HPQ

Business Context and Reporting Period

This summary covers the Annual Report on Form 10-K for Hewlett-Packard Company (HP) for the fiscal year ended October 31, 2003. HP is a leading global provider of IT infrastructure, personal computing, global services, and imaging and printing products. The reporting period reflects the second full year of operations following the May 2002 acquisition of Compaq Computer Corporation. Management focused on completing the integration of Compaq, executing product transition plans, and reducing operating costs to align with market conditions.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 29% year-over-year, driven primarily by the inclusion of Compaq for the full year and an 11% organic growth in the Imaging and Printing Group (IPG). International revenue grew 32% to $43.8 billion.
• Return to Profitability: HP returned to profitability with $2.5 billion in net earnings, reversing a $0.9 billion net loss in fiscal 2002. This turnaround was achieved despite $800 million in restructuring charges and $280 million in acquisition-related charges.
• Segment Performance:
  • IPG: Recorded its highest-ever full-year revenue and profit, with operating profit exceeding $1 billion in the fourth quarter.
  • PSG: Achieved segment profitability for the full year and three of four quarters, driven by cost reductions and market share gains in notebooks.
  • ESG: Reduced its operating loss significantly, achieving profitability in the fourth quarter through cost management and breakeven point reductions.
  • HPS: Delivered strong financial returns, establishing itself as a top-tier player in managed services.
• Restructuring: Fiscal 2003 included $800 million in restructuring charges related to workforce reductions (approximately 8,900 employees) and facility consolidations to align costs with revenue levels.

Guidance, Outlook, and Risks

Management Commentary: Management expects gross margins to remain under pressure due to competitive pricing and mix shifts toward lower-margin products. However, they anticipate these effects will be moderated by operational efficiencies and an improving economic outlook. The company plans to continue investing in R&D ($3.7 billion in 2003) and innovation.

Risks and Contingencies:

• Legal Proceedings: HP faces significant litigation, including consumer class actions regarding ink cartridge capacity and floppy disk controller defects. There are also ongoing patent disputes with Intergraph and EMC, and investigations by the European Commission and the U.S. Department of Justice.
• Supply Chain: The company relies on single-source suppliers for certain components (e.g., laser printer engines) and offshore manufacturing, creating risks related to supply shortages and geopolitical instability.
• Competition: Intense competition in all segments, particularly from Dell in PCs and servers, continues to drive price reductions and margin pressure.
• Environmental: Potential liabilities exist regarding the European Union's Waste Electrical and Electronic Equipment (WEEE) Directive, which mandates financial responsibility for product recycling.

Investor Verification Checklist

• Compaq Integration Synergies: Verify if cost-saving goals from the Compaq acquisition are being met as projected and if market share gains are sustainable.
• Restructuring Execution: Monitor the actual cash outflows for the $850 million in future restructuring commitments and the timeline for achieving the targeted cost structure.
• Legal Exposure: Assess the potential financial impact of pending class actions (ink cartridges, floppy disks) and patent litigation, as outcomes could materially affect cash flows.
• Margin Sustainability: Evaluate the ability to maintain gross margins above 26% amidst continued industry-wide price competition and product mix shifts.
• Inventory Management: Review inventory turns (9.8 in 2003) and days sales outstanding (40 in 2003) to ensure working capital efficiency remains strong.