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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-Q

(Mark One)    

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: January 31, 2010

Or

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                             to                              

Commission file number 1-4423



HEWLETT-PACKARD COMPANY
(Exact name of registrant as specified in its charter)

Delaware   94-1081436
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. employer
identification no.)

3000 Hanover Street, Palo Alto, California

 

94304
(Address of principal executive offices)   (Zip code)

(650) 857-1501
(Registrant's telephone number, including area code)



        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act") during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ý    No o

        Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ý    No o

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ý   Accelerated filer o   Non-accelerated filer o
(Do not check if a smaller
reporting company)
  Smaller reporting company o

        Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes o    No ý

        The number of shares of HP common stock outstanding as of February 28, 2010 was 2,345,093,045 shares.



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
INDEX

 
   
   
  Page
No.
 

Part I.

  Financial Information  

  Item 1.  

Financial Statements

    3  

     

Consolidated Condensed Statements of Earnings for the three months ended January 31, 2010 and 2009 (Unaudited)

    3  

     

Consolidated Condensed Balance Sheets as of January 31, 2010 (Unaudited) and as of October 31, 2009 (Audited)

    4  

     

Consolidated Condensed Statements of Cash Flows for the three months ended January 31, 2010 and 2009 (Unaudited)

    5  

     

Notes to Consolidated Condensed Financial Statements (Unaudited)

    6  

  Item 2.  

Management's Discussion and Analysis of Financial Condition and Results of Operations

    48  

  Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

    80  

  Item 4.  

Controls and Procedures

    80  

Part II.

  Other Information  

  Item 1.  

Legal Proceedings

    81  

  Item 1A.  

Risk Factors

    81  

  Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

    81  

  Item 6.  

Exhibits

    81  

Signature

    82  

Exhibit Index

    83  

Forward-Looking Statements

        This Quarterly Report on Form 10-Q, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of Part I of this report, contains forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, the results of Hewlett-Packard Company and its consolidated subsidiaries ("HP") may differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of revenue, margins, expenses, tax provisions, earnings, cash flows, benefit obligations, share repurchases, acquisition synergies, currency exchange rates or other financial items; any statements of the plans, strategies and objectives of management for future operations, including the execution of cost reduction programs and restructuring plans; any statements concerning expected development, performance or market share relating to products or services; any statements regarding future economic conditions or performance; any statements regarding pending investigations, claims or disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. Risks, uncertainties and assumptions include macroeconomic and geopolitical trends and events; the execution and performance of contracts by HP and its customers, suppliers and partners; the challenge of managing asset levels, including inventory; the difficulty of aligning expense levels with revenue changes; assumptions related to pension and other post-retirement costs; expectations and assumptions relating to the execution and timing of cost reduction programs and restructuring plans; the resolution of pending investigations, claims and disputes; and other risks that are described herein, including but not limited to the items discussed in "Factors that Could Affect Future Results" set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of Part I of this report, and that are otherwise described from time to time in HP's Securities and Exchange Commission reports, including HP's Annual Report on Form 10-K for the fiscal year ended October 31, 2009. HP assumes no obligation and does not intend to update these forward-looking statements.

2



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

        


HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Statements of Earnings

(Unaudited)

 
  Three months ended
January 31
 
 
  2010   2009  
 
  In millions, except
per share amounts

 

Net revenue:

             
 

Products

  $ 21,003   $ 18,629  
 

Services

    10,067     10,089  
 

Financing income

    107     89  
           
   

Total net revenue

    31,177     28,807  
           

Costs and expenses:

             
 

Cost of products

    16,347     14,168  
 

Cost of services

    7,636     7,819  
 

Financing interest

    79     86  
 

Research and development

    681     732  
 

Selling, general and administrative

    2,932     2,893  
 

Amortization of purchased intangible assets

    330     412  
 

In-process research and development charges

        6  
 

Restructuring charges

    131     146  
 

Acquisition-related charges

    38     48  
           
   

Total operating expenses

    28,174     26,310  
           

Earnings from operations

    3,003     2,497  
           

Interest and other, net

    (199 )   (232 )
           

Earnings before taxes

    2,804     2,265  

Provision for taxes

    554     409  
           

Net earnings

  $ 2,250   $ 1,856  
           

Net earnings per share:

             
 

Basic

  $ 0.95   $ 0.77  
           
 

Diluted

  $ 0.93   $ 0.75  
           

Cash dividends declared per share

  $ 0.16   $ 0.16  

Weighted-average shares used to compute net earnings per share:

             
 

Basic

    2,358     2,410  
           
 

Diluted

    2,427     2,464  
           

The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.

3



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Balance Sheets

 
  January 31,
2010
  October 31,
2009
 
 
  In millions, except par value
 
 
  (Unaudited)
   
 

ASSETS

 

Current assets:

             
 

Cash and cash equivalents

  $ 13,547   $ 13,279  
 

Short-term investments

    60     55  
 

Accounts receivable

    14,503     16,537  
 

Financing receivables

    2,765     2,675  
 

Inventory

    6,630     6,128  
 

Other current assets

    14,192     13,865  
           
   

Total current assets

    51,697     52,539  
           

Property, plant and equipment

    11,164     11,262  

Long-term financing receivables and other assets

    11,423     11,289  

Goodwill

    33,068     33,109  

Purchased intangible assets

    6,266     6,600  
           

Total assets

  $ 113,618   $ 114,799  
           

LIABILITIES AND STOCKHOLDERS' EQUITY

 

Current liabilities:

             
 

Notes payable and short-term borrowings

  $ 1,862   $ 1,850  
 

Accounts payable

    13,557     14,809  
 

Employee compensation and benefits

    3,038     4,071  
 

Taxes on earnings

    983     910  
 

Deferred revenue

    6,412     6,182  
 

Accrued restructuring

    899     1,109  
 

Other accrued liabilities

    14,122     14,072  
           
   

Total current liabilities

    40,873     43,003  
           

Long-term debt

    14,009     13,980  

Other liabilities

    16,845     17,052 (1)

Commitments and contingencies

             

Stockholders' equity:

             

HP stockholders' equity

             
 

Preferred stock, $0.01 par value (300 shares authorized; none issued)

         
 

Common stock, $0.01 par value (9,600 shares authorized; 2,349 and 2,365 shares issued and outstanding, respectively)

    23     24  
 

Additional paid-in capital

    14,158     13,804  
 

Retained earnings

    30,391     29,936  
 

Accumulated other comprehensive loss

    (2,944 )   (3,247 )
           
   

Total HP stockholders' equity

    41,628     40,517  
   

Noncontrolling interests

    263     247 (1)
           
   

Total stockholders' equity

    41,891     40,764  
           

Total liabilities and stockholders' equity

  $ 113,618   $ 114,799  
           

(1)
Reflects the adoption of the accounting standard related to the presentation of noncontrolling interests in consolidated financial statements.

The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.

4



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Statements of Cash Flows

(Unaudited)

 
  Three months ended
January 31
 
 
  2010   2009  
 
  In millions
 

Cash flows from operating activities:

             
 

Net earnings

  $ 2,250   $ 1,856  
 

Adjustments to reconcile net earnings to net cash provided by operating activities:

             
   

Depreciation and amortization

    1,162     1,214  
   

Stock-based compensation expense

    181     160  
   

Provision for doubtful accounts—accounts and financing receivables

    51     85  
   

Provision for inventory

    41     83  
   

In-process research and development charges

        6  
   

Restructuring charges

    131     146  
   

Deferred taxes on earnings

    (192 )   (63 )
   

Excess tax benefit from stock-based compensation

    (128 )   (13 )
   

Other, net

    87     3  
   

Changes in operating assets and liabilities:

             
     

Accounts and financing receivables

    1,875     1,780  
     

Inventory

    (543 )   156  
     

Accounts payable

    (1,268 )   (3,089 )
     

Taxes on earnings

    479     263  
     

Restructuring

    (400 )   (209 )
     

Other assets and liabilities

    (1,319 )   (1,252 )
           
       

Net cash provided by operating activities

    2,407     1,126  
           

Cash flows from investing activities:

             
 

Investment in property, plant and equipment

    (821 )   (816 )
 

Proceeds from sale of property, plant and equipment

    112     152  
 

Purchases of available-for-sale securities and other investments

    (9 )    
 

Maturities and sales of available-for-sale securities and other investments

        46  
 

Receipts (payments) in connection with business acquisitions, net

    7     (345 )
           
     

Net cash used in investing activities

    (711 )   (963 )
           

Cash flows from financing activities:

             
 

Issuance of commercial paper and notes payable, net

    78     57  
 

Issuance of debt

    29     2,004  
 

Payment of debt

    (80 )   (69 )
 

Issuance of common stock under employee stock plans

    1,319     299  
 

Repurchase of common stock

    (2,713 )   (1,238 )
 

Excess tax benefit from stock-based compensation

    128     13  
 

Dividends

    (189 )   (193 )
           
     

Net cash (used in) provided by financing activities

    (1,428 )   873  
           

Increase in cash and cash equivalents

    268     1,036  

Cash and cash equivalents at beginning of period

    13,279     10,153  
           

Cash and cash equivalents at end of period

  $ 13,547   $ 11,189  
           

Supplemental schedule of non-cash investing and financing activities:

             
 

Purchase of assets under financing arrangement

  $   $ 264  
 

Purchase of assets under capital lease

  $ 53   $ 12  

The accompanying notes are an integral part of these Consolidated Condensed Financial Statements.

5



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

(Unaudited)

Note 1: Basis of Presentation and Significant Accounting Policies

        In the opinion of management, the accompanying Consolidated Condensed Financial Statements of Hewlett-Packard Company and its consolidated subsidiaries ("HP") contain all adjustments, including normal recurring adjustments, necessary to present fairly HP's financial position as of January 31, 2010, its results of operations and cash flows for the three months ended January 31, 2010 and January 31, 2009. The Consolidated Condensed Balance Sheet as of October 31, 2009 is derived from the October 31, 2009 audited consolidated financial statements. Certain reclassifications have been made to prior-period amounts in order to conform to the current period presentation.

        The results of operations for the three months ended January 31, 2010 are not necessarily indicative of the results to be expected for the full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with "Risk Factors," "Legal Proceedings," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk" and the Consolidated Financial Statements and notes thereto included in Items 1A, 3, 7, 7A and 8, respectively, of the Hewlett-Packard Company Annual Report on Form 10-K for the fiscal year ended October 31, 2009.

        The preparation of financial statements in accordance with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the amounts reported in HP's Consolidated Condensed Financial Statements and accompanying notes. Actual results could differ materially from those estimates.

        The following disclosure on accounting pronouncements includes those that may apply to the historical financial statements.

        In December 2007, the Financial Accounting Standards Board ("FASB") issued a new accounting standard related to noncontrolling interests. The standard establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interests, changes in a parent's ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. The standard also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. In January 2010, the FASB issued Accounting Standards Update No. 2010-02, "Consolidation: Accounting and Reporting for Decreases in Ownership of a Subsidiary—a Scope Clarification." This update clarifies the scope of the decrease in ownership provisions and also requires expanded disclosures. HP adopted these standards in the first quarter of fiscal 2010 with retrospective application of the presentation and disclosure requirements. Noncontrolling interests of $247 million at October 31, 2009 were reclassified from Other liabilities to Stockholders' equity in the Consolidated Condensed Balance Sheet as of October 31, 2009. Income attributable to noncontrolling interests was immaterial for the three months ended January 31, 2010 and January 31, 2009.

        In June 2008, the FASB issued a new accounting standard that clarifies when instruments granted in share-based payment transactions should be included in computing earnings per share ("EPS"). Under the new standard, companies are required to include unvested share-based payment awards that contain non-forfeitable rights to receive dividends in their calculation of basic EPS and are required to

6



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)


calculate basic EPS using the "two-class method." The two-class method of computing EPS is an earnings allocation formula that determines EPS for each class of common stock and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. HP adopted this new accounting standard on a retrospective basis in the first quarter of fiscal 2010, and the adoption did not have a material impact on EPS.

        In June 2009, the FASB issued a new accounting standard related to the consolidation of variable interest entities. It eliminates the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and requires ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. This new standard also requires additional disclosures about an enterprise's involvement in variable interest entities. HP will adopt this new accounting standard in the first quarter of fiscal 2011. HP is continuing to evaluate the impact the adoption of this standard will have on its consolidated condensed financial statements.

Note 2: Stock-Based Compensation

        HP's stock-based compensation plans include incentive compensation plans and an employee stock purchase plan. Incentive compensation plans include principal option plans as well as various stock option plans assumed through acquisitions. Principal option plans include performance-based restricted units ("PRU"), stock options and restricted stock awards.

        Total stock-based compensation expense before income taxes for the three months ended January 31, 2010 and 2009 was $181 million and $160 million, respectively. The resulting income tax benefit for the three months ended January 31, 2010 and 2009 was $58 million and $48 million, respectively.

        In fiscal 2008, HP implemented a program that provides for the issuance of PRUs representing hypothetical shares of HP common stock that may be issued under the Hewlett-Packard Company 2004 Stock Incentive Plan.

        Under the PRU program, a target number of units are awarded at the beginning of each three-year performance period. The number of shares released at the end of the performance period will range from zero to two times the target number depending on performance during the period. The performance metrics of the PRU program are (a) annual targets based on cash flow from operations as a percentage of revenue, and (b) an overall "modifier" based on Total Shareholder Return ("TSR") relative to the S&P 500 over the three-year performance period. TSR is calculated using the quarterly average performance of the S&P 500 during the three-year performance period.

        As the cash flow goals are considered performance conditions, the expense for these awards, net of estimated forfeitures, is recorded over the three-year performance period based on the number of shares that are expected to be earned based on the achievement of the cash flow goals during the performance period.

7



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Stock-Based Compensation (Continued)

        HP estimates the fair value of a target PRU share using the Monte Carlo simulation model, as the TSR modifier contains a market condition. The following weighted-average assumptions were used to determine the weighted-average fair values of the PRU awards:

 
  Three months ended
January 31
 
 
  2010   2009  

Weighted-average fair value of grants per share

  $ 57.13 (1) $ 40.56 (2)

Expected volatility(3)

    38 %   35 %

Risk-free interest rate

    0.73 %   1.34 %

Dividend yield

    0.64 %   0.88 %

Expected life in months

    22     30  

(1)
Reflects the weighted-average fair value for the third year of the three-year performance period applicable to PRUs granted in fiscal 2008, for the second year of the three-year performance period applicable to PRUs granted in fiscal 2009 and for the first year of the three-year performance period applicable to PRUs granted in the three months ended January 31, 2010. The estimated fair value of a target share for the third year for PRUs granted in fiscal 2009 and for the second and third years for PRUs granted in the three months ended January 31, 2010 will be determined on the measurement date applicable to those PRUs, which will be the date that the annual cash flow goals are approved for those PRUs, and the expense will be amortized over the remainder of the applicable three-year performance period.

(2)
Reflects the weighted-average fair value for the second year of the three-year performance period applicable to PRUs granted in fiscal 2008 and for the first year of the three-year performance period applicable to PRUs granted in the three months ended January 31, 2009.

(3)
HP uses historic volatility for PRU awards as implied volatility cannot be used when simulating multivariate prices for companies in the S&P 500.

8



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Stock-Based Compensation (Continued)

        Outstanding PRUs as of January 31, 2010 and changes during the three months ended January 31, 2010 were as follows:

 
  Shares
(in thousands)
 

Outstanding at October 31, 2009

    24,723  

Granted

    7,278  

Vested

     

Change in units due to performance and market conditions

    (1,313 )

Forfeited

    (438 )
       

Outstanding at January 31, 2010

    30,250  
       

Outstanding PRUs assigned a fair value at January 31, 2010

    21,198 (1)
       

(1)
Excludes target shares for the third year for PRUs granted in fiscal 2009 and for the second and third years for PRUs granted in the three months ended January 31, 2010 as the measurement date has not yet been established. The measurement date and related fair value for the excluded PRUs will be established when the annual cash flow goals are approved.

        At January 31, 2010, there was $608 million of unrecognized pre-tax stock-based compensation expense related to PRUs with an assigned fair value, which HP expects to recognize over the remaining weighted-average vesting period of 1.6 years.

        HP estimated the weighted-average fair value of stock options using the Black-Scholes option pricing model with the following weighted-average assumptions:

 
  Three months ended
January 31
 
 
  2010   2009  

Weighted-average fair value of grants per share

  $ 14.42   $ 14.22  

Implied volatility

    30 %   51 %

Risk-free interest rate

    2.34 %   1.79 %

Dividend yield

    0.64 %   0.95 %

Expected life in months

    62     60  

9



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 2: Stock-Based Compensation (Continued)

        Option activity as of January 31, 2010 and changes during the three months ended January 31, 2010 were as follows:

 
  Shares
(in thousands)
  Weighted-
Average
Exercise
Price Per Share
  Weighted-
Average
Remaining
Contractual
Term
(in years)
  Aggregate
Intrinsic
Value
(in millions)
 

Outstanding at October 31, 2009

    233,214   $ 33              

Granted

    189   $ 50              

Exercised

    (35,621 ) $ 35              

Forfeited/cancelled/expired

    (1,713 ) $ 47              
                         

Outstanding at January 31, 2010

    196,069   $ 33     2.6   $ 3,130  
                         

Vested and expected to vest at January 31, 2010

    195,063   $ 32     2.5   $ 3,124  
                         

Exercisable at January 31, 2010

    185,288   $ 32     2.3   $ 3,065  
                         

        The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that option holders would have received had all option holders exercised their options on January 31, 2010. The aggregate intrinsic value is the difference between HP's closing stock price on the last trading day of the first quarter of fiscal 2010 and the exercise price, multiplied by the number of in-the-money options. Total intrinsic value of options exercised for the three months ended January 31, 2010 was $548 million.

        At January 31, 2010, there was $136 million of unrecognized pre-tax stock-based compensation expense related to stock options, which HP expects to recognize over the remaining weighted-average vesting period of 1.5 years.

        Non-vested restricted stock awards as of January 31, 2010 and changes during the three months ended January 31, 2010 were as follows:

 
  Shares
(in thousands)
  Weighted-
Average Grant
Date Fair Value
Per Share
 

Outstanding at October 31, 2009

    6,864   $ 44  

Granted

    686   $ 50  

Vested

    (410 ) $ 41  

Forfeited

    (319 ) $ 43  
             

Outstanding at January 31, 2010

    6,821   $ 45  
             

        At January 31, 2010, there was $116 million of unrecognized pre-tax stock-based compensation expense related to non-vested restricted stock awards, which HP expects to recognize over the remaining weighted-average vesting period of 1.3 years.

