common stock ofsuffered violence and oppression under the apartheid regime.
The lawsuit alleges that HP and other companies helped perpetuate, and profited from, the apartheid regime during the period from September 4, 2001 through1948-1994 by selling products and services to agencies of the South African government. Claims are based on the Alien Tort Claims Act, the Torture Protection Act, the Racketeer Influenced and Corrupt Organizations Act and state law. The complaint seeks, among other things, an accounting, the creation of a historic commission, compensatory damages in excess of $200 billion, punitive damages in excess of $200 billion, costs and attorneys' fees. On November 5, 2001.29, 2004, the court dismissed the plaintiffs' complaint. On December 23, 2004, the plaintiffs appealed the decision to the United States Court of Appeals for the Second Circuit.
Intergraph Hardware Technologies Company v. HP, Dell & Gateway was a lawsuit filed in United States District Court for the Eastern District of Texas, Marshall County, on December 16, 2002, which has been dismissed. The lawsuit seeks unspecifiedsuit accused HP of infringement of three patents related to cache memory (the "Clipper Patents"). Intergraph sought damages constituting a "reasonable royalty" (as well as enhanced damages), an injunction, prejudgment interest, costs and attorneys' fees. On May 7, 2004, Intergraph sued HP in United States District Court for the Eastern District of Texas, Tyler County, for infringement of a patent related to cache memory management; this case has also been dismissed. Intergraph sought an injunction, declaratory relief and attorneys' fees, but not damages. HP answered and counterclaimed, asserting Intergraph's infringement of two HP software patents. HP sought damages and generally allegesan injunction.
On May 28, 2003, HP sued Intergraph Corporation, the parent of Intergraph, in United States District Court for the Northern District of California, San Francisco Division, accusing Intergraph Corporation of infringement of four HP patents related to computer-aided design, video display technology and information retrieval technology. This case has been dismissed. HP sought damages, an injunction, prejudgment interest, costs and attorneys' fees. On April 1, 2004, HP sued Intergraph Corporation in the Mannheim State Court in Mannheim, Germany, and instituted related proceedings in Germany, for infringement of two European Union patents related to computer-aided design. HP sought damages, an injunction and costs. Trial took place in November 2004, and the court dismissed HP's action based on a determination of Intergraph's noninfringement on January 7, 2005. On April 19, 2004, HP sued Z/I Imaging, a subsidiary of Intergraph Corporation, and Intergraph Corporation, in United States District Court for the District of Delaware, accusing Z/I Imaging of infringement of two patents related to image scanning technology. Also on April 19, 2004, HP sued Intergraph Corporation in United States District Court for the Eastern District of Texas for infringement of one patent relating to computer-aided design. In both cases, HP sought damages, an injunction, prejudgment interest, costs and attorneys' fees. These cases have also been dismissed.
On January 21, 2005, HP announced that it had settled all ongoing patent litigation with Intergraph Corporation and that the companies had entered into a patent cross-license agreement. The agreement resolved all legal claims between the two companies and their subsidiaries. Under the terms of the agreement, HP agreed to pay Intergraph $141 million, of which $116 million was recorded as a charge in the first quarter of fiscal 2005 since it related to the cross-license agreement for products shipped in prior years. Both HP and Ms. Fiorina violatedIntergraph have since dismissed, withdrawn or terminated with prejudice all pending lawsuits, and neither company will have any further financial obligations stemming from any such disputes. According to the federal securities lawsterms of the cross-license agreement, HP was granted a license to all Intergraph patents for all fields of use. Intergraph was granted a license to all HP patents in specific fields covered by making statements duringIntergraph's then current product categories.
Stevens v. HP (renamed asErickson v. HP) was an unfair business practices consumer class action filed in the Superior Court of California in Riverside County on July 31, 2000. Consumer class action lawsuits were filed, in coordination with the original plaintiffs, in 33 additional jurisdictions. The various plaintiffs throughout the country claimed to have purchased different models of HP inkjet printers. The basic factual allegation of these actions was that affected consumers who purchased HP printers received half-full or "economy" ink cartridges instead of full cartridges. Plaintiffs claimed that HP's advertising, packaging and marketing representations for the printers led the consumers to believe they would receive full cartridges. These actions sought injunctive relief, disgorgement of profits, compensatory damages, punitive damages and attorneys' fees under various state unfair business practices statutes and common law claims of fraud and negligent misrepresentation. In the initial California matter, the court granted summary judgment in HP's favor and denied class certification. In October of 2003, the California appellate court affirmed the lower court's decisions and dismissed plaintiff's appeal. The matter was certified as a class action in North Carolina state court, where it was filed asHughes v. Hewlett-Packard Company. HP prevailed at the trial of this case, which concluded in September 2003. The litigation is not in trial in other jurisdictions, and the other cases have not been certified as class actions. The last of any appeals period which were misleading in failingruns out on May 10, 2005. Pursuant to disclose that Walter B. Hewlett would oppose the proposed acquisition of Compaqa dismissal agreement signed by HP prior to Mr. Hewlett's disclosure of his opposition to the proposed transaction. A motion to transfer the action to federal courtand plaintiffs' counsel in California is pending, and no lead plaintiff has yeteach jurisdiction, all 33 actions have been appointed.dismissed.
In May 2002, the European Commission of the EU publicly stated that it was considering conducting an investigation into OEM activities concerning the sales of printers and supplies to consumers within the EU. The European Commission contacted HP requesting information on the printing systems businesses. HP is cooperating fully with this inquiry.
In March 2003, the Korea Fair Trade Commission commenced an investigation of the Korean printing and supplies market. The Korea Fair Trade Commission contacted HP requesting information on its printing systems business. A hearing mayis expected to be held in 2004.2005. HP is cooperating fully with this inquiry.
The Government of Canada conducted cost audits of certain contracts between Public Works and Government Services Canada ("PWGSC") and each of Compaq Canada Corp. and Hewlett-Packard (Canada) Co. relating to services provided to the Canadian Department of National Defence ("DND").
Compaq Canada Corp. was combined with Hewlett-Packard (Canada) Co. following HP's acquisition of Compaq. HP cooperated fully with the audit and has conducted its own inquiry, sharing the results of its investigation with PWGSC and DND. On May 14, 2004, HP announced that it had resolved the dispute with the Government of Canada. HP Canada agreed to reimburse the Government of Canada the sum of CDN$146 million (approximately US$105 million), an amount determined by both parties to be appropriate upon investigation. HP recorded $70 million in the second quarter of fiscal 2004 and had recorded $35 million in the prior fiscal year. HP determined that it was important for HP to honor its contractual obligations, rather than engage in protracted litigation with the Government of Canada, despite the lack of evidence that HP employees derived any improper benefit from the complex scheme designed to exploit both parties. HP now intends to take appropriate steps, including legal action, to recover these funds from the individuals and companies responsible.
HP is involved in lawsuits, claims, investigations and proceedings, including those identified above, consisting of patent,intellectual property, commercial, securities, employment, employee benefits and environmental matters, which arise in the ordinary course of business. In accordance with SFAS No. 5, "Accounting for Contingencies," HP makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. HP believes it has adequate provisions for any such matters. HP reviews these provisions at least quarterly and adjusts these provisions to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Based on its experience, HP believes that any damage amounts claimed in the specific matters discussed above are not a meaningful indicator of HP's potential liability. Litigation is inherently unpredictable. However, HP believes that it has valid defenses with respect to legal matters pending against it. Nevertheless, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.
Environmental
HP is party to, or otherwise involved in, proceedings brought by United States or state environmental agencies under the Comprehensive Environmental Response, Compensation and
Liability Act ("CERCLA"), known as "Superfund," or state laws similar to CERCLA. HP is also conducting environmental investigations or remediations at several current or former operating sites pursuant to administrative orders or consent agreements with state environmental agencies. It is our policy to apply strict standards for environmental protection to sites inside and outside the United States, even if not subject to regulations imposed by local governments. The liability for environmental remediation and other environmental costs is accrued when it is considered probable and the costs can be reasonably estimated. Historically, environmental costs have not been material to our operations or financial position.
The European Union has finalized the Waste Electrical and Electronic Equipment Directive, which makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline to enact and implement the directive by individual European Union governments generally was August 13, 2004, although extensions were granted to some countries (such legislation, together with the directive, the "WEEE Legislation"), and producers are financially responsible under the WEEE Legislation when participating in the market beginning in August 2005. HP is continuing to evaluate the impact, if any, of the WEEE Legislation as member states continue to issue their implementation guidance. Further, both the FASB and the International Accounting Standards Board have indicated that they expect to issue specific accounting guidance related to the WEEE Legislation.
Note 13: Segment Information
Description of Segments
HP is a leading global provider of IT products, technologies, solutions and services to individual consumers and businesses. HP's offerings span IT infrastructure and storage, personal computing and other access devices, globalmulti-vendor services including maintenance, consulting and integration and outsourcing, and imaging and printing.
As of July 31, 2004, HPHP's operations are organized its operations into seven business segments: Personal Systems Group ("PSG"), Imaging and Printing Group Personal Systems Group,("IPG"), Enterprise Storage and Servers Software,("ESS"), HP Services ("HPS"), HP Financial Services ("HPFS"), Software 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, homogeneity of products technology and delivery channels.technology. The business segments disclosed in this Form 10-Qthe Consolidated Condensed Financial Statements are based on this organizational structure and information reviewed by HP's management to evaluate the associated business groupsegment results. In the first quarter of fiscal 2004,2005, HP divided its Enterpriseleveraged the strengths of both IPG and PSG to form the Imaging and Personal Systems Group into("IPSG") to maximize efficiency and intensify competitive focus. Given the Enterprise Storagecross-segment linkages in our enterprise offerings, and Servers segmentin order to capitalize on up-selling and cross-selling opportunities, ESS, HPS and Software segment. Segmentare structured beneath a broader Technology Solutions Group ("TSG"). In order to provide a supplementary view of HP's business, aggregated financial data for the threesegments comprising TSG and nine months ended July 31, 2003 hasIPSG is presented herein.
Segment operating results for the first quarter of fiscal 2004 have been restated to reflect this organizational change as well asconform to certain minor product reclassifications.fiscal 2005 organizational realignments. Future changes to this organizational structure may result in changes to the reportablebusiness segments disclosed. A description of the types of products and services provided by each reportablebusiness segment follows.
Imaging and Printing GroupPersonal Systems Group's provides homemission is to leverage both the strengths of PSG and IPG into one unified business imaging, printingthat will focus on business and publishing devicescustomer solutions. This combined organization is designed to enable HP to achieve profitable growth and systems, digital imaging products, printer supplies and consulting services. Home andstrengthen HP's market position. Each of the business imaging, printing and publishing devices and systems include color and monochrome printers for shared and personal use, printer- and copier-based multi-function devices, inkjet all-in-one and laser printers, wide- and large-format inkjet printers and digital presses. Digital imaging products include scanners, Photosmart printers, and digital photography products. Printer supplies include laser and inkjet printer cartridges and other related printing media. Consulting services are provided to customers to optimize the use of printing and imaging assets.
segments within IPSG is described in detail below.
Technology Solutions Group's mission is to coordinate HP's enterprise offerings across organizations to create solutions including support, that allow enterprise customers to manage and transform their infrastructure, operations, applicationsbusiness and business processes underIT environments. TSG allows HP to leverage the resources and capabilities of the HP OpenView brand. In addition, Software deliversportfolio by applying key design principles consistently across business, application and infrastructure services with a suitevision of comprehensive, carrier-grade platforms for developing and deploying next-generation voice, data and converged services to network and service providers under the HP OpenCall brand.
standardization, simplification, modularity and integration. Each of the business segments within TSG is described in detail below.
HP's other business segments are described below.
financial asset management services, for large global and enterprise customers. HP Financial ServicesHPFS also provides an array of specialized financial services to small and medium-sized businesses and education and government entities. HP Financial ServicesHPFS offers innovative, customized and flexible alternatives to balance unique customer cash flow, technology obsolescence and capacity needs.
Segment Data
The results of the reportablebusiness segments are derived directly from HP's internal management reporting system. The accounting policies used to derive reportablebusiness segment results are substantially the same as those used by the consolidated company. Management measures the performance of each business segment based on several metrics, including earnings from operations. These results are used, in part, to evaluate the performance of, and to assign resources to, each of the business segments. Certain operating expenses, which HP manages separately at the corporate level, are not allocated to the business segments. These unallocated costs include primarily amortization of purchased intangible assets, certain acquisition-related charges and charges for purchased IPR&D as well as certain corporate governance costs.
Restructuring charges and any associated adjustments thereto related to restructuring actions initiated prior to fiscal 2004 are not allocated to the reportablebusiness segments. Workforce rebalancing charges are included in business segment results.
Selected financialoperating results information for each reportablebusiness segment was as follows for the three and nine months ended July 31, 2004 and 2003:follows:
| Imaging and Printing Group | Personal Systems Group | Enterprise Storage and Servers | Software | HP Services | HP Financial Services | Corporate Investments | Total | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In millions) | |||||||||||||||||||||||
For the three months ended July 31, 2004: | ||||||||||||||||||||||||
Total net revenue | $ | 5,648 | $ | 5,904 | $ | 3,352 | $ | 223 | $ | 3,466 | $ | 488 | $ | 114 | $ | 19,195 | ||||||||
Earnings (loss) from operations | $ | 837 | $ | 25 | $ | (208 | ) | $ | (45 | ) | $ | 309 | $ | 42 | $ | (52 | ) | $ | 908 | |||||
For the three months ended July 31, 2003: | ||||||||||||||||||||||||
Total net revenue | $ | 5,226 | $ | 4,955 | $ | 3,516 | $ | 190 | $ | 3,097 | $ | 442 | $ | 88 | $ | 17,514 | ||||||||
Earnings (loss) from operations | $ | 745 | $ | (56 | ) | $ | (20 | ) | $ | (50 | ) | $ | 335 | $ | 19 | $ | (37 | ) | $ | 936 | ||||
For the nine months ended July 31, 2004: | ||||||||||||||||||||||||
Total net revenue | $ | 17,656 | $ | 18,082 | $ | 11,048 | $ | 645 | $ | 10,119 | $ | 1,398 | $ | 330 | $ | 59,278 | ||||||||
Earnings (loss) from operations | $ | 2,758 | $ | 132 | $ | 66 | $ | (140 | ) | $ | 896 | $ | 106 | $ | (135 | ) | $ | 3,683 | ||||||
For the nine months ended July 31, 2003: | ||||||||||||||||||||||||
Total net revenue | $ | 16,336 | $ | 15,224 | $ | 10,747 | $ | 553 | $ | 9,112 | $ | 1,460 | $ | 248 | $ | 53,680 | ||||||||
Earnings (loss) from operations | $ | 2,581 | $ | — | $ | 11 | $ | (168 | ) | $ | 971 | $ | 54 | $ | (128 | ) | $ | 3,321 | ||||||
| Three months ended January 31 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total Net Revenue | Earnings (Loss) from Operations | ||||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||||
| In millions | |||||||||||||
Personal Systems Group | $ | 6,873 | $ | 6,187 | $ | 147 | $ | 61 | ||||||
Imaging and Printing Group | 6,067 | 5,910 | 932 | 967 | ||||||||||
Imaging and Personal Systems Group | 12,940 | 12,097 | 1,079 | 1,028 | ||||||||||
Enterprise Storage and Servers | 4,047 | 3,700 | 71 | 153 | ||||||||||
HP Services | 3,815 | 3,176 | 281 | 261 | ||||||||||
Software | 240 | 203 | (40 | ) | (49 | ) | ||||||||
Technology Solutions Group | 8,102 | 7,079 | 312 | 365 | ||||||||||
HP Financial Services | 555 | 441 | 45 | 29 | ||||||||||
Corporate Investments | 115 | 103 | (51 | ) | (36 | ) | ||||||||
Segment total | $ | 21,712 | $ | 19,720 | $ | 1,385 | $ | 1,386 | ||||||
The reconciliation of segment operating results information to HP consolidated totals wasis as follows for the threefollows:
| Three months ended January 31 | ||||||
---|---|---|---|---|---|---|---|
| 2005 | 2004 | |||||
| In millions | ||||||
Net revenue: | |||||||
Segment total | $ | 21,712 | $ | 19,720 | |||
Elimination of intersegment net revenue and other | (258 | ) | (206 | ) | |||
Total HP consolidated | $ | 21,454 | $ | 19,514 | |||
Earnings before taxes: | |||||||
Total segment earnings from operations | $ | 1,385 | $ | 1,386 | |||
Corporate and unallocated costs and eliminations | (50 | ) | (30 | ) | |||
Restructuring charges | (3 | ) | (54 | ) | |||
Amortization of purchased intangible assets | (167 | ) | (144 | ) | |||
Acquisition-related charges | — | (15 | ) | ||||
Interest and other, net | 25 | 11 | |||||
(Losses) gains on investments | (24 | ) | 9 | ||||
Dispute settlement | (116 | ) | — | ||||
Total HP consolidated | $ | 1,050 | $ | 1,163 | |||
Net revenue by segment and nine months ended July 31, 2004 and 2003:business unit
| Three months ended July 31, | Nine months ended July 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 2003 | 2004 | 2003 | |||||||||
| (In millions) | ||||||||||||
Net revenue: | |||||||||||||
Total segments | $ | 19,195 | $ | 17,514 | $ | 59,278 | $ | 53,680 | |||||
Elimination of intersegment net revenue and other | (306 | ) | (166 | ) | (762 | ) | (472 | ) | |||||
Total HP consolidated net revenue | $ | 18,889 | $ | 17,348 | $ | 58,516 | $ | 53,208 | |||||
Earnings before taxes: | |||||||||||||
Total segment earnings from operations | $ | 908 | $ | 936 | $ | 3,683 | $ | 3,321 | |||||
Corporate and unallocated costs, and eliminations | (62 | ) | (78 | ) | (139 | ) | (216 | ) | |||||
Amortization of purchased intangible assets | (146 | ) | (141 | ) | (438 | ) | (420 | ) | |||||
Restructuring charges | (9 | ) | (376 | ) | (101 | ) | (610 | ) | |||||
Acquisition-related charges | (6 | ) | (40 | ) | (30 | ) | (252 | ) | |||||
In-process research and development charges | (28 | ) | — | (37 | ) | — | |||||||
Interest and other, net | 20 | 10 | 33 | 41 | |||||||||
Gains (losses) on investments and other, net | 1 | (24 | ) | 5 | (41 | ) | |||||||
Dispute settlement | — | — | (70 | ) | — | ||||||||
Total HP consolidated | $ | 678 | $ | 287 | $ | 2,906 | $ | 1,823 | |||||
HP allocates assets to the individual segments based on the primary segments benefiting from the assets. HP allocates certain assets, such as deferred tax assets, which cannot be directly attributed to a segment, based on certain drivers. Corporate and unallocated assets are composed primarily of cash and cash equivalents and short-term investments. Total assets by segments have not materially changed from the period ended April 30, 2004.
| Three months ended January 31 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | ||||||||
| In millions | |||||||||
Net revenue: | ||||||||||
Desktops | $ | 3,802 | $ | 3,516 | ||||||
Notebooks | 2,338 | 2,142 | ||||||||
Workstations | 285 | 235 | ||||||||
Handhelds | 290 | 253 | ||||||||
Other | 158 | 41 | ||||||||
Personal Systems Group | 6,873 | 6,187 | ||||||||
Commercial hardware | 1,611 | 1,547 | ||||||||
Consumer hardware | 1,114 | 1,276 | ||||||||
Supplies | 3,272 | 3,026 | ||||||||
Other | 70 | 61 | ||||||||
Imaging and Printing Group | 6,067 | 5,910 | ||||||||
Imaging and Personal Systems Group | 12,940 | 12,097 | ||||||||
Business critical systems | 899 | 915 | ||||||||
Industry standard servers | 2,328 | 1,959 | ||||||||
Storage | 820 | 827 | ||||||||
Other | — | (1 | ) | |||||||
Enterprise Storage and Services | 4,047 | 3,700 | ||||||||
Technology services | 2,389 | 2,090 | ||||||||
Managed services | 754 | 524 | ||||||||
Consulting and integration | 672 | 560 | ||||||||
Other | — | 2 | ||||||||
HP Services | 3,815 | 3,176 | ||||||||
OpenView | 154 | 133 | ||||||||
OpenCall & other | 86 | 70 | ||||||||
Software | 240 | 203 | ||||||||
Technology Solutions Group | 8,102 | 7,079 | ||||||||
HP Financial Services | 555 | 441 | ||||||||
Corporate Investments | 115 | 103 | ||||||||
Total segments | 21,712 | 19,720 | ||||||||
Eliminations of intersegment net revenue and other | (258 | ) | (206 | ) | ||||||
Total HP consolidated | $ | 21,454 | $ | 19,514 | ||||||
Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this document.
