Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended January 31, 2003, for Hewlett-Packard Company (HP). The reporting period reflects the first full quarter of operations following the May 2002 acquisition of Compaq Computer Corporation. HP operates through six segments: Imaging and Printing Group, Personal Systems Group, Enterprise Systems Group, HP Services, HP Financial Services, and Corporate Investments. The company is currently integrating Compaq's operations, managing significant restructuring plans, and navigating a weakened global economic environment.
Key Financial Metrics
| Metric (in millions) | Q1 2003 | Q1 2002 |
|---|---|---|
| Total Net Revenue | $17,877 | $11,383 |
| Gross Margin | $4,736 (26.5%) | $3,027 (26.6%) |
| Earnings from Operations | $879 (4.9%) | $625 (5.5%) |
| Net Earnings | $721 | $484 |
| Diluted EPS | $0.24 | $0.25 |
| Cash from Operating Activities | $647 | $1,721 |
| Cash and Cash Equivalents (End of Period) | $12,641 | $6,983 |
| Total Debt (Short-term + Long-term) | $9,220 | N/A |
Note: Q1 2002 figures are historical HP results prior to the Compaq acquisition. Total Debt for Q1 2003 includes $3,033 million in short-term borrowings and $6,187 million in long-term debt.
Material Changes vs. Prior Period
- Revenue Growth: Net revenue increased 57% year-over-year, primarily driven by the inclusion of Compaq's results. On a combined company basis (pro forma), revenue actually declined 9% due to economic weakness and product roadmap transitions.
- Profitability: While absolute net earnings rose to $721 million, the effective tax rate improved to 22% from 25%. Operating margins compressed slightly on a GAAP basis due to higher amortization and acquisition-related charges.
- Cash Flow: Operating cash flow decreased significantly to $647 million from $1.7 billion in the prior year, attributed to timing of accounts payable, increased inventory levels, and restructuring payments.
- Segment Performance:
- Imaging and Printing: Revenue grew 9% (combined basis), driven by supplies and digital imaging.
- Personal Systems: Revenue declined 19% (combined basis) due to lower volumes and pricing pressure.
- Enterprise Systems: Revenue declined 17% (combined basis) reflecting weak enterprise IT spending.
- HP Services: Revenue declined 9% (combined basis), though managed services grew.
Guidance, Outlook, and Risks
Management Commentary: Management attributes revenue declines on a combined basis to ongoing global economic weakness, competitive pricing, and the consolidation of product offerings following the Compaq acquisition. The company is actively managing costs through workforce reductions and expense control measures. A change in revenue recognition policy for pre-acquisition Compaq businesses (shifting from shipment to delivery) negatively impacted reported revenue by approximately $200 million.
Restructuring: HP expects future cash expenditures of approximately $1.1 billion related to restructuring plans, primarily for employee severance and facility costs, with severance payments expected to be substantially complete by the end of fiscal 2003.
Risks and Contingencies:
- Legal Proceedings: Significant litigation includes consumer class actions regarding inkjet cartridges and floppy disk controllers, patent infringement suits (e.g., Cornell University, Intergraph), and an SEC inquiry regarding the Compaq acquisition vote solicitation.
- Goodwill Impairment: HP is in the process of performing the transitional impairment test for goodwill required by SFAS No. 142, with results due by April 30, 2003.
- Market Conditions: Risks include continued economic downturns, supply chain disruptions, and the challenges of integrating Compaq's operations and culture.
Investor Verification Checklist
- Combined Company Trends: Verify the 9% revenue decline on a pro forma basis to understand organic growth trends independent of the Compaq acquisition.
- Inventory Levels: Review the increase in inventory to $6.09 billion and the decrease in inventory turns (8.6x) to assess potential write-down risks in a slowing market.
- Restructuring Execution: Monitor the $1.1 billion remaining restructuring liability and the timeline for severance payments to gauge future cash outflows.
- Goodwill Testing: Watch for the outcome of the SFAS No. 142 goodwill impairment test due in April 2003, which could result in significant non-cash charges.
- Legal Exposure: Track the status of the inkjet cartridge class action trial (scheduled for June 2003) and the SEC inquiry regarding the Compaq merger.