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 JUNE 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 July 31, 2000, was approximately 1.7 billion.
<PAGE>
COMPAQ COMPUTER CORPORATION
FORM 10-Q
THREE AND SIX MONTHS ENDED JUNE 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 11
Item 3. Quantitative and Qualitative Disclosures About Market Risks 22
PART II
Item 1. Legal Proceedings 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 23
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 30, DECEMBER 31,
(IN MILLIONS, EXCEPT PAR VALUE) 2000 1999
---------------------------------------------------------------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 2,571 $ 2,666
Short-term investments -- 636
Trade accounts receivable, net 6,111 5,622
Leases and other accounts
receivable 1,378 1,063
Inventories 2,348 2,008
Other current assets 1,624 1,854
-------- --------
Total current assets 14,032 13,849
Property, plant and equipment, net 3,327 3,249
Other assets, net 8,669 10,179
-------- --------
$ 26,028 $ 27,277
======== ========
LIABILITIES AND STOCKHOLDERS" EQUITY
Current liabilities:
Short-term borrowings $ 1,111 $ 453
Accounts payable 4,472 4,380
Deferred income 1,023 972
Accrued restructuring costs 743 1,002
Other current liabilities 4,830 5,031
-------- --------
Total current liabilities 12,179 11,838
-------- --------
Postretirement and other
postemployment benefits 693 605
-------- --------
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:
1,728 million and 1,723
million shares at June 30, 2000
and 1,715 million and 1,694
million shares at December 31,
1999) 7,804 7,627
Retained earnings 5,575 4,948
Accumulated other comprehensive
income 583 2,919
Treasury stock (806) (660)
-------- --------
Total stockholders' equity 13,156 14,834
-------- --------
$ 26,028 $ 27,277
======== ========
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 JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- --------------------------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 2000 1999 2000 1999
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue:
Products $ 8,524 $7,781 $16,344 $15,600
Services 1,603 1,639 3,296 3,239
------- ------ ------- -------
Total revenue 10,127 9,420 19,640 18,839
------- ------ ------- -------
Cost of sales:
Products 6,607 6,331 12,718 12,338
Services 1,134 1,153 2,347 2,238
------- ------ ------- -------
Total cost of sales 7,741 7,484 15,065 14,576
------- ------ ------- -------
Selling, general and administrative
expense 1,466 1,732 2,867 3,209
Research and development 354 466 710 870
Other (income) expense, net (3) 8 (49) 42
------- ------ ------- -------
1,817 2,206 3,528 4,121
------- ------ ------- -------
Income (loss) before provision for
income taxes 569 (270) 1,047 142
Provision (benefit) for income taxes 182 (86) 335 45
------- ------ ------- -------
Net income (loss) $ 387 $ (184) $ 712 $ 97
======= ====== ======= =======
Earnings (loss) per common share:
Basic $ 0.22 $(0.10) $ 0.42 $ 0.07
======= ====== ======= =======
Diluted $ 0.22 $(0.10) $ 0.41 $ 0.07
======= ====== ======= =======
Shares used in computing earnings
(loss) per common share:
Basic 1,722 1,693 1,699 1,691
======= ====== ======= =======
Diluted 1,760 1,693 1,739 1,741
======= ====== ======= =======
</TABLE>
See accompanying notes to interim condensed consolidated financial statements.
4
<PAGE>
COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------
(IN MILLIONS) 2000 1999
---------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 712 $ 97
Adjustments to reconcile net
income to net cash
provided by (used in)
operating activities:
Depreciation and amortization 688 728
Deferred income taxes 204 (281)
Other (98) (26)
Changes in operating assets
and liabilities, net of
effects of acquired
businesses (1,937) (206)
------- -------
Net cash provided by
(used in) operating
activities (431) 312
------- -------
Cash flows from investing activities:
Capital expenditures, net (502) (507)
Proceeds from maturities of
short-term investments 636 --
Acquisitions of businesses, net
of cash acquired (370) (514)
Other, net (195) (116)
------- -------
Net cash used in
investing activities (431) (1,137)
------- -------
Cash flows from financing activities:
Increase in short-term borrowings 658 --
Payments to retire Digital
preferred stock -- (400)
Common stock transactions, net 31 50
Dividends to stockholders (85) (68)
------- -------
Net cash provided by
(used in) financing
activities 604 (418)
------- -------
Effect of exchange rate changes on
cash and cash equivalents 163 7
------- -------
Net decrease in cash and
cash equivalents (95) (1,236)
Cash and cash equivalents at
beginning of period 2,666 4,091
------- -------
Cash and cash equivalents at end of
period $ 2,571 $ 2,855
======= =======
SUPPLEMENTAL CASH FLOW INFORMATION
ACQUISITIONS OF BUSINESSES:
Fair value of:
Assets acquired $ 499 $ 630
Liabilities assumed (129) (84)
Options issued -- (32)
------- -------
Cash paid $ 370 $ 514
======= =======
See accompanying notes to interim condensed consolidated financial statements.