OVERVIEW
We are a leading global technology company and generate net revenue and earn our revenues and profits from the sale of products, technologies, solutions and services to consumers, businesses and governments. Our portfolio is broad and includes personal computers, handheld computing devices, home and business imaging and printing devices, publishing systems, personal computers, handheld computing devices,storage and servers, storage solutions, software and a wide array of information technology ("IT") services.services and software solutions. We have seven business segments,segments: the Personal Systems Group ("PSG"), the Imaging and Printing Group ("IPG"), the Personal Systems Group ("PSG"), Enterprise Storage and& Servers ("ESS"), Software, HP Services ("HPS"), HP Financial Services ("HPFS"), Software and Corporate Investments. In order to maximize efficiency, accelerate time to market and intensify competitive focus, we combined the Imaging and Printing Group and the Personal Systems Group into one organization known as the Imaging and Personal Systems Group ("IPSG"). Given the cross-segment linkages in our enterprise offerings, and in order to capitalize on up-selling and cross-selling opportunities, ESS, HPS and Software are structured beneath a broader Technology Solutions Group ("TSG"). While TSG and IPSG are not operating segments, we sometimes provide financial data aggregating the segments within IPSG and TSG in order to provide a supplementary view of our business.
Our performance will bebusiness strategy revolves around the following strategic imperatives:
This approach requires us to excel both in individual product categories and in managing across our broad portfolio in order to drive growth while optimizing cost structure. At the same time, our product and geographic breadth help reduce volatility by balancing our financial results across a related but diversified set of businesses.
Our financial results also are impacted by our ability to address a variety of challengespredict and opportunitiesto respond to industry-wide trends. For instance, underlying our strategy is our belief that physical, static processes will continue to shift to processes that are digital, mobile, virtual and personal. By anticipating these shifts and preparing solutions that make these changes simpler for customers, we have the opportunity to accelerate these shifts and capture revenue and market share. Our approach to preparing these solutions can be seen in responding to the dynamics of the technology industry, which is characterized by rapid change, evolving customer demands and intense competition. Accordingly, we must manage our business in the face of current technology trendsprograms such as shifts toward standardized products, increased utilization of the global labor forceour digital photography initiative, where we offer compatible solutions spanning cameras, printers and corresponding product and service delivery models, and consolidation of competitors. The operations of our business segments provide a robust platform for innovation and are designed to deliver the best possible experience to our customers. Our strategy revolves around continued investment in technology, research and development and innovation; expanding and strengthening our product portfolio; partnering with global industry leaders; delivering on our value proposition to our customers; and working to improve profitability, market share and financial strength. Our financial strength and ability to adapt to the current market and economic conditions are dependent in part on our generation of cash flow, effective management of working capital, funding commitments and other obligations,paper, as well as the growth of our business. In addition, our quarterly financial performance is impacted by seasonality trends, with our third quarter typically our weakest and our fourth quarter typically our strongest.
Net revenue was $18.9 billion in the third quarter of fiscal 2004 as compared to $17.3 billionfocus on flexibility, modularity and integration in the corresponding period of fiscal 2003, representing an increase of 9%. The increase in revenue was due primarily to revenue growth in PSG, IPG and HPS, offset in part by a revenue decline in ESS. Our gross margin as a percentage of revenue decreased to 23.5% from 26.2% in the prior-year period, resulting primarily from unfavorable gross margin impacts in ESS, HPS and PSG, while IPG experienced a slight gross margin increase. Net earnings were $586 million and $297 million in the third quarters of fiscal 2004 and fiscal 2003, respectively. The following performance issues in ESS negatively impacted the current quarter's results: in the U.S., a more disruptive than planned migration to a new order processing and supply chain system; channel management issues in Europe related to channel compensation, overly aggressive discounting and problems with the transition to a centralized claims process; and, the decline in average selling prices ("ASPs") in the storage business.
Net revenue in the first nine months of fiscal 2004 was $58.5 billion as compared to $53.2 billion in the corresponding period of fiscal 2003, representing an increase of 10%. The increase in revenue was due primarily to revenue growth in PSG, IPG, HPS and ESS. Our gross margin as a percentage of revenue decreased to 24.7% from 26.6% in the prior-year period, resulting primarily from unfavorable gross margin impacts in ESS, PSG and HPS, while IPG gross margin remained flat. We had netour enterprise solutions.
earnings Another trend significant to our business and financial results is the shift toward standardized products, which presents revenue opportunities for certain of $2.4 billionour businesses but presents an ongoing challenge to our margins. To help address the potential margin impact of standardization, we take ongoing actions related to both revenue generation and $1.7 billioncost structure management. In the sales and marketing area, we are instituting programs designed to improve the rates at which we sell higher-margin configurations or options. We also continue to focus on managing procurement and labor expenses. Key to our overall efforts in delivering superior products while maintaining a world-class cost structure is the increasingly global nature of technology expertise. This trend is allowing us to develop a global delivery structure to take advantage of regions where advanced technical expertise is available at lower costs. As part of this effort, we continually evaluate our workforce and make adjustments we deem appropriate. When we make adjustments to our workforce, we may incur expenses associated with workforce reductions that delay the benefit of a more efficient workforce structure, but we believe that the fundamental shift to global delivery is crucial to maintaining a long-term competitive cost structure.
In terms of how our execution has translated into financial performance, the following provides our overview of key first nine months of fiscal 2004 and fiscal 2003, respectively.quarter 2005 financial metrics:
| | IPSG | TSG | | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| HP Consolidated | | |||||||||||||||||||||||||||
| PSG | IPG | Total | ESS | HPS | Software | Total | HPFS | |||||||||||||||||||||
| In millions, except per share amounts | ||||||||||||||||||||||||||||
Net revenue | $ | 21,454 | $ | 6,873 | $ | 6,067 | $ | 12,940 | $ | 4,047 | $ | 3,815 | $ | 240 | $ | 8,102 | $ | 555 | |||||||||||
Year over year net revenue % increase | 10 | % | 11 | % | 3 | % | 7 | % | 9 | % | 20 | % | 18 | % | 14 | % | 26 | % | |||||||||||
Earnings (loss) from operations | $ | 1,165 | $ | 147 | $ | 932 | $ | 1,079 | $ | 71 | $ | 281 | $ | (40 | ) | $ | 312 | $ | 45 | ||||||||||
Earnings (loss) from operations as a % of net revenue | 5.4 | % | 2.1 | % | 15.4 | % | 8.3 | % | 1.8 | % | 7.4 | % | (16.7 | )% | 3.9 | % | 8.1 | % | |||||||||||
Net earnings | $ | 943 | |||||||||||||||||||||||||||
Net earnings per share | |||||||||||||||||||||||||||||
Basic | $ | 0.32 | |||||||||||||||||||||||||||
Diluted | $ | 0.32 |
Cash flow provided by operating activities amounted to $319and cash equivalents at January 31, 2005 totaled $13.3 billion, an increase of $639 million forfrom the third quarterOctober 31, 2004 balance of fiscal 2004 and $3.1 billion for the first nine months of fiscal 2004. Adjustments to reconcile net earnings$12.7 billion. The increase was related primarily to net cash provided by operating activities, offset in part by capital expenditures for the third quarterproperty, plant and first nine months of fiscal 2004 amounted to $825 millionequipment and $2.5 billion, respectively. These adjustments in both periods were driven primarily by depreciation and amortization expense. The net impact of the change in assets and liabilities amounted to decreases of $1.1 billion and $1.8 billion for the third quarter and first nine months of fiscal 2004, respectively.
Net cash used in investing activities for the third quarter and first nine months of fiscal 2004 was $374 million and $1.6 billion, respectively. The activities were driven primarily by $361 million and $1.0 billion, respectively, in net capital expenditures and $61 million and $847 million, respectively, in net cash paid for acquisitions. The acquisitions are intended to enhance our capability in IT services, add breadth to our Adaptive Enterprise portfolio and enhance the automation capabilities of our software portfolio.
For the third quarter and first nine months of fiscal 2004, net cash used in financing activities were $614 million and $1.7 billion, respectively. The activities consisted primarily of dividend payments of $244 million and $732 million, respectively, along with $500 million and $1.1 billion, respectively, of repurchases of common stock. Net cash provided by the issuance of common stock under employee plans for the third quarter and first nine months of fiscal 2004 consisted of $241 million and $538 million, respectively, which moderated cash used in financing activities.dividend payments.
We intend the discussion of our financial condition and results of operations that follows to provide information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements.
The discussion of results of operations at the consolidated level is followed by a more detailed discussion of results of operations by segment.
For a further discussion of factors that could impact operating results, see the section entitled "Factors That Could Affect Future Results" below.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Consolidated Condensed Financial Statements, which HP has prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its
estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of HP's Board of Directors. Actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or if changes in the accounting estimate that are reasonably likely to occur, could materially change the financial statements. Management believes there have been no significant changes during the ninethree months ended JulyJanuary 31, 20042005 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of
Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended October 31, 2003.2004.
The Jobs Act
We continue to evaluate whether we will repatriate foreign earnings under the repatriation provisions of the Jobs Act. Up to $14.5 billion is being considered for possible repatriation. Our estimate of the range of tax expense we would accrue on a maximum repatriation eligible for the temporary deduction remains between $850 million and $925 million. We expect to make our repatriation determination by the end of our second fiscal quarter in 2005.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and supercedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values, beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123, no longer will be an alternative to financial statement recognition. We expect to adopt SFAS 123R in our fourth quarter of fiscal 2005, beginning August 1, 2005. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. We are evaluating the requirements of SFAS 123R and we expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share. We have not yet determined the method of adoption or the effect of adopting SFAS 123R, and we have not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.
See Note 1 of the Consolidated Condensed Financial Statements for a full description of other recent accounting pronouncements, including the respective expected dates of adoption and estimated effects on results of operations and financial condition.
RESULTS OF OPERATIONS
The following is a summary of our consolidated operating results for the three and nine months ended July 31, 2004 and 2003. This discussion is followed by a more detailed discussion of operating results by segment. Product category fluctuations highlighted at the consolidated level are more fully explained in the segment discussions. Consolidated resultsResults of operations in dollars and as a percentage of net revenue for such periods were as follows:
| Three months ended July 31, | Nine months ended July 31, | ||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 2003 | 2004 | 2003 | Three months ended January 31 | |||||||||||||||||||||||||||
| Dollars | % of Revenue | Dollars | % of Revenue | Dollars | % of Revenue | Dollars | % of Revenue | 2005 | 2004(2) | ||||||||||||||||||||||
| (In millions) | In millions | ||||||||||||||||||||||||||||||
Net revenue | $ | 18,889 | 100.0 | % | $ | 17,348 | 100.0 | % | $ | 58,516 | 100.0 | % | $ | 53,208 | 100.0 | % | $ | 21,454 | 100.0 | % | $ | 19,514 | 100.0 | % | ||||||||
Cost of sales(1) | 14,443 | 76.5 | 12,810 | 73.8 | 44,052 | 75.3 | 39,054 | 73.4 | 16,537 | 77.1 | % | 14,691 | 75.3 | % | ||||||||||||||||||
Gross margin | 4,446 | 23.5 | 4,538 | 26.2 | 14,464 | 24.7 | 14,154 | 26.6 | 4,917 | 22.9 | % | 4,823 | 24.7 | % | ||||||||||||||||||
Research and development | 862 | 4.6 | 895 | 5.2 | 2,647 | 4.5 | 2,744 | 5.2 | 878 | 4.1 | % | 889 | 4.5 | % | ||||||||||||||||||
Selling, general and administrative | 2,738 | 14.5 | 2,785 | 16.1 | 8,273 | 14.1 | 8,305 | 15.6 | 2,704 | 12.6 | % | 2,578 | 13.2 | % | ||||||||||||||||||
Amortization of purchased intangible assets | 146 | 0.8 | 141 | 0.8 | 438 | 0.7 | 420 | 0.8 | 167 | 0.8 | % | 144 | 0.7 | % | ||||||||||||||||||
Restructuring charges | 9 | — | 376 | 2.2 | 101 | 0.2 | 610 | 1.1 | 3 | — | 54 | 0.3 | % | |||||||||||||||||||
Acquisition-related charges | 6 | — | 40 | 0.2 | 30 | 0.1 | 252 | 0.5 | — | — | 15 | 0.1 | % | |||||||||||||||||||
In-process research and development charges | 28 | 0.1 | — | — | 37 | 0.1 | — | — | ||||||||||||||||||||||||
Earnings from operations | 657 | 3.5 | 301 | 1.7 | 2,938 | 5.0 | 1,823 | 3.4 | 1,165 | 5.4 | % | 1,143 | 5.9 | % | ||||||||||||||||||
Interest and other, net | 20 | 0.1 | 10 | 0.1 | 33 | 0.1 | 41 | 0.1 | 25 | 0.1 | % | 11 | 0.1 | % | ||||||||||||||||||
Gains (losses) on investments and other, net | 1 | — | (24 | ) | (0.1 | ) | 5 | — | (41 | ) | (0.1 | ) | ||||||||||||||||||||
(Losses) gains on investments | (24 | ) | (0.1 | )% | 9 | — | ||||||||||||||||||||||||||
Dispute settlement | — | — | — | — | (70 | ) | (0.1 | ) | — | — | (116 | ) | (0.5 | )% | — | — | ||||||||||||||||
Earnings before taxes | 678 | 3.6 | 287 | 1.7 | 2,906 | 5.0 | 1,823 | 3.4 | 1,050 | 4.9 | % | 1,163 | 6.0 | % | ||||||||||||||||||
Provision for (benefit from) taxes | 92 | 0.5 | (10 | ) | — | 500 | 0.9 | 146 | 0.2 | |||||||||||||||||||||||
Provision for taxes | 107 | 0.5 | % | 227 | 1.2 | % | ||||||||||||||||||||||||||
Net earnings | $ | 586 | 3.1 | $ | 297 | 1.7 | $ | 2,406 | 4.1 | $ | 1,677 | 3.2 | $ | 943 | 4.4 | % | $ | 936 | 4.8 | % | ||||||||||||
Net Revenue
NetThe components of weighted average net revenue growth were as follows:
Three months ended January 31, 2005 | |||
---|---|---|---|
Percentage Points | |||
Personal Systems Group | 3.5 | ||
HP Services | 3.3 | ||
Enterprise Storage and Servers | 1.8 | ||
Imaging and Printing Group | 0.8 | ||
HP Financial Services | 0.6 | ||
Software | 0.2 | ||
Corporate Investments/Other | (0.3 | ) | |
Total HP | 9.9 | ||
For the three months ended January 31, 2005, net revenue increased 9%10% from the prior-year comparable period (5% on a constant currency basis) in the third quarter of fiscal 2004. U.S. revenue increased 1% in the third quarter of fiscal 2004 to $7.2 billion, while international revenue increased 14% to $11.7 billion compared to the prior year period. Net revenue increased 10% (3% on a constant currency basis) in the first nine months of fiscal 2004. U.S. revenue was $21.4 billion for the first nine months of fiscal 2004, representing negligible growth compared to the prior year period. International revenue increased 16% to $37.1 billion compared to the prior year period.. The favorable currency impact in both periods was due primarily to the weakening of the dollar against the euro. U.S. net revenue increased 4% to $7.4 billion, while international net revenue increased 13% to $14.1 billion. PSG experienced net revenue growth across all businesses and regions, with solid market growth in the consumer and commercial segments resulting in overall volume increases. The volume increases were moderated by a slight decline in average selling prices ("ASPs") due to pricing pressures and some of the impact from component cost declines. HPS achieved net revenue growth across all businesses in the first quarter of fiscal 2005. The
The componentsimpact of weighted average revenue growth foracquisitions completed after the three and nine months ended July 31, 2004 are as follows:
| Three months ended July 31, 2004 | Nine months ended July 31, 2004 | |||
---|---|---|---|---|---|
| (Percentage points) | ||||
Personal Systems Group | 5.5 | 5.4 | |||
Imaging and Printing Group | 2.4 | 2.5 | |||
HP Services | 2.1 | 1.9 | |||
HP Financial Services | 0.3 | (0.1 | ) | ||
Enterprise Storage and Servers | (0.9 | ) | 0.6 | ||
Other | (0.5 | ) | (0.3 | ) | |
Total HP | 8.9 | 10.0 | |||
The increase in PSG revenue in both periods resulted primarily from an increase in volumes across all businesses, combined with a slight improvement in ASPs. For the thirdfirst quarter of fiscal 2004 added to the PSG volume and ASP increase was offset by an unfavorable mix shift from notebooks to desktop PCs. Revenuesegment net revenue growth in HPS; favorable currency impacts and major outsourcing deals also contributed to the growth in technology services and managed services. For the three months ended January 31, 2005, ESS net revenue increased due to record unit shipments in the ProLiant server line. Net revenue declines in storage and business critical systems, due to competitive pressures, moderated the overall segment net revenue increase. The IPG for both periodsnet revenue increase in the first quarter of fiscal 2005 was driven by a strong rise in the volume growth of printer supplies reflecting continued expansion of the hardware installed base, due primarily to the strong performance of color-related products. Laserjet suppliesproducts and growth in commercial hardware, with strong shipments of color laser printers experienced strong volume growthprinters. For the three months ended January 31, 2005, HPFS net revenue increased 26% due primarily to a significant increase in operating leases. Growth in Software in the thirdfirst quarter of fiscal 2005 was the result of acquisitions completed after the first quarter of fiscal 2004, due to a growing market sizefavorable currency impacts and the demand for digital photography. HPS' revenue growth in both periods was attributable to growth in all businesses, with the impact of outsourcing deals and the Triaton acquisition driving growth in managed services and customer support. An increase in core consulting and integration services contributed to overall HPS revenue growth in the current quarter while for the first nine months of fiscal 2004 consulting and integration growth was more gradual. The decrease in ESS revenue for the third quarter of fiscal 2004 was the result of declines in storage and business critical servers, moderated by a slight increase in industry standard servers. For the first nine months of fiscal 2004, ESS revenue growth was the result primarily of increased sales in industry standard servers, moderated by a decline in sales of storage and business critical servers. The HPFS increase in net revenue in the third quarter of fiscal 2004 was due primarily to higher levels of operating leases and revenue from equipment sales after the expiration of the associated lease terms. Lower revenue-generating assets, resulting from portfolio amortization and asset sales exceeding new lease originations, and lower interest rates moderated the revenue increase. The decline in HPFS revenue for the first nine months of fiscal 2004 resulted primarily from a decrease in revenue-generating assets, as portfolio amortization and asset sales exceeded new lease originations.larger contracts.
