UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | ||
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended: July 31, 2011 |
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Or |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to |
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Commission file number 1-4423 |
HEWLETT-PACKARD COMPANY
(Exact name of registrant as specified in its charter)
Delaware | 94-1081436 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. employer identification no.) |
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3000 Hanover Street, Palo Alto, California |
94304 |
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(Address of principal executive offices) | (Zip code) | |
(650) 857-1501 (Registrant's telephone number, including area code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act") during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No ý
The number of shares of HP common stock outstanding as of August 31, 2011 was 1,986,967,186 shares.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
INDEX
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Page No. |
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Part I. |
Financial Information | |||||||
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Item 1. | Financial Statements |
4 | |||||
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Consolidated Condensed Statements of Earnings for the three and nine months ended July 31, 2011 and 2010 (Unaudited) |
4 | ||||||
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Consolidated Condensed Balance Sheets as of July 31, 2011 (Unaudited) and as of October 31, 2010 (Audited) |
5 | ||||||
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Consolidated Condensed Statements of Cash Flows for the nine months ended July 31, 2011 and 2010 (Unaudited) |
6 | ||||||
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Notes to Consolidated Condensed Financial Statements (Unaudited) |
7 | ||||||
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Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
56 | |||||
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
92 | |||||
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Item 4. | Controls and Procedures |
92 | |||||
Part II. |
Other Information | |||||||
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Item 1. | Legal Proceedings |
93 | |||||
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Item 1A. | Risk Factors |
93 | |||||
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
93 | |||||
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Item 5. | Other Information |
93 | |||||
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Item 6. | Exhibits |
93 | |||||
Signature |
94 | |||||||
Exhibit Index |
95 |
Forward-Looking Statements
This Quarterly Report on Form 10-Q, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of Part I of this report, contains forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, the results of Hewlett-Packard Company and its consolidated subsidiaries ("HP") may differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of revenue, margins, expenses, earnings, earnings per share, tax provisions, cash flows, benefit obligations, share repurchases, currency exchange rates, the impact of acquisitions, the impact of the earthquake and tsunami that struck Japan in March 2011 or other financial items; any statements of the plans, strategies and objectives of management for future operations, including execution of growth strategies, transformation initiatives and restructuring plans; the exploration of strategic alternatives for HP's PC business and the selection and execution of any strategic plan; any statements concerning the expected development, performance or market share relating to products or services; any statements regarding current or future macroeconomic trends or events and the impact of those trends and events on HP and its financial performance; any statements regarding pending investigations, claims or disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. Risks, uncertainties and assumptions include the impact of macroeconomic and geopolitical trends and events; the competitive pressures faced by HP's businesses; the development and transition of new products and services (and the enhancement of existing products and services) to meet customer needs and respond to emerging technological trends; the execution and performance of contracts by HP and its suppliers, customers and partners; the protection of HP's intellectual property assets, including intellectual property licensed from third parties; integration and other risks associated with business combination and investment transactions; the hiring and retention of key employees; assumptions related to
2
pension and other post-retirement costs; expectations and assumptions relating to the execution and timing of growth strategies, transformation initiatives and restructuring plans; the possibility that the expected benefits of pending business combination transactions may not materialize as expected or that transactions may not be timely completed; the resolution of pending investigations, claims and disputes; and other risks that are described herein, including but not limited to the items discussed in "Factors that Could Affect Future Results" set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of Part I of this report, and that are otherwise described from time to time in HP's Securities and Exchange Commission ("SEC") reports, including HP's Annual Report on Form 10-K for the fiscal year ended October 31, 2010. HP assumes no obligation and does not intend to update these forward-looking statements.
3
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Consolidated Condensed Statements of Earnings
(Unaudited)
|
Three months ended July 31 |
Nine months ended July 31 |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
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2011 | 2010 | 2011 | 2010 | |||||||||||
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In millions, except per share amounts |
||||||||||||||
Net revenue: |
|||||||||||||||
Products |
$ | 20,412 | $ | 20,547 | $ | 63,661 | $ | 62,120 | |||||||
Services |
10,662 | 10,078 | 31,130 | 30,317 | |||||||||||
Financing income |
115 | 104 | 332 | 318 | |||||||||||
Total net revenue |
31,189 | 30,729 | 95,123 | 92,755 | |||||||||||
Costs and expenses: |
|||||||||||||||
Cost of products |
15,669 | 15,730 | 48,286 | 47,936 | |||||||||||
Cost of services |
8,180 | 7,560 | 23,682 | 22,798 | |||||||||||
Financing interest |
80 | 75 | 229 | 227 | |||||||||||
Research and development |
812 | 742 | 2,425 | 2,145 | |||||||||||
Selling, general and administrative |
3,402 | 3,191 | 9,889 | 9,254 | |||||||||||
Amortization of purchased intangible assets |
358 | 383 | 1,196 | 1,060 | |||||||||||
Restructuring charges |
150 | 598 | 466 | 909 | |||||||||||
Acquisition-related charges |
18 | 127 | 68 | 242 | |||||||||||
Total operating expenses |
28,669 | 28,406 | 86,241 | 84,571 | |||||||||||
Earnings from operations |
2,520 | 2,323 | 8,882 | 8,184 | |||||||||||
Interest and other, net |
(121 | ) | (134 | ) | (294 | ) | (424 | ) | |||||||
Earnings before taxes |
2,399 | 2,189 | 8,588 | 7,760 | |||||||||||
Provision for taxes |
473 | 416 | 1,753 | 1,537 | |||||||||||
Net earnings |
$ | 1,926 | $ | 1,773 | $ | 6,835 | $ | 6,223 | |||||||
Net earnings per share: |
|||||||||||||||
Basic |
$ | 0.94 | $ | 0.76 | $ | 3.21 | $ | 2.66 | |||||||
Diluted |
$ | 0.93 | $ | 0.75 | $ | 3.16 | $ | 2.60 | |||||||
Cash dividends declared per share |
$ | 0.24 | $ | 0.16 | $ | 0.40 | $ | 0.32 | |||||||
Weighted-average shares used to compute net earnings per share: |
|||||||||||||||
Basic |
2,054 | 2,322 | 2,129 | 2,342 | |||||||||||
Diluted |
2,080 | 2,376 | 2,161 | 2,398 | |||||||||||
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.
4
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
|
July 31, 2011 |
October 31, 2010 |
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In millions, except par value |
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(Unaudited) |
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ASSETS |
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Current assets: |
|||||||||
Cash and cash equivalents |
$ | 12,953 | $ | 10,929 | |||||
Accounts receivable |
18,121 | 18,481 | |||||||
Financing receivables |
3,167 | 2,986 | |||||||
Inventory |
7,427 | 6,466 | |||||||
Other current assets |
14,611 | 15,322 | |||||||
Total current assets |
56,279 | 54,184 | |||||||
Property, plant and equipment |
11,959 | 11,763 | |||||||
Long-term financing receivables and other assets |
11,178 | 12,225 | |||||||
Goodwill |
38,772 | 38,483 | |||||||
Purchased intangible assets |
6,729 | 7,848 | |||||||
Total assets |
$ | 124,917 | $ | 124,503 | |||||
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Current liabilities: |
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Notes payable and short-term borrowings |
$ | 6,666 | $ | 7,046 | |||||
Accounts payable |
14,489 | 14,365 | |||||||
Employee compensation and benefits |
3,728 | 4,256 | |||||||
Taxes on earnings |
788 | 802 | |||||||
Deferred revenue |
7,390 | 6,727 | |||||||
Accrued restructuring |
763 | 911 | |||||||
Other accrued liabilities |
15,114 | 15,296 | |||||||
Total current liabilities |
48,938 | 49,403 | |||||||
Long-term debt |
19,030 | 15,258 | |||||||
Other liabilities |
17,731 | 19,061 | |||||||
Commitments and contingencies |
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Stockholders' equity: |
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HP stockholders' equity |
|||||||||
Preferred stock, $0.01 par value (300 shares authorized; none issued) |
| | |||||||
Common stock, $0.01 par value (9,600 shares authorized; 2,002 and 2,204 shares issued and outstanding, respectively) |
20 | 22 | |||||||
Additional paid-in capital |
6,978 | 11,569 | |||||||
Retained earnings |
35,099 | 32,695 | |||||||
Accumulated other comprehensive loss |
(3,274 | ) | (3,837 | ) | |||||
Total HP stockholders' equity |
38,823 | 40,449 | |||||||
Noncontrolling interests |
395 | 332 | |||||||
Total stockholders' equity |
39,218 | 40,781 | |||||||
Total liabilities and stockholders' equity |
$ | 124,917 | $ | 124,503 | |||||
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.
5
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Consolidated Condensed Statements of Cash Flows
(Unaudited)
|
Nine months ended July 31 | ||||||||||
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2011 | 2010 | |||||||||
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In millions |
||||||||||
Cash flows from operating activities: |
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Net earnings |
$ | 6,835 | $ | 6,223 | |||||||
Adjustments to reconcile net earnings to net cash provided by operating activities: |
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Depreciation and amortization |
3,722 | 3,556 | |||||||||
Stock-based compensation expense |
475 | 547 | |||||||||
Provision for doubtful accountsaccounts and financing receivables |
41 | 122 | |||||||||
Provision for inventory |
167 | 127 | |||||||||
Restructuring charges |
466 | 909 | |||||||||
Deferred taxes on earnings |
804 | (191 | ) | ||||||||
Excess tax benefit from stock-based compensation |
(160 | ) | (283 | ) | |||||||
Other, net |
(202 | ) | 193 | ||||||||
Changes in operating assets and liabilities: |
|||||||||||
Accounts and financing receivables |
(220 | ) | 845 | ||||||||
Inventory |
(1,139 | ) | (981 | ) | |||||||
Accounts payable |
122 | (128 | ) | ||||||||
Taxes on earnings |
251 | 641 | |||||||||
Restructuring |
(750 | ) | (1,053 | ) | |||||||
Other assets and liabilities |
(173 | ) | (1,756 | ) | |||||||
Net cash provided by operating activities |
10,239 | 8,771 | |||||||||
Cash flows from investing activities: |
|||||||||||
Investment in property, plant and equipment |
(3,154 | ) | (2,901 | ) | |||||||
Proceeds from sale of property, plant and equipment |
782 | 353 | |||||||||
Purchases of available-for-sale securities and other investments |
| (50 | ) | ||||||||
Maturities and sales of available-for-sale securities and other investments |
59 | 197 | |||||||||
Payments made in connection with business acquisitions, net of cash acquired |
(269 | ) | (4,017 | ) | |||||||
Proceeds from business divestiture, net |
89 | 125 | |||||||||
Net cash used in investing activities |
(2,493 | ) | (6,293 | ) | |||||||
Cash flows from financing activities: |
|||||||||||
(Payments) issuance of commercial paper and notes payable, net |
(1,532 | ) | 4,993 | ||||||||
Issuance of debt |
7,298 | 121 | |||||||||
Payment of debt |
(2,271 | ) | (1,274 | ) | |||||||
Issuance of common stock under employee stock plans |
845 | 2,507 | |||||||||
Repurchase of common stock |
(9,617 | ) | (7,079 | ) | |||||||
Excess tax benefit from stock-based compensation |
160 | 283 | |||||||||
Dividends |
(605 | ) | (590 | ) | |||||||
Net cash used in financing activities |
(5,722 | ) | (1,039 | ) | |||||||
Increase in cash and cash equivalents |
2,024 | 1,439 | |||||||||
Cash and cash equivalents at beginning of period |
10,929 | 13,279 | |||||||||
Cash and cash equivalents at end of period |
$ | 12,953 | $ | 14,718 | |||||||
Supplemental schedule of non-cash investing and financing activities: |
|||||||||||
Issuance of common stock and stock awards assumed in business acquisitions |
$ | 2 | $ | 62 | |||||||
Purchase of assets under capital lease |
$ | 9 | $ | 105 |
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.
6
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 1: Basis of Presentation
In the opinion of management, the accompanying Consolidated Condensed Financial Statements of Hewlett-Packard Company and its consolidated subsidiaries ("HP") contain all adjustments, including normal recurring adjustments, necessary to present fairly HP's financial position as of July 31, 2011, its results of operations for the three and nine months ended July 31, 2011 and 2010 and its cash flows for the nine months ended July 31, 2011 and 2010. The Consolidated Condensed Balance Sheet as of October 31, 2010 is derived from the October 31, 2010 audited consolidated financial statements.
The results of operations for the three and nine months ended July 31, 2011 are not necessarily indicative of the results to be expected for the full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with "Risk Factors," "Legal Proceedings," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk" and the Consolidated Financial Statements and notes thereto included in Items 1A, 3, 7, 7A and 8, respectively, of the Hewlett-Packard Company Annual Report on Form 10-K for the fiscal year ended October 31, 2010.
The preparation of financial statements in accordance with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the amounts reported in HP's Consolidated Condensed Financial Statements and accompanying notes. Actual results could differ materially from those estimates.
Reclassifications and Segment Reorganization
In connection with organizational realignments implemented in the first quarter of fiscal 2011, certain costs previously reported as Cost of services have been reclassified as Selling, general and administrative expenses to better align those costs with the functional areas that benefit from those expenditures. HP has made certain segment and business unit realignments in order to optimize its operating structure. Reclassifications of prior year financial information have been made to conform to the current year presentation. None of the changes impacts HP's previously reported consolidated net revenue, earnings from operations, net earnings or net earnings per share. See Note 16 for a further discussion of HP's segment reorganization.
Note 2: Stock-Based Compensation
HP's stock-based compensation plans include HP's principal equity plans as well as various equity plans assumed through acquisitions. HP's principal equity plans include performance-based restricted units ("PRU"), stock options and restricted stock awards.
Total stock-based compensation expense before income taxes for the three and nine months ended July 31, 2011 was $148 million and $475 million, respectively. The resulting income tax benefit for the three and nine months ended July 31, 2011 was $46 million and $150 million, respectively. Total stock-based compensation expense before income taxes for the three and nine months ended July 31, 2010 was $166 million and $547 million, respectively. The resulting income tax benefit for the three and nine months ended July 31, 2010 was $54 million and $176 million, respectively.
7
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 2: Stock-Based Compensation (Continued)
Performance-based Restricted Units
HP's PRU program provides for the issuance of PRUs representing hypothetical shares of HP common stock. Each PRU award reflects a target number of shares ("Target Shares") that may be issued to the award recipient before adjusting for performance and market conditions. The actual number of shares the recipient receives is determined at the end of a three-year performance period based on results achieved versus company performance goals and may range from 0% to 200% of the Target Shares granted. The performance goals are based on HP's annual cash flow from operations as a percentage of revenue and a market condition based on total shareholder return ("TSR") relative to the S&P 500 over the three-year performance period.
Recipients of PRU awards generally must remain employed by HP on a continuous basis through the end of the applicable three-year performance period in order to receive any portion of the shares subject to that award. Target Shares do not have dividend equivalent rights and do not have the voting rights of common stock until earned and issued following the end of the applicable performance period. The expense for these awards, net of estimated forfeitures, is recorded over the requisite service period based on the number of Target Shares that are expected to be earned and the achievement of the cash flow goals during the performance period.
