SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
COMMISSION FILE NUMBER 1-9026
COMPAQ COMPUTER CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 76-0011617
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20555 SH 249, HOUSTON, TEXAS 77070
(281) 370-0670
(Address, including zip code, and telephone number, including area
code, of registrant's principal executive offices)
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 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 [X] No [ ]
The number of shares of the registrant's Common Stock, $.01 par value,
outstanding as of September 30, 2000, was approximately 1.7 billion.
<PAGE>
COMPAQ COMPUTER CORPORATION
FORM 10-Q
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
PART I
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risks 24
PART II
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
(In millions, except par value) 2000 1999
--------------- ---------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................................................... $ 2,927 $ 2,666
Short-term investments .................................................................. -- 636
Trade accounts receivable, net .......................................................... 6,551 5,622
Leases and other accounts receivable .................................................... 1,496 1,063
Inventories ............................................................................. 2,427 2,008
Other current assets .................................................................... 1,565 1,854
--------------- ---------------
Total current assets ............................................................... 14,966 13,849
Property, plant and equipment, net ......................................................... 3,298 3,249
Other assets, net .......................................................................... 8,129 10,179
--------------- ---------------
$ 26,393 $ 27,277
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings ................................................................... $ 489 $ 453
Accounts payable ........................................................................ 4,737 4,380
Deferred income ......................................................................... 1,037 972
Other current liabilities ............................................................... 5,851 6,033
--------------- ---------------
Total current liabilities .......................................................... 12,114 11,838
--------------- ---------------
Long-term debt ............................................................................. 575 --
--------------- ---------------
Postretirement and other postemployment benefits ........................................... 682 605
--------------- ---------------
Commitments and contingencies
--------------- ---------------
Stockholders' equity:
Preferred stock, $.01 par value
(authorized: 10 million shares; issued: none) ....................................... -- --
Common stock and capital in excess of $.01 par value
(authorized: 3 billion shares; issued and outstanding:
1,736 million and 1,705 million shares at September 30, 2000 and
1,715 million and 1,694 million shares at December 31, 1999) ........................ 7,936 7,627
Retained earnings ...................................................................... 6,082 4,948
Accumulated other comprehensive income (loss) .......................................... (63) 2,919
Treasury stock ......................................................................... (933) (660)
--------------- ---------------
Total stockholders' equity .......................................................... 13,022 14,834
--------------- ---------------
$ 26,393 $ 27,277
=============== ===============
</TABLE>
See accompanying notes to interim condensed consolidated financial statements.
3
<PAGE>
COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
(In millions, except per share amounts) 2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Products ................................................... $ 9,523 $ 7,587 $ 25,867 $ 23,187
Services ................................................... 1,677 1,621 4,973 4,860
------------ ------------ ------------ ------------
Total revenue .......................................... 11,200 9,208 30,840 28,047
------------ ------------ ------------ ------------
Cost of sales:
Products ................................................... 7,347 6,009 20,065 18,348
Services ................................................... 1,180 1,063 3,527 3,300
------------ ------------ ------------ ------------
Total cost of sales .................................... 8,527 7,072 23,592 21,648
------------ ------------ ------------ ------------
Selling, general and administrative expense .................... 1,502 1,615 4,369 4,824
Research and development ....................................... 382 401 1,092 1,271
Restructuring and related charges .............................. -- 868 -- 868
Gain on sale of businesses ..................................... -- (1,156) -- (1,182)
Other (income) expense, net .................................... (20) 51 (69) 119
------------ ------------ ------------ ------------
1,864 1,779 5,392 5,900
------------ ------------ ------------ ------------
Income before provision for income taxes ....................... 809 357 1,856 499
Provision for income taxes ..................................... 259 217 594 262
------------ ------------ ------------ ------------
Net income ..................................................... $ 550 $ 140 $ 1,262 $ 237
============ ============ ============ ============
Earnings per common share:
Basic ................................................ $ 0.32 $ 0.08 $ 0.74 $ 0.15
============ ============ ============ ============
Diluted .............................................. $ 0.31 $ 0.08 $ 0.72 $ 0.15
============ ============ ============ ============
Shares used in computing earnings per common share:
Basic ................................................ 1,725 1,693 1,701 1,692
============ ============ ============ ============
Diluted .............................................. 1,769 1,730 1,742 1,737
============ ============ ============ ============
</TABLE>
See accompanying notes to interim condensed consolidated financial statements.
4
<PAGE>
COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------
(In millions) 2000 1999
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income .............................................................................. $ 1,262 $ 237
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization ...................................................... 1,062 1,087
Restructuring and related charges .................................................. -- 868
Deferred income taxes .............................................................. 386 (14)
Gain on sale of businesses ......................................................... -- (1,182)
Other .............................................................................. (119) (4)
Changes in operating assets and liabilities, net of
effects of acquired businesses .................................................... (2,303) (431)
--------------- ---------------
Net cash provided by operating activities ...................................... 288 561
--------------- ---------------
Cash flows from investing activities:
Capital expenditures, net ............................................................... (751) (867)
(Increase) decrease in short-term investments ........................................... 636 (1,444)
Increase in investments, net ............................................................ (189) (44)
Acquisitions of businesses, net of cash acquired ........................................ (370) (517)
Other, net .............................................................................. (55) (218)
--------------- ---------------
Net cash used in investing activities .......................................... (729) (3,090)
--------------- ---------------
Cash flows from financing activities:
Increase in short-term borrowings ....................................................... 36 1,312
Issuance of long-term debt ............................................................. 575 --
Payments to retire Digital preferred stock .............................................. -- (400)
Common stock transactions, net .......................................................... (55) (60)
Dividends to stockholders ............................................................... (128) (102)
--------------- ---------------
Net cash provided by financing activities ...................................... 428 750
--------------- ---------------
Effect of exchange rate changes on cash and cash equivalents ............................... 274 (59)
--------------- ---------------
Net increase (decrease) in cash and cash equivalents ........................... 261 (1,838)
Cash and cash equivalents at beginning of period ........................................... 2,666 4,091
--------------- ---------------
Cash and cash equivalents at end of period ................................................. $ 2,927 $ 2,253
=============== ===============
</TABLE>
See accompanying notes to interim condensed consolidated financial statements.
5
<PAGE>
COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------
(In millions) 2000 1999
-------------- --------------
SUPPLEMENTAL CASH FLOW INFORMATION
ACQUISITIONS OF BUSINESSES:
Fair value of:
Assets acquired ...................... $ 499 $ 811
Liabilities assumed .................. (129) (201)
Options issued ....................... -- (60)
-------------- --------------
Cash paid ............................... 370 550
Less: Cash acquired ..................... -- (33)
-------------- --------------
Net cash paid for acquisitions .......... $ 370 $ 517
============== ==============
SALE OF BUSINESSES
Fair value of:
Equity proceeds ......................... $ -- $ 1,597
Note receivable ......................... -- 204
Cash received ........................... -- 70
-------------- --------------
-- 1,871
Less: Basis in net assets sold ............. -- (689)
-------------- --------------
Gain on sale of businesses ................. $ -- $ 1,182
============== ==============
See accompanying notes to interim condensed consolidated financial statements.
6
<PAGE>
COMPAQ COMPUTER CORPORATION
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying interim condensed consolidated financial statements of
Compaq Computer Corporation ("Compaq") as of September 30, 2000 and December 31,
1999 and for the three and nine month periods ended September 30, 2000 and 1999,
respectively, have been prepared on substantially the same basis as Compaq's
annual consolidated financial statements and should be read in conjunction with
Compaq's Annual Report on Form 10-K for the year ended December 31, 1999. The
interim condensed consolidated financial statements reflect all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
presentation of the results for those periods and the financial condition at
those dates. The consolidated results for interim periods are not necessarily
indicative of results to be expected for the full year.
Compaq completed the acquisitions of Shopping.Com ("SDC") and Zip2 Corp.
("Zip2") and purchased certain assets and liabilities of InaCom Corp. ("Inacom")
in February 1999, April 1999 and February 2000, respectively. These transactions
were accounted for as purchases. In August 1999, Compaq sold a majority interest
in SDC, Zip2 and the AltaVista Company, a business acquired in the Digital
Equipment Corporation ("Digital") acquisition (collectively "AltaVista").