Gross Margin
The weighted average components of the declinechange in gross margin as a percentage of net revenue for the three and nine months ended July 31, 2004 were as follows:
| Three months ended July 31, 2004 | Nine months ended July 31, 2004 | |||
---|---|---|---|---|---|
| (Percentage points) | ||||
Enterprise Storage and Servers | (1.6 | ) | (0.8 | ) | |
HP Services | (0.8 | ) | (0.7 | ) | |
Personal Systems Group | (0.4 | ) | (0.7 | ) | |
Imaging and Printing Group | 0.1 | — | |||
HP Financial Services | 0.1 | 0.1 | |||
Other | (0.1 | ) | 0.2 | ||
Total HP | (2.7 | ) | (1.9 | ) | |
Three months ended January 31, 2005 | |||
---|---|---|---|
Percentage Points | |||
Enterprise Storage and Servers | (1.0 | ) | |
Imaging and Printing Group | (0.5 | ) | |
HP Services | (0.4 | ) | |
HP Financial Services | — | ||
Software | 0.1 | ||
Personal Systems Group | 0.2 | ||
Corporate Investments/Other | (0.2 | ) | |
Total HP | (1.8 | ) | |
For the third quarter and first ninethree months of fiscal 2004, competitive pricing pressures contributedended January 31, 2005, as compared to the same period in the prior year, the gross margin declines fordecline in ESS HPSwas the result of competitive pressures in industry standard servers and PSG. ESS experienced additional margin decline for both periods due to internal execution issuesstorage and an unfavorable mix shift to lower-margin products. HPS experienced further gross margin declines for both periods due to an unfavorablethe mix shift to lower margin service levelsproducts within business critical systems. An aggressive pricing environment and a low-end mix shift in customer support. In addition, aconsumer hardware contributed to the gross margin decline in managed services was due primarily to large outsourcing contracts, which typically have lower margins inIPG for the early stagesfirst quarter of their life cycle. IPGfiscal 2005. The HPS gross margin was favorable forimpacted unfavorably by competitive pricing pressures, workforce rebalancing costs, Triaton GmbH, Triaton France SAS, and Triaton N.A, Inc (USA) (collectively "Triaton") and Synstar plc ("Synstar") integration costs and portfolio mix shifts from higher margin proprietary support to lower margin multi-vendor integrated support within technology services. For the thirdfirst quarter due to cost reductions and increased shipments in supplies. HPFSof fiscal 2005, gross margin increasedamounts in both periods reflecting higher portfolio profitability resulting primarilyHPFS and Software experienced very little change from endthe prior-year comparable period. The gross margin improvement in PSG in the first quarter of lease transactions.fiscal 2005 resulted from lower warranty expenses, component cost declines and supply chain efficiencies.
Operating Expenses
Research and Development
The decrease in research and development expense as a percentage of net revenue in the thirdfirst quarter and first nine months of fiscal 20042005, as compared to the first quarter in the prior year, was due primarily to the increase in net revenue outpacing expense control measuresgrowth as we continued to manage costs. For the three months ended January 31, 2005, total research and investment strategies, particularly in ESS and PSG. These impacts were moderated by increased investment costs in IPG.
Selling, General and Administrative
The decline in selling, general and administrative expensedevelopment spending decreased as a percentage of net revenue in both periods waseach of our major segments. Total research and development spending decreased in IPG, reflecting the cost benefits from the consolidation of certain work to a central location, lower
program spending and efficiencies. Total research and development spending increased slightly in ESS due to workforce rebalancing actions.
Selling, General and Administrative
Selling, general and administrative expense declined as a percentage of net revenue in the first quarter of fiscal 2005, from the prior-year comparable period, due primarily to the increase in net revenue coupled withoutpacing expense control measures. Thesegrowth as we continued to manage costs. Each of our major segments experienced a decline in expenses as a percentage of net revenue for the period, except for IPG, which had only a small percentage increase. Unfavorable currency impacts were moderated by a slightcontributed to the increase in expenses, duetotal expense for the quarter resulting primarily to unfavorable currency impacts resulting from the weakening of the dollar against the euro.
Amortization of Purchased Intangible Assets
We amortize purchased intangible assets with finite lives over their estimated useful lives, generally two to ten years. In fiscal 2004 and 2003,The increase in amortization expense consisted primarily of the amortization recorded in connection with the intangible assets acquired through our acquisitions in fiscal 2002.
Restructuring Charges
In the three and nine months ended July 31, 2004, we recorded restructuring charges of $9 million and $101 million, respectively. The $9 million charge for the three months ended JulyJanuary 31, 2004 consisted2005, as compared to the same period in the prior year, was due to the amortization of a net addition of $37 millionintangible assets related to additional costs, netthe acquisition of reductions,Triaton in employee severanceApril 2004 and other restructuring costs related to restructuring actions approved andSynstar in October 2004.
Restructuring Charges
Restructuring plans implemented in fiscalduring the 2001, 2002 and a net reduction of $28 million2003 fiscal years have remaining liabilities and, accordingly, revisions to the estimated liabilities are recognized in estimated severance and other employee benefits related to restructuring actions approved and implementedearnings in the second and fourth quarterperiod of fiscal 2003.revision.
Of the $101 million charge recorded in the nine months ended July 31, 2004, $24 million related to additional charges taken in connection with the fiscal 2003 second and fourth quarter actions that did not previously meet the recognition criteria of Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," $4 million related to additional costs, net of reductions, in estimated severance and other employee benefits related to restructuring actions approved and implemented in the second and fourth quarter of fiscal 2003, and $3 million related to additional asset impairmentRestructuring charges, net of reductions, takenfor the three months ended January 31, 2005 were $3 million compared to $54 million in the first quarter of fiscal 2004. The first quarter of fiscal 2005 includes a reduction of the liability related to the 2003 plans and a charge related to estimate revisions for the 2002 plan, while the prior year first quarter had net restructuring charges for those same plans.
During the first quarter of fiscal 2005, the previously estimated headcount of 8,600 employees for the fiscal 2003 restructuring plans was reduced by 200 employees to 8,400 employees. Of these 8,400 employees, approximately 8,300 had been terminated or had retired by the end of fiscal 2004. The remaining 100 employees are expected to exit by the end of fiscal 2005.
Restructuring liabilities of $242 million at January 31, 2005 are composed primarily of the remaining cash payments on certain severance benefits for non-U.S. operations and contract termination costs, including canceled facility leases. These obligations will be largely settled by the end of fiscal 2010. In addition, approximately $1 million of costs related to the fiscal 2003 restructuring plans have not yet been accrued, as the requirements for recognition have not yet been met, and will be charged to operations as the restructuring activities occur during the remainder of fiscal 2005.
Workforce Rebalancing
We continue to focus on managing procurement expenses and developing a global delivery structure to take advantage of regions where advanced technical expertise is available at lower costs. As part of this effort, we continually evaluate our workforce and make appropriate adjustments, for which we generally incur severance and related expenses. We expect to incur expenses of approximately $200 million in the first half of fiscal 2005 in connection with workforce rebalancing efforts. In the first quarter of fiscal 2003 second quarter action. The remaining $702005, we reduced headcount by approximately 900 employees in certain business segments and recorded approximately $60 million charge related to additional costs, net of reductions, in estimatedworkforce rebalancing charges for employee severance and other employee benefitsrelated costs. As of January 31, 2005, approximately $20 million had been paid and other restructuring costs relatedthe remainder is expected to restructuring actions approved and implemented inbe paid by the end of fiscal 2002.
Acquisition-Related Charges
Acquisition-related2005. Workforce rebalancing charges are included in the third quarter and first nine months of fiscal 2004 consisted of deferred compensation and professional fees, while the charges in the corresponding periods for fiscalbusiness segment results.
2003 were attributable primarily to costs incurred for employee retention bonuses, as well as professional fees and consulting services.
In-Process Research and Development Charges
In the third quarter and first nine months of fiscal 2004, we recorded IPR&D charges of $28 million and $37 million, respectively, in connection with various small acquisitions.
Interest and Other, Net
The increase in interestInterest and other, net increased $14 million for the three months ended January 31, 2005 compared to the corresponding period in fiscal 2004 primarily from increased interest income due to new investment strategies and higher interest rates offset partially by increased interest expense.
(Losses) Gains on Investments
The net loss for the three months ended January 31, 2005 was attributable to an impairment loss on our equity investments in publicly-traded and privately-held emerging technology companies. The gain in the thirdfirst quarter of fiscal 2004 was attributable primarily to an increase in the elimination of minority interest and lower interest expense offset by lower interest income and higher currency related losses. The decrease in interest and other, net for the first nine months of fiscal 2004 was attributable primarily to higher currency losses from balance sheet remeasurement and related hedging strategies and a decline in interest income reflecting lower interest rates.
Gains (Losses) on Investments and Other, Net
The net gains for the third quarter and first nine months of fiscal 2004 were attributable mainly to gains on a prior period divestiture and on the sale of investments, offset in part by impairment charges on our investment portfolio. The loss for the third quarter and first nine months of fiscal 2003 resulted primarily from impairment charges in excess of gains realized on our investment portfolio.an investment.
Dispute Settlement
In the first nine monthsquarter of fiscal 20042005, we recorded $70reached a legal settlement of $141 million in settlement costsour patent infringement case with Intergraph Hardware Technologies Company ("Intergraph"). We recorded a charge of $116 million related to a dispute with the Government of Canada.cross-license agreement for products shipped in prior years. See Note 12 of the Consolidated Condensed Financial Statements.Statements for a full description of this matter.
Provision for (Benefit from) Taxes
Our effective tax rates were approximately 14%rate was 10.2% and 17%19.5% for the three and nine months ended JulyJanuary 31, 2005 and 2004, respectively. Our effective tax rates were a benefit of approximately 3% and a provision of approximately 8% for the three and nine months ended July 31, 2003, respectively. Our effective tax rates differedrate generally differs from the United StatesU.S. federal statutory rate of 35% in all periods due primarily to the tax rate benefits of certain earnings from operations in lower-tax jurisdictions throughout the world for which no United StatesU.S. taxes have been provided because such earnings are planned to be reinvestedre-invested indefinitely outside the United States. TheU.S. However, other items further reduced the effective tax ratesrate for the three and nine months ended July 31, 2004 were further reduced2005 period, including $61 million in net adjustments to previously estimated tax liabilities. An agreement with the Internal Revenue Service resulted in a $105 million adjustment primarily to reduce accruals of U.S. taxes on earnings outside the U.S. This was offset partly by $44 million in net favorableunfavorable adjustments to previously estimated tax liabilities, of $101 million and $147 million, respectively, which decreasedpredominantly in non-U.S. jurisdictions. Also benefiting the provisions for taxes by approximately $0.03 and $0.05 per share, respectively. The adjustments recorded in the third quarter of 2004 consisted primarily of a net favorable revision to estimated tax accruals upon filing the 2003 U.S. income tax return and the resolution of certain outstanding matters with the tax authorities. Additional net favorable adjustments during the second quarter were attributable primarily to a reduction in taxes on foreign earnings due to a change in regulatory policy. Excluding these adjustments, our tax rates would have been approximately 28% and 22% for the three and nine months ended July 31, 2004, respectively.
The effective tax rates in the fiscal 2003 periods reflected the tax benefits related to restructuring charges, primarily incurred in higher-tax jurisdictions. The effective tax rate for the nine months ended July 31, 2003 also was affected by a benefit of $131 million due to the reversal in the secondfirst quarter of fiscal 20032005 was the dispute settlement with Intergraph. We recorded a pre-tax charge of a valuation allowance previously provided on a deferred tax asset$116 million related to athis settlement. As the settlement is deductible from U.S. capital loss carryforward,taxable income at the realizationstatutory rate of which was previously uncertain.
The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in35%, the period the assessments are determined or resolved. Additionally, the jurisdictions in which our earnings and/or deductions are realized may differ from our current estimates. As a result, our effective tax rate may experience significant volatility on a quarterly basis.for the first quarter of fiscal 2005 was reduced by an additional 2.4%.
Segment Information
A description of the products and services as well as quarter-to-date and year-to-date financial data, for each segment can be found in Note 13 to the Consolidated Condensed Financial Statements. We have restated segment financial data for the three and nine months ended JulyJanuary 31, 20032004 to reflect changes in HP's organizational structure that occurred inat the beginning of the first quarter of fiscal 2004.2005. We describe these changes more fully in Note 13 to the Consolidated Condensed Financial Statements. HP baseshave presented the business segments disclosed in this Form 10-Q based on HP'sour management organizational structure as of JulyJanuary 31, 2004,2005 and the distinct nature of various businesses. Future changes to this organizational structure may result in changes to the reportablebusiness segments disclosed. The results discussions below include the results of each of HP's segments, with the exception of Corporate Investments, for the three and nine months ended July 31, 2004 and 2003.
Imaging and PrintingPersonal Systems Group
| For the three months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 5,648 | $ | 5,226 | |||
Earnings from operations | $ | 837 | $ | 745 | |||
Earnings from operations as a percentage of net revenue | 14.8 | % | 14.3 | % |
| For the nine months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 17,656 | $ | 16,336 | |||
Earnings from operations | $ | 2,758 | $ | 2,581 | |||
Earnings from operations as a percentage of net revenue | 15.6 | % | 15.8 | % |
IPG'sIn order to maximize efficiency, accelerate time to market and intensify competitive focus, we combined the Imaging and Printing Group and the Personal Systems Group into one organization known as the Imaging and Personal Systems Group ("IPSG"). This builds on the collaboration already established between the two business segments. Each of the business segments of IPSG is described in more detail below.
| Three months ended January 31 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | % Increase | ||||||
| In millions | ||||||||
Net revenue | $ | 6,873 | $ | 6,187 | 11.1 | % | |||
Earnings from operations | $ | 147 | $ | 61 | 141.0 | % | |||
Earnings from operations as a % of net revenue | 2.1 | % | 1.0 | % |
The components of weighted average net revenue grew 8% each in the third quarter and in the first nine months of fiscal 2004 compared to the same periods in fiscal 2003.growth by business unit were as follows:
Three months ended January 31, 2005 | ||
---|---|---|
Percentage Points | ||
Desktop PCs | 4.6 | |
Notebook PCs | 3.2 | |
Workstations | 0.8 | |
Handhelds | 0.6 | |
Other | 1.9 | |
Total PSG | 11.1 | |
On a constant currency basis, PSG's net revenue increased 5% and 2%7% for the three months ended January 31, 2005, as compared to the same period in the third quarter and first nineprior year. For the three months of fiscal 2004, respectively. Theended January 31, 2005, the favorable currency impact in both periods was due primarily to the weakening of the dollar against the euro. The segment had solidNet revenue growthincreased across all businesses and regions and was the result primarily of an overall 12% volume increase. Volume increases were the result of strong growth in the third quarterconsumer and first ninecommercial markets, our re-entry into the China market, strong growth in Intel-based personal workstations, the introduction of new digital entertainment products such as the Apple iPod from HP, entertainment notebooks, converged devices and broader product line offerings in pen-based iPaqs. The PSG volume increase was moderated by a slight decline in ASPs with commercial clients, which includes workstations, and consumer clients experiencing declines of 1% and 7%, respectively. The ASP decline was due to component cost declines and was offset partially by a strong monitor attach rate in commercial PCs. Year-over-year net revenue increases in desktop and notebook PCs were 8% and 9%, respectively, while commercial clients and consumer clients net revenue increased 11% and 7%, respectively, from the prior-year comparable period.