5
<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 June 30, 2000 and December 31, 1999
and for the three and six month periods ended June 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. In
Compaq's opinion, 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 June 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 evaluating the effect that such adoption may have on its
consolidated results of operations and financial position.
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 delays the
implementation date of SAB 101 for registrants with fiscal years that begin
between December 16, 1999 and March 15, 2000. Compaq will adopt SAB 101 pursuant
to SAB 101B 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. At June 30, 2000,
Compaq's preliminary purchase price allocation was updated based on receipt of
information outstanding as of the date of the transaction. 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 also
has 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 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
6
<PAGE>
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.
NOTE 4 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 June 30, 2000 were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, JUNE 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------------------------------- --------- ------------ ------------ ------------ --------
<S> <C> <C> <C> <C> <C>
Employee separations $ 491 $ (68) $ 423 $ (93) $ 330
Facility closure costs 96 -- 96 (7) 89
Contract cancellation and other exit
costs 200 (167) 33 (2) 31
----- ----- ----- ----- -----
$ 787 $(235) $ 552 $(102) $ 450
===== ===== ===== ===== =====
</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. Compaq has completed most of the actions
contemplated under the restructuring plan. Accrued restructuring costs at June
30, 2000 include amounts for actions that have already been taken, but for which
expenditures have not yet been made. Accrued restructuring costs as of June 30,
2000 and amounts charged against the provision were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, JUNE 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------------------------------- --------- ------------ ------------ ------------ --------
<S> <C> <C> <C> <C> <C>
Employee separations $ 1,131 $ (962) $ 169 $(103) $ 66
Facility closure costs 414 (184) 230 (39) 191
Relocation 99 (65) 34 (11) 23
Other exit costs 100 (83) 17 (4) 13
------- ------- ----- ----- -----
$ 1,744 $(1,294) $ 450 $(157) $ 293
======= ======= ===== ===== =====
</TABLE>
Compaq expects to substantially complete the initiatives contemplated in
its restructuring plans during the remainder of 2000.
Total regular employee headcount increased from approximately 67,700 at
December 31, 1999 to approximately 69,800 at June 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 800 and 2,600 due to the 1998
and 1999 restructuring actions, respectively. As of June 30, 2000, the remaining
employee separations under the 1998 and 1999 restructuring plans were
approximately 800 and 2,000, respectively.
7
<PAGE>
NOTE 5 CERTAIN BALANCE SHEET COMPONENTS
Raw materials, work in progress and finished goods were $599 million,
$462 million and $1.3 billion, respectively, at June 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 June 30,
2000 and December 31, 1999, respectively.
At June 30, 2000 and December 31, 1999, Compaq held $3.3 and $6.6
billion of equity investments, respectively, included in other non-current
assets. Two of these investments accounted for 67 percent of this balance at
June 30, 2000. As of June 30, 2000 and July 31, 2000, the fair value of Compaq's
available for sale investments was $2.8 billion and $2.5 billion, respectively.
On April 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 June 30, 2000, paid on July 20, 2000. On April 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 June 30, 1999, paid on July 20, 1999.