HP estimates the fair value of a Target Share using a Monte Carlo simulation model, as the TSR modifier contains a market condition. The following weighted-average assumptions, in addition to projections of market conditions, were used to determine the weighted-average fair values of the PRU awards:
|
Nine months ended July 31 |
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|
2011 | 2010 | |||||
Weighted-average fair value of grants per share |
$ | 27.59 | (1) | $ | 57.13 | (2) | |
Expected volatility(3) |
30 | % | 38 | % | |||
Risk-free interest rate |
0.38 | % | 0.73 | % | |||
Dividend yield |
0.75 | % | 0.64 | % | |||
Expected life in months |
19 | 22 |
8
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 2: Stock-Based Compensation (Continued)
period applicable to PRUs granted in fiscal 2009 and for the first year of the three-year performance period applicable to PRUs granted in the nine months ended July 31, 2010.
Non-vested PRUs as of July 31, 2011 and changes during the nine months ended July 31, 2011 were as follows:
|
Shares (in thousands) |
|||
---|---|---|---|---|
Outstanding Target Shares at October 31, 2010 |
18,508 | |||
Granted |
5,950 | |||
Vested |
| |||
Change in units due to performance and market conditions achievement for PRUs vested in the period |
| |||
Forfeited |
(1,637 | ) | ||
Outstanding Target Shares at July 31, 2011 |
22,821 | |||
Outstanding Target Shares assigned a fair value at July 31, 2011 |
17,098 | (1) | ||
At July 31, 2011, there was $177 million of unrecognized pre-tax stock-based compensation expense related to PRUs with an assigned fair value, which HP expects to recognize over the remaining weighted-average vesting period of 1.2 years.
Stock Options
HP estimated the weighted-average fair value of stock options using the Black-Scholes option pricing model with the following weighted-average assumptions:
|
Three months ended July 31 |
Nine months ended July 31 |
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|
2011 | 2010 | 2011 | 2010 | |||||||||
Weighted-average fair value of grants per share(1) |
$ | 8.44 | $ | 13.66 | $ | 10.24 | $ | 14.04 | |||||
Implied volatility |
28 | % | 32 | % | 28 | % | 29 | % | |||||
Risk-free interest rate |
1.64 | % | 1.96 | % | 1.87 | % | 2.29 | % | |||||
Dividend yield |
1.34 | % | 0.69 | % | 0.94 | % | 0.64 | % | |||||
Expected life in months |
61 | 60 | 60 | 61 |
9
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 2: Stock-Based Compensation (Continued)
Option activity as of July 31, 2011 and changes during the nine months ended July 31, 2011 were as follows:
|
Shares (in thousands) |
Weighted- Average Exercise Price Per Share |
Weighted- Average Remaining Contractual Term (in years) |
Aggregate Intrinsic Value (in millions) |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding at October 31, 2010 |
142,916 | $ | 28 | ||||||||||
Granted and assumed through acquisition |
1,243 | $ | 24 | ||||||||||
Exercised |
(33,736 | ) | $ | 24 | |||||||||
Forfeited/cancelled/expired |
(3,311 | ) | $ | 41 | |||||||||
Outstanding at July 31, 2011 |
107,112 | $ | 29 | 2.5 | $ | 961 | |||||||
Vested and expected to vest at July 31, 2011 |
106,145 | $ | 29 | 2.5 | $ | 951 | |||||||
Exercisable at July 31, 2011 |
100,333 | $ | 29 | 2.1 | $ | 890 | |||||||
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that option holders would have received had all option holders exercised their options on July 31, 2011. The aggregate intrinsic value is the difference between HP's closing stock price on the last trading day of the third quarter of fiscal 2011 and the exercise price, multiplied by the number of in-the-money options. Total intrinsic value of options exercised for the three and nine months ended July 31, 2011 was $42 million and $648 million, respectively.
At July 31, 2011, there was $188 million of unrecognized pre-tax stock-based compensation expense related to stock options, which HP expects to recognize over the remaining weighted-average vesting period of 1.8 years.
Restricted Stock Awards
Restricted stock awards are non-vested stock awards that include grants of restricted stock and grants of restricted stock units.
10
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 2: Stock-Based Compensation (Continued)
Non-vested restricted stock awards as of July 31, 2011 and changes during the nine months ended July 31, 2011 were as follows:
|
Shares (in thousands) |
Weighted- Average Grant Date Fair Value Per Share |
|||||
---|---|---|---|---|---|---|---|
Outstanding at October 31, 2010 |
5,848 | $ | 45 | ||||
Granted |
9,156 | $ | 41 | ||||
Vested |
(2,870 | ) | $ | 45 | |||
Forfeited |
(651 | ) | $ | 44 | |||
Outstanding at July 31, 2011 |
11,483 | $ | 42 | ||||
At July 31, 2011, there was $367 million of unrecognized pre-tax stock-based compensation expense related to non-vested restricted stock awards, which HP expects to recognize over the remaining weighted-average vesting period of 1.6 years.
Note 3: Net Earnings Per Share
HP calculates basic earnings per share ("EPS") using net earnings and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes any dilutive effect of outstanding stock options, PRUs, restricted stock units and restricted stock.
The reconciliation of the numerators and denominators of the basic and diluted EPS calculations was as follows:
|
Three months ended July 31 |
Nine months ended July 31 |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2011 | 2010 | 2011 | 2010 | ||||||||||
|
In millions, except per share amounts |
|||||||||||||
Numerator: |
||||||||||||||
Net earnings(1) |
$ | 1,926 | $ | 1,773 | $ | 6,835 | $ | 6,223 | ||||||
Denominator: |
||||||||||||||
Weighted-average shares used to compute basic EPS |
2,054 | 2,322 | 2,129 | 2,342 | ||||||||||
Dilutive effect of employee stock plans |
26 | 54 | 32 | 56 | ||||||||||
Weighted-average shares used to compute diluted EPS |
2,080 | 2,376 | 2,161 | 2,398 | ||||||||||
Net earnings per share: |
||||||||||||||
Basic |
$ | 0.94 | $ | 0.76 | $ | 3.21 | $ | 2.66 | ||||||
Diluted |
$ | 0.93 | $ | 0.75 | $ | 3.16 | $ | 2.60 |
11
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 3: Net Earnings Per Share (Continued)
HP excludes options with exercise prices that are greater than the average market price for HP's common stock from the calculation of diluted EPS because their effect would be anti-dilutive. For the three and nine months ended July 31, 2011, HP excluded from the calculation of diluted EPS options to purchase 26 million shares and 23 million shares, respectively, compared to 8 million shares and 5 million shares for the three and nine months ended July 31, 2010, respectively.
In addition, HP also excludes options whose combined exercise price, unamortized fair value and excess tax benefits are greater than the average market price for HP's common stock because their effect would be anti-dilutive. For the three and nine months ended July 31, 2011, HP excluded from the calculation of diluted EPS options to purchase an additional 1 million shares, compared to an additional 2 million shares and 3 million shares for the three and nine months ended July 31, 2010, respectively.
Note 4: Balance Sheet Details
Balance sheet details were as follows:
Accounts and Financing Receivables
|
July 31, 2011 | October 31, 2010 | |||||
---|---|---|---|---|---|---|---|
|
In millions |
||||||
Accounts receivable |
$ | 18,561 | $ | 19,006 | |||
Allowance for doubtful accounts |
(440 | ) | (525 | ) | |||
|
$ | 18,121 | $ | 18,481 | |||
Financing receivables |
$ | 3,227 | $ | 3,050 | |||
Allowance for doubtful accounts |
(60 | ) | (64 | ) | |||
|
$ | 3,167 | $ | 2,986 | |||
HP has revolving trade receivables-based facilities permitting it to sell certain trade receivables to third parties. In accordance with the accounting requirements under the Accounting Standards Codification relating to "Transfers and Servicing," trade receivables are derecognized from the consolidated balance sheet when sold to third parties. The total aggregate capacity of the facilities was $1.5 billion as of July 31, 2011, including a $1 billion partial recourse facility entered into in May 2011 and an aggregate capacity of $0.5 billion in non-recourse facilities. The recourse obligation is measured using market data from similar transactions and reported as a current liability in the consolidated balance sheet. The recourse obligation as of July 31, 2011 was not material. The total aggregate capacity of the facilities was $524 million as of October 31, 2010.
For the first nine months of fiscal 2011 and 2010, trade receivables sold under these facilities were $1.8 billion and $1.3 billion, respectively, which approximates the amount of cash received. The resulting losses on the sales of trade accounts receivable for the three months and nine months ended July 31, 2011, were not material. HP had $780 million as of July 31, 2011 and $175 million as of October 31, 2010 available under these programs.
12
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 4: Balance Sheet Details (Continued)
Inventory
|
July 31, 2011 |
October 31, 2010 |
|||||
---|---|---|---|---|---|---|---|
|
In millions |
||||||
Finished goods |
$ | 4,820 | $ | 4,431 | |||
Purchased parts and fabricated assemblies |
2,607 | 2,035 | |||||
|
$ | 7,427 | $ | 6,466 | |||
Property, Plant and Equipment
|
July 31, 2011 |
October 31, 2010 |
|||||
---|---|---|---|---|---|---|---|
|
In millions |
||||||
Land |
$ | 651 | $ | 530 | |||
Buildings and leasehold improvements |
8,497 | 8,523 | |||||
Machinery and equipment |
15,922 | 13,874 | |||||
|
25,070 | 22,927 | |||||
Accumulated depreciation |
(13,111 | ) | (11,164 | ) | |||
|
$ | 11,959 | $ | 11,763 | |||
Note 5: Goodwill and Purchased Intangible Assets
Goodwill
Goodwill allocated to HP's business segments as of July 31, 2011 and changes in the carrying amount of goodwill for the nine months ended July 31, 2011 are as follows:
|
Services | Enterprise Servers, Storage and Networking |
HP Software |
Personal Systems Group |
Imaging and Printing Group |
HP Financial Services |
Corporate Investments |
Total | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
In millions |
||||||||||||||||||||||||
Balance at October 31, 2010 |
$ | 16,967 | $ | 6,610 | $ | 7,545 | $ | 2,500 | $ | 2,456 | $ | 144 | $ | 2,261 | $ | 38,483 | |||||||||
Goodwill acquired during the period |
| | 190 | | 16 | | | 206 | |||||||||||||||||
Goodwill adjustments |
267 | 1,504 | (261 | ) | (2 | ) | (1 | ) | | (1,424 | ) | 83 | |||||||||||||
Balance at July 31, 2011 |
$ | 17,234 | $ | 8,114 | $ | 7,474 | $ | 2,498 | $ | 2,471 | $ | 144 | $ | 837 | $ | 38,772 | |||||||||
During the first nine months of fiscal 2011, HP recorded approximately $206 million of goodwill relating to the acquisition of Vertica Systems, Inc. ("Vertica") and the acquisition of assets of Printelligent Corporation ("Printelligent") based on preliminary allocations of the purchase prices. In connection with organizational realignments implemented in the first quarter of fiscal 2011, HP reclassified goodwill related to HP's networking business from Corporate Investments to Enterprise
13
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 5: Goodwill and Purchased Intangible Assets (Continued)
Servers, Storage and Networking ("ESSN") and goodwill related to the communications and media solutions business from HP Software to Services. Additionally, during the nine months ended July 31, 2011, HP recorded an increase to goodwill as a result of currency translation related to an acquired subsidiary whose functional currency is not the U.S. dollar.
Purchased Intangible Assets
HP's purchased intangible assets associated with completed acquisitions are composed of:
|
July 31, 2011 | October 31, 2010 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross | Accumulated Amortization |
Net | Gross | Accumulated Amortization |
Net | |||||||||||||
|
In millions |
||||||||||||||||||
Customer contracts, customer lists and distribution agreements |
$ | 5,242 | $ | (2,205 | ) | $ | 3,037 | $ | 7,075 | $ | (3,436 | ) | $ | 3,639 | |||||
Developed and core technology and patents |
3,929 | (1,882 | ) | 2,047 | 3,797 | (1,418 | ) | 2,379 | |||||||||||
Product trademarks |
200 | (119 | ) | 81 | 199 | (92 | ) | 107 | |||||||||||
Total amortizable purchased intangible assets |
9,371 | (4,206 | ) | 5,165 | 11,071 | (4,946 | ) | 6,125 | |||||||||||
In-process research and development |
142 | | 142 | 301 | | 301 | |||||||||||||
Compaq trade name |
1,422 | | 1,422 | 1,422 | | 1,422 | |||||||||||||
Total purchased intangible assets |
$ | 10,935 | $ | (4,206 | ) | $ | 6,729 | $ | 12,794 | $ | (4,946 | ) | $ | 7,848 | |||||
During the first nine months of fiscal 2011, HP recorded approximately $58 million of purchased intangible assets related to the Vertica and Printelligent acquisitions based on preliminary allocations of the purchase price. During the nine months ended July 31, 2011 and the fiscal year ended October 31, 2010, $4.5 billion and $2.5 billion, respectively, of intangible assets reached the end of their amortization periods. The tables above reflect the elimination of the cost and accumulated amortization of such assets.
Estimated future amortization expense related to finite-lived purchased intangible assets at July 31, 2011 was as follows:
Fiscal year:
|
In millions | |||
---|---|---|---|---|
2011 (remaining three months) |
$ | 355 | ||
2012 |
1,328 | |||
2013 |
1,175 | |||
2014 |
852 | |||
2015 |
715 | |||
2016 |
554 | |||
Thereafter |
186 | |||
Total |
$ | 5,165 | ||
14
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 6: Restructuring Charges
HP records restructuring charges associated with management-approved restructuring plans to either reorganize one or more of HP's business segments, or to remove duplicative headcount and infrastructure associated with one or more business acquisitions. Restructuring charges can include severance costs to eliminate a specified number of employees, infrastructure charges to vacate facilities and consolidate operations, and contract cancellation costs. Restructuring charges are recorded based upon planned employee termination dates and site closure and consolidation plans. The timing of associated cash payments is dependent upon the type of restructuring charge and can extend over a multi-year period. HP records the short-term portion of the restructuring liability in Accrued restructuring and the long-term portion in Other liabilities in the Consolidated Condensed Balance Sheets.
Fiscal 2010 Acquisitions
In connection with the acquisitions of Palm, Inc ("Palm") and 3Com Corporation ("3Com") in fiscal 2010, HP's management approved and initiated plans to restructure the operations of the acquired companies, including severance for employees, contract cancellation costs, costs to vacate duplicative facilities and other items. The total expected combined cost of the plans is $88 million. As of July 31, 2011, HP had recorded the majority of the remaining costs of the plans based upon the anticipated timing of planned terminations and facility closure costs. With respect to the Palm integration plan, no further restructuring charges are anticipated, and the majority of the remaining costs have been paid out. However, as disclosed in Note 17, HP expects to incur additional restructuring and related shutdown costs in the fourth quarter of fiscal 2011 in connection with its August 2011 decision to discontinue the manufacture and sale of WebOS hardware products. The remaining costs pertaining to the 3Com integration plan are expected to be paid out through fiscal 2016 as fixed lease payments are made.
Fiscal 2010 ES Restructuring Plan
On June 1, 2010, HP's management announced a plan to restructure its Enterprise Services business, which includes its Infrastructure Technology Outsourcing, Business Process Outsourcing and Application Services business units. The multi-year restructuring program includes plans to consolidate commercial data centers, tools and applications. The total expected cost of the plan that will be recorded as restructuring charges is approximately $1 billion, including severance costs to eliminate approximately 9,000 positions and infrastructure charges. HP recorded net restructuring charges of $23 million and $183 million, for the three and nine months ended July 31, 2011. As of July 31, 2011, HP had recorded the majority of the severance costs. HP expects to record the majority of the infrastructure charges through fiscal 2012. The timing of the charges is based upon planned termination dates, site closure and consolidation plans. The majority of the associated cash payments are expected to be paid out through the second quarter of fiscal 2012. As of July 31, 2011, approximately 5,200 positions had been eliminated.