PSG's earnings from operations as a percentage of net revenue increased 1.1 percentage points for the three months ofended January 31, 2005, compared to the same period in fiscal 2004. The increase is the result of a gross margin improvement of 0.6 percentage points and a decline in operating expenses as a percentage of net revenue of 0.5 percentage points. The gross margin improvement is due primarily to reduced warranty expense, component cost declines and improvements in supply chain costs and increased option attach rates which carry higher gross margins. The operating expense decline as a percentage of net revenue for the period is the result of a combination of increased net revenue and the effect of continued cost control measures.
Imaging and Printing Group
| Three months ended January 31 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | % Increase (Decrease) | ||||||
| In millions | ||||||||
Net revenue | $ | 6,067 | $ | 5,910 | 2.7 | % | |||
Earnings from operations | $ | 932 | $ | 967 | (3.6 | )% | |||
Earnings from operations as a % of net revenue | 15.4 | % | 16.4 | % |
The components of weighted average net revenue growth by business unit were as follows:
Three months ended January 31, 2005 | |||
---|---|---|---|
Percentage Points | |||
Supplies | 4.2 | ||
Commercial hardware | 1.1 | ||
Consumer hardware | (2.7 | ) | |
Other | 0.1 | ||
Total IPG | 2.7 | ||
On a constant currency basis, IPG's net revenue declined 1.7% for the three and nine months ended JulyJanuary 31, 2004 were as follows.
| Three months ended July 31, 2004 | Nine months ended July 31, 2004 | ||
---|---|---|---|---|
| (Percentage points) | |||
Printer Supplies | 5.2 | 5.7 | ||
Business Printer Hardware | 2.3 | 1.7 | ||
Digital Imaging Products | 0.5 | 0.3 | ||
Home Printer Hardware | (0.6 | ) | — | |
Other | 0.7 | 0.4 | ||
Total IPG | 8.1 | 8.1 | ||
Growth2005 from the prior-year comparable period. The favorable currency impact was due primarily to the weakening of the dollar against the euro. For the three months ended January 31, 2005, the growth in printer supplies net revenue in the third quarter and first nine months of fiscal 2004 was driven byreflected higher shipment volumes reflecting continued expansion of the printer hardware installed base, due primarily to the strong performance of color-related products. The growth in commercial hardware net revenue increase in business printer hardware in the third quarter and first nine months of fiscal 2004 was attributable to unit volume growth in color laser printers, business inkjetmultifunction printers and monochromethe digital press business. New product introductions added to the net revenue growth in color laser printers, as well as increasing multi-function printer demand.and multifunction printers. A continued shift in demand to lower-priced products and a competitive pricing environment moderated the net revenue increase in business printercommercial hardware during the period. The decline in consumer hardware net revenue was driven by decreases in ASPs due to the continued shift in demand to lower-priced products, particularly in the sub-$200 all-in-one market, intense competition in both periods. The net revenue decrease in home printer hardwarethe all-in-one and single function inkjet printers and the ongoing decline in the third quarter of fiscal 2004 was attributable mainly to a decline in single-function printer unit shipments moderated by a shipment increase for all-in-one devices.scanner market.
InFor the third quarter of fiscal 2004, the 0.5 percentage point increase in thethree months ended January 31, 2005, IPG earnings from operations ratio consistedas a percentage of a 0.3net revenue declined by 1.0 percentage point, increasedriven by a 1.1 percentage point decline in gross margin and offset by a 0.20.1 percentage point decreasedecline in operating expensesexpenses. The gross margin decline in imaging and printing is attributable to an aggressive pricing environment and a low-end mix shift in consumer hardware along with a mix shift to lower margin products in supplies. Operating expense, as a percentage of revenue. For the first nine months of the year, the 0.2 percentage point decreasenet revenue, remained relatively flat year-over-year, with slight increases in the earnings from operations ratio was driven primarilyselling, marketing and administrative expenses offset by a 0.2 percentage point increasedecline in operating expenses as a percentageresearch and development expense due to the cost benefits from the consolidation of revenue. The gross margin improvement in the third quarter was due primarilycertain work to a product mix shift towards higher-margin, multi-function products within home printer hardware, offsetcentral location, lower program spending and other efficiencies.
Technology Solutions Group
Given the cross-segment linkages in part by unfavorable yen impactour enterprise offerings, and in order to capitalize on up-selling and cross-selling opportunities, ESS, HPS and Software are structured beneath a broader Technology Solutions Group ("TSG"). The business printer hardware and laserjet supplies. The decreasesegments of TSG are described in operating expenses as a percentage of revenue in the third quarter was the result primarily of an increase in net revenue moderated by the unfavorable currency impacts resulting from the strengthening of the euro. The increase in operating expenses as a percentage of revenue in the first nine months was driven mainly by marketing costs associated with a company-wide product branding campaign, unfavorable currency impacts resulting from the strengthening of the euro and, to a lesser extent, from legal expenses associated with increased patent filings.more detail below.
Personal Systems GroupEnterprise Storage and Servers
| For the three months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 5,904 | $ | 4,955 | |||
Earnings (loss) from operations | $ | 25 | $ | (56 | ) | ||
Earnings (loss) from operations as a percentage of net revenue | 0.4 | % | (1.1 | )% |
| For the nine months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 18,082 | $ | 15,224 | |||
Earnings from operations | $ | 132 | $ | — | |||
Earnings from operations as a percentage of net revenue | 0.7 | % | 0.0 | % |
| Three months ended January 31 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | % Increase (Decrease) | ||||||
| In millions | ||||||||
Net revenue | $ | 4,047 | $ | 3,700 | 9.4 | % | |||
Earnings from operations | $ | 71 | $ | 153 | (53.6 | )% | |||
Earnings from operations as a % of net revenue | 1.8 | % | 4.1 | % |
PSG'sThe components of weighted average net revenue grew 19% each in the third quarter and in the first nine months of fiscal 2004 compared to the same periods in fiscal 2003.growth by business unit were as follows:
Three months ended January 31, 2005 | |||
---|---|---|---|
Percentage Points | |||
Industry standard servers | 10.0 | ||
Storage | (0.2 | ) | |
Business critical systems | (0.4 | ) | |
Total ESS | 9.4 | ||
On a constant currency basis, ESS net revenue increased 15% and 12%5% for the three months ended January 31, 2005 compared to the same period in the third quarter and first nine months of fiscal 2004, respectively.2004. The favorable currency impact in both periods was due primarily to the weakening of the dollar against the euro. For the three months ended January 31, 2005, ESS net revenue growth was driven primarily by unit growth of 23% in our industry standard ProLiant servers, which resulted in a 19% net revenue increase over the prior-year period. Storage net revenue declined 1% as growth in the EVA product line was offset by a decline in the XP product line, while net revenue in the tape business declined 2% from the prior-year period. Net revenue in business critical systems declined by 2% for the three months ended January 31, 2005, reflecting the expected decline of the AlphaServer product line as we execute our end-of-product road map strategy. RISC and Itanium-based servers together experienced net revenue growth of 6%. Integrity server net revenue represented 18% of the business critical servers (excluding Nonstop) revenue mix in the first quarter, up from 9% in the same period in fiscal 2004. NonStop server net revenue declined 19% from the same period in fiscal 2004 due to deals that are not part of normal seasonality being captured in the prior-year period. For the three months ended January 31, 2005, HP-UX server net revenue increased 3% from the same period in the prior year.
ESS earnings from operations as a percentage of net revenue for the three months ended January 31, 2005 declined by 2.3 percentage points, reflecting a 5.1 percentage point decline in gross margin offset by a 2.8 percentage point decline in operating expense as a percentage of net revenue. The gross margin decline was the result of competitive pressures impacting both the industry standard servers and the storage business, along with a mix shift to lower margin products within the business critical systems business as Integrity products assume a greater percentage of business critical systems net revenue and the continued mix shift towards industry standard servers within the segment. The decrease in operating expense as a percentage of net revenue resulted from increased revenues as total operating costs remained flat from the same period in the prior year. In the first quarter of fiscal 2005, ESS operating expense included $33 million related to workforce rebalancing.
HP Services
| Three months ended January 31 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | % Increase | ||||||
| In millions | ||||||||
Net revenue | $ | 3,815 | $ | 3,176 | 20.1 | % | |||
Earnings from operations | $ | 281 | $ | 261 | 7.7 | % | |||
Earnings from operations as a % of net revenue | 7.4 | % | 8.2 | % |
The components of weighted average net revenue growth by business unit for the three and nine months ended July 31, 2004 were as follows.follows:
| Three months ended July 31, 2004 | Nine months ended July 31, 2004 | |||
---|---|---|---|---|---|
| (Percentage points) | ||||
Desktop PCs | 14.4 | 9.7 | |||
Notebook PCs | 4.2 | 8.2 | |||
Workstations | 0.4 | 0.5 | |||
Handhelds | 0.2 | 0.5 | |||
Other | — | (0.1 | ) | ||
Total PSG | 19.2 | 18.8 | |||
Three months ended January 31, 2005 | ||
---|---|---|
Percentage Points | ||
Technology services | 9.4 | |
Managed services | 7.2 | |
Consulting and integration | 3.5 | |
Total HPS | 20.1 | |
The revenue increase in the third quarter of fiscal 2004 resulted primarily from an increase in volumes across all businesses, combined with a slight increase in ASPs. The revenue increase in the first nine months of fiscal 2004 was the result primarily of an increase in volumes across all businesses. The increase in consumer desktop PCs revenue of 23% and 22% in the third quarter and first nine months, respectively, of fiscal 2004 was the result primarily of increased consumer demand and solid revenue growth across all regions. Commercial desktop PC revenue increases of 28% and 13% in the third quarter and first nine months, respectively, of fiscal 2004 were the result primarily of an increase in volumes, combined with a slight increase in ASPs, reflecting the improvement in monitor attachment rates. The increase in notebook PC volumes of 6% and 23% in the third quarter and first nine months, respectively, of fiscal 2004 was the result of the continued growth of mobility. In addition, the volume increase in the first nine months was attributable to the launch of the widescreen and media center notebooks. Workstation revenue increased in both periods, primarily in the Windows®-based personal workstation space, offset in part by declines in UNIX®-based workstations. Handheld revenue increases in the first nine months of fiscal 2004 was due to new product introductions, mainly in the sub-$300 market. In addition, the overall increase in ASPs in the third quarter of fiscal 2004 resulted primarily from widescreen notebook PCs, and to a lesser extent, from revenue increases associated with accessories within the notebook PC business.
In the third quarter of fiscal 2004, the 1.5 percentage point operating profit increase was due to a decline in operating expenses of 1.4 percentage points and a 0.1 percentage point improvement in gross margin as a percentage of revenue. For the first nine months of the fiscal year, the 0.7 percentage point increase in the earnings from operations ratio consisted of a decrease of 1.8 percentage points in operating expenses, offset in part by a decline in gross margin of 1.1 percentage points. The operating expense improvement in both periods resulted from headcount reductions, tightening of administrative costs and lower research and development expense. The gross margin decline in the first nine months of fiscal 2004 was due primarily to an increasingly competitive pricing environment and, to a lesser extent, from increased component prices.
Enterprise Storage & Servers
| For the three months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 3,352 | $ | 3,516 | |||
Loss from operations | $ | (208 | ) | $ | (20 | ) | |
Loss from operations as a percentage of net revenue | (6.2 | )% | (0.6 | )% |
| For the nine months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 11,048 | $ | 10,747 | |||
Earnings from operations | $ | 66 | $ | 11 | |||
Earnings from operations as a percentage of net revenue | 0.6 | % | 0.1 | % |
ESS's net revenue decreased 5% and increased 3% in the third quarter and first nine months of fiscal 2004, respectively, compared to the same periods in fiscal 2003. On a constant currency basis, HPS net revenue decreased 10% and 4%increased 13% for the three months ended January 31, 2005, as compared to the same period in the third quarter and first nine months of fiscal 2004, respectively.2004. The favorable currency impact in both periods was due primarily to the weakening of the dollar against the euro.
The components of weighted average revenue growth, by business unit for Excluding acquisitions made after the three and nine months ended July 31, 2004 were as follows.
| Three months ended July 31, 2004 | Nine months ended July 31, 2004 | |||
---|---|---|---|---|---|
| (Percentage points) | ||||
Industry Standard Servers | 1.0 | 5.2 | |||
Business Critical Servers | (2.1 | ) | (1.0 | ) | |
Storage | (3.6 | ) | (1.4 | ) | |
Total ESS | (4.7 | ) | 2.8 | ||
Overall, segment revenue in both periods was impacted positively by the gradual market recovery in IT spending, but several internal factors impacted ESS performance negatively in the current quarter. First, in the United States a migration to a new order processing and supply chain system was more disruptive than planned. Second, in Europe, results were impacted by channel management issues, including channel compensation, overly aggressive discounting and the transition to a centralized claims process. Third, there was a decline in ASPs in HP's storage business.
Unit sales of industry standard servers increased 19% and 24% in the third quarter and first nine months, respectively, of fiscal 2004 compared to the prior year periods and more than offset the revenue decline attributable to declining ASPs. Industry standard servers experienced 2% revenue growth in the third quarter and 11% growth in the first nine months of fiscal 2004 due to strong worldwide shipments of our ProLiant servers with increased blade server shipments. Revenue growth was moderated by the internal factors noted above. Business critical server revenue decreased 8% in the third quarter and decreased 4% for the first nine months of fiscal 2004 due to a decline in sales of Alpha and Non-Stop servers, which were moderated in part by growth in Integrity servers. The decline in the Alpha business for both periods was due primarily to the planned migration of Alpha customers to other Enterprise offerings. The decrease in NonStop server revenue in the current quarter reflected a maturing of the current installed base. Storage declined 15% in the third quarter and 6% in the first nine months of fiscal 2004 compared to the prior year period, driven by declines in Online and Nearline product lines due to declining ASPs.
The gross margin decline in both periods of fiscal 2004 reflected the impact of both a competitive pricing environment, volume declines in the Americas and certain internal execution issues. In the third quarter of fiscal 2004, HPS net revenue growth for the decline of 5.6 percentage pointsthree months ended January 31, 2005 was 14% from the prior-year comparable period. Net revenue in technology services increased 14% in the operating profit ratiofirst quarter of fiscal 2005, with strong growth in our solutions business, which includes integrated support, business continuity and availability. We are also benefiting from strong momentum in service attachments. Excluding acquisitions made after the first quarter of fiscal 2004, technology services net revenue growth was due to a decrease of 7.4 percentage points8% from the same period in the gross margin, offsetprior year. For the three months ended January 31, 2005, managed services net revenue increased 44% from the same period in partthe prior year, driven by a decreasethe Triaton acquisition in April 2004, favorable currency impacts and higher revenue from large outsourcing deals. Excluding acquisitions made after the first quarter of 1.8 pointsfiscal 2004, managed services net revenue growth was 33%. Net revenue in consulting and integration increased 20% from the prior-year comparable period, with our improved strategic sales focus and customer relationship management resulting in strong order growth in Asia Pacific and the Americas. Excluding acquisitions made after the first quarter of operating expensesfiscal 2004, consulting and integration net revenue growth for the three months ended January 31, 2005, was 17%.
HPS earnings from operations as a percentage of revenue. Fornet revenue for the first ninethree months ended January 31, 2005 declined by 0.8 percentage points. The operating margin decline was a combination of the year, the improvement of 0.5 percentage pointsa decline in the operating profit ratio was due togross margin offset partially by a 3.7 percentage point decrease in operating expenses as a percentage of revenue, offsetnet revenue. First quarter fiscal 2005 results for HPS include approximately $26 million for workforce rebalancing costs. The gross margin decline in part by a 3.2 percentage points decreaseHPS includes pricing pressures and portfolio mix shifts within technology services and the impact of the Synstar and Triaton acquisitions. In technology services, we continue to see our portfolio evolve from higher margin proprietary support to lower margin areas such as multi-vendor integrated support, network environmental services and print services. Efficiencies in the gross margin. Cost savings achieved through continued cost control measures, offset in part by an unfavorable currency impact, droveour operating expense structure contributed to the decline in operating expenses as a percentage of revenue in both periods.net revenue.
Software
| For the three months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 223 | $ | 190 | |||
Loss from operations | $ | (45 | ) | $ | (50 | ) | |
Loss from operations as a percentage of net revenue | (20.2 | )% | (26.3 | )% |
| For the nine months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 645 | $ | 553 | |||
Loss from operations | $ | (140 | ) | $ | (168 | ) | |
Loss from operations as a percentage of net revenue | (21.7 | )% | (30.4 | )% |
| Three months ended January 31 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | % Increase | ||||||
| In millions | ||||||||
Net revenue | $ | 240 | $ | 203 | 18.2 | % | |||
Loss from operations | $ | (40 | ) | $ | (49 | ) | 18.4 | % | |
Loss from operations as a % of net revenue | (16.7 | )% | (24.1 | )% |
Software'sOn a constant currency basis, Software net revenue increased 17% (11% without acquisitions) in the third quarter and the first nine months of fiscal 2004 compared to the same periods in fiscal 2003.13%. The revenue increases in the third quarter and first nine months of fiscal 2004 were 16% and 10%, respectively, on a constant currency basis. The majority of the favorable currency impact in both periods resulted from the weakening of the dollar against the euro. OfAcquisitions that were completed after January 31, 2004 represented 5% of the overall 17%net revenue increase in the third quarter,growth. OpenView, our management solutions software product line, represented 1510 percentage points of growth on a weighted average net revenue basis, while OpenCall, our telecommunications solutions product line, contributed the remaining 28 percentage points of the weighted average net revenue increase. OfOpenView net revenue growth was the overall 17% revenueresult of an increase in larger contracts along with the first nine monthsimpact of fiscal 2004 OpenView represented 10 percentage points of growth on a weighted
basis, while OpenCall contributed the remaining 7 percentage points of the revenue increase. OpenView continuesacquisitions, which have added breadth to build momentum in our Adaptive Enterprise strategy.enterprise portfolio. The strong growth in OpenCall was due to increased spending inby the telecommunications industry.industry associated with the adoption of the next generation of network infrastructure.