Accordingly, Compaq's interim condensed consolidated financial statements
include the results of operations and the estimated fair values of the assets
acquired and liabilities assumed from the respective dates of acquisition
through divestiture or September 30, 2000, as applicable.
NOTE 2 - RECENT PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued,
then subsequently amended, Statement of Financial Accounting Standards No. 133
("FAS 133"), ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. FAS
133, as amended, is effective for all fiscal years beginning after June 15,
2000. This statement establishes a new model for accounting for derivatives and
hedging activities. Under FAS 133, all derivatives must be recognized as assets
and liabilities and measured at fair value. Compaq will adopt FAS 133 effective
January 1, 2001 and is continuing to evaluate the effect that such adoption may
have on its consolidated results of operations and financial position. The
impact of the adoption will be based on factors such as specific derivative and
hedging activities, market conditions and contractual arrangements at the date
of adoption.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), REVENUE RECOGNITION IN FINANCIAL
STATEMENTS. SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition issues in financial statements. In June 2000,
the SEC issued Staff Accounting Bulletin No. 101B ("SAB 101B"), SECOND
AMENDMENT: REVENUE RECOGNITION IN FINANCIAL STATEMENTS. SAB 101B delayed the
implementation date of SAB 101 until no later than the fourth fiscal quarter of
2000. Compaq will adopt SAB 101 pursuant to SAB 101B (including the recent
Frequently Asked Questions and Answers document issued by the SEC in October
2000) as required in the fourth quarter of 2000 and is evaluating the effect
that such adoption may have on its consolidated results of operations and
financial position.
NOTE 3 - ACQUISITIONS
In February 2000, Compaq acquired certain configuration and distribution
assets of Inacom, a provider of information technology services and products,
for approximately $370 million in cash and the assumption of certain related
liabilities. This acquisition was accounted for as a purchase. The estimated
purchase price was allocated to the assets acquired and liabilities assumed,
including goodwill of $230 million. Proforma statements of operations reflecting
this acquisition are not shown as such disclosure is not material. Compaq
entered into a services, supply and sales agreement with Inacom that includes
annual commitments over the next three years, subject to certain conditions, and
related penalties in the
7
<PAGE>
event Compaq does not meet the required targets. As a result of Inacom's filing
for protection under Chapter 11 of the U.S. Bankruptcy Code on June 16, 2000, it
is currently not determinable whether Inacom will have the ability to perform
under this agreement. Compaq also provided a commitment to Inacom to enter into
a $55.5 million secured credit facility, subject to certain conditions. Inacom
has not borrowed any funds against this credit facility and, as a result of
Inacom's bankruptcy filing, Compaq no longer has a lending obligation to Inacom.
In August 1999, Compaq sold a majority interest in AltaVista and
accordingly recognized a gain of $1.2 billion ($670 million, net of tax).
NOTE 4 - CERTAIN BALANCE SHEET COMPONENTS
Raw materials, work in progress and finished goods were $774 million, $269
million and $1.4 billion, respectively, at September 30, 2000 and $448 million,
$394 million and $1.2 billion, respectively, at December 31, 1999.
Accumulated depreciation was $3.0 billion and $2.8 billion at September
30, 2000 and December 31, 1999, respectively.
At September 30, 2000 and December 31, 1999, Compaq held $2.4 billion and
$6.6 billion of equity investments, respectively, included in other non-current
assets. As of September 30, 2000, both the cost basis and fair value of Compaq's
available for sale investments were approximately $1.8 billion, and gross
unrealized gains and losses were approximately $500 million each. As of October
23, 2000, the fair value of these same available for sale investments was $1.2
billion.
Compaq filed a $2 billion shelf registration statement for debt securities
with the Securities Exchange Commission during the second quarter of 2000, which
was declared effective on June 16, 2000. In August 2000, Compaq placed under the
registration statement $300 million of unsecured 7.65 percent notes that mature
on August 1, 2005, and $275 million of unsecured 7.45 percent notes that mature
on August 1, 2002 (collectively, the "Notes"), unless previously redeemed.
Interest will be paid on the Notes on February 1 and August 1 of each year,
beginning on February 1, 2001. The fair value of the Notes approximates carrying
value. The financing is for general corporate purposes (including investments in
Compaq Financial Services and other subsidiaries), capital expenditures, and
repayment of outstanding indebtedness (including commercial paper issued for
working capital purposes). Compaq has the capacity to issue an additional $1.4
billion of debt securities under the shelf registration statement.
On July 27, 2000, the board of directors of Compaq approved a cash
dividend of $0.025 per share of common stock, or approximately $43 million, to
stockholders of record as of September 29, 2000, paid on October 20, 2000. On
July 22, 1999, the board of directors of Compaq approved a cash dividend of
$0.02 per share of common stock, or approximately $34 million, to stockholders
of record as of September 30, 1999, paid on October 20, 1999.
NOTE 5 - COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, are listed
below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------- -----------------------------------
(IN MILLIONS) 2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Net income ........................................ $ 550 $ 140 $ 1,262 $ 237
Other comprehensive income (loss):
Foreign currency translations .................. 1 3 3 (20)
Unrealized gains (losses) on investments ....... (647) 574 (2,985) 639
--------------- --------------- --------------- ---------------
Comprehensive income (loss) ....................... $ (96) $ 717 $ (1,720) $ 856
=============== =============== =============== ===============
</TABLE>
8
<PAGE>
NOTE 6 - OTHER INCOME AND EXPENSE
Other (income) and expense consisted of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- --------------------
(IN MILLIONS) 2000 1999 2000 1999
--------- --------- --------- ---------
Interest and dividend income $ (108) $ (53) $ (200) $ (137)
Investment income, net (38) (8) (144) (17)
Interest expense 74 55 204 148
Currency losses 37 60 64 94
Other (income) expense 15 (3) 7 31
--------- --------- --------- ---------
$ (20) $ 51 $ (69) $ 119
========= ========= ========= =========
NOTE 7 - EARNINGS PER COMMON SHARE
Basic earnings per common share is computed using the weighted average
number of common shares outstanding during the period. Diluted earnings per
common share is computed using the combination of dilutive common share
equivalents and the weighted average number of common shares outstanding during
the period. Incremental shares of 44 million, 37 million, 41 million and 45
million were used in the calculation of diluted earnings per share for the three
month periods ended September 30, 2000 and 1999, and the nine month periods
ended September 30, 2000 and 1999, respectively.
Stock options to purchase 39 million and 70 million shares of common stock
for the three month periods and 41 million and 47 million shares of common stock
for the nine month periods ended September 30, 2000 and 1999, respectively, were
outstanding but not included in the computation of diluted earnings per common
share because the option exercise price was greater than the average market
price of the common shares.
For the nine months ended September 30, 1999, net income used in the
calculation of earnings per common share was adjusted to include a $22 million
gain on the redemption of Digital preferred stock.
NOTE 8 - SEGMENT DATA
During the quarter ended June 30, 2000, Compaq realigned the operations of
its Enterprise Solutions and Services segment, which resulted in the formation
of two reportable segments: Enterprise Computing and Compaq Global Services.
Enterprise Computing designs, develops, manufactures and markets advanced
computing and telecommunication products, including business-critical servers,
industry-standard servers and storage products. Compaq Global Services delivers
worldwide infrastructure design, implementation and management services through
its Professional and Customer Services groups. Compaq's other two reportable
segments, Commercial Personal Computing and Consumer, were unaffected by the
realignment. Financial data for prior periods has been restated to conform to
the current presentation.