NOTE 6 COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss), net of tax, are listed
below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ---------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- -------- ------ -------- -----
<S> <C> <C> <C> <C>
Net income (loss) $ 387 $(184) $ 712 $ 97
Other comprehensive income (loss):
Foreign currency translations 1 (11) 2 (24)
Unrealized gains (losses) on
investments (2,283) 65 (2,338) 65
------- ----- ------- ----
Comprehensive income (loss) $(1,895) $(130) $(1,624) $138
======= ===== ======= ====
</TABLE>
NOTE 7 OTHER INCOME AND EXPENSE
Other (income) and expense consisted of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ---------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- -------- ------ -------- -----
<S> <C> <C> <C> <C>
Interest and dividend income $ (46) $ (32) $ (92) $(84)
Investment (gain) loss (38) 7 (106) (9)
Interest expense 73 34 130 75
Currency losses 21 3 27 34
Other (income) expense (13) (4) (8) 26
------- ----- ------- ----
$ (3) $ 8 $ (49) $ 42
======= ===== ======= ====
</TABLE>
NOTE 8 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 40 million, 50 million and 38 million were
used in the calculation of diluted earnings per share for the six month periods
ended June 30, 2000 and 1999, and the three months ended June 30, 2000,
respectively. Incremental shares of 39 million were not used in the calculation
of diluted loss per share for the three months ended June 30, 1999, due to their
antidilutive effect.
Stock options to purchase 111 million and 75 million shares of common
stock for the three month periods and 60 million and 47 million shares of common
stock for the six month periods ended June 30,
8
<PAGE>
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 three and six months ended June 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 9 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 divisions. 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 JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------- ---------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
ENTERPRISE COMPUTING
Revenue $ 3,433 $ 3,157 $ 6,394 $ 6,353
Operating income 467 120 814 467
COMMERCIAL PERSONAL COMPUTING
Revenue 3,313 3,227 6,185 6,325
Operating income (loss) 62 (224) 43 (200)
CONSUMER
Revenue 1,592 1,202 3,424 2,559
Operating income 31 46 113 128
COMPAQ GLOBAL SERVICES
Revenue 1,704 1,783 3,469 3,517
Operating income 228 264 449 569
OTHER
Revenue 85 51 168 85
Operating income (loss) 5 (103) 23 (179)
CONSOLIDATED SEGMENT TOTALS
Revenue $10,127 $ 9,420 $19,640 $18,839
Operating income $ 793 $ 103 $ 1,442 $ 785
</TABLE>
A reconciliation of Compaq's consolidated segment operating income to
consolidated income (loss) before provision for income taxes follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- --------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- ------- ------- -------- -------
<S> <C> <C> <C> <C>
Consolidated segment operating income $ 793 $ 103 $1,442 $ 785
Corporate and unallocated shared
expenses (224) (399) (395) (669)
Gain on sale of business -- 26 -- 26
----- ----- ------ -----
Income (loss) before provision for
income taxes $ 569 $(270) $1,047 $ 142
===== ===== ====== =====
</TABLE>
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.
9
<PAGE>
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 the Company'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. The 1998 case is currently in the discovery stage 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.
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 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 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.
CONTINGENCIES
Non-current other assets as of June 30, 2000 included approximately $102
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 will seek to
realize the full value of these receivables in Inacom's bankruptcy proceedings
and may aggressively pursue remedies against Inacom's lenders, as the ultimate
recipients of Compaq's funds, or against others. 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.
10
<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 PCs.
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 June 30, 2000, as applicable.
During the second quarter of 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.