InThe operating margin improvement of 7.4 percentage points for the third quarter andthree months ended January 31, 2005 as compared to the first nine months ofsame period in fiscal 2004 the operating loss declines of 6.1 and 8.7 percentage points, respectively, werewas driven primarily by revenue growth coupled with a decrease ofin operating expensesexpense as a percentage of revenue.net revenue and an increase in gross margin. The decrease in operating expense as a percentage of net revenue was attributable to continued expense control measures, offset in part byeffective cost management, particularly of marketing and research and development costs. Despite the unfavorable impact of currency and integration costs, these costs increased expenses from acquisitions.more slowly than the increase in net revenue. The declineimprovement in Software gross margin resulted from an increasingly competitive pricing environment.
HP Services
| For the three months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 3,466 | $ | 3,097 | |||
Earnings from operations | $ | 309 | $ | 335 | |||
Earnings from operations as a percentage of net revenue | 8.9 | % | 10.8 | % |
| For the nine months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 10,119 | $ | 9,112 | |||
Earnings from operations | $ | 896 | $ | 971 | |||
Earnings from operations as a percentage of net revenue | 8.9 | % | 10.7 | % |
HPS' net revenue increased 12% in the third quarter and 11% in the first nine months of fiscal 2004 compared to the same periods in fiscal 2003. On a constant currency basis, revenue increased 8% and 4% in the third quarter and first nine months of fiscal 2004, respectively. The favorable currency impact in both periods was due primarily to the weakening of the dollar against the euro and the yen.
The components of weighted average revenue growth, by business unit for the three and nine months ended July 31, 2004 are as follows:
| Three months ended July 31, 2004 | Nine months ended July 31, 2004 | ||
---|---|---|---|---|
| (Percentage points) | |||
Managed Services | 6.2 | 5.8 | ||
Customer Support | 4.4 | 5.0 | ||
Consulting and Integration | 1.2 | 0.3 | ||
Other | 0.1 | — | ||
Total HPS | 11.9 | 11.1 | ||
The growth in managed services in the third quarter and first nine months of fiscal 2004 was due to increased revenue from large outsourcing deals and the Triaton acquisition. The growth in customer support for the third quarter of fiscal 2004 was driven by favorable currency impacts, business model improvements and the Triaton acquisition. For the first nine monthsperformance of fiscal 2004, the growth in customer support was driven primarily by an increase in multi-technology environment support services and support associated with large comprehensive outsourcing deals. An increase in core consulting and
integration services contributed to growth in the consulting and integration business for the third quarter of fiscal 2004, while for the first nine months of fiscal 2004 the growth was slight.
Earnings from operations as a percentage of net revenue declined 1.9 percentage points in the third quarter of fiscal 2004 and 1.8 percentage points in the first nine months of the year compared to the same periods in fiscal 2003. Operating profit ratio declines in the customer support and managed services businesses drove the overall segment operating profit ratio decline in the third quarter and first nine months of fiscal 2004. In the customer support business, competitive pricing pressures in both renewals and new contracts and a mix shift from higher margin support agreements (e.g., Unix) to lower margin contracts (e.g., networking installations and integrated multi-vendor support offerings) affected the customer support operating profit ratio in both periods. Large outsourcing contracts at the early stages of their life cycle had lower margins, which drove the decline in the managed services operating profit ratio in both periods. The overall segment operating profit ratio decline in the third quarter of fiscal 2004 was moderated by an operating profit ratio improvement in the consulting and integration business as a result of a sales force focus towards engagements with higher profit margin and customer relationship management and continued operational discipline measures.our OpenCall product line.
HP Financial Services
| For the three months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 488 | $ | 442 | |||
Earnings from operations | $ | 42 | $ | 19 | |||
Earnings from operations as a percentage of net revenue | 8.6 | % | 4.3 | % |
| For the nine months ended July 31, | ||||||
---|---|---|---|---|---|---|---|
| 2004 | 2003 | |||||
| (In millions) | ||||||
Net revenue | $ | 1,398 | $ | 1,460 | |||
Earnings from operations | $ | 106 | $ | 54 | |||
Earnings from operations as a percentage of net revenue | 7.6 | % | 3.7 | % |
| Three months ended January 31 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | % Increase | ||||||
| In millions | ||||||||
Net revenue | $ | 555 | $ | 441 | 25.9 | % | |||
Earnings from operations | $ | 45 | $ | 29 | 55.2 | % | |||
Earnings from operations as a % of net revenue | 8.1 | % | 6.6 | % |
HPFS'For the three months ended January 31, 2005, the increase in HPFS net revenue increased 10% infrom the third quarter and declined 4% inprior-year comparable period was the first nine monthsresult primarily of fiscal 2004 compared to the same periods in fiscal 2003. Thea significant increase in net revenue in the third quarter was due primarily tooperating leases and higher levels of operating leases and used equipment sales. Lower revenue-generating assets resulting from portfolio amortization and asset sales exceeding new lease originations combined with lower interest rates moderated
For the increase inthree months ended January 31, 2005, the third quarter. The revenue decline in the first nine months was due primarily to lower revenue-generating assets and lower interest rates.
In the third quarter of fiscal 2004, the 4.3 net1.5 percentage point increase in the earnings from operations, ratioas a percent of net revenue, consisted of a 2.32.7 percentage point increasedecrease in operating expense offset partially by a 1.2 percentage point decline in gross margin and a 2.0 percentage point decreasemargin. The decline in operating expenses as a percentage of net revenue. Forrevenue was the first nine monthsresult of fiscal 2004, the 3.9 net percentage point increase in the earnings from operations ratio consisted of a 3.2 percentage point increase in gross margin and a 0.7 percentage point decrease in operating expenses as a percentage of net revenue. The gross margin improvement in both periods reflected higher portfolio profitability resulting primarily from end of lease transactions. Costcost savings achieved through continued cost controls, which were offset in part by an unfavorable currency impact, drove the declines inimpacts. The gross margin decline was driven by a higher mix of lower margin operating expenses as a percentage of revenue in both periods.lease assets, which was offset partially by lower bad debt expense and lower interest costs.
Financing Originations
| Three months ended January 31 | |||||
---|---|---|---|---|---|---|
| 2005 | 2004 | ||||
| In millions | |||||
Total financing originations | $ | 1,076 | $ | 859 |
New financing originations increased 25% in the first quarter of 2005 compared to the same period in fiscal 2004. The increase resulted from improved integration and engagement with HP's sales and marketing efforts.
Portfolio Assets and Ratios
HPFS is a financial services organization and, as such, maintains a strategy to generate a competitive return on equity by effectively leveraging its portfolio against the risks associated with interest rates and credit. The HPFS business model is asset-intensive, and uses certain internal metrics to measure its performance against other financial services companies, including a segment balance sheet that is derived from HP's internal management reporting system. The accounting policies used to derive these amounts are substantially the same as those used by the consolidated company. However, certain intercompany loans and accounts that are reflected in the segment balances are eliminated in HP's Consolidated Condensed Financial Statements. The portfolio assets and ratios derived from the segment balance sheet for HPFS were as follows:
| January 31, 2005(1) | October 31, 2004(1) | |||||
---|---|---|---|---|---|---|---|
| In millions | ||||||
Portfolio assets | $ | 7,425 | $ | 7,380 | |||
Allowance for doubtful accounts | 189 | 213 | |||||
Operating lease equipment reserve | 59 | 51 | |||||
Total reserve | 248 | 264 | |||||
Net portfolio assets | $ | 7,177 | $ | 7,116 | |||
Reserve coverage | 3.3 | % | 3.6 | % | |||
Debt to equity ratio | 5.1x | 5.1x |
Portfolio assets at January 31, 2005 increased 1% from October 31, 2004. The increase resulted from higher financing originations and a favorable currency impact. The overall percentage of portfolio assets reserved decreased due primarily to the write-off of assets covered by specific reserves.
HPFS funds its operations mainly through a combination of intercompany debt and working capital. The portfolio assets and ratios are derived from the segment balance sheet.
Roll-forward of Financing Receivables-related Reserve:
| October 31, 2004 | Additions to allowance | Deductions, net of recoveries | January 31, 2005 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| In millions | |||||||||||
Allowance for doubtful accounts | $ | 213 | $ | 17 | $ | (41 | ) | $ | 189 | |||
Operating lease equipment reserve | 51 | 4 | 4 | 59 | ||||||||
Total reserve | $ | 264 | $ | 21 | $ | (37 | ) | $ | 248 | |||
Corporate Investments
| Three months ended January 31 | ||||||||
---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | % Increase (Decrease) | ||||||
| In millions | ||||||||
Net revenue | $ | 115 | $ | 103 | 11.7 | % | |||
Loss from operations | $ | (51 | ) | $ | (36 | ) | (41.7 | )% | |
Loss from operations as a % of net revenue | (44.3 | )% | (35.0 | )% |
For the three months ended January 31, 2005, the majority of the net revenue in the Corporate Investments segment related to network infrastructure products, which grew 15% from the prior-year comparable period as a result of continued product enhancements, particularly in gigabit Ethernet switch products.
Expenses related to corporate development, global alliances and HP Labs increased 16% from the same period in the prior year. The increase was the result of higher spending on strategic initiatives and incubation programs. These expenses contributed to the majority of the loss from operations, but were offset in part by operating profit from network infrastructure product sales. The increase in the operating loss was due to a slight decline in gross margin and an increase in operating expense levels. The slight decline in gross margin was due primarily to lower average selling prices for Ethernet switch products. Operating expense levels increased due primarily to headcount growth in research and development and sales and marketing.
LIQUIDITY AND CAPITAL RESOURCES
Nine months ended July 31, | 2004 | 2003 | Decrease | |||||||
---|---|---|---|---|---|---|---|---|---|---|
| (In millions) | |||||||||
Net cash provided by operating activities | $ | 3,101 | $ | 3,674 | $ | (573 | ) | |||
Net cash used in investing activities | (1,612 | ) | (1,077 | ) | (535 | ) | ||||
Net cash used in financing activities | (1,692 | ) | (878 | ) | (814 | ) | ||||
Net (decrease) increase in cash and cash equivalents | $ | (203 | ) | $ | 1,719 | $ | (1,922 | ) | ||
Cash and Cash FlowThe Jobs Act
Our cash balances are held in numerous locations throughout the world, including substantial amounts held outside of the United States. Most of the amounts held outside of the United States could be repatriated to the United States, but, under current law, would be subject to United States federal income taxes, less applicable foreign tax credits. Repatriation of some foreign balances is restricted by local laws. HP has provided for the United States federal tax liability on these amounts for financial statement purposes, except for foreign earnings that are considered indefinitely reinvested outside of the United States. Repatriation could
The Jobs Act, enacted on October 22, 2004, provides for a temporary 85% dividends received deduction on certain foreign earnings repatriated during a one-year period. The deduction would result in additionalan approximate 5.25% federal tax rate on the repatriated earnings. To qualify for the deduction, the earnings must be reinvested in the United States federal incomepursuant to a domestic reinvestment plan established by a company's chief executive officer and approved by its board of directors. Certain other criteria in the Jobs Act must be satisfied as well. The maximum amount of HP's foreign earnings that qualify for the temporary deduction is $14.5 billion. For HP, the one-year period during which the qualifying distributions can be made is fiscal 2005.
We continue to evaluate whether we will repatriate foreign earnings under the repatriation provisions of the Jobs Act. Up to $14.5 billion is being considered for possible repatriation. Our estimate of the range of tax paymentsexpense that we would accrue on a maximum repatriation eligible for the temporary deduction remains between $850 million and $925 million. We now expect to make our repatriation determination by the end of our second fiscal quarter in future years. Where local restrictions prevent an efficient intercompany transfer of funds, our intent is that2005.
Foreign earnings repatriated under the Jobs Act would increase liquidity in the United States, with a corresponding reduction in liquidity at HP's foreign subsidiaries. Some foreign subsidiaries would be required to borrow in order to repatriate their earnings to the U.S. We expect HP's significant positive foreign cash flows would be sufficient to repay any foreign debt and replenish foreign cash balances would remain inover time. Should HP decide not to repatriate foreign earnings under the foreign country andJobs Act, we would meet United States liquidity needs through ongoing cash flows, external borrowings,borrowing, or both. We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed.
SOURCES AND USES OF CASH
| Three months ended January 31 | ||||||
---|---|---|---|---|---|---|---|
| 2005 | 2004 | |||||
| In millions | ||||||
Net cash provided by operating activities | $ | 1,558 | $ | 148 | |||
Net cash used in investing activities | (411 | ) | (299 | ) | |||
Net cash used in financing activities | (508 | ) | (461 | ) | |||
Net increase (decrease) in cash and cash equivalents | $ | 639 | $ | (612 | ) | ||
Operating Activities
Net cash provided by operating activities decreasedrose by approximately $1.4 billion in the ninethree months ended JulyJanuary 31, 20042005 as compared to the corresponding period infirst quarter of fiscal 2003 due primarily to the timing of payments2004. Active management of accounts payable, increased effectiveness in accounts receivable collection efforts and to a lesser extent, increased inventory levels. The decrease waslower restructuring payments improved operating cash flow by approximately $2.3 billion. These increases were offset in part by increased net earnings and lower payments for restructuring actions, as well as lowerhigher pension and other post-retirement contributions, which were $555 million in the ninethree months ended JulyJanuary 31, 2004 as2005 compared to $100 million in the corresponding period in fiscal 2003.three months ended January 31, 2004.
Investing Activities
Net cash used in investing activities increased in the nine months ended July 31, 2004 asby 37% compared to the corresponding period infirst quarter of fiscal 20032004. The increase was due primarily to nethigher capital expenditures reflecting a 25% improvement in financing originations. Beginning in April 2004, we invested in auction rate securities, primarily preferred stocks, in order to generate higher investment returns. Purchases and sales of such securities during the first quarter of fiscal 2005 were approximately $1.5 billion. In the three months ended January 31, 2004, cash paidproceeds from the sales of investments reflect the sale of a non-strategic investment, which was more than offset by cash used for business acquisitions.acquisitions in the same period.
Financing Activities
Net cash used in financing activities was 10% higher in the three months ended January 31, 2005 compared to the first quarter of fiscal 2004. The increase was moderated by decreased net capital expenditures.
The decrease in net cash flows from financing activities was due primarily to increased share repurchases, offset in part by higher issuance of common stock. To a lesser extent, the decline was due to net paymentsdebt under our commercial paper program and lower repayments of total debt of approximately $394 million in the nine months ended July 31, 2004 compared to net payments of approximately $37 million in the nine months ended July 31, 2003. Cash generated from common stock issuances under various employees stock plans moderated the decrease.
Performance Metrics
| July 31, 2004 | October 31, 2003 | July 31, 2003 | |||
---|---|---|---|---|---|---|
Days sales outstanding ("DSO") | 40 | 40 | 40 | |||
Inventory turns | 8.7 | 9.8 | 8.3 |
Trade accounts receivable DSO remained unchanged compared to fiscal 2003 and year-over-year. The decline in annualized inventory turns as compared to fiscal 2003 resulted primarily from seasonal revenue weakness in the current quarter combined with normal inventory build-up for the back-to-school season, while the year-over-year improvement was the result mainly of active inventory management.long-term debt.
In the third quarter of fiscal 2004, HP entered into an agreement with a third party financial institution to sell certain of its trade receivables without recourse. The agreement provides for HP to sell up to 600 million Euros of trade receivables (approximately $720 million based upon exchange rates as of July 31, 2004). During the three month period ended July 31, 2004, HP sold an immaterial amount of trade receivables under this agreement. The sale of receivables did not have a material impact on DSO for the nine months ended July 31, 2004.
Stock Repurchases
We repurchase shares of our common stock under a systematic program to manage the dilution created by shares issued under employee stock plans and for other purposes.also to return cash to stockholders. This program authorizes repurchases in the open market or in private transactions. We completed share repurchases of approximately 29 million shares for $586 million in the first quarter of fiscal 2005. In addition, in November 2004, we paid $51 million in connection with the completion of the fiscal 2004 accelerated share repurchase program. We intend to continue to repurchase shares opportunistically as a means of returning cash to stockholders, as well as offsetting dilution from the issuance of shares under employee benefit plans. In the nine months ended July 31,first quarter of fiscal 2004, we repurchased 51approximately 12 million shares for an aggregate price of $1.1 billion. In the nine months ended July$256 million. As of January 31, 2003,2005, we repurchased 30 million shares for an aggregate pricehad remaining authorization of $549 million. For additional information on share repurchases during the third quarter of 2004, see "Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities—Issuer Purchases of Equity Securities." In May 2004, the Board of Directors of HP authorized an additional $2.0approximately $2.3 billion for future repurchasesshare repurchases.
Key Performance Metrics
| January 31, 2005 | October 31, 2004 | |||
---|---|---|---|---|---|
Days of sales outstanding in accounts receivable | 36 | 43 | |||
Days of supply in inventory | 39 | 39 | |||
Days of purchases outstanding in accounts payable | (45 | ) | (52 | ) | |
Cash conversion cycle | 30 | 30 | |||
Days of sales outstanding in accounts receivable ("DSO") measures the average number of days our receivables are outstanding. DSO is calculated by dividing accounts receivable, net of allowance for doubtful accounts, by a 90-day average net revenue.
Days of supply in inventory ("DOS") measures the average number of days from procurement to sale of our product. DOS is calculated by dividing inventory by a 90-day average cost of goods sold.
Days of purchases outstanding in accounts payable ("DPO") measures the average number of days our accounts payable balances are outstanding. DPO is calculated by dividing accounts payable by a 90-day average cost of goods sold.
Our working capital requirements depend upon our effective management of the cash conversion cycle, which represents effectively the number of days we pay for the purchase of raw materials to the collection of cash from our customers. The cash conversion cycle is the sum of DSO and DOS less DPO.
The sequential improvement in DSO resulted mainly from the timing of higher revenue and collections during the three months ended January 31, 2005 compared to fiscal 2004. The DOS was flat compared to fiscal 2004. The increase in DPO was primarily the result of active management of the payables. These changes resulted in a flat cash conversion cycle compared to fiscal 2004.
LIQUIDITY
As previously discussed, we use cash generated by operations as our primary source of liquidity, since we believe that internally generated cash flows are sufficient to support business operations, capital expenditures and the payment of stockholder dividends, in addition to a level of discretionary investments and share repurchases. We are able to supplement this near term liquidity, if necessary, with broad access to capital markets and credit line facilities through various foreign subsidiaries as well as with U.S. financial institutions.