9
<PAGE>
Summary financial data by business segment follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
ENTERPRISE COMPUTING
Revenue .......................................... $ 3,794 $ 3,195 $ 10,188 $ 9,548
Operating income ................................. 597 295 1,411 762
COMMERCIAL PERSONAL COMPUTING
Revenue .......................................... 3,477 2,727 9,662 9,052
Operating income (loss) .......................... 133 (169) 176 (369)
CONSUMER
Revenue .......................................... 2,127 1,469 5,551 4,028
Operating income ................................. 63 65 176 193
COMPAQ GLOBAL SERVICES
Revenue .......................................... 1,715 1,745 5,184 5,262
Operating income ................................. 254 304 703 873
OTHER
Revenue .......................................... 87 72 255 157
Operating income (loss) .......................... 5 (101) 28 (280)
CONSOLIDATED SEGMENT TOTALS
Revenue .......................................... $ 11,200 $ 9,208 $ 30,840 $ 28,047
Operating income ................................. 1,052 $ 394 $ 2,494 $ 1,179
</TABLE>
A reconciliation of Compaq's consolidated segment operating income to
consolidated income before provision for income taxes follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------ ------------ ------------ ------------
(IN MILLIONS) 2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Consolidated segment operating income .......................... $ 1,052 $ 394 $ 2,494 $ 1,179
Corporate and unallocated shared expenses ...................... (243) (325) (638) (994)
Restructuring and related charges .............................. -- (868) -- (868)
Gain on sale of businesses ..................................... -- 1,156 -- 1,182
------------ ------------ ------------ ------------
Income before provision for income taxes ....................... $ 809 $ 357 $ 1,856 $ 499
============ ============ ============ ============
</TABLE>
NOTE 9 - RESTRUCTURING AND RELATED CHARGES
In September 1999, Compaq's management approved a restructuring plan to
realign Compaq's organization, reduce infrastructure and overhead, and eliminate
excess and duplicative facilities. Restructuring and related charges of $868
million ($600 million, net of tax) were expensed. These charges were composed of
$787 million of accrued restructuring costs, $58 million of related asset
impairment charges and a $23 million pension curtailment loss to recognize a
change in Compaq's projected pension benefit obligation in connection with
employee separations. Components of accrued restructuring costs and amounts
charged against the provision as of September 30, 2000 were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, SEPTEMBER 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Employee separations ............................ $ 491 $ (68) $ 423 $ (204) $ 219
Facility closure costs .......................... 96 -- 96 (10) 86
Contract cancellation and other exit costs ...... 200 (167) 33 (16) 17
------------ ------------ ------------ ------------ ------------
$ 787 $ (235) $ 552 $ (230) $ 322
============ ============ ============ ============ ============
</TABLE>
10
<PAGE>
Accrued restructuring costs for employee separations related to
approximately 7,000 employees worldwide affecting the majority of business
functions, job classes and regions, predominantly occurring in North America and
Europe. Employee separation benefits include severance, medical and other
benefits.
In June 1998, Compaq recorded a restructuring charge of approximately $1.7
billion to integrate the operations of Compaq and Digital, consolidate
duplicative facilities, improve service delivery and reduce overhead.
Approximately $1.5 billion was related to the acquisition of Digital and
recorded as a component of purchase accounting and $286 million related to
Compaq and was charged to operations. Compaq has completed most of the actions
contemplated under the restructuring plan. Accrued restructuring costs as of
September 30, 2000 and amounts charged against the provision were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, SEPTEMBER 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Employee separations ........................... $ 1,131 $ (962) $ 169 $ (123) $ 46
Facility closure costs ......................... 414 (184) 230 (42) 188
Relocation ..................................... 99 (65) 34 (13) 21
Other exit costs ............................... 100 (83) 17 (12) 5
------------ ------------ ------------ ------------ ------------
$ 1,744 $ (1,294) $ 450 $ (190) $ 260
============ ============ ============ ============ ============
</TABLE>
Accrued restructuring costs under both plans at September 30, 2000 include
amounts for actions that have already been taken, but for which expenditures
have not yet been made. Compaq expects to substantially complete the initiatives
contemplated in its restructuring plans in 2000.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
LITIGATION
Compaq is subject to legal proceedings and claims that arise in the
ordinary course of business. Compaq does not believe that the outcome of any of
those matters will have a material adverse effect on Compaq's consolidated
financial position, operating results or cash flows.
Compaq and certain of its current and former officers and directors are
named in two consolidated class action lawsuits pending in the United States
District Court for the Southern District of Texas, Houston Division. One lawsuit
was filed in 1998 and the other in 1999. The 1998 litigation consolidates five
class action lawsuits, brought by persons who purchased Compaq common stock from
July 10, 1997 through March 6, 1998. It asserts claims under Section 10(b) of
the Exchange Act and Rule 10b-5 promulgated thereunder and Section 20(a) of the
Exchange Act. Allegations in the 1998 lawsuit include the claim that the
defendants withheld information and made misleading statements about channel
inventory and factoring of receivables in order to inflate the market price of
Compaq's common stock and further alleges that certain of the individual
defendants sold Compaq common stock at the inflated prices. The 1999 litigation
also consolidates a number of class action lawsuits. The litigation is brought
on behalf of purchasers of Compaq common stock between January 27, 1999 and
April 9, 1999. It asserts claims for alleged violations of Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder; Section 20(a) of the
Exchange Act; and Sections 11 and 15 of the Securities Act. Allegations in the
1999 litigation include the claim that certain defendants and Compaq issued a
series of materially false and misleading statements concerning Compaq's
prospects in 1999 in order to inflate the market price of Compaq's common stock
and further alleges that certain of the individual defendants sold Compaq common
stock at the inflated prices. Lead counsels for the plaintiffs have been
appointed in both the 1998 and 1999 litigation. The plaintiffs seek monetary
damages, interest, costs and expenses in both the 1998 and 1999 litigation. In
the 1998 litigation, the court entered an order granting class certification on
July 18, 2000. Compaq has appealed class certification and is awaiting a
decision. In the interim, the 1998 case is proceeding with discovery and is
subject to being called to trial in September 2001. In the 1999 litigation,
Compaq has filed a motion seeking to have the complaint dismissed and is
awaiting a ruling. Compaq is vigorously defending both lawsuits.
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<PAGE>
Several purported class action lawsuits were filed against Digital during
1994 alleging violations of the Federal Securities laws arising from alleged
misrepresentations and omissions in connection with Digital's issuance and sale
of Series A 8 7/8 percent Cumulative Preferred Stock and Digital's financial
results for the quarter ended April 2, 1994. During 1995, the lawsuits were
consolidated into three cases, which were pending before the United States
District Court for the District of Massachusetts. On August 8, 1995, the
Massachusetts federal court granted the defendants' motion to dismiss all three
cases in their entirety. On May 7, 1996, the United States Court of Appeals for
the First Circuit affirmed in part and reversed in part the dismissal of two of
the cases, and remanded for further proceedings. The parties are proceeding with
discovery.
Compaq is vigorously defending seven consumer class action lawsuits
alleging various defects in computers sold by Compaq. These lawsuits are pending
in Texas, North Carolina, Illinois, California and Washington. All of these
cases are in the discovery stage. Three of these class actions (Thurmond v.
Compaq, LaPray v. Compaq, and Sprung v. Compaq) are part of a series of similar
lawsuits filed against other major computer manufacturers, involving claims that
the computer industry sold computers with allegedly defective floppy disk
controllers. Thurmond is pending in federal district court in Beaumont, Texas;
LaPray in Texas state court in Beaumont; Sprung in Colorado federal district
court. No class has been certified in any of these cases. Compaq is also
providing information to the federal government and state attorneys general in
California and Illinois in response to inquiries regarding floppy disk
controllers in computers sold to government entities.
CONTINGENCIES
Non-current other assets as of September 30, 2000 included approximately
$98 million owed to Compaq in connection with the sale of products. Compaq
believes such amounts were misdirected by its customers to Inacom, which was
acting as agent for Compaq in connection with such sales. Compaq believes that
such funds were improperly applied to reduce Inacom's indebtedness to its
lenders. As a result of Inacom's bankruptcy filing on June 16, 2000, Compaq is
seeking to realize the full value of these receivables in Inacom's bankruptcy
proceedings and has filed litigation against Inacom and Inacom's lenders, as the
ultimate recipients of Compaq's funds. Inacom has sued Compaq for approximately
$46 million that Compaq is holding as a setoff against the $98 million. Whether
these receivables have been impaired, and if so by what amount, cannot be
determined at this time. Compaq does not believe that the outcome of this matter
will have a material adverse effect on Compaq's consolidated financial position.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Founded in 1982, Compaq Computer Corporation ("Compaq"), a Fortune Global
100 company, is the largest supplier of computing systems in the world. Compaq
designs, develops, manufactures and markets hardware, software, solutions and
services, including industry-leading enterprise computing solutions,
fault-tolerant business-critical solutions, communication products, commercial
desktop and portable products, and consumer desktop and portable products.
