HPQ

Business Context and Reporting Period

This Form 10-Q covers Hewlett-Packard Company (HP) for the quarterly period ended January 31, 2002. HP is a global provider of computing, printing, and imaging solutions. The reporting period reflects the first quarter of fiscal year 2002, during which the company operated under a global economic downturn and competitive pricing pressures. The filing also details significant pending transactions, including the proposed merger with Compaq Computer Corporation and the acquisition of Indigo N.V.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net revenue decreased 8% year-over-year to $11.4 billion, driven by a global economic downturn and a shift to lower-priced products. Computing Systems revenue fell 21%, and Embedded and Personal Systems revenue fell 13%.
• Profitability Improvement: Despite lower revenue, Net Earnings increased significantly to $484 million from $141 million. This improvement is largely due to the absence of a $365 million net investment loss and a $102 million restructuring charge recorded in Q1 2001.
• Cash Flow Surge: Operating cash flow turned positive at $1.7 billion, compared to a $523 million outflow in the prior year. This was driven by improved inventory management (inventory decreased by $746 million) and reduced receivables.
• Segment Performance: The Imaging and Printing Systems segment remained profitable with $742 million in operating earnings. Conversely, the Computing Systems segment reported an operating loss of $160 million.

Guidance, Outlook, and Risks

Management Commentary: Management attributes revenue declines to the global economic downturn and competitive pricing. However, they highlight improved gross margins in certain segments due to lower component costs (aided by a weaker Japanese yen) and cost reductions from prior restructuring. The company expects to pay out the remainder of accrued restructuring charges in fiscal 2002.

Pending Acquisitions:

• Compaq Merger: HP signed a definitive agreement to acquire Compaq for an estimated $24 billion. The transaction is subject to shareholder votes (scheduled for March 2002) and regulatory approvals. A $675 million termination fee may be payable if the deal fails under certain conditions.
• Indigo Acquisition: HP commenced an exchange offer to acquire Indigo N.V. for approximately $720 million plus contingent value rights.

Risks and Contingencies:

• Investment Portfolio: HP holds $300 million in emerging technology investments which remain at risk of impairment charges if market conditions worsen.
• Legal Proceedings: HP faces various lawsuits, including patent infringement claims (LaserJet, PA-RISC microprocessors) and consumer class actions regarding ink cartridges and floppy disk controllers. Management does not expect these to have a material adverse impact individually or in the aggregate.
• Merger Risks: Significant risks exist regarding the integration of Compaq, potential loss of customers or employees due to uncertainty, and the possibility that the merger may not be completed.

Investor Verification Checklist

• Verify the status of regulatory approvals and shareholder votes for the Compaq merger, noting the opposition from the Hewlett and Packard families.
• Monitor the $300 million portfolio of emerging technology investments for potential future impairment charges.
• Review the trend in average selling prices (ASP) for PCs and servers, as declining ASPs continue to pressure revenue despite volume growth in some categories.
• Assess the impact of the pending Indigo acquisition on the Imaging and Printing Systems segment margins.
• Track the resolution of pending litigation regarding ink cartridge "economy" claims and floppy disk controller defects.