We maintain debt levels that we establish through consideration of a number of factors, including cash flow expectations, cash requirements for operations, investment plans (including acquisitions), share repurchase activities and the overall cost of capital. Outstanding debt at January 31, 2005
increased slightly to $7.2 billion as compared to $7.1 billion at fiscal year end 2004, bearing weighted average interest rates of 5.2% and 5.3%, respectively. Short-term borrowings increased to $2.8 billion at January 31, 2005 from $2.5 billion at October 31, 2004. The increase reflects $200 million of Series A Medium-Term Notes maturing in 2005. In addition, during the first quarter of fiscal 2005, we issued $685 million and repaid $675 million of commercial paper. We did not issue long-term debt during the first quarter of fiscal 2005.
We have revolving trade receivables-based facilities permitting us to sell certain trade receivables to third parties on a non-recourse basis. The facility with the largest volume is one that is subject to a maximum amount of 525 million euros (approximately $690 million) based on receivables not yet collected by the third party (the "Euro Program"). Trade receivables of approximately $1.8 billion were sold during the first quarter of fiscal 2005, including approximately $1.2 billion under the Euro Program. The aggregate receivables sold but not yet collected by the third parties were approximately $334 million at January 31, 2005, of which approximately $241 million related to the Euro Program. Fees associated with these facilities do not generally differ materially from the cash discounts offered to these customers under the alternative prompt payment programs.
We have the following resources available to obtain short-term or long-term financings, if we need additional liquidity:
| | At January 31, 2005 | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
| Original Amount Available | |||||||||
| Used | Available | ||||||||
| In millions | |||||||||
2002 registration statement | ||||||||||
Debt, global securities and up to $1,500 of Series B Medium Term Notes | $ | 3,000 | $ | 2,000 | $ | 1,000 | ||||
Euro Medium-Term Notes | 3,000 | 976 | 2,024 | |||||||
U.S. Credit Facilities | ||||||||||
Expiring March 2005 | 1,500 | — | 1,500 | |||||||
Expiring March 2009 | 1,500 | — | 1,500 | |||||||
Lines of credit | 2,611 | 146 | 2,465 | |||||||
Commercial paper programs | ||||||||||
U.S. | 4,000 | — | 4,000 | |||||||
Euro | 500 | 323 | 177 | |||||||
$ | 16,111 | $ | 3,445 | $ | 12,666 | |||||
The securities issuable under the 2002 registration statement include notes with due dates of nine months or more from issuance. HP uses U.S. credit facilities for general corporate purposes, including to support our U.S. commercial paper program. HP renewed the 364-day facility expiring on March 11, 2005 with a facility of the same size with a one year duration. The lines of credit are uncommitted and are primarily available through various foreign subsidiaries.
We do not have any rating downgrade triggers that would accelerate the maturity of a material amount of our debt. However, a downgrade in our credit rating would increase the cost of borrowings under our Credit Facilities. Also, a downgrade in our credit rating could limit or, in the case of a significant downgrade, preclude our ability to issue commercial paper under our current programs. If this occurs, we would seek alternative sources of funding, including the issuance of notes under our existing shelf registration statement and our Euro Medium-Term Note Programme or our Credit Facilities.
HP, and not the HPFS financing business, issued or assumed the vast majority of HP's total outstanding shares of common stock. As of September 3, 2004, wedebt. HPFS is a financial services organization and, like other financial services companies, has a business model that is asset-intensive in nature and therefore is more debt-dependent than our other business segments. At January 31, 2005, HPFS had authorizationapproximately $7.2 billion in net portfolio assets, which include short- and long-term financing receivables and operating lease assets.
Contractual Obligations
At January 31, 2005, our unconditional purchase obligations are approximately $827 million, compared with $1.0 billion as previously reported in our Annual Report on Form 10-K for remaining future repurchases of approximately $1.7 billion.the fiscal year ended October 31, 2004.
Funding Commitmentscommitments
As a result of our approved restructuring plans,We estimate that we expect future cash expenditures of $370 million, primarily for employee severance and other employee benefits and facilities costs. Of this amount, $362 million is recorded on our Consolidated Condensed Balance Sheet at July 31, 2004, and $8 million will be expensed in future periods as the costs are incurred or the requirements to record the costs as a liability are met. Cash expenditures related to employee severance for our previously approved restructuring plans are expected to be substantially complete in the current fiscal year.
As of July 31, 2004, we made approximately $470 million of contributions to our pension plans and $40 million in payments of other post-retirement benefits forcontribute a total of $510approximately $920 million into the pension and other post-retirement funding compared to approximately $800plans during fiscal 2005, of which we have already funded $555 million in the prior year period. We presently anticipate contributing an additional $60 million to fund our pension and other post-retirement plans during the remainder of fiscal 2004, of which $45 million relates to pension funding for a total of $570 million in pension and other post-retirement funding for fiscal 2004.three months ended January 31, 2005. Our funding policy is to contribute cash to our pension plans so that we meet the minimum contribution requirements, as established by local government funding and taxing authorities, are met.authorities. In the current fiscal year, we will continue to contribute cash to our global pension plans in amounts that are consistent with local funding requirements and tax considerations.
We issued approximately 53 million non-transferable contingent value rights ("CVRs") in connection with our acquisition of Indigo, in March 2002N.V. that entitle each holder to a one-time contingent cash payment of up to $4.50 per CVR, based on the achievement of certain cumulative revenue results over a three-year period. The future cash pay-out, if any, of the CVRs will be payable after a three-year period that began on April 1, 2002 and could result in a maximum obligation of $237 million. HP hasWe have not incurred a liability associated with the CVRs as of JulyJanuary 31, 2004.
We2005, and we do not expect to pay approximately $300 million inany material cash for an acquisition announcedpayments in the fourth quarter of fiscal 2004. This acquisition is intended to enhance our services capabilities in Europe. The acquisition is subject to the acceptance of the acquired company's shareholders and other customary closing conditions.
We currently expect to fund future expenditures for capital requirements as well as liquidity needs from a combination of available cash balances, cash flows from operations and notes payable and short-term borrowings. We invest excess cash primarily in short-term investments that meet HP's credit rating standards.future.
Borrowings
| July 31, 2004 | October 31, 2003 | Increase (Decrease) | Amount Available as of July 31, 2004(1) | ||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In millions) | |||||||||||
Notes payable and short-term borrowings | $ | 2,212 | $ | 1,080 | $ | 1,132 | $ | 9,321 | ||||
Long-term debt | 4,907 | 6,494 | (1,587 | ) | 3,093 | |||||||
Total short- and long-term debt | $ | 7,119 | $ | 7,574 | $ | (455 | ) | $ | 12,414 | |||
Short- and long-term debt in the nine months ended July 31, 2004 decreased by $455 million as compared to October 31, 2003. The increase in notes payable and short-term borrowings was due mainly to the reclassification of $1.5 billion in long-term debt to short-term, as well as the repayments of approximately $1.8 billion under our commercial paper programs, $117 million of notes payable to banks, net and $224 million of the short-term portion of long-term debt, respectively, offset in part by approximately $1.7 billion issued under our commercial paper programs. Additionally, the decrease in total short- and long-term debt was due to a net $92 million non-cash decrease from foreign currency remeasurement, mark-to-market adjustments and premium and discount amortization, offset in part by $31 million increase from business acquisitions during the nine months ended July 31, 2004.
Notes Payable and Short-term BorrowingsOff-Balance Sheet Arrangements
Notes payable and short-term borrowings, includingAs part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the current portionpurpose of long-term debt, the related average interest rates and amounts remaining available for future borrowings were as follows at September 3, 2004:facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of January 31, 2005, we are not involved in any material unconsolidated SPE transactions.
| As of September 3, 2004 | |||||
---|---|---|---|---|---|---|
| Amount Outstanding | Average Interest Rate | Amount Available | |||
| (In millions) | |||||
Current portion of long-term debt | 1,884 | 7.2 | % | — | ||
Commercial paper | 979 | 1.9 | % | 3,521 | ||
Notes payable to banks, lines of credit and other | 259 | 2.5 | % | 2,228 | ||
Credit facilities | — | — | 3,000 | |||
3,122 | 8,749 | |||||
Indemnifications
In the nine months ended July 31, 2004, we issued a totalordinary course of $460 million of commercial paper at interest rates rangingbusiness, HP enters into contractual arrangements under which HP may agree to indemnify the third party to such arrangement from 1.09%any losses incurred relating to 1.16% under our $4.0 billion U.S. commercial paper program. Hewlett-Packard International Bank PLC, a wholly-owned subsidiarythe services they perform on behalf of HP issued $1.3 billion of certificates of deposit duringor for losses arising from certain events as defined within the nine months ended July 31, 2004, at local currency interest rates ranging from 1.11%particular contract, which may include, for example, litigation or claims relating to 4.90%, under our Euro Commercial Paper/Certificate of Deposit Programme.
We also maintain, through various foreign subsidiaries, lines of credit from a number of financial institutions. We established a $1.5 billion 364-day senior unsecured committed borrowing facility and a $1.5 billion five-year credit facility in March 2004 (together, the "New Credit Facilities"). Interest rates and other terms of borrowing under the New Credit Facilities will vary, as applicable, based on our external credit ratings. The New Credit Facilities are available for general corporate purposes, including supporting the issuance of commercial paper.
Long-term Debt
Book value of long-term debt and amounts registered but unissued under the applicable registration statement or available for future borrowings (in each case, as shown in the Amount Available column) were as follows at September 3, 2004:
| As of September 3, 2004 | |||||
---|---|---|---|---|---|---|
| Amount Outstanding | Amount Available | ||||
| (In millions) | |||||
2002 Shelf Registration Statement | $ | 1,993 | $ | 1,000 | ||
2000 Shelf Registration Statement | 2,806 | — | ||||
Euro Medium-Term Note Programme | 907 | 2,092 | ||||
Other, including assumed Compaq debt | 747 | — | ||||
Fair value adjustment related to SFAS No. 133 | 58 | — | ||||
Less current portion | (1,884 | ) | — | |||
$ | 4,627 | $ | 3,092 | |||
At September 3, 2004, we had outstanding long-term debt totaling $6.6 billion, which excludes the fair value adjustmentpast performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to SFAS No. 133 of $58 million and discounts on debt issuances totaling $170 million, and includes $1.9 billion due within one year. Of our total long-term debt outstanding, approximately $3.0 billion is due between fiscal years 2004 and 2006, approximately $2.6 billion is due between fiscal years 2007 and 2009 and the remainder is due at various dates through fiscal year 2023. For a description of our outstanding debt, see Note 8 to the Consolidated Condensed Financial Statements, which is incorporated herein by reference.
We may issue future long-term borrowings under our shelf registration statement that was declared effective in March 2002 (the "2002 Shelf Registration Statement").
We also may issue future long-term borrowings under our Euro Medium-Term Note Programme, filed with the Luxembourg Stock Exchange. These notes can be denominated in any currency including the euro. However, these notesindemnifications have not been and will not be registered in the United States.
We do not have any rating downgrade triggers that would accelerate the maturity of a material amount of our debt. However, a downgrade in our credit rating would increase the cost of borrowings under our credit facilities. Also, a downgrade in our credit rating could limit or, in the case of a significant downgrade, preclude our ability to issue commercial paper under our current programs. Should this occur, we would seek alternative sources of funding, including the issuance of notes under our existing shelf registration statements and our Euro Medium-Term Note Programme. In addition, we have the ability at our option to draw upon our senior unsecured credit facilities totaling $3.0 billion.
The vast majority of total outstanding debt was issued or assumed by HP and not by our financing business, HPFS. However, HPFS is a financial services organization and, like other financial services companies, has a business model that is asset-intensive in nature and therefore is more debt-dependent than our other business segments. At July 31, 2004, HPFS had approximately $6.4 billion in net financing assets, which include short- and long-term financing receivables and operating lease assets.
Contractual Obligations
At July 31, 2004, our unconditional purchase obligations are approximately $1.1 billion, compared with $651 million as previously reported in our Annual Report on Form 10-K for the fiscal year ended October 31, 2003.immaterial.
FACTORS THAT COULD AFFECT FUTURE RESULTS
Because of the following factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.
The competitive pressures we face could harm our revenue, gross margin and prospects.
We encounter aggressive competition from numerous and varied competitors in all areas of our business, and our competitors may target our key market segments. We compete primarily on the basis of technology, performance, price, quality, reliability, brand, distribution, range of products and services, account relationships, customer service and support, security, and availability of application software. If our products, services, support and cost structure do not enable us to compete successfully based on any of those criteria, it could harm our operations, results and prospects. Further, we may have to continue to lower the prices of many of our products and services to stay competitive, while at the same time trying to maintain or improve revenue and gross margin. Because our business model is based on providing innovative and high quality products, we may spend a proportionately greater amount on research and development than some of our competitors. If we cannot proportionately decrease our cost structure on a timely basis in response to competitive price pressures, our gross margin and therefore our profitability could be adversely affected. In addition, if our pricing and other factors are not sufficiently competitive, or if there is an adverse reaction to our product decisions, we may lose market share in certain areas, which could adversely affect our revenue and prospects. Even if we are able to maintain or increase market share for a particular product, revenue could decline due to increased competition from other types of products or because the product is in a maturing industry. Industry consolidation may affect competition by creating larger, more homogeneous and potentially stronger competitors in the markets in which we compete, and our competitors also may affect our business by entering into exclusive arrangements with existing or potential customers or suppliers.
If we cannot continue to develop, manufacture and market products and services that meet customer requirements for innovation and quality, our revenue and gross margin may suffer.
The process of developing new high technology products and services and enhancing existing products and services is complex, costly and uncertain, and any failure by us to anticipate customers' changing needs and emerging technological trends accurately could significantly harm our market share and results of operations. We must make long-term investments, develop or obtain appropriate intellectual property and commit significant resources before knowing whether our predictions will accurately reflect customer demand for our products and services. After we develop a product, we must be able to manufacture appropriate volumes quickly and at low costs. To accomplish this, we must accurately forecast volumes, mix of products and configurations that meet customer requirements, and we may not succeed at all or within a given product's life cycle. Any delay in the development, production or marketing of a new product could result in our not being among the first to market, which could further harm our competitive position. In addition, in the course of conducting our business, we must adequately address quality issues associated with our products and services, including defects in our engineering, design and manufacturing processes, as well as defects in third party components included in our products. In order to address quality issues, we work extensively with our customers and suppliers and engage in product testing to determine the root cause of the problem and to determine appropriate solutions. However, we may have limited ability to control quality issues,
particularly with respect to faulty components manufactured by third parties. If we are unable to determine the cause, find an appropriate solution or offer a temporary fix (or "patch"), we may delay shipment to customers, which would delay revenue recognition and could adversely affect our revenue and reported results. Finding solutions to quality issues can be expensive and may result in additional warranty, replacement and other costs, adversely affecting our profits. In addition, quality issues can impair our relationships with new or existing customers and adversely affect our reputation, which could have a material adverse effect on our operating results.
If we do not effectively manage our product and services transitions, our revenue may suffer.
Many of the industries in which we compete are characterized by rapid technological advances in hardware performance, software functionality and features; the frequent introduction of new products; short product life cycles; and continual improvement in product price characteristics relative to product performance. If we do not make an effective transition from existing products and services to future offerings, our revenue may decline. Among the risks associated with the introduction of new products and services are delays in development or manufacturing, variations in costs, delays in customer purchases in anticipation of new introductions, difficulty in predicting customer demand for the new offerings and effectively managing inventory levels in line with anticipated demand, risks associated with customer qualification and evaluation of new products and the risk that new products may have quality or other defects or may not be supported adequately by application software. Our revenue and gross margin also may suffer due to the timing of product or service introductions by our suppliers and competitors. This is especially challenging when a product has a short life cycle or a competitor introduces a new product just before our own product introduction. Furthermore, sales of our new products and services may replace sales, or result in discounting, of some of our current offerings, offsetting the benefit of even a successful introduction. There also may be overlaps in the current products and services of HP and portfolios acquired through mergers and acquisitions that we must be managed.manage. In addition, it may be difficult to ensure performance of new customer contracts in accordance with our revenue, margin and cost estimates, and to achieve operational efficiencies embedded in our estimates. Given the competitive nature of our industry, if any of these risks materialize, future demand for our products and services and our results of operations may suffer.
Our revenue, cost of sales, and expenses may suffer if we cannot continue to license or enforce the intellectual property rights on which our business depends or if third parties assert that we violate their intellectual property rights.
We rely upon patent, copyright, trademark and trade secret laws in the United States and similar laws in other countries, and agreements with our employees, customers, suppliers and other parties, to establish and maintain our intellectual property rights in technology and products used in our operations. However, any of our direct or indirect intellectual property rights could be challenged, invalidated or circumvented, or such intellectual property rights may not be sufficient to permit us to take advantage of current market trends or otherwise to provide competitive advantages, which could result in costly product redesign efforts, discontinuance of certain product offerings or other competitive harm. Further, the laws of certain countries do not protect our proprietary rights to the same extent as do the laws of the United States. Therefore, in certain jurisdictions we may be unable to protect our proprietary technology adequately against unauthorized third-party copying or use, which could adversely affect our competitive position. Also, because of the rapid pace of technological change in the information technology industry, much of our business and many of our products rely on key technologies developed or licensed by third parties, and we may not be able to obtain or to continue to obtain licenses and technologies from these third parties at all or on reasonable terms, or such third parties may demand cross-licenses. Third parties also may claim that we or customers indemnified by us are infringing upon their intellectual property rights. Even if we believe that the claims are without merit, the claims can be time-consuming and costly to defend and divert management's attention and
resources away from our business. Claims of intellectual property infringement also might require us to redesign affected products, enter into costly settlement or license agreements or pay costly damage awards. Even if we have an agreement to indemnify us against such costs, the indemnifying party may be unable to uphold its contractual agreements to us. If we cannot or do not license the infringed technology at all or on reasonable terms or substitute similar technology from another source, our operations could suffer. Further, our costs of operations could be affected on an ongoing basis by the imposition of copyright levies or similar fees by rights holders or collection agencies in certain jurisdictions, primarily in Europe. In addition, it is possible that as a consequence of a merger or
acquisition transaction third parties may obtain licenses to some of our intellectual property rights or our business may be subject to certain restrictions that were not in place prior to the transaction. Consequently, we may lose a competitive advantage with respect to these intellectual property rights or we may be required to enter into costly arrangements in order to terminate or limit these agreements.