10



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 3: Net Earnings Per Share

        HP calculates basic earnings per share using net earnings and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes any dilutive effect of outstanding stock options, PRUs, restricted stock units, and restricted stock.

        The reconciliation of the numerators and denominators of the basic and diluted EPS calculations was as follows:

 
  Three months ended
January 31
 
 
  2010   2009  
 
  In millions, except
per share amounts

 

Numerator:

             
 

Net earnings(1)

  $ 2,250   $ 1,856  
           

Denominator:

             
 

Weighted-average shares used to compute basic EPS

    2,358     2,410  
 

Dilutive effect of employee stock plans

    69     54  
           
 

Weighted-average shares used to compute diluted EPS

    2,427     2,464  
           

Net earnings per share:

             
 

Basic

  $ 0.95   $ 0.77  
 

Diluted

  $ 0.93   $ 0.75  

(1)
Net earnings available to participating securities were not significant for the first quarter of fiscal 2010 and 2009. HP considers restricted stock that provides the holder with a non-forfeitable right to receive dividends to be a participating security.

        HP excludes options with exercise prices that are greater than the average market price from the calculation of diluted EPS because their effect would be anti-dilutive. In the first quarter of fiscal 2010 and 2009, HP excluded from the calculation of diluted EPS options to purchase 21 million shares and 107 million shares, respectively. HP also excluded from the calculation of diluted EPS options to purchase an additional 2 million shares and 1 million shares in the first quarter of fiscal 2010 and 2009, respectively, whose combined exercise price, unamortized fair value and excess tax benefits were greater in each of those periods than the average market price for HP's common stock because their effect would be anti-dilutive.

        During the first quarter of fiscal 2010 and 2009, HP granted PRU awards representing at target approximately 7 million shares and 14 million shares, respectively. HP includes the shares underlying PRU awards in the calculation of diluted EPS when they become contingently issuable and excludes such shares when they are not contingently issuable. Accordingly, for the first quarter of fiscal 2010, HP has included 9 million shares underlying the PRU awards granted in fiscal 2009 and 2008 when calculating diluted EPS as those shares became contingently issuable upon the satisfaction of the cash flow from operations condition with respect to the first year of the three-year performance period applicable to the fiscal 2009 awards and the first and second years of the three-year performance period applicable to the fiscal 2008 awards. HP has excluded all other shares underlying the fiscal 2009 and 2008 PRU awards and all shares underlying the fiscal 2010 awards when calculating diluted EPS as those shares are not contingently issuable. For the first quarter of fiscal 2009, HP has included

11



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 3: Net Earnings Per Share (Continued)


2 million shares underlying the PRU awards granted in fiscal 2008 when calculating diluted EPS as those shares became contingently issuable upon the satisfaction of the cash flow from operations condition with respect to the first year of the three-year performance period applicable to the fiscal 2008 awards. HP has excluded all other shares underlying the fiscal 2008 PRU awards and all shares underlying the fiscal 2009 awards when calculating diluted EPS as those shares were not contingently issuable.

Note 4: Balance Sheet Details

        Balance sheet details were as follows:

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

Accounts receivable

  $ 15,069   $ 17,166  

Allowance for doubtful accounts

    (566 )   (629 )
           

  $ 14,503   $ 16,537  
           

Financing receivables

  $ 2,811   $ 2,723  

Allowance for doubtful accounts

    (46 )   (48 )
           

  $ 2,765   $ 2,675  
           

        HP has revolving trade receivables-based facilities permitting it to sell certain trade receivables to third parties on a non-recourse basis. The aggregate maximum capacity under these programs was $538 million as of January 31, 2010. HP sold $506 million of trade receivables during the first three months of fiscal 2010. As of January 31, 2010, HP had $140 million available under these programs.

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

Finished goods

  $ 4,327   $ 4,092  

Purchased parts and fabricated assemblies

    2,303     2,036  
           

  $ 6,630   $ 6,128  
           

12



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 4: Balance Sheet Details (Continued)

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

Land

  $ 521   $ 513  

Buildings and leasehold improvements

    7,776     7,472  

Machinery and equipment

    12,954     12,959  
           

    21,251     20,944  
           

Accumulated depreciation

    (10,087 )   (9,682 )
           

  $ 11,164   $ 11,262  
           

Note 5: Acquisitions

        In November 2009, HP entered into a definitive agreement to acquire 3Com Corporation ("3Com"), a global enterprise provider of networking switching, routing and security solutions, at a price of $7.90 per share in cash or an enterprise value of approximately $2.7 billion. The acquisition has received clearance from U.S. and European Union regulatory authorities and the approval of 3Com's stockholders. The closing of the acquisition is subject to certain closing conditions, including obtaining requisite approvals on clearances under certain antitrust or competition laws. The transaction is expected to close in HP's second fiscal quarter of 2010.

Note 6: Goodwill and Purchased Intangible Assets

        Goodwill allocated to HP's business segments as of January 31, 2010 and changes in the carrying amount of goodwill for the three months ended January 31, 2010 are as follows:

 
  Services   Enterprise
Storage
and
Servers
  HP
Software
  Personal
Systems
Group
  Imaging
and
Printing
Group
  HP
Financial
Services
  Corporate
Investments
  Total  
 
  In millions
 

Balance at October 31, 2009

  $ 16,829   $ 5,005   $ 6,140   $ 2,487   $ 2,460   $ 144   $ 44   $ 33,109  

Goodwill adjustments

    (30 )   (6 )   (1 )   (3 )   (1 )           (41 )
                                   

Balance at January 31, 2010

  $ 16,799   $ 4,999   $ 6,139   $ 2,484   $ 2,459   $ 144   $ 44   $ 33,068  
                                   

        During the three months ended January 31, 2010, HP recorded reductions to goodwill primarily for tax adjustments related to tax deductible stock-based awards for the acquisition of Compaq Computer Corporation for which the acquisition date was before the effective date of the new guidance for business combinations. HP also recorded reductions to goodwill for currency translation related to certain of Electronic Data Systems Corporation's ("EDS") foreign subsidiaries whose functional currency is not the U.S. dollar.

13



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 6: Goodwill and Purchased Intangible Assets (Continued)

        HP's purchased intangible assets associated with completed acquisitions are composed of:

 
  January 31, 2010   October 31, 2009  
 
  Gross   Accumulated
Amortization
  Net   Gross   Accumulated
Amortization
  Net  
 
  In millions
 

Customer contracts, customer lists and distribution agreements

  $ 6,761   $ (3,230 ) $ 3,531   $ 6,763   $ (3,034 ) $ 3,729  

Developed and core technology and patents

    4,169     (2,878 )   1,291     4,171     (2,747 )   1,424  

Product trademarks

    247     (225 )   22     247     (222 )   25  
                           

Total amortizable purchased intangible assets

    11,177     (6,333 )   4,844     11,181     (6,003 )   5,178  

Compaq trade name

    1,422         1,422     1,422         1,422  
                           

Total purchased intangible assets

  $ 12,599   $ (6,333 ) $ 6,266   $ 12,603   $ (6,003 ) $ 6,600  
                           

        For the three months ended January 31, 2010, adjustments made to purchased intangibles relate primarily to currency translation on certain of EDS's foreign subsidiaries whose functional currency is not the U.S. dollar.

        Estimated future amortization expense related to finite lived purchased intangible assets at January 31, 2010 is as follows:

Fiscal year:
  In millions  

2010 (remaining nine months)

  $ 976  

2011

    1,052  

2012

    854  

2013

    716  

2014

    464  

Thereafter

    782  
       

Total

  $ 4,844  
       

Note 7: Restructuring Charges

        In May 2009, HP's management approved and initiated a restructuring plan to structurally change and improve the effectiveness of the Imaging and Printing Group ("IPG"), the Personal Systems Group ("PSG"), and Enterprise Storage and Servers ("ESS"). The total expected cost of the plan is $303 million in severance-related costs associated with the planned elimination of approximately 5,000 positions. As of January 31, 2010, approximately 2,800 positions have been eliminated. HP expects the majority of the restructuring costs to be paid out by the fourth quarter of fiscal 2010. In future

14



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 7: Restructuring Charges (Continued)

quarters, HP expects to record an additional charge of approximately $5 million related to severance costs associated with this plan.

        In connection with the acquisition of EDS on August 26, 2008, HP's management approved and initiated a restructuring plan to streamline the combined company's services business and to better align the structure and efficiency of that business with HP's operating model. The restructuring plan is expected to be implemented over four years from the acquisition date and includes changes to the combined company's workforce as well as changes to corporate overhead functions such as real estate and IT.

        The total expected cost of this restructuring plan is $3.0 billion, consisting mainly of severance costs to eliminate approximately 25,000 positions, costs to vacate duplicative facilities and costs associated with early termination of certain contractual obligations. As of January 31, 2010, over 20,000 positions have been eliminated. HP expects the majority of the restructuring costs associated with severance to be paid out by the second quarter of fiscal 2010. In future quarters, HP expects to record an additional charge of approximately $412 million related to the cost to vacate duplicative facilities and severance costs.

        Approximately $1.5 billion of the expected costs were associated with pre-acquisition EDS and were reflected in the purchase price of EDS. These costs are subject to change based on the actual costs incurred. The remaining costs are primarily associated with HP and were recorded as a restructuring charge.

        The adjustments to the accrued restructuring expenses related to all of HP's restructuring plans described above for the three months ended January 31, 2010 were as follows:

 
   
  Three
months
ended
January 31,
2010
charges
   
   
   
  As of January 31, 2010  
 
  Balance,
October 31,
2009
  Cash
payments
  Non-cash
settlements
and other
adjustments
  Balance,
January 31,
2010
  Total costs
and
adjustments
to date
  Total
expected
costs and
adjustments
 

Fiscal 2009 Plan

  $ 248   $ 1   $ (45 ) $ (6 ) $ 198   $ 298   $ 303  

Fiscal 2008 HP/EDS Plan:

                                           
 

Severance

  $ 747   $ 101   $ (330 ) $ (24 ) $ 494   $ 2,011   $ 2,017  
 

Infrastructure

    419     29     (20 )   (7 )   421     529     935  
                               
 

Total severance and other restructuring activities

  $ 1,166   $ 130   $ (350 ) $ (31 ) $ 915   $ 2,540   $ 2,952  
                               

Total restructuring plans

  $ 1,414   $ 131   $ (395 ) $ (37 ) $ 1,113   $ 2,838   $ 3,255  
                               

        At January 31, 2010 and October 31, 2009, HP had $44 million and $51 million, respectively, of restructuring liabilities associated with previous restructuring actions that are complete but have cash

15



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 7: Restructuring Charges (Continued)


payouts anticipated to occur through 2012. For the three months ended January 31, 2010, cash payouts of $5 million and other adjustments of $2 million were recorded against these liabilities.

        At January 31, 2010 and October 31, 2009, HP included the long-term portion of the restructuring liability of $258 million and $356 million, respectively, in Other liabilities, and the short-term portion in Accrued restructuring in the accompanying Consolidated Condensed Balance Sheets.

Note 8: Fair Value

        HP adopted the provisions related to the fair value of nonfinancial assets and nonfinancial liabilities in the first quarter of fiscal 2010 for the following major categories of nonfinancial items from the Consolidated Condensed Balance Sheet: Property, plant and equipment, Goodwill, Purchased intangible assets, Accrued restructuring and the asset retirement obligations within Other accrued liabilities and Other liabilities. The provisions of the accounting standard related to estimating fair value and related disclosures are applied to nonfinancial assets and nonfinancial liabilities whenever they are required to be measured at fair value, such as when accounting for a business combination, when evaluating and/or determining impairment, or in accordance with certain other accounting pronouncements. For the three months ended January 31, 2010, HP did not measure any nonfinancial assets and nonfinancial liabilities at fair value on a non-recurring basis. The adoption of these provisions did not have a material impact on the consolidated condensed financial statements of HP for the first quarter of fiscal 2010.

        The standard relating to fair value measurements and disclosures codifies a new framework for measuring fair value and expands related disclosures. The framework requires fair value to be determined based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants.

        Valuation techniques used by HP are based upon observable and unobservable inputs. Observable or market inputs reflect market data obtained from independent sources, while unobservable inputs reflect HP's assumptions about market participant assumptions based on best information available. Observable inputs are the preferred source of values. These two types of inputs create the following fair value hierarchy:

        Level 1—Quoted prices (unadjusted) for identical instruments in active markets.

        Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

        Level 3—Prices or valuations that require management inputs that are both significant to the fair value measurement and unobservable.

16



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 8: Fair Value (Continued)

        The following section describes the valuation methodologies HP uses to measure its financial assets and liabilities at fair value.

        Cash Equivalents and Investments: HP holds time deposits, money market funds, commercial paper, other debt securities primarily consisting of corporate and foreign government notes and bonds, and common stock and equivalents. In general, and where applicable, HP uses quoted prices in active markets for identical assets to determine fair value. If quoted prices in active markets for identical assets are not available to determine fair value, HP uses quoted prices for similar assets and liabilities or inputs that are observable either directly or indirectly. If quoted prices for identical or similar assets are not available, HP uses internally developed valuation models, whose inputs include bid prices, and third party valuations utilizing underlying assets assumptions.

        Derivative Instruments: As discussed in Note 9, HP mainly holds non-speculative forwards, swaps and options to hedge certain foreign currency and interest rate exposures. When active market quotes are not available, HP uses industry standard valuation models. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit risk, foreign exchange rates, and forward and spot prices for currencies. In certain cases, market-based observable inputs are not available and, in those cases, HP uses management judgment to develop assumptions which are used to determine fair value.

        The following table presents HP's assets and liabilities that are measured at fair value on a recurring basis:

 
  As of January 31, 2010   As of October 31, 2009  
 
  Fair Value Measured Using    
  Fair Value Measured Using    
 
 
  Total
Balance
  Total
Balance
 
 
  Level 1   Level 2   Level 3   Level 1   Level 2   Level 3  
 
  In millions
 

Assets

                                                 

Time deposits

  $   $ 9,433   $   $ 9,433   $   $ 8,925   $   $ 8,925  

Commercial paper

        1,375         1,375         1,388         1,388  

Money market funds

    586             586     262             262  

Other debt securities

    14     361     35     410     15     372     36     423  

Marketable equity securities

    7     3         10     7     3         10  

Derivatives

        1,058     5     1,063         755     1     756  
                                   
 

Total Assets

  $ 607   $ 12,230   $ 40   $ 12,877   $ 284   $ 11,443   $ 37   $ 11,764  
                                   

Liabilities

                                                 

Derivatives

  $   $ 396   $ 8   $ 404   $   $ 773   $ 1   $ 774  
                                   
 

Total Liabilities

  $   $ 396   $ 8   $ 404   $   $ 773   $ 1   $ 774  
                                   

        The following table presents the changes in Level 3 instruments for the three months ended January 31, 2010 that are measured at fair value on a recurring basis. The majority of the Level 3

17



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 8: Fair Value (Continued)


balances consist of investment securities classified as available-for-sale with changes in fair value recorded in other comprehensive income ("OCI").

 
  Fair Value Measured Using
Significant Unobservable Inputs
(Level 3)
 
Three months ended January 31, 2010
  Other Debt
Securities
  Derivative
Instruments
  Total  
 
  In millions
 

Beginning balance at November 1, 2009

  $ 36   $   $ 36  
 

Total losses (realized/unrealized):

                   
   

Included in earnings(1)

    (1 )       (1 )
   

Included in OCI

        (5 )   (5 )
 

Purchases, issuances, and settlements

        2     2  
               

Ending balance at January 31, 2010

  $ 35   $ (3 ) $ 32  
               

The amount of total losses for the period included in earnings attributable to the change in unrealized losses relating to assets still held as of January 31, 2010

  $ (1 ) $   $ (1 )
               

(1)
Included in Interest and other, net in the accompanying Consolidated Condensed Statements of Earnings.

        The changes in Level 3 instruments for the three months ended January 31, 2009 that were measured at fair value on a recurring basis resulted in a total loss of $2 million. The loss for the period was included in earnings attributable to the change in unrealized losses relating to assets still held as of January 31, 2009.

        HP measures certain assets including cost and equity method investments at fair value on a non-recurring basis. These assets are recognized at fair value when they are deemed to be other-than-temporarily impaired. In the three months ended January 31, 2010, HP did not record any impairment charge relating to these investments. In the three months ended January 31, 2009, HP recorded an impairment charge of $5 million.

        HP reviews the carrying values of the investments when events and circumstances warrant and considers all available evidence in evaluating when declines in fair value are other-than-temporary declines. HP determines fair values for investments in public companies using quoted market prices and records a charge to Interest and other, net when the change in fair values is determined to be other than temporary. HP carries equity investments in privately held companies at cost or at fair value when HP recognizes an other-than-temporary impairment charge.

        HP monitors its investment portfolio for impairment on a periodic basis. In the event that the carrying value of an investment in debt securities exceeds its fair value and the decline in value is determined to be an other-than-temporary decline and (i) HP does not intend to sell the debt security, and (ii) when it is not more likely than not that HP will be required to sell the debt security prior to recovery of its amortized cost basis, HP records an impairment charge to Interest and other, net in the amount of the credit loss and the balance, if any, to other comprehensive income.