The following discussion should be read in conjunction with the interim
condensed consolidated financial statements presented in Item 1.
RESULTS OF OPERATIONS
Compaq completed the acquisitions of Shopping.Com ("SDC") and Zip2 Corp.
("Zip2") and purchased certain assets and liabilities of InaCom Corp. ("Inacom")
in February 1999, April 1999 and February 2000, respectively. These transactions
were accounted for as purchases. In August 1999, Compaq sold a majority interest
in SDC, Zip2 and the AltaVista Company, a business acquired in the Digital
Equipment Corporation ("Digital") acquisition (collectively "AltaVista").
Accordingly, Compaq's interim condensed consolidated financial statements
include the results of operations and the estimated fair values of the assets
acquired and liabilities assumed from the respective dates of acquisition
through divestiture or September 30, 2000, as applicable.
During the quarter ended June 30, 2000, Compaq realigned the operations of
its Enterprise Solutions and Services segment, which resulted in the formation
of two reportable segments: Enterprise Computing and Compaq Global Services.
Enterprise Computing designs, develops, manufactures and markets advanced
computing and telecommunication products, including business-critical servers,
industry-standard servers and storage products. Compaq Global Services delivers
worldwide infrastructure design, implementation and management services through
its Professional and Customer Services groups. Compaq's other two reportable
segments, Commercial Personal Computing and Consumer, were unaffected by the
realignment. Financial data for prior periods has been restated to conform to
the current presentation.
Summary financial data by business segment follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------- ----------------------------------
(IN MILLIONS) 2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
ENTERPRISE COMPUTING
Revenue ...................................... $ 3,794 $ 3,195 $ 10,188 $ 9,548
Operating income ............................. 597 295 1,411 762
COMMERCIAL PERSONAL COMPUTING
Revenue ...................................... 3,477 2,727 9,662 9,052
Operating income (loss) ...................... 133 (169) 176 (369)
CONSUMER
Revenue ...................................... 2,127 1,469 5,551 4,028
Operating income ............................. 63 65 176 193
COMPAQ GLOBAL SERVICES
Revenue ...................................... 1,715 1,745 5,184 5,262
Operating income ............................. 254 304 703 873
OTHER
Revenue ...................................... 87 72 255 157
Operating income (loss) ...................... 5 (101) 28 (280)
CONSOLIDATED SEGMENT TOTALS
Revenue ...................................... $ 11,200 $ 9,208 $ 30,840 $ 28,047
Operating income ............................. $ 1,052 $ 394 $ 2,494 $ 1,179
</TABLE>
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<PAGE>
A reconciliation of Compaq's consolidated segment operating income to
consolidated income before provision for income taxes follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------- -----------------------------------
(IN MILLIONS) 2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Consolidated segment operating income .............. $ 1,052 $ 394 $ 2,494 $ 1,179
Corporate and unallocated shared expenses .......... (243) (325) (638) (994)
Restructuring and related charges .................. -- (868) -- (868)
Gain on sale of businesses ......................... -- 1,156 -- 1,182
--------------- --------------- --------------- ---------------
Income before provision for income taxes ........... $ 809 $ 357 $ 1,856 $ 499
=============== =============== =============== ===============
</TABLE>
OVERVIEW
Compaq reported third quarter and nine month consolidated revenue of $11.2
billion and $30.8 billion, respectively, an increase of 22 percent and 10
percent compared with the prior year periods. Adjusted for the effects of
currency, revenue grew 26 percent and 14 percent for the three and nine months
ended September 30, 2000, respectively, when compared to the comparable periods
in the prior year. Strong growth in Consumer, Commercial Personal Computing and
Enterprise Computing drove higher revenue. In addition, revenue grew
significantly across all regions during the quarter.
Consolidated gross margin of $2.7 billion (23.9 percent of revenue) and
$7.2 billion (23.5 percent of revenue) for the three and nine months ended
September 30, 2000, respectively, was an improvement of 0.7 percentage points
over each of the comparable periods in 1999. Stronger margins in Commercial
Personal Computing and Enterprise Computing led to the overall improvement in
gross margin.
Consolidated operating expense was $1.9 billion and $5.5 billion for the
three and nine months ended September 30, 2000, respectively. Driven by solid
execution of spending discipline, operating expense declined $132 million, or 7
percent, and $634 million, or 10 percent, compared to the comparable periods in
1999. As a percentage of revenue, operating expense declined significantly to
16.8 percent and 17.7 percent for the three and nine months ended September 30,
2000, respectively, from 21.9 percent and 21.7 percent in the comparable prior
year periods. Lower operating expense benefited from Compaq's intense focus on
reducing its cost structure and driving shareholder value. This is being
accomplished through restructuring actions initiated during 1998 and 1999 as
well as other cost containment measures begun by management in the second half
of 1999.
The effective tax rate was 32 percent for the three and nine months ended
September 30, 2000. The effective tax rate was 61 percent and 53 percent for the
comparable periods in 1999. The higher effective tax rate in 1999 was primarily
due to a non-deductible stock option compensation charge and tax rates related
to the gain on sale of businesses and restructuring and related charges.
Compaq reported consolidated net income of $550 million, or $0.31 per
diluted common share, for the third quarter of 2000 compared to consolidated net
income of $140 million, or $0.08 per diluted common share, for the corresponding
period in 1999. Adjusted for net investment income of $25 million (after tax),
earnings per diluted common share were $0.30 for the third quarter of 2000.
Adjusted for non-recurring items, earnings per diluted common share were $0.07
for the third quarter of 1999.
Consolidated net income was $1.3 billion, or $0.72 per diluted common
share, for the nine months ended September 30, 2000 compared to $237 million, or
$0.15 per diluted common share, for the same period in 1999. Adjusted for net
investment income of $94 million (after tax), earnings per diluted common share
were $0.67 for the nine months ended September 30, 2000. Adjusted for
non-recurring items, earnings per diluted common share were $0.11 for the nine
months ended September 30, 1999.
14
<PAGE>
ENTERPRISE COMPUTING
Enterprise Computing designs, develops, manufactures and markets advanced
computing and telecommunication products, including business-critical servers,
industry-standard servers and storage products.
REVENUE
Enterprise Computing revenue increased $599 million, or 19 percent,
compared with the third quarter of 1999 and represented 34 percent of
consolidated revenue during the quarter. On a year to date basis, revenue from
this segment increased $640 million, or 7 percent, compared to the nine months
ended September 30, 1999.
Enterprise Computing revenue consisted of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------- ----------------------------------
(IN MILLIONS) 2000 1999 2000 1999
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Industry Standard Servers(1) ........................... $ 1,586 $ 1,126 $ 4,266 $ 3,332
Storage Products ....................................... 1,395 1,281 3,654 3,712
Business Critical Servers(1) ........................... 813 772 2,265 2,420
Other .................................................. -- 16 3 84
--------------- --------------- --------------- ---------------
$ 3,794 $ 3,195 $ 10,188 $ 9,548
=============== =============== =============== ===============
</TABLE>
Industry Standard Servers revenue grew 41 percent during the quarter as
compared to the prior year. Revenue benefited from strong demand across all
regions as corporations and Internet service providers continued to build out
their data centers. Revenue growth was strongest in the dense, rack-optimized
form-factors as an increasing number of customers value the simplicity and space
saving economies provided by dense servers. High-end servers revenue also
remained strong with solid sales in 4-way and 8-way servers.
Storage Products revenue increased 9 percent during the quarter compared
to the prior year as strong enterprise storage (external storage, software and
high-end tape) sales growth of 44 percent offset the continued price pressure on
the hard disk drive component of attached storage. Enterprise storage growth was
driven by the ongoing trend towards storage area networks. Storage capacity
shipped was 19,000 terabytes, an increase of 60 percent compared to the third
quarter of 1999.