Fiscal 2009 Restructuring Plan
In May 2009, HP's management approved and initiated a restructuring plan to structurally change and improve the effectiveness of the Imaging and Printing Group ("IPG"), Personal Systems Group ("PSG") and ESSN businesses. The total expected cost of the plan is $292 million in severance-related
15
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 6: Restructuring Charges (Continued)
costs associated with the planned elimination of approximately 4,400 positions. As of July 31, 2011, all planned eliminations had occurred and the majority of the restructuring costs had been paid out.
Fiscal 2008 HP/EDS Restructuring Plan
In connection with the acquisition of Electronic Data Systems Corporation ("EDS") on August 26, 2008, HP's management approved and initiated a restructuring plan to combine and align HP's services businesses, eliminate duplicative overhead functions and consolidate and vacate duplicative facilities. The restructuring plan is expected to be implemented over four years from the acquisition date at a total expected cost of $3.4 billion.
The restructuring plan includes severance costs to eliminate approximately 25,000 positions. As of July 31, 2011, all planned eliminations had occurred and the vast majority of the associated severance costs had been paid out. The infrastructure charges in the restructuring plan include facility closure and consolidation costs and the costs associated with early termination of certain contractual obligations. HP expects to record the majority of these costs through fiscal 2011 based upon the execution of site closure and consolidation plans. The associated cash payments are expected to be paid out through fiscal 2016 as fixed lease payments are made.
Approximately $1.5 billion of the expected costs were associated with pre-acquisition EDS and were reflected in the purchase price of EDS. These costs are subject to change based on the actual costs incurred. The remaining costs are primarily associated with HP and will be recorded as a restructuring charge.
Summary of Restructuring Plans
The adjustments to the accrued restructuring expenses related to all of HP's restructuring plans described above for the nine months ended July 31, 2011 were as follows:
|
|
Three months ended July 31, 2011 charges (reversals) |
Nine months ended July 31, 2011 charges |
|
|
|
As of July 31, 2011 | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Balance, October 31, 2010 |
Cash payments |
Non-cash settlements and other adjustments |
Balance, July 31, 2011 |
Total costs and adjustments to date |
Total expected costs and adjustments |
||||||||||||||||||||
|
In millions |
|||||||||||||||||||||||||
Fiscal 2010 acquisitions |
$ | 44 | $ | 1 | $ | 17 | $ | (25 | ) | $ | (1 | ) | $ | 35 | $ | 81 | $ | 88 | ||||||||
Fiscal 2010 ES Plan: |
||||||||||||||||||||||||||
Severance |
$ | 620 | $ | (26 | ) | $ | 92 | $ | (192 | ) | $ | 27 | $ | 547 | $ | 722 | $ | 724 | ||||||||
Infrastructure |
4 | 49 | 91 | (87 | ) | (4 | ) | 4 | 111 | 268 | ||||||||||||||||
Total ES Plan |
$ | 624 | $ | 23 | $ | 183 | $ | (279 | ) | $ | 23 | $ | 551 | $ | 833 | $ | 992 | |||||||||
Fiscal 2009 Plan |
$ | 57 | $ | | $ | | $ | (49 | ) | $ | (5 | ) | $ | 3 | $ | 292 | $ | 292 | ||||||||
Fiscal 2008 HP/EDS Plan: |
||||||||||||||||||||||||||
Severance |
$ | 75 | $ | 16 | $ | 39 | $ | (100 | ) | $ | (11 | ) | $ | 3 | $ | 2,185 | $ | 2,185 | ||||||||
Infrastructure |
408 | 110 | 227 | (297 | ) | 11 | 349 | 920 | 1,225 | |||||||||||||||||
Total HP/EDS Plan |
$ | 483 | $ | 126 | $ | 266 | $ | (397 | ) | $ | | $ | 352 | $ | 3,105 | $ | 3,410 | |||||||||
Total restructuring plans |
$ | 1,208 | $ | 150 | $ | 466 | $ | (750 | ) | $ | 17 | $ | 941 | $ | 4,311 | $ | 4,782 | |||||||||
16
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 6: Restructuring Charges (Continued)
At July 31, 2011 and October 31, 2010, HP included the long-term portion of the restructuring liability of $177 million and $297 million, respectively, in Other liabilities, and the short-term portion in Accrued restructuring in the accompanying Consolidated Condensed Balance Sheets.
Note 7: Fair Value
HP determines fair value based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants.
Valuation techniques used by HP are based upon observable and unobservable inputs. Observable or market inputs reflect market data obtained from independent sources, while unobservable inputs reflect HP's assumptions about market participant assumptions based on best information available. Observable inputs are the preferred source of values. These two types of inputs create the following fair value hierarchy:
Level 1Quoted prices (unadjusted) for identical instruments in active markets.
Level 2Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3Prices or valuations that require management inputs that are both significant to the fair value measurement and unobservable.
The following section describes the valuation methodologies HP uses to measure its financial assets and liabilities at fair value.
Cash Equivalents and Investments: HP holds time deposits, money market funds, commercial paper, other debt securities primarily consisting of corporate and foreign government notes and bonds, and common stock and equivalents. Where applicable, HP uses quoted prices in active markets for identical assets to determine fair value. If quoted prices in active markets for identical assets are not available to determine fair value, HP uses quoted prices for similar assets and liabilities or inputs that are observable either directly or indirectly. If quoted prices for identical or similar assets are not available, HP uses internally developed valuation models, whose inputs include bid prices, and third-party valuations utilizing underlying assets assumptions.
Derivative Instruments: As discussed in Note 8, HP mainly holds non-speculative forwards, swaps and options to hedge certain foreign currency and interest rate exposures. When active market quotes are not available, HP uses industry standard valuation models. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit risk, foreign exchange rates, and forward and spot prices for currencies. In certain cases, market-based observable inputs are not available and, in those cases, HP uses management judgment to develop assumptions which are used to determine fair value.
17
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 7: Fair Value (Continued)
The following table presents HP's assets and liabilities that are measured at fair value on a recurring basis:
|
As of July 31, 2011 | As of October 31, 2010 | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Fair Value Measured Using |
|
Fair Value Measured Using |
|
|||||||||||||||||||||||
|
Total Balance |
Total Balance |
|||||||||||||||||||||||||
|
Level 1 | Level 2 | Level 3 | Level 1 | Level 2 | Level 3 | |||||||||||||||||||||
|
In millions |
||||||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||
Time deposits |
$ | | $ | 8,307 | $ | | $ | 8,307 | $ | | $ | 6,598 | $ | | $ | 6,598 | |||||||||||
Commercial paper |
| 450 | | 450 | | | | | |||||||||||||||||||
Money market funds |
897 | | | 897 | 971 | | | 971 | |||||||||||||||||||
Marketable equity securities |
8 | 3 | | 11 | 11 | 3 | | 14 | |||||||||||||||||||
Foreign bonds |
8 | 385 | | 393 | 8 | 365 | | 373 | |||||||||||||||||||
Corporate bonds and other debt securities |
3 | 2 | 49 | 54 | 3 | 6 | 50 | 59 | |||||||||||||||||||
Derivatives: |
|||||||||||||||||||||||||||
Interest rate contracts |
| 581 | | 581 | | 735 | | 735 | |||||||||||||||||||
Foreign exchange contracts |
| 90 | 37 | 127 | | 150 | 32 | 182 | |||||||||||||||||||
Other derivatives |
| 2 | 5 | 7 | | 5 | 6 | 11 | |||||||||||||||||||
Total Assets |
$ | 916 | $ | 9,820 | $ | 91 | $ | 10,827 | $ | 993 | $ | 7,862 | $ | 88 | $ | 8,943 | |||||||||||
Liabilities |
|||||||||||||||||||||||||||
Derivatives: |
|||||||||||||||||||||||||||
Interest rate contracts |
$ | | $ | 67 | $ | | $ | 67 | $ | | $ | 89 | $ | | $ | 89 | |||||||||||
Foreign exchange contracts |
| 1,013 | 17 | 1,030 | | 880 | 10 | 890 | |||||||||||||||||||
Other derivatives |
| 9 | | 9 | | | | | |||||||||||||||||||
Total Liabilities |
$ | | $ | 1,089 | $ | 17 | $ | 1,106 | $ | | $ | 969 | $ | 10 | $ | 979 | |||||||||||
18
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments
Cash Equivalents and Available-for-Sale Investments
Cash equivalents and available-for-sale investments at fair value as of July 31, 2011 and October 31, 2010 were as follows:
|
July 31, 2011 | October 31, 2010 | ||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Cost | Gross Unrealized Gain |
Gross Unrealized Loss |
Estimated Fair Value |
Cost | Gross Unrealized Gain |
Gross Unrealized Loss |
Estimated Fair Value |
||||||||||||||||||
|
In millions |
|||||||||||||||||||||||||
Cash Equivalents |
||||||||||||||||||||||||||
Time deposits |
$ | 8,299 | $ | | $ | | $ | 8,299 | $ | 6,590 | $ | | $ | | $ | 6,590 | ||||||||||
Commercial paper |
450 | | | 450 | | | | | ||||||||||||||||||
Money market funds |
897 | | | 897 | 971 | | | 971 | ||||||||||||||||||
Total cash equivalents |
9,646 | | | 9,646 | 7,561 | | | 7,561 | ||||||||||||||||||
Available-for-Sale Investments |
||||||||||||||||||||||||||
Debt securities: |
||||||||||||||||||||||||||
Time deposits |
8 | | | 8 | 8 | | | 8 | ||||||||||||||||||
Foreign bonds |
326 | 67 | | 393 | 315 | 58 | | 373 | ||||||||||||||||||
Corporate bonds and other debt securities |
76 | | (22 | ) | 54 | 89 | | (30 | ) | 59 | ||||||||||||||||
Total debt securities |
410 | 67 | (22 | ) | 455 | 412 | 58 | (30 | ) | 440 | ||||||||||||||||
Equity securities in public companies |
3 | 3 | | 6 | 5 | 4 | | 9 | ||||||||||||||||||
Total cash equivalents and available-for-sale investments |
$ | 10,059 | $ | 70 | $ | (22 | ) | $ | 10,107 | $ | 7,978 | $ | 62 | $ | (30 | ) | $ | 8,010 | ||||||||
Cash equivalents consist of investments in time deposits, commercial paper and money market funds with original maturities of ninety days or less. Time deposits were primarily issued by institutions outside the U.S. as of July 31, 2011 and October 31, 2010. Available-for-sale securities consist of short-term investments which mature within twelve months or less and long-term investments with maturities longer than twelve months. Investments include primarily time deposits, fixed-interest securities, and institutional bonds. HP estimates the fair values of its investments based on quoted market prices or pricing models using current market rates. These estimated fair values may not be representative of actual values that will be realized in the future.
The gross unrealized loss as of July 31, 2011 was due primarily to declines in certain debt securities and included $22 million that has been in a continuous loss position for more than twelve months. The gross unrealized loss as of October 31, 2010 was due primarily to declines in the fair value of certain debt securities and included $28 million that has been in a continuous loss position for more than twelve months. HP does not intend to sell these debt securities, and it is not likely that HP will be required to sell these debt securities prior to the recovery of the amortized cost. In the three and nine months ended July 31, 2011, HP did not recognize any impairment charge associated with debt securities. In the three and nine months ended July 31, 2010, HP recognized an impairment charge of $6 million and $8 million, respectively, on total investments.
19
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments (Continued)
Contractual maturities of short-term and long-term investments in available-for-sale securities at July 31, 2011 were as follows:
|
Available-for-Sale Securities | ||||||
---|---|---|---|---|---|---|---|
|
July 31, 2011 | ||||||
|
Cost | Estimated Fair Value |
|||||
|
In millions |
||||||
Due in 1-5 years |
$ | 11 | $ | 11 | |||
Due in more than five years |
399 | 444 | |||||
|
$ | 410 | $ | 455 | |||
A summary of the carrying values and balance sheet classification of all short-term and long-term investments in debt and equity securities as of July 31, 2011 and October 31, 2010 was as follows:
|
July 31, 2011 |
October 31, 2010 |
||||||
---|---|---|---|---|---|---|---|---|
|
In millions |
|||||||
Available-for-sale debt securities |
$ | | $ | 5 | ||||
Included in Other current assets |
| 5 | ||||||
Available-for-sale debt securities |
455 | 435 | ||||||
Available-for-sale equity securities |
6 | 9 | ||||||
Equity securities in privately-held companies |
50 | 154 | ||||||
Other investments |
9 | 9 | ||||||
Included in long-term financing receivables and other assets |
520 | 607 | ||||||
Total investments |
$ | 520 | $ | 612 | ||||
Equity securities in privately held companies include cost basis and equity method investments. Other investments include marketable trading securities. HP includes gains or losses from changes in fair value of these securities, offset by losses or gains on the related liabilities, in Interest and other, net, in HP's Consolidated Condensed Statements of Earnings. The net impact associated with these securities was not material for the three and nine months ended July 31, 2011 and 2010.
Derivative Financial Instruments
HP is a global company that is exposed to foreign currency exchange rate fluctuations and interest rate changes in the normal course of its business. As part of its risk management strategy, HP uses derivative instruments, primarily forward contracts, option contracts, interest rate swaps, and total return swaps, to hedge certain foreign currency, interest rate and, to a lesser extent, equity exposures. HP's objective is to offset gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them, thereby reducing volatility of earnings or protecting fair values of assets and liabilities. HP does not have any leveraged derivatives and does not use derivative contracts for speculative purposes. HP designates its derivatives as fair value hedges, cash flow hedges
20
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments (Continued)
or hedges of the foreign currency exposure of a net investment in a foreign operation ("net investment hedges"). Additionally, for derivatives not designated as hedging instruments, HP categorizes those economic hedges as other derivatives. HP recognizes all derivatives, on a gross basis, in the Consolidated Condensed Balance Sheets at fair value and reports them in Other current assets, Long-term financing receivables and other assets, Other accrued liabilities, or Other liabilities. HP classifies cash flows from the derivative programs as operating activities in the Consolidated Condensed Statements of Cash Flows.
As a result of the use of derivative instruments, HP is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, HP has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors, and HP maintains dollar and term limits that correspond to each institution's credit rating. HP's established policies and procedures for mitigating credit risk on principal transactions and short-term cash include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties. Master agreements with counterparties include master netting arrangements as further mitigation of credit exposure to counterparties. These arrangements permit HP to net amounts due from HP to a counterparty with amounts due to HP from the same counterparty.
To further mitigate credit exposure to counterparties, HP may enter into collateral security arrangements with its counterparties. These arrangements require HP to post collateral or to hold collateral from counterparties when the derivative fair values exceed contractually established thresholds. As of July 31, 2011, the fair value of all derivative instruments under these collateralized arrangements were in a net asset position of approximately $50 million for which approximately $40 million of U.S. Treasury securities have been deposited to a third-party custodian by the counterparties.
Certain of HP's derivative instruments contain credit risk-related contingent features, such as provisions whereby HP and the counterparties to the derivative instruments could request collateralization on derivative instruments in net liability positions if HP's or the counterparties' credit ratings fall below certain thresholds. As of July 31, 2011 and 2010, HP was not required to post any collateral, and HP did not have any derivative instruments with credit risk-related contingent features that were in a significant net liability position.