18



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 9: Financial Instruments

        Cash equivalents and investments at fair value as of January 31, 2010 and October 31, 2009 were as follows:

 
  January 31, 2010   October 31, 2009  
 
  Cost   Gross
Unrealized
Gain
  Gross
Unrealized
Loss
  Estimated
Fair Value
  Cost   Gross
Unrealized
Gain
  Gross
Unrealized
Loss
  Estimated
Fair Value
 
 
  In millions
 

Cash Equivalents

                                                 
 

Time deposits

  $ 9,371   $   $   $ 9,371   $ 8,870   $   $   $ 8,870  
 

Commercial paper

    1,375             1,375     1,388             1,388  
 

Money market funds

    586             586     262             262  
                                   

Total cash equivalents

  $ 11,332   $   $   $ 11,332   $ 10,520   $   $   $ 10,520  
                                   

Investments

                                                 

Debt securities:

                                                 
 

Time deposits

  $ 62   $   $   $ 62   $ 55   $   $   $ 55  
 

Other debt securities

    404     51     (45 )   410     419     49     (45 )   423  
                                   

Total debt securities

  $ 466   $ 51   $ (45 ) $ 472   $ 474   $ 49   $ (45 ) $ 478  
                                   

Equity securities in public companies

  $ 3   $ 2   $   $ 5   $ 3   $ 2   $   $ 5  
                                   

Total cash equivalents and investments

  $ 11,801   $ 53   $ (45 ) $ 11,809   $ 10,997   $ 51   $ (45 ) $ 11,003  
                                   

        Cash equivalents consist of investments with original maturities of ninety days or less. Available-for-sale securities consist of short-term investments which mature within twelve months or less and long-term investments with maturities longer than twelve months. Investments include primarily time deposits, fixed-interest securities, and institutional bonds. As discussed in Note 8, HP estimated the fair values of its investments based on quoted market prices or pricing models using current market rates. These estimated fair values may not be representative of actual values that will be realized in the future.

        The gross unrealized loss as of January 31, 2010 was due primarily to declines in certain debt securities and included $31 million that has been in a continuous loss position for more than twelve months. The gross unrealized loss as of October 31, 2009 was due primarily to declines in certain debt securities and included $20 million that had been in a continuous loss position for more than twelve months. HP does not intend to sell these debt securities, and it is not likely that HP will be required to sell these debt securities prior to the recovery of the amortized cost. In the three months ended January 31, 2010, HP did not recognize any impairment charge associated with debt securities. In the three months ended January 31, 2009, HP recognized an impairment charge of $11 million representing credit losses associated with debt securities.

19



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 9: Financial Instruments (Continued)

        Contractual maturities of short-term and long-term investments in available-for-sale securities at January 31, 2010 were as follows:

 
  Available-for-Sale
Securities
 
 
  January 31, 2010  
 
  Cost   Estimated
Fair Value
 
 
  In millions
 

Due in less than one year

  $ 60   $ 60  

Due in 1-5 years

    28     28  

Due in more than five years

    378     384  
           

  $ 466   $ 472  
           

        There were no sales or maturities of available-for-sale and other securities for the three months ended January 31, 2010. Proceeds from sales and maturities of available-for-sale and other securities were $46 million in the three months ended January 31, 2009. There were no gross realized gains or losses on these securities for both periods. The specific identification method is used to account for gains and losses on available-for-sale securities.

        A summary of the carrying values and balance sheet classification of all short-term and long-term investments in debt and equity securities as of January 31, 2010 and October 31, 2009 was as follows:

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

Time deposit

  $ 55   $ 55  

Available-for-sale debt securities

    5      
           
 

Short-term investments

    60     55  
           

Time deposit

    7      

Available-for-sale debt securities

    405     423  

Available-for-sale equity securities

    5     5  

Equity securities in privately-held companies

    134     129  

Other investments

    13     13  
           
 

Included in long-term financing receivables and other assets

    564     570  
           

Total investments

  $ 624   $ 625  
           

        Equity securities in privately held companies include cost basis and equity method investments. Other investments include marketable trading securities held to generate returns that HP expects to offset changes in certain liabilities related to deferred compensation arrangements. HP includes gains or losses from changes in fair value of these securities, offset by losses or gains on the related liabilities, in Interest and other, net, in HP's Consolidated Condensed Statements of Earnings. The net losses associated with these securities were $2 million and $4 million for the three months ended January 31, 2010 and January 31, 2009, respectively.

20



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 9: Financial Instruments (Continued)

        HP is a global company that is exposed to foreign currency exchange rate fluctuations and interest rate changes in the normal course of its business. As part of its risk management strategy, HP uses derivative instruments, primarily forward contracts, option contracts, interest rate swaps, and total return swaps, to hedge certain foreign currency, interest rate and, to a lesser extent, equity exposures. HP's objective is to offset gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them, thereby reducing volatility of earnings or protecting fair values of assets and liabilities. HP does not have any leveraged derivatives. HP does not use derivative contracts for speculative purposes. HP designates its derivatives as fair value hedges, cash flow hedges or hedges of the foreign currency exposure of a net investment in a foreign operation ("net investment hedges"). Additionally, for derivatives not designated as hedging instruments, HP categorizes those economic hedges as other derivatives. HP recognizes all derivatives in the Consolidated Condensed Balance Sheets at fair value and reports them in Other current assets, Long-term financing receivables and other assets, Other accrued liabilities, or Other liabilities. HP classifies cash flows from the derivative programs as operating activities in the Consolidated Condensed Statements of Cash Flows.

        As a result of the use of derivative instruments, HP is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, HP has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors, and HP maintains dollar and term limits that correspond to each institution's credit rating. HP's established policies and procedures for mitigating credit risk on principal transactions and short-term cash include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties. Master agreements with counterparties include master netting arrangements as further mitigation of credit exposure to counterparties. These arrangements permit HP to net amounts due from HP to a counterparty with amounts due to HP from a counterparty, which reduces the maximum loss from credit risk in the event of counterparty default.

        Certain of HP's derivative instruments contain credit-risk-related contingent features, such as a provision whereby the counterparties to the derivative instruments could request collateralization on derivative instruments in net liability positions if HP's credit rating falls below investment grade. As of January 31, 2010, HP was not required to post any collateral, and HP did not have any derivative instruments with credit-risk-related contingent features that were in a significant net liability position.

        HP enters into fair value hedges to reduce the exposure of its debt portfolio to interest rate risk. HP issues long-term debt in U.S. dollars based on market conditions at the time of financing. HP uses interest rate swaps to modify the market risk exposures in connection with the debt to achieve primarily U.S. dollar LIBOR-based floating interest expense. The swap transactions generally involve principal and interest obligations for U.S. dollar-denominated amounts. Alternatively, HP may choose not to swap fixed for floating interest payments or may terminate a previously executed swap if it believes a larger proportion of fixed-rate debt would be beneficial. When investing in fixed-rate instruments, HP may enter into interest rate swaps that convert the fixed interest returns into variable interest returns and would classify these swaps as fair value hedges. For derivative instruments that are designated and

21



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 9: Financial Instruments (Continued)

qualify as fair value hedges, HP recognizes the gain or loss on the derivative instrument, as well as the offsetting loss or gain on the hedged item, in Interest and other, net in the Consolidated Condensed Statements of Earnings in the current period.

        HP uses a combination of forward contracts and options designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in its forecasted net revenue and, to a lesser extent, cost of sales, operating expense, and intercompany lease loan denominated in currencies other than the U.S. dollar. HP's foreign currency cash flow hedges mature generally within six to twelve months. However, certain leasing revenue-related forward contracts and intercompany lease loan forward contracts extend for the duration of the lease term, which can be up to five years. For derivative instruments that are designated and qualify as cash flow hedges, HP initially records the effective portion of the gain or loss on the derivative instrument in accumulated other comprehensive income or loss as a separate component of stockholders' equity and subsequently reclassifies these amounts into earnings in the period during which the hedged transaction is recognized in earnings. HP reports the effective portion of cash flow hedges in the same financial statement line item as the changes in value of the hedged item. During the three months ended January 31, 2010, HP did not discontinue any cash flow hedge for which it was probable that a forecasted transaction would not occur.

        HP uses forward contracts designated as net investment hedges to hedge net investments in certain foreign subsidiaries whose functional currency is the local currency. These derivative instruments are designated as net investment hedges and, as such, HP records the effective portion of the gain or loss on the derivative instrument together with changes in the hedged items in cumulative translation adjustment as a separate component of stockholders' equity.

        Other derivatives not designated as hedging instruments consist primarily of forward contracts HP uses to hedge foreign currency balance sheet exposures. HP also uses total return swaps and, to a lesser extent, interest rate swaps, based on the equity and fixed income indices, to hedge its executive deferred compensation plan liability. For derivative instruments not designated as hedging instruments, HP recognizes changes in the fair values in earnings in the period of change. HP recognizes the gain or loss on foreign currency forward contracts used to hedge balance sheet exposures in Interest and other, net in the same period as the remeasurement gain and loss of the related foreign currency denominated assets and liabilities. HP recognizes the gain or loss on the total return swaps and interest rate swaps in Interest and other, net in the same period as the gain or loss from the change in market value of the executive deferred compensation plan liability.

        For interest rate swaps designated as fair value hedges, HP measures effectiveness by offsetting the change in fair value of the hedged debt with the change in fair value of the derivative. For foreign

22



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 9: Financial Instruments (Continued)

currency options and forward contracts designated as cash flow or net investment hedges, HP measures effectiveness by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item, both of which are based on forward rates. HP recognizes any ineffective portion of the hedge, as well as amounts not included in the assessment of effectiveness, in the Consolidated Condensed Statements of Earnings. As of January 31, 2010, the portion of hedging instruments' gain or loss excluded from the assessment of effectiveness was not material for fair value, cash flow or net investment hedges. Hedge ineffectiveness for fair value, cash flow and net investment hedges was not material in the three months ended January 31, 2010.

        As discussed in Note 8, HP estimates the fair values of derivatives primarily based on pricing models using current market rates and records all derivatives on the balance sheet at fair value. The gross notional and fair value of derivative financial instruments in the Consolidated Condensed Balance Sheets were recorded as follows:

 
  As of January 31, 2010   As of October 31, 2009  
 
  Gross
Notional(1)
  Other
Current
Assets
  Long-term
Financing
Receivables
and
Other
Assets
  Other
Accrued
Liabilities
  Other
Liabilities
  Gross
Notional(1)
  Other
Current
Assets
  Long-term
Financing
Receivables
and
Other
Assets
  Other
Accrued
Liabilities
  Other
Liabilities
 
 
  In millions
 

Derivatives designated as hedging instruments

                                                             

Fair value hedges:

                                                             
 

Interest rate contracts

  $ 7,575   $   $ 351   $   $ 1   $ 7,575   $   $ 346   $   $ 5  

Cash flow hedges:

                                                             
 

Foreign exchange contracts

    14,604     390     41     88     20     15,056     116     12     389     33  

Net investment hedges:

                                                             
 

Foreign exchange contracts

    1,375     16     12     32     35     1,350     13     12     47     39  
                                           

Total derivatives designated as hedging instruments

  $ 23,554   $ 406   $ 404   $ 120   $ 56   $ 23,981   $ 129   $ 370   $ 436   $ 77  
                                           

Derivatives not designated as hedging instruments

                                                             

Foreign exchange contracts

  $ 13,101   $ 198   $ 18   $ 114   $ 51   $ 16,104   $ 206   $ 20   $ 163   $ 51  

Interest rate contracts(2)

    2,200         32         50     2,211         29         45  

Total return contracts and other

    292     1     4     13         268     2         2      
                                           

Total derivatives not designated as hedging instruments

  $ 15,593   $ 199   $ 54   $ 127   $ 101   $ 18,583   $ 208   $ 49   $ 165   $ 96  
                                           

Total derivatives

  $ 39,147   $ 605   $ 458   $ 247   $ 157   $ 42,564   $ 337   $ 419   $ 601   $ 173  
                                           

(1)
Represents the face amounts of contracts that were outstanding as of January 31, 2010 and October 31, 2009, respectively.

(2)
Represents offsetting swaps acquired through previous business combination that were not designated as hedging instruments.

23



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 9: Financial Instruments (Continued)

        The before-tax effect of a derivative instrument and related hedged item in a fair value hedging relationship for the three months ended January 31, 2010 was as follows:

 
  Gain (Loss) Recognized in Income on Derivative and Related Hedged Item  
Derivative Instrument
  Location   Three
months
ended
January 31,
2010
  Hedged Item   Location   Three
months
ended
January 31,
2010
 
 
   
  In millions
   
   
  In millions
 

Interest rate contracts

  Interest and other, net   $ 9   Fixed-rate debt   Interest and other, net   $ (9 )

        The before-tax effect of derivative instruments in cash flow and net investment hedging relationships for the three months ended January 31, 2010 was as follows:

 
  Gain
Recognized in
OCI on Derivative
(Effective Portion)
  Gain (Loss) Reclassified from
Accumulated OCI Into Income
(Effective Portion)
  Gain Recognized in Income on
Derivative(1) (Ineffective portion and
Amount Excluded from Effectiveness
Testing)
 
 
  Three
months
ended
January 31,
2010
  Location   Three
months
ended
January 31,
2010
  Location   Three
months
ended
January 31,
2010
 
 
  In millions
   
  In millions
   
  In millions
 

Cash flow hedges:

                           
 

Foreign exchange contracts

  $ 425  

Net revenue

  $ (130 )

Net revenue

  $  
 

Foreign exchange contracts

    5  

Cost of products

    15  

Cost of products

     
 

Foreign exchange contracts

     

Other operating expenses

    1  

Other operating expenses

     
 

Foreign exchange contracts

    6  

Interest and other,
net

    4  

Interest and other,
net

     
 

Foreign exchange contracts

    11  

Net revenue

    8  

Interest and other,
net

    4  
                       
   

Total cash flow hedges

  $ 447       $ (102 )     $ 4  
                       

Net investment hedges:

                           
 

Foreign exchange contracts

  $ 3  

Interest and other,
net

  $  

Interest and other,
net

  $  
                       

(1)
Amount of gain recognized in income on derivative represents a $4 million gain related to the amount excluded from the assessment of hedge effectiveness in the three months ended January 31, 2010.

24



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 9: Financial Instruments (Continued)

        HP expects to reclassify a net accumulated other comprehensive gain of approximately $182 million, net of taxes, to earnings in the next twelve months along with the earnings effects of the related forecasted transactions in association with cash flow hedges.

        The before-tax effect of derivative instruments not designated as hedging instruments on the Consolidated Condensed Statements of Earnings for the three months ended January 31, 2010 was as follows:

 
  Gain (Loss) Recognized in Income on Derivative  
 
  Location   Three
months
ended
January 31,
2010
 
 
   
  In millions
 

Foreign exchange contracts

  Interest and other, net   $ 66  

Total return contracts and other

  Interest and other, net     (11 )

Interest rate contracts

  Interest and other, net     (1 )
           

Total

      $ 54  
           

        For the balance of HP's financial instruments, accounts receivable, financing receivables, notes payable and short-term borrowings, accounts payable and other accrued liabilities, the carrying amounts approximate fair value due to their short maturities. The estimated fair value of HP's short- and long-term debt was approximately $16.0 billion at January 31, 2010, compared to a carrying value of $15.9 billion at that date. The estimated fair value of the debt is based primarily on quoted market prices, as well as borrowing rates currently available to HP for bank loans with similar terms and maturities.

Note 10: Financing Receivables and Operating Leases

        Financing receivables represent sales-type and direct-financing leases resulting from the marketing of HP's and third-party products. These receivables typically have terms from two to five years and are usually collateralized by a security interest in the underlying assets. Financing receivables also include

25



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 10: Financing Receivables and Operating Leases (Continued)


billed receivables from operating leases. The components of net financing receivables, which are included in financing receivables and long-term financing receivables and other assets, were as follows:

 
  January 31, 2010   October 31, 2009  
 
  In millions
 

Minimum lease payments receivable

  $ 6,541   $ 6,413  

Allowance for doubtful accounts

    (102 )   (108 )

Unguaranteed residual value

    238     244  

Unearned income

    (570 )   (571 )
           

Financing receivables, net

    6,107     5,978  

Less current portion

    (2,765 )   (2,675 )
           

Amounts due after one year, net

  $ 3,342   $ 3,303  
           

        Equipment leased to customers under operating leases was $3.1 billion at January 31, 2010 and $3.0 billion at October 31, 2009 and is included in machinery and equipment. Accumulated depreciation on equipment under lease was $0.9 billion at January 31, 2010 and October 31, 2009.

Note 11: Guarantees

        In the ordinary course of business, HP may provide certain clients with subsidiary performance guarantees and/or financial performance guarantees, which may be backed by standby letters of credit or surety bonds. In general, HP would be liable for the amounts of these guarantees in the event HP or HP's subsidiaries' nonperformance permits termination of the related contract by the client, the likelihood of which HP believes is remote. HP believes that the company is in compliance with the performance obligations under all material service contracts for which there is a performance guarantee.

        HP has certain service contracts supported by client financing or securitization arrangements. Under specific circumstances involving nonperformance resulting in service contract termination or failure to comply with terms under the financing arrangement, HP would be required to acquire certain assets. HP considers the possibility of its failure to comply to be remote and the asset amounts involved to be immaterial.

        In the ordinary course of business, HP enters into contractual arrangements under which HP may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of HP or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial.

26



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 11: Guarantees (Continued)

        HP provides for the estimated cost of product warranties at the time it recognizes revenue. HP engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers; however, product warranty terms offered to customers, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product class failures outside of HP's baseline experience, affect the estimated warranty obligation. If actual product failure rates, repair rates or any other post sales support costs differ from these estimates, revisions to the estimated warranty liability would be required.

        The changes in HP's aggregate product warranty liabilities for the three months ended January 31, 2010 were as follows:

 
  In millions  

Product warranty liability at October 31, 2009

  $ 2,409  

Accruals for warranties issued

    758  

Adjustments related to pre-existing warranties (including changes in estimates)

    (23 )

Settlements made (in cash or in kind)

    (676 )
       

Product warranty liability at January 31, 2010

  $ 2,468  
       

Note 12: Borrowings

        Notes payable and short-term borrowings, including the current portion of long-term debt, were as follows:

 
  January 31, 2010   October 31, 2009  
 
  Amount
Outstanding
  Weighted-
Average
Interest
Rate
  Amount
Outstanding
  Weighted-
Average
Interest
Rate
 
 
  In millions
 

Current portion of long-term debt

  $ 1,113     0.8 % $ 1,143     1.0 %

Commercial paper

    296     1.0 %   294     1.2 %

Notes payable to banks, lines of credit and other

    453     2.6 %   413     2.0 %
                       

  $ 1,862         $ 1,850        
                       

        Notes payable to banks, lines of credit and other includes deposits associated with HP's banking-related activities of approximately $320 million and $326 million at January 31, 2010 and October 31, 2009, respectively.