Economic uncertainty could affect adversely, our revenue, gross margin and expenses.
Our revenue and gross margin depend significantly on general economic conditions and the demand for computing and imaging products and services in the markets in which we compete. Economic weakness and constrained IT spending has previously resulted, and may result in the future, in decreased revenue, gross margin, earnings or growth rates and problems with our ability to manage inventory levels and realize customer receivables. In addition, customer financial difficulties have previously resulted, and could result in the future, result, in increases in bad debt write-offs and additions to reserves in our receivables portfolio, inability by our lessees to make required lease payments and reduction in the value of leased equipment upon its return to us compared to the value estimated at lease inception. We also have also experienced, and may experience in the future, may experience, gross margin declines in certain businesses, reflecting the effect of items such as competitive pricing pressures, inventory write-downs, charges associated with the cancellation of planned production line expansion, and increases in pension and post-retirement benefit expenses. Economic downturns also may lead to restructuring actions and associated expenses and impairment of investments.expenses. Uncertainty about future economic conditions makes it difficult to forecast operating results and to make decisions about future investments. Further delaysDelays or reductions in information technology spending could have a material adverse effect on demand for our products and services and consequently our results of operations, prospects and stock price.
Terrorist acts, conflicts and wars may seriously harm our business and revenue, costs and expenses and financial condition and stock price.
Terrorist acts, conflicts or wars (wherever located around the world) may cause damage or disruption to HP, our employees, facilities, partners, suppliers, distributors, resellers or customers, which could significantly impact our revenue, costs and expenses and financial condition. Terrorist attacks create many economic and political uncertainties, some of which may materially harm our business and results of operations. The potential for future attacks, the national and international responses to attacks or perceived threats to national security, and other actual or potential conflicts or wars, including the ongoing military operations in Iraq, have created many economic and political uncertainties that could adversely affect our business, results of operations and stock price in ways that we cannot presently predict. In addition, as a major multi-national company with headquarters and significant operations located in the United States, actions against or by the United States may impact our business or employees. We are predominantly uninsured for losses and interruptions caused by terrorist acts, conflicts and wars.
Due to the international nature of our business, political or economic changes or other factors could harm our future revenue, costs and expenses and financial condition.
Sales outside the United States make up more than half of our revenue. Our future revenue, gross margin, expenses and financial condition also could suffer due to a variety of international factors, including:
The factors described above also could disrupt our product and component manufacturing and key suppliers located outside of the United States. For example, we rely on manufacturers in Taiwan for the production of notebook computers and other suppliers in Asia for product assembly and manufacture.
Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.
Our worldwide operations could be subject to natural disasters and other business disruptions, which could seriously harm our revenue and financial condition and increase our costs and expenses. Our corporate headquarters, and a portion of our research and development activities, are located in California, and other critical business operations and some of our suppliers are located in California and Asia, near major earthquake faults. The ultimate impact on us, our significant suppliers and our general infrastructure of being located near major earthquake faults is unknown, but our revenue, profitability and financial condition could suffer in the event of a major earthquake.earthquake and related natural disasters. In addition, some areas, including California and parts of the East Coast and Midwest of the United States, have previously experienced, and may experience in the future, may experience, major power shortages and blackouts. These blackouts could cause disruptions to our operations or the operations of our suppliers, distributors and resellers, or customers. We are predominantly self-insured for lossesLosses and interruptions could also be caused by earthquakes, power shortages,
telecommunications failures, water shortages, tsunamis, floods, typhoons, fires, extreme weather conditions, medical epidemics and other natural or manmade disasters.disasters, for which we are predominantly self-insured.
If we fail to manage distribution of our products and services properly, or if our distributors' financial condition or operations weaken, our revenue, gross margin and profitability could suffer.
We use a variety of different distribution methods to sell our products and services, including third-party resellers and distributors and both retaildirect and directindirect sales to both enterprise accounts and consumers. SinceSuccessfully managing the interaction of our direct and indirect channel efforts to reach all of the potential customer segments for our products and services is a complex process. Moreover, since each distribution method has distinct risks and gross margins, our failure to implement the most
advantageous balance in the delivery model for our products and services could adversely affect our revenue and gross margins and therefore profitability. Moreover, our distribution channel mix may limit our willingness or ability to adjust prices quickly and otherwise to respond to pricing changes by competitors. We may also have limited ability to estimate future product rebate redemptions in order to price our products effectively. Other distribution risks include alienating channel partners, financial weakness of competitors and inventory management problems, asare described below.
Since direct sales may compete withconflicts or if the sales made by third-party resellers and distributors, these third-party resellers and distributors may elect to use other suppliers that do not directly sell their own products or to reduce the retail shelf space available for our products. Any increase in our commitment to direct sales could alienate somefinancial conditions of our channel partners. As a result, we may lose some of our customers who purchase from third-party resellers or distributors.
SomeOur future operating results may be adversely affected by any conflicts that might arise between our various sales channels, the loss or deterioration of any alliance or distribution arrangement or the loss of retail shelf space. Moreover, some of our wholesale and retail distributors may have insufficient financial resources and may not be able to withstand changes in business conditions, including economic weakness and industry consolidation. Revenue from indirect sales could suffer and we could experience disruptions in distribution if our distributors' financial conditions or operations weaken.
We must manage inventory effectively, particularly with respect to sales to distributors.distributors, which involves forecasting demand and pricing issues. Distributors may increase orders during periods of product shortages, cancel orders if their inventory is too high or delay orders in anticipation of new products. Distributors also may adjust their orders in response to the supply of our products and the products of our competitors and seasonal fluctuations in end-user demand. Our reliance upon indirect distribution methods may reduce visibility to demand and pricing issues, and therefore make forecasting more difficult. If we have excess inventory, we may have to reduce our prices and write down inventory, whichinventory. Moreover, our use of indirect distribution channels may limit our willingness or ability to adjust prices quickly and otherwise to respond to pricing changes by competitors. We also may have limited ability to estimate future product rebate redemptions in turn could result in a lower gross margin.order to price our products effectively.
We depend on third party suppliers, and our revenue and gross margin could suffer if we fail to manage supplier issues properly.
Our manufacturing operations depend on our ability to anticipate our needs for components and products and our suppliers' ability to deliver sufficient quantities of quality components and products at reasonable prices in time for us to meet critical manufacturing and distribution schedules. Given the wide variety of systems, products and services that we offer, the large number of our suppliers and contract manufacturers that are dispersed across the globe, and the long lead times that are required to manufacture, assemble and deliver certain components and products, problems could arise in planning production and managing inventory levels that could seriously harm us. We also rely on third party
suppliers for the provision of contingent workers, and our failure effectively to manage our use of such workers effectively could adversely affect our results of operations. We also could be exposed to various legal claims relating to their status. Other supplier problems that we could face include component shortages, excess supply and risks related to fixed-price contracts that would require us to pay more than the open market price, as described below.
issues, we might have to reengineer some products or service offerings, resulting in further costs and delays.
Impairment of our investment portfolio could harm our net earnings.
We have an investment portfolio that includes minority equity and debt investments. In most cases, we do not attempt to reduce or eliminate our market exposure on these investments and may incur losses related to the impairment of these investments and therefore charges to net earnings. Some of our investments are in public and privately-held companies that are still in the start-up or development stage, which have inherent risks because the technologies or products they have under development never may become successful. Furthermore, the values of our investments in publicly-traded companies are subject to significant market price volatility. We often couple our investments in technology companies with a strategic commercial relationship. Our commercial agreements with these companies may not be sufficient to allow us to obtain and integrate such products and services into our offerings or otherwise benefit from the relationship, and third parties, including competitors, subsequently may acquire these companies. Economic weakness could impact our investment portfolio in the future.
The revenue and profitability of our operations have historically varied.
Our revenue, gross margins and profit margins vary among our products and services, customer groups and geographic markets and therefore will be different in future periods than our current revenue and profit margins.results. Overall gross margins and profitability in any given period are dependent partially on the product, customer and geographic mix reflected in that period's net revenue. In particular, our ImagingIPG and Printing Group and certain of its business units such as printer supplies contribute significantly to our gross margins and profitability. Competition, lawsuits, investigations and other risks affecting IPG therefore may have a significant impact on our overall gross margins and profitability. Certain segments, and ESS in particular, have a higher fixed cost structure than others and may experience significant operating profit volatility on a quarterly basis. In addition, newer geographic markets may be relatively less profitable due to investments associated with entering those markets and local pricing pressures. Market trends, competitive pressures, commoditization of products, seasonal rebates, increased component or shipping costs, regulatory impacts and other factors may result in reductions in revenue or pressure on gross margins in a given period, which may necessitate adjustments to our operations.
Unanticipated changes in HP's tax rates or exposure to additional income tax liabilities could affect our profitability.
We are subject to income taxes in both the United States and various foreign jurisdictions, and our domestic and international tax liabilities are subject to the allocation of expenses in different jurisdictions. Our effective tax rates could be adversely affected by changes in the mix of earnings in countries with differing statutory tax rates, in the valuation of deferred tax assets and liabilities or in tax laws or by material audit assessments, which could affect our profitability. In particular, the carrying value of deferred tax assets, which are predominantly in the United States, is dependent on our ability to generate future taxable income in the United States. In addition, the amount of income taxes we pay is subject to ongoing audits in various jurisdictions, and a material assessment by a governing tax authority could affect our profitability. Further, if we elect to repatriate cash held outside the United States pursuant to the Jobs Act, our tax rate may increase.
Our sales cycle makes planning and inventory management difficult and future financial results less predictable.
Our quarterly sales have reflected a pattern in which a disproportionate percentage of such quarters' total sales occur toward the end of eachsuch quarter, and this trend has become more pronounced in recent periods. This uneven sales pattern makes prediction of revenue, earnings and working capital for each financial period difficult, increases the risk of unanticipated variations in quarterly results and financial condition, and places pressure on our inventory management and logistics systems. If predicted demand is substantially greater than orders, there will be excess inventory. Alternatively, if orders substantially exceed predicted demand, we may not be able to fulfill all of the orders received in the last few weeks of each quarter. Other developments late in a quarter, such as a systems failure, component pricing movements or global logistics disruptions, could adversely impact inventory levels and results of operations in a manner that is disproportionate to the number of days in the quarter affected. In addition, we experience some seasonal trends in the sale of our products. For example, sales to governments (particularly sales to the U.S.United States government) are often stronger in the third calendar quarter, consumer sales are often stronger in the fourth calendar quarter, and many customers whose fiscal and calendar years are the same spend their remaining capital budget authorizations in the fourth calendar quarter prior to new budget constraints in the first calendar quarter of the following year. European sales are often weaker during the summer months. Demand during the spring and early summer also may be adversely impacted by market anticipation of seasonal trends. Moreover, to the extent that we introduce new products in anticipation of seasonal demand trends, our discounting of existing products may adversely affect our gross margin prior to or shortly after such product launches. Many of the factors that create and affect seasonal trends are beyond our control. Overall, our third fiscal quarter is typically our weakest and our fourth fiscal quarter our strongest.
Many of the factors that create and affect seasonal trends are beyond our control.
Any failure by us to execute planned cost reductions successfully could result in total costs and expenses that are greater than expected.
Historically, we have undertaken restructuring plans to bring operational expenses to appropriate levels for each of our businesses, while simultaneously implementing extensive new company-wide expense-control programs. In connection with the Compaq acquisition and other cost alignment efforts, we announced workforce restructurings as well as reductions through our early retirement programs involving approximately 17,60026,000 employees worldwide. In addition to these workforce reductions,worldwide in fiscal 2003 we took restructuring charges for incremental workforce reductions of 9,200 employees.and 2002. Hiring in key areas offset some of these workforce reductions. We expect workforce rebalancing actions in the first half of 2005, and we may have additionalfurther workforce reductions or rebalancing actions in the future. Significant risks associated with these actions and other workforce management issues that may impair our ability to achieve anticipated cost reductions or that may otherwise harm our business include delays in implementation of anticipated workforce reductions in highly regulated locations outside of the United States, particularly in Europe and Asia, redundancies among restructuring programs, decreases in employee morale and the failure to meet operational targets due to the loss of employees, particularly sales employees.
In order to be successful, we must attract, retain and motivate key employees, and failure to do so could seriously harm us.
In order to be successful, we must attract, retain and motivate executives and other key employees, including those in managerial, technical, sales, marketing and information technologyIT support positions. In particular, hiringWe also must keep employees focused on HP's strategies and goals, all of which may be more difficult due to uncertainty in connection with the recent termination of our previous Chief Executive Officer. Hiring and retaining qualified executives, engineers, skilled solutions providers in the IT support business and qualified sales representatives is critical to our future. Competitionfuture, and competition for experienced management and technical, marketing and support personnelemployees in the IT industry
can be intense. The failure to hire or loss of key employees could have a significant impact on our operations and stock price. We also must continue to motivate employees and keep them focused on HP's strategies and goals, which may be particularly difficult due to morale challenges, including those posed by workforce reductions and the acquisition and integration of Compaq.
Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain employees, and proposed changes in accounting for equity compensation couldwill adversely affect earnings.
We have historically used stock options and other forms of equity-related compensation as key components of our total rewards employee compensation program in order to align employees' interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. In recent periods, many of HP's employee stock options have had exercise prices in excess of HP's stock price, which reduces their value to employees and could affect our ability to retain or attract present and prospective employees. In addition, the Financial Accounting Standards Board and other agencies have proposedfinalized changes to U.S. generally accepted accounting principles generally accepted in the United States that wouldwill require HP and other companies to record a chargecharges to earnings for employee stock option grants and other equity incentives. Accordingly, HP expects to begin recording such charges in the fourth quarter of fiscal 2005. Moreover, applicable stock exchange listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant options to employees,As a result, we maywill incur increased compensation costs, and may change our equity compensation strategy or find it difficult to attract, retain and motivate employees, any of which could materially and adversely affect our business.
HP's stock price has historically fluctuated and may continue to fluctuate.
HP's stock price, like that of other technology companies, can be volatile. Some of the factors that can affect our stock price are:
General or industry-specific market conditions or stock market performance or domestic or international macroeconomic and geopolitical factors unrelated to HP's performance also may affect the price of HP common stock. For these reasons, investors should not rely on recent trends to predict future stock prices, financial condition, or results of operations or cash flows. In addition, following periods of volatility in a company's securities, securities class action litigation against a company is sometimes instituted. This type of litigation could result in substantial costs and the diversion of management time and resources.
System security risks and systems integration issues could disrupt our internal operations or information technology services provided to customers, which could harm our revenue, increase our expenses and harm our reputation and stock price.
Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate our confidential information or that of third parties, create system disruptions or cause shutdowns. As a result, we could incur significant expenses in addressing problems created by security breaches of our network. Moreover, we could lose existing or potential customers for
information technology outsourcing services or other information technology solutions, or incur significant expenses in connection with our customers' system failures. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design and manufacture, including "bugs" and other problems that can unexpectedly interfere with the operation of the system. The costs to eliminate or alleviate security problems, viruses and bugs could be significant, and the efforts to address these problems could result in interruptions, delays or cessation of service that may impede sales, manufacturing, distribution or other critical functions.
Portions of our IT infrastructure also may experience interruptions, delays or cessations of service or produce errors in connection with ongoing systems integration work. In particular, in connection with the Compaq integration, we are in the process of implementing a new general ledger, order management and data warehouse systems to replace our current systems. As a part of this effort, we are rationalizing various legacy systems, upgrading existing software applications and implementing new data management applications to administer our business information. We may not be successful in implementing the new system,systems, and transitioning data and other aspects of the process could be expensive, time consuming, disruptive and resource intensive. Any disruptions that may occur in the implementation of thisthe new systemsystems or any future systems could adversely affect our ability to report in an accurate and timely manner the results of our consolidated operations, our business segment results, our financial position and cash flows. Disruptions to these systems also could also adversely impact our ability to fulfill orders and interrupt other operational processes. Delayed sales, lower margins or lost
customers resulting from these disruptions could adversely affect our financial results, stock price and reputation.
Any failure by us to manage acquisitions, divestitures and other significant transactions successfully could harm our financial results, business and prospects.
As part of our business strategy, we frequently engage in discussions with third parties regarding, and enter into agreements relating to, possible acquisitions, strategic alliances, joint ventures, divestitures and outsourcing transactions in order to further our business objectives, and in many cases, to manage our product and technology portfolios. In order to pursue this strategy successfully, we must identify suitable candidates for these transactions, complete these transactions, some of which may be large and complex, and manage post-closing issues such as the integration of acquired companies or employees. Integration and other risks of acquisitions, strategic alliances, joint ventures and outsourcing transactions can be more pronounced for larger and more complicated transactions, or if multiple transactions are pursued simultaneously. However, if we fail to identify and complete successfully transactions that further our strategic objectives, we may be required to expend resources to develop products and technology internally, we may be at a competitive disadvantage or we may be adversely affected by negative market perceptions, any of which may have a material adverse effect on our revenue and selling, general and administrative expenses. Integration issues are complex, time-consuming and expensive and, without proper planning and implementation, could significantly disrupt our business. The challenges involved in integration include:
We evaluate and enter into significant transactions, including acquisitions, outsourcing agreements,strategic alliances, joint ventures, divestitures and divestitures,outsourcing agreements, on an ongoing basis. We may not fully realize all of the anticipated benefits of any transaction to the extent anticipated, and the timeframe for achieving benefits of a transaction may depend partially upon the actions of employees, suppliers or other third parties. In addition, the pricing and other terms of our contracts for significant transactions require us
to make estimates and assumptions at the time we enter into these contracts, and, during the course of our due diligence, we may not identify all of the factors necessary to estimate our costs accurately. Any increased or unexpected costs, unanticipated delays or failure to achieve contractual obligations could make these agreements less profitable or unprofitable.