Fair Value Hedges
HP enters into fair value hedges to reduce the exposure of its debt portfolio to interest rate risk. HP issues long-term debt in U.S. dollars based on market conditions at the time of financing. HP uses interest rate swaps to mitigate the market risk exposures in connection with the debt to achieve primarily U.S. dollar LIBOR-based floating interest expense. The swap transactions generally involve principal and interest obligations for U.S. dollar-denominated amounts. Alternatively, HP may choose not to swap fixed for floating interest payments or may terminate a previously executed swap if it believes a larger proportion of fixed-rate debt would be beneficial. When investing in fixed-rate instruments, HP may enter into interest rate swaps that convert the fixed interest returns into variable interest returns and would classify these swaps as fair value hedges. For derivative instruments that are designated and qualify as fair value hedges, HP recognizes the gain or loss on the derivative
21
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments (Continued)
instrument, as well as the offsetting loss or gain on the hedged item, in Interest and other, net in the Consolidated Condensed Statements of Earnings in the current period.
Cash Flow Hedges
HP uses a combination of forward contracts and options designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in its forecasted net revenue and, to a lesser extent, cost of sales, operating expense, and intercompany lease loan denominated in currencies other than the U.S. dollar. HP's foreign currency cash flow hedges mature generally within six to twelve months. However, certain leasing revenue-related forward contracts and intercompany lease loan forward contracts extend for the duration of the lease term, which can be up to five years. For derivative instruments that are designated and qualify as cash flow hedges, HP initially records the effective portion of the gain or loss on the derivative instrument in accumulated other comprehensive income or loss as a separate component of stockholders' equity and subsequently reclassifies these amounts into earnings in the period during which the hedged transaction is recognized in earnings. HP reports the effective portion of cash flow hedges in the same financial statement line item as the changes in value of the hedged item. During the three and nine months ended July 31, 2011 and 2010, HP did not discontinue any cash flow hedge for which it was probable that a forecasted transaction would not occur.
Net Investment Hedges
HP uses forward contracts designated as net investment hedges to hedge net investments in certain foreign subsidiaries whose functional currency is the local currency. These derivative instruments are designated as net investment hedges and, as such, HP records the effective portion of the gain or loss on the derivative instrument together with changes in the hedged items in cumulative translation adjustment as a separate component of stockholders' equity.
Other Derivatives
Other derivatives not designated as hedging instruments consist primarily of forward contracts HP uses to hedge foreign currency balance sheet exposures. HP also uses total return swaps and, to a lesser extent, interest rate swaps, based on the equity and fixed income indices, to hedge its executive deferred compensation plan liability. For derivative instruments not designated as hedging instruments, HP recognizes changes in the fair values in earnings in the period of change. HP recognizes the gain or loss on foreign currency forward contracts used to hedge balance sheet exposures in Interest and other, net in the same period as the remeasurement gain and loss of the related foreign currency denominated assets and liabilities. HP recognizes the gain or loss on the total return swaps and interest rate swaps in Interest and other, net in the same period as the gain or loss from the change in market value of the executive deferred compensation plan liability.
Hedge Effectiveness
For interest rate swaps designated as fair value hedges, HP measures effectiveness by offsetting the change in fair value of the hedged debt with the change in fair value of the derivative. For foreign currency options and forward contracts designated as cash flow or net investment hedges, HP measures
22
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments (Continued)
effectiveness by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item, both of which are based on forward rates. HP recognizes any ineffective portion of the hedge, as well as amounts not included in the assessment of effectiveness, in the Consolidated Condensed Statements of Earnings. As of July 31, 2011 and 2010, the portion of hedging instruments' gain or loss excluded from the assessment of effectiveness was not material for fair value, cash flow or net investment hedges. Hedge ineffectiveness for fair value, cash flow and net investment hedges was not material in the three and nine months ended July 31, 2011 and 2010.
Fair Value of Derivative Instruments in the Consolidated Condensed Balance Sheets
As discussed in Note 7, HP estimates the fair values of derivatives primarily based on pricing models using current market rates and records all derivatives on the balance sheet at fair value. The gross notional and fair value of derivative financial instruments in the Consolidated Condensed Balance Sheets were recorded as follows:
|
As of July 31, 2011 | As of October 31, 2010 | ||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Notional(1) |
Other Current Assets |
Long-term Financing Receivables and Other Assets |
Other Accrued Liabilities |
Other Liabilities |
Gross Notional(1) |
Other Current Assets |
Long-term Financing Receivables and Other Assets |
Other Accrued Liabilities |
Other Liabilities |
||||||||||||||||||||||
|
In millions |
|||||||||||||||||||||||||||||||
Derivatives designated as hedging instruments |
||||||||||||||||||||||||||||||||
Fair value hedges: |
||||||||||||||||||||||||||||||||
Interest rate contracts |
$ | 10,075 | $ | 41 | $ | 481 | $ | | $ | | $ | 8,575 | $ | | $ | 656 | $ | | $ | | ||||||||||||
Cash flow hedges: |
||||||||||||||||||||||||||||||||
Foreign exchange contracts |
16,327 | 80 | 4 | 485 | 169 | 16,862 | 98 | 20 | 503 | 83 | ||||||||||||||||||||||
Net investment hedges: |
||||||||||||||||||||||||||||||||
Foreign exchange contracts |
1,523 | | | 78 | 86 | 1,466 | 8 | 2 | 58 | 62 | ||||||||||||||||||||||
Total derivatives designated as hedging instruments |
27,925 | 121 | 485 | 563 | 255 | 26,903 | 106 | 678 | 561 | 145 | ||||||||||||||||||||||
Derivatives not designated as hedging instruments |
||||||||||||||||||||||||||||||||
Foreign exchange contracts |
10,563 | 38 | 5 | 167 | 45 | 13,701 | 51 | 3 | 129 | 55 | ||||||||||||||||||||||
Interest rate contracts(2) |
2,200 | | 59 | | 67 | 2,200 | | 79 | | 89 | ||||||||||||||||||||||
Other derivatives |
445 | 2 | 5 | 9 | | 397 | 5 | 6 | | | ||||||||||||||||||||||
Total derivatives not designated as hedging instruments |
13,208 | 40 | 69 | 176 | 112 | 16,298 | 56 | 88 | 129 | 144 | ||||||||||||||||||||||
Total derivatives |
$ | 41,133 | $ | 161 | $ | 554 | $ | 739 | $ | 367 | $ | 43,201 | $ | 162 | $ | 766 | $ | 690 | $ | 289 | ||||||||||||
23
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments (Continued)
Effect of Derivative Instruments on the Consolidated Condensed Statements of Earnings
The before-tax effect of a derivative instrument and related hedged item in a fair value hedging relationship for the three and nine months ended July 31, 2011 and 2010 were as follows:
|
Gain (Loss) Recognized in Income on Derivative and Related Hedged Item | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Derivative Instrument
|
Location | Three months ended July 31, 2011 |
Nine months ended July 31, 2011 |
Hedged Item | Location | Three months ended July 31, 2011 |
Nine months ended July 31, 2011 |
|||||||||||||
|
|
In millions |
|
|
In millions |
|||||||||||||||
Interest rate contracts |
Interest and other, net | $ | 68 | $ | (135 | ) | Fixed-rate debt | Interest and other, net | $ | (63 | ) | $ | 138 |
|
Gain (Loss) Recognized in Income on Derivative and Related Hedged Item | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Derivative Instrument
|
Location | Three months ended July 31, 2010 |
Nine months ended July 31, 2010 |
Hedged Item | Location | Three months ended July 31, 2010 |
Nine months ended July 31, 2010 |
|||||||||||||
|
|
In millions |
|
|
In millions |
|||||||||||||||
Interest rate contracts |
Interest and other, net | $ | 215 | $ | 242 | Fixed-rate debt | Interest and other, net | $ | (206 | ) | $ | (230 | ) |
The before-tax effect of derivative instruments in cash flow and net investment hedging relationships for the three and nine months ended July 31, 2011 were as follows:
|
Gain (Loss) Recognized in Other Comprehensive Income ("OCI") on Derivative (Effective Portion) |
Gain (Loss) Reclassified from Accumulated OCI Into Income (Effective Portion) |
Gain Recognized in Income on Derivative (Ineffective portion and Amount Excluded from Effectiveness Testing) |
||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Three months ended July 31, 2011 |
Nine months ended July 31, 2011 |
Location | Three months ended July 31, 2011 |
Nine months ended July 31, 2011 |
Location | Three months ended July 31, 2011 |
Nine months ended July 31, 2011 |
|||||||||||||||||
|
In millions |
|
In millions |
|
In millions |
||||||||||||||||||||
Cash flow hedges: |
|||||||||||||||||||||||||
Foreign exchange contracts |
$ | 115 | $ | (565 | ) | Net revenue |
$ | (333 | ) | $ | (653 | ) | Net revenue |
$ | | $ | | ||||||||
Foreign exchange contracts |
10 | 28 | Cost of products |
9 | 31 | Cost of products |
| | |||||||||||||||||
Foreign exchange contracts |
| 5 | Other operating expenses |
2 | 4 | Other operating expenses |
| | |||||||||||||||||
Foreign exchange contracts |
(37 | ) | (57 | ) | Interest and other, net |
(20 | ) | (52 | ) | Interest and other, net |
| | |||||||||||||
Foreign exchange contracts |
7 | 5 | Net revenue |
3 | 9 | Interest and other, net |
1 | 4 | |||||||||||||||||
Total cash flow hedges |
$ | 95 | $ | (584 | ) | $ | (339 | ) | $ | (661 | ) | $ | 1 | $ | 4 | ||||||||||
Net investment hedges: |
|||||||||||||||||||||||||
Foreign exchange contracts |
$ | (21 | ) | $ | (118 | ) | Interest and other, net |
$ | | $ | | Interest and other, net |
$ | | $ | | |||||||||
24
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments (Continued)
The before-tax effect of derivative instruments in cash flow and net investment hedging relationships for the three and nine months ended July 31, 2010 were as follows:
|
Gain (Loss) Recognized in OCI on Derivative (Effective Portion) |
Gain (Loss) Reclassified from Accumulated OCI Into Income (Effective Portion) |
Gain Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Three months ended July 31, 2010 |
Nine months ended July 31, 2010 |
Location | Three months ended July 31, 2010 |
Nine months ended July 31, 2010 |
Location | Three months ended July 31, 2010 |
Nine months ended July 31, 2010 |
|||||||||||||||||
|
In millions |
|
In millions |
|
In millions |
||||||||||||||||||||
Cash flow hedges: |
|||||||||||||||||||||||||
Foreign exchange contracts |
$ | 114 | $ | 769 | Net revenue |
$ | 375 | $ | 433 | Net revenue |
$ | | $ | | |||||||||||
Foreign exchange contracts |
45 | 38 | Cost of products |
17 | 44 | Cost of products |
| | |||||||||||||||||
Foreign exchange contracts |
(1 | ) | (1 | ) | Other operating expenses |
(1 | ) | | Other operating expenses |
| | ||||||||||||||
Foreign exchange contracts |
11 | 12 | Interest and other, net |
| | Interest and other, net |
| | |||||||||||||||||
Foreign exchange contracts |
(26 | ) | 10 | Net revenue |
5 | 20 | Interest and other, net |
1 | 7 | ||||||||||||||||
Total cash flow hedges |
$ | 143 | $ | 828 | $ | 396 | $ | 497 | $ | 1 | $ | 7 | |||||||||||||
Net investment hedges: |
|||||||||||||||||||||||||
Foreign exchange contracts |
$ | 25 | $ | (19 | ) | Interest and other, net |
$ | | $ | | Interest and other, net |
$ | | $ | | ||||||||||
HP expects to reclassify a net accumulated other comprehensive loss of approximately $162 million, net of taxes, to earnings in the next twelve months along with the earnings effects of the related forecasted transactions in association with cash flow hedges.
The before-tax effect of derivative instruments not designated as hedging instruments on the Consolidated Condensed Statements of Earnings for the three and nine months ended July 31, 2011 and 2010 were as follows:
|
Gain (Loss) Recognized in Income on Derivative | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
Location | Three months ended July 31, 2011 |
Nine months ended July 31, 2011 |
||||||
|
|
In millions |
|||||||
Foreign exchange contracts |
Interest and other, net | $ | (49 | ) | $ | (747 | ) | ||
Other derivatives |
Interest and other, net | (22 | ) | (12 | ) | ||||
Interest rate contracts |
Interest and other, net | | 3 | ||||||
Total |
$ | (71 | ) | $ | (756 | ) | |||
25
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 8: Financial Instruments (Continued)
|
Gain (Loss) Recognized in Income on Derivative | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
Location | Three months ended July 31, 2010 |
Nine months ended July 31, 2010 |
||||||
|
|
In millions |
|||||||
Foreign exchange contracts |
Interest and other, net | $ | (142 | ) | $ | (205 | ) | ||
Other derivatives |
Interest and other, net | 15 | 17 | ||||||
Interest rate contracts |
Interest and other, net | | 5 | ||||||
Total |
$ | (127 | ) | $ | (183 | ) | |||
Other Financial Instruments
For the balance of HP's financial instruments, accounts receivable, financing receivables, notes payable and short-term borrowings, accounts payable and other accrued liabilities, the carrying amounts approximate fair value due to their short maturities. The estimated fair value of HP's short- and long-term debt was approximately $26.0 billion at July 31, 2011, compared to a carrying value of $25.7 billion at that date. The estimated fair value of HP's short- and long-term debt was approximately $22.5 billion at October 31, 2010, compared to a carrying value of $22.3 billion at that date. The estimated fair value of the debt is based primarily on quoted market prices, as well as borrowing rates currently available to HP for bank loans with similar terms and maturities.
Note 9: Financing Receivables and Operating Leases
Financing receivables represent sales-type and direct-financing leases resulting from the placement of HP and third-party products. These receivables typically have terms from two to five years and are usually collateralized by a security interest in the underlying assets. Financing receivables also include billed receivables from operating leases. The components of net financing receivables, which are included in financing receivables and long-term financing receivables and other assets, were as follows:
|
July 31, 2011 |
October 31, 2010 |
|||||
---|---|---|---|---|---|---|---|
|
In millions |
||||||
Minimum lease payments receivable |
$ | 7,675 | $ | 7,094 | |||
Allowance for doubtful accounts |
(136 | ) | (140 | ) | |||
Unguaranteed residual value |
236 | 212 | |||||
Unearned income |
(661 | ) | (596 | ) | |||
Financing receivables, net |
7,114 | 6,570 | |||||
Less current portion |
(3,167 | ) | (2,986 | ) | |||
Amounts due after one year, net |
$ | 3,947 | $ | 3,584 | |||
Equipment leased to customers under operating leases was $4.0 billion and $3.5 billion at July 31, 2011 and October 31, 2010, respectively, and is included in machinery and equipment. Accumulated depreciation on equipment under lease was $1.3 billion at July 31, 2011 and $1.0 billion at October 31, 2010, respectively.
26
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 9: Financing Receivables and Operating Leases (Continued)
In July 2010, the Financial Accounting Standards Board issued amendments to the disclosure requirements pertaining to the credit quality of financing receivables and the allowance for credit losses. The amendments require disclosures related to the credit risk inherent in an entity's portfolio of financing receivables and how that risk is analyzed and assessed in arriving at the allowance for credit losses. The amendments also require enhanced disclosures related to changes in the allowance for credit losses and the reasons for those changes. HP adopted this new standard in the first quarter of fiscal 2011.