27



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 12: Borrowings (Continued)

        Long-term debt was as follows:

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

U.S. Dollar Global Notes

             
 

2002 Shelf Registration Statement:

             
   

$500 issued at discount to par at a price of 99.505% in June 2002 at 6.5%, due July 2012

  $ 499   $ 499  
 

2006 Shelf Registration Statement:

             
   

$600 issued at par in February 2007 at three-month USD LIBOR plus 0.11%, due March 2012

    600     600  
   

$900 issued at discount to par at a price of 99.938% in February 2007 at 5.25%, due March 2012

    900     900  
   

$500 issued at discount to par at a price of 99.694% in February 2007 at 5.4%, due March 2017

    499     499  
   

$1,000 issued at par in June 2007 at three-month USD LIBOR plus 0.06%, due June 2010

    1,000     1,000  
   

$1,500 issued at discount to par at a price of 99.921% in March 2008 at 4.5%, due March 2013

    1,499     1,499  
   

$750 issued at discount to par at a price of 99.932% in March 2008 at 5.5%, due March 2018

    750     750  
   

$2,000 issued at discount to par at a price of 99.561% in December 2008 at 6.125%, due March 2014

    1,993     1,992  
   

$275 issued at par in February 2009 at three-month USD LIBOR plus 1.75%, due February 2011

    275     275  
   

$1,000 issued at discount to par at a price of 99.956% in February 2009 at 4.25%, due February 2012

    1,000     1,000  
   

$1,500 issued at discount to par at a price of 99.993% in February 2009 at 4.75%, due June 2014

    1,500     1,500  
 

2009 Shelf Registration Statement:

             
   

$750 issued at par in May 2009 at three-month USD LIBOR plus 1.05%, due May 2011

    750     750  
   

$1,000 issued at discount to par at a price of 99.967% in May 2009 at 2.25%, due May 2011

    1,000     1,000  
   

$250 issued at discount to par at a price of 99.984% in May 2009 at 2.95%, due August 2012

    250     250  
           

    12,515     12,514  
           

28



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 12: Borrowings (Continued)

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

EDS Senior Notes

             
 

$1,100 issued June 2003 at 6.0%, due August 2013

    1,138     1,140  
 

$300 issued October 1999 at 7.45%, due October 2029

    315     315  
           

    1,453     1,455  
           

Other, including capital lease obligations, at 3.75%-8.63%, due in calendar year 2010-2024

    775     785  

Fair value adjustment related to hedged debt

    379     369  

Less: current portion

    (1,113 )   (1,143 )
           

Total long-term debt

  $ 14,009   $ 13,980  
           

        HP may redeem some or all of the Global Notes set forth in the above table at any time at the redemption prices described in the prospectus supplements relating thereto. The Global Notes are senior unsecured debt.

        HP registered the sale of up to $3.0 billion of debt or global securities, common stock, preferred stock, depositary shares and warrants under a shelf registration statement filed with the Securities and Exchange Commission ("SEC") in March 2002 (the "2002 Shelf Registration Statement"). The 2002 Shelf Registration Statement expired on December 1, 2008, and, accordingly, HP is no longer able to issue any additional securities under this registration statement.

        In May 2009, HP filed a shelf registration statement (the "2009 Shelf Registration Statement") with the SEC to enable the company to offer for sale, from time to time, in one or more offerings, an unspecified amount of debt securities, common stock, preferred stock, depositary shares and warrants. The 2009 Shelf Registration Statement replaced a similar registration statement filed in May 2006 that expired in May 2009.

        In May 2008, HP's Board of Directors approved an increase in the capacity of HP's U.S. commercial paper program by $10.0 billion to $16.0 billion. HP's subsidiaries are authorized to issue up to an additional $1.0 billion of commercial paper, of which $500 million of capacity is currently available to be used by Hewlett-Packard International Bank PLC, a wholly-owned subsidiary of HP, for its Euro Commercial Paper/Certificate of Deposit Programme.

        In October 2008, HP registered for the Commercial Paper Funding Facility ("CPFF") provided by the Federal Reserve Bank of New York. The CPFF program expired on February 1, 2010. HP had not issued any commercial paper under the CPFF program.

        HP has a $2.9 billion five-year credit facility expiring in May 2012. In February 2009, HP entered into a $3.5 billion 364-day credit facility. The February credit facility expired in February 2010, at which time HP entered into a new $3.5 billion 364-day credit facility maintaining the total amount available under its credit facilities at $6.4 billion. Commitment fees, interest rates and other terms of borrowing under the credit facilities vary based on HP's external credit ratings. The credit facilities are senior unsecured committed borrowing arrangements primarily to support the issuance of U.S. commercial

29



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 12: Borrowings (Continued)


paper. HP's ability to have a U.S. commercial paper outstanding balance that exceeds the $6.4 billion supported these credit facilities is subject to a number of factors, including liquidity conditions and business performance.

        HP also maintains uncommitted lines of credit from a number of financial institutions that are available through various foreign subsidiaries. The amount available for use as of January 31, 2010 was approximately $1.5 billion.

        Included in Other, including capital lease obligations, are borrowings that are collateralized by certain financing receivable assets. As of January 31, 2010, the carrying value of the assets approximated the carrying value of the borrowings of $22 million.

        At January 31, 2010, HP was able to issue an unspecified amount of additional debt securities, common stock, preferred stock, depositary shares and warrants under the 2009 Shelf Registration Statement. As of that date, HP also had up to approximately $17.7 billion of available borrowing resources, including $16.2 billion under its commercial paper programs, $6.4 billion of which is supported by its credit facilities, and approximately $1.5 billion under other programs.

Note 13: Income Taxes

        HP's effective tax rate was 19.8% and 18.0% for the three months ended January 31, 2010 and January 31, 2009, respectively. HP's effective tax rate increased due to a decline in the percentage of total earnings earned in lower-tax jurisdictions and a decline in its discrete tax benefits relative to pretax earnings. HP's effective tax rate generally differs from the U.S. federal statutory rate of 35% due to favorable tax rates associated with certain earnings from HP's operations in lower-tax jurisdictions throughout the world. HP has not provided U.S. taxes for all of such earnings because HP plans to reinvest some of those earnings indefinitely outside the United States.

        In the three months ended January 31, 2010, HP recorded discrete items with a net tax benefit of $92 million, decreasing the effective tax rate. These amounts included net tax benefits of $54 million from restructuring and acquisition charges, a tax benefit of $19 million from settlement of a tax audit matter, a net tax benefit of $19 million from adjustments to prior year foreign income tax accruals and credits, and other miscellaneous discrete items.

        In the three months ended January 31, 2009, HP recorded discrete items with a net tax benefit of $91 million, decreasing the effective tax rate. These amounts included net tax benefits of $63 million from restructuring and acquisition charges and other miscellaneous discrete items resulting in a net tax benefit of $28 million.

        During the first three months of fiscal 2010, the amount of gross unrecognized tax benefits remained at $1.9 billion, of which up to $940 million would affect HP's effective tax rate if realized. HP recognizes interest expense and penalties on unrecognized tax benefits within income tax expense. During the first three months of fiscal 2010, there was no material change in the amount of accrued net interest and penalties.

30



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 13: Income Taxes (Continued)

        HP engages in continuous discussion and negotiation with tax authorities regarding tax matters in the various jurisdictions. HP does not expect complete resolution of any Internal Revenue Service ("IRS") audit cycle within the next 12 months. However, it is reasonably possible that certain federal, foreign and state tax issues may be concluded in the next 12 months, including issues involving transfer pricing and other matters. Accordingly, HP believes it is reasonably possible that its existing unrecognized tax benefits may be reduced by an amount up to $115 million within the next 12 months.

        HP is subject to income tax in the United States and over sixty foreign countries and is subject to routine corporate income tax audits in many of these jurisdictions. In addition, HP is subject to numerous ongoing audits by state and foreign tax authorities. HP has received from the IRS Notices of Deficiency for its fiscal 1999, 2000, 2003, 2004 and 2005 tax years, and Revenue Agent's Reports ("RAR's") for its fiscal 2001 and 2002 tax years. The IRS began an audit of HP's 2006 and 2007 income tax returns in 2009. With respect to major foreign and state tax jurisdictions, HP is no longer subject to tax authority examinations for years prior to 1999. HP believes that adequate reserves have been provided for all open tax years.

        The breakdown between current and long-term deferred tax assets and deferred tax liabilities was as follows:

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

Current deferred tax assets

  $ 4,758   $ 4,979  

Current deferred tax liabilities

    (23 )   (83 )

Long-term deferred tax assets

    1,868     1,751  

Long-term deferred tax liabilities

    (4,287 )   (4,230 )
           

Total deferred tax assets net of deferred tax liabilities

  $ 2,316   $ 2,417  
           

Note 14: Stockholders' Equity

        HP's share repurchase program authorizes both open market and private repurchase transactions. In the first quarter of fiscal 2010, HP executed share repurchases of 53 million shares. Repurchases of 54 million shares were settled for $2.7 billion in the first quarter of fiscal 2010, which included 3 million shares repurchased in transactions that were executed in fiscal 2009 but settled in the first quarter of fiscal 2010. HP had approximately 2 million shares repurchased in the first quarter of fiscal 2010 that will be settled in the second quarter of fiscal 2010. HP paid approximately $1.2 billion in connection with repurchases of approximately 34 million shares during the three months ended January 31, 2009.

        On November 19, 2009, HP's Board of Directors authorized an additional $8.0 billion for future share repurchases. As of January 31, 2010, HP had remaining authorization of $9.2 billion for future share repurchases.

31



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 14: Stockholders' Equity (Continued)

        The changes in the components of OCI, net of taxes, were as follows:

 
  Three months ended
January 31
 
 
  2010   2009  
 
  In millions
 

Net earnings

  $ 2,250   $ 1,856  

Net change in unrealized gains (losses) on available-for-sale securities, net of tax of $1 million in 2010 and net of tax benefit of $4 million in 2009

    2     (7 )

Net change in unrealized gains/losses on cash flow hedges:

             
 

Unrealized gains recognized in OCI, net of tax of $157 million in 2010 and $73 million in 2009

    290     129  
 

Losses (gains) reclassified into income, net of tax benefit of $42 million in 2010 and net of tax of $190 million in 2009

    60     (335 )
           

    350     (206 )
           

Net change in cumulative translation adjustment, net of tax benefit of $14 million in 2010 and $211 million in 2009

    (60 )   (382 )

Net change in unrealized components of defined benefit plans, net of tax of $9 million in 2010 and $58 million in 2009

    11     80  
           

Comprehensive income

  $ 2,553   $ 1,341  
           

        The components of accumulated other comprehensive loss, net of taxes, were as follows:

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

Net unrealized gain on available-for-sale securities

  $ 6   $ 4  

Net unrealized gain (loss) on cash flow hedges

    181     (169 )

Cumulative translation adjustment

    (519 )   (459 )

Unrealized components of defined benefit plans

    (2,612 )   (2,623 )
           

Accumulated other comprehensive loss

  $ (2,944 ) $ (3,247 )
           

Note 15: Retirement and Post-Retirement Benefit Plans

        HP offers various defined contribution plans for U.S. and non-U.S. employees. As disclosed in our Consolidated Financial Statements for the fiscal year ended October 31, 2009, prior to April 1, 2009, HP matched employee contributions to the U.S. HP 401(k) Plan with cash contributions up to a maximum of 6% of eligible compensation for U.S. employees hired prior to August 1, 2008 and up to a maximum of 4% of eligible compensation for U.S. employees hired on or after August 1, 2008. Further,

32



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 15: Retirement and Post-Retirement Benefit Plans (Continued)

effective from January 1, 2009 through March 31, 2009, U.S. employees participating in the EDS 401(k) Plan were eligible for a 4% HP matching contribution on eligible compensation.

        Effective April 1, 2009, HP matching contributions under both the U.S. HP 401(k) Plan and the EDS 401(k) Plan were changed to a quarterly, discretionary, performance-based match of up to a maximum of 4% of eligible compensation for all U.S. employees, which is determined each fiscal quarter based on business results. HP matching contributions vary from 0% to 100% of the maximum 4% match, based on such factors as quarterly earnings, market share growth, and performance relative to market and economic conditions. HP's matching contributions for the quarter ended January 31, 2010 was 100% of the maximum 4% match.

        HP's net pension and post-retirement benefit costs were as follows:

 
  Three months ended January 31  
 
  U.S.
Defined
Benefit Plans
  Non-U.S.
Defined
Benefit Plans
  Post-
Retirement
Benefit Plans
 
 
  2010   2009   2010   2009   2010   2009  
 
  In millions
 

Service cost

  $   $ 6   $ 86   $ 77   $ 3   $ 3  

Interest cost

    145     148     172     153     12     18  

Expected return on plan assets

    (166 )   (133 )   (198 )   (165 )   (7 )   (8 )

Amortization and deferrals:

                                     
 

Actuarial loss (gain)

    7     (13 )   56     20     5     1  
 

Prior service benefit

            (2 )   (2 )   (21 )   (19 )
                           

Net periodic benefit (gain) cost

  $ (14 ) $ 8   $ 114   $ 83   $ (8 ) $ (5 )

Special termination benefits

                1          
                           

Net benefit (gain) cost

  $ (14 ) $ 8   $ 114   $ 84   $ (8 ) $ (5 )
                           

        HP previously disclosed in its Consolidated Financial Statements for the fiscal year ended October 31, 2009 that it expected to contribute approximately $745 million to its pension plans and approximately $30 million to cover benefit payments to U.S. non-qualified plan participants. In addition, HP expected to pay approximately $45 million to cover benefit claims for HP's post-retirement benefit plans. HP's funding policy is to contribute cash to its pension plans so that it meets at least the minimum contribution requirements, as established by local government, funding and taxing authorities.

        As of January 31, 2010, HP has made $152 million of contributions to its pension plans, paid $4 million to cover benefit payments to U.S. non-qualified plan participants, and paid $9 million to cover benefit claims under post-retirement benefit plans. HP presently anticipates making additional contributions of approximately $594 million to its pension plans and approximately $24 million to its U.S. non-qualified plan participants and expects to pay up to $36 million to cover benefit claims under post-retirement benefit plans during the remainder of fiscal 2010. HP's pension and other

33



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 15: Retirement and Post-Retirement Benefit Plans (Continued)


post-retirement benefit costs and obligations are dependent on various assumptions. Differences between expected and actual returns on investments will be reflected as unrecognized gains or losses, and such gains or losses will be amortized and recorded in future periods. Poor financial performance of asset markets in any year could lead to increased contributions in certain countries and increased future pension plan expense. Asset gains or losses are determined at the measurement date and amortized over the remaining service life or life expectancy of plan participants. HP's next expected measurement date is October 31, 2010.

Note 16: Litigation and Contingencies

        HP is involved in lawsuits, claims, investigations and proceedings, including those identified below, consisting of intellectual property, commercial, securities, employment, employee benefits and environmental matters that arise in the ordinary course of business. HP records a provision for a liability when management believes that it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. HP believes it has adequate provisions for any such matters. HP reviews these provisions at least quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Based on its experience, HP believes that any damage amounts claimed in the specific matters discussed below are not a meaningful indicator of HP's potential liability. Litigation is inherently unpredictable. However, HP believes that it has valid defenses with respect to legal matters pending against it. Nevertheless, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies or because of the diversion of management's attention and the creation of significant expenses.

Litigation, Proceedings and Investigations

        Copyright levies. As described below, proceedings are ongoing or have been concluded against HP in certain European Union ("EU") member countries, including litigation in Germany, seeking to impose levies upon equipment (such as multifunction devices ("MFDs"), personal computers ("PCs") and printers) and alleging that these devices enable producing private copies of copyrighted materials. The levies are generally based upon the number of products sold and the per-product amounts of the levies, which vary. Some EU member countries that do not yet have levies on digital devices are expected to implement similar legislation to enable them to extend existing levy schemes, while some other EU member countries are expected to limit the scope of levy schemes and applicability in the digital hardware environment. HP, other companies and various industry associations have opposed the extension of levies to the digital environment and have advocated alternative models of compensation to rights holders.

        VerwertungsGesellschaft Wort ("VG Wort"), a collection agency representing certain copyright holders, instituted legal proceedings against HP in June 2001 in Germany relating to whether and to what extent German copyright levies for photocopiers should be imposed on MFDs. On July 6, 2005, the Court of Appeals in Stuttgart Germany ordered HP to pay VG Wort levies based on the published tariffs for photocopiers in Germany (which range from €38.35 to €613.56 per unit), plus interest, on MFDs sold in Germany up to December 2001, and the German Federal Supreme Court later affirmed

34



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 16: Litigation and Contingencies (Continued)


that ruling on appeal. HP subsequently appealed the decision by filing a claim with the German Federal Constitutional Court, which declined to hear HP's appeal, thus concluding these proceedings. HP has made the payments required under the court ruling.

        On September 26, 2005, VG Wort filed an additional lawsuit against HP in the Stuttgart Civil Court in Stuttgart, Germany seeking assurance of full payment of levies on MFD units sold in Germany between 1997 and 2001, as well as for MFDs sold from 2002 onwards. On March 25, 2009, the German Association for Information Technology, Telecommunications and New Media e.V. entered into a settlement agreement with VG Wort and Verwertungsgesellschaft Bild-Kunst, another collection agency representing copyright holders ("VG Bild-Kunst"), that provides for the payment of levies on MFDs sold from 2002 through 2007. The levies vary from approximately €13 to €307 per unit depending on the type of device, the date sold and the copy speed and are subject to reduction if VG Wort or VG Bild-Kunst grants more favorable rates in the future to parties within Germany that are not covered by the settlement. HP has acceded to the settlement and paid all amounts due thereunder.

        In July 2004, VG Wort filed a separate lawsuit against HP in the Stuttgart Civil Court seeking levies on printers. On December 22, 2004, the court held that HP is liable for payments regarding all printers using ASCII code sold in Germany but did not determine the amount payable per unit. HP appealed this decision in January 2005 to the Stuttgart Court of Appeals. On May 11, 2005, the Stuttgart Court of Appeals issued a decision confirming that levies are due. On June 6, 2005, HP filed an appeal to the German Federal Supreme Court in Karlsruhe. On December 6, 2007, the German Federal Supreme Court issued a judgment that printers are not subject to levies under the existing law. The court issued a written decision on January 25, 2008, and VG Wort subsequently filed an application with the German Federal Supreme Court under Section 321a of the German Code of Civil Procedure contending that the court did not consider their arguments. On May 9, 2008, the German Federal Supreme Court denied VG Wort's application. In addition, VG Wort has appealed the decision by filing a claim with the German Federal Constitutional Court challenging the ruling that printers are not subject to levies. HP and the German Association for Information Technology, Telecommunications and New Media e.V. ("BITKOM") have responded to VG Wort's claim, and the parties are awaiting a decision by the court as to whether it will accept the claim for judicial review.