Managing acquisitions, outsourcing transactions, strategic alliances, joint ventures, and divestitures requires varying levels of management resources, which may divert our attention from other business operations. These transactions also have resulted and in the future may result in significant costs and expenses and charges to earnings, including those related to severance pay, early retirement costs, employee benefit costs, asset impairment charges, charges from the elimination of duplicative facilities and contracts, in-process research and development charges, inventory adjustments, legal, accounting and financial advisory fees, and required payments to executive officers and key employees under retention plans. Moreover, HP has incurred and will incur additional depreciation and amortization expense over the useful lives of certain assets acquired in connection with transactions, and, to the extent that the value of goodwill or intangible assets with indefinite lives acquired in connection with a transaction becomes impaired, we may be required to incur additional material charges relating to the impairment of those assets. In order to complete an acquisition, we may issue common stock, potentially creating dilution for existing stockholders, or borrow, affecting our financial condition and potentially our credit ratings. Any prior or future downgrades in our credit rating associated with an acquisition could adversely affect our ability to borrow and result in more restrictive borrowing terms. In addition, HP's effective tax rate on an ongoing basis is uncertain and extraordinary transactions could impact our effective tax rate. As a result, any completed, pending or future transactions may contribute to financial results that differ from the investment community's expectations in a given quarter.
Unforeseen environmental costs could impact our future net earnings.
Some of our operations use substances regulated under various federal, state and international laws governing the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes and the cleanup of contaminated sites. CertainMany of our products are subject to various federal, state and international laws governing chemical substances in products, including those regulating the manufacture and distribution of chemical substances and those restricting the presence of certain substances in electronics products. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, third-partythird-
party property damage or personal injury claims, or our products could be enjoined from entering certain jurisdictions, if we were to violate or become liable under environmental laws or if our products become non-compliant with environmental permits required at present or former facilities.laws. We also face increasing complexity in our product design and procurement operations as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and certain other substances that will apply to specified electronics products put on the market in the European Union as of July 1, 2006 (Restriction of Hazardous Substances Directive) and similar legislation currently proposed for China. The ultimate costs under environmental laws and the timing of these costs are difficult to predict, and liability under some environmental laws relating to contaminated sites can be imposed retroactively and on a joint and several basis. We also could face significant costs and liabilities in connection with product take-back legislation. We record a liability for environmental remediation and other environmental costs when we consider the costs to be probable and the amount of the costs can be reasonably estimated. The European Union has finalized the Waste Electrical and Electronic Equipment Directive, which makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. ThisThe deadline to enact and implement the directive by individual European Union governments generally was August 13, 2004, although extensions have beenwere granted to some countries (such legislation, together with the directive, the "WEEE Legislation"), and producers are to be financially responsible under the WEEE Legislation beginning in August 2005. HP's potential liability resulting from the WEEE Legislation may be substantial. Similar legislation has been or may be enacted in other geographies, including in the United States and Japan, the cumulative impact of which could be significant. It is our policy to apply strict standards for environmental protection to sites inside and outside the United States, even when we are not subject to local government regulations. We record a liability for environmental remediation and other environmental costs when we consider the costs to be probable and the amount of the costs can be reasonably estimated.
Some anti-takeover provisions contained in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could impair a takeover attempt.
We have provisions in our certificate of incorporation and bylaws, each of which could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our Board of Directors. These include provisions:
These provisions, alone or together, could deter or delay hostile takeovers, proxy contests and changes in control or management of HP. As a Delaware corporation, HP also is subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which prevents some stockholders from engaging in certain business combinations without approval of the holders of substantially all of HP's outstanding common stock.
Any provision of our certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of HP common stock, and also could affect the price that some investors are willing to pay for HP common stock.
Item 3.Quantitative and Qualitative Disclosures About Market Risk.
For quantitative and qualitative disclosures about market risk affecting HP, see Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our Annual Report on Form 10-K for the fiscal year ended October 31, 2003,2004, which is incorporated herein by reference. Our exposure to market risk has not changed materially since October 31, 2003.2004.
Item 4.Controls and Procedures.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report (the "Evaluation Date"). Based on this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to HP, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to HP's management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
HP will be required by the Sarbanes-Oxley Act to include an assessment of its internal control over financial reporting and attestation from an independent registered public accounting firm in its Annual Report on Form 10-K beginning with its fiscal year ended October 31, 2005.
The information set forth above under Note 12 contained in the "Notes to Consolidated Condensed Financial Statements" is incorporated herein by reference.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.
There were no unregistered sales of equity securities.
Issuer Purchases of Equity Securities
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs | |||||
---|---|---|---|---|---|---|---|---|---|
Month #1 (May 2004) | 4,310,811 | 20.96 | 4,310,811 | $ | 2,510,524,270 | ||||
Month #2 (June 2004) | 19,346,000 | 21.18 | 19,346,000 | $ | 2,100,732,651 | ||||
Month #3 (July 2004) | — | — | — | $ | 2,100,732,651 | ||||
Total | 23,656,811 | 21.14 | 23,656,811 | — |
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs(a) | ||||||
---|---|---|---|---|---|---|---|---|---|---|
Month #1 (November 2004 final payment on the completed accelerated share repurchase program) | N/A | N/A | N/A | $ | 2,845,253,531 | |||||
Month #1 (November 2004) | 9,500,000 | $ | 19.21 | 9,500,000 | $ | 2,662,738,533 | ||||
Month #2 (December 2004) | 12,900,000 | $ | 20.70 | 12,900,000 | $ | 2,395,647,825 | ||||
Month #3 (January 2005) | 6,650,000 | $ | 20.46 | 6,650,000 | $ | 2,259,564,886 | ||||
Total | 29,050,000 | $ | 20.16 | 29,050,000 | ||||||
HP repurchased shares in the thirdfirst quarter of fiscal 20042005 under an ongoing systematic program to manage the dilution created by shares issued under employee stock plans and also to return cash to shareholders.stockholders. This program authorizes repurchases in the open market or in private transactions. Amounts authorized for future repurchases under the systematic program are approved periodically, withperiodically. No additional authorizations occurred in the most recent increase announced May 28, 2004, whenfirst quarter of fiscal 2005. All shares repurchased in the Boardfirst quarter of Directors of HP authorized an additional $2.0 billion for future repurchases of HP's outstanding shares of common stock.fiscal 2005 were repurchased in private transactions.
HP had total authorization for future repurchases of approximately $2.1$2.3 billion remaining at JulyJanuary 31, 2004.
HP repurchased shares in the third quarter of fiscal 2004 from the Packard Foundation. These purchases were made in accordance with a Memorandum of Understanding, dated September 9, 2002, between HP and the Packard Foundation providing that HP may purchase from the Packard Foundation shares of HP common stock each New York Stock Exchange trading day during the "Sale Period" (defined below) for a purchase price equal to the adjusted, volume-weighted average price for composite New York Stock Exchange transactions on that trading day. The "Sale Period" begins on and includes the second New York Stock Exchange trading day after HP's public announcement of quarterly earnings information and ends on and includes the last business calendar day of the second month of HP's quarterly financial reporting period. HP may repurchase additional shares of HP common stock from the Packard Foundation in the future under the Memorandum of Understanding. In addition, either HP or the Packard Foundation may suspend or terminate sales under the Memorandum of Understanding at any time. The shares repurchased from the Packard Foundation are included in the table above.2005.
The Exhibit Index found on page 6667 of this report sets forth a list of exhibits.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
HEWLETT-PACKARD COMPANY | ||
/s/ ROBERT P. WAYMAN | ||
Robert P. Wayman Chief Executive and Chief Financial Officer (Principal Executive Officer, Principal Financial Officer and Authorized Signatory) |
Date: September 10, 2004March 11, 2005
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
EXHIBIT INDEX
| | Incorporated by Reference | ||||||||
---|---|---|---|---|---|---|---|---|---|---|
Exhibit Number | | |||||||||
Exhibit Description | Form | File No. | Exhibit(s) | Filing Date | ||||||
Agreement and Plan of Reorganization by and among Hewlett-Packard Company, Heloise Merger Corporation and Compaq Computer Corporation. | 8-K | 001-04423 | 2.1 | September 4, 2001 | ||||||
3(a) | Registrant's Certificate of Incorporation. | 10-Q | 001-04423 | 3(a) | June 12, 1998 | |||||
3(b) | Registrant's Amendment to the Certificate of Incorporation. | 10-Q | 001-04423 | 3(b) | March 16, 2001 | |||||
3(c) | Registrant's Amended and Restated By-Laws effective March 17, 2004. | 10-Q | 001-04423 | 3(c) | June 9, 2004 | |||||
4(a) | Indenture dated as of October 14, 1997 among Registrant and Chase Trust Company of California regarding Liquid Yield Option Notes due 2017. | S-3 | 333-44113 | 4.2 | January 12, 1998 | |||||
4(b) | Supplemental Indenture dated as of March 16, 2000 to Indenture dated as of October 14, 1997 among Registrant and Chase Trust Company of California regarding Liquid Yield Option Notes due 2017. | 10-Q | 001-04423 | 4(b) | September 12, 2000 | |||||
4(c) | Second Supplemental Indenture to Indenture dated as of October 14, 1997 among Registrant and J.P. Morgan Trust Company (as successor to Chase Trust Company of California) regarding Liquid Yield Option Notes due 2017. | 10-Q | 001-04423 | 4(c) | September 10, 2004 | |||||
4(d) | Form of Registrant's 7.15% Global notes due June 15, 2005, and related Officers' | 8-K | 001-04423 | 4.1 and 4.3 | June 15, 2000 | |||||
4(e) | Form of Senior Indenture. | S-3 | 333-30786 | 4.1 | March 17, 2000 | |||||
4(f) | Form of Registrant's Fixed Rate Note and Floating Rate Note and related Officers' Certificate. | 8-K | 001-04423 | 4.1, 4.2 and 4.4 | May 24, 2001 | |||||
4(g) | Form of Registrant's 5.75% Global Note due December 15, 2006, and related Officers' Certificate. | 8-K | 001-04423 | 4.1 and 4.2 | December 7, 2001 | |||||
4(h) | Form of Registrant's 5.50% Global Note due July 1, 2007, and form of related Officers' Certificate. | 8-K | 001-04423 | 4.1 and 4.3 | June 27, 2002 | |||||
4(i) | Form of Registrant's 6.50% Global Note due July 1, 2012, and form of related Officers' Certificate. | 8-K | 001-04423 | 4.2 and 4.3 | June 27, 2002 | |||||
4(j) | Form of Registrant's Fixed Rate Note and form of Floating Rate Note. | 8-K | 001-04423 | 4.1 and 4.2 | December 11, 2002 | |||||
4(k) | Form of Registrant's 3.625% Global Note due March 15, 2008, and related Officers' Certificate. | 8-K | 001-04423 | 4.1 and 4.2 | March 14, 2003 | |||||
5-9 | Not applicable. | |||||||||
10(a) | Registrant's 2004 Stock Incentive Plan.* | S-8 | 333-114253 | 4.1 | April 7, 2004 | |||||
10(b) | Registrant's 2000 Stock Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(a) | January 21, 2003 | |||||
10(c) | Registrant's 1997 Director Stock Plan, amended and restated effective November | 001-04423 | 10(c) | |||||||
10(d) | Registrant's 1995 Incentive Stock Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(c) | January 21, 2003 | |||||
10(e) | Registrant's 1990 Incentive Stock Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(d) | January 21, 2003 | |||||
10(f) | Registrant's 1987 Director Option Plan.* | S-8 | 33-30769 | 4 | August 31, 1989 | |||||
10(g) | Amendment of Registrant's 1987 Director Option Plan, effective July 17, 1991.* | 10-K | 001-04423 | 10(g) | January 14, 2005 | |||||
10(h) | Compaq Computer Corporation 2001 Stock Option Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(f) | January 21, 2003 | |||||
10(i) | Compaq Computer Corporation 1998 Stock Option Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(g) | January 21, 2003 | |||||
10(j) | Compaq Computer Corporation 1995 Equity Incentive Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(h) | January 21, 2003 | |||||
10(k) | Compaq Computer Corporation 1989 Equity Incentive Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(i) | January 21, 2003 | |||||
10(l) | Compaq Computer Corporation 1985 Stock Option Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(k) | January 21, 2003 | |||||
Compaq Computer Corporation 1985 Executive and Key Employee Stock Option Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(l) | January 21, 2003 | ||||||
Compaq Computer Corporation 1985 Nonqualified Stock Option Plan, amended and restated effective November 21, 2002.* | 10-K | 001-04423 | 10(m) | January 21, 2003 | ||||||
Compaq Computer Corporation 1985 Nonqualified Stock Option Plan for Non-Employee Directors.* | S-3 | 333-86378 | 10.5 | April 18, 2002 | ||||||
Amendment of Compaq Computer Corporation Non-Qualified Stock Option Plan for Non-Employee | S-3 | 333-86378 | 10.11 | April 18, 2002 | ||||||
Compaq Computer Corporation 1998 Former Nonemployee Replacement Option Plan.* | S-3 | 333-86378 | 10.9 | April 18, 2002 | ||||||
Registrant's Excess Benefit Retirement Plan, amended and restated as of November 1, 1999.* | 10-Q | 001-04423 | 10(c) | September 12, 2000 | ||||||
First Amendment to Registrant's Excess Benefit Retirement Plan, effective November 1, 1999.* | 10-K | 001-04423 | 10(b)(b) | January 21, 2003 | ||||||
Second Amendment to Registrant's Excess Benefit Retirement Plan, effective April 1, 2004.* | 10-Q | 001-04423 | 10(t) | June 9, 2004 | ||||||
Third Amendment to Registrant's Excess Benefit Retirement Plan, effective May 1, 2004.* | 10-Q | 001-04423 | 10(u) | June 9, 2004 | ||||||
Hewlett-Packard Company Cash Account Pension Restoration Plan.* | 10-K | 001-04423 | 10(c)(c) | January 21, 2003 | ||||||
Registrant's Executive Pay-for-Results Plan, amended and restated effective November 1, 2003.* | 10-Q | 001-04423 | 10(c)(c) | March 11, 2004 | ||||||
Registrant's Executive Deferred Compensation Plan, amended and restated effective | 001-04423 | 10(x) | ||||||||
001-04423 | ||||||||||
10(a) | ||||||||||
Registrant's Severance Plan for Executive Officers.* | 10-K | 001-04423 | 10(z)(z) | January 20, 2004 | ||||||
10(b)(b) | Registrant's Executive Severance Agreement.* | 10-Q | 001-04423 | 10(u)(u) | June 13, 2002 | |||||
10(c)(c) | Registrant's Executive Officers Severance Agreement.* | 10-Q | 001-04423 | 10(v)(v) | June 13, 2002 | |||||
10(d)(d) | Form of Indemnity Agreement between Compaq Computer Corporation and its executive officers.* | 10-Q | 001-04423 | 10(x)(x) | June 13, 2002 | |||||
10(e)(e) | Registrant's Service Anniversary Stock Plan, as amended and restated effective July 17, 2003.* | 10-Q | 001-04423 | 10(p)(p) | September 11, 2003 | |||||
10(f)(f) | Form of Stock Option Agreement for Registrant's 2004 Stock Incentive Plan, Registrant's 2000 Stock Plan, as amended, Registrant's 1995 Incentive Stock Plan, as amended, the Compaq Computer Corporation 2001 Stock Option Plan, as amended, the Compaq Computer Corporation 1998 Stock Option Plan, as amended, the Compaq Computer Corporation 1995 Equity Incentive Plan, as amended and the Compaq Computer Corporation 1989 Equity Incentive Plan, as amended.* | 10-Q | 001-04423 | 10(l)(l) | June 9, 2004 | |||||
10(g)(g) | Form of Restricted Stock Agreement for Registrant's 2004 Stock Incentive Plan, Registrant's 2000 Stock Plan, as amended, and Registrant's 1995 Incentive Stock Plan, as amended.* | 10-K | 001-04423 | 10(j)(j) | January 14, 2005 | |||||
10(h)(h) | Form of Restricted Stock Unit Agreement for Registrant's 2004 Stock Incentive Plan.* | 10-K | 001-04423 | 10(k)(k) | January 14, 2005 | |||||
10(i)(i) | Form of Stock Option Agreement for Registrant's 1990 Incentive Stock Option Plan, as amended.* | 10-K | 001-04423 | 10(e) | January 27, 2000 | |||||
10(j)(j) | Form of Common Stock Payment Agreement and Option Agreement for Registrant's 1997 Director Stock Plan, as amended.*‡ |
Form of Stock Option Agreement for Registrant's 1987 Director Option Plan, as amended.* | 10-K | 001-04423 | 10(n)(n) | January 14, 2005 | ||||||
10(l)(l) | Form of Restricted Stock Grant Notice for the Compaq Computer Corporation 1989 Equity Incentive Plan.* | 10-Q | 001-04423 | 10(w)(w) | June 13, 2002 | |||||
10(m)(m) | Form of Stock Option Agreement for the Compaq Computer Corporation 1985 Stock Option Plan, as amended.* | 10-K | 001-04423 | 10(z)(z) | January 21, 2003 | |||||
10(n)(n) | Form of Stock Option Agreement for the Compaq Computer Corporation 1985 Nonqualified Stock Option Plan, as amended.* | 10-K | 001-04423 | 10(a)(1) | January 21, 2003 | |||||
10(o)(o) | Forms of Stock Option Notice for the Compaq Computer Corporation Non-Qualified Stock Option Plan for Non-Employee Directors, as amended.* | 10-K | 001-04423 | 10(r)(r) | January 14, 2005 | |||||
10(p)(p) | Form of Stock Option Agreement for the Compaq Computer Corporation 1985 Executive and Key Employee Stock Option Plan, as amended.* | 10-K | 001-04423 | 10(s)(s) | January 14, 2005 | |||||
10(q)(q) | Form of Long-Term Performance Cash Award Agreement for Registrant's 2004 Stock Incentive Plan and Registrant's 2000 Stock Plan, as amended.* | 10-K | 001-04423 | 10(t)(t) | January 14, 2005 | |||||
11 | Not applicable. | |||||||||
12 | Statement of Computation of Ratio of Earnings to Fixed Charges.‡ | |||||||||
13-14 | Not applicable. | |||||||||
15 | None. | |||||||||
16-17 | Not applicable. | |||||||||
18-19 | None. | |||||||||
20-21 | Not applicable. | |||||||||
22-24 | None. | |||||||||
25-26 | Not applicable. | |||||||||
31 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, |
32 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
The registrant agrees to furnish to the Commission supplementally upon request a copy of (1) any instrument with respect to long-term debt not filed herewith as to which the total amount of securities authorized thereunder does not exceed 10 percent of the total assets of the registrant and its subsidiaries on a consolidated basis and (2) any omitted schedules to any material plan of acquisition, disposition or reorganization set forth above.