Due to the homogenous nature of the leasing transactions, HP manages its financing receivables on an aggregate basis when assessing and monitoring credit risk. Credit risk is generally diversified due to the large number of entities comprising HP's customer base and their dispersion across many different industries and geographical regions. The credit quality of an obligor is evaluated at lease inception and monitored over the term of a transaction. Risk ratings are assigned to each lease based on the creditworthiness of the obligor and other variables that augment or diminish the inherent credit risk of a particular transaction. Such variables include the underlying value and liquidity of the collateral, the essential use of the equipment, the term of the lease, and the inclusion of guarantees, letters of credit, security deposits or other credit enhancements.
The credit risk profile of the gross financing receivables, based on internally assigned ratings, was as follows:
|
July 31, 2011 |
October 31, 2010 |
|||||
---|---|---|---|---|---|---|---|
|
In millions |
||||||
Risk Rating |
|||||||
Low |
$ | 4,239 | $ | 3,793 | |||
Moderate |
2,947 | 2,829 | |||||
High |
64 | 88 | |||||
Total |
$ | 7,250 | $ | 6,710 | |||
Accounts rated low risk typically have the equivalent of a Standard & Poor's rating of BBB- or higher, while accounts rated moderate risk would be the equivalent of BB+ or lower. Based upon impairment analyses, HP identifies and monitors accounts rated high risk and establishes specific reserves against a portion of these receivables.
HP establishes an allowance for doubtful accounts to ensure financing receivables are not overstated due to uncollectability. The allowance balance is comprised of a general reserve, which is determined based on a percentage of the financing receivables balance, and a specific reserve, which is established for certain accounts with identified exposures, such as customer default, bankruptcy or other events, that make it unlikely that HP will recover its investment in the lease. The general reserve percentages are maintained on a regional basis and are based on several factors, which include consideration of historical credit losses and portfolio delinquencies, trends in the overall weighted- average risk rating of the portfolio, and information derived from competitive benchmarking.
27
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 9: Financing Receivables and Operating Leases (Continued)
The allowance for doubtful accounts and the related financing receivables were as follows:
|
Nine months ended July 31, 2011 |
|||
---|---|---|---|---|
|
In millions |
|||
Allowance for doubtful accounts |
||||
Balance, beginning of period |
$ | 140 | ||
Additions to allowance |
34 | |||
Deductions, net of recoveries |
(38 | ) | ||
Balance, end of period |
$ | 136 | ||
|
July 31, 2011 |
October 31, 2010 |
||||||
---|---|---|---|---|---|---|---|---|
|
In millions |
|||||||
Allowance for financing receivables individually evaluated for loss |
$ | 47 | $ | 53 | ||||
Allowance for financing receivables collectively evaluated for loss |
89 | 87 | ||||||
Total |
$ | 136 | $ | 140 | ||||
Gross financing receivables individually evaluated for loss |
$ |
72 |
$ |
75 |
||||
Gross financing receivables collectively evaluated for loss |
7,178 | 6,635 | ||||||
Total |
$ | 7,250 | $ | 6,710 | ||||
Accounts are generally put on non-accrual status (cessation of interest accrual) when they reach 90 days past due. In certain circumstances, such as when the delinquency is deemed to be of an administrative nature, accounts may still accrue interest when they reach 90 days past due. A write-off or specific reserve is generally recorded when an account reaches 180 days past due. As of July 31, 2011, total financing receivables on non-accrual status were $195 million, and total financing receivables greater than 90 days past due and still accruing interest were $94 million.
Note 10: Guarantees
Guarantees and Indemnifications
In the ordinary course of business, HP may provide certain clients with subsidiary performance guarantees and/or financial performance guarantees, which may be backed by standby letters of credit or surety bonds. In general, HP would be liable for the amounts of these guarantees in the event HP or HP's subsidiaries' nonperformance permits termination of the related contract by the client, the likelihood of which HP believes is remote. HP believes that the company is in compliance with the performance obligations under all material service contracts for which there is a performance guarantee.
HP has certain service contracts supported by client financing or securitization arrangements. Under specific circumstances involving nonperformance resulting in service contract termination or failure to comply with terms under the financing arrangement, HP would be required to acquire certain
28
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 10: Guarantees (Continued)
assets. HP considers the possibility of its failure to comply to be remote and the asset amounts involved to be immaterial.
In the ordinary course of business, HP enters into contractual arrangements under which HP may agree to indemnify the third party to such arrangements from any losses incurred relating to the services they perform on behalf of HP or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial.
Warranty
HP provides for the estimated cost of product warranties at the time it recognizes revenue. HP engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers; however, product warranty terms offered to customers, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product class failures outside of HP's baseline experience, affect the estimated warranty obligation. If actual product failure rates, repair rates or any other post sales support costs differ from these estimates, revisions to the estimated warranty liability would be required.
The changes in HP's aggregate product warranty liabilities for the nine months ended July 31, 2011 were as follows:
|
In millions | |||
---|---|---|---|---|
Product warranty liability at October 31, 2010 |
$ | 2,447 | ||
Accruals for warranties issued |
1,966 | |||
Adjustments related to pre-existing warranties (including changes in estimates) |
(40 | ) | ||
Settlements made (in cash or in kind) |
(1,961 | ) | ||
Product warranty liability at July 31, 2011 |
$ | 2,412 | ||
29
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 11: Borrowings
Notes Payable and Short-Term Borrowings
Notes payable and short-term borrowings, including the current portion of long-term debt, were as follows:
|
July 31, 2011 | October 31, 2010 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Amount Outstanding |
Weighted- Average Interest Rate |
Amount Outstanding |
Weighted- Average Interest Rate |
|||||||||
|
In millions |
||||||||||||
Current portion of long-term debt |
$ | 3,323 | 2.2 | % | $ | 2,216 | 2.2 | % | |||||
Commercial paper |
2,864 | 0.3 | % | 4,432 | 0.3 | % | |||||||
Notes payable to banks, lines of credit and other |
479 | 2.3 | % | 398 | 1.5 | % | |||||||
|
$ | 6,666 | $ | 7,046 | |||||||||
Notes payable to banks, lines of credit and other includes deposits associated with HP's banking-related activities of approximately $417 million and $348 million at July 31, 2011 and October 31, 2010, respectively.
30
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 11: Borrowings (Continued)
Long-Term Debt
Long-term debt was as follows:
|
July 31, 2011 |
October 31, 2010 |
|||||||
---|---|---|---|---|---|---|---|---|---|
|
In millions |
||||||||
U.S. Dollar Global Notes |
|||||||||
2002 Shelf Registration Statement: |
|||||||||
$500 issued at discount to par at a price of 99.505% in June 2002 at 6.5%, due July 2012 |
$ | 500 | $ | 500 | |||||
2006 Shelf Registration Statement: |
|||||||||
$600 issued at par in February 2007 at three-month USD LIBOR plus 0.11%, due March 2012 |
600 | 600 | |||||||
$900 issued at discount to par at a price of 99.938% in February 2007 at 5.25%, due March 2012 |
900 | 900 | |||||||
$500 issued at discount to par at a price of 99.694% in February 2007 at 5.4%, due March 2017 |
499 | 499 | |||||||
$1,500 issued at discount to par at a price of 99.921% in March 2008 at 4.5%, due March 2013 |
1,500 | 1,499 | |||||||
$750 issued at discount to par at a price of 99.932% in March 2008 at 5.5%, due March 2018 |
750 | 750 | |||||||
$2,000 issued at discount to par at a price of 99.561% in December 2008 at 6.125%, due March 2014 |
1,996 | 1,994 | |||||||
$275 issued at par in February 2009 at three-month USD LIBOR plus 1.75%, paid February 2011 |
| 275 | |||||||
$1,000 issued at discount to par at a price of 99.956% in February 2009 at 4.25%, due February 2012 |
1,000 | 1,000 | |||||||
$1,500 issued at discount to par at a price of 99.993% in February 2009 at 4.75%, due June 2014 |
1,500 | 1,500 | |||||||
2009 Shelf Registration Statement: |
|||||||||
$750 issued at par in May 2009 at three-month USD LIBOR plus 1.05%, paid May 2011 |
| 750 | |||||||
$1,000 issued at discount to par at a price of 99.967% in May 2009 at 2.25%, paid |
| 1,000 | |||||||
$250 issued at discount to par at a price of 99.984% in May 2009 at 2.95%, due |
250 | 250 | |||||||
$800 issued at par in September 2010 at three-month USD LIBOR plus 0.125%, due September 2012 |
800 | 800 | |||||||
$1,100 issued at discount to par at a price of 99.921% in September 2010 at 1.25%, due |
1,099 | 1,099 | |||||||
$1,100 issued at discount to par at a price of 99.887% in September 2010 at 2.125%, due September 2015 |
1,099 | 1,099 | |||||||
$650 issued at discount to par at a price of 99.911% in December 2010 at 2.2%, due |
649 | | |||||||
$1,350 issued at discount to par at a price of 99.827% in December 2010 at 3.75%, due |
1,348 | | |||||||
$1,750 issued at par in May 2011 at three month USD LIBOR plus 0.28%, due |
1,750 | | |||||||
$500 issued at par in May 2011 at three month USD LIBOR plus 0.4%, due May 2014 |
500 | | |||||||
$500 issued at discount to par at a price of 99.971% in May 2011 at 1.55%, due May 2014 |
500 | | |||||||
$1,000 issued at discount to par at a price of 99.958% in May 2011 at 2.65%, due June 2016 |
1,000 | | |||||||
$1,250 issued at discount to par at a price of 99.799% in May 2011 at 4.3%, due June 2021 |
1,248 | | |||||||
|
19,488 | 14,515 | |||||||
EDS Senior Notes |
|||||||||
$1,100 issued June 2003 at 6.0%, due August 2013 |
1,122 | 1,130 | |||||||
$300 issued October 1999 at 7.45%, due October 2029 |
315 | 315 | |||||||
|
1,437 | 1,445 | |||||||
Other, including capital lease obligations, at 0.60%-8.63%, due in calendar years 2011-2024 |
895 | 845 | |||||||
Fair value adjustment related to hedged debt |
533 | 669 | |||||||
Less: current portion |
(3,323 | ) | (2,216 | ) | |||||
Total long-term debt |
$ | 19,030 | $ | 15,258 | |||||
31
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 11: Borrowings (Continued)
As disclosed in Note 8 to the Consolidated Financial Statements, HP uses interest rate swaps to mitigate the market risk exposures in connection with certain fixed interest global notes to achieve primarily U.S. dollar LIBOR-based floating interest expense. The table above does not reflect the interest rate swap impact on the interest rate.
HP may redeem some or all of the Global Notes set forth in the above table at any time at the redemption prices described in the prospectus supplements relating thereto. The Global Notes are senior unsecured debt.
In May 2009, HP filed a shelf registration statement (the "2009 Shelf Registration Statement") with the SEC to enable the company to offer for sale, from time to time, in one or more offerings, an unspecified amount of debt securities, common stock, preferred stock, depositary shares and warrants. The 2009 Shelf Registration Statement replaced other registration statements filed in March 2002 and May 2006.
In May 2008, HP's Board of Directors approved an increase in the capacity of HP's U.S. commercial paper program by $10.0 billion to $16.0 billion. HP's subsidiaries are authorized to issue up to an additional $1.0 billion of commercial paper, of which $500 million of capacity is currently available to be used by Hewlett-Packard International Bank PLC, a wholly-owned subsidiary of HP, for its Euro Commercial Paper/Certificate of Deposit Programme.
HP has a $3.0 billion five-year credit facility that expires in May 2012 and a $4.5 billion four-year credit facility that expires in February 2015. Commitment fees, interest rates and other terms of borrowing under the credit facilities vary based on HP's external credit ratings. The credit facilities are senior unsecured committed borrowing arrangements primarily to support the issuance of U.S. commercial paper. HP's ability to have a U.S. commercial paper outstanding balance that exceeds the $7.5 billion supported by these credit facilities is subject to a number of factors, including liquidity conditions and business performance.
Within Other, including capital lease obligations, are borrowings that are collateralized by certain financing receivable assets. As of July 31, 2011, the carrying value of the assets approximated the carrying value of the borrowings of $284 million.
As of July 31, 2011, HP had the capacity to issue an unspecified amount of additional debt securities, common stock, preferred stock, depositary shares and warrants under the 2009 Shelf Registration Statement. As of that date, HP also had up to approximately $14.7 billion of available borrowing resources, including $13.6 billion under its commercial paper programs and approximately $1.1 billion relating to uncommitted lines of credit.
Note 12: Income Taxes
Provision for Taxes
HP's effective tax rate was 19.7% and 19.0% for the three months ended July 31, 2011 and July 31, 2010, respectively, and 20.4% and 19.8% for the nine months ended July 31, 2011 and July 31, 2010, respectively. HP's effective tax rate generally differs from the U.S. federal statutory rate of 35% due to favorable tax rates associated with certain earnings from HP's operations in lower-tax jurisdictions throughout the world. The jurisdictions with favorable tax rates that have the most
32
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 12: Income Taxes (Continued)
significant effective tax rate impact in the periods presented include Singapore, the Netherlands, China, Ireland and Puerto Rico. HP has not provided U.S. taxes for all of such earnings because HP plans to reinvest some of those earnings indefinitely outside the United States.
In the three and nine months ended July 31, 2011, HP recorded discrete items with a net tax benefit of $145 million and $302 million, respectively. These amounts included net tax benefits of $62 million and $174 million, respectively, from restructuring and acquisition charges, and net tax benefits of $83 million and $85 million, respectively, for settlement of tax audit matters and other miscellaneous discrete items. In addition, in December 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed into law. HP recorded a tax benefit of $43 million arising from the retroactive research and development credit provided by that legislation in the first quarter of fiscal 2011.
In the three and nine months ended July 31, 2010, HP recorded discrete items with a net tax benefit of $236 million and $375 million, respectively. These amounts included net tax benefits of $206 million and $340 million, respectively, from restructuring and acquisition charges; and net tax benefits of $30 million and $35 million, respectively, associated with adjustments to prior year foreign income tax accruals and credits, settlement of tax audit matters, valuation allowance releases, and other miscellaneous discrete items.
As of July 31, 2011, the amount of gross unrecognized tax benefits was $1.9 billion, of which up to $1.3 billion would affect HP's effective tax rate if realized. HP recognizes interest income and interest expense and penalties on tax overpayments and underpayments within income tax expense. As of July 31, 2011, HP had accrued a net $164 million payable for interest and penalties. In the three and nine months ended July 31, 2011, HP recognized $18 million and $17 million, respectively, of net interest income on net tax overpayments, net of tax.
HP engages in continuous discussion and negotiation with taxing authorities regarding tax matters in various jurisdictions. HP does not expect complete resolution of any Internal Revenue Service ("IRS") audit cycle within the next 12 months. However, it is reasonably possible that certain federal, foreign and state tax issues may be concluded in the next 12 months, including issues involving transfer pricing and other matters. Accordingly, HP believes it is reasonably possible that its existing unrecognized tax benefits may be reduced by an amount up to $198 million within the next 12 months.
HP is subject to income tax in the United States and approximately 80 foreign countries and is subject to routine corporate income tax audits in many of these jurisdictions. In addition, HP is subject to numerous ongoing audits by state and foreign tax authorities. HP has received from the IRS Notices of Deficiency for its fiscal 1999, 2000, 2003, 2004 and 2005 tax years, and Revenue Agent's Reports ("RAR") for its fiscal 2001, 2002 and 2006 tax years. The IRS began an audit of HP's 2007 income tax returns in 2009, and began its audit of HP's 2008 and 2009 income tax returns during 2010 and 2011, respectively. With respect to major foreign and state tax jurisdictions, HP is no longer subject to tax authority examinations for years prior to 1999. HP believes that adequate reserves have been provided for all open tax years.