Business Critical Servers revenue increased during the quarter primarily
due to increased sales of ALPHASERVER(TM) GS systems offset by lower Compaq
HIMALAYA(TM) system sales. The decrease in Business Critical Server revenue on a
year to date basis was primarily driven by the product transition to the
ALPHASERVER GS systems and related component shortages. Compaq shipped over 400
ALPHASERVER GS systems during the quarter. This represented a substantial
increase over the second quarter of 2000, as the previously experienced
component shortage issues have largely been resolved.
OPERATING INCOME
Enterprise Computing operating income increased $302 million, or 102
percent, in the third quarter of 2000 as compared to the corresponding period in
1999. For the nine months ended September 30, 2000, operating income increased
$649 million, or 85 percent, compared to the same period in the prior year.
------------------------
(1) Compaq ALPHASERVER(TM) and PROLIANT(TM) product revenue does not include
attached and enterprise storage, which is captured in Storage Products.
15
<PAGE>
Third quarter 2000 operating income was higher compared with the
corresponding period in 1999 primarily due to strong performance in Industry
Standard Servers and Storage Products, as well as lower operating expenses.
Industry Standard Server gross margin improved due to a continued favorable
shift in product mix. Storage Products gross margin also improved due to a shift
in product mix to higher margin enterprise storage products. Operating expense
declined in whole dollars and as a percentage of revenue in the Enterprise
Computing segment for the quarter and year to date periods due to stringent cost
control practices.
Operating income increased during the nine months ended September 30, 2000
as compared to the prior year period due to stronger Industry Standard Server
and Storage Products performance.
COMMERCIAL PERSONAL COMPUTING
Commercial Personal Computing delivers standards-based computing
emphasizing Internet access through workstations, desktops, portables, monitors,
Internet access devices and life-cycle management products. As previously
reported, Compaq completed the purchase of key assets from InaCom Corp.
("Inacom") during the first quarter of 2000 and subsequently established Custom
Edge Incorporated ("Custom Edge") as a wholly owned subsidiary. This purchase
adds custom configuration capabilities and direct fulfillment logistics that
enable Compaq to better meet customer needs in North America.
REVENUE
Commercial Personal Computing revenue increased $750 million, or 28
percent, compared with the third quarter of 1999 and represented 31 percent of
consolidated revenue during the quarter. Revenue for the year to date period
increased $610 million, or 7 percent.
Revenue increased across all regions during the quarter, benefiting from
strong unit sales growth in higher margin portable product lines. Unit sales of
desktops, including the Compaq IPAQ(TM) desktop, also increased. Continuing in
the migration to Internet access devices, the new Compaq IPAQ(TM) Blackberry
Wireless Email Solutions device was announced in August. Revenue growth for the
year to date period ended September 30, 2000 was primarily due to higher unit
sales of portables and Internet products.
OPERATING INCOME
Commercial Personal Computing operating income increased $302 million,
from a loss of $169 million to income of $133 million compared to the third
quarter of 1999. On a year to date basis, operating income increased $545
million, from a loss of $369 million to income of $176 million.
Operating results strengthened dramatically in this segment for the
quarter and year to date periods due to continued improvement in the business
model, including further integration of the Custom Edge fulfillment capacity,
and successful reduction of operating costs. Gross margins were strong due to a
favorable product configuration mix, an improved business model and supply chain
efficiencies. Operating expense continues to decline due to persistent focus on
streamlining processes and increasing efficiencies.
CONSUMER
The Consumer segment targets home users with Internet-ready desktop PCs,
portables, printers and related products, as well as Internet access and
e-services.
16
<PAGE>
REVENUE
Consumer revenue increased $658 million, or 45 percent, in the third
quarter of 2000 compared with the corresponding quarter in 1999 and accounted
for 19 percent of consolidated revenue. On a year to date basis, revenue
increased $1.5 billion, or 38 percent, compared to the prior year.
Revenue in the Consumer business improved significantly during the three
and nine months ended September 30, 2000 compared to the prior year primarily
due to continued international expansion and substantial growth in unit sales. A
strong back to school season, higher attach rates for printers and monitors, and
a shift in product mix toward portables contributed to higher revenue. The
Consumer segment continues to hold the number one worldwide consumer PC market
share position (according to International Data Corporation).
The "beyond the box" business, which includes Internet access, Internet
traffic, printers, software, financing and warranty upgrades, increased 90
percent during the quarter compared to the third quarter of 1999.
OPERATING INCOME
Consumer operating income declined $2 million, or 3 percent, in the third
quarter of 2000 compared to the prior year period. On a year to date basis,
operating income declined $17 million, or 9 percent.
Such declines were primarily due to lower gross margin as a percentage of
revenue, which was pressured by competitive pricing in North America and costs
related to holding raw material in a supply constrained environment in order to
meet customer demand. Operating expenses increased in whole dollars due to
higher customer support costs, but declined as a percentage of revenue.
COMPAQ GLOBAL SERVICES
Compaq Global Services delivers worldwide infrastructure and solution
design implementation, management, and support services through its Professional
and Customer Services groups. Revenue was as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
(IN MILLIONS) 2000 1999 2000 1999
---------- ---------- ---------- ----------
Customer Services ........ $ 1,052 $ 1,041 $ 3,226 $ 3,205
Professional Services .... 663 704 1,958 2,057
---------- ---------- ---------- ----------
$ 1,715 $ 1,745 $ 5,184 $ 5,262
========== ========== ========== ==========
REVENUE
Compaq Global Services revenue decreased $30 million, or 2 percent,
compared with the third quarter of 1999. This segment represented 15 percent of
consolidated revenue during the quarter. For the nine months ended September 30,
2000, Compaq Global Services revenue declined $78 million, or 1 percent,
compared to the corresponding period in the prior year. Adjusted for the effects
of currency, revenue increased 3 percent for the quarter and year to date
periods.
The decline in Compaq Global Services revenue during the quarter and nine
months ended September 30, 2000 was primarily a result of lower Professional
Services revenue. Adjusted for the effects of currency, Professional Services
revenue declined 2 percent. Revenue improved over the second quarter of 2000
primarily due to growth in new outsourcing contracts. Compaq has narrowed its
focus for Professional Services to target seven practices that are consistent
with its Internet strategy and is now
17
<PAGE>
realigning its workforce to support growth plans. Customer Services revenue grew
5 percent adjusted for the effects of currency, in line with the market.
As previously reported, Compaq has integrated its services organization
with its Worldwide Sales and Marketing organization to create Worldwide Sales
and Services. This has strengthened Compaq's go-to-market capability and
reinforced its customer alignment.
OPERATING INCOME
Compaq Global Services operating income declined $50 million, or 16
percent, in the third quarter of 2000 as compared to the corresponding period in
1999. On a year to date basis, operating income decreased $170 million, or 19
percent.
Profitability in the Customer Services business remains strong.
Professional Services operating results were lower for the three and nine months
ended September 30, 2000 compared to the prior year periods primarily due to
workforce rebalancing and continued reskilling.
CORPORATE AND UNALLOCATED SHARED EXPENSES
The results of the business segments exclude separately managed corporate
and unallocated shared expenses, which are comprised primarily of general and
administrative costs as well as other income and expense items not controlled by
the business segments. Corporate and unallocated shared expenses decreased from
$325 million in the third quarter of 1999 to $243 million in the third quarter
of 2000, a decline of 25 percent. On a year to date basis, corporate and
unallocated shared expenses decreased from $994 million to $638 million, or 36
percent. This decrease reflected management's continued intense efforts to
reduce operating expense as well as a favorable change in other income and
expense items.
RESTRUCTURING AND RELATED CHARGES
In September 1999, Compaq's management approved a restructuring plan to
realign Compaq's organization, reduce infrastructure and overhead, and eliminate
excess and duplicative facilities. Restructuring and related charges of $868
million ($600 million, net of tax) were expensed. These charges were composed of
$787 million of accrued restructuring costs, $58 million of related asset
impairment charges and a $23 million pension curtailment loss to recognize a
change in Compaq's projected pension benefit obligation in connection with
employee separations. Components of accrued restructuring costs and amounts
charged against the provision as of September 30, 2000 were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, SEPTEMBER 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Employee separations .......................... $ 491 $ (68) $ 423 $ (204) $ 219
Facility closure costs ........................ 96 -- 96 (10) 86
Contract cancellation and other exit costs .... 200 (167) 33 (16) 17
------------ ------------ ------------ ------------ ------------
$ 787 $ (235) $ 552 $ (230) $ 322
============ ============ ============ ============ ============
</TABLE>
Accrued restructuring costs for employee separations related to
approximately 7,000 employees worldwide affecting the majority of business
functions, job classes and regions, predominantly occurring in North America and
Europe. Employee separation benefits include severance, medical and other
benefits.