Compaq's other two reportable segments are Commercial Personal Computing and
Consumer. 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 JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- -------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- --------- -------- ------- -------
<S> <C> <C> <C> <C>
ENTERPRISE COMPUTING
Revenue $ 3,433 $3,157 $ 6,394 $ 6,353
Operating income 467 120 814 467
COMMERCIAL PERSONAL COMPUTING
Revenue 3,313 3,227 6,185 6,325
Operating income (loss) 62 (224) 43 (200)
CONSUMER
Revenue 1,592 1,202 3,424 2,559
Operating income 31 46 113 128
GLOBAL SERVICES
Revenue 1,704 1,783 3,469 3,517
Operating income 228 264 449 569
OTHER
Revenue 85 51 168 85
Operating income (loss) 5 (103) 23 (179)
CONSOLIDATED SEGMENT TOTALS
Revenue $10,127 $9,420 $19,640 $18,839
Operating income $ 793 $ 103 $ 1,442 $ 785
</TABLE>
11
<PAGE>
A reconciliation of Compaq's consolidated segment operating income to
consolidated income (loss) before provision for income taxes follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- --------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- ------- ------- -------- -------
<S> <C> <C> <C> <C>
Consolidated segment operating income $ 793 $ 103 $1,442 $ 785
Corporate and unallocated shared
expenses (224) (399) (395) (669)
Gain on sale of business -- 26 -- 26
----- ----- ------ -----
Income (loss) before provision for
income taxes $ 569 $(270) $1,047 $ 142
===== ===== ====== =====
</TABLE>
OVERVIEW
Compaq reported second quarter and six month consolidated revenue of
$10.1 billion and $19.6 billion, respectively, an increase of 8 percent and 4
percent (11 percent and 8 percent at constant currency) compared with the prior
year periods. Strong growth in Consumer and improvement in Enterprise Computing
drove higher revenue.
Consolidated gross margin of $2.4 billion (23.6 percent of revenue) and
$4.6 billion (23.3 percent of revenue) for the three and six months ended June
30, 2000, respectively, increased considerably by 3.0 and 0.7 percentage points
over 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, driven by solid execution of spending
discipline, declined significantly from $2.2 billion to $1.8 billion, a
reduction of $378 million, or 17 percent, compared to the second quarter of
1999. On a year to date basis, operating expense decreased $502 million, or 12
percent, compared to the first six months of 1999. As a percentage of revenue,
operating expense declined to 18.0 percent and 18.2 percent for the three and
six months ended June 30, 2000, respectively, from 23.3 percent and 21.7 percent
in the comparable prior year periods. Operating expense for the twelve month
period ended June 30, 2000 decreased nearly $600 million when compared to the
twelve month period ended June 30, 1999. The reduction in operating expense
primarily reflects 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.
Compaq reported consolidated net income of $387 million, or $0.22 per
diluted common share, for the second quarter of 2000 compared to a consolidated
net loss of $184 million, or $(0.10) per diluted common share, for the
corresponding period in 1999. Adjusted for a net investment gain of $25 million
(after tax), earnings per diluted common share were $0.21 for the second quarter
of 2000. Consolidated net income was $712 million, or $0.41 per diluted common
share, for the six months ended June 30, 2000 compared to $97 million, or $0.07
per diluted common share, for the same period in 1999. Adjusted for a net
investment gain of $69 million (after tax), earnings per diluted common share
were $0.37 for the six months ended June 30, 2000.
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 $276 million, or 9 percent,
compared with the second quarter of 1999 and represented 34 percent of
consolidated revenue during the quarter. On a year to date basis, revenue from
this segment increased $41 million, or 1 percent, compared to the six months
ended June 30, 1999.
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<PAGE>
Enterprise Computing revenue consisted of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- -------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- -------- -------- ------- -------
<S> <C> <C> <C> <C>
Industry Standard Servers(1) $1,489 $1,065 $2,680 $2,206
Storage Products 1,192 1,210 2,259 2,431
Business Critical Servers(1) 750 866 1,452 1,648
Other 2 16 3 68
------ ------ ------ ------
$3,433 $3,157 $6,394 $6,353
====== ====== ====== ======
</TABLE>
Industry Standard Servers revenue grew 40 percent, benefiting from
increased average unit prices during the quarter. Customer demand was strong
across all regions, reflecting strong product acceptance. The build-out of
Internet infrastructures continues to drive server sales, with an increasing
shift toward dense rack-optimized form-factors. Revenue also benefited from
strong sales of 8-way servers in the service provider market. On June 5, 2000,
Compaq announced its new Compaq PROLIANT(TM) DL360 ultra-thin, 2-way server,
which will serve as the cornerstone of its density-optimized line. Compaq
shipped 24,000 units during the quarter.
Storage Products revenue was essentially unchanged compared to the prior
year quarter. Overall storage capacity shipped increased by 70 percent in the
quarter, offset by aggressive price declines per unit of capacity. The high rate
of primary storage capacity shipped enabled Compaq to maintain its worldwide
leadership position (according to International Data Corporation). Enterprise
storage continues to keep pace with robust market growth.