On January 30, 2008, HP received a Notice of Deficiency from the IRS for its fiscal 2003 tax year. At the same time, HP received an RAR from the IRS for its fiscal 2002 tax year that proposed no change in HP's tax liability for that year. The IRS's adjustments for both years, if sustained, would
33
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 12: Income Taxes (Continued)
reduce tax refund claims HP has filed for net operating loss carrybacks to earlier fiscal years and reduce the tax benefits of tax credit carryforwards to subsequent years, by approximately $215 million. HP is contesting the remaining adjustments proposed in the Notice of Deficiency and the RAR. Towards this end, HP filed a petition with the United States Tax Court on April 29, 2008. HP believes that it has provided adequate reserves for any tax deficiencies or reductions in refund claims that could result from the IRS actions.
On July 30, 2009, HP received a Notice of Deficiency from the IRS for its fiscal 2004 and 2005 tax years. On July 8, 2011, HP finalized a closing agreement with the IRS covering specific matters for these tax years. The remaining unresolved IRS adjustments for both years, if sustained, would reduce the tax benefits of tax credit carryforwards to subsequent years by approximately $35 million. HP is contesting these adjustments through IRS Appeals. HP believes that it has provided adequate reserves for any tax deficiencies or reductions in tax benefits that could result from the IRS actions.
The IRS has completed its examination of EDS tax years through 2002 and no unresolved issues remain outstanding. EDS has received RARs for its 2003 through 2006 tax years, proposing tax deficiencies of $110 million. These deficiencies include a $29 million effect on carrybacks to 2000 through 2002. The IRS is currently auditing EDS's tax years 2007 and the short period ended August 26, 2008. HP is appealing certain issues and believes adequate reserves have been provided for all years.
The breakdown between current and long-term deferred tax assets and deferred tax liabilities was as follows:
|
July 31, 2011 |
October 31, 2010 |
|||||
---|---|---|---|---|---|---|---|
|
In millions |
||||||
Current deferred tax assets |
$ | 5,376 | $ | 5,833 | |||
Current deferred tax liabilities |
(38 | ) | (53 | ) | |||
Long-term deferred tax assets |
2,200 | 2,070 | |||||
Long-term deferred tax liabilities |
(5,812 | ) | (5,239 | ) | |||
Total deferred tax assets net of deferred tax liabilities |
$ | 1,726 | $ | 2,611 | |||
Note 13: Stockholders' Equity
Share Repurchase Program
HP's share repurchase program authorizes both open market and private repurchase transactions. In the three and nine months ended July 31, 2011, HP executed share repurchases of 126 million shares and 242 million shares, respectively. For the three months ended July 31, 2011, repurchases of 128 million shares were settled for $4.6 billion. For the nine months ended July 31, 2011, repurchases of 245 million shares were settled for $9.6 billion, which included 4 million shares repurchased in transactions that were executed in fiscal 2010 but settled in the first quarter of fiscal 2011. HP had approximately 1 million shares repurchased in the third quarter of fiscal 2011 that will be settled in the fourth quarter of fiscal 2011. HP paid approximately $2.6 billion in connection with repurchases of approximately 55 million shares during the three months ended July 31, 2010 and paid approximately
34
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 13: Stockholders' Equity (Continued)
$7.1 billion in connection with repurchases of approximately 144 million shares in the first nine months of fiscal 2010.
As of July 31, 2011, HP had remaining authorization of $1.3 billion for future share repurchases under the $10.0 billion repurchase authorization approved by HP's Board of Directors on August 29, 2010. On July 21, 2011, HP's Board of Directors authorized an additional $10.0 billion for future share repurchases.
Comprehensive Income
The changes in the components of OCI, net of taxes, were as follows:
|
Three months ended July 31 |
|||||||
---|---|---|---|---|---|---|---|---|
|
2011 | 2010 | ||||||
|
In millions |
|||||||
Net earnings |
$ | 1,926 | $ | 1,773 | ||||
Net change in unrealized gains on available-for-sale securities, net of tax of $3 million in 2011 and $1 million in 2010 |
5 | 2 | ||||||
Net change in unrealized gains/losses on cash flow hedges: |
||||||||
Unrealized gains recognized in OCI, net of tax of $46 million in 2011 and $58 million in 2010 |
49 | 85 | ||||||
Losses (gains) reclassified into income, net of tax benefit of $117 million in 2011 and net of tax of $145 million in 2010 |
222 | (251 | ) | |||||
|
271 | (166 | ) | |||||
Net change in cumulative translation adjustment, net of tax of $6 million in 2011 and $18 million in 2010 |
3 | (53 | ) | |||||
Net change in unrealized components of defined benefit plans, net of tax of $6 million in 2011 and $5 million in 2010 |
39 | 32 | ||||||
Comprehensive income |
$ | 2,244 | $ | 1,588 | ||||
35
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 13: Stockholders' Equity (Continued)
|
Nine months ended July 31 |
|||||||
---|---|---|---|---|---|---|---|---|
|
2011 | 2010 | ||||||
|
In millions |
|||||||
Net earnings |
$ | 6,835 | $ | 6,223 | ||||
Net change in unrealized gains on available-for-sale securities, net of tax of $1 million in 2011 and $6 million in 2010 |
15 | 11 | ||||||
Net change in unrealized gains/losses on cash flow hedges: |
||||||||
Unrealized (losses) gains recognized in OCI, net of tax benefit of $195 million in 2011 and net of tax of $296 million in 2010 |
(389 | ) | 532 | |||||
Losses (gains) reclassified into income, net of tax benefit of $226 million in 2011 and net of tax of $176 million in 2010 |
435 | (321 | ) | |||||
|
46 | 211 | ||||||
Net change in cumulative translation adjustment, net of tax of $24 million in 2011 and $16 million in 2010 |
135 | (42 | ) | |||||
Net change in unrealized components of defined benefit plans, net of tax of $126 million in 2011 and $73 million in 2010 |
367 | 127 | ||||||
Comprehensive income |
$ | 7,398 | $ | 6,530 | ||||
The components of accumulated other comprehensive loss, net of taxes, were as follows:
|
July 31, 2011 |
October 31, 2010 |
|||||
---|---|---|---|---|---|---|---|
|
In millions |
||||||
Net unrealized gain on available-for-sale securities |
$ | 35 | $ | 20 | |||
Net unrealized loss on cash flow hedges |
(155 | ) | (201 | ) | |||
Cumulative translation adjustment |
(296 | ) | (431 | ) | |||
Unrealized components of defined benefit plans |
(2,858 | ) | (3,225 | ) | |||
Accumulated other comprehensive loss |
$ | (3,274 | ) | $ | (3,837 | ) | |
Note 14: Retirement and Post-Retirement Benefit Plans
Modifications to Defined Contribution Plans
HP offers various defined contribution plans for U.S. and non-U.S. employees. As disclosed in our Consolidated Financial Statements for the fiscal year ended October 31, 2010, HP matching contributions under both the HP 401(k) Plan and the EDS 401(k) Plan in fiscal 2010 were on a quarterly, discretionary, performance-based match of up to a maximum of 4% of eligible compensation for all U.S. employees to be determined each fiscal quarter based on business results. HP's matching contributions for each of the quarters in fiscal 2010 were 100% of the maximum 4% match. Effective in fiscal year 2011, the quarterly employer matching contributions in the HP 401(k) Plan and the EDS 401(k) Plan are no longer discretionary and are equal to 100% of an employee's contributions, up to a maximum of 4% of eligible compensation. In addition, effective December 31, 2010, the EDS 401(k) Plan was merged into the HP 401(k) Plan.
36
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 14: Retirement and Post-Retirement Benefit Plans (Continued)
HP's net pension and post-retirement benefit costs were as follows:
|
Three months ended July 31 | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
U.S. Defined Benefit Plans |
Non-U.S. Defined Benefit Plans |
Post- Retirement Benefit Plans |
|||||||||||||||||
|
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | ||||||||||||||
|
In millions |
|||||||||||||||||||
Service cost |
$ | | $ | 1 | $ | 90 | $ | 80 | $ | 2 | $ | 3 | ||||||||
Interest cost |
148 | 144 | 178 | 157 | 9 | 11 | ||||||||||||||
Expected return on plan assets |
(186 | ) | (166 | ) | (227 | ) | (181 | ) | (9 | ) | (9 | ) | ||||||||
Amortization and deferrals: |
||||||||||||||||||||
Actuarial loss |
9 | 7 | 57 | 51 | | 2 | ||||||||||||||
Prior service benefit |
| | (3 | ) | (3 | ) | (20 | ) | (21 | ) | ||||||||||
Net periodic benefit (gain) cost |
(29 | ) | (14 | ) | 95 | 104 | (18 | ) | (14 | ) | ||||||||||
Settlement loss (gain) |
| 4 | | (2 | ) | | | |||||||||||||
Special termination benefits |
| | 4 | 7 | | | ||||||||||||||
Net benefit (gain) cost |
$ | (29 | ) | $ | (10 | ) | $ | 99 | $ | 109 | $ | (18 | ) | $ | (14 | ) | ||||
|
Nine months ended July 31 | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
U.S. Defined Benefit Plans |
Non-U.S. Defined Benefit Plans |
Post- Retirement Benefit Plans |
|||||||||||||||||
|
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | ||||||||||||||
|
In millions |
|||||||||||||||||||
Service cost |
$ | 1 | $ | 1 | $ | 264 | $ | 248 | $ | 7 | $ | 9 | ||||||||
Interest cost |
445 | 433 | 524 | 494 | 26 | 35 | ||||||||||||||
Expected return on plan assets |
(558 | ) | (497 | ) | (665 | ) | (567 | ) | (27 | ) | (24 | ) | ||||||||
Amortization and deferrals: |
||||||||||||||||||||
Actuarial loss |
25 | 21 | 180 | 160 | 1 | 12 | ||||||||||||||
Prior service benefit |
| | (10 | ) | (7 | ) | (62 | ) | (64 | ) | ||||||||||
Net periodic benefit (gain) cost |
(87 | ) | (42 | ) | 293 | 328 | (55 | ) | (32 | ) | ||||||||||
Settlement loss (gain) |
| 4 | 2 | (2 | ) | | | |||||||||||||
Curtailment gain |
| | | | | (13 | ) | |||||||||||||
Special termination benefits |
| | 12 | 18 | | | ||||||||||||||
Net benefit (gain) cost |
$ | (87 | ) | $ | (38 | ) | $ | 307 | $ | 344 | $ | (55 | ) | $ | (45 | ) | ||||
37
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 14: Retirement and Post-Retirement Benefit Plans (Continued)
Employer Contributions and Funding Policy
HP previously disclosed in its Consolidated Financial Statements for the fiscal year ended October 31, 2010 that in fiscal year 2011 it expected to contribute approximately $747 million to its pension plans and approximately $30 million to cover benefit payments to U.S. non-qualified plan participants. In addition, HP disclosed that it expected to pay approximately $40 million to cover benefit claims for HP's post-retirement benefit plans. HP's funding policy is to contribute cash to its pension plans so that it makes at least the minimum contribution required by local authorities.
During the nine months ended July 31, 2011, HP made $323 million of contributions to its pension plans, paid $19 million to cover benefit payments to U.S. non-qualified plan participants, and paid $20 million to cover benefit claims under post-retirement benefit plans. During the remainder of fiscal 2011, HP anticipates making additional contributions of approximately $424 million to its pension plans and approximately $11 million to its U.S. non-qualified plan participants and expects to pay up to $20 million to cover benefit claims under post-retirement benefit plans. HP's pension and other post-retirement benefit costs and obligations are dependent on various assumptions. Differences between expected and actual returns on investments will be reflected as unrecognized gains or losses, and such gains or losses will be amortized and recorded in future periods. Poor financial performance of invested assets in any year could lead to increased contributions in certain countries and increased future pension plan expense. Asset gains or losses are determined at the measurement date and amortized over the remaining service life or life expectancy of plan participants. HP's next measurement date is October 31, 2011.
Note 15: Litigation and Contingencies
HP is involved in lawsuits, claims, investigations and proceedings, including those identified below, consisting of intellectual property, commercial, securities, employment, employee benefits and environmental matters that arise in the ordinary course of business. HP records a provision for a liability when management believes that it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. HP believes it has adequate provisions for any such matters, and, as of July 31, 2011, it was not reasonably possible that an additional material loss had been incurred in an amount in excess of the amounts already recognized on HP's financial statements. HP reviews these provisions at least quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Based on its experience, HP believes that any damage amounts claimed in the specific matters discussed below are not a meaningful indicator of HP's potential liability. Litigation is inherently unpredictable. However, HP believes that it has valid defenses with respect to legal matters pending against it. Nevertheless, cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.
Litigation, Proceedings and Investigations
Copyright levies. As described below, proceedings are ongoing or have been concluded involving HP in certain European Union ("EU") member countries, including litigation in Germany, Belgium and Austria, seeking to impose or modify levies upon equipment (such as multifunction devices ("MFDs"), personal computers ("PCs") and printers) and alleging that these devices enable producing
38
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
private copies of copyrighted materials. Descriptions of some of the ongoing proceedings are included below. The levies are generally based upon the number of products sold and the per-product amounts of the levies, which vary. Some EU member countries that do not yet have levies on digital devices are expected to implement similar legislation to enable them to extend existing levy schemes, while some other EU member countries are expected to limit the scope of levy schemes and applicability in the digital hardware environment. HP, other companies and various industry associations have opposed the extension of levies to the digital environment and have advocated alternative models of compensation to rights holders.
VerwertungsGesellschaft Wort ("VG Wort"), a collection agency representing certain copyright holders, instituted legal proceedings against HP in the Stuttgart Civil Court seeking levies on printers. On December 22, 2004, the court held that HP is liable for payments regarding all printers using ASCII code sold in Germany but did not determine the amount payable per unit. HP appealed this decision in January 2005 to the Stuttgart Court of Appeals. On May 11, 2005, the Stuttgart Court of Appeals issued a decision confirming that levies are due. On June 6, 2005, HP filed an appeal to the German Federal Supreme Court in Karlsruhe. On December 6, 2007, the German Federal Supreme Court issued a judgment that printers are not subject to levies under the existing law. The court issued a written decision on January 25, 2008, and VG Wort subsequently filed an application with the German Federal Supreme Court under Section 321a of the German Code of Civil Procedure contending that the court did not consider their arguments. On May 9, 2008, the German Federal Supreme Court denied VG Wort's application. VG Wort appealed the decision by filing a claim with the German Federal Constitutional Court challenging the ruling that printers are not subject to levies. On September 21, 2010, the Constitutional Court published a decision holding that the German Federal Supreme Court erred by not referring questions on interpretation of German copyright law to the Court of Justice of the European Union ("CJEU") and therefore revoked the German Federal Supreme Court decision and remitted the matter to it. On July 21, 2011, the German Federal Supreme Court stayed the proceedings and referred several questions to the CJEU with regard to the interpretation of the European Copyright Directive.