        In September 2003, VG Wort filed a lawsuit against Fujitsu Siemens Computer GmbH ("FSC") in the Munich Civil Court in Munich, Germany seeking levies on PCs. This is an industry test case in Germany, and HP has agreed not to object to the delay if VG Wort sues HP for such levies on PCs following a final decision against FSC. On December 23, 2004, the Munich Civil Court held that PCs are subject to a levy and that FSC must pay €12 plus compound interest for each PC sold in Germany since March 2001. FSC appealed this decision in January 2005 to the Munich Court of Appeals. On December 15, 2005, the Munich Court of Appeals affirmed the Munich Civil Court decision. FSC filed an appeal with the German Federal Supreme Court in February 2006. On October 2, 2008, the German Federal Supreme Court issued a judgment that PCs were not photocopiers within the meaning of the German copyright law that was in effect until December 31, 2007 and, therefore, not subject to the levies on photocopiers established by that law. VG Wort has filed a claim with the German Federal Constitutional Court challenging that ruling. FSC and BITKOM have responded to VG Wort's claim, and the parties are awaiting a decision by the court as to whether it will accept the claim for judicial review.

35



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 16: Litigation and Contingencies (Continued)

        ZPU, a joint association of various German collection societies, instituted legal proceedings against HP in 2005 demanding reporting of every PC sold by HP in Germany from January 2002 through December 2005 and seeking a levy of €8.42 plus tax for each PC sold during that period. On December 23, 2009, the German industry association Bundesverband Computerhersteller ("BCH") entered into a settlement agreement with ZPU that provides for the payment of €3.15 per unit for PCs sold in Germany between 2002 and 2003 and €6.30 per units for PCs sold in Germany between 2005 and 2007. The settlement is only valid for those companies who are members of BCH and accede to the settlement and who also agree to pay a levy of €12.15 per unit for PCs without a built-in CD-R or DVD-R and €13.65 per unit for PCs with a built-in CD-R or DVD-R sold in Germany between 2008 and 2010. HP is a member of BCH and has acceded to the settlement.

        Based on industry opposition to the extension of levies to digital products, HP's assessments of the merits of various proceedings and HP's estimates of the units impacted and levies, HP has accrued amounts that it believes are adequate to address the matters described above. However, the ultimate resolution of these matters and the associated financial impact on HP, including the number of units impacted, the amount of levies imposed and the ability of HP to recover such amounts through increased prices, remains uncertain.

        Sky Subscribers Services Limited and British Sky Broadcasting Limited v. EDS and EDS Limited (UK) is a lawsuit filed on August 17, 2004 by Sky Subscribers Services Limited and British Sky Broadcasting Limited against Electronic Data Systems Corporation ("EDS"), a company that HP acquired in August 2008, and EDS Limited (UK) ("EDS UK"), one of EDS's subsidiaries, alleging deceit, negligent misrepresentation, negligent misstatement and breach of contract. The claims arose out of a customer relationship management project that was awarded to EDS in 2000, the principal objective of which was to develop a customer call center in Scotland. EDS's main role in the project was as systems integrator. On November 12, 2004, EDS and EDS UK filed their defense and counterclaim denying the claims and seeking damages for monies owed under the contract. The trial of this action commenced on October 15, 2007, and final arguments concluded on July 30, 2008. At trial, the plaintiffs claimed damages in excess of £700 million, and EDS and EDS UK counterclaimed for damages of approximately £5 million. On January 26, 2010, the court issued a decision finding EDS UK liable to the plaintiffs for deceit in one area of the claim, for negligent misrepresentation and negligent misstatement in another area of the claim, and for breach of contract. The court dismissed all of the plaintiffs' other claims. On March 1, 2010, the court ordered HP to make an interim payment to the plaintiffs of £70 million, which is in addition to an interim payment of £200 million that HP made voluntarily to the plaintiffs in February 2010. The court will issue a final quantification of damages at a later date. HP plans to seek leave from the court to appeal the decision.

        Skold, et al. v. Intel Corporation and Hewlett-Packard Company is a lawsuit in which HP was joined on June 14, 2004 that is pending in state court in Santa Clara County, California. The lawsuit alleges that HP (along with Intel) misled the public by suppressing and concealing the alleged material fact that systems that use the Intel Pentium 4 processor are less powerful and slower than systems using the Intel Pentium III processor and processors made by a competitor of Intel. The plaintiffs seek unspecified damages, restitution, attorneys' fees and costs, and certification of a nationwide class. On February 27, 2009, the court denied with prejudice plaintiffs' motion for nationwide class certification for a third time. The plaintiffs have appealed the court's decision.

36



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 16: Litigation and Contingencies (Continued)

        Inkjet Printer Litigation. As described below, HP is involved in several lawsuits claiming breach of express and implied warranty, unjust enrichment, deceptive advertising and unfair business practices where the plaintiffs have alleged, among other things, that HP employed a "smart chip" in certain inkjet printing products in order to register ink depletion prematurely and to render the cartridge unusable through a built-in expiration date that is hidden, not documented in marketing materials to consumers, or both. The plaintiffs have also contended that consumers received false ink depletion warnings and that the smart chip limits the ability of consumers to use the cartridge to its full capacity or to choose competitive products.

        Baggett v. HP is a consumer class action filed against HP on June 6, 2007 in the United States District Court for the Central District of California alleging that HP employs a technology in its LaserJet color printers whereby the printing process shuts down prematurely, thus preventing customers from using the toner that is allegedly left in the cartridge. The plaintiffs also allege that HP fails to disclose to consumers that they will be unable to utilize the toner remaining in the cartridge after the printer shuts down. The complaint seeks certification of a nationwide class of purchasers of all HP LaserJet color printers and seeks unspecified damages, restitution, disgorgement, injunctive relief, attorneys' fees and costs. On September 29, 2009, the court granted HP's motion for summary judgment against the named plaintiff and denied plaintiff's motion for class certification as moot. On November 3, 2009, the court entered judgment against the named plaintiff. On November 17, 2009, plaintiff filed an appeal of the court's summary judgment ruling with the United States Court of Appeals for the Ninth Circuit.

        Rich v. HP is a consumer class action filed against HP on May 22, 2006 in the United States District Court for the Northern District of California. The suit alleges that HP designed its color inkjet

37



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 16: Litigation and Contingencies (Continued)


printers to unnecessarily use color ink in addition to black ink when printing black and white images and text. The plaintiffs are seeking to certify a nationwide injunctive class and a California-only damages class. A class certification hearing is scheduled for May 7, 2010.

        On December 27, 2001, Cornell University and the Cornell Research Foundation, Inc. filed a complaint, amended on September 6, 2002, against HP in United States District Court for the Northern District of New York alleging that HP's PA-RISC 8000 family of microprocessors, and servers and workstations incorporating those processors, infringe a patent assigned to Cornell Research Foundation, Inc. that describes a way of executing microprocessor instructions. The complaint sought declaratory and injunctive relief and unspecified damages. The patent at issue in this litigation, United States Patent No. 4,807,115, expired on February 21, 2006. Therefore, the plaintiffs are no longer entitled to seek injunctive relief against HP. This matter was tried between May 19 and May 30, 2008, and, on May 30, 2008, a jury returned a verdict in favor of the plaintiffs in the amount of $184 million. On March 30, 2009, the trial court issued four post-trial decisions. The court denied several of HP's post-trial motions, but granted HP's motion to reduce the damages award. The court reduced the award to approximately $53 million and subsequently entered judgment in favor of the plaintiffs in that amount. On April 10, 2009, HP filed a notice that it will appeal the judgment to the United States Court of Appeals for the Federal Circuit. On May 15, 2009, the court awarded approximately $17 million in pre-judgment interest and approximately $1 million in costs and subsequently entered an amended judgment reflecting those awards. On June 2, 2009, the court entered a final amended judgment reflecting the total amount of damages, pre-judgment interest and taxable costs. On June 4, 2009, HP filed an amended notice of appeal.

        Fair Labor Standards Act Litigation. As described below, HP is involved in several lawsuits in which the plaintiffs are seeking unpaid overtime compensation and other damages based on allegations that various employees of EDS or HP have been misclassified as exempt employees under the Fair Labor Standards Act and/or in violation of the California Labor Code or other state laws:

38



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 16: Litigation and Contingencies (Continued)

        The United States of America, ex rel. Norman Rille and Neal Roberts v. Hewlett-Packard Company, et al. In 2004, two private individuals filed a civil "qui tam" complaint under the False Claims Act in the United States District Court for the Eastern District of Arkansas containing generalized allegations that HP and several other companies participated in an industry-wide practice of using partnership and alliance programs to make improper payments and cause the submission of false claims in connection with contracts to provide products and services to the federal government. On April 12, 2007, the U.S. Department of Justice intervened in the qui tam action and filed a complaint against HP (and several other companies in separate actions) on behalf of the United States containing allegations that HP violated the False Claims Act and the Anti-Kickback Act of 1986 by providing millions of dollars in kickbacks to its alliance partners, including "influencer fees" and "new business opportunity rebates." The U.S. complaint further alleges that HP violated the False Claims Act and the Anti-Kickback Act, breached its federal government contracts, induced the federal government to make payments to HP that HP was not entitled to receive under those contracts, and was unjustly enriched by expressly or impliedly making false statements, records or certifications to the federal government that it complied with and would continue to comply with the Anti-Kickback Act and by submitting claims to the government that allegedly were inflated because they included the amounts of the influencer fees and new business opportunity rebates. The U.S. complaint seeks treble damages plus civil penalties in connection with the alleged violations of the False Claims Act, double damages plus civil penalties in connection with the alleged violations of the Anti-Kickback Act and disgorgement of profits earned in connection with the breach of contract and unjust enrichment claims.

        Leak Investigation Proceedings. As described below, HP is or has been the subject of various governmental inquiries concerning the processes employed in an investigation into leaks of HP confidential information to members of the media that concluded in May 2006:

39



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 16: Litigation and Contingencies (Continued)

        In addition, four stockholder derivative lawsuits have been filed in California purportedly on behalf of HP stockholders seeking to recover damages for alleged breach of fiduciary duty and to require HP to improve its corporate governance and internal control procedures as a result of the activities of the leak investigation: Staehr v. Dunn, et al. was filed in Santa Clara County Superior Court on September 18, 2006; Worsham v. Dunn, et al. was filed in Santa Clara County Superior Court on September 14, 2006; Tansey v. Dunn, et al. was filed in Santa Clara County Superior Court on September 20, 2006; and Hall v. Dunn, et al. was filed in Santa Clara County Superior Court on September 25, 2006. On October 19, 2006, the Santa Clara County Superior Court consolidated the four California cases under the caption In re Hewlett-Packard Company Derivative Litigation. The consolidated complaint filed on November 19, 2006, also seeks to recover damages in connection with sales of HP stock alleged to have been made by certain current and former HP officers and directors while in possession of material non-public information. Two additional stockholder derivative lawsuits, Pifko v. Babbio, et al., filed on September 19, 2006, and Gross v. Babbio, et al., filed on November 21, 2006, were filed in Chancery Court, County of New Castle, Delaware; both seek to recover damages for alleged breaches of fiduciary duty and to obtain an order instructing the defendants to refrain from further breaches of fiduciary duty and to implement corrective measures that will prevent future occurrences of the alleged breaches of fiduciary duty. On January 24, 2007, the Delaware court

40



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 16: Litigation and Contingencies (Continued)


consolidated the two cases under the caption In re Hewlett-Packard Company Derivative Litigation and subsequently stayed the proceedings, as the parties had reached a tentative settlement. The HP Board of Directors appointed a Special Litigation Committee consisting of independent Board members authorized to investigate, review and evaluate the facts and circumstances asserted in these derivative matters and to determine how HP should proceed in these matters. On December 14, 2007, HP and the plaintiffs in the California and Delaware derivative actions entered into an agreement to settle those lawsuits. Under the terms of the settlement, HP agreed to continue certain corporate governance changes until December 31, 2012 and to pay the plaintiffs' attorneys' fees. The California court granted final approval to the settlement on March 11, 2008 and subsequently granted plaintiffs' counsel's fee application and dismissed the action. On June 12, 2008, the Delaware court granted final approval to the settlement and the plaintiffs' application for attorneys' fees and also dismissed the action. Because neither the dismissal of the California nor the Delaware derivative action was thereafter appealed, both cases are now concluded.

Environmental

        HP is subject to various federal, state, local and foreign laws and regulations concerning environmental protection, including laws addressing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, the content of its products and the recycling, treatment and disposal of its products including batteries. In particular, HP faces increasing complexity in its product design and procurement operations as it adjusts to new and future requirements relating to the chemical and materials composition of its products, their safe use, the energy consumption associated with those products and product take-back legislation. HP could incur substantial costs, its products could be restricted from entering certain jurisdictions, and it could face other sanctions, if it were to violate or become liable under environmental laws or if its products become non-compliant with environmental laws. HP's potential exposure includes fines and civil or criminal sanctions, third-party property damage or personal injury claims and clean up costs. The amount and timing of costs under environmental laws are difficult to predict.

        HP is party to, or otherwise involved in, proceedings brought by U.S. or state environmental agencies under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), known as "Superfund," or state laws similar to CERCLA. HP is also conducting environmental investigations or remediations at several current or former operating sites pursuant to administrative orders or consent agreements with state environmental agencies.

        HP is also subject to legislation in an increasing number of jurisdictions that makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products (sometimes referred to as "product take-back legislation"). For example, the EU adopted the Waste Electrical and Electronic Equipment Directive in January 2003. That directive makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The EU member states were obliged to make producers participating in the market financially responsible for implementing these responsibilities.

41



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 17: Segment Information

        HP is a leading global provider of products, technologies, software, solutions and services to individual consumers, small and medium sized businesses ("SMBs"), and large enterprises including customers in the government, health and education sectors. HP's offerings span personal computing and other access devices; imaging and printing-related products and services; enterprise information technology ("IT") infrastructure, including enterprise storage and server technology and networking products; software that optimizes business technology investments; financial services including leasing; and multi-vendor customer services, including technology support and maintenance, consulting and integration, information technology and business process outsourcing services and application services.

        HP and its operations are organized into seven business segments for financial reporting purposes: Services, ESS, HP Software, PSG, IPG, HP Financial Services ("HPFS"), and Corporate Investments. HP's organizational structure is based on a number of factors that management uses to evaluate, view and run its business operations, which include, but are not limited to, customer base, homogeneity of products and technology. The business segments disclosed in the accompanying Consolidated Condensed Financial Statements are based on this organizational structure and information reviewed by HP's management to evaluate the business segment results. Services, ESS and HP Software are reported collectively as a broader HP Enterprise Business. In order to provide a supplementary view of HP's business, aggregated financial data for the HP Enterprise Business is presented herein.

        HP has reclassified segment operating results for fiscal 2009 to conform to certain fiscal 2010 organizational realignments. None of the changes impacts HP's previously reported consolidated net revenue, earnings from operations, net earnings or net earnings per share. Future changes to this organizational structure may result in changes to the business segments disclosed.

        A description of the types of products and services provided by each business segment follows.

        Each of the business segments within the HP Enterprise Business is described in detail below.

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HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 17: Segment Information (Continued)


(1)
Windows® is a registered trademark of Microsoft Corporation.

(2)
Itanium® is a registered trademark of Intel Corporation.

(3)
UNIX® is a registered trademark of The Open Group.

HP Software provides enterprise software and services. Enterprise IT management products and services, which are marketed as HP's business technology optimization (BTO) portfolio, help customers to manage IT infrastructure and services, operations, applications, and business processes and to automate data center operations and IT processes. Solutions are delivered in the form of traditional software licenses and, in some cases, via a software-as-a-service (SaaS) distribution model. Other software includes information management, business intelligence, and communications and media solutions. Our information management products and services automate the retention, management, search and segregation of information across the enterprise. Business intelligence solutions enable businesses to standardize on consistent data management schemes, connect and share data across the enterprise and apply analytics. Communications and media solutions enable service providers, media companies, and network equipment providers to create, deliver, and manage consumer and enterprise communications services.

        HP's other business segments are described below.

43



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 17: Segment Information (Continued)

        HP derives the results of the business segments directly from its internal management reporting system. The accounting policies HP uses to derive business segment results are substantially the same as those the consolidated company uses. Management measures the performance of each business

44



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 17: Segment Information (Continued)

segment based on several metrics, including earnings from operations. Management uses these results, in part, to evaluate the performance of, and to assign resources to, each of the business segments. HP does not allocate to its business segments certain operating expenses, which it manages separately at the corporate level. These unallocated costs include primarily amortization of purchased intangible assets, stock-based compensation expense related to HP-granted employee stock options, PRUs and the employee stock purchase plan, certain acquisition-related charges and charges for purchased IPR&D, as well as certain corporate governance costs.

        HP does not allocate to its business segments restructuring charges and any associated adjustments related to restructuring actions.

        Selected operating results information for each business segment was as follows:

 
  Three months ended January 31  
 
  Net Revenue   Earnings (Loss)
from Operations
 
 
  2010   2009(1)   2010   2009(1)  
 
  In millions
 

Services

  $ 8,651   $ 8,747   $ 1,364   $ 1,124  

Enterprise Storage and Servers

    4,391     3,949     552     406  

HP Software

    878     878     167     140  
                   

HP Enterprise Business

    13,920     13,574     2,083     1,670  
                   

Personal Systems Group

    10,584     8,792     530     436  

Imaging and Printing Group

    6,206     5,981     1,054     1,105  

HP Financial Services

    719     636     67     41  

Corporate Investments

    236     196     19     (19 )
                   

Segment total

  $ 31,665   $ 29,179   $ 3,753   $ 3,233  
                   

(1)
As a result of HP's adoption in fiscal 2009 of the revenue recognition standards related to multiple-deliverable revenue arrangements and revenue arrangements that included software, certain previously reported segment and business unit results have been restated. The adoption primarily impacted the Services, Enterprise Storage and Servers and Personal Systems Group financial reporting segments.