Business Critical Servers revenue declined during the quarter and year
to date periods primarily due to product transition and component shortages for
the new Compaq ALPHASERVER(TM) GS product line. As a result, Business Critical
Servers experienced lower than planned shipments. Partially offsetting this
decline were strong sales of Compaq NONSTOP(TM) HIMALAYA(TM) systems. Introduced
during the quarter was the NONSTOP(TM) HIMALAYA S74 server, which offers
customers a significant improvement in performance and capacity. NONSTOP(TM)
HIMALAYA systems are deployed in the financial industry to routinely process
most of the world's financial transactions, such as credit cards, securities,
ATM and EFT networks transactions.
OPERATING INCOME
Enterprise Computing operating income increased $347 million, or 289
percent, in the second quarter of 2000 as compared to the corresponding period
in 1999. For the six months ended June 30, 2000, operating income increased $347
million, or 74 percent, compared to the same period in the prior year.
Second quarter 2000 operating income was higher compared with the
corresponding period in 1999 primarily due to strong performance in Industry
Standard Servers, improved results in Storage Products and lower operating
expenses. Industry Standard Servers gross margin improved during the quarter due
to an increase in average unit prices, reflecting a favorable shift in product
mix. Sales of 8-way servers and dense servers continued to exhibit strong growth
during the quarter. Storage Products exhibited strong improvement in gross
margin and operating profit during the quarter. Gross margin in Storage Products
improved due to a shift in product mix from lower margin attached storage sales
to higher margin products. Operating results from Business Critical Servers
declined due to product transition and component shortages for the new
ALPHASERVER GS product line, which resulted in lower than planned shipments, as
previously discussed. 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.
On a year to date basis, operating income increased due to stronger
performance in Industry Standard Servers. This resulted from improved gross
margin driven by increased average unit prices and a favorable shift in product
mix.
------------------------------------
(1) ALPHASERVER and PROLIANT product revenue does not include attached and
enterprise storage, which is captured in Storage Products.
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<PAGE>
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 during the
first quarter of 2000 and subsequently established Custom Edge Incorporated 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 $86 million, or 3
percent, compared with the second quarter of 1999 and represented 33 percent of
consolidated revenue during the quarter. Revenue for the year to date period
declined $140 million, or 2 percent.
Unit sales growth of 31 percent in higher margin portable product lines
was offset by lower unit sales of desktop PCs. Second quarter average unit
prices were higher compared to the second quarter of 1999. While revenue growth
was relatively modest during the three and six months ended June 30, 2000, such
growth validates Compaq's strategic decision to seek more profitable sales
transactions in conjunction with growing market share.
Channel inventory at June 30, 2000 was lower when compared to levels at
June 30, 1999.
Compaq recently shipped its 100,000th Compaq IPAQ(TM) desktop, making it
the fastest growing new product ramp in Compaq's history. Compaq successfully
launched the IPAQ Pocket PC during the quarter, which has garnered numerous
awards, including the Tech Trendsetter Award.
OPERATING INCOME
The Commercial Personal Computing segment returned to profitability
during the quarter, one quarter ahead of schedule, posting operating income of
$62 million, compared to a loss of $224 million in the second quarter of 1999.
Operating income was $43 million for the six months ended June 30, 2000,
compared to a loss of $200 million in the corresponding period in 1999.
Operating results improved during the quarter due to higher gross margin
and lower operating expense, both as a percentage of revenue and in whole
dollars. Gross margin improved during the quarter due to a shift toward more
profitable sales transactions, as referenced above. The decline in operating
expense reflects an improved cost structure for this segment, which contributed
to the return to profitability during the quarter.
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.
REVENUE
Consumer revenue increased $390 million, or 32 percent, in the second
quarter of 2000 compared with the corresponding quarter in 1999 and accounted
for 16 percent of consolidated revenue. On a year to date basis, revenue
increased $865 million, or 34 percent, compared to the prior year.
Revenue increased during the quarter in the Consumer business as unit
sales grew 38 percent while average unit prices were lower by 4 percent.