In June 1998, Compaq recorded a restructuring charge of approximately $1.7
billion to integrate the operations of Compaq and Digital, consolidate
duplicative facilities, improve service delivery and reduce overhead.
Approximately $1.5 billion was related to the acquisition of Digital and
recorded as a component of purchase accounting and $286 million related to
Compaq and was charged to operations.
18
<PAGE>
Compaq has completed most of the actions contemplated under the restructuring
plan. Accrued restructuring costs as of September 30, 2000 and amounts charged
against the provision were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, SEPTEMBER 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Employee separations .......................... $ 1,131 $ (962) $ 169 $ (123) $ 46
Facility closure costs ........................ 414 (184) 230 (42) 188
Relocation .................................... 99 (65) 34 (13) 21
Other exit costs .............................. 100 (83) 17 (12) 5
------------ ------------ ------------ ------------ ------------
$ 1,744 $ (1,294) $ 450 $ (190) $ 260
============ ============ ============ ============ ============
</TABLE>
Accrued restructuring costs under both plans at September 30, 2000 include
amounts for actions that have already been taken, but for which expenditures
have not yet been made. Compaq expects to substantially complete the initiatives
contemplated in its restructuring plans in 2000. Compaq believes that, upon
conclusion of its restructuring initiatives, its cost structure will be
significantly reduced. However, there can be no assurance that such cost
reductions can be sustained or that the estimated costs of such actions will not
change.
Total regular employee headcount increased from approximately 67,700 at
December 31, 1999 to approximately 69,800 at September 30, 2000. The increase
resulted primarily from employee additions of approximately 2,500 related to the
Inacom asset acquisition as well as selective hiring. This increase was offset
in part by employee separations of approximately 900 and 3,500 due to the 1998
and 1999 restructuring actions, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Compaq's cash and cash equivalents increased to $2.9 billion at September
30, 2000, from $2.7 billion at December 31, 1999.
Net cash provided by operations was comprised of $2.6 billion in net
income adjusted for non-cash items, partially offset by $2.3 billion used in
working capital and other activities. Net cash used in working capital and other
activities resulted primarily from an increase in receivables and a decrease in
accrued restructuring. Net trade accounts receivable were $6.6 billion and $5.6
billion at September 30, 2000 and December 31, 1999, respectively. Days sales
outstanding for the quarter increased to 52 days compared to 48 days in the
fourth quarter of 1999. The increase in days sales outstanding was driven by a
higher level of sales near the end of the third quarter of 2000, relative to the
fourth quarter of 1999. Inventory levels increased to $2.4 billion at September
30, 2000, compared to $2.0 billion at December 31, 1999. Inventory turns for the
third quarter of 2000 decreased to 14.0 compared to 16.1 for the fourth quarter
of 1999. The increase in inventory was partially due to higher raw material
inventory levels at September 30, 2000 as Compaq took a proactive position on
certain components given supply conditions in the quarter.
Net cash used in investing activities resulted from the following items.
Compaq paid cash of $370 million for the purchase of certain assets and
liabilities from Inacom. Compaq also used cash of $751 million for capital
expenditures, net of disposals; $189 million for net investment activity; and
$55 million for other investing activities during the nine months ended
September 30, 2000. These uses of cash were partially offset by proceeds from
short-term investments of $636 million.
Future uses of cash for the remainder of 2000 include capital expenditures
for land, buildings and equipment which are estimated to be $300 million;
purchases of equipment to be leased to third parties of approximately $200
million; cash expenditures related to restructuring activities; and cash
payments for common stock repurchases and dividends.
At September 30, 2000, the estimated costs to be incurred to develop the
purchased in-process technology acquired in the Digital acquisition into
commercially viable products totaled $1.9 billion in
19
<PAGE>
the aggregate through the year 2005 ($120 million in the remainder of 2000, $580
million in 2001, $560 million in 2002, $430 million in 2003, $240 million in
2004 and $10 million in 2005).
Compaq currently expects to fund expenditures for capital requirements as
well as liquidity needs from a combination of available cash balances,
internally generated funds and financing arrangements. Compaq obtained a $2.2
billion 364 day revolving credit facility on September 29, 2000 that bears
interest at LIBOR plus 0.625 percent and expires in September 2001. This
facility replaces the $1 billion revolving credit facility that expired during
the quarter. Compaq also has a $3.0 billion revolving credit facility bearing
interest at LIBOR plus 0.325 percent that expires in October 2002. Both of these
facilities were unused at September 30, 2000. Compaq operates two short-term
commercial paper programs: a $1.5 billion program in the name of Compaq Computer
Corporation, and a $1.0 billion program in the name of Compaq Financial Services
("CFS"). Both programs are supported by the $3.0 billion credit facility
described above. Outstanding commercial paper reduces available borrowings under
this credit facility. At September 30, 2000, Compaq had $207 million and $233
million in commercial paper outstanding under the Compaq and CFS programs,
respectively, with a weighted average interest rate of 6.8 percent.
Additionally, Compaq maintains various uncommitted lines of credit, which
totaled approximately $225 million at September 30, 2000. There were no
outstanding borrowings against these lines at September 30, 2000.
Compaq filed a $2 billion shelf registration statement for debt securities
with the Securities Exchange Commission during the second quarter of 2000, which
was declared effective on June 16, 2000. In August 2000, Compaq placed under the
registration statement $300 million of unsecured 7.65 percent notes that mature
on August 1, 2005, and $275 million of unsecured 7.45 percent notes that mature
on August 1, 2002 (collectively, the "Notes"), unless previously redeemed.
Interest will be paid on the Notes on February 1 and August 1 of each year,
beginning on February 1, 2001. The fair value of the Notes approximates carrying
value. The financing is for general corporate purposes (including investments in
CFS and other subsidiaries), capital expenditures, and repayment of outstanding
indebtedness (including commercial paper issued for working capital purposes).
Compaq has the capacity to issue an additional $1.4 billion of debt securities
under the shelf registration statement.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Compaq participates in a highly volatile industry that is characterized by
intense industry-wide competition. Industry participants confront aggressive
pricing practices by competitors, continually changing customer demand patterns,
and rapid technological developments. The cautionary statements below discuss
important factors that could cause actual results to differ materially from the
projected results contained in the forward-looking statements in this report.
COMPONENT SHORTAGES COULD CURTAIL PRODUCTION. From time to time, supply
for key components in Compaq's products lags behind worldwide demand. In the
event that supply of a key material component is delayed or curtailed, Compaq's
ability to ship the related product in desired quantities and in a timely manner
could be adversely affected. Industry shortages currently exist for certain
types of display panels, drives, and capacitors. These component shortages may
hamper shipments of certain units in the Enterprise Computing product lines as
well as other products. Compaq attempts to mitigate the risks of component
shortages by working closely with key suppliers on product plans, coordinated
product introductions, purchases on the spot market, and selected strategic
purchases.
DELAYS IN IMPLEMENTATION OF CHANGES IN DELIVERY MODELS COULD NEGATIVELY
AFFECT FINANCIAL RESULTS. Compaq sells directly to end users in all market
sectors, but the largest proportion of direct sales is in large enterprise
accounts. Products in Commercial Personal Computing are sold primarily through
third-party resellers while products in Consumer are sold principally through
retail outlets. As compared to Compaq, many Compaq competitors sell a higher
percentage of their personal computer products directly to end user customers.