In September 2003, VG Wort filed a lawsuit against Fujitsu Siemens Computer GmbH ("FSC") in the Munich Civil Court in Munich, Germany seeking levies on PCs. This is an industry test case in Germany, and HP has agreed not to object to the delay if VG Wort sues HP for such levies on PCs following a final decision against FSC. On December 23, 2004, the Munich Civil Court held that PCs are subject to a levy and that FSC must pay € 12 plus compound interest for each PC sold in Germany since March 2001. FSC appealed this decision in January 2005 to the Munich Court of Appeals. On December 15, 2005, the Munich Court of Appeals affirmed the Munich Civil Court decision. FSC filed an appeal with the German Federal Supreme Court in February 2006. On October 2, 2008, the German Federal Supreme Court issued a judgment that PCs were not photocopiers within the meaning of the German copyright law that was in effect until December 31, 2007 and, therefore, not subject to the levies on photocopiers established by that law. VG Wort subsequently filed a claim with the German Federal Constitutional Court challenging that ruling. In January 2011, the Constitutional Court published a decision holding that the German Federal Supreme Court decision was inconsistent with the German Constitution and revoking the German Federal Supreme Court decision. The Constitutional Court remitted the matter to the German Federal Supreme Court for further action. On
39
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
July 21, 2011, the German Federal Supreme Court stayed the proceedings and referred several questions to the CJEU with regard to the interpretation of the European Copyright Directive.
Reprobel, a cooperative society with the authority to collect and distribute the remuneration for reprography to Belgian copyright holders, requested HP by extra-judicial means to amend certain copyright levy declarations submitted for inkjet MFDs sold in Belgium from January 2005 to December 2009 to enable it to collect copyright levies calculated based on the generally higher copying speed when the MFDs are operated in draft print mode rather than when operated in normal print mode. In March 2010, HP filed a lawsuit against Reprobel in the French-speaking chambers of the Court of First Instance of Brussels seeking a declaratory judgment that no copyright levies are payable on sales of MFDs in Belgium or, alternatively, that copyright levies payable on such MFDs must be assessed based on the copying speed when operated in the normal print mode set by default in the device. The schedule for the court proceedings has been determined, and no decision from the court is expected before September 2012.
Based on industry opposition to the extension of levies to digital products, HP's assessments of the merits of various proceedings and HP's estimates of the units impacted and levies, HP has accrued amounts that it believes are adequate to address the matters described above. However, the ultimate resolution of these matters and the associated financial impact on HP, including the number of units impacted, the amount of levies imposed and the ability of HP to recover such amounts through increased prices, remains uncertain.
Skold, et al. v. Intel Corporation and Hewlett-Packard Company is a lawsuit in which HP was joined on June 14, 2004 that is pending in state court in Santa Clara County, California. The lawsuit alleges that HP (along with Intel) misled the public by suppressing and concealing the alleged material fact that systems that use the Intel Pentium 4 processor are less powerful and slower than systems using the Intel Pentium III processor and processors made by a competitor of Intel. The plaintiffs seek unspecified damages, restitution, attorneys' fees and costs, and certification of a nationwide class. On February 27, 2009, the court denied with prejudice plaintiffs' motion for nationwide class certification for a third time. On August 31, 2011, the California Court of Appeal reversed the trial court's denial of class certification and remanded the case back to the trial court for further proceedings on the question of class certification.
Inkjet Printer Litigation. As described below, HP is involved in several lawsuits claiming breach of express and implied warranty, unjust enrichment, deceptive advertising and unfair business practices where the plaintiffs have alleged, among other things, that HP employed a "smart chip" in certain inkjet printing products in order to register ink depletion prematurely and to render the cartridge unusable through a built-in expiration date that is hidden, not documented in marketing materials to consumers, or both. The plaintiffs have also contended that consumers received false ink depletion warnings and that the smart chip limits the ability of consumers to use the cartridge to its full capacity or to choose competitive products.
40
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
court denied all three motions. On March 30, 2009, the plaintiffs filed a renewed motion for class certification. A hearing on the plaintiffs' motion for class certification scheduled for April 9, 2010 was postponed.
On August 25, 2010, HP and the plaintiffs in In re HP Inkjet Printer Litigation, Blennis v. HP and Rich v. HP entered into an agreement to settle those lawsuits on behalf of the proposed classes, which agreement is subject to approval of the court before it becomes final. Under the terms of the proposed settlement, the lawsuits will be consolidated, and eligible class members will each have the right to obtain e-credits not to exceed $5 million in the aggregate for use in purchasing printers or printer supplies through HP's website. As part of the proposed settlement, HP also agreed to provide class members with additional information regarding HP inkjet printer functionality and to change the content of certain software and user guide messaging provided to users regarding the life of inkjet printer cartridges. In addition, class counsel and the class representatives will be paid attorneys' fees and expenses and stipends. On March 29, 2011, the court granted final approval to the settlement. On April 27, 2011, certain class members who objected to the settlement filed an appeal of the court's order granting final approval to the settlement.
Baggett v. HP is a consumer class action filed against HP on June 6, 2007 in the United States District Court for the Central District of California alleging that HP employs a technology in its LaserJet color printers whereby the printing process shuts down prematurely, thus preventing customers from using the toner that is allegedly left in the cartridge. The plaintiffs also allege that HP fails to disclose to consumers that they will be unable to utilize the toner remaining in the cartridge after the printer shuts down. The complaint seeks certification of a nationwide class of purchasers of all HP LaserJet color printers and seeks unspecified damages, restitution, disgorgement, injunctive relief, attorneys' fees and costs. On September 29, 2009, the court granted HP's motion for summary judgment against the named plaintiff and denied plaintiff's motion for class certification as moot. On
41
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
November 3, 2009, the court entered judgment against the named plaintiff. On November 17, 2009, plaintiff filed an appeal of the court's summary judgment ruling with the United States Court of Appeals for the Ninth Circuit. On August 25, 2010, HP and the plaintiff entered into an agreement to settle the lawsuit on behalf of the proposed class, which agreement is subject to approval of the court before it becomes final. Under the terms of the proposed settlement, eligible class members will each have the right to obtain e-credits not to exceed $5 million in the aggregate for use in purchasing printers or printer supplies through HP's website. In addition, class counsel and the class representative will be paid attorneys' fees and expenses and stipends in an amount that is yet to be approved by the court. On October 13, 2010, the court granted preliminary approval of the proposed settlement. The court held a fairness hearing on February 14, 2011 to determine whether to grant final approval of the proposed settlement. On August 31, 2011, the court granted final approval of the settlement. Any objectors to the settlement have 30 days to appeal the grant of final approval.
Fair Labor Standards Act Litigation. HP is involved in several lawsuits in which the plaintiffs are seeking unpaid overtime compensation and other damages based on allegations that various employees of EDS or HP have been misclassified as exempt employees under the Fair Labor Standards Act and/or in violation of the California Labor Code or other state laws. Those matters include the following:
42
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
information technology and help desk support personnel were misclassified as exempt employees. No substantive rulings have been made in the case.
In addition to the above matters, on May 24, 2011, a purported collective action captioned Fenn, et al. v. Hewlett-Packard Company was filed in the United States District Court for the District of Idaho. The suit alleges that customer service representatives working in HP's U.S. call centers are not paid for time spent booting up and shutting down their computers in violation of the Fair Labor Standards Act. Plaintiffs have asked the court to conditionally certify a putative class of alleged similarly situated employees. HP has opposed the request.
India Directorate of Revenue Intelligence Proceedings. As described below, Hewlett-Packard India Sales Private Ltd ("HPI"), a subsidiary of HP, and certain current and former HP employees have received show cause notices from the India Directorate of Revenue Intelligence (the "DRI") alleging underpayment of certain customs duties:
HP intends to contest each of the show cause notices through the judicial process. HP has responded or is in the process of responding to the show cause notices.
Russia GPO and Related Investigations. The German Public Prosecutor's Office ("German PPO") has been conducting an investigation into allegations that current and former employees of HP engaged in bribery, embezzlement and tax evasion relating to a transaction between Hewlett-Packard ISE GmbH in Germany, a former subsidiary of HP, and the General Prosecutor's Office of the Russian
43
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
Federation. The approximately €35 million transaction, which was referred to as the Russia GPO deal, spanned the years 2001 to 2006 and was for the delivery and installation of an IT network.
The U.S. Department of Justice and the SEC have also been conducting an investigation into the Russia GPO deal and potential violations of the Foreign Corrupt Practices Act ("FCPA"). Under the FCPA, a person or an entity could be subject to fines, civil penalties of up to $500,000 per violation and equitable remedies, including disgorgement and other injunctive relief. In addition, criminal penalties could range from the greater of $2 million per violation or twice the gross pecuniary gain or loss from the violation.
In addition to information about the Russia GPO deal, the U.S. enforcement authorities have requested (i) information related to certain other transactions, including transactions in Russia, Serbia and in the Commonwealth of Independent States (CIS) subregion dating back to 2000, and (ii) information related to two former HP executives seconded to Russia and to whether HP personnel in Russia, Germany, Austria, Serbia, the Netherlands or CIS were involved in kickbacks or other improper payments to channel partners or state-owned or private entities.
HP is cooperating with these investigating agencies.
In addition, as described below, HP is involved in stockholder derivative litigation arising from the Russia GPO deal, the related investigations and other matters commenced against current and former members of the HP Board of Directors in which the plaintiffs are seeking to recover certain compensation paid by HP to the defendants and other damages:
44
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
ECT Proceedings. In January 2011, the postal service of Brazil, Empresa Brasileira de Correios e Telégrafos (ECT), notified HP that it had initiated administrative proceedings against an HP subsidiary in Brazil ("HP Brazil") to consider whether to suspend HP Brazil's right to bid and contract with ECT related to alleged improprieties in the bidding and contracting processes whereby employees of HP Brazil and employees of several other companies coordinated their bids for three ECT contracts in 2007 and 2008. In late July 2011, ECT notified HP it had decided to apply the penalties against HP Brazil, suspending HP Brazil's right to bid and contract with ECT for five years, based upon the evidence before it. In August 2011, HP filed petitions with ECT requesting that the decision be revoked and seeking injunctive relief to have the application of the penalties suspended until a final, non-appealable decision is made on the merits of the case. HP is currently awaiting a response from ECT on both petitions.
Leak Investigation Proceedings. As described below, HP is or has been the subject of various governmental inquiries concerning the processes employed in an investigation into leaks of HP confidential information to members of the media that concluded in May 2006:
45
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
In addition, four stockholder derivative lawsuits have been filed in California purportedly on behalf of HP stockholders seeking to recover damages for alleged breach of fiduciary duty and to require HP to improve its corporate governance and internal control procedures as a result of the activities of the leak investigation: Staehr v. Dunn, et al. was filed in Santa Clara County Superior Court on September 18, 2006; Worsham v. Dunn, et al. was filed in Santa Clara County Superior Court on September 14, 2006; Tansey v. Dunn, et al. was filed in Santa Clara County Superior Court on September 20, 2006; and Hall v. Dunn, et al. was filed in Santa Clara County Superior Court on September 25, 2006. On October 19, 2006, the Santa Clara County Superior Court consolidated the four California cases under the caption In re Hewlett-Packard Company Derivative Litigation. The consolidated complaint filed on November 19, 2006, also seeks to recover damages in connection with sales of HP stock alleged to have been made by certain current and former HP officers and directors while in possession of material non-public information. Two additional stockholder derivative lawsuits, Pifko v. Babbio, et al., filed on September 19, 2006, and Gross v. Babbio, et al., filed on November 21, 2006, were filed in Chancery Court, County of New Castle, Delaware; both seek to recover damages for alleged breaches of fiduciary duty and to obtain an order instructing the defendants to refrain from further breaches of fiduciary duty and to implement corrective measures that will prevent future occurrences of the alleged breaches of fiduciary duty. On January 24, 2007, the Delaware court consolidated the two cases under the caption In re Hewlett-Packard Company Derivative Litigation and subsequently stayed the proceedings, as the parties had reached a tentative settlement. The HP Board of Directors appointed a Special Litigation Committee consisting of independent Board members authorized to investigate, review and evaluate the facts and circumstances asserted in these derivative matters and to determine how HP should proceed in these matters. On December 14, 2007, HP and the plaintiffs in the California and Delaware derivative actions entered into an agreement to settle those lawsuits. Under the terms of the settlement, HP agreed to continue certain corporate governance changes until December 31, 2012 and to pay the plaintiffs' attorneys' fees. The California court granted final approval to the settlement on March 11, 2008 and subsequently granted plaintiffs' counsel's fee application and dismissed the action. On June 12, 2008, the Delaware court granted final approval to the settlement and the plaintiffs' application for attorneys' fees and also dismissed the action. Because
46
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 15: Litigation and Contingencies (Continued)
neither the dismissal of the California nor the Delaware derivative action was thereafter appealed, both cases are now concluded.
Environmental
Our operations and our products are subject to various federal, state, local and foreign laws and regulations concerning environmental protection, including laws addressing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, the content of its products and the recycling, treatment and disposal of its products. In particular, HP faces increasing complexity in its product design and procurement operations as it adjusts to new and future requirements relating to the chemical and materials composition of its products, their safe use, the energy consumption associated with those products, including requirements relating to climate change. We also are subject to legislation in an increasing number of jurisdictions that makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products (sometimes referred to as "product take-back legislation"). HP could incur substantial costs, its products could be restricted from entering certain jurisdictions, and it could face other sanctions, if it were to violate or become liable under environmental laws or if its products become non-compliant with environmental laws. HP's potential exposure includes fines and civil or criminal sanctions, third-party property damage or personal injury claims and clean up costs. The amount and timing of costs under environmental laws are difficult to predict.
HP is party to, or otherwise involved in, proceedings brought by U.S. or state environmental agencies under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), known as "Superfund," or state laws similar to CERCLA. HP is also conducting environmental investigations or remediations at several current or former operating sites pursuant to administrative orders or consent agreements with state environmental agencies.
Note 16: Segment Information
Description of Segments
HP is a leading global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses ("SMBs"), and large enterprises, including customers in the government, health and education sectors. HP's offerings span multi-vendor customer services, including infrastructure technology and business process outsourcing, technology support and maintenance, application development and support services, and consulting and integration services; enterprise information technology ("IT") infrastructure, including enterprise server and storage technology, networking products and solutions, information management software and software that optimizes business technology investments; personal computing and other access devices; and imaging and printing-related products and services.
HP and its operations are organized into seven business segments for financial reporting purposes: Services, ESSN, HP Software, PSG, IPG, HP Financial Services ("HPFS"), and Corporate Investments. HP's organizational structure is based on a number of factors that management uses to evaluate, view and run its business operations, which include, but are not limited to, customer base, homogeneity of
47
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 16: Segment Information (Continued)
products and technology. The business segments are based on this organizational structure and information reviewed by HP's management to evaluate the business segment results.
HP has reclassified segment operating results for fiscal 2010 to conform to certain fiscal 2011 organizational realignments. None of the changes impacts HP's previously reported consolidated net revenue, earnings from operations, net earnings or net earnings per share. Future changes to this organizational structure may result in changes to the business segments disclosed.
A description of the types of products and services provided by each business segment follows:
48
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 16: Segment Information (Continued)
49
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 16: Segment Information (Continued)
Segment Data
HP derives the results of the business segments directly from its internal management reporting system. The accounting policies HP uses to derive business segment results are substantially the same as those the consolidated company uses. Management measures the performance of each business segment based on several metrics, including earnings from operations. Management uses these results, in part, to evaluate the performance of, and to assign resources to, each of the business segments. HP does not allocate to its business segments certain operating expenses, which it manages separately at the corporate level. These unallocated costs include primarily restructuring charges and any associated adjustments related to restructuring actions, amortization of purchased intangible assets, stock-based compensation expense related to HP-granted employee stock options, PRUs, restricted stock awards and the employee stock purchase plan, certain acquisition-related charges and charges for purchased in-process research and development, as well as certain corporate governance costs.