45



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 17: Segment Information (Continued)

        The reconciliation of segment operating results information to HP consolidated totals was as follows:

 
  Three months ended
January 31
 
 
  2010   2009  
 
  In millions
 

Net revenue:

             

Segment total

  $ 31,665   $ 29,179  

Eliminations of inter-segment net revenue and other

    (488 )   (372 )
           

Total HP consolidated net revenue

  $ 31,177   $ 28,807  
           

Earnings before taxes:

             

Total segment earnings from operations

  $ 3,753   $ 3,233  

Corporate and unallocated costs and eliminations

    (88 )   24  

Unallocated costs related to stock-based compensation expense

    (163 )   (148 )

Amortization of purchased intangible assets

    (330 )   (412 )

In-process research and development charges

        (6 )

Restructuring charges

    (131 )   (146 )

Acquisition-related charges

    (38 )   (48 )

Interest and other, net

    (199 )   (232 )
           

Total HP consolidated earnings before taxes

  $ 2,804   $ 2,265  
           

        HP allocates its assets to its business segments based on the primary segments benefiting from the assets. There have been no material changes to the total assets in each of HP's segments for the quarter ended January 31, 2010 as compared to the fiscal year ended October 31, 2009.

46



HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements (Continued)

(Unaudited)

Note 17: Segment Information (Continued)

 
  Three months ended
January 31
 
 
  2010   2009(1)(2)  
 
  In millions
 

Net revenue:

             
     

Infrastructure Technology Outsourcing

 
$

3,933
 
$

3,843
 
     

Technology Services

    2,406     2,453  
     

Application Services

    1,509     1,632  
     

Business Process Outsourcing

    734     754  
     

Other

    69     65  
           
 

Services(1)

    8,651     8,747  
           
     

Industry Standard Servers

    2,946     2,322  
     

Storage

    889     913  
     

Business Critical Systems

    556     714  
           
 

Enterprise Storage and Servers

    4,391     3,949  
           
     

Business Technology Optimization

    591     594  
     

Other Software

    287     284  
           
 

HP Software

    878     878  
           

HP Enterprise Business

    13,920     13,574  
           
     

Notebooks

    6,125     4,907  
     

Desktops

    3,840     3,308  
     

Workstations

    375     333  
     

Handhelds

    25     57  
     

Other

    219     187  
           

Personal Systems Group

    10,584     8,792  
           
     

Supplies

    4,081     4,050  
     

Commercial Hardware

    1,291     1,239  
     

Consumer Hardware

    834     692  
           

Imaging and Printing Group

    6,206     5,981  
           

HP Financial Services

    719     636  

Corporate Investments

    236     196  
           
     

Total segments

    31,665     29,179  
           

Eliminations of inter-segment net revenue and other

    (488 )   (372 )
           
     

Total HP consolidated net revenue

  $ 31,177   $ 28,807  
           

(1)
Certain fiscal 2010 organizational reclassifications have been reflected retroactively to provide improved visibility and comparability. For each of the quarters in fiscal year 2009, the reclassifications resulted in the transfer of revenue among the business units within the Services segment only. There was no impact to the previously reported segment financial results.

(2)
As a result of HP's adoption in fiscal 2009 of the revenue recognition standards related to multiple-deliverable revenue arrangements and revenue arrangements that included software, certain previously reported segment and business unit results have been restated. The adoption primarily impacted the Services, Enterprise Storage and Servers and Personal Systems Group financial reporting segments.

47



Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Management's Discussion and Analysis of
Financial Condition and Results of Operations

        The following discussion should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this document.

OVERVIEW

        We are a leading global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses, and large enterprises, including customers in the government, health and education sectors. Our offerings span:

        We have seven business segments for financial reporting purposes: Services, Enterprise Storage and Servers ("ESS"), HP Software, the Personal Systems Group ("PSG"), the Imaging and Printing Group ("IPG"), HP Financial Services ("HPFS"), and Corporate Investments. Services, ESS and HP Software are reported collectively as a broader HP Enterprise Business. While the HP Enterprise Business is not an operating segment, we sometimes provide financial data aggregating the segments within it in order to provide a supplementary view of our business.

        Our strategy and operations are currently focused on the following initiatives:

        We are positioning our businesses to take advantage of important trends in the markets for our products and services. For example, we are aligning our printing business to capitalize on key market trends such as the shift from analog to digital printing and the growth in printable content by developing innovative products for consumers such as the first web-connected home printer, working to enable web and mobile printing, expanding our presence in high-usage annuity businesses including graphics and retail publishing printing, and growing our managed print services business. We are also positioning our enterprise business to capitalize on the trend towards converged infrastructure products that integrate storage, networking, servers and management software. In addition, we have developed IT management software offerings that seek to satisfy the increasing demand for virtualization management and increased automation.

        We have implemented an ongoing program to optimize efficiency and reduce cost across the company. As part of those efforts, we are continuing to execute on our multi-year program to consolidate real estate locations worldwide to fewer core sites in order to reduce our IT spending and real estate costs. In addition, we are continuing to implement the restructuring plan announced in the

48


fourth quarter of fiscal 2008 to optimize the cost structure of our Services business and the restructuring plan announced in May 2009 to structurally change and improve the effectiveness of several of our product businesses. See Note 7 to the Consolidated Condensed Financial Statements in Item 1 for further discussion of these restructuring plans and the associated restructuring charges.

        We are investing some of the savings derived from our efficiency initiatives for growth. For example, we are increasing our sales coverage to better address the market that we cover, including further expansion in emerging markets such as China, India and Brazil. We are creating innovative new products and developing new channels to connect with our customers, particularly in our PC business. In addition, we are expanding our portfolio of products and services that we can offer to our customers, both through acquisitions and through organic growth. A critical component of this strategy was our acquisition of Electronic Data Systems Corporation ("EDS") in August 2008, which has increased the size and breadth of our services business and enabled us to provide comprehensive IT product and services solutions to our customers.

        In November 2009, we entered into a definitive agreement to acquire 3Com Corporation, a global enterprise provider of networking switching, routing and security solutions, at a price of $7.90 per share in cash or an enterprise value of approximately $2.7 billion. The acquisition has received clearance from U.S. and European Union regulatory authorities and the approval of 3Com's stockholders. The closing of the acquisition is subject to certain closing conditions, including obtaining requisite approvals on clearances under certain antitrust or competition laws. The transaction is expected to close in our second fiscal quarter of 2010.

        We now offer one of the IT industry's broadest portfolios of products and services, and we are working to leverage that portfolio as a strategic advantage. For example, in our enterprise business, we are able to provide servers, storage and networking packaged with services that can be delivered to customers in the manner of their choosing, be it in-house, outsourced or as a service via the Internet. Our portfolio of management software completes the package by allowing our customers to manage their IT operations in an efficient and cost-effective manner. In addition, we are working to optimize our supply chain by eliminating complexity, reducing fixed costs, and leveraging our scale to ensure the availability of components at favorable prices even during shortages. We are also expanding our use of industry standard components in our enterprise products to further leverage our scale.

        The following provides an overview of our key financial metrics in the first quarter of fiscal 2010 and demonstrates how our execution of these initiatives has translated into financial performance:

 
   
  HP Enterprise Business    
   
   
 
 
  HP
Consolidated
  Services   ESS   HP
Software
  Total   PSG   IPG   HPFS  
 
  In millions, except per share amounts
 

Net revenue

  $ 31,177   $ 8,651   $ 4,391   $ 878   $ 13,920   $ 10,584   $ 6,206   $ 719  

Year-over-year net revenue % increase (decrease)

    8.2 %   (1.1 )%   11.2 %       2.5 %   20.4 %   3.8 %   13.1 %

Earnings from operations

  $ 3,003   $ 1,364   $ 552   $ 167   $ 2,083   $ 530   $ 1,054   $ 67  

Earnings from operations as a % of net revenue

    9.6 %   15.8 %   12.6 %   19.0 %   15.0 %   5.0 %   17.0 %   9.3 %

Net earnings

  $ 2,250                                            

Net earnings per share

                                                 
 

Basic

  $ 0.95                                            
 

Diluted

  $ 0.93                                            

49


        Cash and cash equivalents at January 31, 2010 totaled $13.5 billion, an increase of $0.2 billion from the October 31, 2009 balance of $13.3 billion. The increase for the first three months of fiscal 2010 was due primarily to $2.4 billion of cash provided from operations and $1.3 billion of proceeds from the issuance of common stock under employee stock plans, which were partially offset by $2.7 billion of cash used to repurchase common stock and $0.7 billion net investment in property, plant and equipment.

        We intend the discussion of our financial condition and results of operations that follows to provide information that will assist in understanding our Consolidated Condensed Financial Statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our Consolidated Condensed Financial Statements.

        The discussion of results of operations at the consolidated level is followed by a more detailed discussion of results of operations by segment.

        For a further discussion of trends, uncertainties and other factors that could impact our operating results, see the section entitled "Factors That Could Affect Future Results."

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

        Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Consolidated Condensed Financial Statements, which we have prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection and disclosure of significant estimates with the Audit Committee of our Board of Directors. Actual results may differ from these estimates under different assumptions or conditions.

        An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes that there have been no significant changes during the three months ended January 31, 2010 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended October 31, 2009.

ACCOUNTING PRONOUNCEMENTS

        The following is a summary of certain accounting pronouncements with application to our consolidated financial statements in future periods.

        In December 2007, the Financial Accounting Standards Board ("FASB") issued a new accounting standard related to business combinations that expands the definition of a "business" and a "business combination"; requires recognition of assets acquired, liabilities assumed, and contingent consideration at their fair value on the acquisition date with subsequent changes recognized in earnings; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination and expensed as incurred; requires in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset; and requires that changes in accounting for deferred

50



tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. The standard also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. In November 2008, the FASB issued a new accounting standard related to defensive intangible assets. Defensive intangible assets are acquired intangible assets that the acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. Under this standard, defensive intangible assets must be initially recognized at fair value and amortized over the benefit period. In April 2009, the FASB issued an accounting standard which clarified the accounting for pre-acquisition contingencies. We adopted all of these standards in the first quarter of fiscal 2010, and there was no material impact on our consolidated condensed financial statements during or at the end of that period. The impact on future periods will depend on the size and nature of the business combinations completed in those periods.

        In December 2008, the FASB issued a new accounting standard that requires additional disclosures about assets held in an employer's defined benefit pension or other postretirement plan. We will adopt this new accounting standard effective October 31, 2010. We will present the required disclosures in the prescribed format on a prospective basis upon adoption. This new standard will only affect the notes to our consolidated financial statements.

        In June 2009, the FASB issued a new accounting standard related to the consolidation of variable interest entities. The standard eliminates the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and requires ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. This new standard also requires additional disclosures about an enterprise's involvement in variable interest entities. We will adopt this new accounting standard in the first quarter of fiscal 2011. We are continuing to evaluate the impact the adoption of this standard will have on our consolidated financial statements.

CONSTANT CURRENCY PRESENTATION

        Revenue from our international operations has historically represented, and we expect will continue to represent, a majority of our overall net revenue. As a result, our revenue growth has been impacted, and we expect will continue to be impacted, by fluctuations in foreign currency exchange rates. In order to provide a framework for assessing how each of our business segments performed excluding the impact of foreign currency fluctuations, we present the year-over-year percentage change in revenue performance on a constant currency basis, which assumes no change in the exchange rate from the prior-year period. This constant currency disclosure is provided in addition to, and not as a substitute for, the year-over-year percentage change in revenue on an as-reported basis.

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RESULTS OF OPERATIONS

        Results of operations in dollars and as a percentage of net revenue were as follows:

 
  Three months ended January 31  
 
  2010   2009  
 
  In millions
 

Net revenue

  $ 31,177     100.0 % $ 28,807     100.0 %

Cost of sales(1)

    24,062     77.2 %   22,073     76.6 %
                   

Gross profit

    7,115     22.8 %   6,734     23.4 %

Research and development

    681     2.2 %   732     2.5 %

Selling, general and administrative

    2,932     9.4 %   2,893     10.1 %

Amortization of purchased intangible assets

    330     1.1 %   412     1.4 %

In-process research and development charges

            6      

Restructuring charges

    131     0.4 %   146     0.5 %

Acquisition-related charges

    38     0.1 %   48     0.2 %
                   

Earnings from operations

    3,003     9.6 %   2,497     8.7 %

Interest and other, net

    (199 )   (0.6 )%   (232 )   (0.8 )%
                   

Earnings before taxes

    2,804     9.0 %   2,265     7.9 %

Provision for taxes

    554     1.8 %   409     1.5 %
                   

Net earnings

  $ 2,250     7.2 % $ 1,856     6.4 %
                   

(1)
Cost of products, cost of services and financing interest.

Net Revenue

        The components of the weighted net revenue change from the prior-year period were as follows:

 
  Three months ended
January 31, 2010
 
 
  Percentage Points
 

Personal Systems Group

    6.2  

Enterprise Storage and Servers

    1.5  

Imaging and Printing Group

    0.8  

HP Financial Services

    0.3  

HP Software

     

Services

    (0.3 )

Corporate Investments/Other

    (0.3 )
       

Total HP

    8.2  
       

        For the three months ended January 31, 2010, net revenue increased 8.2% from the prior-year period (5.4% on a constant currency basis). The PSG segment was the largest contributor to HP net revenue growth as a result of balanced growth across each of the PSG product categories with particular strength in consumer demand. U.S. net revenue increased 7.8% to $10.9 billion for the first quarter of fiscal 2010 as compared to the prior-year period, while net revenue from outside of the United States increased 8.4% to $20.3 billion.

        The PSG net revenue increase for the three months ended January 31, 2010 was primarily the result of a recovering U.S. PC market, combined with continued strength in China and other emerging markets. PSG unit volumes and net revenue increased across all business units except in our handhelds

52



business unit. Offsetting net revenue performance was a decline in average selling prices (ASPs) as a result of competitive pricing pressures.

        ESS net revenue increased for the three months ended January 31, 2010 driven by volume growth in our industry standard servers ("ISS") business unit in part as a result of the latest generation of ISS products. Net revenue declined in the storage and business critical systems business units.

        IPG net revenue increased for the three months ended January 31, 2010 in the commercial and consumer hardware business units and the supplies business unit. Both the consumer and commercial hardware business units experienced unit volume increases in response to improved printer market demand.

        HPFS net revenue increased for the three months ended January 31, 2010 due primarily to portfolio growth and favorable currency movements, the effect of which was partially offset by lower levels of remarketing sales and buyout activities.

        HP Software net revenue growth was flat for the three months ended January 31, 2010 due primarily to continued softness in enterprise spending. Revenue from licenses and support increased, the effect of which was offset by a decrease in services revenue.

        The net revenue decrease in Services for the three months ended January 31, 2010 was due primarily to net revenue declines in the application services, technology services and business process outsourcing business units. Those declines were due primarily to weak market conditions, reduced demand for technology support services as a result of reduced sales of enterprise hardware in the prior-year period, and existing contract completion. Net revenue in infrastructure technology outsourcing increased due to favorable currency impacts and new business.

        Net revenue in Corporate Investments and Other increased for the three months ended January 31, 2010, primarily resulting from increased sales of network infrastructure products.

Gross Margin

        Total HP gross margin decreased by 0.6 percentage points for the three months ended January 31, 2010 as compared to the prior-year period. This decline was a result of strong growth in personal computer and printer hardware revenues that have lower gross margins, the effect of which was partially offset by cost improvements in services.

        PSG gross margin declined for the three months ended January 31, 2010 primarily as a result of ASPs declining at a faster pace than component costs combined with a mix shift towards lower-end products.

        For the three months ended January 31, 2010, IPG gross margin declined due primarily to the unfavorable impact of a mix shift from higher-margin supplies to lower-margin hardware products, the effect of which was partially offset by improvements in commercial hardware margins.

        ESS gross margin decreased for the three months ended January 31, 2010 due primarily to product mix shifts, the effect of which was partially offset by the benefits from lower product unit costs and favorable currency impacts.

        For the three months ended January 31, 2010, HP Software gross margin increased slightly due primarily to a stronger support revenue mix.

        The gross margin in Corporate Investments and Other increased for the three months ended January 31, 2010 primarily as a result of lower product costs for our network infrastructure products.

53


        The gross margin in our Services segment increased for the three months ended January 31, 2010 due primarily to the continued focus on cost structure improvements, including delivery efficiencies and cost controls in our technology services business, and EDS-related acquisition synergies.

        HPFS gross margin increased for the three months ended January 31, 2010 primarily as a result of higher portfolio margins due to favorable financing conditions and improved interest rates for rollover debts.

Operating Expenses

        Total research and development ("R&D") expense decreased for the three months ended January 31, 2010 as compared to the prior-year period, due primarily to continued cost controls and efficiencies as we lowered structural costs. R&D expense as a percentage of net revenue decreased for ESS, HP Software, IPG, PSG and Corporate Investments, and increased for Services for the three months ended January 31, 2010.

        Selling, general and administrative ("SG&A") expense increased for the three months ended January 31, 2010 as compared to the prior-year period due primarily to higher field selling and marketing costs as a result of our investments in sales resources to improve revenue. SG&A expense as a percentage of net revenue decreased for each of our segments except for IPG for the three months ended January 31, 2010.

        The decrease in amortization expense for the three months ended January 31, 2010 as compared to the prior-year period was due primarily to certain intangible assets associated with prior acquisitions reaching the end of their amortization periods.

        Restructuring charges for the three months ended January 31, 2010 were $131 million. These charges included $130 million of severance and facility costs related to our fiscal 2008 restructuring plan and $1 million of severance costs associated with our fiscal 2009 restructuring plan.

        Restructuring charges for the three months ended January 31, 2009 were $146 million, which included $150 million for severance and facility costs related to the fiscal 2008 restructuring plan and a reduction of $4 million related to adjustments to prior fiscal year plans.

        In addition to restructuring charges, as part of our ongoing business operations we incurred workforce rebalancing charges for severance and related costs within certain business segments during the first quarter of fiscal 2010. Workforce rebalancing activities are considered part of normal operations as we continue to optimize our cost structure. Workforce rebalancing costs are included in our business segment results, and we expect to incur additional workforce rebalancing costs in the future.

        For the three months ended January 31, 2010 and 2009, we recorded acquisition-related charges of $38 million and $48 million, respectively, primarily for consulting and integration costs as well as retention bonuses associated with the EDS acquisition.

54


Interest and Other, Net

        Interest and other, net improved by $33 million for the three months ended January 31, 2010 as compared to the prior-year period. The improvement was driven primarily by lower currency losses on balance sheet remeasurement items and lower interest expenses due to lower average debt balances, the effect of which was partially offset by an increase to our litigation reserves and lower interest income as a result of lower interest rates.