Consumer revenue benefited from strong international growth during the quarter
and six months ended June 30, 2000, particularly in the Europe, Middle East and
Africa, Latin America and Asia-Pacific regions. International sales accounted
for 45 percent of Consumer revenue during the second quarter of 2000 compared to
30 percent in the second quarter of 1999. Consumer recently introduced the most
significant Compaq PRESARIO(TM) desktop redesign since 1996, with emphasis on
upgradability and simple Internet access. The "beyond the box" business, which
includes Internet access, Internet traffic, printers, software, financing and
warranty upgrades, more than doubled during the quarter compared to the second
quarter of 1999.
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<PAGE>
Consumer channel inventory levels were significantly lower than levels at
June 30, 1999. Sales out of the channel were strong at the end of the second
quarter of 2000.
OPERATING INCOME
Consumer operating income declined $15 million, or 33 percent, in the
second quarter of 2000 compared to the prior year period. On a year to date
basis, operating income declined $15 million, or 12 percent.
Operating income declined during the quarter primarily due to lower
gross margin as a percentage of revenue and higher operating expenses. Gross
margin was pressured by slight declines in average unit prices that outpaced
declines in average unit costs. The decline in average unit prices resulted from
competitive pricing pressures during the quarter, particularly in North America,
while average unit costs declined due to lower component costs.
COMPAQ GLOBAL SERVICES
Compaq Global Services delivers worldwide infrastructure design,
implementation and management services through its Professional and Customer
Services divisions. Revenue was as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, THREE MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
(IN MILLIONS) 2000 1999 2000 1999
------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Customer Services(2) $1,068 $1,074 $2,174 $2,164
Professional Services(2) 636 709 1,295 1,353
------ ------ ------ ------
$1,704 $1,783 $3,469 $3,517
====== ====== ====== ======
</TABLE>
------------------------------------
(2) Compaq Global Services revenue includes revenue from the sale of products
made in connection with providing solutions and services to customers.
REVENUE
Compaq Global Services revenue decreased $79 million, or 4 percent, and
was essentially flat in constant currency, compared with the second quarter of
1999. This segment represented 17 percent of consolidated revenue during the
quarter. For the six months ended June 30, 2000, Compaq Global Services revenue
declined $48 million, or 1 percent, and increased 2 percent in constant
currency, compared to the corresponding period in the prior year.
Lower Compaq Global Services revenue during the quarter and six months
ended June 30, 2000 was primarily due to decreased Professional Services
revenue. Compaq is aligning its resources to focus on those practices consistent
with its Internet strategy. 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. Customer Services revenue was essentially unchanged.
OPERATING INCOME
Compaq Global Services operating income declined $36 million, or 14
percent, in the second quarter of 2000 as compared to the corresponding period
in 1999. On a year to date basis, operating income decreased $120 million, or 21
percent.
Profitability in the Customer Services business remains strong.
Professional Services operating results were lower compared to the second
quarter of 1999. Compaq is currently aligning its resources to focus on those
practices consistent with its Internet strategy.
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
15
<PAGE>
expense items not controlled by the business segments. Corporate and unallocated
shared expenses decreased from $399 million in the second quarter of 1999 to
$224 million in the second quarter of 2000, a decline of 44 percent. On a year
to date basis, corporate and unallocated shared expenses decreased from
$669 million to $395 million, or 41 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 June 30, 2000 were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, JUNE 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------- ---------- ------------- ------------- ------------- ---------
<S> <C> <C> <C> <C> <C>
Employee separations $491 $ (68) $423 $ (93) $330
Facility closure costs 96 -- 96 (7) 89
Contract cancellation and other exit
costs 200 (167) 33 (2) 31
---- ----- ---- ----- ----
$787 $(235) $552 $(102) $450
==== ===== ==== ===== ====
</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. Compaq has completed most of the actions
contemplated under the restructuring plan. Accrued restructuring costs at June
30, 2000 include amounts for actions that have already been taken, but for which
expenditures have not yet been made. Accrued restructuring costs as of June 30,
2000 and amounts charged against the provision were as follows:
<TABLE>
<CAPTION>
BEGINNING DECEMBER 31, JUNE 30,
(IN MILLIONS) ACCRUAL EXPENDITURES 1999 EXPENDITURES 2000
------------- ---------- ------------- ------------- ------------- ---------
<S> <C> <C> <C> <C> <C>
Employee separations $1,131 $ (962) $169 $(103) $ 66
Facility closure costs 414 (184) 230 (39) 191
Relocation 99 (65) 34 (11) 23
Other exit costs 100 (83) 17 (4) 13
------ ------- ---- ----- ----
$1,744 $(1,294) $450 $(157) $293
====== ======= ==== ===== ====
</TABLE>
Compaq expects to substantially complete the initiatives contemplated in
its restructuring plans during the remainder of 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 June 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 800 and 2,600 due to the 1998
and 1999
16
<PAGE>
restructuring actions, respectively. As of June 30, 2000, the remaining employee
separations under the 1998 and 1999 restructuring plans were approximately 800
and 2,000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Compaq's cash and cash equivalents decreased to $2.6 billion at June 30,
2000, from $2.7 billion at December 31, 1999. The decrease was primarily due to
cash used in operations and investing activities of $431 million each, partially
offset by cash provided by financing activities of $604 million.
