HPQ

Business Context and Reporting Period

This Form 10-Q covers Hewlett-Packard Company (HP) for the quarterly period ended July 31, 2001, and the nine-month period ended on the same date. HP is a global provider of computing and imaging solutions, organized into three primary segments: Imaging and Printing Systems, Computing Systems, and IT Services. The reporting period reflects a challenging global economic environment, characterized by a slowdown in IT spending and foreign currency headwinds, particularly from the weakening Euro.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net revenue decreased 14% in Q3 2001 and 5% for the nine-month period compared to the prior year. This was driven by a 22% drop in Computing Systems revenue and a 10% drop in Imaging and Printing Systems revenue, partially offset by a 3% increase in IT Services.
• Profitability Compression: Net earnings from continuing operations before extraordinary items fell 90% in Q3 and 82% for the nine-month period. Operating margins contracted significantly due to lower sales volumes, competitive pricing pressures, and increased costs of sales.
• One-Time Charges: The nine-month results were impacted by a $400 million litigation settlement with Pitney Bowes (recorded in Q2), a $365 million impairment loss on investments in emerging market companies (Q1), and a $131 million loss on the divestiture of the VeriFone business (Q3).
• Segment Performance: The Computing Systems segment reported an operating loss of $178 million in Q3, compared to $405 million in profit the prior year. The Imaging and Printing Systems segment saw operating earnings decline from $596 million to $386 million.

Guidance, Outlook, and Risks

Management Commentary and Restructuring: Management announced a workforce reduction plan in July 2001 to improve cost structure, targeting the elimination of approximately 6,000 positions. A restructuring charge of $250 million to $300 million is expected, with the majority recorded in Q4 2001. The company anticipates continued upward pressure on the cost of sales ratio due to economic uncertainty and pricing pressures.

Strategic Acquisitions: HP signed definitive agreements to acquire Compaq Computer Corporation (expected to close H1 2002), Indigo N.V. (digital color printing), StorageApps, and Comdisco (business continuity services). These moves aim to strengthen IT solutions, storage virtualization, and printing portfolios.

Risks and Contingencies:

• Economic Uncertainty: Global economic weakness is causing customers to delay IT expenditures, directly impacting revenue growth.
• Inventory Management: Short product life cycles and reliance on third-party distributors create risks of inventory write-downs if demand softens.
• Integration Risks: The pending merger with Compaq and other acquisitions carry significant integration risks regarding culture, systems, and customer retention.
• Investment Portfolio: HP may incur additional impairment charges on its portfolio of private and public emerging market investments due to market volatility.

Investor Verification Checklist

• Restructuring Impact: Verify the final cost and timing of the $250-$300 million workforce reduction charge and its effect on Q4 2001 earnings.
• Compaq Merger Status: Monitor regulatory approvals and shareholder votes required to close the Compaq acquisition, which is critical to HP's future cost structure and market position.
• Inventory Levels: Assess the risk of further inventory write-downs given the 11.7% inventory-to-revenue ratio and the shift to lower-priced products.
• Investment Impairments: Review the remaining $290 million cost basis in emerging market investments for potential future impairment charges.
• Accounting Changes: Note the upcoming adoption of SAB 101 (revenue recognition) and SFAS 142 (goodwill impairment), which may require restatements or changes in future earnings reporting.