Provision for Taxes

        Our effective tax rate was 19.8% and 18.0% for the three months ended January 31, 2010 and January 31, 2009, respectively. Our effective tax rate increased due to a decline in the percentage of total earnings earned in lower-tax jurisdictions and a decline in our discrete tax benefits relative to pretax earnings. Our effective tax rate generally differs from the U.S. federal statutory rate of 35% due to favorable tax rates associated with certain earnings from our operations in lower-tax jurisdictions throughout the world. We have not provided U.S. taxes for all of such earnings because we plan to reinvest some of those earnings indefinitely outside the United States.

        In the three months ended January 31, 2010, we recorded discrete items with a net tax benefit of $92 million, decreasing the effective tax rate. These amounts included net tax benefits of $54 million from restructuring and acquisition charges, a tax benefit of $19 million from settlement of a tax audit matter, a net tax benefit of $19 million from adjustments to prior year foreign income tax accruals and credits, and other miscellaneous discrete items.

        In the three months ended January 31, 2009, we recorded discrete items with a net tax benefit of $91 million, decreasing the effective tax rate. These amounts included net tax benefits of $63 million from restructuring and acquisition charges and other miscellaneous discrete items resulting in a net tax benefit of $28 million.

Segment Information

        A description of the products and services for each segment can be found in Note 17 to the Consolidated Condensed Financial Statements. Future changes to this organizational structure may result in changes to the business segments disclosed.

HP Enterprise Business

        Services, ESS and HP Software are reported collectively as a broader HP Enterprise Business. We describe the results of the business segments of the HP Enterprise Business in more detail below.

Services

        At the beginning of fiscal 2010, we realigned our Services business units to better align them to our enhanced services portfolio and to future growth opportunities. As a result, the U.S. public sector business, previously part of the technology services business, was moved to the infrastructure technology outsourcing business. In addition, part of the hardware maintenance business that originally reported

55



into our infrastructure technology outsourcing business was moved into our technology services business in order to better leverage our integrated service structure.

 
  Three months ended January 31  
 
  2010   2009   % Increase
(Decrease)
 
 
  In millions
 

Net revenue

  $ 8,651   $ 8,747     (1.1 )%

Earnings from operations

  $ 1,364   $ 1,124     21.4 %

Earnings from operations as a % of net revenue

    15.8 %   12.9 %      

        The components of the weighted net revenue change as compared to the prior-year period by business unit were as follows:

 
  Three months ended
January 31, 2010
 
 
  Percentage Points
 

Application services

    (1.4 )

Technology services

    (0.5 )

Business process outsourcing

    (0.2 )

Infrastructure technology outsourcing

    1.0  
       

Total Services

    (1.1 )
       

        Services net revenue decreased 1.1% (5.8% when adjusted for currency) for the three months ended January 31, 2010 as compared to the same period in fiscal 2009. The revenue decline was due primarily to weak market conditions and existing contract completion, the effect of which was partially offset by new client business. Net revenue in application services declined by 8% due primarily to market weakness and existing contract completion. Net revenue in technology services declined by 2% due primarily to reduced demand for technology support services as a result of reduced sales of enterprise hardware in the prior-year period and market weakness in the current-year period, the effect of which was partially offset by growth in consulting services and a favorable currency impact. Net revenue in business process outsourcing decreased by 3% due primarily to weak economic conditions in certain industries with key clients. Net revenue in infrastructure technology outsourcing increased by 2% due to favorable currency impacts and new business, the effect of which was partially offset by existing contract completion and contractual price reductions.

        Services earnings from operations as a percentage of net revenue increased by 2.9 percentage points in the three months ended January 31, 2010 as compared to the same period in fiscal 2009. The operating margin increased due primarily to an increase in gross margin along with a decrease in operating expenses. The gross margin in our Services segment increased for the three months ended January 31, 2010, as compared to the same period in fiscal 2009 due primarily to continued focus on cost structure improvements, including delivery efficiencies and cost controls in our technology services business, and EDS-related acquisition synergies. Operating expense declined as a result of a continued focus on cost structure improvements from overall cost controls.

Enterprise Storage and Servers

 
  Three months ended January 31  
 
  2010   2009   % Increase  
 
  In millions
 

Net revenue

  $ 4,391   $ 3,949     11.2 %

Earnings from operations

  $ 552   $ 406     36.0 %

Earnings from operations as a % of net revenue

    12.6 %   10.3 %      

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        The components of the weighted net revenue change as compared to the prior-year period by business unit were as follows:

 
  Three months ended
January 31, 2010
 
 
  Percentage Points
 

Industry standard servers

    15.8  

Storage

    (0.6 )

Business critical systems

    (4.0 )
       

Total ESS

    11.2  
       

        ESS net revenue increased 11.2% (7.8% when adjusted for currency) for the three months ended January 31, 2010 as compared to the same period in fiscal 2009. ISS net revenue increased 27% in the first quarter of fiscal 2010 as compared to the same period in fiscal 2009 driven primarily by strong unit volume coupled with increased average unit prices as a result of the performance of the latest generation of ISS products. Total ESS blades revenue increased 24% in the first quarter of fiscal 2010 as compared to the same period in fiscal 2009. Storage net revenue declined 3% in the first quarter of fiscal 2010 as compared to the same period in fiscal 2009 due to continued market weakness and a decline in tape and storage networking, the effect of which was partially offset by growth in entry-level storage and products related to our acquisition of Lefthand Networks. Business critical systems net revenue decreased 22% in the first quarter of fiscal 2010 as compared to the same period in fiscal 2009 due primarily to weaker market conditions, competitive pressures and the planned phase-out of the PA-RISC server line.

        ESS earnings from operations as a percentage of net revenue increased by 2.3 percentage points for the three months ended January 31, 2010 as compared to the same period in fiscal 2009 due to a decrease in operating expenses as a percentage of net revenue resulting from operating leverage benefits from increased volume and cost controls. The favorable effect on operating margin from lower operating expenses as a percentage of net revenue was partially offset by a decline in gross margin in the first quarter of fiscal 2010 due primarily to product mix shifts, the effect of which was partially offset by the benefits from lower product unit costs and favorable currency impacts.

HP Software

 
  Three months ended January 31  
 
  2010   2009   % Increase  
 
  In millions
 

Net revenue

  $ 878   $ 878     %

Earnings from operations

  $ 167   $ 140     19.3 %

Earnings from operations as a % of net revenue

    19.0 %   15.9 %      

        HP Software net revenue growth was flat (decreased 3.5% when adjusted for currency) for the three months ended January 31, 2010 as compared to the same period in fiscal 2009 due to continued softness in enterprise spending. Revenue from licenses and support increased, the effect of which was offset by a decrease in services revenue. Net revenue from business technology optimization decreased 1% for the first quarter of fiscal 2010 as compared to the prior-year period due to market demand weakness. Net revenue from other software increased 1% for the first quarter of fiscal 2010 from the corresponding prior-year period due to increased revenue for information management, the effect of which was partially offset by a decline in revenue from communication and media solutions. Revenue for business intelligence solutions was flat as compared to the prior-year period.

        HP Software earnings from operations as a percentage of net revenue increased by 3.1 percentage points for the three months ended January 31, 2010 as compared to the same period in fiscal 2009. The

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operating margin improvement was due primarily to a decrease in operating expenses as a percentage of net revenue coupled with a slight increase in gross margin resulting primarily from stronger support revenue mix. The decrease in operating expenses as a percentage of net revenue in the first quarter of fiscal 2010 was due primarily to lower field selling costs as a result of operational efficiencies and increasing sales productivity, as well as improved R&D costs driven by site consolidation synergies and alignment to lower cost regions.

Personal Systems Group

 
  Three months ended January 31  
 
  2010   2009   % Increase  
 
  In millions
 

Net revenue

  $ 10,584   $ 8,792     20.4 %

Earnings from operations

  $ 530   $ 436     21.6 %

Earnings from operations as a % of net revenue

    5.0 %   5.0 %      

        The components of the weighted net revenue change as compared to the prior-year period by business unit were as follows:

 
  Three months ended
January 31, 2010
 
 
  Percentage Points
 

Notebook PCs

    13.8  

Desktop PCs

    6.1  

Workstations

    0.5  

Other

    0.4  

Handhelds

    (0.4 )
       

Total PSG

    20.4  
       

        PSG net revenue increased 20.4% (17.5% when adjusted for currency) for the three months ended January 31, 2010 as compared to the same period in fiscal 2009. The revenue increase was the result of a recovering U.S. PC market combined with continued strength in China and other emerging markets. PSG unit volume and net revenue increased across all business units except the handhelds business unit for the first quarter of fiscal 2010. The unit volume increase in notebook PCs was due in part to growth of the HP and Compaq mini notebooks. For the first quarter of fiscal 2010, net revenue for notebook PCs increased 25%, while net revenue for desktop PCs increased 16% from the prior-year period. Workstations revenue increased 13% while handhelds revenue declined 56% from the prior-year period. Net revenue for consumer clients increased 26% while net revenue for commercial clients increased 16% from the prior-year period. The net revenue increase in Other PSG was related primarily to increased sales of third-party options, support services and extended warranties. PSG net revenue was also impacted by ASP declines. ASPs in consumer clients declined 8% while ASPs in commercial clients increased slightly. ASPs declined from the prior-year period due primarily to a competitive pricing environment combined with a mix shift toward lower-end models. The ASP decline was offset slightly by an increase in the option and monitor attach rates.

        PSG earnings from operations as a percentage of net revenue for the three months ended January 31, 2010 were 5.0%, which was consistent with the percentage reported in the prior-year period. PSG earnings from operations were impacted by a gross margin decline resulting from ASPs declining at a faster pace than component costs combined with a mix shift towards lower-end products, the effects of which were partially offset by lower supply chain and warranty costs and improvements in the option attach business. Offsetting the decline in gross margin was a decrease in operating expenses

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as a percentage of net revenue primarily due to continued effective cost controls and operating leverage benefits from increased volume.

Imaging and Printing Group

 
  Three months ended January 31  
 
  2010   2009   % Increase
(Decrease)
 
 
  In millions
 

Net revenue

  $ 6,206   $ 5,981     3.8 %

Earnings from operations

  $ 1,054   $ 1,105     (4.6 )%

Earnings from operations as a % of net revenue

    17.0 %   18.5 %      

        The components of the weighted net revenue change as compared to the prior-year period by business unit were as follows:

 
  Three months ended
January 31, 2010
 
 
  Percentage Points
 

Consumer hardware

    2.4  

Commercial hardware

    0.9  

Supplies

    0.5  
       

Total IPG

    3.8  
       

        IPG net revenue increased 3.8% (4.4% when adjusted for currency) for the three months ended January 31, 2010 as compared to the same period in fiscal 2009 reflecting an improvement in market conditions. Net revenue for consumer hardware increased 21% in the first quarter of fiscal 2010 as compared to the same period in fiscal 2009. The net revenue increase in consumer hardware was driven by unit volume growth of 18% in the first quarter of fiscal 2010 from the corresponding period in fiscal 2009. Net revenue for commercial hardware increased 4% in the first quarter of fiscal 2010 as compared to the same period in fiscal 2009. The net revenue increase in commercial hardware was driven primarily by unit volume growth of 11% in the first quarter of fiscal 2010 from the corresponding period in fiscal 2009. Supplies net revenue increased 1% in the first quarter of fiscal 2010 as compared to the same period in fiscal 2009.

        IPG earnings from operations as a percentage of net revenue decreased by 1.5 percentage points for the three months ended January 31, 2010 as compared to the same period in fiscal 2009. The operating margin decline in the first quarter of fiscal 2010 was due primarily to a decrease in gross margin, the effect of which was partially offset by a slight decrease in operating expenses as a percentage of net revenue. The decline in gross margin in the first quarter of fiscal 2010 was due primarily to an unfavorable mix shift from higher-margin supplies towards lower-margin hardware products, the effect of which was partially offset by margin improvements primarily in commercial hardware. The slight decrease in operating expense as a percentage of net revenue in the first quarter of fiscal 2010 was due primarily to continued cost management.

HP Financial Services

 
  Three months ended January 31  
 
  2010   2009   % Increase  
 
  In millions
 

Net revenue

  $ 719   $ 636     13.1 %

Earnings from operations

  $ 67   $ 41     63.4 %

Earnings from operations as a % of net revenue

    9.3 %   6.4 %      

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        For the three months ended January 31, 2010, HPFS net revenue increased by 13.1% as compared to the same period in fiscal 2009. The net revenue increase was due primarily to portfolio growth combined with favorable currency movements, the effect of which was partially offset by lower levels of remarketing sales and buyout activities.

        For the three months ended January 31, 2010, the 2.9 percentage point increase in earnings from operations as a percentage of net revenue was the result of a decrease in operating expenses as a percentage of net revenue and an increase in gross margin. The decrease in operating expenses as a percentage of net revenue was the result of continued cost controls while growing assets and revenue. The gross margin increase was due primarily to higher portfolio margins due to favorable financing conditions and improved interest rates for rollover debts, which was partially offset by lower margins associated with remarketing activity, buyout and end-of-lease activity.

Financing Originations

 
  Three months ended
January 31
 
 
  2010   2009  
 
  In millions
 

Total financing originations

  $ 1,403   $ 1,078  

        New financing originations, which represent the amounts of financing provided to customers for equipment and related software and services and include intercompany activity, increased 30% in the first quarter of fiscal 2010 compared to the same period in fiscal 2009. The increase was driven by higher financing associated with HP product sales resulting from improved integration and engagement with HP's sales efforts and a favorable currency impact.

Portfolio Assets and Ratios

        HPFS maintains a strategy to generate a competitive return on equity by effectively leveraging its portfolio against the risks associated with interest rates and credit. The HPFS business model is asset-intensive and uses certain internal metrics to measure its performance against other financial services companies, including a segment balance sheet that is derived from our internal management reporting system. The accounting policies used to derive these amounts are substantially the same as those used by the consolidated company. However, certain intercompany loans and accounts that are reflected in the segment balances are eliminated in our Consolidated Condensed Financial Statements.

        The portfolio assets and ratios derived from the segment balance sheet for HPFS were as follows:

 
  January 31,
2010
  October 31,
2009
 
 
  In millions
 

Portfolio assets(1)

  $ 10,180   $ 10,017  
           

Allowance for doubtful accounts(2)

    102     108  

Operating lease equipment reserve

    65     71  
           

Total reserves

    167     179  
           

Net portfolio assets

  $ 10,013   $ 9,838  
           

Reserve coverage

    1.6 %   1.8 %

Debt to equity ratio(3)

    7.0x     7.0x  

(1)
Portfolio assets include gross financing receivables of approximately $6.2 billion at January 31, 2010 and $6.1 billion at October 31, 2009 and net equipment under operating leases of $2.2 billion at

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(2)
Allowance for doubtful accounts includes both the short-term and the long-term portions of the allowance on financing receivables.

(3)
HPFS debt consists of intercompany equity that is treated as debt for segment reporting purposes, intercompany debt and debt issued directly by HPFS.

        Net portfolio assets at January 31, 2010 increased 1.8% from October 31, 2009. The increase resulted from a favorable currency impact in the first quarter of fiscal 2010. The overall percentage of portfolio asset reserves decreased due primarily to the write-offs of customer accounts that had been reserved in prior periods.

        For the three months ended January 31, 2010 and 2009, HPFS recorded write-offs, net of recoveries, of $12 million and $13 million, respectively.

Corporate Investments

 
  Three months ended January 31  
 
  2010   2009   % Increase
(Decrease)
 
 
  In millions
 

Net revenue

  $ 236   $ 196     20.4 %

Earnings (loss) from operations

  $ 19   $ (19 )   (200.0 )%

Earnings (loss) from operations as a % of net revenue

    8.1 %   (9.7 )%      

        Net revenue in Corporate Investments relates primarily to network infrastructure products sold under the brand "ProCurve Networking." For the three months ended January 31, 2010, revenue from network infrastructure products increased 12.9% as compared to the same period in fiscal 2009, driven by improved market demand and continued investment in sales coverage.

        Corporate Investments reported positive earnings from operations for the first three months of fiscal 2010 as compared to a loss from operations reported for the same period in fiscal 2009 due primarily to higher earnings from operations generated by network infrastructure products. Gross margin in Corporate Investments increased primarily as a result of lower product costs in the sale of network infrastructure products, the effect of which was partially offset by increased competitive pressure. The earnings from operations in Corporate Investments were offset by expenses carried in the segment associated with corporate development, global alliances and HP Labs; such expenses declined from the prior-year period.

LIQUIDITY AND CAPITAL RESOURCES

        Our cash balances are held in numerous locations throughout the world, including substantial amounts held outside of the United States. Most of the amounts held outside of the United States could be repatriated to the United States but, under current law, would be subject to United States federal income taxes, less applicable foreign tax credits. Repatriation of some foreign balances is restricted by local laws. We have provided for the United States federal tax liability on these amounts for financial statement purposes, except for foreign earnings that are considered indefinitely reinvested outside of the United States. Repatriation could result in additional United States federal income tax payments in future years. Where local restrictions prevent an efficient intercompany transfer of funds,

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our intent is that cash balances would remain outside of the United States and we would meet United States liquidity needs through ongoing cash flows, external borrowings, or both. We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed.

FINANCIAL CONDITION (Sources and Uses of Cash)

 
  Three months ended
January 31
 
 
  2010   2009  
 
  In millions
 

Net cash provided by operating activities

  $ 2,407   $ 1,126  

Net cash (used in) investing activities

    (711 )   (963 )

Net cash (used in) provided by financing activities

    (1,428 )   873  
           

Net increase in cash and cash equivalents

  $ 268   $ 1,036  
           

Operating Activities

        Net cash provided by operating activities increased by approximately $1.3 billion for the three months ended January 31, 2010 as compared to the corresponding period in fiscal 2009. The increase was due primarily to a decrease in utilization of cash resources for payment of operating liabilities such as accounts payable and other current liabilities along with an increase in net earnings, the impact of which was partially offset by a decline in generation of cash resources through the utilization of operating assets such as other current assets and inventory.

        Our key working capital metrics are as follows:

 
  January 31,
2010
  October 31,
2009
 

Days of sales outstanding in accounts receivable

    42     48  

Days of supply in inventory

    25     23  

Days of purchases outstanding in accounts payable. 