Net cash used in operations was comprised of $1.9 billion used in
working capital and other activities, offset in part by net income adjusted for
non-cash items of $1.5 billion. Net cash used in working capital and other
activities resulted primarily from an increase in receivables and inventories.
Accounts receivable were $6.1 billion and $5.6 billion at June 30, 2000 and
December 31, 1999, respectively. Days sales outstanding for the quarter
increased to 54 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 current quarter, relative to the fourth quarter of 1999.
Inventory levels increased to $2.3 billion at June 30, 2000, compared to $2.0
billion at December 31, 1999. Inventory turns for the second quarter of 2000
decreased to 13.1 compared to 16.1 for the fourth quarter of 1999. The increase
in inventory was primarily due to higher raw material inventory levels at June
30, 2000 as Compaq took a proactive position on certain components given the
current supply environment.
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 $502 million for capital
expenditures, net of disposals, and $195 million for other investing activities
in the six months ended June 30, 2000. These uses of cash were partially offset
by proceeds from maturities of short-term investments of $636 million.
Future uses of cash for the remainder of 2000 include cash expenditures
for currently planned restructuring activities estimated to be $350 million;
capital expenditures for land, buildings and equipment which are estimated to be
$400 million; purchases of equipment to be leased to third parties of
approximately $300 million; and cash payments for common stock repurchases and
dividends.
Compaq also plans to use available liquidity to develop the purchased
in-process technology related to the Digital acquisition into commercially
viable products. This primarily consists of planning, designing, prototyping,
high-volume manufacturing verification and testing activities that are necessary
to establish that a product can be produced to meet its design specifications,
including functions, features and technical performance requirements. Bringing
the purchased in-process technology to market also includes developing firmware,
diagnostic software, device drives, and testing the technology for compatibility
and interoperability with commercially viable products. At June 30, 2000, the
estimated costs to be incurred to develop the purchased in-process technology
into commercially viable products totaled $2.1 billion in the aggregate through
the year 2005 ($250 million in the remainder of 2000, $580 million in 2001, $550
million in 2002, $440 million in 2003, $270 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 has a $1.0 billion
revolving credit facility bearing interest at LIBOR plus 0.625 percent that
expires in October 2000 and 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 June 30, 2000. Compaq has also established 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 June 30, 2000, Compaq had $766 million
and $307 million in commercial paper outstanding under the Compaq and CFS
programs, respectively, with a weighted average interest rate of 6.9 percent.
Additionally, Compaq maintains various uncommitted lines of credit, which
totaled approximately $350 million at June 30, 2000. There were no outstanding
borrowings against these lines at June 30, 2000.
17
<PAGE>
Compaq filed a $2 billion shelf registration statement for debt
securities during the second quarter of 2000, which was declared effective on
June 16, 2000. On July 27, 2000, Compaq announced that it planned to offer an
aggregate of $500 million of notes consisting of two-year and five-year notes,
in a public offering under this shelf registration statement. The purpose of
this financing is to support the continued global expansion of CFS business
activity, refinance certain short-term borrowings and for other general
corporate purposes.
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.