Direct sales may afford such competitors an advantage that will allow them to
price products lower than Compaq's products are priced or to compete on terms of
service that Compaq cannot match. Compaq has established a variety of programs
designed to achieve similar operational capabilities by
20
<PAGE>
simplifying its product set and pricing model, re-engineering the channel
delivery model and more rapidly expanding e-commerce capabilities for large,
medium and small businesses, and, early in 2000, Compaq acquired certain
operational assets of Inacom to enhance its configuration, order management, and
direct delivery capabilities in North America. Compaq's future operating results
may be negatively impacted if it is unable to carry out these operational
improvements effectively and achieve similar operational improvements in other
regions. Compaq believes, however, that the trend toward simpler products,
exemplified by the Compaq iPAQ products, will reduce industry reliance on direct
distribution.
COMPETITIVE ENVIRONMENT PLACES PRESSURE ON REVENUE, GROSS MARGINS AND
MARKET SHARE. Competition remains intense in the information technology industry
with a large number of competitors vying for customers and market share,
domestically and internationally. Competition creates an aggressive pricing
environment, which continues to put pressure on revenue, gross margins and
market share. Compaq has experienced this pressure, particularly in its Consumer
and Commercial Personal Computing businesses, and could experience similar
pressures in its Enterprise Computing business in the future.
UNANTICIPATED DELAYS IN PRODUCT SCHEDULES COULD AFFECT PRODUCT DEMAND. The
process of developing new, high-technology products and services is complex and
often uncertain. Successful product transitions and deployment of new products
requires accurate predictions of the product development schedule as well as
volumes, product mix, customer demand and configuration. Compaq may also
anticipate demand and perceived market acceptance that differs from the
product's realizable customer demand and revenue stream. Compaq experienced this
with its iPAQ handheld products in the third quarter and could experience it
with other products in the future. Further, in the face of intense competition
in the industry, any delay in a new product rollout could decrease any advantage
Compaq may have to be the first to market. A failure on the part of Compaq to
carry out a product rollout in the time frame anticipated and in the quantities
appropriately matching current customer demand could directly affect the future
demand for the product and the profitability of Compaq's operations.
NEW FORM FACTORS INTRODUCE UNCERTAINTY INTO THE MARKET. The increasing
reliance on the Internet is creating new dynamics in the computer industry. As
businesses and consumers turn to the Internet, speed and connectivity may become
more critical than stand-alone power for client devices. Compaq is introducing a
new generation of Internet devices built around simple form factors, customized
functions and wireless mobility. Compaq's products will vie for customer
acceptance and market share against those of computer companies as well as
consumer electronics and telecommunications companies. Hardware products, which
are Compaq's traditional area of strength, may become less important than
service offerings in attracting and retaining customers. In addition, as new
form factors are adopted, sales of traditional personal computers may decline.
CHANGES IN PRODUCT, CUSTOMER AND GEOGRAPHIC SALES MIX COULD ADVERSELY
AFFECT EARNINGS. The sales patterns in any period vary depending on the product,
customer, and geographic sales mix of the period. For example, Compaq's
Professional Services business has traditionally provided services that included
the design and implementation of high-end proprietary systems. If the trend for
design and implementation of systems continues to move from proprietary
environments to industry standard products, Compaq will need to continue, and
possibly accelerate, retraining and retooling its services personnel to compete
in the new environment. There can be no assurance that Compaq will be able to
successfully continue training, attracting and retaining the necessary personnel
to achieve this transition as Compaq adapts its service practices to changing
conditions. Likewise, the impact on the profitability of any business segment or
Compaq's overall financial condition may be dependant in part on the product,
customer and geographic sales mix reflected in that quarter's revenues.
COMPETITION FOR TALENTED EMPLOYEES COULD HAMPER BUSINESS OPERATIONS.
Compaq, like all technology companies, must compete for talented employees in a
market where the demand for such individuals
21
<PAGE>
exceeds the number of qualified candidates. As a result, Compaq's human
resources organization focuses significant efforts on attracting and retaining
individuals in key technology positions internationally. These efforts have
generated positive results in terms of both reducing attrition rates and filling
openings created by prior employee losses. However, should Compaq experience a
substantial loss of talent or an inability to attract talent for key openings,
particularly in critical markets, the resulting talent gaps could impact
Compaq's ability to meet its business objectives.
CREDIT RISKS COULD INCREASE IF FINANCIAL CONDITION OF RESELLERS ERODES.
Much of Compaq's revenue results from selling products through distributors and
resellers. Compaq continually monitors and manages the credit it extends to
distributors and resellers and attempts to limit credit risks by utilizing risk
transfer arrangements and obtaining security interests. The industry's trend
from indirect sales models to direct sales models may reduce the market
opportunities for the number of distributors or resellers in the market.
Compaq's business could be adversely affected in the event that the financial
condition of its distributors and resellers erodes. Upon the financial failure
of a distributor or reseller, Compaq could experience disruptions in
distribution as well as a loss associated with the unsecured portion of any
outstanding accounts receivable.
DELAYS IN NEW SYSTEMS IMPLEMENTATION COULD HAMPER OPERATIONAL EFFICIENCY.
Compaq continues to focus on increasing the effectiveness and efficiency of its
business and information management processes to increase customer satisfaction,
improve productivity and lower costs. In connection with these efforts, Compaq
is moving many of its systems from a legacy environment of proprietary systems
to client-server architectures, as well as integrating systems from newly
acquired businesses. Although major portions of this transition have been
completed, completion of the integration of legacy Digital systems complicates
this process. This year is critical to this effort because delays in the
transition to new systems could hamper Compaq's efforts to increase its
operational efficiency. Delays in implementing further improvements could
adversely affect inventory levels, cash and related profitability.
QUARTERLY SALES CYCLE MAKES PLANNING AND OPERATIONAL EFFICIENCIES
DIFFICULT. Compaq, like other computer companies, generally sells more products
in the third month of each quarter than in the first and second months. This
sales pattern places pressure on manufacturing and logistics systems based on
internal forecasts and may adversely affect Compaq's ability to predict its
financial results accurately. In addition, to rationalize manufacturing
utilization, Compaq may build products early in the quarter in anticipation of
demand late in the quarter. Developments late in a quarter, such as
lower-than-anticipated product demand, a systems failure, or component pricing
movements, can adversely impact inventory levels, cash and related
profitability, in a manner that is disproportionate to the number of days in the
quarter affected.
MINORITY INVESTMENTS COULD ADVERSELY AFFECT LIQUIDITY AND EARNINGS. Compaq
holds minority interests in companies having operations or technology in areas
within Compaq's strategic focus. Some of these investments are in research and
development, start-up or development stage companies or companies where
operations are not yet sufficient to establish them as going concerns. As a
result, Compaq may be called upon under contractual or other terms to provide
funding for operations of such companies and may share in the losses of such
entities. Certain investments are in publicly traded companies whose share
prices are highly volatile. While the overall realized financial impact of these
investments has been favorable thus far, adverse changes in market conditions or
poor operating results of underlying investments could result in Compaq
incurring losses or an inability to recover the carrying value of its
investments.
DOING BUSINESS IN CERTAIN LOCATIONS CREATES ADDITIONAL RISKS.
Manufacturing operations in developing countries, such as Brazil and China, and
the expansion of sales into economically volatile areas such as Asia-Pacific,
Latin America and other emerging markets, subject Compaq to a number of economic
and other risks, such as financial instability among resellers in these regions
and the volatility of economic conditions in countries that are dependent on
exports from the United States and European markets. Compaq generally has
experienced longer accounts receivable cycles in emerging markets, in particular
Asia-Pacific and Latin America, when compared to United States and European
markets. Compaq is also
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subject to any political and financial instability in the countries in which it
operates, including inflation, recession, currency devaluation and interest rate
fluctuations. Compaq continues to monitor its business operations in these
regions and takes various measures to manage risks in these areas.
EXPENSE CONSTRAINTS COULD IMPEDE OPERATIONS. Compaq is focused on bringing
its operational expense to appropriate levels for each of its businesses while
simultaneously implementing extensive new programs. The significant risks
associated with these actions include potentially creating delays in
decision-making, lack of clear lines of authority during transitions, customer
confusion about Compaq's future products and services, and an adverse impact on
employee morale and retention. Compaq believes that, upon conclusion of its
restructuring initiatives, its cost structure will be significantly reduced.