50
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 16: Segment Information (Continued)
Selected operating results information for each business segment was as follows:
|
Three months ended July 31 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Net Revenue | Earnings (Loss) from Operations |
|||||||||||
|
2011 | 2010(1) | 2011 | 2010(1) | |||||||||
|
In millions |
||||||||||||
Services |
$ | 9,089 | $ | 8,772 | $ | 1,225 | $ | 1,381 | |||||
Enterprise Servers, Storage and Networking(2) |
5,396 | 5,021 | 699 | 706 | |||||||||
HP Software(3) |
780 | 650 | 151 | 182 | |||||||||
Personal Systems Group |
9,592 | 9,918 | 567 | 469 | |||||||||
Imaging and Printing Group |
6,087 | 6,167 | 892 | 1,040 | |||||||||
HP Financial Services |
932 | 764 | 88 | 72 | |||||||||
Corporate Investments(4) |
266 | 85 | (332 | ) | (88 | ) | |||||||
Segment total |
$ | 32,142 | $ | 31,377 | $ | 3,290 | $ | 3,762 | |||||
|
Nine months ended July 31 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Net Revenue | Earnings (Loss) from Operations |
|||||||||||
|
2011 | 2010(1) | 2011 | 2010(1) | |||||||||
|
In millions |
||||||||||||
Services |
$ | 26,673 | $ | 26,404 | $ | 3,961 | $ | 4,161 | |||||
Enterprise Servers, Storage and Networking(2) |
16,586 | 14,468 | 2,293 | 1,937 | |||||||||
HP Software(3) |
2,241 | 1,966 | 428 | 521 | |||||||||
Personal Systems Group |
29,456 | 30,458 | 1,772 | 1,464 | |||||||||
Imaging and Printing Group |
19,462 | 18,769 | 3,165 | 3,192 | |||||||||
HP Financial Services |
2,644 | 2,238 | 250 | 208 | |||||||||
Corporate Investments(4) |
416 | 211 | (713 | ) | (209 | ) | |||||||
Segment total |
$ | 97,478 | $ | 94,514 | $ | 11,156 | $ | 11,274 | |||||
51
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 16: Segment Information (Continued)
The reconciliation of segment operating results information to HP consolidated totals was as follows:
|
Three months ended July 31 |
Nine months ended July 31 |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2011 | 2010 | 2011 | 2010 | |||||||||
|
In millions |
||||||||||||
Net revenue: |
|||||||||||||
Segment total |
$ | 32,142 | $ | 31,377 | $ | 97,478 | $ | 94,514 | |||||
Elimination of inter-segment net revenue and other |
(953 | ) | (648 | ) | (2,355 | ) | (1,759 | ) | |||||
Total HP consolidated net revenue |
$ | 31,189 | $ | 30,729 | $ | 95,123 | $ | 92,755 | |||||
Earnings before taxes: |
|||||||||||||
Total segment earnings from operations |
$ | 3,290 | $ | 3,762 | $ | 11,156 | $ | 11,274 | |||||
Corporate and unallocated costs and eliminations |
(114 | ) | (175 | ) | (118 | ) | (375 | ) | |||||
Unallocated costs related to stock-based compensation expense |
(130 | ) | (156 | ) | (426 | ) | (504 | ) | |||||
Amortization of purchased intangible assets |
(358 | ) | (383 | ) | (1,196 | ) | (1,060 | ) | |||||
Restructuring charges |
(150 | ) | (598 | ) | (466 | ) | (909 | ) | |||||
Acquisition-related charges |
(18 | ) | (127 | ) | (68 | ) | (242 | ) | |||||
Interest and other, net |
(121 | ) | (134 | ) | (294 | ) | (424 | ) | |||||
Total HP consolidated earnings before taxes |
$ | 2,399 | $ | 2,189 | $ | 8,588 | $ | 7,760 | |||||
In connection with certain fiscal 2011 organizational realignments, HP reclassified total assets of its networking business from Corporate Investments to ESSN and total assets of the communications and media solutions business from HP Software to Services. There have been no other material changes to the total assets of HP's segments since October 31, 2010.
52
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 16: Segment Information (Continued)
Net revenue by segment and business unit
|
Three months ended July 31 |
Nine months ended July 31 |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2011 | 2010(1) | 2011 | 2010(1) | |||||||||||
|
In millions |
||||||||||||||
Net revenue: |
|||||||||||||||
Infrastructure Technology Outsourcing |
$ | 3,884 | $ | 3,692 | $ | 11,303 | $ | 11,091 | |||||||
Technology Services |
2,754 | 2,611 | 8,069 | 7,894 | |||||||||||
Application Services |
1,698 | 1,664 | 5,054 | 5,029 | |||||||||||
Business Process Outsourcing |
658 | 727 | 1,989 | 2,177 | |||||||||||
Other |
95 | 78 | 258 | 213 | |||||||||||
Services |
9,089 | 8,772 | 26,673 | 26,404 | |||||||||||
Industry Standard Servers |
3,302 | 3,042 | 10,137 | 9,044 | |||||||||||
Storage(2) |
976 | 904 | 2,968 | 2,741 | |||||||||||
HP Networking(3) |
659 | 572 | 1,921 | 1,086 | |||||||||||
Business Critical Systems |
459 | 503 | 1,560 | 1,597 | |||||||||||
Enterprise Servers, Storage and Networking |
5,396 | 5,021 | 16,586 | 14,468 | |||||||||||
HP Software(4) |
780 | 650 | 2,241 | 1,966 | |||||||||||
Notebooks |
5,082 | 5,314 | 15,929 | 16,979 | |||||||||||
Desktops |
3,777 | 3,941 | 11,314 | 11,591 | |||||||||||
Workstations |
547 | 459 | 1,623 | 1,257 | |||||||||||
Other(5) |
186 | 204 | 590 | 631 | |||||||||||
Personal Systems Group |
9,592 | 9,918 | 29,456 | 30,458 | |||||||||||
Supplies |
4,143 | 4,130 | 13,113 | 12,542 | |||||||||||
Commercial Hardware |
1,292 | 1,389 | 4,194 | 4,028 | |||||||||||
Consumer Hardware |
652 | 648 | 2,155 | 2,199 | |||||||||||
Imaging and Printing Group |
6,087 | 6,167 | 19,462 | 18,769 | |||||||||||
HP Financial Services |
932 | 764 | 2,644 | 2,238 | |||||||||||
Corporate Investments(6) |
266 | 85 | 416 | 211 | |||||||||||
Total segments |
32,142 | 31,377 | 97,478 | 94,514 | |||||||||||
Eliminations of inter-segment net revenue and other |
(953 | ) | (648 | ) | (2,355 | ) | (1,759 | ) | |||||||
Total HP consolidated net revenue |
$ | 31,189 | $ | 30,729 | $ | 95,123 | $ | 92,755 | |||||||
53
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 16: Segment Information (Continued)
addition, net revenue reported for the Infrastructure Technology Outsourcing business unit and eliminations of inter-segment net revenue have both been reduced to reflect a change in our inter-segment reporting model. There was no impact on the previously reported financial results for HPFS and IPG or for the business units within IPG.
Note 17: Subsequent Events
In August 2011, HP and an indirect wholly-owned subsidiary of HP entered into an Offer Agreement with Autonomy Corporation plc ("Autonomy"). Pursuant to the Offer Agreement, HP announced the terms of a recommended cash offer (the "Offer") under which HP would acquire the entire issued and to be issued share capital of Autonomy for £25.50 per share in cash, representing an enterprise value of approximately $11 billion. The Offer is subject to customary conditions including, acceptance of the Offer by the holders of at least 75% of the Autonomy share capital; subject to certain exceptions, that the members of Autonomy's board of directors will continue to recommend the Offer; expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; clearance of other required regulatory approvals; and other customary conditions. HP intends to fund the Offer with a combination of HP's cash resources and debt financing. Pursuant to the cash confirmation process mandated by Section 2.5(a) of the UK City Code on Takeovers and Mergers, HP has agreed with its financial advisors for the Offer that it will hold a minimum of $4.25 billion in cash reserves available to fund the Offer for a specified period expected to extend until the completion of the acquisition. In addition, HP has purchased foreign exchange options at a cost of approximately $333 million to limit its foreign exchange risk in connection with the acquisition. Changes in the fair value of the options will be recognized in earnings until the options are exercised.
In August 2011, HP entered into a new £5 billion ($8.2 billion) 364-day unsecured bridge term loan agreement (the "Bridge Facility"). The Bridge Facility may be used for cash consideration to fund the acquisition of Autonomy, including amounts used to refinance indebtedness to fund that acquisition.
In August 2011, HP announced that its Board of Directors had authorized the evaluation of strategic alternatives for PSG. HP's preferred alternative is the separation of its PC business into a separate company through a spin-off or other transaction, but the evaluation process is ongoing. HP expects the evaluation process to be completed by the end of calendar year 2011 and any separation or other strategic plan to be implemented within approximately 12-18 months after the date of the original announcement.
54
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)
Note 17: Subsequent Events (Continued)
In August 2011, HP announced that it will discontinue the manufacture and sale of all of its WebOS hardware products, including its WebOS smartphones and the HP TouchPad, and will explore alternatives to optimize the value of the WebOS software. In connection with this decision, HP expects to record a one-time charge in its fourth fiscal quarter of 2011 of approximately $1 billion for restructuring and related shutdown costs. A majority of these charges are expected to be paid in HP's fourth fiscal quarter. In addition, as HP works through alternatives for the WebOS software, which HP acquired in connection with its acquisition of Palm, HP will evaluate the goodwill and other intangible assets related to the Palm acquisition for any potential impairment and, if appropriate, recognize a related non-cash charge in the appropriate period. The carrying value of the goodwill and other intangible assets related to the Palm acquisition was approximately $1.2 billion as of July 31, 2011.
55
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this document.
OVERVIEW
We are a leading global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses, and large enterprises, including customers in the government, health and education sectors. Our offerings span:
We have seven business segments for financial reporting purposes: Services, Enterprise Servers, Storage and Networking ("ESSN"), HP Software, the Personal Systems Group ("PSG"), the Imaging and Printing Group ("IPG"), HP Financial Services ("HPFS"), and Corporate Investments.
Our strategy and operations are currently focused on the following initiatives:
Competitive Positioning
We are positioning our businesses to take advantage of important trends in the markets for our products and services, including the emergence of cloud computing as a complement to, and in some cases a replacement for, on-premise, proprietary computing resources. Our primary areas of strategic focus are cloud computing, solutions and software, while we continue to expand and leverage our strong existing technologies, including printing hardware, software and services. We are also exploring strategic alternatives for our PC business, with a preference for a separation of our PC business into a separate company through a spin-off or other transaction. Our converged infrastructure products integrate storage, networking, servers and management software and our core data center capabilities form the backbone of a set of cloud offerings that will help customers transition their computing environments from a traditional structure to a hybrid environment and, in many cases, ultimately to a cloud-based environment. In addition, our enterprise services offerings give us a platform to be more solution-oriented and a better strategic partner with our customers, provide opportunities to drive usage of HP products and solutions, and give us the opportunity to implement and manage all the technologies upon which our customers rely. We are also aligning our printing business to capitalize on key market trends such as the shift from analog to digital printing and the growth in printable content by developing innovative products, including ePrint solutions and web-connected printers, which enable web and mobile printing, expanding our presence in high-usage annuity businesses including graphics and retail publishing printing, and growing our managed print services business.
56
Investing for Growth
We are investing for growth by strengthening our position in our core markets and accelerating growth in adjacent markets in anticipation of market trends, such as cloud computing, unstructured data, data center consolidation and automation, digitization, analytics and IT security. In addition, in May 2011, we announced that we are going to make changes to our services business, including accelerating portfolio investments in higher value services, enhancing our sales and delivery capabilities, and better aligning our services strategy with HP's overall strategy to better enable us to meet the needs of our customers. We are also creating innovative new products and developing new channels to connect with our customers. In addition, we have been making focused investments in innovation to strengthen our portfolio of products and services that we can offer to our customers, both through organic investments as well as through acquisitions, including our recently announced offer to acquire all of the issued and to be issued share capital of Autonomy Corporation plc ("Autonomy"). Once completed, the addition of Autonomy is expected to accelerate HP's offerings in cloud-based solutions and software that address the changing needs of businesses and support the IPG enterprise strategy to continue its growth in document and content management. These investments will allow us to expand in higher margin and higher growth industry segments and further strengthen our portfolio of hardware, software and services.
Leveraging our Portfolio and Scale
We now offer one of the IT industry's broadest portfolios of products and services, and we leverage that portfolio to our strategic advantage. For example, we are able to provide servers, storage and networking products packaged with services that can be delivered to customers in the manner of their choosing, be it in-house, outsourced as a service via the Internet or via a hybrid environment. Our portfolio of management software completes the package by allowing our customers to manage their IT operations in an efficient and cost-effective manner. In addition, we are working to optimize our supply chain by eliminating complexity, reducing fixed costs, and leveraging our scale to ensure the availability of components at favorable prices even during shortages. We are also expanding our use of industry standard components in our enterprise products to further leverage our scale.
Driving Operational Excellence
We are continuing to work to optimize operational excellence across the company. Operational excellence remains critical to the success of HP, and we are implementing effectiveness, productivity and quality initiatives throughout the company. For example, we are continuing to execute our ongoing initiatives to transform our supply chain and leverage our corporate infrastructure and to maximize the efficiency of our research and development efforts. We are also continuing to execute on our multi-year program to consolidate real estate locations worldwide to fewer core sites in order to optimize our IT spending and real estate costs. In addition, we are continuing to implement the restructuring plan announced in June 2010 relating to our enterprise services business. See Note 6 to the Consolidated Condensed Financial Statements in Item 1 for further discussion of this restructuring plan and the associated restructuring charges.
57
The following provides an overview of our key financial metrics in the third quarter and first nine months of fiscal 2011 and demonstrates how our execution has translated into financial performance:
|
HP(1) Consolidated |
Services | ESSN | HP Software |
PSG | IPG | HPFS | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
In millions, except per share amounts |
||||||||||||||||||||||
Three Months Ended July 31 |
|||||||||||||||||||||||
Net revenue |
$ | 31,189 | $ | 9,089 | $ | 5,396 | $ | 780 | $ | 9,592 | $ | 6,087 | $ | 932 | |||||||||
Year-over-year net revenue % increase (decrease) |
1.5 | % | 3.6 | % | 7.5 | % | 20.0 | % | (3.3 | )% | (1.3 | )% | 22.0 | % | |||||||||
Earnings from operations |
$ | 2,520 | $ | 1,225 | $ | 699 | $ | 151 | $ | 567 | $ | 892 | $ | 88 | |||||||||
Earnings from operations as a % of net revenue |
8.1 | % | 13.5 | % | 13.0 | % | 19.4 | % | 5.9 | % | 14.7 | % | 9.4 | % | |||||||||
Net earnings |
$ | 1,926 | |||||||||||||||||||||
Net earnings per share |
|||||||||||||||||||||||
Basic |
$ | 0.94 | |||||||||||||||||||||
Diluted |
$ | 0.93 | |||||||||||||||||||||
Nine Months Ended July 31 |
|||||||||||||||||||||||
Net revenue |
$ | 95,123 | $ | 26,673 | $ | 16,586 | $ | 2,241 |