HPQ

Business Context and Reporting Period

This Form 10-Q covers Hewlett-Packard Company (HP) for the quarterly period ended July 31, 2003, and the nine-month period ended July 31, 2003. HP is a global provider of information technology products, services, and solutions. The reporting period reflects the ongoing integration of the Compaq Computer Corporation acquisition (closed May 2002) and the implementation of significant restructuring plans to align costs with current business conditions.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 5% year-over-year for the quarter and 38% for the nine-month period, driven primarily by the inclusion of Compaq results and growth in the Imaging and Printing Group (IPG) and Personal Systems Group (PSG). On a constant currency basis, quarterly revenue declined 2%.
• Profitability Improvement: HP returned to profitability with net earnings of $297 million for the quarter, compared to a net loss of $2,029 million in the same period of 2002. Operating earnings improved from a loss of $2,476 million to earnings of $301 million.
• Restructuring Charges: Restructuring charges decreased significantly to $376 million for the quarter (down from $1,612 million in Q3 2002) and $610 million for the nine months (down from $1,630 million). This reflects the completion of major workforce reductions initiated in fiscal 2002 and 2003.
• Acquisition-Related Charges: Charges dropped to $40 million for the quarter from $378 million in the prior year, as the bulk of Compaq integration costs were incurred in fiscal 2002.
• Segment Performance:
  • Imaging and Printing Group: Revenue grew 10% in the quarter, driven by printer supplies and business hardware.
  • Personal Systems Group: Revenue grew 5% in the quarter, though average selling prices declined due to competitive pressure.
  • Enterprise Systems Group: Revenue remained flat (0.5% increase) due to weak enterprise spending and pricing pressure, though operating losses narrowed significantly.

Guidance, Outlook, and Risks

• Outlook: Management expects the fourth quarter to be favorably impacted by the seasonally strong back-to-school period, the "Big Bang 2" product launch, and strength in the managed services order backlog. However, competitive pricing pressures are expected to moderate average revenue per unit.
• Restructuring Commitments: HP expects future cash expenditures of approximately $1.0 billion related to approved restructuring plans, primarily for severance and facility costs, with the majority of severance payments expected by the end of fiscal 2004.
• Key Risks:
  • Competition: Aggressive pricing and product innovation by competitors continue to pressure gross margins.
  • Supply Chain: Reliance on third-party suppliers and single-source components creates risks of shortages or cost increases.
  • Legal Proceedings: Significant pending litigation includes consumer class actions regarding inkjet cartridges and floppy disk controllers, as well as patent disputes with Intergraph and EMC.
  • Integration: Risks associated with the ongoing integration of Compaq and other acquisitions, including the potential for goodwill impairment.

Investor Verification Checklist

• Verify the sustainability of gross margin improvements (26.2% in Q3) amidst continued competitive pricing pressures in the PC and server markets.
• Monitor the execution of the $1.0 billion restructuring cash commitment and its impact on future operating expenses.
• Assess the status of pending litigation, specifically the Stevens v. HP inkjet cartridge class action and Alvis v. HP floppy disk controller case, for potential financial exposure.
• Review the "Combined Company" pro forma results to understand organic growth trends excluding the one-time impact of the Compaq acquisition.
• Track inventory levels ($6.14 billion) and days sales outstanding (40 days) to ensure working capital management remains efficient.