    (51 )   (57 )
           

Cash conversion cycle

    16     14  
           

        Days of sales outstanding in accounts receivable ("DSO") is calculated by dividing ending accounts receivable, net of allowance for doubtful accounts, by a 90-day average net revenue.

        Days of supply in inventory ("DOS") measures the average number of days from procurement to sale of our product. DOS is calculated by dividing ending inventory by a 90-day average cost of goods sold.

        Days of purchases outstanding in accounts payable ("DPO") is calculated by dividing ending accounts payable by a 90-day average cost of goods sold.

        Our working capital requirements depend upon our effective management of the cash conversion cycle, which represents effectively the number of days that elapse from the day we pay for the purchase of raw materials to the collection of cash from our customers. The cash conversion cycle is the sum of DSO and DOS less DPO.

        The decrease in DSO was due primarily to lower accounts receivable at January 31, 2010 as a result of improved linearity across the quarter. The increase in DOS was due to higher inventory levels at January 31, 2010. The decrease in DPO was due primarily to the timing of supplier purchases and payments in the first quarter.

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Investing Activities

        Net cash used in investing activities decreased by approximately $0.3 billion for the three months ended January 31, 2010 as compared to the corresponding period in fiscal 2009 due primarily to higher cash payments made in connection with fiscal 2009 acquisitions.

Financing Activities

        Net cash used in financing activities increased by approximately $2.3 billion for the three months ended January 31, 2010 as compared to the corresponding period in fiscal 2009. The increase was due primarily to a decline in the issuance of debt and increased repurchases of our common stock, the impact of which was partially offset by the cash received through more issuances of common stock under employee stock plans.

        For more information on our share repurchase programs, see Note 14 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

CAPITAL RESOURCES

Debt Levels

        We maintain debt levels that we establish through consideration of a number of factors, including cash flow expectations, cash requirements for operations, investment plans (including acquisitions), share repurchase activities, overall cost of capital, and targeted capital structure. Outstanding borrowings increased to $15.9 billion as of January 31, 2010 as compared to $15.8 billion at October 31, 2009, bearing weighted average interest rates of 2.7% each at January 31, 2010 and October 31, 2009. During the first three months of fiscal 2010, we issued $2.5 billion and repaid $2.4 billion of commercial paper. As of January 31, 2010, we had $22 million in total borrowings collateralized by certain financing receivable assets.

        Our weighted-average interest rate reflects the average effective rate on our borrowings prevailing during the period; it factors in the impact of swapping some of our global notes with fixed interest rates for global notes with floating interest rates. For more information on our interest rate swaps, see Note 9 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

        For more information on our borrowings, see Note 12 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

Available Borrowing Resources

        At January 31, 2010, we had the following resources available to obtain short-term or long-term financings if we need additional liquidity:

 
  At January 31, 2010  
 
  In millions
 

2009 Shelf Registration Statement(1)

    Unspecified  

Commercial paper programs(1)

    16,200  

Uncommitted lines of credit(1)

    1,500  

Revolving trade receivables-based facilities(2)

    140  

(1)
For more information on our available borrowings resources, see Note 12 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

(2)
For more information on our revolving trade receivables-based facilities, see Note 4 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

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Credit Ratings

        Our credit risk is evaluated by three independent rating agencies based upon publicly available information as well as information obtained in our ongoing discussions with them. The ratings for the fiscal year ended October 31, 2010 were:

 
  For the three months ended January 31, 2010
 
  Standard & Poor's
Ratings Services
  Moody's Investors
Service
  Fitch Ratings
Services

Short-term debt ratings

  A-1   Prime-1   F1

Long-term debt ratings

  A   A2   A+

        We do not have any rating downgrade triggers that would accelerate the maturity of a material amount of our debt. However, a downgrade in our credit rating would increase the cost of borrowings under our credit facilities. Also, a downgrade in our credit rating could limit our ability to issue commercial paper under our current programs. If this were to occur, we would seek alternative sources of funding, including drawdowns under our credit facilities or the issuance of notes under our existing shelf registration statements.

CONTRACTUAL AND OTHER OBLIGATIONS

Guarantees and Indemnifications

        For more information on liabilities that may arise from guarantees and indemnification, see Note 11 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

Litigation and Contingencies

        For more information on liabilities that may arise from litigation and contingencies, see Note 16 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

Off-Balance Sheet Arrangements

        As part of our ongoing business, we have not participated in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of January 31, 2010, we are not involved in any material unconsolidated SPEs.

FACTORS THAT COULD AFFECT FUTURE RESULTS

        Because of the following factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

Competitive pressures could harm our revenue, gross margin and prospects.

        We encounter aggressive competition from numerous and varied competitors in all areas of our business, and our competitors may target our key market segments. We compete primarily on the basis of technology, performance, price, quality, reliability, brand, reputation, distribution, range of products and services, ease of use of our products, account relationships, customer training, service and support, security, availability of application software, and Internet infrastructure offerings. If our products, services, support and cost structure do not enable us to compete successfully based on any of those criteria, our operations, results and prospects could be harmed.

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        Unlike many of our competitors, we have a portfolio of businesses and must allocate resources across these businesses while competing with companies that specialize in one or more of these product lines. As a result, we may invest less in certain areas of our businesses than our competitors do, and these competitors may have greater financial, technical and marketing resources available to them than our businesses that compete against them. Industry consolidation also may affect competition by creating larger, more homogeneous and potentially stronger competitors in the markets in which we compete, and our competitors also may affect our business by entering into exclusive arrangements with existing or potential customers or suppliers.

        We may have to continue to lower the prices of many of our products and services to stay competitive, while at the same time trying to maintain or improve revenue and gross margin. The markets in which we do business, particularly the personal computer and printing markets, are highly competitive, and we encounter aggressive price competition for all of our products and services from numerous companies globally. Over the past several years, price competition in the market for personal computers, printers and related products has been particularly intense as competitors have aggressively cut prices and lowered their product margins for these products. In addition, competitors in some of the markets in which we compete with a greater presence in lower-cost jurisdictions may be able to offer lower prices than we are able to offer. Our results of operations and financial condition may be adversely affected by these and other industry-wide pricing pressures.

        Because our business model is based on providing innovative and high quality products, we may spend a proportionately greater amount on research and development than some of our competitors. If we cannot proportionately decrease our cost structure on a timely basis in response to competitive price pressures, our gross margin and, therefore, our profitability could be adversely affected. In addition, if our pricing and other factors are not sufficiently competitive, or if there is an adverse reaction to our product decisions, we may lose market share in certain areas, which could adversely affect our revenue and prospects.

        Even if we are able to maintain or increase market share for a particular product, revenue could decline because the product is in a maturing industry. Revenue and margins also could decline due to increased competition from other types of products. For example, refill and remanufactured alternatives for some of HP's LaserJet toner and inkjet cartridges compete with HP's supplies business. In addition, other companies have developed and marketed new compatible cartridges for HP's LaserJet and inkjet products, particularly in jurisdictions outside of the United States where adequate intellectual property protection may not exist. HP expects competitive refill and remanufacturing and cloned cartridge activity to continue to pressure margins in IPG, which in turn has a significant impact on HP margins and profitability overall.

If we cannot continue to develop, manufacture and market products and services that meet customer requirements for innovation and quality, our revenue and gross margin may suffer.

        The process of developing new high technology products and services and enhancing existing products and services is complex, costly and uncertain, and any failure by us to anticipate customers' changing needs and emerging technological trends accurately could significantly harm our market share and results of operations. We must make long-term investments, develop or obtain appropriate intellectual property and commit significant resources before knowing whether our predictions will accurately reflect customer demand for our products and services. After we develop a product, we must be able to manufacture appropriate volumes quickly and at low costs. To accomplish this, we must accurately forecast volumes, mixes of products and configurations that meet customer requirements, and we may not succeed at doing so at all or within a given product's life cycle. Any delay in the development, production or marketing of a new product could result in our not being among the first to market, which could further harm our competitive position.

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        In the course of conducting our business, we must adequately address quality issues associated with our products and services, including defects in our engineering, design and manufacturing processes, as well as defects in third-party components included in our products. In order to address quality issues, we work extensively with our customers and suppliers and engage in product testing to determine the cause of the problem and to determine appropriate solutions. However, we may have limited ability to control quality issues, particularly with respect to faulty components manufactured by third parties. If we are unable to determine the cause, find an appropriate solution or offer a temporary fix (or "patch"), we may delay shipment to customers, which would delay revenue recognition and could adversely affect our revenue and reported results. Finding solutions to quality issues can be expensive and may result in additional warranty, replacement and other costs, adversely affecting our profits. If new or existing customers have difficulty operating our products, our operating margins could be adversely affected, and we could face possible claims if we fail to meet our customers' expectations. In addition, quality issues can impair our relationships with new or existing customers and adversely affect our brand and reputation, which could have a material adverse effect on our operating results.

Economic weakness and uncertainty could adversely affect our revenue, gross margin and expenses.

        Our revenue and gross margin depend significantly on worldwide economic conditions and the demand for computing and imaging products and services in the markets in which we compete. Economic weakness and uncertainty have resulted, and may result in the future, in decreased revenue, gross margin, earnings or growth rates and difficulty managing inventory levels. Sustained uncertainty about current global economic conditions may result in our customers continuing to postpone spending, which could adversely affect demand for our products and services. Economic weakness and uncertainty also make it more difficult for us to make accurate forecasts of revenue, gross margin and expenses.

        We also have experienced, and may experience in the future, gross margin declines in certain businesses, reflecting the effect of items such as competitive pricing pressures, inventory write downs and increases in component and manufacturing costs resulting from higher labor and material costs borne by our manufacturers and suppliers that, as a result of competitive pricing pressures or other factors, we are unable to pass on to our customers. In addition, our business may be disrupted if we are unable to obtain equipment, parts and components from our suppliers—and our suppliers from their suppliers—due to the insolvency of key suppliers or the inability of key suppliers to obtain credit.

        Economic weakness and uncertainty could cause our expenses to vary materially from our expectations. Any renewed financial turmoil affecting the banking system and financial markets or any significant financial services institution failures could negatively impact our treasury operations, as the financial condition of such parties may deteriorate rapidly and without notice in times of market volatility and disruption. Poor financial performance of asset markets could lead to increased pension and post-retirement benefit expenses. Other income and expense could vary materially from expectations depending on changes in interest rates, borrowing costs, currency exchange rates, hedging expenses and the fair value of derivative instruments. Economic downturns also may lead to restructuring actions and associated expenses.

We depend on third-party suppliers, and our revenue and gross margin could suffer if we fail to manage suppliers properly.

        Our operations depend on our ability to anticipate our needs for components, products and services and our suppliers' ability to deliver sufficient quantities of quality components, products and services at reasonable prices in time for us to meet critical schedules. Given the wide variety of systems, products and services that we offer, the large number of our suppliers and contract manufacturers that are dispersed across the globe, and the long lead times that are required to manufacture, assemble and deliver certain components and products, problems could arise in planning production and managing inventory levels that could seriously harm us. Other supplier problems that we could face include

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component shortages, excess supply, risks related to the terms of our contracts with suppliers, risks associated with contingent workers, and risks related to our relationships with single source suppliers, as described below.

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Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.

        Our worldwide operations could be subject to earthquakes, power shortages, telecommunications failures, water shortages, tsunamis, floods, hurricanes, typhoons, fires, extreme weather conditions, medical epidemics or pandemics and other natural or manmade disasters or business interruptions, for which we are predominantly self-insured. The occurrence of any of these business disruptions could seriously harm our revenue and financial condition and increase our costs and expenses. Our corporate headquarters, and a portion of our research and development activities, are located in California, and other critical business operations and some of our suppliers are located in California and Asia, near major earthquake faults. In addition, all six of our worldwide IT data centers are located in the southern United States, making our operations more vulnerable to natural disasters or other business disruptions occurring in that geographical area. The manufacture of product components, the final assembly of our products and other critical operations are concentrated in certain geographic locations, including Shanghai, Singapore and India. We also rely on major logistics hubs primarily in Asia to manufacture and distribute our products and in the southwestern United States to import products into the Americas region. Our operations could be adversely affected if manufacturing, logistics or other operations in these locations are disrupted for any reason, including natural disasters, information technology system failures, military actions or economic, business, labor, environmental, public health, or political issues. The ultimate impact on us, our significant suppliers and our general infrastructure of being located near major earthquake faults and being consolidated in certain geographical areas is unknown, but our revenue, profitability and financial condition could suffer in the event of a major earthquake or other natural disaster.

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System security risks, data protection breaches and systems integration issues could disrupt our internal operations or information technology services provided to customers, and any such disruption could reduce our expected revenue, increase our expenses, damage our reputation and adversely affect our stock price.

        Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate our confidential information or that of third parties, create system disruptions or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our products or otherwise exploit any security vulnerabilities of our products. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including "bugs" and other problems that could unexpectedly interfere with the operation of the system. The costs to us to eliminate or alleviate security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant, and the efforts to address these problems could result in interruptions, delays, cessation of service and loss of existing or potential customers that may impede our sales, manufacturing, distribution or other critical functions.

        We manage and store various proprietary information and sensitive or confidential data relating to our business. In addition, our outsourcing services business routinely processes, stores and transmits large amounts of data for our clients, including sensitive and personally identifiable information. Breaches of our security measures or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us or our clients, including the potential loss or disclosure of such information or data as a result of fraud, trickery or other forms of deception, could expose us, our customers or the individuals affected to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise harm our business. We also could lose existing or potential customers for outsourcing services or other information technology solutions or incur significant expenses in connection with our customers' system failures or any actual or perceived security vulnerabilities in our products. In addition, the cost and operational consequences of implementing further data protection measures could be significant.

        Portions of our IT infrastructure also may experience interruptions, delays or cessations of service or produce errors in connection with systems integration or migration work that takes place from time to time. We may not be successful in implementing new systems and transitioning data which could cause business disruptions and be more expensive, time consuming, disruptive and resource-intensive. Such disruptions could adversely impact our ability to fulfill orders and interrupt other processes. Delayed sales, lower margins or lost customers resulting from these disruptions have adversely affected in the past, and in the future could adversely affect, our financial results, stock price and reputation.

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The revenue and profitability of our operations have historically varied, which makes our future financial results less predictable.

        Our revenue, gross margin and profit vary among our products and services, customer groups and geographic markets and therefore will likely be different in future periods than our current results. Our revenue depends on the overall demand for our products and services. Delays or reductions in IT spending could materially adversely affect demand for our products and services, which could result in a significant decline in revenues. Overall gross margins and profitability in any given period are dependent partially on the product, customer and geographic mix reflected in that period's net revenue. In particular, IPG and certain of its business units such as printer supplies contribute significantly to our gross margin and profitability. In addition, our services business has contributed significantly to our revenue and operating profit in recent periods. Competition, lawsuits, investigations and other risks affecting those businesses therefore may have a significant impact on our overall gross margin and profitability. Certain segments, and ESS in particular, have a higher fixed cost structure and more variation in gross margins across their business units and product portfolios than others and may therefore experience significant operating profit volatility on a quarterly basis. In addition, newer geographic markets may be relatively less profitable due to investments associated with entering those markets and local pricing pressures, and we may have difficulty establishing and maintaining the operating infrastructure necessary to support the high growth rate associated with some of those markets. Market trends, competitive pressures, commoditization of products, seasonal rebates, increased component or shipping costs, regulatory impacts and other factors may result in reductions in revenue or pressure on gross margins of certain segments in a given period, which may necessitate adjustments to our operations.

HP's stock price has historically fluctuated and may continue to fluctuate, which may make future prices of HP's stock difficult to predict.

        HP's stock price, like that of other technology companies, can be volatile. Some of the factors that could affect our stock price are:

        General or industry specific market conditions or stock market performance or domestic or international macroeconomic and geopolitical factors unrelated to HP's performance also may affect the price of HP common stock. For these reasons, investors should not rely on recent trends to predict future stock prices, financial condition, results of operations or cash flows. In addition, following periods of volatility in a company's securities, securities class action litigation against a company is sometimes instituted. If instituted against HP, this type of litigation could result in substantial costs and the diversion of management time and resources.

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Our revenue, cost of sales, and expenses may suffer if we cannot continue to license or enforce the intellectual property rights on which our businesses depend or if third parties assert that we violate their intellectual property rights.

        We rely upon patent, copyright, trademark and trade secret laws in the United States, similar laws in other countries, and agreements with our employees, customers, suppliers and other parties, to establish and maintain intellectual property rights in the technology and products we sell, provide or otherwise use in our operations. However, any of our direct or indirect intellectual property rights could be challenged, invalidated or circumvented, or such intellectual property rights may not be sufficient to permit us to take advantage of current market trends or otherwise to provide competitive advantages, either of which could result in costly product redesign efforts, discontinuance of certain product offerings or other competitive harm. Further, the laws of certain countries do not protect proprietary rights to the same extent as the laws of the United States. Therefore, in certain jurisdictions we may be unable to protect our proprietary technology adequately against unauthorized third-party copying or use; this too could adversely affect our competitive position.

        Because of the rapid pace of technological change in the information technology industry, much of our business and many of our products rely on key technologies developed or licensed by third parties. We may not be able to obtain or continue to obtain licenses and technologies from these third parties at all or on reasonable terms, or such third parties may demand cross-licenses to our intellectual property. In addition, it is possible that as a consequence of a merger or acquisition, third parties may obtain licenses to some of our intellectual property rights or our business may be subject to certain restrictions that were not in place prior to the transaction. Consequently, we may lose a competitive advantage with respect to these intellectual property rights or we may be required to enter into costly arrangements in order to terminate or limit these rights.

        Third parties also may claim that we or customers indemnified by us are infringing upon their intellectual property rights. For example, in recent years individuals and groups have begun purchasing intellectual property assets for the sole purpose of asserting claims of infringement and attempting to extract settlements from large companies such as HP. If we cannot or do not license the infringed technology at all or on reasonable terms, or substitute similar technology from another source, our operations could be adversely affected. Even if we believe that the claims are without merit, they can be time-consuming and costly to defend and may divert management's attention and resources away from our business. Claims of intellectual property infringement also might require us to redesign affected products, enter into costly settlement or license agreements, pay costly damage awards, or face a temporary or permanent injunction prohibiting us from importing, marketing or selling certain of our products. Even if we have an agreement to indemnify us against such costs, the indemnifying party may be unable to uphold its contractual obligations