However, there can be no assurance that such cost reductions can be sustained,
that the estimated costs of such actions will not change, or that certain
targeted areas require additional headcount or investment to achieve desired
levels of profitability.
YEAR 2000 COMPLIANCE. Compaq is currently not aware of Year 2000 problems
in any of its products, critical systems or services. However, the success to
date of its Year 2000 efforts cannot guarantee that a Year 2000 problem
affecting third parties upon which it relies will not become apparent in the
future.
EFFECTIVE TAX RATE. Compaq anticipates an effective tax rate of 32 percent
for 2000. Compaq's manufacturing entity in Singapore is subject to a tax holiday
that is not expected to extend beyond 2001. Compaq's tax rate has historically
been heavily dependent upon the proportion of earnings derived from its
Singaporean manufacturing subsidiary and its ability to reinvest those earnings
permanently outside the United States. If Compaq's intercompany transfer pricing
with respect to its Singaporean manufacturing subsidiary for prior years
requires significant adjustment due to audits or regulatory changes, Compaq's
overall tax rate could increase.
CURRENCY FLUCTUATIONS. Compaq's risks associated with currency
fluctuations are discussed in Item 3 below.
Because of the foregoing factors, as well as other variables affecting
Compaq's operating results, past financial performance should not be considered
a reliable indicator of future performance, and investors should not use
historical trends to anticipate results or trends in future periods.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Compaq is exposed to market risks, which include changes in United States
and international interest rates as well as changes in currency exchange rates
as measured against the U.S. dollar and each other. Compaq attempts to reduce
these risks by utilizing financial instruments, including derivative
transactions.
Compaq uses market valuations and value-at-risk valuation methods to
assess the market risk of its financial instruments and derivative portfolios.
It uses software by RiskMetrics to estimate the value-at-risk of its financial
instruments and derivative portfolios based on estimates of volatility and
correlation of market factors drawn from RiskMetrics data sets for the dates
calculated. RiskMetrics defines loss as a reduction in the value of a portfolio
in the event of adverse market conditions, using a predetermined confidence
interval, over a specified period of time. Compaq included all fixed income
investments, interest rate swaps, and foreign exchange contracts in the
value-at-risk calculation. The holding period for these instruments varies from
one day to nine months. The measured value-at-risk from holding derivative and
other financial instruments, using a 95 percent confidence level and assuming
normal market conditions during the period ended September 30, 2000 was
immaterial.
The value of the U.S. dollar affects Compaq's financial results. Changes
in exchange rates may positively or negatively affect Compaq's revenues, gross
margins, operating expenses and retained earnings as expressed in U.S. dollars.
Compaq engages in hedging programs aimed at limiting in part the impact of
currency fluctuations. Compaq primarily uses forward exchange contracts to hedge
those assets and liabilities that impact the income statement when remeasured
according to accounting principles generally accepted in the United States. For
some markets, Compaq has determined that ongoing hedging of non-U.S. dollar net
monetary assets is not cost effective and instead attempts to minimize currency
exposure risk through working capital management. There can be no assurance that
such an approach will be successful, especially if a significant and sudden
decline occurs in the value of local currencies. Compaq purchases foreign
currency option contracts from time to time as well as short-term forward
exchange contracts to protect against currency exchange risks associated with
the anticipated revenues of Compaq's international marketing subsidiaries, with
the exception of Latin America and other subsidiaries that reside in countries
in which such activity would not be cost effective or local regulations preclude
this type of activity. These hedging activities provide only limited protection
against currency exchange risks. Factors that could impact the effectiveness of
Compaq's hedging programs include accuracy of sales forecasts, volatility of the
currency markets and availability of hedging instruments. All currency contracts
that are entered into by Compaq are components of hedging programs and are
entered into for the sole purpose of hedging an existing or anticipated currency
exposure, not for speculation. Although Compaq maintains these programs to
reduce the impact of changes in currency exchange rates, Compaq's revenues or
costs are adversely affected when the U.S. dollar sustains a strengthening
position against currencies in which Compaq sells products and services or a
weakening exchange rate against currencies in which Compaq incurs costs.
Changes in interest rates affect interest income earned on Compaq's cash
equivalents and short-term investments, and interest expense on short-term
borrowings. Compaq does not enter into derivative transactions related to its
cash, cash equivalents or short-term investments. Compaq does periodically enter
into interest rate swap transactions for the purpose of hedging existing or
anticipated liabilities. All interest rate swaps entered into by Compaq are for
the sole purpose of hedging existing or anticipated interest rate sensitive
positions, and not for speculation.
Compaq is exposed to equity price risks on the marketable portion of
investments in publicly traded equity securities. These investments are
generally in companies having operations or technology in areas within Compaq's
strategic focus. Compaq does not attempt to reduce or eliminate its market
exposure on these securities. A 20 percent adverse change in equity prices would
result in an approximate $364 million decrease in the fair value of Compaq's
available for sale securities as of September 30, 2000. As of September 30, 2000
and October 23, 2000, the fair value of Compaq's available for sale investments
were $1.8 billion and $1.2 billion, respectively.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 10 to interim condensed consolidated financial statements.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit No. Description
4.1 Indenture dated May 2, 2000 between Compaq Computer
Corporation and the Bank of New York, as Trustee (incorporated
herein by reference to Exhibit 4.1 to Registration Statement
of Compaq Computer Corporation on Form S-3 (Reg. No.
333-36750)).
4.2 Designation of Terms of Compaq Computer Corporation 7.45%
Global Note due August 1, 2002 and 7.65% Global Note due
August 1, 2005.
4.3 Form of Compaq Computer Corporation 7.45% global Note Due
August 1, 2002.
4.4 Form of Compaq Computer Corporation 7.65% Global Note Due
August 1, 2005.
10.1 $2,200,000,000 Revolving Credit Agreement (364-Day) dated as
of September 29, 2000, among Compaq Computer Corporation, The
Chase Manhattan Bank, as sole Administrative Agent, Bank of
America National Association, as Syndication Agent, CitiBank,
N.A., and Bank One, N.A., as Documentation Agents, and the
other banks party thereto.
10.2 Retention Agreement dated September 8, 2000 between Compaq
Computer Corporation and Michael J. Larson
27 EDGAR financial data schedule
(b) Reports on Form 8-K
(i) Report on Form 8-K dated October 25, 2000, containing Compaq's
news release dated October 24, 2000, announcing its earnings
release for the third quarter of 2000.
(ii) Report on Form 8-K dated August 9, 2000, announcing Compaq's
completion of a public offering and sale of $575 million
aggregate principal amount of notes, consisting of $275
million principal amount of 7.45% Notes due 2002, and $300
million principal amount of 7.65% Notes due 2005.
(iii) Report on Form 8-K dated August 3, 2000, announcing Compaq's
filing with the Securities and Exchange Commission of a
Prospectus Supplement, dated August 1, 2000, to the
Prospectus, dated June 16, 2000, in connection with the
offering of an aggregate of $575,000,000 in principal amount
of notes, consisting of two series, with one series due August
1, 2002 for an aggregate principal amount of $275,000,000 and
the other series due August 1, 2005 for an aggregate principal
amount of $300,000,000.
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(iv) Report on Form 8-K dated July 28, 2000, containing Compaq's
news release dated July 27, 2000, announcing the filing with
the Securities and Exchange Commission of a Preliminary
Prospectus Supplement, dated July 26, 2000, to the Prospectus
filed by Compaq on June 16, 2000, in connection with the
offering of an aggregate of $500 million in principal amount
of notes, consisting of two series, with one series due 2002
and the other series due 2005.
(v) Report on Form 8-K dated July 25, 2000, containing Compaq's
news release dated July 25, 2000, announcing its earnings
release for the second quarter of 2000 and attaching the
financial discussion document from Compaq's website,
supplementing the information in the news release for the
second quarter of 2000.
All other items specified by Part II of this report are inapplicable and
accordingly have been omitted.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
October 26, 2000 COMPAQ COMPUTER CORPORATION
/s/ JESSE J. GREENE, Jr.
--------------------------------------
Jesse J. Greene, Jr., Senior Vice
President and Chief Financial Officer
(as authorized officer and as
principal financial officer)
26