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. Historically, Compaq has not kept pace with changes in the
industry's sales and distribution model and has faced challenges in developing
and implementing processes for order entry, production of individualized units
and direct distribution. Compaq has established a variety of programs designed
to achieve these capabilities by 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 in North America, Compaq
acquired certain operational assets of Inacom to enhance its configuration,
order management, and direct delivery capabilities. 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 its iPAQ products, will reduce industry
reliance on direct distribution. In addition, Compaq confronts other risks
associated with the acquisition of direct capacity in North America, including
the transition of manufacturing and distribution to former Inacom facilities,
reliance on resale of the products of other computer manufacturers, and low
profitability associated with acting as a configurator for other OEMs.
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, microprocessors, memory and capacitors. Compaq has
experienced these component shortages which hampered its ability to ship certain
units ordered in the second quarter 2000 for the new ALPHASERVER GS product line
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.
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 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, Commercial Personal
Computing and storage businesses and could experience similar pressures in its
high-end industry-standard server 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
18
<PAGE>
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 second quarter and could experience it with other
products in the future. Further, in the face of intense competition in the
market, 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 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. Most recently, Compaq
has seen a shift in the sales mix in its Professional Services business.
Compaq's Professional Services business has traditionally provided services that
included the design and implementation of high-end proprietary systems. As the
design and implementation of systems increasingly moves from a proprietary
environment to industry standard products, Compaq must retrain and retool its
services personnel to compete in the new environment. There can be no assurance
that Compaq will be able successfully to train, attract and retain the necessary
personnel to achieve this transition as Compaq focuses its service practices on
its Internet strategy. 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.
INABILITY TO ATTRACT AND RETAIN EMPLOYEES COULD HAMPER BUSINESS
OPERATIONS. In searching for new employees and retaining its current employees
Compaq competes with other technology companies, including start-up Internet
companies that may be perceived as offering more significant opportunities to
realize wealth. In its integration and restructuring efforts, Compaq lost a
number of sales and service employees in Europe and it is currently experiencing
high attrition rates among certain engineering groups. Compaq's failure to
attract key employees to fill these openings or the loss of significant numbers
of additional key employees could make it difficult for Compaq to achieve its
current business plans.
CREDIT RISKS COULD INCREASE IF FINANCIAL CONDITION OF RESELLERS ERODES.
Compaq's primary means of distribution is 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. Recently, many distributors and
resellers have been consolidating in response to changes in the profitability of
their businesses. Further, the industry's transition from an indirect sales
model to a direct sales model has reduced the need 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, integrating the systems from the Digital
acquisition that are not
19
<PAGE>
integrated 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 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.
RESTRUCTURING ACTIVITIES COULD IMPEDE OPERATIONS. Compaq undertook
significant restructuring activities in 1999 that will continue to be carried
out in 2000. In addition, certain actions remain to be completed from its
restructuring activities initiated in 1998. Compaq expects to substantially
complete the initiatives contemplated in its restructuring plans during 2000.
These activities are focused on alignment around four business segments, each of
which will be structured to be competitive within its sphere of operations.
Compaq is focused on bringing its operational expenses 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's high-end business in
particular has been affected by the steps necessary to achieve appropriate
expense levels in the field, particularly in France and Germany, and the need to
implement appropriate sales and services organization recruitment, training and
incentive plans. 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.
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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 which is not expected to extend beyond 2001. Compaq's tax rate has
historically been heavily dependent upon the proportion of earnings that is
derived from its Singaporean manufacturing subsidiary and its ability to
reinvest those earnings permanently outside the United States. Compaq has ceased
utilization of a portion of its Singaporean manufacturing subsidiary's
production capacity during 2000. The profitability of this facility is expected
to decrease significantly, accompanied by a corresponding decrease in the impact
of the tax holiday on Compaq's effective tax rate. In addition, should Compaq's
intercompany transfer pricing with respect to its Singaporean manufacturing
subsidiary for prior years require 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 June 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 $552 million decrease in the fair value of Compaq's
available for sale securities as of June 30, 2000. As of June 30, 2000 and July
31, 2000, the fair value of Compaq's available for sale investments was $2.8
billion and $2.5 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
27 EDGAR financial data schedule
(b) Reports on Form 8-K
(i) 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.
(ii) 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.
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.
August 1, 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)
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