HPQ

Business Context and Reporting Period

This Form 10-Q covers Hewlett-Packard Company (HP) for the quarterly period ended April 30, 2001, and the six-month period ended on the same date. HP is a global provider of computing and imaging solutions and services, organized into three major segments: Imaging and Printing Systems, Computing Systems, and IT Services. The filing reflects the impact of a global economic downturn, softening IT spending, and significant one-time charges.

Key Financial Metrics

Note: Debt figures represent Notes payable/short-term borrowings ($3,221M) plus Long-term debt ($2,843M) as of April 30, 2001.

Material Changes vs. Prior Period

• Revenue Decline: Net revenue decreased 4% year-over-year for the quarter and 1% for the six-month period. Product sales fell 6% (quarter) and 3% (six months), while service revenue grew 9% and 12% respectively.
• Profitability Compression: Net earnings from continuing operations dropped 93% for the quarter and 78% for the six-month period compared to the prior year. Operating margins contracted significantly due to lower volumes and pricing pressures.
• Segment Performance:
  • Imaging and Printing: Revenue declined 3% (quarter) and 2% (six months) due to lower hardware unit shipments and price declines.
  • Computing Systems: Revenue declined 7% (quarter) and 3% (six months), driven by weakness in home/commercial PCs and Unix servers. The segment reported an operating loss of $130 million for the quarter.
  • IT Services: Revenue grew 9% (quarter) and 11% (six months), driven by consulting and outsourcing.
• One-Time Charges: The quarter included a $400 million litigation settlement with Pitney Bowes and a $365 million impairment loss on investments in emerging market companies (recorded in the first quarter of the fiscal year).

Guidance, Outlook, and Risks

Management Commentary: Management attributes the decline in U.S. revenues to the economic downturn and notes that international revenue was negatively impacted by softening consumer IT spending in Europe, partially offset by growth in Asia Pacific and Latin America. Foreign currency fluctuations (specifically the weakening Euro) adversely impacted revenue growth by approximately 4 percentage points.

Outlook: HP expects continued upward pressure on the cost of sales ratio for the second half of fiscal 2001 due to economic uncertainty and competitive pricing pressures, particularly in low-end printers and PCs. Management anticipates potential additional charges on its investment portfolio given current market conditions.

Risks and Contingencies:

• Litigation: The $400 million Pitney Bowes settlement was finalized in June 2001 but recorded in this quarter's results.
• Investment Impairment: HP holds risky investments in start-up and emerging market companies; further impairment charges are possible.
• Market Conditions: Short product life cycles, reliance on third-party distributors, and global economic uncertainty pose significant risks to future revenue and margins.
• Inventory: Inventory levels as a percentage of revenue increased to 11.7% due to the economic slowdown, though active management has reduced this from a peak of 12.4% in January 2001.

Investor Verification Checklist

• Verify the $400M Litigation Charge: Confirm the accounting treatment of the Pitney Bowes settlement recorded in Q2 despite the cash payment occurring in June 2001.
• Assess Investment Portfolio Health: Review the remaining $300 million cost basis in emerging market investments and the likelihood of future impairment charges.
• Monitor Computing Systems Turnaround: Evaluate the sustainability of the operating loss in the Computing Systems segment amidst PC market softness.
• Check Currency Hedging Effectiveness: Verify the impact of the weakening Euro on future quarters given the 4% revenue drag noted in the filing.
• Review Stock Repurchase Program: Confirm the remaining $2.0 billion authorization for share buybacks and its impact on diluted EPS.